-----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, KFdpVbsM8F8rUWsoVtYpgkPCSCHzNVTdnzRC9Ouanq9HJoqv4qvF68nRlonr5JGI CD1tmXdsOI1ZaS4xLYKo8Q== 0000950123-98-000453.txt : 19980123 0000950123-98-000453.hdr.sgml : 19980123 ACCESSION NUMBER: 0000950123-98-000453 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971031 FILED AS OF DATE: 19980122 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HEALTH MANAGEMENT SYSTEMS INC CENTRAL INDEX KEY: 0000861179 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 132770433 STATE OF INCORPORATION: NY FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20946 FILM NUMBER: 98510579 BUSINESS ADDRESS: STREET 1: 401 PARK AVE SOUTH CITY: NEW YORK STATE: NY ZIP: 10016 BUSINESS PHONE: 2126854545 MAIL ADDRESS: STREET 1: 401 PARK AVENUE SOUTH CITY: NEW YORK STATE: NY ZIP: 10016 10-K 1 HEALTH MANAGEMENT SYSTEMS, INC. 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------------- FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended October 31, 1997 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-20946 HEALTH MANAGEMENT SYSTEMS, INC. (Exact name of registrant as specified in its charter) New York 13-2770433 -------- ---------- (State or other jurisdiction of (I.R.S. Employer) incorporation or organization) Identification No.) 401 Park Avenue South New York, New York 10016 ------------------ ----- (Address of principal executive offices) (Zip Code) (212) 685-4545 (Registrant's telephone number, including area code) -------------------------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- None Securities registered pursuant to Section 12(g) of the Act: Common Stock ------------ (Title of Class) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| The aggregate market value of the registrant's common stock held by non-affiliates as of January 13, 1998 was $96,461,021 based on the closing price on the Nasdaq National Market System on that day. Number of shares outstanding of the registrant's common stock, $.01 par value, on January 13, 1998 was 17,220,069. Documents Incorporated by Reference: Document Where Incorporated -------- ------------------ Proxy Statement for the Annual Meeting Part III to be held on March 3, 1998 ================================================================================ 2 TABLE OF CONTENTS
Page Contents Number - -------- ------ Cover Page......................................................................................i PART I Item 1. Business.......................................................................1 Item 2. Properties....................................................................12 Item 3. Legal Proceedings.............................................................13 Item 4. Submission of Matters to a Vote of Security Holders...........................13 PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.........13 Item 6. Selected Financial Data.......................................................14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................................14 Item 8. Financial Statements and Supplementary Data...................................14 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..........................................................14 PART III Item 10. Directors and Executive Officers of the Registrant............................14 Item 11. Executive Compensation........................................................14 Item 12. Security Ownership of Certain Beneficial Owners and Management................14 Item 13. Certain Relationships and Related Transactions................................14 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..............14 Signatures ..............................................................................15 Index to Consolidated Financial Information...............................................16 Exhibit Index.............................................................................17
3 PART I Special Note Regarding Forward-Looking Statements Certain statements in this Form 10-K constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Health Management Systems, Inc. ("HMSY") , or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. The important factors that could cause actual results to differ materially from those indicated by such forward looking statements include, but are not limited to (i) the information being of a preliminary nature and therefore subject to further adjustment; (ii) the ability of HMSY to contain costs in view of its revised revenue outlook, to grow internally or by acquisition and to integrate acquired businesses into the HMSY group of companies; (iii) the uncertainties of litigation; (iv) HMSY's dependence on significant customers; (v) changing conditions in the healthcare industry which could simplify the reimbursement process and adversely affect HMSY's business; (vi) government regulatory and political pressures which could reduce the rate of growth of healthcare expenditures; (vii) competitive actions by other companies, including the development by competitors of new or superior services or products or the entry into the market of new competitors; (viii) the ability of HMSY to deal with the Year 2000 Problem on a timely basis; (ix) all the risks inherent in the development, introduction, and implementation of new products and services; and other factors both referenced and not referenced in this Form 10-K. When used in this Form 10-K, the words "estimate," "project," "anticipate," "expect," "intend," "believe," and similar expressions are intended to identify forward-looking statements, and the above described risks inherent therein. Item 1. Business Overview Health Management Systems, Inc. ("HMSY" or the "Company") furnishes proprietary information management and data processing products and services to hospitals and other healthcare providers and to government health service agencies and other healthcare payors. These services address the various types of data generated by the interaction of the participants in the healthcare delivery process: the provider of care, the third-party payor, and the patient. Through its product and service offerings, the Company acts as an outsourcer of information management functions addressing the operational, administrative, financial, and clinical data that result from the rendering of healthcare services. The Company's product and service offerings benefit its clients by enhancing revenue (achieved through improved reimbursability and collectability), accelerating cash flow, reducing operating and administrative costs (by supplying advanced information analytics), and improving decision-making capabilities (via the provision of useful information). Healthcare providers receive payment for services from patients, third-party payors, or a combination thereof. Third-party payors include commercial insurance companies, governments or their intermediaries, health maintenance organizations, preferred provider organizations, third-party administrators for self-insured companies, and managed care companies. Although patients generally retain primary responsibility for payment for all healthcare services, hospitals usually process claims for which third-party payors bear responsibility. Obtaining reimbursement from third-party payors has become increasingly difficult because of frequent changes in reimbursement formulae and contract provisions, requirements for pre-admission certification and utilization review, and administrative procedures instituted by third-party payors in an effort to control costs. To be successful in obtaining payment from third-party payors, hospitals and other healthcare providers require regulatory knowledge and technical skills to manage complex data collection, integration, analysis, and accounts receivable management needs. To ensure that program costs are not greater than necessary, third-party payors require knowledge and skills analogous to those required by providers. 1 4 Using the operational, financial, administrative, and clinical data generated as part of the healthcare delivery process, the Company applies proprietary software and other analytical tools to transform data into valuable information that clients use to (i) minimize operating and administrative costs while improving profitability, (ii) measure the quality of care, and (iii) optimize payments transferred between payors and providers. Customers of the Company utilize the Company's products and services to improve their decision-making and operating capabilities and to achieve improved operational, administrative, financial, and clinical performance. The Company believes its customers benefit from the Company's unique understanding of the healthcare delivery process, from the perspective of both providers and payors. Fiscal year 1997 was one of cost realignment and management reorganization for HMSY. This reorganization accommodated a substantial decrease in revenue generated from certain of the Company's service offerings and integrated into HMSY's corporate structure three businesses acquired during the year. The Company emerged from fiscal year 1997 with a reorganized management structure, which further integrates and consolidates the various business units within the Company in congruence with its strategic objectives. To better understand the this strategy, a brief review of the Company's historic evolution is provided. Since its founding in 1974, the Company has furnished retrospective revenue recovery (Retroactive Claims Reprocessing ["RCR"]sm ) services to large governmental and voluntary hospitals. In 1985, the Company introduced retrospective revenue recovery (Third Party Liability Recovery ["TPLR"]sm ) services to governmental payors. In 1986, the Company introduced concurrent revenue recovery outsourcing (Comprehensive Account Management Services ["CAMS"]sm ). From its inception, the Company utilized electronic data interchange ("EDI") functionality wherever possible as part of its revenue recovery services but offered EDI services on a stand-alone basis only infrequently, through a wholly-owned subsidiary (Accelerated Claims Processing, Inc. ["ACPI"]) incorporated in 1985. In 1990, the Company entered the EDI marketplace in a more substantial manner through the acquisition of Quality Medi-Cal Adjudication, Incorporated ("QMA"). With the advent of managed care in the early 1990's, the Company anticipated the likely increased future relevance of functionality dealing with the prospective aspect of healthcare reimbursement. In 1995, HMSY completed the acquisition of Health Care microsystems, Inc. ("HCm"), a purveyor of decision support systems ("DSS") and services to providers of healthcare, as an initial step towards the provision of managed care support services to the healthcare industry. Also in 1995, anticipating the opportunity of acquiring a number of managed care information systems entities not yet ready for the public marketplace, the Company and Welsh, Carson, Anderson & Stowe ("WCAS"), a limited partnership affiliated with WCAS, certain other affiliates of WCAS, independent investors, and certain of the Company's executive officers and directors entered into a subscription agreement pursuant to which a new company, Health Information Systems Corporation ("HISCo"), was formed and capitalized, and in which HMSY held a 43% equity interest. In July 1995, HISCo acquired a vendor of indemnity and managed care legacy systems and software to healthcare payors, Health Systems Architects, Inc.(later renamed HSA Managed Care Systems, Inc. ["HSA"]). In March 1996, the Company acquired CDR Associates, Inc. ("CDR"), a provider of third-party liability recovery services to payors (principally Blue Cross/Blue Shield organizations, and other commercial and managed care insurers of healthcare risk). As the Company began fiscal year 1997, it comprised three principal components: (i) transfer payment services, encompassing RCR, CAMS, and TPLR (including CDR); (ii) managed care support services, as furnished by HCm, and (iii) electronic data interchange services, encompassing ACPI and QMA. In the beginning of fiscal year 1997, HMSY acquired a software company offering clinical information systems to providers of healthcare--Quality Standards in Medicine, Inc. ("QSM")-- and integrated QSM with HCm. In March 1997, the Company acquired the 57 % of the HISCo equity it had not previously owned, changed HISCo's name to HSA, and added it to HCm and QSM, thereby completing the Managed Care Support ("MCS") services division. In July 1997, the Company acquired substantially all the assets of the Global Health Systems, Inc. and GHS Management Services, Inc. (collectively "Global") subsidiaries of GHS, Inc. Initially believing Global to be principally a vendor of managed care software systems to providers of healthcare, Global was aligned with HSA. It is in this configuration 2 5 that the Company reported its Business Segment Information. See Note 13 to Notes to Consolidated Financial Statements on page F-25 of this Form 10-K. At the end of fiscal year 1997, the Company further streamlined its organization, resulting in two operating divisions: (i) Transfer Payment Services Division ("Transfer Payment Division"), and (ii) Software Systems and Services Division ("Software Division"). Each of the two Divisions is led by a senior vice president, reporting to a single chief operating officer. This construct installed Robert V. Nagelhout as Executive Vice President and Chief Operating Officer of HMSY, with Donald J. Staffa serving as Senior Vice President of the Transfer Payment Division and Thomas J. Kazamek serving as Senior Vice President of the Software Division. As part of this reorganization, the Company also centralized its sales and marketing, finance, and human resources functions at the corporate level, and further strengthened accountability for corporate-wide technology, information, and development methodology. The Transfer Payment Division comprises three operating units: (i) provider services, including RCR and CAMS; (ii) payor services, including TPLR and CDR; and (iii) a new unit directed at a redefined hospital business office outsourcing opportunity, which includes HMSY's EDI companies (ACPI and QMA) and Global. This new unit delivers less expansive outsourcing services than those contemplated by the Company's CAMS offerings, and views EDI as an enabling technology rather than a stand-alone business offering. In addition, the unit positions Global as an outsourcer of risk management functionality to provider business offices and management services organizations. The Software Division comprises two operating units: (i) HCm's DSS services, and (ii) HSA's Managed Care Information Services ("MCIS"). Previously, DSS was referred to as MCS. Healthcare Reform and Regulatory Matters The healthcare reimbursement process continues to change. Federal, state, and local governments, as well as other third-party payors, have initiated policies to reduce the rate of increase in healthcare expenditures. Many of these policy initiatives have contributed to the complex and time-consuming nature of obtaining healthcare reimbursement for medical services provided. Changes occurring in the healthcare industry, most notably managed care and capitation, have created an increasingly complex reimbursement environment that impacts both providers and payors. This environment is made even more complex as the historical distinction between providers and payors becomes less clear. Providers must ensure that they are properly reimbursed by third-party payors for healthcare services rendered in accordance with pre-established contracts. Likewise, payors must ensure that they are making payments for only those services for which they are responsible and in the dollar amounts specified. Although the Company cannot predict the nature of future healthcare reforms that will be adopted by federal, state, and local governments, the Company believes that the shifting of traditional insurance risk to providers of care, the consolidation of providers, and the resulting additional information management requirements placed on providers should increase the demand for the Company's offerings. Moreover, the Company believes that providers, payors, and patients--both separately and together--will benefit from the Company's integration of cost and other financial and clinical data, enabling identification and management by all participants (providers, payors, and patients) of the outcomes achieved. The Company observes the intensification of interest in ensuring compliance by providers and payors with the statutory, regulatory, and contractual requirements of managed care. The Company believes that the intensifying concern regarding compliance has increased its costs, as the Company seeks to ensure its own compliance and that of its customers. At the same time, the Company believes that the increased focus on compliance creates a potential market for its products and services. 3 6 The Medicare program is administered by the Health Care Financing Administration ("HCFA"), an agency of the U.S. Department of Health and Human Services. HCFA currently contracts with numerous insurance carriers and intermediaries to process regional claims for reimbursement. Although HCFA has established the regulatory framework for Medicare claims administration, Medicare intermediaries have the authority to develop independent procedures for administering the claims reimbursement process. The Medicaid program is subject to regulation by HCFA, but is administered by state governments. State governments provide for Medicaid claims reimbursement either through the establishment of state-owned and operated processing centers or through contractual arrangements with third-party fiscal agents who own and operate their own processing centers. The requirements and procedures for reimbursement implemented by Medicaid differ from state to state. Similar to the claims administration processes of Medicare and Medicaid, many national health insurance companies and self-insured employers administer reimbursement of claims through local or regional offices. Consequently, because guidelines for the reimbursement of claims are generally established by third-party payors at local or regional levels, hospital and other provider reimbursement managers must remain current with the local procedures and requirements of third-party payors. The ownership and operation of hospitals is subject to comprehensive federal and state regulation, which may affect hospital reimbursement. Since adoption, the Medicare and Medicaid programs have undergone significant and frequent changes, and it is realistic to expect additional changes in the future. Such changes could have an adverse effect on the operations of hospitals and other providers of healthcare, and consequently reduce the amount of the Company's revenue. The Company's services also are subject to regulations pertaining to billing services, which primarily involve recordkeeping requirements and other provisions designed to prevent fraud. The Company believes that it operates in a manner consistent with such regulations, the enforcement of which is increasingly more stringent. Finally, the Social Security Act imposes certain requirements on the Company with regard to confidentiality and disclosure of Medicare and Medicaid provider and beneficiary data. Specifically, the Company is prohibited from disclosing information that is obtained by or from the Department of Health and Human Services except as otherwise provided by regulations or other federal law. Generally, the Company is required to maintain standards of confidentiality that are comparable to those of an agency administering the Medicare or Medicaid program when the Company uses data obtained from such programs. The rapidity of consolidation within the healthcare industry over the past several years has created opportunities for the Company in its role as data consolidator. Yet the rapidity of change suggests that some of the consolidation may be undone over the next several years, as providers are downsized and integrated delivery networks ("IDN's") begin to unbundle. The Company believes these dynamics constitute both a risk to its existing business relationship with Columbia Healthcare Corporation ("C/HCA"), the Company's second largest client, and an opportunity for new business in the future. Principal Products and Services: Transfer Payment Division The Transfer Payment Division offers products and services to both providers and payors. Provider offerings comprise RCR and CAMS. Payor offerings comprise TPLR services, including those offered by CDR. Retroactive Claims Reprocessing (RCR) Services for Providers Since its founding in 1974, the Company has provided its RCR services to large public and voluntary hospitals. As a result of the magnitude and complexity of the information requirements involved in the healthcare claims reimbursement process, a hospital's patient accounting department processes an enormous amount of data each day, normally recouping a majority of third-party revenue due for patient services. Nevertheless, due to various factors, it is virtually impossible for any hospital to identify and obtain payment for all of the open balances that are eligible for third-party reimbursement. These factors include (i) incorrect or incomplete billing information provided by patients, (ii) difficulties in verifying patient insurance eligibility and payment status, (iii) problems in controlling the completeness and accuracy of patient information as it accumulates and flows through the frequently unintegrated platforms comprising the hospital's overall information management system, and (iv) the necessity for 4 7 constant modification and reprogramming of billing, reporting, and compliance routines due to the frequent and complex changes to payor information and compliance requirements. As a consequence of these and related factors, a hospital's patient accounting department often has incorrect or incomplete information regarding certain claims, resulting in such claims either being rejected by third-party payors or not being billed at all. For most hospitals, rejected or unbilled claims represent a relatively small percentage of total revenue, and the cost for any particular hospital to install the data processing system and hire the technical personnel that would be necessary to identify every claim covered by insurance and to accumulate all the information needed to submit each claim on an ongoing basis would be prohibitive. Through the application of the Company's proprietary technology, the Company's RCR services produce for its hospital clients incremental revenue, which otherwise would remain uncollected. RCR services are used by a hospital (most commonly for its emergency room and outpatient clinics) to realize third-party revenue from patient accounts after the hospital has expended its own best efforts at billing and collection, but before the accounts are referred to a collection agency. The Company's specialized data aggregation, data purification, data editing, and electronic claim preparation and transmission routines are designed to facilitate the reimbursement of accounts that remain unpaid because necessary billing information was missing or because third-party coverage was not known. RCR services require the hospital to provide the Company with copies of existing data files, demand minimal hospital staff support, and involve no patient contact. Each RCR client determines the scope of the services to be performed by the Company and the frequency with which such services are delivered. The scope of RCR services may involve a hospital's emergency room, outpatient, and/or inpatient departments. The frequency of processing and billing on behalf of a client is determined by a number of factors, including the client's internal billing and follow-up processes, as well as applicable statutory and regulatory time limitations on submission of claims. Average contingent fees for RCR range from 15% to 25% of the incremental revenue generated on behalf of the client. Revenue generated on behalf of new RCR clients is generally highest during the first full year of processing because the Company is able to liquidate the client's accounts receivable to the maximum extent of the available statutory claiming limitation. After the initial processing period, billings normally span shorter processing periods and generate smaller amounts of revenue. The incremental revenue generated on behalf of the Company's clients will vary significantly from client to client due to differences in the sophistication of the clients' data systems and the scope and frequency of the services performed. Since 1974, RCR services have generated in excess of $1.2 billion for hospitals from Medicaid, Medicare, and commercial insurers nationwide. Over the last three fiscal years, such services have generated over $0.4 billion in incremental reimbursements. The Company currently has 63 RCR clients in eight states and the District of Columbia. Comprehensive Accounts Management Services (CAMS) for Providers As a result of the technology and expertise developed in providing RCR services, the Company is able to provide custom institutionalized data processing, computer software, and operations support services to hospitals, public health clinics, outpatient treatment facilities, and companies that serve the healthcare industry. In contrast to RCR services, which retrospectively reprocess patient accounts receivable data, CAMS delivered to healthcare providers provide concurrent third-party claim identification, editing, preparation, and electronic claims submission. The Company integrates data derived from the hospital's disparate data collection systems and manages the electronic interfaces between the hospital and the transfer payment agencies upon which the hospital is dependent for reimbursement. CAMS is designed to provide an integrated and comprehensive solution to a hospital's accounts receivable liquidation requirements by combining (i) an intimate familiarity with the principal in-house shared data collection and patient accounting systems found in large urban hospitals with (ii) expertise in the management and liquidation of accounts receivable, thereby offering a hospital a unique opportunity to improve the effectiveness of its accounts receivable management program (enhance revenue and accelerate cash flow) while decreasing its administrative costs. 5 8 As part of CAMS, the Company develops customized automated interfaces between a hospital's various data collection, billing, and accounts receivable systems, and the claims processing systems of third-party payors. To establish these interfaces, the Company must satisfy the unique information and data processing requirements of each hospital and of the various intermediaries used by third-party payors in each jurisdiction. The Company obtains information from the client hospital's internal charge capture, medical records, utilization review, and patient accounting systems as required to submit electronically complete and accurate reimbursement claims. The Company then performs pre-billing edits, uses its computer platforms to facilitate correction of pre-billing edit failures, and performs electronic billing of valid claims. Upon payment by the third-party payors, the Company captures remittance data from intermediaries for electronic posting to the hospital's accounts receivable system. CAMS systems apply a variety of technologies (including bar coding devices) to track location and document status information and to extract requisite information from medical records, utilization review, and patient accounting systems at the client site. CAMS also generates (for delivery in paper or electronic media form) automated management reports for use by the hospital's patient accounting and financial management personnel that would otherwise be unavailable to them. Third-party Liability Recovery (TPLR) Services for Payors Since 1985, the Company has offered TPLR services principally to state Medicaid agencies, as a means of identifying third parties with prior liability for Medicaid claims. As part of its TPLR offering, the Company provides hospital-based claims audits on behalf of payors, for the purpose of recovering credit balances and duplicate payments. The Company provides services to state Medicaid agencies as well as to Medicaid HMO's and to Blue Cross/Blue Shield organizations and commercial insurers (including managed care payors). The Medicaid program, which was established in 1965, exists as the payor of last resort for healthcare services required by financially and medically needy individuals. The Medicaid program is administered by the individual states, with joint federal and state funding of costs. In 1985, the federal government, recognizing that state Medicaid agencies were improperly paying substantial amounts for healthcare claims for individuals having some other form of third-party healthcare insurance, imposed statutory regulations requiring states to take active measures to pursue the third parties. TPLR processing is performed according to the requirements of each individual client. In providing these services, the Company uses proprietary information management and analytic methodologies similar to those used in providing RCR services, although TPLR services require the creation of independent databases of far greater magnitude. TPL contracts generally have one to three year terms and provide for contingent fees that typically range from 10% to 15% of the amounts recovered for the client. The Company recognizes revenue at the time a recovery to be submitted on behalf of the client third-party payor or its intermediary is approved by the client for purposes of initiating the recovery process. TPLR revenues are subject to annual fluctuations similar to those experienced with RCR services. In April 1996, the Company acquired CDR in a merger transaction to augment the Company's TPLR services to state Medicaid agencies. CDR is a provider of hospital-based claim audits on behalf of payors. CDR's principal client base is comprised of Blue Cross/Blue Shield organizations and their related managed care organizations. In addition, CDR's clients include several commercial insurance carriers and HMO's. In fiscal year 1996, the Company began application of its proprietary information management and analysis methodologies similar to those used for providing RCR and TPLR services, to offer services known as Employer Retroactive Claims Reprocessing Recovery ("ERCR") services to self-insured employers. ERCR has not yielded consistently positive results, although the Company still maintains five such contracts; the ERCR offering has been incorporated into the Company's TPLR services. 6 9 Since 1985, TPLR services (exclusive of those offered by CDR) have generated in excess of $559 million, of which $383 million has been generated in the last three years. The Company currently has 43 TPLR engagements in 21 states, inclusive of CDR and ERCR. Principal Products and Services: Software Division The Software Division offers products and services for both payors and providers. At this time, provider services comprise DSS offerings; payor services comprise MCIS offerings. Decision Support Software (DSS) and Services for Providers Recent changes in the healthcare marketplace have intensified the information demands at all levels in provider organizations, whether hospitals or IDN's. Additionally, payors have new and/or expanded information requirements that existing legacy systems do not support. Competition for covered lives under various managed care paradigms is forcing providers to deliver healthcare as efficiently and cost-effectively as possible, without compromising quality. The focus of healthcare information technology is changing from collecting departmental financial data (with a focus on charge capture and billing of incidents of medical service) to gathering and aggregating enterprise-wide information at the patient/member level, with an emphasis on clinical operations, cost identification, cost reduction, and complex coordination of benefits data. Two requirements emerge from these trends: (i) future information management functionality must be tailored for complex and diverse IDN's spanning hospital divisions, managed care business lines, physician group practices, and ancillary services; and (ii) information systems and services must help providers function in a capitated environment. The growth of managed care and the consolidation of healthcare institutions is significantly increasing the complexity of the industry and the associated demand for decision support systems. In the managed care environment, the Company believes that decision support is the linchpin for integrating, analyzing, and understanding key operational, financial, administrative, and clinical data obtained from institutions' transaction-based healthcare information systems. As such, DSS is increasingly being relied upon to guide the management practices of providers (in areas ranging from managed care contracting and clinical pathways development to physician profiling) to ensure the success and financial and operational viability of their organizations. The current clients for the Company's DSS services include more than 500 hospitals and IDN's located primarily in the United States. These hospitals range in size from 50 to more than 1,000 beds, and include many of the most progressive and complex health systems in the country, as well as some of the largest multi-site hospital chains, managed care organizations, and long-term care institutions. In development with several major healthcare organizations for the past three years, the Company's new suite of DSS products and services, called HCm Alliance(TM) for Managed Care ("Alliance"), will be available in the market in early calendar year 1998. Alliance will enable healthcare providers to perform clinical, cost, and contract management from the perspective of the provider, payor, and/or administrator. Employing advanced systems integration, data validation, and distribution methods, Alliance will support evolving data warehousing and information systems initiatives. Alliance was built with an open system architecture, running on a variety of platforms that support client server processing and World Wide Web applications. In addition to purchasing the Company's software, customers will have the option of partnering with the Company or outsourcing part or all of the operation of the Alliance system to the Company. The Company will continue to integrate clinical quality measures within its DSS offering. In partnering relationships, the Company dedicates considerable resources to providing a wide variety of related consulting applications, including managed care strategic consulting, systems installation, data acquisition, development and training, contract and clinical management, and managed care reporting. Through its HCm Alliance(TM) for Financial Modeling ("FM") product, the Company offers hospitals and long-term care organizations an enterprise-wide financial analysis and modeling application, with capabilities including productivity analysis, budgeting and forecasting, long-range planning and analysis, and provider resource 7 10 management. FM incorporates multi-dimensional, on-line analytical processing technology, integrated with electronic mail applications and standard spreadsheet tools to support communications and analysis. The Company also provides FM-related application consulting services, focusing on analysis and development of cost accounting, contract management, budgeting, business lines, and treatment patterns. Managed Care Information Systems (MCIS) and Services for Payors Both public and private entities are rapidly embracing managed care health plans as a means of providing healthcare coverage. With this increased demand, the number of existing payors, the number of start-up entities, and the number of IDN's seeking to offer managed care products has greatly increased. To support their businesses, these payors require systems to: manage patient membership, provider contracts, and networks; process and adjudicate claims; manage risk; and perform medical management. The Company's MCIS offerings provide large-scale transaction processing systems to more than 45 large and medium-sized commercial payors and managed care plans, including some of the largest Blue Cross/Blue Shield organizations. The three principal offerings are Health Enterprise Systems ("HES") , Provider Information Management System ("PIMS") , and The Capitation Facility ("TCF"). HES is a risk management solution for payors seeking a strategy to manage their own health plans and market their own products, providing data processing for plans offering traditional indemnity coverage through complete managed care programs. Comprised of modular systems, HES automates four major areas of healthcare administration: membership and billing; provider administration; capitation; and benefits and claims. PIMS is a data repository enabling proactive management based on information such as credentialing, accreditation, and pricing arrangements. TCF, the Company's stand-alone capitation offering, manages the payment to providers of pre-negotiated per capita amounts. In conjunction with development partners and on its own, the Company intends during fiscal year 1998 to adapt and/or migrate various of its MCIS offerings to an open system architecture, running on platforms that support client server and World Wide Web applications. The Company's MCIS offerings are sold on a stand-alone basis, or can be integrated into existing systems, the latter option enabling payors to preserve their investments in information technology. The Company believes that these offerings dramatically reduce the cost of processing claims through auto-adjudication. As with all its products, the Company is able to provide its MCIS offerings on an outsourcing or consulting basis. Principal Products and Services: Other Electronic Data Interchange (EDI) for Providers Through its RCR, CAMS, and TPLR offerings, the Company has developed the capability to submit healthcare claims data and to receive remittance data electronically from a diverse array of third-party payors. In addition, the Company provides electronic billing and follow-up services for claims submitted to Medi-Cal (the California Medicaid program). The Company also provides stand-alone EDI services to clients in Illinois, New York, and Pennsylvania. In total, the Company provides EDI services to 137 hospitals and healthcare organizations. The Company's strategy includes the continued development of EDI services as an integral component of its hospital business office outsourcing offering. Customers The Company's client base includes more than 600 hospitals, IDN's, multi-hospital systems, large commercial payors, Blue Cross/Blue Shield organizations, and state Medicaid agencies in 46 states and the District of Columbia. The Company also has a limited number of clients in the United Kingdom. Among the Company's domestic clients are the nation's three largest public health systems. The Company works with selected development partners in the research, development, and testing of its software products and services. 8 11 Market Trends/Opportunities The demands of managing the delivery of patient care with ever increasing qualitative and quantitative rigor will continue to drive the need for increased amounts of operational, financial, administrative, and clinical information. The Company believes that it possesses the data content, analytic tools, technology, and process management skills required to respond to the current and anticipated needs of provider and payor clients for tools and services to manage this evolving complexity. Cost pressures continue to drive horizontal and vertical integration of providers and payors alike. Consolidation among healthcare organizations is creating larger healthcare delivery systems with greater regional market power. This phenomenon is creating a new market for the Company's products, with fewer but larger client prospects. Despite some recent analyses suggesting that the rapidity of this change may be undone over the next several years, as providers are downsized and IDN's begin to unbundle, the Company believes that it has the opportunity to leverage its products and services across a larger enterprise, making the Company's products and services more cost effective for clients. As well, the shifting of financial risk from payors to providers creates the opportunity for the Company to provide its MCIS offerings to providers as well as payors. A certain portion of the Company's traditional receivables management services has been capitated and is no longer subject to recovery through its RCR offering. Due to managed care, however, providers' commercial insurance portfolios are becoming more problematic. Providers are increasingly seeking assistance from vendors to optimize reimbursement from commercial insurance claims, which are frequently rejected erroneously as managed care claims. In addition, the Company expects that there will be a growing trend toward outsourcing by healthcare provider organizations in the future. Competition Although the Company's products and services involve various proprietary aspects, its business is highly competitive and has been consolidating rapidly. While the Company believes that no one company competes with all aspects of its business, several companies, some of which may be larger and have greater financial resources than the Company, compete with the Company in providing one or more of the Company's offerings. The Company also encounters competition from companies attempting to expand the scope of their products and services within or into the healthcare information management services industry. Transfer Payment Division The Company's RCR and CAMS provider offerings compete with systems integration companies (such as Electronic Data Systems Corporation ["EDS"]), hospital computer systems vendors (such as HBOC & Company ["HBOC"] and Shared Medical Systems Corporation ["SMS"]), EDI companies (such as National Data Corporation ["NDC"], including the former CIS Technologies, Inc.), MedE America Corporation ("MedE"), and QuadraMed Corporation ["QMDC"]), and national public accounting firms. The Company competes on the basis of its proprietary systems, existing relationships, long-standing reputation in the provider market segment, and pricing. The payor offerings of the Company's Transfer Payment Division target federal and state healthcare agencies and large commercial payors, and compete primarily with national public accounting firms (especially Public Consulting Group, a frequent business partner of Deloitte & Touche LLP). The Company competes on the basis of its proprietary systems, historically high recovery rates, and pricing. Software Division The Company's DSS offering competes with products provided by Transition Systems, Inc. ("TSIX") and HBOC. QMDC, with its recent acquisition of Medicus Systems, has emerged as a competitor. Companies that offer financial management products, including Hyperion Software and PeopleSoft, Inc., are also competitors. The Company competes on the basis of its proprietary software and management consulting services. 9 12 The Company's MCIS offerings for the managed care market compete against many companies, including Health Systems Design Corporation and ERISCO, Inc. ("ERISCO"), a subsidiary of Cognizant Corporation, as well as with in-house systems development groups. The Company also sells these products to large provider organizations, and views IDN's as a potential market for its existing products and services. In the provider market, competition comes from large hospital computer systems vendors, such as HBOC and SMS, which also offer managed care information systems as part of their solutions. In the traditional indemnity market, the Company's MCIS offerings compete with claims adjudication and provider management products from ERISCO, Synertech, a subsidiary of Highmark, Inc., Resource Information Management Systems, Inc., and Rothenberg Health Systems, Inc., which has announced its intent to be acquired by QMDC. As the Company enters the IDN market, it will compete with HBOC's Amisys Division and SMS. CSC Healthcare, a subsidiary of Computer Sciences Corporation, has also been investing in and may emerge as a strong competitor in the IDN market. The Company's MCIS offerings compete on the basis of its proprietary software, healthcare software development expertise, and large-scale project management capabilities. Other The Company's EDI offerings compete with numerous entities, including MedE, NDC, and QMDC. Significant Contracts The Company's largest client is a group of healthcare facilities under the governance of Los Angeles County, for which the Company provides RCR and CAMS, including managed care services. During the fiscal years ended October 31, 1997, 1996, and 1995, this group accounted for 12%, 12%, and 15%, respectively, of the Company's total revenue. The Company's second largest client is C/HCA, for which the Company provides DSS. This client accounted for 12%, 8%, and 4%, respectively, of the Company's total revenue in 1997, 1996, and 1995. The Company provides its services to C/HCA principally pursuant to a series of 12-month work order agreements. There is no assurance that any of these agreements will be renewed. The Company's ten largest clients accounted for approximately 53% of the Company's revenue in fiscal year 1997. Five of the Company's ten largest contracts with these clients expire in fiscal year 1998. There can be no assurance that any of these contracts will be renewed. New Products and Services The Company's strategy is to continue to strengthen its position as a leading provider of decision support software and services, managed care information systems and services, and transfer payment products and services for both providers and payors. In addition, the Company will continue to leverage its existing software and services to enhance its outsourcing services offerings. Key components of the Company's strategy include (i) increasing levels of investment in product research and development, (ii) enhancing its outsourcing capabilities, (iii) leveraging existing relationships with large clients through provision of additional Company products and services, and (iv) expanding the Company's strategic development partnerships with provider and payor organizations for all aspects of its business. Mergers and Acquisitions The Company may acquire companies that supply healthcare providers and payors with information management software, systems, or services if the offerings of such companies would benefit from access to the Company's technology, software applications, or client base. The Company believes that such acquisition opportunities exist due, in part, to competitive pressures on local service businesses that lack adequate capital, 10 13 technical, and management resources. The Company also believes that consolidation will continue to occur within the healthcare information services industry. Relationship with Health Information Systems Corporation (HISCo) The Company and HISCo entered into an agreement, dated as of October 31, 1995 (the "HISCo Agreement"), pursuant to which the Company was to provide HISCo with certain services ("Basic Services"), including executive, acquisition support, and corporate support services. For these Basic Services, the Company was entitled to receive a fee, payable monthly, calculated at the Company's then current standard hourly rates established for internal allocations plus 20%. The term of the HISCo Agreement was to continue until the later of (i) June 30, 2000 or (ii) the expiration of any outstanding work order related to additional services. The Company believed that the terms of the HISCo Agreement were fair and reasonable and were no less favorable to the Company than those that could have been obtained with respect to comparable engagements with independent third parties. In fiscal years 1997 and 1996, the Company received approximately $331,000 and $161,000 in fees from HISCo for services provided pursuant to the HISCo Agreement. In fiscal years 1997 and 1996, HISCo received $0 and $569,000 in fees for software development services provided the Company pursuant to the HISCo agreement. These software development fees were expensed by the Company. In March 1997, the Company, which owned 43% of HISCo's equity, acquired the remaining 57% of HISCo's equity for $3,689,000, net of cash acquired, from WCAS, a limited partnership affiliated with WCAS, certain other affiliates of WCAS, independent investors, and certain of the Company's executive officers and directors. In connection with this acquisition, the HISCo agreement was terminated and HISCo and its sole operating subsidiary, Health Systems Architects, Inc., were merged and renamed HSA Managed Care Systems, Inc. ("HSA"). HSA provides automated business and information solutions, including software and services, to the bearers of risk in the healthcare industry. The acquisition was accounted for using the purchase method and accordingly the results of operations of HSA from the date of acquisition through October 31, 1997 are included in the accompanying financial statements. The $2,309,000 excess of the purchase price over fair market value of the net assets acquired was recorded as goodwill and is being amortized over a period not to exceed 20 years. See Note 2(b) of Notes to Consolidated Financial Statements on page F-17 of this Form 10-K. In connection with the sale of their respective equity interests in HISCo to the Company, certain officers and directors of the Company derived gross proceeds as follows: Paul J. Kerz, $101,000; Laurence B. Simon, $62,000; Donald J. Staffa, $31,000; Russell L. Carson, $79,000; and Richard H. Stowe, $30,000. Relationship with HHL Financial Services, Inc. (HHL) HHL Financial Services, Inc. ("HHL") was a client of the Company, accounting for 2%, 5%, and 10% of the Company's total revenue during the fiscal years ended October 31, 1997, 1996, and 1995, respectively. During the third quarter of fiscal year 1996, the Company recorded a one-time charge occasioned by HHL's default on its obligations under a data processing agreement with the Company. The one-time charge consisted of (i) a reversal of third quarter revenue of $2,180,000, (ii) estimated net costs relating to the Company's continued contractual obligation with HHL of $3,823,000, (iii) a write-off of prior period accounts receivable of $2,881,000, and (iv) a write-off of its investment in HHL of $927,000. The after-tax impact of the one-time charge was a $5,838,000 reduction to net income. On October 21, 1996, the Company and HHL entered into an agreement which set forth interim terms for the Company to continue to provide data processing services to HHL in exchange for payment in advance. On October 29, 1996, the Company entered into an agreement with HHL and HHL's primary creditor providing for mutual general releases and the cessation of all claims. In that agreement, the Company also settled its liabilities due to HHL of $1,950,000 for a payment of $870,000 resulting in the reversal of $1,080,000 in liabilities as an offset to other operating expenses. In addition, the Company agreed to provide for a period of up to 18 months a reduced level of service in exchange for payment in advance. In January 1997, HHL filed a petition in bankruptcy and on October 30, 1997 HHL canceled all future service requirements with the Company. 11 14 Prior to their resignations in June 1996, Paul J. Kerz, Chairman, President, and Chief Executive Officer and a director of the Company, had served as Chairman and a director of HHL, and Russell L. Carson and Richard H. Stowe, directors of the Company, had served as directors of HHL. See Note 16(a) to Notes to Consolidated Financial Statements on page F-26 of this Form 10-K. Acquisition of Quality Standards in Medicine, Inc. (QSM) On November 25, 1996, the Company acquired QSM in a merger transaction. Founded in 1986, QSM furnishes clinical quality management and improvement systems to hospital providers located primarily in 11 states and the District of Columbia. The Company issued 260,000 shares of common stock in the QSM merger transaction, which was treated as a tax-free reorganization for federal income tax purposes and was accounted for using the pooling of interests method. QSM has been operationally joined with HCm. Accordingly, the accompanying consolidated financial statements have been retroactively restated to include the financial position, results of operations, and cash flows of QSM. Acquisition of the Assets of Global Health Systems, Inc. and GHS Management Services, Inc. (Global) In July 1997, the Company acquired for $2,146,000 in cash substantially all the assets of Global, which provided systems and services for managed care, public health, and ambulatory care facilities. The acquisition was accounted for using the purchase method and accordingly the results of operations for Global from the date of acquisition through October 31, 1997 are included in the accompanying consolidated financial statements. The excess of the purchase price over the fair market value of the net assets acquired was $1,701,000. This excess was recorded as goodwill and is being amortized over a period not to exceed 20 years. During 1997, Global was operated as part of the Company's MCIS offering. Employees As of October 31, 1997, the Company had 837 employees: 401 in the Software Division and 436 in the Transfer Payment Division. No employees are covered by a collective bargaining agreement or are represented by a labor union. Effective January 1, 1998, the Company's co-founder, Laurence B. Simon, relinquished his executive responsibilities to concentrate on new product planning and development on a part-time basis. Financial Information about Industry Segments Specific financial information with respect to the Company's industry segments is provided in Note 13, Business Segment Information, in the Notes to Consolidated Financial Statements on page F-25 on this Form 10-K. Item 2. Properties The Company's New York City offices consist of 146,000 square feet. In addition, the Company leases approximately 147,400 square feet of office space in approximately 25 locations throughout the United States. Information regarding the Company's leases is included in Note 14 of Notes to Consolidated Financial Statements on page F-26 of this Form 10-K. The Company operates IBM CMOS processors, associated peripheral devices from Hitachi Data Systems and EMC Corporation, communications devices, a large number of microcomputers, and extensive local and wide area networks. These technologies facilitate both product development and production processes. The Company's data processing operations afford both batch processing and national on-line network capabilities and are controlled by multiple levels of physical and software security. Each of the Company's critical systems is backed up on a nightly basis. Copies of the Company's operating systems, key applications software, and critical client data are maintained offsite to ensure continuity of business. The Company does not rely on unique 12 15 hardware or software systems and its purchase and maintenance agreements with vendors provide for back-up support in case of computer systems failure. Item 3. Legal Proceedings In April and May 1997, five purported class action lawsuits were commenced in the United States District Court for the Southern District of New York against the Company and certain of its present and former officers and directors alleging violations of the Securities Exchange Act of 1934 arising out of allegedly false and misleading statements. These lawsuits, which seek damages in an unspecified amount, have been consolidated into a single proceeding captioned In re Health Management Systems, Inc. Securities Litigation (97 Civ. 1865 (HB)) and a Consolidated Amended Complaint has been filed. Defendants have made a motion to dismiss the Consolidated Amended Complaint. The motion was submitted to the Court on December 18, 1997 following oral argument and is sub judice. Discovery has been stayed pending a determination of the Company's motion to dismiss. The Company believes it has meritorious defenses to the claims asserted against it and intends to vigorously defend this litigation should the pending motion to dismiss not be granted. It is too early to form any opinion as to the eventual outcome of this matter. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters The Company's common stock is included in the Nasdaq National Market System (symbol: HMSY). As of the close of business on December 31, 1997 , there were approximately 14,500 holders of the Company's common stock, including the individual participants in security position listings. The Company has not paid any cash dividends on its common stock and does not anticipate paying cash dividends in the foreseeable future. The Company's present intention is to retain earnings to support the future growth of its business. The Company's credit agreement with its bank contains limitations on the Company's ability to pay cash dividends. The table below summarizes the high and low closing prices per share for the Company's common stock for the fiscal year periods indicated, as reported on the Nasdaq National Market System. First Second Third Fourth Quarter Quarter Quarter Quarter --------------------------------------------- 1997: Market Price: High $27.75 12.37 7.50 10.00 Low 13.00 4.75 4.50 5.63 1996: Market Price: High $26.83 31.75 37.00 31.75 Low 21.33 24.50 25.50 22.25 1995: Market Price: High $15.33 17.17 22.83 23.67 Low 11.11 12.55 14.09 17.17 13 16 Item 6. Selected Financial Data The information required by Item 6 is found on pages F-7 to F-8 of this report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by Item 7 is found on pages F-1 to F-6 of this report. Item 8. Financial Statements and Supplementary Data The information required by Item 8 is found on pages F-10 to F-13 of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant The information required by Item 10 will be included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1997, and is hereby incorporated herein by reference to such Proxy Statement. Item 11. Executive Compensation The information required by Item 11 will be included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1997, and is hereby incorporated herein by reference to such Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by Item 12 will be included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1997, and is hereby incorporated herein by reference to such Proxy Statement. Item 13. Certain Relationships and Related Transactions The information required by Item 13 will be included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1997, and is hereby incorporated herein by reference to such Proxy Statement. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K A. Financial Statements - See Index to Consolidated Financial Information on page 16. B. Schedule Schedule II - Valuation and Qualifying Accounts C. Reports on Form 8-K None D. Exhibits See Exhibit Index 14 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HEALTH MANAGEMENT SYSTEMS, INC. (Registrant) By: /s/ Paul J. Kerz -------------------------------------- Paul J. Kerz President and Chief Executive Officer Date: January 13, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Title Date - ---------- ----- ---- /s/ Paul J. Kerz Chairman, President and January 13, 1998 - --------------------------- Chief Executive Officer, Paul J. Kerz and Director /s/ Phillip Siegel Vice President and January 13, 1998 - --------------------------- Chief Financial Officer Phillip Siegel /s/ Robert V. Nagelhout Executive Vice President, January 13, 1998 - --------------------------- Chief Operating Officer, Robert V. Nagelhout and Director /s/ Donald J. Staffa Senior Vice President and January 13, 1998 - --------------------------- Director Donald J. Staffa /s/ Russell L. Carson Director January 13, 1998 - --------------------------- Russell L. Carson /s/ William W. Neal Director January 13, 1998 - --------------------------- William W. Neal /s/ Galen D. Powers Director January 13, 1998 - --------------------------- Galen D. Powers /s/ Ellen A. Rudnick Director January 13, 1998 - --------------------------- Ellen A Rudnick /s/ Richard H. Stowe Director January 13, 1998 - --------------------------- Richard H. Stowe 15 18 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL INFORMATION Page Contents Number - -------- ------ Management's Discussion and Analysis of Results of Operations and Financial Condition F-1 Selected Consolidated Financial Data F-7 Report of Independent Certified Public Accountants F-9 Consolidated Statements of Operations for the Years Ended October 31, 1997, 1996, and 1995 F-10 Consolidated Balance Sheets as of October 31, 1997 and 1996 F-11 Consolidated Statements of Shareholders' Equity for the Years Ended October 31, 1997, 1996, and 1995 F-12 Consolidated Statements of Cash Flows for the Years Ended October 31, 1997, 1996, and 1995 F-13 Notes to Consolidated Financial Statements F-14 Schedule: Schedule II - Valuation and Qualifying Accounts F-30 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Certain statements set forth below under this caption constitute "forward-looking statements" within the meaning of the Reform Act. See "Special Note Regarding Forward-Looking Statements" on page 1 for additional factors relating to such statements Overview The Company's Transfer Payment Division has delivered RCR services since 1974 and began to deliver its TPLR and CAMS offerings in 1985 and 1986, respectively. The Company augmented its TPLR product line by acquiring CDR in a merger transaction in April 1996. CDR is a provider of hospital-based claim audits to payors (principally Blue Cross/Blue Shield organizations) within the healthcare industry. In fiscal year 1998, hospital business office outsourcing services, including EDI and Global product offerings, will be one of three units in the Transfer Payment Division, in addition to the provider and payor units. The Company's Software Division was referred to as MCS during 1997. The Company entered the DSS business in February 1995 when the Company merged with HCm, which provides microcomputer-based decision support software and services to the healthcare industry. In November 1996, the Company acquired QSM, a Boston-based company providing clinical information systems to providers, in a merger transaction. QSM has been combined with HCm. In March 1997, the Company, which owned 43% of HISCo's equity, acquired from WCAS, a limited partnership affiliated with WCAS, certain other affiliates of WCAS, independent investors, and certain of the Company's executive officers and directors, the remaining 57% of HISCo's equity which, at the end of fiscal year 1997, became the MCIS segment of the Software Division. At the time of the acquisition, HISCo merged with its operating subsidiary, Health Systems Architects, Inc. and was renamed HSA Managed Care Systems, Inc. HSA provides automated business and information solutions, including software and services, to the bearers of risk in the healthcare industry. These solutions comprise the MCIS product offering of the Software Division. In July 1997, the Company acquired substantially all the assets of Global Health Systems, Inc. and GHS Management Services, Inc., subsidiaries of GHS, Inc. These subsidiaries provided computerized record-based processing systems and services for managed care, public health and ambulatory care facilities. For the balance of fiscal year 1997, Global's results have been combined with those of HSA. In fiscal year 1998, Global will be reported as part of hospital business office outsourcing unit in the Transfer Payment Division. The remaining portion of the Company's business is currently comprised of EDI services. The Company entered the EDI market in 1990 when the Company acquired QMA, which provides electronic billing and automated denial reprocessing services, principally in the state of California. The HCm, CDR, and QSM mergers were accounted for using the pooling of interests method, and the QMA, HISCo, and Global acquisitions were accounted for using the purchase method. F-1 20 Results of Operations The table below summarizes the Company's results of operations and the percentage of total revenue of selected line items for the last three fiscal years.
Years Ended October 31, 1997 1996 (a) 1995 (a) ($ In Thousands) - -------------------------------------------------------------------------------------------------------------- Amount % Amount % Amount % --------------------- -------------------- --------------------- Revenue: Transfer Payment Division RCR $ 17,108 19% $ 28,212 28% $ 22,961 25% CAMS 15,431 17% 18,505 18% 23,945 26% TPLR 16,849 19% 26,407 26% 19,479 22% ------------ -------- ----------- ------- ------------ -------- 49,388 55% 73,124 72% 66,385 73% Software Division DSS 24,873 28% 19,510 19% 15,888 18% MCIS (b) 9,422 10% 0 0% 0 0% ------------ -------- ----------- ------- ------------ -------- 34,295 38% 19,510 19% 15,888 18% EDI (c) 5,834 7% 8,692 9% 8,222 9% - -------------------------------------------------------------------------------------------------------------- 89,517 100% 101,326 100% 90,495 100% Cost of services: Compensation 52,361 58% 49,370 49% 44,157 49% Data processing 7,593 9% 10,282 10% 8,167 9% Occupancy 10,383 12% 8,001 8% 6,669 7% Other 18,018 20% 20,220 20% 14,042 16% - -------------------------------------------------------------------------------------------------------------- 88,355 99% 87,873 87% 73,035 81% Operating margin before amortization of intangibles 1,162 1% 13,453 13% 17,460 19% Amortization of intangibles 1,331 1% 204 0% 243 0% - -------------------------------------------------------------------------------------------------------------- Operating (loss) income (169) (0)% 13,249 13% 17,217 19% Net interest and net other income 2,746 3% 987 1% 942 1% Loss on investment 0 0% (927) (1)% 0 0% Merger related costs (537) (1)% (494) (0)% (1,045) (1)% Equity in (loss) earnings of affiliate (310) (0)% 50 0% 0 0% - -------------------------------------------------------------------------------------------------------------- Income before income taxes 1,730 2% 12,865 13% 17,114 19% Income tax benefit (expense) 351 0% (5,574) (6)% (8,152) (9)% - -------------------------------------------------------------------------------------------------------------- Net income $ 2,081 2% $ 7,291 7% $ 8,962 10% - --------------------------------------------------------------------------------------------------------------
(a) The fiscal year 1996 and 1995 operating results have been restated to include the effect of the QSM merger in November 1996, which was accounted for using the pooling of interests method. (b) During fiscal year 1997, and since the acquisition of Global on July 15, 1997, the operating results of Global were consolidated with HSA. In fiscal year 1998, the operating results of Global will be reported as part of hospital business office outsourcing in the Transfer Payment Division. (c) In fiscal year 1998, EDI will be reported as part of hospital business office outsourcing in the Transfer Payment Division. F-2 21 Years Ended October 31, 1997 and 1996 Revenue for the fiscal year ended October 31, 1997 was $89,517,000, a decrease of $11,809,000 or 12% from the prior year. Before the HHL revenue reversal of $2,180,000 in the third quarter of fiscal year 1996, consolidated revenue decreased $13,989,000 or 14%. Revenue from the Transfer Payment Division was $49,388,000, a decrease of $23,736,000 or 32% from the prior year. Before the HHL revenue reversal, Transfer Payment Division revenue decreased $25,916,000 or 34% from the prior year due to the non-recurrence in 1997 of one-time projects in 1996, a contract hiatus with a major client, lower billing volumes and fee rates, and contract expirations. Revenue from DSS services was $24,873,000, an increase of $5,363,000 or 27% over the prior year due to the continued growth of software consulting fees and maintenance contract revenue. Revenue from MCIS for fiscal year 1997 was $9,422,000. There was no comparable prior year revenue for MCIS because HSA and Global were acquired during fiscal year 1997 in transactions accounted for under the purchase method. Revenue from EDI services was $5,834,000, a decrease of $2,858,000 or 33% from the prior year due primarily to client losses. Cost of services for the fiscal year ended October 31, 1997 was $88,355,000, an increase of $482,000 or less than 1% from the prior year. Prior to the effect of the one-time HHL charge of $6,704,000 in the third quarter of 1996, comprised of $1,362,000 of compensation costs, $2,199,000 of data processing costs, and $3,143,000 of other operating costs (including $2,881,000 of bad debt expense related to HHL receivables and $262,000 of net other operating expenses), cost of services increased $7,186,000 or 9% over the prior year. This increase was due primarily to the added cost of services resulting from the acquisitions of HSA and Global, which added costs of services by $9,249,000, and increased operating costs of DSS services of $3,228,000, which increases were offset by certain cost reductions in the Transfer Payment Division and EDI businesses. Compensation expense for the fiscal year ended October 31, 1997 was $52,361,000 or 59% of total cost of services, an increase of $2,991,000 or 6% over the prior year. Compensation expense in 1997 compared to 1996 prior to the HHL one-time charge of $1,362,000 in the third quarter of 1996 increased $4,353,000 or 9%. The increased compensation expense was primarily attributable to operating costs resulting from the HSA and Global acquisitions, which increased compensation expense by $6,395,000, and increased compensation cost from DSS services of $2,642,000. Included in compensation expense in 1997 was severance cost of $568,000 in connection with two reductions in force in the Transfer Payment Division. These increases were partially offset by lower compensation expenses, including bonus and profit sharing expenses, in the Transfer Payment Division and EDI businesses. Data processing expense for the fiscal year ended October 31, 1997 was $7,593,000, a decrease of $2,689,000 or 26% from the prior year. Prior to the effect of the HHL one-time charge in the third quarter of 1996 of $2,199,000, data processing expense decreased $490,000 or 6%. The decrease in cost was due to certain cost reductions and lower Transfer Payment Division revenue, which more than offset the $1,087,000 increase in operating costs from the HSA and Global acquisitions. Occupancy expense for the fiscal year ended October 31, 1997 was $10,383,000, an increase of $2,382,000 or 30% over the prior year. This increase was primarily due to the expansion of the Company's facilities, including additional floors at the Company's New York City offices, and $813,000 in additional operating expense from the acquisitions of HSA and Global. Other operating expense for the fiscal year ended October 31, 1997 was $18,018,000, a decrease of $2,202,000 or 11% from the prior year. Prior to the effect of the HHL one-time charge of $3,143,000 in the third quarter of 1996, other operating expenses increased $941,000 or 6%. The increase was due to an additional $954,000 in other operating expenses attributable to HSA and Global. F-3 22 Operating margin before amortization of intangible assets for the fiscal year ended October 31, 1997 was $1,162,000, a decrease of $12,291,000 or 91% from the prior year. The Company's operating margin rate before amortization of intangible assets was 1.3%, compared to 13.3% in the prior year. Prior to the effect of the HHL one-time charge and revenue reversal in 1996, operating margin before amortization decreased $21,175,000 or 95%. Amortization of intangible assets for the fiscal year ended October 31, 1997 was $1,331,000, an increase of $1,127,000 from the prior year. The increase resulted primarily from the amortization of goodwill acquired in the HSA and Global acquisitions. Net interest and net other income for the fiscal year ended October 31, 1997 was $2,746,000, an increase of $1,759,000. The increase was partially due to a reversal of $877,000 in accrued interest expense resulting from a favorable resolution of an Internal Revenue Service ("IRS") audit during fiscal year 1997. In addition, the Company wrote off its investment in HHL of $927,000 in 1996 as part of the one-time charge. Merger related costs of $537,000 were incurred in the fiscal year ended October 31, 1997 related to the Company's merger with QSM in November 1996. Merger related costs of $494,000 were incurred in fiscal year end October 31, 1996 related to the Company's merger with CDR in April 1996. The Company recognized a loss of $310,000 through March 18, 1997 (the date on which the Company acquired the remaining 57% of HISCo's equity which it did not already own) from its equity investment in HISCo, compared to earnings of $50,000 in the prior year. The Company's income tax benefit for the fiscal year ended October 31, 1997 was $351,000. The tax benefit was primarily due to a reversal of $1,093,000 in accrued taxes arising from the favorable IRS audit resolution in 1997. Exclusive of the IRS audit resolution, the effective tax rate was 42.9%. This compares to income tax expense of $5,574,000 and an effective tax rate of 43.3% for fiscal year 1996. Net income for the fiscal year ended October 31, 1997 was $2,081,000, a decrease of $5,210,000 or 71% from the prior year. Earnings per share were $0.12 in 1997 compared to $0.39 in 1996. Earnings per share excluding all one-time events were $0.06 in 1997 compared to $0.72 in 1996. Years Ended October 31, 1996 and 1995 Revenue for the fiscal year ended October 31, 1996 was $101,326,000, an increase of $10,831,000 or 12% over the prior year. Before the HHL revenue reversal of $2,180,000 in the third quarter of 1996, revenue was $103,506,000, an increase of $13,011,000 or 14% over the prior year. Revenue from Transfer Payment Division after the revenue reversal increased $6,739,000 or 10%, principally due to revenue generated by the Company's RCR and TPLR engagements, which increased by 23% and 36%, respectively. Revenue from DSS services was $19,510,000, an increase of $3,622,000 or 23% over the prior year. Revenue from EDI services was $8,692,000, an increase of $470,000 or 6% over the prior year. Cost of services for the fiscal year ended October 31, 1996 was $87,873,000, an increase of $14,838,000 or 20% over the prior year. During the third quarter of fiscal year ended October 31, 1996, the Company recorded a one-time charge pertaining to its relationship with HHL, a major CAMS customer, which defaulted on its obligation under a data processing agreement with the Company. This charge increased cost of services by $6,704,000 and accounted for 9% of the increase over the prior year. The $6,704,000 charge was comprised of $1,362,000 of net compensation costs, and $2,199,000 of net data processing costs, both associated with the continued servicing of the HHL data processing agreement, plus $3,143,000 of other operating costs, including $2,881,000 of bad debt expense related to HHL receivables and $262,000 of net other operating expenses. Compensation expense for the fiscal year ended October 31, 1996 was $49,370,000, an increase of $5,213,000 or 12% over the prior year. Before the one-time charge of $1,362,000 in the third quarter of 1996, compensation expense was $48,008,000, an increase of $3,851,000 or 9% over the prior year. This increase reflected a 17% increase in the average number of employees supporting business growth and expansion, offset by savings related to the non-recurring fiscal year 1995 CDR S corporation distributions to its former shareholders of $1,978,000 and salary savings associated with employee turnover. F-4 23 Data processing expense for the fiscal year ended October 31, 1996 was $10,282,000, an increase of $2,115,000 or 26% over the prior year. Before the one-time HHL charge of $2,199,000 in the third quarter of 1996, data processing expense was $8,083,000, a decrease of $84,000 or 1% from the prior year. This decrease was attributable to high levels of expense in fiscal year 1995 associated with the enhancement of the Company's data processing infrastructure which were non-recurring in nature. Occupancy expense for the fiscal year ended October 31, 1996 was $8,001,000, an increase of $1,332,000 or 20% over the prior year. This increase was primarily due to the expansion of the Company's facilities, including the Company's headquarters. Other operating expense for the fiscal year ended October 31, 1996 was $20,220,000, an increase of $6,178,000 or 44% over prior year. Before the one-time HHL charge of $3,143,000 in the third quarter of 1996, other operating expense was $17,077,000, an increase of $3,035,000 or 22% over the prior year. The increase was due to $1,604,000 in provision for non-HHL bad debts and higher levels of direct project costs, professional fees and employee related costs. The Company also settled its liabilities due to HHL of $1,950,000 for a payment of $870,000, resulting in the reversal of $1,080,000 in liabilities as an offset to other operating expenses. Operating margin before amortization of intangible assets for the fiscal year ended October 31, 1996 was $13,453,000, a decrease of $4,007,000 or 23% from the $17,460,000 realized in the prior year. The Company's operating margin rate before amortization of intangible assets was 13%, compared to 19% in fiscal year 1995. Operating margin before amortization of intangibles and prior to the one-time charge and revenue reversal for HHL was $22,337,000, an increase of $4,877,000 or 28%. Exclusive of the effect of the one-time charge and revenue reversal, the operating margin rate would have been 22%, an increase of three percentage points over the 19% realized in the prior year. Amortization of intangible assets for the fiscal year ended October 31, 1996 was $204,000, a decrease of $39,000 or 16% from the prior year. The decrease resulted from the full amortization of one of the Company's intangible assets. Net interest and net other income for the fiscal year ended October 31, 1996 was $987,000, an increase of $45,000 over the prior year. During 1996, the Company wrote off its investment in HHL of $927,000 as part of the one-time charge. Merger related costs of $494,000 were incurred in the year ended October 31, 1996 related to the Company's merger with CDR in April 1996. Merger related costs of $1,045,000 were incurred in 1995 related to the Company's merger with HCm. See Note 2(e) of Notes to Consolidated Financial Statements on page F-18 of this Form 10-K. The Company reported equity in earnings of its HISCo affiliate of $50,000 and $0 in fiscal years 1996 and 1995, respectively. The Company's income tax expense for the fiscal year ended October 31, 1996 was $5,574,000, resulting in an effective tax rate of approximately 43%. This compares to income tax expense of $8,152,000 and an effective tax rate of approximately 48% for fiscal year 1995. The reduction in the effective tax rate results from the non-taxability of income from CDR for the first six months of the fiscal year due to its status as an S corporation, and from the decrease of non-tax deductible merger costs from the comparable prior year period. Had taxes been computed as if CDR had been a C corporation for the first six months of 1996, the effective tax rate in 1996 would have been 2.4% higher. Income tax expense without the HHL one-time charge and revenue reversal in the third quarter of 1996 would have been $9,823,000, an increase of $861,000 or 10% over fiscal year 1995. Net income for the fiscal year ended October 31, 1996 was $7,291,000, a decrease of $1,671,000 or 19% from the prior year. Earnings per share was $0.39 in 1996 compared to $0.51 in 1995. Earnings per share excluding all one-time events was $0.72 in 1996 compared to $0.57 in 1995. Liquidity and Capital Resources On May 28, 1997, the Board of Directors authorized the Company to repurchase such number of shares of its common stock that have an aggregate purchase price not in excess of $10,000,000. Pursuant to this authorization, the F-5 24 Company began and expects to continue repurchasing shares from time to time on the open market or in negotiated transactions at prices deemed appropriate by the Company. Repurchased shares are deposited in the Company's treasury and used for general corporate purposes. As of October 31, 1997, the Company had repurchased in the open market 314,500 shares having an aggregate purchase price of $1,863,000. On June 30, 1997, the Company amended its unsecured revolving credit facility with a major money center financial institution in order to remain in compliance with one of the financial covenants of the credit agreement. The Company's plans to repurchase up to $10,000,000 in common stock would have brought the Company below the minimum consolidated tangible net worth test in fiscal year 1998. The amended credit agreement reduced the credit facility to $30,000,000 and lowered the minimum consolidated tangible net worth test for fiscal years 1998 and 1999. At October 31, 1997, the Company had $53,799,000 in net working capital, a decrease of $954,000 from the level at October 31, 1996. The Company's principal sources of liquidity at October 31, 1997 consisted of cash, cash equivalents, and short-term investments aggregating $39,080,000, net accounts receivable of $39,519,000, and an available balance of $28,400,000 under its line of credit. Accounts receivable at October 31, 1997 reflected a decrease of $3,211,000 or 8% from the October 31, 1996 balance. There has been no significant change in the nature, age, or composition of the Company's accounts receivable portfolio. Year 2000 The Company, like all companies in general and information systems companies in the specific, expects to feel the impact of technological change and obsolecence. In fiscal year 1997, the Company began engaging with the implications of the "Year 2000 Problem.," a situation caused by the inability of many computer systems to distinguish the century associated with a date whose year is designated by two digits, i.e. January 1 in the year 19XX versus January 1 in the year 20XX. As an information systems and services vendor, the Company is concerned with ensuring that the Company's systems are reengineered wherever necessary to handle an expanded date field (which will unambiguously differentiate between like dates in the 20th and 21st centuries) and with ensuring that the data received from clients has been properly reformatted to present the date unambiguously and is properly interpreted when processed by the Company. The Company's fiscal year 1998 budget includes substantial funding directed at assuring that the Company's software products and services offerings are able to deal with the Year 2000 Problem on a timely basis. Notwithstanding the Company's efforts in this regard, there does exist the risk that the Year 2000 Problem will manifest itself in unanticipated ways, thereby adversely affecting the Company's performance in the future; such failures of the Company and/or failures on the part of the computer systems of the Company's clients could have a material adverse impact on the Company's ability to do business in the future. Inflation The Company's business is labor intensive. Wages and other employee-related expenses increase during periods of inflation and when shortages in the skilled labor market occur. Although the moderate inflation rates of the past several years have not imposed significant problems for the Company, the Company implemented selective wage increases in fiscal year 1997 to assure retention of qualified personnel in key areas of its operations. Recently Issued Accounting Standards In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earning Per Share". SFAS 128 establishes standards for computing and presenting earnings per share. In accordance with the effective date of SFAS 128, the Company will adopt SFAS 128 as of January 31, 1998. SFAS 128 is not expected to have a material impact on the Company's financial statements. F-6 25 SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended October 31, 1997 (a) 1996 (b) 1995 (b) 1994 (b) 1993 (b) (Amounts In Thousands, Except Per Common Share Data) - ------------------------------------------------------------------------------------------------------------------------------------ Statement of Operations Data: Revenue $ 89,517 101,326 90,495 73,940 59,949 Cost of services 88,355 87,873 73,035 61,094 48,989 - ------------------------------------------------------------------------------------------------------------------------------------ Operating margin before amortization of intangibles 1,162 13,453 17,460 12,846 10,960 Amortization of intangibles (c) 1,331 204 243 190 303 - ------------------------------------------------------------------------------------------------------------------------------------ Operating (loss) income (169) 13,249 17,217 12,656 10,657 Net interest and net other income (expense) 2,746 987 942 464 (144) Loss on investment 0 (927) 0 0 0 Merger related costs (537)(d) (494)(e) (1,045)(f) (59)(f) 0 Equity in (loss) earnings of affiliate (g) (310) 50 0 0 0 - ------------------------------------------------------------------------------------------------------------------------------------ Income before income taxes and extraordinary items 1,730 12,865 17,114 13,061 10,513 Income tax benefit (expense) 351 (5,574) (8,152) (6,353) (4,766) - ------------------------------------------------------------------------------------------------------------------------------------ Income before extraordinary item 2,081 7,291 8,962 6,708 5,747 Extraordinary loss, net of tax benefit (h) 0 0 0 0 (306) - ------------------------------------------------------------------------------------------------------------------------------------ Net income 2,081 7,291 8,962 6,708 5,441 - ------------------------------------------------------------------------------------------------------------------------------------ Accretion of preferred stock redemption value 0 0 0 0 (33) Net income attributable to common shareholders $ 2,081 7,291 8,962 6,708 5,408 - ------------------------------------------------------------------------------------------------------------------------------------ Per Common Share Data: Income before extraordinary item $ 0.12 0.39 0.51 0.40 0.37 Net income attributable to common shareholders $ 0.12 0.39 0.51 0.40 0.35 Weighted average shares outstanding 17,918 18,461 17,579 16,674 15,508 - ------------------------------------------------------------------------------------------------------------------------------------ Selected Operating Data: Operating margin as a percentage of revenue 1% 13% 19% 17% 18% Operating (loss) income as a percentage of revenue (0)% 13% 19% 17% 18% - ------------------------------------------------------------------------------------------------------------------------------------ October 31, 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------------ Balance Sheet Data: Cash and short-term investments $ 39,080 39,521 30,112 27,827 26,447 Working capital 53,799 54,753 41,413 35,732 28,319 Total assets 109,694 109,643 88,101 70,689 60,802 Common shareholders' equity 79,806 74,612 58,203 46,662 38,181 ====================================================================================================================================
F-7 26 Notes to Selected Consolidated Financial Data (a) Includes the revenue and costs associated with the Company's HSA and Global acquisitions. See Notes 2(a) and 2(b) of Notes to Consolidated Financial Statements. (b) Financial data for the years 1994 through 1996 has been restated to reflect the merger with QSM in 1997. Financial data for 1993 are immaterial for QSM and amounts for that year have not been restated for the merger. See Note 2(c) of Notes to Consolidated Financial Statements. (c) Intangible assets were principally recorded in connection with the Company's 1989 recapitalization, its acquisition of QMA in 1990, and its HSA and Global acquisitions in 1997. See Notes 1(e) and 6 of Notes to Consolidated Financial Statements. (d) Includes costs associated with the Company's merger with QSM. See Note 2(c) of Notes to Consolidated Financial Statements. (e) Includes costs associated with the Company's merger with CDR. See Note 2(d) of Notes to Consolidated Financial Statements. (f) Includes costs associated with the Company's merger with HCm. See Note 2(e) of Notes to Consolidated Financial Statements. (g) In March 1997, the Company acquired the remaining outstanding shares of HISCo not already owned by the Company. The acquisition was accounted for using the purchase method. See Note 2(b) of Notes to Consolidated Financial Statements. (h) The extraordinary loss of $306,000, net of income tax benefit of $257,000, reflects the write-off of the unamortized debt discount attributable to the prepayment of subordinated debentures issued in connection with the Company's 1989 recapitalization. F-8 27 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Shareholders Health Management Systems, Inc.: We have audited the accompanying consolidated financial statements of Health Management Systems, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We did not audit the financial statements of Health Information Systems Corporation (HISCo), a 43% owned investee company, for the year ended October 31, 1996. The Company's investment in HISCo at October 31, 1996 was $6,824,000 and its loss in equity for the year ended October 31, 1996 was $50,000. The financial statements of HISCo for the aforementioned periods were audited by other auditors whose reports were furnished to us, and our opinion, insofar as it relates to the amounts included for HISCo, is based solely on the reports of the other auditors. 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 and the reports of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Health Management Systems, Inc. and subsidiaries as of October 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP Short Hills, New Jersey November 21, 1997 F-9 28 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts In Thousands, Except Per Share Amounts)
Years Ended October 31, ------------------------------ 1997 1996 1995 --------- -------- ------- Revenue: Trade $ 89,186 95,719 81,073 Affiliates 331 5,607 9,422 --------- -------- ------- 89,517 101,326 90,495 Cost of services: Compensation 52,361 49,370 44,157 Data processing 7,593 10,282 8,167 Occupancy 10,383 8,001 6,669 Other 18,018 20,220 14,042 --------- -------- ------- 88,355 87,873 73,035 --------- -------- ------- Operating margin before amortization of intangibles 1,162 13,453 17,460 Amortization of intangibles 1,331 204 243 --------- -------- ------- Operating (loss) income (169) 13,249 17,217 Other income (expense): Net interest and net other income 2,746 987 942 Loss on investment 0 (927) 0 Merger related costs (537) (494) (1,045) Equity in (loss) earnings of affiliate (310) 50 0 --------- -------- ------- 1,899 (384) (103) Income before income taxes 1,730 12,865 17,114 Income tax benefit (expense) 351 (5,574) (8,152) --------- -------- ------- Net income $ 2,081 7,291 8,962 ========= ======== ======= Earnings per share data: Net income per common share $ 0.12 0.39 0.51 ========= ======== ======= Weighted average shares outstanding 17,918 18,461 17,579 ========= ======== =======
See accompanying notes to consolidated financial statements. F-10 29 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ($ In Thousands, Except Per Share Amounts) October 31, October 31, 1997 1996 --------- ------- Assets Current assets: Cash and cash equivalents $ 20,694 22,340 Short-term investments 18,386 17,181 Accounts receivable, net 39,519 42,730 Other current assets 3,384 4,706 --------- ------- Total current assets 81,983 86,957 Property and equipment, net 7,988 7,823 Goodwill, net 12,316 5,247 Other intangible assets, net 1,059 10 Capitalized software costs, net 3,060 1,472 Investments in affiliates 0 6,824 Deferred income taxes 2,721 0 Other assets 567 1,310 --------- ------- Total assets $ 109,694 109,643 ========= ======= Liabilities and Shareholders' Equity Current liabilities: Accounts payable and accrued expenses $ 16,153 19,676 Amounts payable to affiliates 0 585 Deferred revenue 5,122 4,975 Deferred income taxes 6,909 6,968 --------- ------- Total current liabilities 28,184 32,204 Other liabilities 1,704 2,770 Deferred income taxes 0 57 --------- ------- Total liabilities 29,888 35,031 --------- ------- Shareholders' equity: Preferred stock - $.01 par value; 5,000,000 shares authorized; none issued and outstanding 0 0 Common stock - $.01 par value; 45,000,000 shares authorized; 17,773,653 shares issued and 17,459,153 shares outstanding at October 31, 1997; 17,520,991 shares issued and outstanding at October 31, 1996 178 175 Capital in excess of par value 67,304 62,541 Retained earnings 13,506 11,425 Unrealized appreciation on short-term investments 681 471 --------- ------- 81,669 74,612 Less treasury stock, at cost (314,500 shares) (1,863) 0 --------- ------- Total shareholders' equity 79,806 74,612 --------- ------- Total liabilities and shareholders' equity $ 109,694 109,643 ========= ======= See accompanying notes to consolidated financial statements. F-11 30 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ($ In Thousands)
Unrealized Common Stock Appreciation ------------------- Capital In Retained (Depreciation) Total Par Excess Of Earnings on Short-term Treasury Shareholders' Shares Value Par Value Deficit) Investments Stock Equity ------ ----- --------- -------- ----------- ----- ------ Balance at October 31, 1994 15,976,423 $160 45,710 1,185 (12) 0 47,043 Adjustments for Quality Standards in Medicine, Inc. ("QSM") pooling of interest 172,150 1 4,958 (5,340) 0 0 (381) ---------------------------------------------------------------------------------- Balance at October 31, 1994, as restated 16,148,573 161 50,668 (4,155) (12) 0 46,662 Net income 0 0 0 8,962 0 0 8,962 Stock option activity 272,595 3 1,078 0 0 0 1,081 Employee Stock Purchase Plan activity 141,744 1 1,202 0 0 0 1,203 Disqualifying dispositions 0 0 477 0 0 0 477 Unearned compensation 0 0 14 0 0 0 14 Appreciation on short-term investments 0 0 0 0 476 0 476 Adjustment to reflect change in Health Care microsystems, Inc. fiscal year 0 0 0 (672) 0 0 (672) ---------------------------------------------------------------------------------- Balance at October 31, 1995 16,562,912 165 53,439 4,135 464 0 58,203 Net income 0 0 0 7,290 0 0 7,290 Stock option activity 794,994 8 5,629 0 0 0 5,637 Employee Stock Purchase Plan activity 163,085 2 2,330 0 0 0 2,332 Disqualifying dispositions 0 0 1,143 0 0 0 1,143 Appreciation on short-term investments 0 0 0 0 7 0 7 ---------------------------------------------------------------------------------- Balance at October 31, 1996 17,520,991 175 62,541 11,425 471 0 74,612 Net income 0 0 0 2,081 0 0 2,081 Stock option activity 69,480 1 333 0 0 0 334 Employee Stock Purchase Plan activity 95,332 1 708 0 0 0 709 Stock issued to retire QSM debt 87,850 1 1,434 0 0 0 1,435 Stock options issued to non-employees 0 0 98 0 0 0 98 Disqualifying dispositions 0 0 2,190 0 0 0 2,190 Treasury stock acquisition (314,500) 0 0 0 0 (1,863) (1,863) Appreciation on short-term investments 0 0 0 0 210 0 210 ---------------------------------------------------------------------------------- Balance at October 31, 1997 17,459,153 $178 67,304 13,506 681 (1,863) 79,806 ==================================================================================
See accompanying notes to consolidated financial statements. F-12 31 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS ($ In Thousands)
Years Ended October 31, ----------------------------------- 1997 1996 1995 ----------- ----------- ---------- Operating activities: Net income $ 2,081 7,291 8,962 Adjustments to reconcile net income to net cash provided by operating activities: Loss on investment 0 927 0 Depreciation and amortization 3,811 3,117 2,772 Software capitalization (1,498) (1,151) (840) Amortization of intangibles 1,331 204 243 Amortization of unearned compensation 0 0 14 Provision for doubtful accounts 538 4,485 183 Loss (gain) on disposal of assets 17 0 (19) Deferred tax (benefit) expense (1,635) (424) 1,203 Equity in loss (earnings) of affiliate 310 (50) 0 Stock options issued to non-employees 98 0 0 Other 0 0 (3) Changes in assets and liabilities: Decrease (increase) in accounts receivable 5,008 (15,188) (9,206) Decrease (increase) in other current assets 4,137 (793) (1,063) Increase (decrease) in accounts payable and accrued expenses (2,910) 3,196 5,229 Increase (decrease) in amounts payable to affiliates (747) 902 0 Increase (decrease) in deferred revenue (575) 881 (983) Increase (decrease) in other assets and liabilities, net (1,531) 2,187 717 ----------- ----------- ---------- Net cash provided by operating activities 8,435 5,584 7,209 ----------- ----------- ---------- Investing activities: Capital asset expenditures (2,462) (4,456) (1,513) Investment in affiliates 0 (28) (7,268) Acquisition of assets of subsidiaries of GHS, Inc. (2,146) 0 0 Acquisition of Health Information Systems Corporation, net of cash acquired (3,689) 0 0 Net (purchases) proceeds from sale of short-term investments (964) 2,106 (5,464) ----------- ----------- ---------- Net cash used in investing activities (9,261) (2,378) (14,245) ----------- ----------- ---------- Financing activities: Proceeds from issuance of common stock 709 2,332 1,346 Proceeds from exercise of stock options 334 5,637 1,081 Common stock repurchase (1,863) 0 0 Proceeds from notes payable 0 340 494 Repayment of notes payable 0 0 (342) ----------- ----------- ---------- Net cash (used in) provided by financing activities (820) 8,309 2,579 ----------- ----------- ---------- Net (decrease) increase in cash and cash equivalents (1,646) 11,515 (4,457) Cash and cash equivalents at beginning of period 22,340 10,825 15,029 Adjustment to cash to reflect change in Health Care microsystems, Inc. fiscal year 0 0 253 ----------- ----------- ---------- Cash and cash equivalents at end of period $ 20,694 22,340 10,825 =========== =========== ==========
See accompanying notes to consolidated financial statements. F-13 32 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Founded in 1974, Health Management Systems, Inc. (the "Company") provides information management software, systems and services to healthcare providers and payors. (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. (b) Cash and Cash Equivalents For purposes of financial reporting, the Company considers all highly liquid investments purchased with an original maturity of three months or less (including money market instruments of $6,283,000 and $5,873,000 at October 31, 1997 and 1996, respectively) to be cash equivalents. (c) Short-Term Investments Short-Term investments are recorded at fair value. Included in short-term investments are investments classified as available for sale and carried at fair value. Debt securities that the Company does not have the intent and ability to hold to maturity are classified either as "available for sale" or as "trading" and are carried at fair value. Unrealized gains and losses on securities classified as available for sale are carried as a separate component of shareholders' equity. Unrealized gains and losses on securities classified as trading are reported in earnings. Management determines the appropriate classification of its investments in debt and equity securities at the time of purchase and reevaluates such determination at each balance sheet date. At October 31, 1997 and 1996, the Company recorded cumulative unrealized appreciation of $681,000 and $471,000, respectively, on these short-term investments. (d) Depreciation and Amortization of Property and Equipment Property and equipment are recorded at cost. Depreciation is provided over the estimated useful lives of the property and equipment utilizing the straight-line method. Amortization of leasehold improvements is provided over the estimated useful lives of the assets or the terms of the leases, whichever is shorter, utilizing the straight-line method. The estimated useful lives are as follows: Equipment 3-5 years Leasehold improvements 5-8 years Furniture and fixtures 5-7 years (e) Intangible Assets Intangible assets have been recorded primarily as a result of the recapitalization of the Company in 1989, the acquisition of Quality Medi-Cal Adjudication, Incorporated ("QMA") in 1990, the acquisition of the remaining shares of Health Information Systems Corporation. ("HISCo") in March 1997, and the acquisition of the assets of Global Health Systems, Inc. and GHS Management Services, Inc. (collectively "Global"), subsidiaries of GHS, Inc., in July 1997. Intangible assets consist of software, customer lists, and goodwill, which are being amortized on a straight-line basis over three years, three years and between ten and forty years, respectively. F-14 33 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies, continued (f) Software Development Costs The Company capitalizes software development costs (related to software developed for resale) incurred subsequent to the establishment of technological feasibility of the product, including costs incurred to develop upgrades subsequent to the commercial release of the product. Amortization of software development costs is determined on a product-by-product basis to be the greater of the amount computed on a straight-line basis over the expected economic life of the product, generally estimated to be 36-60 months, or using the ratio of current gross revenue to total current and anticipated future gross revenue, whichever is greater. Software development costs are stated at original cost of $3,755,000 and $2,257,000 less accumulated amortization of $1,735,000 and $785,000 at October 31, 1997 and 1996, respectively. Amortization expense for the years ended October 31, 1997, 1996, and 1995 was $992,000, $543,000, and $587,000, respectively. In addition, amounts included in software development costs of $3,686,000 and related accumulated amortization of $2,646,000 are attributable to HISCo's historical balance sheet. The Company acquired the remaining shares of HISCo's equity which it did not already own in fiscal year 1997. (g) Revenue Recognition The Company generally recognizes revenue for financial reporting purposes when billings are submitted to third-party payors or their third-party intermediaries as a consequence of services performed by the Company for a client. Several client contracts contain periodic fee limitations that the Company believes will be exceeded in the normal course of business. As a result, the fees allowable under these contracts are recognized on a straight-line basis over the fee limitation period as services are performed, and amounts billed in excess of revenue recognized are deferred. Other contracts have sliding fee scales for which revenue is fairly predictable. For these, the Company recognizes revenue, at the estimated effective fee rate, ratably over the client's contract year. Finally, certain contracts are subject to fixed-fee arrangements covering specified periods, which the Company realizes on a straight-line basis over the corresponding periods. The Company recognizes revenue from consulting services as the services are provided. Revenue from software products sold to customers under license agreements is deferred and recognized as revenue upon software installation and satisfaction of significant Company obligations, if any. Revenue from ongoing maintenance agreements is deferred and recognized as revenue on a straight-line basis over the periods of the respective maintenance agreements. (h) Income Taxes Income taxes are accounted for under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. F-15 34 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies, continued (i) Net Income Per Common Share Net income per common share has been computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during each year. Common stock equivalents utilizing the treasury stock method are included in the computation of weighted average number of shares outstanding for the years ended October 31, 1997, 1996, and 1995. In 1997, the weighted average number of shares outstanding has been reduced primarily as a result of the effect a lower average market price for the Company's common stock had in determining the number of outstanding options included in the weighted average shares outstanding. See Exhibit 11 - Computation of Earnings Per Share. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share". SFAS 128 establishes standards for computing and presenting earnings per share. In accordance with the effective date of SFAS 128, the Company will adopt SFAS 128 as of January 31, 1998. SFAS 128 is not expected to have a material impact on the Company's consolidated financial statements. (j) Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (k) Reclassifications Certain reclassifications were made to prior year amounts to conform to the 1997 presentation. (l) Fair Value of Financial Instruments The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. With the exception of short-term investments (see Note 1(c)), the carrying amounts of the Company's financial instruments included in the accompanying consolidated balance sheets approximate estimated fair value as of October 31, 1997 and 1996. (m) Stock-Based Compensation Effective October 31, 1997, the Company adopted the disclosure-only provision of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," and applies APB opinion No. 25 and related Interpretations in accounting for its plans. Accordingly, no employee compensation costs have been recognized for its stock purchase plan and stock option plans. See Note 12-Stock-Based Compensation Plans. (n) Accounting for the Impairment of Long-Lived Assets In accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company reviewed its long-lived assets and based on the expected future cash flows, determined that there is no impairment of such assets. In accordance with the effective date of SFAS 121, the Company adopted SFAS 121 as of October 31, 1997. F-16 35 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Business Combinations (a) Acquisition of the Assets of Global Health Systems Inc. and GHS Management Services, Inc. In July 1997, the Company acquired substantially all the assets of Global for $2,146,000. Global provides computerized record-based processing systems and services for managed care, public health and ambulatory care facilities. The acquisition was accounted for using the purchase method and accordingly the results of operations for Global from the date of acquisition through October 31, 1997 are included in the accompanying consolidated financial statements. The $1,701,000 excess of the purchase price over the fair market value of the assets acquired was recorded as goodwill and is being amortized over a period not to exceed 20 years. During fiscal year 1997, Global's operating results were consolidated with those of HSA. (b) Acquisition of Health Information Systems Corporation In March 1997, the Company, which owned 43% of the equity of Health Information Systems Corporation ("HISCo"), acquired the remaining 57% of HISCo's equity for $3,689,000, net of cash acquired from Welsh, Carson, Anderson & Stowe ("WCAS"), a limited partnership affiliated with WCAS, other affiliates of WCAS, independent investors, and certain of the Company's executive officers and directors. HISCo has been renamed HSA Managed Care Systems, Inc. HSA provides automated business and information solutions, including software and services, to the bearers of risk in the healthcare industry. At the end of fiscal year 1997, HSA became the MCIS segment of the Company's Software Systems and Services Division ("Software Division"). The acquisition was accounted for using the purchase method and accordingly the results of operations of HSA from the date of acquisition through October 31, 1997 are included in the accompanying consolidated financial statements. The $2,309,000 excess of the purchase price over the fair market value of the net assets acquired was recorded as goodwill and is being amortized over a period not to exceed 20 years. The following unaudited pro forma financial information presents the combined results of operations of the Company and HSA as if the acquisition had occurred as of the beginning of fiscal year 1997 and 1996, after giving effect to certain adjustments. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and HSA constituted a single entity during such periods. (Unaudited) Year ended October 31, 1997 1996 ---- ---- Revenue $94,582,000 116,892,000 =========== =========== Net Income $ 1,671,000 7,358,000 =========== =========== Earnings per share $ 0.09 0.40 =========== =========== F-17 36 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Business Combinations, continued (c) Merger with Quality Standards in Medicine, Inc. In November 1996, the Company completed the acquisition of Quality Standards in Medicine, Inc. ("QSM"), a Boston-based company providing clinical quality management systems, for 260,000 shares of the Company's common stock. This transaction was accounted for using the pooling of interests method. Accordingly, the accompanying consolidated financial statements have been retroactively restated through 1994 for periods presented to include the financial position, results of operations, and cash flows of QSM. Prior to 1994, QSM's financial data is unavailable. Founded in 1986, QSM provides hospitals with sophisticated systems and consulting services to help define and measure the quality of care. QSM had 1995 revenue of $768,000 and has clients located primarily in 13 states and the District of Columbia. Operationally, QSM has been combined with HCm, providing Decision Support Software ("DSS") as part of the Company's Software Division. (d) Merger with CDR Associates, Inc. In April 1996, the Company acquired all the outstanding capital stock of CDR Associates, Inc. ("CDR") in exchange for 460,000 shares of the Company's stock in a merger transaction which was accounted for using the pooling of interests method. Accordingly, the accompanying consolidated financial statements have been retroactively restated for all periods presented to include the financial position, results of operations, and cash flows of CDR. The CDR product makes up part of the Company's Third Party Liability Recovery ("TPLR") Services in the Company's Transfer Payment Services Division ("Transfer Payment Division"). (e) Merger with Health Care microsystems, Inc. In February 1995, the Company acquired all of the outstanding capital stock of Health Care microsystems, Inc. ("HCm") in a merger transaction which was accounted for using the pooling of interests method. Accordingly, the accompanying consolidated financial statements have been retroactively restated for all periods presented to include the financial position, results of operations, and cash flows of HCm. In addition, the accompanying consolidated financial statements reflect certain adjustments to conform the accounting policies of the two companies. HCm's DSS offerings are included in the Software Division. HCm previously used the fiscal year ended December 31 for its financial reporting. To conform to the Company's October 31 fiscal year end, HCm's operating results for the period November 1, 1994 through December 31, 1994 have been included in the operating results of the Company for the fiscal years ended October 31, 1995 and 1994. The resulting duplication of revenue and net income of HCm for the period November 1, 1994 through December 31, 1994 amounted to $2,842,000 and $672,000, respectively, which has been adjusted by a $672,000 charge to retained earnings during the year ended October 31, 1995. 3. Net Accounts Receivable Net accounts receivable as of October 31, 1997 and 1996 consisted of the following: 1997 1996 - -------------------------------------------------------------------------------- Trade $39,519,000 42,330,000 Affiliates -- 400,000 - -------------------------------------------------------------------------------- $39,519,000 42,730,000 ================================================================================ Trade accounts receivable are reflected net of an allowance for doubtful accounts of $1,428,000 and $1,682,000 at October 31, 1997 and 1996, respectively. F-18 37 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. Fees Held in Escrow The Company is obligated to maintain a portion of fees received from two clients in escrow accounts. The Company's obligation to maintain such fees in escrow terminates at either: (a) the earlier of six years from the dates of service associated with fees generated and settlement of the client's Medicaid and/or Medicare audits for each applicable year, and/or (b) termination of the contract. Due to the 1994 renewal of one client contract that eliminated future escrow requirements and the Company's fulfillment of its maximum escrow deposit for the second client, the Company completed its obligation to make escrow deposits as of October 31, 1994. For the years ended October 31, 1997 and 1996 fees held in escrow were $772,000 and $1,128,000, respectively. 5. Property and Equipment Property and equipment as of October 31, 1997 and 1996 consisted of the following: 1997 1996 - -------------------------------------------------------------------------------- Equipment $ 14,697,000 12,639,000 Leasehold improvements 5,728,000 5,527.000 Furniture and fixtures 4,877,000 3,904,000 - -------------------------------------------------------------------------------- 25,302,000 22,070,000 Less accumulated depreciation and amortization (17,314,000) (14,247,000) - -------------------------------------------------------------------------------- $ 7,988,000 7,823,000 ================================================================================ Depreciation and amortization expense related to property and equipment charged to operations for the years ended October 31, 1997, 1996, and 1995 was $2,819,000, $2,574,000, and $2,185,000, respectively. 6. Goodwill and Other Intangible Assets Goodwill and other intangible assets as of October 31, 1997 and 1996 consisted of the following: 1997 1996 - -------------------------------------------------------------------------------- Goodwill $ 14,298,000 6,487,000 Less accumulated amortization (1,982,000) (1,240,000) - -------------------------------------------------------------------------------- 12,316,000 5,247,000 ================================================================================ Other intangible assets 3,349,000 1,756,000 Less accumulated amortization (2,290,000) (1,746,000) - -------------------------------------------------------------------------------- $ 1,059,000 10,000 ================================================================================ Amortization expense related to intangible assets charged to operations for the years ended October 31, 1997, 1996, and 1995, was $1,331,000, $204,000, and $243,000, respectively. F-19 38 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses as of October 31, 1997 and 1996 consisted of the following: 1997 1996 - -------------------------------------------------------------------------------- Accrued compensation $ 4,633,000 6,185,000 Accrued direct project costs 3,282,000 2,330,000 Accrued HHL one-time charges 719,000 3,658,000 Accounts payable and other accrued expenses 7,519,000 7,503,000 - -------------------------------------------------------------------------------- $16,153,000 19,676,000 ================================================================================ 8. Credit Facility On June 30, 1997, the Company amended its unsecured revolving credit facility with a major money center financial institution in order to remain in compliance with one of the financial covenants of the credit agreement. The credit facility has a term of three years, carries an unused commitment fee of 20 basis points, and bears interest at the institution's prime lending rate, or LIBOR plus 5/8%, at the Company's option. The revolving credit facility contains, among other things, restrictions on additional borrowings, capital expenditures, leases, sales of assets, and payments of dividends. The revolving credit facility also contains covenants that require the Company to maintain minimum tangible consolidated shareholders' equity and limit debt-to-equity and debt-to-asset relationships as defined in the agreement. The Company's plans to repurchase up to $10,000,000 in common stock would have brought the Company below the minimum consolidated tangible net worth test in fiscal year 1998. The amended credit agreement reduced the credit facility to $30,000,000 and lowered the minimum consolidated tangible net worth test for fiscal years 1998 and 1999. The Company had an available balance under this credit facility of $28,400,000 at October 31, 1997 and $39,950,000 at October 31, 1996. See Note 16(c) - Related Party Transactions. Cash interest payments including bank charges attributable to the aforementioned credit facility for the years ended October 31, 1997, 1996, and 1995 were $0, $68,000, and $60,000, respectively. 9. Income Taxes Income tax benefit (expense) for the years ended October 31, 1997, 1996, and 1995 was comprised of the following: 1997 1996 1995 - -------------------------------------------------------------------------------- Current tax expense: Federal $ (716,000) (4,264,000) (4,677,000) State and local (568,000) (1,734,000) (2,272,000) - -------------------------------------------------------------------------------- (1,284,000) (5,998,000) (6,949,000) - -------------------------------------------------------------------------------- Deferred tax benefit (expense): Federal 1,136,000 448,000 (1,285,000) State and local 499,000 (24,000) 82,000 - -------------------------------------------------------------------------------- 1,635,000 424,000 (1,203,000) - -------------------------------------------------------------------------------- Income tax benefit (expense), net $ 351,000 (5,574,000) (8,152,000) ================================================================================ F-20 39 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. Income Taxes, continued A reconciliation of the income tax benefit (expense) to the federal statutory rate of 34% follows:
1997 1996 1995 - --------------------------------------------------------------------------------------------------------- Income tax benefit (expense): Computed at Federal Statutory rate $ (588,000) (34.0)% (4,374,000) (34.0)% (5,819,000) (34.0)% State and local tax expense, net of federal benefit (46,000) (2.7)% (1,160,000) (9.0)% (1,445,000) (8.4)% Amortization of goodwill (70,000) (4.0)% (55,000) (0.4)% (55,000) (0.3)% Merger related costs (183,000) (10.6)% (157,000) (1.2)% (355,000) (2.1)% Equity loss in affiliate (88,000) (5.1)% 0 0.0% 0 0.0% Municipal interest 258,000 14.9% 233,000 1.8% 216,000 1.3% IRS audit resolution 1,093,000 63.2% 0 0.0% 0 0.0% CDR S Corporation income 0 0.0% 325,000 2.5% 0 0.0% QSM's corporate loss 0 0.0% (304,000) (2.4)% (217,000) (1.3)% Other, net (25,000) (1.4)% (82,000) (0.6)% (477,000) (2.8)% - --------------------------------------------------------------------------------------------------------- Total income tax benefit (expense) $ 351,000 20.3% (5,574,000) (43.3)% (8,152,000) (47.6)% =========================================================================================================
Deferred income taxes are recognized for the future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities. The types of temporary differences that give rise to the deferred tax liability, and the effect on the deferred income tax benefit (expense) of changes in those temporary differences, are as follows: 1997 1996 1995 - -------------------------------------------------------------------------------- Accounts receivable $ 3,298,000 (3,294,000) (1,609,000) Fees held in escrow 188,000 108,000 117,000 Depreciable and amortizable assets 12,000 397,000 (400,000) Allowance for doubtful accounts (206,000) 653,000 0 Unbilled costs 259,000 (156,000) (6,000) Accounts payable and other accrued expenses (1,273,000) (170,000) 403,000 Deferred revenue (196,000) 275,000 (543,000) Deferred rent 14,000 237,000 72,000 Contract termination contingency 1,093,000 479,000 0 HHL one-time charges (1,434,000) 2,070,000 0 Other (120,000) (175,000) 763,000 - -------------------------------------------------------------------------------- Deferred income tax benefit (expense) $ 1,635,000 424,000 (1,203,000) ================================================================================ F-21 40 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. Income Taxes, continued Temporary differences that give rise to a significant portion of the deferred tax assets and deferred tax liabilities at October 31, 1997 were as follows: Deferred tax assets: Accounts receivable/deferred items $ 1,061,000 Property and equipment 2,838,000 HHL one-time charges 689,000 Allowance for doubtful accounts 573,000 Accounts payable and accrued expenses 367,000 Net operating loss carryforward 1,396,000 Other 692,000 ------------ Total deferred tax assets before valuation 7,616,000 Less: Valuation allowances (1,396,000) ------------ Total deferred tax assets after valuation $ 6,220,000 ============ Deferred tax liabilities: Accounts receivable/deferred items $ 7,436,000 Property and equipment 892,000 Other 2,080,000 ------------ Total deferred tax liabilities $ 10,408,000 ============ Net current deferred tax liabilities $ (6,909,000) Net noncurrent deferred tax assets (liabilities) 2,721,000 ------------ Total net deferred tax liabilities $ (4,188,000) ============ The valuation allowance for the years ended October 31, 1997 and 1996 were $1,396,000 and $0, respectively. At October 31, 1997, the Company had a net operating loss carryforward for federal income tax purposes of $1,396,000 which is available to offset future federal taxable income of the Company's QSM subsidiary through 2012. The Company's management believes that the utilization of such net operating loss carryforward is in doubt. Cash payments attributable to income taxes for the years ended October 31, 1997, 1996, and 1995 were $1,263,000, $5,896,000, and $6,355,000, respectively. The Company has had significant disqualifying disposition transactions during the three years ended October 31, 1997. Disqualifying dispositions are non-cash transactions and are excluded from the statements of cash flows. The tax benefit derived from disqualifying dispositions increased shareholder's equity by $2,190,000, $1,143,000, and $477,000 during the fiscal years ended October 31, 1997, 1996, and 1995. 10. Treasury Stock On May 28, 1997, the Board of Directors authorized the Company to repurchase such number of shares of its common stock that have an aggregate purchase price not in excess of $10,000,000. Pursuant to this authorization, the Company began repurchasing and expects to continue repurchasing these shares from time to time on the open market or in negotiated transactions at prices deemed appropriate by the Company. Purchased shares are deposited in the Company's treasury and are to be used for general corporate purposes. As of October 31, 1997, the Company had repurchased in the open market 314,500 shares having an aggregate purchase price of $1,863,000. F-22 41 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. Profit Sharing and 401(k) Plan The Company has a discretionary defined contribution profit sharing plan in which a substantial number of its employees participate. For the years ended October 31, 1997, 1996, and 1995, profit sharing expense was $197,000, $944,000, and $800,000 respectively. Effective January 1, 1992, the Company amended its profit sharing plan to include a 401(k) plan, which permits an employee to contribute a portion of the employee's compensation, subject to certain limitations. At its discretion, the Company may make annual contributions to the 401(k) plan for the benefit of participating employees. For the years ended October 31, 1997, 1996, and 1995, 401(k) plan expense was $804,000, $611,000, and $543,000, respectively. See Note 18-Subsequent Events. 12. Stock-Based Compensation Plans At October 31, 1997, the Company had three stock-based compensation plans, which are described below. The Company has adopted the disclosure-only provisions of SFAS 123 and applies APB Opinion No. 25 and related Interpretations in accounting for its plans. Accordingly, no employee compensation costs have been recognized for its stock purchase plan and stock option plans. Had compensation costs for the Company's three stock-based compensation plans been determined consistent with SFAS 123, the Company's net income and earnings per share would have been adjusted to the pro forma amounts indicated below: 1997 1996 - -------------------------------------------------------------------------------- Net income As reported $ 2,081 $ 7,291 Pro forma 837 6,630 Net income per share As reported 0.12 0.39 Pro forma 0.05 0.36 - -------------------------------------------------------------------------------- The effect noted above by applying the disclosure-only provisions of SFAS 123 may not be representative of the effect of reporting net income in future years. The fair value of the stock options granted in 1997 and 1996 is estimated at the grant date using the Black-Scholes option-pricing model with the following assumptions for 1997 and 1996; dividend yield of 0%; expected volatility of 51.4%; a risk-free interest rate of 5.9%; and expected lives of 5 years. Effective May 31, 1989, the Company adopted the Health Management Systems, Inc. Stock Option and Restricted Stock Purchase Plan (the "Plan") under which: (a) options can be granted to purchase shares of the Company's common stock at an exercise price equal to (incentive stock options) or less than (non-qualified stock options) the estimated fair market value of the Company's common stock, or (b) rights can be granted in the form of an award to purchase shares of the Company's common stock at a price equal to, more than, or less than the estimated fair market value of the Company's common stock. Subsequent amendments to the Plan, which have been approved by shareholders, have increased the number of shares available to be issued under the Plan to 6,750,000 shares. The stock options become exercisable and expire at various dates through November 2007. As of October 31, 1997, no stock appreciation rights or stock purchase awards had been granted. Fiscal year 1997 stock option awards totaling 484,004 options were granted in November 1997. F-23 42 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Stock-Based Compensation Plans, continued The Company's 1995 Non-Employee Director Stock Option Plan (the "NEDP") was adopted by the Board of Directors on November 30, 1994, which action was subsequently approved by shareholders at the Annual Meeting of Shareholders held on March 7, 1995. Under the NEDP, directors of the Company who are not employees of the Company or its subsidiaries are granted options to purchase 1,500 shares of common stock of the Company during the fourth fiscal quarter of each year commencing with fiscal year 1995. Options for the purchase of up to 112,500 shares of common stock may be granted under the NEDP and the Company will reserve the same number of shares for issuance. The options available for grant are automatically increased to the extent any granted options expire or terminate unexercised. Presented below is a summary of the stock option plans for the years ended October 31, 1997, 1996, and 1995:
1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------ Weighted Weighted Weighted average exercise average exercise average exercise Shares price Shares price Shares price - ------------------------------------------------------------------------------------------------------------------ Options outstanding at 1,962,752 $ 12.47 2,778,584 $ 10.51 2,147,787 $ 6.90 beginning of year Granted 1,570,794 9.09 135,828 27.63 926,479 16.97 Exercised (69,424) 3.90 (794,688) 7.10 (272,663) 3.96 Cancelled (1,540,342) 15.23 (156,972) 17.48 (23,019) 11.92 - ------------------------------------------------------------------------------------------------------------------ Options outstanding at end of year 1,923,780 $ 7.82 1,962,752 $ 12.47 2,778,584 $ 10.51 ================================================================================================================== Weighted average grant-date fair value of options granted $ 9.09 $ 26.31 $ 16.97 ==================================================================================================================
The following table summarizes information for stock options outstanding at October 31, 1997:
Number Weighted average Weighted Weighted Range of outstanding remaining average exercise Number average exercise exercise prices as of 10/31/97 contractual life price exercisable price - --------------------------------------------------------------------------------------------------- $0.43 - 5.88 1,080,794 8.91 $5.50 341,423 $4.69 6.67 - 10.06 605,068 6.16 8.27 579,443 8.30 15.31 - 70.51 237,918 8.16 17.24 182,376 17.33 - --------------------------------------------------------------------------------------------------- $0.43 - 70.51 1,923,780 7.95 $7.82 1,103,242 $8.67 ===================================================================================================
On May 28, 1997, the Board of Directors authorized a stock option exchange program for employee participants in the Plan. Eligible employees who held stock options ("Old Options") with exercise prices in excess of $10.00 per share were able to exchange them for stock options ("New Options") exercisable for a lesser number of shares with an exercise price of $5.88 per share, the average price of the Company's common stock on the Nasdaq National Market System on June 2, 1997. Approximately 1,600,000 Old Options were eligible to be exchanged for 900,000 New Options. Certain executive officers of the Company were either F-24 43 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Stock-Based Compensation Plans, continued ineligible to participate, or had limitations on their ability to participate in the stock option exchange. Eligible employees had approximately one month's time until June 30, 1997, to exchange their Old Options for New Options. At the end of the exchange program, 1,209,100 Old Options were exchanged for 606,300 New Options. On May 28, 1993, the Board of Directors adopted the Health Management Systems, Inc. Employee Stock Purchase Plan (the "ESPP"), which was subsequently approved by shareholders at the Annual Meeting of Shareholders held on February 28, 1994. The Company has reserved for issuance up to 1,125,000 shares of common stock pursuant to the ESPP, which is intended to qualify as an "employee stock purchase plan" within the meaning of Section 423 of the Internal Revenue Code of 1986. The plan provides that all full-time employees of the Company and its subsidiaries may elect to participate in the ESPP without regard to length of service if their customary employment is a minimum of 20 hours per week. For the years ended October 31, 1997 and 1996, the Company had sold 95,332 and 163,426 shares, respectively, of common stock pursuant to the ESPP for aggregate consideration of $709,000 and $2,332,000, respectively which activity is reflected in the accompanying consolidated financial statements. The weighted-average fair value of those purchase rights granted in 1997 and 1996, respectively, based on the Black-Scholes model were $10.68 and $7.77, respectively. 13. Business Segment Information The Company delivers software and services that comprise three business segments: Transfer Payment Division, Software Division, and Other services comprised of Electronic Data Interchange ("EDI"). The Transfer Payment Division includes the Company's RCR, CAMS, and TPLR product offerings. The Software Division includes the Company's DSS and MCIS product offerings. In fiscal year 1998, EDI will be included as an operating unit in the Transfer Payment Division.
Transfer Software Payment Division Division Other Consolidated - --------------------------------------------------------------------------------------------- 1997 Revenue $ 49,388,000 34,295,000 5,834,000 89,517,000 Operating (loss) income (3,871,000) 3,657,000 45,000 (169,000) Total assets 81,258,000 27,565,000 871,000 109,694,000 Depreciation and amortization 2,420,000 2,581,000 141,000 5,142,000 Capital expenditures 902,000 2,990,000 68,000 3,960,000 - --------------------------------------------------------------------------------------------- 1996 Revenue $ 73,124,000 19,510,000 8,692,000 101,326,000 Operating income 9,302,000 2,497,000 1,450,000 13,249,000 Total assets 95,368,000 12,510,000 1,765,000 109,643,000 Depreciation and amortization 2,403,000 736,000 182,000 3,321,000 Capital expenditures 4,067,000 1,535,000 5,000 5,607,000 - --------------------------------------------------------------------------------------------- 1995 Revenue $ 66,385,000 15,888,000 8,222,000 90,495,000 Operating income 14,183,000 1,825,000 1,209,000 17,217,000 Total assets 75,181,000 10,763,000 2,157,000 88,101,000 Depreciation and amortization 2,106,000 775,000 134,000 3,015,000 Capital expenditures 1,240,000 853,000 260,000 2,353,000 - ---------------------------------------------------------------------------------------------
F-25 44 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. Commitments The Company leases office space and equipment under operating leases which expire at various dates. The lease agreements provide for rent escalations. Total rent expense for the years ended October 31, 1997, 1996, and 1995, including escalations, was $7,634,000, $6,313,000, and $5,275,000, respectively. Minimum annual lease payments for each of the next five years ending October 31 and thereafter are as follows: Year Payments ---------------------------------------------- 1998 $ 5,929,000 1999 5,445,000 2000 3,978,000 2001 3,781,000 2002 3,588,000 Thereafter 7,368,000 ---------------------------------------------- Total $ 30,089,000 ============================================== 15. Significant Contracts The Company's largest client is a group of healthcare facilities under the governance of Los Angeles County, for which the Company provides RCR and CAMS, including managed care services. During the fiscal years ended October 31, 1997, 1996, and 1995, this group accounted for 12%, 12%, and 15%, respectively, of the Company's total revenues. The Company's second largest client is Columbia//HCA ("C/HCA"), for which the Company provides DSS. This client accounted for 12%, 8%, and 4%, respectively, of the Company's total revenue in 1997, 1996, and 1995. The Company provides its services to C/HCA principally under a series of 12-month work order agreements, each expiring at different times. There is no assurance that any of these agreements will be renewed. The Company's ten largest clients accounted for approximately 53% of the Company's revenue in fiscal year 1997. Five of the Company's ten largest contracts with these clients expire in fiscal year 1998. There can be no assurance that any of these contracts will be renewed. 16. Related Party Transactions (a) HHL Financial Services, Inc. Effective January 31, 1992, the Company entered into a management and data processing services agreement ("Management Agreement") with HHL Financial Services, Inc. ("HHL"). Under the Management Agreement, the Company provided HHL with executive management, data processing, and technical support services through June 30, 1996, subject to certain termination and renewal provisions. Effective July 1, 1993, the Management Agreement was amended ("Outsourcing Amendment") to include the Company's provision of comprehensive data processing and information management services to HHL. The five-year term of the Outsourcing Amendment called for fixed annual fees that range from $6,700,000 to $9,500,000 subject to upward adjustment in the event of material changes in the scope of service and/or growth in HHL revenue in excess of 7% annually. F-26 45 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. Related Party Transactions, continued On August 21, 1996, the Company announced a one-time charge and revenue reversal pertaining to its relationship with HHL, which was in default of the Outsourcing Amendment. The Company's one-time charge related to (i) the full reservation of prior period accounts receivable of $2,881,000, (ii) accrual of net costs to be incurred in excess of anticipated revenue relating to the Company's continued contractual obligation with HHL of $3,823,000, and (iii) the write-off of its investment in HHL of $927,000, resulting in a total one-time charge of $7,631,000. Additionally, revenue of $2,180,000 earned and initially recorded in the third quarter was reversed. The result of the total write-off and revenue reversal recognized in the third quarter of $9,811,000 translates to an after-tax impact of $5,563,000, or $0.30 per share. On October 29, 1996, the Company entered into an agreement with HHL and HHL's primary financial creditor providing for mutual general releases and the cessation of all claims. The Company also settled its liabilities due to HHL of $1,950,000 for a payment of $870,000 resulting in the reversal of $1,080,000 in liabilities as an offset to other operating expenses. In addition, the Company agreed to provide, for a period of up to 18 months, a reduced level of service to HHL in exchange for payment in advance. During this 18 month period, HHL has the right to lower the level of service requested and therefore lower the amount paid in advance. Also, HHL has the right to cancel the service completely on 30 days prior written notice. As of October 31, 1996, the Company had incurred and offset $165,000 in net expenses for its contractual obligations with HHL. During 1997, the Company had incurred and offset $2,739,000 in net expenses for its contractual obligations with HHL. The remaining accrual of $719,000 is scheduled to be offset over the next five years against a contractual obligation of the Company to a third party. During the years ended October 31, 1997, 1996, and 1995, the Company received approximately $1,849,000, $5,446,000, and $8,877,000 in fees from HHL related to these agreements and in connection with jointly executed client projects. During the same periods HHL charged the Company expenses for services totaling $250,000, $1,557,000, and $1,337,000, respectively, in connection with work done on jointly executed client projects. (b) HISCo The Company and HISCo entered into an agreement, dated as of October 31, 1995 (the "HISCo Agreement"), pursuant to which the Company was to provide HISCo with certain services ("Basic Services"), including executive, acquisition support, and corporate support services. For these Basic Services, the Company was entitled to receive a fee, payable monthly, calculated at the Company's then current standard hourly rates established for internal allocations plus 20%. The term of the HISCo Agreement was to continue until the later of (i) June 30, 2000 or (ii) the expiration of any outstanding work order related to additional services. The Company believes that the terms of the HISCo Agreement were fair and reasonable and were no less favorable to the Company than those that could have been obtained with respect to comparable engagements with independent third parties. In fiscal years 1997 and 1996, the Company received approximately $331,000 and $161,000 in fees from HISCo for services provided pursuant to the HISCo Agreement. In fiscal years 1997 and 1996, HISCo received $0 and $569,000 in fees for software development services provided to the Company pursuant to the HISCo agreement. These software development fees were expensed by the Company. F-27 46 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. Related Party Transactions, continued In March 1997, the Company, which owned 43% of HISCo's equity, acquired the remaining 57% of HISCo's equity for $3,689,000, net of cash acquired. In connection with this acquisition, the HISCo agreement was terminated and HISCo merged with its sole operating subsidiary, Health Systems Architects, Inc. and was renamed HSA Managed Care Systems, Inc. HSA provides automated business and information solutions, including software and services, to the bearers of risk in the healthcare industry. The acquisition was accounted for using the purchase method and accordingly the results of operations of HSA from the date of acquisition through October 31, 1997 are included in the accompanying financial statements. The $2,309,000 excess of the purchase price over fair market value of the net assets acquired was recorded as goodwill and is being amortized over a period not to exceed 20 years. In connection with the sale of their respective equity interests in HISCo to the Company, certain officers and directors of the Company derived gross proceeds as follows: Paul J. Kerz, $101,000; Laurence B. Simon, $62,000; Donald J. Staffa, $31,000; Russell L. Carson, $79,000; and Richard H. Stowe, $30,000. The Company's total revenue from related parties was $331,000, $5,607,000 and $9,422,000 in 1997, 1996, and 1995, respectively. (c) Robert V. Nagelhout Effective April 16, 1997, the Company guaranteed all of the obligations of Robert V. Nagelhout arising under a $1,600,000 loan made to Mr. Nagelhout by the financial institution with which the Company has an outstanding credit facility. Mr. Nagelhout is a director of the Company and its Executive Vice President and Chief Operating Officer. The loan is payable on a monthly basis as to interest only, at an interest rate equal to the prime rate announced from time to time by the financial institution. The loan will mature on April 16, 1999, at which time the entire unpaid principal balance of the loan, together with accrued and unpaid interest, will become due and payable. The amount of the loan reduced the available borrowings under the Company's credit facility. Mr. Nagelhout has granted the Company a first security interest in 500,000 shares of HMS common stock owned by him to secure the Company's guaranty of his loan obligations. F-28 47 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. Quarterly Financial Data (unaudited) The table below summarizes the Company's unaudited quarterly operating results for its last three fiscal years.
First Second Third Fourth ($ In Thousands, Except Earnings Per Common Share) Quarter Quarter Quarter Quarter - ---------------------------------------------------------------------------------------------------- 1997: Revenue $22,272 20,108 22,103 25,034 Cost of services 18,945 22,319 23,063 24,028 - ---------------------------------------------------------------------------------------------------- Operating margin (loss) before amortization of intangibles 3,327 (2,211) (960) 1,006 Operating income (loss) 3,281 (2,450) (1,472) 472 Net income (loss) 1,803 281 (603) 600 Net income (loss) per common share $ 0.10 0.02 (0.03) 0.03 - ---------------------------------------------------------------------------------------------------- 1996: Revenue $25,619 25,707 25,935 24,065 Cost of services 19,920 20,238 28,555 19,160 - ---------------------------------------------------------------------------------------------------- Operating margin (loss) before amortization of intangibles 5,699 5,469 (2,620) 4,905 Operating income (loss) 5,644 5,414 (2,671) 4,862 Net income (loss) 3,610 3,102 (2,097) 2,676 Net income (loss) per common share $ 0.20 0.17 (0.12) 0.14 - ---------------------------------------------------------------------------------------------------- 1995: Revenue $21,136 21,174 23,236 24,949 Cost of services 16,789 17,106 19,147 19,993 - ---------------------------------------------------------------------------------------------------- Operating margin (loss) before amortization of intangibles 4,347 4,068 4,089 4,956 Operating income 4,267 4,013 4,035 4,902 Net income 1,640 2,196 2,268 2,858 Net income per common share $ 0.10 0.13 0.13 0.16 - ----------------------------------------------------------------------------------------------------
18. Subsequent Events Effective October 31, 1997, the Company terminated its profit sharing plan, including the 401(k) plan. A replacement, but identical, 401(k) plan was established as of November 1, 1997. Assets of the terminated profit sharing plan will be distributed to plan participants subsequent to approval by the IRS.. 19. Legal In April and May 1997, five purported class action lawsuits were commenced in the United States District Court for the Southern District of New York against the Company and certain of its present and former officers and directors alleging violations of the Securities and Exchange Act of 1934 arising out of allegedly false and misleading statements. These lawsuits, which seek damages in an unspecified amount, have been consolidated into a single proceeding captioned In re Health Management Systems, Inc. Securities Litigation (97 Civ. 1865 (HB)) and a Consolidated Amended Complaint has been filed. Defendants have made a motion to dismiss the Consolidated Amended Complaint. The motion was submitted to the Court on December 18, 1997 following oral argument and is sub judice. Discovery has been stayed pending a determination of the Company's motion to dismiss. The Company believes it has meritorious defenses to the claims asserted against it and intends to vigorously defend this litigation should the pending motion to dismiss not be granted. It is too early to form any opinion as to the eventual outcome of this matter. F-29 48 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In Thousands, Except Per Share Amounts) Allowance for doubtful accounts: Balance, October 31, 1994 $ 269,000 Provision 111,000 Recoveries -- Charge-offs (84,000) ----------- Balance, October 31, 1995 296,000 Provision 4,485,000 Recoveries -- Charge-offs (3,099,000) ----------- Balance, October 31, 1996 1,682,000 Provision 538,000 Recoveries -- Charge-offs (792,000) ----------- Balance, October 31, 1997 $ 1,428,000 =========== F-30 49 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT INDEX Exhibit Number - ------- 2.1 Agreement and Plan of Merger dated as of January 18, 1995 among Health Management Systems, Inc., HCm Acquisition Corp., and all the shareholders of Health Care microsystems, Inc., as amended (Incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended October 31, 1994 and to Exhibit 10.2 to the Company's Registration Statement on Form S-3, file no. 33-91518) 2.2 Agreement and Plan of Merger, dated as of April 29, 1996 among Health Management Systems, Inc., CDR Acquisition Corp., CDR Associates, Inc., and all the shareholders of CDR Associates, Inc. (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated April 29, 1996) 2.2(i) First Amendment to Agreement and Plan of Merger, dated as of April 29, 1996, among Health Management Systems, Inc., CDR Acquisition Corp., CDR Associates, Inc., and all the shareholders of CDR Associates, Inc. (Incorporated by reference to Exhibit 2.2(i) to the Company's Annual Report on Form 10-K for the year ended October 31, 1996 [the 1996 Form 10-K].) 2.3 Agreement and Plan of Merger, dated as of September 3, 1996, by and among Health Management Systems, Inc., QSM Acquisition Corporation and Quality Standards in Medicine, Inc. (Incorporated by reference to Exhibit 2.1 to the Company's Registration Statement on Form S-4, File No. 333-13513 [the S-4]) 2.3(i) Amendment to Agreement and Plan of Merger, dated as of November 20, 1996, by and among Health Management Systems, Inc., QSM Acquisition Corporation, and Quality Standards in Medicine, Inc. (Incorporated by reference to Exhibit 10.1 to Post-Effective Amendment No. 1 to the S-4) 2.4 Form of Escrow Agreement by and among Health Management Systems, Inc., Quality Standards in Medicine, Inc., Coleman & Rhine LLP, Rodrigo Rocha, William B. Munier and Peter B. Stovell (Incorporated by reference to Exhibit 2.2 to the S-4) 2.5 Agreement and Plan of Merger, dated as of March 18, 1997, by and among Health Management Systems, Inc., HISCo Acquisition Corp., Health Information Systems Corporation and HSA Managed Care Systems, Inc. (Incorporated by reference to Exhibit 2.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1997 [the April 1997 Form 10-Q].) 2.6 Asset Purchase Agreement, dated as of March 10, 1997, by and among GHS, Inc., Global Health Systems, Inc. GHS Management Services, Inc., Health Management Systems, Inc. and Global Health Acquisition Inc. (Incorporated by reference to Exhibit 2.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1997 [the July 1997 Form 10-Q].) 2.6(i) Assignment and Assumption Agreement, dated as of July 15, 1997, between Global Health Acquisition Corp. and HSA Managed Care Systems, Inc. (Incorporated by reference to Exhibit 2.2 to the July 1997 Form 10-Q.) 17 50 Exhibit Number - ------- 3.1 Amended and Restated Certificate of Incorporation of Health Management Systems, Inc. (Incorporated by reference to Exhibit 3.1 to Amendment No. 1 [Amendment No. 1] to the Company's Registration Statement on Form S-1, File No. 33-4644 [the Registration Statement] and Exhibit 3(i) to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1996 [the January 1996 Form 10-Q]) 3.2 By-Laws of Health Management Systems, Inc. (Incorporated by reference to Exhibit 3.2 to Amendment No. 1) 10.1 Financial Management Services Agreement, dated August 1, 1989, between Health Management Systems, Inc. and the County of Los Angeles (Incorporated by reference to Exhibit 10.2 to the Registration Statement) *10.2(i) Master Software License Agreement, dated June 29, 1992, by and between Health Care microsystems, Inc. and Healthtrust, Inc. - The Hospital Company. *10.2(ii) Amendment, dated as of September 1, 1995, to Master Software License, dated June 29, 1992, by and between Health Care microsystems, Inc. and Columbia/HCA. 10.3(i) Health Management Systems, Inc. Stock Option and Restricted Stock Purchase Plan, as amended (Incorporated by reference to Exhibit 10.3 to the Registration Statement, to Exhibit 10.3 to Amendment No. 2 [Amendment No. 2] to the Registration Statement, Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994 [the January 1994 Form 10-Q] and Exhibit to the January 1996 Form 10-Q.) *10.3(ii) Amendment No. 6, dated as of December 2, 1997, to the Health Management Systems, Inc., Stock Option and Restricted Stock Purchase Plan 10.3(iii) Health Management Systems, Inc. Employee Stock Purchase Plan, as amended (Incorporated by reference to Exhibit 10.2 to the January 1994 Form 10-Q and to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995 [the January 1995 Form 10-Q]) 10.3(iv) Health Management Systems, Inc. 1995 Non-Employee Director Stock Option Plan (Incorporated by reference to Exhibit 10.2 to the January 1995 Form 10-Q) 10.3(v) Health Management Systems, Inc. Profit Sharing Plan (Incorporated by reference to Exhibit 10.3(iv) to the Company's Annual Report on Form 10-K for the year ended October 31, 1995 [the 1995 Form 10-K]) 10.3(vi) Health Management Systems, Inc. Profit Sharing Plan, as amended (Incorporated by reference to Exhibit 10.3(vi) to the 1995 Form 10-K) 10.4(i) Credit Agreement and Guaranty Among Health Management Systems, Inc., as Borrower, Accelerated Claims Processing, Inc., Quality Medi-Cal Adjudication, Incorporated, Health Care microsystems, Inc., and CDR Associates, Inc., as Guarantors, and The Chase Manhattan Bank, as Bank (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1996 [the July 1996 Form 10-Q]) 18 51 Exhibit Number - ------- 10.4(ii) First Amendment to Credit Agreement and Guaranty and Waiver (Incorporated by reference to Exhibit 10.1(i) to the July 1996 Form 10-Q) 10.4(iii) Guaranty Agreement, dated as of April 16, 1997, between Health Management Systems, Inc. and The Chase Manhattan Bank (Incorporated by reference to Exhibit 10.1 to the April 1997 Form 10-Q) 10.4(iv) Second Amendment to Credit Agreement and Guaranty, dated as of April 16, 1997, among Health Management Systems, Inc., Accelerated Claims Processing, Inc., Quality Medical Adjudication, Incorporated, Health Care microsystems, Inc., CDR Associates, Inc., and The Chase Manhattan Bank (Incorporated by reference to Exhibit 10.1 to the July 1997 Form 10-Q) 10.4(v) Third Amendment to Credit Agreement and Guaranty, dated as of June 30, 1997, among Health Management Systems, Inc., Accelerated Claims Processing, Inc., Quality Medical Adjudication, Incorporated, Health Care Microsystems, Inc., CDR Associate, Inc., HSA Managed Care Systems, Inc., Quality Standards in Medicine, Inc. and The Chase Manhattan Bank (Incorporated by reference to Exhibit 10.1 to the July 1997 Form 10-Q) 10.5(i) Leases, dated February 1, 1980, September 24, 1981, September 24, 1982, and January 6, 1986, as amended, between 401 Park Avenue South Associates and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.13 to the Registration Statement and to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994) 10.5(ii) Lease, dated as of March 15, 1996, by and between 387 PAS Enterprises, as Landlord, and Health Management Systems, Inc., as Tenant (Incorporated by reference to Exhibit 10.2 to the July 1996 Form 10-Q) 10.6 Lease, dated September 1996, by and between Pacific Corporate Towers LLC, Health Management Systems, Inc., and Health Care microsystems, Inc. (Incorporated by reference to Exhibit 10.13 to the 1996 Form 10-K) 10.7 Master Lease Agreement, effective as of December 1, 1991, between Hitachi Data Systems Credit Corporation and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.15 to the Registration Statement) 10.8 Services Agreement, dated as of October 31, 1995, between HISCo and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.19(iv) to the 1995 Form 10-K) 10.9 Agreement and Release of Claims dated as of October 29, 1996, by and among HHL Financial Services, Inc., Health Management Systems, Inc., and the First National Bank of Chicago (Incorporated by reference to Exhibit 10.12 to the 1996 Form 10-K) 10.10 Security Agreement, dated as of April 16, 1997, by and between Robert V. Nagelhout and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.3 to the April 1997 Form 10-Q) 10.11 Promissory note, dated as of April 16, 1997, by and between Robert V. Nagelhout and The Chase Manhattan Bank. (Incorporated by reference to Exhibit 10.4 to the April 1997 Form 10-Q) 19 52 Exhibit Number - ------- 10.12 Consulting Service Agreement, dated as of May 1, 1997, by and between Improved Funding Techniques, Inc. and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.2 to the July 1997 Form 10-Q) 10.13 Employment Agreement, as of May 1, 1997, by and between Joseph H. Czajkowski and CDR Associates, Inc., a wholly-owned subsidiary of Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.3 to the July 1997 Form 10-Q) 10.14 Employment Agreement, as of May 1, 1997, by and between Jeffrey R. Donnelly and CDR Associates, Inc., a wholly-owned subsidiary of Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.4 to the July 1997 Form 10-Q) *11.0 Computation of Earnings per Share *21.1 List of subsidiaries of Health Management Systems, Inc. *23.1 Consent of KPMG Peat Marwick LLP, independent certified public accountants 24.2 Consent of Ernst & Young LLP, independent certified public accountants. (Incorporated by reference to Exhibit 24.2 to the October 1996 Form 10-K) 24.3 Report of independent certified public accountants on the financial statements of Health Information Systems Corporation as of and for the period ended October 31, 1996 (Incorporated by reference to Exhibit 24.3 to the 1996 Form 10-K) 24.5 Report of independent certified public accountants on the financial statements of Health Care microsystems, Inc. as of December 31, 1994 and 1993 and for the years then ended (Incorporated by reference to Exhibit 24.5 to the 1995 Form 10-K *27 Financial Data Schedule, which is submitted electronically to the Securities and Exchange Commission for informational purposes only * Filed herewith 20 EX-10.2.I 2 MASTER SOFTWARE LICENSE AGREEMENT 1 EXHIBIT 10.2(i) MASTER SOFTWARE LICENSE This Master Software License (the "Agreement") is made and entered into as of the 29th day of June, 1992 (the "Effective Date"), by and between Health Care microsystems, Inc. (the "Licensor"), a California corporation having its principal place of business at 3655 Torrance Boulevard, Suite 350, Torrance, California 90503, and Healthtrust, Inc. The Hospital Company (the "Licensee"), a Delaware corporation having its principal place of business at 4525 Harding Road, Nashville, Tennessee 37205. WHEREAS, Licensor desires to license to Licensee certain Software (defined below) and Documentation (defined below); WHEREAS, Licensee desires to acquire from Licensor a perpetual, non-exclusive, paid-up, royalty-free, worldwide license for the Software and the Documentation and to sublicense the Software and the Documentation to health care providers owned or operated by or affiliated with Licensee; and WHEREAS, Licensee desires to have Licensor perform software support and maintenance services in connection with the Software and the Documentation and Licensor desires to perform such services pursuant to the terms and conditions contained herein. NOW, THEREFORE, in consideration of the mutual premises contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Definitions 1.1 "Affiliated User" is defined to include any hospital, clinic or other health care provider that Licensee operates or in which Licensee holds a 50% or greater equity interest. 2 1.2 "Documentation" is defined to include any user manuals, training materials, specifications and other material related to the Software. 1.3 "Software" is defined as the software furnished by Licensor to Licensee, including any related interfaces and any custom software, as more fully described in Schedule A annexed hereto, which is incorporated herein by reference. 2. Software License 2.1 Licensor hereby grants to Licensee, subject to the terms and conditions hereinafter set forth, a perpetual, non-exclusive, royalty-free, worldwide license to use the Software, and to sublicense use of the Software to Affiliated Users in accordance with the terms and conditions of license agreements in the form attached hereto as Exhibit 1 (the "User License Agreements"), solely for the data processing needs of Licensee and Affiliated Users, including without limitation Licensee's operation of a central data center. The license granted hereunder includes without limitation the right to reproduce or copy all or any portion of the Software in machine-readable or printed form as determined by Licensee to be reasonably required for its own internal data processing needs and archival and backup purposes, and to copy and distribute run units of the Software for use by Affiliated Users that sublicense the Software under User License Agreements. Except as provided in this Section 2.1 and in Section 15, the license granted hereunder shall be nontransferable. Subject to Section 18, the license granted hereunder shall be terminable in the event that Licensee fails to make any payment when due of the license fees in accordance with Schedule A. 2.2 Licensee acknowledges that portions of the Software licensed under this Agreement are owned by Micro Data Base Systems, Inc. ("MDBS"), Programmed Intelligence, Inc. ("PI"), or Information Resources, Inc. ("IRI"). Licensee further acknowledges that the MDBS, PI and IRI portions of the Software may not be used by Licensee as stand-alone software products, but only as component parts of the Software. 2 3 2.3 The license for the Software and the Documentation granted hereunder and the terms and conditions of this Agreement shall cover all custom software and related documentation developed on a time-and-materials or flat-fee basis by Licensor at Licensee's request. 3. Documentation License Licensor hereby grants to Licensee a perpetual, non-exclusive, royalty-free, worldwide license to use the Documentation in conjunction with Licensee's use of the Software and to sublicense use of the Documentation to Affiliated Users in conjunction with Affiliated Users' use of the Software. Licensor will be the primary source for the Documentation, but, as a convenience, Licensor further grants Licensee the right to reproduce and distribute copies of the Documentation for its own use and for use by Affiliated Users. In the event Licensee exercises the right to reproduce and distribute copies of the Documentation or any portion thereof, such copies shall include Licensor's copyright notices; provided, however, that this provision shall not apply to de minimus copying for the personal convenience of employees of Licensee or Affiliated Users. The Documentation shall be furnished to Licensee in printed form, and shall consist of all user manuals, training materials and specifications for the Software. Subject to Section 18, the license granted hereunder shall be terminable in the event that Licensee fails to make any payment when due of the license fees in accordance with Schedule A. 4. License Fee, Taxes and Expenses; Delivery 4.1 As consideration for the perpetual license to use and to sublicense use of the Software and the Documentation granted to Licensee herein, Licensee shall pay to Licensor a one-time license fee in the amount and payable in accordance with the payment schedule set forth in Schedule A. 4.2 Licensee shall pay all sales, use and personal property taxes assessed in connection with this Agreement and each Affiliated User shall be responsible for any sales, use and 3 4 personal property taxes assessed in connection with its User License Agreement; provided, however, that Licensor shall pay all taxes based on Licensor's business operations (including without limitation employment taxes and taxes levied on Licensor's income). 4.3 Licensee shall reimburse Licensor at Licensor's cost for its reasonable and necessary direct out-of-pocket expenses incurred in connection with Licensor's performance hereunder, including without limitation long-distance toll charges, overnight courier charges and postage. If Licensor travels to Licensee's site in connection with Licensor's performance under this Agreement and such travel is approved in advance by an authorized representative of Licensee, Licensee shall reimburse Licensor for Licensor's reasonable and necessary expenses at cost. Licensee shall be invoiced monthly in arrears for all such expenses and payments shall be due within 30 days of Licensee's receipt of such invoices; provided, however, that Licensee shall have no obligation to reimburse Licensor for any such expenses not invoiced within 180 days of the date incurred by Licensor. 4.4 Licensor shall pay all freight, shipping and handling costs for delivery of the Software and the Documentation and shall bear all risk of loss, including any insurance costs; provided, however, Licensee shall reimburse Licensor for freight, shipping and handling costs in accordance with the terms of Section 4.3 upon delivery and acceptance of the Software and Documentation. 5. Affiliated User License and Fees 5.1 Licensor agrees that Licensee may sublicense the Software and the Documentation for use by any Affiliated User that executes a User License Agreement. 5.2 Licensee shall pay Licensor sublicense fees on behalf of each Affiliated User that executes a User License Agreement for the Software and the Documentation as determined in accordance with the price schedule set forth in Schedule A. 4 5 5.3 The Software shall not be used to process the data of an Affiliated User until a User License Agreement has been entered into with that Affiliated User. 6. Source Code 6.1 Licensor has not provided Licensee with a copy of, and Licensee acquires no rights of any kind with respect to, the Software source code except as provided herein. In the event of Licensor's discontinuance of or failure in material respects to provide support and maintenance services for the Software pursuant to the terms and conditions of this Agreement or any other existing agreement with Licensee, or Licensor has otherwise defaulted under this Agreement or other agreement related to the Software, Licensor shall deliver to Licensee a copy of the Software source code for the current version of the Software and all internal documentation related thereto (including a list of and information regarding how to license third-party software used to develop or maintain the Licensed Software). 6.2 In the event Licensee determines that Licensor has failed in material respects to provide support and maintenance services for the Software or has otherwise defaulted as described in Section 6.1, Licensee shall provide Licensor with written notice describing in reasonable detail the reasons for Licensee's determination and an opportunity for 30 days after Licensor's receipt of such notice for Licensor to cure the material failure or default as described by Licensee. The pendency of a dispute regarding such a material failure or default shall not entitle Licensee to receive a copy of the Software source code and related documentation. 6.3 Subject to the foregoing, Licensor hereby grants Licensee a license to use such source code and related documentation in order to maintain and modify the Software licensed by Licensee and sublicensed by Affiliated Users. Licensor hereby acknowledges Licensee's and Affiliated Users' right to participate in a user's support group with other users of all or part of the Software. 5 6 6.4 Upon delivery of the source code and related documentation to Licensee, Licensor's support and maintenance obligations hereunder shall terminate; provided, however, that delivery of the source code and related documentation to Licensee shall not affect Licensee's obligation to pay Licensor sublicense fees under Section 5.2. If the source code is delivered to Licensee as a result of a notice by Licensee under Section 6.2, delivery of the source code shall constitute Licensee's sole remedy for claims related to support and maintenance services hereunder. 7. Hardware Licensee is responsible for providing computer equipment and operating system software (collectively, the "Hardware") that conforms with Licensor's specifications as set forth in Schedule B annexed hereto, which is incorporated herein by reference, as may be modified by mutual consent of the parties from time to time. Licensee acknowledges that a parallel printer port must be available for use in connection with security mechanisms that may be provided by Licensor. 8. Licensor's Warranties 8.1 Ownership and Quiet Enjoyment. Licensor hereby warrants and represents to Licensee and Affiliated Users that Licensor owns all right, title and interest in and to the Software and the Documentation or otherwise has the right to grant to Licensee the license to use and to sublicense same as set forth in this Agreement without violating or infringing upon any rights of any third party and without breach of any third-party license to Licensor, and there is currently no actual or threatened suit by any third party based on an alleged violation, infringement or breach by Licensor. Use of the Software and the Documentation in accordance with this Agreement and any User License Agreement shall not be disturbed or interfered with during the continuation of the license granted hereunder except as provided in Section 10.2. 6 7 8.2 For any period during which Licensee maintains support and maintenance of the Software through Licensor as set forth in Section 9, Licensor further warrants and represents to Licensee and Affiliated Users as follows: (a) Software Operation. The Software and each module or component thereof shall operate on the Hardware and shall perform substantially in accordance with the Documentation and pages 36-59 of Licensor's proposal dated June 7, 1991, attached hereto as Exhibit 2; provided, however, if Licensee or an Affiliated User makes an unauthorized modification to the Software, then this warranty shall terminate with respect to such Licensee or Affiliated User. (b) Performance Standards. Each of Licensor's employees, agents or representatives assigned to perform services hereunder shall have the proper skill, training and background so as to be able to perform in a competent and professional manner and all work will be so performed in a manner compatible with Licensee's or each Affiliated User's business operations at its premises. 8.3 EXCEPT AS OTHERWISE EXPRESSLY PROVIDED HEREIN, LICENSOR DOES NOT MAKE AND EXPRESSLY DISCLAIMS ALL OTHER WARRANTIES WITH RESPECT TO THE SOFTWARE, INCLUDING WITHOUT LIMITATION THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. 9. Master Software Support and Maintenance 9.1 Licensor shall promptly notify Licensee of any defects or malfunctions in the Software or the Documentation of which it learns from any source. Licensor shall use its best efforts reasonable under the circumstances to correct any material defects or malfunctions in the Software or the Documentation and provide Licensee and Affiliated Users with corrected copies of same in accordance with a schedule to be mutually agreed to by the parties. Licensor's obligation hereunder shall not affect any other liability that it may have to Licensee or Affiliated Users. 7 8 9.2 Licensor shall provide to Licensee and Affiliated Users copies of the Software and the Documentation made generally available to its customers and reflecting any enhancements to the Software and the Documentation made by Licensor. Such enhancements shall include without limitation all modifications to the Software that increase the speed, efficiency or ease of operation of the Software, or add additional capabilities to or otherwise improve the functions of the Software, but shall not include new products that bring substantial new functionality to the Software. 9.3 Licensor shall use its best efforts reasonable under the circumstances to cause the Software to operate as warranted in Section 8.2(a) and shall provide one copy of any updated release of the Software, or part thereof, to Licensee and Affiliated Users which Licensee and Affiliated Users may copy in the appropriate quantity and substitute for a prior release. In addition, Licensor shall provide published bulletins describing new releases, maintenance releases, temporary problem resolutions and circumventions, support level changes and other information with respect to the Software, which updated releases Licensee and Affiliated Users may obtain at no additional cost, except for Licensor's then applicable mailing and media charges plus any reasonable costs as the parties may mutually agree related to installation of such releases. 9.4 Licensor shall commit the resources of at least one full-time employee to respond to any request by Licensee to correct any failure of the Software to perform as warranted in Section 8.2(a), within a period of 48 hours after Licensee provides reasonably detailed notice of such failure. Licensor shall use its best efforts promptly to remedy any such failure of the Software, either by providing a permanent fix or replacement to the Software or by providing a temporary work around. 9.5 Subject to the provisions of Schedule A, Section V.2.a., whereby Licensee may earlier terminate the services described in this Section 9, Licensor shall provide the Software support and maintenance services described in this Section 9 for the charges set forth in Section 9.6 below for a five-year period commencing upon the Effective Date of this Agreement (the "Initial Term"), and, upon expiration of the Initial Term, shall continue 8 9 to provide such services on a year-to-year basis unless, no less than six months prior to the expiration of the Initial Term or 60 days prior to the expiration of any one-year renewal term, either party gives the other party written notice of the notifying party's desire to: (a) renegotiate the terms and conditions of this Agreement related to Licensor's Software support and maintenance services, provided that if an agreement on new terms is not reached prior to the expiration of the applicable term, Licensor's Software support and maintenance services shall be deemed terminated in accordance with Section 9.5(b); or (b) terminate Licensor's Software support and maintenance services, provided, however, that if either party determines to terminate such services, termination shall be subject to a two-year wind-down period (the "Wind-down Period") commencing on the date the expiration of the Initial Term or the renewal term is effective, which shall be subject to the following additional terms and conditions: (i) During the first year of the Wind-down Period, the terms of this Agreement related to Software support and maintenance services shall remain in effect and Licensee may elect on behalf of Affiliated Users to discontinue Licensor's Software support and maintenance services to up to five Affiliated Users; (ii) During the second year of the Wind-down Period, the terms of this Agreement related to Software support and maintenance services shall remain in effect and Licensee may elect on behalf of Affiliated Users to discontinue Licensor's Software support and maintenance services to up to one-half the number of Affiliated Users that are receiving such services as of the first day of the second year of the Wind-down Period; and (iii) Licensee shall have no obligation to pay for and Licensor shall have no obligation to provide any Software support and maintenance services after the expiration of the Wind-down Period. 9 10 9.6 During the term of Licensor's software support and maintenance services, Licensee shall pay to Licensor an annual support and maintenance fee in accordance with the terms set forth in Schedule A. At any time after the expiration of the first year of the Initial Term, Licensor's software support and maintenance fees shall be subject to annual increases, provided that Licensor provides Licensee with written notice of any such increase at least 90 days prior to the expiration of each one-year period. Annual increases shall in no event exceed the lesser of: (i) a percentage increase equal to two and one-half percent (2 1/2%) plus the percentage increase in the Consumer Price Index for Urban Consumers, All Cities Average, For all Items (1984-1986 = 100), as published by the Bureau of Labor Statistics of the United States Department of Labor during the most recent twelve-month period for which such figures are available; or (ii) ten percent (10%). 9.7 If Licensor travels to Licensee's or an Affiliated User's site and such travel is approved in advance by an authorized representative of Licensee, Licensee shall reimburse Licensor for its reasonable and necessary expenses at cost. Licensee shall be invoiced monthly in arrears for all such expenses and payments shall be due within 30 days of Licensee's receipt of such invoice; provided, however, that Licensee shall have no obligation to reimburse Licensor for any such expenses not invoiced within 180 days of the date incurred by Licensor. 9.8 (a) Licensee agrees that all enhancements to the Software furnished by Licensor pursuant to this Agreement shall be installed within six months of Licensee's receipt of any such enhancements, provided that if Licensor is responsible for installation, Licensor shall cooperate with Licensee to install the Software within such time period. As mutually agreed by the parties at such time as enhancements are provided, either Licensee shall install the enhancements or Licensee shall engage Licensor to install the enhancements at its standard hourly rate for software installation services. (b) Licensee agrees to provide Licensor with sufficient support and test time on Licensee's or an Affiliated User's computer system to duplicate a reported problem, certify that the problem is with the Software, and certify that the 10 11 problem has been corrected, and to otherwise reasonably cooperate with Licensor in connection with Licensor's support and maintenance services. (c) As long as Licensor is providing support and maintenance services to Licensee, Licensee shall install and maintain a 1200 or 2400 baud modem and associated dial-up telephone line. Licensee shall pay for installation, maintenance and use of such equipment and associated telephone line-use charges. Licensor, at its option, shall use this modem and telephone line in connection with error correction, installation of enhancements and assistance to Licensee in connection with its use of the Software. Such access by Licensor shall be subject to prior approval by Licensee in each instance. As long as Licensor is providing support and maintenance services to Licensee, Licensee shall also install and maintain a tape backup system that conforms to the specifications set forth in Schedule B to be used for regular tape backups by Licensee and transfer of data and Software updates between Licensee and Licensor. (d) Except as authorized by Section 6, Licensee shall not modify or attempt to modify the Software without the prior written consent of Licensor. (e) Licensee agrees that any copies of the Software or the Documentation that it makes pursuant to this Agreement shall bear all copyright, trademark and other proprietary notices included therein by Licensor and, except as expressly authorized herein, Licensee shall not distribute same to any third party without Licensor's prior written consent. 9.9 The Software support and maintenance fees, stated in Schedule A, Section V., are subject to mutually acceptable adjustment to be negotiated by the parties in the event: (a) Licensee assumes support obligations for the Affiliated Users but in so doing fails to: (i) provide a level of staffing for the assumed obligations consistent with the level of staffing previously provided by Licensor or (ii) staff its Affiliated User support function with persons trained by Licensor or otherwise determined by Licensor to be qualified and Licensor's 11 12 cost in providing the Software support described in this Section 9, as measured by the average number of calls made by the Licensee and Affiliated Users to Licensor's corporate support center for such support versus the volume of calls to such center prior to Licensee's assumption of support obligations for the Affiliated Users, does not increase significantly due to Licensee's assumption of such obligations; or, (b) the parties mutually agree to add more application software programs or interfaces to the Software described in Schedule A. 10. Limitations of Liability 10.1 Except as provided in Section 16, Licensor shall have no liability for consequential, exemplary, indirect, special or incidental damages, whether based on contract, tort or any other legal theory, arising out of or related to this Agreement or the transactions contemplated herein, nor shall Licensor be liable for any loss of data or lost profits of Licensee, or for any amount in excess of the license fees paid to Licensor by Licensee under this Agreement, even if Licensor is apprised of the likelihood of such damages occurring. 10.2 Subject to Licensor's obligations under Section 16.2, in the event that the use of the Software or any portion thereof is held by a court of competent jurisdiction to infringe or constitute the wrongful use of any third party's proprietary rights and Licensee's right to use the Software is enjoined, or if Licensor in the reasonable exercise of its discretion instructs Licensee to cease using the Software in order to mitigate potential damages arising from a third party's claim that use of the Software infringes on its rights, Licensee shall cease using the Software. In either event (other than by reason of a temporary restraining order not exceeding 30 days), Licensor shall (i) replace the Software with equally suitable non-infringing software, (ii) modify the Software so that its use by Licensee as permitted hereunder ceases to be infringing or wrongful, (iii) procure for Licensee the right to continue using the Software as permitted hereunder, or (iv) after reasonable efforts under clauses (i), (ii) and (iii) of this sentence, refund to Licensee a 12 13 pro rata portion of the license fee as follows: (I) within one year of the Effective Date, 100%; (II) for the second one-year period following the Effective Date, 80%; (III) for the third one-year period following the Effective Date, 60%; (IV) for the fourth one-year period following the Effective Date, 40%; or (V) during the period running from the fourth anniversary through the tenth anniversary of the Effective Date, if Licensee continues to receive Software support and maintenance services from Licensor pursuant to Section 9, 20%. 10.3 Other than as expressly contained in Sections 16.2 and 10.2, Licensor shall have no liability whatsoever to indemnify Licensee for any loss or damage arising out of or related to any allegation or determination that Licensee's use of the Software as permitted hereunder infringes or constitutes wrongful use of any proprietary right. 11. Title to Software and Documentation The Software and the Documentation provided hereunder and all copies thereof are proprietary to Licensor and title thereto remains in Licensor (or in third parties who have licensed any part of the Software to Licensor). Other than the rights in and to the Software and the Documentation granted to Licensee hereunder, Licensee acquires no rights in the Software or the Documentation, including patents, copyrights, trademarks, and trade secrets, if any, embodied therein. Licensee acknowledges that Licensor claims that the Software contains valuable proprietary information and trade secrets developed or acquired by Licensor. Licensee agrees to secure and protect the Software and the Documentation and copies thereof in a manner consistent with the maintenance of Licensor's rights therein and to take reasonable action by instruction or agreement with its employees or independent contractors who are permitted access to the Software and the Documentation to satisfy its obligations hereunder. 13 14 12. Confidentiality 12.1 "Confidential Information" is defined to include the identity of patients, the content of any medical records, financial and tax information, information regarding Medicare and Medicaid claims submission and reimbursements, the object and source codes for the Software, the Documentation, and such other information so designated in writing prior to disclosure by the party claiming that the information to be disclosed is confidential or proprietary business information. 12.2 The party receiving the Confidential Information (the "Receiving Party") from the party who owns or holds in confidence such Confidential Information (the "Owning Party") may use the Confidential Information solely for the purpose of performing its obligations or enforcing its rights under this Agreement. 12.3 The Receiving Party shall not disclose the Confidential Information except to those persons having a need to know for purposes authorized in Section 12.2. Each party shall take appropriate action, by instruction to or agreement with its employees, agents and subcontractors, to maintain the confidentiality of the Confidential Information. Except as provided in Section 12.4 below, Licensee shall not disclose the Documentation or the Software to any independent contractor or subcontractor engaged primarily in the business of developing health care applications software or to any of the companies identified as competitors of Licensor on Schedule C annexed hereto (which schedule may be modified from time to time by mutual consent of the parties, which consent shall not be unreasonably withheld) without the prior consent of Licensor, which consent shall not be unreasonably withheld. Licensee may disclose any Confidential Information on an as-needed basis to its non-employee fiduciaries, including without limitation Licensee's or Affiliated Users' attorneys, accountants, auditors, controlling persons, officers, directors or trustees, without Licensor's prior consent. The Receiving Party shall promptly notify the Owning Party in the event that the Receiving Party learns of an unauthorized release of Confidential Information. 14 15 12.4 The Receiving Party shall have no obligation with respect to: (a) Confidential Information made available to the general public without restriction by the Owning Party or by an authorized third party; (b) Confidential Information known to the Receiving Party independently of disclosures by the Owning Party under this Agreement; (c) Confidential Information independently developed by the Receiving Party; or (d) Confidential Information that the Receiving Party may be required to disclose pursuant to subpoena or other lawful process; provided, however, that the Receiving Party notifies the Owning Party in a timely manner to allow the Owning Party to appear and protect its interests. 12.5 Upon the termination or expiration of the license, each party shall (i) immediately cease to use the other party's Confidential Information, (ii) return to the other party such Confidential Information and all copies thereof within ten (10) days of the termination, unless otherwise provided in this Agreement, and (iii) upon request, certify in writing to the other party that it has complied with its obligations set forth in this Section 12, unless otherwise provided in this Agreement. 12.6 The parties acknowledge that monetary remedies may be inadequate to protect rights in Confidential Information and that, in addition to legal remedies otherwise available, injunctive relief is an appropriate judicial remedy to protect such rights. 12.7 Licensor shall not use Confidential Information received from Licensee or Affiliated Users for the purpose of developing information or statistical compilations for use by third parties or for any other commercial exploitation. 12.8 Each party agrees to provide reasonable assistance and cooperation upon the reasonable request of the 15 16 other party in connection with any litigation against third parties to protect the requesting party's Confidential Information, provided that the party seeking such assistance and cooperation shall reimburse the other party for its reasonable out-of-pocket expenses. 13. Publicity Neither party shall refer to the existence of this Agreement or disclose its terms or use the name of the other party in any press release, advertising or materials distributed to prospective customers, without the prior written consent of the other party. Licensor shall not represent, directly or indirectly, that any product or service of Licensor has been approved or endorsed by Licensee or any Affiliated User. Notwithstanding the foregoing, Licensor shall have the right to identify as clients Licensee and Affiliated Users that have executed User License Agreements on Licensor's list of clients, such list to be used by Licensor solely on a one-for-one basis with individual prospects for marketing purposes but not to be used in any mass marketing or general advertising materials or media. 14. Books and Records 14.1 If required by applicable law, the parties agree that until the expiration of four (4) years after the furnishing of services under this Agreement, Licensor will make available to the Secretary of the United States Department of Health and Human Services (the "Secretary") and the United States Comptroller General, and their duly authorized representatives, this Agreement, each User License Agreement executed hereunder and all books, documents and records necessary to certify the nature and extent of the costs of the goods and services provided under this Agreement and the User License Agreements. No attorney-client, accountant-client or other legal privilege shall be deemed to have been waived by the parties by virtue of this provision. 14.2 Licensee shall have the right, at its expense, during normal business hours and with reasonable advance notice, 16 17 to review and photocopy Licensor's books and records that pertain directly to the accounts of the Licensee and the Affiliated Users, the fees payable to Licensor under this Agreement and the User License Agreements, or the goods and services provided by Licensor hereunder or under the User License Agreements. 14.3 If Licensor carries out the duties of this Agreement or any User License Agreement through a subcontract worth $10,000 or more over a twelve-month period with a related organization, the subcontract will also contain a clause substantially identical to Sections 14.1 and 14.2 to permit access by Licensee, the Secretary, the United States Comptroller General and their representatives to the related organization's books and records. 14.4 Licensee's rights under this Section 14 shall survive for a period of four (4) years after termination or expiration of this Agreement. 15. Assignment Neither Licensee nor Licensor shall assign or transfer this Agreement or any of its rights or obligations hereunder without the prior written consent of the other, which consent shall not be unreasonably withheld; provided, however, that (i) either party may assign its rights or obligations hereunder to a subsidiary in which the assigning party holds a 50% or greater equity interest without the consent of the other party and (ii) either party may assign its rights and obligations hereunder in connection with any transaction involving the sale of all or substantially all of its assets without the consent of the other party. This Agreement shall inure to the benefit of and bind successors and permitted assigns of Licensor and Licensee. In no event shall consent to assignment be conditioned upon the payment of any fee. 16. Indemnity 16.1 Each party shall indemnify and hold harmless the other party and its affiliates, directors, officers, employees and 17 18 agents (collectively, the "indemnitee") against any and all losses, liabilities, judgments, awards and costs (including legal fees and expenses) arising out of or related to any third-party claim for personal injury or property damage (other than intellectual property infringement claims), including any damages finally awarded attributable to such claim and any reasonable expense incurred by indemnitee in assisting indemnitor in defending against such claim, that arises out of any action or inaction by the indemnitor or its employees or agents; provided, however, that indemnitee gives indemnitor: (i) written notice within a reasonable time after indemnitee is served with legal process in an action asserting such claims, provided that the failure or delay to notify indemnitor shall not relieve indemnitor from any liability that it may have to indemnitee hereunder so long as the failure or delay shall not have prejudiced the defense of such claim; (ii) reasonable assistance in defending the claim; and (iii) sole authority to defend or settle such claim. In the event indemnitor elects not to defend any such claim, indemnitee shall have the option but not the duty to reasonably settle or defend the claim at its cost and indemnitor shall indemnify indemnitee for such settlement or any damages finally awarded against indemnitee attributable to such claim, reasonable costs and expenses (including attorneys' fees), and interest on such recoverable funds advanced. 16.2 Licensor agrees to indemnify and hold harmless Licensee and its affiliates, directors, officers, employees and agents (collectively, "indemnitee") against any and all losses, liabilities, judgments, awards and costs (including legal fees and expenses) arising out of or related to any third-party claim that Licensee's use or possession of the Software or the Documentation or the license granted hereunder infringes or violates the copyright, patent, trade secret or other proprietary rights of any third party, including any damages finally awarded attributable to such claim and any reasonable expense incurred by indemnitee in assisting Licensor in defending against such claim; provided, however, that indemnitee gives Licensor: (i) written notice within a reasonable time after indemnitee is served with legal process in an action asserting such claims, provided that the failure or delay to notify Licensor shall not relieve Licensor from any liability that it may have to indemnitee hereunder so long as the failure or delay shall not have prejudiced the defense of such 18 19 claim; (ii) reasonable assistance in defending the claim; and (iii) sole authority to defend or settle such claim. In the event Licensor elects not to defend any such claim, indemnitee shall have the option, but not the duty, to reasonably settle or defend the claim at its cost and Licensor shall indemnify indemnitee for such settlement or any damages finally awarded against indemnitee attributable to such claim, reasonable costs and expenses (including attorneys' fees) and interest on such recoverable funds advanced. Notwithstanding the foregoing, Licensor's obligations to indemnify Licensee under this Section 16.2 shall not extend to claims arising more than five years after discontinuation of Software support and maintenance services under Section 9. The indemnity provided by this Section 16.2 extends only to damages and costs awarded against Licensee (or payable by Licensee pursuant to a settlement agreement) and costs and expenses associated with the defense of such third-party claims; any assertion by Licensee that it is damaged by virtue of any inability to use the Software as a result of a third party claim shall be governed by Section 10.2 hereof, which provides the sole and exclusive remedies therefor. 17. Work Environment When Licensor's employees are physically assigned to work on the premises of Licensee's corporate headquarters site, Licensee shall provide to Licensor's employees a reasonable work environment, including reasonable office space, furniture, supplies and equipment, within or in proximity to the buildings housing Licensee's corporate headquarters, to enable Licensor to perform its obligations under this Agreement and any work order executed hereunder. 19 20 18. Termination and Survival 18.1 The license granted hereunder is perpetual and may not be terminated by Licensor except upon Licensee's failure to cure a material breach of this Agreement, including nonpayment of any Software license fee when due, within 60 days of receipt of Licensor's written notice describing the nature of the alleged material breach. In the event of a termination of the license, Licensee shall within 60 days, at Licensee's option, either deliver to Licensor or destroy the Software and the Documentation in Licensee's possession. Within 60 days following termination, Licensee shall certify in writing to Licensor that all copies of the Software and the Documentation in Licensee's possession have been returned or destroyed. 18.2 Subject to Section 18.4, the sublicense granted to each Affiliated User is perpetual and may not be terminated by Licensor except upon that Affiliated User's failure to cure a material breach of its User License Agreement within 60 days of receipt of Licensor's written notice describing the nature of the alleged material breach. In the event of a termination of an Affiliated User's sublicense, that Affiliated User shall within 10 days, at Affiliated User's option, either deliver to Licensor or destroy the Software and the Documentation in such Affiliated User's possession. Within 10 days following termination such Affiliated User shall certify in writing to Licensor that all copies of the Software and the Documentation in such Affiliated User's possession have been returned or destroyed. 18.3 Expiration or termination of Licensor's support and maintenance obligations shall not constitute a termination of the license granted hereunder or of the respective rights and obligations of the parties created by this Agreement. 18.4 Termination of the license to use and to sublicense use of the Software granted to Licensee pursuant to Section 18.1 shall not automatically cause the termination or otherwise interfere with validly existing sublicenses previously granted by Licensee to Affiliated Users as authorized herein; provided, however, that in the event the license granted to Licensee hereunder is terminated pursuant to Section 18.1, the sublicenses may be terminated by Licensor. 20 21 18.5 Any provision of this Agreement related to confidentiality, publicity and indemnification or which by its terms provides for survival shall survive the termination of this Agreement. 19. Notices All notices required or permitted under this Agreement shall be in writing and sent to the other party at the address specified below or to such other address as either party may substitute from time to time by written notice to the other and shall be deemed validly given upon receipt of such notice given by certified mail, postage prepaid, or personal or courier delivery to: Healthtrust, Inc. - Health Care microsystems, The Hospital Company Inc. 4525 Harding Road Suite 350 Nashville, Tennessee 37205 3655 Torrance Boulevard Attention: Director of Torrance, California 90503 Information Services Attention: Thomas J. Kazamek with a copy to: with a copy to: Healthtrust, Inc. - Health Care microsystems, The Hospital Company Inc. 4525 Harding Road Suite 350 Nashville, Tennessee 37205 3655 Torrance Boulevard Attention: Philip D. Torrance, California 90503 Wheeler, Esq. Attention: Robert V. Nagelhout 20. Governing Law This Agreement shall be governed by and construed in all respects in accordance with the substantive laws of the State of Tennessee. 21 22 21. Severability All agreements, clauses and covenants contained herein are severable, and in the event any of them shall be held to be unconstitutional, invalid, illegal, or unenforceable, the remainder of this Agreement shall be interpreted as if such unconstitutional, invalid, illegal or unenforceable agreements, clauses or covenants were not contained herein. IT IS EXPRESSLY UNDERSTOOD AND AGREED THAT EACH AND EVERY PROVISION OF THIS AGREEMENT THAT PROVIDES FOR A LIMITATION OF LIABILITY, DISCLAIMER OF WARRANTIES OR EXCLUSION OF DAMAGES IS INTENDED BY THE PARTIES TO BE SEVERABLE AND INDEPENDENT OF ANY OTHER PROVISION AND TO BE ENFORCED AS SUCH. FURTHER, IT IS EXPRESSLY UNDERSTOOD AND AGREED THAT IN THE EVENT THAT ANY REMEDY HEREUNDER IS DETERMINED TO HAVE FAILED OF ITS ESSENTIAL PURPOSE, ALL LIMITATIONS OF LIABILITY AND EXCLUSIONS OF DAMAGES SET FORTH HEREIN SHALL REMAIN IN EFFECT. 22. Waiver; Modification The failure by either party to exercise any right provided hereunder shall not be deemed a waiver of such right. This Agreement may be amended, modified or supplemented only by a writing signed by the parties to this Agreement. Such amendments, modifications or supplements shall be deemed as much a part of this Agreement as if so incorporated herein. 23. Integration The parties hereto acknowledge that they have read this Agreement in its entirety and understand and agree to be bound by all of its terms and conditions, and further agree that this Agreement, any User License Agreement executed hereunder and any exhibits or schedules hereto or thereto constitute a complete and exclusive statement of the understanding between the parties with respect to the subject matter hereof which supersede any and all other communications between the parties, whether written or oral. Any prior agreements, promises, negotiations or representations related to the subject matter hereof not expressly set forth in this Agreement, any User License Agreement executed hereunder or any exhibits or schedules hereto or thereto are of no force and effect. 22 23 24. Independent Contractor Licensor, in performance of this Agreement, is acting as an independent contractor and shall have the exclusive control of the manner and means of performing the work contracted for hereunder. Personnel supplied by Licensor hereunder, whether or not located on Licensee's premises, are not Licensee's employees or agents and shall not hold themselves out as such, and Licensor assumes full responsibility for their acts and for compliance with any applicable employment and tax laws with respect to such employees. Nothing contained in this Agreement shall be construed to create a joint venture or partnership between the parties. 25. Force Majeure Neither party hereto shall be liable for any failure or delay in performance of its obligations hereunder by reason of any event or circumstance beyond its reasonable control, including without limitation acts of God, war, riot, strike, labor disturbance, fire, explosion, flood, or shortage or failure of suppliers. 26. Export Control Regulations Licensee shall be responsible for complying with all export regulations required to provide the Software to any Affiliated User located outside of the United States. 27. Hiring of Employees During the term of this Agreement and for one (1) year thereafter, neither Licensor nor Licensee will, without the prior written consent of other party, which may be withheld in that party's sole discretion, offer employment to, employ or subcontract 23 24 work to any person employed then or within the preceding twelve (12) months by the other party. This provision shall also be binding upon affiliates of both parties. 28. Counterparts This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same document. In making proof of this Agreement, it shall not be necessary to produce or account for more than one such counterpart executed by the party against whom enforcement of this Agreement is sought. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their authorized representatives as of the date first set forth above. LICENSEE: LICENSOR: By: By: ------------------------------ ------------------------------- Hilary E. Adams, III, Thomas J. Kazamek, Senior Vice-President Chief Operating Officer 24 25 Schedule A Software and Fees I. Licensed Software The Software is described on Attachments 1 and 2 to this Schedule A. II. Corporate License Fee The fees payable to Licensor by Licensee for the license granted to Licensee to use the Software and the Documentation and to sublicense the use of the Software and the Documentation to Affiliated Users shall be as follows: 1. $350,000 due and payable on execution of the Master Software License and Professional Services Agreement by Licensor and Licensee; and 2. $600,000 due and payable within ten (10) days following acceptance of the Product Management program in the first three pilot hospitals as further described in Work Order 001 executed hereunder; and 3. In the event Licensee elects to (i) sublicense the use of the Software and the Documentation to more than 15 Affiliated Users or (ii) sublicense programs A-1 26 comprising the Software other than the Product Management, Payment Verification, Budgeting and Desktop Delivery System programs, then, upon the first exercise of either election, a single payment of $150,000 to be due and payable with payment of the applicable sublicense fee. III. Affiliated User Sublicense Fees (a) The sublicense fees to be paid to Licensor by Licensee for or on behalf of Affiliated Users per program actually sublicensed are set forth on Schedule A, Attachment 1; provided, however, the sublicense fees payable to Licensor for up to 90 sublicenses are subject to the caps described in Section IV below. Sublicense fees are due and payable as follows: 1. For the first three sublicenses of a particular licensed program comprising the Software: A. 75% of the sublicense fees for each licensed program within thirty (30) days following installation of such licensed program; and B. 25% of the sublicense fees for each licensed program within thirty (30) days following acceptance of such licensed program. 2. After the first three sublicenses of a particular licensed program, 100% within thirty (30) days following grant of the applicable sublicense. (b) Notwithstanding paragraph (a) above, if Licensee acquires or is acquired by any entity, person or group that holds a 50% or greater equity interest in 20 or more hospitals, clinics or healthcare providers (such healthcare providers shall be deemed to be Affiliated Users but are hereinafter referred to as the "Designated Providers" for the purpose of computing sublicense A-2 27 fees), Licensee may sublicense use of the Software and the Documentation to such Designated Provider by executing a User License Agreement in the form of Exhibit 1; provided, however, that the license fees payable in accordance with Section 3.1 of the User License Agreement and Schedule A, Attachment 1 to this Agreement may be adjusted at Licensor's request (i) first, by applying the formula rate of increase set forth in Section 9.6 of this Agreement to the license fees set forth in Schedule A, Attachment 1 for the period commencing on the Effective Date through the effective date of such acquisition to establish the minimum license fee per Software program (the "Base Fees"), and (ii) second, by Licensor and Licensee, who shall negotiate in good faith to arrive at the license fees to be charged; provided, however such sublicense fees shall not be greater than an amount equal to twice the Base Fees. In the event any User License Agreements are executed by Designated Providers, Schedule A to this Agreement shall be amended to include a new Attachment 3 setting forth the agreed-upon license fees applicable to such Designated Providers. A-3 28 IV. License/Sublicense Fee Cap Notwithstanding Sections II and III above, the total fees payable by Licensee for its license and up to 90 sublicenses shall not exceed $4,000,000; provided, however, that in the event Licensee (i) notifies Licensor in writing on or before September 1, 1993 of Licensee's election to pay a lump sum for all such fees equal to the difference between the total license and sublicense fees paid by Licensee to date and (a) $3,200,000 if Licensee elects to continue to use as a corporate multi-facility application and to sublicense use of the Desktop Delivery System program to Affiliated Users or (b) $3,000,000 if Licensee elects to surrender its right to use as a corporate multi-facility application and to further sublicense use of the Desktop Delivery System program, and (ii) remits payment to Licensor for such fees within thirty (30) days of such notice, then the total fees payable by Licensee for its license and up to 90 sublicenses shall not exceed $3,200,000 inclusive of the right to continue using as a corporate multi-facility application and sublicensing use of the Desktop Delivery System program or $3,000,000 with surrender of the right to use as a corporate multi-facility application and to further sublicense use of the Desktop Delivery System program; provided, however, the fee caps set forth in this Section IV apply for the first ninety (90) sublicenses granted by Licensee and the license fees per program comprising the Software as set forth in Attachment 1 to this Schedule A shall apply beginning with the ninety-first (91st) sublicense granted by License. The fee caps provided in this Section IV shall not apply to sublicenses issued to Designated Providers. V. Software Support and Maintenance Fees 1. Subject to the caps provided in this Section, software support and maintenance fees for Licensee, Affiliated Users and Designated Providers shall be based on a percentage of the sum of: (a) total corporate license fees (described in Section II, but excluding any lump sum payment described in Section IV) paid by Licensee to Licensor for the license to use the Software and the Documentation and to sublicense such use pursuant to Section II above, plus (b) the aggregate sublicense fees as determined pursuant A-4 29 to the price schedule attached to this Schedule A for such Software programs sublicensed and actually installed. Such percentage to be calculated on a sliding scale as follows: Percentage of Amount of License/Sublicense Fees Paid License Fees - -------------------------------------- ------------ Up to $750,000 20% $750,001 to $1,500,000 15% Over $1,500,000 (up to applicable cap of $3,200,000 or $4,000,000) 10% 2. a. Notwithstanding the foregoing, Software support and maintenance fees for the first year of this Agreement, commencing on the Effective Date, shall be $240,000 and shall be due and payable (i) $140,000 upon execution of this Agreement and (ii) $100,000 on September 1, 1992. If the Product Management program is not accepted by Licensee pursuant to Work Order No. 001, Licensor shall refund $90,000 to Licensee and Licensor shall negotiate with each Pilot Hospital (as defined in Work Order No. 001) for Software support and maintenance services to commence one year after the Effective Date. b. For all years of this Agreement subsequent to the first year, the total fees payable by Licensee for annual Software support and maintenance for its license and 90 sublicenses shall be calculated using the formula set forth in paragraph 1 of this Section V, but in no event shall such annual fees exceed $512,500 irrespective of the Software programs sublicensed and actually installed; provided, however, that in the event Licensee elects to limit its total license fees to either $3,200,000 or $3,000,000 (as described in Section IV for its license and 90 sublicenses, then the total fees payable by Licensee for annual Software support and maintenance for its license and 90 sublicenses shall in no event exceed $432,500 irrespective of the Software programs sublicensed and actually installed. These fees shall be due and payable within thirty (30) days after each anniversary date of the Effective Date of this Agreement. A-5 30 c. In the event Licensee enters into more than 90 sublicenses, the fee caps contained in Section V.2.b shall be increased by an amount equal to 10% of the sublicense fees due and payable to Licensor within thirty (30) days after the grant of such additional sublicenses. d. After the first year's payment of annual Software support and maintenance fees, such fees will be calculated as of and due and payable after each anniversary date of the Effective Date of the Master Software License and Professional Services Agreement; provided, however, Software support and maintenance fees payable in connection with any programs sublicensed after an anniversary date of the Effective Date shall be prorated over the period commencing on the date of grant of the sublicense for such programs and ending on the next succeeding anniversary date. A-6 31 VI. Pass-through Fees A. MDBS/IQ (per computer) MDBS/PI $750 MDBS/IQ (per file server MDBS/PI $1,500 used as a database server in any network) B. Express/EIS II (per end user) IRI $400 C. Distributed Budgeting MDBS/IQ $1,500 (per site) Pass-through fees shall be due and payable within thirty (30) days following grant of the applicable sublicense. Total pass-through fees payable by Licensee for Express/EIS II shall be capped and shall not exceed $40,000. Each $400 payment shall be credited against this $40,000 cap. A-7 32 Schedule A Attachment 1 Affiliated User Price Schedule License Ownership Fee --------- ------- A. TEAMWORK(TM) Programs Product Management HCm $16,250 Payment Verification HCm 8,750 Budgeting and Budgeting Interface HCm 8,000 Labor Planning and Control and Labor Planning and Control Interface HCm 4,675 Distributed Budgeting HCm 2,500 Capital Budgeting (CapTrac) HCm 3,000 Standard Costing and Standard Costing Interface HCm 11,875 Labor Productivity HCm 18,750 Rate Setting (RTrac) HCm 2,000 B. Desktop Delivery System HCm 25,000 - Departmental Analysis - Patient Care Management (which includes Physician Analysis, Product Analysis and Payor Analysis) - Key Indicators A-8 33 Schedule A Attachment 2 TEAMWORK(TM) MODULES TEAMWORK(TM) Product Management is a comprehensive product line management system which turns case mix into a true decision support system. It contains sophisticated forecasting and modeling features to support payor contract evaluation and modeling, clinical treatment profile development, user-defined product, outlier, and acuity classifications, and detailed reporting by payor, physician, product, etc. Intelligent Query Ad-hoc Reporting, included within the TEAMWORK(TM) Product Management module, provides complete ad-hoc query and custom reporting capabilities to the entire TEAMWORK(TM) product line. Its menu-driven design facilitates the development of user-defined reports and on-line data base queries. Output can be displayed on the screen, printed, written to a file, or transferred directly into LOTUS worksheet format. TEAMWORK(TM) Payment Verification is an integrated module of the TEAMWORKTM Product Management application designed to track and monitor detailed contract information and to produce "Explanations of Reimbursement" detailing the net amount due the hospital from the payor with the payment due date, as well as a step-by-step explanation of the reimbursement calculation. TEAMWORK(TM) Desktop Delivery System is a unique new management tool which instantly delivers strategic and operational information to your desktop. By integrating data from multiple systems and different vendors, the system provides a standard and efficient way to share information throughout your organization. This powerful system uses the latest technology combined with an easy to use graphical interface to turn your information into knowledge throughout your entire staff. There are three "modules" included with this system: - Departmental Analysis A-9 34 - Patient Care Management (which includes Physician Analysis, Product Analysis and Payor Analysis) - Key Indicators TEAMWORK(TM) Budgeting is a sophisticated yet easy to use tool which facilitates the development of the hospital's entire operating budget. It contains features for statistical forecasting from historical data, fixed, flexible or product based budget development, automated budget worksheets, financial modeling and comprehensive performance and productivity reports. TEAMWORK(TM) Labor Planning and Control is used to plan and control the hospital's labor expenses, using detailed information by employee to develop the budget and monitor performance. It contains features for flexible budget development using standards by job code and performance reports by pay period and by month. TEAMWORK(TM) Standard Costing is used to develop procedure-level standard costs. It supports 80/20 selection of the procedures for which a detailed bill of materials will be developed, and will calculate a standard cost for all procedures. It contains comprehensive overhead allocation calculations and standards verification reports. CapTrac(TM) Capital Budgeting is a comprehensive capital planning and tracking system for health care facilities which can function independently, or in conjunction with established TEAMWORK(TM) applications, in a single or multi-user environment. The system includes capital budgeting and performance tracking. TEAMWORK(TM) Labor Productivity Management is a comprehensive productivity management system that assists all management team members to track productivity by employee and department, allowing for the most efficient use of labor resources while maintaining high standards for patient care. RTrac(TM) Rate Optimization System helps the hospital to maximize their net revenues by properly assessing the impact of rate changes by procedure. A-10 35 Distributed Budgeting works in conjunction with the TEAMWORK(TM) Budgeting system to provide department heads with a tool to facilitate budget development. Distributed Budgeting is an automated system used to review historical data, enter budget requests, and print detail and summary reports to evaluate the budget as it is being developed. The completed budget is then submitted to the budget department in an automated manner via diskette. A-11 36 SCHEDULE B The Hardware Licensor acknowledges that the Software will operate on a 386 or faster IBM, Compaq or Gateway personal computer system, using the DOS Operating System Version 4.0 or 5.0 or Novell Netware 386 Version 3.11A or subsequent versions, together with Licensor's security sentinel and Tecmar QT or Datavault tape backup system. Licensor shall provide its security sentinel as an accessory item to be billed separately to Licensee at a cost of $75. B-1 37 SCHEDULE C HCm Competitor List American Express Information Systems Dilts, Kappeler, Durham & Company Dun & Bradstreet Software Ernst & Young (excluding the Audit Group) Gerber Alley Global Software, Inc. HBO and Company Hospital Cost Consultants IBAX Innovative Software Solutions, Inc. Maximus, Inc. Medicus Systems Corporation Meditech Phamis, Incorporated Shared Medical Systems, Inc. Sun Health Systems Transition Systems, Inc. C-1 38 EXHIBIT 1 FORM USER LICENSE AGREEMENT ----------------------------------------- This USER LICENSE AGREEMENT (the "Agreement") is made and entered into as of the ____ day of ________________, 199_, by and between Healthtrust, Inc. The Hospital Company ("Sublicensor") and ________________________________, a ____________ corporation, whose principal place of business is in __________________________ ("Affiliated User"). WHEREAS, Sublicensor has licensed from Health Care microsystems, Inc., a California corporation ("Licensor") the Software (defined below), and certain documentation related to the Software (the "Documentation"), and has been authorized to sublicense the Software and the Documentation in accordance with the terms and conditions of the Master Software License (the "Master Agreement"), and Sublicensor desires to sublicense the Software and the Documentation to Affiliated User; and WHEREAS, Affiliated User is a hospital, clinic or other health care provider that Sublicensor operates or in which Sublicensor holds a 50% or greater equity interest and desires to acquire from Sublicensor a perpetual, non-exclusive, paid-up, royalty-free, worldwide license for the Software and the Documentation of Licensor; and WHEREAS, Affiliated User desires to obtain software support and maintenance services for the Software and the Documentation pursuant to the terms and conditions contained in the Master Agreement. NOW THEREFORE, in consideration of the premises, the mutual obligations contained herein and other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, the parties covenant and agree as follows: SECTION I - DEFINITIONS 39 1.1 "Documentation" is defined to include any user manuals, training materials, specifications and other material related to the Software. 1.2 "Software" is defined as the software, furnished by Licensor to Affiliated User, including any related interfaces, as more fully described in Schedule AA, which is incorporated herein by reference. SECTION II - LICENSE 2.1 Upon full payment of the Software license fee to Licensor by Sublicensor on behalf of Affiliated User for the Software listed in Schedule AA, Sublicensor hereby grants to Affiliated User a fully-paid, perpetual, non-exclusive, royalty-free license to use the Software and the Documentation at Affiliated User's premises or at Sublicensor's offices solely for the data processing needs of Affiliated User, subject to the terms and conditions set forth in the Master Agreement. The license granted hereunder includes without limitation the right to reproduce or copy all or any portion of the Software in machine-readable or printed form as determined by Affiliated User to be reasonably required for its own internal data processing needs and archival and backup purposes, the right to share data with Sublicensor and other Affiliated Users that have executed User License Agreements and the right to reproduce copies of the Documentation for its own use. 2.2 Affiliated User acknowledges that portions of the Software licensed under this Agreement are owned by Micro Data Base Systems, Inc. ("MDBS"), Programmed Intelligence, Inc. ("PI"), or Information Resources, Inc. ("IRI"). Affiliated User further acknowledges that the MDBS, PI and IRI portions of the Software may not be used by Affiliated User as stand-alone software products, but only as component parts of the Software. Affiliate User agrees to execute separate agreements with each of MDBS, PI and IRI in the forms attached as Schedule CC. 2 40 SECTION III - LICENSE FEE, TAXES AND EXPENSES 3.1 As consideration for the perpetual license to use the Software and the Documentation granted to Affiliated User herein, Affiliated User agrees to pay to Sublicensor a one-time license fee in the amount and payable in accordance with the payment schedule set forth in Schedule A to the Master Agreement. 3.2 Affiliated User shall pay all sales, use and personal property taxes assessed in connection with this Agreement; provided, however, that Licensor and Sublicensor shall pay all taxes based on Licensor and Sublicensor's business operations (including without limitation employment taxes and taxes levied on their respective income). 3.3 Affiliated User shall reimburse Sublicensor for the reasonable and necessary out-of-pocket expenses incurred by Licensor or Sublicensor and paid by Sublicensor on behalf of Affiliated User in connection with this Agreement, including any hardware and security device(s) described in Schedule BB. SECTION IV - SOFTWARE SUPPORT AND MAINTENANCE Software support and maintenance services shall be provided by Licensor to Affiliated User in accordance with the terms and conditions of the Master Agreement pursuant to the fee schedule adopted by Sublicensor from time to time. SECTION V - ADDITIONAL TERMS The provisions of the Master Agreement relative to Licensor's Warranties, Limitations of Liability, Title to Software and Documentation, Confidentiality, Publicity, Books and Records, Indemnity and Termination and Survival and Severability are hereby incorporated by reference and adopted herein. 3 41 SECTION VI - MISCELLANEOUS 6.1 Affiliated User may, without the consent of Licensor, assign this Agreement and its rights and obligations hereunder to (i) an entity that Licensee operates or in which Licensee holds a 50% or greater interest that succeeds to the business of Affiliated User or (ii) a third party that is not affiliated with Affiliated User or Sublicensor and that purchases all or substantially all of the assets of or ownership interest in Affiliated User, provided that such third-party assignee's continued use of the Software and the Documentation shall be conditioned upon the execution of a license agreement with Licensor and such assignee shall take the Software and the Documentation subject to Licensor's then current rates for Software support and maintenance. This Agreement shall inure to the benefit of and bind successors and permitted assigns of Licensor, Sublicensor and Affiliated User. 6.2 This Agreement shall be governed by and construed in all respects in accordance with the substantive laws of the State of Tennessee. 6.3 All remedies available to either party for one or more breaches by the other party are and shall be deemed cumulative and may be exercised separately or concurrently without waiver of any other remedies. The failure of either party to act on a breach of this Agreement by the other shall not be deemed a waiver of such breach or a waiver of future breaches, unless such waiver shall be in writing and signed by the party against whom enforcement is sought. 4 42 6.4 All notices required or permitted under this Agreement shall be in writing and shall be sent to the other party at the address specified above or to such other address as either party may substitute from time to time by written notice to the other and shall be deemed validly given upon receipt of such notice given by certified mail, postage prepaid, or personal or courier delivery to: If to Sublicensor: Healthtrust, Inc. - The Hospital Company P. O. Box 4350 Nashville, Tennessee 37202-4350 Attention: Director of Information Services, with a copy to: Healthtrust, Inc. - The Hospital Company P. O. Box 4350 Nashville, Tennessee 37202-4350 Attention: Philip D. Wheeler, Esq. If to Affiliated User: _____________________________ _____________________________ _____________________________ _____________________________ 6.5 This Agreement and the Master Agreement, and any schedules and exhibits attached hereto and thereto, constitute the entire agreement of the parties hereto with respect to the subject matter hereof and supersede all prior representations, proposals, discussions, and communications, whether oral or in writing. This Agreement may be modified only in writing and shall be enforceable in accordance with its terms when signed by the parties sought to be bound. 6.6 Affiliated User acknowledges that Licensor reserves the right to enforce the terms and conditions of this Agreement, including without limitation the right to terminate the license 5 43 granted hereunder for breach by the Affiliated User of the terms hereof. 6.7 This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together constitute one and the same document. In making proof of this Agreement, it shall not be necessary to produce or account for more than one such counterpart executed by the party against whom enforcement by this Agreement is sought. 6 44 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized representatives, as of the date first above written. Healthtrust, Inc. - The Hospital ------------------------------- Company [Hospital's name] By: By: ------------------------------- ------------------------------- Title: Title: ---------------------------- ---------------------------- 7 45 SCHEDULE AA Schedule of Licensed Programs Licensed TEAMWORK(TM) Programs Ownership Programs - --------------------- --------- -------- Product Management, including HCm [ ] MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Payment Verification, including HCm [ ] MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Budgeting and Budgeting Interface, including HCm [ ] MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Labor Planning and Control and Labor Planning and Control Interface, including HCm [ ] MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Distributed Budgeting, including HCm [ ] Distributed Budgeting MDBS/IQ and MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Capital Budgeting (CapTrac) HCm [ ] AA-1 46 SCHEDULE AA (continued) Standard Costing and Standard Costing Interface, HCm [ ] including MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Labor Productivity, including HCm [ ] MDBS/IQ (per computer) MDBS/PI [ ] or MDBS/IQ (per network) MDBS/PI [ ] Rate Setting (RTrac) HCm [ ] Desktop Delivery System, HCm [ ] including Express/EIS II (per end user) IRI AA-2 47 SCHEDULE BB The Hardware Affiliated User shall use the Software on a 386 or faster IBM, Compaq or Gateway personal computer system, using the DOS Operating System Version 4.0 or 5.0 or Novell Netware 386 Version 3.11A or subsequent versions, together with Licensor's security sentinel and Tecmar QT or Datavault tape backup system. BB-1 48 SCHEDULE CC USER ACKNOWLEDGEMENT OF SOFTWARE LICENSE -- MDBS User's Name: Address: 1) User has entered into a license for certain software supplied by Health Care microsystems, Inc. ("HCm"). Such software includes programs supplied to HCm by Micro Data Base Systems, Inc. ("MDBS"), P.O. Box 248, Lafayette, Indiana 47902, U.S.A. 2) User disclaims any ownership rights and other intellectual property rights in such software, and any accompanying copyrights therein, and acknowledges that its right to use such software is defined in its license. 3) User's license does not authorize the use of the MDBS portion of the Software as a stand-alone software product, but only as part of the Software. 4) User may make the minimum necessary number of copies reasonably needed for use, backup and archival purposes only and may use, copy or modify the Software only in accordance with its license. 5) User has covenanted, through its license, that it will not delete any identifying marks or copyright notices in or on the Software. 6) This document is not intended to serve as an addendum, supplement or modification to or of User's license. In the event of any conflict between this document and User's license, the license shall control. USER: By: -------------------------------- CC-1 49 Name: ------------------------------- Title: ------------------------------ Date: ------------------------------- CC-2 50 SCHEDULE CC (continued) USER ACKNOWLEDGEMENT OF SOFTWARE LICENSE -- INTELLIGENT QUERY User's Name: Address: 1) User has entered into a license for certain software supplied by Health Care microsystems, Inc. ("HCm"). Such software includes programs supplied to HCm by Programming Intelligence, Inc. ("PI"), 3069 Amwiler Road, Atlanta, Georgia 30360. 2) User disclaims any ownership rights and other intellectual property rights in such software, and any accompanying copyrights therein, and acknowledges that its right to use such software is defined in its license. 3) User's license does not authorize the use of the PI portion of the Software as a stand-alone software product, but only as part of the Software. 4) User may make the minimum necessary number of copies reasonably needed for use, backup and archival purposes only and may use, copy or modify the Software only in accordance with its license. 5) User has covenanted, through its license, that it will not delete any identifying marks or copyright notices in or on the Software. 6) This document is not intended to serve as an addendum, supplement or modification to or of User's license. In the event of any conflict between this document and User's license, the license shall control. CC-3 51 USER: By: -------------------------------- Name: ------------------------------- Title: ------------------------------ Date: ------------------------------- CC-4 52 SCHEDULE CC (continued) USER ACKNOWLEDGEMENT OF SOFTWARE LICENSE -- INFORMATION RESOURCES, INC. User's Name: Address: 1) User has entered into a license for certain software supplied by Health Care microsystems, Inc. ("HCm"). Such software includes programs supplied by Information Resources, Inc. ("IRI"). 2) User disclaims any ownership rights and other intellectual property rights in such software, and any accompanying copyrights therein, and acknowledges that its right to use such software is defined in its license. 3) User's license does not authorize the use of the IRI portion of the Software as a stand-alone software product, but only as part of the Software. 4) User may make the minimum necessary number of copies reasonably needed for use, backup and archival purposes only and may use, copy or modify the Software only in accordance with its license. 5) User has covenanted, through its license, that it will not delete any identifying marks or copyright notices in or on the Software. 6) This document is not intended to serve as an addendum, supplement or modification to or of User's license. In the event of any conflict between this document and User's license, the license shall control. USER: CC-5 53 By: -------------------------------- Name: ------------------------------- Title: ------------------------------ Date: ------------------------------- CC-6 54 EXHIBIT 2 LICENSOR'S PROPOSAL DATED JUNE 7, 1991 Pages 36-59 of the Licensor's Proposal dated June 7, 1991, attached hereto, are incorporated by reference herein. EX-10.2.II 3 AMENDMENT TO MASTER SOFTWARE LICENSE 1 EXHIBIT 10.2(ii) CONFIDENTIAL This Amendment to the Master Software License, dated the 29th day of June, 1992, (the "Agreement") is made and entered into as of the 1st day of September, 1995 (the "Effective Date"), by and between Health Care microsystems, Inc. (the "Licensor"), a California corporation having its principal place of business at 3655 Torrance Boulevard, Suite 350, Torrance, California 90503, and Columbia/HCA (the "Licensee"), a Delaware corporation having its principal place of business at One Park Plaza, Nashville, Tennessee 37203. In the event of any conflict between the terms and conditions of this Amendment and those contained in the Agreement, the terms and conditions of this Amendment shall govern. Master Software License - Section 9.5 Section 9.5 of the Agreement shall be replaced by the following paragraph: 9.5 Subject to the provisions of Schedule A, Section V.2a., whereby Licensee may earlier terminate the services described in this Section 9, Licensor shall provide the Software support and maintenance services described in this Section 9 for the charges set forth in Section 9.6 below for a period commencing upon the Effective Date of this Agreement and running through December 31, 2000 (the "Initial Term"), and, upon expiration of the Initial Term, shall continue to provide such services on a year-to-year basis unless, no less than six months prior to the expiration of the Initial Term or 60 days prior to the expiration of any one-year renewal term, either party gives the other party written notice of the notifying party's desire to: Master Software License - Section 19 Section 19 of the Agreement shall be replaced by the following paragraph: All notices required or permitted under this Agreement shall be in writing and sent to the other party at the address specified below or to such other address as either party may substitute from time to time by written notice to the other and shall be deemed validly given upon receipt of such notice given by certified mail, postage prepaid, or personal or courier delivery to: 2 CONFIDENTIAL Columbia/HCA, Inc. Health Care microsystems, Inc. One Park Plaza Suite 350 Nashville, Tennessee 37203 3655 Torrance Boulevard Attention: Torrance, California 90503 Richard Chapman, CIO Attention: Thomas J. Kazamek with a copy to: with a copy to: Columbia/HCA, Inc. Health Care microsystems, Inc. One Park Plaza Suite 350 Nashville, Tennessee 37203 3655 Torrance Boulevard Attention: Samuel A. Greco Torrance, California 90503 Attention: Robert V. Nagelhout Schedule A - Section III (a) Paragraph 1 Schedule A - Section III (a) Paragraph 1 of the Agreement shall be replaced by the following paragraph: (a) The sublicense fees to be paid to Licensor by Licensee for or on behalf of Affiliated Users per program actually sublicensed are set forth on Schedule A, Attachment 1; provided, however, the sublicense fees payable to Licensor for up to 190 sublicenses are subject to the caps described in Section IV below. Sublicense fees shall be due and payable as follows: Schedule A - Section IV The following Paragraph 2 shall be added to Schedule A - Section IV: 2. All License/Sublicense Fee Caps are based on the Corporate License and first 90 Sublicenses of all software described in Section A Attachment 2. The License Fee for the next 100 Product Management systems is $1,250,000 in total and 10 additional PCM Licenses for $200,000 in total. The License Fee for the next 100 Product Management systems and 10 additional PCM Licenses shall be due and payable within thirty (30) days from the execution of this Amendment. Schedule A - Section V - Paragraph 2b. 3 CONFIDENTIAL Schedule A - Section V - Paragraph 2b of the Agreement shall be replaced by the following paragraph: b. The total fees payable by Licensee for annual Software support and maintenance for its license and 190 sublicensee shall in no event exceed $601,720 irrespective of the Software programs sublicensed and actually installed. Schedule A - Section VI Schedule A - Section VI of the Agreement shall be replaced by the following: A. MDBS/IQ (per computer) MDBS/PI $ 750 MDBS/IQ (per file server MDBS/PI $1,500 used as a database server in any network) B. Express/IRI Workstation Royalty (per end user workstation) $ 400 C. Express/IRI Royalty - Financial Modeling (per license to Financial Modeling) $1,500 Pass-through fees shall be due and payable within thirty (30) days following grant of the applicable sublicense. Total workstation pass-through fees payable by Licensee for Express/EIS II shall be capped and shall not exceed $40,000. Each $400 Workstation payment shall be credited against this $40,000 cap. Express royalties for Financial Modeling shall be excluded from this cap. THE PARTIES ACKNOWLEDGE THAT THEY HAVE READ THE MASTER SOFTWARE LICENSE TOGETHER WITH THIS AMENDMENT AND AGREES TO BE BOUND BY THEIR TERMS AND CONDITIONS. FURTHER, THE PARTIES AGREE THAT THE AGREEMENT AND THIS AND ANY PRIOR AMENDMENTS ARE THE COMPLETE AND EXCLUSIVE STATEMENT OF THE AGREEMENT BETWEEN THE PARTIES, WHICH SUPERSEDES ALL PROPOSALS OR PRIOR AGREEMENTS, ORAL OR WRITTEN, 4 CONFIDENTIAL AND ALL OTHER COMMUNICATIONS BETWEEN THE PARTIES RELATING TO THE SUBJECT MATTER OF THIS AGREEMENT AND THIS AND PRIOR AMENDMENTS. LICENSEE: LICENSOR: By: By: --------------------------- -------------------------- Samuel A. Greco Thomas J. Kazamek, Senior Vice-President Chief Operating Officer 5 CONFIDENTIAL Schedule A - Attachment 1 Schedule A - Attachment 1 of the Agreement shall be replaced by the following: Schedule A Attachment 1 Affiliated User Price Schedule License Ownership Fee --------- ------- A. TEAMWORK(tm) Product Management HCm $16,250 (Licenses 1-90) Product Management HCm $12,500 (Licenses 91-190) Payment Verification HCm 8,750 Capital Budgeting HCm 3,000 (CapTrac) Standard Costing and Standard Costing HCm 11,875 Interface Labor Productivity HCm 18,750 Rate Setting (RTrac) HCm 2,000 B. Patient Care Management HCm 25,000 Financial Modeling (Budgeting and Departmental reporting) (Licenses 1-90) Patient Care Management HCm 20,000 (Licenses 91-100) EX-10.3.II 4 ALMENDMENT NO. 6 TO STOCK OPTION 1 EXHIBIT 10.3(ii) HEALTH MANAGEMENT SYSTEMS, INC. Amendment No. 6 to Stock Option and Restricted Stock Purchase Plan Amendment, dated as of December 2, 1997 (the "Effective Date"), to the Stock Option and Restricted Stock Purchase Plan (the "Plan") of Health Management Systems, Inc., a New York corporation (the "Company"), subject to the approval of shareholders. 1. All terms not otherwise defined in the Amendment shall have meanings ascribed to them in the Plan. 2. The Plan, as amended, provides that the Board of Directors (or the Committee) shall have the sole authority and discretion to determine the number of shares of Common Stock that may be issued under each Award or Option. 3. In order to ensure that compensation with respect to Awards and/or Options granted under the Plan will continue to be deductible for income tax purposes under Section 162(m) of the Code, this amendment ("Amendment No. 6") to the Plan, adopted by the Board of Directors on December 2, 1997, subject to approval by the shareholders of the Company, limits the number of shares of Common Stock that may be subject to an Award and/or Option awarded to any single Employee in any fiscal year of the Company to 150,000 shares, and requires that grants be made by a committee of the Board of Directors consisting solely of at least two "outside directors." 4. Pursuant to the foregoing, the following is hereby inserted as Section 2.10 of the Plan: 2.10 "Outside Director" means a director of the Company who is an "outside director" within the meaning of Section 162(m) of the Code and the regulations promulgated thereunder. 5. Pursuant to the foregoing, current Sections 2.10, 2.11, 2.12 and 2.13 of the Plan are hereby renumbered to be Sections 2.11, 2.12, 2.13 and 2.14, respectively. 6. Pursuant to the foregoing, Section 3 of the Plan 2 is hereby eliminated in its entirety, and the following is inserted in its place and stead: Section 3. Eligibility. Awards and/or Options may be granted to any Employee. The Board of Directors (or the Committee) shall have the sole authority to select the persons to whom Awards and/or Options are to be granted hereunder, and to determine whether a person is to be granted a Non-Qualified Option, an ISO or an Award or any combination thereof. No person shall have any right to participate in the Plan. Any person selected by the Board of Directors or the Committee for participation during any one period will not by virtue of such participation have the right to be selected as a Participant for any other period. No person may be granted, in any fiscal year of the Company, Awards and/or Options to purchase more than 150,000 shares of Common Stock. 7. Pursuant to the foregoing, Section 5.1 of the Plan is hereby eliminated in its entirety, and the following is inserted in its place and stead: 5.1 The Plan shall be administered by the Board of Directors or, if established at any time by the Board of Directors, by a committee thereof (the "Committee"). The Committee shall be appointed from time to time by, and shall serve at the pleasure of, the Board of Directors. To the extent that the Board of Directors determines it to be desirable to qualify Awards and/or Options granted hereunder as "performance-based compensation" within the meaning of Section 162(m) of the Code, the Plan shall be administered by a Committee consisting solely of two or more Outside Directors. 8. Other than as amended hereby, the Plan shall remain in full force and effect. 9. This Amendment No 6. shall be effective as of the Effective Date. EX-11 5 COMPUTATION OF EARNINGS PER SHARE 1 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE (In Thousands, Except Per Share Amounts) Years Ended October 31, ----------------------- 1997 1996 1995 ------- ------ ------ Primary Earnings per Share: Earnings data: Net income $ 2,081 7,291 8,962 ======= ====== ====== Weighted average shares outstanding Average shares of common stock outstanding 17,613 17,166 16,435 Net effect of dilutive stock options - based on the treasury stock method using average market price 305 1,295 1,144 ------- ------ ------ Weighted average shares outstanding 17,918 18,461 17,579 ======= ====== ====== Earnings per common share: Net income $ 0.12 0.39 0.51 ======= ====== ====== EX-21.1 6 LIST OF SUBSIDIARIES OF HEALTH MANAGEMENT SYSTEMS 1 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT 21.1 - LIST OF SUBSIDIARIES OF HEALTH MANAGEMENT SYSTEMS, INC. STATE OF SUBSIDIARY INCORPORATION ---------- ------------- Accelerated Claims Processing, Inc. Delaware 401 Park Avenue South New York, NY 10016 Quality Medi-Cal Adjudication, Incorporated California 2897 Kilgore Road Rancho Cordova, CA 95670 Health Care microsystems, Inc. California 200 North Sepulveda Boulevard El Segundo, CA 90245 CDR Associates, Inc. Maryland 9642 Deereco Road Timonium, MD 21093 Quality Standards in Medicine, Inc. Delaware 581 Boylston Street Boston, MA 02116 HSA Managed Care Systems, Inc. Delaware 234 Spring Lake Drive Itasca, IL 60143 EX-23.1 7 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Health Management Systems, Inc.: We consent to incorporation by reference in the registration forms S-3 (File Nos. 33-91518 and 333-06769), and forms S-8 (File Nos. 33-65560, 33-76770, 33-95326, 33-76638 and 33-33706) of Health Management Systems, Inc. of our report dated November 21, 1997 relating to the consolidated balance sheets of Health Management Systems, Inc. and subsidiaries as of October 31, 1996 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended October 31, 1997, and related schedule, which report appears herein. /s/ KPMG Peat Marwick LLP Short Hills, New Jersey January 21, 1998 EX-27 8 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial statement information extracted from Consolidated Balance Sheets at October 31, 1997 and 1996 and the Statement of Operations for the years ended October 31, 1997, 1996, and 1995 and is qualified in its entirety by reference to such financial statements. 1,000 Year Year Year Oct-31-1997 Oct-31-1996 Oct-31-1995 Nov-01-1996 Nov-01-1995 Nov-01-1994 Oct-31-1997 Oct-31-1996 Oct-31-1995 20,694 22,340 0 18,386 17,181 0 40,947 44,412 0 (1,428) (1,682) 0 0 0 0 81,983 86,955 0 25,302 22,070 0 (17,314) (14,247) 0 109,694 109,643 0 28,184 32,204 0 0 0 0 0 0 0 0 0 0 178 175 0 79,628 74,437 0 109,694 109,643 0 89,517 101,326 90,495 89,517 101,326 90,495 0 0 0 88,355 87,873 73,035 1,899 (384) (103) 538 4,485 183 0 (987) (942) 1,730 12,865 17,114 (351) 5,574 8,152 (169) 13,249 17,217 0 0 0 0 0 0 0 0 0 2,081 7,291 8,962 0.12 0.39 0.51 0.12 0.39 0.51
-----END PRIVACY-ENHANCED MESSAGE-----