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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] 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: 0-50194
HMS HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-3656261
(State or other jurisdiction of (I.R.S. Employer)
incorporation or organization) Identification No.)
401 PARK AVENUE SOUTH, NEW YORK, NEW YORK 10016
(Address of principal executive offices) (Zip Code)
(212) 725-7695
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK
(Title of Class)
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 by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The approximate aggregate market value of the registrant's common stock
held by non-affiliates (based on the last reported sales price on the NASDAQ
National Market System) was $55.7 million on June 30, 2002. The approximate
aggregate market value of the registrant's common stock held by non-affiliates
(based on the last reported sale price on the Nasdaq National Market System) was
$48.8 million on March 14, 2003.
The number of shares common stock, $.01 par value, outstanding as of
March 14, 2003 was 18,257,854.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement of the registrant to be
delivered to shareholders in connection with the 2003 Annual Meeting of
Shareholders are incorporated by reference into Part III of this Form 10-K.
HMS HOLDINGS CORP. AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business......................................................................................3
Item 2. Properties...................................................................................11
Item 3. Legal Proceedings............................................................................12
Item 4. Submission of Matters to a Vote of Security Holders..........................................12
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters........................13
Item 6. Selected Financial Data......................................................................14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........15
Item 7A. Quantitative and Qualitative Disclosures About Market Risks..................................31
Item 8. Financial Statements and Supplementary Data..................................................31
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.........31
PART III
Item 10. Directors and Executive Officers of the Registrant...........................................31
Item 11. Executive Compensation.......................................................................31
Item 12. Security Ownership of Certain Beneficial Owners and Management...............................32
Item 13. Certain Relationships and Related Transactions...............................................32
Item 14. Controls and Procedures......................................................................32
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................32
Signatures..................................................................................................33
Certifications..............................................................................................34
Consolidated Financial Statements...........................................................................36
Exhibit Index...............................................................................................64
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING" STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. FOR THIS PURPOSE
ANY STATEMENTS CONTAINED HEREIN THAT ARE NOT STATEMENTS OF HISTORICAL FACT MAY
BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING THE FOREGOING, THE
WORDS "BELIEVES," "ANTICIPATES," "PLANS," "EXPECTS" AND SIMILAR EXPRESSIONS ARE
INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE STATEMENTS INVOLVE
UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY CAUSE OUR ACTUAL
RESULTS TO DIFFER MATERIALLY, FORM THOSE IMPLIED BY THE FORWARD LOOKING
STATEMENTS. AMONG THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS
INCLUDE THOSE RISKS IDENTIFIED IN "ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - RISK FACTORS" AND OTHER RISKS
IDENTIFIED IN THIS FORM 10-K AND PRESENTED ELSEWHERE BY MANAGEMENT FROM TIME TO
TIME. SUCH FORWARD-LOOKING STATEMENTS REPRESENT MANAGEMENT'S CURRENT
EXPECTATIONS AND ARE INHERENTLY UNCERTAIN. INVESTORS ARE WARNED THAT ACTUAL
RESULTS MAY DIFFER FROM MANAGEMENT'S EXPECTATIONS.
PART I
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ITEM 1. BUSINESS
OVERVIEW
At a special meeting held on February 27, 2003, the shareholders of
Health Management Systems, Inc. approved the creation of a holding company
structure. Following that meeting, all the outstanding shares of Health
Management Systems, Inc. common stock were exchanged on a one-for-one basis for
the shares of common stock of HMS Holdings Corp., the new parent company. The
adoption of the holding company structure, pursuant to an Agreement and Plan of
Merger approved at the shareholders meeting, constituted a reorganization with
no change in ownership interests and no dilutive impact to the former
shareholders of Health Management Systems, Inc.
HMS Holdings Corp. furnishes revenue recovery, business process and
business office outsourcing services to healthcare payors and providers. We help
our clients increase revenue, accelerate collections, and reduce operating and
administrative costs. We operate two businesses through our wholly owned
subsidiaries, Health Management Systems, Inc. (Health Management Systems)
(formerly our Payor Services Division) and Accordis Inc. (Accordis) (formerly
our Provider Services Division).
Health Management Systems offers state Medicaid and other government
agencies that administer health care entitlement programs a broad range of
services that are designed to identify and recover amounts that should have been
the responsibility of a third party, or that were paid inappropriately. Further,
by assisting these agencies in properly accounting for the services that they
deliver, we also help to ensure that they receive the full amount of program
funding to which they are entitled.
Accordis provides business office outsourcing services for hospitals,
emergency medical transport agencies, and other healthcare providers. These
business office services may include identifying third-party resources,
submitting timely and accurate bills to third-party payors and patients,
recovering and properly accounting for the amounts due, responding to customer
service questions from patients, and securing the appropriate cost-based
reimbursement from entitlement programs. Clients may outsource the entirety of
their business office operations to us, or discrete revenue cycle activities.
In 1999, our Quality Standards in Medicine, Inc. (QSM) subsidiary
acquired substantially all of the assets and specified liabilities of Health
Receivables Management, LLC, an Illinois-based company that furnished Medicaid
applications service, accounts receivable management, and collections services
to providers. Following the acquisition, QSM's name was changed to Health
Receivables Management, Inc. (HRM). The operations of HRM have been consolidated
into Accordis.
3
HEALTHCARE REFORM AND REGULATORY MATTERS
The healthcare reimbursement landscape continues to evolve. Federal,
state, and local governments, as well as other third-party payors, continue
their efforts to reduce the rate of growth in healthcare expenditures. Many of
these policy initiatives have contributed to the complex and time-consuming
nature of obtaining healthcare reimbursement for medical services.
Hospitals are subject to comprehensive federal and state regulation,
which affects hospital reimbursement. Medicaid and Medicare account for a
significant portion of hospital revenue. Since adoption, the Medicare and
Medicaid programs have undergone significant and frequent changes, and it is
realistic to expect additional changes in the future. Our services are subject
to regulations pertaining to billing for Medicaid and Medicare services, which
primarily involve record keeping requirements and other provisions designed to
prevent fraud. We believe that we operate in a manner consistent with such
regulations, the enforcement of which is increasingly more stringent. Violations
of such regulations could adversely affect our business, financial condition and
results of operations.
On January 31, 2003, we announced that we had received a subpoena from
the United States Attorney's Office for the Southern District of New York in
connection with an investigation under the Health Issuance Portability and
Accountability Act of 1996 relating to possible federal health care offenses.
See Items 3. Legal Proceedings.
The Medicare program is administered by the Center for Medicare and
Medicaid Services (CMS), an agency of the United States Department of Health and
Human Services. CMS currently contracts with several intermediaries and fiscal
agents to process regional claims for reimbursement. Although CMS has
established the regulatory framework for Medicare claims administration,
Medicare intermediaries have the authority to develop independent procedures for
administering the claims reimbursement process. The Medicaid program is subject
to regulation by CMS, but is administered by state governments. State
governments provide for Medicaid claims reimbursement either through the
establishment of state operated processing centers or through contractual
arrangements with third-party fiscal agents who operate their own processing
centers. The requirements and procedures for reimbursement implemented by
Medicaid differ from state to state. Similar to the claims administration
processes of Medicare and Medicaid, many national health insurance companies and
self-insured employers administer reimbursement of claims through local or
regional offices. Consequently, because guidelines for the reimbursement of
claims are generally established by third-party payors at local or regional
levels, hospital and other provider reimbursement managers must remain current
with the local procedures and requirements of third-party payors. Generally, we
are required to maintain standards of confidentiality that are comparable to
those of an agency administering the Medicare or Medicaid program when we use
data obtained from such programs.
The Health Insurance Portability and Accountability Act of 1996
requires the Secretary of Health and Human Services to adopt national standards
for certain types of electronic health information transactions and the data
elements used in such transactions and to adopt standards to ensure the
integrity and confidentiality of health information. All covered entities
(providers, payors, and clearinghouses) will be mandated to implement
administrative, physical, and technical safeguards to protect health data
covered by HIPAA. The regulations are in the following stages of finalization
and implementation:
TRANSACTION AND CODE SET STANDARDS. The final regulation governing
transaction and code set standards was published and was expected to
become effective on October 16, 2002. However, on December 27, 2001 the
Administrative Simplification Compliance Act (ASCA) was enacted
providing for a one-year extension of the date for complying with the
HIPAA standard transactions and code set requirements for any covered
entity that submits to the Secretary of Health and Human Services a
plan on how the entity will come into compliance with the requirements
by October 16, 2003. We have submitted such a plan and expect to be in
full compliance with the standard transaction and code set requirements
by the October 16, 2003 deadline.
PRIVACY REGULATION. The privacy regulation was published as a final
regulation and became effective on April 14, 2001, requiring all
covered entities to be fully compliant by April 2003. The final changes
to the HIPAA Privacy Rule were published in the Federal Register on
August 14, 2002. The April 14, 2003, compliance date was not changed,
although the date by which covered entities must have business
associate agreements in place has, under certain circumstances, been
extended beyond April 2003. We expect to be in full compliance with the
privacy regulation by the April 14, 2003 deadline.
4
DATA SECURITY. The data security regulation was published as a final
regulation on February 20, 2003, with an effective date of April 21,
2003. Full compliance is required two years after the effective date.
Any material restriction on the ability of healthcare providers and
payors to obtain or disseminate health information could adversely affect our
business, financial condition, and results of operations. With the release of
the final HIPAA Privacy and Security rules, the "protection of individually
identifiable healthcare information" becomes a key component of the way we and
other covered entities perform our day-to-day business.
PRINCIPAL PRODUCTS AND SERVICES
ACCORDIS
Accordis offers hospitals and other healthcare providers Business
Office Outsourcing services and Reimbursement services.
BUSINESS OFFICE OUTSOURCING SERVICES. Our Business Office Outsourcing
services encompass all or a portion of the patient accounting activities that
make up a healthcare provider's revenue cycle. Such revenue cycle activities may
include third-party resource identification and validation, submission of timely
and accurate bills to primary and secondary payors, generation of patient
statements, response to patient and third-party questions, recovery of payments
due, and proper accounting for payments, contractual allowances and write-offs.
These services are designed to increase the provider's revenue, improve the
proportion of provider gross charges ultimately collected, accelerate cash flow,
lower days in accounts receivable, and reduce administrative costs. A client may
outsource one or more aspects of its patient accounting processes or may
outsource the business office in its entirety, enabling the client to re-deploy
staff. In some cases, our services are used by providers who need assistance in
managing large backlogs of aged or complex accounts. At the request of a client,
we are also able to provide bad debt collection services through a wholly owned
subsidiary.
Our electronic third-party resource identification capability is based
on our original service, Retroactive Claims Reprocessing (RCR), through which we
use data warehousing and electronic data matching techniques to identify
third-party coverage for unpaid accounts. RCR technology generates additional
revenue for clients following the completion of their own billing and collection
efforts. Today, we offer RCR technology to clients either as a stand-alone
service or as a value-added component of the Business Office Outsourcing
service.
REIMBURSEMENT SERVICES. Our Reimbursement services include four related
offerings: (1) Medicare Bad Debt Cost Report services, (2) Disproportionate
Share services, (3) Medicaid Application services, and (4) Indirect Medical
Education billing for Medicare managed care.
Federal legislation allows a healthcare provider to claim reimbursement
from Medicare Part A for coinsurance and deductible amounts that remain
uncollected after reasonable collection efforts. Our Medicare Bad Debt Cost
Report services assist providers in isolating unpaid Medicare coinsurance and
deductible balances that qualify for reimbursement on the Medicare Cost Report.
Since 1986, Medicare has allowed hospitals serving a disproportionate
share of low-income patients to claim additional reimbursement to offset payment
shortfalls. Regardless of whether Medicaid paid for the service, the hospital
can qualify for reimbursement if the inpatient stay is Medicaid-eligible.
Through our Disproportionate Share services, we assist providers in qualifying
for maximum reimbursement on the Medicare Cost Report for inpatient services
delivered to Medicaid-eligible patients.
We also provide Medicaid Application services, which assist eligible
patients in properly enrolling in public aid, thereby ensuring that providers
receive reimbursement for care rendered to such patients.
Teaching hospitals are permitted to claim supplemental reimbursement
from Medicare for Indirect Medical Education (IME) costs associated with
inpatient Medicare managed care enrollees. We assist these hospitals in
identifying and documenting qualifying amounts.
5
HEALTH MANAGEMENT SYSTEMS
Health Management Systems offers Third Party Liability (TPL) services
to governmental agencies that administer healthcare entitlement programs, most
notably state Medicaid agencies.
Established in 1965, the Medicaid program is the payor of last resort
for healthcare services required by financially and medically needy individuals.
The Medicaid program is administered by individual states, and is jointly funded
by the federal and state governments. In the early 1980's, recognizing that
state Medicaid agencies were improperly paying amounts for healthcare claims for
individuals having some other form of third-party health insurance, the federal
government imposed statutory obligations requiring states to take active
measures to pursue those liable third parties.
In 1985, we began to offer TPL services to state Medicaid agencies, as
a means of identifying third parties with prior liability for Medicaid claims.
Health Management Systems applies proprietary information management and
coordination of benefit methodologies in order to identify duplicate payments,
overpayments, compliance-related erroneous payments, and other inappropriate
payments. We then assist the Medicaid agency in recovering amounts due from
liable third parties. This post-payment revenue recovery methodology can be
defined as:
o Identification: We use proprietary software to match Medicaid and
other program data files to insurance eligibility files obtained by
us from third parties such as Medicare, Commercial Insurers, HMOs,
Third Party Administrators, TriCare, and others. This process
identifies potential third-party eligibility.
o Validation: After identification of potential third-party
liability, we validate insurance eligibility by verifying coverage
for specific benefits. This process is performed by deploying
automated electronic transactions and call center representatives.
o Recovery: When eligibility and coverage are in effect for a
specific Medicaid member and related episode of care, we pursue
recovery of the Medicaid payment from the liable third-party. Most
often we recover from third-parties through direct billing of
insurers or disallowance of overpayments to the provider of
services. On occasion, we recover payments through negotiated
settlements.
o Cost Avoidance: Upon verification of coverage or payment of claims
by liable third-parties, we electronically submit this coverage
data to our Medicaid clients. This data is used to avoid paying
similar claims for the Medicaid member on a going forward basis.
Our TPL services also include subrogation services whereby we identify,
investigate and recover accident-related medical costs where a casualty insurer
(e.g., automobile or property insurance) should pay in lieu of Medicaid, or
where a deceased beneficiary's estate should reimburse Medicaid.
In addition to our TPL services described above, we also offer the
following services:
MEDICAL SUPPORT ENFORCEMENT (MSE). Comprehensive medical support
services that assist state Medicaid and Child Support Enforcement agencies
identify health plan coverage available to children through their non-custodial
or custodial parents including assistance with enrollment.
REVENUE MAXIMIZATION. Helping ensure that states receive the full
amount of federal health and human service funding to which they are entitled.
GLOBAL HEALTH INFORMATION SYSTEM (GHIS OR GLOBAL). The GHiS is a
comprehensive fully integrated suite of software modules designed to meet the
specific needs of public health care organizations and community health clinics.
The software includes a full suite of modules from Registration through Case
Management. We also offer training and client directed customization services in
connection with GHiS.
6
CUSTOMERS
Accordis' clients are public, voluntary and for-profit acute care
hospitals and associated clinics, large physician practices, skilled nursing
facilities, and emergency medical transport agencies. Among Accordis' clients
are the nation's three largest public health systems. We engage in both
multi-year and short-term engagements with our clients and substantially all of
the engagements provide for contingent fees calculated as a percentage of the
amounts recovered or collected for the client.
Health Management Systems' clients primarily consist of state health
and human services agencies and county and municipal governments. Contracts are
typically awarded for one- to five-year terms, and provide for contingent fees
calculated as a percentage of the amounts recovered for the client. We have
contracts with 21 different states.
Our largest client is the Los Angeles County Department of Health
Services in California. This client accounted for 14%, 12%, 7% and 11% of our
total revenue in the fiscal years ended December 31, 2002 and 2001, the two
months ended December 31, 2000 and the fiscal year ended October 31, 2000,
respectively. The loss of this customer would have a material adverse effect on
Accordis and HMS Holdings Corp. We provide Los Angeles County (or designated
facilities within Los Angeles County) with, among other services, secondary
third-party resource identification and recovery services, commercial insurance
billing services, Medi-Cal billing and follow-up services, and financial
management and consulting services relating to both inpatient and outpatient
accounts. Either party may terminate the agreement with or without cause upon 30
days written notice, except that financial management and consulting services
require 90 days written notice of termination. We provide services to this
client pursuant to a contract awarded in June 1999 for a one-year period with
three annual automatic renewals through June 2003. Although we cannot be assured
that the contract will be renewed after June 2003, we have been providing
services to this client for more than 20 years.
The clients constituting our ten largest clients change periodically.
The concentration of revenue in such accounts was 56%, 51%, 57% and 51% of our
revenue in the fiscal years ended December 31, 2002 and 2001, the two months
ended December 31, 2000 and the fiscal year ended October 31, 2000,
respectively. In many instances, we provide our services pursuant to agreements
subject to competitive re-procurement. All of these agreements expire between
2003 and 2007. We cannot be assured that any of these agreements will be renewed
and, if renewed, that the fee rates will be equal to those currently in effect.
MARKET TRENDS/OPPORTUNITIES
ACCORDIS
A number of factors are forcing healthcare providers to manage their
patient accounts more efficiently. Although the aggregate Medicare and Medicaid
funding received by hospitals may be growing, federal and state healthcare cost
control initiatives are acting to reduce the proportion of Medicare- and
Medicaid-classified hospital charges that are reimbursed by government sources.
The coordination of benefits associated with ongoing changes to the eligibility
for, and coverage available under, governmental, managed care, and commercial
insurance programs is increasingly complex. The rising underinsured and
uninsured populations pose a significant challenge especially to public
hospitals, which comprise a considerable portion of our client base. As
providers deliver increasingly more services in outpatient settings, their
accounts receivable portfolios have become skewed toward high volume, low
balance accounts, creating significantly more work for the business office
staff. With the increasing complexity of the healthcare reimbursement
environment and shortages of qualified labor in many areas, it is more and more
difficult for an individual provider institution to maintain in-house the
expertise required to operate patient accounting functions. As a result of these
pressures, and as well to reduce cost, providers are now engaging outside help
at an earlier stage in the revenue cycle and are seeking help in executing more
of the functions of their business offices. A number have entirely outsourced
the management of their patient accounting functions, as they seek to focus
limited management and financial resources on the delivery of patient care.
We offer providers a cost-effective outsourcing alternative by virtue
of our specialized workforce, through which we offer business office expertise,
facility with patient accounting technology-based tools, extensive knowledge of
federal, state, and local health regulations and experience in dealing with
government agencies, commercial insurance companies, and others involved in
administering medical assistance or insurance programs.
7
HEALTH MANAGEMENT SYSTEMS
The payor revenue services market is defined by a broad body of federal
legislation related to healthcare entitlement programs such as Medicare,
Medicaid, and programs administered by the Veterans' Administration, the
Department of Defense and the Public Health Service. Three factors drive the
financial characteristics of the market: (1) the hierarchy of programs and
payors, (2) the shared funding of programs between federal and state governments
(varying by state and program), and (3) the funding mechanism -- the
governmental budget and appropriations process.
According to the U.S. Department of Health and Human Services (HHS)
budget for fiscal year 2004, the federal government will spend $442 billion on
HHS health programs, e.g. Medicaid, Medicare, and State Children's Health
Insurance Program (SCHIP).
The most significant driver of Health Management Systems' business is
the Medicaid program. By the program's design, more people enroll in the program
when the economy weakens, thereby increasing Medicaid expenditures. In most
states, the Medicaid program is the second largest budget component. Medicaid
spending is expected to increase over 10% in fiscal year 2003. Furthermore,
current estimates show that state and federal Medicaid expenditures will exceed
$300 billion in fiscal year 2004. Portions of the Medicaid program, which give
rise to TPL activity, are growing faster, such as nursing home care,
community-based long-term care, and payments to health plans. Outpatient
prescription drugs are presently the fastest growing service category under
Medicaid, with estimated expenditure growth of approximately 15% in fiscal year
2004.
The National Association of State Budget Officers (NASBO) has reported
that state surveys project aggregate shortfalls of approximately $30 billion for
fiscal year 2003 and $80 billion for fiscal year 2004. This budget shortfall and
the rise in Medicaid expenditures continue to create a market demand for our
services.
COMPETITION
ACCORDIS
Accordis competes with the many regional and local companies that
provide accounts receivable management services, with large computer software
and systems vendors that provide healthcare business office outsourcing services
(e.g., the SMS division of Seimens, Electronic Data Systems Corporation, and the
HBOC division of McKesson), with medium to large healthcare services companies
(e.g., Advanced Receivables Strategy, Inc., a Perot Systems company), national
collections companies (e.g., Outsourcing Solutions, Inc. and NCO Group, Inc.),
and large consulting and public accounting firms (e.g. Cap Gemini,
PricewaterhouseCoopers).
We compete on the basis of our proprietary technology and systems,
healthcare business office and payor program expertise, existing relationships,
long-standing reputation in the provider market segment, and pricing. We also
believe that no single competitor competes on a national basis across the full
range of services we offer.
HEALTH MANAGEMENT SYSTEMS
Health Management Systems targets federal and state healthcare
agencies, and Medicaid managed care organizations. We compete primarily with
Public Consulting Group, with large national public accounting firms, and with
small regional firms specializing in one or more specific areas of TPL services.
We compete on the basis of our dominant position in the TPL marketplace, our
extensive data network, our proprietary systems, historically high recovery
rates, and pricing.
BUSINESS STRATEGY
ACCORDIS
The Accordis business strategy is to offer hospitals and other
healthcare providers a comprehensive outsourcing solution for their business
office requirements. These Business Office Outsourcing services have been
designed to capitalize on our extensive knowledge of federal, state, and local
healthcare regulations and the
8
healthcare business office, our experience in dealing with third-party payors,
our information processing capabilities, and our specialized workforce. We
distinguish our services from those offered by other vendors via our proprietary
technology, our capacity to craft custom solutions, the business office and
third-party claiming environment expertise of our staff, and our substantial
installed reference base. Additionally, our proprietary on-line information
processing network, called "AccessLine," enables us to consolidate account
information for each patient, enhance account data obtained from clients through
electronic links to external databases, generate claims to third parties, and
organize account information in a format that facilitates cost-effective
processing and recovery activities. AccessLine terminals placed onsite provide
the client with instant access to individual account status.
Our growth strategy has several elements, including:
PROCUREMENT OF CONTRACTS FOR HEALTHCARE SYSTEMS. We intend to
direct sales and marketing efforts towards large hospital systems
comprising multiple facilities in multiple states as a means of
accelerating market penetration, increasing the cost-effectiveness of
our services, and positioning us as a premier provider of business
office services.
EXPANSION TO FULL OUTSOURCING. We will continue to extend our
engagements to encompass total business office outsourcing, helping
providers to increase cash collections, accelerate cash flow, and
reduce costs.
FURTHER DEVELOPMENT OF EXISTING CLIENTS. In many cases, we
provide limited services to a client and may be one of several
companies providing such services. Consequently, we believe we have
significant opportunities to expand the scope of services provided to
such clients.
DEVELOPMENT OF EXPANDED SERVICES. We intend to use our
proprietary technology and regulatory knowledge to offer related but
new revenue cycle services designed to increase revenue, accelerate
cash flow, lower days in accounts receivable, and reduce costs for
healthcare providers.
HEALTH MANAGEMENT SYSTEMS
The Health Management Systems business strategy includes the following
elements:
EXPANDING SERVICE OFFERINGS. Health Management Systems
continues to develop new recovery services in collaboration with our
state Medicaid clients. We develop data mining-based recovery projects,
analyzing Medicaid and Medicare paid claims and eligibility to identify
overpayments and opportunities for effective coordination of benefits.
We have developed unique electronic interfaces to pharmacy benefit
managers, enabling electronic billing and remittance of pharmacy
claims.
ENHANCING CURRENT PROCESSING. We continually seek new sources
of third-party coverage data to increase the yield from our revenue
recoveries. These sources may include state wage and tax files, vital
statistics files, new hire reports, and the like. We are also enhancing
our call center technology and staffing to increase the yield from our
recovery efforts, and opened a national service center in Dallas, Texas
in late 2002.
EXPANDING DISTRIBUTION CAPABILITIES. We have partnered with
several "best of breed" organizations to reach prospective clients and
offer enhanced services to existing clients. These partners include
software, services and consulting organizations, most notably EDS and
Maximus.
EXPANSION TO FULL OUTSOURCING. We have acquired the knowledge
and technical capabilities to fully outsource state TPL operations, and
are observing an increased willingness on the part of our clients to
move in that direction. State Medicaid agencies have long accepted the
practice of Business Process Outsourcing as many have outsourced
Medicaid administrative and information systems operations to
technology and service vendors such as ACS, EDS, and Unisys.
9
STRATEGIC REVIEW
In late fiscal year 2000 we began a strategic examination of our
operating businesses and general infrastructure. During the 1990's our business
plan focused on growth through mergers with and purchases of several businesses,
such that at the beginning of 2001 we were operating two divisions, each
containing two business units (or groups). The Revenue Services Division
included the Provider Revenue Services Group and the Payor Revenue Services
Group. The Software Division included the Decision Support Group and the Payor
Systems Group. We were incurring operating losses and had not achieved
operational synergies or effective marketing and selling opportunities across
our operating units. The strategic review was undertaken to implement a focused
business plan, divest non-strategic assets and reduce infrastructure and
overhead costs.
DIVESTITURES AND MONETIZATION OF NON-STRATEGIC ASSETS
As a fundamental element of the strategic review we completed the
following divestitures:
SALE OF EDI BUSINESS. In January 2001 we sold our electronic
transaction processing (EDI) business, consisting of substantially all the
assets of our wholly owned subsidiary, Quality Medi-Cal Adjudication,
Incorporated, and certain assets of our wholly owned subsidiary, Health
Receivables Management, Inc. The sale price of $3.0 million resulted in a
pre-tax loss of $100,000. This business, which operated in the Provider Revenue
Services Group, was a commodity billing service, and we determined the service
was more appropriately purchased from specialized external vendors.
SALE OF CDR BUSINESS. In July 2001, we sold our credit balance audit
business through the sale of substantially all the assets of our wholly owned
subsidiary, CDR Associates, Inc. The sale price of $3.2 million resulted in a
pre-tax gain of $1.7 million. The business was not core to the technology-based
third party liability processing business of the Payor Revenue Services Group,
and consequently we sought to monetize this non-strategic asset through its
sale.
SALE OF HEALTH CARE MICROSYSTEMS, INC. (HCM). In December 2001 we sold
our wholly owned subsidiary, Health Care microsystems, Inc. which operated as
our Decision Support Group. The sale price of $9.8 million resulted in a pre-tax
gain of $1.9 million. We had originally entered the software business in 1995
through our merger with HCm, a company that furnished microcomputer-based
distributed decision support software systems and consulting services to
healthcare providers and payors. We determined this business was not critical to
our strategy of providing business office outsourcing services and consequently
we sought to monetize this non-strategic asset. In 2002, we increased the
estimated gain on the disposal of this segment by $300,000, reflecting the
favorable resolution of certain operating liabilities. As this business was a
separate reportable segment, representing a separate class of customer and major
business, its operating results are presented as discontinued operations for all
periods presented.
CLOSURE OF PAYOR SYSTEMS GROUP (PSG)
In 1995, we purchased a 43% equity interest in Health Information
Systems Corporation (HISCo). Then in 1997, we purchased the remaining 57%
ownership stake, at which time HISCo merged with its sole operating subsidiary,
Health Systems Architects, Inc., and was renamed HSA Managed Care Systems, Inc.
(HSA). This entity constituted our Payor Systems Group and furnished various
information technology based consulting and other services and software products
to managed care organizations. In March 2001 the PSG business received
notification from its development partner canceling their participation in our
managed care system development initiative. As a consequence, we recognized a
restructuring charge of $5.1 million and an asset impairment charge of $3.5
million associated with the PSG business. Later in June 2001, the PSG business
received a cancellation notice from its largest customer. In light of these
events, we determined to proceed with an orderly closure of PSG by accelerating
a wind-down of its remaining operations. In 2002, we received a $2.7 million
contract termination fee, which was not included in the disposal estimate.
Additionally, in 2002, we reduced the estimated loss on disposal of this segment
by $400,000, based on the actual operating results of PSG. As this business was
a separate reportable segment, representing a separate class of customer and
major business, its operating results are presented as discontinued operations
for all periods presented.
10
At the end of calendar year 2001, we completed our strategic review and
are now organized around two core businesses, Accordis and Health Management
Systems, with a business plan focused on growing revenues and operating
profitably.
RESTRUCTURING CHARGES, ASSET IMPAIRMENTS, AND OTHER ITEMS
In addition to the business divestitures and closure discussed above,
we incurred several other charges in fiscal year 2001 resulting from the
strategic review of our business operations, infrastructure, and management
team. In particular:
o In April 2001, we incurred a restructuring charge of $800,000 for facility
exit costs and employee severance costs associated with the closure of our
Washington, D.C. office.
o Throughout 2001, we incurred $1.4 million in compensation costs for
severance and retention bonuses that were paid during the year, resulting
from our divestiture efforts and headcount reduction efforts.
o In December 2001, we incurred a restructuring charge of $1.8 million
consisting of $500,000 for severance costs associated with reductions in
the information technology and facilities maintenance departments, and $1.3
million for facility exit costs associated with a plan to reduce the amount
of office space we occupy at our headquarters in New York City. This office
space reduction effort culminated in our executing a sublease in January
2003, resulting in an additional restructuring charge of $800,000 in
December 2002 for facility exit costs.
o In December 2001, we recognized a charge of $1.3 million for the impairment
of goodwill resulting from the 1997 acquisition of the Global business
unit. This impairment charge was based on a recoverability analysis which
had been triggered by the significant underperformance of the unit relative
to the expected historical results and the current projections of future
operating results. The impairment charge was measured based on the
projected discounted future cash flows from the business unit over the
remaining fifteen year amortization period of the goodwill using a discount
rate reflective of our cost of funds.
CHANGE IN FISCAL YEAR END
In October 2001, our Board of Directors approved a change in our fiscal
year to December 31st from October 31st. The change was made retroactive to
January 1, 2001. As a result of this change, we have presented the transition
period of November 1, 2000 to December 31, 2000. All prior fiscal years are
presented with an October 31st year-end date.
EMPLOYEES
As of December 31, 2002, we employed 506 employees. No employees are
covered by a collective bargaining agreement or are represented by a labor
union. We believe our relations with our employees are good.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
Specific financial information with respect to our industry segments is
provided in Note 16, Segment and Geographical Information, of the Notes to
Consolidated Financial Statements.
AVAILABLE INFORMATION
We maintain a website that contains various information about us and
our services. It is accessible at www.hmsholdings.com. Through our website,
shareholders and the general public may access free of charge (other than any
connection charges from internet service providers) filings we make with the
Securities and Exchange Commission as soon as practicable after filing. Filing
accessibility in this manner includes the Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q and current reports on Form 8-K.
ITEM 2. PROPERTIES
Our New York City corporate headquarters consists of approximately
81,000 square feet. In addition, as of December 31, 2002, we lease approximately
155,000 square feet of office space in 17 locations throughout the
11
United States. See Note 15(a) of the Notes to Consolidated Financial Statements
for additional information about our lease commitments.
ITEM 3. LEGAL PROCEEDINGS
(A) HHL FINANCIAL SERVICES
On June 28, 1998, eight holders of promissory notes (the Notes) of HHL
Financial Services, Inc. (HHL) commenced a lawsuit against us and others in the
Supreme Court of the State of New York, County of Nassau, alleging
various breaches of fiduciary duty between 1990 and 1996 against HHL (the first
cause of action) and that defendants intentionally caused HHL's default under
the Notes (the second cause of action). The complaint alleges that the
defendants caused HHL to make substantial unjustified payments to us which,
ultimately, led to defaults on the Notes and to HHL's filing for Chapter 11
bankruptcy protection in 1997. The plaintiffs are seeking damages in the amount
of $2.3 million (for the unpaid notes) plus interest. As a result of motion
practice before the Bankruptcy Court, the breach of fiduciary duty claim was
dismissed. A motion to dismiss the remaining cause of action, for tortious
interference with contract, was denied by the New York Supreme Court, and an
appeal was taken. On March 3, 2003, the Appellate Division Second Department
affirmed the lower Court's decision holding that the Complaint pleaded a
cognizable cause of action for tortious interference. We will now answer the
Complaint, and both sides will engage in discovery. We intend to continue our
vigorous defense of this lawsuit. Management believes the risk of loss is not
probable and accordingly has not recognized any accrued liability for this
matter. Although the outcome of this matter cannot be predicted with certainty,
we believe that any liability that may result will not, in the aggregate, have
a material adverse effect on our financial position or cash flows, although it
could be material to our operating results in any one accounting period.
(B) SUBPOENA FROM THE UNITED STATES ATTORNEY'S OFFICE On January
31, 2003, we announced that we had received a subpoena issued under the Health
Insurance Portability and Accountability Act of 1996 from the United States
Attorney's Office for the Southern District of New York in connection with an
investigation relating to possible Federal health care offenses. The subpoena
seeks the production of certain documents from January 1982 to present relating
to medical reimbursement claims submitted by us to Medicare, Medicaid and other
federal healthcare programs, particularly on behalf of a significant client of
Accordis. At this point in the investigation, the United States Attorney's
Office has not filed any complaint asserting any violations of law.
We are cooperating fully with the investigation and are in the
process of assembling and producing the documents called for by the subpoena.
Our board of directors has appointed a special committee to oversee our response
to the investigation.
We are not able to give any assurances as to the duration or outcome of
the investigation or as to the effect that any proceedings that may be brought
by the government may have on our financial condition or results of operations.
The initiation of proceedings against us, even if we are ultimately successful
in defending them, could have a material adverse effect on our business. Over
the near term, we anticipate that revenue and expense levels will be adversely
affected as management undertakes to comply with the demands of data gathering
and review of the matters covered by the subpoena.
Other legal proceedings to which we are a party, in the opinion of our
management, are not expected to have a material adverse effect on our financial
position, results of operations, or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of our Shareholders was held on February 27, 2003.
The 13,263,812 shares of common stock present at the meeting out of a total
18,276,274 shares outstanding and entitled to vote, ratified, by a vote of
13,108,035 shares of common stock for, 107,656 shares against and 48,121 shares
abstaining, the Agreement and Plan of Merger, pursuant to which each share of
Health Management Systems, Inc. common stock was exchanged for common stock of
HMS Holdings Corp. and as a result of which HMS Holdings Corp., a New York
corporation formed by HMS, became the parent company of HMS.
12
PART II
- -------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Our common stock is included in the NASDAQ-AMEX National Market System
(symbol: HMSY). As of the close of business on March 14, 2003, there were
approximately 6,000 holders of our common stock, including the individual
participants in security position listings. We have not paid any cash dividends
on our common stock and do not anticipate paying cash dividends in the
foreseeable future. Our current intention is to retain earnings to support the
future growth of our business.
The table below summarizes the high and low sales prices per share for
our common stock for the periods indicated, as reported on the NASDAQ-AMEX
National Market System.
HIGH LOW
---- ---
Year ended December 31, 2002:
Quarter ended December 31, 2002 $4.03 $3.00
Quarter ended September 30, 2002 3.62 2.40
Quarter ended June 30, 2002 5.14 2.87
Quarter ended March 31, 2002 5.55 2.95
Year ended December 31, 2001:
Quarter ended December 31, 2001 $3.30 $1.50
Quarter ended September 30, 2001 2.04 0.91
Quarter ended June 30, 2001 2.10 1.15
Quarter ended March 31, 2001 1.88 1.13
EQUITY COMPENSATION PLAN INFORMATION
Information regarding our equity compensation plans, including both
shareholder approved plans and non-shareholder approved plans, will be included
in our Proxy Statement for the 2003 Annual Meeting of Shareholders, which will
be mailed within 120 days after the close of the Company's year ended December
31, 2002, and is hereby incorporated herein by reference to such Proxy
Statement.
13
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA (SEE NOTES)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED TWO MONTHS
YEAR ENDED YEAR ENDED OCTOBER 31, ENDED
DECEMBER 31, DECEMBER 31, --------------------------------- DECEMBER 31,
2002 2001 2000 1999 1998 2000
---------------------------------------------------------------------------
Statement of Operations Data:
Revenue:
Accordis $ 36,331 $ 31,329 $ 42,562 $ 39,195 $ 32,542 $ 5,474
Health Management Systems 32,283 27,419 22,287 28,755 24,695 3,733
-------- -------- -------- -------- -------- --------
68,614 58,748 64,849 67,950 57,237 9,207
Cost of services 71,656 76,818 76,520 65,905 56,280 10,895
-------- -------- -------- -------- -------- --------
Operating income (loss) (3,042) (18,070) (11,671) 2,045 957 (1,688)
Gain on sale of assets -- 1,605 -- -- -- --
Net interest and net other income 517 667 1,024 1,206 1,675 138
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes and cumulative
effect of change in accounting principle (2,525) (15,798) (10,647) 3,251 2,632 (1,550)
Income tax expense (benefit) -- -- (4,530) 1,149 1,023 (642)
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before cumulative effect of change in
accounting principle (2,525) (15,798) (6,117) 2,102 1,609 (908)
Discontinued operations:
Income (loss) from discontinued operations, net -- (5,053) 2,656 5,381 4,479 (35)
Estimated gain (loss) on disposal of
discontinued operations, net 3,460 (200) -- -- -- --
Gain on sale of discontinued operations, net -- 1,587 -- -- -- --
-------- -------- -------- -------- -------- --------
Discontinued operations 3,460 (3,666) 2,656 5,381 4,479 (35)
Income (loss) before cumulative effect
of change in accounting principle 935 (19,464) (3,461) 7,483 6,088 (943)
Cumulative effect of change in accounting
principle, net of tax benefit -- -- (21,965) -- -- --
-------- -------- -------- -------- -------- --------
Net income (loss) $ 935 $(19,464) $(25,426) $ 7,483 $ 6,088 $ (943)
======== ======== ======== ======== ======== ========
PER COMMON SHARE DATA:
Basic and diluted income (loss) per share:
From continuing operations $ (0.14) $ (0.88) $ (0.35) $ 0.12 $ 0.09 $ (0.05)
From discontinued operations 0.19 (0.21) 0.15 0.31 0.25 --
From change in accounting principle -- -- (1.26) -- -- --
-------- -------- -------- ------- -------- --------
Total $ 0.05 $ (1.09) $ (1.46) $ 0.43 $ 0.34 $ (0.05)
======== ======== ======== ======== ======== ========
Weighted average common shares 18,199 17,857 17,467 17,357 17,833 17,252
-------- -------- -------- -------- -------- --------
OCTOBER 31,
DECEMBER 31, DECEMBER 31, --------------------------------- DECEMBER 31,
2002 2001 2000 1999 1998 2000
---------------------------------------------------------------------------
Balance Sheet Data:
Cash and short-term investments $ 25,282 $ 25,042 $ 16,740 $ 33,817 $ 28,402 $ 13,574
Working capital 28,625 26,238 30,562 58,437 56,703 29,055
Total assets 61,666 60,394 79,563 123,367 102,936 75,637
Shareholders' equity 47,768 45,781 65,598 91,232 83,269 64,673
14
NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA
o Included in each respective year's amounts are the revenue and costs
associated with the following acquisitions, accounted for using the
purchase method of accounting : HRM acquired June 1999.
o Regarding Restructuring Costs and Other Charges, see Notes 13 and 14 of
the Notes to Consolidated Financial Statements.
o After analyzing the SEC's "Frequently Asked Questions and Answers"
bulletin released on October 12, 2000 pertaining to Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
101), we elected early adoption for our fiscal year ended October 31,
2000, implementing a change in accounting in regard to revenue
generated from clients seeking reimbursement from third-party payors
where our fees are contingent upon the client's collections from third
parties. As of November 1, 1999, we recognized revenue pertaining to
such clients once the third-party payor remitted payment to its client.
The change reduced revenue by $3.0 million and increased net loss by
$503,000 for fiscal year 2000, excluding the cumulative effect of the
change. The cumulative effect pertaining to this change as of the
beginning of our fiscal year 2000 was $22.0 million, net of tax
benefit. See Note 12 of the Notes to Consolidated Financial Statements.
o Discontinued Operations. In fiscal year 2001, we sold Health Care
microsystems, Inc. which operated as our Decision Support Group, and
implemented a formal plan to close the Payor Systems Group through an
orderly wind-down of its operations. As these two businesses were
previously presented as separate reportable segments and represented
separate classes of customers and major businesses, the operating
results are presented as discontinued operations for all periods
presented. See Note 14 of the Notes to Consolidated Financial
Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION. We principally recognize revenue for our service
offerings when third party payors remit payment to the Company's customers. This
policy is in effect because our fees are principally contingent upon our
customers' collections from third parties. Under this revenue recognition
policy, our operating results may vary significantly from quarter to quarter due
to the timing of such collections by our customers and the fact that a
significant portion of our operating expenses are fixed.
ACCOUNTING FOR INCOME TAXES. We have generated net operating losses for
tax purposes each of the last four years. These losses generated cumulative
federal net operating loss carryforwards of $25 million as of December 31, 2002.
In addition, due to our restructuring efforts certain charges written off in the
current year are not currently deductible for income tax purposes. These
differences result in gross deferred tax assets. We must assess the likelihood
that the gross deferred tax assets, net of any deferred tax liabilities, will be
recovered from future taxable income and to the extent we believe the recovery
is not likely, we have established a valuation allowance.
Significant management judgment is required in determining this
valuation allowance. We have recorded a valuation allowance of $8.5 million as
of December 31, 2002, due to uncertainties related to our ability to utilize
some of our net deferred tax assets, primarily consisting of certain net
operating loss carryforwards before they expire. The valuation allowance is
based on our estimate of taxable income and the period over which the net
deferred tax assets will be recoverable. In the event that these estimates
differ or we adjust these estimates in future periods we may need to establish
an additional valuation allowance which could materially impact our financial
position and results of operations.
Conversely, if we are profitable in the future at levels which cause
management to conclude that it is more likely than not that we will realize all
or a portion of the net deferred tax assets, for which a valuation is currently
15
provided, we would record the estimated net realizable value of the net deferred
tax asset at that time and would then provide income taxes at a rate equal to
our combined federal and state effective rate of approximately 42%.
The net deferred tax asset as of December 31, 2002 was $8.9 million,
net of a valuation allowance of $8.5 million.
VALUATION OF LONG LIVED AND INTANGIBLE ASSETS AND GOODWILL. Goodwill,
representing the excess of acquisition costs over the fair value of net assets
of acquired businesses, is not amortized but is reviewed for impairment at least
annually and written down only in the periods in which it is determined that the
recorded value is greater than the fair value. For the purposes of performing
this impairment test, our business segments are our reporting units. The fair
values of those reporting units, to which goodwill has been assigned, is
compared with their recorded values. If recorded values are less than the fair
values, no impairment is indicated. Goodwill acquired in business combinations
completed before July 1, 2001 had been amortized through December 31, 2001 on a
straight-line basis over a period of ten to forty years.
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important which could trigger an impairment
review include the following:
o Significant underperformance relative to expected historical or
projected future operating results;
o Significant changes in the manner of our use of the acquired assets
or the strategy for our overall business;
o Significant negative industry or economic trends;
o Significant decline in our stock price for a sustained period; and
o Our market capitalization relative to net book value.
We determine the recoverability of the carrying value of our long-lived
assets based on a projection of the estimated undiscounted future net cash flows
expected to result from the use of the asset. When we determine that the
carrying value of long-lived assets may not be recoverable, we measure any
impairment by comparing the carrying amount of the asset with the fair value of
the asset. For identifiable intangibles we determine fair value based on a
projected discounted cash flow method using a discount rate reflective of our
cost of funds.
In 2002, Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets" became effective and as a result, we
ceased to amortize approximately $8.4 million of goodwill which would have
resulted in approximately $267,000 of amortization in 2002. No impairment loss
resulted from the initial goodwill impairment test, or from the annual
impairment test that was performed during 2002.
ESTIMATING VALUATION ALLOWANCES AND ACCRUED LIABILITIES, SUCH AS BAD
DEBTS, AND RESTRUCTURING CHARGES. The preparation of financial statements
requires our management to make estimates and assumptions that affect the
reported amount of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reported period. Specifically, management
must make estimates of the uncollectability of our accounts receivable.
Management specifically analyzes accounts receivable and analyzes historical bad
debts, customer concentrations, customer credit-worthiness, current economic
trends and changes in our customer payment terms when evaluating the adequacy of
the allowance for doubtful accounts. The accounts receivable balance was $15.3
million, net of allowance for doubtful accounts of $3.4 million as of December
31, 2002.
Management has estimated a certain amount of charges as of December 31,
2002 related to restructuring activities. We have recorded an estimated
liability based on a reasonable assessment of the probable costs to be incurred.
As additional information becomes available in 2003, we may revise the
estimates. Such revisions in estimates of the potential restructuring
liabilities could materially impact the results of operation and financial
position.
DISCONTINUED OPERATIONS. The accompanying financial statements are
prepared using discontinued operations accounting for our discontinued Decision
Support Group (DSG) and Payor Systems Group (PSG)
16
businesses. Under discontinued operations accounting, amounts are accrued for
estimates of our expected liabilities related to discontinued operations through
their eventual discharge. The DSG business was sold in December 2001. At
December 31, 2001, the PSG business's remaining liabilities principally
consisted of lease termination and related facility costs, and employee
severance expenses. At December 31, 2002, substantially all liabilities have
been liquidated and any adjustments related to costs to be incurred during the
close down or losses from operations, have been reflected in the 2002 estimated
gain on disposal of discontinued operations. In the event that any liabilities
should arise from these discontinued operations, there could be a material
impact on our financial position and results of operations.
The above listing is not intended to be a comprehensive list of all of
our accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by accounting principles generally accepted
in the United States of America, with no need for management's judgment in their
application. There are also areas in which the audited consolidated financial
statements and notes thereto included in this Form 10-K contain accounting
policies and other disclosures required by accounting principles generally
accepted in the United States of America.
STRATEGIC REVIEW
In late fiscal year 2000 we began a strategic examination of our
operating businesses and general infrastructure. During the 1990's our business
plan focused on growth through mergers with and purchases of several businesses,
such that at the beginning of 2001 we were operating two divisions, each
containing two business units (or groups). The Revenue Services Division
included the Provider Revenue Services Group and the Payor Revenue Services
Group. The Software Division included the Decision Support Group and the Payor
Systems Group. We were incurring operating losses and had not achieved
operational synergies or effective marketing and selling opportunities across
our operating units. The strategic review was undertaken to implement a focused
business plan, divest non-strategic assets and reduce infrastructure and
overhead costs.
DIVESTITURES AND MONETIZATION OF NON-STRATEGIC ASSETS
As a fundamental element of the strategic review we completed the
following divestitures:
SALE OF EDI BUSINESS. In January 2001 we sold our electronic
transaction processing (EDI) business, consisting of substantially all the
assets of our wholly owned subsidiary, Quality Medi-Cal Adjudication,
Incorporated, and certain assets of its wholly owned subsidiary, Health
Receivables Management, Inc. The sale price of $3.0 million resulted in a
pre-tax loss of $100,000. This business, which operated in the Provider Revenue
Services Group, was a commodity billing service, and we determined the service
was more appropriately purchased from specialized external vendors.
SALE OF CDR BUSINESS. In July 2001 we sold our credit balance audit
business through the sale of substantially all the assets of our wholly owned
subsidiary, CDR Associates, Inc. The sale price of $3.2 million resulted in
pre-tax gain of $1.7 million. The business was not core to the technology-based
third party liability processing business of the Payor Revenue Services Group,
and consequently we sought to monetize this non-strategic asset through its
sale.
SALE OF HEALTH CARE MICROSYSTEMS, INC. In December 2001 we sold our
wholly owned subsidiary, Health Care microsystems, Inc. which operated as our
Decision Support Group. The sale price of $9.8 million resulted in a pre-tax
gain of $1.9 million. We had originally entered the software business in 1995
through our merger with HCm, a company that furnished microcomputer-based
distributed decision support software systems and consulting services, to
healthcare providers and payors. We determined this business was not critical to
our strategy of providing business office outsourcing services. In 2002, we
increased the estimated gain on the disposal of this segment by $300,000,
reflecting the favorable resolution of certain operating liabilities. As this
business was a separate reportable segment, representing a separate class of
customer and major business, its operating results are presented as discontinued
operations for all periods presented.
17
CLOSURE OF PAYOR SYSTEMS GROUP (PSG)
Our Payor Systems Group, which consisted of Health Information Systems
Corporation and its sole operating subsidiary, Health Systems Architects, Inc.,
furnished various information technology based consulting and other services,
and software products to managed care organizations. In March 2001 the PSG
business received notification from its development partner, canceling their
participation in our managed care system development initiative. As a
consequence, we recognized a restructuring charge of $5.1 million and an asset
impairment charge of $3.5 million associated with the PSG business. Later in
June 2001 the PSG business received a cancellation notice from its largest
customer. In light of these events, we determined to proceed with an orderly
closure of PSG by accelerating a wind-down of its remaining operations. In 2002,
we received a $2.7 million contract termination fee, which was not included in
the disposal estimate. Additionally, in 2002, we reduced the estimated loss on
disposal of this segment by $400,000, based on the actual operating results of
PSG. As this business was a separate reportable segment, representing a separate
class of customer and major business, its operating results are presented as
discontinued operations for all periods presented.
At the end of calendar year 2001, we completed our strategic review and
are now organized around two core businesses, Accordis and Health Management
Systems, with a business plan focused on growing revenues and reaching
profitability.
RESTRUCTURING CHARGES, ASSET IMPAIRMENTS, AND OTHER ITEMS
In addition to the business divestitures and closure discussed above we
incurred several other charges in fiscal year 2001 resulting from the strategic
review of our business operations, infrastructure, and management team. In
particular:
o In April 2001, we incurred a restructuring charge of $800,000 for facility
exit costs and employee severance costs associated with the closure of our
Washington, D.C. office.
o Throughout 2001 we incurred $1.4 million in compensation costs for
severance and retention bonuses that were paid during the year, resulting
from our divestiture efforts and headcount reduction efforts.
o In December 2001, we incurred a restructuring charge of $1.8 million
consisting of $500,000 for severance costs associated with reductions in
the information technology and facilities maintenance departments, and $1.3
million for facility exit costs associated with a plan to reduce the amount
of office space we occupy at our headquarters in New York City. This office
space reduction effort culminated in our executing a sublease in January
2003, resulting in an additional restructuring charge of $800,000 in
December 2002 for facility exit costs.
o In December 2001, we recognized a charge of $1.3 million for the impairment
of goodwill resulting from the 1997 acquisition of the Global business
unit. This impairment charge was based on a recoverability analysis which
had been triggered by the significant underperformance of the unit relative
to the expected historical results and the current projections of future
operating results. The impairment charge was measured based on the
projected discounted future cash flows from the business unit over the
remaining fifteen year amortization period of the goodwill using a discount
rate reflective of our cost of funds.
18
YEARS ENDED DECEMBER 31, 2002 AND 2001
The following table sets forth, for the periods indicated, certain
items in our Consolidated Statements of Operations expressed as a percentage of
revenue:
2002 2001
---------- ---------
Revenue 100.0% 100.0%
Cost of services:
Compensation 55.1% 57.5%
Data processing 8.9% 15.8%
Occupancy 9.0% 11.1%
Direct project costs 14.8% 16.3%
Other operating costs 15.3% 23.3%
Restructuring costs 1.3% 3.9%
Impairment of assets -- 2.3%
Amortization of intangibles -- 0.6%
------- -------
Total cost of services 104.4% 130.8%
------- -------
Operating loss (4.4)% (30.8)%
Gain on sale of assets -- 2.8%
Net interest income 0.8% 1.1%
------- -------
Loss from continuing operations before income taxes (3.6)% (26.9)%
Income tax expense (benefit) -- --
------- -------
Loss from continuing operations (3.6)% (26.9)%
Net income (loss) from discontinued operations 5.0% (6.2)%
------- -------
Net income (loss) 1.4% (33.1)%
======= =======
Revenue for the year ended December 31, 2002 was $68.6 million, an
increase of $9.9 million or 16.8% compared to revenue of $58.7 million in the
prior fiscal year ended December 31, 2001.
Health Management Systems, which provides third party liability
identification and recovery services to state Medicaid agencies, generated
revenue of $32.3 million in 2002, a $4.9 million or 17.7% increase over the
prior year revenue of $27.4 million. This increase primarily reflected $3.6
million of revenue during the current year from five new state clients,
including a contract re-award with an expanded scope of services. In addition,
revenue increased by $2.7 million across the comparable client base reflecting
specific non-recurring revenue opportunities with certain clients based on their
particular needs, differences in the timing of when client projects were
completed in the current year compared with the prior year, and changes in the
volume, yields and scope of client projects. These non-recurring revenue
opportunities are generally situations where we have an opportunity to earn
additional revenue from a client which we do not expect will recur in the
current year or which did not exist in the prior year. These increases were
partially offset by a $1.4 million decrease in revenue resulting from the sale
of the business of our former CDR Associates subsidiary in July 2001.
Accordis, which provides outsourced business office services for
hospitals, generated revenue of $36.3 million in 2002, a $5.0 million or 16%
increase from the prior year revenue of $31.3 million. This increase primarily
consisted of $3.2 million of revenue from 19 new customers since the prior year
period, and a $2.5 million increase with three customers resulting from an
expansion in the scope of services provided. In addition, revenue increased by
$2.7 million across the comparable client base reflecting specific non-recurring
revenue opportunities with certain clients based on their particular needs,
differences in the timing of when client projects were completed in the current
year compared with the prior year, and changes in the volume and yields of
client projects. These increases were partially offset by a decrease in revenue
of $3.4 million associated with 17 terminated or inactive customer
relationships.
19
Operating expenses as a percentage of revenue were 104.4% in the
current year compared to 130.8% in the prior year and for 2002 were $71.7
million, a decrease of $5.2 million, or 6.7%, compared to prior year operating
expenses of $76.8 million. Operating expenses in 2002 included a $900,000
restructuring charge and, as discussed in more detail below, 2001 operating
expenses were adversely impacted by several non-recurring charges, restructuring
costs, asset impairments, write-offs and higher service development initiatives.
Compensation expense as a percentage of revenue was 55.1% in the
current year compared to 57.5% in the prior year and for 2002 was $37.8 million,
an increase of $4.0 million, or 11.9% from the prior year period expense of
$33.8 million. This increase resulted from an increase in staff, reflective of
the growth in revenues and general increases in compensation rates, partially
offset by a decrease of $1.2 million from the sale of the business of our former
CDR Associates subsidiary in July 2001. At December 31, 2002, we had 506
employees, compared to 433 employees at December 31, 2001.
Data processing expense as a percentage of revenue was 8.9% in the
current fiscal year compared to 15.8% in the prior fiscal year and for 2002 was
$6.1 million, a decrease of $3.2 million or 34.4% compared to the prior year
expense of $9.3 million. The prior year costs included: (a) a charge of $1.4
million associated with the write-off of an internally developed software
initiative based on our assessment of the project's future prospects, (b) a
related charge of $1.5 million for external software commitments which had been
integral to the same project but were no longer of value to us, and (c) a charge
of $300,000 for two unrelated software assets that were no longer in use.
Partially offsetting these decreases was a current year charge of $600,000 for
the disposal and impairment of hardware and software items resulting from the
termination of an unrelated service initiative.
Occupancy expense as a percentage of revenue was 9.0% in the current
year compared to 11.1% in the prior year and for 2002 was $6.1 million, a
decrease of $400,000 or 5.5% from the prior year expense of $6.5 million. This
decrease was principally due to reductions in utilities, services and other
expenses generally as a result of prior year reductions in space.
Direct project expense as a percentage of revenue was 14.8% in the
current year compared to 16.3% in the prior year and for 2002 was $10.2 million,
an increase of $600,000 or 6% from the prior fiscal year expense of $9.6
million. This increase reflects an $800,000 increase in expense related to
Accordis, and a $200,000 decrease in expense related to Health Management
Systems. The Accordis increase was principally due to increased expenses
associated with a 16% increase in revenue. The decrease related to Health
Management Systems reflects a $600,000 reduction in marketing partner expenses
partially offset by increased expenses associated with a 17.7% increase in
revenues.
Other operating expenses as a percentage of revenue were 15.3% in the
current year compared to 23.3% in the prior year and for 2002 were $10.5
million, a decrease of $3.2 million or 23.1% compared to the prior year expense
of $13.7 million. Consulting and professional fees including related travel
costs decreased by $500,000, from $5.5 million in 2001 to $5.0 million in 2002,
principally due to two service development and system enhancement and
reconfiguration activities that were terminated in the second quarter of 2002.
During 2001, we recognized bad debt expense of $2.7 million related to a
receivable due from the District of Columbia. See Note 3 of the Notes to
Consolidated Financial Statements.
Restructuring costs as a percentage of revenue were 1.3% in the current
year compared to 3.9% in the prior year and in 2002 were $900,000, a decrease of
$1.4 million from 2001. Restructuring costs in 2001 reflect the net of: (1) a
total charge of $1.8 million in December 2001, consisting of $1.3 million for
facility exit costs to vacate one floor at our headquarters in New York City,
and $500,000 for severance costs associated with reductions in the information
technology and facilities maintenance departments, (2) a net charge of $800,000
for facility exit costs and employee termination costs associated with the
closure of our Washington, D.C. office in March 2001, and (3) in October 2001, a
$300,000 reduction to the restructuring charge incurred in October 2000
associated with a facility consolidation initiative that was subsequently not
undertaken. Restructuring costs in 2002 reflect: (1) an additional $800,000
restructuring charge associated with reducing the amount of office space we
occupy at our headquarters in
20
New York City based on an executed sublease and (2) an additional $100,000 in
facility exit costs associated with the closure of our Washington, D.C. office.
In December 2001, we recognized an impairment of assets charge of $1.3
million for the full impairment of goodwill which arose from our 1997
acquisition of Global's computerized medical record based processing system
business. The impairment charge was measured based on the projected discounted
future cash flows from the business unit over the remaining 15 year amortization
period of the goodwill using a discount rate reflective of our cost of funds.
Operating loss for the year ended December 31, 2002 was $3.0 million
compared to $18.1 million for the prior year. The Accordis operating loss was
$7.6 million for the year ended December 31, 2002 compared to an operating loss
of $14.6 million in the prior year. Health Management Systems had an operating
profit of $4.6 million for the year ended December 31, 2002 compared to an
operating loss of $3.5 million in the prior year. The decrease in the Accordis
operating loss largely reflects several non-recurring items in 2001 including
$3.2 million in data processing charges associated with a specific internal
development initiative as discussed above, and the $2.7 million bad debt charge
related to a receivable from the District of Columbia. The return of Health
Management Systems to operating profitability largely reflects the increase in
revenue discussed above, and the prior year reflecting non-recurring charges
including a $1.3 million goodwill impairment charge for the Global business and
the $800,000 restructuring charge associated with closing the Washington D.C.
office.
In 2001, we recognized a net gain on sale of assets of $1.6 million
from the sale of the EDI business in January 2001 and the CDR business in July
2001. The sale of the EDI business resulted in a loss of $100,000 on a sale
price of $2.8 million; the sale of the CDR business resulted in a gain of $1.7
million on a sale price of $3.2 million.
In 2002 and 2001, we did not recognize any income tax benefit against
our losses from continuing operations or the net income (losses) from
discontinued operations, but did recognize in 2001 a current income tax expense
of $312,000 from the gain on sale of HCm. This absence of an income tax benefit
in 2001 reflects an increase in our valuation allowance for the recovery of our
net deferred income tax assets. We have incurred significant taxable losses the
last several years. Most of our deferred income tax assets are in the form of
net operating loss carryforwards. A recoverability analysis was performed based
on our recent taxable loss history and projections of future taxable operating
results.
Net interest income of $500,000 in fiscal year 2002 compared with
$700,000 in the prior year reflects a shift to shorter term investments and a
reduction in market interest rates.
Loss from continuing operations was $2.5 million in the current year
compared with a loss of $15.8 million in the prior year. The $13.3 million
reduction in loss largely reflects the reduction of non-recurring charges,
restructuring charges, asset impairments and asset write-offs during the current
fiscal year discussed above.
DISCONTINUED OPERATIONS
As more fully discussed in Item 1 and Note 1(b) of the Notes to
Consolidated Financial Statements, we reported the results of our Payor Systems
Group (PSG) and Decision Support Group (DSG) as discontinued operations for all
periods presented. Income from discontinued operations in 2002 of $3.5 million
was principally attributable to (1) a $2.7 million contract termination fee
which was not included in the original loss on disposal estimate for PSG, (2) a
reduction in the estimated loss on disposal of PSG of $448,000 based on actual
operating results, and (3) $311,000 resulting from the favorable resolution of
certain operating liabilities. Loss from discontinued operations for fiscal year
2001 was $3.7 million. The year 2001 loss from discontinued operations reflects
a restructuring charge of $5.1 million and an asset impairment charge of $4.6
million incurred in the PSG business during April 2001, upon the loss of its
development partner. The restructuring charge related to the write-off of the
subject development initiative and related employee terminations and facility
exit costs. The asset impairment charge related to the write-off of goodwill and
other intangibles resulting from our prior acquisition of
21
the PSG business. We determined to close PSG in July 2001, and the estimated
loss on disposal of $200,000 represents the anticipated loss during the
wind-down period. We sold our wholly owned subsidiary, Health Care microsystems,
Inc., which had operated as DSG, in December 2001, recognizing a gain, after
income tax expense, of $1.6 million on a sale price of $9.8 million. Thus, net
loss on discontinued operations was $3.7 million in 2001.
CHANGE IN FISCAL YEAR END
In October 2001, our Board of Directors approved a change in our fiscal
year to December 31st from October 31st. The change was made retroactive to
January 1, 2001. As a result of this change, we have presented the transition
period of November 1, 2000 to December 31, 2000. All prior fiscal years are
presented with an October 31st year-end date. Consequently, in the following
discussions of results of operations, we compare the December 31, 2001 results
with the prior year October 31, 2000 results.
YEAR ENDED DECEMBER 31, 2001 AND FISCAL YEAR ENDED OCTOBER 31, 2000
CONTINUING OPERATIONS:
The following table sets forth, for the periods indicated, certain
items in our Consolidated Statements of Operations expressed as a percentage of
revenue:
2001 2000
------ ------
Revenue 100.0% 100.0%
Cost of services:
Compensation 57.5% 58.1%
Data processing 15.8% 11.1%
Occupancy 11.1% 12.0%
Direct project costs 16.3% 15.3%
Other operating costs 23.3% 15.5%
Restructuring costs 3.9% 1.3%
Impairment of assets 2.3% --
Other charges -- 4.1%
Amortization of intangibles 0.6% 0.6%
------- -------
Total cost of services 130.8% 117.6%
------- -------
Operating loss (30.8)% (18.0)%
Gain on sale of assets 2.8% --
Net interest income 1.1% 1.6%
------- -------
Loss from continuing operations before income taxes
and cumulative effect of change in accounting principle (26.9)% (16.4)%
Income tax benefit -- (7.0)%
------- -------
Loss from continuing operations before cumulative
effect of change in accounting principle (26.9)% (9.4)%
Net income (loss) from discontinued operations (6.2)% 4.1%
------- -------
Loss before cumulative effect of change in
accounting principle (33.1)% (5.3)%
Cumulative effect of change in accounting principle, net of
tax benefit -- (33.9)%
------- -------
Net loss (33.1)% (39.2)%
======= =======
22
Revenue for the fiscal year ended December 31, 2001 was $58.7 million,
a decrease of $6.1 million or 9.4% compared to revenue of $64.8 million in the
prior fiscal year ended October 31, 2000.
Health Management Systems, which provides third party liability
identification and recovery services to state Medicaid agencies, generated
revenue of $27.4 million in 2001, a $5.1 million or 23% increase over the prior
year revenue of $22.3 million. This increase reflected: (1) $5.3 million in
additional revenue from expanded services for four existing clients, (2) $1.8
million in new revenue from initiation of services for one new client, and (3)
other revenue from expansion of services with several other clients. These
increases were partly offset by a decrease of $1.4 million resulting from the
termination of one client relationship and another $1.4 million decrease
reflecting a reduction in service revenues with another existing client. The
sale of the CDR business had a negligible impact on revenues, as the sold
business still functions as a subcontractor to us.
Accordis, which outsources accounts receivable management services for
hospitals, generated revenue of $31.3 million in 2001, an $11.3 million or 26.5%
decrease from the prior year revenue of $42.6 million. This decrease consisted
of: (1) a $4.6 million reduction resulting from the sale of our EDI business at
the start of the fiscal year, (2) a $4.0 million decrease related to the
termination of one client relationship, and (3) a $2.0 million reduction
resulting from a non-recurring one-time revenue opportunity with a client in the
prior fiscal year.
Operating expenses as a percentage of revenue were 130.8% in 2001
compared to 117.6% in the prior fiscal year and for 2001 were $76.8 million, an
increase of $300,000, or less than 1%, compared to prior year operating expenses
of $76.5 million. On a comparative basis, 2001 included a half year of operating
expenses for the CDR business that was sold in July 2001, while the prior year
included a full year of operating expenses for our EDI business that was sold at
the beginning of 2001. The impact on operating expenses from the sale of the CDR
business was substantially offset by increased subcontractor fees, as the sold
business still functions as a subcontractor in support of our Health Management
Systems business. The sale of the EDI business did result in a reduction of
operating expenses, although we incurred an increase in subcontractor fees for
services provided by the acquiror of this business, in support of several
projects in our Accordis business. As discussed in more detail below, fiscal
year 2001 operating expenses were adversely impacted by several non-recurring
charges, restructuring costs, asset impairments, write-offs and increased
product development initiatives.
Compensation expense as a percentage of revenue was 57.5% in 2001
compared to 58.1% in the prior fiscal year and for 2001 was $33.8 million, a
decrease of $3.9 million, or 10.2% from the prior year period expense of $37.7
million. Of this total decrease, $3.6 million was occasioned by the sale of our
EDI and CDR businesses. We experienced additional compensation expense decreases
from our headcount reduction efforts and in our employee benefit plans. These
decreases were mitigated by compensation increases of $1.4 million in
non-recurring severance and retention bonuses associated with our headcount
reduction efforts and an increase in performance bonus grants. At December 31,
2001, we had 433 employees, compared to 535 employees at October 31, 2000.
Data processing expense as a percentage of revenue was 15.8% in 2001
compared to 11.1% in the prior fiscal year and for 2001 was $9.3 million, an
increase of $2.1 million or 28.6% compared to the prior fiscal year expense of
$7.2 million. Data processing expense in 2001 included three non-recurring
charges. We incurred a charge of $1.4 million associated with the write-off of
internally developed software initiatives, of which $1.1 million had been
additions in 2001. These internal software initiatives were abandoned based on
our assessment of the projects' future prospects. Related to a particular
internal development initiative, we also incurred a charge of $1.5 million for
external software commitments which had been integral to the project, but were
now no longer of value to us. Lastly, we recognized a charge of $300,000 for
several other external software purchases that were no longer in use. These
expense increases were offset in part by a $700,000 decrease in equipment
rental, software license and supply costs reflecting our efforts to reduce
infrastructure costs across our information technology operations and a $400,000
decrease occasioned by the sale of our EDI and CDR businesses.
Occupancy expense as a percentage of revenue was 11.1% in 2001 compared
to 12.0% in the prior fiscal year and for 2001 was $6.5 million, a decrease of
$1.3 million or 16.1% from the prior fiscal year expense of $7.8 million. This
decrease includes $500,000 resulting from the sale of our EDI and CDR
businesses, $100,000 for the
23
closure of our Washington, D.C. office, and a net $400,000 from a new lease
agreement at our headquarters in New York City which removed one floor from the
Company's prime lease obligation. Additional reductions of approximately
$300,000 in 2001 were primarily related to telephone and utilities costs,
generally as a function of reductions in space and headcount.
Direct project expense as a percentage of revenue was 16.3% in 2001
compared to 15.3% in the prior fiscal year and for 2001 was $9.6 million, a
decrease of $300,000 or 3.4% from the prior fiscal year expense of $9.9 million.
This decrease is reflective of a $2.9 million reduction in expense related to
Accordis, partially offset by a $2.6 million increase in expense related to
Health Management Systems. The Accordis decrease was a function of the District
of Columbia client relationship in fiscal year 2000 that was substantially
serviced through a subcontractor. We did not have business with the District of
Columbia in fiscal year 2001. In addition, a decrease of $400,000 resulted from
the sale of our EDI business. These decreases in Accordis were partly offset by
an increase of $900,000 in subcontractor service fees incurred for the types of
services previously fulfilled internally by the EDI operations which were sold
at the beginning of 2001. The increase in Health Management Systems direct
project expense reflects a $1.5 million increase for subcontractor service fees
incurred for the types of services previously fulfilled internally by our CDR
operations sold in July 2001 and also reflects the 23% increase in revenues
compared to fiscal year 2000.
Other operating expenses as a percentage of revenue was 23.3% in 2001
compared to 15.5% in the prior fiscal year and for 2001 were $13.7 million, an
increase of $3.6 million or 35.6% compared to the prior fiscal year expense of
$10.1 million. During 2001, we recognized bad debt expense of $2.7 million
related to a receivable due from the District of Columbia. See Note 3 of the
Notes to Consolidated Financial Statements. Expenses in 2001 reflect a $1.1
million increase in consulting and professional service fees mostly associated
with system enhancement and product development efforts. In 2001, we also
incurred: (1) a charge of $300,000 in the form of an advance that was expensed
to reflect the termination of a business relationship with a marketing partner,
and (2) a charge of $300,000 for stock option compensation expense related to a
stock option grant to two members of the Board of Directors. These cost
increases were partly offset by a $1.5 million expense reduction resulting from
the sale of our EDI and CDR businesses.
Restructuring costs as a percentage of revenue were 3.9% in 2001
compared to 1.3% in the prior fiscal year and in 2001 were $2.3 million. This
charge reflects the net of: (1) a total charge of $1.8 million in December 2001,
consisting of $1.3 million for facility exit costs to vacate one floor at our
New York City headquarters, and $500,000 for severance costs associated with
reductions in the information technology and facilities maintenance departments,
(2) a net charge of $800,000 for facility exit costs and employee termination
costs associated with the closure of our Washington, D.C. office in March 2001,
and (3) in October 2001, a $300,000 reduction to the restructuring charge
incurred in October 2000 associated with a facility consolidation initiative
that was subsequently not undertaken.
Restructuring costs in fiscal year 2000 of $800,000 represented
$400,000 in employee termination costs, principally for reductions in our
information systems operations department and $400,000 for facility exit costs
for space consolidation.
In December 2001, we recognized an impairment of assets charge of $1.3
million for the full impairment of goodwill which arose from our 1997
acquisition of Global's computerized medical record based processing system
business. The impairment charge was measured based on the projected discounted
future cash flows from the business unit over the remaining 15 year amortization
period of the goodwill using a discount rate reflective of our cost of funds.
In 2000, we incurred Other Charges of $2.7 million related to the
separation agreement with our former chief executive officer.
Operating loss for the year ended December 31, 2001 was $18.1 million
compared to $11.7 million for the fiscal year ended October 31, 2000. The
Accordis operating loss was $14.6 million for the year ended December 31, 2001
compared to an operating loss of $7.9 million in the prior year. Health
Management Systems had an operating
24
loss of $3.5 million for the year ended December 31, 2001 compared to an
operating loss of $3.7 in the prior year. The increase in the Accordis operating
loss largely reflects the decrease in revenue discussed above, the total $3.2
million in data processing charges associated with a specific internal
development initiative as discussed above, and the $2.7 million bad debt charge
related to a receivable from the District of Columbia. The decrease in the
Health Management Systems operating loss largely reflects the increase in
revenue discussed above, almost entirely offset by the $1.3 million goodwill
impairment charge for the Global business and the $800,000 restructuring charge
associated with closing the Washington D.C. office.
In 2001, we recognized a net gain on sale of assets of $1.6 million
from the sale of our EDI business in January 2001 and our CDR business in July
2001. The sale of the EDI business resulted in a loss of $100,000 on a sale
price of $2.8 million; the sale of the CDR business resulted in a gain of $1.7
million on a sale price of $3.2 million.
In 2001, we did not recognize any income tax benefit against our losses
from continuing operations or the net losses from discontinued operations, but
did recognize a current income tax expense of $312,000 from the gain on sale of
HCm. This absence of an income tax benefit reflects an increase in our valuation
allowance for the recovery of our net deferred income tax assets. We have
incurred significant taxable losses the last several years. Most of our deferred
income tax assets are in the form of net operating loss carryforwards. The
recoverability analysis was performed based on our recent taxable loss history
and projections of future taxable operating results.
Net interest income of $700,000 in fiscal year 2001 compared with $1.1
million in the prior year reflected our generally lower average balances in cash
and short term investments during the year.
Loss from continuing operations was $15.8 million in 2001 compared with
a loss of $6.1 million in the prior year. The $9.7 million increased loss
largely reflected the non-recurring charges, restructuring charges, asset
impairments and asset write-offs during 2001 discussed above.
DISCONTINUED OPERATIONS:
As more fully discussed in Item 1 and Note 1(b) of the Notes to
Consolidated Financial Statements, we reported the results of PSG and DSG as
discontinued operations for all periods presented. Loss from discontinued
operations for 2001 was $5.1 million, compared to income of $2.7 million in the
prior year. The 2001 loss from discontinued operations is reflective of a
restructuring charge of $5.1 million and an asset impairment charge of $4.6
million incurred in the PSG business during April 2001, upon the loss of its
development partner. The restructuring charge related to the write-off of the
subject development initiative and related employee terminations and facility
exit costs. The asset impairment charge related to the write-off of goodwill and
other intangibles resulting from our prior acquisition of the PSG business. We
determined to close PSG in July 2001, and the estimated loss on disposal of
$200,000 represents the anticipated loss during the wind-down period. We sold
our wholly owned subsidiary, HCm, which had operated as DSG, in December 2001,
recognizing a gain, after income tax expense, of $1.6 million on a sale price of
$9.8 million. Thus, net loss on discontinued operations was $3.7 million in 2001
compared to net income of $2.7 million in the prior year.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE:
As previously reported, we implemented a change in accounting with
regard to revenue generated from clients seeking reimbursement from third-party
payors where our fees are contingent upon the client's collections from third
parties. Effective at the beginning of fiscal year 2000, we began to recognize
revenue pertaining to such clients once the third-party payor had remitted
payment to its client. This eliminated our unbilled account receivables and
substantially reduced the related deferred tax liabilities. The cumulative
effect of this change in accounting principle as of the beginning of our fiscal
year 2000 was a charge of $22.0 million, net of tax benefit. See Note 13 of the
Notes to Consolidated Financial Statements.
25
Net loss was $19.5 million in 2001 or $1.09 per common share compared
to a loss of $25.4 million or $1.46 per common share in the prior fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
Historically, our principal sources of funds are operations and the
remaining proceeds from our initial public offering in 1992. At December 31,
2002, our cash and short-term investments and net working capital were $25.3
million and $28.6 million, respectively. Although we expect that operating cash
flows will be a primary source of liquidity, the current significant cash and
short term investment balances and working capital position are also fundamental
sources of liquidity and capital resource. The current cash and short term
investment balances are more than sufficient to meet our short term funding
needs that are not met by operating cash flows. Operating cash flows could be
adversely effected by a decrease in demand for our services. Our typical
customer relationship, however, usually has a duration of several years, such
that we do not expect any current decrease in demand. We estimate that we will
purchase approximately $2.5 million of property and equipment during 2003, which
is consistent with the amounts purchased during recent years. The payments due
by period for our contractual obligations, consisting principally of facility
lease obligations and equipment rental and software license obligations, are as
follows (in thousands):
Less than
Total One Year 2-3 Years 4-5 Years After 5 years
----- -------- --------- --------- -------------
$43,702 $6,011 $10,641 $7,770 $19,280
We have entered into sublease arrangements for some of our facility
obligations and expect to receive the following rental receipts (in thousands):
Less than
Total One Year 2-3 Years 4-5 Years After 5 years
----- -------- --------- --------- -------------
$12,080 $1,941 $4,500 $2,406 $3,233
For the year ended December 31, 2002, cash provided by operations was
$300,000 compared with cash used by operations of $100,000 for the prior year.
During the current year, cash used in investing activities was $500,000
reflecting $3.4 million of property and equipment purchases, which was
substantially offset by the maturity of $3.0 million of short-term investments.
Cash provided by financing activities was $300,000 reflecting $800,000 from the
exercise of stock options and the issuance of stock under the employee stock
purchase plan and $400,000 from the partial repayment of a note receivable from
an officer, which amounts were partially offset by $900,000 used to repurchase
our common stock in the open market. During the current year, cash provided by
discontinued operations was $3.0 million, principally reflecting a termination
fee received from a former customer of PSG.
On May 28, 1997, the Board of Directors authorized us to repurchase
such number of shares of our common stock that have an aggregate purchase price
not in excess of $10,000,000. During 2002, we purchased 292,100 shares on the
open market at a total cost of $869,000. Through March 14, 2003, we purchased an
additional 35,800 shares on the open market at a total cost of $105,000.
Cumulatively since the inception of the repurchase program, we have repurchased
1,644,916 shares having an aggregate purchase price of $9,289,000.
26
INFLATION
Historically, inflation has not been a material factor affecting our
revenue, and general operating expenses have been subject to normal inflationary
pressure. However, our business is labor intensive. Wages and other
employee-related expenses increase during periods of inflation and when
shortages in the skilled labor market occur. We also have a performance-based
bonus plan to foster retention of and incent certain employees.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
(SFAS 146). SFAS 146 supercedes Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit and Activity (including Certain Costs Incurred in a Restructuring)" and
required that a liability for the cost associated with an exit or disposal
activity be recognized when the liability is incurred, as opposed to the date of
an entity's commitment to an exit plan. The provisions of SFAS 146 are effective
for exit or disposal activities that are initiated after December 31, 2002 and
do not affect amounts currently reported in our Consolidated Financial
Statements. SFAS 146 will affect the types and timing of costs included in
future restructuring programs, if any.
RISK FACTORS
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR COMPLIANCE STATEMENT
FOR FORWARD-LOOKING STATEMENTS
In passing the Private Securities Litigation Reform Act of 1995 (the
Reform Act), Congress encouraged public companies to make "forward-looking
statements" by creating a safe harbor to protect companies from securities law
liability in connection with forward-looking statements. We intend to qualify
both our written and oral forward-looking statements for protection under the
Reform Act and any other similar safe harbor provisions.
"Forward-looking statements" are defined by the Reform Act. Generally,
forward-looking statements include expressed expectations of future events and
the assumptions on which the expressed expectations are based. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they are subject to
numerous known and unknown risks and uncertainties which could cause actual
events or results to differ materially from those projected. Due to those
uncertainties and risks, prospective investors are urged not to place undue
reliance on written or oral forward-looking statements of the Company. We
undertake no obligation to update or revise this safe harbor compliance
statement for forward-looking statements to reflect future developments. In
addition, we undertake no obligation to update or revise forward-looking
statements to reflect changed assumptions, the occurrence of unanticipated
events or changes to future operating results over time.
We provide the following risk factor disclosure in connection with our
continuing effort to qualify our written and oral forward-looking statements for
the safe harbor protection of the Reform Act and any other similar safe harbor
provisions. Important factors currently known to management that could cause
actual results to differ materially from those in forward-looking statements
include the following:
OUR OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS DUE TO
VARIABILITY IN THE TIMING OF WHEN WE RECOGNIZE CONTINGENCY FEE REVENUE AND OTHER
FACTORS. AS A RESULT, YOU WILL NOT BE ABLE TO RELY ON OUR OPERATING RESULTS IN
ANY PARTICULAR PERIOD AS AN INDICATION OF OUR FUTURE PERFORMANCE
27
Our revenue and consequently our operating results may vary
significantly from period to period as a result of a number of factors,
including the loss of customers due to consolidation in the healthcare industry,
fluctuations in sales activity given our sales cycle of approximately three to
eighteen months, and general economic conditions as they affect healthcare
providers and payors. Further, we have experienced fluctuations in our revenue
of up to 25% between reporting periods due to the timing of periodic revenue
enhancement projects and the timing and delays in third-party payors'
adjudication of claims and ultimate payment to our clients where our fees are
contingent upon such collections. The extent to which future revenue
fluctuations could occur due to these factors is not known and cannot be
predicted. As a result, our results of operations are subject to significant
fluctuations and our results of operations for any particular quarter or fiscal
year may not be indicative of results of operations for future periods. A
significant portion of our operating expenses are fixed, and are based
primarily on revenue and sales forecasts. Any inability on our part to reduce
spending or to compensate for any failure to meet sales forecasts or receive
anticipated revenues could magnify the adverse impact of such events on our
operating results.
WE ARE SUBJECT TO CLAIMS IF OUR SERVICE OFFERINGS CONTAIN ERRORS
OR EXPERIENCE FAILURES OR DO NOT MEET CUSTOMER
EXPECTATIONS AND COULD LOSE CUSTOMERS AND REVENUE
The healthcare claiming environment is complex. On behalf of our
clients, our Accordis buiness processes a very high volume of transactions in
this environment. From time to time we have been subject to claims by clients
and could be subject to claims by clients in the future for errors in our
service offerings, primarily for failures to secure reimbursement amounts
otherwise payable to our clients. We have often resolved such claims by
providing additional services to the client or by reducing fees on additional
projects. There can be no assurance that contractual limitations of our
responsibility for damages will be effective in these situations or that clients
will not seek significant damages for errors in our services. Further, these
performance failures could result in a loss of customers and resulting loss of
revenue. In addition, service performance failures could result in a delay in
market acceptance for our services, diversion of development resources, damage
to our reputation or increased service costs. We are currently discussing with
an Accordis client a claim for damages based on the client's assertion that it
has been significantly financially harmed by errors in our service. We are
currently assessing the claim both internally and with the client and believe
that it is likely that the claim will be settled in a manner that will not
adversely affect our financial position, results of operations, or ongoing
relationship with the client. However, there can be no assurances that the
claim will be settled or that the client will not seek to hold us responsible
for a substantial amount of alleged damages.
THE MAJORITY OF OUR CONTRACTS WITH CUSTOMERS MAY BE TERMINATED FOR CONVENIENCE
The majority of our contracts with customers are terminable upon short
notice for the convenience of either party. Although to date none of our
material contracts have ever been terminated under these provisions, we cannot
assure you that a material contract will not be terminated for convenience in
the future. Any termination of a material contract, if not replaced, could have
a material adverse effect on our business, financial condition and results of
operations.
WE FACE SIGNIFICANT COMPETITION FOR OUR SERVICES
Competition for our services is intense and is expected to increase.
Increased competition could result in reductions in our prices, gross margins
and market share. We compete with other providers of healthcare information
management and data processing services, as well as healthcare consulting firms.
Some competitors have formed business alliances with other competitors that may
affect our ability to work with some potential customers. In addition, if some
of our competitors merge, a stronger competitor may emerge.
Current and prospective customers also evaluate our capabilities
against the merits of their existing information management and data processing
systems and expertise. Major information management systems companies, including
those specializing in the healthcare industry, that do not presently offer
competing services may enter our markets. Many of our competitors and potential
competitors have significantly greater financial,
28
technical, product development, marketing and other resources, and market
recognition than we have. As a result, our competitors may be able to respond
more quickly to new or emerging technologies, changes in customer requirements
and changes in the political, economic or regulatory environment in the
healthcare industry. In addition, several of our competitors may be in a
position to devote greater resources to the development, promotion, and sale of
their services than us.
SIMPLIFICATION OF THE HEALTHCARE TRANSFER PAYMENT PROCESS COULD REDUCE
THE NEED FOR OUR SERVICES
The complexity of the healthcare transfer payment process, and our
experience in offering services that improve the ability of our customers to
recover incremental revenue through that process, have been contributing factors
to the success our service offerings. Complexities of the healthcare transfer
payment process include multiple payors, the coordination and utilization of
clinical, operational, financial and/or administrative review instituted by
third-party payors in an effort to control costs and manage care. If the payment
processes associated with the healthcare industry are simplified, the need for
our services, or the price customers are willing to pay for our services, could
be reduced.
WE ARE SUBJECT TO GOVERNMENT REGULATION IN OUR COLLECTIONS SERVICES
The collection industry in the United States is regulated both at the
federal and state level. In addition to specific regulation regarding debts for
healthcare services and among other collection regulations the Federal Fair Debt
Collection Practices Act (FFDCPA) regulates any person who regularly collects
or attempts to collect, directly or indirectly consumer debts owed or asserted
to be owed to another person. The FFDCPA establishes specific guidelines and
procedures that debt collectors must follow in communicating with consumer
debtors, including the time, place and manner of such communications and places
restrictions on communications with individuals other than consumer debtors in
connection with the collection of any consumer debt. Additionally , the FFDCPA
contains various notice and disclosure requirements and prohibits unfair or
misleading representations by debt collectors. Many states require that we be
licensed at a debt collection company and we believe that we currently hold
applicable licenses from all states where required. If we fail to comply with
applicable laws and regulations, it could result in the suspension or
termination of our ability to conduct collections, which would have a material
adverse effect on us.
CHANGES IN THE UNITED STATES HEALTHCARE ENVIRONMENT COULD HAVE A MATERIAL
NEGATIVE IMPACT ON OUR REVENUE AND NET INCOME
The healthcare industry in the United States is subject to changing
political, economic and regulatory influences that may affect the procurement
practices and operations of healthcare organizations. Our services are designed
to function within the structure of the healthcare financing and reimbursement
system currently being used in the United States. During the past several years,
the healthcare industry has been subject to increasing levels of governmental
regulation of, among other things, reimbursement rates, certain capital
expenditures, and data confidentiality and privacy. From time to time, certain
proposals to reform the healthcare system have been considered by Congress.
These proposals, if enacted, may increase government involvement in healthcare,
lower reimbursement rates and otherwise change the operating environment for our
clients. Healthcare organizations may react to these proposals and the
uncertainty surrounding such proposals by curtailing or deferring their
retention of service providers such as us. See also "Item 1. Business --
Healthcare Reform and Regulatory Matters" for additional discussion on this
topic. We cannot predict what impact, if any, such proposals or healthcare
reforms might have on our results of operations, financial condition or
business.
OUR BUSINESS IS SUBJECT TO EXTENSIVE AND COMPLEX GOVERNMENTAL REGULATIONS AND
VIOLATIONS OF ANY OF THOSE REGULATIONS COULD RESULT IN SIGNIFICANT PENALTIES
Most of the services offered by our Accordis business involve the
billing and collection of healthcare claims. These services require the
interpretation and application of sometimes ambiguous reimbursement regulations
29
under various government entitlement programs such as Medicaid and Medicare. In
addition, during the past several years, federal and state governments have
placed an increased emphasis on detecting and eliminating fraud and abuse in
Medicare, Medicaid, and other health care programs. Violation of health care
billing laws or regulations governing our services could result in the
imposition of substantial civil or criminal penalties, including temporary or
permanent exclusion from participation in government health care programs such
as Medicare and Medicaid, and loss of customers.
The interpretation and application of the healthcare reimbursement
rules to particular customer patient accounting environments involves judgment.
If a regulatory agency were to disagree with certain judgments we have made or
will make in providing healthcare billing services to a customer we could be
subject to penalties, or fines or other sanctions by regulators. In addition we
could find it necessary to alter or eliminate some of our services.
CERTAIN PROVISIONS IN OUR CERTIFICATE OF INCORPORATION COULD DISCOURAGE
UNSOLICITED TAKEOVER ATTEMPTS, WHICH COULD DEPRESS THE MARKET PRICE OF OUR
COMMON STOCK
Our certificate of incorporation authorizes the issuance of up to
5,000,000 shares of "blank check" preferred stock with such designations, rights
and preferences as may be determined by our Board of Directors. Accordingly, our
Board of Directors is empowered, without shareholder approval, to issue
preferred stock with dividend, liquidation, conversion, voting or other rights,
which could adversely affect the voting power or, other rights of holders of our
common stock. In the event of issuance, preferred stock could be utilized, under
certain circumstances, as a method of discouraging, delaying or preventing a
change in control. Although we have no present intention to issue any shares of
preferred stock, we cannot assure you that we will not do so in the future. In
addition, our by-laws provide for a classified board of directors, which could
also have the effect of discouraging a change of control.
ADVERSE RESOLUTION OF PENDING LITIGATION MAY CAUSE US TO INCUR A
SIGNIFICANT LOSS
We are party to a pending legal proceeding as described under "Item 3.
Business -- Legal Proceedings" in which the Plaintiffs are seeking damages in
the amount of $2.3 million, plus interest. Although we believe that we have
meritorious defenses to the claims of liability or for damages in this action
against us, we cannot assure you that an outcome favorable to us will be reached
in this litigation or that additional lawsuits will not be filed against us.
Further, we cannot assure you that this lawsuit will not have a disruptive
effect upon the operations of our business, that the defense of the lawsuit will
not consume the time and attention of our senior management, or that the
resolution of the lawsuit or future lawsuits will not have a material adverse
effect upon our results of operations, financial position and cash flow.
ADVERSE RESOLUTION OF ONGOING INVESTIGATION BY THE UNITED STATES
ATTORNEY'S OFFICE WILL CAUSE ADVERSE IMPACT ON REVENUE AND EXPENSE LEVELS
OVER THE NEAR, AND AN ADVERSE RESOLUTION COULD CAUSE A MATERIAL ADVERSE
EFFECT ON OUR BUSINESS THEREAFTER
On January 31, 2003, we announced that we had received a subpoena
issued under the Health Insurance Portability and Accountability Act of 1996
from the United States Attorney's Office for the Southern District of New York
in connection with an investigation relating to possible Federal health care
offenses. The subpoena seeks the production of certain documents from January
1982 to present relating to medical reimbursement claims submitted by us to
Medicare, Medicaid and other federal healthcare programs, particularly on behalf
of a significant client of Accordis. At this point in the investigation, the
United States Attorney's Office has not filed any complaint asserting any
violations of law.
We are cooperating fully with the investigation and are in the
process of assembling and producing the documents called for by the subpoena.
Our board of directors has appointed a special committee to oversee our response
to the investigation.
30
We are not able to give any assurances as to the duration or outcome of
the investigation or as to the effect that any proceedings that may be brought
by the government may have on our financial condition or results of operations.
The initiation of proceedings against us, even if we are ultimately successful
in defending ourself, could have a material adverse effect on our business. Over
the near term, we anticipate that revenue and expense levels will be adversely
affected as management undertakes to comply with the demands of data gathering
and review of the matters covered by the subpoena.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Our holdings of financial instruments are comprised of federal, state
and local government debt. All such instruments are classified as securities
available for sale. We do not invest in portfolio equity securities or
commodities or use financial derivatives for trading purposes. Our debt security
portfolio represents funds held temporarily, pending use in our business and
operations. We manage these funds accordingly. We seek reasonable assuredness of
the safety of principal and market liquidity by investing in rated fixed income
securities while, at the same time, seeking to achieve a favorable rate of
return. Our market risk exposure consists principally of exposure to changes in
interest rates. Our holdings are also exposed to the risks of changes in the
credit quality of issuers. We typically invest in the shorter-end of the
maturity spectrum or highly liquid investments.
The table below presents the historic cost basis, and the fair value
for our investment portfolio as of December 31, 2002, and the related weighted
average interest rates by year of maturity (in thousands):
Matures Year Ending Total Total
December 31, 2003 Historical Cost Fair value
- --------------------------------------------------------------------------------------------------
Fixed income governmental securities $1,100 $1,100 $1,108
Average interest rate 4.15% 4.15%
- --------------------------------------------------------------------------------------------------
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is found on pages 36 to 62 of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
- --------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 will be included in our Proxy
Statement for the 2003 Annual Meeting of Shareholders which will be mailed
within 120 days after the close of our year ended December 31, 2002, and is
hereby incorporated herein by reference to such Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 will be included in our Proxy
Statement, which will be mailed within 120 days after the close of our year
ended December 31, 2002, and is hereby incorporated herein by reference to such
Proxy Statement.
31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 will be included in our Proxy
Statement, which will be mailed within 120 days after the close of our year
ended December 31, 2002, and is hereby incorporated herein by reference to such
Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 will be included in our Proxy
Statement, which will be mailed within 120 days after the close of our year
ended December 31, 2002, and is hereby incorporated herein by reference to such
Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, we carried
out an evaluation, under the supervision and with the participation of our
management, including our Chairman and Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934. Based upon that evaluation, our
Chairman and Chief Executive Officer and Chief Financial Officer concluded that
our disclosure controls and procedures are effective in enabling us to record,
process, summarize and report information required to be included in the
Company's periodic SEC filings within the required time period.
There have been no significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent to
the date we carried out our evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
A. Financial Statements, Financial Statement Schedule and
Exhibits
1. The financial statements are listed in the Index to
Consolidated Financial Statements on page 36.
2. Financial Statement Schedule II - Valuation and
Qualifying Accounts is set forth on page 63. All
other financial statement schedules have been omitted
as they are either not required, not applicable, or
the information is otherwise included.
3. The Exhibits are set forth on the Exhibit Index on
page 64.
B. Reports on Form 8-K
None.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HMS HOLDINGS CORP.
------------------
(Registrant)
BY: /s/ William F. Miller, III
---------------------------
William F. Miller, III
Chairman and Chief Executive Officer
DATE: March 20, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
/s/ William F. Miller, III Chairman, Chief Executive Officer, March 20, 2003
- -------------------------- and Director (Principal Executive Officer)
William F. Miller, III
/s/ Philip Rydzewski Chief Financial Officer (Principal March 20, 2003
- --------------------- Financial and Accounting Officer)
Philip Rydzewski
/s/ Randolph G. Brown Director March 20, 2003
- ---------------------
Randolph G. Brown
/s/ James T. Kelly Director March 20, 2003
- ---------------------
James T. Kelly
/s/ William W. Neal Director March 20, 2003
- ---------------------
William W. Neal
/s/ Galen D. Powers Director March 20, 2003
- ---------------------
Galen D. Powers
/s/ Ellen A. Rudnick Director March 20, 2003
- ---------------------
Ellen A. Rudnick
/s/ Richard H. Stowe Director March 20, 2003
- ---------------------
Richard H. Stowe
33
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, William F. Miller, III, certify that:
1. I have reviewed this annual report on Form 10-K of HMS Holdings Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I (herein, the Certifying
Officers) are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) designed such internal controls to ensure that material
information relating to the registrant, including its
consolidated subsidiaries (collectively, the Company), is made
known to the Certifying Officers by others within the Company,
particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's internal
controls as of a date within 90 days prior to the filing date
of this annual report (the Evaluation Date); and
c) presented in this annual report the conclusions of the
Certifying Officers about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's Certifying Officers have disclosed, based on our most
recent evaluation, to the registrant's auditors and the audit committee of the
registrant's Board of Directors:
a) all significant deficiencies (if any) in the design or
operation of internal controls which could adversely affect
the registrant's ability to record, process, summarize and
report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's Certifying Officers have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/ William F. Miller, III
- --------------------------
William F. Miller, III
Chairman and Chief Executive Officer
See also the certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, which is also attached to this report.
34
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Philip Rydzewski, certify that:
1. I have reviewed this annual report on Form 10-K of HMS Holdings Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I (herein, the Certifying
Officers) are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) designed such internal controls to ensure that material
information relating to the registrant, including its
consolidated subsidiaries (collectively, the Company), is made
known to the Certifying Officers by Others within the Company,
particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's internal
controls as of a date within 90 days prior to the filing date
of this annual report (the Evaluation Date); and
c) presented in this annual report the conclusions of the
Certifying Officers about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's Certifying Officers have disclosed, based on our most
recent evaluation, to the registrant's auditors and the audit committee of the
registrant's Board of Directors:
a) all significant deficiencies (if any) in the design or
operation of internal controls which could adversely affect
the registrant's ability to record, process, summarize and
report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's Certifying Officers have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/ Philip Rydzewski
- --------------------
Philip Rydzewski
Senior Vice President and Chief Financial Officer
See also the certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, which is also attached to this report.
35
HMS HOLDINGS CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
CONSOLIDATED FINANCIAL STATEMENTS: NUMBER
- ---------------------------------- ------
Independent Auditors' Report........................................................................37
Consolidated Balance Sheets as of December 31, 2002 and 2001........................................38
Consolidated Statements of Operations for the Years Ended December 31, 2002 and 2001, the
Two Months Ended December 31, 2000, and the Year Ended October 31, 2000...........................39
Consolidated Statements of Shareholders' Equity and Comprehensive Income/(Loss) for
the Years Ended December 31, 2002 and 2001, the Two Months Ended December 31, 2000, and
the Year Ended October 31, 2000...................................................................40
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002 and 2001, the Two
Months Ended December 31, 2000, and the Year Ended October 31, 2000...............................41
Notes to Consolidated Financial Statements..........................................................42
FINANCIAL STATEMENT SCHEDULE:
Schedule II - Valuation and Qualifying Accounts.....................................................63
36
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
HMS Holdings Corp.:
We have audited the accompanying consolidated financial statements of
HMS Holdings Corp. and subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedule as listed in the accompanying
index. These consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of HMS Holdings
Corp. and subsidiaries as of December 31, 2002 and 2001, and the results of
their operations and their cash flows for the years ended December 31, 2002 and
2001, the two months ended December 31, 2000, and the year ended October 31,
2000 in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
As discussed in note 6 to the consolidated financial
statements, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 142 "Goodwill and Other Intangible Assets", in 2002.
Also, as discussed in notes 1 and 12 to the consolidated financial statements,
the Company adopted the provisions of the Securities and Exchange Commission's
Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements",
in 2000.
/s/ KPMG LLP
Princeton, New Jersey
February 28, 2003
37
HMS HOLDINGS CORP. AND SUBSIDIARIES
December 31, December 31,
2002 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 24,174 $ 21,020
Short-term investments 1,108 4,022
Accounts receivable, net 15,312 12,720
Prepaid expenses and other current assets 1,207 2,420
-------- --------
Total current assets 41,801 40,182
Property and equipment, net 4,664 4,228
Capitalized software costs, net 248 466
Goodwill, net 5,679 5,679
Deferred income taxes, net 8,920 8,920
Other assets 354 650
Net assets of discontinued operations -- 269
-------- --------
Total assets $ 61,666 $ 60,394
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other liabilities $ 13,091 $ 13,105
Net liabilities of discontinued operations 85 839
-------- --------
Total current liabilities 13,176 13,944
Other liabilities 722 669
-------- --------
Total liabilities 13,898 14,613
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock - $.01 par value; 5,000,000 shares authorized; none issued -- --
Common stock - $.01 par value; 45,000,000 shares authorized;
19,885,390 shares issued and 18,276,274 shares outstanding at December 31, 2002;
19,332,089 shares issued and 18,015,073 shares outstanding at December 31, 2001 199 193
Capital in excess of par value 74,959 73,550
Unearned stock compensation (33) (128)
Accumulated deficit (17,820) (18,755)
Accumulated other comprehensive income (loss) 8 (42)
Treasury stock, at cost; 1,609,116 shares at December 31, 2002 and 1,317,016
shares at December 31, 2001 (9,184) (8,315)
Note receivable from officer for sale of stock (361) (722)
-------- --------
Total shareholders' equity 47,768 45,781
-------- --------
Total liabilities and shareholders' equity $ 61,666 $ 60,394
======== ========
See accompanying notes to consolidated financial statements.
38
HMS HOLDINGS CORP. AND SUBSIDIARIES
Year Year Two Year
ended ended months ended ended
December 31, December 31, December 31, October 31,
2002 2001 2000 2000
------------ ------------ ----------- ----------
Revenue $ 68,614 $ 58,748 $ 9,207 $ 64,849
-------- -------- -------- --------
Cost of services:
Compensation 37,834 33,808 6,239 37,656
Data processing 6,092 9,281 1,172 7,217
Occupancy 6,148 6,503 1,305 7,753
Direct project costs 10,167 9,593 737 9,931
Other operating costs 10,512 13,665 1,383 10,079
Restructuring costs 903 2,280 -- 821
Impairment of assets -- 1,335 -- --
Other charges -- -- -- 2,662
Amortization of intangibles -- 353 59 401
-------- -------- -------- --------
Total cost of services 71,656 76,818 10,895 76,520
-------- -------- -------- --------
Operating loss (3,042) (18,070) (1,688) (11,671)
Gain on sale of assets -- 1,605 -- --
Net interest income 517 667 138 1,024
-------- -------- -------- --------
Loss from continuing operations before income taxes and
cumulative effect of change in accounting principle (2,525) (15,798) (1,550) (10,647)
Income tax benefit -- -- (642) (4,530)
-------- -------- -------- --------
Loss from continuing operations before cumulative effect
of change in accounting principle (2,525) (15,798) (908) (6,117)
Discontinued operations:
Income (loss) from discontinued operations, net -- (5,053) (35) 2,656
Estimated gain (loss) on disposal of discontinued operations, net 3,460 (200) -- --
Gain on sale of discontinued operation, net -- 1,587 -- --
-------- -------- -------- --------
Discontinued operations 3,460 (3,666) (35) 2,656
Income (loss) before cumulative effect of
change in accounting principle 935 (19,464) (943) (3,461)
Cumulative effect of change in accounting
principle, net of tax benefit ("cumulative effect") -- -- -- (21,965)
-------- -------- -------- --------
Net income (loss) $ 935 $(19,464) $ (943) $(25,426)
======== ======== ======== ========
Basic and diluted earnings per share data:
Loss per share from continuing
operations before cumulative effect $ (0.14) $ (0.88) $ (0.05) $ (0.35)
Income (loss) per share from discontinued operations, net 0.19 (0.21) -- 0.15
Loss per share from cumulative effect, net -- -- -- (1.26)
-------- -------- -------- --------
Net income (loss) per share $ 0.05 $ (1.09) $ (0.05) $ (1.46)
======== ======== ======== ========
Weighted average common shares outstanding 18,199 17,857 17,252 17,467
======== ======== ======== ========
Pro forma net loss assuming new accounting
principle is applied retroactively N/A N/A N/A $ (3,461)
========
Pro forma basic loss per share assuming new
accounting principle is applied retroactively N/A N/A N/A $ (0.20)
========
See accompanying notes to consolidated financial statements.
39
HMS HOLDINGS CORP. AND SUBSIDIARIES
Common Stock RETAINED
--------------------- Capital In Unearned Earnings/
# of Shares Par Excess Of Stock Accumulated '
Issued Value Par Value Compensation Deficit
----------------------------------------------------------------------
Balance at October 31, 1999 18,450,737 $184 $71,714 $-- $ 27,078
Comprehensive loss:
Net loss -- -- -- -- (25,426)
Change in net unrealized
appreciation on
short-term investments -- -- -- -- --
Total comprehensive loss
Shares issued under employee
stock purchase plan 46,095 1 134 -- --
Exercise of stock options 67,090 1 309 -- --
Disqualifying disposition -- -- 13 -- --
Purchase of treasury stock -- -- -- -- --
----------- ---- ------- ----- --------
Balance at October 31, 2000 18,563,922 $186 $72,170 $-- $ 1,652
Comprehensive loss:
Net loss -- -- -- -- (943)
Change in net unrealized
appreciation on
short-term investments -- -- -- -- --
Total comprehensive loss
Unearned stock compensation -- -- 433 (433) --
----------- ---- ------- ----- --------
Balance at December 31, 2000 18,563,922 $186 $72,603 ($433) $ 709
Comprehensive loss:
Net loss -- -- -- -- (19,464)
Change in net unrealized
appreciation on
short-term investments -- -- -- -- --
Total comprehensive loss
Shares issued for note receivable 550,000 5 717 -- --
Shares issued under employee
stock purchase plan 157,667 1 161 -- --
Exercise of stock options 60,500 1 69 -- --
Purchase of treasury stock -- -- -- -- --
Stock compensation expense -- -- -- 305 --
----------- ---- ------- ----- --------
Balance at December 31, 2001 19,332,089 $193 $73,550 ($128) ($18,755)
Comprehensive income:
Net income -- -- -- -- 935
Change in net unrealized
appreciation on
short-term investments -- -- -- -- --
Total comprehensive income
Repayment of note receivable -- -- -- -- --
Shares issued under employee
stock purchase plan 49,983 1 128 -- --
Exercise of stock options 503,318 5 710 -- --
Purchase of treasury stock -- -- -- -- --
Remeasurement of unearned
stock compensation -- -- 46 (46) --
Stock compensation expense -- -- 525 141 --
----------- ---- ------- ----- --------
Balance at December 31, 2002 19,885,390 $199 $74,959 ($ 33) ($17,820)
=========== ==== ======= ===== ========
ACCUMULATED NOTE
Other Treasury Stock Receivable Total
Comprehensive ----------------------- from Sale Shareholders
Income/(Loss) # of Shares Amount of Stock Equity
-----------------------------------------------------------------------
Balance at October 31, 1999 $ 6 1,049,000 ($7,750) $-- $ 91,232
Comprehensive loss:
Net loss -- -- -- -- (25,426)
Change in net unrealized
appreciation on
short-term investments (116) -- -- -- (116)
--------
Total comprehensive loss (25,542)
Shares issued under employee
stock purchase plan -- -- -- -- 135
Exercise of stock options -- -- -- -- 310
Disqualifying disposition -- -- -- -- 13
Purchase of treasury stock -- 262,666 (550) -- (550)
----- --------- ------- ----- --------
Balance at October 31, 2000 ($110) 1,311,666 ($8,300) $-- $ 65,598
Comprehensive loss:
Net loss -- -- -- -- (943)
Change in net unrealized
appreciation on
short-term investments 18 -- -- -- 18
--------
Total comprehensive loss
Unearned stock compensation -- -- -- -- (925)
----- --------- ------- ----- --------
Balance at December 31, 2000 ($ 92) 1,311,666 ($8,300) $-- $ 64,673
Comprehensive loss:
Net loss -- -- -- -- (19,464)
Change in net unrealized
appreciation on
short-term investments 50 -- -- -- 50
--------
Total comprehensive loss (19,414)
Shares issued for note receivable -- -- -- (722) --
Shares issued under employee
stock purchase plan -- -- -- -- 162
Exercise of stock options -- -- -- -- 70
Purchase of treasury stock -- 5,350 (15) -- (15)
Stock compensation expense -- -- -- -- 305
----- --------- ------- ----- --------
Balance at December 31, 2001 ($ 42) 1,317,016 ($8,315) ($722) $ 45,781
Comprehensive income:
Net income -- -- -- -- 935
Change in net unrealized
appreciation on
short-term investments 50 -- -- -- 50
--------
Total comprehensive income 985
Repayment of note receivable -- -- -- 361 361
Shares issued under employee
stock purchase plan -- -- -- -- 129
Exercise of stock options -- -- -- -- 715
Purchase of treasury stock -- 292,100 (869) -- (869)
Remeasurement of unearned
stock compensation -- -- -- -- --
Stock compensation expense -- -- -- -- 666
----- --------- ------- ----- --------
Balance at December 31, 2002 $ 8 1,609,116 ($9,184) ($361) $ 47,768
===== ========= ======= ===== ========
See accompanying notes to consolidated financial statements.
40
HMS HOLDINGS CORP. AND SUBSIDIARIES
Year Year Two Year
ended ended months ended ended
December 31, December 31, December 31, October 31,
2002 2001 2000 2000
----------- ------------ ---------- ----------
Operating activities:
Net income (loss) $ 935 $(19,464) $ (943) $(25,426)
Adjustments to reconcile net income (loss) to cash provided by (used in)
operating activities:
(Income) loss from discontinued operations (3,460) 3,666 35 (2,656)
Depreciation and amortization 2,518 2,197 393 2,189
Amortization of intangibles -- 353 59 401
Loss on disposal and write-off of capitalized software costs
and property and equipment 693 2,126 -- --
Provision for doubtful accounts 311 2,792 12 92
Net gain on sale of assets, CDR operations and EDI operations -- (1,605) -- --
Goodwill impairment -- 1,335 -- --
Stock compensation expense 666 305 -- --
Increase in deferred taxes -- -- (666) (2,247)
Disqualifying disposition -- -- -- 13
Cumulative effect of change in accounting principle, net of tax -- -- -- 21,965
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (2,903) 793 695 (9,227)
(Increase) decrease in prepaid expenses and other current assets 1,213 2,339 569 (2,042)
(Increase) decrease in other assets 296 (171) (18) 347
Increase (decrease) in accounts payable, accrued expenses
and other liabilities 39 5,267 (1,503) 1,063
-------- -------- -------- --------
Net cash provided by (used in) operating activities 308 (67) (1,367) (15,528)
-------- -------- -------- --------
Investing activities:
Purchases of property and equipment (3,429) (2,246) (54) (2,096)
Investment in software -- (1,198) (215) (1,267)
Proceeds from sale of assets, EDI operations, net -- 661 -- --
Proceeds from sale of assets, CDR operations, net -- 2,887 -- --
Net proceeds from sales/(purchases) of short-term investments 2,964 3,415 (1,202) 11,224
-------- -------- -------- --------
Net cash provided by (used in) investing activities (465) 3,519 (1,471) 7,861
-------- -------- -------- --------
Financing activities:
Proceeds from issuance of common stock 129 162 -- 135
Proceeds from exercise of stock options 715 70 -- 310
Repayment of note receivable from officer for purchase of common stock 361 -- -- --
Net note receivable repayments from former officer -- -- -- 900
Purchases of treasury stock (869) (15) -- (550)
-------- -------- -------- --------
Net cash provided by financing activities 336 217 -- 795
-------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents 179 3,669 (2,838) (6,872)
Cash and cash equivalents at beginning of period 21,020 6,187 10,573 16,310
Cash provided by (used in) discontinued operations 2,975 11,164 (1,548) 1,135
-------- -------- -------- --------
Cash and cash equivalents at end of period $ 24,174 $ 21,020 $ 6,187 $ 10,573
======== ======== ======== ========
Supplemental disclosure of noncash investing and financing activities:
Service credits received as consideration from sale of assets $ -- $ 2,259 $ -- $ --
======== ======== ======== ========
Sale of common stock to officer for note receivable $ -- $ 722 $ -- $ --
======== ======== ======== ========
Change in unearned compensation $ 46 -- -- --
======== ======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ -- $ 30 $ -- $ 59
======== ======== ======== ========
Cash paid for income taxes $ 215 $ 204 $ 1 $ 166
======== ======== ======== ========
41
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A)
ORGANIZATION AND BUSINESS
At a special meeting held on February 27, 2003, the shareholders of
Health Management Systems, Inc. approved the creation of a holding company
structure. Following that meeting, all the outstanding shares of Health
Management Systems, Inc. common stock were exchanged on a one-for-one basis for
the shares of common stock of HMS Holdings Corp. (the Company), the new parent
company. The adoption of the holding company structure, pursuant to an Agreement
and Plan of Merger approved at the shareholders meeting, constituted a
reorganization with no change in ownership interests or accounting basis and no
dilutive impact to the former shareholders of Health Management Systems, Inc.
HMS Holdings Corp. furnishes revenue recovery, business process and
business office outsourcing services to healthcare payors and providers. The
Company helps clients increase revenue, accelerate collections, and reduce
operating and administrative costs. The Company operates two businesses through
its wholly owned subsidiaries, Health Management Systems, Inc. (formerly Payor
Services Division) and Accordis Inc. (formerly Provider Services Division).
(B) BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
(i) Change in Fiscal Year
On October 30, 2001, the Board of Directors approved a change
of the Company's fiscal year to December 31 from October 31. The change
was retroactive to January 1, 2001. Accordingly, the Company changed
its fiscal quarters to the calendar quarters. As a result of this
change, the Company has presented the transition period of November 1
to December 31, 2000. All prior fiscal years are presented with an
October 31 year-end date.
(ii) Discontinued Operations of Business Segments
During 2001, the Company sold its Decision Support Group (DSG)
business unit and implemented a formal plan to proceed with an orderly
closure of the Payor Systems Group (PSG) business unit. In prior
periods, DSG and PSG had been separate reportable segments. The current
and historical operating results of DSG and PSG have been reported as
discontinued operations on the accompanying Consolidated Statements of
Operations. The current and noncurrent assets and liabilities of DSG
and PSG are presented on a net basis as discontinued operations on the
Consolidated Balance Sheets for all periods presented.
(iii) Principles of Consolidation
The consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation.
(C) CASH AND CASH EQUIVALENTS
For purposes of financial reporting, the Company considers all highly
liquid investments purchased with an original maturity of three months or less
to be cash equivalents.
(D) SHORT-TERM INVESTMENTS
Short-term investments are recorded at fair value. Debt securities that
the Company does not have the intent and ability to hold to maturity are
classified either as "available for sale" or as "trading" and are carried at
fair value. All of the Company's short-term investments are available for sale
and carried at fair value. Unrealized gains and losses on securities classified
as available for sale are carried as a separate component of shareholders'
equity. Unrealized gains and losses on securities classified as trading are
reported in earnings. Management determines the appropriate classification of
its investments in debt and equity securities at the time of purchase and
reevaluates such determination at each balance sheet date.
42
(E) DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is provided
over the estimated useful lives of the property and equipment utilizing the
straight-line method. Amortization of leasehold improvements is provided over
the estimated useful lives of the assets or the terms of the leases, whichever
is shorter, using the straight-line method. The estimated useful lives are as
follows:
Equipment 3-5 years
Leasehold improvements 5-10 years
Furniture and fixtures 5-7 years
(F) SOFTWARE DEVELOPMENT COST
The Company capitalizes software development costs incurred related to
software developed for resale subsequent to the establishment of technological
feasibility until the product is released for commercial use. Similarly, costs
incurred to develop upgrades are capitalized until the upgrades are commercially
released. Before technological feasibility has been established, the Company
expenses all costs incurred for the product. Any cash received from a
development partner is recorded first as an offset to any previously capitalized
software development costs on the project before revenue is recognized.
The Company also capitalizes certain software development costs related
to software developed for internal use while in the application development
stage. All other costs to develop software for internal use, either in the
preliminary project stage or post implementation stage are expensed as incurred.
Amortization of software development costs is calculated on a straight-line
basis over the expected economic life of the product, generally estimated to be
36-48 months.
(G) GOODWILL
Goodwill, representing the excess of acquisition costs over the fair
value of net assets of acquired businesses, is not amortized but is reviewed for
impairment at least annually and written down only in the periods in which it is
determined that the recorded value is greater than the fair value. For the
purposes of performing this impairment test, the Company's business segments are
its reporting units. The fair values of those reporting units, to which goodwill
has been assigned, is compared with their recorded values. If recorded values
are less than the fair values, no impairment is indicated. Goodwill acquired in
business combinations completed before July 1, 2001, had been amortized through
December 31, 2001, on a straight-line basis over a period of ten to forty years.
(H) LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying value of its assets to the estimated undiscounted
future net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying value of the assets exceeds the fair value of the
assets and would be charged to earnings. Assets to be disposed of are reported
at the lower of the carrying amount or fair value less the cost to sell.
(I) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. This method also requires the recognition of future
tax benefits for net operating loss carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized as income in the period that includes the
enactment date. The Company provides a valuation allowance to reduce deferred
tax assets to their estimated realizable value.
(J) NET INCOME PER COMMON SHARE
Basic earnings per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share is calculated by dividing net income by the
43
weighted average number of common shares and common stock equivalents
outstanding during the period. The Company had weighted average common shares
and common stock equivalents outstanding during the years ended December 31,
2002 and 2001, the two months ended December 31, 2000, and the year ended
October 31, 2000 of 18,199,000, 17,857,000, 17,252,000 and 17,467,000
respectively for weighted average common shares, and 2,254,000, 748,000, 41,000,
and 10,000 respectively for common stock equivalents. The common stock
equivalents are excluded from the weighted average shares used to compute
diluted net loss per share as they would be antidilutive to the per share
calculation. The Company's common stock equivalents consist of stock options.
(K) REVENUE RECOGNITION
The Company recognizes revenue for its contingency fee based services
when third party payors remit payments to the Company's customers and
consequently the contingency is deemed to have been satisfied. This revenue
recognition policy is specifically addressed in the SEC's "Frequently Asked
Questions and Answers" bulletin released on October 12, 2000 pertaining to Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements
(SAB101). The Company elected early adoption in the fourth quarter of its year
ended October 31, 2000, implementing a change in accounting principle. The
change in accounting principle was implemented effective November 1, 1999.
Prior to November 1, 1999, the Company recognized revenue pertaining to
clients seeking reimbursement from third-party payors when billings were
submitted to clients or their third-party payors or intermediaries as a
consequence of completion and acceptance of services performed by the Company
for a client. Certain of these clients' contracts contain periodic fee
limitations or fixed-fees. The fees allowable under these contracts are
recognized once the cash is collected by the client on a straight-line basis
over the fee limitation or fixed-fee period and amounts billed in excess in any
one period are deferred.
Transaction-related revenue is recognized based upon the completion of
those transactions or services rendered during a given period.
(L) STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation under
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation." As permitted by SFAS No. 123, the Company has elected
to continue following the provisions of Accounting Principles Board (APB)
Opinion No. 25. "Accounting for Stock Issued to Employees," and to adopt only
the disclosure provision of SFAS No. 123. Accordingly, no employee compensation
costs have been recognized for its stock purchase plan and stock option plans,
except as described in Note 11. Had compensation costs for the Company's stock
options been determined consistent with the fair value method prescribed by SFAS
123, the Company's net income (loss) and related per share amounts would have
been adjusted to the pro forma amounts indicated below:
Year Ended Year Ended Two Months Ended Year Ended
December 31, December 31, December 31, October 31,
(in thousands, except per share amounts) 2002 2001 2000 2000
- -----------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 935 $ (19,464) $ (943) $ (25,426)
Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of
related tax effects $ (1,686) $ (475) $ (194) $ (2,333)
----------- ----------- ------------ ------------
Pro forma net loss $ (751) $ (19,939) $ (1,137) $ (27,759)
=========== =========== ============ ============
Net income (loss) per basic
and diluted share As reported $ 0.05 $ (1.09) $ (0.05) $ (1.46)
Pro forma $ (0.04) $ (1.12) $ (0.07) $ (1.59)
The effect presented above by applying the disclosure-only provisions
of SFAS 123 may not be representative of the pro forma effect in future years.
44
The fair value of the stock options granted in the years ended December
31, 2002 and 2001, the two months ended December 31, 2000, and the year ended
October 31, 2000 is estimated at the grant date using the Black-Scholes
option-pricing model with the following assumptions: dividend yield of 0% (the
Company does not pay dividends); expected volatility of 65.1%, 69.1%, 65.2% and
271.3%; a risk-free interest rate of 2.8%, 3.6%, 5.3% and 6.1%; and expected
lives of 4.69, 3.77, 3.70 and 3.70 years, respectively.
(M) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for the Company's cash, cash equivalents, accounts
receivable, and accounts payable approximate fair value. The fair market value
for short-term securities is based on quoted market prices where available.
(N) COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) recorded by the Company is comprised
of unrealized gains and losses on short-term investments.
(O) USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenue and
expenses during the reported period. The actual results could differ from those
estimates.
(P) RECLASSIFICATIONS
Certain reclassifications were made to prior year amounts to conform to
the current presentation.
(Q) NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
(SFAS 146). SFAS 146 supercedes Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)" and
requires that a liability for the cost associated with an exit or disposal
activity be recognized when the liability is incurred, as opposed to the date of
an entity's commitment to an exit plan. The provisions of SFAS 146 are effective
for exit or disposal activities that are initiated after December 31, 2002 and
do not affect amounts currently reported in the Company's Consolidated Financial
Statements. SFAS 146 will affect the types and timing of costs included in
future restructuring programs, if any.
2. SHORT-TERM INVESTMENTS
The Company's holdings of financial instruments are comprised of
federal, state and local government debt. All such instruments are classified as
securities available for sale.
The table below presents the historical cost basis, and the fair value
for the Company's investment portfolio at December 31, 2002 and 2001 (in
thousands):
Historical Fair
Cost Value
-------------------------
December 31, 2002: Fixed Income Governmental Securities $ 1,100 $ 1,108
-------------------------
(all securities mature in the year ending December 31, 2003)
December 31, 2001: Fixed Income Governmental Securities $ 3,972 $ 4,022
-------------------------
(all securities matured in the year ended December 31, 2002)
45
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. ACCOUNTS RECEIVABLE
(A) ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are reflected net of an allowance for doubtful
accounts of $3.4 million and $3.3 million at December 31, 2002 and 2001,
respectively.
(B) AMOUNTS DUE FROM THE DISTRICT OF COLUMBIA
In July 2001, the Company recognized bad debt expense in the total
amount of $2.7 million for the full amount of outstanding accounts receivable
from the District of Columbia (District or D.C.). This $2.7 million of accounts
receivable consisted of $1.6 million for retroactive Disproportionate Share
Hospital (DSH) revenue recovery services for the D.C. Medicaid program, and $1.1
million for retroactive Medicaid rate adjustment services rendered to D.C.
General Hospital. This bad debt expense is reflected in Other Operating Costs in
the Consolidated Statements of Operations.
With regard to the $1.6 million account receivable item, as a result of
the Company's efforts in seeking payment, the Chief Contracting Officer of the
District Department of Health informed the Company of the decision through a
letter dated May 23, 2001, that the contract pursuant to which the Company
rendered services in connection with the DSH revenue recovery project, including
eight amendments to that contract, had been signed by a Contracting Officer of
the Department of Human Services without the requisite contracting authority and
therefore the contract was determined by the Chief Contracting Officer to be
void ab initio. The Company believes the decision of the Chief Contracting
Officer is erroneous. Nonetheless, in light of the decision and the complex and
prolonged administrative process that will accompany an effort to resolve this
issue, the Company has determined to recognize bad debt expense for this
receivable.
With regard to the $1.1 million account receivable item, the Company
had asserted a claim against the District of Columbia Public Benefit Corporation
(PBC) for services rendered to D.C. General Hospital. The Company received a
letter dated April 6, 2001, from the Chief Executive Officer of the PBC stating
why he believed no additional amounts were due the Company for the services
rendered. The Company requested additional information and documentary support
for the CEO's denial but these materials have not been provided. Effective April
30, 2001, the PBC was dissolved and responsibility for the Company's claim was
transferred to the Executive Director of the D.C. Financial Responsibility and
Management Assistance Authority. After the Company's further efforts to pursue
collection with the Executive Director, the Company was informed by letter dated
July 18, 2001 from the District's Corporation Counsel, that the matter was
referred to the Department of Health for investigation. In light of the PBC
CEO's denial, the subsequent correspondence between the parties, the
unwillingness of the D.C. government to provide documentary support for the
denial of payment, and the complex and prolonged administrative process that
will accompany an effort to resolve this issue, the Company has determined to
recognize bad debt expense for this receivable.
In conjunction with the bad debt expense discussed above, the Company
recognized a reduction in accrued subcontractor expense in 2001 in the amount of
$2.5 million, for the related contractual contingency based payment that would
have been due to the main service provider to the Company in fulfillment of
these projects for the District. This reduction in subcontractor expense is
included in Direct Project Costs in the Consolidated Statements of Operations.
Also, the Company has determined that an advance of $2.5 million it had made to
this same subcontractor is uncollectible and has recognized expense in 2001 in
the amount of the advance. This additional expense is also included in Direct
Project Costs in the Consolidated Statements of Operations and largely offsets
the reduction above, in accrued subcontractor expense.
46
4. PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2002 and 2001 consisted of
the following (in thousands):
December 31, December 31,
2002 2001
---------------------------
Equipment $ 11,269 $ 9,002
Leasehold improvements 4,950 4,905
Furniture and fixtures 4,193 3,968
---------------------------
20,412 17,875
Less accumulated depreciation and amortization (15,748) (13,647)
---------------------------
Property and equipment, net $ 4,664 $ 4,228
===========================
Depreciation and amortization expense related to property and equipment
charged to operations for the years ended December 31, 2002 and 2001, the two
months ended December 31, 2000, and the year ended October 31, 2000 was $2.3
million, $2.0 million, $393,000 and $2.2 million, respectively.
5. CAPITALIZED SOFTWARE COSTS
Capitalized software costs as of December 31, 2002 and 2001 consisted
of the following (in thousands):
December 31, December 31,
2002 2001
-------------------------------
Capitalized software costs $ 658 $ 658
Less accumulated amortization (410) (192)
-------------------------------
Capitalized software costs, net $ 248 $ 466
===============================
In January 2001, in conjunction with its sale of its EDI business, the
Company sold capitalized software with a cost of $1.1 million see Note 14.
During the year ended December 31, 2001, the Company wrote-off capitalized
software costs of $1.5 million, of which $1.1 million were additions during that
year. These internal software initiatives were abandoned based on the Company's
assessment of the projects' future prospects. Amortization expense for the years
ended December 31, 2002 and 2001, the two months ended December 31, 2000, and
the year ended October 31, 2000 was $218,000, $192,000, none, and none,
respectively.
6. GOODWILL
Goodwill as of December 31, 2002 and 2001 consisted of the following
(in thousands):
December 31, December 31,
2002 2001
--------------------------------
Goodwill $ 8,366 $ 8,366
Less accumulated amortization (2,687) (2,687)
--------------------------------
Goodwill, net $ 5,679 $ 5,679
================================
Amortization expense related to intangible assets charged to operations
for the years ended December 31, 2002 and 2001, the two months ended December
31, 2000, and the year ended October 31, 2000 was none, $353,000, $59,000 and
$401,000, respectively.
Effective January 1, 2002, the Company adopted SFAS 142. SFAS 142
eliminates amortization of goodwill and indefinite-lived intangible assets,
addresses the amortization of intangible assets with finite lives and addresses
impairment testing and recognition for goodwill and intangible assets. As a
result of adoption, amortization ceased for goodwill. No impairment loss
resulted from the initial goodwill impairment test, or from the annual
impairment test that was performed during 2002.
47
The following reflects the impact that SFAS 142 would have had on net
income and earnings per common share of prior periods if adopted at the
beginning of the year ended October 31, 2000 ($ in thousands except per share
data):
Year ended Two months ended Year ended
December 31, 2001 December 31, 2000 October 31, 2000
------------ ------------ -------------
Loss from continuing operations, as reported $ (15,798) $ (908) $ (6,117)
Add back: goodwill amortization, net of tax 353 34 231
------------ ------------ -------------
Adjusted loss from continuing operations (15,445) (874) (5,886)
------------ ------------ -------------
Gain (loss) from discontinued operations, as reported (3,666) (35) 2,656
Add back: goodwill amortization, net of tax 102 30 176
------------ ------------ -------------
Adjusted gain (loss) from discontinued operations (3,564) (5) 2,832
------------ ------------ -------------
Adjusted net loss $ (19,009) $ (879) $ (3,054)
------------ ------------ -------------
Loss per share from continuing operations, as reported $ (0.88) $ (0.05) $ (0.35)
Goodwill amortization 0.02 0.00 0.01
------------ ------------ -------------
Adjusted loss per share from continuing operations (0.86) (0.05) (0.34)
Adjusted loss per share from discontinued operations (0.20) (0.00) 0.16
------------ ------------ -------------
Adjusted loss per share $ (1.06) $ (0.05) $ (0.17)
------------ ------------ -------------
Weighted average shares outstanding 17,857 17,252 17,467
------------ ------------ -------------
During the year ended December 31, 2001, the Company recognized an
impairment charge of $1.3 million, the amount of the remaining unamortized
goodwill related to its Global line of business which had been acquired in 1997.
The impairment charge resulted from the Company's recoverability assessment
which was triggered by the significant underperformance of the unit relative to
the expected historical results and the current projections of future operating
results. The impairment charge was measured based on the projected discounted
future cash flows from the business unit over the remaining fifteen year
amortization period of the goodwill using a discount rate reflective of the
Company's cost of funds.
7. ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
Accounts payable, accrued expenses and other liabilities as of December
31, 2002 and 2001 consisted of the following (in thousands):
December 31, December 31,
2002 2001
------------------------------
Accounts payable $ 2,936 $ 3,337
Accrued compensation 3,477 2,349
Accrued direct project costs 1,941 2,273
Accrued restructuring costs 2,191 2,087
Accrued software license obligations 934 1,426
Accrued other expenses 1,612 1,633
------------------------------
$ 13,091 $ 13,105
==============================
48
8. INCOME TAXES
The income tax expense (benefit) for the periods applicable was
allocated as follows (in thousands):
Two Months
Year Ended Year Ended Ended Year Ended
December 31, December 31, December 31, October 31,
2002 2001 2000 2000
-----------------------------------------------------------------
Loss from continuing operations $ - $ - $ (642) $ (4,530)
Discontinued operations:
Income (loss) from discontinued operations - - (24) 1,967
Gain on sale - 312 - -
-----------------------------------------------------------------
Total tax expense (benefit) $ - $ 312 $ (666) $ (2,563)
-----------------------------------------------------------------
Income tax expense (benefit) from continuing operations was comprised
of the following (in thousands):
Two Months
Year Ended Year Ended Ended Year Ended
December 31, December 31, December 31, October 31,
2002 2001 2000 2000
----------------------------------------------------------------
Current tax expense (benefit)
Federal $ - $ - $ - $ (1,075)
State and local - - - 516
----------------------------------------------------------------
$ - $ - $ - $ (559)
----------------------------------------------------------------
Deferred tax expense (benefit):
Federal $ - $ - $ (506) $ (2,517)
State and local - - (136) (1,454)
----------------------------------------------------------------
$ - $ - $ (642) $ (3,971)
----------------------------------------------------------------
Income tax expense (benefit) $ - $ - $ (642) $ (4,530)
----------------------------------------------------------------
A reconciliation of the income tax expense (benefit) from continuing
operations to the applicable federal statutory rates follows (in thousands):
Year Ended Year Ended Two Months Ended Year Ended
December 31, December 31, December 31, October 31,
2002 % 2001 % 2000 % 2000 %
---------------------------------------------------------------------------------
Income tax expense (benefit):
Computed at federal statutory rate $ (859) (34.0) $ (5,529) (35.0) $ (527) (34.0) $ (3,620) (34.0)
State and local tax expense, net of
federal benefit (171) (6.8) (950) (6.0) (89) (5.7) (610) (5.7)
Amortization of goodwill - - 46 0.3 9 0.6 99 0.9
Municipal interest (48) (1.9) (82) (0.5) (9) (0.6) (329) (3.1)
Increase (decrease) in valuation
allowance 1,412 55.9 6,239 39.5 - - (164) (1.5)
Benefit of subsidiary merger (330) (13.0) - - - - - -
Other, net (4) (0.2) 276 1.7 (26) (1.7) 94 0.9
---------------------------------------------------------------------------------
Total income tax expense (benefit) $ - - $ - - $ (642) (41.4) $ (4,530) (42.5)
---------------------------------------------------------------------------------
49
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income taxes are recognized for the future tax consequences of
temporary differences between the financial statement and tax bases of assets
and liabilities. The tax effect of temporary differences that give rise to a
significant portion of the deferred tax assets and deferred tax liabilities at
December 31, 2002 and 2001 were as follows (in thousands):
December 31, December 31,
2002 2001
-------------------------
Deferred tax assets:
Allowance for doubtful accounts $ 1,488 $ 1,491
Property and equipment 1,008 1,192
Restructuring cost 1,160 2,388
Goodwill and other intangibles 1,639 1,657
Software 752 712
Federal and state net operating loss carryforward 13,921 13,134
Deferred stock compensation 321 -
Other 670 508
-------------------------
Total deferred tax assets before valuation allowance 20,959 21,082
Less valuation allowance (8,493) (8,493)
-------------------------
Total deferred tax assets after valuation allowance 12,466 12,589
-------------------------
Deferred tax liabilities:
Capitalized research and development cost 110 280
Federal impact of states net operating losses 1,965 1,902
Other 1,471 1,487
-------------------------
Total deferred tax liabilities 3,546 3,669
-------------------------
Total net deferred tax assets $ 8,920 $ 8,920
-------------------------
Net current deferred tax assets $ - $ -
Net non-current deferred tax assets 8,920 8,920
-------------------------
Total net deferred tax assets $ 8,920 $ 8,920
-------------------------
At December 31, 2002, the Company had net operating loss carryforwards
of $24.7 million and $30.3 million, which are available to offset future federal
and state/local taxable income, respectively. Of the federal amount, $4.0
million is subject to annual limitation of $266,000 under Internal Revenue Code
Section 382. The federal and state/local net operating loss carryforwards expire
between years 2012 through 2021.
During the year ended December 31, 2001 the Company recognized an
increase in the valuation allowance related to the realizability of its deferred
tax assets in the amount of $7.5 million. The valuation allowance was
specifically associated with the Company's net operating loss carryforwards
(NOLs), which account for the majority of the Company's deferred tax assets. The
Company believes the available objective evidence, principally its recent
taxable losses, creates sufficient uncertainty regarding the realizability of
its NOLs, that it is more likely than not, that some of the NOLs are not
realizable. The Company determined the amount of the valuation allowance based
on its assessment of the recoverability of the deferred tax assets by projecting
future taxable income. The projection included the reversal of known temporary
differences, and reflected managements' estimates of future results of
operations after considering the significant changes in the Company's business
represented by the business divestitures, sales of assets, and operational and
infrastructure restructurings as discussed in Note 14. The realizability of the
Company's deferred tax assets and the corresponding valuation allowance will be
adjusted in the future based on the Company's actual taxable income results and
updated estimates of future taxable income. The Company believes that it is more
likely than not that the results of future operations will generate sufficient
taxable income to realize the deferred tax assets, net of valuation allowance,
based on its projection of future operating results.
50
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. EQUITY
(A) COMMON STOCK
The terms of the Company's (HMS Holdings) authorized capital are
identical in all material respects to the terms of HMSY's (Health Management
Systems, Inc.) authorized capital stock prior to the shareholder approval of the
holding company structure.
(B) TREASURY STOCK
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 million. 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.
During the year ended December 31, 2002, the Company repurchased a total of
292,100 shares of common stock for $869,000 at an average price of $2.97 per
share. During the year ended December 31, 2001, the Company repurchased a total
of 5,350 shares of common stock for $15,000 at an average price of $2.80 per
share. In fiscal year 2000, the Company repurchased a total of 262,666 shares of
common stock for $550,000, or $2.09 per share, from the Company's former Chief
Executive Officer. Since the inception of the repurchase program in June 1997,
the Company has repurchased 1,609,116 shares of common stock at an average price
of $5.71 per share having an aggregate purchase price of $9.2 million.
(C) PREFERRED STOCK
The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 5,000,000 shares of "blank check" preferred stock with such
designations, rights and preferences as may be determined by the Company's Board
of Directors. As of December 31, 2002 no preferred stock has been issued.
10. EMPLOYEE BENEFIT PLAN
The Company sponsors a benefit plan to provide retirement benefits for
its employees known as HMS Holdings Corp 401(k) Plan (the Plan). Participants
may make voluntary contributions to the Plan of up to 15% of their annual base
pre-tax compensation not to exceed the federally determined maximum allowable
contribution. The Plan permits discretionary Company contributions. The Company
contributions are not in the form of the Company's common stock and participants
are not permitted to invest their contributions in the Company's stock. For the
years ended December 31, 2002 and 2001, the two months ended December 31, 2000,
and the year ended October 31, 2000, the Company contributions to the Plan were
$451,000, $264,000, $95,000 and $653,000, respectively.
11. STOCK-BASED COMPENSATION PLANS
(A) 1999 LONG-TERM INCENTIVE PLAN
The Company's 1999 Long-Term Incentive Stock Plan (the Plan), which
replaced the Health Management Systems, Inc. Stock Option and Restricted Stock
Purchase Plan terminated in May 1999, was approved by its shareholders at the
Annual Meeting of Shareholders held on March 9, 1999. The primary purposes of
the Plan are (i) to promote the interests of the Company and its shareholders by
strengthening the Company's ability to attract and retain highly competent
individuals to serve as Directors, officers and other key employees and (ii) to
provide a means to encourage stock ownership and proprietary interest by such
persons. The Plan provides for the grant of (a) options to purchase shares of
the Company's common stock at an exercise price no less than 100% of the
estimated fair market value of the Company's common stock; (b) stock
appreciation rights (SAR) representing the right to receive a payment, in cash,
shares of common stock, or a combination thereof, equal to the excess of the
fair market value of a specified number of shares of the Company's common stock
on the date the SAR is exercised over the fair market value of such shares on
the date the SAR was granted; or (c) stock awards made or valued, in whole or in
part, by reference to shares of common stock. Options are granted under the Plan
with various vesting provisions up to five years, including time based and/or
performance based vesting periods. Stock options currently outstanding become
exercisable and expire at various dates through December 2012. Options expire
ten years after the date of grant. As of December 31, 2002, no SAR's or stock
purchase awards had been granted. The Plan authorizes the issuance of up to
4,751,356 shares of common stock. The Plan expires in January 2009.
On December 15, 2000 all non-employee members of the Board of Directors
were granted options under the Plan to purchase shares of common stock. Three
members were granted options to purchase 25,000 shares at an
51
exercise price of $1.07 per share, the then current market price. These options
vested as to 33% on the grant date and the remaining 67% in two equal
installments, commencing one year after the date of grant.
In 2001, two members of the Board of Directors were each granted
options under the Plan to purchase 150,000 shares of common stock, at an
exercise price of $1.07 per share, the then current market price. The options
vest as follows: 30,000 shares on the date of grant, 45,000 shares on the first
anniversary, and the remaining 75,000 shares thereafter in eight equal quarterly
installments. This grant represented 25,000 options for service as board members
consistent with the grant above made to the other non-employee directors, 25,000
options for additional board member service for participation in the Company's
strategic review, divestiture assessment and operational re-engineering and
100,000 options for additional consulting service beyond their status as board
members for participation in the Company's strategic review, divestiture
assessment and operational re-engineering. The Company therefore recognizes
compensation expense for 100,000 shares of each option grant using variable
stock option accounting.
Based on the fair value of the options using the Black-Scholes option
pricing model, the Company recorded stock compensation expense totaling $141,000
and $305,000 for the years ended December 31, 2002 and 2001, respectively, as a
component of other operating costs in the accompanying Consolidated Statements
of Operations. Unearned stock compensation totaled $33,000 and $128,000 at
December 31, 2002 and 2001, respectively, as a component of shareholders' equity
in the accompanying Consolidated Balance Sheets. The fair value of the remaining
non-vested compensatory options at December 31, 2002 and 2001 were $3.11 and
$2.75 per option respectively, based on the Black-Scholes option-pricing model
with the following assumptions; expected volatility of 58% and 59%, a risk free
interest rate of 3.82% and 4.00%, and an expected life of 10 years. These
options are subject to re-measurement at the end of each reporting period based
on changes in the fair value of the common stock until vesting is complete
pursuant to each option agreement.
(B) 1995 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
The Company's 1995 Non-Employee Director Stock Option Plan (the NEDP)
was adopted by the Board of Directors on November 30, 1994. Under the NEDP,
directors of the Company who are not employees of the Company or its
subsidiaries may be granted options to purchase 1,500 shares of common stock of
the Company during the fourth quarter of each year commencing with fiscal year
1995. Options for the purchase of up to 112,500 shares of common stock may be
granted under the NEDP and the Company will reserve the same number of shares
for issuance. The options available for grant are automatically increased to the
extent any granted options expire or terminate unexercised. The last awards
under the NEDP were in October 2000. As of December 31, 2002 and 2001, 39,750
options were outstanding.
(C) OPTIONS ISSUED OUTSIDE THE PLANS
On June 4, 2002, as ratified by the shareholders at the Company's
annual meeting, the Company granted 250,000 stock options at an exercise price
of $2.48 per share to a member of the Board of Directors. All of the options
were fully vested on the grant date, June 4, 2002. This grant represented 60,000
options for service as a board member consistent with a similar grant to the
other board members in December 2001, and 190,000 options as an inducement to
join the board. The Company immediately recognized a total of $525,000 in
compensation expense consisting of $478,800 based on the fair value of the
options using the Black-Scholes option pricing model for the 190,000 options and
$46,200 for the 60,000 options based on the difference between the current
market price of the stock on the grant date and the exercise price.
During 2001, the Company issued options outside its stock plans. In
January 2001, in conjunction with his joining the Company, the Chairman and
Chief Executive Officer was granted options to purchase 750,000 shares of common
stock at $1.31 per share, the then current market price. The options vest as
follows: 100,000 on January 10, 2002 and the remaining 650,000 options vest
ratably in eight equal quarterly installments, commencing June 30, 2002. In
March 2001, in conjunction with his joining the Company, the President and Chief
Operating Officer was granted options to purchase 700,000 shares of the
Company's common stock at $1.19 per share, the then current market price. The
options vest as follows: 100,000 on March 30, 2002 and the remaining 600,000
options vest ratably in eight equal quarterly installments, commencing June 30,
2002. As of December 31, 2002, 668,750 of these options granted to these two
officers, were exercisable.
52
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(D) SUMMARY OF OPTIONS
Presented below is a summary of the Company's options for the years
ended December 31, 2002 and 2001, the two months ended December 31, 2000, and
the year ended October 31, 2000 (in thousands):
Year Ended Year Ended Two Months Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000 October 31, 2000
------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
average average average average
exercise exercise exercise exercise
Shares price Shares price Shares price Shares price
------------------------------------------------------------------------------------------
Outstanding at
beginning of period 5,782 $2.76 3,686 $4.81 2,869 $6.06 3,336 $6.85
Granted 1,448 3.32 3,376 1.68 925 1.07 536 4.79
Exercised (503) 1.42 (61) 1.15 - - (67) 4.59
Cancelled (1,102) 4.66 (1,219) 6.07 (108) 5.95 (936) 8.22
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding at
end of period 5,625 $2.65 5,782 $2.76 3,686 $4.81 2,869 $6.06
===========================================================================================================================
Weighted average fair value of
options granted (Black-Scholes) $1.82 $0.89 $0.56 $4.74
=================================================================================
The following table summarizes information for stock options
outstanding at December 31, 2002 (in thousands):
Number Weighted Weighted Weighted
Range of outstanding average average average
exercise as of remaining exercise Number exercise
prices December 31,2002 contractual life price exercisable price
- ----------------------------------------------------------------------------------------------------
$1.07 624 7.96 $1.07 549 $1.07
1.19 700 8.24 1.19 325 1.19
1.27- 1.31 825 8.05 1.31 385 1.31
1.50- 2.47 466 8.56 1.74 216 1.69
2.48 1,111 9.06 2.48 822 2.48
2.82- 3.41 1,073 9.95 3.39 339 3.41
3.95- 23.00 826 5.97 6.19 411 6.75
- ---------------------------------------------------------------------------------------------------
$1.07-$23.00 5,625 8.36 $2.65 3,047 $2.56
===================================================================================================
(E) EMPLOYEE STOCK PURCHASE PLAN
On May 28, 1993, the Board of Directors adopted the Health Management
Systems, Inc. Employee Stock Purchase Plan (the ESPP). The purpose of the ESPP
was to provide a method whereby all eligible employees of the Company may
acquire a proprietary interest in the Company through the purchase of shares of
common stock. Under the ESPP, employees may purchase the Company's common stock
through payroll deductions. The Company reserved for issuance up to 1,125,000
shares of common stock pursuant to the ESPP.
At the beginning of each year, participants were granted an option to
purchase shares of the Company's common stock at an option price equal to 85% of
the fair market value of the Company's common stock on the lower of either the
first business day of the plan year or any day within 10 days of the end of each
quarter.
For the years ended December 31, 2002 and 2001, the two months ended
December 31, 2000, and the year ended October 31, 2000, employees purchased
49,983, 157,667, none and 46,095 shares, respectively, of common stock pursuant
to the ESPP for aggregate consideration of $128,000, $162,000, none and
$135,000, respectively.
53
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2002, the ESPP was discontinued as substantially all
of the shares reserved for issuance by the Board of Directors had been issued.
12. CHANGE IN ACCOUNTING PRINCIPLE FOR REVENUE RECOGNITION
After analyzing the SEC's "Frequently Asked Questions and Answers"
bulletin released on October 12, 2000 pertaining to Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements (SAB 101), the Company
elected early adoption in the fourth quarter of its fiscal year ended October
31, 2000, implementing a change in accounting principle with regard to revenue
generated from clients seeking reimbursement from third party payors where the
Company's fees are contingent upon the client's collections from third parties.
The Company now recognizes revenue pertaining to such clients once the third
party payor has remitted payment to the Company's client. This change eliminated
unbilled accounts receivable and substantially reduced deferred income tax
liabilities. The cumulative effect of this change in accounting principle as of
the beginning of the Company's fiscal year 2000 was $22.0 million, net of income
tax benefit of $18.2 million.
As of October 31, 1999, the Company had unbilled accounts receivable of
$41.7 million under its historic accounting policy, pre-dating the SEC release
of SAB 101. Of this amount, a total of $40.8 million has subsequently completed
its cycle and has been included in the Company's revenue and operating results
through December 31, 2002, of which $500,000, $12.4 million, $3.3 million and
$24.6 million occurred during the years ended December 31, 2002 and 2001, the
two months ended December 31, 2000 and the year ended October 31, 2000,
respectively. The remaining $900,000 of receivables is for services the Company
performed associated with claims for uncollectible bad debts and
disproportionate share credits that are in process of settlement through the
Medicare cost report appeal procedure. These items have been filed and accepted
for processing and are currently pending before the Provider Reimbursement
Review Board, one of the final administrative steps in the Medicare cost report
appeal process. This process can routinely take several years to complete. These
receivables will be invoiced when the Company's clients receive settlements.
The Consolidated Statements of Operations for the year ended October
31, 2000 and thereafter have been presented in the accompanying financial
statements based on this newly adopted revenue recognition policy. The change
reduced revenue by $3.0 million and increased net loss by $503,000 for the year
ended October 31, 2000, excluding the cumulative effect of the change. The
cumulative effect pertaining to this change as of the beginning of the Company's
year ended October 31, 2000 is $22.0 million, net of tax benefit. The $22.0
million cumulative effect reflects $41.7 million of unbilled accounts receivable
offset by $1.5 million of related direct costs and $18.2 million of income tax
benefit.
13. TRANSACTIONS WITH OFFICERS AND OTHER RELATED PARTIES
(A) TRANSACTIONS WITH CHIEF EXECUTIVE OFFICER
As a condition of joining the Company, the new Chief Executive Officer
was provided financing to acquire 550,000 common shares directly from the
Company at $1.31 per share, the then current market price. In January 2001, the
Company's former Accelerated Claims Processing, Inc. subsidiary, a Delaware
corporation, provided this financing, in the form of a full recourse note in the
amount of $722,000, bearing interest at the rate of 6.5% per annum, payable in
two equal annual installments commencing January 2002. The first installment of
$361,000 in principal and $47,000 in interest was received in January 2002. The
second and final installment of $361,000 in principal and $23,000 in interest
was received in January 2003. The sale of common stock was exempt from the
registration provisions of the Securities Act of 1933 pursuant to Section 4(2)
of that Act relating to transactions not involving a public offering.
Additionally, the Company granted the new Chief Executive Officer stock options
to purchase 750,000 shares at $1.31 per share (see Note 11).
(B) SEPARATION AGREEMENT WITH FORMER CHIEF EXECUTIVE OFFICER
Pursuant to the terms of a Separation Agreement executed in October
2000, the Company provided separation compensation to the former Chief Executive
Officer of $1.5 million and an additional payment of $150,000 in exchange for
his non-compete through April 2006. The agreement also provides for full salary
continuation for two years at an annual rate of $364,000, a consulting
arrangement for $50,000 per year thereafter until April 2006, and health
insurance coverage for the related periods. The total charge of $2.7 million
related to the separation agreement is presented as Other Charges on the
Consolidated Statement of Operations for the year ended October 31, 2000. As of
December 31, 2002 and 2001, $214,000 and $550,000, respectively, remained as
liabilities pursuant to the terms of the agreement.
54
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In conjunction with the separation agreement, the former Chief
Executive Officer repaid his entire outstanding loan balance to the Company in
the amount of $1.5 million in October 2000. Also in conjunction with the
separation agreement, the Company purchased 262,666 shares of common stock from
the former Chief Executive Officer at $2.09 per share, the then fair market
value.
(C) RELATED PARTY TRANSACTIONS
The Company paid approximately $61,000, $171,000 $14,000 and $87,000
for the years ended December 31, 2002 and 2001, the two months ended December
31, 2000, and the year ended October 31, 2000, respectively, in fees to a law
firm at which one director of the Company is a senior partner.
14. RESTRUCTURINGS, DISCONTINUED OPERATIONS AND DIVESTITURES
STRATEGIC REVIEW
In late fiscal year 2000, the Company began a strategic examination of
its operating businesses and general infrastructure. During the 1990's, the
Company's business plan focused on growth through mergers with and purchases of
several businesses, such that at the beginning of 2001, the Company was
operating two divisions, each containing two business units (or groups). The
Revenue Services Division included the Provider Revenue Services Group and the
Payor Revenue Services Group. The Software Division included the Decision
Support Group and the Payor Systems Group. The Company was incurring operating
losses and had not achieved operational synergies or effective marketing and
selling opportunities across its operating units. The strategic review was
undertaken to implement a focused business plan, divest non-strategic assets and
reduce infrastructure and overhead costs.
As a result of the above, the Company incurred restructuring charges,
discontinued operations of two business segments, one through closure and one
through sale, and divested certain non-strategic assets as follows:
(A) RESTRUCTURINGS
In October 2000, the Company recorded a restructuring charge of
$821,000. This charge was subsequently adjusted by $327,000 in October 2001, to
a net charge of $494,000. The net charge consisted of severance costs associated
with a reduction in the Company's operations support information technology
group (16 employees representing $375,000) and facility costs associated with
the consolidation of certain office space ($119,000). As a result of a change in
the original estimate regarding the occupancy portion, there remained no
liability at December 31, 2001 compared to $442,000 at each of December 31,
2000, and October 31, 2000. Of the $375,000 restructuring charge relating to
compensation, no liability remained at December 31, 2001.
In April 2001, the Company recognized a restructuring charge of
$785,000. This charge was subsequently adjusted by $38,000 in November 2001, to
a net charge of $747,000. This net charge related to the closure of the
Washington, D.C. office, consisting of $198,000 in employee costs (representing
4 employees), $299,000 in office lease and fixed asset costs, and $250,000 for
the write-off of an initial fee paid for a third party liability recovery system
which the Company had determined would not be put into use. Of the total
restructuring charges, $103,000 and $269,000 remained as accrued liabilities at
December 31, 2002 and 2001 respectively.
In December 2001, the Company recognized a restructuring charge of $1.8
million consisting of $1.3 million for facility costs associated with reducing
the amount of space the Company occupies at its headquarters in New York City,
and $500,000 for severance costs associated with reducing 20 employees in the
information technology and facilities maintenance departments. During 2002, the
Company paid out $500,000 for severance costs. Also in December 2002, the
Company increased this restructuring charge by $800,000 for additional
facilities costs associated with reducing its New York City office space. As of
December 31, 2002 and 2001, $2.1 million and $1.8 million respectively, remained
as accrued liabilities.
(B) DISCONTINUED OPERATIONS OF BUSINESS SEGMENTS
(i) Discontinuance of Payor Systems Group
On July 31, 2001, the Company implemented a formal plan to proceed with
an orderly closing of its Payor Systems Group (PSG). This decision followed from
the notice of contract termination the Company received from the largest
customer of PSG, which accounted for 56% of the total revenue in PSG at that
time. The Company's formal plan of discontinuance includes provisions for
on-going service to existing clients according to the current contract terms
while pursuing early release from existing contract relationships or
opportunities to assign the contracts to other service providers. As of July 31,
2001 the Company had estimated a pre-tax loss on disposal of $1.6 million, as an
55
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
estimate of the future results of operations for PSG until the final cessation
of operations, largely reflective of employee severance costs and a general
deterioration in operating results as the revenue base declines. As a result of
experiencing significant success in exiting various business obligations, the
Company reduced its estimated loss to $200,000 as of December 31, 2001. As of
December 31, 2002, $85,000 remain as accrued liabilities. In 2002, the Company
received a $2.7 million contract termination fee which was not included in the
disposal estimate. In addition, the Company reduced the estimated loss on
disposal by $448,000, based on actual operating results from 2002. Consequently,
the Company recognized income from discontinued operations, in the accompanying
financial statements, of $3.1 million in 2002.
The results of PSG's operations have been reported as discontinued
operations in the Consolidated Statements of Operations for all periods
presented.
In April 2001, the Company incurred a restructuring charge of $5.1
million related to PSG, resulting from the decision to discontinue development
of its managed care system offering, after considering alternatives to its
development partner's notification that it neither wished to purchase PSG nor
continue to financially participate in the development of the system. The
charge consisted of $3.5 million for the write-off of capitalized software
development and equipment, $810,000 for employee severance and consulting
costs associated with approximately 60 positions, $678,000 for lease
termination costs and leasehold improvement write-offs, and $128,000 in other
miscellaneous costs. In July 2001, the Company recognized a net reduction to
these restructuring charges resulting from a $635,000 negotiated settlement
received from the development partner, and additional lease termination costs
of $320,000. Of the total restructuring charges, zero and $422,000 in lease
termination and related facility costs remained as liabilities at December 31,
2002 and 2001 respectively, and are reflected in the net liability of
discontinued operations.
Also, during April 2001, as a result of the events leading to the
restructuring charge discussed above, the Company recognized an asset
impairment charge of $4.6 million relating to the write-off of the goodwill
and other intangible assets associated with the Company's prior acquisition of
PSG.
(ii) Sale of Decision Support Group
On December 11, 2001, the Company sold its healthcare decision support
software systems and services business, Health Care microsystems, Inc. (HCm), a
wholly owned subsidiary, which operated as the Company's Decision Support Group
(DSG) business segment, to HCm's executive management team (Purchaser). The
total sale price of $9.8 million consisted of $9.2 million in cash and the
assumption of $600,000 of the Company's liabilities by the Purchaser. The net
assets sold of $7.0 million, post closing price adjustments of $500,000 and
related transaction costs of $400,000 totaled $7.9 million, resulting in a gain
of $1.9 million. This gain of $1.9 million is reflected net of income taxes of
$312,000, resulting in net gain on sale of discontinued operations of $1.6
million. In 2002, the Company increased the estimated gain on the disposal of
this segment by $311,000, resulting from the favorable resolution of certain
operating liabilities.
As a result of the sale of this business segment, DSG has been
reflected in the accompanying financial statements as a discontinued operation.
(iii) Discontinued Operations Information
Results of operations from discontinued operations were as follows (in
thousands):
56
Year Ended Two Months Ended Year Ended
December 31, 2001 December 31, 2000 October 31, 2000
---------------------------- ---------------------------- ------------------------------
PSG DSG Total PSG DSG Total PSG DSG Total
Revenue $ 8,228 $ 20,727 $ 28,955 $ 1,361 $ 3,186 $ 4,547 $ 11,457 $ 21,781 $ 33,238
--------- -------- --------- -------- ------- ------- -------- -------- --------
Income (loss) before
income taxes $ (8,443) $ 3,390 $ (5,053) $ (148) $ 89 $ (59) $ 1,288 $ 3,335 $ 4,623
Income tax expense
(benefit) - - - (60) 36 (24) 548 1,419 1,967
--------- -------- --------- -------- ------- -------- -------- -------- --------
Income (loss) from
discontinued
operations $ (8,443) $ 3,390 $ (5,053) $ (88) $ 53 $ (35) $ 740 $ 1,916 $ 2,656
========= ======== ========= ======== ======== ======== ======== ========= ========
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Assets and liabilities of the discontinued operations were as follows (in
thousands):
December 31, 2002 December 31, 2001
-------------------------- ----------------------------
PSG DSG Total PSG DSG Total
Current assets $ - $ - $ - $852 $ - $852
Current liabilities (85) - (85) (1,691) - (1,691)
------ --- ----- ------- --- -------
Net current liabilities ($85) $ - ($85) ($839) $ - ($839)
===== === ===== ======= === =======
Property and equipment $ - $ - $ - $78 $ - $78
Capitalized software costs - - - 191 - 191
---- --- ---- ------ --- ------
Net noncurrent assets $ - $ - $ - $269 $ - $269
==== === ==== ====== === ======
(C) DIVESTITURES
(i) Sale of Electronic Transaction Processing Business
Effective January 1, 2001, the Company sold its electronic transaction
processing (EDI) business, consisting of substantially all of the assets of
the Company's wholly owned subsidiary, Quality Medi-Cal Adjudication,
Incorporated, and certain of the assets of its wholly owned subsidiary, Health
Receivables Management, Inc., to Medi, Inc. (Medi), a privately held entity.
The total sale price of $3.0 million consisted of: (i) $450,000 in cash at
closing, (ii) a one-year secured promissory note in the principal amount of
$275,000 and, (iii) $2.3 million of service credits. The Company applies these
service credits against invoices for services rendered by Medi to the Company
pursuant to a services agreement entered into between the parties at the time
of closing. For the years ended December 31, 2002 and 2001, the Company
utilized service credits of $1.1 million and $1.2 million, respectively. The
Company's EDI business generated revenue and net loss of $4.0 million and
$200,000, respectively, during the year ended December 31, 2000. The net
assets sold and related transaction costs totaled $3.1 million, resulting in a
loss on sale of assets of $61,000.
(ii) Sale of CDR Associates, Inc.
In July 2001, the Company sold substantially all of the assets of CDR
Associates, Inc. (CDR), a formerly wholly owned subsidiary, to CDR Associates,
L.L.C., a Delaware limited liability corporation, principally owned by the
former management team of CDR. The total sales price of $3.2 million consisted
of $2.9 million in cash at closing and $280,000 in four scheduled payments to be
made over the next seven months. The net assets sold of $1.3 million and related
transaction costs of $200,000, totaled $1.5 million, resulting in a gain on the
sale of assets of $1.7 million. The Company's CDR business generated revenue and
net income of $2.3 million and $500,000, respectively, during the year ended
December 31, 2001, through the date of sale. During the year ended October 31,
2000, the Company's CDR business generated revenue and net income of $2.8
million and $400,000, respectively. During the two months ended December 31,
2000, the Company's CDR business generated revenue and net loss of $500,000 and
$100,000, respectively.
57
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. COMMITMENTS
(A) LEASE COMMITMENTS
The Company leases office space data processing equipment and software
licenses under operating leases that expire at various dates through 2013. The
lease agreements provide for rent escalations. Rent expense, net of sublease
income, for the years ended December 31, 2002 and 2001, the two months ended
December 31, 2000 and the year ended October 31, 2000 was $4.5 million, $4.5
million, $986,000 and $7.9 million, respectively. Sublease income was $1.1
million, $1.0 million, $175,000 and $826,000 for the years ended December 31,
2002 and 2001, the two months ended December 31, 2000, and the year ended
October 31, 2000, respectively. Minimum annual lease payments to be made and
sublease payments to be received for each of the next five years ending December
31 and thereafter are as follows (in thousands):
Year Payments Sublease Receipts
--------------- --- --------------- --- ---------------------
2003 $ 6,011 $ 1,941
2004 5,700 2,227
2005 4,941 2,273
2006 4,100 1,454
2007 3,670 952
Thereafter 19,280 3,233
--------------- --- --------------- --- ---------------------
Total $ 43,702 $ 12,080
--------------- --- --------------- --- ---------------------
(B) LEGAL
(I) HHL FINANCIAL SERVICES
On June 28, 1998, eight holders of promissory notes (the Notes) of HHL
Financial Services, Inc. (HHL) commenced a lawsuit against us and others in the
Supreme Court of the State of New York, County of Nassau, alleging various
breaches of fiduciary duty between 1990 and 1996 against HHL (the first cause of
action) and that defendants intentionally caused HHL's default under the Notes
(the second cause of action). The complaint alleges that the defendants caused
HHL to make substantial unjustified payments to us which, ultimately, led to
defaults on the Notes and to HHL's filing for Chapter 11 bankruptcy protection
in 1997. The plaintiffs are seeking damages in the amount of $2.3 million (for
the unpaid notes) plus interest. As a result of motion practice before the
Bankruptcy Court, the breach of fiduciary duty claim was dismissed. A motion to
dismiss the remaining cause of action, for tortious interference with contract,
was denied by the New York Supreme Court, and an appeal was taken. On March 3,
2003, the Appellate Division Second Department affirmed the lower Court's
decision holding that the Complaint pleaded a cognizable cause of action for
tortious interference. We will now answer the Complaint, and both sides will
engage in discovery. We intend to continue our vigorous defense of this lawsuit.
Management believes the risk of loss is not probable and accordingly has not
recognized any accrued liability for this matter. Although the outcome of this
matter cannot be predicted with certainty, we believe that any liability that
may result will not, in the aggregate, have a material adverse effect on our
financial position or cash flows, although it could be material to our operating
results in any one accounting period.
(II) SUBPOENA FROM THE UNITED STATES ATTORNEY'S OFFICE
On January 31, 2003, the Company announced that it had received a
subpoena issued under the Health Insurance Portability and Accountability Act
of 1996 from the United States Attorney's Office for the Southern District of
New York in connection with an investigation relating to possible Federal
health care offenses. The subpoena seeks the production of certain documents
from January 1982 to present relating to medical reimbursement claims submitted
by the Company to Medicare, Medicaid and other federal healthcare programs,
particularly on behalf of a significant client of Accordis. At this point in
the investigation, the United States Attorney's Office has not filed any
complaint asserting any violations of law.
The Company is cooperating fully with the investigation and is in
the process of assembling and producing the documents called for by the
subpoena. The Company's board of directors has appointed a special committee to
oversee the Company's response to the investigation.
The Company is not able to give any assurances as to the duration or
outcome of the investigation or as to the effect that any proceedings that may
be brought by the government may have on the Company's financial
58
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
condition or results of operations. The initiation of proceedings against the
Company, even if the Company is ultimately successful in defending itself,
could have a material adverse effect on the Company's business. Over the near
term, the Company anticipates that revenue and expense levels will be adversely
affected as management undertakes to comply with the demands of data gathering
and review of the matters covered by the subpoena.
Other legal proceedings, including claims and assertions against the
Company, to which the Company is a party, in the opinion of the Company's
management, are not expected to have a material adverse effect on the Company's
financial position, results of operations, or liquidity.
16. SEGMENT AND GEOGRAPHICAL INFORMATION
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of An Enterprise and Related Information." SFAS No. 131 established standards
for reporting information about operating segments in annual financial
statements and in interim financial reports issued to stockholders.
(A) SEGMENT INFORMATION
Accordis offers hospitals and other healthcare providers a
comprehensive array of technology-based revenue cycle services. These services
include identifying third-party resources, submitting timely and accurate bills
to third-party payors and patients, recovering and properly accounting for the
amounts due, and securing the appropriate cost-based reimbursement from
entitlement programs. Clients may use one or more services, or outsource the
entirety of their business office operations to the Company. Health Management
Systems offers state Medicaid and other government agencies that administer
health care entitlement programs a broad range of services that are designed to
identify and recover amounts that should have been the responsibility of a third
party, or that were paid inappropriately. Further, by assisting these agencies
in properly accounting for the services that they deliver, the Company also
helps to insure that they receive the full amount of entitlement program funding
to which they are entitled. The Company measures the performance of its
operating segments through "Operating Income" as defined in the accompanying
Consolidated Statements of Operations.
59
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Total Health
Holdings, Manage-
continuing ment
(in thousands) operations Accordis Systems Corporate
- ----------------------------------------------------------------------------------------------------
Year ended December 31, 2002
Revenue $68,614 $36,331 $32,283 $ -
Operating loss (3,042) (7,641) 4,599 -
Total assets 61,666 16,637 10,827 34,202
Goodwill 5,679 4,596 1,083 -
Depreciation and amortization 2,518 1,327 1,191 -
Capital expenditures and software capitalization 3,429 1,923 1,506 -
- ----------------------------------------------------------------------------------------------------
Year ended December 31, 2001
Revenue 58,748 31,329 27,419 -
Operating loss (18,070) (14,610) (3,460) -
Total assets 60,394 16,210 10,222 33,962
Goodwill 5,679 4,596 1,083 -
Depreciation and amortization 2,550 1,456 1,094 -
Capital expenditures and software capitalization 3,444 2,564 880 -
- ----------------------------------------------------------------------------------------------------
Two months ended December 31, 2000
Revenue 9,207 5,474 3,733 -
Operating loss (1,688) (1,408) (280) -
Total assets 60,823 25,223 13,106 22,494
Goodwill 7,366 4,823 2,543 -
Depreciation and amortization 452 271 181 -
Capital expenditures and software capitalization 269 194 75 -
- ----------------------------------------------------------------------------------------------------
Year ended October 31, 2000
Revenue 64,849 42,562 22,287 -
Operating income (loss) (11,671) (7,929) (3,742) -
Total assets 64,882 25,582 14,306 24,994
Goodwill 7,425 4,862 2,563 -
Depreciation and amortization 2,590 1,877 713 -
Capital expenditures and software capitalization $3,363 $2,082 $1,281 $ -
- ----------------------------------------------------------------------------------------------------
Total HMS assets presented above, do not include the assets of the
discontinued operations which are separately disclosed on the face of the
accompanying Consolidated Balance Sheets.
Assets, including prepaid expenses, property and equipment and
goodwill have been allocated to identified segments based upon actual usage,
occupancy or other correlations with operating metrics. Other corporate assets,
including cash, short-term investments and deferred tax assets, are shown in
the corporate category. Prior years amounts include reclassifications to
conform to the Company's current methodology.
(B) GEOGRAPHIC INFORMATION
The Company operates within the continental United States.
(C) MAJOR CUSTOMERS
The Company's largest client is the Los Angeles County Department of
Health Services in California. This client accounted for 14%, 12%, 7% and 11% of
the Company's total revenue in the fiscal years ended December 31, 2002 and
2001, the two months ended December 31, 2000 and the fiscal year ended October
31, 2000. The loss of this customer would have a material adverse effect on
Accordis and HMS Holdings Corp. The Company provides the County (or designated
facilities within the County) with, among other services, secondary third-party
60
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
resource identification and recovery services, commercial insurance billing
services, Medi-Cal billing and follow-up services, and financial management and
consulting services relating to both inpatient and outpatient accounts. Either
party may terminate the agreement with or without cause upon 30 days written
notice, except that financial management and consulting services require 90 days
written notice of termination. The Company provides services to this client
pursuant to a contract awarded in June 1999 for a one-year period with three
annual automatic renewals through June 2003. Although the Company cannot be
assured that the contract will be renewed after June 2003, we have been
providing services to this client for more than twenty years.
(D) CONCENTRATION OF REVENUE
The clients constituting the Company's 10 largest clients change
periodically. The concentration of revenue in such accounts was 56%, 51%, 57%
and 51% of the Company's revenue in the fiscal years ended December 31, 2002 and
2001, the two months ended December 31, 2000 and the fiscal year ended October
31, 2000, respectively. In many instances, the Company provides its services
pursuant to agreements subject to competitive re-procurement. All of these
agreements expire between 2003 and 2007. The Company cannot provide assurance
that any of these agreements will be renewed and, if renewed, that the fee rates
will be equal to those currently in effect.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
The table below summarizes the Company's unaudited quarterly operating
results for its last two fiscal years.
(in thousands, except per share amounts) First Second Third Fourth
Year ended December 31, 2002 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------
Revenue $ 16,870 $ 16,744 $ 17,024 $ 17,976
Operating income (loss) (878) (1,889) 204 (479)
Discontinued operations, net -- 2,900 -- 560
Net income (loss) (719) 1,141 328 185
Basic and diluted income (loss) per share $ (0.04) $ 0.06 $ 0.02 $ 0.01
- -------------------------------------------------------------------------------------------------
Year ended December 31, 2001
Revenue $ 14,515 $ 15,645 $ 14,267 $ 14,321
Operating loss (756) (1,349) (8,341) (7,624)
Discontinued operations, net 927 (4,880) (862) 1,149
Net income (loss) 524 (5,618) (5,073) (9,297)
Basic and diluted income (loss) per share $ 0.03 $ (0.31) $ (0.28) $ (0.52)
- -------------------------------------------------------------------------------------------------
(a) In the second quarter of 2002, the Company's discontinued
operation, PSG, recorded income from operations of $2.9 million,
primarily as the result of a termination fee received from a former
customer of the PSG, which was not included in the prior disposal
estimate. PSG's operating results are presented as discontinued
operations for all periods presented, see Note 14.
(b) In the fourth quarter of 2002, the Company's discontinued
operation, PSG, recorded income from operations of $247,000,
primarily resulting from lower than estimated disposal costs.
Additionally, the Company's discontinued operation, DSG, recorded
income from operations of $313,000 reflecting lower than estimated
closing costs. PSG and DSG's operating results are presented as
discontinued operations for all periods presented, see Note 14.
(c) In the second quarter of 2001, the Company recorded a restructuring
charge of $785,000, see Note 14. Additionally, in the second
quarter, the Company's discontinued operation, PSG, incurred a
restructuring charge of $5.1 million and recognized an asset
impairment charge of $4.6 million. PSG's operating results are
presented as discontinued operations for all periods presented, see
Note 14.
(d) In the third quarter of 2001, the Company discontinued the PSG
business segment and recorded an estimated pre-tax loss on disposal
of $1.6 million. This amount was subsequently reduced in the fourth
quarter to $200,000. PSG's operating results are presented as
discontinued operations for all periods presented, see Note 14.
Additionally, the Company (i) sold its CDR business, resulting in a
gain on sale of assets of $1.7 million, see Note 14, (ii) recorded
bad debt expense of $2.7 million related to accounts receivable
from the District of Columbia, see Note 3, (iii) recorded a
write-off of capitalized software costs of $1.5 million, and (iv)
incurred a charge of $1.6 million for external software commitments
that were no longer of value to the Company.
61
HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(e) In the fourth quarter of 2001, the Company (i) recorded a
restructuring charge of $1.8 million, see Note 14, (ii) recorded a
goodwill impairment charge of $1.3 million related to its Global
line of business, see Note 6 and (iii) disposed of the DSG business
segment, resulting in a gain on sale of discontinued operation of
$1.6 million, net of tax. DSG's operating results are presented as
discontinued operations for all periods presented, see Note 14.
62
HMS HOLDINGS CORP. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFING ACCOUNTS
(in thousands)
Allowance for doubtful accounts:
Balance, October 31, 1999 $1,345
Provision 92
Recoveries -
Charge-offs (277)
-------------
Balance, October 31, 2000 1,160
Provision 12
Recoveries -
Charge-offs -
-------------
Balance, December 31, 2000 1,172
Provision 2,792
Recoveries -
Charge-offs (623)
-------------
Balance, December 31, 2001 3,341
Provision 311
Recoveries 16
Charge-offs (301)
-------------
Balance, December 31, 2002 $3,367
-------------
63
HMS HOLDINGS CORP. AND SUBSIDIARIES
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2 Agreement and Plan of Merger, dated as of December 16, 2002, among
Health Management Systems, Inc., HMS Holdings Corp. and HMS Acquisition
Corp. (Incorporated by reference to Exhibit 2.1 to No. 1 ("Amendment
No. 1") to HMS Holdings Corp.'s Registration Statement on Form S-4,
File No. 333-100521 (the "Form S-4"))
3.1 Restated Certificate of Incorporation HMS Holdings Corp. (Incorporated
by reference to Exhibit 3.1 to Amendment No. 1)
3.2 By-laws of HMS Holdings Corp. (Incorporated by reference to Exhibit 3.2
to the Form S-4)
10.1 Health Management Systems, Inc. Employee Stock Purchase Plan, as
amended (Incorporated by reference to Exhibit 10.2 to the January 1994
Form 10-Q and to Exhibit 10.1 to Health Management Systems, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended January 31, 1995
(the "January 1995 Form 10-Q"))
10.2 Health Management Systems, Inc. 1995 Non-Employee Director Stock Option
Plan (Incorporated by reference to Exhibit 10.2 to the January 1995
Form 10-Q)
10.3 Health Management Systems, Inc. Profit Sharing Plan (Incorporated by
reference to Exhibit 10.3(iv) to Health Management Systems, Inc.'s
Annual Report on Form 10-K for the year ended October 31, 1995 (the
"1995 Form 10-K"))
10.4 Health Management Systems, Inc. Profit Sharing Plan, as amended
(Incorporated by reference to Exhibit 10.3(vi) to the 1995 Form 10-K)
10.5 Health Management Systems, Inc. 1999 Long-Term Incentive Stock Plan
(Incorporated by reference to Exhibit 4 to Health Management Systems,
Inc.'s Registration Statement on Form S-8, File No. 333-77121)
10.6 Employment Agreement, dated as of October 2, 2000, between Health
Management Systems, Inc. and William F. Miller III (Incorporated by
reference to Exhibit 10.17(i) to Health Management Systems, Inc.'s
Annual Report on Form 10-K for the year ended October 31, 2000 (the
"2000 Form 10-K"))
10.7 Restricted Stock Purchase Agreement for 550,000 Common Shares dated
January 10, 2001, between Health Management Systems, Inc. and William
F. Miller III (Incorporated by reference to Exhibit 10.17(ii) to the
2000 Form 10-K)
10.8 Pledge Agreement, dated January 10, 2001, between Accelerated Claims
Processing, Inc. and William F. Miller III (Incorporated by reference
to Exhibit 10.17(iii) to the 2000 Form 10-K)
10.9 Promissory note, dated January 10, 2001, in the principal amount of
$721,875 between William F. Miller III and Accelerated Claims
Processing, Inc. (Incorporated by reference to Exhibit 10.17(iv) to the
2000 Form 10-K)
10.10 Employment Agreement dated as of March 30, 2001 by and between Health
Management Systems, Inc. and Robert M. Holster (Incorporated by
reference to Exhibit 10.2(i) to Health Management Systems, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended April 30, 2001 (the
"April 2001 Form 10-Q"))
10.11 Stock Option Agreement dated as of March 30, 2001 by and between Health
Management Systems, Inc. and Robert M. Holster (Incorporated by
reference to Exhibit 10.2(ii) to the April 2001 Form 10-Q)
10.12 Stay in Place/Separation Agreement, dated October 31, 2000, between
Health Management Systems, Inc. and William Lucia (Incorporated by
reference to Exhibit 10.12 to Amendment No. 1)
*10.13 Employment Agreement dated as of January 1, 2003 by and between Health
Management Systems, Inc. and William C. Lucia
10.14 Agreement for Financial Management Services, dated June 1, 1999,
between Health Management Systems, Inc. and the County of Los Angeles
(Incorporated by reference to Exhibit 10.13 to Amendment No. 1)
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.15(i) Leases, dated September 24, 1981, September 24, 1982, and January
6, 1986, as amended, between 401 Park Avenue South Associates and
Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.13 to Health Management Systems, Inc.'s Registration
Statement on Form S-1, File No. 33-46446, dated June 9, 1992 and
to Exhibit 10.5 to Health Management Systems, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended January 31, 1994)
10.15(ii)Lease, dated as of March 15, 1996, by and between 387 PAS Enterprises,
as Landlord, and Health Management Systems, Inc., as Tenant
(Incorporated by reference to Exhibit 10.2 to Health Management
Systems, Inc.'s Quarterly Report on Form 10-Q for the quarter
ended July 31, 1996 (the "July 1996 Form 10-Q"))
10.15(iii) Fifth Amendment, dated May 30, 2000 to the lease for the entire
eighth, ninth, and tenth floors and part of the eleventh and
twelfth floor between 401 Park Avenue South Associates, LLC and
Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.1 to Health Management Systems, Inc.'s Quarterly Report
on Form 10-Q for the quarter ended July 31, 2000 (the "July 2000
Form 10-Q"))
10.15(iv) Sixth Amendment, dated May 1, 2000 to the lease for the entire
eighth, ninth, and tenth floors and part of the eleventh and
twelfth floor between 401 Park Avenue South Associates, LLC and
Health Management Systems, Inc. Tenant (Incorporated by reference
to Exhibit 10.2 to the July 2000 Form 10-Q)
10.15(v) Seventh Amendment, dated April 1, 2001 to the lease for the entire
eighth, ninth, and tenth floors and part of the eleventh floor
between 401 Park Avenue South Associates, LLC and Health
Management Systems, Inc. Tenant (Incorporated by reference to
Exhibit 10.1(v) to the April 2001 Form 10-Q)
10.15(vi) Third Amendment, dated May 30, 2000 to the lease for a portion of
the eleventh floor between 401 Park Avenue South Associates, LLC
and Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.3 to the July 2000 Form 10-Q)
10.15(vii) Fourth Amendment, dated May 1, 2000 to the lease for a portion of
the eleventh floor between 401 Park Avenue South Associates, LLC
and Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.4 to the July 2000 Form 10-Q)
10.15(viii) Fifth Amendment, dated May 1, 2003 to the lease for a portion of
the eleventh floor between 401 Park Avenue South Associates, LLC
and Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.1(vi) to the April 2001 Form 10-Q)
10.15(ix) Fifth Amendment, dated May 30, 2000 to the lease for the fourth
floor and the penthouse between 401 Park Avenue South Associates,
LLC and Health Management Systems, Inc. (Incorporated by reference
to Exhibit 10.7 to the July 2000 Form 10-Q)
10.15(x) Sixth Amendment, dated May 1, 2000 to the lease for the fourth
floor and the penthouse between 401 Park Avenue South Associates,
LLC and Health Management Systems, Inc. (Incorporated by reference
to Exhibit 10.8 to the July 2000 Form 10-Q)
10.15(xi) Seventh Amendment, dated March 1, 2001 to the lease for the fourth
floor and the penthouse between 401 Park Avenue South Associates,
LLC and Health Management Systems, Inc. (Incorporated by reference
to Exhibit 10.1(iv) to the April 2001 Form 10-Q)
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.16 (i) Sublease Agreement, dated December 23, 1997, between Health
Management Systems, Inc. and Shandwick USA, Inc. (Incorporated by
reference to Exhibit 10.1 to Health Management Systems, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended January 31,
1998 (the "January 1998 Form 10-Q"))
10.16(ii) Consent to Sublease, dated December 23, 1997, by 387 P.A.S.
Enterprises to the subletting by Health Management Systems, Inc.
to Shandwick USA, Inc. (Incorporated by reference to Exhibit 10.2
to the January 1998 Form 10-Q)
*10.17 Sublease Agreement, dated as of January 2003, between Health
Management Systems, Inc. and Vitech Systems Group, Inc
*21 List of Subsidiaries of HMS Holdings Corp.
*23 Consent of KPMG LLP, independent certified public accountants
*99.1 Certification of Chief Executive Officer
*99.2 Certification of Chief Financial Officer
* Filed herewith.