-----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, TkGsZALYiH9vSazRXQRT5/YGnNa4LJ0vbIG5yiAzgzhFo0G0TI4+2cT7BzFW7gug mpBEVZKeAB3YfAn6Fz+fRA== 0000950123-97-000396.txt : 19970123 0000950123-97-000396.hdr.sgml : 19970123 ACCESSION NUMBER: 0000950123-97-000396 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19961031 FILED AS OF DATE: 19970122 SROS: NONE 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: 1934 Act SEC FILE NUMBER: 000-20946 FILM NUMBER: 97509094 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, 1996 / / 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 10016 NEW YORK, NEW YORK (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (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 Indicate by check mark if disclosure of delinquent files 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 of the registrant's common stock held by non-affiliates as of January 15, 1997 was $220,635,524 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 15, 1997 was 17,635,064. DOCUMENTS INCORPORATED BY REFERENCE: DOCUMENT WHERE INCORPORATED - -------- ------------------ PROXY STATEMENT FOR THE ANNUAL MEETING PART III - -------------------------------------- TO BE HELD ON MARCH 4, 1997 2 TABLE OF CONTENTS
Page Contents Number - -------- ------ Cover Page ...................................................................... i PART I Item 1. Business ............................................................ 1 Item 2. Properties .......................................................... 12 Item 3. Legal Proceedings ................................................... 12 Item 4. Submission of Matters to a Vote of Security Holders ................. 12 PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 13 Item 6. Selected Financial Data ............................................. 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................................... 13 Item 8. Financial Statements and Supplementary Data ......................... 13 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ................................................ 13 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 Schedule, and Reports on Form 8-K ..... 14 Signatures ................................................................... 18 Index to Consolidated Financial Information .................................. 19 Exhibit Index ................................................................ 20
ii 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 HMSY, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: changes in general economic and business conditions; loss of market share through competition; introduction of competing services by other companies; changes in the degree of protection created by HMSY's intellectual property rights; pressure on prices from competition or from purchasers of HMSY's services; regulatory changes to the health care reimbursement process; regulatory obstacles to the introduction of new services that are important to HMSY's growth; availability of qualified personnel; the loss of any significant customers; 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. ITEM 1. BUSINESS OVERVIEW Health Management Systems, Inc. ("HMSY" or the "Company") furnishes proprietary information management and data processing services and software to hospitals and other health care providers and to government health service agencies and other health care payors. These services address the various types of data generated by the interaction of the participants in the health process: the health care provider, the third-party payor, and the patient. Through its retrospective, concurrent, and prospective service offerings, the Company acts as an outsourcer of information management addressing the clinical, operational, administrative, and financial data which result from the rendering of health care services. The Company's service offerings benefit its clients by enhancing revenue and accelerating cash flow (achieved through improved reimbursability and collectability), reducing operating and administrative costs (by supplying advanced information analytics), and improving decision making capabilities (via the provision of useful information). Hospitals 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 health care 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, 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 providers of care require regulatory knowledge and technical skills to manage complex data collection, integration, analysis, and accounts receivable management requirements. To ensure that program costs are no greater than required, third-party payors require knowledge and skills analogous to those required by providers. Among the Company's diversified services are those designed to minimize the degree of error that results from the enormous transaction processing and information management requirements associated with the health care transfer payment process. Since its founding in 1974, the Company has concentrated on applying its expertise in health care reimbursement processes and information systems technology to the liquidation of health care accounts receivable. More recently, the Company has expanded its product suite from its historic focus on (i) maximizing liquidations of the accounts receivable at pre-determined reimbursement rates, to include (ii) decision support software products which enable health care providers to assemble, analyze, and evaluate mission-critical cost and quality information, facilitating efforts by the provider to consider the proposed patient care in terms of its benefit, cost, reimbursability, profitability, and quality. The Company believes that its development of proprietary computer software, 1 4 systems, and databases dedicated exclusively to the analysis, management, and liquidation of health care accounts receivable by providers and payors and the concentration of its clients among the nation's largest urban health care provider institutions and large purchasers of health care make HMSY unique among companies providing accounts receivable management and decision support services to hospitals, government health care agencies, and other companies serving the health care industry. Unless otherwise noted, all information in this report has been adjusted to give effect to a three-for-two stock split in the form of a 50% stock dividend, distributed on December 29, 1995 to all shareholders of record as of December 15, 1995. HEALTH CARE REFORM AND REGULATORY MATTERS The health care reimbursement process has been subject to constant change, more recently at an accelerating rate. Federal, state, and local governments, as well as other third-party payors, have initiated policies designed to reduce the rate of increase in health care expenditures. Many of these policy initiatives have contributed to the complex and time consuming process of obtaining health care reimbursement for medical services provided. Legislation is continually submitted and acted upon at the federal, state, and local government levels seeking to "reform" the health care and welfare systems. Most of these proposals seek to expand or limit health care coverage to the under and uninsured while reducing the rate of increase in health care costs by introducing elements of "managed competition" and "managed care," as well as by reducing the administrative costs of the health care reimbursement process. It is not possible at this time to predict which, if any, reforms will be adopted, when such reforms will be implemented, or the impact of such reforms. However, the Company believes the shifting of traditional insurance risk to providers of care and the additional information management requirements placed on the providers contemplated in many of these proposals may increase the demand for the Company's services. Moreover, the Company believes that patients, providers, and payors, individually and in various combinations, will seek information to be derived by the Company's integration of cost and other financial and clinical data, enabling identification and management of the outcomes achieved. 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 more than 80 insurance carriers and intermediaries to process regional reimbursement claims. 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 processors. The requirements and procedures for reimbursement implemented by Medicaid program administrators differ from state to state. Similar to the claims administration process 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 health care in general, 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. 2 5 PRINCIPAL SERVICES The Company delivers services and software that comprise three business segments and five principal product offerings. Those three business segments are: (1) Proprietary Services - Information and Outsourcing ("Proprietary Services"), (2) Proprietary Analytics - Managed Care Support ("Managed Care Support") services, and (3) Electronic Data Interchange. The table below sets forth for the periods indicated the percentage of consolidated revenue represented by each of these product offerings and is followed by a discussion summarizing the nature of the product offering. Fiscal Year Ended October 31, ----------------------------- 1996 1995 1994 ---- ---- ---- Proprietary Services Retroactive Claims Reprocessing 28% 26% 26% Comprehensive Accounts Management 18% 27% 30% Third-party Liability Recovery 26% 21% 16% --- --- --- 72% 74% 72% Managed Care Support 19% 17% 17% Electronic Data Interchange 9% 9% 11% --- --- --- Total 100% 100% 100%
All of the Company's product offerings provide a high level of recurring revenue. Over 90% of the Company's Proprietary Services revenue, exclusive of affiliates ("Core Proprietary Revenue"), in fiscal year 1996 was attributable to entities that became clients of the Company prior to 1996. This is consistent with revenue patterns experienced by the Company in prior years. RETROACTIVE CLAIMS REPROCESSING ("RCR")(SM) As a result of the magnitude and complexity of the information requirements involved in the health care claims reimbursement process, a hospital's patient accounting department processes an enormous amount of data each day, normally recouping a majority of third-party payments 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 data as it accumulates and flows through the frequently unintegrated platforms comprising the hospital's overall information management system, and (iv) the necessity for 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 systems 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 on-going 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 frequently 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 the existence of third-party coverage was not known. RCR services require the hospital only to provide the Company with copies of existing data files, demand minimal hospital staff support, and involve no patient contact. 3 6 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. 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 $1.1 billion in incremental third-party claims reimbursements for hospitals. Over the last three fiscal years, such services have generated over $364 million in incremental reimbursements. RCR services are currently provided principally to large public and voluntary (not-for-profit) hospitals and other health care providers in 10 states and the District of Columbia. RCR contracts generally have three-year terms and are cancelable by the Company or the client upon 90 days notice. Contingent fees for RCR services typically range from 20% to 30% of the incremental revenue generated on behalf of the client. The Company recognizes revenue at the time a client's billing is submitted to a third-party payor or its intermediary. COMPREHENSIVE ACCOUNTS MANAGEMENT SERVICES ("CAMS")(SM) 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, companies that serve the health care industry, and payors such as state Medicaid agencies. In contrast to RCR services, which retrospectively reprocess patient accounts receivable data, CAMS delivered to health care providers provides concurrent third-party claim identification, editing, preparation, and electronic 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 (a) an intimate familiarity with the principal in-house shared data collection and patient accounting systems found in large urban hospitals with (b) 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. 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. 4 7 Most of the Company's CAMS clients were former RCR clients. The Company believes that demand for its CAMS will increase as a result of (a) the trend by many hospitals and providers of information services to the health care industry to outsource various administrative, data processing, and patient accounting functions and (b) the increased data processing requirements caused by the continuing growth in outpatient services as an alternative to inpatient treatment. The Company encourages the conversion of RCR clients to CAMS engagements as a logical product evolution at a client facility. The Company currently provides CAMS in four states. CAMS contracts generally have a duration of three to five years. The fee structure for CAMS varies by the type of patient service involved and the location of the client, with typical contingent fees ranging from 0.4% to 12.5% of the client's total inpatient revenue and from 4.0% to 12.5% of the client's total outpatient revenue. The differences in inpatient and outpatient fees are attributable principally to the higher volume and smaller per claim amounts for outpatient claims. In certain cases, the Company's fees are subject to annual limitations, regardless of the amount of revenue generated on behalf of the client. The majority of CAMS contracts that are currently subject to fee limitations provide for a higher level of revenue during the first 24 months of the contracts to compensate the Company for its start-up costs. The Company generally recognizes CAMS revenue monthly, based on the revenue generated on behalf of its client. Revenue derived from CAMS contracts with fee ceilings is recognized ratably over the limitation period. THIRD-PARTY LIABILITY RECOVERY ("TPLR")(SM) The Medicaid program, which was established in 1965, exists as the payor of last resort for health care 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 health care claims for individuals having some other form of third-party health care insurance, enacted regulations requiring states to take active measures to pursue the third parties. In 1985, HMSY began to offer TPLR services, principally to state Medicaid agencies, as a means of identifying third parties with prior liability for Medicaid claims. TPLR processing is performed according to the requirements of each individual client. In providing these services, the Company uses proprietary information management and analysis methodologies that are similar to those used in providing RCR services, although TPLR services require the creation of independent databases of far greater magnitude than is required for RCR clients. TPLR contracts generally have one to three year terms and provide for contingent fees that typically range from 7% to 20% 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. The Company has begun the 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 Recovery ("ERCR")sm services to self-insured employers. ERCR contracts generally have one to three year terms and provide for contingent fees that typically range from 10% to 30% of the amounts recovered for the client. The Company recognizes revenue at the time a billing is submitted on behalf of the client to a third-party payor or administrator. ERCR revenue is subject to annual fluctuations similar to those experienced with RCR and TPLR services. The Company currently has six ERCR engagements in three states. In April 1996, the Company acquired CDR Associates, Inc. ("CDR") to augment the Company's TPLR services. CDR is a provider of hospital-based claim audits on behalf of payors for the purpose of recovery. CDR's principal client base is comprised of Blue Cross and Blue Shield carriers and their related managed care organizations. In addition, CDR clients include several commercial carriers and HMOs. The Company currently has TPLR engagements, inclusive of ERCR and CDR, in 22 states and the District of Columbia. 5 8 MANAGED CARE SUPPORT ("MCS") MCS services are provided by Health Care microsystems, Inc. ("HCm"), which merged with HMSY in February 1995. MCS consists of microcomputer based decision support applications and related consulting services, which assist health care providers in assembling, analyzing, and evaluating information in order to provide cost-effective, high quality services. Unlike the Company's other services, MCS clients retain the Company on a fee for service basis. HCm is a leading provider of decision support systems and applications for microcomputer-based platforms. HCm's current service offerings cover a broad range of financial, clinical, and operational disciplines. These include application modules for: physician profiling, budgeting and financial modeling, clinical case management, cost accounting, productivity management, patient demographics, and contract management. HCm also offers cost management and general management consulting services, as well as systems integration services aimed at facilitating the integration of clinical, business, and strategic decision-making. 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. HCm has over 400 clients, which include hospitals, clinic facilities, and physician groups located in 44 states and the District of Columbia. ELECTRONIC DATA INTERCHANGE ("EDI") Through its RCR, CAMS, and TPLR offerings, the Company has developed the capability to submit health care reimbursement data to and receive remittance data electronically from a diverse array of third-party payors. To further this capability and to expand its presence in this separate service sector, HMSY acquired Quality Medi-Cal Adjudication, Incorporated ("QMA") in February 1990. QMA, based in Sacramento, California, provides approximately 148 hospitals and health care providers, principally in California with additional clients in Nevada and New York, with electronic billing and follow-up services for claims submitted to Medi-Cal (the California Medicaid program) and various commercial insurance carriers. The Company also provides EDI services to clients through its Accelerated Claims Processing, Inc. ("ACPI") subsidiary. ACPI provides EDI services to clients in the Illinois, New York, and Pennsylvania markets. Since the acquisition of QMA, the Company has been involved in a significant transfer of its proprietary technology and expertise to the EDI platform of QMA. As a result, QMA's EDI platform has been converted to encompass the range of functionality required for an all-payor system. Conversion of the platform to facilitate distribution and support in major industrial states outside California has been accomplished and its enhancement continues. QMA's electronic data interchange services are offered in conjunction with varying levels of follow-up services under contracts that typically span three years. Fees for routine electronic billing submissions are established on a per claim basis and vary depending on the level of follow-up service provided. QMA also offers billing services at fixed monthly fees regardless of volume to approximately 40% of its clients. Revenue is recognized at the time billings are submitted to third-party payors or their intermediaries. For providing follow-up services relative to certain claims, QMA is entitled to a contingent fee equal to a percentage of the amount recovered for the hospital. By application of the Company's RCR technology, QMA has been able to secure additional revenue pursuant to these contingent fee provisions. 6 9 MARKET FOR THE COMPANY'S SERVICES Although the Company's services involve various proprietary aspects, its business is highly competitive. 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 aspects of the Company's services. The Company may also encounter increased competition from companies attempting to expand the scope of their services in, or to enter, the health care information management services industry. PROPRIETARY SERVICES The principal market for the Company's RCR services and CAMS consists of the approximately 600 largest acute care hospitals in the United States having 300 or more beds or more than 100,000 outpatient (including emergency room) visits per year. The Company's hospital clients are almost exclusively large urban public and voluntary (not-for-profit) hospitals and other health care providers, primarily due to (i) the severe financial constraints facing such institutions, (ii) the significant commitment of such institutions to providing emergency and other non-elective services, and (iii) the resulting complexities of securing complete and accurate reimbursement data with respect to such services. Proprietary hospitals, which tend to be smaller institutions, derive a greater proportion of their revenue from elective procedures, making the problems of patient data collection and management less onerous. Although the number of large acute care hospitals has not changed significantly in recent years, the intensity of their use of information systems technology has increased rapidly, primarily as a result of demands for information made by third-party payors and government regulators, as well as by the need to control costs and better manage hospital resources. This trend has led many hospitals to install sophisticated patient registration, charge capture, and patient accounting systems. Rather than discouraging the use of RCR services, the Company believes that these new systems have aided the expansion of such services, as the RCR services and CAMS operate most effectively when they can draw upon more comprehensive service and patient data already gathered by a hospital's data collection systems. As of October 31, 1996, the Company believes that institutions comprising approximately 25% of the potential market are currently RCR clients of the Company. The Company believes that no other organization provides an offering directly competitive with its RCR services. The Company's belief is supported by (i) the frequent instances in which the Company has been the recipient of "sole-source" contract awards from government entities routinely requiring competitive bidding unless uniqueness can be conclusively established and (ii) the frequency with which a competitive bidding situation, when otherwise required, has resulted in the Company's being adjudged by the governmental entity the only responsive bidder. In general, RCR services compete on the basis of the Company's special revenue enhancement expertise, its contingent fee pricing, and the uniqueness of its approach to interacting with a hospital's patient accounting and other information systems. The Company also anticipates that it may offer CAMS to businesses providing financial, administrative, and information management outsourcing services to the health care industry. In providing these services, the Company indirectly competes with several large national and regional consulting and systems integration firms and with numerous small local firms that deliver some form of billing services to hospitals. The market for the Company's TPLR services consists of the Medicaid and related entitlement program administrative agencies of the 50 states and the District of Columbia, plus a number of federal agencies, including HCFA, the Veterans' Administration, the Department of Defense, and the Department of Housing and Urban Development. The Company believes that its technology is useful in improving coordination of benefits activities of various third-party administrators, corporate purchasers of benefits, Blue Cross entities, and other commercial health insurance carriers, and a number of initiatives are under way. In addition, the use of TPLR technology in the form of the ERCR product offering has proven to be applicable to the analysis of claims paid by large self-pay employers. The Company competes for TPLR contracts with the consulting divisions of certain national public accounting firms, as well as with several large data processing service companies, on the basis of its revenue enhancement and third-party billing expertise and its extensive Medicaid, Medicare, and other reimbursement program experience. 7 10 MANAGED CARE SUPPORT Recent changes in the health care marketplace have intensified the information demands at all levels in provider organizations, whether hospitals or integrated delivery systems. Competition for covered lives under various managed care paradigms is forcing providers to deliver health care as efficiently and cost-effectively as possible without compromising quality. The focus of health care information technology is changing from collecting departmental financial data (with a focus on billing and charge capture) to gathering and aggregating enterprise-wide information 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 requirements must be tailored for complex, diverse, integrated delivery systems 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 payment environment. HCm's current client base includes over 400 hospitals in the United States. These hospitals range in size from 50 to 1,100 beds, and include many of the most progressive health systems in the United States, as well as some of the largest multi-site hospital chains. The growth of managed care and integrated health care networks is significantly increasing the demand for decision support information systems ("DSS"). In the new health care environment, it is believed that DSS are the linchpin for integrating, analyzing, and understanding key clinical, financial, and administrative data derived from an institution's transaction-based, health care information systems. As such, DSS are increasingly being relied upon to guide the management practices of providers (in areas ranging from managed care contracting to physician profiling) to ensure the success and validity of their organizations. As a recognized leader in the field of DSS, with experience working in partnerships with complex health care delivery systems, HCm is well positioned to expand its service offering penetration relative to the 6,000 acute care providers nationwide, along with newly emergent health care entities. The Company competes for MCS contracts with hospital computer systems vendors (such as HBO and Company and Shared Medical Systems Corporation) and decision support vendors (such as Transition Systems Inc. and Medicus Corporation) on the basis of its advanced microcomputer software applications. ELECTRONIC DATA INTERCHANGE The principal market for QMA's EDI services includes over 400 acute care hospitals in California. In addition, QMA's all-payor billing workstation, which permits a hospital's billing office to bill multiple third-party payors electronically using a single microcomputer workstation, may prove attractive to acute care hospitals in other states on a stand-alone basis or in conjunction with the Company's enhanced platform configuration under continuing development. The stand-alone EDI business is a highly competitive and highly fragmented industry niche throughout the country. On a national basis, several larger entities are consolidating many local EDI companies. EDI services provided by QMA in California compete with Blue Cross and a number of small, primarily local companies offering Medi-Cal, Medicare, and commercial insurance billing services, as well as with the hospitals' own billing units. SIGNIFICANT CONTRACTS The Company's largest client is a group of health care facilities under the governance of Los Angeles County for which the Company provides CAMS and RCR services. During the fiscal years ended October 31, 1996, 1995, and 1994, this group accounted for 12%, 15%, and 17% of the Company's revenue, respectively. The group of health care institutions operating under the aegis of The City of New York was the Company's second largest client in 1996 and 1995, and the Company's third largest client in 1994, accounting for 8%, 11%, and 6% of the Company's total revenue in 1996, 1995, and 1994, respectively. The Company's contract with this client expired on September 30, 1996. The Company continues to process claims for this client under an interim arrangement, while a new contract has been bid and is being negotiated. While the Company is optimistic that negotiations will be successful, there can be no assurance that a new contract will be consummated; loss of this client could have a material adverse effect on the Company. The Company's ten largest clients accounted for approximately 54% of the Company's revenue in fiscal year 1996. 8 11 HHL Financial Services, Inc. ("HHL") has been a significant client of the Company since 1994, accounting for 5%, 10%, and 13% of the Company's total revenue in fiscal years 1996, 1995, and 1994, respectively. HHL went into default of its contractual obligations to the Company during the course of 1996. As a result, the Company took an after tax charge against earnings of $5,838,000 in fiscal year 1996. See Relationship with HHL Financial Services, Inc. BUSINESS STRATEGY This section of Form 10-K contains forward-looking statements involving various risks that may cause actual results to differ materially. These risks include but are not limited to the ability of HMSY to grow internally or by acquisition and to integrate acquired businesses into the HMSY group of companies, changing conditions in the health care industry which could simplify the reimbursement process and adversely affect HMSY's business, government regulatory and political pressures which could reduce the rate of growth of health care expenditures, competitive actions by other companies, and other risks referred to in HMSY's registration statements and periodic reports filed with the Securities and Exchange Commission. The expertise developed by the Company over the last 23 years in the health care reimbursement arena provides a solid foundation for the expansion of the Company's services to non-governmental payors (commercial insurance carriers and large self-insured corporations) and other companies servicing the health care industry (accounts receivable management companies and third-party claims administrators). The Company intends to expand its client base by continuing to offer technologically innovative, cost-effective services that increase the ability of health care providers to receive reimbursement for health care services for which they are eligible but are otherwise unable to collect. The Company's strategy seeks to exploit its data processing skills and knowledge of the health care reimbursement process in providing value-added services to hospitals and third-party payors and their intermediaries. The Company also intends to take advantage of the current trend among many hospitals to "outsource" data processing and patient accounting functions, as well as the recent growth in the volume of outpatient services as an alternative to inpatient treatment. NEW SERVICES In response to the varying needs of individual clients, the Company historically has devoted significant resources to expanding the range of its services and will continue to do so. As a result of these efforts, the Company intends to develop new services that will benefit existing as well as future hospital, large self-insured corporate, other health care provider, and government agency clients in managing the reimbursement process. These new services are expected to include the utilization of the QMA EDI platform in claiming jurisdictions outside the State of California. ACQUISITIONS The Company's strategy includes the expansion of its business through selective acquisitions. The Company may acquire companies that supply health care providers with automated billing, electronic media claiming, accounts receivable management, and health care utilization management information services if the services or operations of such companies would benefit from access to the Company's proprietary computer technology or software applications. The Company believes that many such acquisition opportunities exist due, in part, to competitive pressures on local service businesses that lack adequate capital, technical, and management resources. The Company also believes that consolidation will continue to occur within the health care information services industry. CDR ASSOCIATES, INC. On April 29, 1996, the Company acquired all the outstanding capital stock of CDR in a merger transaction ("CDR Merger") in exchange for 460,000 shares of the Company's stock. CDR is a supplier of third-party liability recovery services to the health care industry. The CDR Merger was treated as a tax-free reorganization for federal income tax purposes, and was accounted for using the pooling of interests method of accounting. 9 12 QUALITY STANDARDS IN MEDICINE, INC. On November 25, 1996, the Company consummated a merger (the "QSM merger") with Quality Standards in Medicine, Inc. ("QSM"). Founded in 1986, QSM furnishes clinical quality management and improvement systems to hospital providers in 13 states and the District of Columbia and the United Kingdom. The Company issued 260,000 shares of common stock in the QSM Merger, which is being treated as a tax-free reorganization for federal income tax purposes and will be accounted for utilizing the pooling of interests method of accounting. QSM had calendar year 1995 revenue of $840,000, and will be operationally joined with HCm, the Company's decision support systems subsidiary. CORPORATE HISTORY The Company was founded in 1974 and completed an initial public offering in December 1992. During its first decade, the Company's efforts were directed to providing RCR services to hospitals principally located in the greater metropolitan New York City market place. In the early 1980's, the Company introduced RCR services to hospitals on a national basis. TPLR services were introduced in 1985, and the hospital-based CAMS services began in 1986. In 1990, the Company expanded its EDI capabilities with the acquisition of QMA; the provision of MCS services began with the Company's acquisition of HCm in 1995. During 1995, the Company entered into an agreement with Welsh, Carson, Anderson and Stowe VI, L.P. ("WCAS VI"), a Delaware limited partnership affiliated with the investment firm of Welsh, Carson, Anderson and Stowe ("WCAS"), affiliates of WCAS, and certain of their respective executive officers and partners to form Health Information Systems Corporation ("HISCo") for the purpose of investing in health care information management companies that require significant additional investment and maturation. That same year HISCo completed its initial acquisition when it purchased Health Systems Architects, Inc. from Policy Management Systems Corporation. In 1996 the Company expanded its TPLR offerings with the acquisition of CDR and subsequent to its fiscal year end augmented its MCS services with the acquisition of QSM. RELATIONSHIP WITH HHL FINANCIAL SERVICES, INC. HHL has been a significant client of the Company since 1994, accounting for 5%, 10%, and 13% of the Company's total revenues during the fiscal years ended October 31, 1996, 1995, and 1994, respectively. During 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 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. 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 has 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 the 18 month period, HHL has the right to lower the level of service requested and therefore the amount paid in advance and/or cancel the service completely on 30 days prior written notice. 10 13 RELATIONSHIP WITH HEALTH INFORMATION SYSTEMS CORPORATION As of October 31, 1996 and 1995, the Company had a $6,824,000 and $6,746,000 equity investment, respectively, which represented approximately a 43% ownership interest, in HISCo, a privately owned Delaware corporation. The investment in HISCo has been accounted for using the equity method. Under the equity method, the Company recognizes in earnings its proportionate share of net income or loss of HISCo. HISCo was organized during 1995 by the Company, together with WCAS VI, and certain of their respective executive officers and partners, to acquire interests in health information systems and service companies which do not satisfy the criteria for acquisitions made directly by the Company. The Company and HISCo entered into an agreement, dated as of October 31, 1995 (the "HISCo Agreement"), pursuant to which the Company provides HISCo with certain services ("Basic Services"), including executive, acquisition support, and corporate support services. For these Basic Services, the Company is entitled to receive a fee, payable monthly, calculated at the Company's then current standard hourly rates established for internal allocations plus 20%. The Company, in addition, may provide to subsidiaries ("Subsidiaries") of HISCo, and such Subsidiaries may provide to the Company, additional services on such terms as the parties may mutually agree. The HISCo Agreement also allows HISCo or any of its Subsidiaries to provide services to the Company pursuant to separate work orders to which the parties mutually agree. The term of the HISCo Agreement continues 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 are fair and reasonable and are 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 1996 and 1995, the Company received approximately $161,000 and $545,000, respectively, in fees from HISCo for services provided pursuant to the HISCo Agreement. In fiscal year 1996, HISCo received approximately $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. EMPLOYEES The Company believes that a key to its success will be the ability to maintain and enhance the skill and experience level of management. To this end, the Company offers competitive salaries and an annual bonus program in which substantially all employees participate, a stock option program in which 379 or 50% of employees currently participate, and an employee stock purchase plan in which 552 or 73% of employees currently participate. As of October 31, 1996, the Company had 754 employees. No employees are covered by a collective bargaining agreement or are represented by a labor union. The Company continues to be led by two of its founders, Paul J. Kerz, Chairman, President and, Chief Executive Officer, and Laurence B. Simon, Senior Vice President for Product Development. Since its founding in 1974, the Company has continually sought to recruit executives with extensive experience in financial controls, systems development, information processing, health care information management, and project management. 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 included in this Form 10-K. 11 14 ITEM 2. PROPERTIES The Company's executive offices and data processing center occupy 146,000 square feet of space in New York City leased through 2006. An additional 9,400 square feet of space is leased for offices in Washington, D.C.; Boston, Massachusetts; Chicago, Illinois; and Los Angeles and San Francisco, California. QMA leases 30,000 square feet of space in Sacramento, California. HCm leases 68,900 square feet of space in Torrance and El Segundo, California; Nashville, Tennessee; Waltham, Massachusetts; Rolling Meadow, Illinois; Tempe, Arizona; North Palm Beach, Florida; and Seattle, Washington. CDR leases 3,100 square feet of space in Timonium, Maryland. The Company operates state-of-the-art CMOS processors leased from IBM to facilitate product development and production processes, associated peripheral devices from Hitachi and EMC, communications devices, a large number of microcomputers, and extensive local and wide area networks. 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 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. Purchase and maintenance agreements with vendors provide for backup support in case of computer systems failure. The Company has no reliance on proprietary hardware or software systems to execute its business. ITEM 3. LEGAL PROCEEDINGS No material legal proceedings are pending. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 12 15 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 January 15, 1997, there were approximately 16,500 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 ------- ------- ------- ------- 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
ITEM 6. SELECTED FINANCIAL DATA The information required by Item 6 is found on pages F-6 to F-7 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-5 of this report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by Item 8 is found on pages F-8 to F-27 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 13 16 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 1997 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1996, 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 1997 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1996, 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 1997 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1996, 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 1997 Annual Meeting of Shareholders, which will be mailed within 120 days after the close of the Company's fiscal year ended October 31, 1996, and is hereby incorporated herein by reference to such Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K A. Financial Statements - See Index to Consolidated Financial Information on Page 19. B. Schedule Schedule II - Valuation and Qualifying Accounts C. Reports on Form 8-K Current Report on Form 8-K, dated September 3, 1996 - Item 5, Other Matters; Item 7, Financial Statements and Exhibits. D. Exhibits 14 17
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. 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) 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)) 3.2 By-Laws of Health Management Systems, Inc. (Incorporated by reference to Exhibit 3.2 to Amendment No. 1) 10.1(i) Contract, dated January 28, 1980, as amended, between Health Management Systems, Inc. and New York City Health and Hospitals Corporation (Incorporated by reference to Exhibit 10.1(i) to the Registration Statement) 10.1(ii) Contract dated September 8, 1982, as amended, between Health Management Systems, Inc. and New York City Health and Hospitals Corporation (Incorporated by reference to Exhibit 10.1(ii) to the Registration Statement) 10.1(iii) Contract dated October 1, 1993, between Health Management Systems, Inc. and New York City Health and Hospitals Corporation (Incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994) 10.2 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) 10.3(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 and Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994)
15 18
Exhibit Number - ------ 10.3(ii) Health Management System, Inc. Employee Stock Purchase Plan, as amended (Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994 and to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995) 10.3(iii) Health Management Systems, Inc. 1995 Non-Employee Director Stock Option Plan (Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995) 10.3(iv) 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) 10.3(v) Health Management Systems, Inc. Profit Sharing Plan, as amended (Incorporated by reference to Exhibit 10.3(v) to the Company's Annual Report on Form 10-K for the year ended October 31, 1995) 10.4 Interim Operating Agreement, dated April 12, 1991, among Health Management Systems, Inc., HHL Financial Services, Inc., and Welsh, Carson, Anderson and Stowe V, L.P. (Incorporated by reference to Exhibit 10.8 to the Registration Statement) 10.5(i) Management and Data Processing Services Agreement, effective as of January 31, 1992, between HHL Financial Services, Inc. and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.9 to the Registration Statement) 10.5(ii) Amendment No. 1 among HHL Financial Services, Inc., Professional Data Services, Inc., and Health Management Systems, Inc. to Management and Data Processing Agreement (Incorporated by reference to Exhibit 10.9(ii) to the Company's Annual Report for the year ended October 31, 1993) 10.6 Termination Agreement, dated as of January 31, 1992, among HHL Financial Services, Inc., Health Management Systems, Inc., and the other parties named therein (Incorporated by reference to Exhibit 10.10 to the Registration Statement) 10.7(i) Credit Agreement and Guaranty among Health Management Systems, Inc., as Borrower, Accelerated Claims Processing, Inc., and Quality Medi-Cal Adjudication, Incorporated, as Guarantors and The Chase Manhattan Bank, N.A., as Bank, dated April 26, 1993, as amended (Incorporated by reference to Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1993 and to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995) 10.7(ii) Second Amendment to Credit Agreement and Guaranty, dated as of March 30, 1995 among Health Management Systems, Inc., Accelerated Claims Processing, Inc., and Quality Medi-Cal Adjudication, Incorporated and The Chase Manhattan Bank, N.A. (Incorporated by reference to Exhibit 10.12(iii) to the Company's Annual Report on Form 10-K for the year ended October 31, 1995) 10.7(iii) 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) 10.7(iv) First Amendment to Credit Agreement and Guaranty and Waiver (Incorporated by reference to Exhibit 10.1(i) to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
16 19
Exhibit Number - ------ 10.8 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) 10.8(i) 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 Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1996) 10.9 Lease, dated March 20, 1990, between Quality Medi-Cal Adjudication, Incorporated and Kilgore Business Park (Incorporated by reference to Exhibit 10.14 to the Registration Statement) 10.10 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) 10.11(i) Subscription Agreement, dated as of October 31, 1995, among Health Information Systems Corporation ("HISCo") and the Several Persons Named in Schedule I thereto (Incorporated by reference to Exhibit 10.19 (i) to the Company's Annual Report on Form 10-K for the year ending October 31, 1995) 10.11(ii) Registration Rights Agreement, dated as of October 31, 1995, among HISCo and the Several Persons Named in Annex I thereto (Incorporated by reference to Exhibit 10.19 (ii) to the Company's Annual Report on Form 10-K for the year ending October 31, 1995). 10.11(iii) Asset Purchase Agreement, dated as of June 30, 1995, between HISCo and Policy Management Systems Corporation (Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated June 19, 1995) (Incorporated by reference to Exhibit 10.19(iii) to the Company's Annual Report on Form 10-K for the year ending October 31, 1995) 10.11(iv) 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 Company's Annual Report on Form 10-K for the year ending October 31, 1995) * 10.12 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 * 10.13 Lease, dated September 1996, by and between Pacific Corporate Towers LLC, Health Management Systems, Inc., and Health Care microsystems, Inc. * 11.0 Computation of Earnings per Share * 21.1 List of subsidiaries of Health Management Systems, Inc. * 24.1 Consent of KPMG Peat Marwick LLP, independent certified public accountants * 24.2 Consent of Ernst & Young LLP, independent certified public accountants * 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 * 24.4 Consent of Coopers & Lybrand LLP, independent certified public accountants 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 of the Company's Annual Report on Form 10-k for the year ended October 31, 1995) * 27 Financial Data Schedule, which is submitted electronically to the Securities and Exchange Commission for informational purposes only * Filed herewith
17 20 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 -------------------------------------- President and Chief Executive Officer -------------------------------------- January 22, 1997 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 22, 1997 - --------------------------- Chief Executive Officer, Paul J. Kerz and Director /s/ PHILLIP SIEGEL Vice President and January 22, 1997 - --------------------------- Chief Financial Officer Phillip Siegel /S/ ROBERT V. NAGELHOUT Chairman and Chief January 22, 1997 - --------------------------- Executive Officer of HCm Robert V. Nagelhout and Director /S/ DONALD J. STAFFA Senior Vice President and January 22, 1997 - --------------------------- Director Donald J. Staffa /S/ RUSSELL L. CARSON Director January 22, 1997 - --------------------------- Russell L. Carson /S/ WILLIAM W. NEAL Director January 22, 1997 - --------------------------- William W. Neal /S/ GALEN D. POWERS Director January 22, 1997 - --------------------------- Galen D. Powers /S/ RICHARD H. STOWE Director January 22, 1997 - --------------------------- Richard H. Stowe 18 21 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-6 Report of Independent Certified Public Accountants .............................. F-8 Consolidated Statements of Operations for the Years Ended October 31, 1996, 1995, and 1994 ........................................................................ F-9 Consolidated Balance Sheets as of October 31, 1996 and 1995 ..................... F-10 Consolidated Statements of Shareholders' Equity for the Years Ended October 31, 1996, 1995, and 1994 .............................................. F-11 Consolidated Statements of Cash Flows for the Years Ended October 31, 1996, 1995, and 1994 F-12 Notes to Consolidated Financial Statements ...................................... F-13 SCHEDULE: Schedule II - Valuation and Qualifying Accounts ................................. F-27
19 22 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. 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, ($ In Thousands) 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------- Amount % Amount % Amount % --------------------- -------------------- ---------------- Revenue: Proprietary Services: RCR $ 28,212 28% $ 22,961 26% $ 18,890 26% CAMS 18,505 18% 23,945 27% 21,941 30% TPLR 26,407 26% 19,479 21% 11,816 16% ------- --- ------ --- ------ --- 73,124 73% 66,385 74% 52,647 72% MCS 18,853 19% 15,120 17% 12,500 17% EDI 8,692 9% 8,222 9% 8,029 11% ------- --- ------ --- ------ --- 100,669 100% 89,727 100% 73,176 100% Cost of services: Compensation 48,564 48% 43,373 48% 35,355 48% Data processing 10,257 10% 8,144 9% 6,872 10% Occupancy 7,840 8% 6,529 7% 5,920 8% Other 19,660 20% 13,581 15% 11,167 15% ------- --- ------ --- ------ --- 86,321 86% 71,627 80% 59,314 81% Operating margin before amortization of intangibles 14,348 14% 18,100 20% 13,862 19% Amortization of intangibles 204 -- 243 -- 190 -- ------- --- ------ --- ------ --- Operating income 14,144 14% 17,857 20% 13,672 19% Net interest and net other income 987 1% 942 1% 464 -- Loss on investment (927) (1)% -- -- -- -- Merger related costs (494) -- (1,045) (1)% (59) -- Equity in earnings of affiliate 50 -- -- -- -- -- ------- --- ------ --- ------ --- Income before income tax expense 13,760 14% 17,754 20% 14,077 19% Income tax expense (5,574) (6)% (8,152) (9) (6,353) (8)% ------- --- ------ --- ------ --- Net income $ 8,186 8% $ 9,602 11% $ 7,724 11% ------- --- ------ --- ------ ---
F-1 23 OVERVIEW The Company has delivered RCR services since 1974 and began to deliver its TPLR and CAMS offerings in 1985 and 1986, respectively. Together, RCR, TPLR, and CAMS are considered the Company's Proprietary Services. The Company augmented its TPLR product line by merging with CDR in April 1996. CDR provides third-party liability recovery services to the health care industry. The next most significant segment of the Company's business is proprietary analytics or MCS. The Company entered the MCS segment in February 1995 when the Company merged with HCm, which provides microcomputer-based decision support software and services to the health care industry. The remaining segment 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 EDI services, principally in California. The HCm and CDR mergers were accounted for using the pooling of interests method of accounting, and the QMA acquisition was accounted for using the purchase method of accounting. Since 1994, the Company has achieved a compound annual revenue growth rate of 17% with over 90% of Core Proprietary Revenue in each of the years secured from entities which had become clients of the Company in prior years. During this two-year period, TPLR has expanded vigorously, with a compound annual growth rate of 50%, and RCR has consistently shown strong growth with a compound annual growth rate since 1994 of 22%. One of the Company's strategies is to convert existing RCR clients to the more comprehensive and stable CAMS offering; this strategy should result in expanded CAMS revenue, to the detriment of RCR revenue, but with greater overall revenue to the Company. CAMS revenue has declined since 1994 primarily due to the reduction of revenue from HHL. Exclusive of HHL, CAMS revenue has grown nominally since 1994. The Company's Proprietary Revenue has grown at an annual compound rate of 18% since 1994. The Company's MCS services revenue, rendered by HCm, has grown at an annual compound rate of 23% since 1994. The EDI service line has experienced only minor growth during the period, as the Company's principal objective in this service line has been to accrete expanded functionality to the EDI platform to offset the pricing pressures of a highly competitive market. The Company generally achieves lower recoveries, and therefore lower revenue, for each RCR and TPLR client in billings subsequent to the first billing for such clients. In addition, submission of billings is subject to a number of circumstances beyond the Company's control, including delays in receipt of client data and changes in client requirements. Due to such characteristics, revenue for quarters in which processing for new or expanded services for RCR and TPLR clients is significant will tend to be greater than other quarters. Although the number of RCR and TPLR clients and their service requirements have increased significantly over the last several years, there can be no assurance that the Company's client base or their service requirements will increase at the same rate in the future. Due largely to the HHL one-time charge, the Company's operating expense structure has grown at a compound annual rate of 21% from 1994 to 1996, a rate of growth that exceeds that of revenue and is therefore reflected in the decline of the Company's operating margin rate from 19% in 1994 to 14% in 1996. Exclusive of the effect of the one-time charge associated with the HHL write-off, operating expenses have grown at a compound annual rate of 16% since 1994 and operating margin has grown to 23%. As a service business, the largest portion of the Company's costs of services is employee compensation, comprising approximately 56% of total operating costs in 1996 or 59% before the HHL one-time charge. The Company offers competitive salaries and maintains an annual bonus and stock option award program in which substantially all full-time employees are eligible to participate. Measured as a percentage of revenue, the Company has been successful at maintaining compensation costs at a self-imposed target of approximately one-half of total revenue. Other non-compensation operating expenses during this period have grown at an annual compound rate of 26% since 1994 which is a more rapid rate than the compensation component, reflecting the growth of direct project costs and the Company's expansion of its data processing infrastructure. Exclusive of the effect of the one-time charge associated with HHL, non-compensation operating expenses have grown at an annual compound rate of 23%. The Company's income tax dynamics have changed over the two-year period from 1994. The Company's tax position has evolved from recording an income tax expense in 1994 of $6,353,000 to $5,574,000 in 1996, representing an effective income tax rate ranging from 45% in 1994 to 41% in 1996. The somewhat lower effective tax rate in 1996 reflects the Company's acquisition of CDR, which was an S corporation for the first two quarters of 1996, and the net effect of the non-deductibility of merger related costs. Had taxes been computed assuming 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. F-2 24 YEARS ENDED OCTOBER 31, 1996 AND 1995 Revenue for the year ended October 31, 1996 was $100,669,000, an increase of $10,942,000 or 12% over the prior year. During the year ended October 31, 1996, the Company recorded a reversal of $2,180,000 of HHL revenue. Revenue for the year ended October 31, 1996 before the reversal was $102,849,000, an increase of $13,122,000 or 15% over the prior year. Revenue from Proprietary Services after the revenue reversal increased $6,739,000 or 10%, to $73,124,000, principally due to revenue generated by the Company's RCR and TPLR engagements which increased by 23% and 36%, respectively. Revenue from MCS services was $18,853,000, an increase of $3,733,000 or 25% 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 year ended October 31, 1996 was $86,321,000, an increase of $14,694,000 or 21% over the prior year. During the 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 accounts for 9% of the increase over the prior year. The $6,704,000 charge was comprised of (i) $1,362,000 of net compensation costs, and (ii) $2,199,000 of net data processing costs, both associated with the continued servicing of the HHL data processing agreement, plus (iii) $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 associated with the continued servicing of the HHL data processing agreement. Compensation expense, the Company's largest component, totalled $48,564,000, an increase of $5,191,000 or 12% over the prior year. Compensation expense prior to the one-time charge of $1,362,000 was $47,202,000, an increase of $3,829,000 or 9%. Exclusive of the effect of the one-time charge, this increase reflected a 17% increase in the average number of employees in support of business growth and expansion, offset by savings related to the non-recurring fiscal year 1995 CDR S corporation distributions of $1,978,000 and salary savings associated with employee turnover. Data processing expense was $10,257,000, an increase of $2,113,000 or 26% over fiscal year 1995. Data processing expense prior to the one-time charge of $2,199,000 was $8,058,000, a decrease of $86,000 or 1%. Exclusive of the effect of the one-time charge, 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 not recurring in nature. Occupancy expense was $7,840,000, an increase of $1,311,000 or 20% over fiscal year 1995. This increase was primarily due to the expansion of the Company's facilities, including the Company's headquarters. Other operating expense was $19,660,000, an increase of $6,079,000 or 45% over fiscal year 1995. Other operating expense prior to the one-time charge of $3,143,000 was $16,517,000, an increase of $2,936,000 or 22%. The Company recorded $1,604,000 in provision for non-HHL bad debts. 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. Exclusive of the effects of the aforementioned items, the remaining increase was principally attributable to higher levels of direct project costs, including professional fees and employee related costs. Operating margin before amortization of intangible assets for the year ended October 31, 1996 was $14,348,000, a decrease of $3,752,000 or 21% from the $18,100,000 amount realized in fiscal year 1995. The Company's operating margin rate before amortization of intangible assets was 14%, compared to 20% in fiscal year 1995. Operating margin before amortization of intangibles and prior to the one-time charge and revenue reversal for HHL was $23,232,000, an increase of $5,132,000 or 28%. Exclusive of the effect of the one-time charge and revenue reversal, the operating margin rate would have been 23%, an increase of three percentage points over the 20% realized in the prior year. Amortization of intangible assets for the 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. F-3 25 Net interest and net other income of $987,000 in the year ended October 31, 1996 increased by $45,000 from $942,000 in fiscal year 1995; the increase was primarily due to $47,000 of loan origination fees associated with the Company's securing a new line of credit with a major money center financial institution. The Company wrote off its investment in HHL of $927,000 in 1996 as part of the one-time charge. The Company reported equity in earnings of its HISCo affiliate of $50,000 and $0 in fiscal years 1996 and 1995, respectively. 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. The Company's income tax expense for the year ended October 31, 1996 was $5,574,000, resulting in an effective tax rate of approximately 41%. This compares to income tax expense of $8,152,000 and an effective tax rate of approximately 46% 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 assuming 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 would have been $9,547,000, an increase of $1,395,000 or 17% over fiscal year 1995. Net income and earnings per share for the year ended October 31, 1996 were $8,186,000 and $0.45, a 15% and 18% decrease, respectively, from net income of $9,602,000 and $0.55 in earnings per share reported in the prior year. Net income and earnings per share prior to the one-time charge, revenue reversal, and merger costs were $14,518,000 and $0.79, an increase of $3,871,000 and $0.18 over the prior year, or 36% and 30%, respectively. YEARS ENDED OCTOBER 31, 1995 AND 1994 Revenue for the year ended October 31, 1995 was $89,727,000, an increase of $16,551,000 or 23% over fiscal year 1994. Revenue from Proprietary Services increased $13,738,000 or 26%, to $66,385,000, reflecting strong performance in a number of RCR, TPLR, and CAMS engagements, as well as the continued extension of services to existing clients. Revenue from MCS services was $15,120,000, an increase of $2,620,000 or 21% over the prior year. Revenue from EDI services was $8,222,000, an increase of $193,000 or 2% over fiscal year 1994. Cost of services for the year ended October 31, 1995 was $71,627,000, an increase of $12,313,000 or 21% over fiscal year 1994, trailing the rate of revenue growth for the same period. Compensation expense of $43,373,000 increased $8,018,000 or 23% compared to fiscal year 1994. This increase reflected: (i) a 12% increase in the average number of employees, in support of business growth and expansion, (ii) a bonus accrual for the principals of CDR of approximately $1,067,000, an increase of $801,000 or over 300%; and (iii) routine salary and benefit cost increases. Data processing expense was $8,144,000, an increase of $1,272,000 or 19% over fiscal year 1994. This increase was attributable to costs associated with the continuing enhancement of the Company's data processing environments. Occupancy expense was $6,529,000, an increase of $609,000 or 10% over fiscal year 1994, related primarily to the expansion of the Company's New York City facilities begun in the first quarter of 1994. Other operating expense of $13,581,000 represented an increase of $2,414,000 or 22% over fiscal year 1994 and was principally attributable to higher levels of costs directly associated with professional fees and the increased number of employees over the prior year. Operating margin before amortization of intangibles for the year ended October 31, 1995 was $18,100,000, an increase of $4,238,000 or 31% over the $13,862,000 amount realized in fiscal year 1994. The Company's operating margin rate was 20%, as compared to 19% in fiscal year 1994. Amortization of intangibles for the year ended October 31, 1995 was $243,000, an increase from $190,000 reported in the year ended October 31, 1994. This increase was primarily associated with amortization related to acquired EDI software rights. Net interest and net other income of $942,000 in the year ended October 31, 1995 increased by $478,000 from $464,000 in fiscal year 1994, due to the investment in higher interest yielding securities and the implementation of an F-4 26 enhanced cash management system. Merger related costs of $1,045,000 were incurred in the year ended October 31, 1995 related to the merger with HCm in February 1995. The Company reported no equity in earnings of affiliate during the year ended October 31, 1995 (see Note 1(g) of Notes to Consolidated Financial Statements). The Company's income tax expense for the year ended October 31, 1995 was $8,152,000, resulting in an effective tax rate of approximately 46%. This compares to income tax expense of $6,353,000 and an effective tax rate of approximately 45% for the prior year. The 28% increase in income tax expense in 1995 was primarily attributable to the Company's improved pre-tax profitability, which increased 26% from the comparable prior year, offset by a higher effective tax rate as a result of the non-deductibility of the costs incurred in connection with the merger with HCm. As a result of the Company's expanded revenue base, improved operating results, and increased interest income, net income for the year ended October 31, 1995 rose to $9,602,000, a 24% increase when compared to $7,724,000 reported in the prior year. The Company's performance translated to earnings per share for the year ended October 31, 1995 of $0.55, an increase of $0.09 or 20% from the $0.46 reported in the prior year. LIQUIDITY AND CAPITAL RESOURCES At October 31, 1996, the Company had $56,621,000 in net working capital, an increase of $14,978,000 over the level at October 31, 1995. The Company's principal sources of liquidity at October 31, 1996 consisted of cash, cash equivalents, and short-term investments aggregating $39,455,000, and net accounts receivable of $42,418,000. Accounts receivable at October 31, 1996 reflected an increase of $10,788,000 or 34% over the October 31, 1995 balance. This increase was attributable to a change in the age and composition of the Company's accounts receivable portfolio from the prior year due to the growth of receivables related to TPLR services. TPLR has a longer collection cycle than RCR and CAMS receivables which comprised a higher percentage of the prior year receivables. On July 15, 1996, the Company entered into a $40,000,000 unsecured revolving credit facility with a major money center financial institution. The credit facility, which was fully available as of October 31, 1996, 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. As part of the formation of HISCo, the Company has committed to invest up to an additional $41,000,000 in HISCo as transactions and operations of HISCo warrant such investment. The Company's ongoing HISCo funding commitment, combined with the Company's continued expansion of its business through possible future acquisitions and ventures, may require the Company to seek additional financing on relatively short notice. INFLATION The Company's business is technologically and labor intensive. The relative cost of technology has not changed significantly over the last several years. Wages and other employee-related expenses increase during periods of inflation and when shortages in the skilled labor marketplace occur. Although the moderate inflation rates of the past several years have not posed significant problems for the Company, a substantial increase in the rate of inflation could adversely affect the Company. RECENTLY ISSUED ACCOUNTING STANDARDS In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." SFAS 123 provides elective accounting for stock-based employee compensation arrangements using a fair value model. Companies currently accounting for such arrangements under Accounting Principles Board Opinion 25 ("APB 25"), "Accounting for Stock Issued to Employees," may continue to do so; however, SFAS 123 supersedes the disclosure requirements of APB 25 and is applicable to all companies with stock-based compensation arrangements. The Company proposes to adopt the disclosure provisions of SFAS 123. The disclosure provisions of the Statement are effective for the Company's fiscal year beginning November 1, 1996 with comparative information being provided for the Company's fiscal year ended October 31, 1996. The impact of the disclosure provisions of SFAS 123 is not reasonably determinable at this time. F-5 27 SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended October 31, ($ In Thousands, Except Per Common Share Data) 1996 1995 1994 1993 1992 (a) - ---------------------------------------------- ---- ---- ---- ---- -------- STATEMENT OF OPERATIONS DATA: Revenue $ 100,669 89,727 73,176 59,949 47,468 Cost of services 86,321 71,627 59,314 48,989 39,420 --------- ------ ------ ------ ------ Operating margin before amortization of intangibles 14,348 18,100 13,862 10,960 8,049 Amortization of intangibles (b) 204 243 190 303 3,166 --------- ------ ------ ------ ------ Operating income 14,144 17,857 13,672 10,657 4,883 Net interest and net other income (expense) 987 942 464 (114) (2,586) Loss on investment (927) -- -- -- -- Merger related costs (494)(c) (1,045)(d) (59)(d) -- (7,133) Equity in earnings of affiliate (e) 50 -- -- -- -- --------- ------ ------ ------ ------ Income (loss) before income taxes and extraordinary item 13,760 17,754 14,077 10,543 (4,837) Income tax (expense) (5,574) (8,152) (6,353) (4,766) (1,280) --------- ------ ------ ------ ------ Income (loss) before extraordinary item 8,186 9,602 7,724 5,777 (6,117) Extraordinary loss, net of tax benefit -- -- -- (306)(f) -- --------- ------ ------ ------ ------ Net income (loss) 8,186 9,602 7,724 5,471 (6,117) --------- ------ ------ ------ ------ Accretion of preferred stock redemption value -- -- -- (33) (185) Net income (loss) attributable to common shareholders $ 8,186 9,602 7,724 5,438 (6,302) --------- ------ ------ ------ ------ PER COMMON SHARE DATA: Income (loss) before extraordinary item $ 0.45 0.55 0.46 0.37 (0.63) Net income (loss) 0.45 0.55 0.46 0.35 (0.63) Weighted average shares outstanding (g) 18,289 17,407 16,674 15,508 9,967 --------- ------ ------ ------ ------ SELECTED OPERATING DATA: Operating margin as a percentage of revenue 14% 20% 19% 18% 17% Operating income as a percentage of revenue 14% 20% 19% 18% 10%
October 31, 1996 1995 1994 1993 1992(a) --------- ------ ------ ------ ----- BALANCE SHEET DATA: Cash and short-term investments $ 39,455 30,088 27,760 26,447 7,792 Working capital 56,621 41,643 35,942 28,319 13,128 Total assets 109,181 87,195 69,777 60,802 37,592 Long-term debt obligations -- -- -- -- 18,971 Redeemable preferred stock -- -- -- -- 1,134 Common shareholders' equity 76,529 59,224 47,043 38,181 273 ========= ====== ====== ====== =====
F-6 28 SELECTED CONSOLIDATED FINANCIAL DATA NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA (a) The financial results as of and for the year ended October 31, 1992 reflect the effects of a merger termination agreement between HMS and HHL. (b) Intangible assets were principally recorded in connection with HMS's 1989 recapitalization and its acquisition in 1990 of QMA. See Notes 1(e) and 5 of Notes to Consolidated Financial Statements. (c) Includes costs associated with HMS's acquisition of CDR. See Note 1(n) of Notes to Consolidated Financial Statements. (d) Includes costs associated with HMS's acquisition of HCm. See Note 1(m) of Notes to Consolidated Financial Statements. (e) HMS has an investment in HISCo, a privately held Delaware corporation, which is accounted for under the equity method of accounting. See Note 1(g) of Notes to Consolidated Financial Statements. (f) 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. (g) Common stock equivalents have not been included in the computation of weighted average number of shares outstanding in 1992 since the effect would have been antidilutive, except for 234,698 common stock equivalents that have been included relating to stock options issued during 1992 at an exercise price deemed, for financial reporting purposes, to be below fair market value. F-7 29 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 Care microsystems, Inc. (HCm), a wholly owned consolidated subsidiary, for the year ended October 31, 1994 and Health Information Systems Corporation (HISCo), a 43% owned investee company, for the years ended October 31, 1996 and 1995. The financial statements of HCm reflect total revenue constituting 17% in 1994 of the related consolidated totals. The Company's investment in HISCo at October 31, 1996 and 1995 was $6,824,000 and $6,746,000 and its equity in earnings of HISCo was $50,000 for the year ended October 31, 1996 and $0 for the period from June 19, 1995 through October 31, 1995. The financial statements of HCm and HISCo for the aforementioned periods were audited by other auditors whose reports were furnished to us, and our opinion, insofar as it relates to the amounts included for HCm and HISCo, is based solely on the reports of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Health Management Systems, Inc. and subsidiaries as of October 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG Peat Marwick New York, New York November 22, 1996 F-8 30 CONSOLIDATED STATEMENTS OF OPERATIONS Health Management Systems, Inc. and Subsidiaries
Years Ended October 31, ($ In Thousands, Except Per Common Share Amounts) 1996 1995 1994 - ------------------------------------------------- ---- ---- ---- Revenue: Trade $ 95,062 80,305 63,275 Affiliates 5,607 9,422 9,901 --------- ------ ------ 100,669 89,727 73,176 Cost of services: Compensation 48,564 43,373 35,355 Data processing 10,257 8,144 6,872 Occupancy 7,840 6,529 5,920 Other 19,660 13,581 11,167 --------- ------ ------ 86,321 71,627 59,314 --------- ------ ------ Operating margin before amortization of intangibles 14,348 18,100 13,862 Amortization of intangibles 204 243 190 --------- ------ ------ Operating income 14,144 17,857 13,672 Net interest and net other income 987 942 464 Loss on investment (927) 0 0 Merger related costs (494) (1,045) (59) Equity in earnings of affiliate 50 0 0 --------- ------ ------ Income before income tax expense 13,760 17,754 14,077 Income tax expense (5,574) (8,152) (6,353) --------- ------ ------ Net income $ 8,186 9,602 7,724 --------- ------ ------ Net income per common share $ 0.45 0.55 0.46 --------- ------ ------ Weighted average shares outstanding 18,289 17,407 16,674 --------- ------ ------
See accompanying notes to consolidated financial statements. F-9 31 CONSOLIDATED BALANCE SHEETS Health Management Systems, Inc. and Subsidiaries
As of October 31, ($ In Thousands, Except Per Share Amounts) 1996 1995 - ------------------------------------------ ---- ---- Assets: Current assets: Cash and cash equivalents $ 22,274 10,801 Short-term investments 17,181 19,287 Accounts receivable, net 42,418 31,630 Other current assets 4,936 4,139 -------- ------ Total current assets 86,809 65,857 Property and equipment, net 7,774 5,874 Intangible assets, net 5,257 5,461 Capitalized software costs, net 1,472 865 Investments in affiliates 6,824 7,673 Other assets 1,045 1,465 -------- ------ Total assets $109,181 87,195 -------- ------ Liabilities and Shareholders' Equity: Current liabilities: Accounts payable and accrued expenses $ 17,551 14,842 Amounts payable to affiliates 902 0 Deferred revenue 4,767 3,941 Deferred income taxes 6,968 5,431 -------- ------ Total current liabilities 30,188 24,214 Other liabilities 2,407 1,739 Deferred income taxes 57 2,018 -------- ------ Total liabilities 32,652 27,971 -------- ------ 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; 17,348,841 shares issued and outstanding at October 31, 1996; 16,390,762 shares issued and outstanding at October 31, 1995 174 164 Capital in excess of par value 57,583 48,481 Retained earnings 18,301 10,115 Unrealized appreciation on short-term investments 471 464 -------- ------ Total shareholders' equity 76,529 59,224 -------- ------ Commitments and contingencies Total liabilities and shareholders' equity $109,181 87,195 -------- ------
See accompanying notes to consolidated financial statements. F-10 32 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Health Management Systems, Inc. and Subsidiaries
Unrealized Appreciation Common Stock ---------------------- Capital In Retained (Depreciation) Par Excess Of Earnings on Short-term Shareholders' ($ In Thousands) Shares Value Par Value (Deficit) Investments Equity - ---------------- ----------- ----- ------ --------- ------------- ------------ Balance at October 31, 1993 15,511,831 $156 44,394 (6,539) 170 38,181 Net income 0 0 0 7,724 0 7,724 Stock option activity 348,659 3 480 0 0 483 Employee Stock Purchase Plan activity 115,933 1 801 0 0 802 Unearned compensation 0 0 35 0 0 35 Depreciation on short-term investments 0 0 0 0 (182) (182) ---------- ---- ------ ------ --- ------ Balance at October 31, 1994 15,976,423 160 45,710 1,185 (12) 47,043 Net income 0 0 0 9,602 0 9,602 Stock option activity 272,595 3 1,078 0 0 1,081 Employee Stock Purchase Plan activity 141,744 1 1,202 0 0 1,203 Disqualifying dispositions 0 0 477 0 0 477 Unearned compensation 0 0 14 0 0 14 Appreciation on short-term investments 0 0 0 0 476 476 Adjustment to reflect change in Health Care microsystems, Inc. fiscal year 0 0 0 (672) 0 (672) ----------- --- ------ ------ --- ------ Balance at October 31, 1995 16,390,762 164 48,481 10,115 464 59,224 Net income 0 0 0 8,186 0 8,186 Stock option activity 794,994 8 5,629 0 0 5,637 Employee Stock Purchase Plan activity 163,085 2 2,330 0 0 2,332 Disqualifying dispositions 0 0 1,143 0 0 1,143 Appreciation on short-term investments 0 0 0 0 7 7 ----------- --- ------ ------ --- ------ Balance at October 31, 1996 17,348,841 $174 57,583 18,301 471 76,529 ----------- --- ------ ------ --- ------
See accompanying notes to consolidated financial statements. F-11 33 CONSOLIDATED STATEMENTS OF CASH FLOWS Health Management Systems, Inc. and Subsidiaries
Years Ended October 31, ($ In Thousands) 1996 1995 1994 - ---------------------------------------- -------- ------ ------ Operating activities: Net income $ 8,186 9,602 7,724 Adjustments to reconcile net income to net cash provided by operating activities: Loss on investment 927 0 0 Depreciation and amortization 3,093 2,750 2,524 Software capitalization (1,151) (840) (721) Amortization of intangibles 204 243 190 Write-down of software development costs 0 0 332 Amortization of unearned compensation 0 14 35 Provision for doubtful accounts 4,485 183 277 Loss on disposals of assets 0 (19) 0 Deferred tax (benefit) expense (424) 1,203 1,007 Equity in earnings of affiliate (50) 0 0 Other 0 (3) 40 Changes in assets and liabilities: Increase in accounts receivable (15,273) (9,289) (7,308) Increase in other current assets (797) (1,046) (159) Increase in accounts payable and accrued expenses 2,709 5,165 1,266 Increase in amounts payable to affiliates 902 0 0 Increase (decrease) in deferred revenue 826 (728) (755) Increase (decrease) in other assets and liabilities, net 2,238 644 (386) -------- ------ ------ Net cash provided by operating activities 5,875 7,879 4,066 -------- ------ ------ Investing activities: Capital asset expenditures (4,449) (1,503) (2,827) Investments in affiliates (28) (7,268) 0 Intangible assets resulting from acquisitions 0 0 (550) Purchase of short-term investments 0 (7,252) (9,025) Proceeds from sale of short-term investments 2,106 1,788 0 -------- ------ ------ Net cash used in investing activities (2,371) (14,235) (12,402) -------- ------ ------ Financing activities: Proceeds from issuance of common stock, net 2,332 1,203 802 Proceeds from exercise of stock options 5,637 1,081 483 Repayment of notes payable 0 (342) (479) -------- ------ ------ Net cash provided by financing activities 7,969 1,942 806 -------- ------ ------ Net increase (decrease) in cash and cash equivalents 11,473 (4,414) (7,530) Cash and cash equivalents at beginning of year 10,801 14,962 22,492 Adjustment to cash to reflect change in Health Care microsystems, Inc. fiscal year 0 253 0 -------- ------ ------ Cash and cash equivalents at end of year $ 22,274 10,801 14,962 -------- ------ ------
See accompanying notes to consolidated financial statements. F-12 34 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Founded in 1974, Health Management Systems, Inc. ("HMSY" or the "Company") furnishes proprietary data processing and information management services and software to providers of health care, public and commercial payors of health care expenses, and other companies serving the health care industry. (a) Principles of Consolidation The consolidated financial statements include the accounts of HMSY 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 $5,873,000 and $2,741,000 at October 31, 1996 and 1995, respectively) to be cash equivalents. The Company has had significant disqualifying disposition transactions during the three years ended October 31, 1996. Disqualifying dispositions are non-cash transactions and are excluded from the statements of cash flows. Disqualifying dispositions aggregated $1,143,000, $477,000, and $0 during the fiscal years ended October 31, 1996, 1995, and 1994. (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, 1996 and 1995, the Company recorded cumulative unrealized appreciation of $471,000 and $464,000, 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 and the acquisition of Quality Medi-Cal Adjudication, Incorporated ("QMA") in 1990. Intangible assets consist of software, non-compete agreements, and goodwill, which are being amortized on a straight-line basis over three years, 43 months, and between 10 and 40 years, respectively. F-13 35 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND 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 $2,257,000 and $3,929,000 less accumulated amortization of $785,000 and $3,064,000 at October 31, 1996 and 1995, respectively. Amortization expense for the years ended October 31, 1996, 1995, and 1994 was $543,000, $587,000, and $486,000, respectively. During 1996, fully amortized software development costs of $2,822,000 and the related accumulated amortization were written off the balance sheet. (g) Investment in Health Information Systems Corporation At October 31, 1996 and 1995, the Company had an investment of $6,824,000 and $6,746,000, respectively, which represented approximately a 43% ownership interest in Health Information Systems Corporation ("HISCo"), a privately owned Delaware corporation. The investment in HISCo has been accounted for using the equity method of accounting. Under the equity method, the Company recognizes in earnings its proportionate share of net income or loss of HISCo. During June 1995, the Company, together with Welsh, Carson, Anderson & Stowe VI, L.P., a Delaware limited partnership affiliated with Welsh, Carson, Anderson & Stowe ("WCAS"), affiliates of WCAS, and certain of their respective executive officers and partners, formed HISCo for the purpose of investing in health care information management companies that require significant additional investment and maturation. Condensed financial information of HISCo as of and for the year ended October 31, 1996 and four months ended October 31, 1995, respectively, is summarized below:
As of October 31, 1996 1995 HISCo Consolidated Balance Sheets: Current assets $ 8,355,000 6,318,000 Total assets $16,616,000 15,833,000 - -------------------------------------------------------------------------------------------------- Current liabilities $ 2,473,000 1,807,000 - -------------------------------------------------------------------------------------------------- Stockholders' equity 14,143,000 14,026,000 Total liabilities and stockholders' equity $16,616,000 15,833,000 - -------------------------------------------------------------------------------------------------- Periods Ended October 31, 1996 1995 - -------------------------------------------------------------------------------------------------- HISCo Consolidated Statements of Operations: Revenue $16,296,000 5,284,000 - -------------------------------------------------------------------------------------------------- Operating margin 167,000 550,000 - -------------------------------------------------------------------------------------------------- Net income $ 117,000 1,000 - --------------------------------------------------------------------------------------------------
F-14 36 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED (h) 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. (i) 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. (j) 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, 1996, 1995, and 1994. (k) 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. (l) Reclassifications Certain reclassifications were made to prior year amounts to conform to the 1996 presentation. (m) Merger with Health Care microsystems, Inc. On February 14, 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 of accounting. 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. F-15 37 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED 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. (n) Merger with CDR Associates, Inc. On April 29, 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 of accounting. 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. (o) Recently Issued Accounting Standards In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which requires pro forma disclosure of net income and earnings per share using a fair value based method of accounting for all employee stock options or similar equity instrument plans. The Company will implement the disclosure provisions of SFAS 123 effective October 31, 1997. (p) 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, 1996 and 1995. 2. ACCOUNTS RECEIVABLE Accounts receivable as of October 31, 1996 and 1995 consisted of the following:
1996 1995 - ----------------------------------------------------------------------- Trade $42,018,000 31,517,000 Affiliates 400,000 113,000 - ----------------------------------------------------------------------- $42,418,000 31,630,000 - -----------------------------------------------------------------------
Trade accounts receivable are reflected net of an allowance for doubtful accounts of $1,682,000 and $296,000 at October 31, 1996 and 1995, respectively. F-16 38 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. 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) the termination of 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, 1996, 1995, and 1994, revenue subject to such escrow requirements approximated $378,000, $260,000, and $4,738,000, respectively. 4. PROPERTY AND EQUIPMENT Property and equipment as of October 31, 1996 and 1995 consisted of the following:
1996 1995 - ------------------------------------------------------------------------------------------- Equipment $ 12,472,000 9,697,000 Leasehold improvements 5,510,000 3,438,000 Furniture and fixtures 3,903,000 2,034,000 - ------------------------------------------------------------------------------------------- 21,885,000 15,169,000 Less accumulated depreciation and amortization (14,111,000) (9,295,000) - ------------------------------------------------------------------------------------------- $ 7,774,000 5,874,000 - -------------------------------------------------------------------------------------------
Depreciation and amortization expense related to property and equipment charged to operations for the years ended October 31, 1996, 1995, and 1994 was $2,550,000, $2,205,000, and $2,038,000, respectively. 5. INTANGIBLE ASSETS Intangible assets as of October 31, 1996 and 1995 consisted of the following:
Accumulated Cost Amortization Balance - ------------------------------------------------------------------------------------ 1996 Software costs $ 1,756,000 (1,746,000) 10,000 Goodwill 6,487,000 (1,240,000) 5,247,000 - ------------------------------------------------------------------------------------ $ 8,243,000 (2,986,000) 5,257,000 - ------------------------------------------------------------------------------------ 1995 Software costs $ 10,356,000 (10,312,000) 44,000 Goodwill 6,487,000 (1,070,000) 5,417,000 - ------------------------------------------------------------------------------------ $ 16,843,000 (11,382,000) 5,461,000 - ------------------------------------------------------------------------------------
Amortization expense related to intangible assets charged to operations for the years ended October 31, 1996, 1995, and 1994, was $204,000, $243,000, and $190,000, respectively. During the year ended October 31, 1996, the fully amortized costs and related accumulated amortization associated with software costs and non-compete agreements were written off the balance sheet. F-17 39 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses as of October 31, 1996 and 1995 consisted of the following:
1996 1995 - ------------------------------------------------------------------------------------------ Accrued compensation $ 6,009,000 8,011,000 Accrued HHL one-time charges 3,658,000 0 Accounts payable and other accrued expenses 7,884,000 6,831,000 - ------------------------------------------------------------------------------------------ $ 17,551,000 14,842,000 - ------------------------------------------------------------------------------------------
7. CREDIT FACILITIES On July 15, 1996, the Company entered into a $40,000,000 unsecured revolving credit facility with a major money center financial institution which replaced a similar $10,000,000 unsecured revolving credit facility with the same institution. 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. As of October 31, 1996 and 1995, no amounts were outstanding under this credit facility. As of October 31, 1996, the Company had a $50,000 letter of credit outstanding related to leased telephone equipment at its QMA subsidiary. Cash interest payments including bank charges attributable to the aforementioned debts for the years ended October 31, 1996, 1995, and 1994 were $68,000, $60,000, and $88,000, respectively. 8. INCOME TAXES Income tax expense for the years ended October 31, 1996, 1995, and 1994 was comprised of the following:
1996 1995 1994 - --------------------------------------------------------------------------------------------------------- Current tax expense: Federal $(4,264,000) (4,677,000) (3,286,000) State and local (1,734,000) (2,272,000) (2,060,000) - --------------------------------------------------------------------------------------------------------- (5,998,000) (6,949,000) (5,346,000) - --------------------------------------------------------------------------------------------------------- Deferred tax benefit (expense): Federal 448,000 (1,285,000) (578,000) State and local (24,000) 82,000 (429,000) - --------------------------------------------------------------------------------------------------------- 424,000 (1,203,000) (1,007,000) - --------------------------------------------------------------------------------------------------------- Income tax expense, net $(5,574,000) (8,152,000) (6,353,000) - ---------------------------------------------------------------------------------------------------------
F-18 40 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. INCOME TAXES, CONTINUED A reconciliation of the income tax expense to the federal statutory rate of 34% follows:
1996 1995 1994 - -------------------------------------------------------------------------------------------------------- Income tax expense computed at Federal statutory rate $ (4,678,000)(34.0)% $(6,036,000)(34.0)% $(4,786,000) (34.0)% State and local tax expense, net of federal benefit (1,160,000) (8.4) (1,445,000) (8.1) (1,643,000) (11.7) Amortization of goodwill (55,000) (0.4) (55,000) (0.3) (55,000) (0.3) Merger related costs (157,000) (1.1) (355,000) (2.0) -- -- CDR "S" Corp income 325,000 2.4 -- -- -- -- Other, net 151,000 1.0 (261,000) (1.5) 131,000 0.9 - -------------------------------------------------------------------------------------------------------- Total income tax expense $ (5,574,000)(40.5)% $(8,152,000)(45.9)% $(6,353,000) (45.1)% - --------------------------------------------------------------------------------------------------------
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:
1996 1995 1994 Accounts receivable $(3,294,000) (1,609,000) (1,263,000) Fees held in escrow 108,000 117,000 107,000 Depreciable and amortizable assets 397,000 (400,000) 456,000 Allowance for doubtful accounts 653,000 0 0 Unbilled costs (156,000) (6,000) 17,000 Non-compete agreements, net 0 0 (224,000) Accounts payable and accrued expenses (170,000) 403,000 81,000 Deferred revenue 275,000 (543,000) (723,000) Deferred rent 237,000 72,000 352,000 Contract termination contingency 479,000 0 0 HHL one-time charges 2,070,000 0 0 Other (175,000) 763,000 190,000 - ---------------------------------------------------------------------------------------------------------- Deferred income tax benefit (expense) $ 424,000 (1,203,000) (1,007,000) - ----------------------------------------------------------------------------------------------------------
F-19 41 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. INCOME TAXES, CONTINUED Temporary differences that give rise to a significant portion of the deferred tax assets and deferred tax liabilities at October 31, 1996 are as follows:
Deferred tax assets Deferred tax liabilities - -------------------------------------------------------------------------------------------------------- Accounts receivable/deferred items $ 678,000 9,979,000 Property and equipment 1,539,000 664,000 HHL one-time charges 2,070,000 0 Allowance for doubtful accounts 759,000 0 Accounts payable and accrued expenses 603,000 0 Contract termination contingency 0 3,096,000 Other 1,432,000 367,000 Total deferred taxes 7,081,000 14,106,000 - -------------------------------------------------------------------------------------------------------- Net deferred tax liability $ -- 7,025,000 - --------------------------------------------------------------------------------------------------------
Based on the Company's financial history and current situation, management believes it is more likely than not that the Company will realize the benefits of the deferred tax assets as shown above. Accordingly, no valuation allowance has been provided. Cash payments attributable to income taxes for the years ended October 31, 1996, 1995, and 1994 were $5,896,000, $6,355,000, and $4,917,000, respectively. 9. 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, 1996, 1995, and 1994, profit sharing expense was $944,000, $800,000, and $582,000, respectively. Effective January 1, 1992, the Company amended its profit sharing plan to include for its employees 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, 1996, 1995, and 1994, 401(k) plan expense was $611,000, $543,000, and $368,000, respectively. 10. EMPLOYEE STOCK PURCHASE PLAN 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. F-20 42 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. EMPLOYEE STOCK PURCHASE PLAN, CONTINUED For the years ended October 31, 1996 and 1995, the Company had sold 163,085 and 141,744 shares, respectively, of common stock pursuant to the ESPP for aggregate consideration of $2,332,000 and $1,203,000, which activity is reflected in the accompanying financial statements. 11. STOCK OPTION PLAN AND RESTRICTED STOCK PURCHASE PLAN 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 allowed to be issued under the Plan to 6,750,000 shares. Stock option activity for the years ended October 31, 1996, 1995, and 1994 was as follows:
1996 1995 1994 - -------------------------------------------------------------------------------------------------------- Options outstanding, beginning of period 2,754,383 2,143,641 1,921,679 Options granted 127,700 906,042 626,120 Options surrendered (153,895) (22,705) (55,499) Options exercised (794,994) (272,595) (348,659) - -------------------------------------------------------------------------------------------------------- Options outstanding, end of period 1,930,194 2,754,383 2,143,641 - -------------------------------------------------------------------------------------------------------- Options exercisable, end of period 1,358,006 1,774,925 1,425,509 - -------------------------------------------------------------------------------------------------------- Average exercise price of options granted $ 26.47 16.97 9.99 - --------------------------------------------------------------------------------------------------------
The stock options become exercisable on various dates through December 1999 and expire at various dates through October 2005. As of October 31, 1996, no stock appreciation rights or stock purchase awards had been granted. Fiscal 1996 stock option awards totaling 421,000, and normally granted during the fiscal year, were granted in November 1996. F-21 43 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN 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. The purpose of the NEDP is to provide compensation in the form of equity participation in the Company, in consideration of the services provided by directors not employed by the Company. Under the NEDP, directors of the Company who are not employees of the Company or its subsidiaries are granted options to purchase common stock of the Company. 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. The NEDP provides that a grant of options to purchase 1,500 shares of common stock will be made to each non-employee director during the fourth fiscal quarter of each fiscal year commencing with fiscal year 1995. The exercise price of options issued under the NEDP will be the fair market value of the common stock as of the date of grant, and must be paid in cash at the time of exercise. Options granted under the NEDP will have a term of ten years, with 25% of the options exercisable immediately upon grant and an additional 25% exercisable at the end of each of the three subsequent fiscal years. In the event that the holder of options granted under the NEDP ceases to be a director for any reason, all outstanding vested options will be exercisable for one year following the date the director's service on the Board of Directors of the Company terminates, or until their expiration date, whichever period is shorter. Unvested options lapse immediately upon cessation of the director's service on the Board of Directors. No options may be granted under the NEDP after October 31, 2004. The NEDP is administered by the Compensation Committee of the Company's Board of Directors. The Compensation Committee may amend the NEDP, except that shareholder approval is required to increase the number of shares available under the NEDP other than for anti-dilution purposes, to change the class of participants eligible to participate in the NEDP, or to increase materially the benefits to such participants. The provisions of the NEDP relating to the number of options to be awarded to directors, the exercise price of such options, and the timing of awards may not be amended more than once every six months, other than to conform to changes in certain statutes. NEDP stock option activity for the years ended October 31, 1996 and 1995 was as follows:
1996 1995 - -------------------------------------------------------------------------------- Options outstanding, beginning of period 11,250 0 Options granted 6,000 11,250 Options surrendered (563) 0 Options exercised 0 0 Options outstanding, end of period 16,687 11,250 - -------------------------------------------------------------------------------- Options exercisable, end of period 7,683 2,813 - -------------------------------------------------------------------------------- Average exercise price of options granted $ 23.00 17.50 - --------------------------------------------------------------------------------
F-22 44 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENT 13. BUSINESS SEGMENT INFORMATION The Company delivers services and software that comprise three business segments: Proprietary Services-Information and Outsourcing ("Proprietary Services"), Proprietary Analytics-Managed Care Support Services ("MCS"), and Other, which is currently comprised of EDI services. Proprietary Services include the Company's RCR, CAMS, and TPLR product offerings which constitute an outsourcing of various aspects of the information processing functions associated with the health care transfer payment process. MCS provides microcomputer based decision support applications and related consulting services, which assist health care providers assemble, analyze, and evaluate information in order to support provision of cost-effective, high quality services.
Proprietary Services MCS Other Consolidated - ----------------------------------------------------------------------------------------------------------------- 1996 Sales $ 73,124,000 18,853,000 8,692,000 100,669,000 Operating income 9,302,000 3,392,000 1,450,000 14,144,000 Total assets 95,618,000 11,798,000 1,765,000 109,181,000 Depreciation and amortization 2,403,000 712,000 182,000 3,297,000 Capital expenditures 4,067,000 1,528,000 5,000 5,600,000 1995 Sales $ 66,385,000 15,120,000 8,222,000 89,727,000 Operating income 14,183,000 2,465,000 1,209,000 17,857,000 Total assets 75,181,000 10,046,000 2,157,000 87,384,000 Depreciation and amortization 2,106,000 753,000 134,000 2,993,000 Capital expenditures 1,240,000 843,000 260,000 2,343,000 1994 Sales $ 52,647,000 12,500,000 8,029,000 73,176,000 Operating income 9,855,000 2,274,000 1,543,000 13,672,000 Total assets 58,775,000 9,103,000 1,899,000 69,777,000 Depreciation and amortization 1,932,000 657,000 125,000 2,714,000 Capital expenditures 2,525,000 951,000 72,000 3,548,000
F-23 45 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENT 14. COMMITMENTS The Company leases office space and equipment under operating leases which expire at various dates through May 31, 2006. The lease agreements provide for rent escalations. Total rent expense for the years ended October 31, 1996, 1995, and 1994, including escalations, was $6,214,000, $5,193,000, and $4,037,000, respectively. Minimum annual lease payments for each of the next five years ending October 31 and thereafter are as follows:
Year Payments -------------------------------------------------------------- 1997 $ 4,652,000 1998 3,946,000 1999 3,406,000 2000 2,881,000 2001 2,832,000 Thereafter 9,097,000 -------------------------------------------------------------- Total $ 26,814,000 --------------------------------------------------------------
15. SIGNIFICANT CONTRACTS For the years ended October 31, 1996, 1995, and 1994, the Company's largest client accounted for 12%, 15%, and 17%, respectively, of the Company's consolidated revenue. The next largest client accounted for approximately 8%, 11%, and 6%, respectively, of the Company's consolidated revenue for the same periods. The Company's contract with this client expired on September 30, 1996. The Company continues to process claims for this client under an interim arrangement, while a new contract has been bid and is being negotiated. While the Company is optimistic that negotiations will be successful, there can be no assurance that a new contract will be consummated; loss of this client could have a material adverse effect on the Company. 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 provides 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. 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 $5,838,000, or $0.32 per share. F-24 46 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENT 16. RELATED PARTY TRANSACTIONS, CONTINUED As of October 31, 1996, the Company has incurred and offset $165,000 in net expenses for its contractual obligations with HHL. The remaining accrual at October 31, 1996 was $3,658,000 for probable future net cash expenditures related to the Company's continuing contractual obligations with HHL. The Company anticipates that substantially all amounts accrued as of October 31, 1996 will be paid out or otherwise satisfied by the end of fiscal year 1997. 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 has agreed to provide, for a period of up to 18 months, a reduced level of services to HHL in exchange for payment in advance. During this 18 month period, HHL has the right to lower the level of services 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. During the years ended October 31, 1996, 1995, and 1994, the Company received approximately $5,446,000, $8,877,000, and $9,548,000 in fees from HHL related to these agreements, and, in connection with jointly executed client projects, HHL has charged the Company expenses for services totaling $1,557,000, $1,337,000, and $1,091,000, in 1996, 1995, and 1994, respectively. (b) HISCo To finance additional proposed acquisitions, effective October 31, 1995, the Company and HISCo entered into a subscription agreement (the "Subscription Agreement"). The Subscription Agreement contemplated that, for a period of three years commencing on October 31, 1995, HISCo may require the Company to purchase, on a pro rata basis, up to an aggregate additional 4,136,700 shares of HISCo common stock ("Additional Shares") for a per share purchase price of $10.00, or an aggregate purchase price of $41,367,000. With respect to each acquisition, the Subscription Agreement requires HISCo to deliver written notice to the Company specifying, among other information, the terms of the proposed acquisition and the aggregate number of Additional Shares that HISCo proposes to sell to the Company. The Company cannot decline to purchase its respective pro rata portions of Additional Shares. The Company and HISCo entered into an agreement, dated as of October 31, 1995 (the "HISCo Agreement"), pursuant to which the Company will provide HISCo with certain services ("Basic Services"), including executive, acquisition support, and corporate support services. For these Basic Services, the Company is entitled to receive a fee, payable monthly, calculated at the Company's then current standard hourly rates established for internal allocations plus 20%. The Company, in addition, may provide to subsidiaries ("Subsidiaries") of HISCo, and such Subsidiaries may provide to the Company, additional services on such terms as the parties may mutually agree. The term of the HISCo Agreement continues 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 are fair and reasonable and are no less favorable to the Company than those that could have been obtained with respect to comparable engagements with independent third parties. In fiscal year 1996 and 1995, the Company received approximately $161,000 and $545,000 in fees from HISCo for services provided pursuant to the HISCo Agreement. In fiscal year 1996, HISCo received approximately $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. The Company's total revenue from related parties was $5,607,000, $9,422,000 and $9,901,000 in 1996, 1995, and 1994, respectively. F-25 47 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENT 17. QUARTERLY FINANCIAL DATA (UNAUDITED) The table below summarizes the Company's unaudited quarterly operating results for its last three fiscal years.
(In Thousands, Except Earnings Per Common Share) First Quarter Second Quarter Third Quarter Fourth Quarter - ----------------------------------------------------------------------------------------------------------------------------- 1996: Revenue $ 25,390 25,577 25,785 23,917 Cost of services 19,558 19,872 28,135 18,756 - ----------------------------------------------------------------------------------------------------------------------------- Operating margin (loss) before amortization of intangibles 5,832 5,705 (2,350) 5,161 Operating income (loss) 5,777 5,650 (2,401) 5,118 Net income (loss) 3,743 3,338 (1,827) 2,932 Net income (loss) per common share $ 0.21 0.18 (0.11) 0.16 - ----------------------------------------------------------------------------------------------------------------------------- 1995: Revenue $ 20,985 21,041 23,020 24,681 Cost of services 16,471 16,752 18,786 19,618 - ----------------------------------------------------------------------------------------------------------------------------- Operating margin before amortization of intangibles 4,514 4,289 4,234 5,063 Operating income 4,434 4,234 4,180 5,009 Net income 1,807 2,417 2,413 2,965 Net income per common share $ 0.11 0.14 0.14 0.17 - ----------------------------------------------------------------------------------------------------------------------------- 1994: Revenue $ 17,091 17,620 18,742 19,723 Cost of services 14,093 14,481 14,966 15,774 - ----------------------------------------------------------------------------------------------------------------------------- Operating margin before amortization of intangibles 2,998 3,139 3,776 3,949 Operating income 2,958 3,099 3,734 3,881 Net income 1,647 1,706 2,238 2,133 Net income per common share $ 0.10 0.10 0.13 0.13 - -----------------------------------------------------------------------------------------------------------------------------
18. SUBSEQUENT EVENTS On November 25, 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 is being treated as a pooling of interests. 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 $840,000, and has clients in 13 states, the District of Columbia, and the United Kingdom. Operationally, QSM will be combined with HCm, the Company's decision support systems subsidiary as part of the Managed Care Support business segment. F-26 48 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS Allowance for doubtful Accounts: - --------------------------------
Balance, October 31, 1993 $ 154,000 Provision 190,000 Recoveries 0 Charge-offs (75,000) Balance, October 31, 1994 269,000 Provision 111,000 Recoveries 0 Charge-offs (84,000) ---------- Balance, October 31, 1995 296,000 Provision 4,485,000 Recoveries 0 Charge-offs (3,099,000) Balance, October 31, 1996 $ 1,682,000 ============
F-27 49
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. 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) 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)) 3.2 By-Laws of Health Management Systems, Inc. (Incorporated by reference to Exhibit 3.2 to Amendment No. 1) 10.1(i) Contract, dated January 28, 1980, as amended, between Health Management Systems, Inc. and New York City Health and Hospitals Corporation (Incorporated by reference to Exhibit 10.1(i) to the Registration Statement) 10.1(ii) Contract dated September 8, 1982, as amended, between Health Management Systems, Inc. and New York City Health and Hospitals Corporation (Incorporated by reference to Exhibit 10.1(ii) to the Registration Statement) 10.1(iii) Contract dated October 1, 1993, between Health Management Systems, Inc. and New York City Health and Hospitals Corporation (Incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994) 10.2 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) 10.3(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 and Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994)
20 50
Exhibit Number - ------ 10.3(ii) Health Management System, Inc. Employee Stock Purchase Plan, as amended (Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1994 and to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995) 10.3(iii) Health Management Systems, Inc. 1995 Non-Employee Director Stock Option Plan (Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995) 10.3(iv) 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) 10.3(v) Health Management Systems, Inc. Profit Sharing Plan, as amended (Incorporated by reference to Exhibit 10.3(v) to the Company's Annual Report on Form 10-K for the year ended October 31, 1995) 10.4 Interim Operating Agreement, dated April 12, 1991, among Health Management Systems, Inc., HHL Financial Services, Inc., and Welsh, Carson, Anderson and Stowe V, L.P. (Incorporated by reference to Exhibit 10.8 to the Registration Statement) 10.5(i) Management and Data Processing Services Agreement, effective as of January 31, 1992, between HHL Financial Services, Inc. and Health Management Systems, Inc. (Incorporated by reference to Exhibit 10.9 to the Registration Statement) 10.5(ii) Amendment No. 1 among HHL Financial Services, Inc., Professional Data Services, Inc., and Health Management Systems, Inc. to Management and Data Processing Agreement (Incorporated by reference to Exhibit 10.9(ii) to the Company's Annual Report for the year ended October 31, 1993) 10.6 Termination Agreement, dated as of January 31, 1992, among HHL Financial Services, Inc., Health Management Systems, Inc., and the other parties named therein (Incorporated by reference to Exhibit 10.10 to the Registration Statement) 10.7(i) Credit Agreement and Guaranty among Health Management Systems, Inc., as Borrower, Accelerated Claims Processing, Inc., and Quality Medi-Cal Adjudication, Incorporated, as Guarantors and The Chase Manhattan Bank, N.A., as Bank, dated April 26, 1993, as amended (Incorporated by reference to Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1993 and to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995) 10.7(ii) Second Amendment to Credit Agreement and Guaranty, dated as of March 30, 1995 among Health Management Systems, Inc., Accelerated Claims Processing, Inc., and Quality Medi-Cal Adjudication, Incorporated and The Chase Manhattan Bank, N.A. (Incorporated by reference to Exhibit 10.12(iii) to the Company's Annual Report on Form 10-K for the year ended October 31, 1995) 10.7(iii) 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) 10.7(iv) First Amendment to Credit Agreement and Guaranty and Waiver (Incorporated by reference to Exhibit 10.1(i) to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
21 51
Exhibit Number - ------ 10.8 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) 10.8(i) 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 Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1996) 10.9 Lease, dated March 20, 1990, between Quality Medi-Cal Adjudication, Incorporated and Kilgore Business Park (Incorporated by reference to Exhibit 10.14 to the Registration Statement) 10.10 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) 10.11(i) Subscription Agreement, dated as of October 31, 1995, among Health Information Systems Corporation ("HISCo") and the Several Persons Named in Schedule I thereto (Incorporated by reference to Exhibit 10.19 (i) to the Company's Annual Report on Form 10-K for the year ending October 31, 1995) 10.11(ii) Registration Rights Agreement, dated as of October 31, 1995, among HISCo and the Several Persons Named in Annex I thereto (Incorporated by reference to Exhibit 10.19 (ii) to the Company's Annual Report on Form 10-K for the year ending October 31, 1995). 10.11(iii) Asset Purchase Agreement, dated as of June 30, 1995, between HISCo and Policy Management Systems Corporation (Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated June 19, 1995) (Incorporated by reference to Exhibit 10.19(iii) to the Company's Annual Report on Form 10-K for the year ending October 31, 1995) 10.11(iv) 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 Company's Annual Report on Form 10-K for the year ending October 31, 1995) * 10.12 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 * 10.13 Lease, dated September 1996, by and between Pacific Corporate Towers LLC, Health Management Systems, Inc., and Health Care microsystems, Inc. * 11.0 Computation of Earnings per Share * 21.1 List of subsidiaries of Health Management Systems, Inc. * 24.1 Consent of KPMG Peat Marwick LLP, independent certified public accountants * 24.2 Consent of Ernst & Young LLP, independent certified public accountants * 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 * 24.4 Consent of Coopers & Lybrand LLP, independent certified public accountants 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 of the Company's Annual Report on Form 10-k for the year ended October 31, 1996.) * 27 Financial Data Schedule, which is submitted electronically to the Securities and Exchange Commission for informational purposes only * Filed herewith
22 EX-2.2.I 2 FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER 1 Exhibit 2.2(i) FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER This is a First Amendment (the "Amendment") to that certain Agreement and Plan of Merger (the "Merger Agreement"), made and entered into as of April 29, 1996, by and among HEALTH MANAGEMENT SYSTEMS, INC., a New York corporation ("HMS"), CDR ACQUISITION CORP., a Maryland corporation and wholly-owned subsidiary of HMS ("Sub"), CDR Associates, Inc., a Maryland corporation ("CDR"), and the principal shareholders of CDR, whose names appear on the signature page of the Merger Agreement (the "Principals"). This Amendment is dated as of April 29, 1996. 1. Section 6.2(c) of the Merger Agreement is hereby deleted in its entirety. 2. Section 15.3(a) of the Merger Agreement is hereby deleted in its entirety and the following inserted in its place and stead: (a) The indemnities set forth in this Article 14 and all representations, warranties and covenants hereunder shall survive for a period ending on, and not to exceed, the date on which the Company issues its Annual Report on Form 10-K for the fiscal year ending October 31, 1996, together with the accompanying audited financial statements thereto. Upon the expiration of such period, the Principals shall have no liability for Damages under such indemnification provisions unless HMS has been given notice of a claim asserting liability by a third party prior to the expiration of such period and thereafter provides notice to the Principals in the manner provided in Section 15.2 above. 3. Except as set forth in this Amendment, the Agreement and Plan remains in full force and effect without modification thereto. IN WITNESS WHEREOF, HMS, CDR and each Principal have caused this Amendment to be duly signed all as of the date first above written. HEALTH MANAGEMENT SYSTEMS, INC. By: /s/ Paul J. Kerz ---------------- Paul J. Kerz CDR ASSOCIATES, INC. By: /s/ Jeffrey R. Donnelly ------------------------ JEFFREY R. DONNELLY /s/ Joseph H. Czajkowski ------------------------- JOSEPH H. CZAJKOWSKI EX-10.12 3 AGREEMENT AND RELEASE OF CLAIMS 1 Exhibit 10.12 AGREEMENT AND RELEASE OF CLAIMS Agreement and Release of Claims (hereinafter the "Agreement"), dated as of 29 October 1996, by and among HHL FINANCIAL SERVICES, INC., a Delaware corporation with offices at 1000 Woodbury Road, Woodbury, NY 11797 ("HHL"); HEALTH MANAGEMENT SYSTEMS, INC., a New York corporation with offices at 401 Park Avenue South, New York, NY 10016 ("HMS"); and, solely for the limited purpose set forth herein, THE FIRST NATIONAL BANK OF CHICAGO, a national banking association with offices at One First National Plaza, Chicago, Illinois 60670 ("First Chicago"). WHEREAS, HHL and HMS are parties to that certain Amendment No. 1 to Management and Data Processing Agreement dated 1 July 1993 between HHL and HMS (the "Data Processing Agreement"); WHEREAS, HHL and HMS are desirous of memorializing certain agreements among themselves regarding certain contracts between them and amending certain terms and provisions of the Data Processing Agreement; WHEREAS, various disputes have arisen between HMS and HHL, and between HMS and First Chicago, and the parties hereto are desirous of entering into this Agreement to release one another, subject to certain conditions and limitations hereafter set forth, from certain liabilities regarding rights and claims that they have against one another which arise from acts, events or circumstances occurring before the effective date of this Agreement; and WHEREAS, by entering into this Agreement none of the parties hereto acknowledges or admits any liability in connection with such disputes. NOW, THEREFORE, HHL, HMS and, solely for the limited purpose set forth in Sections 5 through 17 hereof, First Chicago do hereby stipulate and agree as follows: Section 1. Continuation of Subcontract Arrangements. Subject to the right of each of HHL and HMS, as a prime contractor to a customer, to terminate the other as a subcontractor solely due to the failure of the subcontractor to perform its contractual obligations or the expressed dissatisfaction of the prime contractor's customer, all subcontracts in force and effect between HHL and HMS as of the Effective Date (as hereinafter defined) shall remain in full force and effect following the Effective Date. Without limiting the generality of the foregoing: 2 (a) HMS shall have the right to remain as subcontractor to HHL on existing subcontracts so long as HHL retains the related primary contract and/or the renewal/extension thereof. (b) HHL shall have the right to remain as subcontractor to HMS on existing subcontracts so long as HMS retains the related primary contract and/or the renewal/extension thereof. (c) As part of the renewal of its contract with Cook County Hospital ("CCH"), HMS will use its best efforts to cause HHL's subcontract for services to CCH to be renewed and HHL will have the right to remain as subcontractor to HMS so long as HMS retains the primary contract and/or the renewal/extension thereof. HHL will pay to HMS HHL's pro rata share of the actual fees paid by HMS to the law firm in Chicago representing HMS in its contract negotiations with CCH, such pro rata share to be apportioned based on HHL's and HMS's respective revenues received pursuant to such contract renewal. Accordingly, HHL and HMS agree that during the twelve (12) month period following the date of such contract renewal HMS may deduct, from revenue received on HHL's behalf from CCH pursuant to the contract renewal and prior to the remittance of such payments to HHL, an amount equal to seventy (70%) percent of the monthly legal fees to be paid to such law firm (which amount shall be equal to 70% of $8,000 or $5,600 per month). HHL and HMS acknowledge and agree that such allocation is based upon the historical pro rata share of the CCH revenues received by each of HHL and HMS. Promptly following the end of such twelve (12) month period, HHL and HMS shall reallocate as between themselves the total aggregate legal fees paid to such law firm based upon the pro rata share of the CCH revenues actually received by each of HHL and HMS for such twelve (12) month period. The aggregate actual amount for which HHL shall be responsible following such reallocation shall be referred to herein as the "Adjusted Amount." The difference between the aggregate amount so deducted from HHL's revenues and the Adjusted Amount shall be referred to herein as the "Fee Difference." Following such reallocation, if the aggregate amount so deducted from HHL's revenues shall exceed the Adjusted Amount, HMS shall promptly pay to HHL an amount equal to the Fee Difference, and if the Adjusted Amount shall exceed the aggregate amount so deducted from HHL's revenues, HHL shall promptly pay to HMS an amount equal to the Fee Difference. (d) In connection with the sale of all or a portion of its assets, HHL may assign or sell its primary contracts (where HMS is the subcontractor) and/or its subcontracts (where HMS is the primary contractor) to third parties, subject to the written consent of HMS, which consent shall not be unreasonably withheld or delayed, provided such 2 3 Purchaser (as hereinafter defined) agrees to the terms of any subcontract between HHL and HMS, as modified herein. Section 2. License of AccessLine System and Software. (a) On the date hereof, HMS shall pay $50,000 to HHL in exchange for the grant by HHL to HMS of a royalty-free nonexclusive license in perpetuity for the AccessLine system and software. Contingent upon its receipt of such payment, and subject to the terms and conditions hereinafter set forth, HHL hereby grants to HMS a royalty-free nonexclusive license in perpetuity to use the AccessLine system and software owned by HHL without limitation as to rights (including the right to sublicense, except as set forth below) including but not limited to possession by HMS of, but not title to, all source code materials (defined as including all program codes, file layouts, copybooks, file creation utilities and job control language) and rights to all program and user documentation and associated training material as such items currently exist and are in the possession of HMS. HHL shall have no future obligations to supply maintenance or updates to the AccessLine system or software; provided, however, that HMS shall have rights to all future AccessLine enhancements implemented by HMS under contract with HHL, and HMS will be free to make any changes or modifications it deems appropriate so long as such changes or modifications do not adversely affect the conduct by HHL or its successors or assigns of HHL's business. (b) During the term of the Data Processing Agreement, HMS shall not sublicense the AccessLine system or software to third parties in the United States, except as expressly authorized by HHL in writing with the consent of First Chicago. Promptly following the date hereof, HHL shall deliver to HMS fifty (50) AccessLine terminals and four (4) 32-port controllers, provided that HHL is not required to purchase, or make any expenditure in connection with, the provision of such equipment. HHL makes no representations or warranties as to (i) the condition of such equipment except that it shall be in working condition at the time of the transfer thereof by HHL to HMS, or (ii) the AccessLine system and/or software, and HMS shall accept all such items AS IS. (c) HHL may sell or otherwise transfer all or a portion of its assets or business to one or more third parties, and the license granted herein to HMS shall not prevent HHL from consummating such transactions by granting similar, nonexclusive licenses of the AccessLine system and software to such third parties. 3 4 Section 3. Continuation of Data Processing. (a) HMS shall continue to provide data processing services to HHL under the terms of the Data Processing Agreement consistent with current service levels and staffing in accordance with Attachment 1 attached hereto and incorporated herein by reference (including (x) the reduction of dedicated programming staff by two (2) programmers, one programmer reduction to occur six (6) months after the Effective Date and the second programmer reduction three (3) months thereafter and (y) the reduction of dedicated programming staff to not less than two (2) programmers, in the event the Monthly Aggregate Data Processing Fees (as hereinafter defined) shall be reduced to less than $200,000 per month, provided that HMS shall satisfy its performance requirements hereunder) subject to the following amended terms and conditions: (b) All minimum monthly data processing fees shall be paid by HHL to HMS monthly in advance by the 25th day of the prior month and HMS shall receive $200,000 from HHL as advance payment for the last month of the Data Processing Agreement, such advance payment to be made as provided in Section 5 herein. (c) (i) The monthly minimum data processing fees shall be the greater of (x) five (5%) percent of HHL's monthly revenues (excluding the revenues of HLS Financial Group, Inc.) and (y) the following minimum amounts:
Monthly Minimum Data Quarter Ended Processing Fee ----------------------------------------------------------- 31 Jan 1997 $300,000 30 Apr 1997 $250,000 31 Jul 1997 $250,000 31 Oct 1997 $240,000 31 Jan 1998 $220,000 30 Apr 1998 $200,000
(ii) HHL's monthly minimum data processing fee obligations may be reduced from time to time, subject to the provisions of Section 3(d)(iii) hereof and the following conditions or any combination thereof: 4 5 (A) If HHL sells all or a portion of its assets or business to any purchaser (a "Purchaser"), and such Purchaser enters into a data processing services agreement with HMS as set forth in subsection (f) below (but not if the Purchaser is subject to the provisions of Section 3(f)(ii) below), then with respect to each Purchaser to which HMS grants approval, which approval shall not be unreasonably withheld or delayed, HMS shall assume the responsibility for the collection of its data processing fees from such Purchaser and shall reduce HHL's minimum monthly data processing fee and Disaster Recovery cost obligations (as set forth in Section 3(e) below) by an amount equal to the minimum monthly data processing fees and Disaster Recovery cost obligations of each such Purchaser; and/or (B) If HHL reduces its requirement for AccessLine services from HMS (including but not limited to a reduction in its operations, closure of offices or termination of clients), then HHL's monthly minimum data processing fee and Disaster Recovery cost obligations shall be reduced by an amount obtained by multiplying: (i) each of the monthly minimum data processing fees (or Disaster Recovery costs, as appropriate) applicable after the date of such service requirement reduction, as reduced by any prior reduction(s) effected pursuant to paragraph (A) above or this Paragraph (B), by (ii) the quotient obtained by dividing (y) HHL's Fiscal Year 1996 revenue from such discontinued operations or its business no longer supported by AccessLine, by (z) HHL's total Fiscal Year 1996 revenue (excluding the revenue of HLS Financial Group, Inc.). HHL shall provide 30 days' advance written notice to HMS of such reduction, together with adequate supporting documentation related thereto. (iii) To the extent that HHL's final minimum monthly data processing fee obligation is reduced from time to time, pursuant to the foregoing provisions, to an amount which in the aggregate with the minimum monthly data processing fee obligations of all Purchaser(s) totals less than $200,000, HMS shall refund promptly to HHL (x) the amount by which the $200,000 advance payment specified in Section 3(b) hereof exceeds the reduced monthly minimum data processing fee obligation plus (y) the amount, if any, paid to HMS by the Purchaser(s) as advance payment(s) for the last month of each such Purchaser's data processing agreement with HMS. 5 6 (iv) Any excess of (x) the monthly fee calculated with reference to five (5%) percent of HHL's monthly revenues (excluding the revenues of HLS Financial Group, Inc.) over (y) the monthly minimum data processing fees of HHL that were paid in the previous month, shall be payable within 10 days after invoicing. If data processing services are limited solely to the use of the Ross/Financial System, the monthly minimum data processing fee will be reduced to $20,000. HHL shall inform HMS of its prior month's revenues by the 15th day of each month. (v) The term "Effective Date" as used herein shall mean 8 October 1996. (d) (i) The term of the Data Processing Agreement is hereby amended so that the remaining term thereof shall be a term of eighteen (18) months commencing 1 November 1996. The Data Processing Agreement shall not automatically renew. (ii) Notwithstanding any other provision hereof, during the term of the Data Processing Agreement as so amended, HHL may terminate the Data Processing Agreement prior to the end of such eighteen (18) month period upon 30 days' advance written notice to HMS. (iii) During the term of the Data Processing Agreement as so amended or the term(s) of any data processing agreements(s) between HMS and one or more Purchaser(s) which have been entered into pursuant to the provisions of Section 3(f) hereof (the "Purchaser Data Processing Agreement(s)"), HMS may elect to terminate such Purchaser Data Processing Agreement(s) with such Purchaser(s) and/or the Data Processing Agreement in the event that at any time HHL's and any successor's monthly minimum data processing fee obligations to HMS together with the monthly minimum data processing fee obligations of all Purchaser(s) to HMS (collectively, the "Monthly Aggregate Data Processing Fees") shall be reduced to less than $100,000 per month in the aggregate. HMS shall make such election by giving 60 days' advance written notice to HHL and the Purchaser(s) of HMS's election to terminate the Data Processing Agreement and/or the Purchaser Data Processing Agreement(s). Notwithstanding the foregoing, HHL and the Purchaser(s) shall have the right on one occasion only to suspend HMS's notice(s) of termination (the "HMS Termination Notice(s)") by giving HMS written notice (the "Reply Notice") of their intention to pay to HMS, on a month to month basis, the full amount of the difference between (a) $100,000 and (b) the Monthly Aggregate Data Processing Fees as so reduced (the "Aggregate Shortfall 6 7 Amount"). The Reply Notice shall be given within 30 days of the receipt by HHL and the Purchaser(s) of the HMS Termination Notice(s) and shall be accompanied by the payment of the Aggregate Shortfall Amount with respect to the first month in which the Monthly Aggregate Data Processing Fees were reduced to less than $100,000. Upon delivery of the Reply Notice and the initial monthly Aggregate Shortfall Amount, the term of the Data Processing Agreement and the term(s) of the Purchaser Data Processing Agreement(s) shall continue uninterrupted in accordance with the terms hereof and thereof. Thereafter, HHL and the Purchaser(s) shall pay to HMS the monthly Aggregate Shortfall Amount on the 25th day of the following month. In the event an Aggregate Excess Amount (as hereinafter defined) shall be paid to HMS by HHL and/or one or more Purchaser(s) with respect to any month for which HHL and/or the Purchaser(s) shall have paid an Aggregate Shortfall Amount, HMS shall, upon receipt of such Aggregate Excess Amount, refund the Individual Shortfall Amount (as hereinafter defined) for that month to each respective payor thereof (in each case, up to the amount of such payor's Individual Excess Amount (as hereinafter defined)) or to such parties as shall be otherwise directed by HHL and/or the Purchaser(s) in writing. As used herein, the term "Aggregate Excess Amount" shall mean any excess of (x) the aggregate of (A) the monthly fee of HHL calculated with reference to five (5%) percent of HHL's monthly revenues (excluding the revenues of HLS Financial Group, Inc.) plus (B) the monthly fee of one or more Purchaser(s) calculated with reference to five (5%) percent of such Purchaser(s) monthly revenues over (y) the sum of the Monthly Aggregate Data Processing Fees and the Aggregate Shortfall Amount (if any). As utilized herein, the term "Individual Excess Amount" shall mean the respective amount paid by HHL and each of the Purchaser(s) as a portion of the Aggregate Excess Amount. As utilized herein, the term "Individual Shortfall Amount" shall mean the respective amount paid by HHL and each of the Purchaser(s) as a portion of the Aggregate Shortfall Amount. At any time during the period that HHL and the Purchaser(s) shall be paying monthly Aggregate Shortfall Amounts to HMS, HHL and the Purchaser(s) may elect to discontinue the payment of the monthly Aggregate Shortfall Amounts and to terminate the Data Processing Agreement and the Purchaser Data Processing Agreement(s) by giving 30 days advance written notice (the "HHL/Purchaser(s) Termination Notice") to HMS of their election to terminate such agreement(s). Such termination shall be effective 30 days following the delivery to HMS of the HHL/Purchaser(s) Termination Notice, and HHL and the Purchaser(s) shall have no obligation to pay any such monthly Aggregate Shortfall Amounts for such 30 day period. HMS shall have no obligation to provide data processing services under the Data Processing Agreement and the Purchaser Data Processing 7 8 Agreement(s) for more than 60 days following the last day of the month with respect to which the last Aggregate Shortfall Amount has been paid. (iv) The Data Processing Agreement and HMS's obligation to provide data processing services thereunder shall terminate automatically if any fee due from HHL under the Data Processing Agreement is overdue for more than 15 days or if there is any other material default by HHL under the Data Processing Agreement which is not cured within 15 days after written notice thereof from HMS; provided, however, that the Data Processing Agreement shall not terminate from a material non-payment default if it is not reasonably practicable for HHL to cure such material default within such 15 day period and HHL shall have within such 15 day period (x) commenced good faith efforts to cure such default and be continuing to diligently pursue such efforts, and (y) given HMS written notice of the reasons for HHL's inability to promptly cure such default, as well as HHL's good faith estimate as to the completion date for such cure; provided, however, that notwithstanding the foregoing, if such material non-payment default has not been cured by HHL within 90 days after written notice thereof from HMS, the Data Processing Agreement shall terminate. (v) Upon termination of the Data Processing Agreement for whatever reason, HHL's obligations for processing fees (including monthly minimum data processing fees) and Disaster Recovery costs will cease to accrue. Any amounts paid in advance by HHL to HMS shall be applied to any HHL data processing fees and Disaster Recovery costs which accrue for the month prior to such termination. To the extent that payments made in advance by HHL to HMS exceed any obligations of HHL to HMS at the termination of the Data Processing Agreement, HMS shall refund such amount to HHL promptly; to the extent that payments made in advance by HHL to HMS are less than any obligations of HHL at the termination of the Data Processing Agreement, HHL shall pay such amount to HMS promptly. (e) HHL shall pay to HMS $12,000 per month in advance for Disaster Recovery, as reduced from time to time pursuant to Section 3(c)(ii) hereof. Disaster Recovery and the cost therefor shall be cancelable by HHL on 30 days' advance written notice to HMS. (f) HMS shall enter into separate agreement(s) with any Purchaser(s) (other than HMS) of all or a portion of the assets or business of HHL, if any, pursuant to which HMS will commit to provide 8 9 the same data processing services as are to be provided to HHL pursuant to the Data Processing Agreement, as modified by the terms specified herein for HHL and subject to the following additional provisions: (i) Minimum monthly data processing fees and Disaster Recovery costs shall be prorated among HHL and all Purchaser(s) based approximately on revenue as provided above in Section 3(c) hereof. (ii) Each additional entity receiving data processing services shall be required to pay to HMS $10,000 per month in addition to the fees provided for in Section 3(c) hereof; provided, however, that any additional entity which: (1) agrees to receive data processing for 6 months or less; (2) will be converting to another provider of data processing services (whether pursuant to a license for AccessLine or another software system); and (3) can be supported within the current AccessLine framework (e.g., via a new office/letter code without the need for a separate MVS partition) shall be exempt from the $10,000 per month payment and shall be able to terminate services on 30 days written notice. (iii) All such agreement(s) with Purchaser(s) shall terminate eighteen (18) months after 1 November 1996 except as otherwise provided herein. (iv) If HHL licenses the AccessLine system and software to one or more Purchaser(s), HMS shall provide each such Purchaser with a copy of the AccessLine system and software, as defined in Section 2(a) above, provided that HMS shall be reimbursed for its reasonable costs in connection therewith. (v) HMS shall cooperate in and provide support for the conversion by any or all Purchaser(s) from HMS's data processing services to another data processing system (including processing of AccessLine on another hardware platform), including but not limited to provision of such Purchaser's data and documentation, provided that HMS shall be reimbursed by each Purchaser for its reasonable costs in connection therewith. (g) HMS and HHL shall develop, by 31 October 1996 or as soon thereafter as practicable, the form of a standard agreement for data processing services between HMS and each such Purchaser, including but not limited to the terms of subsection (f) above. 9 10 (h) The Data Processing Agreement shall be deemed to be amended in part as of the Effective Date in accordance with the terms hereof. Without limiting the generality of the foregoing, the following specific amendments and deletions to the Data Processing Agreement shall be deemed to be effective as of the Effective Date: (i) Schedules A, B, C and D to the Data Processing Agreement shall be deleted therefrom in their entirety and the new Schedules A, B, C and D attached hereto shall be substituted therefor in their place. (ii) Items 1 and 2 of Schedule H and all of Schedule I to the Data Processing Agreement shall be deleted therefrom in their entirety. (iii) The following Articles and Sections shall be deleted in their entirety from the Data Processing Agreement: Article I, Section 2.3(e), Section 2.4(d), Section 4.1, Section 4.2, Section 6.2, Section 6.3, Section 9.4(e)(i) and Section 9.5(e)(i). (iv) Section 2.3(c) and Section 4.3(b) of the Data Processing Agreement are hereby amended so that the phrase "16 full-time programming support personnel" shall read "six (6) full time programming support personnel". Section 4.3(b) of the Data Processing Agreement is hereby amended so that the phrase "not less than 12 full-time equivalent support personnel nor more than" shall be deleted from therefrom. Section 2.3(c) and Section 4.3(b) shall also be deemed to be further modified pursuant to the terms of Section 3(a) hereof. (v) Section 4.7 of the Data Processing Agreement is amended to conform to the terms of Section 3(c), (d) and (e) hereof. (vi) Section 5.1 of the Data Processing Agreement is amended to conform to the terms of Sections 3(b) and 3(e) hereof. (vii) Section 6.1 of the Data Processing Agreement is amended to conform to the terms of Section 3(d) hereof. (viii) Section 10.4 of the Data Processing Agreement is amended to conform to the terms of Section 2 hereof. (ix) Section 11.1 and Section 11.9 of the Data Processing Agreement shall be deemed to be amended to delete all references therein to the Oversight Committee and its function. 10 11 (x) In all other respects, following the Effective Data the Data Processing Agreement shall continue in full force and effect in accordance with its terms, as amended hereby. In the event of any inconsistency between this Agreement and the Data Processing Agreement, this Agreement shall govern. (i) Capitalized terms utilized herein and not defined herein shall have the respective meanings ascribed to them in the Data Processing Agreement. Section 4. Intercompany Payments between HMS and HHL. Each of HMS and HHL: (a) Shall continue to use its best efforts to collect all accounts receivable from customers on behalf of the other which arise in connection with the subcontracts referred to in Section 1 hereof. For all payments received by HMS or HHL on behalf of the other after the Effective Date, each shall promptly remit such payments to the other. (b) Obtain and/or provide to the other certain goods and services on a mutually agreeable basis (including but not limited to voice and data telecommunications services, laser printing, subleased space, and support services). Each of HHL and HMS shall promptly pay, upon receipt of an invoice from the other, for such services or goods obtained or provided after October 1, 1996. Section 5. HMS Payables. HMS shall on the date hereof pay $1,070,000 to HHL and shall waive all future rights of set off, counterclaim, and recoupment with respect to the accounts payable due and owing from HMS to HHL. Upon the effectiveness of this Agreement, such amount plus the license fee for the AccessLine software and system (as per Section 2 hereof) minus the $200,000 to be retained by HMS pursuant to Section 3(b) hereof shall be wired to HHL's operating account at First Chicago pursuant to HHL's direction given hereby, and First Chicago shall debit such account in the amount of $870,000 to be applied against its HHL loans. Section 6. Releases. (a) Background. HMS believes it holds valid contractual claims of approximately $6 million against HHL. HHL and First Chicago on the one hand, and HMS on the other hand, dispute whether the amounts HHL is contractually obligated to pay HMS for data processing represent above market amounts. HMS and First Chicago have disputed whether First Chicago's security interest in HHL's assets is prior to rights asserted by HMS of recoupment and set off. HMS represents that it has 11 12 recouped and set off approximately $1,889,000 with respect to (y) expenses invoiced to HMS which were incurred by HHL on HMS's behalf and (z) accounts receivable of HHL collected by HMS prior to the Effective Date. (b) Release of HHL and First Chicago by HMS. HMS on behalf of itself, its affiliates, successors and assigns, in consideration of the mutual covenants and agreements contained herein, hereby waives, releases and forever discharges each of HHL and First Chicago, their respective stockholders, subsidiaries, affiliates, legal counsel and their successors and assigns (collectively, "Representatives"), and their respective officers, directors, employees and agents (collectively, the "Officials") (but only with respect to actions taken in their respective capacities as officers, directors, employees and/or agents of HHL or First Chicago, respectively) from any and all liability regarding each and every right and claim of any nature whatsoever related to HHL, in law or in equity, whether known or unknown and existing as of the Effective Date, against (i) HHL, its Representatives and Officials, or (ii) First Chicago, its Representatives and Officials solely in connection with First Chicago's loans to HHL, in either case including without limitation, all claims made, relating to or arising, directly or indirectly, out of rights or actions based upon theories of contract, tort, set off or recoupment including, without limitation, any and all claims against HHL arising under the Data Processing Agreement which accrued on or prior to the Effective Date (the "HMS Released Claims"); provided, however, that (x) except as set forth above, HMS shall not be deemed to have released any of its rights to enforce this Agreement, the Data Processing Agreement, as amended hereby, and/or any other rights or obligations under any subcontract agreements referenced in Section 1 hereof that survive the Effective Date, and (y) the HMS Released Claims Against HHL shall not be released to the extent, if any, that HHL becomes a debtor under Title 11 of the United States Code (a "Debtor") and the HHL Released Claims or any claims of the estate of HHL arising solely upon the commencement of a Title 11 case by HHL and solely as a result of its status as a Debtor ("Estate Claims") are asserted against HMS. (c) Release of HMS by HHL and First Chicago. Each of HHL and First Chicago on behalf of themselves, their respective affiliates, successors and assigns, in consideration of the mutual covenants and agreements contained herein, hereby waives, releases and forever discharges HMS, its Representatives and its Officials (but only with respect to actions taken in their respective capacities as Officials of HMS) from any and all liability regarding each and every right and claim of any nature whatsoever related to HHL, in law or in equity, whether known or unknown and existing as of the Effective Date, against 12 13 HMS, its Representatives and its Officials (but in the case of First Chicago and its Representatives and Officials, solely in connection with its loans to HHL), including without limitation, all claims made, relating to or arising directly or indirectly, out of rights or actions based upon theories of contract, tort, set off or recoupment including, without limitation, any and all claims against HMS arising under the Data Processing Agreement which accrued on or prior to the Effective Date (respectively, the "HHL Released Claims Against HMS" and the "First Chicago Released Claims Against HMS"); provided, however, except as set forth above, that neither HHL nor First Chicago shall be deemed to have released any of their respective rights to enforce this Agreement, the Data Processing Agreement, as amended hereby, any other rights or obligations under any subcontract agreements referenced in Section 1 hereof that survive the Effective Date, and/or the liens and security interests of First Chicago granted by HMS or its Representatives or Officials, and all documents, instruments or agreements evidencing or governing the same. (d) Release of First Chicago by HHL. HHL on behalf of itself, its affiliates, successors and assigns, in consideration of the mutual covenants and agreements contained herein, hereby waives, releases and forever discharges First Chicago, its Representatives and its Officials (but only with respect to actions taken in their respective capacities as Officials of First Chicago and relating to the relationship of HHL and HMS) from any and all liability regarding each and every right and claim of any nature whatsoever, in law or in equity, whether known or unknown and existing as of the Effective Date, against First Chicago, its Representatives and Officials and relating to the relationship of HHL and HMS, including without limitation, all claims made, relating to or arising, directly or indirectly, out of rights or actions based upon theories of contract, tort, set off or recoupment and relating to the relationship of HHL and HMS (the "HHL Released Claims Against First Chicago", and collectively with the HHL Released Claims against HMS, the "HHL Released Claims"); provided, however, that HHL shall not be deemed to have released any of its rights to enforce this Agreement, the Data Processing Agreement, as amended hereby, and/or any other rights or obligations under any subcontract agreements referenced in Section 1 hereof that survive the Effective Date. (e) Release of HHL by First Chicago. First Chicago on behalf of itself, its affiliates, successors and assigns, in consideration of the mutual covenants and agreements contained herein, hereby waives, releases and forever discharges HHL, its Representatives and Officials (but only with respect to actions taken in their respective capacities as Officials of HHL) to the extent relating to the relationship of HMS and 13 14 HHL from any and all liability regarding each and every right and claim of any nature whatsoever, in law or in equity, whether known or unknown and existing as of the Effective Date, against HHL, its Representatives and Officials and to the extent relating to the relationship of HHL and HMS, including without limitation, all claims made, relating to or arising directly or indirectly, out of rights or actions based upon theories of contract, tort, set off or recoupment and to the extent relating to the relationship of HHL and HMS (the "First Chicago Released Claims Against HHL" and collectively with the First Chicago Released Claims Against HMS, the "First Chicago Released Claims"); provided, however, that First Chicago shall not be deemed to have released (i) any other rights or remedies against HHL, or any Representatives or Officials of HHL or of any of its affiliates or subsidiaries, including, without limitation, its rights or remedies under or in connection with its amended and restated Term and Revolving Credit Loan Agreement with HHL or any other agreement, document or instrument related thereto or delivered in connection therewith, any indebtedness, liability or obligation of HHL, its subsidiaries or affiliates thereunder or related thereto, or any lien, security interest (including without limitation any security interest in any obligations owing from HMS to HHL which survive the Effective Date), encumbrance or right of set off or recoupment arising thereunder or related thereto, including, without limitation, the liens and security interests of First Chicago granted by any Representatives or Officials of HHL or of any of its affiliates or subsidiaries (excluding therefrom the First Chicago Released Claims Against HHL), or (ii) any of its rights to enforce this Agreement, the Data Processing Agreement, as amended hereby, and/or any subcontract agreements referenced in Section 1 hereof that survive the Effective Date. (f) Use of the HMS Released Claims. In the event that HHL becomes a Debtor and either HHL or its estate's representative shall raise any claims against HMS on account of the HHL Released Claims or the Estate Claims, HMS shall only use the HMS Released Claims as defenses, set offs, and recoupments against the HHL Released Claims and the Estate Claims. In no event shall HMS use the HMS Released Claims to obtain an affirmative recovery against HHL. (g) The term "affiliates" when used herein with respect to HHL shall not include HMS, and the term "affiliates" when used herein with respect to HMS shall not include HHL. Section 7. Waiver of Future Rights. HMS waives all rights of set off, counterclaim, and recoupment with respect to its payables to HHL, the exercise of which would be adverse to HHL or First Chicago, including, but not limited to, the payables to HHL described in Section 4 hereof; provided, however, that the foregoing 14 15 shall not prevent HMS from asserting any and all of the HMS Released Claims as counterclaims and/or rights of set off and recoupment against the HHL Released Claims or any Estate Claims, if such claims are brought by the estate of HHL against HMS. HMS shall not challenge the allowability of First Chicago's claim in any case involving HHL under Title 11 of the United States Code and shall not challenge such claim's priorities, seniority, and secured status. Section 8. Assignments by First Chicago and HMS. If HHL becomes a Debtor and (a) the HHL Released Claims or any Estate Claims are asserted against HMS and (b) HMS pays any amounts to the estate of HHL in respect of such claims ("HMS Payments"), First Chicago shall transfer to HMS, promptly after receipt thereof, the amount First Chicago receives from the HHL estate resulting from the HMS Payments, other than amounts received by First Chicago as reimbursement of cash collateral used to prosecute the litigation giving rise to such HMS Payments ("First Chicago HMS Receipts"); provided, however, that if any portion of the cash collateral used to prosecute the litigation has not been reimbursed to First Chicago at the time of such receipt ("Unreimbursed Cash Collateral"), First Chicago may deduct from the First Chicago HMS Receipts to be transferred to HMS an amount equal to the product of (i) the Unreimbursed Cash Collateral, multiplied by (ii) the quotient obtained by dividing (A) the First Chicago HMS Receipts by (B) the HMS Payments. First Chicago shall not consent to any use of its cash collateral to sue HMS or its related parties; First Chicago shall not be deemed to have given such consent if a bankruptcy court has ordered the use of its cash collateral following First Chicago's objection to such use. If HHL becomes a Debtor and HMS obtains a distribution from the HHL estate on behalf of any of the HMS Released Claims notwithstanding Section 7 above, HMS shall transfer to First Chicago, promptly after receipt thereof, the amount HMS receives on account of those claims, without set off, counterclaim, recoupment or other defense of any kind. HMS shall not assign its rights to such distribution without the prior written consent of First Chicago. To the extent First Chicago and HMS do not agree on how to enforce this Section 8, they shall each submit the dispute to binding arbitration in the Borough of Manhattan of New York City under the auspices of, and in accordance with the rules of, the American Arbitration Association. Section 9. Power and Authority. Each party signing below represents and warrants that such party has full power and authority to execute this Agreement and to perform all covenants and agreements to be performed hereunder, and that such party has not previously assigned or transferred all or any part of any claim or right covered by this Agreement. Each party signing below represents and warrants that all corporate action necessary to execute, deliver and perform this Agreement and the obligations contained herein has been duly taken. Section 10. Benefit of Counsel. Each party hereto represents and warrants that it has read and reviewed this Agreement in its entirety and has sought and obtained the benefit of full, complete and competent legal advice in connection with this Agreement. 15 16 Section 11. Binding Agreement. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns. Section 12. Entire Understanding; Integration. This Agreement, together with the Data Processing Agreement as amended herein, contains the entire understanding among the parties hereto concerning the subject matter hereof and supersedes and replaces all prior negotiations, proposed agreements and agreements entered into by any of the parties hereto with respect to the subject matter hereof and thereof, including, without limitation, the Agreement In Principle dated 8 October 1996. This Agreement shall be deemed to be an integrated agreement. Each provision hereof is in consideration of all other provisions hereof. No provision hereof shall be deemed to be severable. Section 13. Amendments. This Agreement may be amended, modified or supplemented only by a writing signed by all the parties hereto. This Agreement may not be modified orally and any purported oral modification shall not be effective. Section 14. Counterparts. This Agreement may be executed in multiple counterparts and, as long as each party has executed one counterpart, this Agreement is enforceable. Section 15. Disclosure. Subject to all rules, regulations and statutes providing for public or judicial disclosure, and except as disclosure of this Agreement shall be deemed necessary to attorneys and accounting firms, representatives, financial advisors, lenders, investment bankers, purchasers or potential purchasers of all or a portion of the business of any party hereto that execute an appropriate confidentiality agreement to maintain this Agreement in strictest confidence, the parties hereto shall keep this Agreement confidential for the benefit of HHL and its creditors. Section 16. Headings. All headings contained in this Agreement are for reference purposes only and shall not be used to interpret this Agreement. Section 17. Applicable Law. This Agreement shall be governed by and construed under the laws of the State of New York with respect to contracts to be entered into and performed entirely within such state, without regard to principles of conflicts of law. Each of the parties hereto hereby irrevocably consents to the service of process in any action or proceeding by the mailing thereof by United States registered or certified mail postage prepaid at its address set forth herein. 16 17 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the date first set forth above. [CORPORATE SEAL] HHL FINANCIAL SERVICES, INC. By: /s/ Robert Holster --------------------------- HEALTH MANAGEMENT SYSTEMS, INC. [CORPORATE SEAL] By: /s/ Phillip Siegel --------------------------- AS TO SECTIONS 5 THROUGH 17 HEREOF ONLY THE FIRST NATIONAL BANK OF CHICAGO By: /s/ Jacqueline Yardley --------------------------- 17 18 STATE OF NEW YORK ) ) SS.: COUNTY OF NASSAU ) On Nov. 4, 1996 before me Nancy Gates personally came Robert M. Holster to me known, who, by me duly sworn, did depose and say that deponent resides at 1000 Woodbury Rd., Woodbury, N.Y. that deponent is the President of HHL Financial Services, Inc., the corporation described in, and which executed the foregoing Agreement and Release of Claims, that deponent knows the seal of the corporation, that the seal affixed to the Agreement and Release of Claims is the corporate seal, that it was affixed by order of the board of the corporation; and that the deponent signed deponent's name by like order. /s/ Nancy Gates _______________________________________ Notary Public [SEAL] STATE OF NEW YORK ) ) SS.: COUNTY OF NEW YORK ) On October 30, 1996 before me Marilou P. Reventar personally came Phillip Siegel to me known, who, by me duly sworn, did depose and say that deponent resides at 33 Cavalier Rd., Westport, CT that deponent is the Chief Financial Officer of Health Management Systems, Inc., the corporation described in, and which executed the foregoing Agreement and Release of Claims, that deponent knows the seal of the corporation, that the seal affixed to the Agreement and Release of Claims is the corporate seal, that it was affixed by order of the board of the corporation; and that the deponent signed deponent's name by like order. /s/ Marilou P. Reventar ________________________________________ Notary Public [SEAL] 19 STATE OF ILLINOIS ) ) SS.: COUNTY OF COOK ) On October 31, 1996 before me Francine Beckert personally came Jacqueline P. Yardley to me known, who, by me duly sworn, did depose and say that deponent is the Vice President of The First National Bank of Chicago, the national bank association described in, and which executed the foregoing Agreement and Release of Claims. /s/ Francine Beckert ________________________________________ Notary Public [SEAL] 20 SCHEDULE A PHYSICAL ENVIRONMENT HARDWARE HMS will supply Client with a hardware configuration, to satisfy Client processing requirements of AccessLine and its supplementary reporting system based on the use of SAS and Tablebase consisting of up to the following as required to meet service level commitments:
CPU - MIPS 40 MEGABYTES 128 CHANNELS 36 DASD GIGABYTES 172 TAPE 34XX 8
or equivalent equipment HMS will supply Client with a hardware configuration, to satisfy client financial requirements of the Ross Renaissance Series System, consisting of the following:
CPU - VAX 4000-3000 - MEGABYTES 32 DASD - R400X Storage - GIGABYTES 4 TAPE - TS207 Tape Drive 1
or equivalent equipment HMS will supply Client with a communication gateway configuration, to satisfy handling of all Client related data lines, consisting of the following:
37XX Communications Controller 2 3728 Matrix Switch 1 Communications Channels 4
or equivalent equipment 21 SCHEDULE B HHL FINANCIAL SERVICES, INC. SOFTWARE ENVIRONMENT SYSTEMS SOFTWARE (OR EQUIVALENTS)
PRODUCT/FEATURE VENDOR PURPOSE - ------------------------------------------------------------------------------------------------- 5665 - XA3 MVS/DFP IBM MVS/ESA 5665 - 289 ACF/VTAM IBM Telecomm 5665 - 327 DFDSS IBM Backup/Restore 5665 - ACF/SSP V3 IBM Telecomm 5665 - 362 netview MVS/XA IBM Telecomm 5665 - 370 MVS/Ditto IBM File Utility 5665 - 402 ISPF/PDFV3 IBM Program Main. 5665 - 488 SDSF IBM Spool Utility 5668 - 854 ACF/NCP for 3725 IBM Telecomm 5668 - 949 SMP/E IBM MVS/ESA 5668 - 958 VS COBAL II IBM Programming 5668 - 962 Assembler HV2R1 IBM Programming 5685 - 025 TSO/E V2 IBM MVS/ESA 5685 - 029 RMF V4 IBM MVS/ESA 5685 - 054 ISPF V3 IBM Program Main. 5685 - 083 CICS/ESA V3 IBM Telecomm 5695 - 047 JES2 MVS/SP V4 IBM MVS/ESA 5740 - SM1 OS/VS Sort/Merge IBM Sort 5740 - XXH RACF IBM Security DASD Design Strategy DASD Reports FAVER/MVS Goal Systems VSAM Bkup/Rstr VSAM Capacity Plus Softworks VSAM Compress
22 HHL FINANCIAL SERVICES, INC. SOFTWARE ENVIRONMENT SYSTEMS SOFTWARE
PRODUCT/FEATURE VENDOR PURPOSE - ------------------------------------------------------------------------------------------------- TMON/CICS ESA 1.0 Landmark CICS Perf Mon XPEDITER/CICS/TSO Compuware CICS Debug Tubes/VTAM Macro-4 Multi-Sess SAS (Base.ETS.FSP) SAS Institute 4-GL STOPX-37.BudgetDASD Empact DASD Mang PanValet, PanApt Computer Associates Program Maint JESLOG Ricomm JCL Capture TABLEBASE Data Kinetics Application Development VIEW/DELIVER CA Report Management JOBTRAC CA Job Scheduling MEDIA CA Tape Management GROUP 1 SOFTWARE Group 1 Mailing Application
23 SCHEDULE C PERFORMANCE STANDARDS I. BASELINE A) Transaction Volume Client agrees and understands that the physical hardware and communications environments specified in Schedule A have been configured to provide online services with the capacity to process up to 1 million transactions per day under the AccessLine application. Client acknowledges that any new product or service offerings by Client, newly acquired Applications Software or new acquisitions by Client may require a re-evaluation of the current Data Center performance standards. B) Online Usage Client agrees and understands that online availability is based on the current batch windows agreed upon in Section D below. If Client requests an extension of the online window, the system may not come up on time the following morning. C) Data Input Client agrees to submit all data in accordance with existing standards for input at the times of batch processing availability set forth below in Paragraph I (D) Systems Availability. D) Systems Availability 1) Holidays Observed Holidays observed as of the Effective Date of this Amendment are as follows: New Year's Day Labor Day Memorial Day Thanksgiving Day Independence Day Christmas Day 24 2) On-Line Operating Hours (Client's Local Office Times) HMS scheduled hours of on-line operation as of the Effective Date are as follows: 8:00 AM - 7:30 PM (Local Time) Monday - Friday 8:00 AM - 12:00 PM (Local Time) Saturday 3) Batch Operating Hours 7:30 PM - 7:30 AM (ET) Monday - Friday 3:00 PM - 8:00 AM (ET) Saturday through Sunday 8:00 AM - 7:30 AM (ET) Sunday through Monday NOTE: If HHL utilizes two CICS Regions (Production and Branch) Monday - Friday, end times will be 9:00 PM Local Time II. DATA CENTER A) Online Availability AccessLine Online Systems shall be available 98% of the time scheduled to be available on a monthly basis. Actual online performance will be calculated monthly by computing the number of hours that the Central Processing Unit was actually operational on an online basis as a percentage of the number of hours it was scheduled to be operational on an online basis, exclusive of preventative, but not scheduled, maintenance. Preventative maintenance by HMS and the resultant lack of online systems availability during the above scheduled hours of operation are that which are required due to Client's actions. Downtime caused by Operations error, Systems error, hardware malfunction, telephone line failure or Data Center environmental failures will be included in the calculation of the online availability statistics. Downtime caused by client errors, environmental conditions external to the client site such as loss of power, air conditioning and/or acts of God will not be included in the calculation of the online availability statistics. 25 B) Response Time AccessLine response time shall not exceed, on average, more than three (3.0) seconds per response, except that the Phoenix office shall be excluded from this standard. Response time shall be defined as the time taken for the Central Processor to receive a transaction from the 3174 Communications Controller (or equivalent), process the transaction, and transmit the resulting response back to the Controller located at the client site. C) Reports AccessLine critical reports shall be available for remote printing on time without significant errors each month. Actual performance will be calculated monthly by computing the total number of critical reports which were available on time and without significant error to the number of critical reports which were scheduled to be available on time and without significant error. On time is defined as meeting the standard corresponding to each critical report as set forth below not less than 95% of the time. Critical reports shall include:
ON TIME STANDARD - REPORT WITHIN: ---------------------------------------------------------------------------- 1. Client Remittances 72 hours of client's customary billing cycle close 2. Accounts Receivable Statements " " " " 3. Invoices " " " " 4. Status Reports 10 days of client's month end 5. Placement Analysis " " " " 6. Closed " " " " 7. Acknowledgment 48 hours of each loading to AccessLine of Client's customers' accounts
26 D) Performance Reports HMS will report to Client on a daily basis regarding the matters delineated in Paragraphs II (A) and (B) above with respect to its adherence to, or deviation from, the performance standards set forth in this Schedule C during both the preceding day and the current month through such preceding day. HMS will report to Client on a monthly basis regarding the matters delineated in Paragraph II (C) above with respect to its adherence to, or deviation from, the performance standards set forth in this Schedule C during the preceding month. 27 SCHEDULE D APPLICATIONS SOFTWARE HMS will utilize AccessLine custom software to provide Client with functionality needed to perform collection and follow-up services for Client-related product lines. Software consists of a series of online and batch programs written in COBOL II utilizing CICS functionality and providing Client with the ability to inquire and update online and to receive on demand or at scheduled intervals of time various batch reports that will be used internally by Client or be distributed by Client to its customers. In addition, certain applications residing outside the CICS environment (e.g. ARCL) will be maintained. SAS will be available for use only against AccessLine master files. HMS will utilize a third party software package from Ross called the Renaissance Series for financial support and associated DEC Software to support the system. On an ongoing basis, enhancement requests made by Client for purposes of enhancing software will be recorded weekly by HMS on the HHL Programming Log for purposes of prioritizing, changing, and implementing such changes. An index of all AccessLine and related SAS programs and a software tape will be generated to serve as the baseline of programs available at time of execution of this Amendment. Thereafter, the index and tape backup will be done not less than on a quarterly basis to serve as a record of the then-current version of the software. 28 ATTACHMENT 1 August 1996 ACCESSLINE SERVICE LEVEL COMMITMENTS This document defines HMS's service level commitments to HHL. Services are grouped into five tables according to the functional categories listed below. Within the appropriate category, an entry for each service specifies the unit of the Data Center responsible for its execution and the commitment according to which the service will be performed. Please see the HHL Data Center Contact Matrix for information on who to contact for AccessLine problems and questions. Revised 24 October 1996 TABLE OF CONTENTS Routine Operations ...................................... 1 Output Processing ....................................... 4 Telecommunications ...................................... 5 Programming ............................................. 6 AccessLine Administration ............................... 8 29 1. ROUTINE OPERATIONS Description of Services: Provide and maintain AccessLine, including online, batch, and referral processing. (ALL TIMES LISTED ARE EASTERN TIME)
ROUTINE OPERATIONS (1) Service Responsible Unit Commitment 1. Online Availability Computer Ops AccessLine Dates Start Time End Time Region(3) Available Available 98% of time scheduled on monthly basis. Production Monday-Friday 0800 1930 Saturday 0800 1200 last day of 0800 2100 month first day of 1100 1930 month East (Branch) Monday-Friday 0800 1930 Saturday 0800 1200 last day of 0800 2100 month first day of 1100 1930 month West Monday-Friday 1100 2230 Saturday 1100 1500 last day of 1100 2400 month first day of 1400 2230 month 2. Response Time Computer Ops 90% of all transactions completed within 3 seconds. 3. Batch Processing(2) Computer Ops Complete batch processing by 0800 local time, unless on month end schedule. 4. CIS Download Computer Ops Complete successful download by 0800 local standard time. (mainframe to field)
- ------------------------------------------------------------------------------- AccessLine Service Level Commitments--October 1996 Revised Page 1 30 ROUTINE OPERATIONS(1)
Service Responsible Unit Commitment 5. CIS Data Upload Computer Ops Cutoff for field to upload data to the mainframe: 2100 local standard (field to mainframe) time. 6. OCM Download Computer Ops Complete successful downloaded by 0800 local standard time. (mainframe to field) 7. Account loads Computer Ops Type of Referral Accounts loaded within... (referrals) under 20K records with no 24 hours itemized bills and no UB info under 10K records with 24 hours itemized bills and UB info 11K-20K records with itemized 48 hours bills and UB info over 20K records, pend 7 calendar days referral and special cleanup projects 8. ARCL Processing Support existing ARCL loads according to above standards; convert ARCL to Ad Hoc as programming resource permits. 9. DFU Processing Convert to mainframe operation as soon as possible. 10. DAS Transmission Information available within 3 business days after referral load (directory assistance) 11. SAS Processing Availability to go directly against VSAM master files during normal run time. (All direct access against VSAM master files should be coordinated with Richie Lipack) 12. Reload client referrals Completed within 72 hours 13. Machine Downtime Problems and abends that affect AccessLine uptime are handled as a high (12-24 hour) priority. Information will be communicated to users as soon as it is received by Computer Ops. - -----------------------------------------------------------------------------------------------------------------------------
AccessLine Service Level Commitments-October 1996 Revised Page 2 31 PLEASE NOTE: 1. The Data Center is closed and AccessLine is unavailable on the following days: New Years Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, Christmas Day. 2. Nightly batch processing may be delayed at month-end due to the need for additional online time required to post payments. If necessary, the Data Center reserves the right to cancel lower priority batch jobs to maintain daytime online availability. 3. When East and West regions are consolidated into Branch region, Monday- Friday end times will be 2100 hours local time. - ------------------------------------------------------------------------------- AccessLine Service Level Commitments -- October 1996 Revised Page 3 32 II. OUTPUT PROCESSING Description of Services: Produce and distribute AccessLine output, including letters, statements and reports. OUTPUT PROCESSING
Service Responsible Unit Commitment 1. Letter Processing HMS Computer Ops Letters at U.S.P.S. the next business day after requested (on an exception basis, may require additional days during times of increased online time and corresponding batch delays but not later than third business day after requested.) 2. Acknowledgement Reports Sent to HHL office within 1 day from date of account load 3. Month-end Processing Client Remittances, Reports printed for all remittances within 3 calendar days Invoices and following weekend or month-end date Statements Statistics Completed by the first business day following month-end A/R Trial Balances Completed by the second business day following weekend or month-end All remaining month-end I/O Control Delivered/transmitted to field locations and/or HHL clients processing, report within 10 calendar days after month-end printing and distribution
One copy of all reports will be printed at the data center. Additional copies will be remoted to office for printing. AccessLine Service Level Commitments-October 1996 Revised Page 4 33 III. TELECOMMUNICATIONS Description of Services: Respond to requests for installations and changes in both voice (telephone, predictive dialer) and data (terminal to mainframe connections). Maintain network infrastructure. TELECOMMUNICATIONS
Service Responsible Unit Commitment - ------ ----------------- ---------- 1. New dedicated lines Communications Services Within 30 business days after approval. (installations or office moves, Unit Dependent on phone company installation. T-1s or 800 numbers) 2. New dial-up terminal 30 business days after approval, provided client AHA number ("Beehive")** is supplied. Dependent on phone company installation. 3. Discontinue Service** Hub sites (Woodbury, Eatontown, Miami, Atlanta, Lincolnwood, Phoenix, and North Hollywood): 90 business days after approval. All other sites: 10 business days notice 4. Strategic Infrastructure To be determined on a case-by-case basis according to size Projects and scope of project. Requires prior HHL management approval. 5. Implementation of PC file Refer to "Programming and Data Exchange Protocol." transfers 6. Maintenance and testing of Regions will be notified 30 days prior to scheduled test communication component of procedures. disaster recovery plan
- ------------------------------ ** Request forms and existing protocols for these services can be found in the "Accessline Data Network TSU Binder." However, some service levels in the existing protocol may have been altered. Current service level commitments are reflected in this table. - -------------------------------------------------------------------------------- AccessLine Service Level Commitments--October 1996 Revised Page 5 34 IV. PROGRAMMING
- ----------------------------------------------------------------------------------------------------------------------------- PROGRAMMING - ----------------------------------------------------------------------------------------------------------------------------- SERVICE RESPONSIBLE UNIT COMMITMENT - ----------------------------------------------------------------------------------------------------------------------------- 1. Add task to Programming Log/ HMS/HHL Within 10 business days Assign priority management, AccessLine Support - ---------------------------------------------------------------------------------------------------------------------------- 2. Programming(1) Programming Effort Elapsed Time(2) - -------------------------------------------- ------------------------------------------------- Critical Production Problems (Walk-ins) Dependent on task As soon as possible. - -------------------------------------------- ------------------------------------------------- New Business Standard HHL 800 Referrals 8-20 hours 14 calendar days (no reformatting necessary) Depending on resources - -------------------------------------------- ------------------------------------------------- Simple reformats (convert 40-60 hours To be determined into standard 800 format) depending on resources. - -------------------------------------------- ------------------------------------------------- Custom Reformats (medium 60-100 hours To be determined complexity, multi-file/ depending on multi-record structure) resources. - -------------------------------------------- ------------------------------------------------- Complex referrals (complex over 100 hours To be determined file structures; may require depending on enhancements to resources. AccessLine functionality) - -------------------------------------------- ------------------------------------------------- Corporate Development Detailed project estimate/plan based on the formula below - -------------------------------------------- Enhancements Elapsed business days = Total effort (hours) - -------------------------------------------- ------------------- Maintenance/Production Problems 7 x % programmer's time allocated to task - -----------------------------------------------------------------------------------------------------------------------------
- ---------------------------- (1) Programming includes systems analysis and specification writing, coding, and initial testing. Service levels assume that measurement begins once a task has been prioritized as high or medium and assigned to an available programming resource. (2) For all referral, additional time may be required for user/client interaction. - ------------------------------------------------------------------------------- AccessLine Service Level Commitments -- October 1996 Revised Page 6 35
PROGRAMMING - ------------------------------------------------------------------------------------------------------------------- SERVICE RESPONSIBLE UNIT COMMITMENT - ------------------------------------------------------------------------------------------------------------------- 3. PROGRAMMING STAFF PROGRAMMING SIX PROGRAMMERS/ANALYSTS UNTIL 8 APRIL 1997. FIVE UNTIL 8 JULY 1997. FOUR THEREAFTER - ------------------------------------------------------------------------------------------------------------------- 4. TEST ENHANCEMENT HHL/USERS DEPENDENT UPON COMPLEXITY OF THE TASK AND USER AVAILABILITY - ------------------------------------------------------------------------------------------------------------------- 5. IMPLEMENT ENHANCEMENT/ HHL/COMPUTER NEXT VERSION CONTROL DATE AFTER TASK IS COMMUNICATE CHANGES TO USERS OPS COMPLETED (VERSION CONTROL OCCURS TWICE PER MONTH) - -------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------ ACCESSLINE SERVICE LEVEL COMMITMENTS -- OCTOBER 1996 REVISED PAGE 7 36 V. ACCESSLINE ADMINISTRATION Description of Services: Provide support to AccessLine users and clients in their use of AccessLine System. ACCESSLINE ADMINISTRATION
Service Responsible Commitment Unit 1. Client Profile Updates HHL Ops AHA Code/Temporary Complete within 24 hours. AHA Code Assignment Branch Address Update as needed, in conjunction with Letter projects. Report Setup Complete within 24 hours. 2. Carrier Directory Updates Complete within 5 days. For critical changes, call Jean McAllister at (516) 677-8313. These will be completed within 24 hours. 3. Reports (lost, special requests) Computer Ops Urgent reports: within 48 hours. User should fax completed Report Request Form (attached) to (212) 889-0628. Non-urgent reports: within 5 working days. May be dependent on Programming and/or Operations. Information communicated to user as soon as it is received. 4. AccessLine System Table Updates HHL Ops Complete within 48 hours. (Status Messages, Close Reasons, Variant, Profit Center, Report Tables, closing schedule, Special Dates Tables, Associate Attorney additions and modifications)
- ------------------------------------------------------------------------------- AccessLine Service Level Commitments -- October 1996 Revised Page 8 37 ACCESSLINE ADMINISTRATION
Service Responsible Commitment Unit 5. Maintenance of AccessLine Security HHL Ops Account Representative IDs: completed within 48 hours. (RACF User security. Controls functions and AccessLine IDs with "PM" level and above: requests reviewed by assignment of security levels, Richie Lipack as needed. including password assignment) 6. Letter Enhancements HHL Ops Monitor and coordinate letter request with Compliance personnel (Letter text, RE Criteria, (when text changes are requested) and User. or Pointer Files) Complete within 48-72 hours of receiving compliance approval, if no programming intervention needed. Complete within one week if programming intervention is required. 7. Communications HHL Ops Programming Log Maintenance Distribute every 2 weeks. Request Received Log AccessLine Enhancement Screen Complete before or when enhancement goes live.
- ------------------------------------------------------------------------------- AccessLine Service Level Commitments -- October 1996 Revised Page 9 EX-10.13 4 LEASE-DATED 9/96 1 EXHIBIT 10.13 STANDARD OFFICE LEASE THIS LEASE is made and entered into as of this nineteenth day of September, 1996 by and between PACIFIC CORPORATE TOWERS LLC, a Delaware limited liability company ("Landlord"), and HEALTH MANAGEMENT SYSTEMS INC., a New York corporation, and HEALTH CARE MICROSYSTEMS, INC., a California corporation (collectively, "Tenant"). Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the Premises described as Suite No. 600 on the sixth (6th) floor and Suite No. 700 on the seventh (7th) floor in the building ("Building") whose address is 200 N. Sepulveda Blvd., El Segundo, California, as designated on the plan attached hereto and incorporated herein as Exhibit "A" (the "Premises") of the project consisting of the building(s), parking structure(s), land and any other land or improvements surrounding the buildings which are designated from time to time by Landlord as appurtenant to or servicing the building(s) (the "Project"), now known as Pacific Corporate Towers, for the term and upon the terms and conditions hereinafter set forth, and Landlord and Tenant hereby agree as follows: ARTICLE 1 BASIC LEASE PROVISIONS 1.1 Term. (a) Scheduled Occupancy Date. December 15, 1996, subject to Article 2.1 hereof and Paragraph 7.0 of the Work Letter Agreement attached as Exhibit "C". (b) Scheduled Commencement Date. June 15, 1997, subject to Article 2.2. (c) Scheduled Expiration Date. June 14, 2007, subject to Article 2.2. 1.2 Rentable Square Footage. Thirty-three Thousand Four Hundred Forty-five (33,445) consisting of Twenty-three Thousand Eight Hundred Sixty (23,860) rentable square feet in Suite No. 700, and Nine Thousand Five Hundred Eighty-five (9,585) in Suite No. 600, subject to Article 3.1. 1.3 Basic Rental.
Lease Month Base Annual Rent Monthly Installment ----------- ---------------- ------------------- 1 - 60 $541,809.00 $45,150.75 61 - 120 $622,077.00 $51,839.75
1.4 Base Year. 1997 1.5 Tenant's Proportionate Share. Three percent (3%) 2 1.6 Security Deposit. None. 1.7 Permitted Use. General Office. 1.8 Broker. CB Commercial Real Estate Group, Inc. for Landlord and Tenant. 1.9 Parking Spaces. Ninety-five (95) unreserved and thirty-two (32) reserved parking spaces subject to the terms and conditions of Article 23. If Tenant expands the Premises in accordance with Article 33, Tenant shall be entitled to use four (4) additional parking spaces per each additional one thousand (1,000) rentable square feet added to the Premises. 1.10 Parking Charge. None during the initial ten (10) year term, subject to Article 23. 1.11 Tenant Address Prior to Lease Commencement Date. 3655 Torrance Boulevard, Suite 350, Torrance, CA 90503 ARTICLE 2 TERM 2.1 Early Occupancy. Tenant shall have the right to occupy the Premises for a six (6) month period prior to the Commencement Date ("Early Occupancy Period") commencing upon the expiration of Tenant's Fixturization Period (as defined in the Work Letter Agreement). Tenant's occupancy of the Premises during the Early Occupancy Period shall be without payment of Basic Rental and Tenant's Proportionate Share of Direct Costs as determined below, but shall otherwise be subject to all the terms and conditions of this Lease. 2.2 Lease Commencement. The term of this Lease ("Lease Term") shall commence ("Commencement Date") on the date that is six (6) months after the first day of the Early Occupancy Period. The term of this Lease shall expire, unless earlier terminated, on the date that is one (1) day prior to the tenth (10th) anniversary of the Commencement Date. 2.3 Possession. Subject to and upon approval of the Final Working Drawings and Specifications and Work Cost Estimate by the parties pursuant to the Work Letter Agreement, Landlord shall diligently construct the Tenant Building Standard Work in the Premises. If Landlord is unable to deliver possession of the Premises to Tenant on or before the Scheduled Occupancy Date, Landlord shall not be subject to any liability for its failure to do so, and such failure shall not affect the validity of this Lease nor the obligations of Tenant hereunder, but the Early Occupancy Period shall commence in accordance with Article 2.1 and the Lease Term shall commence in accordance with Article 2.2. At any time during the Lease Term, Landlord may deliver to Tenant a notice executed by Landlord in the form as set forth in Exhibit "D", attached hereto, which Tenant shall execute and return to Landlord within five (5) business days of receipt thereof. -2- 3 2.4 Right to Terminate. Subject to compliance with the terms and conditions contained in this Article 2.4, Tenant shall have the right to terminate this Lease as of the end of the eighty-fourth (84th) month of the Lease Term ("Termination Right"). Tenant may exercise the Termination Right by giving Landlord written notice of such termination not later than the last day of the seventy-eighth (78th) month of the Lease Term. As consideration for the early termination of this Lease, Tenant shall pay to Landlord, concurrently with delivery of its notice of exercise of the Termination Right, an amount equal to ("Termination Payment"): (i) the unamortized tenant improvement costs and leasing commissions incurred by Landlord in connection with this Lease; plus (ii) plus the amount of One Hundred Fifty-five Thousand Five Hundred Nineteen Dollars and Twenty-five Cents ($155,519.25). For purposes of determining the Termination Payment, the Work Cost (as defined in the Work Letter Agreement) incurred by Landlord in connection with the Tenant Building Standard Work constructed by Landlord for Tenant in accordance with the Work Letter Agreement and the leasing commissions paid to the brokers identified in Article 1.8 of the Basic Lease Provisions shall be amortized over the ten (10) year Lease Term. Landlord shall give Tenant written notice of the Termination Payment within ten (10) days after Tenant's written request therefor. Tenant's failure to exercise the Termination Right and to concurrently pay the Termination Payment prior to the end of the seventy-eighth (78th) month of the Lease Term shall be deemed Tenant's waiver of the Termination Right and Tenant shall have no further right to terminate the Lease pursuant to this Article 2.4. If Tenant timely exercises the Termination Right and concurrently pays the Termination Payment, this Lease shall terminate at the end of the eighty-fourth (84th) month of the Lease Term and Tenant shall surrender and vacate the Premises in accordance with Article 29 hereof prior to such date. If a default by Tenant exists under this Lease on the date of the delivery of Tenant's notice of exercise of the Termination Right to Landlord, then such notice shall be of no force and effect, and Tenant shall have no right to exercise the Termination Right; provided, however, that if Tenant cures such default and again gives notice of exercise of the Termination Right not later than the last day of the seventy-eighth (78th) month of the Lease Term, such subsequent notice shall be effective. If a default by Tenant beyond any applicable cure period exists under this Lease at any time after Tenant exercises the Termination Right, then Landlord may at its sole discretion elect to have Tenant's exercise of the Termination Right to be of no force and effect, in which case, Landlord may apply the Termination Payment to the Basic Rental and Additional Rent next accruing and this Lease shall continue and expire at the end of the Lease Term. ARTICLE 3 RENTAL 3.1 Basic Rental. Tenant agrees to pay to Landlord during the term hereof, at Landlord's office or to such other person or at such other place as directed from time to time by written notice to Tenant from Landlord, the initial monthly and annual sums as set forth in Article 1.3 of the Basic Lease Provisions, payable in advance on the first day of each calendar month, without demand, setoff or deduction, and in the event this Lease commences or the date of expiration of this Lease occurs other than on the first day or last day of a calendar month, the rent for such month shall be prorated. Notwithstanding the foregoing, Tenant shall pay to Landlord concurrently with the execution of this Lease the monthly installment of Basic Rental -3- 4 due for the first month of the Lease. Basic Rental shall be subject to increase from time to time pursuant to the subsequent provisions of this Article 3. Landlord shall cause the rentable square footage of the sixth (6th) floor of the Premises to be measured by Pace Compumetrics using the modified BOMA standard. Landlord shall cause Pace Compumetrics to certify to both Landlord and Tenant the rentable square footage of the sixth (6th) floor of the Premises using such method. The rentable square footage of the sixth (6th) floor of the Premises as measured by Pace Compumetrics shall be conclusive on the parties. Upon receipt of such certification, the monthly Basic Rental set forth in Article 1.C of the Basic Lease Provisions shall be adjusted to be equal to the product obtained by multiplying One Dollar and Thirty-five Cents ($1.35) for each rentable square foot in the Premises for the first sixty (60) months of the Lease Term and One Dollar and Fifty-five Cents ($1.55) for each rentable square foot in the Premises during the last sixty (60) months of the Lease Term. 3.2 Increase in Costs. The term "Base Year" means the calendar year set forth in Article 1.4 of the Basic Lease Provisions. If, in any calendar year during the term of this Lease commencing with the calendar year immediately after the Base Year (each such year a "Comparison Year"), (i) the "Tax Costs" (as hereinafter defined) paid or incurred by Landlord shall be higher than the Tax Costs for the Base Year, (ii) the "Operating Costs" (as hereinafter defined) paid or incurred by Landlord shall be higher than the Operating Costs for the Base Year, or (iii) the "Insurance Costs" (as hereinafter defined) paid or incurred by Landlord shall be higher than the Insurance Costs for the Base Year, Tenant shall pay Landlord as Additional Rent Tenant's Proportionate Share (as provided in Article 1.5 of the Basic Lease Provisions) of such increase in the amount by which the respective Tax Costs, Operating Costs and Insurance Costs, paid or incurred by Landlord in such Comparison Year exceed the respective Tax Costs, Operating Costs and Insurance Costs paid or incurred by Landlord for the Base Year. Notwithstanding the foregoing, Tenant's Proportionate Share of the increase in Controllable Costs (as defined below) due and owing Landlord in any year during the Lease Term shall not increase by more than five percent (5%) from the previous Comparison Year or Base Year, as applicable. In the event either the Premises and/or the Project is expanded or reduced, then Tenant's Proportionate Share shall be appropriately adjusted, and as to the calendar year in which such change occurs, Tenant's Proportionate Share for such year shall be determined on the basis of the number of days during that particular calendar year that each such Tenant's Proportionate Share was in effect. In the event this Lease shall terminate on any date other than the last day of a calendar year, Tenant's Proportionate Share of Tax Costs, Operating Costs and Insurance Costs for such calendar year in which this Lease terminates shall be prorated on the basis of the relationship which the number of days which have elapsed from the commencement of said calendar year to and including said date on which this Lease terminates bears to three hundred sixty (360). Any and all amounts due and payable by Tenant pursuant to Articles 3.2, 3.3 and 3.4 hereof shall be deemed "Additional Rent" and Landlord shall be entitled to exercise the same rights and remedies upon default in these payments. 3.3 Definitions. As used herein, the following terms shall have the following meanings: -4- 5 (a) "Tax Costs" shall mean any and all real estate taxes and other similar charges on real property or improvements, assessments, water and sewer charges, and all other charges assessed or levied upon the Project and appurtenances thereto and the parking or other facilities thereof, or the real property (the "Property") thereunder (collectively the "Real Property") or attributable thereto or on the rents, issues or income received or derived therefrom which are assessed or levied by the United States, the State of California or any local government authority or agency or any political subdivision thereof, and shall include Landlord's reasonable legal fees, costs and disbursements incurred in connection with proceedings for reduction of Tax Costs or any part thereof, provided, however, if at any time after the date of this Lease the methods of taxation now prevailing shall be altered so that in lieu of or as a supplement to or a substitute for the whole or any part of any Tax Costs, there shall be assessed or levied (a) a tax, assessment, levy, imposition or charge wholly or partially as a net income, capital or franchise levy or otherwise on the rents, issues, profits or income derived therefrom, or (b) a tax, assessment, levy (including but not limited to any municipal, state or federal levy), imposition or charge measured by or based in whole or in part upon the real property and imposed upon Landlord, or (c) a license fee measured by the rent payable under this Lease, then all such taxes, assessments or levies or the part thereof so measured or based, shall be deemed to be included in the term "Tax Costs". Notwithstanding the foregoing, Tax Costs shall not include any federal or state income tax levied upon Landlord or the rents derived from the Project except to the extent such income taxes are imposed in lieu of or as a substitute for any of the Tax Costs described in the foregoing sentence. Notwithstanding anything to the contrary herein, Tenant shall not be required to pay its Proportionate Share of any increase in Tax Costs resulting from a sale of the Project at any time during the first sixty (60) months of the Lease Term. (b) "Operating Costs" shall mean all costs, expenses and amounts of every kind and nature incurred by Landlord in connection with the maintenance, operation, replacement, ownership and repair of the Project, the equipment, adjacent walks, malls and landscaped and common areas and the parking structure, areas and facilities of the Project, including, but not limited to, salaries, wages, medical, surgical and general welfare benefits and pension payments, payroll taxes, fringe benefits, employment taxes, workers' compensation, uniforms and dry cleaning thereof for all persons who perform duties connected with the operation, maintenance and repair of the Project, its equipment and the adjacent walks and landscaped areas, including janitorial, gardening, security, parking, operating engineer, elevator, painting, plumbing, electrical, carpentry, heating, ventilation, air conditioning, window washing, hired services (but excluding persons performing services not uniformly available to or performed for the benefit of substantially all building tenants), a reasonable allowance for depreciation of the cost of acquiring or the rental expense of personal property used in the maintenance, operation and repair of the Project, accountant's fees incurred in the preparation of rent adjustment statements, reasonable legal fees incurred for the benefit of the Project, real estate tax consulting fees, personal property taxes on property used in the maintenance and operation of the Project, capital expenditures incurred to effect economies of operation and capital expenditures required by government regulations, laws, or ordinances determined in accordance with generally accepted accounting principles as applied to real estate industry standards; the cost of all charges for electricity, gas, water and other utilities furnished to the Project, including any taxes thereon; the cost of all building and cleaning supplies and materials; the cost of all charges for cleaning, maintenance and -5- 6 service contracts and other services with independent contractors (including property management fees); and license, permit and inspection fees relating to the Project. In the event, during any calendar year, the Project is less than one hundred percent (100%) occupied at all times, the Operating Costs shall be adjusted in accordance with real estate industry standards to reflect the Operating Costs of the Project as though one hundred percent (100%) occupied at all times, and the increase or decrease in rent shall be based upon such Operating Costs as so adjusted. Operating Costs shall also include all management fees. Landlord shall not, in any subsequent year, add any categories of Operating Costs that were not included within the Base Year; provided, however, that Landlord may change the name of the categories under which it allocates Operating Costs from time to time. Landlord shall have the right, from time to time, to equitably allocate some or all of the Operating Costs among different tenants of the Project (i.e. office space and retail space tenants of the Project). "Operating Costs" shall not include any of the following: (i) any ground lease rental, (ii) costs incurred by Landlord with respect to goods and services (including utilities) furnished to tenants to the extent that Landlord is reimbursed directly for the cost of such service by such tenants, (iii) costs incurred by Landlord for the repair of damage to the Building or Project to the extent of insurance proceeds received by Landlord for such costs; (iv) costs, including permit, license and inspection costs, incurred with respect to the design, planning, construction and installation of tenant improvements for new tenants in the Project, (v) leasing commissions, attorneys' fees and other costs in connection with leasing space in the Building or Project or in connection with disputes with individual tenants, (vi) costs for services provided directly to specific tenants for which Landlord is reimbursed by such tenants, (vii) interest, points, fees, and other costs of debt service on any financing encumbering the Building, Project or land on which is the Project is situated, (viii) advertising expenses; (ix) any compensation paid to clerks, attendants or other persons in commercial (for profit) concessions operated by Landlord in the Project, and (x) tax penalties or interest incurred as a result of Landlord's failure to pay any Tax Cost(s) prior to the delinquency date therefor. (c) "Insurance Costs" shall mean the cost of all charges for fire and extended coverage, commercial liability and all other insurance for the Project required to be carried by Landlord under the Lease or now or hereafter maintained by Landlord with respect to the Project. (d) "Direct Costs" as used herein shall mean the Tax Costs, Operating Costs, and Insurance Costs. (e) "Controllable Costs" shall mean costs incurred by Landlord for landscape, maintenance, janitorial, security and other services provided to the Building or Project by third party service providers. 3.4 Determination of Payment. (a) Landlord shall, prior to the commencement of each Comparison Year, furnish to Tenant a written estimate showing in reasonable detail Landlord's estimated Direct Costs for the next following Comparison Year and the amount of Tenant's Proportionate Share of -6- 7 the increase in Tax Costs, Operating Costs and Insurance Costs appropriately prorated on a monthly basis for such Comparison Year. Thereafter, on each monthly rental payment date, Tenant shall pay to Landlord the monthly amount of Tenant's Proportionate Share of the estimated increase in Direct Costs as shown in said written estimate. Landlord reserves the right to revise any estimate of Direct Costs if actual or projected Tax Costs, Operating Costs or Insurance Costs show an increase or decrease from any earlier estimate for the same Comparison Year. Landlord shall deliver such revised estimate to Tenant together with a written explanation of the actual or projected increase in Tax Costs, Operating Costs or Insurance Costs at any time during the Comparison Year, and Tenant shall commence payment of such estimated amount on the next monthly rental payment as shown in the revised estimate. Neither Landlord's failure to deliver nor the late delivery of such estimate shall constitute a default by Landlord hereunder or a waiver of Landlord's right to receive Tenant's Proportionate Share of the estimated increase in Direct Costs and Tenant shall continue to pay on the basis of the most recent estimate until Landlord delivers a new estimate of Direct Costs to Tenant. Within one hundred eighty (180) calendar days following the close of each Comparison Year during the term hereof, Landlord shall endeavor to furnish to Tenant a written statement (the "Reconciliation") showing in reasonable detail Landlord's actual Tax Costs, Operating Costs and Insurance Costs for the relevant Comparison Year, together with a full statement of any adjustments necessary to reconcile any sums paid (or credited) hereunder as Tenant's Proportionate Share of Tax Costs, Operating Costs and Insurance Costs during such Comparison Year with those sums actually payable and due hereunder for such Comparison Year as set forth in the Reconciliation. If the Reconciliation shows that additional sums are due from Tenant hereunder, Tenant shall pay such sums to Landlord within thirty (30) days of receipt of the Reconciliation; provided, however, that if the amount owed by Tenant is in excess of one (1) monthly installment of Basic Rental, then Tenant shall pay such additional amount owed to Landlord on the first day of each month in monthly installments equal to the then current monthly installment of Basic Rental until such time as said additional sum is paid in full. If the Reconciliation shows that a credit is due Tenant, such credit shall be credited against the next sums becoming due from Tenant hereunder, unless Landlord's estimate of Tenant's Proportionate Share of Tax Costs, Operating Costs and Insurance Costs for the next calendar year is zero (0), in which case, Landlord shall pay the amount of the credit due to Tenant within thirty (30) days after the date of such Reconciliation. Notwithstanding that the term of this Lease has expired and Tenant has vacated the Premises, Tenant shall pay to Landlord any additional sums due Landlord and Landlord shall rebate to Tenant the amount of any credit due Tenant, as set forth in the Reconciliation for the Comparison Year in which the Lease Term expired. (b) In the event of any dispute as to any Additional Rental due hereunder, Tenant shall have the right after reasonable notice and at reasonable times to inspect Landlord's accounting records at Landlord's accounting office and if, after such inspection, Tenant still disputes such Additional Rental, a certification as to the proper amount shall be made by an independent certified public accountant. Tenant agrees to pay the cost of such certification unless it is subsequently determined that Landlord's original statement was in error to Tenant's disadvantage by more than five percent (5%) of the Direct Costs. As a condition precedent to its exercise of its rights of dispute aforesaid, Tenant shall timely pay to Landlord all amounts set forth in the statement which Tenant wishes to dispute. -7- 8 ARTICLE 4 INTENTIONALLY OMITTED ARTICLE 5 HOLDING OVER Should Tenant, with Landlord's written consent, hold over after termination of this Lease, Tenant shall become a tenant from month to month only upon each and all of the terms herein provided as may be applicable to a month to month tenancy and any such holding over shall not constitute an extension of this Lease. During such holding over, Tenant shall pay in advance, monthly, a rental rate equal to one hundred twenty-five percent (125%) of the Basic Rental in effect for the last month of the Lease Term, plus all other payments required to be made by Tenant hereunder including but not limited to Tenant's Proportionate Share of Direct Costs. If Tenant holds over after termination of this Lease without the express written consent of Landlord, Tenant shall become a tenant at sufferance only, at a rental rate equal to one hundred twenty-five percent (125%) of the Basic Rental in effect upon the date of such termination (prorated on a daily basis) for the first two (2) months of such holding over, and thereafter at a rental rate equal to one hundred fifty percent (150%) of the Basic Rental in effect upon the date of such termination (prorated on a daily basis), and otherwise subject to the terms, covenants and conditions herein specified so far as applicable. Acceptance by Landlord of rent after such termination shall not constitute a hold over hereunder or result in a renewal. If Tenant holds over and fails to surrender the Premises upon the expiration or termination of this Lease, Tenant shall indemnify, defend and hold Landlord harmless from all costs, losses, expenses or liabilities, including without limitation, costs and attorney fees proximately caused by such holding over and failure to surrender. ARTICLE 6 PERSONAL PROPERTY TAXES Tenant shall pay, prior to delinquency, all taxes assessed against or levied upon fixtures, furnishings, equipment and all other personal property of Tenant located in the Premises. In the event any or all of Tenant's fixtures, furnishings, equipment and other personal property shall be assessed and taxed with property of Landlord, Tenant shall pay to Landlord its share of such taxes within ten (10) days after delivery to Tenant by Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant's property. Tenant shall assume and pay to Landlord at the time of paying Basic Rental any excise, sales, use, rent, occupancy, garage, parking, gross receipts or other taxes (other than net income taxes) which may be imposed on or on account of letting of the Premises or the payment of Basic Rental or any other sums due or payable hereunder, and which Landlord may be required to pay or collect under any law now in effect or hereafter enacted. Tenant shall pay directly to the party or entity entitled thereto all business license fees, gross receipts taxes and similar taxes and impositions which may from time to time be assessed against or levied upon Tenant, as and when the same become due and before delinquency. Notwithstanding anything to the contrary contained herein, any sums payable by Tenant under this Article 6 shall not be included in the computation of "Tax Costs." -8- 9 ARTICLE 7 USE Tenant shall use and occupy the Premises only for the use set forth in Article 1.7. of the Basic Lease Provisions and shall not use or occupy the Premises or permit the same to be used or occupied for any other purpose without the prior written consent of Landlord, and Tenant agrees that it will use the Premises in such a manner so as not to interfere with or infringe the rights of other tenants in the Project. Tenant shall, at its sole cost and expense, promptly comply with all laws, statutes, ordinances and governmental regulations or requirements now in force or which may hereafter be in force relating to or affecting the condition, use or occupancy of the Premises or the Project, including all requirements for alterations, improvements or structural changes required by Tenant's specific use and occupancy of the Premises. Tenant shall not do or permit to be done anything which will invalidate or increase the cost of any fire and extended coverage insurance policy covering the Project and/or the property located therein and Tenant shall comply with all rules, orders, regulations and requirements of any organization which sets out standards, requirements or recommendations commonly referred to by major fire insurance underwriters. Tenant shall promptly upon demand reimburse Landlord for any additional premium charges for such policy by reason of Tenant's failure to comply with the provisions of this Article. ARTICLE 8 CONDITION OF PREMISES Except for the work to be performed by Landlord pursuant to the Work Letter Agreement attached hereto as Exhibit "C," Tenant hereby agrees that the Premises shall be taken "as is", "with all faults", "without any representations or warranties", and Tenant hereby agrees and warrants that it has inspected the condition of the Premises and the suitability of same for Tenant's purposes, and Tenant does hereby waive and disclaim any objection to, cause of action based upon, or claim that its obligations hereunder should be reduced or limited because of the condition of the Premises or the Project or the suitability of same for Tenant's purposes. Tenant acknowledges that neither Landlord nor any agent nor any employee of Landlord has made any representations or warranty with respect to the Premises or the Project or with respect to the suitability of either for the conduct of Tenant's business. The taking of possession of the Premises by Tenant shall conclusively establish that the Premises and the Project were at such time in satisfactory condition. Tenant hereby waives and releases its right to make repairs at Landlord's expense pursuant to Sections 1941 and 1942 of the Civil Code of California or under any similar law, statute or ordinance now or hereafter in effect. If during the term any asbestos is discovered in the Premises (other than in the Tenant Building Standard Work or in personal property, fixtures or other items brought into the Premises by Tenant), and removal of such asbestos is required by a governmental agency to comply with all applicable Environmental Laws (as defined in Section 28.4), then Landlord shall remove such asbestos at its sole cost and expense; provided, however, Landlord shall have no obligation to remove any asbestos in the Premises to the extent Tenant's acts or omissions gave rise to the requirement to remove such asbestos to comply with Environmental Laws, nor shall Landlord have any obligation to remove any asbestos which is present in the Tenant Building Standard Work or in any personal property, -9- 10 fixtures or other items brought into the Premises by Tenant. The cost of any asbestos removal undertaken by Landlord in accordance with the foregoing sentence shall not be deducted from the Allowance (as defined in the Work Letter Agreement). ARTICLE 9 REPAIRS AND ALTERATIONS Tenant shall keep the Premises in good condition and repair. All damage or injury to the Premises or the Project caused by the act or negligence of Tenant, its employees, agents or visitors, guests, invitees or licensees shall be promptly repaired by Tenant, at its sole cost and expense, to the satisfaction of Landlord. Landlord may make any repairs which are not promptly made by Tenant and charge Tenant for the cost thereof, which cost shall be paid by Tenant within ten (10) days from invoice from Landlord. Landlord shall maintain the common areas of the Project and the cost thereof shall be an Operating Cost. Tenant shall be responsible for the design and function of all non-standard improvements of the Premises, whether or not installed by Landlord at Tenant's request. Tenant waives all rights to make repairs to the Premises at the expense of Landlord, or to deduct the cost thereof from the rent. Tenant shall make no alterations, changes or additions in or to the Premises without Landlord's prior written consent, which shall not be unreasonably withheld, and then only by contractors or mechanics who shall be subject to the prior written approval of Landlord, which shall not be unreasonably withheld, and further subject to the approval by Landlord of fully detailed and dimensioned plans and specifications pertaining to the work in question, to be prepared and submitted by Tenant at its sole cost and expense. Notwithstanding the foregoing, Tenant may make non-structural or decorative alterations which do not affect the Building systems or the Building shell in an amount not more than $20,000 during the term of the Lease without obtaining Landlord's prior written consent but otherwise subject to all of the terms and conditions of this Article 9, including the requirement that Tenant deliver plans and specifications for such work to Landlord prior to the commencement thereof. Tenant shall at its sole cost and expense obtain all necessary approvals and permits pertaining to any work. If Landlord, in approving any work, specifies a commencement date therefor, Tenant shall not commence any work prior to such date. Tenant hereby indemnifies and agrees to defend and hold Landlord free and harmless from all liens and claims of lien, and all other liability, claims and demands arising out of any work done or material supplied to the Premises by or at the request of Tenant. If permitted alterations, changes, or additions are made, they shall be made at Tenant's expense and shall be and become the property of Landlord, except that Landlord may, by written notice to Tenant given at least thirty (30) days prior to the end of the Lease Term, require Tenant at Tenant's expense to promptly both remove any such alteration, change or addition and to repair any damage to the Premises caused by such removal and restore the Premises to the condition that existed prior to such alteration in accordance with all applicable laws, statutes, building codes and regulations in effect as of the date of such restoration. Notwithstanding the foregoing, Tenant shall have no obligation to remove the Tenant Building Standard Work. With regard to repairs, alterations or any other work arising from or related to this Article 9, Landlord shall be entitled to receive an administrative/supervision fee based on the total cost of all (i) work performed; (ii) materials, plans and drawings furnished; and (iii) all other costs and expenses related to such repairs, alterations or other work ("Total Alteration Cost"). If the total Alteration Cost is Ten Thousand -10- 11 Dollars ($10,000) or less, the administrative/supervision fee shall be fifteen percent (15%) of such amount. If the Total Alteration Cost exceeds Ten Thousand Dollars ($10,000), the administrative/supervision fee shall be five percent (5%) of such amount. The foregoing administrative/supervision fee shall not be applicable to any tenant improvements constructed by Landlord in the Premises either pursuant to the Work Letter Agreement or pursuant to Article 33 hereof. ARTICLE 10 LIENS Tenant shall keep the Premises, Building and Project free from any mechanics' liens, vendors liens or any other liens arising out of any work performed, materials furnished or obligations incurred by Tenant (but the foregoing obligation shall not extend to work performed, materials furnished or obligations incurred by Landlord), and agrees to defend, indemnify and hold harmless Landlord from and against any such lien or claim or action thereon, together with costs of suit and reasonable attorneys' fees incurred by Landlord in connection with any such claim or action. Before commencing any work of alteration, addition or improvement to the Premises, Tenant shall give Landlord at least ten (10) business days' written notice of the proposed commencement of such work (to afford Landlord an opportunity to post appropriate notices of non-responsibility) and, if required by Landlord in writing, shall secure, at Tenant's own cost and expense, a completion and lien indemnity bond, satisfactory to Landlord, for said work. In the event that there shall be recorded against the Premises or the Building or the property of which the Premises is a part any claim or lien arising out of any such work performed, materials furnished or obligations incurred by Tenant and such claim or lien shall not be removed or discharged or bonded and removed within ten (10) business days of filing, Landlord shall have the right but not the obligation to pay and discharge said lien without regard to whether such lien shall be lawful or correct or to require that Tenant deposit with Landlord in cash, lawful money of the United States, one hundred fifty percent (150%) of the amount of such claim, which sum may be retained by Landlord until such claim shall have been removed of record or until judgment shall have been rendered on such claim and such judgment shall have become final, at which time Landlord shall have the right to apply such deposit in discharge of the judgment on said claim and any costs, including attorneys' fees incurred by Landlord, and shall remit the balance thereof to Tenant. If Landlord pays and discharges said lien, then Tenant shall reimburse Landlord for all costs and expenses incurred by Landlord in discharging such lien, including attorneys' fees, within ten (10) business days after the date of receipt of Landlord's invoice therefor. ARTICLE 11 PROJECT SERVICES 11.1 Building Hours. Landlord agrees to furnish to the Premises, from 8:00 a.m. to 6:00 p.m. Mondays through Fridays and 9:00 a.m. to 1:00 p.m. on Saturdays, local and national holidays excepted, air conditioning and heat, elevator service, electric current for normal lighting and fractional horsepower office machines and, on the same floor as the Premises, water for lavatory and drinking purposes, all in such reasonable quantities as in the reasonable judgment of Landlord is necessary for the comfortable occupancy of the Premises. Janitorial and maintenance -11- 12 services will be furnished five (5) days per week. Such janitorial service shall be provided in accordance with standards for comparable class "A" office buildings in the City of El Segundo. The cost of all such services furnished to the Premises by Landlord shall be an Operating Cost. The current holidays for the Project are: New Year's Day, Presidents' Day, Memorial Day, the Fourth of July, Labor Day, Thanksgiving Day and Christmas Day; provided, however, that Landlord may observe such other holidays from time to time as may be observed by comparable office building projects in the City of El Segundo. Tenant shall comply with all rules and regulations which Landlord may reasonably establish for the proper functioning and protection of the air conditioning, heating, elevator, electrical and plumbing systems. Landlord shall not be liable for, and there shall be no rent abatement as a result of, any stoppage, reduction or interruption of any such services caused by governmental rules, regulations or ordinances, riot, strike, labor dispute, breakdowns, accidents or necessary repairs. Except as specifically provided in this Article 11, Tenant agrees to pay for all utilities and other services utilized by Tenant for all overtime or additional building services furnished to Tenant not uniformly furnished to all tenants of the Project at Landlord's expense. Landlord's obligation to render to the Premises the services set forth in this Article 11 is conditional upon the payment by Tenant of all sums due under this Lease. 11.2 Utility Use. Tenant shall not without the written consent of Landlord use any apparatus or device in the Premises, including without limitation, machines using current in excess of 110 volts, except for photocopiers and computers that are consistent with general office use, which will in any way increase the amount of electricity or water usually furnished or supplied for use of the Premises as general office space; nor connect any apparatus, machine or device with water pipes or electric current (except through existing electrical outlets in the Premises), for the purpose of using electric current or water. 11.3 Excess Electricity Use. If Tenant shall require electric current in excess of that which Landlord is obligated to furnish under Section 11.1 above, Tenant shall first obtain the consent of Landlord, which Landlord shall not unreasonably withhold; provided, however, it shall be deemed reasonable for Landlord to withhold such consent if alterations are required to be made to the Project's electrical system to provide such additional service or if Landlord would be unable to offer the same level of electric service to other tenants in the Building. If Tenant requests such additional electrical current, Landlord may cause an electric current meter to be installed in the Premises to measure the amount of electric current consumed in the Premises. The cost of any such meter and of installation, maintenance and repair thereof shall be paid for by Tenant and Tenant agrees to pay to Landlord, promptly upon demand therefor by Landlord, for all such electric current consumed in the Premises or by any such use as shown by said meter at the rates charged for such service by the local public utility furnishing the same, plus the actual administrative costs incurred by Landlord in keeping account of the electric current so consumed. 11.4 Heat Generating Machines. If any lights, machines or equipment (including but not limited to computers) are used by Tenant in the Premises which materially affect the temperature otherwise maintained by the air conditioning system, or generate substantially more heat in the Premises than would be generated by the building standard lights and usual fractional horsepower office equipment, Landlord shall have the right to install any machinery and -12- 13 equipment which Landlord reasonably deems necessary to restore temperature balance, including but not limited to modifications to the standard air conditioning equipment, and the cost thereof, including the cost of installation and any additional cost of operation and maintenance occasioned thereby, shall be paid by Tenant to Landlord upon demand by Landlord. Landlord shall not be liable under any circumstances for loss of or injury to property, however occurring, through or in connection with or incidental to failure to furnish any of the foregoing. 11.5 After-Hours HVAC. If Tenant requires heating, ventilation and/or air conditioning during hours other than those hours set forth in Section 11.1 above, Tenant shall give Landlord such advance notice as Landlord shall reasonably require and shall pay Landlord for the use of such equipment such charges as Landlord may impose from time to time for such after hours usage. As of the date of this Lease, the current charge for after-hours heating, ventilating and air conditioning is Thirty-five Dollars ($35.00) per hour, which charge is inclusive of Landlord's administrative charges for providing such service. Landlord agrees that the portion of any after-hours HVAC charge that is attributable to labor and administrative costs shall not increase during any calendar year by more than the percentage increase in the Consumer Price Index, All Urban Consumers-Los Angeles, Long Beach, Anaheim, during such calendar year. 11.6 Recurrent Utility Use. Landlord may impose a reasonable charge for any utilities or services, including without limitation electric current, required to be provided by Landlord by reason of any substantial recurrent use of the Premises other than during the times provided in Section 11.1 above. ARTICLE 12 RIGHTS OF LANDLORD Landlord and its agents shall have the right to enter the Premises at all reasonable times for the purpose of cleaning the Premises, examining or inspecting the same, serving or posting and keeping posted thereon notices as provided by law, or which Landlord deems necessary for the protection of Landlord or the Property, showing the same to prospective tenants or purchasers of the Project, and for making such alterations, repairs, improvements or additions to the Premises or to the Project as Landlord may deem necessary or desirable. Except in an emergency and any entry for cleaning the Premises, Landlord shall provide Tenant with twenty-four (24) hours notice of its intended entry. If necessary, Landlord and Tenant shall schedule Landlord's entry for maintenance, repairs, alterations, or improvements to the Premises at a time during regular business hours to avoid any unreasonable interference with Tenant's use of the Premises. If Tenant shall not be personally present to open and permit an entry into the Premises at any time when such an entry by Landlord is necessary or permitted hereunder, Landlord may enter by means of a master key or may enter forcibly, without liability to Tenant except for any failure to exercise reasonable care for Tenant's property. -13- 14 ARTICLE 13 INDEMNITY; EXEMPTION OF LANDLORD FROM LIABILITY 13.1 Indemnity. Tenant shall indemnify, defend and hold Landlord harmless from and against any and all claims arising from Tenant's use of the Premises or from the conduct of its business in the Premises, or from any work or thing which may be permitted or suffered by Tenant in the Premises or arising out of the use thereof and shall further indemnify, defend and hold Landlord harmless from and against any and all claims arising from any breach or default in the performance of any obligation on Tenant's part to be performed under this Lease or arising from any negligence of Tenant or any of its agents, contractors, employees or invitees, patrons, customers or members and from any and all costs, attorneys' fees, expenses and liabilities incurred in the defense of any claim or any action or proceeding brought thereon, including negotiations in connection therewith. Tenant hereby assumes all risk of damage to property or injury to persons in or about the Premises from any cause, and Tenant hereby waives all claims in respect thereof against Landlord. 13.2 Exemption of Landlord from Liability. Landlord shall not be liable for injury to Tenant's business, or loss of income therefrom, or for damage that may be sustained by the person, goods, wares, merchandise or property of Tenant, its employees, invitees, customers, agents, or contractors, or any other person in, on or about the Premises directly or indirectly caused by or resulting from fire, steam, electricity, gas, water, or rain which may leak or flow from or into any part of the Premises, or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, light fixtures, or mechanical or electrical systems, whether such damage or injury results from conditions arising upon the Premises or upon other portions of the Building or from other sources or places and regardless of whether the cause of such damage or injury or the means or repairing the same is inaccessible to Tenant. Landlord shall not be liable to Tenant for any damages arising from any act or neglect of any other tenant of the building. Tenant acknowledges that Landlord's election to provide mechanical surveillance or to post security personnel in the Building is solely within Landlord's discretion; Landlord shall have no liability in connection with the decision whether or not to provide such services and Tenant hereby waives all claims based thereon. Landlord shall not be liable for losses due to theft, vandalism, or like causes. Tenant shall defend, indemnify, and hold Landlord harmless from any such claims made by any employee, licensee, invitee, contractor, agent, or other person whose presence in, on or about the Premises or the Building is attendant to the business of Tenant. 13.3 Exceptions to Indemnity. The indemnity obligations of Tenant set forth in this Article 13 shall not extend to any claim, demand, loss, cost or liability to the extent caused by the gross negligence or willful misconduct of Landlord. -14- 15 ARTICLE 14 INSURANCE 14.1 Tenant's Insurance. Tenant, shall at all times during the Lease Term and Early Occupancy Period, and at its own cost and expense, procure and continue in force the following insurance coverage: (i) Commercial General Liability Insurance with a combined single limit for bodily injury and property damage of not less than Three Million Dollars ($3,000,000) per occurrence and Five Million Dollars ($5,000,000) in the annual aggregate, including products liability coverage if applicable, covering the use of the Premises and the performance of Tenant of the indemnity agreements set forth in Article 13 hereof; (ii) a policy of standard fire, extended coverage and special extended coverage insurance (all risks), including a vandalism and malicious mischief endorsement, sprinkler leakage coverage and earthquake sprinkler leakage where sprinklers are provided in an amount equal to the full replacement value new without deduction for depreciation of all fixtures, furniture, and leasehold improvements installed by or at the expense of Tenant; and (iii) insurance on all plate or tempered glass in the Premises for the replacement cost of such glass. 14.2 Form of Policies. The aforementioned minimum limits of policies shall in no event limit the liability of Tenant hereunder. Such insurance shall name Landlord and such other persons or firms with insurable interests, as Landlord specifies from time to time, as additional insureds with an appropriate endorsement to the policy(s) and shall be with companies having a rating of not less than A-VIII in Best's Insurance Guide. Tenant shall furnish to Landlord, from the insurance companies, or cause the insurance companies to furnish, certificates of coverage. No such policy shall be cancelable or subject to reduction of coverage or other modification or cancellation except after thirty (30) days prior written notice to Landlord by the insurer. All such policies shall be endorsed to agree that Tenant's policy is primary and that any insurance covered by Landlord is excess and not contributing with any insurance requirement hereunder. Tenant shall, at least fifteen (15) days prior to the expiration of such policies, furnish Landlord with renewals or binders. Tenant agrees that if Tenant does not take out and maintain such insurance or furnish Landlord with renewals or binders, Landlord may (but shall not be required to) procure said insurance on Tenant's behalf and charge Tenant the cost thereof, which amount shall be payable by Tenant upon demand with interest from the date such sums are expended. Additionally, Tenant shall maintain Worker's Compensation required by law and shall provide Landlord with evidence of coverage. Said evidence shall be in the form of a certificate of insurance and shall provide for Landlord to receive thirty (30) days notice of cancellation from the insurer. 14.3 Landlord's Insurance. Landlord shall, at Landlord's expense, procure and maintain at all times during the Lease Term and Early Occupancy Period, a policy or policies of insurance covering loss or damage to the Building in the amount of the full replacement cost new without deduction for depreciation thereof (exclusive of Tenant's trade fixtures, inventory, personal property and equipment), providing protection against all perils included within the classification of fire and extended coverage, vandalism coverage and malicious mischief, sprinkler leakage, water damage, and special extended coverage on building. Additionally, Landlord may -15- 16 (but shall not be required to) carry: (i) Bodily Injury and Property Damage Liability Insurance and/or Excess Liability Coverage Insurance; (ii) Earthquake and/or Flood Damage Insurance; or (iii) Rental Income Insurance at its election or if required by its lender from time to time during the term hereof, in such amounts and with such limits as Landlord or its lender may deem appropriate. The costs of all such insurance shall be included in Insurance Costs. 14.4 Waiver of Subrogation. Both parties release each other and their respective authorized representatives from any claims for damage to any person or the Premises, and to the fixtures, personal property, improvements, and alterations of either Landlord or Tenant, in or on the Premises, Building or Project, that are caused by or result from risks insured against under any insurance policies carried by the parties and in force at the time of any such damage. Any policy or policies of fire, extended or similar casualty insurance which either party obtains in connection with the Premises shall include a clause or endorsement denying the insurer any rights of subrogation against the other party to the extent any rights have been waived by the insured prior to the occurrence of injury of loss. 14.5 Compliance With Law. Tenant agrees that it will not, at any time, during the Lease Term, carry any stock of goods or do anything in or about the Premises that will in any way tend to increase the insurance rates upon the Building. Tenant agrees to pay Landlord forthwith upon demand the amount of any increase in premiums for insurance against loss by fire that may be charged during the Lease Term on the amount of insurance to be carried by Landlord on the Building resulting from the foregoing, or from Tenant doing any act in or about said Premises that does so increase the insurance rates, whether or not Landlord shall have consented to such act on the part of Tenant. If Tenant installs upon the Premises any electrical equipment which constitutes an overload of electrical lines of the Premises, Tenant shall at its own expense make whatever changes are necessary to comply with requirements of the insurance underwriters and any governmental authority having jurisdiction thereover, but nothing herein contained shall be deemed to constitute Landlord's consent to such overloading. Tenant shall, at its own expense, comply with all requirements of the insurance authority having jurisdiction over the Project necessary for the maintenance of reasonable fire and extended coverage insurance for the Premises, including without limitation thereto, the installation of fire extinguishers or an automatic dry chemical extinguishing system. ARTICLE 15 ASSIGNMENT AND SUBLETTING 15.1 Prohibition on Assignment. Except as expressly provided in this Article 15, Tenant shall not and have no power to, either voluntarily or by operation of law, sell, assign, transfer or hypothecate this Lease, or sublet the Premises or any part thereof, or permit the Premises or any part thereof to be occupied by anyone other than Tenant or Tenant's employees without the prior written consent of Landlord, which consent shall not be unreasonably withheld, subject to compliance with this Article 15. If Tenant is a corporation, limited liability company, unincorporated association or partnership, then except as expressly provided in Section 15.1(h) below, the sale, assignment, transfer or hypothecation of any stock, membership or other ownership interest in such corporation, limited liability company, association or partnership in the -16- 17 aggregate in excess of twenty-five percent (25%) shall be deemed a prohibited assignment within the meaning and provisions of this Article 15. Tenant may transfer its interest pursuant to this Lease upon the following express conditions: (a) That the proposed transferee shall be subject to the prior written consent of Landlord, which consent shall not be unreasonably withheld; provided, however, without limiting the generality of the foregoing, it shall be reasonable for Landlord to deny such consent if any of the following are applicable: (i) The use to be made of Premises by the proposed transferee is (A) not generally consistent with the character and nature of all other tenancies in the Building or Project, (B) a use which conflicts with any so-called "exclusive" then in favor of, or for any use which is the same as that stated in any percentage lease to, another tenant of the Building or Project, or (C) a use which would be prohibited by any other portion of this Lease (including but not limited to any Rules and Regulations then in effect); (ii) The character, moral stability, reputation and financial responsibility of the proposed transferee are not reasonably satisfactory to Landlord or in any event not at least equal to those which were possessed by Tenant as of the date of execution of this Lease; (iii) The transferee is either a governmental agency or instrumentality thereof; (iv) The proposed transfer would cause Landlord to be in violation of another lease or agreement to which Landlord is a party, or would give an occupant of the Project a right to cancel its lease; (v) The terms of the proposed transfer will allow the transferee to exercise a right of renewal, right of expansion, right of first offer, or other similar right held by Tenant (or will allow the transferee to occupy space leased by Tenant pursuant to any such right); or (vi) Either the proposed transferee, or any person or entity which directly or indirectly, controls, is controlled by, or is under common control with, the proposed transferee, (i) occupies space in the Project at the time of the request for consent, (ii) is negotiating with Landlord to lease space in the Project at such time, or (iii) has negotiated with Landlord to lease space in the Project during the twelve (12) month period immediately preceding the request for consent notice from Tenant; (b) That Tenant shall pay Landlord's standard processing fee of Five Hundred Dollars ($500) and reasonable attorneys' fees incurred in connection with the review of the request for consent to the transfer, regardless of whether Landlord consents thereto; -17- 18 (c) That the proposed transferee shall execute an agreement pursuant to which it shall agree to perform faithfully and be bound by all of the terms, covenants, conditions, provisions and agreements of this Lease; (d) That an executed duplicate original of said assignment and assumption agreement or other transfer on Landlord's then standard form, shall be delivered to Landlord within five days after the execution thereof. Such transfer shall not be binding upon Landlord until the delivery thereof to Landlord and the execution and delivery of Landlord's consent thereto. It shall be a condition to Landlord's consent to any subleasing, assignment or other transfer of part or all of Tenant's interest in the Premises (hereinafter referred to as a "Transfer") that (i) Tenant shall be required to pay Landlord's standard processing fee referenced in subsection (b) above and reasonable attorneys' fees and other costs incurred in connection with the review and execution thereof; (ii) upon Landlord's consent to any Transfer, Tenant shall pay and continue to pay as Additional Rent over the term of the sublease or assignment to Landlord fifty percent (50%) of the amount by which (A) the rent or other sums paid to Tenant as a result of such assignment or subletting less the amortized cost of any leasehold improvements constructed for such transferee and brokerage fees incurred by Tenant in connection with the Transfer amortized over the term of the sublease or assignment exceed (B) the total sums which Tenant is obligated to pay Landlord under this Lease (prorated to reflect obligations allocable to that portion of the Premises subject to such Transfer); (iii) any sublessee of part or all of Tenant's interest in the Premises shall agree that in the event Landlord gives such sublessee notice that Tenant is in default under this Lease and that so long as such default continues, such sublessee shall thereafter make all sublease or other payments directly to Landlord, which will be received by Landlord without any liability whether to honor the sublease or otherwise (except to credit such payments against sums due under this Lease), and any sublessee shall agree to attorn to Landlord or its successors and assigns at their request should this Lease be terminated for any reason, except that in no event shall Landlord or its successors or assigns be obligated to accept such attornment; (iv) any such Transfer and consent shall be effected on forms, supplied or approved by Landlord and/or its legal counsel; (v) Landlord may require that Tenant not then be in default hereunder in any respect; and (vi) Tenant or the proposed subtenant or assignee shall agree to pay Landlord, upon demand, as additional rent, a sum equal to the additional costs, if any, incurred by Landlord for maintenance and repair as a result of any change in the nature of occupancy caused by such subletting or assignment. If Landlord consents to a requested assignment or sublease, Tenant hereby agrees that (i) it shall thereupon be deemed, automatically and irrevocably to have assigned to Landlord as additional security for the performance and observance of Tenant's obligations and covenants under this Lease, all rent or other sums received or to be received by Tenant in connection therewith and (ii) Landlord as assignee may collect such rent or other sums and apply the same toward Tenant's obligations under this Lease. Notwithstanding the foregoing, Tenant shall have the right to collect such rent and other sums unless and until Tenant commits any act of default hereunder. Tenant hereby agrees and acknowledges that the above conditions imposed upon the granting of Landlord's consent to any proposed Transfer by Tenant are reasonable. In lieu of giving such consent, Landlord may, at Landlord's option, elect to terminate this Lease and release Tenant from any prospective liability under the Lease as to the portion of the Premises to be sublet or assigned as of the proposed effective date of any proposed assignment or subletting. Any sale assignment, hypothecation, -18- 19 transfer or subletting of this Lease which is not in compliance with the provisions of this Article 15 shall be void and shall, at the option of Landlord, terminate this Lease. In no event shall the consent by Landlord to an assignment or subletting be construed as relieving Tenant, any assignee, or sublessee from obtaining the express written consent of Landlord to any further assignment or subletting or as releasing Tenant from any liability or obligation hereunder whether or not then accrued and Tenant shall continue to be fully liable therefor. No collection or acceptance of rent by Landlord from any person other than Tenant shall be deemed a waiver of any provision of this Article 15 or the acceptance of any assignee or subtenant hereunder, or a release of Tenant (or of any successor of Tenant or any subtenant holding theretofore or thereafter accruing); (e) Tenant shall not enter into any sublease or assignment in which any of the following is applicable: (i) The determination of the amount of rent is expressed in whole or in part as a percentage of the income or profits derived by the tenant or subtenant or assignee from the space leased (other than an amount based on a fixed percentage or percentages of gross receipts or gross sales); (ii) More than ten percent (10%) of rent is expressly attributable to personal property, determined at the time the personal property is placed in service and by reference to relative fair market values of the personal and other property of the tenant, subtenant or assignee (and not by reference to any allocation contained in the sublease or assignment documents); or (iii) Services are expressly required to be rendered to a tenant or occupant unrelated to subTenant's or assignee's use of the space and primarily for its convenience and which are other than those usually or customarily rendered in connection with the rental of space for occupancy only; (f) In any sublease or assignment in which the amount of rent is determined in whole or in part by reference to the gross sales or receipts of the subtenant or assignee such sublease or assignment shall contain a provision which prohibits subleasing or assigning or if subleasing or assigning is permitted it shall prohibit the tenant or any successor in interest from subleasing all or any portion of its leasehold interest for an amount of rent determined in whole or in part from the income or profits derived by any person from such interest (other than an amount based in a fixed percentage or percentages of receipts or sales). (g) Notwithstanding anything contained in this Article 15, so long as no default by Tenant then exists under this Lease, and Health Management Systems, Inc. or a Permitted Transferee is the Tenant under the Lease, Tenant shall have the right to sublet or assign a portion of the Premises to a wholly-owned subsidiary or affiliate of Health Care Microsystems, Inc. without the prior written consent of Landlord but otherwise subject to all of the terms of this Article 15 except as set forth below; provided, however, that such sublease or assignment shall not be effective until Tenant has given Landlord at least thirty (30) days written notice of such -19- 20 sublease or assignment, identified the subtenant or assignee, and delivered to Landlord an executed copy of such sublease or assignment (which shall include an undertaking by the affiliate to assume, perform and be bound by all of the obligations of Tenant under the Lease) and such financial information with respect to the subtenant or assignee as Landlord may reasonably request. In no event shall such assignment or subletting release Tenant from any liability under this Lease. Landlord shall not have any right to recapture with respect to the portion of the Premises subject to such sublease or assignment or to any "bonus rent" payable to Landlord pursuant to Section 15.1(d)(ii). As used herein, an "affiliate" shall mean any entity controlling, controlled by or under common control with Health Care Microsystems, Inc. The rights granted hereunder may only be transferred or assigned to a Permitted Transferee of Health Management Systems, Inc. (as defined in Section 15.1(h) below). Any additional subletting or assignment by the affiliate permitted hereunder shall be subject to all of the terms and conditions of this Article 15. (h) Notwithstanding anything contained in this Article 15, so long as no default by Tenant then exists under this Lease, a transfer by Health Management Systems, Inc. of all of the stock of Health Care Microsystems, Inc. either by sale or through merger to or with a person or entity having a net worth of not less than the net worth of Health Management Systems, Inc. at the end of 1995, or a transfer of all or substantially all of the stock, membership interest or assets or a merger of Health Management Systems, Inc. to or with a person or entity having a net worth of not less than the net worth of Health Management Systems, Inc. at the end of 1995 shall not be deemed an assignment requiring the prior written consent of Landlord hereunder, but shall otherwise be subject to compliance with the following conditions: Tenant shall give Landlord at least thirty (30) days written notice of such transfer identifying the person or entity acquiring the stock of Health Care Microsystems, Inc. by sale or through merger or the transferee of the stock, membership interest, or assets of Health Management Systems, Inc. or the surviving corporation from a merger with Health Management Systems, Inc., provide Landlord with such financial information as Landlord may reasonably require to verify that the transferee or surviving corporation satisfies the net worth requirements set forth above, and in the case of the transfer of the stock of Health Care Microsystems, Inc. by sale or through merger or a transfer of all or substantially all of the assets or a merger of Health Management Systems, Inc., the transferee or surviving corporation shall execute and deliver to Landlord an assumption of all of the Tenant's obligations under the Lease. A transferee meeting all of the requirements of this Section 15.1(h) shall hereafter be referred to as a "Permitted Transferee." Notwithstanding the transfer of all of the stock of Health Care Microsystems, Inc. by sale or through merger or the transfer or all or substantially all of the stock, membership interest or assets or the merger of Health Management Systems, Inc. to or with a Permitted Transferee, all of the terms and conditions of this Lease shall remain in full force and effect. If the transfer to a Permitted Transferee occurs during the first five (5) years of the Lease term, Health Management Systems, Inc. shall remain fully liable for all of the obligations of the Tenant under the Lease until the expiration of the fifth year of the term of the Lease, whereupon Health Management Systems, Inc. shall be released from any prospective liability under this Lease from and after the expiration of the fifth year of the Lease term, so long as no default by Tenant exists at the expiration of the fifth year of the Lease term.. If a transfer to a Permitted Transferee occurs after the fifth year of the term of the Lease, Health Management Systems, Inc. shall be released upon the Permitted Transferee's assumption of the Tenant's -20- 21 obligations under the Lease and so long as no default by Tenant exists at the time of the transfer. If the stock of Health Care Microsystems, Inc. is transferred to a Permitted Transferee by sale of through merger, or the stock, membership interest, or assets of Health Management Systems, Inc. is transferred to a Permitted Transferee or Health Management Systems, Inc. is merged with a Permitted Transferee, the Permitted Transferee shall become a tenant under the lease with Health Care Microsystems, Inc.. ARTICLE 16 DAMAGE OR DESTRUCTION If the Project is damaged by fire or other insured casualty and the insurance proceeds have been made available therefor by the holder or holders of any mortgages or deeds of trust covering the Premises or the Project, the damage shall be repaired by and at the expense of the Landlord to the condition that existed prior to said casualty to the extent such insurance proceeds are available therefor and provided such repairs can, in Landlord's opinion, be made within ninety (90) days after the occurrence of the damage without the payment of overtime or other premiums. Until such repairs are completed, rent shall be abated in proportion to the part of the Premises which is unusable by Tenant in the conduct of its business (but there shall be no abatement of rent by reason of any portion of the Premises being unusable for a period equal to one (1) day or less). If the damage is due to the fault or neglect of Tenant or its employees, agents or visitors, there shall be no abatement of rent. If repairs cannot, in Landlord's opinion, be made within ninety (90) days after the occurrence of the damage, Landlord may, at its option, make them within a reasonable time and in such event this Lease shall continue in effect and the rent shall be abated in the manner provided in this Article 16. Landlord's election to make such repairs must be evidenced by written notice to Tenant within thirty (30) days after the learning of the occurrence of the damage. If Landlord does not so elect within such thirty (30) day period to make such repairs which cannot be made within said ninety (90) days, then either party may, by written notice to the other, cancel this Lease as the date of the occurrence of such damage. A total destruction of the Project shall automatically terminate this Lease. Except as provided in this Article, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business or property arising from such damage or destruction or the making of any repairs, alterations or improvements in or to any portion of the Project or the Premises or in or to fixtures, appurtenances and equipment therein. Tenant understands that Landlord will not carry insurance of any kind to Tenant's furniture, furnishings, fixtures or equipment, and that Landlord shall not be obligated to repair any damage thereto or replace the same. With respect to any damage which Landlord is obligated to repair or elects to repair, Tenant, as a material inducement to Landlord entering into this Lease, irrevocably waives and releases its rights under the provisions of Sections 1932(2) and 1933(4) of the California Civil Code. ARTICLE 17 SUBORDINATION The Property and the Project are currently not subject to any ground or underlying lease, mortgage or deed of trust. Landlord shall have the right to cause this Lease to be and become and remain subject and subordinate to any and all ground or underlying leases, mortgages or -21- 22 deeds of trust which may hereafter be executed covering the Premises, the Project or the Property or any renewals, modifications, consolidations, replacements or extensions thereof, for the full amount of all advances made or to be made thereunder and without regard to the time or character of such advances, together with interest thereon and subject to all the terms and provisions thereof, provided, however, that Landlord obtains from the lender or other party in question a written undertaking in favor of Tenant to the effect that such lender or other party will not disturb Tenant's right of possession under this Lease if Tenant is not then or thereafter in breach of any covenant or provision of this Lease; and Tenant agrees, within ten (10) business days after Landlord's written request therefor, to execute, acknowledge and deliver upon request any and all documents or instruments requested by Landlord or necessary or proper to assure the subordination of this Lease to any such mortgages, deed of trust, or leasehold estates. In the event of any foreclosure sale, transfer in lieu of foreclosure or termination of the lease in which Landlord is lessee, Tenant shall attorn to the purchaser, transferee or lessor as the case may be, and recognize that party as Landlord under this Lease, provided such party acquires and accepts the Premises subject to the terms and conditions of this Lease. Tenant waives the protection of any statute or rule of law which gives or purports to give Tenant any right to terminate this Lease or surrender possession of the Premises upon the transfer of Landlord's interest. ARTICLE 18 EMINENT DOMAIN If the whole of the Premises or so much thereof as to render the balance commercially unusable by Tenant shall be taken under power of eminent domain, or is sold, transferred or conveyed in lieu thereof, this Lease shall automatically terminate as of the date of such condemnation, or as of the date possession is taken by the condemning authority, at Landlord's option. No award for any partial or entire taking shall be apportioned, and Tenant hereby assigns to Landlord any award which may be made in such taking or condemnation, together with any and all rights of Tenant now or hereafter arising in or to the same or any part thereof; provided, however, that nothing contained herein shall be deemed to give Landlord any interest in or to require Tenant to assign to Landlord any award made to Tenant for the taking of personal property and fixtures belonging to Tenant and removable by Tenant at the expiration of the term hereof as provided hereunder or for the interruption of, or damage to, Tenant's business. In the event of a partial taking, or a sale, transfer or conveyance in lieu thereof, which does not result in a termination of this Lease, the rent shall be apportioned according to the ratio that the part of the Premises remaining useable by Tenant bears to the total area of the Premises. ARTICLE 19 DEFAULT 19.1 Events of Default. Each of the following acts or omissions of Tenant or of any guarantor of Tenant's performance hereunder, or occurrences, shall constitute an "Event of Default"; (a) Failure or refusal to pay Basic Rental, Additional Rent [Article 3] or any other amount provided hereunder within five (5) calendar days after the same becomes due or -22- 23 payable hereunder; said five (5) day period shall be in lieu of, and not in addition to, the notice requirements pertaining to the unlawful detainer statutes (i.e. C.C.P. sections 1161, 1161.1(a)-(e)); (b) Failure to perform or observe any other covenant or condition of this Lease to be performed or observed within thirty (30) days following written notice to Tenant of such failure. Such thirty (30) day notice shall also constitute any notice required under Section 1161 of the California Code of Civil Procedure; (c) Abandonment or vacating or failure to accept tender of possession of the Premises or any significant portion thereof; (d) The taking in execution or by similar process or law (other than by eminent domain) of the estate hereby created; (e) To the extent permitted by law, the filing by Tenant or any guarantor hereunder in any court pursuant to any statute of a petition in bankruptcy or insolvency or for reorganization or arrangement of for the appointment of a receiver of all or a portion of Tenant's property; the filing against Tenant or any guarantor hereunder of any such petition, or the commencement of a proceeding for the appointment of a trustee, receiver or liquidator for Tenant, or for any guarantor hereunder, or of any of the property of either, or a proceeding by any governmental authority for the dissolution or liquidation of Tenant or any guarantor hereunder, if such proceeding shall not be dismissed or trusteeship discontinued within sixty (60) days after commencement of such proceeding or the appointment of such trustee or receiver; or the making by Tenant or any guarantor hereunder of an assignment for the benefit of creditors. Tenant hereby stipulates to the lifting of the automatic stay in effect and relief from such stay for Landlord in the event Tenant files a petition under the United States Bankruptcy laws, for the purpose of Landlord pursuing its rights and remedies against Tenant and/or a guarantor of this Lease; and (f) Tenant's failure to cause to be released or bonded and removed any mechanics liens filed against the Premises or the Project within twenty (20) days after the date the same shall have been filed or recorded. ARTICLE 20 REMEDIES 20.1 Remedies for Default. In the event of a breach of or default under this Lease as provided in Article 19 hereof, Landlord may exercise all of its remedies as may be permitted by law, including but not limited to the remedy provided by Section 1951.4 of the California Civil Code, and including, terminating this Lease, reentering the Premises and removing all persons and property therefrom, which property may be stored by Landlord at a warehouse or elsewhere at the risk, expense and for the account of Tenant. If Landlord elects to terminate this Lease, Landlord shall be entitled to recover from Tenant the aggregate of all amounts permitted by law, including but not limited to, the cost of recovering the Premises and including (i) the worth at the time of award of the unpaid rent which had been earned at the time of termination; (ii) the worth at the -23- 24 time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; (iii) the worth at the time of the award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; and (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of events would be likely to result therefrom. The "worth at the time of award" of the amounts referred to in (i) and (ii) above is computed by allowing interest at the rate of ten percent (10%) per annum. The "worth at the time of award" of the amount referred to in (iii) above shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). Further, Tenant shall be liable for the unamortized portion of the leasing commissions paid by or owing by Landlord arising from this Lease and any extensions thereof. 20.2 Effect on Indemnity Obligation. Nothing in this Article 20 shall be deemed to affect Landlord's right to indemnification for liability or liabilities arising prior to the termination of this Lease for personal injuries or property damage under the indemnification clause or clauses contained in this Lease. 20.3 Maintenance of Lease in Effect. Notwithstanding anything to the contrary set forth herein, Landlord's re-entry to perform acts of maintenance or preservation of or in connection with efforts to relet the Premises or any portion thereof, or the appointment of a receiver upon Landlord's initiative to protect Landlord's interest under this Lease shall not terminate Tenant's right to possession of the Premises or any portion thereof and, until Landlord does elect to terminate this Lease, this Lease shall continue in full force and effect and Landlord shall enforce all of Landlord's rights and remedies hereunder including, without limitation, the right to recover from Tenant as it becomes due hereunder all Basic Rental, Additional Rent and other charges required to be paid by Tenant under the terms hereof. 20.4 Cumulative Remedies. All rights, powers and remedies of Landlord hereunder and under any other agreement now or hereafter in force between Landlord and Tenant shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Landlord by law, and the exercise of one or more rights or remedies shall not impair Landlord's right to exercise any other right or remedy. 20.5 Interest; Late Charge. Any amount due from Tenant to Landlord hereunder which is not paid within thirty (30) days of when due shall bear interest at the lower of 18% per annum or the maximum lawful rate of interest from the due date until paid, unless otherwise specifically provided herein, but the payment of such interest shall not excuse or cure any default by Tenant under this Lease. In addition to such interest: (a) if Basic Rental is not paid within ten (10) days after the same is due, a late charge equal to 1 1/2% of the amount overdue or $100, whichever is greater, shall be assessed and shall accrue for each calendar month or part thereof until such rental, including the late charge, is paid in full, which late charge Tenant hereby agrees is a reasonable estimate of the damages Landlord shall suffer as a result of Tenant's late payment and -24- 25 (b) an additional charge of $25 shall be assessed for any check given to Landlord by or on behalf of Tenant which is not honored by the drawee thereof; which damages include Landlord's additional administrative and other costs associated with such late payment and unsatisfied checks and the parties agree that it would be impracticable or extremely difficult to fix Landlord's actual damage in such event. Such charges for interest and late payments and unsatisfied checks are separate and cumulative and are in addition to and shall not diminish or represent a substitute for any or all of Landlord's rights or remedies under any other provision of this Lease. 20.6 Additional Damages. Tenant shall be liable for any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease, or which in the ordinary cause of things would be likely to result therefrom. ARTICLE 21 TRANSFER OF LANDLORD'S INTEREST Landlord shall have the right to transfer and assign, in whole or in part, all of its rights and obligations hereunder and in the Project and other property referred to herein, and in such event and upon such transfer (any such transferee to have the benefit of, and be subject to, the rights and obligations of Landlord hereunder), Landlord shall be released from any further obligations hereunder and Tenant agrees to look solely to such successor-in-interest of Landlord for the performance of such obligations. ARTICLE 22 BROKER Each party represents and warrants to the other party that it has not had dealings in any manner with any real estate broker, finder or other person with respect to the Premises and the negotiation and execution of this Lease except CB Commercial Real Estate Group, Inc. Except as to commissions and fees to be paid as provided in this Article 22, Tenant shall indemnify, defend, and hold harmless Landlord from all damage, loss, liability and expense (including reasonable attorneys' fees and related costs) arising out of or resulting from any claims for commissions or fees that may or have been asserted against Landlord by any broker, finder or other person with whom Tenant has or purportedly has dealt with in connection with the Premises and the negotiation and execution of this Lease. Landlord shall pay broker leasing commissions to CB Commercial Real Estate Group, Inc. in connection with the negotiation and execution of this Lease pursuant to a separate agreement. Landlord and Tenant agree that Landlord shall not be obligated to pay any broker leasing commissions, consulting fees, finder fees or any other fees or commissions arising out of or relating to any extended term of this Lease or to any expansion or relocation of the Premises at any time. ARTICLE 23 PARKING -25- 26 Tenant shall be entitled to use the number of parking spaces set forth in Article 1.9 of the Basic Lease Provisions ("Permitted Parking Spaces"). Tenant's use of the Permitted Parking Spaces shall be free of charge during the initial ten (10) year Lease Term ("Initial Term"). If Tenant exercises the Option pursuant to Article 31.1, Landlord's prevailing monthly charge for parking during the Option Term shall be added to the Prevailing Market Rental determined in accordance with Article 31.1. Tenant has informed Landlord that all of Tenant's employees will not be working in the Premises on a daily basis and that therefore some of the Permitted Parking Spaces would not be used if Landlord issued only one parking pass per parking space. Tenant has requested that Landlord issue an unlimited number of parking passes so that Tenant's employees may use parking spaces on days when the regular user of such space is absent. Landlord agrees to issue an unlimited number of parking passes to accommodate Tenant's needs; provided, however, that Tenant's use of parking spaces without charge during the Initial Term shall be limited to the Permitted Parking Spaces. If Tenant uses more than the number of Permitted Parking Spaces, Tenant shall pay Landlord's standard monthly charge for use of such additional parking spaces on a monthly basis within ten (10) days after the date of Landlord's invoice therefore. Notwithstanding the foregoing, Landlord reserves the right to monitor Tenant's use of the parking passes and to reduce the number of parking passes made available to Tenant to the number of Permitted Parking Spaces if Tenant fails to pay the monthly parking charges for any parking spaces used in excess of the Permitted Parking Spaces or if Landlord requires such additional spaces for the use by other tenants. Parking shall be available upon the terms and conditions (other than charges for parking passes) established from time to time by Landlord or Landlord's operator of such parking facilities. Tenant shall be entitled to receive one hundred fifty (150) hours of parking validations free of charge each month during the initial Lease Term for Tenant's visitor parking and a discount of fifty percent (50%) off the then current charges for parking validations for visitor parking in excess of said one hundred fifty (150) hours. All visitor parking shall be in parking areas designated by Landlord upon terms and conditions to be established from time to time by Landlord or Landlord's operator of such parking facilities. ARTICLE 24 WAIVER No waiver by Landlord of any provision of this Lease shall be deemed to be a waiver of any other provision hereof or of any subsequent breach by Tenant of the same or any other provision. No provision of this Lease may be waived, except by an instrument in writing executed by the waiving party. Landlord's consent to or approval of any act by Tenant requiring Landlord's consent or approval shall not be deemed to render unnecessary the obtaining of Landlord's consent to or approval of any subsequent act of Tenant, whether or not similar to the act so consented to or approved. No act or thing done by Landlord or Landlord's agents during the term of this Lease shall be deemed an acceptance of a surrender of the Premises, and no agreement to accept such surrender shall be valid unless in writing and signed by Landlord. Any payment by Tenant or receipt by Landlord of an amount less than the total amount then due hereunder shall be deemed to be in partial payment only thereof and not a waiver of the balance due or an accord and satisfaction, notwithstanding any statement or endorsement to the contrary on any check or any other instrument delivered concurrently therewith or in reference thereto. Accordingly Landlord may accept any such amount and negotiate any such check without -26- 27 prejudice to Landlord's right to recover all balances due and owing and to pursue its other rights against Tenant under this Lease, regardless of whether Landlord makes any notation on such instrument of payment or otherwise notifies Tenant that such acceptance or negotiation is without prejudice to Landlord's rights. -27- 28 ARTICLE 25 ESTOPPEL CERTIFICATE Tenant shall, at any time and from time to time, upon not less than ten (10) business days' from the date of receipt from Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying the following information (but not limited to the following information in the event further information is requested by Landlord): (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as modified, is in full force and effect); (ii) the dates to which the rental and other charges are paid in advance, if any; (iii) the amount of Tenant's security deposit, if any; (iv) acknowledging that there are not, to Tenant's knowledge, any uncured defaults on the part of Landlord hereunder, and no events or conditions then in existence which, with the passage of time or notice or both, would constitute a default on the part of Landlord hereunder, or specifying such defaults, events or conditions, if any are claimed; and (v) such other statements regarding the Lease as may be reasonably requested by Landlord. It is expressly understood and agreed that any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the real property. Tenant's failure upon Landlord's reasonable request to deliver such statement within such time shall, at the option of Landlord, constitute a default under this Lease. Furthermore, Tenant's failure to deliver such statement within such time shall constitute an admission by Tenant that all statements contained therein are true and correct. Tenant agrees to execute all documents required in accordance with this Article 25 within ten (10) business days after the date of receipt of said documents and the failure to execute such documents within ten (10) business days shall entitle Landlord to execute such documents on behalf of Tenant as Tenant's attorney-in-fact. Tenant does hereby make, constitute and irrevocably appoint Landlord as Tenant's attorney-in-fact and in Tenant's name, place and stead to execute such documents pursuant to this Article. ARTICLE 26 LIABILITY OF LANDLORD The liability of Landlord, any agent of Landlord, or any of their respective officers, directors, shareholders or employees to Tenant for or in respect of any default by Landlord under the terms of this Lease or in respect of any other claim or cause of action shall be limited to the interest of Landlord in the Project, and Tenant agrees to look solely to Landlord's interest in the Project for the recovery and satisfaction of any judgment against Landlord, any agent of Landlord, or any of their respective officers, directors, shareholders and employees. ARTICLE 27 INABILITY TO PERFORM This Lease and the obligations of Tenant hereunder shall not be affected or impaired because Landlord is unable to fulfill any of its obligations hereunder or is delayed in doing so, if such inability or delay is caused by reason of unavailability of materials, strike or other labor -28- 29 troubles or any other cause previously or at such time beyond the reasonable control of anticipation of Landlord. ARTICLE 28 HAZARDOUS MATERIALS 28.1 Environmental Law Compliance. During the term of this Lease, Tenant shall comply with all Environmental Laws and Environmental Permits (each as defined in Article 28.4 hereof) applicable to the operation or use of the Premises, will cause all other persons occupying or using the Premises to comply with all such Environmental Laws and Environmental Permits, and will immediately pay or cause to be paid all costs and expenses incurred by reason of such compliance. 28.2 Prohibition. Tenant shall not generate, use, treat, store, handle, release or dispose of, or permit the generation, use, treatment, storage, handling, release or disposal of Hazardous Materials (as defined in Article 28.4 hereof) on the Premises, or the Project, or transport or permit the transportation of Hazardous Materials to or from the Premises or the Project except for limited quantities used or stored at the Premises and required in connection with the routine operation and maintenance of the Premises, and then only upon the written consent of Landlord and in compliance with all applicable Environmental Laws and Environmental Permits. 28.3 Indemnity. Tenant agrees to defend, indemnify and hold harmless Landlord from and against all obligations (including removal and remedial actions), losses, claims, suits, judgments, liabilities, penalties, damages (including consequential and punitive damages), costs and expenses (including attorneys' and consultants' fees and expenses) of any kind or nature whatsoever that may at any time be incurred by, imposed on or asserted against Landlord directly or indirectly based on, or arising or resulting from (a) the actual or alleged presence of Hazardous Materials on the Project which is caused or permitted by Tenant and (b) any Environmental Claim relating in any way to Tenant's operation or use of the Premises (the "Hazardous Materials Indemnified Matters"). The provisions of this Article 28.3 shall survive the expiration or sooner termination of this lease. 28.4 Definitions. As used herein, the following terms shall have the following meanings: "Hazardous Materials" means (i) petroleum or petroleum products, natural or synthetic gas, asbestos in any form that is or could become friable, urea formaldehyde foam insulation, and radon gas; (ii) any substances defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous wastes," "restricted hazardous wastes," "toxic substances," "toxic pollutants," "contaminants" or "pollutants," or words of similar import, under any applicable Environmental Law; and (iii) any other substance exposure to which is regulated by any governmental authority. "Environmental Law" means any federal, state or local statute, law, rule, regulation, ordinance, code, policy or rule of common law now or hereafter in effect and in each case as amended, and any judicial or administrative interpretation thereof, including any judicial or administrative order, consent decree or judgment, relating to the environment, health, safety or Hazardous Materials, including without limitation, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, -29- 30 42 U.S.C. sections 9601 et seq.; the Resource Conservation and Recovery Act, 42 U.S.C. sections 6901 et seq.; the Hazardous Materials Transportation Act, 49 U.S.C. sections 1801 et seq.; the Clean Water Act, 33 U.S.C. sections 1251 et seq.; the Toxic Substances Control Act, 15 U.S.C. sections 2601 et seq.; the Clean Air Act, 42 U.S.C. sections 7401 et seq.; the Safe Drinking Water Act, 42 U.S.C. sections 300f et seq.; the Atomic Energy Act, 42 U.S.C. sections 2011 et seq.; the Federal Insecticide, Fungicide and Rodenticide Act, 7 U.S.C. sections 136 et seq.; the Occupational Safety and Health Act, 29 U.S.C. sections 651 et seq. "Environmental Claims" means any and all administrative, regulatory or judicial actions, suits, demands, demand letters, claims, liens, notices of non-compliance or violation, investigations, proceedings, consent orders or consent agreements relating in any way to any Environmental Law or any Environmental Permit, including without limitation (i) any and all Environmental Claims by governmental or regulatory authorities for enforcement, cleanup, removal, response, remedial or other actions or damages pursuant to any applicable Environmental law and (ii) any and all Environmental Claims by any third party seeking damages, contribution, indemnification, cost recovery, compensation or injunctive relief resulting from Hazardous Materials or arising from alleged injury or threat of injury to health, safety or the environment. "Environmental Permits" means all permits, approvals, identification numbers, licenses and other authorizations required under any applicable Environmental Law. ARTICLE 29 SURRENDER OF PREMISES; REMOVAL OF PROPERTY 29.1 No Merger. The voluntary or other surrender of this Lease by Tenant to Landlord, or a mutual termination hereof, shall not work a merger, and shall at the option of Landlord, operate as an assignment to it of any or all subleases or subtenancies affecting the Premises. 29.2 Surrender. Upon the expiration of the Lease Term, or upon any earlier termination of this Lease, Tenant shall quit and surrender possession of the Premises to Landlord in as good order and condition as the same are now and hereafter may be improved by Landlord or Tenant, reasonable wear and tear and repairs which are Landlord's obligation excepted, and shall, without expense to Landlord, remove or cause to be removed from the Premises all debris and rubbish, all furniture, equipment, business and trade fixtures, free-standing cabinet work, moveable partitioning and other articles of personal property owned by Tenant or installed or placed by Tenant at its own expense in the Premises, and all similar articles of any other persons claiming under Tenant unless Landlord exercises its option to have any subleases or subtenancies assigned to it, and Tenant shall repair all damage to the Premises resulting from the installation and removal of such items to be removed and restore such areas to the condition that existed prior to the installation thereof in accordance with all applicable laws, statutes, building codes and regulations in effect as of the date of such repair and restoration. 29.3 Disposition of Personal Property. Whenever Landlord shall reenter the Premises as provided in Article 12 hereof, or as otherwise provided in this Lease, any property of Tenant not removed by Tenant upon the expiration of the Lease Term (or within forty-eight (48) hours after a termination by reason of Tenant's default), as provided in this Lease, shall be considered abandoned and Landlord may remove any or all of such items and dispose of the same in any manner or store the same in a public warehouse or elsewhere for the account and at the expense -30- 31 and risk of Tenant, and if Tenant shall fail to pay the cost of storing any such property after it has been stored for a period of ninety (90) days or more, Landlord may sell any or all of such property at public or private sale, in such manner and at such times and places as Landlord, in its sole discretion, may deem proper, without notice or to demand upon Tenant, for the payment of all or any part of such charges or the removal of any such property, and shall apply the proceeds of such sale: first, to the cost and expense of such sale, including reasonable attorneys' fees for services rendered; second, to the payment of the cost of or charges for storing any such property; third, to the payment of any other sums of money which may then or thereafter be due to Landlord from Tenant under any of the terms hereof; and fourth, the balance, if any, to Tenant. 29.4 Removal of Alterations. All fixtures, equipment, alterations, additions, improvements and/or appurtenances attached to or built into the Premises prior to or during the Early Occupancy Period and Lease Term, whether by Landlord or Tenant and whether at the expense of Landlord or Tenant, or of both, shall be and remain part of the Premises and shall not be removed by Tenant at the end of the Lease Term except to the extent otherwise expressly provided for in Article 29.2 hereof or unless such removal is required by Landlord pursuant to the provisions of Article 9 above. Such fixtures, equipment, alterations, additions, improvements and/or appurtenances shall include but not be limited to: all floor coverings, drapes, paneling, built-in cabinetry, molding, doors, vaults (including vault doors), plumbing systems, electrical systems, lighting systems, silencing equipment, built-in portions of communication systems, all fixtures and outlets for the systems mentioned above and for all telephone, radio, telegraph and television purposes, and any special flooring or ceiling installations. 29.5 Notice of Surrender. Tenant shall, at least ninety (90) days before the last day of the Lease Term, give to Landlord a written notice of intention to surrender the Premises on that date, but Tenant's failure to give such notice shall not be construed as an extension of the Lease Term or as consent of Landlord to any holding over by Tenant. ARTICLE 30 MISCELLANEOUS 30.1 Severability; Entire Agreement. Any provision of this Lease which shall prove to be invalid, void, or illegal shall in no way affect, impair or invalidate any other provision hereof and any such other provisions shall remain in full force and effect. Except for that certain Confidentiality Agreement dated September 19, 1996, executed by Landlord and Tenant, this Lease and the Exhibits constitute the entire agreement between the parties hereto with respect to the subject matter hereof, and no prior agreement or understanding pertaining to any such matter shall be effective for any purpose. No provision of this Lease may be amended or supplemented except by an agreement in writing signed by the parties hereto or their successor in interest. This Lease shall be governed by and construed in accordance with the laws of the State of California. 30.2 Attorneys' Fees. (a) If Tenant or Landlord shall bring any action for any relief against the other, declaratory or otherwise, arising out of or under this Lease, including any suit by Landlord for the -31- 32 recovery of rent or possession of the Premises, the losing party shall pay the successful party a reasonable sum for attorneys' fees in such suit and such attorneys' fees shall be deemed to have accrued on the commencement of such action and shall be paid whether or not such action is prosecuted to judgment. (b) Reasonable attorneys' fees shall include fees for services rendered prior to the commencement of any such action or litigation and, when legal services are rendered by an attorney at law who is an employee of a party, shall be determined as to amount, including overhead, by consideration of the same factors, including but not limited by, the importance of the matter, time applied, difficulty and results, as are considered when an attorney not in the employ of a party is engaged to render such service. 30.3 Time of Essence. Time is of the essence with respect to the performance of every provision of this Lease and the strict performance of each shall be a condition precedent to Tenant's right to remain in possession of the Premises or to have this Lease continue in effect. 30.4 Headings. The article headings contained in this Lease are for convenience only and do not in any way limit or amplify any term or provision hereof. The terms "Landlord" and "Tenant" as used herein shall include the plural as well as the singular, the neuter shall include the masculine and feminine genders and the obligations herein imposed upon Tenant shall be joint and several as to each of the persons, firms or corporations of which Tenant may be composed. 30.5 Reserved Area. Tenant hereby acknowledges and agrees that the exterior walls of the Premises and the area between the finished ceiling of the Premises and the slab of the floor of the Building thereabove have not been demised hereby and the use thereof together with the right to install, maintain, use, repair and replace pipes, ducts, conduits and wires leading through, under or above the Premises in locations which will not materially interfere with Tenant's use of the Premises and serving other parts of the Project are hereby excepted and reserved unto Landlord. 30.6 No Option. The submission of this Lease by Landlord, its agent or representative for examination or execution by Tenant does not constitute an option or offer to lease the Premises upon the terms and conditions contained herein or a reservation of the Premises in favor of Tenant, it being intended hereby that this Lease shall only become effective upon the execution hereof by Landlord and delivery of a fully executed counterpart hereof to Tenant. 30.7 Use of Project Name; Improvements. Tenant shall not be allowed to use the name, picture or representation of the Project, or words to that effect, in connection with any business carried on in the Premises or otherwise (except as Tenant's address) without the prior written consent of Landlord. In the event that Landlord undertakes any additional improvements on the real property including but not limited to new construction or renovation or additions to the existing improvements, Landlord shall not be liable to Tenant for any noise, dust, vibration or interference with access to the Premises or disruption in Tenant's business caused thereby and rental hereunder shall under no circumstances be abated; provided, however, Landlord shall use reasonable efforts to minimize any such disruption during regular business hours, except in an -32- 33 emergency. Landlord shall use diligent efforts to give Tenant at least five (5) days notice of any major construction that will take place near the Premises or interfere with access to the Premises. 30.8 Rules and Regulations. Tenant shall observe faithfully and comply strictly with the Rules and Regulations attached to this Lease and made a part hereof, and such other Rules and Regulations as Landlord may from time to time reasonably adopt for the safety, care and cleanliness of the Project, the facilities thereof, or the preservation of good order therein. Landlord shall not be liable to Tenant for violation of any such Rules and Regulations, or for the breach of any covenant or condition in any lease by any other tenant in the Project. A waiver by Landlord of any Rule or Regulation for any other tenant shall not constitute nor be deemed a waiver of the Rule or Regulation for this Tenant. Landlord shall equally enforce the Rules and Regulations in accordance with each Tenant's lease. 30.9 Quiet Possession. Upon Tenant's paying the Basic Rental, Additional Rent and other sums provided hereunder and observing and performing all of the covenants, conditions and provisions on Tenant's part to be observed and performed hereunder, Tenant shall have quiet possession of the Premises for the entire Lease Term, subject to all of the provisions of this Lease. 30.10 Rent. All payments required to be made hereunder shall be deemed to be rent, whether or not described as such. 30.11 [Intentionally Omitted]. 30.12 Successors and Assigns. Subject to the provisions of Article 15 hereof, all of the covenants, conditions and provisions of this Lease shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns. 30.13 Notices. Any notice required or permitted to be given hereunder shall be in writing and may be given by personal service evidenced by a signed receipt or sent by registered or certified mail, return receipt requested, addressed to Tenant at the addresses set forth below or to Landlord at the address of the place from time to time established for the payment of rent and which shall be effective upon proof of delivery. Copies of all notices to Landlord should be sent to the following address: GE Capital Investment Advisors, 444 Market Street, Suite 2100, San Francisco, California 94111 Attention: General Counsel. Notices to Tenant should be sent to the following address: Health Care Microsystems, Inc. 200 North Sepulveda Blvd., Suite 700 El Segundo, CA 900245 Attn: Ms. Francine S. Wiegelman ------------------------------- -33- 34 and to: Health Management Systems, Inc. 401 Park Avenue South New York, NY 10016 Attn: Mr. Vincent C. Hartley With a copy to: Coleman & Rhine 1120 Avenue of the Americas 19th Floor New York, NY 10036 Attn: Mr. Bruce Coleman Either party may by notice to the other specify a different address for notice purposes except that, upon Tenant's taking possession of the Premises, the Premises shall constitute Tenant's address for notice purposes. A copy of all notices to be given to Landlord hereunder shall be concurrently transmitted by Tenant to such party hereafter designated by notice from Landlord to Tenant. 30.14 Persistent Delinquencies. In the event that Tenant shall be delinquent by more than fifteen (15) days in the payment of rent on three (3) separate occasions in any twelve (12) month period, Landlord shall have the right to terminate this Lease by thirty (30) days written notice given by Landlord to Tenant within thirteen (13) months of the first of the last three (3) such delinquencies and then ten (10) days of the last such delinquency. 30.15 Right of Landlord to Perform. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be performed by Tenant at Tenant's sole cost and expense and without any abatement of rent. If Tenant shall fail to pay any sum of money, other than rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder, and such failure shall continue beyond any applicable period of notice set forth in this Lease, Landlord may, but shall not be obligated so to do, and without waiving or releasing Tenant from any obligations of Tenant, make any such payment or perform any such other act on Tenant's part to be made or performed as is in this Lease provided. All sums so paid by Landlord and all reasonable incidental costs, together with interest thereon at the rate of ten percent (10%) per annum from the date of such payment by Landlord, shall be payable to Landlord on demand and Tenant covenants to pay any such sums, and Landlord shall have (in addition to any other right or remedy of Landlord) the same rights and remedies in the event of the nonpayment thereof by Tenant as in the case of default by Tenant in the payment of the rent. 30.16 Access, Changes in Project, Facilities, Name. (a) Every part of the Project except the inside surfaces of all walls, windows and doors bounding the Premises (including exterior building walls, core corridor walls and doors and any core corridor entrance), and any space in or adjacent to the Premises used for shafts, stacks, pipes, conduits, fan rooms, ducts, electric or other utilities, sinks or other building facilities, and the use thereof, as well as access thereto through the Premises for the purposes of operation, maintenance, decoration and repair, are reserved to Landlord. -34- 35 (b) Tenant shall permit Landlord to install, use and maintain pipes, ducts and conduits within the walls, bearing columns and ceilings of the Premises. (c) Landlord reserves the right, without incurring any liability to Tenant therefor, to make such changes in or to the Building and the fixtures and equipment thereof, as well as in or to the street entrances, halls, passages, elevators, stairways and other improvements thereof, as it may deemed necessary or desirable. In making any such changes, Landlord shall use diligent efforts not to unreasonably interfere with Tenant's use of the Premises. (d) Landlord may adopt any name for the Project and Landlord reserves the right to change the name or address of the Building at any time. If Landlord changes the address of the Building, Landlord shall reimburse Tenant for the cost of new stationery and business cards in an amount not to exceed Seven Thousand Dollars ($7,000) within thirty (30) days after receipt of Tenant's invoice together with reasonable supporting documentation for such cost. 30.17 Corporate Authority. If Tenant is a corporation, each individual executing this Lease on behalf of said corporation represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of said corporation in accordance with a duly adopted resolution of the Board of Directors of said corporation or in accordance with the By-laws of said corporation, and that this Lease is binding upon said corporation in accordance with its terms. If Tenant is a corporation, said corporation and each individual executing this Lease on behalf of said corporation covenants that Tenant shall provide to Landlord a copy of such resolution of the Board of Directors authorizing the execution of this Lease on behalf of such corporation, which copy of resolution shall be duly certified by the secretary or an assistant secretary of the corporation to be a true copy of a resolution duly adopted by the Board of Directors of said corporation. In the event Tenant fails to comply with the requirements set forth in this Article 30.17, then each individual executing this Lease shall be personally liable for all of Tenant's obligations in this Lease. 30.18 Identification of Tenant. (a) If more than one person or entity executes this Lease as Tenant, (i) each of them shall be jointly and severally liable for the keeping, observing and performing of all of the terms, covenants, conditions and provisions of this Lease to be kept, observed and performed by Tenant, (ii) the term "Tenant" as used in this Lease shall mean and include each of them jointly and severally, and (iii) the act of or notice from, or notice or refund to, or the signature of, any one or more of them, with respect to the tenancy of this Lease, including, but not limited to, any renewal, extension, expiration, termination or modification of this Lease, shall be binding upon each and all of the persons executing this Lease as Tenant with the same force and effect as if each and all of them had so acted or so given or received such notice or refund or so signed. (b) If Tenant's interest in this Lease shall be assigned to a partnership (or to two or more persons, individually and as co-partners of a partnership) pursuant to Article 15 hereof (any such partnership and such persons hereinafter referred to in this Article 30.18(b) as -35- 36 "Partnership Tenant"), the following provisions of this Lease shall apply to such Partnership Tenant: (i) The liability of each of the parties comprising Partnership Tenant shall be joint and several. (ii) Each of the parties comprising the Partnership Tenant hereby consents in advance to, and agrees to be bound by, any written instrument which may hereafter be executed, changing, modifying or discharging this Lease, in whole or in part, or surrendering all or any part of the Premises to the Landlord, and by notices, demands, requests or other communication which may hereafter be given, by Partnership Tenant or any of the parties comprising Partnership Tenant. (iii) Any bills, statements, notices, demands, requests or other communications given or rendered to Partnership Tenant or to any of the parties comprising Partnership Tenant shall be deemed given or rendered to Partnership Tenant and to all such parties and shall be binding upon Partnership Tenant and all such parties. (iv) If Partnership Tenant admits new partners, all of such new partners shall, by their admission to Partnership Tenant, be deemed to have assumed performance of all of the terms, covenants and conditions of this Lease on Tenant's part to be observed and performed. (v) Partnership Tenant shall give prompt notice to Landlord of the admission of any such new partners, and, upon demand of Landlord, shall cause each such new partner to execute and deliver to Landlord an agreement in form satisfactory to Landlord, wherein each such new partner shall assume performance of all of the terms, covenants and conditions of this Lease on Partnership Tenant's part to be observed and performed (but neither Landlord's failure to request any such agreement nor the failure of any such new partner to execute or deliver any such agreement to Landlord shall violate the provisions of clause (iv) of this Article 30.18(b) or relieve any such new partner of his obligations thereunder). 30.19 Building Codes. After completion of the Tenant Building Standard Work, any and all costs attributable to or related to the applicable building codes of the City of El Segundo (or any other authority having jurisdiction over the Project) arising from Tenant's plans, specifications, improvements, or alterations shall be paid by Tenant at its sole cost and expense. The costs of any alterations or improvements to the common areas of the Project incurred by Landlord to comply with applicable statutes, codes, rules or regulations enacted after the date of this Lease shall be an Operating Cost determined in accordance with generally accepted accounting principles as applied to real estate industry standards. 30.20 Transportation and Energy Management. Tenant shall fully comply with all present and future programs intended to manage parking, transportation, traffic, energy or any other programs affecting the Project. -36- 37 30.21 Exhibits. The Exhibits attached hereto are incorporated herein by this reference as if fully set forth herein. 30.22 Waiver of Jury Trial. LANDLORD AND TENANT HEREBY KNOWINGLY, VOLUNTARILY, AND INTENTIONALLY WAIVE THE RIGHT TO A TRIAL BY JURY IN RESPECT TO ANY LITIGATION BASED HEREON, ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS LEASE OR ANY DOCUMENTS CONTEMPLATED TO BE EXECUTED IN CONNECTION HEREWITH OR ANY COURSE OF CONDUCT, COURSE OF DEALINGS, STATEMENTS (WHETHER ORAL OR WRITTEN) OR ACTIONS OF EITHER PARTY ARISING OUT OF OR RELATED IN ANY MANNER WITH THE PREMISES (INCLUDING WITHOUT LIMITATION, ANY ACTION TO RESCIND OR CANCEL THIS LEASE OR ANY CLAIMS OR DEFENSES ASSERTING THAT THIS LEASE WAS FRAUDULENTLY INDUCED OR AS OTHERWISE VOID OR VOIDABLE). THIS WAVIER IS A MATERIAL INDUCEMENT FOR LANDLORD TO ENTER INTO AND ACCEPT THIS LEASE. /s/ /s/ - ----------------------- ---------------- LANDLORD TENANT ARTICLE 31 OPTION TO EXTEND 31.1 Grant of Option. Landlord hereby grants to Tenant one (1) option (the "Option") to extend the Initial Term for an additional five (5) years (the "Option Term") upon and subject to the terms and conditions set forth in this Lease. Tenant shall have no right to extend the Initial Term except as provided herein. The Option shall be personal to Health Management Systems, Inc. and Health Care Microsystems, Inc., and shall not be transferable or assignable to any assignee of the Lease other than a Permitted Transferee. The Option shall be exercised, if at all, by Tenant's delivery of written notice of exercise to Landlord no later than six (6) months nor earlier than twelve (12) months prior to the expiration date of the Initial Term. The Basic Rental to be paid during the Option Term shall be ninety-five percent (95%) of the Prevailing Market Rental, as hereinafter defined. As used herein, the term "Prevailing Market Rental" shall mean the rental and all other monetary payments and escalations that Landlord could obtain from a third party tenant comparable to Tenant desiring to lease the Premises for the Option Term, taking into account the age of the Project, the size of the Premises, the type and quality of tenant improvements, the location and floor levels of the Premises, the quality of construction of the Project and the Premises, the services provided under the terms of the Lease, the rental and brokers commissions then being paid and any refurbishment allowance then being obtained by tenants comparable to Tenant for the renewal of leases of space comparable to the Premises in the City of El Segundo and all other factors that would be relevant to a third party in determining the rental such party would be willing to pay to lease the Premises for the Option Term. There shall be added to the Prevailing Market Rental, Landlord's then effective monthly parking charge for use of the parking spaces allocated to Tenant pursuant to Article 1.9 hereof for the Option Term, which parking charges may be increased from time to time during the Option Term. -37- 38 Notwithstanding anything contained herein to the contrary, if a default by Tenant exists under any of the terms, covenants or conditions of this Lease at the time Tenant exercises such Option, then Tenant's exercise of the Option shall be of no force and effect, provided, however, if Tenant cures such default and gives notice of exercise of the Option prior to the expiration of the time period for giving such notice, then such subsequent notice shall be effective. If (i) a default by Tenant beyond any applicable cure period exists under this Lease at any time after Tenant exercises the Option or (ii) Tenant and/or its permitted affiliates (as defined in Article 15.1(g) hereof) do not occupy at least a full floor of the Premises either at the time Tenant exercises the Option or at any time thereafter prior to the commencement date of the Option Term (the "Option Commencement Date"), then in each case Tenant shall have no rights hereunder to extend the Initial Term. 31.2 Determination of Prevailing Market Rental. On or before five (5) days after Tenant provides Landlord with notice of Tenant's exercise of the Option, Landlord and Tenant shall commence negotiations to agree upon the Prevailing Market Rental applicable thereto. If Landlord and Tenant are unable to reach agreement on the Prevailing Market Rental within twenty (20) days after the date negotiations commence, then the Prevailing Market Rental shall be determined as follows: (a) If Landlord and Tenant are unable to agree on the Prevailing Market Rental within said twenty (20) day period, then, within ten (10) days thereafter, Landlord and Tenant shall each simultaneously submit to the other in a sealed envelope its good faith estimate of the Prevailing Market Rental. If the higher of such estimates is not more than one hundred five percent (105%) of the lower of such estimates, then the Prevailing Market Rental shall be the average of the two estimates. (b) If the matter is not resolved by the exchange of estimates as provided in subparagraph (a) above, then either Landlord or Tenant may, by written notice to the other on or before ten (10) days after the exchange of such estimates, require that the disagreement be resolved by arbitration. Within ten (10) days after such notice, the parties shall select as an arbitrator a mutually acceptable MAI appraiser with experience in real estate activities, including at least ten (10) years' experience in appraising office space in the County of Los Angeles, California. If the parties cannot agree on an appraiser, then, within a second period of ten (10) days, each party shall select an independent MAI appraiser meeting the aforementioned criteria and, within a third period of ten (10) days, the two appointed appraisers shall select a third appraiser meeting the aforementioned criteria and the third appraiser shall determine the Prevailing Market Rental pursuant to subparagraph (c) below. If one party shall fail to make such appointment within said second ten (10) day period, then the appraiser chosen by the other party shall be the sole arbitrator. (c) Once the arbitrator has been selected as provided for in subparagraph (b) above, then, as soon as practicable but in any case within fourteen (14) days thereafter, the arbitrator shall select one of the two estimates of the Prevailing Market Rental submitted by Landlord and Tenant, which estimate shall be the one that is closer to the Prevailing Market Rental as determined by the arbitrator. The arbitrator's selection shall be rendered in writing to both Landlord and Tenant and shall be final and binding upon them and shall not be subject to -38- 39 appeal. If the arbitrator believes that expert advice would materially assist such arbitrator, then the arbitrator may retain one or more qualified persons, including, but not limited to, legal counsel, brokers, architects or engineers, to provide such expert advice. The party whose estimate is not chosen by the arbitrator shall pay the costs of the arbitrator and of any experts retained by the arbitrator; provided, however, that any fees of any counsel or expert engaged directly by Landlord or Tenant shall be borne by the party retaining such counsel or expert. ARTICLE 32 SIGNAGE Except as provided in this Article 32, Tenant shall not place any sign upon the Premises or the Project without Landlord's prior written consent, which consent may be withheld by Landlord in its sole and absolute discretion. All signs shall be installed by Landlord at Tenant's sole cost and expense. Notwithstanding the foregoing and subject to Landlord's approval of the sign in accordance with this Article 32, Tenant shall have the right to place a sign on the "eyebrow" of the northwest side of Building with the initials "HCm" in size and type acceptable to Landlord and in compliance with all applicable codes of the City of El Segundo, in the location designated by Landlord. Tenant shall provide Landlord with plans and specifications showing the size, design, and other requirements for Tenant's eyebrow sign. Within fifteen (15) days after receipt of such plans, Landlord shall give Tenant written notice of any disapproval thereof, specifying Landlord's reasons for disapproval in writing. Thereafter, Tenant shall revise its plans and specifications to satisfy Landlord's objections. After Landlord has approved the plans and specifications for Tenant's sign, Landlord shall cause the sign to be installed on the eyebrow of the Building and all costs and expenses of installation thereof, together with any reasonable costs incurred by Landlord to thereafter maintain the eyebrow sign, shall be paid by Tenant to Landlord within fifteen (15) days after the date of Landlord's invoice therefor. Notwithstanding the foregoing, upon ninety (90) days written notice provided to Tenant at any time from October 1, 1997 through January 1, 1999, Landlord shall have the right to remove Tenant's sign on the "eyebrow" of the Building and install the sign of another tenant in the Building who has been granted eyebrow signage rights pursuant to a lease executed prior to January 1, 1999, and elected to place its eyebrow sign on the Building so long as such other tenant leases space from Landlord in the Building, the square footage of which is one hundred percent (100%) larger than the Premises. If Landlord removes Tenant's sign from the "eyebrow" of the Building in accordance with the previous sentence, Landlord shall replace Tenant's eyebrow sign with a panel identifying Tenant on the multi-tenant monument sign dedicated to the Building facing Sepulveda Boulevard. Tenant shall be entitled to the top line of such multi-tenant monument sign during such time that the Premises leased by Tenant are twenty percent (20%) greater than any space in the Building rented by Landlord to another tenant who has been granted monument sign rights. Landlord shall be responsible for all costs of removal of Tenant's eyebrow sign and replacement thereof with a panel in the multi-tenant monument sign. Notwithstanding the foregoing, in no event shall Tenant's eyebrow sign be removed from the Building during the first twelve (12) months of the Early Occupancy Period and Term. If Landlord has not given Tenant written notice of Landlord's intent to remove the eyebrow sign prior to January 1, 1999, then Tenant's eyebrow sign may not be removed during the balance of the Initial Term. If Tenant's eyebrow sign is removed for a larger tenant in accordance with this Article 32, and such larger tenant later vacates the Building -39- 40 prior to the expiration of the Initial Term, and any tenant who has been granted eyebrow signage rights who is at least one hundred percent (100%) larger than Tenant does not elect to use the eyebrow sign, then Tenant may replace its eyebrow sign on the Building for the remainder of the Initial Term, at Tenant's sole cost and expense. ARTICLE 33 EXPANSION RIGHTS; RIGHT OF FIRST REFUSAL 33.1 First Expansion Option. Landlord hereby grants Tenant an option to lease ("First Expansion Option") additional space located on the sixth floor (6th) floor of the Building contiguous to the Premises consisting of approximately Two Thousand (2,000) square feet, as designated on the plan attached hereto and incorporated herein as Exhibit "E" ("First Expansion Space"). Tenant may exercise the First Expansion Option at any time commencing with the Commencement Date and terminating upon the expiration of the twenty-fourth (24th) month of the Lease Term by delivering to Landlord irrevocable written notice of such exercise. Time is of the essence with respect to the time period during which Tenant must deliver to Landlord its written notice of exercise of the First Expansion Option. If Tenant fails to deliver written notice of its exercise of the First Expansion Option to Landlord prior to the expiration of the twenty-fourth (24th) lease month, then the First Expansion Option shall expire and shall be of no further force or effect. If Tenant timely exercises the First Expansion Option, then Landlord shall prepare and execute an amendment to this Lease that incorporates the First Expansion Space into the Premises and subjects the First Expansion Space to all of the terms and conditions of the Lease, except that Tenant shall have no rights of early occupancy with respect to the First Expansion Space. The amendment shall provide for the term of the Lease to commence as to the First Expansion Space on the earlier of (i) the date of substantial completion of any tenant improvements constructed by Landlord in the First Expansion Space for Tenant's benefit, or if Landlord is prevented from or delayed in completing such tenant improvements due to Tenant Delays (as defined in the Work Letter Agreement) then upon the date which such work would have been substantially completed but for such Tenant Delays or (ii) the date Tenant first takes possession of or commences the operation of its business in the First Expansion Space and to expire concurrently with the Lease Term. The amendment shall also provide for Tenant to pay Basic Rental for the First Expansion Space at the same rent as set forth in Article 1.3 of the Basic Lease Provisions and for an allowance for the construction of tenant improvements in an amount equal to Thirty-seven Dollar ($37.00) per rentable square foot in the First Expansion Space. The amendment shall attach a Work Letter Agreement similar to that attached hereto as Exhibit "C" for the construction of tenant improvements in the First Expansion Space. If Landlord and Tenant, after good faith negotiations, do not execute the Amendment within thirty (30) days after the date Landlord delivers a draft of the amendment to Tenant, Tenant's exercise of the First Expansion Option shall be deemed null and void and Landlord shall be free to lease the First Expansion Space to third parties. 33.2 Second Expansion Option. Landlord hereby grants Tenant an option to lease ("Second Expansion Option") additional space on the sixth (6th) floor of the Building consisting of -40- 41 approximately five thousand (5,000) square feet, as designated on the plan attached hereto as Exhibit "E" ("Second Expansion Space") with Tenant's occupancy of the Second Expansion Space occurring between the sixtieth (60th) and sixty-sixth (66th) month of the Lease Term. Tenant may exercise the Second Expansion Option at any time commencing with the fifty-fourth (54th) month of the Lease Term and terminating at the expiration of the sixtieth (60th) month of the Lease Term by delivering to Landlord its irrevocable written notice of such exercise. Time is of the essence with respect to the time period during which Tenant must deliver to Landlord its written notice of exercise of the Second Expansion Option. If Tenant fails to deliver written notice of its exercise of the Second Expansion Option to Landlord during the Second Expansion Option exercise period, then the Second Expansion Option shall expire and be of no further force and effect. If Tenant exercises the Second Expansion Option, then Landlord shall prepare and execute an amendment to this Lease that incorporates the Second Expansion Space into the Premises and subjects the Second Expansion Space to all of the terms and conditions of the Lease, except (i) Tenant shall not have any rights of early occupancy of the Second Expansion Space; (ii) the term of the Lease with respect to the Second Expansion Space shall commence upon the earlier of (A) the date of substantial completion of any tenant improvements constructed in the Second Expansion Space by Landlord for Tenant's benefit or the date upon which such tenant improvements would have been substantially completed but for any Tenant Delays, or (B) the date Tenant first takes possession of or commences the operation of its business in the Second Expansion Space and shall terminate concurrently with the Lease Term, and (iii) and Landlord shall grant Tenant an allowance for the construction of tenant improvements in the Second Expansion Space in an amount equal to Twenty-five Dollars ($25.00) per square foot of the Second Expansion Space less the "Salvage Costs" as defined herein. For the purposes of this Lease, "Salvage Costs" shall mean the fair market value of any existing improvements that are consistent with the design of the tenant improvements contemplated by Tenant which Tenant desires to retain therein upon taking possession of the Second Expansion Space as reasonably determined by Landlord and Tenant. The amendment shall attach a Work Letter Agreement similar to that attached hereto as Exhibit "C" for the construction of tenant improvements in the Second Expansion Space. If Landlord and Tenant, after good faith negotiations, do not execute the amendment within thirty (30) days after the date Landlord delivers a draft of the amendment to Tenant, Tenant's exercise of the Second Expansion Option shall be deemed null and void, and Landlord shall be free to lease the Second Expansion Space to third parties. 33.3 Right of First Refusal. If at any time during the Initial Term, Landlord reaches an agreement with a third party who desires to lease the portion of the sixth (6th) floor of the Building consisting of approximately fourteen thousand (14,000) rentable square feet, as designated on the plan attached hereto and incorporated herein as Exhibit "E" (the AFirst Refusal Space), Landlord shall give Tenant written notice of the terms and conditions on which such third party is willing to lease the First Refusal Space ("Offer"). If Landlord receives the Offer during the first seventy-two (72) months of the Lease Term, Tenant shall have the right to lease the First Refusal Space on the same terms and conditions set forth in the Lease except, (i) Tenant shall not have any right of early occupancy of the First Refusal Space, (ii) the term of the Lease with respect to the First Refusal Space shall commence upon the earlier of (A) the date of substantial -41- 42 completion of any tenant improvements constructed in the First Refusal Space by Landlord for Tenant's benefit or the date on which the tenant improvements would have been substantially completed but for Tenant Delays or (B) the date that Tenant first takes possession of or commences the operation of its business in the Premises and shall terminate concurrently with the Lease Term, and (iii) Landlord shall grant Tenant an allowance for the construction of tenant improvements in the Right of First Refusal Space equal to Twenty-five Dollars ($25.00) per square foot of the First Refusal Space less any Salvage Cost with respect to the First Refusal Space. If Landlord receives the Offer at any time after the end of the seventy-second (72nd) month of the Lease Term, Tenant shall have a right of first refusal to lease the First Refusal Space on the same terms and conditions as set forth in the Offer. Tenant may exercise the right of first refusal by giving Landlord written notice of such exercise with five (5) business days after the date of Tenant's receipt of the Offer. Tenant's failure to give written notice of its exercise of the right of first refusal within said five (5) business day period shall be deemed Tenant's waiver of its right of first refusal to lease the First Refusal Space as provided herein. If Tenant gives written notice of its exercise of the right of first refusal, then Landlord shall prepare an amendment to this Lease that incorporates the First Refusal Space into the Premises on the applicable terms and conditions as contemplated in this Article 33.3. If Landlord and Tenant, after good faith negotiations, do not execute an amendment to this Lease that incorporates the First Refusal Space into the Premises as contemplated herein within thirty (30) days after Landlord delivers a draft of the amendment to Tenant, then Tenant's right of first refusal with respect to the First Refusal Space shall be deemed terminated and Landlord shall have the right to lease the First Refusal Space free and clear of such right of first refusal. 33.4 Limitation on Rights. If a default by Tenant exists under this Lease on the date of Tenant's notice of exercise of any of the rights granted in this Article 33, then such notice shall be of no force and effect; provided, however, if Tenant cures such default and again gives notice of exercise of such rights prior to the expiration of the time period provided herein for giving such notice, such subsequent notice shall be effective. If a default by Tenant beyond any applicable cure period exists under this Lease at any time after Tenant has exercised a right granted under this Article 33, then Landlord may at its sole discretion elect to have Tenant's exercise of such right to be of no force and effect. From and after the date that any of the First Expansion Space, Second Expansion Space or First Refusal Space is made subject to this Lease, then the term "Premises" as used herein shall be deemed to refer to the original Premises demised under this Lease as well as such First Expansion Space, Second Expansion Space or First Refusal Space, as applicable, made subject to the Lease. ARTICLE 34 CONFERENCE ROOM Tenant shall have the nonexclusive right, in common with other tenants of the Project, to use any project conference room including the 17th floor of the building in the Project known as 222 North Sepulveda Blvd. Tenant may use such conference rooms for up to a total of thirty-two (32) hours per month free of charge during the Initial Term. Such conference rooms shall be available upon terms and conditions to be established from time to time by Landlord, but Landlord -42- 43 makes no representations or warranties to Tenant regarding the availability of the Project conference rooms. ARTICLE 35 HEALTH FITNESS CENTER If Landlord constructs or installs a health fitness center in the Project, Landlord shall waive the initial initiation fee for the first two hundred (200) employees of Tenant that register to use the health fitness center prior to the expiration of the second (2nd) year from the date such health fitness center opens. Notwithstanding the foregoing, Tenant acknowledges that Landlord has made no representations or warranties regarding the installation or construction of a health fitness center, and Landlord is under no obligation to install, construct, or operate the same in the Project at any time during the Lease Term. IN WITNESS WHEREOF, the parties hereto have executed this Lease as of the date set forth above. TENANT: HEALTH MANAGEMENT SYSTEMS, INC., a New York corporation By: /s/ Vincent C. Hartley ---------------------------------- Vincent C. Hartley Its: Director of Administration ---------------------------------- HEALTH CARE MICROSYSTEMS, INC., a California corporation By: /s/ Thomas Kazamek ----------------------------------- Its: Chief Operating Officer ----------------------------------- -43- 44 LANDLORD: PACIFIC CORPORATE TOWERS LLC, a Delaware limited liability company By: GE Capital Investment Advisors, Inc., Its authorized investment advisor By: /s/ Daniel Bradley -------------------------------- Its: Vice President -------------------------------- -44- 45 [GRAPHIC OF PACIFIC CORPORATE TOWERS PREMISES] 46 [GRAPHIC OF PACIFIC CORPORATE TOWERS PREMISES] 47 EXHIBIT "B" RULES AND REGULATIONS 1. No sign, advertisement or notice shall be displayed, printed or affixed on or to the Premises or to the outside or inside of the Building or so as to be visible from outside the Premises or Building without Landlord's prior written consent. Landlord shall have the right to remove any non-approved sign, advertisement or notice, without notice to and at the expense of Tenant, and Landlord shall not be liable in damages for such removal. All approved signs or lettering on doors and walls shall be printed, painted, affixed or inscribed at the expense of Tenant by Landlord or by a person selected by Landlord and in a manner and style acceptable to Landlord. 2. Tenant shall not obtain for use on the Premises ice, drinking water, waxing, cleaning, interior glass polishing, rubbish removal, towel or other similar services, or accept barbering or bootblackening, or coffee cart services, milk, soft drinks or other like services on the Premises, except from persons authorized by Landlord and at the hours and under regulations fixed by Landlord. No vending machines or machines of any description shall be installed, maintained or operated upon the Premises without Landlord's prior written consent. 3. The sidewalks, hall, passages, exits, entrances, elevators and stairways shall not be obstructed by Tenant or used for any purpose other than for ingress and egress from Tenant's Premises. 4. Toilet rooms, toilets, urinals, wash bowls and other apparatus shall not be used for any purpose other than for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. 5. Tenant shall not overload the floor of the Premises or mark, drive nails, screw or drill into the partitions, ceilings or floor or in any way deface the Premises. 6. In no event shall Tenant place a load upon any floor of the Premises or portion of any such flooring exceeding the floor load per square foot of area for which such floor is designed to carry and which is allowed by law, or any machinery or equipment which shall cause excessive vibration to the Premises or noticeable vibration to any other part of the Building. Prior to bringing any heavy safes, vaults, large computers or similarly heavy equipment into the Building, Tenant shall inform Landlord in writing of the dimensions and weights thereof and shall obtain Landlord's consent thereto, which consent Landlord shall have the right to deny. Such consent shall not constitute a representation or warranty by Landlord that the safe, vault or other equipment complies, with regard to distribution of weight and/or vibration, with the provisions of this Rule 6 nor relieve Tenant from responsibility for the consequences of such noncompliance, and any such safe, vault or other equipment which Landlord determines to constitute a danger of damage to the Building or a nuisance to other Tenants, either alone or in combination with other heavy and/or vibrating objects and equipment, shall be promptly removed by Tenant upon Landlord's written notice of such determination and demand for removal thereof. -1- 48 7. Tenant shall not use or keep in the Premises or Project any kerosene, gasoline or inflammable, explosive or combustible fluid or material, or use any method of heating or air-conditioning other than that supplied by Landlord. 8. Tenant shall not lay linoleum, tile, carpet or other similar floor covering so that the same shall be affixed to the floor of the Premises in any manner except as approved by Landlord. 9. Tenant shall not install or use any blinds, shades, awnings or screens in connection with any window or door of the Premises and shall not use any drape or window covering facing any exterior glass surface other than the standard drapes, blinds or other window covering established by Landlord. 10. Tenant shall cooperate with Landlord in obtaining maximum effectiveness of the cooling system by closing drapes when the sun's rays fall directly on windows of the Premises. Tenant shall not obstruct, alter, or in any way impair the efficient operation of Landlord's heating, ventilating and air-conditioning system. Tenant shall not tamper with or change the setting of any thermostats or control valves. 11. The Premises shall not be used for manufacturing or for the storage of merchandise except as such storage may be incidental to the permitted use of the Premises. Tenant shall not, without Landlord's prior written consent, occupy or permit any portion of the Premises to be occupied or used for the manufacture or sale of liquor or tobacco in any form, or a barber or manicure shop, or as an employment bureau. The Premises shall not be used for lodging or sleeping or for any improper, objectionable or immoral purpose. No auction shall be conducted on the Premises. 12. Tenant shall not make, or permit to be made, any unseemly or disturbing noises, or disturb or interfere with occupants of Building or neighboring buildings or premises or those having business with it by the use of any musical instrument, radio, phonographs or unusual noise, or in any other way. 13. No bicycles, vehicles or animals of any kind shall be brought into or kept in or about the Premises, and no cooking shall be done or permitted, except by microwave and toaster oven, by any tenant in the Premises, except that the preparation of coffee, tea, hot chocolate and similar items for tenants, their employees and visitors shall be permitted. No tenant shall cause or permit any unusual or objectionable odors to be produced in or permeate from or throughout the Premises. 14. The sashes, sash doors, skylights, windows and doors that reflect or admit light and air into the halls, passageways or other public places in the Building shall not be covered or obstructed by any tenant, nor shall any bottles, parcels or other articles be placed on the window sills. -2- 49 15. No additional locks or bolts of any kind shall be placed upon any of the doors or windows by any tenant, nor shall any changes be made in existing locks or the mechanisms thereof unless Landlord is first notified thereof, gives written approval, and is furnished a key therefor. Each tenant must, upon the termination of his tenancy, give to Landlord all keys of stores, offices, or toilets or toilet rooms, either furnished to, or otherwise procured by, such tenant, and in the event of the loss of any keys so furnished, such tenant shall pay Landlord the cost of replacing the same or of changing the lock or locks opened by such lost key if Landlord shall deem it necessary to make such change. 16. Landlord shall have the right to prohibit any advertising by any tenant in the Premises, Building or Project which, in Landlord's opinion, tends to impair the reputation of the Building or its desirability as an office building and upon written notice from Landlord any tenant shall refrain from and discontinue such advertising. 17. Landlord reserves the right to control access to the Building by all persons after reasonable hours of generally recognized business days and at all hours on Sundays and legal holidays. Each tenant shall be responsible for all persons for whom he requests after hours access and shall be liable to Landlord for all acts of such persons. Landlord shall have the right from time to time to establish reasonable rules pertaining to freight elevator usage, including the allocation and reservation of such usage for tenants' initial move-in to their premises, and final departure therefrom. Landlord shall notify Tenant of any change in the holiday schedule for the Project. 18. Any person employed by any tenant to do janitorial work shall, while in the Building and outside of the Premises, be subject to and under the control and direction of the Office of the Building (but not as an agent or servant of Landlord, and the tenant shall be responsible for all acts of such persons). 19. All doors opening on to public corridors shall be kept closed, except when being used for ingress and egress. 20. The requirements of tenants will be attended to only upon application to the Office of the Building. 21. Canvassing, soliciting and peddling in the Building are prohibited and each tenant shall cooperate to prevent the same. 22. All office equipment of any electrical or mechanical nature shall be placed by tenants in the Premises in settings approved by landlord, to absorb or prevent any vibration, noise or annoyance. 23. No air conditioning unit or other similar apparatus shall be installed or used by any tenant without the prior written consent of Landlord. Tenant shall pay the cost of all electricity used for air conditioning in the Premises if such electrical consumption exceeds normal office -3- 50 requirements, regardless of whether additional apparatus is installed pursuant to the preceding sentence. 24. There shall not be used in any space, or in the public halls of the Building, either by any tenant or others, any hand trucks except those equipped with rubber tires and side guards. 25. All electrical ceiling fixtures hung in offices or spaces along the perimeter of the Building must be florescent and/or of a quality, type, design and bulb color approved by Landlord. Tenant shall not permit the consumption in the Premises of more than 2 1/2 watts per net usable square foot in the Premises in respect of office lighting nor shall Tenant permit the consumption in the Premises of more than 1 1/2 watts per net usable square foot of space in the Premises in respect of the power outlets therein, at any one time. In the event that such limits are exceeded, Landlord shall have the right to remove any lighting fixture of any florescent tube or bulb therein as it deems necessary and/or to charge Tenant for the cost of the additional electricity consumed. 26. Parking (a) Garage hours shall be 5:00 a.m. to 8:00 p.m., Monday through Friday, and 5:00 a.m. to 5:00 p.m. Saturday, state and federal holidays excepted, as revised from time to time by Landlord. (b) Automobiles must be parked entirely with the stall lines on the floor. (c) All directional signs and arrows must be observed. (d) The speed limit shall be 5 miles per hour. (e) Parking is prohibited in areas not striped for parking. (f) Parking cards or any other device or form of identification supplied by Landlord (or its operator) shall remain the property of Landlord (or its operator). Such parking identification device must be displayed as requested and may not be mutilated in any manner. The serial number of the parking identification device may not be obliterated. Devices are not transferable or assignable and any device in the possession of an unauthorized holder will be void. There will be a replacement charge to the Tenant or person designated by Tenant of $25.00 for loss of any parking card. (g) Unless otherwise provided in the Lease, the monthly rate for parking is payable one (1) month in advance and must be paid by the third business day of each month. Failure to do so will automatically cancel parking privileges and a charge at the prevailing daily rate will be due. No deductions or allowances from the monthly rate will be made for days parker does not use Parking Facilities. -4- 51 (h) Tenant may validate visitor parking by such method or methods as the Landlord may approve, at the validation rate from time to time generally applicable to visitor parking, except as otherwise provided in the Lease. (i) Landlord (and its operator) may refuse to permit any person who violates the within published rules to park in the garage, and any violation of the rules shall subject the automobile to removal from the garage at the parker's expense. In either of said events, Landlord (or its operator) shall refund a pro rata portion of the current monthly parking rate and the sticker or any other form of identification supplied by Landlord (or its operator) will be returned to Landlord (or its operator). (j) Garage managers or attendants are not authorized to make or allow any exceptions to these Rules and Regulations. (k) Every parker is required to park and lock his own automobile. All responsibility for any loss or damage to automobiles or any personal property therein is assumed by the parker. (l) Loss or theft of parking identification devices from automobiles must be reported to the garage manager immediately, and a lost or stolen report must be filed by the parker at that time. (m) The Parking Facilities are for the sole purpose of parking one automobile per space. Washing, waxing, cleaning or servicing of any vehicles by the parker or his agents is prohibited. (n) Landlord (and its operator) reserves the right to refuse the issuance of monthly stickers or other parking identification devices to any Tenant and/or its employees who refuse to comply with the above Rules and Regulations and all posted and unposted City, State or Federal ordinances, laws or agreements. (o) Tenant agrees to acquaint all employees with these Rules and Regulations. -5- 52 EXHIBIT "C" WORK LETTER AGREEMENT This Work Letter Agreement ("Letter") supplements the Standard Office Lease (the "Amendment") dated as of September 19, 1996, executed concurrently herewith by and between Landlord and Tenant ("Lease"), covering certain premises described in the Lease (the "Premises"). All terms not defined herein shall have the same meaning as set forth in the Lease. 1.0 Plans and Drawings for Premises. 1.1 Sign Approval Schedule. Promptly after execution of this Lease Landlord shall furnish Tenant with a schedule setting forth the projected time periods for submission and approval of plans and specifications and cost estimates and showing the deadlines for any actions required to be taken by the parties during the plan approval process. Landlord may from time to time during the plan approval process modify or amend such schedule due to any delays that are encountered. 1.2 Space Plans. Promptly after the execution of the Lease, Tenant shall cause Tenant's architect to furnish to Landlord and Landlord's architect, for review and approval, a preliminary space plan sufficient to convey the architectural design of the Premises for Tenant's leasehold improvements ("Space Plans"). The Space Plans shall include any improvements Tenant intends to make to the common areas of the seventh (7th) floor (i.e. elevator lobby and corridors). If Landlord or Landlord's architect shall disapprove of any part of the Space Plans, Landlord shall, within five (5) days after receipt thereof, advise Tenant in writing of such revisions and reasons therefor, as are reasonably required by Landlord or Landlord's architect to approve the Space Plans. Landlord and Tenant shall thereafter negotiate in good faith to reach agreement upon revisions to the Space Plans. After Landlord and Tenant have reached such agreement, Tenant shall then submit to Landlord and Landlord's architect for review and approval, a revision of the Space Plans incorporating the revisions requested by Landlord or Landlord's architect. The cost for the initial Space Plan and one revision thereto shall be deducted from the Allowance (as defined in Paragraph 4.0 below). Any further Space Plan revisions shall be at Tenant's sole cost and expense. 1.3 Working Drawings. Tenant shall cause Tenant's architect to prepare from the approved Space Plans and to furnish to Landlord and Landlord's architect for review and approval complete architectural plans, drawings and specifications and complete engineered mechanical, structural and electrical Working Drawings for (i) all of the Premises showing the demising plan, finish schedule (i.e. carpeting and other floor coverings), including the finish schedule for any improvements to the common areas of the seventh (7th) floor of the Premises, and Tenant's design work desired by Tenant therefor, and (ii) any internal or external communications or special utility facilities which -1- 53 will require conduits or other improvements within common areas (collectively "Final Working Drawings and Specifications"; the work shown thereon being called the "Tenant Building Standard Work"), all in such form and in such detail as may be reasonably required by Landlord. The Final Working Drawings and Specifications shall be prepared by Tenant's architect and Tenant shall use an engineer approved by Landlord to perform the engineering work on the mechanical and electrical plans. Tenant's architect and the engineer retained by Tenant shall furnish all services necessary for the preparation of the Final Working Drawings and Specifications and for securing approvals and permits as, by reason of the nature of the Tenant Building Standard Work, shall be required from any governmental authority having jurisdiction or compliance deemed necessary by Landlord including without limitation ACM (asbestos containing material), hazardous wastes or materials, OSHA, CAL-OSHA, life-safety, sprinklers and the like. If Landlord or Landlord's architect shall disapprove of any part of the Final Working Drawings and Specifications, Landlord shall, within ten (10) days after receipt thereof, advise Tenant in writing of such revisions and reasons therefor as are reasonably required by Landlord or Landlord's architect to approve the Final Working Drawings and Specifications. Landlord and Tenant shall thereafter negotiate in good faith to reach agreement upon revisions to the Final Working Drawings and Specifications. After Landlord and Tenant have reached such agreement, Tenant shall then submit to Landlord and Landlord's architect for review and approval, a revision of the Final Working Drawings and Specifications incorporating the revisions requested by Landlord or Landlord's architect. Notwithstanding the foregoing, if Landlord disapproves the portion of the Final Working Drawings and Specifications relating to the finish schedule for Tenant's proposed improvements to the common area of the seventh (7th) floor, Landlord shall provide written notice of such disapproval separate and apart from any other disapproval of the Final Working Drawings and Specifications. Tenant shall not be required to revise the finish schedule for the proposed improvements to the common area of the seventh (7th) floor to overcome Landlord's objections; provided, however, that Landlord shall have no obligation to perform any improvements to the restrooms on the seventh (7th) floor of the Premises (other than code compliance alterations) unless Landlord approves the finish schedule and the portion of the Final Working Drawings and Specifications pertaining to Tenant's proposed improvements to the common areas of the seventh (7th) floor of the Premises. Final Working Drawings and Specifications shall comply with all conditions set forth in paragraph 1.4 below. Unless otherwise specified in the Final Working Drawings and Specifications, Landlord shall use building standard materials for the Tenant Building Standard Work. All architectural and engineering fees and consultant fees incurred by Landlord in connection with the review and approval of the Space Plans and Final Working Drawings and Specifications shall be deducted from the Allowance but shall be included within the limitation on the fee to be paid to Landlord's construction manager pursuant to Paragraph 4.2(ix) hereof. The cost of the initial Final Working Drawings and Specifications and one revision thereto shall be deducted from the Allowance. Any further Final Working Drawings and Specifications revisions shall be at Tenant's sole cost and expense. 1.4 Requirements of Final Working Drawings and Specifications. The Final Working Drawings and Specifications shall: (i) be in conformance with the Base Building shell and with the design, construction and equipment of the Building and with Landlord's Building standards and specifications in effect for the Project; (ii) comply with all -2- 54 applicable laws and ordinances, and the rules and regulations of all governmental authorities having jurisdiction; (iii) comply as Landlord deems reasonably necessary with all ACM, hazardous waste, American with Disabilities Act, OSHA, CAL-OSHA, life-safety, and sprinkler rules, regulations, ordinances or laws; (iv) comply with all applicable insurance regulations for a fire resistive Class A Building; and (v) include locations and complete and exact dimensions. 1.5 Changes at Tenant's Expense. If Tenant makes any changes to the Final Working Drawings and Specifications after Landlord's approval thereof or if the Final Working Drawings and Specifications or any amendment thereof or supplement thereto shall require changes in the Building shell, the increased cost of the Building shell work caused by such changes shall (to the extent such increase is in excess of the Allowance) be charged against Tenant, including without limitation permits, consultants, mitigation fees, surcharges, additional supervisory fees or administrative fees. The cost thereof shall include all direct architectural and/or engineering fees and expenses in connection therewith, including the fees of Landlord's architect incurred in reviewing any such changes, amendments or supplements to the Final Working Drawings and Specifications (which shall be limited in accordance with Paragraph 4.2(ix) hereof), as well as compensation from Tenant for the costs of any delays which arise from such changes, such costs including but not limited to lost rent, Final Working Drawings and Specifications triggering code work, title work and the like. If any such change, deletion or addition increases the cost of construction and installation of the Tenant Building Standard Work (to the extent such increase is in excess of the Allowance), Tenant shall immediately pay to Landlord the full amount of the increase in the cost of such construction and installation prior to Landlord's commencement of such addition or change. Tenant's failure to make any payment with respect to change orders shall be deemed a default under the Lease and the amount so delinquent shall be deemed Additional Rent and Landlord may exercise all rights and remedies set forth in Article 20 of the Lease; and in addition, Landlord may delay construction until such payment is made and such delay shall be deemed a Tenant-caused delay subject to the provisions of Paragraph 7.0 of this Exhibit C. 2.0 Costs of Work. 2.1 Landlord shall provide those building standard tenant improvements pursuant to mutually approved Final Working Drawings and Specifications prepared by the Tenant's architect. All items of Tenant Building Standard Work (whether or not the cost thereof is covered by the Allowance) shall become the property of Landlord upon expiration or earlier termination of the Lease and shall remain on the Premises at all times during the Lease Term. 2.2 At such time as Landlord has approved the Final Working Drawings and Specifications, Landlord shall request bids for the installation of the Tenant Building Standard Work from the following contractors: Sheldon Stevens, Turelk, Interscape, Innerspace and Carr. Landlord and Tenant shall jointly determine which contractor's bid to accept. The bid from the contractor selected by Landlord and Tenant shall be used for purposes of preparing the Work Cost Statement pursuant to Subparagraph 2.3 hereof. -3- 55 2.3 Prior to the commencement of any Tenant Building Standard Work, Landlord shall submit to Tenant a written estimate of Work Cost (as defined in Paragraph 4.2 below) on all Tenant Building Standard Work, which written estimate shall be based on the Final Working Drawings and Specifications. Thereupon, the contractor selected pursuant to Section 2.2 above ("Contractor") and Tenant shall either approve the estimate or disapprove specific items and submit to Landlord a revision of the Final Working Drawings and Specifications to reflect the deletion and/or substitution for such disapproved items. Submission and approval of the Work Cost estimate shall proceed in accordance with the schedule provided in Paragraph 5 below. Upon Landlord's approval of such estimate, the approved estimate is to be hereinafter known as "Work Cost Statement." Landlord shall have the right to purchase special installations requiring extended material delivery lead items as set forth in the Final Working Drawings and Specifications and to commence the construction of the items included in said Work Cost Statement pursuant to Subparagraph 3.1 hereof. 2.4 Until Landlord approves the estimate and the Working Drawings and the Final Working Drawings and Specifications are signed by Landlord and Tenant, Landlord shall be under no obligation to perform the installation of the Tenant Building Standard Work. 3.0 Construction. 3.1 Following Landlord's approval of the Work Cost Statement, Landlord shall direct the Contractor (as determined in Paragraph 2.2) to commence and diligently proceed with the construction of all of the Tenant Building Standard Work, subject to delays beyond the reasonable control of Landlord or the Contractor. Promptly upon the commencement of the Tenant Building Standard Work, Landlord shall furnish Tenant with a schedule setting forth the projected completion dates therefor and showing the deadlines for any actions required to be taken by Tenant during such construction, and Landlord may from time to time during the prosecution of the Tenant Building Standard Work modify or amend such schedule due to delays encountered by Landlord. Landlord shall make a reasonable effort to meet such schedule as the same may be modified or amended. 3.2 Concurrently with Landlord's construction of the Tenant Building Standard Work, Landlord shall, at Landlord's sole cost and expense, improve and upgrade the common areas (i.e., the restrooms, elevator lobby and corridors) of the sixth (6th) floor of the Building consistent with Landlord's building standard for the common areas of the Building. If Landlord has approved the finish schedule and the Final Working Drawings and Specifications for Tenant's proposed improvement of the common areas of the seventh (7th) floor of the Premises, then Landlord shall also, at Landlord's sole cost and expense, improve and upgrade the restrooms on the seventh (7th) floor of the Building to Landlord's building standard for restrooms in the Building. In addition, Landlord shall, at Landlord's sole cost and expense and without deduction from the Allowance, clean the heating, ventilating and air conditioning ducts serving the Premises in conjunction with the installation of the Tenant Building Standard Work. 3.3 Tenant shall have a thirty (30) day period ("Fixturization Period") prior to the Scheduled Occupancy Date for the purpose of installing Tenant's personal property and -4- 56 equipment. The Fixturization Period shall commence upon the date of substantial completion of Tenant's Building Standard Work, or if Landlord is prevented from or delayed in completing the Tenant Building Standard Work due to Tenant Delays (as defined in Section 7.0 below), then the date upon which the Tenant Building Standard Work would have been substantially completed but for such acts or omissions of Tenant. Tenant's Building Standard Work shall be substantially complete on the date when all of Tenant's Building Standard Work has been substantially completed in accordance with this Work Letter Agreement, except for punchlist items. In addition, Tenant may enter the Premises not earlier than fourteen (14) days prior to substantial completion of the Tenant Building Standard Work for the sole purpose of installing Tenant's personal property and equipment so long as such entry does not interfere with the orderly construction and completion of the Tenant Building Standard Work. Tenant shall notify Landlord of its desired times of entry during the Fixturization Period or during the last fourteen (14) days prior to substantial completion of the Tenant Building Standard Work and shall submit the scope of work to be performed and the names of the contractors who will perform such work. Tenant shall indemnify, defend and hold Landlord harmless from and against any and all suits, claims, actions, losses, costs or expenses including claims for worker's compensation of any nature whatsoever together with reasonable attorneys' fees arising out of or in connection with the installation of Tenant's personal property, fixtures or equipment during the Fixturization Period. Landlord and Tenant shall cause their respective contractors to cooperate so that each party may complete its work in the Premises without interfering with the other. Tenant shall not be required to pay any Basic Rental or Tenant's Proportionate Share of Direct Costs during the Fixturization Period, but all other terms and conditions of the Lease shall apply. 3.4 Upon substantial completion of the Tenant Building Standard Work, representatives of Landlord and Tenant shall jointly conduct a walk-through inspection of the Premises and shall prepare a schedule of punchlist items for the Tenant Building Standard Work requiring correction or completion by Landlord. Landlord shall correct or complete the items on the punchlist within a reasonable period of time following the substantial completion of the Tenant Building Standard Work. 4.0 Allowance and Work Cost. 4.1 Allowance. Landlord shall grant to Tenant an allowance ("Allowance") of Thirty-seven Dollars ($37.00) per rentable square foot in the Premises, to be applied toward the Work Cost. 4.2 Work Cost. "Work Cost" means: (i) the cost of preparation of the initial Space Plans and Final Working Drawings and Specifications, and one revision thereof; (ii) governmental agency plan check, permit and other fees; (iii) sales and other taxes; (iv) Title 24 fees; (v) inspection costs; (vi) the actual costs and charges for material and labor, contractor's profit and general overhead incurred by Landlord for the Tenant Building Standard Work; (vii) all other reasonable costs to be expended by Landlord in the construction of the Tenant Building Standard Work, (viii) cost of furniture, fixtures and equipment -5- 57 installed in the Premises as part of the Tenant Building Standard Work, (ix) all design, architectural and engineering fees and consultant fees incurred by Landlord in connection with the review and approval of the Space Plans, Working Drawings and Final Working Drawings and Specifications and the costs of Landlord's construction manager (provided that all such fees and costs shall not exceed $1.00 per rentable square foot in Premises). If more than one revision to any of the Space Plans, Working Drawings and Final Working Drawings and Specifications is required, the cost thereof shall be paid by Tenant at its sole cost and expense. 4.3 Costs in Excess of Allowance. If the amount provided in the Work Cost Statement exceeds the Allowance (the amount by which the Work Cost exceeds the Allowance shall be referred to herein as the "Excess Cost"), Tenant shall pay the Excess Cost to Landlord by paying a portion of each progress payment requested by the Contractor under the contract equal to the proportion that the total Excess Cost bears to the total amount set forth in the Work Cost Statement multiplied by the amount requested by the Contractor in its request for payment. All such payments of Excess Cost shall be due and payable on the same date that Landlord is required to pay the request for payment under the Contractor's contract. Tenant's failure to make any payment of the Excess Cost when due, or to make any payment with respect to change orders that cause the Work Cost to exceed the Allowance, shall be deemed an Event of Default under the Lease and the amount so delinquent shall be deemed Additional Rent and Landlord may exercise all rights and remedies set forth in Article 20 of the Lease with respect to such Event of Default; and in addition, Landlord may delay construction until such payment is made and such delay shall be deemed a Tenant-caused delay subject to the provisions of Paragraph 7.0 of this Exhibit C. 4.4 Unapplied Allowance. If upon completion of the Tenant Building Standard Work, any portion of the Allowance has not been applied to the Work Cost (such portion shall hereafter be referred to as the "Unapplied Allowance"), Landlord shall give written notice to Tenant of the amount of the Unapplied Allowance within fifteen (15) days after completion of the Tenant Building Standard Work. Tenant may use the Unapplied Allowance to pay the cost of furnishings, fixtures or equipment to be used by Tenant solely in the Premises or to defray moving expenses incurred by Tenant in relocating to the Premises. Landlord shall reimburse Tenant from the Unapplied Allowance for the cost of installing furnishings, fixtures or equipment to be used solely in the Premises by Tenant and/or moving expenses incurred by Tenant in relocating to the Premises. Landlord shall use diligent efforts to reimburse Tenant for such amounts within fifteen (15) days after Landlord's receipt of detailed invoices for such costs or expenses but in no event shall such reimbursement be made later than thirty (30) days from the date of Landlord's receipt of such invoices; provided, however, Landlord shall have no obligation to use any portion of the Unapplied Allowance to reimburse Tenant for furnishings, fixtures or equipment and/or moving expenses unless and until Tenant takes possession of the Premises and accepts the same in accordance with Article 8 of the Lease. Landlord shall have no obligation to use any portion of the Unapplied Allowance to pay the cost of furnishings, fixtures or equipment to be used solely in the Premises and/or to pay moving expenses from and after the date that is ninety (90) days after the date that Tenant takes possession of the Premises. In the alternative, Tenant may elect to -6- 58 apply a portion of the Unapplied Allowance not to exceed Three Dollars ($3.00) per rentable square foot in the Premises to the Basic Rental becoming due under the Lease. Tenant may exercise such right by giving written notice to Landlord within fifteen (15) days after the date Landlord notifies Tenant of the amount of any Unapplied Allowance. If Tenant exercises such right, a portion of the Unapplied Allowance not to exceed Three Dollars ($3.00) per rentable square foot shall be applied to the first installments of monthly Basic Rental becoming due under the Lease until such amount is used in full. 5.0 Intentionally Omitted 6.0 Intentionally Omitted. 7.0 Delays. It is agreed that the Fixturization Period shall not commence until Landlord has substantially completed all Tenant Building Standard Work to be performed by Landlord by this Work Letter Agreement; provided, however, that if Landlord shall be delayed in substantially completing said work as a result of any of the following (collectively, "Tenant Delays"): (i) Tenant's failure to complete any action item on or before the due date which is the responsibility of Tenant, or (ii) Any change orders, or (iii) Tenant's request for materials, finishes, or installations other than Building Standard Work, or (iv) Any delay of Tenant in making payment to Landlord as provided herein, or (v) Any other delay attributable to Tenant or by a party employed by Tenant or under Tenant's control or due to failure of Tenant to perform or act in order to facilitate Tenant's tenancy, then as soon as possible following the commencement of the Fixturization Period, Landlord shall provide to Tenant a reasonable particularized statement of the number of days of Tenant Delays, and the Early Occupancy Period shall be reduced and the Commencement Date of the Lease shall be advanced by the number of days of such Tenant Delays. 8.0 Indemnity and Insurance. 8.1 Indemnity. To the extent Tenant constructs or installs any tenant improvements in the Premises, Tenant, Tenant's contractor and subcontractors, agents, employees and representatives agree to save, indemnify and hold harmless Landlord against any and all liability, claims, mechanics liens, judgments, or demands, including demands arising from injuries to or death of persons (Tenant's employees, employees of Tenant's contractor(s) and employees of all -7- 59 subcontractors and sub-subcontractors of Tenant's contractor included) and damage to property, or any other loss, loss of rent, damage, or expense, arising directly or indirectly out of the obligations herein undertaken or out of the operations conducted by Tenant and/or its contractor(s), subcontractors or sub-subcontractors save and except liability, claims, judgments or demands arising through the gross negligence or sole willful misconduct of Landlord and will make good to and reimburse Landlord for any expenditures, including actual attorneys' fees, which Landlord may incur by reason of such matters and, if requested by Landlord will defend any such suits at the sole cost and expense of contractor. 8.2 Insurance. If Tenant constructs or installs any tenant improvements in the Premises, the Tenant shall, at its sole expense, be responsible for the securing of insurance by the Tenant's contractor(s) and for the maintenance of same by the Tenant's contractor(s) until completion and final acceptance of the work. Certificates of Insurance affording evidence of same shall be obtained from the Tenant's contractor(s) by the Tenant and delivered to the Landlord prior to the commencement of any work by the Tenant's contractor. The required insurance coverage is as follows: 1. Worker's Compensation and Employers' Liability Insurance including coverage under the U.S. Longshoremen's and Harborworkers' Act and affording 30 days written notice of cancellation to Contractor. The Employers' Liability minimum limits required are as follows: Bodily Injury by accident $100,000. each accident Bodily Injury by disease $500,000. policy limit Bodily Injury by disease $100,000. each employee 2. General Liability Insurance on an Occurrence basis for an amount of $5,000,000 each occurrence and including the following coverage: a) Premises and Operations coverage with X, C and U exclusions deleted, if applicable. b) Owners and Contractors Protective coverage. c) Products and Completed Operations coverage. d) Blanket Contractual coverage, including both oral and written contracts. e) Personal Injury coverage. f) Broad Form Property Damage coverage, including completed operations. g) An endorsement naming Landlord as additional insured. h) An endorsement affording 30 days written notice to Contractor in event of cancellation or material reduction in coverage. i) An endorsement providing that such insurance as is afforded under policy of Tenant's contractor(s) is primary insurance as respects the Owner and that any other insurance maintained by Owner is excess and noncontributing with the insurance required hereunder. -8- 60 j) Insurance covering ACM, hazardous materials, life-safety systems, sprinklers, OSHA, CAL-OSHA and the like. No endorsement limiting or excluding a required coverage is permitted. CLAIMS-MADE COVERAGE IS NOT ACCEPTABLE. 3. Business Auto Liability Insurance for an amount of $5,000,000 combined single limit for bodily injury and/or property damage liability including: a) Owned Autos, b) Hired or Borrowed Autos, c) Nonowned Autos, and d) An endorsement affording 30 days written notice of cancellation to Landlord in event of cancellation or material reduction in coverage. A certificate and endorsements affording evidence of the above requirements must be delivered to Landlord before Tenant's contractor performs any work at or prepares or delivers materials to the site of construction. Tenant shall require its contractor(s) to require its subcontractors to provide insurance where Tenant's contractor(s) would be required to carry insurance under this insurance section and to be responsible for obtaining the appropriate certificates or other evidence of insurance. Tenant's contractor(s) shall maintain all of the foregoing insurance coverage in force until the work under this agreement is fully completed and accepted except as to 2c, (Products and Completed Operation Coverage), which is to be maintained for ten (10) years following completion of the work and acceptance by Landlord and Tenant. All insurance, except Workers' Compensation, maintained by Tenant's contractor and its subcontractors shall preclude subrogation claims by the insurer against anyone insured thereunder. The requirements for the foregoing insurance shall not derogate from the provisions for indemnification of Landlord by Tenant under the "indemnity" paragraph of this agreement. If the Tenant fails to secure and maintain the required insurance from Tenant's contractors, the Landlord shall have the right (without any obligation to do so, however) to secure same in the name and for the account of the Tenant's contractor(s) in which event the Tenant shall pay the cost thereof and shall furnish upon demand, all information that may be required in connection therewith. Further, such failure to secure and maintain the required insurance shall constitute a default under the Lease and Landlord shall be entitled to immediately have all tenant improvement work cease. 9.0 Miscellaneous. (a) If Tenant constructs or installs any tenant improvements in the Premises, Tenant and Tenant's contractors shall abide by all safety and construction rules and regulations of -9- 61 Landlord, and all work and deliveries shall be scheduled through Landlord. Entry by Tenant's contractors shall be deemed to be under all the terms, covenants, provisions and conditions of said Lease except the covenant to pay rent and additional rent. All Tenant's materials, work, installations and decorations of any nature brought upon or installed in the Premises before the commencement of the Early Occupancy Period shall be at Tenant's risk, and neither Landlord nor any party acting on Landlord's behalf shall be responsible for any damage thereto or loss or destruction thereof. Tenant shall award its contracts and conduct its activities hereunder in a manner consistent with Landlord's contractor's labor agreement affecting the Building. (b) Tenant shall reimburse Landlord for any extra expenses incurred by Landlord in the construction of the Tenant Building Standard Work by reason of faulty work done by Tenant or its contractors, or by reason of delays caused by such work, or by reason of cleanup which fails to comply with Landlord's rules and regulations. (c) Tenant's contractors shall not post any signs other than those required by law in connection with the construction on any part of the Project or Premises. 10.0 Incorporation. This Work Letter Agreement is hereby incorporated into the Lease executed between Landlord and Tenant concurrently herewith. TENANT: HEALTH MANAGEMENT SYSTEMS, INC., a New York corporation By: /s/ Vincent C. Hartley ---------------------------------- Vincent C. Hartley Its: Director of Administration ---------------------------------- -10- 62 HEALTH CARE MICROSYSTEMS, INC., a California corporation By: /s/ Thomas Kazamek --------------------------------------- Its: Chief Operating Officer --------------------------------------- LANDLORD: PACIFIC CORPORATE TOWERS LLC, a Delaware limited liability company By: GE Capital Investment Advisors, Inc., Its authorized investment advisor By: /s/ Daniel Bradley --------------------------------------- Its: Vice President --------------------------------------- -11- 63 EXHIBIT "D" NOTICE OF LEASE TERM DATES TO: ___________________________________ ___________________________________ ___________________________________ ___________________________________ RE: Standard Office Lease dated _________________ between PACIFIC CORPORATE TOWERS LLC, a Delaware limited liability company ("Landlord") and HEALTH MANAGEMENT SYSTEMS, INC., a New York corporation, and HEALTH CARE MICROSYSTEMS, INC., a California corporation (collectively, "Tenant") concerning Suite No. 600 on the sixth (6th) floor and Suite No. 700 on the seventh (7th) floor of the office building located at 200 N. Sepulveda Blvd., El Segundo, California. Dear Tenant: In accordance with the Standard Office Lease (the "Lease"), we wish to advise you and/or confirm as follows: 1. The Premises are Ready for Occupancy, and the Early Occupancy Period has commenced or shall commence on _________________. 2. The Lease Term shall commence on ________________ for a term of ___________ ending on _______________________. 3. Rent will commence to accrue on _____________________, in the amount of ________________. 4. If the Lease Commencement Date is other than the first day of the month, the first billing will contain a pro rata adjustment. Each billing thereafter, with the exception of the final billing, shall be for the full amount of the monthly installment as provided for in the Lease. 5. Your rent checks should be made payable to ____________________ at _______________________. -1- 64 6. The exact number of rentable square feet within the Premises is _______ square feet. LANDLORD: PACIFIC CORPORATE TOWERS LLC, a Delaware limited liability company By: GE CAPITAL INVESTMENT ADVISORS, INC., its authorized investment advisor By: Daniel Bradley ---------------- Its: Vice President ---------------- Agreed to and accepted this _____ day of _____ 1996. TENANT: HEALTH MANAGEMENT SYSTEMS, INC., a New York Corporation By: Vincent Hartley ------------------- Its: Director of Administration --------------------------- HEALTH CARE MICROSYSTEMS, INC., a California corporation By: Thomas Kazamek ---------------- Its: Chief Operating Officer ----------------------- -2- 65 EXHIBIT E EXPANSION SPACE Notwithstanding anything contained in Article 33 of the Lease, the following terms shall have the following meanings: "First Refusal Space" shall mean the remainder of the space on the sixth (6th) floor of the Building that does not constitute the original Premises, First Expansion Space or Second Expansion Space. "First Expansion Space" shall mean approximately two thousand rentable square feet located contiguous to the Premises on the sixth (6th) floor of the Building in a location designated, as shown on Exhibit A, approximate to corresponding gridlines R through P and quadrants 17 through 19. "Second Expansion Space" shall be contiguous to either the First Expansion Space beginning at gridlines R through P of Exhibit A and expanding forward, or if the First Expansion Space is not taken, then the Second Expansion Space shall mean contiguous to the current premises beginning at gridline R and moving forward through gridline P, and coinciding with quadrants 17 through 19. -1- 66 CONFIDENTIALITY AGREEMENT This Agreement is made and entered into as of September 19, 1996 by and between Health Management Systems, Inc., a New York corporation, and Health Care Microsystems, Inc., a California corporation (collectively, "Tenant"), and Pacific Corporate Towers LLC, a Delaware limited company ("Landlord"). Landlord and Tenant are entering into a lease of certain premises in the building located at 200 North Sepulveda Boulevard, El Segundo, California (the "Premises"). In connection with the lease ("Proposed Transaction"), Landlord has granted certain terms and conditions as an inducement to Tenant to enter into the Proposed Transaction. Landlord would not have proposed these terms and conditions to Tenant without Tenant's agreement to keep such terms and conditions confidential. Tenant, and its agents, officers, shareholders, employees, advisors, contractors, affiliates and representatives (including, without limitation, brokers, accountants and attorneys)(collectively "Representatives"), will acquire various information relating to the terms and conditions of the Proposed Transaction. The parties desire to maintain the confidentiality of such information pursuant to the provisions of this Agreement. For purposes of this Agreement, the term "Information" means any and all information, materials and documents, in written or oral form, relating to the terms and conditions of the Proposed Transaction, including, without limitation, the economic terms and conditions of the Proposed Transaction. Tenant agrees to keep confidential, and not to publish, disclose or otherwise divulge to anyone, the Information, and to cause its Representatives to keep confidential, and to not publish, disclose or otherwise divulge to anyone, the Information, except that Tenant shall be permitted to disclose the Information: (i) to any Representative of Tenant who needs to know the Information, provided that such Representative is advised of this Agreement; (ii) to the extent required to comply with federal and state income tax laws; (iii) to the extent required by applicable laws and governmental regulations or by any subpoena or similar legal process, provided that the Tenant provides prompt written notice to Landlord prior to such disclosure so that Landlord may seek a protective order or other remedy to prevent or limit such disclosure; (iv) to the extent such disclosure is contemplated under the lease for the Proposed Transaction; (v) to the extent Landlord shall have consented to such disclosure in writing; or (vi) in any arbitration or litigation proceeding between Landlord and Tenant arising out of this Lease. Notwithstanding the foregoing, nothing herein shall prohibit the disclosure by Tenant or Landlord, after the consummation of the Proposed Transaction, of the fact that Tenant has leased the Premises in the Building. Without prejudice to any rights and remedies otherwise available, Landlord shall be entitled to equitable relief by way of injunction or otherwise without proof of actual damages if Tenant or its Representatives breach or threaten to breech any of the provisions of this Agreement. In the event of any litigation concerning this Agreement, the prevailing party shall be entitled to recover its reasonable attorneys' fees and costs of suit. Tenant shall be responsible for the breach of this Agreement by any of its Representatives. No failure or delay of Landlord in 67 exercising any right, power or privilege hereunder will operate as a waiver thereof. This Agreement shall be governed by the laws of the State of California. This Agreement shall terminate on the second (2nd) anniversary of the date first set forth above. This Agreement may be executed in counterparts, each of which shall be deemed an original of this Agreement. In Witness Whereof, the parties have executed this Agreement as of the date first set forth above. LANDLORD: PACIFIC CORPORATE TOWERS LLC, a Delaware limited liability company By: GE Capital Investment Advisors, Inc., its authorized investment advisor By: /s/ Daniel Bradley ------------------------- Its: Vice President ------------------------- TENANT; HEALTH MANAGEMENT SYSTEMS, INC. a New York corporation By: /s/ Vincent C. Hartley ----------------------------- Its: Director of Administration ----------------------------- -2- 68 HEALTH CARE MICROSYSTEMS, INC. a California corporation By: /s/ Thomas Kazamek -------------------------- Its: Chief Operating Officer EX-11.0 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, ----------------------- 1996 1995 1994 ---- ---- ---- Primary Earnings Per Share: Earnings data: Net income $ 8,186 9,602 7,724 ======= ====== ====== Weighted average shares outstanding Average shares of common stock outstanding 16,994 16,263 15,786 Net effect of dilutive stock options - based on the treasury stock method using average market price 1,295 1,144 888 ------- ------ ------ Weighted average shares outstanding 18,289 17,407 16,674 ======= ====== ====== Earnings per common share: Net income $ 0.45 0.55 0.46 ======= ====== ======
EX-21.1 6 LIST OF SUBSIDIARIES 1 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT 21.1 - LIST OF SUBSIDIARIES OF HEALTH MANAGEMENT SYSTEMS, INC.
SUBSIDIARY STATE OF 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 3655 Torrance Boulevard Torrance, CA 90503 CDR Associates, Inc. Maryland 9642 Deereco Road Timonium, MD 90503 Quality Standards in Medicine, Inc. Delaware 581 Boylston Street Boston, MA 02116
EX-24.1 7 CONSENT OF KPMG PEAT MARWICK LLP 1 [LETTER HEAD KPMG PEAT MARWICH LLP] Exhiibit 24.1 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), forms S-8 (File Nos. 33-65560, 33-76770, 33-76638, 33-95326 and 33-33706) and form S-4 (File No. 333-135313) of Health Management Systems, Inc. of our report dated November 22, 1996 relating to the consolidated balance sheets of Health Management Systems, Inc. and subsidiaries as of October 31, 1995 and 1996, 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, 1996, and related schedule, which report appears herein. KPMG Peat Marwick LLP New York, New York January 17, 1997 EX-24.2 8 CONSENT OF ERNST & YOUNG LLP 1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Health Management Systems, Inc.: We consent to the incorporation by reference of our report dated November 15, 1996 with respect to the consolidated financial statements of Health Information Systems Corporation and Subsidiary included in the Annual Report (Form 10-K) of Health Management Systems, Inc. for the year ended October 31, 1996 in the Registration Statement (Form S-4 No. 333-13513) and Registration Statements (Form S-3 Nos. 33-91518 and 333-06769 and Form S-8 Nos. 33-65560, 33-33706, 33-76770, 33-76638 and 33-95326) of Health Management Systems, Inc. New York, New York Ernst & Young LLP January 15, 1997 EX-24.3 9 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACC'T 1 Report of Independent Auditors The Board of Directors and Stockholders Health Information Systems Corporation We have audited the accompanying consolidated balance sheets of Health Information Systems Corporation (the Company ) and Subsidiary as of October 31, 1996 and 1995 and the related consolidated statements of income, stockholders equity and cash flows for the year ended October 31, 1996 and the period from June 8, 1995 (date of inception) to October 31, 1995. These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Health Information Systems Corporation and Subsidiary at October 31, 1996 and 1995 and the consolidated results of their operations and their cash flows for the year ended October 31, 1996 and the period from June 8, 1995 (date of inception) to October 31, 1995 in conformity with generally accepted accounting principles. November 15, 1996 Ernst & Young LLP New York, New York EX-24.4 10 CONSENT OF COOPERS & LYBRAND LLP 1 EXHIBIT 24.4 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in this annual report on Form 10-k of out report dated February 7, 1995, on our audits of the financial statements of Health Care microsystems, Inc. as of and for the years ended December 31, 1994 and 1993, included in the Registration Statement on Form S-4 (File No. 333-13513) in the Registration Statements on Forms S-3 (File Nos. 33-91518 and 333-06769) and in the Registration Statements on Forms S-8 (Nos. 33-65560, 33-76638, 33-76770, 33-95326 and 33-33706) of Health Management Systems, Inc. /s/ Coopers & Lybrand L.L.P. - ---------------------------- Coopers & Lybrand L.L.P. Los Angeles, California January 14, 1997 EX-27 11 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL STATEMENT INFORMATION EXTRACTED FROM CONSOLIDATED BALANCE SHEETS AT OCTOBER 31, 1996 AND 1995 AND THE STATEMENT OF OPERATIONS FOR THE YEARS ENDED OCTOBER 31, 1996, 1995, AND 1994 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000861179 HEALTH MANAGEMENT SYSTEMS, INC. 1,000 YEAR YEAR YEAR OCT-31-1996 OCT-31-1995 OCT-31-1994 NOV-01-1995 NOV-01-1994 NOV-01-1993 OCT-31-1996 OCT-31-1995 OCT-31-1994 22,274 10,801 0 17,181 19,287 0 42,081 31,517 0 (1,682) (296) 0 0 0 0 86,809 65,857 0 21,885 15,169 0 (14,111) (9,295) 0 109,181 87,195 0 30,188 24,214 0 0 0 0 0 0 0 0 0 0 0 164 0 0 0 0 109,181 87,195 0 100,669 89,727 73,176 100,669 89,727 73,176 0 0 0 86,321 71,627 59,134 (384) 103 (405) 4,485 111 190 (987) (942) (464) 13,760 17,754 14,077 5,574 8,152 6,353 8,186 9,602 7,724 0 0 0 0 0 0 0 0 0 8,186 9,602 7,724 .45 .55 .46 0 0 0
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