-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F9K8wvryx5//HFNHEAFNZYXCij2enn8DR4rLNfwd1A6mEYAsauwiQ/3Zqn0xcZTV 6/ZEcAiZtK+r0GkP3rbQPw== 0000950135-97-005202.txt : 19971229 0000950135-97-005202.hdr.sgml : 19971229 ACCESSION NUMBER: 0000950135-97-005202 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971224 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRANSITION SYSTEMS INC CENTRAL INDEX KEY: 0001009301 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-FACILITIES SUPPORT MANAGEMENT SERVICES [8744] IRS NUMBER: 042887598 STATE OF INCORPORATION: MA FISCAL YEAR END: 0928 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-28182 FILM NUMBER: 97744709 BUSINESS ADDRESS: STREET 1: ONE BOSTON PLACE CITY: BOSTON STATE: MA ZIP: 02108 BUSINESS PHONE: 6177234222 MAIL ADDRESS: STREET 1: ONE BOSTON PLACE CITY: BOSTON STATE: MA ZIP: 02108 10-K 1 TRANSITION SYSTEMS 1 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 September 30, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-28182 ------- TRANSITION SYSTEMS, INC. ------------------------ (Exact Name of Registrant as Specified in Its Charter) MASSACHUSETTS 04-2887598 ------------- ---------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification Number) ONE BOSTON PLACE, BOSTON, MASSACHUSETTS 02108 --------------------------------------- ----- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, including Area Code: (617) 723-4222 -------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share 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 the 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. [ ] As of December 22, 1997, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $169,107,122, based on the last sale price of such stock on such date, as reported by the Nasdaq National Market. For purposes of the foregoing calculation, the Company has assumed that each director, executive officer and beneficial owner of 5% or more of the voting stock of the Company is an affiliate. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of December 22, 1997, there were outstanding 17,765,017 shares of common stock, $.01 par value per share (the "Common Stock"), and 356,262 shares of non-voting common stock, $.01 par value per share (the "Non-Voting Common Stock"). DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the registrant's Definitive Proxy Statement for its Annual Meeting of Stockholders to be held on February 10, 1998 are incorporated by reference into Part III of this Annual Report on Form 10-K. 2 PART I ITEM 1A. RISK FACTORS THIS FORM 10-K CONTAINS CERTAIN "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE FORWARD-LOOKING STATEMENTS REPRESENT THE COMPANY'S BELIEFS, EXPECTATIONS AND INTENTIONS CONCERNING FUTURE EVENTS, INCLUDING, WITHOUT LIMITATION, FINANCIAL MATTERS, PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, PRODUCTS AND SERVICES, THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY, AND THE ASSUMPTIONS UNDERLYING SUCH BELIEFS, EXPECTATIONS AND INTENTIONS. THE WORDS "EXPECT," "ANTICIPATE," "INTEND," "PLAN," "BELIEVE," "SEEK," "ESTIMATE" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THIS FORM 10-K ALSO CONTAINS OTHER FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE NOT GUARANTIES OF FUTURE PERFORMANCE, AND INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE THE COMPANY'S FUTURE RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY. MANY OF SUCH FACTORS ARE BEYOND THE COMPANY'S ABILITY TO CONTROL OR PREDICT. READERS ARE ACCORDINGLY CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS. THE COMPANY DISCLAIMS ANY INTENT OR OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS WHETHER IN RESPONSE TO NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. THESE FORWARD-LOOKING STATEMENTS ARE FURTHER QUALIFIED BY IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS, INCLUDING, WITHOUT LIMITATION, THOSE DISCUSSED IN THE FOLLOWING RISK FACTORS. FLUCTUATIONS IN ANNUAL AND QUARTERLY PERFORMANCE. The Company has experienced a seasonal pattern in its operating results, in which the first quarter of each fiscal year typically has the lowest revenue and net income, frequently lower than the last quarter of the previous fiscal year, and the fourth quarter of each fiscal year typically has the highest revenue and net income. The Company believes that this seasonal pattern is attributable in part to its sales compensation programs, which historically have been based on the attainment of fiscal year goals. The Company's revenue can be expected to vary significantly as a result of changes in order backlog, cancellation or postponement of product deliveries, fluctuations in demand for existing products and delays in the implementation of the Company's products, whether caused by the Company or the customer. The Company relies on sales under large contracts of a small number of products to a small number of customers, and the sales cycles for most of the Company's products are long and difficult to predict, resulting in variability of its revenues. The unpredictability of revenues could in any quarter result in a shortfall relative to quarterly expectations. A significant portion of the Company's expenses are relatively fixed and are based in large part on the Company's forecasts of future sales. If revenues are below expectations in any given period, the Company's inability to adjust spending to compensate fully for the lower revenues may magnify the adverse effect of such a shortfall on the Company's operating results. Other factors which may contribute to fluctuations in operating results include: the Company's ability to develop, introduce and market new products and product enhancements and the timing and extent of any market acceptance of such products; the Company's ability to respond to new product introductions and price reductions by its competitors; the timing, cancellation or rescheduling of significant orders; the availability of third-party software provided in conjunction with the Company's products and changes in the cost of such third-party software; the Company's ability to attract, retain and motivate qualified personnel; the timing and amount of research and development and other expenditures by the Company; and general economic conditions. Delays in material payments under customer contracts could adversely affect the availability of funds for the Company and could result in the need for additional borrowing to fund current operations. Additionally, any delays in the Company's performance under these contracts could have a material adverse effect on period-to-period earnings. Accordingly, the Company believes that period-to-period comparisons of results of operations are not necessarily meaningful and should not be relied upon as any indication of future performance. LONG SALES AND IMPLEMENTATION CYCLES. The Company's sales process is often subject to delays associated with the lengthy approval process that typically accompanies a customer's significant capital expenditures. During this process, the Company expends substantial time, effort and funds demonstrating the product, preparing a contract proposal and negotiating the contract. Any failures by the Company to procure a signed agreement after expending significant time, effort and funds could have a material adverse effect on the Company's business, financial condition and results of operations. Even after an agreement has been signed, the implementation of the Company's software products generally requires a significant commitment of resources by the Company and by the customer. Full implementation of the Company's software system at a customer site typically takes from three to twelve months. 2 3 The length of time required to complete an implementation depends on many factors, some of which are outside the control of the Company, including the state of the customer's existing information systems and the customer's ability to commit the personnel and other resources necessary to complete elements of the implementation process for which the customer is responsible. In certain instances, the implementation process has been prolonged substantially as a result of delays attributable to the customer. The Company's agreements with certain of its customers provide for a reduction in the implementation fee if, among other things, the Company fails to meet certain implementation milestones on a timely basis. Delays in implementation of substantial contracts have in the past contributed, and may in the future contribute, to the Company's failure to achieve expected revenue levels in a given quarter. The failure of the Company to maintain timely and cost-efficient implementation procedures could have a material adverse effect on the Company's business, financial condition and results of operations. See "Item 1B. Business -- Sales and Marketing" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON KEY PERSONNEL. The Company's future success depends to a significant extent on its executive officers, including Robert F. Raco, Donald C. Cook and Christine Shapleigh, M.D., who have been with the Company since its inception, and certain other senior operational, technical and sales and marketing personnel. The loss of the services of any of these individuals could have a material adverse effect on the Company's business, financial condition and results of operations. Although each of the three named individuals has signed an employment agreement with the Company which includes non-competition covenants, there can be no assurance that any of these individuals or any other key employee will not voluntarily terminate his or her employment with the Company. The Company believes that its future success will also depend significantly on its ability to attract, motivate and retain additional highly-skilled operational, technical and sales and marketing personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting, assimilating and retaining the personnel required to grow and operate profitably. DEPENDENCE ON A LIMITED NUMBER OF PRODUCTS. The Company expects to derive a significant portion of its revenues in fiscal 1998 and in future years from a limited number of products and services. Most of this revenue is expected to derive from licenses of the Company's core Transition II system and a limited number of other add-on products and services related to Transition II. As a result, the reduction, delay or cancellation of orders for this product would have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON NEW PRODUCTS; TECHNOLOGICAL OBSOLESCENCE. The Company's success has depended and will continue to depend on its ability to develop and introduce new products and enhanced versions of existing products in response to rapidly changing demand for technologically-advanced decision support systems for the health care industry. The development of new and enhanced products for this market is a complex and uncertain process requiring high levels of innovation and accurate anticipation of technological and market trends. There can be no assurance that the Company will be able to innovate, develop or market new products and product enhancements successfully, that any new products or product enhancements will gain market acceptance or that the Company will be able to respond effectively to technological changes or product announcements by competitors. The Company's failure to do any of these things could have a material adverse effect on the Company's business, financial condition and results of operations. INTENSELY COMPETITIVE MARKET. The market for health care information systems and services is intensely competitive and rapidly evolving. The Company competes directly with vendors of decision support systems for health care providers, a number of which are larger than the Company. Other vendors of health care information systems, including vendors currently targeting decision support systems for payors, may enter the markets in which the Company competes. The Company also faces competition from internal management information systems departments of large hospital networks, some of which have developed or may develop financial and clinical outcomes management systems or other cost control solutions. The Company believes that the principal competitive factors influencing the market for its products include vendor and product reputation, product architecture, functionality and features, ease of use, rapidity of implementation, quality of customer support, product performance and price. There can be no assurance that the Company will be able to compete successfully with respect to any of these factors. Moreover, many of the Company's current and prospective competitors have substantially greater financial, technical, managerial, sales, marketing and other resources than the Company and may be able to respond more effectively to new or emerging technologies and changes in customer requirements, initiate or withstand significant price decreases or devote greater resources to the development, promotion and sale of their products than the Company. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase their ability to offer products that address the needs of the Company's customers. New competitors or new alliances among competitors may emerge and quickly acquire market share. Competition may result in significant price reductions, decreased gross margins, loss of market share and reduced acceptance of the Company's products. The Company has on occasion experienced price pressure attributable to competition. There can be no assurance that the Company will be able to compete successfully in the future or that competition will not have a material adverse effect on the 3 4 Company's business, financial condition and results of operations. See "Item 1B. Business -- Research and Product Development" and " -- Competition." CONSOLIDATION AND UNCERTAINTY IN THE HEALTH CARE INDUSTRY. Many health care providers are consolidating to create larger health care delivery enterprises with greater regional market power. Such consolidation could erode the Company's target market. In addition, the resulting enterprises could have greater bargaining power, which could erode the price of the Company's products and services. The reduction in the size of the Company's target market or the failure of the Company to maintain adequate price levels could have a material adverse effect on the Company's business, financial condition and results of operations. The health care industry is also subject to changing political, economic and regulatory influences that may affect the procurement practices and operations of participants in the health care industry. During the past several years, the United States health care industry has been subject to an increase in governmental regulation and reform proposals. These reforms, if enacted, may increase governmental involvement in health care, lower reimbursement rates and otherwise change the operating environment for the Company's customers. Health care industry participants may react to these proposals and the uncertainty surrounding them by curtailing or deferring investments, including those for the Company's products and services. The Company cannot predict with any certainty what impact, if any, such legislative or market-driven reforms could have on its business, financial condition and results of operations. See "Item 1B. Business - -- Industry Background." RISKS ASSOCIATED WITH SIGNIFICANT GOVERNMENT CONTRACT. The Company derived approximately 5.7%, 7.0% and 5.2% of its revenues in fiscal 1995, 1996 and 1997, respectively, from a single contract, with subsequent modifications, entered into with the United States Department of Veterans Affairs (the "VA"). There can be no assurance that the VA will continue to purchase the Company's products and services in similar amounts. Changes in the VA's procurement priorities or significant reductions or delays in procurement of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, the VA cannot make all the payments required under the contract without the appropriation of the necessary funds through the Congressional budget process. Shutdowns of the United States government could lead to delays in the procurement process and could contribute to a failure to appropriate funds. There can be no assurance that the VA will not exercise its contractual right to terminate the contract at will or that the necessary funds will be appropriated. QUALITY ASSURANCE AND PRODUCT ACCEPTANCE. Although the Company devotes substantial resources to producing highly reliable software, the Company's software and third-party software offered by the Company may from time to time contain errors. Any such error could result in a loss of valid data, delay in installation or delay in product releases. Because the reliability of the Company's products is important to its customers, such errors or delays could have a material adverse effect on the continued market acceptance of the Company's products, could expose the Company to claims from customers and third parties and could result in a material adverse effect on the Company's business, financial condition and results of operations. Although the Company's license agreements with customers contain contractual limitations on liability, there can be no assurance that such contractual provisions will provide adequate protection against claims that may be asserted against the Company. DEPENDENCE ON PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT. The Company's ability to compete effectively depends to a significant extent on its ability to protect its proprietary information. The Company relies primarily on copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. The Company has not filed any patent applications with respect to its intellectual property. The Company generally enters into confidentiality agreements with its consultants and employees and generally limits access to and distribution of its technology, software and other proprietary information. Although the Company intends to defend its intellectual property, there can be no assurance that the steps taken by the Company to protect its proprietary information will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. The Company is also subject to the risk of alleged infringement by it of intellectual property rights of others. Although the Company is not currently aware of any material infringement claims with respect to the Company's current or future products, there can be no assurance that third parties will not assert such claims. Any such claims could require the Company to enter into license arrangements or could result in protracted and costly litigation, regardless of the merits of such claims. No assurance can be given that any necessary licenses will be available or that, if available, such licenses can be obtained on commercially reasonable terms. Furthermore, litigation may be necessary to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. See "Item 1B. Business Intellectual Property." DEPENDENCE ON THIRD-PARTY TECHNOLOGY LICENSES. The Company's products are dependent upon licenses from a number of third-party vendors, including Computer Corporation of America (CCA), Oracle Corporation, Sterling Software (United 4 5 States of America), Inc., HealthVISION, Inc. and HCIA Inc. ("HCIA") and Premier, Inc. with respect to certain database management systems ("DBMSs"), other software components and clinical benchmarking data. Most of these licenses expire within one to four years, can be renewed only by mutual consent and may be terminated if the Company breaches the terms of the license and fails to cure the breach within a specified period of time. There can be no assurance that such licenses will continue to be available to the Company on commercially reasonable terms, if at all. The loss of or inability to maintain any of these licenses could result in the discontinuation of, or delays or reductions in, product shipments unless and until equivalent technology is identified, licensed and integrated with the Company's software. Any such discontinuation, delay or reduction would have a material adverse effect on the Company's business, financial condition and results of operations. Most of the Company's third-party licenses, including its license from New England Medical Center, Inc. ("NEMC") for the original version of the Transition I software, are non-exclusive, and there can be no assurance that the Company's competitors will not obtain licenses to and utilize such technology in competition with the Company. There can be no assurance that the vendors of technology utilized in the Company's products will continue to support such technology in its current form, nor can there be any assurance that the Company will be able to modify its own products to adapt to changes in such technology. In addition, there can be no assurance that financial or other difficulties that may be experienced by such third-party vendors will not have a material adverse effect upon the technologies incorporated in the Company's products, or that, if such technologies become unavailable, the Company will be able to find suitable alternatives. RISK OF PRODUCT LIABILITY CLAIMS. Certain of the Company's products provide applications that relate to patient medical histories and treatment plans. Any failure by the Company's products to provide accurate and timely information could result in product liability claims against the Company by its customers or their patients. A successful claim brought against the Company could have a material adverse effect on the Company's business, financial condition and results of operations. Even unsuccessful claims could result in the expenditure of funds in litigation, as well as diversion of management time and resources. To date, no product liability claims have been made against the Company. Nonetheless, there can be no assurance that the Company will not be subject to such claims. RISKS ASSOCIATED WITH IDENTIFYING AND INTEGRATING ACQUISITIONS. The Company intends to grow, in part, through acquisitions of complementary products, technologies and businesses. The Company's ability to expand successfully through acquisitions depends on many factors, including the successful identification and acquisition of products, technologies or businesses and management's ability to integrate and operate the acquired products, technologies or businesses effectively. There is significant competition for acquisition opportunities in the health care information systems industry, which may intensify due to consolidation in the industry. The Company will compete for acquisition opportunities with other companies that have significantly greater financial and managerial resources. There can be no assurance that the Company will be successful in acquiring any complementary products, technologies or businesses or that the Company will be able to integrate successfully any acquired products, technologies or businesses into its current business and operations. The failure to integrate successfully any significant products, technologies or businesses could have a material adverse effect on the Company's business, financial condition and results of operations. RISKS ASSOCIATED WITH GOVERNMENT REGULATORY PROPOSALS. The United States Food and Drug Administration (the "FDA") has promulgated a draft policy for the regulation of certain computer products as medical devices under the 1976 Medical Device Amendments to the Federal Food, Drug and Cosmetic Act (the "FDC Act"). To the extent that particular computer software is determined to be a medical device under the policy, developers and vendors of such software could be required, depending on the product, to: (i) register and list their products with the FDA; (ii) notify the FDA and demonstrate substantial equivalence to other products on the market before marketing such products; or (iii) obtain FDA approval by demonstrating safety and effectiveness before marketing a product. In addition, such products would be subject to the FDC Act's general controls, including those relating to good manufacturing practices and adverse experience reporting. Although it is not possible to anticipate the final form of the FDA's policy, the Company expects that, whether or not the draft is finalized, the FDA is likely to become increasingly active in regulating computer software that is intended for use in health care settings. The FDA, if it chooses to regulate such software, can impose extensive requirements governing pre- and post-market conditions such as device investigation, approval, labeling and manufacturing. Compliance with such requirements, if imposed, could be burdensome, time-consuming and expensive. There can be no assurance that such further regulation, if adopted, will not have a material adverse effect on the Company's business, financial condition and results of operations. 5 6 POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Common Stock has been, and could in the future be, subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by the Company or its competitors, trends in, or changes in priorities with respect to health care spending in the United States and certain other countries and other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices for many high technology companies. These broad market fluctuations may adversely affect the market price of the Common Stock. See "Item 5. Market for Registrant's Common Equity and Related Stockholder Matters--Price Range of Common Stock." EFFECT OF CERTAIN CHARTER AND BY-LAW PROVISIONS AND ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCES OF PREFERRED STOCK. The Company's Articles of Organization, its By-Laws and certain Massachusetts laws contain provisions that may discourage acquisition bids for the Company and that may reduce the temporary fluctuations in the trading price of the Common Stock which are caused by accumulations of stock, thereby depriving stockholders of certain opportunities to sell their stock at temporarily higher prices. The Company's Articles of Organization permit the issuance of shares of Preferred Stock without stockholder approval and upon such terms as the Board of Directors may determine. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of the outstanding stock of the Company. The Company has no present plans to issue any shares of Preferred Stock. ABSENCE OF DIVIDENDS. The Company does not anticipate paying cash dividends on the Common Stock in the foreseeable future. See "Item 5. Market for Registrant's Common Equity and Related Stockholder Matters--Dividends." 6 7 ITEM 1B. BUSINESS Transition Systems, Inc. provides management information technology to hospitals, integrated delivery networks, physician groups and other healthcare organizations. Using TSI products, these organizations are able to increase efficiency, improve quality of care and lower the cost of care delivery. TSI product lines span the health care organization's information technology needs, providing data integration services, master person identifier solutions, disease management products and a clinical data repository as well as enterprise wide financial, operational and clinical decision support in a real time environment. INDUSTRY BACKGROUND Pressure by employers, health insurers and government payors to control health care costs is driving a movement towards managed care and new forms of reimbursement for health care providers. These new managed care reimbursement models, including capitation, case rates, per diems and other fixed payment arrangements, are shifting the financial risk of providing care from payors to providers. Payors are also demanding that providers differentiate their services by demonstrating quality of care. These and other pressures are leading to industry consolidation and the formation of multi-entity provider networks, including integrated delivery networks ("IDNs"). These changes have altered the information needs of health care providers trying to compete in this new environment. Institutions must understand their costs in order to manage the profitability of their clinical processes and their many types of managed care contracts. Institutions also need to be able to compare practice patterns and outcomes of different clinicians or affiliated providers and to monitor utilization and outcomes on a continuous basis. Further, systems must be put in place that help clinicians translate their new understanding of improved care delivery into daily clinical operations. Information tools are required at the point of care that help clinicians improve their overall productivity as well as insure quality and cost effective care. The existing information systems installed in most provider organizations were developed to meet the needs of providers in a fee-for-service environment. These systems are typically transaction-based departmental systems (e.g., laboratory, pharmacy, radiology and nursing) focused on recording billing information for a single department. They are suitable primarily for collecting financial data, rather than for analyzing clinical and operational information. Existing departmental systems generally have been designed to operate as stand- alone systems and typically are limited in their ability to share data. Because these legacy systems do not integrate clinical, operational and financial data across the enterprise, they do not provide the information the Company believes is necessary for managers or clinicians to evaluate the cost of care by patient, clinical specialty or episode of care. Further, these systems were designed mainly to capture charges in a fee-for-service environment, rather than to lower costs, improve utilization and demonstrate quality. THE TSI SOLUTION All TSI products extend the core concepts of management information, accountability and control. These products are based on the foundation of providing information technology tools that enable healthcare organizations to: analyze past clinical, operational and financial practices; model new approaches for the future; transform those models into actionable plans; and, measure actual practice against those plans. Recent additions to the TSI product lines have extended these capabilities to include disease-specific tools that focus on improving the day to day efficiency and effectiveness of care providers as well as the real-time measurement of clinical protocols. TSI products have also expanded to include clinical data repository technology. The focus of TSI products is to empower the enterprise with information that can be used to change and improve the clinical and financial performance of the organization. More than 1,000 healthcare organizations in the United States and abroad have chosen TSI as their information technology solution to support their ongoing improvement efforts. TSI's products are based on an open, three-tiered client/server architecture, providing high flexibility and ease-of-use. TSI's products run in a Windows client environment and support multiple server platforms, including mainframes, AS/400s and UNIX-based systems. PRODUCTS TSI's initial product, Transition I, was introduced in 1985. Since 1985, TSI has developed new products on a regular basis. The 7 8 Company's current product offerings are as follows: TRANSITION II. At the core of the Transition family of products is Transition II, an integrated decision support system designed to provide the clinical, operational and financial information that is needed to manage and improve the delivery of care. Together, the clinical and financial components of Transition II enable an organization to: (i) delineate responsibility and accountability for managing costs; (ii) control resource utilization and reduce costs; (iii) measure variances from rules-based protocols on a daily basis; (iv) manage a mix of complex reimbursement contracts by case or member; (v) analyze and measure quantifiable improvements in the patient care process; and (vi) develop clinical and departmental budgets and variance analyses that adjust for actual volume and mix. Transition II creates a clinical and financial data repository by integrating data from across the enterprise. The system gathers information from the many departmental information systems within the organization through interfaces that enable concurrent updating of distributed data. Transition II analyzes this data in order to determine the patient-level costs of care and identify areas for improvement. This information allows the organization to evaluate its cost structure, make changes in clinical processes to reduce costs and accurately price reimbursement contracts on a profitable basis. Transition II also analyzes and measures clinical process and outcomes data, identifying the practice patterns that most consistently result in the highest quality at the lowest cost. In addition, the system includes capabilities for case mix, reimbursement and utilization management, cost and profitability analysis, strategic planning, modeling and forecasting. ENTERPRISE MANAGER SERIES, formerly known as Transition II for Integrated Delivery Systems. Contains several different components that meet the needs of emerging integrated delivery networks. This product incorporates the functionality of Transition II and extends it across multiple entities. It also adds capabilities designed to meet the special needs of integrated delivery networks, such as analyses focusing on groups of patient-members and their associated health care activities. Different types of members can be categorized, for example, by disease type, age, sex, insurance product or employer. Enterprise Manager Series includes tools to: (i) measure and monitor the cost and quality of care longitudinally and determine where in a provider network appropriate care can be provided most cost effectively; (ii) manage the financial risks of capitation; (iii) provide risk pool accounting and management both centrally and to physician groups; (iv) manage physician panels and determine panel sizing and (v) centrally identify and consolidate multiple patient identifiers across an enterprise and resolve them to a common master patient index. TRANSITION IV. Co-developed with HealthVISION, Inc. This product brings together the HealthVISION real time clinical data repository with the financial and clinical decision support capabilities in Transition II. Transition IV extends the capabilities of Transition II by providing very detailed clinical data on which to base the analysis, clinical plans and performance measurements. The system offers user-defined real time alerts that enable intervention to redirect care. Benefits include: reduction of clinical re-work, more clinically meaningful analysis, real time measurements, incorporation of financial information. The objective of Transition IV is to enhance the quality of care by providing real time information to guide patient care decisions. TRANSITION FOR QUALITY. TSI's Transition for Quality product offers tools that complement the analytical power of Transition II's clinical component and provides on-line case management. With Transition for Quality, an organization can define a broad range of quality issues and identify cases for review and follow up based on outcome measures and variance from critical paths. Using this information, the organization can concurrently monitor the progress and outcomes of cases and intervene in response to automatic alerts. In addition, Transition for Quality provides healthcare organizations with compliance tools to comply with the Joint Commission on Accreditation of Healthcare Organization's Oryx initiative. TRANSITION PERSPECTIVE AND CLINICAL ABCs. These benchmarking products offered in conjunction with Premier Inc. and HCIA, Inc., respectively enable Transition II customers to use external benchmarking data to further support their process improvement efforts. VITAL ONCOLOGY. This product which has been co-developed with the Company's newly acquired entity, Vital Software, automates the clinical processes unique to medical oncology while enhancing the quality of care. Vital Oncology significantly increases the productivity of physicians and nurses, reduces the likelihood for error, and improves patient care. SERVICES AND SUPPORT IMPLEMENTATION ASSISTANCE. Almost all new sales of products and many sales of add-on products include implementation assistance. Implementation is carried out by a team of specialists who oversee the process on-site. Implementation of Transition II typically takes from three to twelve months. 8 9 SOFTWARE MAINTENANCE CONTRACTS. TSI offers software maintenance contracts for all software products. Under these contracts, TSI provides ongoing support, including updates and enhancements to the software modules and telephone access to a Help Desk staffed by an experienced team of support professionals. CONSULTING SERVICES. TSI also offers post-implementation consulting services intended to assist customers in maximizing the benefits available through the use of the Transition family of products. TSI's staff can assess performance of the customer's system and advise the customer on its growing needs. While these services do not currently constitute a major source of revenue, the Company believes they have the potential to grow in importance. INTEGRATION SERVICES. TSI offers data extraction services to develop the conversion protocols necessary to obtain data feeds from an organization's source systems, so as to enable data from these source systems to be integrated with data from TSI applications. Typical extractions are from general ledger, payroll, admission/discharge/transfer, medical records abstracting, patient billing and various departmental systems. CUSTOMERS TSI's customers include a broad range of hospitals, integrated delivery networks, managed care organizations and physician practices in the United States and around the world. The Company's products are installed at more than 1,000 customer sites. TECHNOLOGY TSI has products deployed on both two-tier client/server and three-tier client/server/server architectures. Each of the products utilizes the architecture strategy best suited for the data access requirements inherent to each product. This enables the Company to provide the power and flexibility of distributed data and processing combined with a wide range of user platforms. For example Transition II comprises a broad range of integrated applications that draw from a central repository of patient-level clinical and financial data. It features an open, three-tiered client/server/server architecture that includes, at the client level, a Microsoft Windows-compliant point-and-click interface. The Company believes these features differentiate Transition II from other available decision support products. MULTIPLE PLATFORMS. TSI's products are designed to operate with a variety of hardware platforms, operating systems and database management systems. This strategy enables the Company to provided a practical and affordable solution for small and mid-size group health plans and community hospitals as well as large teaching hospitals and vertically-integrated health care delivery networks. Microsoft Windows (3.1, 95 and NT) is the client standard for all products. Transition II host tier options include IBM 370/390 mainframes running the Model 204 DBMS, IBM AS/400s with DB2/400 and UNIX servers (Hewlett-Packard HP9000 and IBM RS/6000) running the Oracle DBMS. The application tier requires an Intel based processor. The Enterprise Manager Series of products utilizes the Transition II architecture with a SQL Server component for specific population studies. Transition for Quality is offered on both the HP9000 and the RS/6000 running either Oracle or Sybase. Transition IV repository options include UNIX servers (HP9000, RS/6000) running either the Oracle, Sybase or Informix DBMS. The Transition IV application tier is an Intel processor running NT with the SQL Server DBMS. Vital Oncology is an Intel processor running NT with the SQL Server DBMS. THREE-TIERED CLIENT/SERVER/SERVER ARCHITECTURE. Transition II together with the Enterprise Manager Series and benchmarking employs a three-tiered computing architecture in which workstations (clients) and host-servers share the work of managing and processing information. This client/server environment allows a user to realize greater processing efficiency at a lower cost than traditional terminal/host or PC-LAN configurations. The Data Server tier pulls data from an organization's disparate transaction system databases and other data sources and batch processes it daily into a value-added data repository. This tier performs the processing necessary to calculate unit costs, reimbursement, quality indicators and critical path variances. The system incorporates a variety of communications protocols, together with data interfaces developed during the system implementation process, to extract data from the disparate databases throughout an organization in which transactional cost, process and outcomes information is stored, allowing the organization to preserve its existing investment in information technology. The Application Server, the middle tier, performs the value-added data integration, storage and access required to support the clinical and financial analysis of the data. This tier currently runs on file servers compatible with a variety of UNIX and Windows NT 9 10 platforms. This tier relies on direct data feeds from the Data Server tier and provides SQL-compliant database structures to integrate other data sources and to handle ad-hoc queries among all tiers of the architecture. The Client tier performs on-line clinical and financial analysis through a Microsoft Windows-compliant point-and-click interface. The Transition II application was developed using Microsoft's Visual C++ development environment and is compatible with Windows 3.1, 3.11, Windows `95, Windows NT and other operating environments supported by the Microsoft Foundation Classes. The architecture has been expanded to incorporate a Visual Basic rapid development strategy exploiting Microsoft's ActiveX, COM/DCOM and Web enabling directions. With Transition II, there is no need to layer a separate executive information system on top of the application. Instead, Transition II provides a graphical, mouse-driven user interface which allows even inexperienced users to navigate through intuitive screens and windows of information, to select the information to be reviewed at various levels of detail and to transform numerical data into charts and graphs. The system can be customized to set user preferences, display styles and sorting parameters, enabling users to develop their own objects and applications. The system provides tightly coupled interfaces to CCA Model 204, DB2/400 and Oracle databases. Additionally, the Transition II system integrates external data through compliance with the ODBC (Open Database Connectivity) and OLE 2.0 (Object Linking and Embedding) protocols. ODBC provides standard SQL connectivity to a variety of SQL-compliant relational and non-relational databases, while the OLE 2.0 protocol provides a display, update and editing environment for Windows programs such as Microsoft Excel, Microsoft Word and PC SAS. As a result, additional data from a customer's legacy systems can be used in its native form without the need for data import. DECISION SUPPORT OBJECTS. To facilitate use throughout an organization of the information made available by Transition II, the Company has developed Decision Support Objects. Decision Support Objects are graphical, Windows-based mini-applications that simplify the task of navigating through the wealth of data available from the Company's system by selecting, retrieving and analyzing relevant information and presenting it in readily usable graphical, tabular or narrative form. Each Decision Support Object is designed to guide the user through the analysis of a particular clinical, operational or financial issue or problem, without the need to master complex commands or data structures. For example, the Decision Support Object for Physician Analysis enables a clinical manager with limited computer training to examine the resource utilization of groups of physicians at the departmental level or to review practice patterns of individual doctors. TSI believes that its Decision Support Objects provide an important competitive advantage. Other vendors have relied upon executive information system ("EIS") solutions that are separate from the underlying decision support system. EIS products typically extract and summarize data and present it in a graphical format. Because the data is filtered, it is disconnected from the source data, and the user has no control over the level of detail that is accessible. By contrast, with TSI's Decision Support Objects, all data in the system, not just a selected summary, may be accessed. As questions occur to the user, he or she can navigate to any related information, "drill down" through levels of detail to individual transactions, perform statistical analysis and modeling on the data and generate reports in a variety of formats. There are no artificially imposed "walls" to limit the information available to the user. SALES AND MARKETING At September 30, 1997, TSI had a direct sales force of nineteen, consisting of fourteen direct sales persons and five sales management executives organized in three geographic regions covering the United States and Canada. The Company's direct sales and sales management personnel are compensated through salaries plus commissions based on quarterly and annual quotas. TSI also sells through distributors based in New Zealand, Australia, Sweden and the Netherlands. Distributors provide local support for implementations and ongoing maintenance support. In order to better exploit its market opportunities, the Company assigns to each direct sales person responsibility either for new account sales or for add-on sales to the Company's existing client base. The Company believes that dividing the new sales and add-on sales functions has enabled it more effectively to generate revenue from both target market segments. New account sales tend to be more complex and have a longer sales cycle, averaging six to twelve months, while add-on sales typically have a shorter sales cycle but may require more detailed and specific product knowledge. The Company uses periodic newsletters and press releases, participation in trade shows, direct mail and telemarketing to generate and pursue leads. Company employees also speak at health care industry conferences and publish case studies and articles. The Company sponsors annual user group conferences at which customers can learn about the Company's new product offerings and exchange information about their own experiences with TSI's products. The Company's May 1997 user group conference attracted approximately 1,300 attendees. 10 11 BACKLOG At September 30, 1996 and 1997, the Company's backlog was $16.4 million and $17.5 million, respectively. The Company includes in backlog all unrecognized revenue attributable to signed contracts for software sales and implementation and deferred revenue associated with maintenance contracts. The Company had $6.0 million and $7.1 million of deferred revenue associated with maintenance contracts at September 30, 1996 and 1997, respectively. Of its backlog of $17.5 million at September 30, 1997, the Company estimates that approximately 90% will be recognized as revenue during the twelve-month period following such date. There can be no assurance, however, that orders included in backlog will generate revenues in the amount estimated or that such revenues will be recognized during the specified twelve-month period. COMPETITION The market for health care information systems and services is intensely competitive and rapidly evolving. The Company competes directly with other vendors of decision support systems to health care providers. Other vendors of health care information systems, including vendors currently targeting decision support systems for payors, may enter the markets in which the Company competes. The Company also faces competition from internal management information systems departments of large hospital networks, many of which have developed or may develop financial and clinical outcomes management systems or other cost control solutions. The Company believes that the principal competitive factors influencing the market for its products include vendor and product reputation, product architecture, functionality and features, ease of use, rapidity of implementation, quality of customer support, product performance and price. Competition may result in significant price reductions, decreased gross margins, loss of market share and lack of acceptance of the Company's products. There can be no assurance that the Company will be able to compete successfully in the future or that competition will not have a material adverse effect on the Company's business, financial condition and results of operations. See "Item 1A. Risk Factors--Competition." RESEARCH AND PRODUCT DEVELOPMENT The Company's products consist primarily of internally-developed software. In addition, the Company has incorporated in its products DBMSs, graphical user interfaces, and other software developed by third-party vendors. The Company believes that the timely development of new products and enhancements to existing products is essential to maintaining its competitive position in the market and positioning itself as an innovator. Since the Company's inception in 1985, TSI has developed and released functionality upgrades as well as new products on a yearly basis. The Company's current research and development efforts include expanding the capabilities of Transition IV and expanding the Vital Oncology product to additional disease specific applications. In addition, enhancements are planned for the core Transition II and Transition for Quality products. A key strategic initiative focus on the incorporation of OLAP based analytical reporting throughout the suite of products. The Company's research and development activities are conducted in its Boston office. As of September 30, 1997, its research and development staff consisted of 51 employees. The Company's total research and development expenditures were $3.6 million, $4.0 million and $4.6 million in fiscal 1995, 1996 and 1997, respectively. Capitalized software as a percentage of total research and development expenditures has declined from 19.7% in 1995 to 17.5% in 1996 and 15.3% in 1997. In each of fiscal 1995, 1996 and 1997, the Company capitalized $0.7 million of software development costs while amortization of capitalized development costs in such years amounted to $0.8 million, $0.8 million and $0.7 million respectively. INTELLECTUAL PROPERTY The Company's ability to compete effectively depends to a significant extent on its ability to protect its proprietary information. The Company relies primarily on trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. The Company generally enters into confidentiality agreements with its consultants, key employees and sales representatives and generally controls access to and distribution of its software and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization or to develop similar technology independently. Although the Company intends to defend its intellectual property, there can be no 11 12 assurance that the steps taken by the Company to protect its proprietary information will be adequate to prevent misappropriation of its intellectual property or that the Company's competitors will not independently develop software that is substantially equivalent or superior to the Company's software. The Company is subject to the risk of alleged infringement by it of the intellectual property rights of others. Although the Company is not currently aware of any material infringement claims with respect to the Company's current or future products, there can be no assurance that third parties will not assert such claims or that any such claims will not require the Company to enter into license arrangements or result in protracted and costly litigation, regardless of the merits of such claims. No assurance can be given that any necessary licenses will be available or that, if available, such licenses can be obtained on commercially reasonable terms. Furthermore, litigation may be necessary to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. See "Item 1A. Risk Factors -- Dependence on Proprietary Technology; Risk of Infringement." EMPLOYEES As of September 30, 1997, the Company had 192 full-time employees, including 90 in operations, 51 in research and development, 34 in sales and marketing and 17 in general administration and finance. The Company believes its future success will depend in large part upon the continued service of its key technical and senior management personnel and upon the Company's continuing ability to attract and retain highly-qualified technical and managerial personnel. Competition for highly-qualified personnel is intense and there can be no assurance that the Company will be able to retain its key managerial and technical employees or that it will be able to attract and retain additional highly-qualified technical and managerial personnel in the future. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppage and considers its relationships with its employees to be good. ITEM 2. PROPERTIES The Company's principal offices occupy approximately 27,000 square feet of office space in Boston, Massachusetts under a lease expiring in August 2000. The Company also leases space for sales offices in Arizona, California, Georgia, Illinois, Pennsylvania and Texas. The Company believes that its existing facilities will be adequate to meet its currently anticipated requirements and that, if additional space is needed, such space will be available on acceptable terms. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material litigation, and is not aware of any pending or threatened litigation that would have a material adverse effect on the Company or its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's stockholders during the fourth quarter of the fiscal year ended September 30, 1997. 12 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK Since April 18, 1996, the Company's Common Stock has been publicly traded on the Nasdaq National Market under the symbol "TSIX." The following table sets forth, for the quarterly periods indicated, the high and low sale price per share of Common Stock as reported on the Nasdaq National Market:
HIGH LOW ---- --- Fiscal Year ended September 30, 1997: First Quarter $22.00 $ 8.25 Second Quarter $16.63 $11.75 Third Quarter $18.25 $ 9.00 Fourth Quarter $21.75 $16.88
HOLDERS OF RECORD As of December 16, 1997, there were 36 holders of record of the Common Stock and one holder of record of the Non-Voting Common Stock. The number of record holders of the Common Stock is not representative of the number of beneficial holders because many shares are held by depositories, brokers or other nominees. DIVIDENDS The Company has never declared or paid any cash dividends on its Common Stock. The Company's bank line of credit generally prohibits the payment of cash dividends to stockholders. Also, the Company currently intends to retain its earnings, if any, to fund its business and therefore does not anticipate paying cash dividends in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES The following information is furnished with regard to all securities sold by the Company during the fiscal year ended September 30, 1997 which were not registered under the Securities Act: On September 19, 1997, in conjunction with the Company's acquisition of Vital, the Company issued to the stockholders of Vital an aggregate of 252,003 shares of Common Stock. The issuance was made in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933, as amended, relating to the sales by an issuer not involving a public offering. 13 14 ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data of the Company set forth below have been derived from the Company's consolidated financial statements for the periods indicated. This selected consolidated financial data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and the notes thereto included elsewhere in this Form 10-K. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
FISCAL YEAR ENDED ------------------------------------------------------------------------- SEPTEMBER 30, September 30, September 30, September 24, September 25, 1997 1996 1995 1994 1993 ------------------------------------------------------------------------- Revenue $44,565 $34,269 $27,386 $24,497 $16,884 Income before income taxes and extraordinary items 12,948 10,611 9,975 8,521 2,363 Provision for income taxes 7,629 4,324 4,349 3,407 945 Net income before extraordinary item 5,319 6,287 5,626 5,114 1,418 Extraordinary item: Loss on early extinguishment of debt - 2,149 - - - Net income 5,319 4,138 5,626 5,114 1,418 Series A non-voting preferred stock dividends - 593 - - - Net income allocable to common stockholders $ 5,319 $3,545 $ 5,626 $ 5,114 $ 1,418 ------- ------- ------- ------- ------- Total assets $89,819 $74,284 $27,737 $20,274 $17,040 Working capital 63,568 55,672 14,207 8,207 6,082 Long-term debt - 21 - - 1,000 Stockholders' equity $73,519 $60,633 $16,192 $10,566 $ 6,923
(1) The Company has never declared or paid cash dividends on the Common Stock. 14 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS DISCUSSION AND ANALYSIS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS REPRESENT THE COMPANY'S BELIEFS, EXPECTATIONS AND INTENTIONS CONCERNING FUTURE EVENTS, INCLUDING, WITHOUT LIMITATION, FINANCIAL MATTERS, PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, PRODUCTS AND SERVICES, THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY, AND THE ASSUMPTIONS UNDERLYING SUCH BELIEFS, EXPECTATIONS AND INTENTIONS. SUCH STATEMENTS ARE NOT GUARANTIES OF FUTURE PERFORMANCE, AND INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE THE COMPANY'S FUTURE RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY. MANY OF SUCH FACTORS ARE BEYOND THE COMPANY'S ABILITY TO CONTROL OR PREDICT. READERS ARE ACCORDINGLY CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS. THE COMPANY DISCLAIMS ANY INTENT OR OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS WHETHER IN RESPONSE TO NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. THESE FORWARD-LOOKING STATEMENTS ARE FURTHER QUALIFIED BY IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS, INCLUDING, WITHOUT LIMITATION, THOSE DISCUSSED IN "ITEM 1A. RISK FACTORS" ON THE COMPANY'S ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION FOR THE YEAR ENDED SEPTEMBER 30, 1997. OVERVIEW The Company provides management information technology to hospitals, integrated delivery networks, physician groups and other health care organizations. The Company's product lines span the health care organization's information technology needs, providing enterprise-wide financial and clinical decision support, data integration services, disease management products and master person identifier solutions as well as a clinical data repository. The Company was founded in 1985 and has been profitable in each fiscal year since 1987. The Company's revenues are derived from sales of software licenses and related implementation services and of software maintenance. The software and implementation revenues associated with the licensing and installation of the Company's products at an individual customer site typically range from $0.1 million to $1.2 million. Software maintenance contracts are sold separately at the time of the initial software license sale and are generally renewable annually. Annual software maintenance fees range from 15% to 18% of the initial software license fee for the product and provide a source of recurring revenue for the Company. Software and implementation revenues are accounted for using the percentage of completion method, and revenue is recognized as contract milestones are reached. The implementation process generally takes from three to twelve months. The length of time required to complete an implementation depends on many factors outside the control of the Company, including the state of the customer's existing information systems and the customer's ability to commit the personnel and other resources necessary to complete elements of the implementation process for which the customer is responsible. Revenue attributable to a contract milestone is recognized upon certification by the customer that the milestone has been met. As a result, the Company may be unable to predict accurately the amount of revenue it will recognize in any period in connection with the sale of its products. The payment terms of a contract may provide that the amount of the contract price that the Company is entitled to bill upon achievement of a milestone is less than the revenue recognized by the Company in connection with the achievement of that milestone. In such cases, the excess of the revenue recognized over the amount billed is included in accounts receivable as an "unbilled account receivable." Software maintenance fees, which are generally received annually in advance, are recorded as deferred revenue on the Company's balance sheet and are recognized as revenue ratably over the life of the contract. See Notes 2 and 3 of Notes to Consolidated Financial Statements. Cost of software and implementation revenue consists primarily of the cost of third-party software that is resold by the Company or included in the Company's products; personnel costs, the cost of related benefits, travel and living expenses, costs of materials and other costs related to the installation and implementation of the Company's products; and amortization of capitalized software development costs. Cost of maintenance revenue consists primarily of maintenance fees payable by the Company associated with the third-party software included in the Company's products and personnel costs incurred in providing maintenance and technical support services to the Company's customers. 15 16 The Company's research and development expenses consist primarily of personnel-related costs, including employee salaries and benefits and payments to consultants. The Company capitalizes certain software development costs in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Capitalized software costs are amortized over the life of the product (generally three years) and amounts amortized are included in cost of software and implementation revenue. Capitalized software as a percentage of total research and development expense has declined from 19.7% in fiscal 1995 to 17.6% in fiscal 1996 and 15.3% in fiscal 1997. In each of fiscal 1995, 1996 and 1997 the Company capitalized $0.7 million of software development costs, while amortization of capitalized software development costs in such years amounted to $0.8 million, $0.8 million and $0.7 million respectively. In January 1996, the Company repurchased from New England Medical Center and the other stockholders of the Company 87.4% of the shares of common stock then issued and outstanding on a fully diluted basis for an aggregate purchase price of approximately $111.4 million (the "Recapitalization"). The principal purpose of this transaction was to provide liquidity for the existing stockholders of the Company while permitting them to retain an ownership interest in the Company. The transaction has been accounted for by the Company as a leveraged recapitalization. To finance the repurchase of these shares, the Company issued to Warburg, Pincus Ventures, L.P. and NationsBank Investment Corporation ("NIC") shares of preferred stock for an aggregate of $55.0 million. The Company also issued to NIC Senior Subordinated Notes in the aggregate principal amount of $10.0 million and a related warrant and made borrowings of $40.0 million under a term loan and a revolving credit facility. In April 1996, the Company completed an initial public offering of 6,900,000 shares of its common stock, which generated net proceeds of $114.4 million. The outstanding balance of these borrowings was repaid in full and all outstanding Series A non-voting preferred stock was redeemed upon the closing of the initial public offering. On July 22, 1996, the Company acquired substantially all of the outstanding stock and a note held by a selling principal of Enterprising HealthCare, Inc. ("Enterprising HealthCare"), based in Tucson, Arizona, for a total purchase price of approximately $1.8 million in cash. Enterprising HealthCare provides system integration products and services for the health care market. The acquisition was accounted for under the purchase method with the results of Enterprising HealthCare included from July 22, 1996. Purchased technology costs of $1.6 million are being amortized on a straight-line basis over seven years. Pro forma results of operations have not been presented, as the effect of this acquisition on the financial statements was not material. On January 31, 1997 the Company acquired a 19.5% ownership interest in HealthVISION, Inc. ("HealthVISION") for $6 million in cash. HealthVISION, is a provider of electronic medical record software based in Santa Rosa, California. The Company holds an option to purchase the remaining outstanding shares of HealthVISION. This option expires on December 31, 1998. On September 19, 1997, the Company acquired all outstanding shares of Vital Software Inc. ("Vital"), a privately held developer of products that automate the clinical processes unique to medical oncology. The purchase price was approximately $6.3 million, which was comprised of $2.7 million in cash and 252,003 shares of the Company's common stock with a value of $3.6 million. The purchase price was allocated entirely to purchased research and development. The purchased research and development, which had not reached technological feasibility and which had no alternative future use, was valued using a risk adjusted cash flow model, under which expected future cash flows associated with in-process research and development were discounted considering risks and uncertainties related to the viability of and potential changes in future target markets and to the completion of the products that will be ultimately marketed by the Company. Purchased research and development, which is not deductible for tax purposes, was charged to operations at the acquisition date. Vital's operating results have not been included in the consolidated financial statements from the date of acquisition due to immateriality. The Company changed its fiscal year end from the last Saturday of September of each year to September 30. The change was effective with the three months ended June 30, 1996. 16 17 RESULTS OF OPERATIONS The following table sets forth certain revenue and expense data as a percentage of the Company's total revenues for each period presented:
SEPTEMBER SEPTEMBER SEPTEMBER 30, 1997 30, 1996 30, 1995 - ------------------------------------------------------------------------------- Revenues: Software and implementation 74.1% 72.5% 72.6% Maintenance 25.9 27.5 27.4 ----- ----- ----- Total revenues 100.0 100.0 100.0 ----- ----- ----- Cost of revenues: Software and implementation 23.2 21.4 22.7 Maintenance 6.4 9.2 8.5 Research and development 8.7 9.7 10.5 Sales and marketing 15.5 13.2 14.8 General and administrative 8.7 6.9 8.6 Compensation charge - 8.8 - Acquired in-process research and development 14.1 - - ----- ----- ----- Total operating expenses 76.6 69.2 65.1 ----- ----- ----- Income from operations 23.4 30.8 34.9 Net interest income 5.6 0.2 1.5 ----- ----- ----- Income before income taxes and extraordinary item 29.0 31.0 36.4 Provision for income taxes 17.1 12.6 15.9 ----- ----- ----- Net income before extraordinary item 11.9 18.4 20.5 Extraordinary item: Loss on early extinguishment of debt, net of taxes - 6.3 - ----- ----- ----- Net income 11.9 12.1 20.5 Series A non-voting preferred stock dividends - 1.7 - ----- ----- ----- Net income allocable to common stockholders 11.9% 10.4% 20.5% ===== ===== =====
FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996 Revenues. The Company's total revenues increased 30.0% to $44.6 million in 1997, from $34.3 million in 1996. Software and implementation revenues grew 32.8% to $33.0 million in 1997, compared to $24.9 million in 1996. The growth in software and implementation revenue is primarily due to sales to new TSI customers, increased consolidation among existing customers which resulted in the sale of additional site licenses, and the expansion of TSI's product line which resulted in increased product sales to existing customers. Maintenance revenue grew 22.7% to $11.5 million in 1997, compared to $9.4 million in 1996, due to continued growth in the Company's installed base of customers. Cost of revenues. Cost of software and implementation revenue increased 40.5% to $10.3 million (or 31.2% of software and implementation revenue) in 1997, from $7.3 million (or 29.5% of software and implementation revenue) in 1996. The dollar increase is primarily due to costs associated with additional implementation staff and professional consultants as well as increased royalty costs for third-party software. Cost of maintenance revenue decreased 10.4% to $2.8 million (or 24.6% of maintenance revenue) in 1997 from $3.2 million (or 33.6% of maintenance revenue) in 1996. The decrease in cost of maintenance revenue is primarily due to the reduced technical support necessary on mature products. Research and development. Research and development expenses increased 17.0% to $3.9 million in 1997 from $3.3 million in 1996. The increase in spending is primarily a result of organizational changes which resulted in a net increase in the number of staff assigned to research and development roles. Research and development expenses as a percent of total revenue decreased slightly to 8.7% in 1997, compared to 9.7% in 1996. The decrease is primarily due to increased productivity from investments in technologies made in prior years and maturing of the core product lines. The Company expects that research and development expenses will increase as a percentage of revenue in future periods as new development projects are undertaken. Sales and Marketing. Sales and marketing expenses increased 53.6% to $6.9 million in 1997, from $4.5 million in 1996. Sales and marketing expenses as a percent of total revenue also increased to 15.5% in 1997 from 13.2% in 1996. The increase in spending is primarily due to additional staff and marketing programs as well as increased commission expense directly related to the growth in revenue. 17 18 General and Administrative. General and administrative expenses increased 64.2% to $3.9 million in 1997, from $2.4 million in 1996. General and administrative expenses as a percent of total revenue also increased to 8.7% in 1997 from 6.9% in 1996. The increase in spending is primarily due to professional services and other costs associated with becoming a publicly traded company as well as additional administrative expenses related to Enterprising HealthCare, which was acquired in July 1996. Acquired In-Process Research and Development. Acquired in-process research and development expense includes a charge for purchased research and development of $6.3 million relating to the acquisition of Vital in September 1997. Net Interest Income. Net interest income increased to $2.5 million in 1997 from $0.1 million in 1996. The increase in net interest income is primarily due to the repayment out of the proceeds of the Company's initial public offering in April 1996 of debt incurred in the January 1996 Recapitalization and interest earned on cash balances generated from operations and the balance of the proceeds of the Company's initial public offering. Provision for Income Taxes. The Company's effective income tax rate increased to 58.9% in 1997 from 40.6% in 1996, primarily due to the effect of the charge for in-process research and development associated with the acquisition of Vital, which is not deductible for tax purposes. The tax rate for 1997 without the effect of the charge for in-process research and development was 39.7%. FISCAL YEARS ENDED SEPTEMBER 30, 1996 AND SEPTEMBER 30, 1995 Revenues. The Company's total revenues increased 25.1%, from $27.4 million in fiscal 1995 to $34.3 million in fiscal 1996. Software and implementation revenue increased 25.1%, from $19.9 million in fiscal 1995 to $24.9 million in fiscal 1996. The increase in software and implementation revenue was due primarily to growth in sales to integrated delivery systems and increased penetration of the small hospital market through sales of the Company's AS/400 and UNIX products. Maintenance revenue increased 25.3%, from $7.5 million in fiscal 1995 to $9.4 million in fiscal 1996, due to continued growth in the Company's installed base. Cost of Revenues. Cost of software and implementation revenue increased 18.1%, from $6.2 million (or 31.3% of software and implementation revenue) in fiscal 1995 to $7.3 million (or 29.5% of software and implementation revenue) in fiscal 1996. The increase in cost of software and implementation revenue was attributable to higher royalty costs associated with third-party software, due to a greater proportion of revenue generated from the AS/400, UNIX and Clinical ABCs products, which have a higher content of third-party software, and to growth in the Company's implementation staff. Cost of maintenance revenue increased 35.3%, from $2.3 million (or 31.1% of maintenance revenue) in fiscal 1995 to $3.2 million (or 33.6% of maintenance revenue) in fiscal 1996. The increase was attributable to higher third-party software maintenance costs and to growth in the Company's support staff. Research and Development. Research and development expense increased 15.6%, from $2.9 million (or 10.5% of total revenues) in fiscal 1995 to $3.3 million (or 9.7% of total revenues) in fiscal 1996. The increase in expense relates to the Company's continued development of its current products and to the development of new products. Sales and Marketing. Sales and marketing expense increased 10.9%, from $4.1 million (or 14.8% of total revenues) in fiscal 1995 to $4.5 million (or 13.2% of total revenues) in fiscal 1996. The increase was primarily related to the increased costs associated with larger sales and sales support staffs and commission expenses resulting from higher sales levels. General and Administrative. General and administrative expenses remained relatively unchanged at $2.4 million in each of fiscal 1995 and fiscal 1996 (8.6% and 6.9% of total revenues in such years, respectively). As a percentage of revenue, general and administrative expenses declined in 1996 due to reduced accruals for bonuses and continued control over spending. Other Operating Expenses. Other operating expenses in fiscal 1996 included a compensation charge of $3.0 million arising from the acquisition by the Company, in connection with the January 1996 Recapitalization, of shares of common stock issued to certain executive officers pursuant to the exercise of options. Net Interest Income. Net interest income decreased from $0.4 million in fiscal 1995 to $0.1 million in fiscal 1996. The decrease in net interest income was due to the increase in interest expense attributable to the indebtedness incurred in the Recapitalization, prior to its repayment in April 1996, which offset the interest income earned on the net proceeds generated by the Company's initial public offering. Provision for Income Taxes. The Company's effective income tax rate decreased from 43.6% in fiscal 1995 to 40.6% in fiscal 1996 due to certain provisions taken in the prior year. Extraordinary Item. During fiscal 1996 the Company incurred an extraordinary loss of $2.1 million representing the after-tax effect of the write-off of $3.6 million of unamortized capitalized financing costs attributable to indebtedness 18 19 incurred in the Recapitalization that was repaid out of the proceeds of the Company's initial public offering. Preferred Stock Dividend. The holders of the Series A preferred stock issued in connection with the Recapitalization were entitled to receive, when and as declared by the Board of Directors, out of funds legally available therefore, preferential cumulative dividends at the rate of 12% per annum. The Company was not obligated to pay dividends prior to the redemption of the Series A preferred stock, and no dividends were declared by the Board. The Series A preferred stock was subject to mandatory redemption, provided funds were legally available therefore, upon the closing of an initial public offering, or the sale of the Company, but in no event later than January 2006. Upon the closing of the Company's initial public offering, at which time funds became legally available for the redemption of the Series A preferred stock and payment of dividends, the Company redeemed in full the Series A preferred stock and accrued and paid dividends thereon from the date of the Recapitalization. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1997, the Company had cash and cash equivalents of $58.5 million, an increase of $7.0 million from the amount at September 30, 1996. The Company's working capital at September 30, 1997 was $63.6 million, an increase of $7.9 million from the amount at September 30, 1996. The increase in working capital is primarily attributable to the increase in cash of $7.0 million. The increase in cash and cash equivalents was comprised primarily of net cash provided by operating activities of $16.2 million offset by net cash used by investing activities of $10.5 million. Net cash provided by operating activities in fiscal 1997 was generated primarily from net income before the charge for in-process research and development of $6.3 million associated with the acquisition of Vital. The net cash used by investing activities was attributable primarily to two transactions made by the Company during 1997. On January 31, 1997, the Company acquired a 19.5% equity interest in HealthVISION for $6.0 million in cash. On September 19, 1997, the Company acquired all outstanding shares of Vital. The purchase price was approximately $6.3 million, which was comprised of $2.7 million in cash and 252,003 shares of the Company's common stock with a value of $3.6 million. The Company has an unsecured revolving line of credit in the amount of $15 million. The credit facility contains covenants setting minimum net worth, maximum leverage ratio and minimum net income requirements for the Company. There have been no amounts drawn on this line. Advances under the revolving line of credit bear interest, at the Company's election, either at a "base rate" or at a "eurodollar rate." The base rate is a floating rate equal to the greater of (a) the prime rate or (b) the federal funds effective rate plus one-half of one percent (.50%). The eurodollar rate is equal to the sum of (x) a rate determined by reference to the then-current interbank offered rate for dollar-denominated eurodollar deposits, with certain adjustments, plus (y) one percent (1.0%). The Company believes available funds, cash generated from operations and its unused line of credit of $15 million will be sufficient to finance the Company's operations and planned capital expenditures for at least the next twelve months. There can be no assurance, however, that the Company will not require additional financing during that time or thereafter. Recent Accounting Pronouncements. In 1997, the Financial Accounting Standards Board ("FASB") released the Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." SFAS 128 simplifies the standards for computing earnings per share ("EPS") and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. SFAS 128 requires restatement of all prior-period EPS data presented. Management has not yet determined the impact of SFAS 128 on the Company's statements. In October 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition" which supersedes SOP 91-1, "Software Revenue Recognition." This SOP provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. This SOP is effective for transactions entered into in fiscal years beginning after December 15, 1997. The Company does not believe this statement will have a material effect on the Company's financial position or results of operations. 19 20 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED FINANCIAL STATEMENTS The Company's Consolidated Financial Statements and Notes thereto as of September 30, 1997 and 1996 and for each of the three years in the period ended September 30, 1997 are listed in the Index to Financial Statements in Items 14(a)(1) and 14(a)(2) of this Form 10-K and appear at pages F-1 to F-14. QUARTERLY RESULTS The following table presents selected quarterly statement of operations data for each of the eight quarters in the period ended September 30, 1997. This data is unaudited but, in the opinion of the Company's management, reflect all adjustments that the Company considers necessary for a fair presentation of these data in accordance with generally accepted accounting principles. The quarterly results presented below are not necessarily indicative of future results of operations. SELECTED QUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED --------------------------------------------------------- December 31, March 31, June 30, September 30, STATEMENT OF OPERATIONS DATA 1996 1997 1997 1997 --------------------------------------------------------- Revenue $8,486 $9,819 $12,570 $13,690 Income before income taxes 2,965 3,645 5,936 402 Provision for income taxes 1,186 1,458 2,374 2,611 Net income (loss) 1,779 2,187 3,562 (2,209) Net income (loss) per share $ 0.09 $ 0.11 $ 0.17 $ (0.12)
THREE MONTHS ENDED -------------------------------------------------------- December 30, March 31, June 30, September 30, STATEMENT OF OPERATIONS DATA 1995 1996 1996 1996 -------------------------------------------------------- Revenue $ 6,558 $ 7,518 $10,102 $10,091 Income (loss) before income taxes and extraordinary items 1,999 (1,542) 4,864 5,290 Provision (benefit) for income taxes 820 (632) 1,994 2,142 Net income (loss) before extraordinary item 1,179 (910) 2,870 3,148 Extraordinary item: Loss on early extinguishment of debt - - 2,149 - Net income 1,179 (910) 721 3,148 Series A non-voting preferred stock dividends - - 593 - Net income (loss) allocable to common stockholders 1,179 (910) 128 3,148 Net income (loss) per share $ 0.08 $ (0.07) $ 0.01 $ 0.15
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 20 21 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the captions "Directors and Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 10, 1998, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year ended September 30, 1997 (the "Definitive Proxy Statement"), is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information set forth under the caption "Remuneration of Directors and Executive Officers" in the Company's Definitive Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Company's Definitive Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption "Certain Transactions" in the Company's Definitive Proxy Statement is incorporated herein by reference. 21 22 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Report: (1) Consolidated Financial Statements Page Report of Independent Accountants................................. F-1 Consolidated Balance Sheets as of September 30, 1997 and 1996..... F-2 Consolidated Statements of Operations for the years ended September 30, 1997, 1996 and 1995 .............................. F-3 Consolidated Statements of Cash Flows for the years ended September 30, 1997, 1996 and 1995 .............................. F-4 Consolidated Statements of Stockholders' Equity for the years ended September 30, 1997, 1996 and 1995 .................. F-5 Notes to Consolidated Financial Statements........................ F-7 (2) Financial Statement Schedules Financial statement schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements and Notes thereto. (3) Exhibits The documents listed below, except for documents identified by asterisks, are being filed as exhibits herewith. Documents identified by asterisks are not being filed herewith and, pursuant to Rule 12b-32 of the General Rules and Regulations promulgated by the Commission under the Exchange Act, reference is made to such documents as previously filed as exhibits with the Commission. The Company's file number under the Exchange Act is 0-28182. *3.2 Form of Amended and Restated Articles of Organization *3.4 Amended and Restated By-Laws *3.5 Articles of Amendment to the Articles of Organization, as filed with the Secretary of State of the Commonwealth of Massachusetts on April 3, 1996 *4.1 Specimen certificate for Common Stock *+10.1 Transition Systems, Inc. 1995 Incentive and Non-Statutory Stock Option Plan *+10.2 1996 Employee Stock Purchase Plan *10.3 Recapitalization Agreement, dated as December 8, 1995, among the Company, Warburg, Pincus Ventures, L.P. and the Stockholders of the Company *10.4 Amendment No. 1 to the Recapitalization Agreement dated as of December 8, 1995, among the Company, Warburg, Pincus Ventures, L.P. and the Stockholders of the Company, dated as of January 23, 1996, among the Company, Warburg, Pincus Ventures, L.P. and the Stockholders of the Company *10.5 Joinder Agreement, dated as of January 24, 1996, among the Company, Warburg, Pincus Ventures, L.P., New England Medical Center, Inc. and NationsBank Investment Corporation *10.6 Registration Rights Agreement, dated as of January 24, 1996, between the Company and certain Investors *+10.7 Employment Agreement, dated as of January 24, 1996, between the Company and Donald C. Cook *+10.8 Employment Agreement, dated as of January 24, 1996, between the Company and Christine Shapleigh, M.D. *+10.9 Employment Agreement, dated as January 24, 1996, between the Company and Robert F. Raco *+10.10 Non-Competition Agreement, dated as of January 24, 1996, between the Company and Jerome H. Grossman, M.D. *10.11 Credit Agreement, dated January 24, 1996, among the Company, NationsBank, N.A., as Agent and as Lender, and certain Lenders party thereto from time to time *10.13 Promissory Note (Revolving Loan) of Transition Systems, Inc., dated January 24, 1996, in favor of NationsBank, N.A. in the principal amount of $6 million *10.15 Promissory Note (Revolving Loan) of Transition Systems, Inc., dated January 24, 1996, in favor of the First National Bank of Boston in the principal amount of $4.5 million *10.17 Promissory Note (Revolving Loan) of Transition Systems, Inc., dated January 24, 1996, in favor of Fleet Bank of Massachusetts, N.A. in the principal amount of $4.5 million *10.18 Subordinated Note and Warrant Purchase Agreement, dated as of January 24, 1996, between the Company and 22 23 NationsBank Investment Corporation *10.20 Non-Voting Common Stock Purchase Warrant, dated January 24, 1996, granted by the Company to NationsBank Investment Corporation *10.21 Software License Agreement, dated as December 3, 1985, between the Company and New England Medical Center Hospitals, Inc. *10.23 OEM Software License Agreement, dated as of June 30, 1986, between the Company and Praxis International, Inc. (formerly Computer Corporation of America), as amended (confidential treatment granted for certain portions pursuant to Rule 406) *10.24 Letter Agreement, dated October 20, 1995, between the Company and HCIA Inc. *10.25 Sublease, dated as of March 17, 1992, between the Company and Ernst & Young, for office space in One Boston Place, Boston, Massachusetts *10.26 Transition Systems, Inc. Amended and Restated 1995 Incentive and Non-Statutory Stock Option Plan *10.27 First Amendment, dated April 1, 1996, to Non-Voting Common Stock Purchase Warrant granted by the Company to NationsBank Investment Corporation *10.28 Addendum to License Agreement between Computer Corporation of America and the Company (confidential treatment granted for certain portions pursuant to Rule 406) **10.1 Credit Agreement dated April 26, 1996 between the Company and NationsBank, N.A. as Agent and the Lenders party thereto (Exhibits B through I and all Schedules omitted) ***+10.29 Employment Agreement, dated as of July 19, 1996, among the Company, Enterprising HealthCare, Inc. and Anthony R. Fonze 11.1 Computation of Earnings Per Share 21.1 List of Subsidiaries of the Company 23.1 Consent of Coopers & Lybrand L.L.P. 24.1 Power of Attorney (included on the signature page to this Form 10-K) 27.1 Financial Data Schedule for September 30, 1997 and year then ended * Incorporated by reference to the similarly numbered exhibit filed with the Company's Registration Statement on Form S-1, File No. 333-01758. ** Incorporated by reference to the similarly numbered exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 30, 1996. *** Incorporated by reference to the similarly numbered exhibit filed with the Company's Annual Report on Form 10-K for the year ended September 30, 1996. + Management contract or compensatory plan, contract or arrangement in which a director or Named Executive Officer participates. The Company will furnish a copy of any of the foregoing exhibits to any stockholder who so requests in writing at the rate of $0.35 per page, plus shipping and handling, upon payment of such fee by bank check or money order payable to the Company. Please submit any such written request to Ms. Paula Malzone, CFO and Treasurer, Transition Systems, Inc., One Boston Place, Boston, Massachusetts 02108. (b) Reports on Form 8-K No Reports on Form 8-K were filed by the Company during the fourth quarter of the fiscal year ended September 30, 1997. 23 24 TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF TRANSITION SYSTEMS, INC.: We have audited the accompanying consolidated balance sheets of Transition Systems, Inc. as of September 30, 1997 and 1996 and the related consolidated statements of operations, cash flows, and stockholders' equity for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transition Systems, Inc. as of September 30, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1997, in conformity with generally accepted accounting principles. Boston, Massachusetts November 17, 1997 F-1 25 CONSOLIDATED BALANCE SHEETS
FISCAL YEAR ENDED ----------------------------------- SEPTEMBER 30, SEPTEMBER 30, 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $58,484,640 $51,505,079 Accounts receivable, net (Note 3) 19,339,546 13,418,624 Other current assets 696,292 1,831,074 Deferred income taxes (Note 12) 852,973 2,062,000 ---------- ---------- Total current assets 79,373,451 68,816,777 ---------- ---------- Property and equipment, net (Note 4) 1,356,805 1,108,120 Capitalized software costs, net 1,410,697 1,399,006 Purchased technology (Note 15) 1,375,817 1,611,438 Intangible assets, net 302,641 120,240 Long-term deferred income taxes (Note 12) - 1,228,000 Investment (Note 5) 6,000,000 - ---------- ---------- Total assets $89,819,411 $74,283,581 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable 279,687 595,112 Accrued expenses 6,680,269 4,279,934 Income taxes payable 1,476,251 2,014,825 Deferred revenue 7,368,824 6,254,748 ---------- ---------- Total current liabilities 15,805,031 13,144,619 ---------- ---------- Notes payable - 21,344 Deferred income taxes (Note 12) 495,845 485,000 ---------- ---------- Total liabilities 16,300,876 13,650,963 ---------- ---------- Commitments (Notes 6 and 14) STOCKHOLDERS' EQUITY (NOTES 2 AND 8): Common stock, $.01 par value; 30,000,000 shares authorized at September 30, 1997 and 1996; 17,713,683 shares issued and outstanding at September 30, 1997, 16,645,097 shares issued and outstanding at September 30, 1996 177,137 166,451 Non-voting common stock, $.01 par value; 1,000,000 shares authorized at September 30, 1997 and 1996; 356,262 shares issued and outstanding at September 30, 1997 and 1996 3,563 3,563 Non-voting common stock warrant 394,539 394,539 Additional paid-in capital 46,716,986 39,160,834 Retained earnings 26,226,310 20,907,231 ---------- ---------- Total stockholders' equity 73,518,535 60,632,618 ---------- ---------- Total liabilities and stockholders' equity $89,819,411 $74,283,581 ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-2 26 CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEAR ENDED ------------------------------------------------ SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------ REVENUES: Software and implementation $33,017,206 $24,860,650 $19,877,780 Maintenance 11,547,873 9,408,644 7,508,330 ---------- ---------- ---------- Total revenues 44,565,079 34,269,294 27,386,110 ---------- ---------- ---------- COST OF REVENUES: Software and implementation 10,312,564 7,341,239 6,213,638 Maintenance 2,835,327 3,164,514 2,338,701 Research and development 3,872,285 3,309,895 2,862,883 Sales and marketing 6,921,500 4,505,693 4,064,207 General and administrative 3,883,948 2,365,579 2,360,252 Compensation charge - 3,023,964 - Acquired in-process research and development (Note 15) 6,292,529 - - ---------- ---------- ---------- Total operating expenses 34,118,153 23,710,884 17,839,681 ---------- ---------- ---------- Income from operations 10,446,926 10,558,410 9,546,429 Interest income 2,501,468 1,294,077 428,985 Interest expense - (1,240,935) - ---------- ---------- ---------- Income before income taxes and extraordinary items 12,948,394 10,611,552 9,975,414 Provision for income taxes 7,629,315 4,324,296 4,349,181 ---------- ---------- ---------- Net income before extraordinary item 5,319,079 6,287,256 5,626,233 Extraordinary item: Loss on early extinguishment of debt (net of taxes of $1,492,000) - 2,148,697 - ---------- ---------- ---------- Net income $ 5,319,079 $ 4,138,559 $ 5,626,233 ========== ========== ========== Series A non-voting preferred stock dividends - 593,476 - Net income allocable to common stockholders $ 5,319,079 $ 3,545,083 $ 5,626,233 ========== ========== ========== INCOME PER SHARE (NOTE 2): Net income before extraordinary item $ 0.26 $ 0.37 $ 0.41 Extraordinary item - (0.13) - ---------- ---------- ---------- Net income 0.26 0.24 0.41 Net income allocable to common stockholders $ 0.26 $ 0.21 $ 0.41 Weighted average common shares outstanding 20,557,983 16,971,721 13,886,129 ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-3 27 CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEAR ENDED ------------------------------------------------ SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,319,079 $ 4,138,559 $ 5,626,233 Adjustments to reconcile net income to net cash provided by operating activities: Extraordinary item, gross - 3,641,858 - Write-off of in-process research and development 6,292,529 - - Deferred income taxes 2,447,872 (1,639,794) (759,467) Depreciation and amortization 1,632,036 1,442,799 1,378,970 Compensation charge in connection with the recapitalization - 3,023,964 - Compensation charge related to options granted (91,415) 91,415 - Tax benefit from stock option exercises 2,770,129 - - Changes in operating assets and liabilities net of effects from purchase of businesses: Accounts receivable (5,920,922) (1,788,625) (3,010,165) Other current assets 1,134,782 (962,928) (195,227) Accounts payable (315,425) (97,982) (77,789) Accrued expenses 2,387,823 242,531 611,841 Due to affiliates - (9,335) (484,619) Deferred revenue 1,114,076 1,219,972 978,041 Taxes payable (538,574) 730,825 920,000 ----------- ---------- ----------- Net cash provided by operating activities 16,231,990 10,033,259 4,987,818 ----------- ---------- ----------- CASH FLOWS PROVIDED BY (USED BY) INVESTING ACTIVITIES: Purchase of investments (250,000) (1,595,359) (6,997,879) Maturities of investments 250,000 3,163,875 1,458,182 Sales of investments - 5,755,112 - Purchase of property and equipment (910,684) (571,633) (515,044) Additions to capitalized software costs (711,663) (703,746) (699,996) Additions to intangible assets (217,030) (124,626) (5,550) Investment (6,000,000) - - Acquisition of businesses, net of cash acquired (2,667,530) (1,727,729) - ------------ ---------- ----------- Net cash (used by) provided by investing activities (10,506,907) 4,195,894 (6,760,287) ------------ ---------- ----------- CASH FLOWS PROVIDED BY (USED BY) FINANCING ACTIVITIES: Proceeds from initial public offering - 114,428,895 - Issuance of Series A preferred stock - 20,000,000 - Redemption of Series A preferred stock - (20,000,000) - Payments of Series A preferred stock dividends - (593,476) - Proceeds from issuance of debt - 49,605,461 - Early extinguishment of debt - (50,000,000) - Proceeds from issuance of Series B preferred stock - 33,612,000 - Proceeds from issuance of Series C preferred stock - 1,388,000 - Payment of fees related to recapitalization - (3,360,127) - Purchase of common stock - (111,410,217) - Exercise of options 1,236,634 783,100 - Payments on note payable (8,646) - - Proceeds from stock purchase plan 32,080 - - Proceeds from warrants issued - 394,539 - Equity issuance costs (5,590) (1,415,960) - ------------ ---------- ----------- Net cash provided by financing activities 1,254,478 33,432,215 - ------------ ---------- ----------- Net increase (decrease) in cash and cash equivalents 6,979,561 47,661,368 (1,772,469) Cash and cash equivalents - beginning of year 51,505,079 3,843,711 5,616,180 ------------ ---------- ----------- Cash and cash equivalents - end of year $58,484,640 $51,505,079 $ 3,843,711 ============ ========== =========== SUPPLEMENTAL INFORMATION: Income taxes paid $ 2,507,680 $ 3,063,153 $ 3,896,246 Interest paid - $ 1,119,444 -
The accompanying notes are an integral part of the consolidated financial statements. F-4 28 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Non-voting Common Stock Common Stock Non-voting Treasury Stock ----------------------- ----------------- Common Stock ----------------------------- Shares Amount Shares Amount Warrant Shares Amount - --------------------------------------------------------------------------------------------------------------------------- Balance at September 24, 1994 30,060,000 $300,600 (1,670,000) $ (1,470,950) Net income ----------- -------- ----------- ------------- Balance at September 30, 1995 30,060,000 300,600 (1,670,000) (1,470,950) ----------- -------- ----------- ------------- Stock options exercised 1,320,191 13,202 Repurchase of common stock in connection with the recapitalization (28,592,404) $(108,386,253) Retirement of treasury shares (30,262,404) (302,624) 30,262,404 109,857,203 Issuance of common stock warrant $394,539 Issuance of common stock in initial public offering 6,900,000 69,000 Equity issuance costs Issuance of common stock with conversion of Series B convertible preferred stock 8,627,310 86,273 Issuance of non-voting common stock with conversion of Series C convertible preferred stock 356,262 $3,563 Compensation expense Dividends on Series A non-voting preferred stock Net income ----------- -------- ------- ------ -------- ----------- ------------- Balance at September 30, 1996 16,645,097 166,451 356,262 3,563 394,539 - - ----------- -------- ------- ------ -------- ----------- ------------- Stock options exercised 813,371 8,134 Issuance of common stock related to acquisition of Vital Software 252,003 2,520 Issuance of common stock in connection with employee stock purchase plan 3,212 32 Equity issuance costs Cancellation of compensatory stock option grants Income tax benefit from stock options exercised Net income ----------- -------- ------- ------ -------- ----------- ------------- Balance at September 30, 1997 17,713,683 $177,137 356,262 $3,563 $394,539 - - =========== ======== ======= ====== ======== =========== =============
F-5 29
Additional Total Paid-in Retained Stockholders' Capital Earnings Equity - -------------------------------------------------------------------------------- Balance at September 24, 1994 $11,735,915 $ 10,565,565 Net income 5,626,233 5,626,233 ----------- ------------ Balance at September 30, 1995 17,362,148 16,191,798 ----------- ------------ Stock options exercised $ 769,898 783,100 Repurchase of common stock in connection with the recapitalization (108,386,253) Retirement of treasury shares (109,554,579) - Issuance of common stock warrant 394,539 Issuance of common stock in initial public offering 114,359,895 114,428,895 Equity issuance costs (1,415,959) (1,415,959) Issuance of common stock with conversion of Series B convertible preferred stock 33,525,727 33,612,000 Issuance of non-voting common stock with conversion of Series C convertible preferred stock 1,384,437 1,388,000 Compensation expense 91,415 91,415 Dividends on Series A non-voting preferred stock (593,476) (593,476) Net income 4,138,559 4,138,559 ------------ ----------- ------------ Balance at September 30, 1996 39,160,834 20,907,231 60,632,618 ------------ ----------- ------------ Stock options exercised 1,228,500 1,236,634 Issuance of common stock related to acquisition of Vital Software 3,622,480 3,625,000 Issuance of common stock in connection with employee stock purchase plan 32,048 32,080 Equity issuance costs (5,590) (5,590) Cancellation of compensatory stock option grants (91,415) (91,415) Income tax benefit from stock options exercised 2,770,129 2,770,129 Net income 5,319,079 5,319,079 ------------ ----------- ------------ Balance at September 30, 1997 $ 46,716,986 $26,226,310 $ 73,518,535 ============ =========== ============
F-6 30 NOTE 1. NATURE OF THE BUSINESS: Transition Systems, Inc. (the "Company") is a leading provider of integrated clinical and financial decision support systems for hospitals, integrated delivery networks, physician groups and other healthcare organizations. The Company was founded in 1985 as a for-profit, majority-owned subsidiary of New England Medical Center, Inc. ("NEMC"). The Company was a majority-owned subsidiary of NEMC until the January 1996 leveraged recapitalization transaction (the "Recapitalization") described in Note 8. NOTE 2. SUMMARY OF ACCOUNTING POLICIES: Fiscal Year The Company changed its fiscal year from the last Saturday of September of each year to September 30. The change was effective with the three months ended June 30, 1996. Principles of Consolidation The consolidated financial statements include the accounts of Transition Systems, Inc. and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated. Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with a maturity date of three months or less at the time of purchase to be cash equivalents. Cash equivalents are stated at cost plus accrued interest which approximates market. Investments in Debt and Equity Securities 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. Realized or unrealized gains or losses applicable to the transfer of securities to the available-for-sale category and subsequent sale of these investments were immaterial. Capitalized Software Costs Software development costs subsequent to the establishment of technological feasibility are capitalized. Capitalized internally developed software costs approximated $700,000 for fiscal years 1997, 1996 and 1995. Amortization of capitalized software costs, which begins with the general release of a product to customers, is included in cost of software and implementation revenues and amounted to approximately $700,000, $767,000 and $767,000 for the fiscal years ended 1997, 1996 and 1995, respectively. Amortization of capitalized software costs is provided on a product-by-product basis at the greater of the amount calculated on a straight-line basis over the estimated economic life of the products, generally three years, or the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product. Accumulated amortization of software development costs was $4,816,000, $4,116,000 and $3,349,000 at the end of fiscal years 1997, 1996 and 1995, respectively. All other expenditures for research and development are charged to operations when incurred. Purchased Technology Costs Purchased technology costs are carried at cost less accumulated amortization which is calculated on a straight-line basis over an estimated useful life of seven years. Accumulated amortization on purchased technology costs was $274,890 in 1997 and $0 in 1996. Intangible Assets Intangible assets include the costs incurred to register trademarks, copyrights and related legal expenses and debt issuance costs. Amortization is computed using the straight-line method over estimated useful lives ranging from three to five years. Property and Equipment Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows: Equipment 3 to 5 years Furniture and fixtures 3 to 5 years Leasehold improvements the lesser of the useful life or remaining lease term
Maintenance and repair costs are expensed when incurred and betterments are capitalized. Upon retirement or sale, the cost of the assets disposed and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to income. F-7 31 Revenue Recognition The percentage of completion method is used by the Company primarily in connection with sales in which the customer is implementing the Company's core products for the first time. Add-on sales in which an existing customer licenses new modules or adds additional functionality do not generally involve substantial implementation effort and are recognized upon contract execution and shipment of the product. In fiscal 1996, the Company changed its method of recognizing software license revenue when associated with substantial implementation effort from percentage of completion based principally on costs incurred to percentage of completion based principally upon progress and performance as measured by achievement of contract milestones. The change in method was made in accordance with Accounting Principles Board Opinion No. 20 in contemplation of an initial public offering and in recognition of the Company's increased focus on providing a solution that combines software and implementation, as well as to facilitate the timely quarterly reporting requirements as a Securities and Exchange Commission ("SEC") registrant. The financial statements for all periods presented have been restated to reflect this change. The effect of the restatement was a decrease in software and implementation revenue in fiscal year 1995 of approximately $1,391,000 and a decrease in net income in fiscal year 1995 of $797,000. Revenues from maintenance contracts are recognized ratably over the life of the service contract, generally twelve months. Deferred revenue relates primarily to these maintenance contracts. Advertising and Promotion Expense All advertising and promotion costs are expensed as incurred. All contract procurement costs are included in sales and marketing expense and are expensed as incurred. Income Taxes Deferred tax assets and liabilities are recognized based on temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. Risks and Uncertainties The Company sells its products primarily to hospitals and other health care institutions. The Company performs ongoing credit evaluations of its customers. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. The Company invests its daily excess cash in a money market fund with a major bank. The Company has not experienced any material losses on its investments. The preparation of 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, liabilities and litigation at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and would impact future results of operations and cash flows. Net Income Per Common Share Net income per common share is computed based upon the weighted average number of common shares and common equivalent shares (using the treasury stock method) outstanding after giving effect to the Company's initial public offering. Common equivalent shares are included in the per share calculations where the effect of their inclusion would be dilutive. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 83 ("SAB 83") all common and common equivalent shares and other potentially dilutive instruments, including stock options, warrants and preferred stock issued during the twelve-month period prior to the initial filing date of the Registration Statement for the Company's initial public offering, have been included in the calculation as if they were outstanding for all periods presented. Recent Accounting Pronouncements In 1997, the Financial Accounting Standards Board ("FASB") released the Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." SFAS 128 simplifies the standards for computing earnings per share ("EPS") and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. SFAS 128 requires restatement of all prior-period EPS data presented. Management has not yet determined the impact of SFAS 128 on the Company's statements. F-8 32 NOTE 3. ACCOUNTS RECEIVABLE: At September 30, accounts receivable consisted of the following:
1997 1996 - ----------------------------------------------------------- Billed $11,973,755 $ 9,360,605 Unbilled 7,540,791 4,183,019 ----------- ---------- 19,514,546 13,543,624 Allowance for doubtful accounts (175,000) (125,000) ---------- ---------- $19,339,546 $13,418,624 =========== ==========
Unbilled accounts receivable arise from differences in the timing of revenue recognition and billing under the contract terms. Provisions and write-offs for bad debts for fiscal years 1997, 1996 and 1995 were $102,250, $73,000 and $156,200, respectively. NOTE 4. PROPERTY AND EQUIPMENT: Property and equipment at September 30, 1997 and 1996 consisted of the following:
1997 1996 - ----------------------------------------------------------- Equipment $3,536,726 $2,796,786 Furniture and fixtures 1,078,888 933,481 Leasehold improvements 355,540 330,203 --------- --------- 4,971,154 4,060,470 Accumulated depreciation and amortization (3,614,349) (2,952,350) --------- --------- $1,356,805 $1,108,120 ========= =========
Depreciation expense for the fiscal years 1997, 1996 and 1995 was $661,999, $514,204 and $606,384, respectively. NOTE 5. INVESTMENT: On January 31, 1997 the Company acquired a 19.5% ownership interest in HealthVISION, Inc. for $6 million in cash. HealthVISION is a provider of electronic medical record software based in Santa Rosa, California. This investment is being accounted for on the cost basis. The Company holds an option to purchase the remaining outstanding shares of HealthVISION. This option expires on December 31, 1998. NOTE 6. RELATED PARTY AGREEMENTS AND TRANSACTIONS: The Company had an arrangement to reimburse NEMC for administrative services provided to the Company by employees of NEMC. Under this arrangement, the Company incurred expenses of $24,200 in fiscal year 1996, and $96,800 in fiscal year 1995. This arrangement was terminated as of January 24, 1996. Since that date, these administrative services have been performed internally by Company personnel. This change has not resulted in a material increase in the Company's costs. The Company obtained certain other services through NEMC, including health benefits for its employees, for which it incurred a total of $134,114 and $420,133 in operating expenses in fiscal years 1996 and 1995, respectively. The Company discontinued this arrangement as of December 31, 1995, and arranged to provide comparable benefits directly to its employees. This change has not resulted in a material increase in the Company's cost of providing and administering these employee benefits. Additionally, the Company used the computer facilities of New England Medical Center Hospitals, Inc., an affiliate of NEMC, pursuant to a data processing agreement. This service was provided at a charge of $82,467 in fiscal year 1996 and $109,956 in fiscal year 1995. This service was discontinued in June 1996. F-9 33 NOTE 7. LINE OF CREDIT--BANK: On April 26, 1996, the Company entered into a $25 million unsecured revolving line of credit with a bank group led by NationsBank, N.A. as agent and as lender. The credit facility contains covenants setting minimum net worth, maximum leverage ratio and minimum net income requirements for the Company. On September 20, 1996, the Company amended its total revolving credit commitment from $25 million to $15 million. There have been no amounts drawn on this line. Advances under the revolving line of credit bear interest, at the Company's election, either at a "base rate" or at a "eurodollar rate." The base rate is a floating rate equal to the greater of (a) the prime rate or (b) the federal funds effective rate plus one-half of one percent (.50%). The eurodollar rate is equal to the sum of (x) a rate determined by reference to the then-current interbank offered rate for dollar denominated eurodollar deposits, with certain adjustments, plus (y) one percent (1.0%). The eurodollar interest rate was 5.7% at September 30, 1997. NOTE 8. STOCKHOLDERS' EQUITY: On February 26, 1996, the Company's Board of Directors approved a 334-for-1 split of the Company's Common Stock to be effected in the form of a stock dividend to the stockholders of record as of March 28, 1996. This stock split has resulted in a reclassification of $112,695 and $187,003 from the Company's additional paid-in capital and retained earnings accounts, respectively, to the Company's Common Stock account, representing the par value of shares issued. All share and per share amounts have been restated to retroactively reflect the stock split. In addition, on February 26, 1996, the Board of Directors also voted to retire and return to the status of authorized and unissued capital stock all shares of Common Stock then held in the Company's treasury, and adopt an amendment to the Articles of Organization of the Company to, among other things, increase the authorized shares of Common Stock and Non-Voting Common Stock to 30,000,000 and 1,000,000 shares, respectively, which was subsequently approved by the stockholders of the Company. On April 18, 1996, the Company completed an initial public offering of 6,900,000 shares of its common stock which generated net proceeds of $114.4 million. A substantial part of the proceeds were used to redeem $20.6 million of Series A preferred stock and accrued dividends, to repay the $34.7 million outstanding principal amount and accrued interest under the secured term loan facility, to repay the $10.3 million outstanding principal amount and accrued interest under the senior subordinated notes and to repay the $5.1 million outstanding principal amount and accrued interest under the Company's revolving credit facility. Stock Option Plans In 1995, the Company's Board of Directors adopted, and the stockholders approved, the 1995 Incentive and Nonstatutory Stock Option Plan. The Plan provides for the grant of nonqualified and incentive stock options to employees and others to purchase the Company's Common Stock. Options granted during fiscal 1995 provided for vesting over three years and expiration ten years after the date of grant. Options granted during fiscal 1997 and 1996 provided for vesting over five years and expiration ten years after the date of grant. At September 30, 1997 and 1996, 6,070,116 shares of Common Stock were authorized for issuance under the plan. A summary of the Company's stock option activity for the years ended September 30 follows:
WEIGHTED AVERAGE NUMBER EXERCISE OF OPTIONS PRICE - ----------------------------------------------------------- Outstanding at September 24, 1994 668,000 $0.003 Granted 3,663,646 1.20 --------- ------ Outstanding at September 30, 1995 4,331,646 1.02 Granted 1,079,564 6.74 Exercised (1,320,191) 0.59 Canceled (27,165) 1.20 --------- ------ Outstanding at September 30, 1996 4,063,854 2.67 Granted 802,400 15.15 Exercised (813,371) 1.52 Canceled (495,364) 13.71 --------- ------ Outstanding at September 30, 1997 3,557,519 $ 4.22 ========= ======
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), requires that companies either recognize compensation expense for grants of stock, stock options, and other equity instruments based on fair value, or provide pro forma disclosure of net income and earnings per share in the notes to the financial statements. The Company adopted the disclosure provisions of SFAS 123 in 1997 and has applied APB Opinion 25 and related interpretations in accounting for its stock option plans in 1997. Accordingly, no compensation cost has been recognized for its stock F-10 34 option plans. The effects of applying SFAS 123 in this pro forma disclosure are not likely to be representative of the effects on reported income or loss for future years. SFAS 123 does not apply to awards prior to 1996 and additional awards in future years are anticipated. At September 30, 1997, 1996 and 1995, respectively, options to purchase 2,080,823, 2,195,716, and 1,803,600 shares of Common Stock were exercisable with a weighted average exercise price of $1.80, $1.20, and $1.20, respectively. Exercise prices for options outstanding as of September 30, 1997 ranged from $1.20 to $18.81. The weighted average remaining contractual life of those options is 8.1 years. The weighted average fair value of the Common Stock at date of grant for options granted in 1997 and 1996 was $8.12 and $3.61 per option, respectively. The fair value of these options at date of grant was estimated using the Black-Scholes model with the following weighted average assumptions: a risk free interest rate of 6.1% in 1997 and 5.4% in 1996; a dividend yield of 0%; a volatility factor of the expected market price of the Company's Common Stock of 55% and a weighted average expected life of the options of 5 years. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company's net income and earnings per share for the years ended September 30, 1997 and 1996 would have been reduced to the pro forma amounts indicated as follows:
1997 1996 ------------------------------------------- EARNINGS EARNINGS PER PER NET INCOME SHARE NET INCOME SHARE - ------------------------------------------------------------ As reported $5,319,079 $0.26 $3,545,083 $0.21 Pro forma 3,970,478 0.19 2,696,238 0.16
At September 30, 1997 and September 30, 1996, options to purchase 1,047,035 and 1,354,071 shares of Common Stock, respectively, were available for grant. The following table summarizes information about stock options outstanding at September 30, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ---------------------------------------------------------------------------------------------- REMAINING WEIGHTED- WEIGHTED- RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ---------------------------------------------------------------------------------------------- $ 1.20 2,221,459 7.6 $ 1.20 1,826,003 $ 1.20 3.90 735,160 8.3 3.90 197,420 3.90 11.00 - 13.50 270,900 9.1 12.36 57,400 13.50 18.50 - 18.81 330,000 9.8 18.39 - - ------------ -------- --- ------ -------- ------ 3,557,519 8.1 $ 4.22 2,080,823 $ 1.80
In connection with the Recapitalization, the Company accelerated the vesting of options to purchase an aggregate of 2,442,208 shares of Common Stock granted to certain executive officers during fiscal 1995, so as to make such options exercisable in full immediately prior to the closing of the Recapitalization. On January 24, 1996, an aggregate of 638,608 shares of Common Stock were issued to such officers upon their exercise of such options. NOTE 9. RECAPITALIZATION: In January 1996, prior to its contemplation of an initial public offering, the Company effected a Recapitalization, in which the Company repurchased 28,592,404 shares of Common Stock then issued and outstanding from NEMC and the other stockholders of the Company for an aggregate of approximately $111.4 million. In addition, Warburg, Pincus Ventures, L.P. ("WP Ventures") purchased from certain executive officers of the Company an aggregate of 2,308,608 shares of Common Stock, including an aggregate of 638,608 shares of Common Stock acquired by such executive officers pursuant to their exercise of stock options, for an aggregate of approximately $9.0 million. WP Ventures then contributed such shares of Common Stock to the Company. The principal purpose of the Recapitalization was to provide liquidity to the Company's existing stockholders while permitting them to retain an ownership interest in the Company, and the Company has accounted for the transaction as a leveraged recapitalization. To finance the repurchase of these shares, the Company issued to certain institutional investors 20,000 shares of Series A non-voting preferred stock for an aggregate of $20.0 million, 33,512 shares of Series B convertible preferred stock (convertible into 8,627,310 shares of Common Stock) for an aggregate of $33.6 million and 1,388 shares of Series C non-voting convertible preferred stock (convertible into 356,262 shares of Common Stock) for an aggregate of $1.4 million. In addition, the Company entered into a secured term loan in the amount of $35.0 million and received an advance of $5.0 million under a secured revolving credit facility in the maximum principal amount of $15.0 million, and issued Senior Subordinated Notes, due 2003, in the aggregate principal amount of $10.0 million (the "Senior Subordinated Notes"). The holder of the Senior F-11 35 Subordinated Notes also received a warrant to acquire an aggregate of 297,928 shares of non-voting common stock at an initial exercise price of $3.90 per share, subject to adjustment in certain circumstances. In addition, in the second quarter of fiscal 1996 the Company incurred a non-cash compensation charge of $3.0 million. This compensation charge arose from the purchase by the Company (both directly and indirectly, through WP Ventures) from certain of its executive officers of 972,608 shares of Common Stock that had been acquired by such officers immediately prior to the Recapitalization through the exercise of employee stock options. The amount of the compensation charge is equal to the difference between the aggregate $765,800 exercise price paid by such officers upon such exercise and the $3,789,764 of aggregate proceeds received by the officers from the purchase by the Company of such shares. NOTE 10. EXTRAORDINARY ITEM: In fiscal 1996, the Company incurred an extraordinary loss of approximately $2,149,000 representing the after tax effect of the write-off of approximately $3,642,000 of unamortized capitalized financing costs. These costs were attributable to indebtedness incurred in the Recapitalization that was repaid out of the proceeds of the Company's initial public offering. NOTE 11. PREFERRED STOCK DIVIDEND: The holders of the Series A preferred stock (issued in connection with the Recapitalization on January 24, 1996) were entitled to receive, when and as declared by the Board of Directors, out of funds legally available therefore, preferential cumulative dividends at the rate of 12% per annum. The Company was not obligated to pay dividends prior to the redemption of the Series A preferred stock, and no dividends were declared by the Board. The Series A preferred stock was subject to mandatory redemption, provided funds were legally available therefore, upon the closing of an initial public offering or the sale of the Company, but in no event later than January 2006. Upon the closing of the Company's initial public offering, on April 23, 1996, at which time funds became legally available for the redemption of the Series A preferred stock and payment of dividends, the Company redeemed in full the Series A preferred stock and paid dividends thereon from the date of the Recapitalization. NOTE 12. INCOME TAXES: Provision for income taxes consists of the following:
1997 1996 1995 - ------------------------------------------------------------- Federal: Current $4,535,392 $ 5,129,464 $3,967,648 Deferred 2,090,046 (1,412,919) (624,593) --------- ---------- --------- 6,625,438 3,716,545 3,343,055 State: Current 646,054 835,029 1,141,000 Deferred 357,823 (227,278) (134,874) --------- ---------- --------- 1,003,877 607,751 1,006,126 --------- ---------- --------- Provision for income taxes $7,629,315 $ 4,324,296 $4,349,181 ========= ========== =========
A reconciliation between the Company's effective rate and the U.S. statutory rate is as follows:
SEPTEMBER SEPTEMBER SEPTEMBER 30, 1997 30, 1996 30, 1995 - ----------------------------------------------------------------- U.S. statutory rate 35.0% 35.0% 35.0% State taxes, net of federal benefits 5.0 5.6 6.0 Acquired in-process research and development 17.0 - - Other 1.9 - 2.6 ---- --- --- Effective income tax rate 58.9% 40.6% 43.6% ==== === ===
F-12 36 Components of the Company's deferred tax liabilities and assets are as follows:
SEPTEMBER 30, 1997 1996 - ----------------------------------------------------------- Capitalized software $(576,219) $ (597,164) Depreciation 103,252 112,164 Accounts receivable reserve 51,059 51,469 Accrued vacation 280,165 183,076 Reserves and other 498,871 418,019 Revenue recognition - 1,409,436 Compensation charge - 1,228,000 -------- --------- Net deferred tax assets $ 357,128 $2,805,000 ======== =========
There are no valuation allowances recorded against the Company's deferred tax assets, since taxable income in the carryback period is sufficient to realize the benefit of future deductions. NOTE 13. EMPLOYEE BENEFIT PLANS: 401(k) Plan The Company maintains a savings plan for its eligible employees under Section 401(k) of the Internal Revenue Code. The plan allows employees to defer up to a percentage of their income equal to the lesser of the IRS statutory rate or 15% on a pre-tax basis through contributions to the plan. Contributions by the Company under this plan are discretionary. Total contributions by the Company under the plan approximated $306,000, $263,000 and $214,000 in fiscal years 1997, 1996 and 1995, respectively. The Company previously obtained health benefit plans through NEMC (see Note 6). Beginning January 1, 1996, the Company established independent health benefit plans for its employees that provide a similar level of benefits. Employee Stock Purchase Plan In 1996, the Company adopted an Employee Stock Purchase Plan (the "Stock Purchase Plan"), under which employees may purchase up to 300,000 shares of Common Stock. During each six-month offering period under the Stock Purchase Plan, participating employees are entitled to purchase shares through payroll deductions. The maximum number of shares which may be purchased is determined on the first day of the offering period pursuant to a formula under which a specific percentage of the employee's projected base pay for the offering period is divided by a percentage of the market value of one share of Common Stock on the first day of the offering period. During each offering period, the price at which the employee will be able to purchase the Common Stock will be a specific percentage of the last reported sale price of the Common Stock of the NASDAQ National Market on the date on which the offering period commences or concludes, whichever is lower. The Stock Purchase Plan is administered by the Compensation Committee. All employees, other than certain highly-compensated employees, who meet certain minimum criteria based on hours worked per week and length of tenure with the Company are eligible to participate in the Stock Purchase Plan. No employee may purchase shares pursuant to the Stock Purchase Plan if, after such purchase such employee would own more than five percent of the total combined voting power or value of the securities of the Company. NOTE 14. COMMITMENTS: The Company leases office and office equipment under operating lease arrangements which expire on various dates through 2001. Certain operating lease arrangements include options to renew for additional periods or payment terms that are subject to increases due to taxes and other operating costs of the lessor. Future minimum lease commitments, by year and in the aggregate, under these long-term noncancelable operating leases consist of the following at September 30, 1997:
OPERATING FISCAL YEAR LEASES - ----------------------------------------------------------- 1998 $659,311 1999 601,710 2000 493,411 2001 53,057 --------- Total minimum lease payments $1,807,489 =========
F-13 37 Rent expense amounted to $552,578, $369,569 and $380,019 in fiscal years 1997, 1996 and 1995, respectively. The Company has an agreement with a vendor of third-party software to pay a fixed annual license fee through June 1998. In addition, under the agreement the Company is entitled to obtain maintenance services from the vendor on an annual basis for an additional fixed fee. Aggregate annual expenses under the agreement as renegotiated are expected to approximate $2,000,000. Aggregate license and maintenance fees under this agreement were $2,000,000, $2,004,000 and $1,675,200 for fiscal years 1997, 1996 and 1995, respectively. NOTE 15. CONSOLIDATION AND ACQUISITIONS: On July 22, 1996, the Company acquired substantially all of the outstanding stock and a note held by a selling principal of Enterprising HealthCare, Inc. ("Enterprising HealthCare"), based in Tucson, Arizona, for a total purchase price of approximately $1.8 million in cash. Enterprising HealthCare provides system integration products and services for the health care market. The acquisition was accounted for under the purchase method with the results of Enterprising HealthCare included from July 22, 1996. Purchased technology costs of $1.6 million are being amortized on a straight-line basis over 7 years. Pro forma results of operations have not been presented, as the effect of this acquisition on the financial statements was not material. On September 19, 1997, the Company acquired all outstanding shares of Vital Software Inc. ("Vital"), a privately held developer of products that automate the clinical processes unique to medical oncology. The purchase price was approximately $6.3 million, which was comprised of $2.7 million in cash and 252,003 shares of the Company's common stock with a value of $3.6 million. The purchase price was allocated entirely to purchased research and development. Purchased research and development, which had not reached technological feasibility and which had no alternative future use, was valued using a risk adjusted cash flow model, under which expected future cash flows associated with in-process research and development were discounted considering risks and uncertainties related to the viability of and potential changes in future target markets and to the completion of the products that will be ultimately marketed by Transition Systems, Inc. Purchased research and development, which is not deductible for tax purposes, was charged to operations at the acquisition date. Vital's operating results have not been included in the consolidated financial statements from the date of acquisition due to immateriality. F-14 38 SIGNATURE 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, in the City of Boston, Commonwealth of Massachusetts as of December, 1997. TRANSITION SYSTEMS, INC. By /s/ Robert F. Raco ------------------------------------- Robert F. Raco President and Chief Executive Officer POWER OF ATTORNEY Each individual whose signature appears below hereby constitutes and appoints Robert F. Raco, Donald C. Cook, Christine Shapleigh and Paula J. Malzone, and each of them, his true and lawful attorneys-in-fact and agents with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing which they, or any of them, may deem necessary or advisable to be done in connection with this Form 10-K, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or any substitute or substitutes for any or all of them, may lawfully do or cause to be done by virtue hereof. 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 on and on the dates indicated. SIGNATURES TITLE DATE - ---------- ----- ---- /s/ Robert F. Raco President, Chief Executive December 24, 1997 - ------------------------ Officer and Director Robert F. Raco (Principal Executive Officer) /s/ Paula Malzone Chief Financial Officer December 24, 1997 - ------------------------ (Principal Financial and Paula Malzone Accounting Officer) /s/ Patrick T. Hackett Director December 24, 1997 - ------------------------ Patrick T. Hackett /s/ Robert S. Hillas Director December 24, 1997 - ------------------------ Robert S. Hillas /s/ Peter Van Etten Director December 24, 1997 - ------------------------ Peter Van Etten /s/ Allen F. Wise Director December 24, 1997 - ------------------------ Allen F. Wise EX-11.1 2 COMPUTATION OF EARNINGS 1 Exhibit 11.1 TRANSITION SYSTEMS, INC. Computation of Earnings per Share For the year ended September 30, 1997 Weighted average shares outstanding: Common stock outstanding (1) 17,432,479 Common stock equivalent 3,125,504 Pro forma weighted average number of common shares and common equivalent shares outstanding 20,557,983 ---------- Net income: Net income before extraordinary item 5,319,079 Extraordinary item -- Net income 5,319,079 Net income allocable to common stockholders 5,319,079 Earnings per share: Net income before extraordinary item 0.26 Extraordinary item -- Net income 0.26 Net income allocable to common stockholders 0.26 For the year ended September 30, 1996 Weighted average shares outstanding: Common stock outstanding (1) 13,214,432 Common stock equivalent 3,757,289 Pro forma weighted average number of common shares and common equivalent shares outstanding 16,971,721 ---------- Net income: Net income before extraordinary item 6,287,256 Extraordinary item (2,148,697) Net income 4,138,559 Net income allocable to common stockholders 3,545,083 Earnings per share: Net income before extraordinary item 0.37 Extraordinary item (0.13) Net income 0.24 Net income allocable to common stockholders 0.21
(1) Gives effect to the Recapitalization. See Note 9 of Notes to the Consolidated Financial Statements. EX-21.1 3 SUBSIDIARIES 1 Exhibit 21.1 TRANSITION SYSTEMS, INC. SUBSIDIARIES Name Jurisdiction of Incorporation - -------------------------------------------------------------------------------- Transition Systems International, Inc. Massachusetts TSI Virgin Islands Foreign Sales Corporation United States Virgin Islands Enterprising HealthCare, Inc. Arizona Vital Software, Inc. California EX-23.1 4 CONSENT OF INDEPENDENT ACCOUNTANTS 1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Transition Systems, Inc. on Forms S-8 (File No. 333-10411 and File No. 333-10413) of our report, dated November 17, 1997, on our audits of the consolidated financial statements of Transition Systems, Inc. as of September 30, 1997 and 1996, and for each of the three years in the period ended September 30, 1997, which report is included in this Annual Report on Form 10-K. /s/ Coopers & Lybrand, L.L.P. Coopers & Lybrand, L.L.P. Boston, Massachusetts December 23, 1997 EX-27.1 5 FINANCIAL DATA SCHEDULE
5 1,000 YEAR SEP-30-1997 OCT-01-1996 SEP-30-1997 58,485 0 19,515 175 0 79,373 4,971 3,614 89,819 15,805 0 0 0 177 73,341 89,819 0 44,565 0 13,148 0 180 0 12,948 7,629 5,319 0 0 0 5,319 .26 .26
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