AMS Averts Financial Disaster in Mississippi

Company Needed to Settle Case Quickly<@VM>Mississippi Wins Apology<@VM>Little Long-Term Damage <@VM>Contractors Beware<@VM>Anatomy of Mississippi v. AMS Inc.

Paul Brands

By William Welsh, Staff Writer

American Management Systems Inc. avoided a financial train wreck last month when it reached a settlement with the state of Mississippi over the company's alleged failure to deliver an automated tax system on schedule.

After a Mississippi jury Aug. 23 ordered AMS to pay $474.5 million in damages for breaching its contract with the state's Tax Commission, the Fairfax, Va.-based company had 10 days to post a bond that analysts estimated would have approached $660 million.

On Aug. 28, AMS and its attorneys settled the case, agreeing to pay the state $185 million over 13 years. AMS will pay about $23.5 million, and the company's two insurance carriers will cover the rest, a company official said.

AMS Chairman and Chief Executive Officer Paul Brands told investors shortly after the verdict that the bond comprised 125 percent of the amount of the award, a 15 percent penalty and 8 percent interest through an appeals process he expected to take two years.

"There was no way that [AMS] could have financially afforded to put the bond together," said Thomas Meagher, vice president of equity research of BB&T Capital Markets, Richmond, Va. For a company with 1999 revenue of $1.24 billion and earnings of $56.9 million, the 10-day deadline for posting the huge bond left little "maneuvering room," he added.

The Mississippi State Tax Commission and Department of Information Services had sued AMS for its work on the State Tax Automated Revenue system. AMS in December 1993 signed an $11.2 million contract with the state to deliver 36 tax applications through an automated and integrated system, but after numerous delays and problems, the state in April 1999 terminated the project and filed suit against AMS, alleging breach of contract and seeking $234 million in actual damages and $750 million in punitive damages.

As for the actual damages, the state claimed $18 million for staff support to the project, $32 million to hire a new contractor and $184 million for lost savings because the state continued to use less efficient methods of compiling and reporting tax payments, collections and refunds.

The state claimed that, despite three attempts in 64 months, AMS had not even launched one of the 36 tax applications promised. AMS, however, said it was on schedule according to the terms of the most recent contract amendment, and was scheduled to go live within 10 days of the termination.

The jury largely agreed with Mississippi, awarding the state $474.5 million for actual and punitive damages.

If AMS had appealed the verdict and lost, this would not necessarily have bankrupted the company, but it "would have been very expensive and would have hung over the company, not for just a quarter, but for many years," said Bill Loomis, managing director of the technology research group Legg Mason Wood Walker Inc., Baltimore.

As evidence of investors' concerns over the jury award that Brands called "of unprecedented magnitude," AMS' stock plummeted 31 percent to $15 from $21.81 the day the verdict was announced. The stock rose $4.50 to $21.31 the day the settlement was announced.

AMS issued a statement saying it will take an after-tax charge of about $23.5 million, or 56 cents per diluted share, in its fiscal third quarter to cover its costs relative to the settlement.

The balance of the $185 million fine will be paid by AMS' insurers, said Mark Andrews, executive vice president and general manager of the company's state and local government group. "We aren't going to have any more cash outlays beyond what is in the [statement]," he said.

AMS is one of the top 10 IT consulting firms in the state and local government marketplace. In the tax and revenue area alone, AMS has completed or is in the process of implementing similar automated tax projects in about 20 states, according to Anne Burt, a company spokesperson.

Ironically, the same day the verdict was returned in Mississippi, the National Association of State Information Resource Executives of Lexington, Ky., announced it had chosen the withholding tax module of AMS' Advantage Revenue product, as implemented as part of an integrated tax system by the state of Kansas, to receive an outstanding achievement in information technology award.

AMS initially planned to appeal the verdict, but the size of the bond and the interest payments it would have to make while the appeal was pending would have strained company resources, analysts said. It is not clear AMS would have succeeded on appeal.

"It is difficult to overturn jury verdicts where they've made findings of fact and where they were properly instructed in the trial court," said Jonathan Cain, an attorney with Mintz, Levin, Cohn, Ferris, Glovsky & Popeo, P.C. in Reston, Va.

In response to persistent questions from investors asking why AMS hadn't settled before going to court, Brands said that pretrial negotiations were in the hands of AMS' insurers and that the parties could not reach a satisfactory settlement.

"The insurance [people] were in the lead. because it was fundamentally their dollars," said Brands in an Aug. 29 conference call with investors to discuss the settlement.

The insurance companies are American International Group Inc. of New York and The Chubb Corp. of Warren, N.J., according to Armin Moeller, a partner at Phelps Dunbar LLP of Jackson, Miss., who represented Mississippi in the case. Officials from AMS and the insurance companies would not confirm that these two insurance companies represent AMS.

The state might have settled before trial if the insurance companies had been willing and if AMS had admitted fault, said Moeller.

"There was refusal [by AMS] to admit in any manner that they had failed to carry out promises made, and that they had done anything wrong despite smoking-gun evidence from their own files," he said.

AIG, the insurance company with the largest amount of coverage at stake, was particularly unwilling to settle beforehand, Moeller said.As part of the settlement, the state also received a letter of apology from Brands to the employees of the State Tax Commission and the Department of Information Technology Services. The Aug. 28 letter states that on the STARS project in Mississippi, AMS "fell short of the high standards of performance that the company has set for itself."

But in his conference call with investors, Brands also asserted that the settlement agreement "expressly provides that AMS was not at fault and did not breach its contract with the state." The settlement also releases each party from any future claims related to the case.

AMS needed to negotiate a quick settlement with the state following the jury's hefty judgment, many legal and industry observers said.

"For a defendant like AMS that has made a large amount of its business doing tax systems, the last thing it wants is to have continuing litigation with one of 50 [possible] customers," Cain said.Business analysts expect no permanent damage to the company's strong reputation in the state and local marketplace and anticipate no adverse affects on its future business prospects arising from the Mississippi incident.

"It may be a short-term deterrent to other states doing business with them, but I think they'll get past that," Meagher said. "In the long term, they'll be fine. They've been a player in this industry for a long time."

"It is not unusual for companies that are in the [state and local] business like AMS to run into problems like this over the course of several years," said Tom Davies, a senior vice president with Current Analysis, Sterling, Va. "The thing is to address it immediately and move on."

Brands was similarly optimistic about his company's prospects.

"It will hurt us to some degree," he said regarding the controversy, "but I am confident that we can clearly move forward and win additional work."

For a company with so much business in the state and local government marketplace, it's hard to see how AMS' momentum might be slowed by the settlement. Many of AMS' state government clients voiced their support for the company throughout the crisis, according to Brands.

As the case dragged on, AMS was diligent about informing clients of the legal developments and disclosing the situation on all of its subsequent procurement activities, Brands said.

If anything, the Mississippi project might force AMS to change its contract arrangement with states, analysts said. Whereas STARS was a fixed-price contract, some of AMS' more recent contract arrangements are benefits-funded contracts.

"Almost without exception, fixed-price contracts are the type that systems integrators have stubbed their toes on in the state and local [marketplace]," said Davies. Although AMS is expected to survive this setback, the lawsuit likely will cause systems integrators to reassess how they draw up their contracts and partnerships with the states, analysts said.

Meagher said some companies may choose not to do business with certain states if the companies are vulnerable to verdicts that are way out of proportion to the size of the contract, as was the case in Mississippi.

"The verdict was outlandish," Loomis said. "I've never seen a verdict like that on a $100 million program, much less a $10 million program."

The verdict and settlement will raise a red flag for the technology services industry and may discourage these companies from doing business with the state of Mississippi, Brands told investors.

In light of the outcome, AMS is now reluctant to do additional work with the Mississippi government, he said.

"It is my suspicion that there will be a very significant amount of interest in this particular case," said Andrews, who observed that as a result of the case, companies will first study the business environment in states where they might do business.

However, Harley Duncan, executive director of the Washington-based Federation of Tax Administrators said he believes it will be business as usual in Mississippi and the rest of the states. He thinks vendors will continue to ask the same questions before bidding on a project as they normally would.

"I don't think it will dissuade people from doing business in Mississippi," he said.

The Mississippi State Tax Commission will receive $30 million of the settlement to fund the automated, integrated tax system, now known as the Phoenix project.

For the most part, the project will be built in-house with the help of consultants if necessary, said Ed Buelow, tax commission chairman.

In a statement announcing the settlement, the Mississippi tax commission and department of IT services said that "contractors with integrity have nothing to fear" from the verdict and settlement. Further, they said that Mississippi is willing to work with any vendor, including AMS.Dec. 13, 1993

The Mississippi State Tax Commission and the Mississippi Department of Information Technology sign a three-year, $11.2 million contract with American Management Systems Inc. to develop the State Tax Automated Revenue System.

April 21, 1998

The first of three times Mississippi notifies AMS that it is in material breach of the STARS contract. The notification also is made Feb. 25, 1999, and March 19, 1999.

Jan. 31, 1999

Withholding 3 is scheduled to be delivered by AMS to the tax commission for testing. Withholding 1 and Withholding 2 were delivered in 1997 and 1998, respectively, but both times AMS and the tax commission amended the contract and revised the project schedule.

April 22, 1999

Mississippi terminates STARS and files a complaint against AMS in the First Judicial District of the Circuit Court of Hinds County, Miss. The state seeks actual damages totaling $234 million and punitive damages totaling $750 million for AMS' alleged failure to fulfill its contractual obligations on STARS. The system was scheduled to go live May 3, 1999, according to AMS. The company had been paid $6 million at the time the contract was terminated.

Aug. 7, 2000

The trial begins for the State of Mississippi v. American Management Systems Inc.

Aug. 23, 2000

The jury awards $299.5 million in compensatory damages and $175 million in punitive damages to Mississippi.

Aug. 28, 2000

AMS and the tax commission reach a negotiated settlement in which AMS agrees to pay $185 million over 13 years. Of this amount, AMS will pay $23.5 million and the AMS' insurance companies will pay the rest.

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