UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

For the transition period from                                        to                                       

Commission File Number: 0-50194

HMS HOLDINGS CORP.

(212) 725-7965
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [   ]

     Aggregate market value of voting stock held by non-affiliates as of September 30, 2004 was $118.6 million.

     The number of shares common stock, $.01 par value, outstanding as of November 2, 2004 was 19,266,679.

HMS HOLDINGS CORP. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

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HMS HOLDINGS CORP. AND SUBSIDIARIES

     See accompanying notes to condensed consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

1. Unaudited Interim Financial Information

     The management of HMS Holdings Corp. (the Company) is responsible for the accompanying unaudited interim condensed consolidated financial statements and the related information included in the notes to the condensed consolidated financial statements. In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments, including normal recurring adjustments necessary for the fair presentation of the Company’s financial position and results of operations and cash flows for the periods presented. Results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.

     These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company as of and for the year ended December 31, 2003 included in the Company’s Annual Report on Form 10-K for such year, as filed with the Securities and Exchange Commission (the SEC).

2. 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 provisions of SFAS No. 123. Accordingly, no employee compensation costs have been recognized for the Company’s stock option plans. 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:

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.

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     In March 2004, the Financial Accounting Standards Board (“FASB”) issued an Exposure Draft of a proposed Statement of Financial Accounting Standards entitled “Share-Based Payment.” This proposed Statement addresses accounting for stock based compensation and would result in stock based compensation costs, including options, being recognized as an expense in the financial statements. The proposed Statement would eliminate the ability to account for stock based compensation transactions using APB Opinion No. 25, and generally would require that such transactions be accounted for using a fair value based method. In October 2004, the FASB voted to delay the effective date of its proposed standard such that if approved, the proposed Statement would be applied prospectively to public entities for awards that are granted, modified or settled in cash in interim or annual periods beginning after June 15, 2005.

3. Basis of Presentation and Principles of Consolidation

     (a) Organization and Business

     HMS Holdings Corp. furnishes revenue recovery, cost containment and business office outsourcing services to healthcare providers and public health care payors. 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. and Accordis Inc.

     (b) 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) Reclassifications

     Certain reclassifications were made to prior period amounts to conform to the current period presentation.

4. Income Taxes

     During the quarter ended September 30, 2004, the Company recognized income tax expense of $35,000, principally an alternative minimum tax liability resulting from the Company’s utilization of existing net operating loss carryforwards (NOLs) to offset current taxable income. The Company did not recognize any change in its net deferred tax assets of $8.9 million. The resultant valuation allowance of $8.2 million at September 30, 2004 is specifically associated with the Company’s 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 management’s estimates of future results of operations after considering the significant changes in the Company’s business represented by its business divestitures, sales of assets, and operational and infrastructure restructurings. 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

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

income to realize its deferred tax assets, net of valuation allowance, based on its projection of future operating results.

5. Earnings Per Share

     Basic income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated by dividing net income by the weighted average number of common shares and dilutive common share equivalents outstanding during the period. The Company had weighted average common shares and common share equivalents outstanding during the three months ended September 30, 2004 and 2003, of 22,264,621 and 20,285,905, respectively. For the three months ended September 30, 2004 and 2003, the Company had weighted average common shares outstanding of 19,213,304 and 18,369,417, respectively. The Company had weighted average common shares and common share equivalents outstanding during the nine months ended September 30, 2004 and 2003, of 22,179,082 and 20,010,826, respectively. For the nine months ended September 30 2004 and 2003, the Company had weighted average common shares outstanding of 19,002,879 and 18,310,934, respectively. For the nine month period ended September 30, 2003, the common share equivalents are not added to the weighted average shares as it would be antidilutive to the per share calculation because the Company incurred a net loss during that period. The Company’s common share equivalents consist of options issued to employees to purchase shares of the Company’s Common Stock.

6. Commitments – Legal Proceedings

     In April 2004, the Company reached an agreement with the United States Attorney’s Office for the Southern District of New York to settle certain matters raised in the course of the United States Attorney’s investigation of medical reimbursement claims submitted to Medicaid and other federal healthcare programs on behalf of a significant client of Accordis. In August 2004, the Company entered into a Stipulation and Order of Settlement and Dismissal Agreement and paid the United States government $1.35 million to settle this matter. At the same time, the qui tam lawsuit against the Company that was the basis of the government’s investigation was dismissed. As part of the settlement agreement, the Company entered into a Compliance Agreement with the Office of the Inspector General for the Department of Health and Human Services. The Compliance Agreement covers a three-year period and principally requires the Company to continue its existing compliance program and to make annual filings certifying compliance.

     The investigation focused on claims submitted since 1982. The issues raised by the government primarily concerned the appropriateness of completing healthcare reimbursement claims with general diagnosis information when specific diagnosis information was not available.

     The Company recorded a charge of $1.7 million in the quarter ended March 31, 2004 to reflect the settlement and related legal and other expenses. During the quarter ended September 30, 2004, all amounts due under the settlement agreement were paid.

     Other legal proceedings to which the Company is a party, in the opinion of the Company’s management, are not expected to have a material adverse effect on the Company’s financial position, results of operations, or liquidity.

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

7. Segment Information

     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 Accordis, or discrete components of the revenue cycle.

     Health Management Systems works on behalf of government healthcare programs to contain costs by recovering expenditures that were the responsibility of a third-party, or that were paid inappropriately. Health Management Systems’ clients include state and county Medicaid programs, their managed care plans, state prescription drug programs, child support enforcement agencies, and other public programs. By assisting these agencies in properly accounting for the services they deliver, Health Management Systems also helps ensure that they receive the full amount of program funding to which they are entitled. The Company measures the performance of its operating segments through “Operating Income (Loss)” as defined in the accompanying Condensed Consolidated Statements of Operations.

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     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.

8. Restructuring

     The following table presents a summary of the activity in accrued liabilities for restructuring charges (in thousands):

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Special Note Regarding Forward-Looking Statements

     This Quarterly Report on Form 10-Q 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 from 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” and other risks identified in our Form 10-K for the year ended December 31, 2003 and presented elsewhere by management from time to time. Such forward-looking statements represent management’s current expectations and are inherently uncertain. Investors are cautioned that actual results may differ from management’s expectations.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

     As there were no changes to our critical accounting policies during 2004, please refer to our Annual Report on Form 10-K for the year ended December 31, 2003 for a summary of our policies.

Current Overview

     Following a strategic review during 2001 to implement a new business plan, divest non-strategic assets and reduce infrastructure and overhead costs, we have concentrated on two operating businesses conducted by our Health Management Systems and Accordis subsidiaries. Our goals have been to strengthen the operational management teams, improve and further develop our service delivery capabilities, clarify our targeted customer bases and how best to reach those audiences, increase revenue through new client acquisition and expansion of opportunities with existing clients, rationalize our cost structure, and develop long-term strategies for the future of the businesses.

     We believe at this time that these initiatives have been largely completed. We are now focused on continued revenue growth and client acquisition, superior execution of service delivery, and on-going maintenance of the appropriate strategic agendas for the future.

     Revenue Considerations

     A macro economic factor benefiting our Health Management Systems business is the rising cost of healthcare, which has contributed to the expansion of entitlement programs such as Medicaid. Medicaid has grown on average approximately 10% per year over the last several years. At the same time, state budgets nationwide continue to be strained by increasing state expenditures. In light of these circumstances and consistent with national business trends, state governments are more receptive to engaging vendors to help in coordination of benefits and cost containment activities, which presents an opportunity in our marketplace for revenue growth.

     Our Accordis business also benefits from the increase in healthcare spending. Healthcare providers, in particular hospitals, struggle to maintain operating margins as costs increase rapidly as the proportion of underinsured and uninsured patients increase. Consistent with national business trends toward outsourcing, we expect to see an increase in the opportunity for business office outsourcing with healthcare providers as they focus on managing their cost infrastructures by concentrating on their core

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missions and taking advantage of opportunities to decrease costs in non-core activities. What remains unknown is whether and how quickly healthcare providers, primarily hospitals, will act on outsourcing their businesses. During the last few years, Accordis has experienced substantial success providing specialized Reimbursement Services to hospitals. These services consist of Medicare Bad Debt reporting, Disproportionate Share reporting, Medicaid Application services, and Medicare Indirect Medical Education Program reimbursement. Also, during the last two years, Accordis has experienced substantial success providing revenue cycle management services to Emergency Medical Transport providers in the form of technology-based billing and collection services designed to optimize reimbursement, improve cash flow and reduce the cost of these functions.

     Most of our client engagements are unique in their scope and the particular needs and environment of the client. As a consequence, we do not have general key performance indicators for our two businesses that we use to measure their success. However, within each client engagement, there are specific metrics and goals that management uses to monitor performance and measure success against the client’s and our own expectations.

     Almost all of our business is on a contingency fee basis whereby we recognize revenue only after our client has received payment from a third-party. In addition, many of the services we perform in both our businesses are project oriented in nature. These projects often recur on an annual basis, but do not necessarily recur on a monthly or quarterly basis. This can lead to significant quarterly variations in revenue and operating results, as our operating expenses are largely fixed on a quarter-to-quarter basis. For a more detailed discussion of risks affecting our business, please refer to our Annual Report on Form 10-K for the year ended December 31, 2003.

     Operating Expenses

     At the beginning of 2003, as a final element of our strategic review and in order to better focus on our two core operating businesses, we implemented a corporate re-organization, placing the Health Management Systems and Accordis operations into separate corporate entities and creating HMS Business Services as a provider of data processing and general and administrative services to these two operating businesses. This action has provided for improved operational and financial management of the two businesses with improved clarity with respect to the financial relationships in each business and their respective operating results, including the charges for services provided by the shared services entity.

     As a service company, 50% to 55% of our operating expenses are compensation related. We adjust our employee headcount based on known business needs and current expectations about the near term future. Based on recent operating results, compensation expense tends to grow with increases in revenue although not on a directly corresponding basis since many employee functions do not require additional staff as revenues increase.

     Direct project expenses are incurred based on the requirements of particular client engagements and include subcontractor costs, temporary labor and other costs directly related to those engagements. Direct project expenses have averaged approximately 17% to 18% of revenue on an annual basis, with quarterly fluctuations of plus or minus 2%.

     Occupancy and data processing expenses have not been substantially impacted by our growth in revenue over the past two years. These are largely infrastructure costs that would only be affected by significant growth or shrinkage in our businesses, or a dramatic change in our operational delivery model.

     Other operating expenses reflect certain costs of doing business such as insurance, legal fees, accounting and tax fees, and costs associated with the requirements of being a publicly traded company. Additional significant components of this category of expense include business expenses for other

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external professional services based on the needs of the operating business, travel and entertainment expenses, employee recruiting, training and activity costs, and miscellaneous office expenses.

     Operating Results

     Aside from the above discussion regarding revenue fluctuations due to our revenue recognition policy and the project nature of some of our business, our operating expenses can increase based on discrete spending activities such as the monetary settlement, legal fees and other expenses we incurred related to the investigation by, and our settlement with, the United States Attorney’s Office.

Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003

     The following table sets forth, for the periods indicated, certain items in our Condensed Consolidated Statements of Operations expressed as a percentage of revenue:

     Revenue for the three month period ended September 30, 2004 was $21.3 million, an increase of $2.6 million or 13.8% compared to revenue of $18.7 million in the prior year quarter.

     Health Management Systems, which provides coordination of benefits and cost containment services to state Medicaid agencies, generated revenue of $10.9 million for the three months ended September 30, 2004, a $2.1 million or 23.6% increase over revenue for the three months ended September 30, 2003 of $8.8 million. This increase primarily reflected an increase of $1.4 million across the comparable client base resulting from 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. 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. Revenue for the current year quarter included $400,000 of revenue from three new customers, and a $300,000 increase with two customers resulting from an expansion in the scope of services provided.

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     Accordis, which provides outsourced business office services for hospitals, generated revenue of $10.4 million for the three months ended September 30, 2004, a $500,000 or 5% increase from $9.9 million for the three months ended September 30, 2003. Prior year revenue reflected the uneven revenue stream of our project-based revenue, resulting in approximately 31% of Accordis’ fiscal year 2003 revenue being recognized in the third quarter of the year. Revenue for the current year quarter included $1.1 million of revenue from six new customers, and a $600,000 increase with three customers resulting from an expansion in the scope of services provided. Revenue for the current year quarter decreased by $900,000 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. There was also a decrease in revenue of $300,000 in the current year quarter associated with four terminated or inactive client relationships.

     Compensation expense as a percentage of revenue was 51.1% for the three months ended September 30, 2004 compared to 51.4% for the three months ended September 30, 2003 and for the current quarter was $10.9 million, an increase of $1.3 million, or 13.3% from the prior year quarter expense of $9.6 million. This increase resulted from headcount growth over the comparable prior year period, a general increase in compensation rates and increased costs of fringe benefits. At September 30, 2004, we had 561 employees, a 14% increase over 494 employees at September 30, 2003.

     Data processing expense as a percentage of revenue was 5.8% for the three months ended September 30, 2004 compared to 6.3% for the three months ended September 30, 2003 and for the current quarter was $1.2 million, which was consistent with prior year quarter.

     Occupancy expense as a percentage of revenue was 6.6% for the three months ended September 30, 2004 compared to 7.3% for the three months ended September 30, 2003 and was $1.4 million for both the current quarter and the prior year quarter.

     Direct project expense as a percentage of revenue was 19.8% for the three months ended September 30, 2004 compared to 17.5% for the three months ended September 30, 2003 and for the current quarter was $4.2 million, an increase of $900,000 or 28.8% from the prior year quarter expense of $3.3 million. A $600,000 increase in Health Management Systems direct project expense primarily resulted from increased subcontractor participation in certain special billing projects completed in the quarter, increased subcontractor requirements to support an existing client, and a general increase in efforts associated with a higher revenue base. A $300,000 increase in Accordis direct project expense primarily resulted from several new Accordis client engagements.

     Other operating costs as a percentage of revenue were 10.0% for the three months ended September 30, 2004 compared to 10.5% for the three months ended September 30, 2003 and for the current quarter were $2.1 million, an increase of $200,000 or 7.9% compared to the prior year quarter expense of $2.0 million. This increase represents expenses related to compliance with the Sarbanes-Oxley Act of 2002, partially offset by reduced consulting fees.

     Costs resulting from the United States Attorney’s investigation as a percentage of revenue were 0.2% for the three months ended September 30, 2004 compared to 1.6% for the three months ended September 30, 2003. Current quarter expenses were $46,000, a decrease of $252,000 compared to the prior year quarter expense of $298,000. Settlement was reached on this matter in April 2004 and reflected in the first quarter of 2004; current quarter expenses consist solely of legal expenses associated with finalizing the settlement.

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     Operating income for the three months ended September 30, 2004 was $1.4 million compared to $1.0 million for the three months ended September 30, 2003. Accordis had an operating loss of $1.0 million for the quarter ended September 30, 2004 compared to an operating loss of $300,000 for the prior year quarter. The increase in Accordis operating loss primarily resulted from the incremental costs associated with new client start-up, partially offset by the reduction in U.S. Attorney costs consistent with the settlement having been reached in April 2004. Health Management Systems had an operating profit of $2.4 million for the quarter ended September 30, 2004 compared to an operating profit of $1.3 million for the quarter ended September 30, 2003 primarily due to the $2.1 million revenue growth partially offset by higher subcontractor and other expense compared to the prior year quarter.

     Net interest and other income was $118,000 for the three months ended September 30, 2004 compared with net interest income of $46,000 for the three months ended September 30, 2003. This increase resulted from a higher yield on short-term investments.

     In 2004, we recognized income tax expense of $35,000, principally an alternative minimum tax liability resulting from our utilization of existing net operating loss carryforwards to offset current taxable income. In 2003, we did not recognize any income tax expense or benefit against our net losses. We have incurred significant taxable losses in the last several years. Most of our deferred income tax assets are in the form of net operating loss carryforwards.

     Net income was $1.5 million in the current year quarter compared with a net income of $1.3 million in the prior year quarter. This increase in net income primarily resulted from increased profit associated with revenue growth in Health Management Systems, partially offset by higher losses incurred by Accordis.

Nine Months Ended September 30, 2004 Compared To Nine Months Ended September 30, 2003

     The following table sets forth, for the periods indicated, certain items in our Condensed Consolidated Statements of Operations expressed as a percentage of revenue:

     Revenue for the nine months ended September 30, 2004 was $61.9 million, an increase of $8.5 million or 15.8% compared to revenue of $53.5 million in the prior year period.

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     Health Management Systems, which provides third party liability identification and recovery services to state Medicaid agencies, generated revenue of $31.3 million for the nine months ended September 30, 2004, a $4.5 million or 16.9% increase over revenue for the nine months ended September 30, 2003 of $26.8 million. This increase primarily reflected an increase of $3.4 million across the comparable client base resulting from 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. 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. Revenue for the current year quarter included $700,000 of revenue from two new customers, and a $400,000 increase with three customers resulting from an expansion in the scope of services provided.

     Accordis, which provides outsourced business office services for hospitals, generated revenue of $30.6 million for the nine months ended September 30, 2004, a $3.9 million or 14.7% increase from $26.7 million for the nine months ended September 30, 2003. Revenue for the current year period increased by $3.1 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. Revenue for the current year period included $2.4 million of revenue from eight new customers, and an $800,000 increase with four customers resulting from an expansion in the scope of services provided. There was also a decrease in revenue of $2.4 million in the current year period associated with seven terminated or inactive client relationships.

     Compensation expense as a percentage of revenue was 52.6% for the nine months ended September 30, 2004 compared to 54.4% for the nine months ended September 30, 2003 and for the current year period was $32.5 million, an increase of $3.4 million, or 11.8% from the prior year period expense of $29.1 million. This increase resulted from headcount growth over the comparable prior year period, a general increase in compensation rates and increased costs of fringe benefits. At September 30, 2004, we had 561 employees, a 14% increase over 494 employees at September 30, 2003.

     Data processing expense as a percentage of revenue was 5.8% for the nine months ended September 30, 2004 compared to 6.7% for the nine months ended September 30, 2003 and was $3.6 million for both the current nine month period and the prior year period.

     Occupancy expense as a percentage of revenue was 6.6% for the nine months ended September 30, 2004 compared to 7.9% for the nine months ended September 30, 2003 and was $4.1 million, a decrease of $100,000 compared to the prior year period expense of $4.2 million. This decrease primarily reflected subletting one floor at our New York City headquarters during the second quarter of 2003.

     Direct project expense as a percentage of revenue was 18.8% for the nine months ended September 30, 2004 compared to 17.9% for the nine months ended September 30, 2003 and for the current period was $11.6 million, an increase of $2.1 million or 21.7% from the prior year period expense of $9.6 million. An increase of $1.7 million in Health Management Systems direct project expense primarily resulted from increased subcontractor participation in special billing projects completed in the current year period, increased subcontractor requirements to support an existing client, and general increases associated with a higher revenue base. A $400,000 increase in Accordis direct project expense primarily resulted from several new Accordis client engagements.

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     Other operating costs as a percentage of revenue were 9.9% for the nine months ended September 30, 2004 compared to 10.3% for the nine months ended September 30, 2003 and for the current period were $6.1 million, an increase of $700,000 or 12.0% compared to the prior year period expense of $5.5 million. This increase represents expenses related to compliance with the Sarbanes-Oxley Act of 2002, utilization of temporary professionals for start-up programming associated with new customers, recruiting fees consistent with new hiring activity, and an increase in travel expenses.

     Costs resulting from the United States Attorney’s investigation as a percentage of revenue were 2.9% for the nine months ended September 30, 2004 compared to 3.7% for the nine months ended September 30, 2003. Current period expenses were $1.8 million, compared to the prior year period expense of $2.0 million. The costs for the current period include the settlement reached with the United States government of approximately $1.35 million with the remaining balance for legal and other settlement expenses. The expenses in the prior year period represented legal and associated expenses only.

     Operating income for the nine months ended September 30, 2004 was $2.1 million compared to an operating loss of $400,000 for the nine months ended September 30, 2003. Accordis had an operating loss of $3.9 million for the nine months ended September 30, 2004 compared to an operating loss of $5.0 million for the prior year period. The reduction in the Accordis operating loss was principally due to incremental profit associated with the $3.9 million increase in revenue and various cost saving measures, together with a $0.2 million reduction in expenses associated with the U.S. Attorney investigation, which was settled in April 2004. Health Management Systems had an operating profit of $6.0 million for the nine months ended September 30, 2004 compared to an operating profit of $4.5 million for the period ended September 30, 2003. The increase in operating profit was primarily due to $4.5 million revenue growth partially offset by higher subcontractor, compensation and other expense compared to the prior year quarter.

     Net interest and other income was $236,000 for the nine months ended September 30, 2004 compared with net interest income of $202,000 for the nine months ended September 30, 2003.

     In 2004, we recognized income tax expense of $35,000, principally an alternative minimum tax liability resulting from our utilization of existing net operating loss carryforwards to offset current taxable income. In 2003, we did not recognize any income tax expense or benefit against our net losses. We have incurred significant taxable losses in 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 income was $2.3 million in the current year period compared with a net loss of $31,000 in the prior year period. This increase in net income resulted from improved operating results in both the Health Management Systems and Accordis businesses.

Off-Balance Sheet Financing Arrangements

     We do not have any off-balance sheet financing arrangements.

Liquidity and Capital Resources

     Historically, our principal sources of funds are operations. At September 30, 2004, our cash, cash equivalents and short-term investments and net working capital were $25.9 million and $37.8 million, respectively. During the quarter ended September 30, 2004, we paid the previously accrued liability resulting from the settlement of the United States Attorney’s investigation of approximately $1.4 million. Although we expect that operating cash flows will be a primary source of liquidity, the current cash and short-term investment balances and working capital position are also fundamental sources of liquidity and capital resources. 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 affected by a decrease in demand for our services. Our typical client relationship, however,

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usually has a duration of several years, and as a result we do not expect any current decrease in demand. We estimate that we will purchase approximately $2.5 million of property and equipment during 2004. 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):

     We have entered into sublease arrangements for some of our facility obligations and expect to receive the following rental receipts (in thousands):

     For the nine months ended September 30, 2004, cash used by operations was $400,000 compared with cash used in operations of $600,000 for the prior year period. The current year period’s difference between the $400,000 cash used by operations and net income of $2.3 million includes depreciation and amortization expense of $1.7 million and increases in accounts payable, accrued expenses and other liabilities of $400,000, which amounts were fully offset by a $5.1 million increase in accounts receivable. The increase in accounts receivable was primarily due to the increase in quarterly revenue and the timing of approximately $3.7 million of cash collections received in the first week of October. During the current year period, cash used in investing activities was $2.2 million, reflecting purchases of property and equipment and investment in software. Cash provided by financing activities was $1.8 million consisting of proceeds received from the exercise of employee stock options.

     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 million. During the nine months ended September 30, 2004, no purchases were made. Cumulatively since the inception of the repurchase program, we have repurchased 1,644,916 shares having an aggregate purchase price of $9.3 million.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

     Our holdings of financial instruments are comprised of state 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.

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     The table below presents the historic cost basis, and the fair value for our investment portfolio as of September 30, 2004, and the related weighted average interest rates by year of maturity (in thousands):

Item 4. Controls and Procedures

     As of September 30, 2004, we carried out an evaluation, under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer and Interim Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based upon that evaluation, our Chairman and Chief Executive Officer and Interim Chief Financial Officer concluded that our disclosure controls and procedures were effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period.

     There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

     In April 2004, we reached an agreement with the United States Attorney’s Office for the Southern District of New York to settle certain matters raised in the course of the United States Attorney’s investigation of medical reimbursement claims submitted to Medicaid and other federal healthcare programs on behalf of a significant client of Accordis. In August 2004, we entered into a Stipulation and Order of Settlement and Dismissal Agreement and paid the United States government $1.35 million to settle this matter. At the same time, the qui tam lawsuit against us that was the basis of the government’s investigation was dismissed. As part of the settlement agreement, we entered into a Compliance Agreement with the Office of the Inspector General for the Department of Health and Human Services. The Compliance Agreement covers a three-year period and principally requires us to continue our existing compliance program and to make annual filings certifying compliance.

     The investigation focused on claims submitted since 1982. The issues raised by the government primarily concerned the appropriateness of completing healthcare reimbursement claims with general diagnosis information when specific diagnosis information was not available.

     We have recorded a charge of $1.7 million in the quarter ended March 31, 2004 to reflect the settlement and related legal and other expenses. During the quarter ended September 30, 2004, all amounts due under the settlement agreement were paid.

     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 6. Exhibits

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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Exhibit Index

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