1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) X Quarterly Report Pursuant to Section 13 or 15(d) - ---------- of the Securities Exchange Act of 1934 For the Quarterly Period Ended March 31, 1997 or Transition Report Pursuant to Section 13 or 15(d) - ---------- of the Securities Exchange Act of 1934 For the Transition Period from ________ to __________ COMMISSION FILE NUMBER 0-28182 ------- TRANSITION SYSTEMS, INC. ------------------------ (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2887598 ------------- ---------- (State or other jurisdiction (I.R.S. Employer of incorporation) Identification Number) ONE BOSTON PLACE, BOSTON, MASSACHUSETTS 02108 --------------------------------------------- (Address of principal executive offices) (Zip Code) (617) 723-4222 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. OUTSTANDING AT CLASS MAY 2, 1997 ----- ----------- COMMON STOCK, 17,076,416 $.01 PAR VALUE SHARES NON-VOTING COMMON STOCK, 356,262 $.01 PAR VALUE SHARES 2 TRANSITION SYSTEMS, INC. FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 1997 TABLE OF CONTENTS Page No. ------------ PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS: Consolidated Balance Sheets as of March 31, 1997 (unaudited) and September 30, 1996 ....................... 3 Consolidated Statements of Operations for the Three Months and Six Months Ended March 31, 1997 (unaudited) and March 30, 1996 (unaudited) .............................................. 4 Consolidated Statements of Cash Flows for the Six Months Ended March 31, 1997 (unaudited) and March 30, 1996 (unaudited) ......... 5 Notes to Interim Consolidated Financial Statements ...................... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ..................................... 7 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................... 11 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K......................................... 11 SIGNATURES ........................................................................... 12 2 3 TRANSITION SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS MARCH 31, SEPTEMBER 30, 1997 1996 ASSETS (unaudited) Current assets: Cash and cash equivalents $50,080,000 $51,505,000 Short term investments 250,000 -- Accounts receivable, net 15,269,000 13,419,000 Other current assets 2,210,000 1,831,000 Deferred income taxes 653,000 2,062,000 ----------- ----------- Total current assets 68,462,000 68,817,000 ----------- ----------- Property and equipment, net 1,240,000 1,108,000 Capitalized software costs, net 1,404,000 1,399,000 Purchased technology, net 1,494,000 1,612,000 Intangible assets, net 262,000 120,000 Long-term deferred income taxes 1,228,000 1,228,000 Equity investment 6,000,000 -- ----------- ----------- Total assets $80,090,000 $74,284,000 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 442,000 $ 595,000 Accrued expenses 5,154,000 4,280,000 Income taxes payable 864,000 2,015,000 Deferred revenue 6,620,000 6,255,000 ----------- ----------- Total current liabilities 13,080,000 13,145,000 ----------- ----------- Notes payable 17,000 21,000 Deferred income taxes 485,000 485,000 ----------- ----------- Total liabilities $13,582,000 $13,651,000 ----------- ----------- Commitments Stockholders' equity: Common stock 171,000 166,000 Non-voting common stock 4,000 4,000 Non-voting common stock warrant 395,000 395,000 Additional paid-in capital 41,065,000 39,161,000 Retained earnings 24,873,000 20,907,000 ----------- ----------- Total stockholders' equity 66,508,000 60,633,000 ----------- ----------- Total liabilities and stockholders' equity $80,090,000 $74,284,000 =========== =========== The accompanying notes are an integral part of the consolidated financial statements 3 4 TRANSITION SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) Three Months Ended Six Months Ended -------------------------- -------------------------- March 31, March 30, March 31, March 30, 1997 1996 1997 1996 ----------- ----------- ----------- ----------- Revenues: Software and implementation $ 7,026,000 $ 5,223,000 $12,886,000 $ 9,630,000 Maintenance 2,793,000 2,295,000 5,419,000 4,446,000 ----------- ----------- ----------- ----------- Total revenues 9,819,000 7,518,000 18,305,000 14,076,000 ----------- ----------- ----------- ----------- Cost of Revenues: Software and implementation 2,465,000 1,852,000 4,670,000 3,508,000 Maintenance 677,000 714,000 1,336,000 1,522,000 Research and development 883,000 820,000 1,761,000 1,628,000 Sales and marketing 1,680,000 1,133,000 3,044,000 2,021,000 General and administrative 1,050,000 679,000 2,031,000 1,226,000 Compensation charge -- 3,024,000 -- 3,024,000 ----------- ----------- ----------- ----------- Total operating expenses 6,755,000 8,222,000 12,842,000 12,929,000 ----------- ----------- ----------- ----------- Income (loss) from operations 3,064,000 (704,000) 5,463,000 1,147,000 Interest income 581,000 61,000 1,147,000 209,000 Interest expense -- (899,000) -- (899,000) ----------- ----------- ----------- ----------- Income (loss) before income taxes 3,645,000 (1,542,000) 6,610,000 457,000 Provision (benefit) for income taxes 1,458,000 (632,000) 2,644,000 188,000 =========== =========== =========== =========== Net income (loss) $ 2,187,000 $ (910,000) $ 3,966,000 $ 269,000 =========== =========== =========== =========== Net income (loss) per share $ 0.11 $ (0.07) $ 0.19 $ 0.02 Weighted average common shares outstanding (1) 20,506,000 13,886,000 20,702,000 13,886,000 (1) See note 2 of notes to interim consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements 4 5 TRANSITION SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Six Months Ended ---------------------------- March 31, March 30, 1997 1996 ----------- ------------- Cash flows from operating activities: Net income $ 3,966,000 $ 269,000 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income taxes -- 107,000 Depreciation and amortization 786,000 711,000 Compensation charge in connection with the recapitalization -- 3,024,000 Other (91,000) 6,000 Tax benefit from stock option exercises 1,492,000 -- Changes in operating assets and liabilities: (Increase) decrease in accounts receivable (1,850,000) 684,000 Increase in other current assets (379,000) (1,050,000) Decrease in deferred tax asset 1,409,000 -- (Decrease) increase in accounts payable (153,000) 152,000 Increase in accrued expenses 874,000 1,410,000 Decrease in taxes payable (1,151,000) (1,185,000) Increase in deferred revenue 365,000 211,000 ----------- ------------- Net cash provided by operating activities 5,268,000 4,339,000 Cash flows provided by (used by) investing activities: Purchases of investments (250,000) -- Sales and maturities of investments -- 7,324,000 Purchases of property and equipment (432,000) (264,000) Additions to capitalized software costs (355,000) (350,000) Additions to intangible assets (159,000) (2,000) Equity investment (6,000,000) -- ----------- ------------- Net cash provided by (used by) investing activities (7,196,000) 6,708,000 Cash flows provided by (used by) financing activities: Proceeds from issuance of debt -- 49,605,000 Payment of principal on term loan -- (1,000,000) Net proceeds from issuance of preferred stock -- 53,158,000 Purchase of common stock -- (111,410,000) Payment of fees related to recapitalization -- (3,336,000) Exercise of options 513,000 767,000 Proceeds from warrants issued -- 395,000 Other (10,000) (121,000) ----------- ------------- Net cash provided by (used by) financing activities 503,000 (11,942,000) Net decrease in cash and cash equivalents (1,425,000) (895,000) Cash and cash equivalents - beginning of period 51,505,000 3,844,000 =========== ============= Cash and cash equivalents - end of period $50,080,000 $ 2,949,000 =========== ============= Supplemental information: Income taxes paid $ 896,000 $ 455,000 Interest paid -- -- The accompanying notes are an integral part of the consolidated financial statements 5 6 TRANSITION SYSTEMS, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, and have been prepared by the Company without audit. In the opinion of management, the accompanying consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, except for the effects of the Recapitalization effected by the Company in January 1996 and the Company's initial public offering in April 1996, necessary for a fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods indicated. While the Company believes that the disclosures presented are adequate to make the information not misleading, these financial statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended September 30, 1996 which are contained in the Company's Annual Report on Form 10-K for such fiscal year. The results of operations for the three and six months ended March 31, 1997 are not necessarily indicative of the results to be expected for the entire fiscal year ending September 30, 1997. 2. COMPUTATION OF PRO FORMA EARNINGS PER SHARE Net income per common share is computed based upon the weighted average number of common shares and common equivalent shares outstanding during each period. Common equivalent shares are included in the per share calculations where the effect of their inclusion would be dilutive. Net income per share for the three and six month periods ended March 30, 1996, on a pro forma basis, gives effect to the Company's Recapitalization, and the issuance of common stock in the initial public offering. In accordance with the Securities and Exchange Commissions Staff Accounting Bulletin No. 83 ("SAB 83") all common and common equivalent shares and other potentially dilutive instruments, including stock options, warrants and preferred stock issued during the twelve-month period prior to the filing date (April 18, 1996) of the Company's Registration Statement for its initial public offering have been included in the calculation as if they were outstanding for all periods presented. 3. EQUITY INVESTMENT On January 31, 1997, the Company acquired a 19.5% equity interest in HealthVISION, Inc. for $6 million in cash. HealthVISION is a provider of electronic medical record software based in Santa Rosa, California. This investment is being accounted for on the cost basis. 4. RECENT ACCOUNTING PRONOUNCEMENTS In 1997, the Financial Accounting Standards Board ("FASB") released the Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share". SFAS 128 simplifies the standards for computing earnings per share ("EPS") and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. SFAS 128 requires restatement of all prior-period EPS data presented. Management has not yet determined the impact of SFAS 128 on the Company's financial statements. 6 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF -------------------------------------------------------------------------- OPERATIONS ---------- This document contains forward-looking statements which involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that may contribute to such differences include those listed under "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996, File No. 0-28182. The following information should be read in conjunction with the consolidated financial statements included herein and the notes thereto as well as the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996. OVERVIEW - -------- The Company provides integrated clinical and financial decision support systems to hospitals, integrated delivery systems and other health care institutions. The Company was founded in 1985 to apply management control techniques to the health care delivery process, with the objective of improving quality and lowering costs. The Company has experienced a seasonal pattern in its operating results, in which the first quarter of each fiscal year typically has the lowest revenue and net income, frequently lower than the last quarter of the previous fiscal year, and the fourth quarter typically has the highest revenue and net income. While the Company has taken steps to moderate this seasonal pattern, there can be no assurance that it will be able to eliminate the seasonality of its operating results. RESULTS OF OPERATIONS - --------------------- REVENUES The Company's total revenues increased 31% to $9.8 million for the three months ended March 31, 1997 from $7.5 million for the same period in the prior year. For the six months ended March 31, 1997, total revenues increased 30% to $18.3 million from $14.1 million for the same six month period in the prior year. Software and implementation revenue increased 35% to $7.0 million for the three months ended March 31, 1997 from $5.2 million for the same period in the prior year and increased 34% to $12.9 million for the six months ended March 31, 1997 from $9.6 million for the same period in the prior year. The increase in software and implementation revenue was due primarily to continued market penetration of the Company's products and increased add-on software sales to its existing customer base, as well as increased efficiency of system implementations resulting in additional revenue generated from backlog. Maintenance revenue increased 22% to $2.8 million for the three months ended March 31, 1997 from $2.3 million for the same period in the prior year, and increased 22% to $5.4 million for the six months ended March 31, 1997 from $4.4 million for the same period in the prior year. The growth in maintenance revenue is attributable to the growth in the Company's installed base. 7 8 COST OF REVENUE Cost of software and implementation revenue consists primarily of the cost of third-party software that is resold by the Company or included in the Company's products, personnel costs, the cost of related benefits, travel and living expenses, costs of materials and other costs related to the installation and implementation of the Company's products, and amortization of capitalized software development costs. Cost of maintenance revenue consists primarily of maintenance costs associated with the third-party software included in the Company's products and personnel costs incurred in providing maintenance and technical support services to the Company's customers. Cost of software and implementation revenue increased 33% to $2.5 million for the three months ended March 31, 1997 from $1.9 million for the same period in the prior year. For the six months ended March 31, 1997, cost of software and implementation revenue increased 33% to $4.7 million from $3.5 million for the same period last year. As a percentage of software and implementation revenue, cost of software and implementation revenue remained constant at 35% for the three months ended March 31, 1997 and March 30, 1996, and remained constant at 36% for the six months ended March 31, 1997 and March 30, 1996. The increase in spending was primarily due to a net increase of eighteen persons in the Company's implementation staff, as well as higher third-party software costs. Cost of maintenance revenue was essentially unchanged at $0.7 million for the three months ended March 31, 1997 and 1996, and decreased 12% to $1.3 million for the six months ended March 31, 1997 from $1.5 million for the same period in the prior year. As a percentage of maintenance revenue, cost of maintenance revenue decreased to 24% from 31% for the three months ended March 31, 1997 and March 30, 1996, respectively, and decreased to 25% from 34% for the six months ended March 31, 1997 and March 30, 1996, respectively. The decrease was primarily due to the reorganization of the Company's technical support department. Several employees in the technical support department were reassigned to research and development due to the maturation of the Company's midrange product, reducing support needs. RESEARCH AND DEVELOPMENT Research and development expense increased 8% to $0.9 million for the three months ended March 31, 1997 from $0.8 million for the same period in the prior year. For the six months ended March 31, 1997, research and development expenses increased 8% to $1.8 million from $1.6 million for the same period in the prior year. As a percentage of revenues, research and development expense decreased to 9% from 11% for the three months ended March 31, 1997 and March 30, 1996, respectively, and decreased to 10% from 12% for the six months ended March 31, 1997 and March 30, 1996, respectively. The increase in spending was mainly due to the reorganization of the Company's technical support department. This increase was partly offset by the transfer of certain personnel in the product planning group from a research and development role in fiscal 1996 to a marketing role in 1997. The decrease as a percentage of revenues was mainly due to the Company's investment in technology and development tools in prior years, resulting in increased productivity and less rapid growth in research and development expenditures. The Company expects that research and development expenses will increase as a percentage of revenue in future periods as new development projects are undertaken. 8 9 SALES AND MARKETING Sales and marketing expense increased 48% to $1.7 million for the three months ended March 31, 1997 from $1.1 million for the same period in the prior year, and increased 51% to $3.0 million for the six months ended March 31, 1997 from $2.0 million for the same period in the prior year. As a percentage of revenues, sales and marketing expense increased to 17% for the three months ended March 31, 1997 from 15% for the three months ended March 30, 1996 and increased to 17% from 14% for the six months ended March 31, 1997 and March 30, 1996 respectively. The increase was primarily due to a net increase of fifteen new sales and sales support personnel. Sales commissions also increased over last year due to increased sales volume. GENERAL AND ADMINISTRATIVE General and administrative expense increased 55% to $1.0 million for the three months ended March 31, 1997 from $0.7 million for the same period in the prior year, and increased 66% to $2.0 million for the six months ended March 31, 1997 from $1.2 million for the same period in the prior year. As a percentage of revenues, general and administrative expense increased to 11% from 9% for the three months ended March 31, 1997 and March 30, 1996, respectively, and increased to 11% from 9% for the six months ended March 31, 1997 and March 30, 1996, respectively. The increase was primarily due to increased costs related to becoming a publicly-traded company, and expenses related to Enterprising HealthCare, Inc., which the Company acquired in July 1996. OTHER OPERATING EXPENSES Other operating expenses for the three and six months ended March 30, 1996 included a compensation charge of $3.0 million arising from the acquisition by the Company, in connection with the January 1996 Recapitalization, of shares of Common Stock issued to certain executive officers pursuant to the exercise of options. INTEREST INCOME (EXPENSE) Interest income for the three months ended March 31, 1997 was $0.6 million, compared to $0.1 million in interest income and $0.9 million in interest expense for the same period in the prior year. During the six months ended March 31, 1997, the Company had $1.1 million in interest income compared to $0.2 million in interest income and $0.9 million in interest expense for the same period in the prior year. The increase in interest income, and the decrease in interest expense is related to the extinguishment in April 1996 of the debt related to the January 1996 Recapitalization, as well as the interest income earned on the cash balances that the Company generated from operations and the proceeds of the Company's April 1996 initial public offering. PROVISION FOR INCOME TAXES The Company's effective income tax rate decreased to 40% for the six months ended March 31, 1997 from 41% for the same period in the prior year. The decrease was primarily attributable to the tax benefit obtained by the Company's investing a portion of its cash in tax exempt securities during the current year. For the three months ended March 30, 1996, the Company recorded an income tax benefit resulting from the loss before taxes due to the compensation charge related to the January 1996 recapitalization. 9 10 RECENT ACCOUNTING PRONOUNCEMENTS In 1997, the Financial Accounting Standards Board ("FASB") released the Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share". SFAS 128 simplifies the standards for computing earnings per share ("EPS") and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. SFAS 128 requires restatement of all prior-period EPS data presented. Management has not yet determined the impact of SFAS 128 on the Company's financial statements. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Cash and cash equivalents decreased to $50.1 million at March 31, 1997 from $51.5 million at September 30, 1996. The decrease is attributable primarily to the Company's January 1997 acquisition of a 19.5% equity interest in HealthVISION for $6 million in cash, which was partially offset by cash provided by operating activities during the six month period ended March 31, 1997. The Company believes that available funds, cash generated from operations and its unused line of credit of $15 million, will be sufficient to finance the Company's operations and planned capital expenditures for at least the next twelve months. There can be no assurance, however, that the Company will not require additional financing during that time or thereafter. 10 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS At the Annual Meeting of Stockholders of the Company on February 11, 1997 the shareholders elected Robert S. Hillas and Allen F. Wise to three-year terms as Class I directors of the Company, and ratified the appointment of Coopers & Lybrand L.L.P. as the Company's independent public accountants for the 1997 fiscal year. The number of votes cast with respect to each nominee or proposal were as follows: Authority Abstentions and 1. Election of Directors For Withheld Broker Non-Votes ------------------------ --- -------- ---------------- Robert S. Hillas 15,305,717 33,800 - Allen F. Wise 15,305,717 33,800 - Abstentions and 2. Proposal to Ratify For Against Broker Non-Votes Appointment of --- ------- ---------------- Coopers & Lybrand 15,338,182 1,335 - ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS EXHIBIT NUMBER DESCRIPTION ------ ----------- *3.2 Amended and Restated Articles of Organization *3.4 Amended and Restated By-Laws *3.5 Articles of Amendment to the Articles of Organization, as filed with the Secretary of State of the Commonwealth of Massachusetts on April 3, 1996. *4.1 Specimen Certificate for Common Stock 11.1 Computation of Per Share Earnings 27 Financial Data Schedule * Incorporated herein by reference to the similarly-numbered exhibit included in the company registration statement on Form S-1, File No. 333-01758. (b) REPORTS ON FORM 8-K none 11 12 SIGNATURES Pursuant to the requirements 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. Transition Systems, Inc. (Registrant) Dated: May 9, 1997 /s/ Robert F. Raco ------------------------------------------------ Robert F. Raco President, Chief Executive Officer and Director (principal executive officer) Dated: May 9, 1997 /s/ Paula J. Malzone ------------------------------------------------ Paula J. Malzone Treasurer and Controller (principal financial and accounting officer) 12