10-Q 1 a10-q.txt 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ----------- FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO __________ COMMISSION FILE NUMBER 0-27502 ----------- HEALTH SYSTEMS DESIGN CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 94-3235734 (State or other Jurisdiction of (I.R.S. Employer Identification Number) Incorporation or Organization) 1111 BROADWAY, OAKLAND, CALIFORNIA 94607 (Address of principal executive offices) (Zip code) (510) 251-1330 (Registrant's telephone number, including area code) ----------- 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 / / The registrant had 6,756,729 shares of common stock outstanding as of July 31, 2000. Exhibit index is located on page 11 ================================================================================ HEALTH SYSTEMS DESIGN CORPORATION INDEX

1 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HEALTH SYSTEMS DESIGN CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)

2 HEALTH SYSTEMS DESIGN CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS) (UNAUDITED)

3 HEALTH SYSTEMS DESIGN CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)

4 HEALTH SYSTEMS DESIGN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2000 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information on substantially the same basis as the annual audited financial statements. However, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three and nine month period ended June 30, 2000 are not necessarily indicative of the results that may be expected for the year ending September 30, 2000. These consolidated financial statements should be read in conjunction with the financial statements and footnotes thereto for the year ended September 30, 1999 included in the Company's Form 10-K Annual Report. 2. REVENUE RECOGNITION The Company licenses its internally developed software products and other software products directly to end-users and indirectly through remarketers, under the terms of product license contracts. The Company also generates revenues from sales of implementation services, fees for product enhancement, post-contract support, consulting services and training services performed for customers who license the Company's products and reselling hardware and third party products. If the contract does not require significant production or customization of software, license revenue is recognized when all the following conditions are met: a signed contract is obtained, delivery has occurred, the fee is fixed and determinable, and collection is probable. The Company generally recognizes DIAMOND-Registered Trademark- 725 license revenue upon shipment of the software to end users, as no significant production or customization of this software is required, and the installation period is relatively short. The Company generally recognizes DIAMOND-Registered Trademark- 950C/S license revenue on a percentage-of-completion basis based on the labor hours required to implement the system, as this software generally requires an extended installation period and can require significant enhancements. If the software license agreement provides for acceptance criteria that extend beyond the published specifications of the applicable product, then revenues are recognized upon the earlier of customer acceptance or the expiration of the acceptance period. Implementation, consulting and training fees are billed either on an hourly or a monthly basis and are recognized as services are rendered. Third party software and hardware are typically billed and recognized as revenue when delivered to the end user. The Company generally recognizes DIAMOND-Registered Trademark- enhancement revenues on a percentage-of-completion basis based on the labor hours required to complete the applicable release project. Post-contract support services are billed on a monthly basis. Customers who purchase post-contract support services under maintenance agreements have the right to receive unspecified product updates and upgrades. Revenues from post-contract support services are recognized ratably over the term of the support period. If post-contract support services are included free or at a discount in a license agreement, such amounts are recorded at their fair market value based on the value established by independent sale of such post-contract support services to customers and license fee revenue is correspondingly reduced. Customers that do not purchase post-contract support must purchase product updates and upgrades under separate agreements that are subject to the criteria of the Company's revenue recognition policy. 5 3. CAPITALIZED SOFTWARE DEVELOPMENT COSTS The Company accounts for capitalized software costs in accordance with SFAS 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." The Company begins capitalizing software development costs upon the establishment of technological feasibility, which is established upon the completion of a working model or, in the case of major releases, detailed program design. Costs incurred prior to technological feasibility are charged to expense as incurred. Capitalization ceases when the product is considered available for general release to customers. Capitalized software development costs are amortized to direct costs over the estimated economic lives of the software products based on actual sales experience and product life expectancy. Generally, estimated economic lives of the software products do not exceed 3 years. The Company recorded amortization of $711,000 and $319,000 for the three months ended June 30, 2000 and 1999, respectively and $1,534,000 and $810,000 for the nine months ended June 30, 2000 and 1999, respectively. 4. ADOPTION OF NEW ACCOUNTING STANDARDS In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" which is required to be adopted for fiscal quarters beginning after June 15, 2000. Adoption of this pronouncement is not expected to have a material impact on the Company's financial statements taken as a whole. In June 1999, the FASB issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective date of SFAS No. 133" which extended the required adoption date for SFAS No. 133 to fiscal years beginning after June 15, 2000. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. The Company adopted SAB 101 in the first quarter of 2000. The adoption did not have a significant effect on the Company's results of operations or financial position. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Health Systems Design Corporation (the Company) provides health benefits information systems software to a broad range of organizations that administer health benefits. The Company's principal product line, DIAMOND-Registered Trademark- consists of DIAMOND-Registered Trademark- 725 and DIAMOND-Registered Trademark- 950C/S. The Company's principal software products, DIAMOND-Registered Trademark-, enable organizations to manage information about members, employer groups, providers, benefit plans, referrals and authorizations and health care services. DIAMOND-Registered Trademark- supports a wide range of administrative and financial transactions related to provider reimbursement, premium billing, customer service, patient care management and a variety of other functions. The Company's revenues are derived from licensing DIAMOND-Registered Trademark- products, providing the associated implementation, product enhancements, post-contract support, consulting services and training services and reselling hardware and third party products. If there are no uncertainties surrounding a contract, as described by generally accepted accounting principles, then the Company generally recognizes DIAMOND-Registered Trademark- 950C/S license revenue on a percentage of completion basis based on the labor hours required to implement the system. The Company's ability to make individual system sales in a particular period will significantly impact its financial performance in future periods. As the Company has pursued larger system sales (DIAMOND-Registered Trademark- 950C/S), it has seen and expects to continue to see variability in the recognition of system sales revenue. If there are no uncertainties surrounding a contract, as described by generally accepted accounting principles, then the Company generally recognizes DIAMOND-Registered Trademark- 725 license revenue upon shipment of the software to end users. Implementation, post-contract support, consulting fees and training are billed either on an hourly or monthly basis and are recognized as services are rendered. Hardware and third party products are typically billed and recognized as revenues when delivered to the client. Significant portions of system revenues recognized in the nine months ended June 30, 2000 resulted from license sales executed in prior periods. RESULTS OF OPERATIONS REVENUES. Total revenues were $3,951,000 and $7,828,000 for the three months ended June 30, 2000 and 1999, respectively, representing a decrease of 50%. total revenues were $15,241,000 and $20,994,000 for the nine months ended June 30, 2000 and 1999, respectively, representing a decrease of 27%. Two customers accounted for approximately 34% of total revenues for the three months and three customers accounted for approximately 47% of total revenues for the nine months ended June 30, 2000, respectively. Covation LLC represented 17% of total revenues for the nine month ended June 30, 2000, Blue Shield of California represented 18% and 15% and Kaiser Permanente represented 15% and 15% of total revenues for the three and nine months ended June 30, 2000, respectively. The decrease in total revenues is due to lower new system sales in the three and nine months ended June 30, 2000 compared to the same periods in the prior fiscal year. No other customers exceeded 10% of total revenues in the periods presented. In addition, at June 30, 2000, a total of 61% of Accounts Receivable and 46% of Unearned Revenue was related to Covation LLC, Blue Shield of California and Kaiser Permanente. In the nine months ended June 30, 2000, the company experienced a decrease in license and implementation bookings relative to the nine months ended June 30, 1999. The Company expects this slowdown in bookings to have a negative impact on revenues in the future. During the three and nine months ended June 30, 2000, the Company completed billing milestones under several contracts which resulted in a decrease of Unearned Revenue and an increase in Accounts Receivable. SYSTEM SALES. System sales revenues consist of license fees for the Company's products, implementation and enhancement fees, and revenues associated with reselling third-party software and hardware. System sales revenues were $2,693,000 and $6,608,000 for the three months ended June 30, 2000 and 1999, respectively, representing a decrease of 59%. System sales revenues were $11,346,000 and $17,438,000 for the nine months ended June 30, 2000 and 1999, respectively, representing a decrease of 35%. The decrease in system sales revenue is due primarily to lower bookings in prior quarters. SERVICES AND OTHER. Services and other revenues are comprised of system support, consulting and training revenues. Services and other revenues were $1,258,000 and $1,220,000 for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 3%. Services and other revenues were $3,895,000 and $3,556,000 for the nine months ended June 30, 2000 and 1999, respectively, representing an increase of 10%. The increase in services and other revenues was due primarily to an increase in support fees resulting from the Company's larger installed DIAMOND-Registered Trademark- 950C/S customer base partially offset by a decrease in consulting and training revenue. 7 COST OF REVENUES. Cost of revenues was $2,917,000 and $2,965,000 for the three months ended June 30, 2000 and 1999, respectively, representing a decrease of 2%. Cost of revenues was $8,509,000 and $7,637,000 for the nine months ended June 30, 2000 and 1999, respectively, representing an increase of 11%. Cost of revenues increased from 38% of total revenues in the three months ended June 30, 1999 to 74% of total revenues in the three months ended June 30, 2000 and from 36% of total revenues in the nine months ended June 30, 1999 to 56% of total revenues in the nine months ended June 30, 2000. Costs of revenues, as a percentage of total revenues, increased primarily due to the decrease in total revenues and increases in amortization expense and rent. No long-term trend should be implied from either of these periods to period comparisons. OPERATING EXPENSES. GENERAL AND ADMINISTRATIVE. General and administrative expenditures were $1,716,000 and $1,252,000 for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 37%. General and administrative expenditures were $4,616,000 and $4,109,000 for the nine months ended June 30, 2000 and 1999, respectively, representing an increase of 12%. General and administrative expenditures as a percentage of total revenues for the three and nine months ended June 30, 2000 were 43% and 30%, respectively, compared to 14% and 20% for the three and nine months ended June 30, 1999, respectively. The increase in general and administrative expenditures during the period is primarily due to increase in personnel costs and other administrative costs. General and administrative expenses include the salaries and benefits, contractor and other expenses associated with general management, finance and administrations. SALES AND MARKETING. Sales and marketing expenditures were $812,000 and $1,089,000 for the three months ended June 30, 2000 and 1999, respectively, representing a decrease of 25%. Sales and marketing expenditures were $2,570,000 and $3,627,000 for the nine months ended June 30, 2000 and 1999, respectively, representing a decrease of 29%. Sales and marketing expenditures as a percentage of revenues for the three and nine months ended June 30, 2000 were 21% and 17%, respectively, compared to 14% and 17% respectively for the three and nine months ended June 30, 1999. The decrease in sales and marketing expenditures during the period were primarily due to a decrease in commissions, personnel and travel related expenditures. PRODUCT DEVELOPMENT. Product development expenditures, net of software capitalization, were $2,434,000 and $2,149,000 for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 13%. Product development expenditures, net of software capitalization, were $5,707,000 and $6,643,000 for the nine months ended June 30, 2000 and 1999, respectively, representing a decrease of 14%. Product development expenditures as a percentage of revenues for the three and nine months ended June 30, 2000 were 62% and 37%, respectively, compared to 27% and 32%, respectively for the three and nine months ended June 30, 1999. The decrease in product development expenditures during the nine month period ending June 30, 2000 was primarily due to decrease in personnel partially offset by a decrease in capitalization. The increase in product development expenditures during the three month period ended June 30, 2000 was primarily due to a decrease in personnel offset by a decrease in capitalization. The Company believes that product development expenditures are essential to maintaining its competitive position and expects these costs to continue to constitute a significant percentage of total revenues in the near future. The Company capitalized $78,000 and $869,000 of product development costs in the three months ended June 30, 2000 and 1999, respectively. The Company capitalized $1,195,000 and $1,739,000 of product development costs in the nine months ended June 30, 2000 and 1999, respectively. Capitalized product development expenditures as a percentage of total product expenditures were 3% and 29% for the three months ended June 30, 2000 and 1999, respectively. Capitalized product development expenditures as a percentage of total product expenditures were 17% and 21% for the nine months ended June 30, 2000 and 1999, respectively. The increase in product development costs capitalized, for the three and nine months ended June 30, 2000, was due primarily to the stage of development of major releases. The Company begins capitalizing software development costs upon the establishment of technological feasibility, which is established upon the completion of a working model or, in the case of major releases, detailed program design. Costs incurred prior to technological feasibility are charged to expense as incurred. Capitalization ceases when the product is considered available for general release to customers. INTEREST INCOME AND EXPENSE. Interest income, net of interest expense, was $83,000 and $96,000 for the three months ended June 30, 2000 and 1999, respectively. Interest income, net of interest expense, was $250,000 and $305,000 for the nine months ended June 30, 2000 and 1999, respectively. The decrease in interest income, net of expense, was primarily due to the amount of cash invested and interest paid on capital lease obligations. Interest income represents interest earned on the Company's excess cash balances, which are generally placed in short term investments, money market funds, and government securities. PROVISION FOR INCOME TAXES. The provision for income taxes was $7,000 and $22,000 for the three months ended June 30, 2000 and 1999 respectively. The provision for income taxes was $24,000 and $35,000 for the nine months ended June 30, 2000 and 1999 respectively. The decrease in the provision for income taxes for the nine month period ended June 30, 2000 was due to recording higher state taxes than in the prior comparable periods. 8 LIQUIDITY AND CAPITAL RESOURCES Net cash provided by (used in) operating activities was ($3,401,000) and $3,079,000 during the nine months ended June 30, 2000 and 1999, respectively. The increase in cash used by operating activities, as compared to the nine month ended June 30, 1999, resulted primarily from an increased loss, an increase in accounts receivable and a decrease in accrued liabilities partially offset by a decrease in unbilled revenue. Net cash provided by (used in) investing activities was $1,518,000 and ($3,144,000) during the nine months ended June 30, 2000 and 1999, respectively. The increase in cash provided by investing activities, as compared to the nine month ended June 30, 1999, consisted primarily of sales of short-term marketable securities during the current period. Net cash provided by (used in) financing activities was ($177,000) and $106,000 during the nine months ended June 30, 2000 and 1999, respectively. The increase in cash used by financing activities, as compared to the nine month ended June 30, 1999, was primarily due to repayments of capital lease obligations. As of June 30, 2000 and 1999, the Company had cash and cash equivalents in the amounts of $2,116,000 and $9,482,000 respectively. Based upon expense reductions incurred since June 30, 2000, anticipated receivable collections, and various strategic alternatives, the Company believes that available funds and cash flows from operations and short-term marketable securities will be adequate to fund its presently anticipated working capital requirements for at least the next 12 months. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: Statements in this report concerning the future results of operations, financial condition and business of the Company are "forward-looking" statements as defined in the Securities Act of 1933 and the Securities and Exchange Act of 1934. Investors are cautioned that information contained in these forward-looking statements is inherently uncertain, and that actual performance and results may differ materially due to numerous risk factors. Such risks and uncertainties include Healthcare and Government Regulation; risks related to acquisitions; variability of operating results due to the long sales cycle and implementation period of the Company's products; dependence of the Company's results of operations on certain large customers; the Company's dependence on a single product line; the dynamic nature of the market in which the Company's product line competes; development of new products and enhancements to the current product; the Company's ability to attract and retain qualified personnel and other risks described in the Company's other filings with the Securities and Exchange Commission. 9 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 11.1 Statement re: computation of earnings per share 27 Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K have been filed during the quarter for which this report is filed. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Health Systems Design Corporation Date: August 14, 2000 By: /s/ Arthur M. Southam --------------------------- Arthur M. Southam, President and Chief Executive Officer By: /s/ Christopher C. Ohman ---------------------------- Christopher C. Ohman, Executive Vice President and Chief Financial Officer 10 HEALTH SYSTEMS DESIGN CORPORATION INDEX TO EXHIBITS

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HEALTH SYSTEMS DESIGN CORP 10-Q