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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 DECEMBER 31, 1998
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 0-21031
QUADRAMED CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 52-1992861
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1003 W. CUTTING BLVD., SUITE 2
RICHMOND, CALIFORNIA, 94804
(Address of Principal Executive
Offices, including Zip Code)
Registrant's telephone number, including area code: (510)620-2340
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(Title of Class)
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 report), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to the Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant, as of March 31, 1999 was approximately $101,000,000 (based upon the
closing price for shares of the Registrant's Common Stock as reported by the
Nasdaq National Market for the last trading date prior to that date). Shares of
Common Stock held by each officer, director and holder of 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
On March 5, 1999, approximately 20,090,205 shares of the Registrant's
Common Stock, $0.01 par value per share, were outstanding.
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QUADRAMED CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I............................................................................................. 3
ITEM 1. BUSINESS......................................................................... 3
ITEM 2. PROPERTIES....................................................................... 15
ITEM 3. LEGAL PROCEEDINGS................................................................ 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................. 15
PART II............................................................................................ 16
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............ 16
ITEM 6. SELECTED FINANCIAL DATA AND SUPPLEMENTARY DATA................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS................................................................ 17
ITEM 8. FINANCIAL STATEMENTS............................................................. 34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE......................................................... 34
PART III........................................................................................... 35
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................. 35
ITEM 11. EXECUTIVE COMPENSATION.......................................................... 35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................. 35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................. 35
PART IV............................................................................................ 36
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K................ 36
SIGNATURES......................................................................................... 42
POWER OF ATTORNEY.................................................................................. 42
INDEX TO FINANCIAL STATEMENTS...................................................................... 45
EXHIBIT INDEX...................................................................................... 72
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PART I
ITEM 1. BUSINESS.
Except for the historical financial information contained herein, the
matters discussed in this Annual Report on Form 10-K may be considered
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Such statements include declarations regarding the intent, belief or
current expectations of the Company and its management. Prospective investors
are cautioned that any such forward-looking statements are not guarantees of
future performance and involve a number of risks and uncertainties and that
actual results could differ materially from those indicated by such
forward-looking statements. Among the important factors that could cause actual
results to differ materially from those indicated by such forward-looking
statements include those risks identified in "Item 7 -- Management's Discussion
and Analysis of Financial Condition and Results of Operation -- Certain Factors
That Might Affect Future Operating Results" and other risks identified from time
to time in the Company's reports and registration statements filed with the
Securities and Exchange Commission.
OVERVIEW
QuadraMed Corporation ("QuadraMed" or the "Company") develops, markets
and sells software products and services designed to enable health care
providers and payors to increase operational efficiency, improve cash flow,
measure the cost of care and effectively administer managed care contracts. In
addition, QuadraMed provides health information management, business office
outsourcing, compliance and consulting services. QuadraMed and its subsidiaries
have approximately 3,800 customers. In addition, QuadraMed has received
endorsements from approximately 15 state and regional hospital associations.
The Company was incorporated in September 1993 in California under the
name QuadraMed Corporation and reincorporated in Delaware in 1996. The Company
has expanded significantly since its inception in 1993, primarily through the
acquisition of other businesses, products and services. Since 1995, the Company
has completed the following significant acquisitions:
COMPANY ACQUIRED DESCRIPTION OF COMPANY ACQUIRED DATE ACQUIRED
---------------- ------------------------------- -------------
Healthcare Design Systems Health care financial management and decision support software December 1995
Medicus Systems Corporation Health care financial management and decision support software November 1997*
Rothenberg Health Systems, Inc. Capitation management software December 1997
Cabot Marsh Corporation Health care consulting and compliance company February 1998
("Cabot Marsh")
Pyramid Health Group, Inc. Cash flow management services June 1998
("Pyramid") company
Integrated Medical Networks, Inc. Health care financial management September 1998
("IMN")
The Compucare Company Enterprise wide software March 1999
- ------------
* QuadraMed acquired 56.7% of the outstanding capital stock of Medicus
Systems Corporation on November 9, 1997. The remaining 43.3% shares of capital
stock were purchased by the Company in May 1998.
* Unless the context otherwise requires, references herein to the
"Company" and "QuadraMed" refer to QuadraMed Corporation, a Delaware
corporation, its subsidiaries and QuadraMed Corporation, its California
predecessor. The Company's executive offices are located at 1003 West
Cutting Blvd. 2nd Floor, Richmond, California 94804 and the telephone
number is (510)620-2340.
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The Company has expanded in substantial part through acquisitions of
products, technologies and businesses. The Company intends to continue to
acquire products technologies and businesses in the future. The Company's
ability to expand successfully through acquisitions depends on many factors,
including the successful identification and acquisition of products,
technologies or businesses and management's ability to effectively negotiate and
consummate acquisitions and integrate and operate the new products, technologies
or businesses. There is significant competition for acquisition opportunities in
the Company's industry, which may intensify due to increasing consolidation in
the health care industry, thereby increasing the costs of capitalizing on
acquisition opportunities. The Company competes for acquisition opportunities
with other companies that have significantly greater financial and management
resources than the Company. The inability to successfully identify appropriate
acquisition opportunities, consummate acquisitions or successfully integrate
acquired products, technologies, operations, personnel or businesses could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, acquisitions may divert management's
attention from other business concerns, expose the Company to the risks of
entering markets in which it has no direct prior experience or to risks
associated with the market acceptance of acquired products and technologies, or
result in the loss of key employees of the Company or the acquired company.
Moreover, acquisitions may result in potentially dilutive issuances of equity
securities, the incurrence of additional debt and the recognition of
amortization expenses related to goodwill and other intangible assets, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company may not be able to identify or
successfully complete acquisitions of products, technologies or businesses in
the future. In addition, declines in the Company's stock price will negatively
affect the Company's ability to consummate acquisitions that are accretive to
earnings.
Realizing benefits from acquisitions will depend in significant part
upon the successful integration of the acquired businesses, including their
products and employees, with the Company, and there can be no assurance that
such integration will not entail substantial costs, delays or other problems or
that such integration will be successfully completed. The effort to integrate
the businesses will divert the attention of management from other matters and
will result in significant operational and administrative expense. Any
difficulties encountered in the integration process could have a material
adverse effect on the revenues and operating results of the Company. In
addition, the process of combining the companies could cause the interruption
of, or a disruption in, the business activities of the Company, which could have
a material adverse effect on the operations and financial performance of the
Company. Even if these businesses are successfully integrated into the Company,
the acquired operations may not achieve sales, productivity and profitability
commensurate with the Company's historical or projected operating results.
Failure to achieve such projected results would have a material adverse effect
on the Company's financial performance, and in turn, on the market value of the
Company's Common Stock. There can be no assurance that the Company will realize
any of the anticipated benefits of its acquisitions, or that such acquisitions
will enhance the Company's business or financial performance.
Acquisitions involve a number of special risks including, without
limitation, managing geographically dispersed operations, failure of the
acquired business to achieve expected results, failure to retain key personnel
of the acquired business, inability to integrate the new business into existing
operations and risks associated with unanticipated events or liabilities,
potential increases in stock compensation expense and increased compensation
expense resulting from newly hired employees, the assumption of unknown
liabilities and potential disputes with the sellers of one or more acquired
entities, all of which could have a material adverse effect on the Company's
business, results of operations and financial condition. Additionally, customer
dissatisfaction or performance problems at a single acquired company could have
an adverse effect on the Company's reputation and its sales and marketing
initiatives. With the addition of the Pyramid, IMN and Compucare businesses,
the Company's anticipated future operations may place a strain on its management
systems and resources. The Company expects that it will be required to continue
to improve its financial and management controls, reporting systems and
procedures, and will need to expand, train and manage its work force.
Specifically, the Company is planning to implement a new financial accounting
system during 1999. There can be no assurance that the Company will be able to
effectively manage these tasks, and the failure to do so could have a material
adverse effect on its business, financial condition and results of operations.
With the acquisitions of IMN and Compucare the Company has entered the
market for enterprise products, which exposes the Company to additional risks
and uncertainties. These enterprise products have considerably higher average
sales prices than those traditionally offered by the Company and therefor tend
to lengthen the Company's sales cycle and increase the potential variability of
the Company's quarterly operating results.
The year 2000 computer issue creates additional risks for the Company.
Year 2000 compliance is an issue for virtually all businesses whose computer
systems and applications may require significant hardware and software upgrades
or modifications. Accordingly, the Company's customers are devoting a
substantial portion of their information systems spending and implementation
resources to fund such upgrades and modifications which tends to divert spending
away from the Company's products and solutions.
A substantial portion of the Company's revenues have been and are
expected to be derived from the sale of software products and services to
hospitals. Consolidation in the health care industry, particularly in the
hospital and managed care markets, could cause a decrease in the number of
existing or potential purchasers of the Company's products and services or the
loss of one or more of the Company's significant customers, insofar as customers
may be acquired by another company that uses products or services, which
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could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the decision to purchase the
Company's products often involves the approval of several members of management
of a hospital or health care provider. Consequently, it is difficult for the
Company to predict the timing or outcome of the buying decisions of customers or
potential customers.
The health care industry in the United States is subject to changing
political, economic and regulatory influences that may affect the procurement
practices and operations of health care organizations. The Company believes that
the commercial value and appeal of its products may be adversely affected if the
current health care financing and reimbursement system were to reverse its
current evolution to a managed care model back to a fee-for-service model. In
addition, many of the Company's customers are providing services under capitated
service agreements, and a reduction in the use of capitation arrangements as a
result of regulatory or market changes could have a material adverse effect on
the Company's business, financial condition and results of operations. During
the past several years, the health care industry has been subject to increasing
levels of governmental regulation of, among other things, reimbursement rates
and certain capital expenditures. Certain proposals to reform the health care
system have been and are being considered by Congress. These proposals, if
enacted, could change the operating environment for the Company's clients in
ways that cannot be predicted. Health care organizations may react to these
proposals by curtailing or deferring investments, including those for the
Company's products and services.
Changes in current health care financing and reimbursement systems could
result in the need for unplanned product enhancements, in delays or
cancellations of product orders or shipments or in the revocation of endorsement
of the Company's products by hospital associations or other customers. Any of
these occurrences could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, many
health care providers are consolidating to create integrated health care
delivery systems with greater regional market power. As a result, these emerging
systems could have greater bargaining power, which may lead to price erosion of
the Company's products. The failure of the Company to maintain adequate price
levels would have a material adverse effect on the Company's business, financial
condition and results of operations. Other market-driven reforms could also have
adverse effects on the Company's business, financial condition and results of
operations.
The Company's performance also depends in significant part upon the
continued service of its executive officers, its product managers and other key
sales, marketing, and development personnel. The loss of the services of any of
its executive officers or the failure to hire or retain other key employees
could have a material adverse effect on the Company's business, financial
condition and results of operations. Additions of new, and departures of
existing, personnel can be disruptive and could have a material adverse effect
on the Company's business, financial condition and results of operations.
DRG[check mark](R) and QuadraMed(R) are registered trademarks of the
Company. All other trademarks and trade names referred to in this Annual Report
on Form 10-K are the property of their respective owners.
QUADRAMED'S SUITE OF PRODUCTS
QuadraMed's web-enabled, enterprise-wide products are primarily sold with
modular, open architecture design and flexible electronic interfaces. Offerings
are structured to utilize data from disparate health care information systems,
thereby extending the functional value of today's legacy system investments. As
a result of this modular design, additional applications can be readily
integrated into customers' existing applications. The Company's solutions
support providers in the planning, management, documentation and evaluation of
patient care. QuadraMed has enabled its customers to generate operational
efficiencies, improve cash flow and measure the cost and quality of care. The
Company is divided into three operating divisions including business office,
health information management and the enterprise division (beginning in 1999).
The Company currently processes substantially all of its customer data at its
facilities in Richmond, California and Neptune, New Jersey. While the Company
backs up its data nightly and has safeguards for emergencies such as power
interruption or breakdown in temperature controls, it has no mirror processing
site to which processing could be transferred in the case of a catastrophic
event at either of these facilities. The occurrence of a major catastrophic
event at either the Richmond or the Neptune facility could lead to an
interruption of data processing and could have a material adverse effect on the
Company's business, financial condition and results of operations.
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Products in the Business Office Division
The Company's business lines in the Business Office Division target a
provider's chief financial officer as the primary buyer. The divisions'
solutions address the complex administrative and financial management demands
placed on healthcare organizations today, providing the technology and expertise
to increase cash flow and reduce administrative costs. The division is comprised
of the following product and service categories: decision support,
patient-focused solutions, electronic business office, managed care, executive
information systems and business office outsourcing.
Specific products and services under the decision support solutions area include
Performance Measurement, Enterprise and Patient Costing, The Budget Advisor(TM),
Payroll Planner(TM) and ORYX Reporting.
QuadraMed's Performance Measurement products provide integrated comparative
perspectives on clinical, financial and market performance for providers. The
Company's products generally include database analysis software and national and
regional benchmark data that may be licensed to the customer. The customer
provides its own internally generated clinical and financial information to the
Company, and the Company performs risk and severity adjustments on such
information based on patient demographics and health status and formats it for
comparison against the national and regional data. The updated and adjusted data
sets are returned to the customer for use with the database analysis software.
The Company's performance measurement solution has been accepted for inclusion
on the Joint Commission on Accreditation of Healthcare Organization's initial
list of performance measurement systems.
The Clinical Performance Measurement solution is a software application that
measures clinical outcomes and resource utilization based on diagnosis, patient,
physician and other variables. This product is used as a benchmarking tool to
compare hospital-level information against 101 risk and severity adjusted
outcome indicators. The benchmarking information is derived from a standardized
national set of 10 million patient records. The outcomes database is organized
into major categories including: overall mortality, obstetrics, surgery,
neonatal, radiology and general medical. The customer typically produces reports
that compare its performance against competitor or peer group providers and
against expected outcomes derived from the national and regional data set.
The Financial Performance Measurement solution is a software application that
employs cost accounting, length-of-stay, and other benchmark information to
allow customers to measure cost, clinical resource utilization and profitability
by physician, payor, diagnosis and procedure. Most providers have access to
charge and reimbursement information for procedures and diagnoses, but do not
have accurate measures for the cost of care in these categories. Therefore,
these providers cannot accurately track profitability by procedure or diagnosis.
Through an interface with Clinical Performance Measurement, providers can
benchmark the risk adjusted outcomes and financial performance by physician,
diagnosis, patient and other variables. This application can also be used to
analyze the profitability of managed care and capitated contracts.
QuadraMed's Market Analysis Performance Measurement solution is a software
application that consists of licensed software and database information that is
derived from statewide and national hospital billing data sets and other
demographic and population statistics. This application enables customers to
perform market share, community health assessment, managed care activity and
physician admitting pattern analyses.
QuadraMed offers an Enterprise-wide Cost Accounting tool for optimizing resource
allocation and cost containment, in addition to a Patient-Level Cost and Quality
Analysis tool for improving service while reducing costs. Care Delivery Costing
software products are designed for workload-driven staffing and care delivery
costing analysis addressing the informational needs from both the clinical and
financial management perspective. Using well established objective workload
measurement methodologies, patient care managers can utilize these software
tools to optimize the allocation of patient care resources, maintain clinical
standards, utilize benchmarking database resources for comparative analysis and
manage labor costs in a variety of in-patient and out-patient care settings.
Under patient-focused solutions, the following product and service offerings are
included: Staffing Resource Management and Benchmarking, HEDIS Reporting and
Patient Care Staff Management Consulting. Patient-focused Resource Management
tools facilitate budgeting decisions regarding patient care resource allocation.
Products enable labor cost and productivity benchmarking comparisons and support
a provider's strategic planning process. Staff management consulting enables
providers to define staffing and skill-mix levels based on patient-specific
requirements to deliver quality, cost-effective patient care. Staff Management
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consulting also allows providers to compare and trend workload, staffing and
productivity, identify opportunities for re-aligning staff responsibilities to
provide increased time for direct patient care by conducting work sample
studies.
The electronic business office encompasses the following solutions: Electronic
Data Interchange (EDI), Electronic Remittance Advice (ERA), Medicare Secondary
Billing (MSB), Eligibility, 72-Hour Advisor and Contract Management. The
Company's EDI products enable providers to edit claims on site, format detailed
claims data for all payors, and electronically submit them for processing. The
edited claims data is the foundation of a detailed database of information that
can be incorporated with QuadraMed's decision support and compliance products.
EDI is a software application that downloads summary and detailed claims data
from existing legacy financial information systems, and then edits and formats
it to meet payor-specific requirements, including unique data fields. As part of
the editing process, QuadraMed's EDI screens the data for payor-specific
demographic, diagnosis or procedure information and identifies illogical data
inputs that are not within expected ranges. For example, the software would
alert the operator if it encountered inputs that indicated that a male patient
had given birth. After the standardized claim has been edited for payor-specific
requirements, QuadraMed EDI transmits the claim to the payor.
ERA is a software application that receives detailed payment information from
payors. Known as electronic remittance advice, ("ERA"), translates this data and
automatically posts this information to a provider's financial system. Prior to
posting, ERA data is extracted to generate automated contractual adjustments
based on payor-appropriate criteria, applicable deductibles and co-insurance,
and to track write-offs taken at the time of billing.
Medicare Secondary Billing is a module designed to assist providers in
accelerating the traditional Medicare billing cycle by eliminating the 14-day
payment hold for billing Medigap carriers. The module automatically reviews all
open Medicare claims daily by logging onto the Medicare claims inquiry system,
and then, based on that analysis, generates appropriate, collated, ready-to-mail
UB92s and Explanation of Benefits ("EOB's") for secondary carriers.
Eligibility is a module which automatically verifies the eligibility of
Medicare, Medicaid, Blue Cross and other specified in-patient admissions types
by continuously polling the patient admitting system and then cross-checking
these patient profiles against health plan eligibility and benefits inquiry
databases. This module is designed to assist providers in proactively managing
the risk of uncompensated and undercompensated care.
The 72 Hour Advisor module, which is a complement to the Eligibility module, is
designed to assist providers in identifying instances when a patient receives
outpatient services less than 72 hours prior to being admitted for an inpatient
episode. If all care is not bundled as one episode, a Medicare billing conflict
is created, which is in violation of HCFA regulations and typically delays
payment for all care administered. The 72 Hour Advisor constantly polls key
in-patient and out-patient registration systems to check for date conflicts
within the 72 hour window.
QuadraMed's Contract Management application tracks providers' multiple managed
care, capitated, governmental and other payor contract terms, including coverage
and reimbursement for individual diagnoses and procedures. The application
calculates expected reimbursement and the contractual allowance, which is the
difference between the standard charge generated by the provider and the actual
amount owed by the payor under the contract. Expected reimbursement and
contractual allowance amounts can be posted automatically to the provider's
financial information system at the time of billing. Contract Management allows
providers to measure the allocation of revenues and the profitability of
contracts based on specific payor contract terms. Contract Management's pricing
module eliminates labor intensive, error prone manual repricing of bills, a
process that often leads to inaccurate reimbursement and financial statements.
In addition, Contract Management is used as a modeling tool for managed care
contract negotiation and detailed analysis of contract performance.
QuadraMed offers EZ-Cap(R), Prime Analysis M.D., Managed Care Retrospective
Payment Recovery (MPR) and Contractual Financial Outcomes (CFO) under its
managed care offerings. EZ CAP Managed Care Information System is a software
application designed to assist medical groups, Independent Practice Associations
("IPA's"), hospitals, Physician-Hospital Organizations ("PHO's") and other
organizations that receive capitation payments from health plans and are at
financial risk for healthcare services. EZ CAP's key functional areas include
enrollee demographic data, benefits verification and co-payment information,
automated authorizations, flexible provider compensation methods, case
management and utilization tools, provider claims processing and claims data
capture, and detailed reporting capabilities.
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In the area of executive information systems, the following products are
offered: Smartlink 2000 Reporting & Analysis, Smartlink 2000 Data Mart,
Smartlink 2000 A/R and Prime Analysis M.D. Smartlink 2000 is a flexible
reporting tool for enterprise-wide reporting and analysis. The product
consolidates access to information across disparate internal systems. It uses
transactional data from current systems to create management analysis and
reports.
The Business Office division also includes business office outsourcing. The
following services are included: full business office outsourcing, A/R reduction
and billing services and interim management consulting. QuadraMed provides
partial and complete business office department outsourcing services, including
the billing and collection of receivables for the business office, and managed
care contract administration and negotiations for the contract management
department. The Company offers business office outsourcing services for
hospitals, physicians, home health care agencies and other providers. The focus
of these services is to increase cash flow and to improve operational
efficiencies for healthcare providers. Under full outsourcing arrangements, the
Company hires and/or replaces existing personnel at the facility. The Company
typically implements selected components of its suite of products to enhance the
efficiency of the business office or contract management department. In partial
business office outsourcing arrangements, the Company bills and collects
receivables that have aged beyond a certain point, or that involve specified
payers or payment arrangements.
The infrastructure for the Company's outsourcing business was acquired by the
Company. In addition, the Company often uses its software products to provide
outsourcing services. As a result, the Company has not been required to make
significant capital expenditures in order to service existing outsourcing
contracts. However, if the Company experiences a period of substantial expansion
in its outsourcing business, it may be required to make substantial investments
in capital assets and personnel, and there can be no assurance that it will be
able to assess accurately the investment required and negotiate and perform in a
profitable manner any of the outsourcing contracts it may be awarded. The
Company's failure to estimate accurately the resources and related expenses
required for a project or its failure to complete its contractual obligations in
a manner consistent with the project plan upon which a contract was based could
have a material adverse effect on its business, financial condition and results
of operations. In addition, the Company's failure to meet a client's
expectations in the performance of its services could damage the Company's
reputation and adversely affect its ability to attract new business. Finally,
the Company could incur substantial costs and expend significant resources
correcting errors in its work, and could possibly become liable for damages
caused by these errors.
Products in the Health Information Management Operating Division
QuadraMed's Health Information Management (HIM) division business lines
primarily target medical records directors, as well as chief financial officers
throughout the provider system. The division is comprised of the following
products and services: coding and abstracting, compliance, document imaging and
workflow, and HIM outsourcing and consulting.
Products and services under the coding and abstracting solutions include
nCoder+, InfoMaster and CodeMaster Express. Coding and Abstracting software
products are designed to consolidate the flow of patient-related data from
disparate hospital systems into a Windows-based system. The Coding and
Abstracting system is designed to maximize the productive results of the coding
process at the critical point where proper reimbursement decisions are in the
hands of coding personnel. Knowledge-based methodology and database resources
are integrated with on-line access to clinical notes, definitions, and coding
reference guides to assist in the accurate interpretation and validation of
coding and DRG assignment decisions.
Under the area of compliance, the following products and services are offered:
Inpatient Coding FACTS, Outpatient Coding FACTS, ComplySource(TM) and
compliance consulting and education.
QuadraMed's FACTS solution, introduced in the third quarter of 1997, is a
software application designed to assist hospitals in managing the complexities
of federal requirements under HIPAA and in submitting accurate billing and
clinical data. The product complements providers' existing compliance efforts by
monitoring coding and billing practices for compliance with mandated guidelines.
FACTS includes the following six modules: a 72-hour rule compliance module
designed to identify claims for non-physician services performed within three
days of a hospital admission; a prospective payment system module designed to
select billing records with a high probability of inaccurate coding which may
lead to overpayments by payees which may, in turn, trigger federal government
fines for inappropriate billing practices; a data quality monitoring tool that
is designed to identify inconsistencies
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in coding and to flag inclusive codes that may result in potential overestimates
of revenue; a benchmarking study that utilizes publicly available data to
identify a hospital's exposure to potential fraud and abuse by analyzing
correlations between a given hospital's DRG codes and national norms and
identifying a hospital's exposure at the DRG level; a laboratory report based on
a thorough review of a provider's detail billing data identifying clinical
laboratory billing practices of that provider which are of the type generally
scrutinized by the government; and a Medicare Billing Compliance Guide designed
to assist hospitals and other providers in implementing fraud and abuse
compliance programs.
ComplySource is a legal and compliance software resource package designed to
provide consolidated access to important legal and government compliance-related
documents, layman's synopsis of all statutes related to healthcare compliance,
OIG fraud alerts, and focused database tools such as compliance disciplinary
action, education attendance lists, audit tracking, mandatory compliance
activities and hotline calls. The product can be implemented via the Intranet or
Internet.
An adjunct to QuadraMed's software offerings is the range of compliance and
consulting offerings that are designed to provide value-added service to
clients, and better position the Company as a provider of more comprehensive
solutions. Currently, compliance and consulting services fall under four main
categories: Managed Care, Financial Reviews & Management, Patient-Focused
Studies, and Compliance Services. These services include: accuracy and
compliance assessments of clinical and patient accounting charge capture
mechanisms, managed care contract performance reviews and re-negotiations (with
integrated retrospective payment recovery services for underperforming
contracts), and clinically-oriented, patient-focused data analysis and reviews
by Master prepared Registered Nurses.
QuadraMed offers a compliance program, including compliance assessment, auditing
and education expertise through a team of over 100 credentialed healthcare
attorneys, medical record professionals, registered nurses and physicians. These
services are designed to improve the ability of healthcare providers to prevent
Medicare and Medicaid fraud and abuse by identifying potentially fraudulent
coding in a medical bill. Many of these services are augmented by the use of
integrated software technologies. These services include: organizational risk
and compliance assessment, clinical data management compliance audits and
assessments, physician and ancillary services compliance audit and education
services, and professional development services which offer subscriber-based,
toll-free "expert help desk" coding and billing compliance assistance and
topical compliance seminar series throughout the country.
In the areas of document imaging and workflow, the following solutions are
offered: Electronic Document Management (EDM) and Chart Engine. Electronic
Document Management is a software application for patient accounting and medical
records departments that captures, indexes, stores and retrieves paper-based
demographic, clinical and financial information and records. This product is
based on an open software architecture, which utilizes electronic files that
integrate financial and ancillary department electronic information with scanned
images of paper documents. The Company believes that this application improves
provider work flow, reduces administrative cost and helps providers move toward
paperless business offices and medical records departments. Multi-user access to
the electronic patient account file reduces the need for paper files and storage
while offering access to account information from any work station. The
combination of existing electronic financial information and scanned images with
multi-user capabilities effectively creates an electronic patient account file
that can be routed through billing and administration departments, thus
improving work flow. In addition to licensing this software application, the
Company offers customers the option of purchasing the hardware required to
implement this solution. Chart Engine utilizes barcode tracking and portable
barcode readers for chart location and site inventories. Providers can view
patient demographic information in one screen while updating deficiencies and
generating reports.
The Health Information Management (HIM) operating division includes HIM
outsourcing. The following services are included: Charge Description Master
(CDM) Review, Master Patient Index Clean Up, Interim HIM Management Service,
general outsourcing and HIM on-site staff services.
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Products in the Enterprise Operating Division
QuadraMed's newest operating unit, the Enterprise Division, established in 1999
provides solutions that are designed to flow across an extended enterprise of
inpatient and outpatient locations and across business entity lines. The
Company's enterprise business lines target a provider's chief financial officer
and chief executive officer. The Company provides access via LAN, WAN or Web, to
patient information from disparate locations in the enterprise. The division is
comprised of the following solutions: Enterprise and Healthcare iQ.
In March 1999, QuadraMed acquired The Compucare Company whose primary product is
the AFFINITY(TM) Enterprise Solution. AFFINITY is an integrated hospital
information system that provides clinical and financial information. AFFINITY
offers a suite of hospital applications that are designed to provide compliance
with federal and state regulations while automating decision making and
increasing productivity. AFFINITY provides a patient-centered database that
enables a provider to track patients throughout the continuum of care, without
duplication of effort. AFFINITY applications are accessible via a web browser,
allowing physicians and other authorized users to have access to real-time
patient information, from remote locations. AFFINITY integrates financial
information such as patient accounting and DRG/case mix with clinical data such
as medication charting and plan of care to automate state and federal reporting,
billing, and other administrative activities.
Healthcare iQ, the Company's Internet offering, allows clients access to
benchmarking data, comparative analysis tools and resource libraries via the
Internet. Healthcare iQ provides Internet access to some of the industry's most
comprehensive information resources and online analytical tools. Benefits of
Healthcare iQ include access to decision support data and information resources
via the Internet. In fiscal 1999 QuadraMed offers three distinct products via
its Healthcare iQ Internet offering. Performance iQ is a decision support data
base and analytical tool for clinical, financial and market analysis
information. The Company's American Hospital Directory (AHD) provides hospital
profiles showing characteristics, services, financial statements and utilization
statistics. ComplySource iQ is an online library of legal and compliance
reference resources.
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CUSTOMERS
Historically, QuadraMed has marketed its products primarily to
hospitals, with additional marketing to hospital associations, physician groups,
payors and self-administered employers. Substantially all of the Company's
revenues have been derived from the sale of software products and services to
hospitals. With the industry trend toward the formation of IDNs, the Company has
designed its product suite to accommodate this emerging industry sector. To
date, QuadraMed and its subsidiaries have approximately 3,800 customers, a
substantial majority of which are hospitals, located in all 50 states, the
District of Columbia, Canada, South Africa and the Philippines. The Company
expects to maintain a high percentage of hospital customers for the foreseeable
future, but also expects its customer mix to begin to shift toward other
providers, including IDNs, as well as payors and employers. The health care
industry is subject to changing political, economic and regulatory influences
that may affect the procurement practices and operation of health care
organizations. Changes in current health care financing and reimbursement
systems could result in the need for unplanned product enhancements, in delays
or cancellations of product orders or shipments or in the revocation of
endorsement of the Company's products by hospital associations or other
customers. Any of these occurrences could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
many health care providers are consolidating to create integrated health care
delivery systems with greater regional market power. As a result, these emerging
systems could have greater bargaining power, which may lead to price erosion of
the Company's products. The failure of the Company to maintain adequate price
levels would have a material adverse effect on the Company's business, financial
condition and results of operations. Other market-driven reforms could also have
unpredictable effects on the Company's business, financial condition and results
of operations.
SALES AND MARKETING
As of March 5, 1999, the Company employed 92 direct sales
representatives and product managers, and a marketing support staff of 12
individuals. The Company markets its products and services through direct sales
contacts, strategic alliances, participation in trade shows and advertisements
in industry publications. In addition, senior management plays an active role in
the sales process by cultivating industry contacts.
The Company supplements its marketing arrangements through endorsement
agreements. The Company has endorsement agreements and/or marketing agreements
for certain of its products with state and regional hospital associations, which
include: New Jersey Hospital Association, Pennsylvania Hospital Association,
Florida Hospital Association, Connecticut Hospital Association, Healthcare
Association of New York State, Greater Cleveland Hospital Association, Hospital
Council of Northern & Central California, Association of Iowa Hospitals & Health
Systems, Wisconsin Health & Hospital Association, Virginia Hospital and
Healthcare Association, Montana Hospital Association, Metropolitan Chicago
Health Care Council, Texas Hospital Association and the Georgia Hospital
Association.
In addition, the Company has built a regional account manager
organization within the national sales force responsible for particular
customers rather than particular products. This approach will require additional
training so that sales personnel may become more familiar with the Company's
broader range of product and service offerings. There can be no assurance that
the Company will be successful in its efforts to restructure its sales and
marketing approach, and any failure to successfully implement such strategy
could have a material adverse effect on its business, financial condition and
results of operations.
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RESEARCH AND DEVELOPMENT
As of March 5, 1999, the Company employed 177 people in the areas of
product design, research and development and 40 people in the areas of quality
assurance and technical support. The Company's product development strategy is
focused on continually enhancing existing products by increasing their
functionality and ease of use. In addition, the Company is enhancing the
reporting capabilities for its performance measurement clinical and financial
applications, expanding its outpatient and inpatient databases and improving its
comparative reporting and benchmarking capabilities with third-party databases.
A significant amount of the Company's research and development resources are
dedicated to integrating acquired technology into the Company's suite of
products. See "-Products Under Development and Joint Development Projects."
In fiscal years 1996, 1997, and 1998, the Company's research and
development expenses totaled $5.0 million, $11.0 million, and $15.9 million,
respectively, representing 6.8%, 11.1%, and 10.0%, respectively, of its total
revenues. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
COMPETITION
Competition in the market for the Company's products and services is
intense and is expected to increase. Increased competition could result in price
reductions, reduced gross margins and loss of market share, any of which could
materially adversely affect the Company's business, financial condition and
results of operations. The Company's competitors include other providers of
health care information software and services, as well as health care consulting
firms. The combined company's principal competitors include: (i) CIS
Technologies, Inc., a division of National Data Corporation, Inc., and
Sophisticated Software, Inc. in the market for its EDI products; (ii) MedE
AMERICA in the market for its claims processing service; (iii) Healthcare Cost
Consultants, Inc., a division of CIS Technologies, and Trego Systems, Inc. in
the market for its contract management products; (iv) Optika Imaging Systems,
Inc. and LanVision Systems, Inc. in the market for its electronic document
management products; (v) Healthcare Microsystems, Inc., a division of Health
Management Systems, Inc., HCIA Inc. and MediQual Systems, Inc., a division of
Cardinal Health, Inc., in the market for its decision support products; (vi) HMS
in the market for its business office outsourcing services; and (vii) a
subsidiary of Minnesota Mining and Manufacturing, in the market for its medical
records products.
GOVERNMENT REGULATION AND HEALTH CARE REFORM
The United States Food and Drug Administration (the "FDA") is
responsible for assuring the safety and effectiveness of medical devices under
the Federal Food, Drug and Cosmetic Act. Computer products are subject to
regulation when they are used or are intended to be used in the diagnosis of
disease or other conditions, or in the cure, mitigation, treatment or prevention
of disease, or are intended to affect the structure or function of the body. The
FDA could determine in the future that any predictive aspects of the Company's
products make them clinical decision tools subject to FDA regulation. Compliance
with these regulations could be burdensome, time consuming and expensive. The
Company also could become subject to future legislation and regulations
concerning the development and marketing of health care software systems. These
could increase the cost and time necessary to market new products and could
affect the Company in other respects not presently foreseeable. The Company
cannot predict the effect of possible future legislation and regulation.
The confidentiality of patient records and the circumstances under which
such records may be released for inclusion in the Company's databases are
subject to substantial regulation by state governments. These state laws and
regulations govern both the disclosure and the use of confidential patient
medical record information. Although compliance with these laws and regulations
is at present principally the responsibility of the hospital, physician or other
health care provider, regulations governing patient confidentiality rights are
evolving rapidly. Additional legislation governing the dissemination of medical
record information has been proposed at both the state and federal level. This
legislation may require holders of such information to implement security
measures that may require substantial expenditures by the Company. There can be
no assurance that changes to state or federal laws will not materially restrict
the ability of health care providers to submit information from patient records
using the Company's products.
The health care industry in the United States is subject to changing
political, economic and regulatory influences that may affect the procurement
practices and operations of health care organizations. The Company believes that
the commercial value and appeal of its products may be adversely affected if the
current health care financing and reimbursement system were to reverse its
current
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evolution to a managed care model back to a fee-for-service model. In addition,
many of the Company's customers are providing services under capitated service
agreements, and a reduction in the use of capitation arrangements as a result of
regulatory or market changes could have a material adverse effect on the
Company's business, financial condition and results of operations. During the
past several years, the health care industry has been subject to increasing
levels of governmental regulation of, among other things, reimbursement rates
and certain capital expenditures. Certain proposals to reform the health care
system have been and are being considered by Congress. These proposals, if
enacted, could change the operating environment for the Company's clients in
ways that cannot be predicted. Health care organizations may react to these
proposals by curtailing or deferring investments, including those for the
Company's products and services.
INTELLECTUAL PROPERTY
The Company considers its methodologies, computer software and many of
its databases to be proprietary. The Company seeks to protect its proprietary
information through nondisclosure agreements with its employees. The Company's
policy is to have employees enter into nondisclosure agreements containing
provisions prohibiting the disclosure of confidential information to anyone
outside the Company, requiring disclosure to the Company of any new ideas,
developments, discoveries or inventions conceived during employment, and
requiring assignment to the Company of proprietary rights to such matters that
are related to the Company's business.
The Company also relies on a combination of trade secrets, copyright and
trademark laws, contractual provisions and technical measures to protect its
rights in various methodologies, systems, products and databases. The Company
has no patents or copyrights covering its software technology. Any infringement
or misappropriation of the Company's proprietary software and databases would
disadvantage the Company in its efforts to retain and attract new customers in a
highly competitive market and could cause the Company to lose revenues or incur
substantial litigation expense.
There can be no assurance that measures taken by the Company to protect
its intellectual property will be adequate or that the Company's competitors
will not independently develop products and services that are substantially
equivalent or superior to those of the Company. Substantial litigation regarding
intellectual property rights exists in the software industry, and the Company
expects that software products may be increasingly subject to third-party
infringement claims as the number of competitors in the Company's industry
segment grows and the functionality of products overlaps. However, due to the
nature of its application software, the Company believes that patent, trade
secret and copyright protection are less significant than the Company's ability
to further develop, enhance and modify its current products.
Although the Company believes that its products do not infringe on the
intellectual rights of others, there can be no assurance that such a claim will
not be asserted against the Company in the future, or that a license or similar
agreement will be available on reasonable terms in the event of an unfavorable
ruling on any such claim. Any such claim may require the Company to incur
substantial litigation expenses or subject the Company to significant
liabilities and could have a material adverse effect on the Company's business,
financial condition and results of operations.
EMPLOYEES
As of March 5, 1999, the Company employed 2,674 people, including 437
in general administration, 217 in product design, research and development
quality assurance and technical support, 104 in sales and marketing and 1,916 in
operations. None of the Company's employees is represented by a union or other
collective bargaining group. The Company believes its relationship with its
employees to be satisfactory.
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EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, and their ages as of March 5,
1999, are as follows:
NAME AGE POSITION
- ---- --- --------
James D. Durham 52 Chairman of the Board and Chief Executive Officer
John V. Cracchiolo 42 Executive Vice President, President and Chief Operating Officer
Patrick Ahearn 45 President, Business Office Division
Andrew J. Hurd 35 President, Health Information Management Division
Keith M. Roberts 34 Executive Vice President, Chief Financial Officer, General
Counsel and Assistant Secretary
Bernie J. Murphy 33 Vice President, Finance and Chief Accounting Officer
BACKGROUND
James D. Durham serves as QuadraMed's Chairman of the Board and Chief
Executive Officer. Mr. Durham founded the Company in September 1993. From
November 1992 to December 1993, Mr. Durham served as the Chief Executive Officer
of Trim Healthcare Systems, Inc., a reimbursement consulting services company.
From April 1992 to April 1993, Mr. Durham served as Chief Executive Officer of
Care Partners, Inc., an accounts receivable processing and funding company
co-founded by Mr. Durham. From February 1986 until its acquisition by Ameritech
in February 1992, Mr. Durham served as President and Chief Executive Officer of
Knowledge Data Systems, Inc., a health care information systems company. Mr.
Durham holds a B.S. with honors in Industrial Engineering from the University of
Florida and an M.B.A. with an emphasis in Finance from the University of
California, Los Angeles and is a Certified Public Accountant.
John V. Cracchiolo serves as QuadraMed President and Chief Operating
Officer. Mr. Cracchiolo joined the Company in May 1995 as its Executive Vice
President, Chief Financial Officer and Secretary. In March 1998, Mr. Cracchiolo
became the Company's President and Chief Operating Officer. Prior to joining the
Company, Mr. Cracchiolo worked for PSICOR, Inc., a health care services company,
serving as its Chief Financial Officer from February 1993 to May 1995, and its
corporate Controller from May 1989 to February 1993. Previously, Mr. Cracchiolo
worked in various management positions for software, hardware, defense
contractor and personnel and professional services organizations within the
health care and other industries. Mr. Cracchiolo holds a B.S. in Business
Administration from California State University, Long Beach and is a Certified
Public Accountant.
Andrew D. Hurd serves as President of QuadraMed's Health Information
Management Division. Mr. Hurd joined the Company in January 1998 as Executive
Vice President, Business Development. From November 1995 to January 1998, Mr.
Hurd was Vice President, Health Care Financial Services at National Data
Corporation, an EDI company. From 1988 to November 1995, Mr. Hurd was the Vice
President and General Manager of Amsco International, a medical supply company.
Mr. Hurd holds a B.A in Marketing and a B.S in Business Administration from
Northern Arizona University.
Patrick Ahearn, President of QuadraMed's Business Management Division,
joined the Company in 1998. Before joining QuadraMed, Mr. Ahearn was Chief
Financial and Chief Information Officer at the Medical Center at Princeton, New
Jersey, a non-profit teaching integrated delivery network. In addition to his
financial and information system responsibilities, he was involved in the
development of the Medical Center's Physician Hospital Organization (PHO),
Medical Services Organization (MSO), its real estate company and its for-profit
ventures. Prior to his experience at Princeton, Mr. Ahearn worked in New York
City for a CPA firm, Pannell Kerr Forster. His experience was almost exclusively
in the healthcare arena and included both the audit and consulting aspects of
the practice. Mr. Ahearn received a Bachelors of Business Administration from
Iona College, New York.
Keith M. Roberts serves as QuadraMed's Executive Vice President, General
Counsel, Assistant Secretary and Chief Financial Officer. Mr. Roberts joined the
Company in March 1997 as Vice President and General Counsel and became Executive
Vice President, General Counsel and Assistant Secretary in February 1998. In
July 1998, Mr. Roberts also became the Company's Chief Financial Officer. From
May 1995 to March 1997, Mr. Roberts was an associate of Brobeck, Phleger &
Harrison LLP, a private law firm. From September 1992 to May 1995, Mr. Roberts
was an associate of Hale & Dorr, a private law firm. Mr. Roberts holds a J.D.
from Stanford Law School and a B.A. in economics and philosophy from the
University of Rochester.
Bernie J. Murphy serves as QuadraMed's Vice President, Finance and Chief
Accounting Officer. Mr. Murphy joined the Company in June 1996 as Corporate
Controller. In February 1998, Mr. Murphy became the Company's Vice President,
Finance and Chief Accounting Officer. From July 1988 to June 1996, Mr. Murphy
worked at Arthur Andersen LLP,
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where he served as a manager in the audit practice for the last three years of
employment with that firm. Mr. Murphy holds a B.S. in Business Administration
from the University of San Francisco and is a Certified Public Accountant.
ITEM 2. PROPERTIES.
The Company's executive and corporate offices are located in Richmond
California, in approximately 22,000 square feet of leased office space under a
lease that expires in June 2003. The Company also maintains several regional
offices throughout the United States.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company may be involved in litigation relating to
claims arising out of its operations in the normal course of business. As of the
date of this Report, the Company is not a party to any legal proceedings which,
if decided adversely to the Company, would, individually or in aggregate, have a
material adverse effect on the Company's business, financial condition or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
NONE
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock has been quoted on the Nasdaq National Market
since October 10, 1996 under the symbol "QMDC." The following table sets forth
the range of high and low closing sales prices reported on the Nasdaq National
Market for Company Common Stock for the periods indicated.
High Low
---- ---
Year Ended December 31, 1996
Fourth Quarter (October 10, 1996 through December 31, 1996) $ 13 1/2 8 9/16
Year Ended December 31, 1997
First Quarter 12 1/4 9 5/8
Second Quarter 10 5/8 6 3/4
Third Quarter 20 6 3/4
Fourth Quarter 27 1/2 17
Year Ended December 31, 1998
First Quarter 35 1/4 18 15/16
Second Quarter 33 1/2 22 7/8
Third Quarter 31 3/4 19 5/8
Fourth Quarter 27 15 1/16
Year Ended December 31, 1999
First Quarter (through March 5, 1999) 29 11 7/16
As of March 5, 1999, there were approximately 229 holders of record of
the Company's Common Stock. The Company believes that the number of beneficial
holders of Company Common Stock substantially exceeds this number.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on the Common
Stock. The Company currently intends to retain all future earnings, if any, to
fund the development and growth of its business and does not anticipate paying
any cash dividends on the Common Stock in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA AND SUPPLEMENTARY DATA.
The following selected financial data of the Company for the fiscal
years ended December 31, 1994, 1995, 1996, 1997 and 1998, are derived from, and
are qualified by reference to, the audited financial statements and should be
read in conjunction with the consolidated financial statements and the notes
thereto.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
1996 1997 1998
1994 1995 Restated(1) Restated(1) Restated(1)
------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues ................................. $ 6,102 $ 46,221 $ 74,269 $ 99,625 $ 159,394
Loss from operations ..................... (4,780) (19,366) (836) (33,167) (13,967)
Net loss ................................. (4,865) (23,577) (4,324) (33,938) (18,610)
Basic and diluted net loss per share(2).. $ (2.26) $ (3.29) $ (0.51) $ (2.56) $ (0.98)
======== ========= ========= ========= ==========
AS OF DECEMBER 31,
--------------------------------------------------------------------------
1995 1996 1997
1994 Restated(1) Restated(1) Restated(1) 1998
------- ----------- ----------- ----------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit) ...... $(1,494) $ (3,071) $ 9,382 $ 16,678 $ 93,006
Total assets ................... 2,801 27,212 50,369 105,288 240,886
Stockholders' equity (deficit).. (1,457) (9,565) (1,794) 33,729 71,845
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- ----------
(1) Restated to reflect business combinations accounted for as pooling of
interests. See Note 12 of Notes to Consolidated Financial Statements.
(2) See Note 2 of Notes to Consolidated Financial Statements for an
explanation of the determination of the number of shares used in
computing net income per share. In February 1997, the Financial
Accounting Standards board issued Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS No. 128") which requires
disclosure of basic earnings per share and diluted earnings per share
and is effective for periods ending subsequent to December 15, 1997.
ITEM 7. OTHER INFORMATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
OVERVIEW
QuadraMed develops, markets and sells software products and services
designed to enable health care providers and payors to increase operational
efficiency, improve cash flow, measure the cost of care and effectively
administer managed care contracts. In addition, QuadraMed provides business
office outsourcing, compliance and consulting services. QuadraMed and its
subsidiaries have approximately 3,800 healthcare customers. In addition,
QuadraMed has received endorsements from approximately 15 state and regional
hospital associations.
The Company has expanded significantly since its inception in 1993,
primarily through the acquisition of other businesses, products and services.
Accordingly, the Company's consolidated financial statements have been restated
to include historical results of entities acquired on a pooling of interests
basis. The addition of historical results of acquired entities should be
considered when reading the period to period comparisons for fiscal years 1996,
1997 and 1998. Additionally, reference is made to the consolidated financials
statements and notes thereto for the effect of such acquisitions.
Since December 1995, the Company has completed the following significant
acquisitions:
DESCRIPTION OF
COMPANY ACQUIRED COMPANY ACQUIRED POOLING/PURCHASE DATE ACQUIRED
- ---------------- ---------------- ---------------- -------------
Healthcare Design Systems Health care financial management Purchase December 1995
and decision support software
Medicus Systems Corporation Health care financial management Purchase November 1997*
and decision support software
Rothenberg Health Systems, Inc. Capitation management software Pooling December 1997
and Healthcare Research Affiliates, and H.E.D.I.S. reporting
Inc. (collectively, "Rothenberg")
Cabot Marsh Corporation Health care compliance and Purchase February 1998
consulting company
Pyramid Health Group, Inc. Cash flow management services Pooling June 1998
("Pyramid") company
Integrated Medical Networks, Inc. Health care financial management Pooling September 1998
("IMN")
The Compucare Company Enterprise wide software Pooling March 1999
- ------------
* QuadraMed acquired 56.7% of the outstanding capital stock of Medicus
Systems Corporation on November 9, 1997. The remaining 43.3% shares of
capital stock were purchased by the Company in May 1998.
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In September 1998, the Company acquired all the outstanding capital
stock of Integrated Medical Networks, Inc.("IMN") in exchange for 1,550,000
shares of common stock. The acquisition was accounted for as a pooling of
interests. In accordance with pooling accounting rules, the Company's
consolidated financial statements have been restated to include the historical
operating results of IMN for the 1997 and 1996 fiscal years.
In June 1998, the Company acquired all the outstanding capital stock of
Pyramid Health Group, Inc. ("Pyramid") in exchange for 2,740,000 shares of
common stock, of which 274,000 shares of common stock have been placed into
escrow for a period of one year under the terms and conditions of the
acquisition agreement. The acquisition was accounted for as a pooling of
interests. In accordance with pooling accounting rules, the Company's
consolidated financial statements have been restated to include the historical
operating results of Pyramid for the 1997 and 1996 fiscal years.
In March 1998, the Company acquired Velox Systems Corporation ("Velox")
for an aggregate purchase price of 40,562 shares of the Company's common stock,
the market value of which was approximately $1,500,000 and approximately
$3,100,000 in cash. In connection with this acquisition, which was accounted for
as a purchase, the Company allocated the purchase price based upon the estimated
fair value of the assets and liabilities assumed. The valuation was based on
accepted appraisal methodologies used at the time of the allocation. Since that
time, the SEC has provided new guidance with respect to the valuation of
intangible assets in purchase business combinations, including in-process R&D
("IPR&D"). In response to this new guidance, the Company elected to
retroactively adjust the amount of intangibles assigned to IPR&D from the
previously reported $4,800,000 to $1,500,000 in the quarter ended March 31,
1998.
In February 1998, the Company acquired Cabot Marsh Corporation ("Cabot
Marsh") for an aggregate purchase price of 382,767 shares of the Company's
common stock, the market value of which was approximately $8,400,000 and
approximately $2,800,000 in cash. In connection with this acquisition, which was
accounted for as a purchase, the Company allocated the purchase price based upon
the estimated fair value of the assets and liabilities assumed. The valuation
was based on accepted appraisal methodologies used at the time of the
allocation. Since that time, the SEC has provided new guidance with respect to
the valuation of intangible assets in purchase business combinations, including
IPR&D. In response to this new guidance, the Company elected to retroactively
adjust the amount of intangibles assigned IPR&D from the previously reported
$6,200,000 to $4,200,000 in the quarter ended March 31, 1998.
The Company acquired Rothenberg in December 1997. In exchange for all
the outstanding capital stock of Rothenberg, the Company issued 1,588,701 shares
of common stock. The acquisition was accounted for on a pooling of interests
basis. In accordance with pooling accounting rules, the Company's consolidated
financial statements have been restated to include the historical operating
results of Rothenberg for the 1996 fiscal year.
In November 1997, the Company acquired 56.7% of Medicus Systems
Corporation ("Medicus"). The Company's purchase price for the 56.7 percent
interest in Medicus which it acquired was approximately $26.3 million, which was
comprised of a cash payment of $21.7 million, the issuance of a note payable for
approximately $1.6 million to one selling stockholder, the value of warrants
issued to the selling stockholders of $700,000, and transaction costs of $2.3
million. In connection with the acquisition, which was accounted for as a
purchase, the Company allocated the purchase price based upon the estimated fair
value of the Company's proportionate share of the assets acquired and
liabilities assumed. Intangible assets acquired aggregated to $30.2 million, of
which $1.7 million, $6.7 million and $21.8 million were assigned to acquired
software, acquired intangible assets, and acquired research and development
in-process, respectively. Because there was no assurance that the Company would
be able to successfully complete the development and integration of the acquired
research and development in-process or that it had alternative future use at the
acquisition date, the acquired research and development in-process was charged
to expense by the Company in the year ended December 31, 1997. The Company's
proportionate share of net tangible liabilities assumed in the acquisition
totaled approximately $12.8 million. In May 1998, the Company completed its
acquisition of Medicus by purchasing the remaining 43.3% interest in Medicus.
The Company allocated the remaining 43.3% purchase price based on the estimated
fair value of the assets and liabilities assumed. The valuation was based on
accepted appraisal methodologies used at the time of the allocation. Since that
time, the SEC provided new guidance with respect to the valuation of intangible
assets in purchase business combinations, including IPR&D. In response to this
guidance, the Company elected to retroactively adjust the amount of intangibles
assigned to acquired in-process research and development from the previously
reported $17,146,000 to $4,763,000 in the quarter ended June 30, 1998. The
remaining intangible balance will be amortized over a 7 year average period.
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During 1998, the Company recorded $4,202,000 of non-recurring charges.
These charges primarily related to costs associated with closing of a
duplicative operating facility within the Company's business office outsourcing
operations. Such costs included future rents and lease obligations the Company
is contractually obligated to fulfill as well as severance packages for
employees working out of that office.
In February 1997, the Company entered into an arrangement to provide EDI
processing and management services to EDI USA, Inc. an organization owned and
established by thirteen independent Blue Cross and Blue Shield Plans to build
and operate an EDI transaction network. The Company and EDI USA, Inc. terminated
this arrangement in December 1997. The Company recorded non-recurring charges of
$2,492,000 for the year ended December 31, 1997, related to costs incurred in
connection with the processing arrangement and the termination thereof.
As of March 5, 1999, QuadraMed and its subsidiaries had approximately
3,800 customers, approximately 80% of which were hospitals, located in all 50
states, the District of Columbia, Canada, Puerto Rico, South Africa and the
Philippines. The Company expects to maintain a high percentage of hospital
customers, but also expects its customer mix to transition to a higher
percentage of other providers, including integrated delivery health care systems
("IDSs"), as well as physicians, payors and employers. No single customer
accounted for more than 10% of the Company's revenues in 1996, 1997 and 1998.
The Company licenses a variety of products and provides a variety of
services. License revenue includes license, installation, consulting and
post-contract customer support fees, third-party hardware sales and other
revenues related to licensing of the Company's software products. Service
revenue is composed of business office and health information management
outsourcing, cash flow management, compliance and consulting services.
The Company's product offering includes a variety of products which can
be licensed individually or as a suite of interrelated products. Products are
licensed either under term arrangements (which range from one year to three
years and typically include monthly or annual payments over the term of the
arrangement) or on a perpetual basis. Revenues from term licenses are recognized
monthly or annually over the term of the license arrangement, beginning at the
date of installation. Revenues from perpetual licenses are recognized upon
shipment of the software if there is persuasive evidence of an agreement,
collection of the resulting receivable is probable and the fee is fixed and
determinable. If an acceptance period is required, revenues are recognized upon
the earlier of customer acceptance or the expiration of the acceptance period.
Revenues from certain products are recognized on a percentage of completion
basis of accounting as determined by the achievement of certain performance
milestones during the product installation process.
Certain services are also provided to certain of the Company's licensees
of software products. These services consist primarily of consulting and
post-contract customer support. Consulting services generally consist of
installation of software at customer sites and revenue is recognized upon
completion of installation. Unbilled receivables consist of work performed or
software delivered which has not been billed under the terms of the contractual
arrangement with the customer. Post-contract customer support is recognized
ratably over the term of the support period. Deferred revenue primarily consists
of revenue deferred under annual maintenance and annual license agreements on
which amounts have been received from customers and for which the earnings
process has not been completed.
The Company provides business office and health information management
outsourcing, cash flow management, compliance and consulting services to
hospitals under contract service arrangements. Outsourcing revenues typically
consist of fixed monthly fees plus, in the case of business office outsourcing,
incentive-based payments that are based on a percentage of dollars recovered for
the provider for which the service is being performed. The monthly fees are
recognized as revenue on a monthly basis at the end of each month. Incentive
fees are recognized as the conditions upon which such fees are based are
realized based on collection of accounts from payors. Cash flow management
services typically consist of fixed fee services and additional incentive
payments based on a certain percentage of revenue returns realized or estimated
to be realized by the customer as a result of the services provided by the
Company. The fixed fee portion is recognized as revenue upon the completion of
the project with the customer. Compliance and
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20
consulting revenues are recognized as the services are provided. The Company has
experienced operating margins at differing levels related to licenses and
services. The service business has historically realized fluctuating margins
that were significantly lower than margins associated with licenses.
The Company capitalizes a portion of its software costs for internally
developed software products. These capitalized costs relate primarily to the
development of new products and the extension of applications to new markets or
platforms using existing technologies. The capitalized costs are amortized on a
straight-line basis over the estimated lives (usually five years) of the
products, commencing when each product is available to the market.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items
from the consolidated statement of operations of QuadraMed expressed as a
percentage of total revenues.
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1997 1998
----- ----- -----
Revenues:
Licenses .................... 46.7% 44.5% 46.8%
Services .................... 53.3 55.5 53.2
Total revenues .............. 100.0 100.0 100.0
Operating expenses:
Cost of licenses ............ 19.5 18.5 18.2
Cost of services ............ 34.0 35.8 33.9
General and administration... 29.0 26.4 15.5
Sales and marketing ......... 10.2 10.0 8.9
Research and development..... 6.8 11.1 10.0
Amortization of intangibles.. 1.6 1.7 4.1
Acquisition costs ........... -- 3.1 6.4
Non-recurring charges ....... -- 4.7 2.7
Write-off of acquired in-
process research and
development ............... -- 21.9 9.1
----- ----- -----
Total operating expenses 101.1 133.2 108.8
----- ----- -----
Loss from operations ............. (1.1) (33.2) (8.8)
Interest income (expense), net ... (3.7) (0.5) (0.3)
Other income (expense), net ...... 0.5 0.6 --
----- ----- -----
Net loss before provision
for income taxes ............... (4.3) (33.1) (9.1)
Provision for income taxes ....... 0.2 1.1 2.6
Income (loss) from discontinued
operations ..................... (1.4) 0.1 --
----- ----- -----
Net loss ......................... (5.9)% (34.1)% (11.7)%
===== ===== =====
Years Ended December 31, 1998 and 1997
RESTATEMENT OF QUARTERLY FINANCIAL DATA
Subsequent to the Securities and Exchange Commission's letter to the
Association of Independent Certified Public Accountants dated September 9, 1998,
regarding its views on in-process research and development ("IPR&D") the Company
re-evaluated its IPR&D charges on its 1998 acquisitions. The amounts allocated
to IPR&D and intangible assets in the first and second quarters of 1998 were
based on accepted appraisal methodologies used at the time of the allocations.
Since that time, the SEC provided new guidance with respect to the valuation of
intangible assets in purchase business combinations, including IPR&D. In
response to this new guidance, the Company elected to retroactively adjust the
amount of intangibles assigned to IPR&D related to these acquisitions. The
Company reduced its estimate of the amount allocated to IPR&D for its 1998
acquisitions by $18.2 million from the $32.7 million previously reported in the
first, second, and third quarters of 1998 to $14.5 million. Amortization of
intangibles increased $952,000 for the nine months ended September 30, 1998,
related to the amended amounts for the IPR&D.
Company management believes that the amended IPR&D charge of $14.5
million is valued consistently with the SEC staff's current views regarding
valuation methodologies. There can be no assurance, however, that the SEC will
not take issue with any of the assumptions used in the Company's allocations
and require the Company to further revise the amount allocated to IPR&D. The
Company amended its quarterly earnings on Form 10-Q for the first, second, and
third quarters of 1998. The following table depicts the adjustments made to the
values ascribed to IPR&D during the year ended December 31, 1998 (in thousands):
ACQUISITION AS REPORTED AS RESTATED
Velox $ 4,800 $ 1,500
Cabot Marsh 6,200 4,200
Medicus (43.3%) 17,146 4,763
Other acquisitions 4,585 4,031
------- -------
Total $32,731 $14,494
======= =======
The effect of these adjustments on the previously reported condensed
consolidated quarterly financial statements is present in the "QUARTERLY
RESULTS OF OPERATIONS/SUPPLEMENTARY FINANCIAL INFORMATION" included in the
consolidated financial statements.
Revenues
Licenses. License revenues increased 68.2% to $74.7 million in 1998 from
$44.4 million in 1997. Software license revenues include license, installation,
consulting and post-contract customer support fees, third-party hardware sales
and other revenues related to licensing of the Company's software products. The
increase in license revenues was primarily due to revenues associated with the
acquisition of Medicus and to a lesser extent, revenues from new customers for
the Company's coding and capitation software products.
Services. Service revenues increased 53.4% to 84.7 million in 1998 from
$55.3 million in 1997. The increase in service revenues was primarily due to new
customers associated with the Company's health information management
outsourcing business, and to a lesser extent, customers associated with the
acquisition of Cabot Marsh during the first quarter of 1998.
The substantial increases in revenues for 1998 and 1997 reflect the
completion of numerous acquisitions, several of which were significant. The
Company currently expects to complete fewer acquisitions in 1999. As a result
the Company does not expect revenues to increase at historical rates in the
future.
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Cost of Revenues
Cost of licenses. Cost of licenses increased 56.9% to $29.0 million in
1998 from $18.5 million in 1997. Cost of licenses consists primarily of
salaries, benefits and allocated costs related to software installations,
hardware costs, customer support and royalties to third parties. As a percentage
of license revenues, cost of licenses decreased to 38.8% in 1998 from 41.6% in
1997. Cost of licenses increased primarily due to additional personnel hired to
support software installations and customer support for new customers during
1998. As a percentage of license revenues, cost of revenues decreased primarily
due to an increased revenue base during 1998.
Cost of services. Cost of services increased 51.7% to $54.1 million in
1998 from $35.6 million in 1997. Cost of services includes expenses associated
with services performed primarily in connection with health information
management outsourcing, compliance and consulting services. As a percentage of
service revenues, cost of services decreased to 63.8% in 1998 from 64.5% in
1997. Cost of services increased primarily due to additional personnel costs
associated with the Company's health information management outsourcing business
and to a lesser extent, additional operating costs as a result of its
acquisition of Cabot Marsh during the first quarter of 1998.
Operating Expenses
General and Administration. General and administration expenses decreased 5.8%
to $24.7 million in 1998 from $26.3 million in 1997, and decreased as a
percentage of total revenues to 15.5% in 1998 from 26.4% in 1997. The decrease
in general and administration expense and as a percentage of total revenues was
primarily due to a larger revenue base, the reduction of certain overhead costs
associated with prior acquisitions and to a lesser extent, legal and other costs
the Company incurred in 1997 to settle certain litigation initiated in prior
years.
Sales and Marketing. Sales and marketing expenses increased 41.7% to $14.2
million in 1998 from $10.0 million in 1997, and decreased as a percentage of
total revenues to 8.9% in 1998 from 10.0% in 1997. Sales and marketing expenses
increased primarily from the hiring of additional sales personnel during 1998
and increased advertising costs, including sponsoring and participating in more
trade shows during 1998. As a percentage of total revenues, sales and marketing
expenses decreased primarily due to a larger revenue base in 1998.
Research and Development. Research and development expenses increased
44.3% to $15.9 million in 1998 from $11.0 million in 1997, and decreased as a
percentage of total revenues to 10.0% in 1998 from 11.1% in 1997. The increase
in research and development expenses was due to the hiring of additional
programmers from acquired companies and the ongoing development of product
enhancements and new products. As a percentage of total revenues, research and
development expenses decreased primarily due to a larger revenue base. The
Company capitalized $745,000, $673,000 and $2.7 million of software development
costs in fiscal 1998, 1997 and 1996, respectively, which represented 12.9%, 5.8%
and 14.5% of total research and development expenditures in fiscal 1998, 1997
and 1996. Amortization of capitalized software development costs totaled
$350,000, $134,000 and $32,000 in fiscal 1998, 1997 and 1996, respectively. The
Company believes that research and development expenditures are essential to
maintaining its competitive position. As a result, the Company intends to
continue to make investments in the development of new products and in the
further integration of acquired technologies into the Company's suite of
products. The Company believes that these expenses will increase in the future,
both in absolute terms and as a percentage of total revenues.
Amortization of Intangibles. Amortization of intangibles increased to
$6.5 million in 1998 from $1.7 million in 1997. The increase in amortization of
intangibles is due primarily to the acquisition of 56.7% of Medicus in November
1997, the purchase of the remaining 43.3% of Medicus in May 1998, and the
acquisitions of Cabot Marsh and Velox during the first quarter of 1998. As a
result of the Company's adjustment of the amount of intangibles assigned to
acquired in-process research and development in 1998, the Company expects that
amortization of intangibles will increase significantly in future periods.
Acquisition Costs. The Company incurred $10.3 million of acquisition
costs associated with the acquisitions of Pyramid, Codemaster and Integrated
Medical Networks during 1998. Acquisition costs related to financial advisors
hired by the Company and the acquired companies, legal and accounting fees.
During the fourth quarter ended December 31, 1997, the Company completed two
acquisitions which were accounted for on a pooling of interests basis. In
connection with these acquisitions, the Company incurred $3.1 million in
acquisition and related costs.
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Non-recurring Charges. The Company recorded $4.2 million of
non-recurring charges in 1998. These charges primarily related to costs
associated with closing of a duplicative operating facility within the Company's
business office outsourcing operations. Such costs included future rents and
lease obligations the Company is contractually obligated to fulfill as well as
severance packages for employees working out of that office. Such employees were
paid severance packages in which they were paid through November 1998.
Non-recurring charges in during 1997 were associated with start-up costs
incurred for the claims processing arrangement entered into with EDI-USA, Inc.
No such charges were incurred in 1998 as this arrangement was terminated in
December 1997. As a result of initiatives undertaken by the Company to
integrate acquired businesses and consolidate duplicate operations, the Company
anticipates recording significant non-recurring charges during 1999.
Acquired Research and Development. In connection with the acquisitions
of Velox, Cabot Marsh, the remaining 43.3% interest in Medicus, and several
other acquisitions, the Company allocated $14.5 million to in-process research
and development ("IPR&D") for the year ended December 31, 1998. This amount was
expensed as a non-recurring charge because the IPR&D projects identified has
not yet reached technological feasibility and has no alternative future use.
The following table depicts the allocations to IPR&D for the year ended
December 31, 1998 (in thousands):
Velox $ 1,500
Cabot Marsh 4,200
Medicus (43.3%) 4,763
Other acquisitions 4,031
-------
Total $14,494
=======
The amounts allocated to IPR&D during the year ended December 31, 1998,
were evaluated based on the SEC's current views regarding valuation
methodologies. The allocation to IPR&D was determined by estimating the costs
to develop the purchased technology into commercially viable products,
estimating the resulting net cash flows from each project, excluding the cash
flows related to the portion of each project that was incomplete at the
acquisition date and discounting the resulting net cash flows to their present
value. Each of the project forecasts was based upon future discounted cash
flows, taking into account the stage of development of each in-process project,
the cost to develop that project, and the associated risks. In each case, the
selection of the applicable discount rate was based on consideration of the
Company's weighted average cost of capital, as well as other factors including
the useful life of each technology, profitability levels of each technology,
the uncertainty of technology advances that were known at the time, and the
stage of completion of each technology.
If the projects are not successfully developed, the sales and
profitability of the Company may be adversely affected in future periods.
Additionally, the value of other intangible assets may be impaired. Following
is a description of the significant allocations to IPR&D for the year ended
December 31, 1998.
VELOX. At the acquisition date, Velox was conducting development,
engineering and testing activities associated with the next generation of
SMARTLINK, a product which focuses on accounts receivable analysis and reporting
in hospitals, large physician practices, and other entities. Upon completion,
SMARTLINK was planned to have significant scalability, a multilayer
architecture, and the ability to address Windows NT 5.0 and the next generation
of Microsoft SQL Server. At the acquisition date, Velox was approximately 35%
complete with the research and development related to SMARTLINK. The Company
anticipated that SMARTLINK product development would be completed in phases
beginning in the last half of 1998, after which the Company expected to begin
generating economic benefits from the value of the completed IPR&D.
Revenues attributable to SMARTLINK were estimated to be $1.3 million in
1998 and $5.0 million in 1999. IPR&D revenue, as a percentage of total
projected company revenue, was expected to peak in 1999 and decline thereafter
as new product technologies were expected to be introduced by the Company.
Operating expenses (expressed as a percentage of revenue) average 79% over the
projection period. The costs to complete the IPR&D were expected to be $293,000
in 1998 and $239,000 in 1999. A risk-adjusted discount rate of 20% was utilized
to discount projected cash flows.
CABOT MARSH. At the acquisition date, Cabot Marsh was conducting
development, engineering, and testing activities associated primarily with the
next generation of RAMS, a compliance product related to inpatient and
outpatient coding. At the acquisition date, Cabot Marsh was approximately 80%
complete with the development of the IPR&D. The Company anticipated that the
project would be completed in phases beginning in the second half of 1998, after
which the Company expected to begin generating economic benefits from the value
of the completed IPR&D.
Revenues attributable to the next generation of RAMS were estimated to
be $807,000 in 1998 and $11.3 million in 1999. IPR&D revenue, as a percentage of
total projected company revenue, was expected to peak in 1999 and decline
thereafter as new product technologies were expected to be introduced by the
Company. Operating expenses (expressed as a percentage of revenue) average 57%
over the projection period. The costs to complete the IPR&D efforts were
expected to be $140,000 in 1998 and $427,000 in 1999. A risk-adjusted discount
rate of 19% was utilized to discount projected cash flows.
MEDICUS. At the acquisition date, Medicus was conducting development,
engineering, and testing activities associated with the next generations of the
Company's Clinical Data Systems ("CDS") and Patient Focused Systems ("PFS")
product lines. At the acquisition date, Medicus was approximately 30% and 60%
complete with CDS and PFS, respectively. The Company anticipated that CDS and
PFS would be completed in 1999. After these release dates, the Company expected
to begin generating economic benefits from the value of the completed IPR&D.
Revenues attributable to CDS were estimated to be $6.0 million in 1999
and $18.0 million in 2000. IPR&D revenue, as a percentage of total projected
product revenue, was expected to peak in 2000 and decline thereafter as new
product technologies were expected to be introduced by the Company. Revenues
attributable to PFS were estimated to be $7.2 million in 2000 and $9.8 million
in 2001. IPR&D revenue, as a percentage of total projected product revenue, was
expected to peak in 2000 and decline thereafter as new technologies were
expected to be introduced by the Company. For both projects, operating expenses
(expressed as a percentage of revenue) average 61% over the projection period.
The costs to complete the CDS IPR&D efforts were expected to be $14,000 in 1998
and $1.2 million in 1999. The costs to complete the PFS IPR&D efforts were
expected to be $6,000 in 1998 and $309,000 in 1999. For each of the projects, a
risk-adjusted discount rate of 18% was utilized to discount projected cash
flows.
In connection with the acquisition of 56.7% of the outstanding stock of
Medicus in November, 1997, the Company allocated $21.9 million related to
IPR&D. This amount was expensed as a non-recurring charge because the IPR&D
projects identified had not yet reached technological feasibility and had no
alternative future use. The amounts allocated to IPR&D for the year ended
December 31, 1997, were evaluated based on current industry practices.
Provision for Income Taxes. Provision for income taxes increased to $4.2
million in 1998 from $1.1 million in 1997. The provision for income taxes is
primarily due to state and alternative minimum tax liabilities on certain of the
Company's legal entities. In addition, amounts allocated to acquired in-process
research and development are not deductible for tax purposes. For financial
reporting purposes, a 100% valuation allowance of $14.1 million and $16.3
million has been recorded against the Company's deferred tax assets consisting
primarily of the benefits associated with the Company's net operating loss
carryforwards in 1998 and 1997, as management is unable to conclude that it is
more likely than not that these assets will be realizable.
Years Ended December 31, 1997 and 1996
Revenues
Licenses. License revenues increased 28.0% to $44.4 million in 1997 from
$34.7 million in 1996. The increase was due to license revenues from new
customers and an increase in perpetual license agreements entered into during
the latter half of 1997.
Services. Service revenues increased 39.5% to $55.3 million in 1997 from
$39.6 million in 1996. The increase in service revenues was primarily due to new
customers associated with the health information management outsourcing business
and to a lessor extent, new customers acquired in the Synergy acquisition in
April 1997 and Healthcare Revenue Management, Inc. in September 1997.
Cost of Revenues
Cost of Licenses. Cost of license revenues increased 27.5% to $18.5
million in 1997 from $14.5 million in 1996. As a percentage of license revenues,
cost of licenses decreased slightly to 41.6% in 1997 from 41.8% in 1996. The
increase in cost of licenses was principally due to additional personnel hired
during 1997 to support software installations and, to a lesser extent, increases
in third-party hardware sales.
Cost of Services. Cost of service revenues increased 41.1% to $35.6
million in 1997 from $25.3 million in 1996. As a percentage of service revenues,
cost of services increased to 64.5% in 1997 from 63.8% in 1996. The increase in
cost of services was principally due to additional operating costs associated
with the Company's health information management outsourcing business and to a
lessor extent, operating costs from the acquisitions of Synergy and Healthcare
Revenue Management, Inc., acquired in April 1997 and September 1997,
respectively.
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Operating Expenses
General and Administration. General and administration expenses
increased 21.8% to $26.3 million in 1997 from $21.6 million in 1996, and
decreased as a percentage of total revenues to 26.4% in 1997 from 29.0% in 1996.
The increase in general and administration expenses reflects costs associated
with the Company's health information management outsourcing business, the
hiring of additional senior officers in 1997 and an increase in the number of
offices throughout the United States. The Company also incurred significant
legal and other costs during 1997 to settle certain litigation initiated in
prior years. As a percentage of total revenues, general and administration costs
decreased primarily due to a larger revenue base in 1997.
Sales and Marketing. Sales and marketing expenses increased 32.0% to
$10.0 million in 1997 from $7.6 million in 1996, and decreased as a percentage
of total revenues to 10.0% in 1997 from 10.2% in 1996. The increase in sales and
marketing expenses resulted principally from the addition of sales and marketing
personnel and increased advertising efforts associated with advertising in
publications, creating product brochures and participating in industry
conferences during 1997.
Research and Development. Research and development expenses increased
119.3% to $11.0 million in 1997 from $5.0 million in 1996, and increased as a
percentage of total revenues to 11.1% in 1997 from 6.8% in 1996. The increase in
research and development expenses is principally due to the hiring of additional
personnel for various software development projects.
Amortization of Intangibles. Amortization of intangibles increased to
$1.7 million in 1997 from $1.2 million in 1996. The increase in the amortization
of intangibles is due to the acquisitions of Synergy in April 1997, Healthcare
Revenue Management, Inc. in September 1997 and 56.7% of Medicus in November
1997.
Acquisition Costs. During the fourth quarter ended December 31, 1997,
the Company completed two acquisitions which were accounted for on a pooling of
interests basis. In connection with these acquisitions, the Company incurred
$3.1 million in acquisition and related costs.
Non-Recurring Charges. The Company recorded non-recurring charges of
$4.7 million in 1997. These non-recurring charges were comprised of $2.5 million
related to the termination of the claims processing arrangement with EDI USA,
Inc. and other charges associated with the write down of certain assets which
were determined to have no future realizable value.
Acquired In-Process Research and Development. In connection with the
acquisition of 56.7% of the outstanding stock of Medicus in November 1997, the
Company recorded a $21.9 million write-off related to acquired in-process
research and development that had not achieved technological feasibility and had
no alternative future use.
Interest Income (Expense). Interest expense decreased to $473,000 in
1997 compared to $2.7 million in 1996. The decrease in interest expense was
primarily due to various notes payable assumed from acquired companies, which
was offset by interest earned on higher cash balances, resulting from the
Company's initial public offering of common stock in October 1996 and follow-on
common stock offering in October 1997. The Company's public equity offerings
raised net proceeds of approximately $26.4 million and $57.3 million,
respectively. Interest expense in 1996 was principally the result of debt the
Company incurred in connection with the acquisition of Healthcare Design
Systems, Inc. and for working capital purposes.
Provision for Income Taxes. The Company recorded a provision for income
taxes of $1.1 million in 1997 compared $147,000 in 1996. The provision for
income taxes in 1997 relates to state and alternative minimum tax liabilities of
the Company. In addition, amounts allocated to acquired in-process research and
development are not deductible for tax purposes. For financial reporting
purposes, a 100% valuation allowance of $16.3 million and $10.0 million has been
recorded against the Company's deferred tax assets consisting primarily of the
benefits associated with the Company's net operating loss carryforwards in 1997
and 1996, as management is unable to conclude that it is more likely than not
that these assets will be realizable.
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LIQUIDITY AND CAPITAL RESOURCES
In October 1996, the Company completed its initial public offering of
common stock, which resulted in net proceeds to the Company of approximately
$26.1 million. In October 1997, the Company completed a follow-on offering of
common stock, which resulted in net proceeds to the Company of approximately
$57.3 million. In May 1998, the Company completed an offering of $115.0 million
principal amount of Convertible Subordinated Debentures, including the initial
purchasers' over-allotment option. The debentures are due May 1, 2005 and bear
interest, which is payable semi-annually at 5.25 percent per annum. Proceeds to
the Company from the offering were $110.8 million.
At December 31, 1998, the Company had $59.3 million of cash and cash
equivalents, $64.7 million of short and long-term investments and $93.0 million
in net working capital. Net cash used in operating activities was $26.7 million
and $5.6 million in the years ended December 31, 1998 and 1997, respectively.
Net cash provided by operating activities in 1996 was $3.1 million. Net cash
used in operating activities in 1998 was principally attributable to the
Company's net loss in 1998, a substantial portion of which was comprised of
non-cash charges to write-off acquired in-process research and development
related to the remaining acquisition of 43.3% of Medicus in May 1998 and other
acquisitions and acquisition and non-recurring costs recorded during 1998. In
addition, while accounts receivable increased during 1998, accounts payable and
accrued liabilities decreased during 1998. The increase in accounts receivable
was primarily due to the significant increase in revenues in 1998, while the
decrease in accounts payable and accrued liabilities was primarily due to the
payment of acquisition and severance related costs associated with acquisitions
in the latter half of 1997 and the pay down of other accrued liabilities from
acquired companies. Net cash provided by operating activities in fiscal year
1996 was principally attributable to an increase in depreciation and
amortization expense and deferred revenue in 1996.
Net cash used in investing activities was $85.0 million, $31.1 million
and $4.6 million in the years ended December 31, 1998, 1997 and 1996,
respectively. Investing activities in fiscal year 1998 primarily included the
purchase of short and long-term investments, cash paid for several acquisitions
and the purchase of equipment by the Company. Investing activities in fiscal
year 1997 primarily included cash paid for the Medicus and Synergy acquisitions,
purchases of equipment and the capitalization of computer software development
costs. Investing activities in fiscal year 1996 related to additions to capital
equipment and the capitalization of computer software development costs.
Net cash provided by financing activities was $126.2 million, $60.0
million and $10.5 million in the years ended December 31, 1998, 1997 and 1996,
respectively. Net cash provided by financing activities in 1998 primarily
related to the offering of $115 million Convertible Subordinated Debentures,
which raised net proceeds of $110.8 million in April 1998 and the exercise of
common stock warrants issued to former Medicus stockholders in November 1997 and
the exercise of common stock options during 1998. Net cash provided by financing
activities in fiscal year 1997 included $57.3 million in proceeds from the
Company's follow-on common stock offering in October 1997, which was partially
offset by the repayment of notes payable in connection with the November 1997
acquisition of Medicus. Net cash provided by financing activities in fiscal year
1996 included proceeds from the issuance of convertible preferred stock and
proceeds from the Company's initial public offering, which proceeds were offset
by repayment of notes payable. Net cash provided by financing activities in
fiscal year 1995 included borrowings related to notes payable and contributed
capital to Rothenberg.
In September 1998, the Company entered into an arrangement to guarantee
a line of credit of another company for up to $12,500,000. Outstanding balances
under the line of credit accrue interest at 8.5 percent and are due in October
2001. The Company has also entered into a reseller agreement with the same
company. Under the terms of the reseller agreement, the
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25
Company has a non-exclusive license to resell the company's software. This
reseller agreement remains in effect for an initial term of three years,
expiring in September 2001, and thereafter is subject to renewal for additional
one year terms.
The Company believes that its current cash and investments will be
sufficient to fund operations at least through December 31, 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Interest Rate Risk. The Company's exposure to market risk for changes
in interest rates primarily relates to its investment portfolio and Subordinated
Convertible Debentures. It is the Company's intent to ensure the safety and
preservation of its invested principal funds by limiting default risk, market
risk and reinvestment risk. The Company invests in high-quality issuers and
includes money market funds, corporate debt securities and debt securities
issued by the United States government. The Company invests, by policy, in
securities with maturities of two years or less. The Company does not invest in
derivative financial or foreign investments. The table below presents fair
values of principal amounts and weighted average interest rates for the
Company's investment portfolio at December 31, 1998 (in thousands, except
average interest rates):
Weighted
Aggregate Average Interest
Fair Value Rate
---------- ----------------
Cash and cash equivalents
Corporate debt securities 25,603 5.79%
Debt securities issued by the U.S.
Government -- --
Money market funds 33,690 5.11
------
Total cash and cash equivalents 59,283
======
Short term investments:
Corporate debt securities 14,040 5.58
Debt securities issued by the U.S.
Government 9,003 5.19
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Total short-term investments 23,043
======
Long-term investments:
Corporate debt securities 19,450 5.42
Debt securities issued by the U.S.
Government 22,162 5.54%
------
Long-term investments 41,612
======
Outstanding Debt. As of December 31, 1998, the Company has outstanding
long-term debt of $134,184,000, consisting of Convertible Subordinated
Debentures of $115,000,000 and notes payable of $19,184,000. The Company's
long-term debt matures as follows:
Weighted
Maturity Carrying Fair Average
Date Amount Value Interest Rate
- -------- -------- ------- -------------
2000 19,184 19,184 7.875%
2005 115,000 97,775 5.25%
YEAR 2000 COMPLIANCE
Many computer systems have experienced or will experience problems
processing dates beyond the year 1999. Therefore, some computer hardware and
software will need to be modified prior to the year 2000 in order to remain
functional. The Company is assessing both the internal readiness of its computer
systems and the compliance of its computer products and software sold to
customers for addressing the year 2000 issue. The Company expects to implement
successfully the systems and programming changes necessary to address the year
2000 issues and does not believe that the cost of such actions will have a
material adverse effect on the Company's business, results of operations or
financial condition. There can be no assurance, however, that there will not be
a delay in, or increased costs associated with, the implementation of such
changes, and the Company's inability to implement such changes could have an
adverse effect on its business, financial condition and results of operations.
The Company has designed and tested the most current versions of its
products to be year 2000 compliant. A significant number of the Company's
customers are running product versions that are not year 2000 compliant. While
the Company has been encouraging such customers to migrate to current product
versions, it is possible that the Company may experience increased expenses in
addressing migration issues and may lose customers. In addition, there can be no
assurances that the Company's current products do not contain undetected errors
or defects associated with year 2000 date functions that may result in material
costs to the Company. Some commentators have stated that significant amounts of
litigation will arise out of year 2000 compliance issues. Because of the
unprecedented nature of such litigation it is uncertain whether or to what
extent the Company may be affected by it.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" which requires companies to
record derivative financial instruments on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. The key interior
for hedge accounting is that the hedging relationship must be highly effective
in achieving offsetting changes in fair value or cash flows. SFAS No. 133 as
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999. This Statement will not have a material impact on the financial condition
or results of the operations of the Company.
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants (AICPA) issued Statement of
Position (SOP) 98-4 "Deferral of the Effective Date of a Provision of SOP 97-2,
"Software Revenue Recognition" which defers for one year the application of
provisions in SOP 97-2 which limit what is considered vendor-specific objective
evidence of the fair value of the various elements in a multiple element
arrangement. All other provisions of SOP 97-2 remain in effect. This SOP was
effective as of March 31, 1998. In 1998, the AICPA issued SOP 98-9.
"Modification of SOP 97-2, "Software Revenue Recognition, With Respect to
Certain Transactions," which amends paragraphs 11 and 12 of SOP 97-2 Software
Revenue Recognition, to require recognition of revenue using the "residual value
method" under certain conditions. Effective December 15, 1998, SOP 98-9 amends
SOP 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2 "Software
Revenue Recognition," to extend the deferral of the application of certain
passages of SOP 97-2 provided by SOP 98-1 through fiscal years beginning on or
before March 15, 1999. All other provisions of this SOP are effective for
transactions entered into in fiscal years beginning after March 15, 1999. The
Company does not anticipate that these statements will have a material adverse
impact on its statement of operations.
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CERTAIN FACTORS THAT MIGHT EFFECT FUTURE OPERATING RESULTS
HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
We incurred net losses of $4.3 million, $33.9 and $18.6 million in
fiscal years 1996, 1997 and 1998, respectively. As of December 31, 1998, our
accumulated deficit was $115.7 million. These losses include write-offs for
acquired in-process research and development of $21.9 million and $14.5 million
in fiscal years 1997 and 1998. In connection with our acquisitions, we have and
will incur significant non-recurring charges and we will be required to amortize
significant expenses related to goodwill and other intangible assets in future
periods. It is uncertain whether we will be able to achieve or sustain revenue
growth or profitability on a quarterly or annual basis.
POTENTIAL VARIABILITY IN QUARTERLY OPERATING RESULTS
Our quarterly operating results have varied significantly in the past.
Our quarterly revenues and operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside our
control. These factors include:
- - integration of acquired businesses with our business;
- - variability in demand for our products and services;
- - the introduction of product enhancements and new products by us and our
competitors;
- - the timing and significance of announcements concerning our present or
prospective strategic alliances;
- - the termination of, or a reduction in, the products and services we
offer,
- - the loss of customers due to consolidation in the health care industry;
- - delays in product delivery requested by our customers;
- - the length of the sales cycle for our products or the timing of our
sales;
- - the amount of new potential contracts at the beginning of any particular
quarter;
- - budgeting cycles of our customers and changes in our customer's budgets;
- - our investment in marketing, sales, research and development, and
administrative personnel necessary to support our anticipated
operations;
- - costs incurred in connection with our marketing and sale promotional
activities;
- - software defects and other quality factors in our products; and
- - general economic conditions and resulting effects on the health care
industry.
We cannot accurately forecast the timing of our customer purchases due
to the complex procurement decision process associated with most health care
providers and payors. As a result, we typically experience sales cycles that
extend over several quarters. In addition, certain products we acquired as a
result of our acquisition of Integrated Medical Networks in September 1998 and
The Compucare Company in March 1999 have higher average selling prices and
longer sales cycles than many of our other products. This may increase the
volatility of our quarterly operating results. Moreover, our operating expense
levels, which will increase with the addition of acquired businesses, are
relatively fixed. Accordingly, if future revenues are below our expectations, we
would experience a disproportionate adverse affect on our net income and
financial results. Further, it is likely that, in some future quarter, our
revenues or operating results may fall below the expectations of
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securities analysts and investors. In such an event, the trading price of our
Common Stock would likely be materially and adversely affected.
Integration Of Acquired Companies Into The Company
Realizing benefits from acquisitions depends in significant part upon
several factors and is accompanied by a number of risks, including:
- - successful integration of the operations, products and personnel of the
acquired company;
- - possible costs, delays or other problems we may incur to successfully
complete such integration;
- - the potential interruption or disruption of our ongoing business and the
distraction of management from other matters; and
- - significant operational and administrative expense relating to such
integration.
Any difficulties encountered in the integration process could have a
material adverse effect on our business, operating results and financial
condition. Even if we are able to successfully integrate these businesses with
our business, the acquired operations may not achieve sales, productivity and
profitability commensurate with our historical or projected operating results.
Failure to achieve such projected results would have a material adverse effect
on our financial performance, and in turn, on the market value of the our Common
Stock. There can be no assurance that we will realize any of the anticipated
benefits of our acquisitions or that such acquisitions will enhance our business
or financial performance.
Dependence On Acquisition Strategy
We intend to continue to expand in part through acquisitions of
products, technologies and businesses. Our ability to expand successfully
through acquisition depends on many factors, including:
- - the successful identification and acquisition of products, technologies
or businesses;
- - management's ability to effectively negotiate and consummate
acquisitions and integrate and operate the new products, technologies or
businesses;
- - significant competition for acquisition opportunities in our industry,
which may intensify due to increasing consolidation in the health care
industry, thereby increasing the costs of capitalizing on acquisition
opportunities;
- - competition for acquisition opportunities with other companies that have
significantly greater financial and management resources than us;
RISKS ASSOCIATED WITH ACQUISITIONS; NEED TO MANAGE CHANGING OPERATIONS
Acquisitions involve a number of special risks including:
- - managing geographically dispersed operations;
- - failure of the acquired business to achieve expected results;
- - failure to retain key personnel of the acquired business;
- - inability to integrate the new business into existing operations and
risks associated with unanticipated events or liabilities;
- - potential increases in stock compensation expense and increased
compensation expense resulting from newly hired employees; and
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- - the assumption of unknown liabilities and potential disputes with the
sellers of one or more acquired entities; and
- - exposure to the risks of entering markets in which we have no direct
prior experience or to risks associated with the market acceptance of
acquired products and technologies.
Management evaluated and purchased a new management and accounting
system and will implement the system in 1999. Information systems expansion or
replacement can be a complex, costly and time-consuming process, and there can
be no assurance that our system transition and further implementation can be
accomplished without disruption of our business. Any business disruption or
other system transition difficulties could have a material adverse effect on
our business, financial condition and results of operations.
We may not be successful in addressing these risks and our failure to do
so could have a material adverse effect on our business, results of operations
and financial condition.
Additionally, customer dissatisfaction or performance problems at a
single acquired company could have an adverse effect on its sales and marketing
initiatives and on our reputation. With the addition of the acquired businesses,
our anticipated future operations may place a strain on our management systems
and resources. We expect that we will be required to continue to improve our
financial and management controls, reporting systems and procedures, and will
need to expand, train and manage our workforce. There can be no assurance that
we will be able to effectively manage these tasks, and the failure to do so
could have a material adverse effect on our business, financial condition and
results of operations.
Moreover, future acquisitions by us may result in potentially dilutive
issuances of equity securities, the incurrence of additional debt and the
recognition of amortization expenses related to goodwill and other intangible
assets. Our inability to successfully deal with these factors could have a
material adverse effect on our business, financial condition and results of
operations.
DEPENDENCE ON KEY PERSONNEL
We are substantially dependent upon the continued service of our
executive officers, product managers and other key sales, marketing and
development personnel. If we fail to retain the services of any of our executive
officers or fail to hire, retain and motivate other key employees, our business
will be adversely affected. Furthermore, additions of new, and departures of
existing, personnel could have a disruptive effect on our business and
operations.
RISKS RELATED TO HOSPITAL AND MANAGED CARE MARKETS; UNCERTAINTY IN THE
HEALTHCARE INDUSTRY
A substantial portion of our revenues have been and are expected to be
derived from the sale of software products and services to hospitals.
Consolidation in the health care industry, particularly in the hospital and
managed care markets, could cause a decrease in the number of existing or
potential purchasers of our products and services, which could adversely affect
our business. In addition, the decision to purchase our products often involves
the approval of several members of management of a hospital or health care
provider. Consequently, it is difficult for us to predict the timing or outcome
of the buying decisions of our customers or potential customers.
The health care industry in the United States is subject to changing
political, economic and regulatory influences that may affect the procurement
practices and operations of health care organizations. We believe that the
commercial value and appeal of our products may be adversely affected if the
current health care financing and reimbursement system were to reverse its
current evolution to a managed care model back to a fee-for-service model. In
addition, many of our customers are providing services under capitated service
agreements, and a reduction in the use of capitation arrangements as a result of
regulatory or market changes could have a material adverse effect on our
business, financial condition and operating results. During the past several
years, the health care industry has been subject to increasing levels of
governmental regulation of, among other things, reimbursement rates and certain
capital expenditures. Certain proposals to reform the health care system have
been and are being considered by Congress. These proposals, if enacted, could
change the operating environment of our clients in ways that cannot be
predicted. Health care organizations may react to these proposals by curtailing
or deferring investments, including those for our products and services.
Changes in current health care financing and reimbursement systems could
result in the need for unplanned product enhancements, in delays or
cancellations of product orders or shipments or in the revocation of endorsement
of our products by hospital associations or other customers. Any of these
occurrences could have a material adverse effect on our business. In addition,
many health care providers are consolidating to create integrated health care
delivery systems with greater regional market power. As a result, these emerging
systems could have greater bargaining power, which may lead to price erosion of
our products. If we fail
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to maintain adequate price levels, our business, financial condition and results
of operations would be adversely affected. Other market-driven reforms could
also have adverse effects on our business, financial condition and results of
operations.
HIGHLY COMPETITIVE MARKET
Competition in the market for our products and services is intense and
is expected to increase. Increased competition could result in price reductions,
reduced gross margins and loss of market share, any of which could materially
adversely affect our business, financial condition and results of operations. We
compete with other providers of health care information software and services,
as well as health care consulting firms. Some principal competitors include,
among others:
- - CIS Technologies, Inc., a division of National Data Corporation, Inc.,
and Sophisticated Software, Inc. in the market for our EDI products;
- - MedE AMERICA in the market for our claims processing service;
- - Healthcare Cost Consultants, Inc., a division of CIS Technologies, Inc.,
and Trego Systems, Inc. in the market for our contract management
products;
- - McKesson HBOC, Inc., Optika Imaging Systems, Inc. and LanVision Systems,
Inc. in the market for our electronic document management products;
- - Transition Systems, Inc. and Healthcare Microsystems, Inc., a division
of Health Management Systems Inc., HCIA Inc. and MediQual Systems, Inc.,
a division of Cardinal Health, Inc., in the market for our decision
support products;
- - McKesson HBOC, Inc., Shared Medical Systems, Inc., MediTech Corporation
and Eclipses Corporation in the market for our enterprise products;
- - HMS and ARTRAC, a division of Medaphis in the market for our business
office outsourcing services;
- - a subsidiary of Minnesota Mining and Manufacturing, in the market for
our medical records products; and
- - Transcend Services, Inc. and SMART Corporation in the market for our
health information management services.
In addition, current and prospective customers evaluate our capabilities
against the merits of their existing information systems and expertise.
Furthermore, major software information systems companies, including those
specializing in the health care industry, not presently offering products that
compete with those offered by us, may enter our markets. In addition, many of
our competitors and potential competitors have significantly greater financial,
technical, product development, marketing and other resources and market
recognition than us. Many of our competitors also currently have, or may develop
or acquire, substantial installed customer bases in the health care industry. As
a result of these factors, our competitors may be able to respond more quickly
to new or emerging technologies, changes in customer requirements and political,
economic or regulatory changes in the health care industry and may devote
greater resources to the development, promotion and sale of their products than
us. There can be no assurance that we will be able to compete successfully
against current and future competitors or that such competitive pressures will
not materially adversely affect our business, financial condition and operating
results.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of Common Stock by existing stockholders under Rule 144 of
the Securities Act and through the exercise of registration rights could lower
the market price of our Common Stock. As of January 31, 1999, approximately
1,850,000 shares are available for sale in the public market subject to
compliance with Rule 144. Certain of our existing stockholders holding an
aggregate of 1,304,706 shares of Common Stock as of January 31, 1999 have rights
under certain circumstances to require us to register their shares for future
sale, excluding shares issued in the acquisitions of IMN and Pyramid, discussed
below.
In September 1998, we closed the acquisition of IMN . In connection with
the acquisition of IMN, we issued an aggregate of 1,550,000 shares of Common
Stock and agreed to file a registration statement under the Securities Act prior
to January 1, 1999 to register all such shares. In June 1998, we closed the
acquisition of Pyramid. In connection with the acquisition of Pyramid, we issued
an aggregate of 2,784,508 shares of Common Stock and warrants to purchase 62,710
shares of Common Stock.
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Sales of a substantial number of the aforementioned shares in the public
markets or the prospect of such sales could adversely affect or cause
substantial fluctuations in the market price of the Common Stock and impair our
ability to raise additional capital through the sale of our securities.
NEW PRODUCT DEVELOPMENT AND SYSTEM ENHANCEMENT
Our performance depends in large part upon our ability to provide the
increasing functionality required by our customers through the timely
development and successful introduction of new products and enhancements to our
existing suite of products. We have historically devoted significant resources
to product enhancements and research and development and believe that
significant continuing development efforts will be required to sustain our
operations and integrate the products and technologies of acquired businesses
with our products. There can be no assurance that we will successfully or in a
timely manner develop, acquire, integrate, introduce and market new product
enhancements or products, or that product enhancements or new products developed
by us will meet the requirements of hospitals or other health care providers and
payors and achieve or sustain market acceptance.
LIMITED PROPRIETARY RIGHTS; RISK OF INFRINGEMENT
We rely on a combination of trade secrets, copyright and trademark laws,
nondisclosure and other contractual provisions to protect our proprietary
rights. We have not filed any patent applications covering our technology. There
can be no assurance that measures taken by us to protect our intellectual
property will be adequate or that our competitors will not independently develop
products and services that are substantially equivalent or superior to the
products and services we offer.
There is substantial litigation regarding intellectual property rights
in the software industry. We expect that software products may be increasingly
subject to third-party infringement claims as the number of competitors in our
industry segment grows and the functionality of products overlaps. We believe
that our products do not infringe upon the proprietary rights of third parties.
However, there can be no assurance that third parties will not assert
infringement claims against us in the future. The Company may incur substantial
litigation expenses in defending any such claim regardless of the merit of the
claim. In the event of an unfavorable ruling on any such claim, we cannot
guarantee that a license or similar agreement will be available to us on
reasonable terms, if at all. Infringement may result in significant monetary
liabilities which would have a material adverse effect on our business,
financial condition and results of operations. We cannot guarantee that we will
be successful in the defense of these or similar claims.
RISK OF PRODUCT DEFECTS; FAILURE TO MEET PERFORMANCE CRITERIA
Products such as our products frequently contain errors or failures,
especially when initially introduced or when new versions are released. Although
we conduct extensive testing on our products, software errors have been
discovered in certain enhancements and products after their introduction. We
cannot guarantee that despite such testing by us, and by our current and
potential customers, products under development, enhancements or shipped
products will be free of errors or performance failures, resulting in, among
other things;
- - loss of revenues and customers;
- - delay in market acceptance;
- - diversion of resources;
- - damage to our reputation; or
- - increased service and warranty costs.
The occurrence of any of these consequences could have a material
adverse effect upon our business, financial condition and results of operations.
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YEAR 2000
As is true for most companies, the Year 2000 computer issue creates a
risk for us. If systems do not correctly recognize date information when the
year changes to 2000, there could be an adverse impact on our operations. We
face risks in four areas: systems used by us to run our business, systems used
by our suppliers, potential warranty or other claims from our customers, and the
potential reduction in spending by other companies on our products and solutions
as a result of significant information systems spending on Year 2000
remediation.
We have conducted a thorough inventory and evaluation of our systems,
equipment and facilities. We have a number of projects underway to replace or
upgrade systems, equipment and facilities that we know to be Year 2000
non-compliant. We have not identified alternative remediation plans if upgrade
or replacement is not feasible. We will consider the need for such remediation
plans as we continue to assess the year 2000 risk. For the Year 2000
non-compliance issues identified to date, the cost of upgrade or remediation is
not expected to be material to our operating results. If implementation of
replacement systems is delayed, or if significant new non-compliance issues are
identified, our results of operations or financial condition could be materially
adversely affected.
We are also in the process of contacting our critical suppliers to
determine that such suppliers' operations and the products and services they
provide are Year 2000 compliant. To date, we are unaware of any current
suppliers that are not Year 2000 ready. In the event that our suppliers are not
Year 2000 compliant, we will seek alternative sources of supplies. However, such
failures remain a possibility and could have an adverse impact on our results of
operations or financial condition.
We believe our current products are Year 2000 compliant. However, since
all customer situations cannot be anticipated, particularly those involving
third party products, we may see an increase in warranty and other claims as a
result of the Year 2000 transition. In addition, litigation regarding Year 2000
compliance issues is expected to escalate. For these reasons, the impact of
customer claims could have a material adverse impact on our results of
operations or financial condition.
Year 2000 compliance is an issue for virtually all businesses whose
computer systems and applications may require significant hardware and software
upgrades or modifications. Companies owning and operating such systems may plan
to devote a substantial portion of their information systems' spending to fund
such upgrades and modifications and divert spending away from our products and
solutions. Such changes in our customers' spending patterns could have a
material adverse impact on our sales, operating results or financial condition.
RISK OF INTERRUPTION OF DATA PROCESSING
We currently process substantially all our customer data at our
facilities in Richmond, California and Neptune, New Jersey. Although we back up
our data nightly and have safeguards for emergencies such as power interruption
or breakdown in temperature controls, we have no mirror processing site to which
processing could be transferred in the case of a catastrophic event at either of
these facilities. In the event that a major catastrophic event occurs at either
the Richmond or the Neptune facility, possibly leading to an interruption of
data processing, our business, financial condition and results of operations
could be adversely affected.
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RISKS RELATED TO OUTSOURCING BUSINESS
We provide compliance, consulting and business office outsourcing and
cash flow management services, including the billing and collection of
receivables. We acquired the infrastructure for our outsourcing business through
an acquisition. In addition, we often use our software products to provide
outsourcing services. As a result, we have not been required to make significant
capital expenditures in order to service existing outsourcing contracts.
However, if we experience a period of substantial expansion in our outsourcing
business, we may be required to make substantial investments in capital assets
and personnel. We cannot guarantee that we will be able to assess accurately the
investment required and negotiate and perform in a profitable manner any of the
outsourcing contracts we may be awarded. Our failure to either estimate
accurately the resources and related expenses required for a project, or to
complete our contractual obligations in a manner consistent with the project
plan upon which a contract was based, could have a material adverse effect on
our business, financial condition and results of operations. In addition, our
failure to meet a client's expectations in the performance of our services could
damage our reputation and adversely affect our ability to attract new business.
Finally, we could incur substantial costs and expend significant resources
correcting errors in our work, and could possibly become liable for damages
caused by these errors.
GOVERNMENT REGULATION
The United States Food and Drug Administration (the "FDA") is
responsible for assuring the safety and effectiveness of medical devices under
the Federal Food, Drug and Cosmetic Act. Computer products are subject to
regulation when they are used or are intended to be used in the diagnosis of
disease or other conditions, or in the cure, mitigation, treatment or prevention
of disease, or are intended to affect the structure or function of the body. The
FDA could determine in the future that any predictive aspects of our products
make them clinical decision tools subject to FDA regulation. Compliance with
these regulations could be burdensome, time consuming and expensive. We could
also become subject to future legislation and regulations concerning the
development and marketing of health care software systems. Such legislation
could increase the cost and time necessary to market new products and could
affect us in other respects not presently foreseeable. We cannot predict the
effect of possible future legislation and regulation.
State governments substantially regulate the confidentiality of patient
records and the circumstances under which such records may be released for
inclusion in our databases. These state laws and regulations govern both the
disclosure and the use of confidential patient medical record information.
Although compliance with these laws and regulations is at present principally
the responsibility of the hospital, physician or other health care provider,
regulations governing patient confidentiality rights are evolving rapidly.
Additional legislation governing the dissemination of medical record information
has been proposed at both the state and federal levels. This legislation may
require holders of such information to implement security measures that may
require us to incur substantial expenditures. We are not sure that changes to
state or federal laws will not materially restrict the ability of health care
providers to submit information from patient records using our products.
RISK OF PRODUCT-RELATED CLAIMS
Some of our products and services are used in the payment, collection,
coding and billing of health care claims and the administration of managed care
contracts. If our employees or our products fail to accurately assess, process
or collect these claims, our customers may file claims against us. We have been
and currently are involved in claims for money damages related to services
provided by our accounts receivable management business. We maintain insurance
to protect against certain claims associated with the use of our products, but
there can be no assurance that our insurance coverage would adequately cover any
claim brought against us. A successful claim brought against us that is in
excess of, or is not covered by, our insurance coverage could adversely affect
our business, financial condition and results of operations. Even a claim
without merit could result in significant legal defense costs and would consume
management time and resources. We do not know whether we will be subject to
material claims in the future which may result in liability in excess of our
insurance coverage, or which our insurance may not cover. We may not be able to
obtain appropriate insurance in the future at commercially reasonable rates. In
addition, if we are found liable, we would have to significantly alter our
products resulting in additional unanticipated research and development
expenses.
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RISKS ASSOCIATED WITH CERTAIN INVESTMENTS
We have made equity investments to acquire minority interests in certain
early stage companies. We do not have the ability to control the operations of
any of these companies. Investing in such early stage companies is subject to
certain significant risks. There can be no assurance that any of these companies
will be successful or achieve profitability or that we will ever realize a
return on our investments. In addition, to the extent any of such companies fail
or become bankrupt or insolvent, we may lose some or all of our investment. We
intend to continue to make additional investments in such companies in the
future. Losses resulting from such investment could have a material adverse
effect on our operating results.
POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISION
Our Board of Directors has the authority to issue up to 5,000,000 shares
of Preferred Stock and to determine the price, rights preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of Common Stock
may be subject to, and may be adversely affected by, the rights of the holders
of any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock may have the effect of delaying, deferring or preventing a
change of control of the Company without further action by the stockholders and
may adversely affect the voting and other rights of the holders of Common Stock.
We have no present plans to issue shares of Preferred Stock.
Further, certain provisions of our Certificate of Incorporation and
Bylaws could discourage potential takeover attempts and make attempts by
stockholders to change management more difficult. For example, our Board of
Directors is classified into three classes of directors serving staggered,
three-year terms and has the authority without action by our stockholders to
impose various procedural and other requirements that could make it more
difficult for stockholders to effect certain corporate actions. In addition, our
Certificate of Incorporation provides that directors may be removed only by the
affirmative vote of the holders of two-thirds of the shares of capital stock of
the Company entitled to vote. Any vacancy on the Board of Directors may be
filled only by vote of the majority of directors then in office. Further, our
Certificate of Incorporation provides that any "Business Combination" (as
therein defined) requires the affirmative vote of two-thirds of the shares
entitled to vote, voting together as a single class. These provisions, and
certain other provisions of the Certificate of Incorporation which may have the
effect of delaying proposed stockholder actions until the next annual meeting of
stockholders, could have the effect of delaying or preventing a tender offer for
the Company's Common Stock or other changes of control or management of the
Company, which could adversely affect the market price of our Common Stock.
Finally, certain provisions of Delaware law could have the effect of delaying,
deterring or preventing a change in control of the Company, including Section
203 of the Delaware General Corporation Law, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years from the date the person became an
interested stockholder unless certain conditions are met.
VOLATILITY OF STOCK PRICE
The stock market in general, and the Nasdaq National Market, has
historically experienced extreme price and volume fluctuations that have often
been unrelated to the operating performance of companies and which has affected
the market price of securities of many companies. The trading price of our
Common Stock is likely to be highly volatile and could also be subject to
significant fluctuations in price in response to such factors as:
- - variations in quarterly results of operations;
- - announcements of new products or acquisitions by us or our competitors;
- - governmental regulatory action;
- - developments or disputes with respect to proprietary rights;
- - general trends in our industry and overall market conditions; and
- - other event or factors, many of which are beyond our control.
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34
The market price of our Common Stock may also be affected by movements
in prices of equity securities in general.
ITEM 8. FINANCIAL STATEMENTS.
The Company's Consolidated Financial Statements are located on the pages
indicated below:
PAGE
----
Report of Arthur Andersen LLP, Independent Public Accountants ..... F-1
Report of Deloitte & Touche LLP, Independent Auditors ............. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ...... F-3
Consolidated Statements of Operations for the years ended
December 31, 1996, 1997 and 1998 ............................... F-4
Consolidated Statement of Changes in Stockholders' Equity (Deficit)
and Comprehensive Loss for the years ended
December 31, 1996, 1997 and 1998 ............................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998 ............................... F-7
Notes to Consolidated Financial Statements ........................ F-8
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
34
35
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is incorporated by reference from
the Company's Proxy Statement, to be mailed to shareholders for the Annual
Meeting to be held on or about May 18, 1999. The information concerning the
Company's executive officers required by this item is incorporated by reference
to the section of Part I hereof entitled "Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference from
the Company's Proxy Statement, to be mailed to shareholders for the Annual
Meeting to be held on or about May 18, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference from
the Company's Proxy Statement, to be mailed to shareholders for the Annual
Meeting to be held on or about May 18, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference from
the Company's Proxy Statement, to be mailed to shareholders for the Annual
Meeting to be held on or about May 18, 1999.
35
36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Annual Report on
Form 10-K:
1. Financial Statements.
The consolidated financial statements contained herein are as
listed on the "Index" on page 45.
2. Financial Statement Schedule.
Reference is made to Schedule II following the signature pages
hereto.
3. Exhibits. Reference is made to Item 14(c) of this Annual Report
on Form 10-K.
(b) Reports on Form 8-K. The Company filed the following reports on Form 8-K
during the last quarter of the fiscal year covered by this Annual Report
on Form 10-K:
1. Current Report on Form 8-K, as filed with the Commission on
September 11, 1998.
2. Current Report on Form 8-K, as filed with the Commission on
October 15, 1998.
(c) Exhibits.
2.1 Assets Purchase Agreement dated December 31, 1995, by and among
QuadraMed Corporation, a Delaware corporation and California
corporation.(1)
2.2 Assets Purchase Agreement dated December 31, 1995, by and among
QuadraMed Acquisition Corporation, Kaden Arnone, Inc. and its
stockholders.(1)
2.3 Exchange Agreement dated June 25, 1996, by and among QuadraMed Holdings,
Inc., QuadraMed Corporation, and certain stockholders listed on Schedule
A thereto.(1)
2.4 Acquisition Agreement and Plan of Merger, dated December 2, 1996 between
the Company and InterMed Acquisition Corporation, a wholly-owned
subsidiary of the Company. and InterMed Healthcare Systems Inc. and its
Stockholders.(2)
2.5 Acquisition Agreement and Plan of Merger, dated as of March 1, 1997, by
and among QuadraMed Corporation, Healthcare Recovery Acquisition
Corporation, Healthcare Recovery Incorporated and its Shareholders (the
"HRI Acquisition Agreement and Plan of Merger").(3)
2.6 First Amendment to HRI Acquisition Agreement and Plan of Merger, dated
as of April 22, 1997.(3)
2.7 Second Amendment to HRI Acquisition Agreement and Plan of Merger, dated
as of April 24, 1997.(3)
2.8 Acquisition Agreement and Plan of Merger, dated as of September 24,
1997, by and among QuadraMed Corporation, HRM Acquisition Corporation,
Healthcare Revenue Management, Inc. and its Stockholders (the
"Acquisition Agreement and Plan of Merger").(4)
2.9 First Amendment to Acquisition Agreement and Plan of Merger, dated as of
September 29, 1997.(4)
2.10 Agreement and Plan of Reorganization by and between QuadraMed
Corporation and Medicus Systems Corporation, dated as of November 9,
1997.(5)
36
37
2.11 Amendment No. 1 to Agreement and Plan of Reorganization, dated as of
February 26, 1998.(10)
2.12 Amendment No. 2 to Agreement and Plan of Reorganization, dated as of
March 24, 1998.(10)
2.13 Acquisition Agreement and Plan of Merger dated as of December 29, 1997,
by and among QuadraMed Corporation and Resource Health Partners, L.P.
(6)
2.14 Acquisition Agreement and Plan of Merger dated as of February 2, 1998,
by and among QuadraMed Corporation and Cabot Marsh Corporation.(7)
2.15 Acquisition Agreement and Plan of Merger, dated June 1, 1998, by and
among QuadraMed Corporation, Pyramid Health Acquisition Corporation,
Pyramid Health Group, Inc. and its Shareholders.(11)
2.16 Acquisition Agreement and Plan of Merger, dated September 30, 1998, by
and among QuadraMed Corporation and IMN Corp.(12)
3.1 Reserved.
3.2 Second Amended and Restated Certificate of Incorporation of the
Company.(1)
3.3 Reserved.
3.4 Amended and Restated Bylaws of the Company.(1)
4.1 Reference is made to Exhibits 3.2 and 3.4.(1)
4.2 Form of Common Stock certificate.(1)
4.3 Form of Exchange Agreement dated March 16, 1994, by and among the
Company, THCS Holding, Inc. and certain stockholders listed on Schedule
A thereto.(1)
4.4 Reserved.
4.5 Reserved.
4.6 Reserved.
4.7 Amended and Restated Agreement Regarding Adjustment Shares dated June
25, 1996, by and among the Company, QuadNet Corporation and the
individuals listed on Schedule A thereto.(1)
4.8 Amended and Restated Shareholder Rights Agreement dated June 25, 1996,
by and between the Company and the investors listed on Schedule A
thereto.(1)
4.9 Stock Purchase Warrant dated September 27, 1995 issued to James D.
Durham and amendment #1 thereto dated July 10, 1997.(8)
4.10 Reserved.
4.11 Form of Warrant to Purchase Common Stock.(1)
4.12 Registration Rights Agreement dated December 5, 1996, by and between the
Company and the investors listed on Schedule A thereto.(8)
4.13 Registration Rights Agreement, dated as of December 29, 1997, by and
among QuadraMed Corporation, Resource Health Partners, L.P. and certain
stockholders.(6)
37
38
4.14 Registration Rights Agreement, dated as of June 5, 1998, by and among
QuadraMed Corporation and the shareholders of Pyramid Health Group, Inc.
named therein.(11)
4.15 Registration Rights Agreement, dated as of September 30, 1998 by and
among QuadraMed Corporation, IMN Corp. and the shareholders of IMN Corp.
named herein.(12)
4.16 Subordinated Indenture, dated as of May 1, 1998 between QuadraMed
Corporation and The Bank of New York.(13)
4.17 Officers' Certificate delivered pursuant to Sections 2.3 and 11.5 to the
Subordinated Indenture.(13)
4.18 Registration Rights Agreement, dated April 27, 1998 by and among
QuadraMed Corporation and the Initial Purchasers named therein. (13)
4.19 Form of Global Debenture.(13)
4.20 Form of Certificated Debenture.(13)
10.1 1996 Stock Incentive Plan of the Company.(1)
10.2 1996 Employee Stock Purchase Plan of the Company.(1)
10.3 Summary Plan Description, QuadraMed Corporation 401(k) Plan.(1)
10.4 Form of Indemnification Agreement between the Company and its directors
and executive officers.(1)
10.5 Reserved.
10.6 Lease dated February 26, 1996 for facilities located at 1345 Campus
Parkway, Building M, Block #930, Lot #51.02, Neptune, New Jersey.(1)
10.7 Lease dated May 23, 1994 for facilities located at 80 East Sir Francis
Drake Boulevard, Suite 2A, Larkspur, California.(1)
10.8 Reserved.
10.9 Reserved.
10.10 Stock Purchase Agreement dated March 3, 1994, by and between the Company
and James D. Durham.(1)
10.11 Reserved.
10.12 Reserved.
10.13 Reserved.
10.14 Reserved.
10.15 Credit Terms and Conditions dated July 2, 1997, by and between Imperial
Bank and the Company, with addendum thereto.(8)
10.16 Reserved.
10.16.1 Reserved.
10.17 Reserved.
38
39
10.18 Reserved.
10.19 Reserved.
10.20 Reserved.
10.21 Reserved.
10.22 Reserved.
10.23 Reserved.
10.24 Reserved.
10.25 Reserved.
10.26 Reserved.
10.27 Reserved.
10.28 Reserved.
10.29 Reserved.
10.30 Reserved.
10.31 Reserved.
10.32 Reserved.
10.32 Reserved.
10.34 Reserved.
10.35 Reserved.
10.36 Reserved.
10.37 Reserved.
10.38 Reserved.
10.39 Letter dated July 1, 1997 from the Company to Lemuel C. Stewart, Jr.
regarding terms of employment.(9)
10.40 Form of Stock Purchase Agreement dated as of November 9, 1997 by and
among QuadraMed Corporation and certain stockholders of Medicus Systems
Corporation.(5)
10.41 Form of Stock Purchase Warrant dated as of November 9, 1997 issued to
certain stockholders of Medicus (including as Appendix A to Exhibit
10.40).(5)
10.42 Letter dated November 1, 1997 from the Company to James D. Durham,
regarding terms of employment.(5)
10.43 Letter dated November 13, 1997 from the Company to John V. Cracchiolo,
regarding terms of employment.(5)
10.44 Reserved.
39
40
10.45 Letter dated January 15, 1998 from the Company to Andrew J. Hurd,
regarding terms of employment.(10)
10.46 Employment Agreement dated September 29, 1997 by and between Steven D.
McCoy and the Company.(10)
10.47 Letter dated March 17, 1998 from the Company to Keith M. Roberts
regarding terms of employment.(10)
10.48 Employment Agreement dated February 4, 1998 by and between Ruthann Russo
and the Company.(10)
10.49 Employment Agreement, dated June 5, 1998, between QuadraMed Corporation
and Nitin T. Mehta.(14)
10.50 Mergers and Acquisitions Advisory Fee Agreement, dated June 5, 1998,
between QuadraMed Corporation and Mehta & Company, Inc.(14)
21 List of Subsidiaries of the Registrant.(10)
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2 Consent of Deloitte & Touche LLP, Independent Auditors.
24.1 Power of Attorney (set forth in the signature page hereto).
27.1 Financial Data Schedule for the Year Ended 12/31/1998.
27.2 Financial Data Schedule for the Year Ended 12/31/1997.
27.3 Financial Data Schedule for the Year Ended 12/31/1996.
- ------------
(1) Incorporated herein by reference from the exhibit with the same number
to the Company's Registration Statement on Form SB-2, No. 333-5180-LA,
as filed with the Commission on June 28, 1996, as amended by Amendment
No. 1, Amendment No. 2 and Amendment No. 3 thereto, as filed with the
Commission on July 26, 1996, September 9, 1996, and October 2, 1996,
respectively.
(2) Incorporated herein by reference from the exhibit with the same number
to the Company's Current Report on Form 8-K, as filed with the
Commission on January 9, 1997.
(3) Incorporated herein by reference from the exhibit with the same number
to the Company's Current Report on Form 8-K, as filed with the
Commission on May 9, 1997, as amended on July 8, 1997 and March 10,
1998.
(4) Incorporated herein by reference from the exhibit with the same number
to the Company's Current Report on Form 8-K, as filed with the
Commission on October 10, 1997, as amended on March 10, 1998.
(5) Incorporated by reference from the exhibit with the same number to the
Company's Current Report on Form 8-K, as filed with the commission on
November 21, 1997.
(6) Incorporated herein by reference from Exhibit 2.11 to the Company's
Current Report on Form 8-K, as filed with the Commission on January 13,
1998.
(7) Incorporated herein by reference from Exhibit 2.12 to the Company's
Current Report on Form 8-K, as filed with the Commission on February 18,
1998.
(8) Incorporated herein by reference from the exhibit with the same number
to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997, as filed with the Commission on August 14, 1997, as
amended September 4, 1997.
40
41
(9) Incorporated by reference from the exhibit with the same number to the
Company's Registration Statement on Form S-3, No. 333-36189, as filed
with the Commission on September 23, 1997, as amended by Amendment No. 1
and Amendment No. 2 thereto, as filed with the Commission on October 1,
1997 and October 15, 1997 respectively.
(10) Incorporated herein by reference from the Company's Annual Report on
Form 10-K, as filed with the Commission on March 31, 1998, as amended
April 20, 1998.
(11) Incorporated herein by reference from the Company's Current Report on
Form 8-K, as filed with the Commission on June 6, 1998.
(12) Incorporated herein by reference from the Company's Current Report on
Form 8-K, as filed with the Commission on October 15, 1998.
(13) Incorporated herein by reference from the Company's Registration
Statement on Form S-3, No. 333-55775, as filed with the Commission on
June 2, 1998, as amended by Amendment No. 1 thereto, as filed with the
Commission on June 17, 1998.
(14) Incorporated herein by reference from the Company's Current Report on
Form 8-K/A, as filed with the Commission on June 17, 1998.
41
42
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.
QUADRAMED CORPORATION
Date: March 31, 1998
By: /s/ JAMES D. DURHAM
--------------------------------------
James D. Durham
Chairman of the Board, President and
Chief Executive Officer (Principal
Executive Officer)
By: /s/ KEITH M. ROBERTS
--------------------------------------
Keith M. Roberts
Executive Vice President, Chief
Financial Officer and General Counsel
By: /s/ BERNIE J. MURPHY
--------------------------------------
Bernie J. Murphy
Vice President, Finance and
Chief Accounting Officer
(Principal Accounting Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints, jointly and severally, John V. Cracchiolo and
Keith M. Roberts, and each of them, as his true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments)to this Report on Form 10-K, and to file
the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JAMES D. DURHAM Chairman of the Board and Chief March 31, 1998
- ---------------------------- Executive Officer (Principal
James D. Durham Executive Officer)
/s/ KEITH M. ROBERTS Executive Vice President, Chief March 31, 1998
- ---------------------------- Financial Officer (Principal Financial
Keith M. Roberts and Accounting Officer) and General Counsel
/s/ BERNIE J. MURPHY Vice President, Finance and Chief March 31, 1998
- ---------------------------- Accounting Officer (Principal
Bernie J. Murphy Accounting Officer)
42
43
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ALBERT L. GREENE Director March 31, 1998
- ----------------------------
Albert L. Greene
/s/ KENNETH E. JONES Director March 31, 1998
- ----------------------------
Kenneth E. Jones
/s/ THOMAS F. MCNULTY Director March 31, 1998
- ----------------------------
Thomas F. McNulty
/s/ JOAN P. NEUSCHELER Director March 31, 1998
- ----------------------------
Joan P. Neuscheler
/s/ CORNELIUS T. RYAN Director March 31, 1998
- ----------------------------
Cornelius T. Ryan
43
44
Schedule II
QUADRAMED CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
(Restated -- See Note 12 to Consolidated Financial Statements)
Additions Additions
Balance at Charged to Charged to
Description Beginning of Year Costs and Expenses Other Accounts* Deductions End of Year
----------- ----------------- ------------------ -------------- ---------- -----------
Year ended December 31, 1996
Allowance for doubtful accounts..... $ 1,857 $ 4,548 -- $ (4,392) $ 2,014
Year ended December 31, 1997
Allowance for doubtful accounts..... $ 2,014 $ 4,577 -- $ (4,415) $ 2,176
Year ended December 31, 1998
Allowance for doubtful accounts..... $ 2,176 $ 5,724 1,902 $ (5,066) $ 4,736
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
(See Note 2 to Consolidated Financial Statements)
Additions
Additions Charged to
Balance at Charged to Other
Description Beginning of Year Costs and Expenses Accounts* Payments End of Year
- ----------- ----------------- ------------------ ---------- --------- -----------
Year ended December 31, 1996
Restructuring Accrual............. $ -- $ -- $ -- $ -- $ --
Year ended December 31, 1997
Restructuring Accrual............. $ -- $ -- $ 1,334 $ -- $ 1,334
Year ended December 31, 1998
Restructuring Accrual............. $ 1,334 $ 3,020 $ -- $ (2,775) $ 1,579
* This includes adjustments recorded in purchase accounting associated
with the Company's acquisition of Medicus Systems Corporation in
November 1997.
44
45
INDEX TO FINANCIAL STATEMENTS
QUADRAMED CORPORATION
PAGE
----
Report of Independent Public Accountants ................................ F-1
Independent Auditors' Report ............................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ............ F-3
Consolidated Statements of Operations for the years ended
December 31, 1996, 1997 and 1998 .................................... F-4
Consolidated Statements of Changes in Stockholders'
Equity (Deficit) and Comprehensive Loss for the years ended
December 31, 1996, 1997 and 1998 .................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998 .................................... F-7
Notes to Consolidated Financial Statements .............................. F-8
45
46
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of QuadraMed Corporation:
We have audited the accompanying consolidated balance sheets of
QuadraMed Corporation (a Delaware corporation) and subsidiaries as of December
31, 1997 and 1998, and the related consolidated statements of operations,
statements of changes in stockholders' equity (deficit) and comprehensive loss
and cash flows for each of the three years in the period ended December 31,
1998. These consolidated 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 did not audit the consolidated
statements of operations, statements of stockholders' equity and cash flows of
FRA Acquisitions, Inc. and subsidiary for the year ended December 31, 1996 which
statements represent total revenues of 12% of the 1996 consolidated total. Those
statements were audited by other auditors whose report has been furnished to us
and our opinion, insofar as it relates to the amounts included for that entity,
is based solely on the report 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 provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of QuadraMed
Corporation and subsidiaries as of December 31, 1997 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed under 14(a) are
presented for purposes of complying with the Securities and Exchange
Commission's rules and are not part of the basic financial statements. These
schedules have been subjected to auditing procedures applied in the audit of the
basic financial statements and, in our opinion, fairly state in all material
respects the financial data required to be set forth therein in relation to the
basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
San Jose, California
February 17, 1999
F-1
47
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
FRA Acquisitions, Inc.
Rothenberg Health Systems Inc.
Woodland Hills, California:
We have audited the consolidated statements of operations, shareholder's equity,
and cash flows of FRA Acquisitions, Inc. and subsidiary (the "Company") for the
year ended December 31, 1996 (which financial statements are not presented
herein). 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of operations and cash flows of the Company for
the year ended December 31, 1996 in conformity with generally accepted
accounting principles.
/s/ Deloitte & Touche LLP
Los Angeles, California
April 25, 1997
F-2
48
QUADRAMED CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
-------------------------
1997 1998
--------- ---------
(RESTATED)
(SEE NOTE 12)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................... $ 44,666 $ 59,293
Short-term investments .............................................. 1,032 23,043
Accounts receivable, net of allowance for uncollectible
accounts of $2,176 and $4,736, respectively ..................... 20,179 29,980
Unbilled receivables ................................................ 4,018 9,112
Notes and other receivables ......................................... 2,354 4,018
Prepaid expenses and other .......................................... 2,550 2,212
--------- ---------
Total current assets ......................................... 74,799 127,658
--------- ---------
LONG-TERM INVESTMENTS ................................................... -- 41,612
EQUIPMENT, at cost:
Equipment ........................................................... 12,679 18,757
Less-- Accumulated depreciation and amortization .................... (5,813) (10,782)
--------- ---------
Equipment, net .................................................. 6,866 7,975
--------- ---------
CAPITALIZED SOFTWARE DEVELOPMENT COSTS, net of accumulated
amortization of $134 and $516, respectively ......................... 1,525 3,814
ACQUIRED SOFTWARE, net of accumulated amortization
of $643 and $1,610, respectively .................................... 4,178 3,211
INTANGIBLES, net of accumulated amortization
of $2,501 and $7,905, respectively .................................. 15,836 50,672
NON-MARKETABLE INVESTMENTS ............................................. 1,200 1,200
DEBT OFFERING COSTS AND OTHER ........................................... 884 4,744
--------- ---------
$ 105,288 $ 240,886
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of capital lease obligations ..................... $ 168 $ 146
Notes payable ....................................................... 10,640 11
Accounts payable .................................................... 3,728 3,225
Accrued payroll and related ......................................... 7,377 6,993
Accrued interest .................................................... 4,461 1,018
Other accrued liabilities ........................................... 19,262 14,657
Deferred revenue .................................................... 11,827 8,602
Minority interest ................................................... 658 --
--------- ---------
Total current liabilities .................................... 58,121 34,652
NOTES PAYABLE ........................................................... 13,153 19,184
CONVERTIBLE SUBORDINATED DEBENTURES ..................................... -- 115,000
CAPITAL LEASE OBLIGATIONS, less current portion ......................... 285 205
--------- ---------
Total liabilities ............................................ 71,559 169,041
--------- ---------
CONTINGENCIES (Note 14) ................................................. -- --
STOCKHOLDERS' EQUITY:
Common stock, $0.01 par, 50,000 shares authorized,
16,772 and 19,972 shares issued and outstanding, respectively ....... 96 134
Additional paid-in capital .......................................... 129,564 191,476
Deferred compensation ............................................... -- (3,940)
Unrealized loss on available-for-sale securities .................... -- (157)
Accumulated deficit ................................................. (95,931) (115,668)
--------- ---------
Total stockholders' equity ................................... 33,729 71,845
--------- ---------
$ 105,288 $ 240,886
========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
F-3
49
QUADRAMED CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
-------- --------- ---------
(RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12)
REVENUES:
Licenses ........................................ $ 34,657 $ 44,372 $ 74,655
Services ........................................ 39,612 55,253 84,739
-------- --------- ---------
Total revenues ........................... 74,269 99,625 159,394
-------- --------- ---------
OPERATING EXPENSES:
Cost of licenses ................................ 14,485 18,467 28,977
Cost of services ................................ 25,261 35,643 54,069
General and administration ...................... 21,565 26,260 24,731
Sales and marketing ............................. 7,582 10,009 14,180
Research and development ........................ 5,028 11,024 15,909
Amortization of intangibles ..................... 1,184 1,719 6,544
Acquisition costs ............................... -- 3,111 10,255
Non-recurring charges ........................... -- 4,705 4,202
Write-off of acquired research and
development in process ...................... -- 21,854 14,494
-------- --------- ---------
Total operating expenses ................. 75,105 132,792 173,361
-------- --------- ---------
LOSS FROM OPERATIONS ................................ (836) (33,167) (13,967)
-------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ................................ (3,085) (1,479) (6,245)
Interest income ................................. 361 1,006 5,828
Other income (expense) .......................... 393 683 (34)
-------- --------- ---------
Total other income (expense) ............. (2,331) 210 (451)
-------- --------- ---------
LOSS BEFORE INCOME TAXES
AND MINORITY INTEREST ........................... (3,167) (32,957) (14,418)
PROVISION FOR INCOME TAXES .......................... 147 1,136 4,192
-------- --------- ---------
LOSS BEFORE MINORITY INTEREST ....................... (3,314) (34,093) (18,610)
-------- --------- ---------
MINORITY INTEREST IN LOSS ........................... -- 37 --
LOSS FROM CONTINUING OPERATIONS ..................... (3,314) (34,130) (18,610)
-------- --------- ---------
INCOME (LOSS) FROM DISCONTINUED OPERATIONS .......... (1,010) 118 --
-------- --------- ---------
NET LOSS ............................................ $ (4,324) $ (33,938) $ (18,610)
======== ========= =========
BASIC AND DILUTED NET LOSS FROM CONTINUING
OPERATIONS ..................................... $ (0.39) $ (2.57) $ (0.98)
======== ========= =========
BASIC AND DILUTED NET INCOME (LOSS) FROM DISCONTINUED
OPERATIONS ..................................... $ (0.12) $ 0.01 $ --
======== ========= =========
BASIC AND DILUTED NET LOSS PER SHARE ................ $ (0.51) $ (2.56) $ (0.98)
======== ========= =========
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES OUTSTANDING:
BASIC AND DILUTED ............................... 8,476 13,239 19,087
======== ========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
F-4
50
QUADRAMED CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SERIES A SERIES B
CONVERTIBLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
------------------------- -------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- ---------- --------- ------------- ------------
(RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12)
BALANCE AT DECEMBER 31, 1995 .......... 912 $ 9 892 $ 9 7,182 $ 6
--------- --------- --------- --------- --------- ---------
Issuance of common stock at
$3.75 per Share ................... -- -- -- -- 56 1
Conversion of notes payable to
related parties to Series B
preferred stock
at $5.25 per share, net of
issuance costs .................... -- -- 740 7 -- --
Contributed capital to pooled entities -- -- -- -- -- --
Issuance of warrant to purchase
common stock ...................... -- -- -- -- -- --
Amortization of deferred
compensation ...................... -- -- -- -- -- --
Issuance of Series A preferred
stock under exchange
agreement ......................... 251 -- -- -- -- --
Repurchase of Series B preferred
stock ............................. -- -- (6) -- -- --
Conversion of Series A and B
preferred stock to common
stock ............................. (1,163) (9) (1,626) (16) 2,789 25
Exercise of common stock options ...... -- -- -- -- 40 --
Issuance of common stock from
initial public offering, net
of issuance costs ................. -- -- -- -- 2,500 25
Net loss .............................. -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1996 .......... -- -- -- -- 12,567 57
--------- --------- --------- --------- --------- ---------
Issuance of common stock in
connection with the Synergy
acquisition ....................... -- -- -- -- 182 2
Issuance of common stock in
connection with Healthcare
Revenue Management, Inc.
acquisition ....................... -- -- -- -- 113 1
Amortization of deferred
compensation ...................... -- -- -- -- -- --
Capital contributed to pooled entities -- -- -- -- -- --
Spin-off of subsidiary ................ -- -- -- -- -- --
Issuance of common stock purchase
warrants in connection with the
acquisition of Medicus Systems
Corporation ........................ -- -- -- -- -- --
Conversion of notes payable to
contributed capital ................ -- -- -- -- -- --
Issuance of common stock through
Employee Stock Purchase Plan ....... -- -- -- -- 14 --
Exercise of warrants to purchase
common stock ....................... -- -- -- -- 322 --
Exercise of common stock options ....... -- -- -- -- 107 1
Issuance of common stock from public
offering, net of issuance costs ... -- -- -- -- 3,467 35
UNREALIZED
LOSS ON
AVAILABLE- TOTAL
ADDITIONAL DEFERRED FOR-SALE ACCUMULATED STOCKHOLDERS' COMPREHENSIVE
PAID IN CAPITAL COMPENSATION SECURITIES DEFICIT EQUITY (DEFICIT) LOSS
--------------- ------------ ------------- ------------- --------------- -------------
(RESTATED) (RESTATED) (RESTATED) (RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12) (SEE NOTE 12) (SEE NOTE 12) (SEE NOTE 12)
BALANCE AT DECEMBER 31, 1995 .......... $ 25,015 $ (430) $ -- $ (53,945) $ (29,336)
--------- --------- --------- --------- ---------
Issuance of common stock at
$3.75 per Share ................... 209 -- -- -- 210
Conversion of notes payable to
related parties to Series B
preferred stock
at $5.25 per share, net of
issuance costs .................... 3,862 -- -- -- 3,869
Contributed capital to pooled entities 1,246 -- -- -- 1,246
Issuance of warrant to purchase
common stock ...................... 381 (381) -- -- --
Amortization of deferred
compensation ...................... -- 108 -- -- 108
Issuance of Series A preferred
stock under exchange agreement .... -- -- -- -- --
Repurchase of Series B preferred
stock ............................. (53) -- -- -- (53)
Conversion of Series A and B
preferred stock to common stock ... -- -- -- -- --
Exercise of common stock options ...... 100 -- -- -- 100
Issuance of common stock from
initial public offering, net
of issuance costs ................. 26,361 -- -- -- 26,386
Net loss .............................. -- -- -- (4,324) (4,324) (4,324)
--------- --------- --------- --------- --------- -------
BALANCE AT DECEMBER 31, 1996 .......... 57,121 (703) -- (58,269) (1,794) (4,324)
--------- --------- --------- --------- ---------
Issuance of common stock in
connection with the Synergy
acquisition ....................... 1,680 -- -- -- 1,682
Issuance of common stock in
connection with Healthcare
Revenue Management, Inc.
acquisition ....................... 2,330 -- -- -- 2,331
Amortization of deferred
compensation ...................... -- 703 -- -- 703
Capital contributed to pooled
entities .......................... 251 -- -- -- 251
Distributions by pooled entities ....... -- -- -- (40) (40)
Spin-off of subsidiary ................. -- -- -- (3,684) (3,684)
Issuance of common stock purchase
warrants in connection with
the acquisition of Medicus
Systems Corporation ................ 700 -- -- -- 700
Conversion of notes payable to
contributed capital ................ 9,578 -- -- -- 9,578
Issuance of common stock through
Employee Stock Purchase Plan ....... 135 -- -- -- 135
Exercise of warrants to purchase
common stock ....................... -- -- -- -- --
Exercise of common stock options ....... 476 -- -- -- 477
Issuance of common stock from public
offering, net of issuance costs .... 57,293 -- -- -- 57,328
F-5
51
SERIES A SERIES B
CONVERTIBLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
--------------- --------------- ---------------------------- ADDITIONAL
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT PAID IN CAPITAL
------ ------ ------ ------ ------------- ------------ ---------------
(RESTATED) (RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12) (SEE NOTE 12)
Net loss ............................. -- -- -- -- -- -- --
------ ------ ------ ------ -------- --------- ---------
BALANCE, DECEMBER 31, 1997 ........... -- -- -- -- 16,772 96 129,564
------ ------ ------ ------ -------- --------- ---------
Issuance of common stock and to
record the effect of an
immaterial acquisition
accounted for on a pooling of
interests basis ................. -- -- -- -- 507 5 212
Issuance of common stock in
connection with the InterLink
acquisition ..................... -- -- -- -- 65 1 1,467
Issuance of common stock in
connection with the Cabot Marsh
acquisition ..................... -- -- -- -- 384 4 8,417
Issuance of common stock in
connection with the Velox
acquisition ..................... -- -- -- -- 41 -- 1,372
Issuance of common stock in
connection with the Medicus
acquisition ..................... -- -- -- -- 892 15 24,518
Issuance of common stock through
Employee Stock Purchase Plan ..... -- -- -- -- 38 -- 467
Issuance of restricted shares of
common stock ..................... -- -- -- -- -- -- 3,940
Exercise of warrants to purchase
common stock ..................... -- -- -- -- 907 9 17,404
Exercise of common stock options ..... -- -- -- -- 366 4 4,115
Comprehensive Loss ................... -- -- -- -- -- -- --
Net loss ............................. -- -- -- -- -- -- --
------ ------ ------ ------ -------- --------- ---------
BALANCE, DECEMBER 31, 1998 ........... -- $ -- -- $ -- 19,972 $ 134 $191,476
====== ====== ====== ====== ======== ========= =========
UNREALIZED
LOSS ON
AVAILABLE- TOTAL
DEFERRED FOR-SALE ACCUMULATED STOCKHOLDERS' COMPREHENSIVE
COMPENSATION SECURITIES DEFICIT EQUITY (DEFICIT) LOSS
------------ ---------- ----------- ---------------- ------------
(RESTATED) (RESTATED) (RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12) (SEE NOTE 12) (SEE NOTE 12)
Net loss ............................. -- -- (33,938) (33,938) (33,938)
--------- ----- --------- ------- -------
BALANCE, DECEMBER 31, 1997 ........... -- -- (95,931) 33,729 (33,938)
Issuance of common stock and to
record the effect of an
immaterial acquisition
accounted for on a pooling of
interests basis ................. -- -- (1,127) (910)
Issuance of common stock in
connection with the InterLink
acquisition ..................... -- -- -- 1,468
Issuance of common stock in
connection with the Cabot Marsh
acquisition ..................... -- -- -- 8,421
Issuance of common stock in
connection with the Velox
acquisition ..................... -- -- -- 1,372
Issuance of common stock in
connection with the Medicus
acquisition ..................... -- -- -- 24,533
Issuance of common stock through
Employee Stock Purchase Plan ..... -- -- -- 467
Issuance of restricted shares
of common stock .................. (3,940) -- -- --
Exercise of warrants to purchase
common stock ..................... -- -- -- 17,413
Exercise of common stock options ..... -- -- -- 4,119
Comprehensive Loss ................... -- (157) -- (157) (157)
Net loss ............................. -- -- (18,610) (18,610) $(18,610)
--------- ----- --------- -------- --------
BALANCE, DECEMBER 31, 1998 ........... $ (3,940) $(157) $(115,668) $ 71,845 $(18,767)
========= ===== ========= ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
52
QUADRAMED CORPORATION
CONSOLIDATED STATEMENTS
OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------
1996 1997 1998
------------- ------------- ---------
(RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................... $ (4,324) $ (33,938) $ (18,610)
Adjustments to reconcile net loss to net
Cash provided by (used for) operating activities --
Depreciation and amortization ...................... 2,836 5,563 9,849
Amortization of deferred compensation .............. 108 703 --
Income (loss) from discontinued operations ......... 1,010 (118) --
Write-off of in-process research and development ... -- 21,854 14,494
Minority interest in net loss ...................... -- (37) --
Changes in assets and liabilities, net of acquisitions--
Accounts receivable and unbilled receivables ......... (1,876) (4,492) (14,159)
Prepaid expenses and other ........................... (80) (1,154) (534)
Accounts payable and accrued liabilities ............. 1,348 5,623 (13,804)
Deferred revenue ..................................... 4,092 444 (3,892)
--------- --------- ---------
Cash provided by (used for) operating activities . 3,114 (5,552) (26,656)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for the acquisition of Cabot Marsh,
net of cash acquired ................................. -- -- (2,748)
Cash paid for the acquisition of Velox,
net of cash acquired ................................. -- -- (3,121)
Cash paid for the acquisitions of other companies,
net of cash acquired ................................. -- (286) (6,832)
Cash paid for the acquisition of Synergy HMC,
net of cash acquired ................................. -- (2,776) --
Cash paid for the acquisition of Medicus
Systems Corporation, net of cash acquired ............ -- (21,454) --
Purchased technology ................................... -- (460) --
Purchase of available-for-sale securities .............. -- (1,032) (63,577)
Additions to equipment ................................. (3,824) (3,225) (5,458)
Purchase of non-marketable investments ................. -- (1,200) --
Repayments under notes receivable and other ............ -- -- (539)
Capitalization of computer software
development costs .................................. (745) (673) (2,688)
--------- --------- ---------
Cash used for investing activities .............. (4,569) (31,106) (84,963)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of principal on capital lease obligations ..... (177) (140) (184)
Borrowings (repayments) under notes and loans payable .. (21,144) 2,030 1,642
Issuance of convertible notes payable to related parties 3,869 -- --
Proceeds from the issuance of convertible
subordinated notes payable, net of offering costs... -- -- 110,827
Distributions by pooled entities........................ -- (40) (1,370)
Contributed capital to pooled entities.................. 1,246 -- --
Issuance of common stock, net of issuance costs ........ 26,596 57,579 --
Issuance of common stock through Employee
Stock Purchase Plan ................................ -- 135 467
Proceeds from exercise of common stock options and
warrants to purchase common stock .................. 100 477 14,864
--------- --------- ---------
Cash provided by financing activities ........... 10,490 60,041 126,246
--------- --------- ---------
Net increase in cash and cash equivalents .............. 9,035 23,383 14,627
CASH AND CASH EQUIVALENTS, beginning of period ............. 12,248 21,283 44,666
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of period ................... $ 21,283 $ 44,666 $ 59,293
========= ========= =========
F-7
53
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------
1996 1997 1998
------------- ------------- -------
(RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Cash paid for interest ............................... $ 1,270 $ 1,197 $ 7,637
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING TRANSACTIONS:
Purchase of equipment subject to capital lease ....... 128 -- --
Repurchase of Series B preferred stock in
exchange for extinguishment of shareholder
receivable ....................................... 53 -- --
Conversion of notes payable to related
parties to convertible preferred stock ........... 3,869 -- --
Conversion of notes payable and accrued
interest to related parties to contributed capital -- 9,578 --
Conversion of convertible preferred stock to
common stock ..................................... 25 -- --
Issuance of common stock in connection with
the Cabot Marsh acquisition ...................... -- -- 8,400
Issuance of common stock in connection with the
Velox acquisition ................................ -- -- 1,500
Issuance of common stock in connection with the
InterLink acquisition ............................ -- -- 1,500
Conversion of subordinated notes payable to
common stock ..................................... -- -- 8,000
Issuance of common stock in connection with
the Synergy acquisition .......................... -- 2,000 --
Issuance of common stock in connection with
acquisition of Healthcare Revenue Management, Inc. -- 2,300 --
Issuance of common stock warrants and common stock
in connection with acquisition of Medicus
Systems Corporation .............................. -- 700 24,533
Issuance of restricted common stock .................. $ -- $ -- $ 3,940
The accompanying notes are an integral part of these
consolidated financial statements.
F-8
54
QUADRAMED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. THE COMPANY
QuadraMed Corporation (the Company) was incorporated in California in
September 1993. In August 1996, the Company reincorporated in Delaware. The
Company operates in a single industry segment and offers a suite of decision
support, financial management and electronic data interchange (EDI) software
products that are designed to enable health care providers to increase
operational efficiency and measure the cost of care and to facilitate the
negotiation of managed care contracts and capitation agreements. In addition to
its software products, the Company provides business office outsourcing and cash
flow management services.
The Company is subject to a number of risks, including, but not limited to,
its dependence on the hospital market, uncertainty in the health care industry,
risks associated with acquisitions (successful integration and operation of new
products, technologies or businesses), and its ability to increase market share
for its products from larger competitors. There can be no assurance that the
Company will successfully integrate acquired subsidiaries or be able to increase
market share for its products from larger competitors.
2. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and transactions are
eliminated in consolidation.
Cash and Cash Equivalents
For purposes of the Statements of Cash Flows, the Company considers all
highly liquid investments with an original maturity of three months or less to
be cash equivalents. These investments have consisted of certificates of
deposit, money market accounts and commercial maturities of three months or
less.
Short and Long-Term Investments
The Company considers its short and long term securities to be
available-for-sale-securities and accordingly are stated at fair value. The
difference between amortized cost (cost adjusted for amortization of premiums
and accretion of discounts which are recognized as adjustments to interest
income) and fair value, representing unrealized holdings gains or losses, are
recorded as a separate component of stockholders' equity until realized. The
Company's policy is to record debt securities as available-for-sale because the
sale of such securities may be required prior to maturity. Any gains and losses
on the sale of debt securities are determined on a specific identification
basis. Realized gains and losses are included in interest income (expense) in
the accompanying statement of operations. There were no short or long term
investments during 1996. At December 31, 1997, the fair value of the investments
approximated amortized cost and, as such, gross unrealized holding gains and
losses were not material. At December 31, 1998, unrealized holding losses were
$157,000. The amortized cost, aggregate fair value and gross unrealized holding
gains and losses by major security type were as follows:
As of December 31, 1997:
AMORTIZED AGGREGATE
COST FAIR VALUE
--------- --------------
(IN THOUSANDS)
Debt securities issued by
the United States Government $ 408 $ 408
Corporate debt securities 624 624
------ ------
$1,032 $1,032
====== ======
F-9
55
As of December 31, 1998:
UREALIZED
GAIN (LOSS)
ON AVAILABLE-
AMORTIZED AGGREGATE FOR-SALE
COST FAIR VALUE SECURITIES
-------- -------------- --------------
(IN THOUSANDS)
Short-term:
Debt securities issued by
the United States Government $ 8,996 $ 9,003 $ 7
Corporate debt securities 14,040 14,040 -
-------- -------- --------
$ 23,036 $ 23,043 $ 7
======== ======== ========
Long-term:
Debt securities issued by
the United States Government $ 22,157 $ 22,162 $ 5
Corporate debt securities 19,619 19,450 (169)
-------- -------- --------
$ 41,776 $ 41,612 $ (164)
======== ======== ========
Total Unrealized Loss $ (157)
========
Comprehensive Income
In 1997, Financial Accounting Standards Board ("FASB") issued Statements
of Financial Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive
Income," which was adopted by the Company in the first quarter of 1998. The
Company has integrated the presentation of comprehensive income (loss) with the
Consolidated Financial Statements of Changes in Stockholders' Equity (Deficit).
Non-Marketable Investments
In July 1997, the Company acquired an 11 percent equity interest in
VantageMed Corporation ("VantageMed"), a company that develops and sells
software to physician groups. The Company paid $1,200,000 for its equity
interest in VantageMed which is accounted for on the cost method. In addition,
the Company has provided VantageMed a revolving line of credit in the amount of
$500,000. The line of credit bears interest at a rate of 8% per annum and all
outstanding balances, including accrued interest, are due on December 31, 1998.
There were no outstanding borrowings at December 31, 1997. VantageMed borrowed
$500,000 against the line of credit during 1998. The $500,000 outstanding
balance under the line of credit was converted to additional equity interest
subsequent to December 31, 1998. Subsequent to December 31, 1998, the Company
also acquired an additional $3,000,000 equity interest in VantageMed in exchange
for cash. In connection with these additional equity investments, the Company
owns 19 percent of the capital stock of VantageMed.
F-10
56
Equipment
Equipment is stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the related assets which
is generally three to seven years. Leasehold improvements are amortized over the
term of the lease. Maintenance and repairs are expensed as incurred.
Software Development Costs
Software development costs are capitalized upon the establishment of
technological feasibility, which the Company defines as establishment of a
working model which is typically the beta version of the software. Capitalized
software development costs require a continuing assessment of their
recoverability. This assessment requires considerable judgment by management
with respect to various factors, including, but not limited to, anticipated
future gross product revenues, estimated economic lives and changes in software
and hardware technology. The Company capitalized software development costs of
$745,000, $673,000 and $2,688,000 in 1996, 1997 and 1998, respectively.
Amortization of capitalized software development costs was $32,000, $134,000 and
$350,000 for the years ended December 31, 1996, 1997 and 1998, respectively.
Amortization is based upon the greater of the amount computed using (a) the
ratio that current gross revenues for a product bear to the total of current and
anticipated future gross revenues for that product or (b) the straight-line
method over the remaining estimated economic life of the product, generally five
years.
Revenue Recognition
The Company licenses a variety of products and provides a variety of
services. License revenue includes license, installation, consulting and
post-contract customer support fees, third-party hardware sales and other
revenues related to licensing of the Company's software products. Service
revenue is composed of business office and health information management
outsourcing, cash flow management, compliance and consulting services.
The license product suite is comprised of three primary elements: financial
management, decision support compliance and EDI software. Each of these elements
includes a variety of products which can be licensed individually or as a suite
of interrelated products. Products are licensed either under term arrangements
(which range from one year to three years and typically include monthly or
annual payments over the term of the arrangement) or on a perpetual basis.
Revenues from term licenses of financial management, decision support,
compliance and EDI products are recognized monthly or annually over the term of
the license arrangement, beginning at the date of installation. Revenues from
perpetual licenses of decision support, financial management, EDI and certain
compliance products are recognized upon shipment of the software if there is
persuasive evidence of an agreement, collection of the resulting receivable is
probable and the fee is fixed and determinable. If an acceptance period is
required, revenues are recognized upon the earlier of customer acceptance or the
expiration of the acceptance period. Revenues from certain compliance products
are recognized on a percentage of completion basis of accounting as determined
by the achievement of certain performance milestones during the product
installation process.
Other services are also provided to certain of the Company's licensees of
software products. These services consist primarily of consulting and
post-contract customer support. Consulting services generally consist of
installation of software at customer sites and revenue is recognized upon
completion of installation. Unbilled receivables consist of work performed or
software delivered which has not been billed under the terms of the contractual
arrangement with the customer. Post-contract customer support is recognized
ratably over the term of the support period. Deferred revenue primarily consists
of revenue deferred under annual maintenance and annual license agreements on
which amounts have been received from customers and for which the earnings
process has not been completed.
The Company provides business office and health information management
outsourcing, cash flow management compliance and consulting services to
hospitals under contract service arrangements. Outsourcing revenues typically
consist of fixed monthly fees plus, in the case of business office outsourcing,
incentive-based payments that are based on a percentage of dollars recovered for
the provider for which the service is being performed. The monthly fees are
recognized as revenue on a monthly basis at the end of each month. Incentive
fees are recognized as the conditions upon which such fees are based are
realized based on collection of accounts from payors. Cash flow management
services typically consist of fixed fee services and additional incentive
payments based on a certain percentage of revenue returns realized or estimated
to be realized by the customer as a result of the services provided by the
F-11
57
Company. The fixed fee portion is recognized as revenue upon the completion of
the project with the customer. Compliance and consulting revenues are recognized
as the services are provided.
Deferred revenue primarily consists of annual maintenance revenues that are
recognized ratably over the period. Deferred revenue also consists of
undelivered product and services yet to be performed as of year end. The Company
expects to recognize the revenues within one year.
Cost of license revenues consists primarily of salaries, benefits, hardware
costs and allocated costs related to the installation process and customer
support and royalties to third parties.
Cost of service revenues consists primarily of salaries, benefits and
allocated costs related to providing such services.
Major Customers
In the years ended December 31, 1996, 1997 and 1998, no single customers
accounted for more than 10% of total revenue.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of accounts receivable. The
Company does not require collateral on trade accounts receivable as the
Company's customer base consists primarily of hospitals and, to a lesser extent,
hospital associations, physician groups, medical payors and self-administered
employers. The Company provides reserves for credit losses.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts receivable and accounts payable, approximate
their fair values. The fair value of the Company's Convertible Subordinated
Debentures at December 31, 1998 was $97.8 million.
Intangibles
Intangibles include goodwill, which represents the amount of purchase price
in excess of the fair value of the tangible net assets, and acquired software
purchased in acquisitions completed by the Company and are amortized on a
straight-line basis over a period of five to ten years. Goodwill is evaluated
quarterly for impairment and written down to net realizable value if necessary.
No impairment has been recorded to date. Intangible assets also include acquired
customer lists, tradenames and assembled work forces which are amortized on a
straight-line basis over a period of five to ten years.
Intangible assets include the following at December 31 (in thousands):
1997 1998
-------- --------
Customer lists $ 16,621 $ 20,951
Goodwill 241 35,285
Work force and trade names 1,475 2,341
-------- --------
18,337 58,577
Less: Accumulated amortization (2,501) (7,905)
-------- --------
$ 15,836 $ 50,672
======== ========
Net Loss Per Share
Basic net income (loss) per share is computed using the weighted average
number of common shares outstanding during the period. Diluted net income (loss)
per share is computed using the weighted average number of common and common
equivalent shares outstanding during the period. Common equivalent shares
consist of stock options and warrants (using the treasury stock method) and
convertible subordinated debentures (using the if converted method). Common
equivalent shares are excluded from the dilutive computation only if their
effect is anti-dilutive. As the Company recorded a net loss in each of three
years in the period ended December 31, 1998, no common equivalent shares are
included in diluted weighted average common shares outstanding.
F-12
58
Acquisition Costs
During 1998, the Company incurred $10,255,000 of acquisition costs
associated with the acquisitions of Pyramid, Codemaster and Integrated Medical
Networks, which were all accounted for on a pooling of interests basis.
Acquisition costs related to financial advisors hired by the Company and the
acquired companies, legal and accounting fees. During the fourth quarter ended
December 31, 1997, the Company completed two acquisitions which were accounted
for on a pooling of interests basis. In connection with these acquisitions, the
Company incurred and expensed $3,111,000 in acquisition and related costs.
Non-Recurring Charges
During 1998, the Company recorded $4,202,000 of non-recurring charges.
These charges primarily consisted of $3,020,000 of costs associated with closing
of a duplicative operating facility within the Company's business office
outsourcing operations. Such costs included future rents due for its Howell, New
Jersey office and lease obligations the Company is contractually obligated to
fulfill relating to furniture and equipment which was determined not to have any
future net realizable value. In addition, all of the employees, which
approximated 50, were involuntarily terminated during the third quarter ended
September 30, 1998 as part of the closing of this duplicative facility. In
addition, the Company also closed another smaller office for which the Company
accrued for future rent obligations during 1998. In connection with the
Company's acquisition of 43.3% of Medicus in November 1997, the Company recorded
a reserve in purchase accounting to continue the plan of Medicus' management
team to close its office in Alameda, California. At December 31, 1997, the
reserve for future rents for its Alameda, California facility were $1,334,000.
The following table sets forth the Company's restructuring reserves and the
activity against the reserves for the year ended December 31, 1998(In
thousands):
Additions
Balance at Charged to Balance at
Description December 31, 1997 Costs and Expenses Payments December 31, 1998
----------- ----------------- ------------------ -------- -----------------
Personnel costs ................. $ -- $ 820 $ (820) $ --
Rents and lease obligations ..... 1,334 1,260 (1,015) 1,579
Other operating costs ........... 940 (940) --
------- ------- ------- -------
Total Restructuring Accrual.... $ 1,334 $ 3,020 $(2,775) $ 1,579
======= ======= ======= =======
During 1997, the Company incurred certain non-recurring charges. In
February 1997, the Company entered into an arrangement to provide EDI processing
and management services to EDI USA, Inc. In connection with this claims
processing arrangement, and the termination thereof in December 1997, the
Company recorded a charge of $2,492,000. As a result of completed acquisitions
accounted for on a pooling of interest basis during 1997 and prior to 1997, the
Company recorded certain charges to write-off assets which were determined to
have no future realizable value.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and to
disclose contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates include the realizability of acquired intangible assets. Due to the
Company's large number of acquisitions generating these intangible assets, the
Company periodically evaluates the integration efforts related to these
acquisitions and the realizability of the related acquired intangible assets.
Reclassifications
Certain reclassifications have been made to the 1997 consolidated financial
statements to conform to the 1998 presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" which requires companies to
record derivative financial instruments on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. The key criterion
for hedge accounting is that the hedging relationship must be highly effective
in achieving offsetting changes in fair value or cash flows. SFAS No. 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999. This Statement will not have a material impact on the financial condition
or results of the operations of the Company.
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accounts (AICPA) issued Statement of
Position (SOP) 98-4, "Deferral of the Effective Date of a Provision of SOP
97-2, 'Software Revenue Recognition,'" which defers for one year the
application of provisions in SOP 97-2 which limit what is considered
vendor-specific objective evidence of the fair value of the various elements in
a multiple element arrangement. All other provisions of SOP 97-2 remain in
effect. This SOP was effective as of March 31, 1998. In 1998, the AICPA issued
SOP 98-9, "Modification of SOP 97-2, 'Software Revenue Recognition,' With
Respect to Certain Transactions," which amends paragraphs 11 and 12 of SOP 97-2,
Software Revenue Recognition, to require recognition of revenue using the
"residual value method" under certain conditions. Effective December 15, 1998,
SOP 98-9 amends SOP 98-4, "Deferral of the Effective Date of a Provision of SOP
97-2, 'Software Revenue Recognition,'" to extend the deferral of the application
of certain passages of SOP 97-2 provided by SOP 98-4 through fiscal years
beginning on or before March 15, 1999. All other provisions of this SOP are
effective for transactions entered into in fiscal years beginning after March
15, 1999. The Company does not anticipate that these statements will have a
material adverse impact on its statement of operations.
F-13
59
In-Process Research and Development
In connection with the acquisition of 56.7% of the outstanding stock in
Medicus in November, 1997, the Company allocated $21.9 million related to
in-process research and development ("IPR&D")(see Note 12). This amount was
expensed as a non-recurring charge because the IPR&D projects identified had not
yet reached technological feasibility and had no alternative future use. The
amounts allocated to IPR&D for the year ended December 31, 1997, were evaluated
based on current industry practices.
In connection with the acquisitions of Velox, Cabot Marsh, the remaining
43.3% interest in Medicus, and several other purchase business combinations, the
Company allocated $14.5 million to IPR&D for the year ended December 31, 1998
(see Note 12). This amount was expensed as a non-recurring charge because the
IPR&D projects identified had not yet reached technological feasibility and had
no alternative future use. The following table depicts the allocations to IPR&D
for the year ended December 31, 1998 (in thousands):
Velox $ 1,500
Cabot Marsh 4,200
Medicus (43.3%) 4,763
Other acquisitions 4,031
-------
Total $14,494
=======
The allocations to IPR&D during the year ended December 31, 1998, were
evaluated based on the SEC's current views regarding valuation methodologies.
The value allocated to IPR&D was determined by estimating the costs to develop
the purchased technology into commercially viable products, estimating the
resulting net cash flows from each project, excluding the cash flows related to
the portion of each project that was incomplete at the acquisition date, and
discounting the resulting net cash flows to their present value. Each of the
project forecasts was based upon future discounted cash flows, taking into
account the stage of development of each in-process project, the cost to develop
that project, the expected income stream, the life cycle of the product
ultimately developed, and the associated risks. In each case, the selection of
the applicable discount rate was based on consideration of the Company's
weighted average costs of capital, as well as other factors including the useful
life of each technology, profitability levels of each technology, the
uncertainty of technology advances that were known at the time, and the stage of
completion of each technology.
If the projects are not successfully developed, the sales and profitability
of the Company may be adversely affected in future periods. Additionally, the
value of other intangible assets may be impaired. Following is a discussion of
the significant allocations to IPR&D during the year ended December 31, 1998.
VELOX. At the acquisition date, Velox was conducting development,
engineering, and testing activities associated with SMARTLINK, a product which
focuses on accounts receivable analysis and reporting in hospitals, large
physician practices, and other entities. Upon completion, this product was
planned to have significant scalability, a multilayer architecture, and the
ability to address Windows NT 5.0 and the next generation of Microsoft SQL
Server. At the acquisition date, Velox was approximately 35% complete with the
development of this product. The Company anticipated that SMARTLINK would be
completed in the last half of 1998, after which the Company expected to begin
generating economic benefits from the value of the completed IPR&D.
Revenues attributable to SMARTLINK were estimated to be $1.3 million in
1998 and $5.0 million in 1999. IPR&D revenue, as a percentage of total projected
company revenue, was expected to peak in 1999 and decline thereafter as new
product technologies were expected to be introduced by the company. Operating
expenses (expressed as a percentage of revenue) average 79% over the projection
period. The costs to complete the IPR&D were expected to be $293,000 in 1998 and
$239,000 in 1999. A risk-adjusted discount rate of 20% was utilized to discount
projected cash flows.
CABOT MARSH. At the acquisition date, Cabot Marsh was conducting
development, engineering, and testing activities associated primarily with the
next generation of RAMS, a compliance product related to inpatient and
outpatient coding. At the acquisition date, Cabot Marsh was approximately 80%
complete with the development of the IPR&D. The Company anticipated that the
project would be completed in the second half of 1998, after which the Company
expected to begin generating economic benefits from the value of the completed
IPR&D.
Revenues attributable to the next generation of RAMS were estimated to be
$807,000 in 1998 and $11.3 million in 1999. IPR&D revenue, as a percentage of
total projected company revenue, was expected to peak in 1999 and decline
thereafter as new product technologies were expected to be introduced by the
company. Operating expenses (expressed as a percentage of revenue) average 57%
over the projection period. The costs to complete the IPR&D efforts were
expected to be $140,000 in 1998 and $427,000 in 1999. A risk-adjusted discount
rate of 19% was utilized to discount projected cash flows.
MEDICUS. At the acquisition date, Medicus was conducting development,
engineering, and testing activities associated with the next generations of the
company's Clinical Data Systems ("CDS") and Patient Focused Systems ("PFS")
project lines. At the acquisition date, Medicus was approximately 30% and 60%
complete with CDS and PFS, respectively. The Company anticipated that CDS would
be completed at the end of 1998, with PFS scheduled for completion in mid-1999.
After these release dates, the Company expected to begin generating economic
benefits from the value of the completed IPR&D.
Revenues attributable to CDS were estimated to be $6.0 million in 1999 and
$18.0 million in 2000. IPR&D revenue, as a percentage of total projected product
revenue, was expected to peak in 2000 and decline thereafter as new product
technologies were expected to be introduced by the company. Revenues
attributable to PFS were estimated to be $7.2 million in 2000 and $9.8 million
in 2001. IPR&D revenue, as a percentage of total projected product revenue, was
expected to peak in 2000 and decline thereafter as new technologies were
expected to be introduced by the company. For both projects, operating expenses
(expressed as a percentage of revenue) average 61% over the projection period.
The costs to complete the CDS IPR&D efforts were expected to be $14,000 in 1998
and $1.2 million in 1999. The costs to complete the PFS IPR&D efforts were
expected to be $6,000 in 1998 and $309,000 in 1999. For each of the projects, a
risk-adjusted discount rate of 18% was utilized to discount projected cash
flows.
Notes and other receivables
In December 1997, the Company entered into an agreement with Arcadian
Management Services, Inc. ("Arcadian") to develop a centralized business office
and to provide full business office outsourcing services for its managed
hospitals. In connection with this agreement, the Company purchased certain
accounts receivable from Chama Inc. ("Chama"), a customer of Arcadian, for the
purpose of increasing cash flow while the central business office was being
implemented. At December 31, 1998 approximately $2.2 million of these
receivables remained outstanding. The remaining balances are included in notes
and other receivables on the accompanying consolidated balance sheet. In
October 1998, Chama filed for reorganization under Chapter 11. Prior to the
filing, the Company had perfected a security interest in the receivables
purchased from Chama and, pursuant to a court order, the receivables owned by
the Company are being segregated as they are collected. Management of the
Company believes these receivables are collectible.
Also included in notes and other receivables is accrued interest receivable
of approximately $1.3 million related to the Company's marketable investments.
Accrued interest on these investments is paid to the Company periodically on
specified dates depending on the investment instrument. As discussed in Note 2,
"Non-Marketable Investments", the Company has provided a $500,000 line of
credit to VantageMed. Outstanding balances due the Company under the line of
credit were $500,000 at December 31, 1998. The $500,000 outstanding balance
under the line of credit was converted to additional equity interest subsequent
to December 31, 1998.
F-14
60
3. LINE OF CREDIT GUARANTEE
In September 1998, the Company entered into an arrangement to guarantee a
line of credit of another company for up to $12,500,000. Outstanding balances
under the line of credit accrue interest at 8.5 percent and are due in October
2001. The Company has also entered into a reseller agreement with the same
company. Under the terms of the reseller agreement, the Company has a
non-exclusive license to resell the company's software. This reseller agreement
remains in effect for an initial term of three years, expiring in September
2001, and thereafter is subject to renewal for additional one year terms.
4. NOTES PAYABLE
The Company's notes payable consisted of the following (in thousands):
DECEMBER 31,
------------------------
1997 1998
-------- --------
Notes payable to Director and Stockholder of
Medicus Systems Corporation, unsecured, bearing
interest at 5 percent, due January 5, 1998
Repaid in full in January 1998 ........................ $ 1,620 $ --
Notes payable to Stockholder of
Integrated Medical Networks, Inc., bearing
interest at 7.875% percent, due January 4, 2000 ....... 12,671 19,184
Convertible subordinated notes, bearing interest at 10
percent, converted to shares of common stock in 1998 .. 8,000 --
Subordinated notes, bearing interest at 15
percent, due and repaid in full in June 1998 .......... 750 --
Miscellaneous notes payable ........................... 752 11
-------- --------
23,793 19,195
-------- --------
Less: Current portion ...................... (10,640) (11)
-------- --------
$ 13,153 $ 19,184
======== ========
During 1997, Rothenberg Health Systems, Inc. (see Note 12) converted
certain promissory ($5,000,000) and junior promissory ($3,700,000) notes
aggregating $8,700,000, along with accrued interest of $878,000 to contributed
capital.
During 1998, Pyramid Health Group, Inc. (see Note 12) converted certain
subordinated notes ($8,000,000) to common stock in connection with the
acquisition by the Company. Accrued interest of $4.5 million relating to the
subordinated notes was repaid by the Company during 1998.
In April 1998, the Company completed an offering of $115 million principal
amount of Convertible Subordinated Debentures, including the underwriters'
over-allotment option. The debentures are due May 1, 2005 and bear interest at
5.25 percent per annum. The Debentures are convertible into common stock at any
time prior to the redemption or final maturity, initially at the conversion
price of $33.25 per share (resulting in an initial conversion ratio of 30.075
shares per $1,000 principal amount). Net proceeds to the Company from the
offering were $110,827,000.
5. CAPITAL AND OPERATING LEASE OBLIGATIONS
The Company leases its headquarters and certain other facilities under
operating leases and a portion of its equipment under capital lease
arrangements. The minimum future lease payments required under the Company's
capital and operating leases at December 31, 1998 are as follows (in thousands):
CAPITAL OPERATING
LEASES LEASES
------- ---------
1999 ..................................... $ 204 $ 4,904
2000 ..................................... 173 4,408
2001 ..................................... 47 3,262
2002 ..................................... 29 2,626
2003 ..................................... -- 1,605
Thereafter ............................... -- 3,327
------- -------
Total minimum payments .............. 453 $20,132
=======
Interest on capital lease obligations at a
rate of 8.5 percent ...................... (102)
-------
Net minimum principal payments ........... 351
Current maturities ....................... (146)
-------
$ 205
=======
Rental expense was approximately $2,645,000, $3,245,000 and $3,310,000 for
fiscal 1996, 1997 and 1998, respectively.
F-15
61
6. BRIDGE FINANCING
In January 1996, the Company entered into a bridge loan agreement with
certain preferred stockholders of the Company (the "Bridge Investors"), pursuant
to which such Bridge Investors loaned an aggregate of $3,869,160 to the Company.
In addition, the Bridge Investors were issued warrants to purchase an aggregate
of 957,376 shares of Common Stock at a purchase price of $3.75 per share. The
warrants were partially exercised into 240,960 and 430,705 shares of Common
Stock during 1997 and 1998, respectively. The remaining warrants expire on
January 31, 2001. In June 1996, the notes issued in connection with the Bridge
Loan Agreement were converted into an aggregate of 734,000 shares of Series B
Preferred Stock. The 250,653 shares of the Company's Series A Preferred Stock
issuable under the exchange agreement discussed in Note 7 were issued at the
time of the conversion of notes into Series B Preferred Stock. The proceeds from
the Bridge Financing were used to pay down a portion of the amounts payable to
the sellers of Healthcare Design Systems, which was acquired by the Company in
December 1995.
7. CONVERTIBLE PREFERRED STOCK
Upon the Company's initial public offering in 1996, all outstanding shares
of Convertible Preferred Stock were converted into Common Stock.
In June 1996, 6,400 shares of Series B Preferred Stock were returned to the
Company in exchange for the extinguishment of a shareholder receivable for
approximately $53,000.
Exchange Agreements
As part of its original capitalization, the Company entered into an
agreement with its original three investors, whereby the original investors had
the right to exchange the investors' Common Stock of THCS Holding, Inc. for
250,653 shares of the Company's Series A Preferred Stock. As of December 31,
1996, all such shares have been issued under this right.
Warrants
In connection with a bridge financing in 1994, the Company issued warrants
to purchase 16,000 shares of Series A Preferred Stock at $4.79 per share. These
warrants were partially exercised into 5,313 shares of Common Stock during 1997.
The remaining warrants expire on September 29, 1999. The value of the warrants
at the date of issuance was nominal; therefore, no value was assigned to the
warrants for accounting purposes.
In connection with a line of credit arrangement the Company entered into
during 1996, which has since expired, the Company issued a warrant to purchase
common stock. The warrant was exercised into 7,663 shares of common stock
during 1998.
In connection with the acquisition of the minority interest in
Medicus in May 1998, a former officer and director of Medicus exercised a
warrant to purchase 67,503 shares of common stock of the Company.
In addition, Medicus issued a warrant to purchase 100,000 shares of common
stock to an unaffiliated entity at $7.80 per share. The warrant is exercisable
anytime prior to March 1999. In connection with the acquisition of the remaining
43.3 percent minority interest in Medicus in May 1998, the warrant was exercised
into 100,000 shares of common stock of the Company.
F-16
62
8. COMMON STOCK
In September 1994, the Company entered into consulting arrangements with
two individuals pursuant to which each individual was issued warrants to
purchase 17,000 shares of Common Stock at a purchase price of $4.79 per share.
These warrants were exercised for shares of Common Stock during 1997.
In October 1995, the Company entered into a joint development arrangement
with another software company pursuant to which the Company issued a warrant to
purchase 28,560 shares of Common Stock at a purchase price of $5.25 per share.
The warrant was partially exercised for 18,984 shares of Common Stock during
1997. The remaining warrants expire on June 25, 2001.
In December 1995, the Company issued a warrant to KTU, an affiliate of the
Company's Chief Executive Officer, to purchase up to 134,574 shares of Common
Stock at an exercise price of $3.75 per share. In June 1996, the Company's Chief
Executive Officer transferred the warrant to Trigon Resources Corporation, a
corporation owned by him and his children.
In September 1995 and June 1996, the Company issued warrants to its Chief
Executive Officer to purchase up to 355,600 shares of Common Stock at $3.75 per
share. In connection with the warrant issued in June 1996, the Company recorded
deferred compensation for $381,000, representing the intrinsic value of the
warrant at the date of issuance which would be amortized over the vesting
period. The Company recorded compensation expense of $45,000 and $336,000 for
the years ended December 31, 1996 and 1997, respectively, as a result of the
vesting of the warrants. As of December 31, 1997, these warrants were fully
exercisable.
In connection with the acquisition of Rothenberg Health Systems, Inc. by
Resource Health Partners, L.P. ("RHP") in November 1995 (see Note 12), RHP
granted Class C limited partnership units in RHP to certain officers and
employees of Rothenberg Health Systems, Inc. These units, which were valued at
$440,000, vest over a period of seven years. The related agreements also contain
provisions for accelerated vesting should there be a sale of all or
substantially all of the assets of Rothenberg Health Systems, Inc. With respect
to shares granted to employees who were not shareholders of Rothenberg Health
Systems, Inc. at the date of the acquisition, the Company recorded deferred
compensation expense as a component of stockholders' equity, which was being
amortized ratably over the seven year vesting period. In connection with the
acquisition of Rothenberg Health Systems, Inc., the Company amortized the
remaining deferred compensation during 1997.
In connection with the acquisition of the net assets of Healthcare Design
Systems, the Company issued rights to two former Healthcare Design Systems
employees as part of their employment agreement with the Company whereby these
employees were granted the right to purchase 73,333 shares of common stock at
$3.75 per share. Rights to purchase 55,786 shares were exercised in 1996. The
right to purchase the remaining 17,547 shares has expired.
In October 1996, the Company completed its initial public offering of
2,500,000 shares of its common stock, which raised $26,386,000, net of offering
costs and the underwriters discount of $3,614,000.
In October 1997, the Company completed a follow-on offering of 3,300,000
shares of common stock, of which 2,972,198 shares were offered by the Company
and 327,802 shares were offered by selling stockholders. In addition, the
underwriters exercised an over-allotment option to purchase an additional
495,000 shares. Total proceeds to the Company were $57,328,000 net of offering
costs and the underwriters' discount of $4,083,000.
In 1998, the Board of Directors and Stockholders of the Company approved to
increase the authorized shares of common stock from 20,000,000 to 50,000,000. In
June 1996, the Company effected a l-for-25 reverse stock split. The accompanying
financial statements have been restated to reflect this increase in authorized
shares and the reverse stock split.
In November 1998, the Company issued 237,0000 shares of restricted common
stock with a fair market value of $16.625 to certain officers of the Company. In
connection with the common stock issuance, the Company recorded deferred
compensation for
F-17
63
$3,940,000, representing the intrinsic value of the restricted common stock
at the date of issuance which will be amortized over the vesting period of five
years.
9. STOCK OPTION AND PURCHASE PLANS
Stock Option Plans
1986 Stock Option Plan
Under the Pyramid Health Group, Inc. ("Pyramid") 1986 Employee Stock Plan
("the 1986 Plan"), options could be granted to key employees, directors and
consultants. The 1986 Plan provided for the issuance of Nonqualified Stock
Options only. The options, option prices, dates of grant and number of shares
granted were determined by the Board of Directors, although options could not be
granted at prices less than 85 percent of the fair market value of the Company's
common stock. Options vested 26 percent at the first year anniversary of the
date of grant and 2% each month thereafter. Options under the 1986 Plan expire
five years from the date of grant. The 1986 Plan was terminated on March 31,
1997.
1997 Stock Option Plans
In 1997, Pyramid adopted the 1997 Stock Option Plan ("the 1997 Plan")
whereby options may be granted to employees, directors and consultants. The 1997
Plan is administered by the Board of Directors or a committee thereof. The 1997
Plan provides for the issuance of incentive stock options to employees and
nonqualified stock options to employees and consultants. A total of 325,228
shares have been reserved for issuance under the 1997 Plan. The 1997 Plan
expires on March 31, 2007, unless terminated earlier by the Board of Directors.
The exercise price of all incentive stock options granted to employees who would
be 10 percent shareholders in the Company must not be less than 110 percent of
the fair market value of the shares on the grant date. If granted to any other
employee, the exercise price of the incentive stock options must not be less
than the fair market value of the shares on the grant date. The exercise price
for nonqualified stock options to a person who is a 10 percent shareholder of
the Company must not be less than 110 percent of the fair market value of the
stock on the date of grant. The exercise price for nonqualified stock options to
any other person must not be less than 85 percent of the fair market value of
the shares on the date of grant. The options are generally granted for a
ten-year term. Options vest 20 percent at the first anniversary of the date of
grant and 1.67 percent each month thereafter. No shares were exercisable under
the 1997 Plan at December 31, 1997. There were 308,362 shares available for
grant under the 1997 Plan at December 31, 1997. The 1997 Plan has been merged
into the Company's Option Plan during 1998.
Under the Company's 1994 Stock Option Plan and its successor plan, the 1996
Stock Incentive Plan, which became effective in October 1996 (collectively, the
"Option Plan"), the Board of Directors may grant incentive and nonqualified
stock options to employees, directors and consultants. The exercise price per
share for an incentive stock option cannot be less than the fair market value on
the date of grant. The exercise price per share for a nonqualified stock option
cannot be less than 85% of the fair market value on the date of grant. Option
grants under the Option Plan generally expire ten years from the date of grant
and generally vest over a four-year period. Options granted under the Option
Plan are exercisable subject to the vesting schedule. As of December 31, 1998, a
total of 3,085,463 shares of Common Stock have been authorized by the Company's
stockholders for grant under the Option plan.
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its option plans. Had compensation cost for the Company's option
plans been determined based on the fair value at the grant dates for the awards
calculated in accordance with the method prescribed by SFAS No. 123, the
Company's net loss and net loss per share would have been the pro forma amounts
indicated below (in thousands, except per share amounts):
1996 1997 1998
----------- ----------- -----------
Net loss ............................ As reported $ (4,324) $ (33,938) $ (18,610)
Pro forma $ (4,904) $ (35,693) $ (31,248)
Basic and diluted net loss
per share ......................... As reported $ (0.51) $ (2.56) $ (0.98)
Pro forma $ (0.58) $ (2.70) $ (1.64)
F-18
64
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following assumptions as
of December 31, 1997 and 1998:
1997 1998
---------- ------------
Expected dividend yield .......... 0.0 % 0.0 %
Expected stock price volatility... 73.0 % 77.5 %
Risk-free interest rate .......... 5.50%-5.54% 4.74%
Expected life of options ......... 4.5 years 6.82 years
The weighted average fair value of options granted during 1996, 1997, and
1998 was $8.41, $13.14 and $23.99 per share, respectively. Option activity under
the option plans is as follows:
OPTIONS OUTSTANDING
----------------------------
WEIGHTED
AVAILABLE AVERAGE
FOR NUMBER OF EXERCISE
GRANT SHARES PRICE
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Balance, December 31, 1995 115 654 $ 2.88
Authorized ........... 830 -- --
Granted .............. (247) 415 8.41
Exercised ............ -- (63) 2.13
Canceled ............. 39 (103) 3.80
------ ------ ------
Balance, December 31, 1996 737 903 9.88
------ ------ ------
Authorized ........... 767 -- --
Granted .............. (1,523) 1,577 13.14
Exercised ............ -- (115) 3.87
Canceled ............. 251 (365) 11.22
------ ------ ------
Balance, December 31, 1997 232 2,000 10.70
------ ------ ------
Authorized ........... 767 -- --
Granted .............. (915) 1,367 23.99
Exercised ............ -- (366) 11.78
Canceled ............. 163 (163) 14.11
------ ------ ------
Balance, December 31, 1998 247 2,838 $16.77
====== ====== ======
The following table summarizes information about stock options outstanding
at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ -------------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AVERAGE AVERAGE EXERCISABLE AVERAGE
RANGE OF AS OF REMAINING EXERCISE AS OF EXERCISE
EXERCISE PRICES 12/31/98 CONTRACTUAL LIFE PRICE 12/31/98 PRICE
- ----------------- ----------- ---------------- --------- ----------- ---------
$0.11 - $ 2.50 97,235 6.29 $ 0.19 85,429 $ 0.13
$3.75 145,725 4.98 $ 3.75 113,149 $ 3.75
$3.76 - $ 8.30 149,396 6.09 $ 7.20 82,831 $ 7.06
$8.34 - $9 13 409,378 7.71 $ 8.93 137,975 $ 8.94
$9.63 159,161 7.30 $ 9.63 51,778 $ 9.63
$11.07 - $11.50 335,865 6.67 $ 11.50 178,937 $ 11.50
$12.00 - $17.19 132,876 6.45 $ 14.81 67,813 $ 14.73
$17.97 -.$18.60 158,643 7.17 $ 18.22 141,861 $ 18.25
$19.14 - $26.26 921,232 8.25 $ 22.94 101,242 $ 22.33
$27.00 - $39.16 328,910 9.03 $ 33.16 8,910 $ 33.37
- ---------------- --------- --------- --------- --------- ---------
$ 0.11 - $39.16 2,838,421 7.53 $ 16.77 969,925 $ 11.29
================ ========= ========= ========= ========= =========
Stock Purchase Plan
The Company's Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Company's Board of Directors in June 1996. A total of 200,000
shares of Common Stock has been reserved for issuance under the Purchase Plan.
The Purchase Plan will enable eligible employees to designate up to 10% of their
compensation for the purchase of stock. The purchase price is 85% of the lower
of the fair market value of the Company's Common Stock on the first day or the
last day of each six-month purchase period. During the years ended December 31,
1997 and 1998, 13,580 and 37,310 shares of common stock were issued under the
plan for an aggregate purchase price of $135,000 and $467,000, respectively.
F-19
65
10. RELATED PARTY TRANSACTIONS
The Company, through the acquisition of Rothenberg Health Systems, Inc.,
assumed a long-term agreement expiring in 2010 to provide management services to
Physical Therapy Provider Network, Inc. ("PTPN"), an affiliated entity. Under
the terms of the agreement, the Company provides PTPN with management services,
employees and facilities and incurs other operating costs on behalf of PTPN. All
employee, facility and other operating costs are directly reimbursed by PTPN.
The Company also receives a 50 percent share of PTPN's net income before taxes,
which is shown in other income (expense) in the statement of operations. Direct
costs incurred by the Company and reimbursed by PTPN were $879,000, $965,000 and
$988,000 in 1996, 1997 and 1998, respectively.
11. EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) Savings Plan (the "Plan"). All eligible
employees can participate in the Plan. Under the terms of the Plan, employees
may elect to contribute 1% to 15% of their pre-tax compensation to the Plan.
Employee contributions are 100% vested at all times. The Company may make
discretionary contributions to the Plan, which vest annually over a four-year
vesting period. There were no contributions made to the Plan in 1996 and $72,000
and $194,000 was contributed by the Company in 1997 and 1998, respectively.
In connection with the acquisition of Rothenberg Health Systems, Inc. in
December 1997, the Company assumed Rothenberg's 401(k) Savings Plan (the
"Rothenberg Plan"). Pursuant to the Rothenberg Plan, employees may elect to
defer up to 10 percent of their pre-tax compensation to the Plan. The Company
may make matching contributions up to 25 percent of the employees' contribution.
For the years ended December 31, 1996 and 1997, the Company made contributions
of $36,000 and $72,000, respectively. Employees vest in company contributions
based on their years of service. Partial vesting begins after two years of
continuous employment. In addition, the Company, at its discretion, contributes
amounts to a profit sharing pool. These amounts are allocated to the accounts of
eligible employees principally based on the proportion that each eligible
employee's compensation bears to the total compensation of all eligible
employees. The contribution is determined yearly by the Board of Directors of
Rothenberg based on its performance and profitability. The Company accrued
contributions to the profit sharing pool of $75,000 and $126,000 for the years
ended December 31, 1996 and 1997, respectively. Twenty percent of the amount
allocated to an employee for a given year vests immediately if the employee has
two years of service with the Company or, if the employee does not have two
years of service, after two years of service with the Company. The remaining
amount allocated vests at a rate of 20 percent for each additional year so that
the Company's contributions are fully vested four years after the date of
vesting of the first 20 percent. Notwithstanding the foregoing, the Company's
contributions immediately vest when the employee reaches age 65 or upon the
death or permanent disability of the employee while employed. The Company plans
to transition the Rothenberg Plan into the Company's Plan during 1998.
As a result of the acquisition of 56.7 percent of Medicus Systems
Corporation in November 1997, eligible employees of that Company may participate
in Medicus' 401(k) Savings Plan (the "Medicus Plan"). The Medicus Plan has
substantially the same terms and conditions as the Company's Plan. The Medicus
Plan was transitioned into the Company's Plan during 1998.
12. ACQUISITIONS
In December 1996, the Company acquired all of the outstanding capital stock
of InterMed Healthcare Systems Inc. ("InterMed") for 291,079 shares of Common
Stock and options to purchase 25,208 shares of Common Stock. The acquisition was
accounted for as a pooling of interests. The accompanying consolidated financial
statements have been restated to reflect the acquisition of InterMed on a
pooling of interests basis. Upon the closing of the acquisition, the assets and
liabilities of InterMed were recorded at net book value and consisted primarily
of accounts receivable, fixed assets and capitalized software development costs.
Liabilities assumed consisted of vendor payables and two loans payable. The
outstanding balances on the loans payable of $1,100,000 were repaid by the
Company in December 1996.
In April 1997, the Company acquired Healthcare Recovery, Inc., a successor
in interest to the Synergy Companies doing business as Synergy HMC. The
aggregate purchase price was $3,400,000, consisting of $1,400,000 in cash and
181,855 shares of Common Stock (the aggregate fair market value of which was
$2,000,000). The Company also repaid $1,700,000 in indebtedness of Synergy HMC.
In connection with the acquisition, the Company recorded $4,900,000 of
intangibles, which primarily included customer lists that are being amortized
ratably over a seven year period.
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66
In September 1997, the Company completed the acquisition of Healthcare
Revenue Management, Inc. ("HRM") for consideration consisting of 112,706 shares
of Common Stock (the aggregate fair market value of which was $2,300,000) and
$200,000 in cash. The acquisition was accounted for as a purchase. Additionally,
an intangible for customer lists was recorded in the amount of $3,100,000 and
will be amortized ratably over a ten year period.
In November 1997, Pyramid acquired all the outstanding capital stock of
Microport Applications, Inc. ("Microport") in exchange for shares of common
stock. The acquisition was accounted for as a purchase. In connection with this
acquisition, Pyramid recorded intangible assets of approximately $300,000.
In December 1997, the Company acquired all of the outstanding capital stock
of Fleming SoftLink Systems, Inc. ("SoftLink") in exchange for 110,857 shares of
Common Stock, of which 11,086 shares of Common Stock were placed into escrow for
a period of one year under the terms and conditions of the acquisition
agreement. The acquisition was accounted for as a pooling of interests. Upon
closing of acquisition, the assets and liabilities of SoftLink were recorded at
net book value and consisted primarily of accounts receivable, accrued
liabilities and, to a lesser extent, deferred revenue. The accompanying
consolidated financial statements have been restated to reflect the acquisition
of SoftLink on a pooling of interests basis.
In December 1997, the Company acquired all of assets and assumed all of the
liabilities of RHP, and acquired and merged with its two wholly owned
subsidiaries Resource Holdings, Ltd. ("RHL") and FRA Acquisitions Inc. ("FRA")
(collectively doing business as "Rothenberg Health Systems, Inc."). The mergers
were completed pursuant to an Acquisition Agreement and Plan of Merger (the
"Acquisition Agreement"). The Company issued 1,588,701 shares of its Common
Stock, of which 155,014 were placed into escrow for a period of one year under
the terms and conditions of the Acquisition Agreement, in exchange for all of
the capital stock of RHL and FRA. The acquisition was accounted for as a pooling
of interests. The accompanying consolidated financial statements have been
restated to reflect the acquisition of RHL and FRA on a pooling of interests
basis. Upon closing of the acquisition, the assets and liabilities of Rothenberg
Health Systems, Inc. were recorded at net book value and consisted primarily of
cash, accounts receivable and accrued liabilities.
Prior to the merger with the Company, in November 1995, FRA and RHP
acquired 100 percent of the outstanding shares of Rothenberg Health Systems,
Inc. ("Rothenberg") for consideration that consisted of short-term notes payable
of $9,600,000 due, and paid, in January 1996 and partnership interests in RHP.
The estimated fair value of the partnership interests was $2,200,000. Following
the acquisition of Rothenberg, all shares of Rothenberg owned by RHP were
contributed to FRA, resulting in FRA owning 100 percent of the outstanding
shares of Rothenberg. The acquisition was accounted for as a purchase.
Accordingly, the purchase price was allocated based upon the estimated fair
value of the assets acquired and liabilities assumed. The purchase price
allocated to in-process research and development was $8,600,000 and was charged
to expense in the year ended December 31, 1995.
In November 1997, the Company acquired 3,111,105 shares of Common Stock of
Medicus Systems Corporation ("Medicus") or 56.7 percent of the then issued and
outstanding shares of Medicus Common Stock from certain selling stockholders.
Pursuant to individual stock purchase agreements (the "Stock Purchase
Agreements"), the Company agreed to pay the selling stockholders $7.50 per
share, in cash and a note payable, together with a warrant ("Warrant") entitling
the selling stockholders to acquire 0.3125 shares of QuadraMed Common Stock for
each share of Medicus Common Stock sold at a price of $24 per share subject to
adjustments and certain limitations. The consideration paid by the Company to
selling stockholders in November 1997 was approximately $21,700,000 in cash and
a note payable for approximately $1,600,000 to a selling stockholder which was
due and repaid by the Company in January 1998, plus Warrants to
purchase an aggregate of 972,220 shares of QuadraMed Common Stock at $24 per
share.
F-21
67
The Company's purchase price for the 56.7 percent interest in Medicus which
it acquired was approximately $26.3 million, which was comprised of a cash
payment of $21.7 million, the issuance of a note payable for approximately $1.6
million to one selling stockholder, the value of warrants issued to the selling
stockholders of $700,000, and transaction costs of $2.3 million. In connection
with the acquisition, which was accounted for as a purchase, the Company
allocated the purchase price based upon the estimated fair value of the
Company's proportionate share of the assets acquired and liabilities assumed.
Intangible assets acquired aggregated to $30.2 million, of which $1.7 million,
$6.7 million and $21.8 million were assigned to acquired software, acquired
intangible assets, and acquired research and development in-process,
respectively. Because there was no assurance that the Company would be able to
successfully complete the development and integration of the acquired research
and development in-process or that it had alternative future use at the
acquisition date, the acquired research and development in-process was charged
to expense by the Company in the year ended December 31, 1997. The Company's
proportionate share of net tangible liabilities assumed in the acquisition
totaled approximately $12.8 million.
Minority interest as of December 31, 1997 of $658,000 represents the
remaining 43.3 percent interest in the net assets and liabilities of Medicus
attributable to the minority stockholders. The Company completed the merger with
Medicus in the second quarter of 1998. Accordingly, the minority interest was
classified as a current liability in the accompanying December 31, 1997
consolidated balance sheet.
In May 1998, the Company completed its acquisition of Medicus by purchasing
the remaining 43.3% interest in Medicus. The Company allocated the remaining
43.3% purchase price based on the estimated fair value of the assets and
liabilities assumed. Approximately $4.8 million of the total intangibles was
assigned to acquired in-process research and development. The remaining
intangible balance will be amortized over a 7 year average period.
In January 1998, the Company acquired entities affiliated with InterLink
Corporation for an aggregate purchase price of 65,224 shares of the Company's
common stock, the aggregate fair market value of which was $1.5 million and
approximately $1.7 million in cash and the extinguishment of notes receivable.
In connection with this acquisition, which was accounted for as a purchase, the
Company allocated the purchase price based upon the estimated fair value of the
assets and liabilities assumed. Approximately $1.3 million of the total
intangibles was assigned to acquired in-process research and development. The
remaining balance will be written-off over a ten year period.
In February 1998, the Company acquired Cabot Marsh Corporation for an
aggregate purchase price of 382,767 shares of the Company's common stock, the
market value of which was approximately $8.4 million and approximately $2.8
million in cash. In connection with this acquisition, which was accounted for as
a purchase, the Company allocated the purchase price based upon the estimated
fair value of the assets and liabilities assumed. Approximately $4.2 million of
total intangibles was assigned to acquired in-process research and development.
The remaining intangible balance will be amortized over a ten year average
period.
In March 1998, the Company acquired Velox Systems Corporation ("Velox") for
an aggregate purchase price of 40,562 shares of the Company's common stock, the
market value of which was approximately $1.4 million and approximately $3.1
million in cash. In connection with this acquisition, which was accounted for as
a purchase, the Company allocated the purchase price based upon the estimated
fair value of the assets and liabilities assumed. Approximately $1.5 million of
the total intangibles was assigned to acquired in-process research and
development. The remaining intangible balance will be amortized over a 7 year
average period.
In June 1998, the Company acquired all of the outstanding capital stock of
Pyramid Health Group, Inc. ("Pyramid") in exchange for 2,740,000 shares of
common stock of which 274,000 shares of common stock have been placed in escrow
for a period of one year under the terms and conditions of the acquisition
agreement. The acquisition was accounted for on a pooling of interests basis.
The
F-22
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accompanying consolidated financial statements have been restated to reflect the
acquisition of Pyramid on a pooling of interest basis.
In September 1998, the Company acquired all the outstanding capital stock
of Integrated Medical Networks, Inc. ("IMN") in exchange for 1,550,000 shares of
common stock. The acquisition was accounted for on a pooling of interests basis.
The accompanying consolidated financial statements have been restated to reflect
the acquisition of IMN on a pooling of interests basis.
In 1998, the Company acquired all of the outstanding capital stock of
another healthcare company, in exchange for 507,000 shares of common stock of
the Company. The acquisition was accounted for on a pooling of interests basis,
but was not material to restate the consolidated financial statements.
A reconciliation of the current consolidated financial statements with
previously reported separate Company information for entities with which the
Company has pooled is presented below:
1996 1997 1998
--------- --------- ---------
Revenues:
QuadraMed $ 19,088 $ 32,443 $ 82,237
Rothenberg and Softlink 10,043 12,483 --
Pyramid and IMN 45,138 54,699 77,157
--------- --------- ---------
Consolidated $ 74,269 $ 99,625 $ 159,394
========= ========= =========
Net income (loss):
QuadraMed $ 153 $ (21,197) $ (15,532)
Rothenberg and Softlink (1,111) (4,437) --
Pyramid and IMN (3,366) (8,304) (3,078)
--------- --------- ---------
Consolidated $ (4,324) $ (33,938) $ (18,610)
========= ========= =========
The unaudited pro forma results of operations of the Company, Synergy HMC,
HRM and Medicus for the year ended December 31, 1997 are as follows (in
thousands):
PRO FORMA
COMBINED
----------
Revenues $ 118,941
Net loss $ (20,083)
Basic and diluted net loss per share $ (1.52)
The unaudited pro forma results of operations of the Company, Cabot Marsh
and Velox for the year ended December 31, 1998 are as follows (in thousands):
PRO FORMA
COMBINED
----------
Revenues $ 161,147
Net loss $ (12,175)
Basic and diluted net loss per share $ (0.64)
13. DISCONTINUED OPERATIONS
In March 1997, Pyramid, a subsidiary acquired in a pooling of interest
basis, spun-off a subsidiary to its stockholders by distributing all of the
subsidiary's capital stock in the form of a one-for-one stock dividend. To
reflect this distribution, the $3,684,000 fair value of the net assets of the
discontinued operations was charged against the Company's accumulated deficit
and has been reflected as a discontinued operation in the accompanying
consolidated financial statements.
14. CONTINGENCIES
In 1996 and 1997, Pyramid settled certain litigation related to copying
charges in various states. Pyramid is currently, and may be in the future, a
party to pricing related litigation in other states. Pyramid has estimated its
exposure for such litigation, and has accrued such costs at December 31, 1997
and 1998, respectively.
From time to time, the Company may be involved in litigation relating to
claims arising out of its operations in the normal course of business. As of
December 31, 1998, the Company was not a party to any legal proceedings which,
if decided adversely to the Company, would, individually or in the aggregate,
have a material adverse effect on the Company's business, financial condition or
results of operations.
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69
15. INCOME TAXES
The Company has accounted for income taxes pursuant to Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes," since its
inception. SFAS No. 109 provides for an asset and liability approach to
accounting for income taxes under which deferred income taxes are provided based
upon enacted tax laws and rates applicable to the periods in which taxes become
payable. The Company had incurred net operating losses in each year through
December 31, 1998.
The components of the net deferred tax asset are as follows (in thousands):
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1997 1998
---------- ------------- --------
(RESTATED) (RESTATED)
(SEE NOTE 12) (SEE NOTE 12)
Deferred tax assets:
Net operating loss carryforwards ............... $ 3,827 $ 8,709 $ 6,180
Accruals and reserves .......................... 3,730 6,083 5,559
Writeoff of acquired research and development in
process ..................................... 2,764 2,452 3,270
-------- -------- --------
10,321 17,244 15,009
-------- -------- --------
Deferred tax liabilities:
Depreciation ................................... 301 396 469
Intangible assets .............................. -- 582 485
-------- -------- --------
301 978 954
-------- -------- --------
Net deferred tax asset before allowance ............ 10,020 16,266 14,055
Valuation allowance ................................ (10,020) (16,266) (14,055)
-------- -------- --------
Net deferred tax asset ......................... $ -- $ -- $ --
======== ======== ========
The significant components of the provision for income taxes are as follows
(in thousands):
1996 1997 1998
------- ------- -------
Current:
Federal ............ $ -- $ 970 $ 3,563
State .............. -- 166 629
------- ------- -------
Total current ...... -- 1,136 4,192
Deferred:
Federal ........... 642 (1,312) 1,879
State ............. 107 (249) 332
------- ------- -------
Total deferred .... 749 (1,561) 2,211
Change in valuation
allowance, net of
the effect of
acquisitions ...... (602) 1,561 (2,211)
------- ------- -------
$ 147 $ 1,136 $ 4,192
======= ======= =======
Reconciliation of the provision for income taxes computed at the statutory
rate to the effective tax rate are as follows:
1996 1997 1998
---- ---- ----
Federal income tax rate .......... (34)% (34)% (34)%
Change in valuation allowance .... 34 6 (7)
Write off of acquired research ...
and development in process .. -- 27 53
Other ............................ 1 4 --
Alternative minimum tax .......... -- 1 1
--- --- ---
1% 4% 13%
=== === ===
A valuation allowance has been recorded for the entire deferred tax asset
as a result of uncertainties regarding the realization of the asset including
the limited operating history of the Company.
As of December 31, 1998, the Company had net operating loss carryforwards
for Federal and state income tax reporting purposes of approximately $16,500,000
and $9,300,000, respectively. These carryforwards expire in various periods from
2010 to 2012. The Tax Reform Act of 1986 contains provisions which may limit the
net operating loss and research and development credit
F-24
70
carryforwards to be used in any given year upon the occurrence of certain
events, including a significant change in ownership interest.
16. DISTRIBUTOR AGREEMENT
In 1997, Pyramid entered into a distributor agreement with a software
company whereby the other company granted Pyramid a non-exclusive,
non-transferable right to reproduce, market and license certain of the other
company's software to Pyramid's customers. The initial term of the agreement is
two years. Under the terms of the agreement, Pyramid agreed to a minimum
purchase of software having a value of $2.5 million. Pyramid had not sold any
software to its customers as of December 31, 1997 and does not expect to meet
the $2.5 million minimum purchase commitment. The Company recorded a loss
contingency of $2.5 million in 1997.
17. SEGMENT REPORTING
In June 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"), which was adopted by the
Company for the fiscal year ended December 31, 1998. This statement establishes
standards for reporting selected segment information quarterly and to report
entity-wide disclosures about products and services, geographic areas and major
customers.
The Company reported on two operating segments in 1998: the Business Office
Division (BO) and Health Information Management (HIM) Division. The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies. The Company evaluates performance based on
profit or loss from operations before income taxes not including nonrecurring
gains and losses. The Company does not track long-lived assets by segment and
therefore related disclosures are not relevant and are not presented.
The Company's reportable segments are strategic business units that offer
different products and services. Each segment, with its own unique position in
the healthcare technology marketplace, yields individual technology and service
criteria. The Company's business lines in the Business Office Division target a
provider's chief financial officer as the primary buyer. The divisions'
solutions address the complex administrative and financial management demands
placed on healthcare organizations today, providing the technology and expertise
to increase cash flow and reduce administrative costs. The division is comprised
of the following product and service categories: decision support,
patient-focused solutions, electronic business office, managed care, executive
information systems and business office outsourcing.
QuadraMed's Health Information Management (HIM) division's business lines
primarily target medical records directors, as well as chief financial officers
throughout the provider system. The division is comprised of the following
products and services: coding and abstracting, compliance, document imagining
and workflow, and HIM outsourcing and consulting.
Less than 5% of the Company's revenues were generated from Canada. For the
year ended December 31, 1998, the following table reports selected segment
information required by SFAS No. 131:
BO HIM TOTAL
-------- -------- --------
License revenues $ 52,797 $ 21,858 $ 74,655
Service revenues 26,209 58,530 84,739
-------- -------- --------
Total revenues 79,006 80,388 159,394
Interest income 5,766 62 5,828
Interest expense 4,668 1,577 6,245
-------- -------- --------
Interest income (expense), net 1,098 (1,515) (417)
Depreciation & amortization expense 2,999 6,822 9,821
Provision for income taxes 2,155 2,037 4,192
Segment earnings 1,391 (20,001) (18,610)
Segment assets $185,753 $ 55,133 $240,886
18. SUBSEQUENT EVENTS
In February 1999, the Company entered into a definitive agreement to
acquire The Compucare Company. The Company will acquire all of the outstanding
capital stock of The Compucare Company in exchange for approximately 3,000,000
shares of common stock. The acquisition is expected to be accounted for on a
pooling of interests basis.
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19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS/SUPPLEMENTARY FINANCIAL
INFORMATION
Subsequent to the Securities and Exchange Commission's letter to the AICPA
dated September 9, 1998, regarding its views on in-process research and
development ("IPR&D") the Company re-evaluated its IPR&D charges on its 1998
acquisitions. The amounts allocated to IPR&D and intangible assets in the first
and second quarters of 1998 were based on accepted appraisal methodologies used
at the time of the allocations. Since that time, the SEC provided new guidance
with respect to the valuation of intangible assets in purchase business
combinations, including, IPR&D. In response to this new guidance, the Company
elected to retroactively adjust the amount of intangibles assigned to acquired
IPR&D related to these acquisitions. The Company reduced its estimate of the
amount allocated to IPR&D for these acquisitions by $18.2 million from the $32.7
million previously reported in the first, second, and third quarters of 1998 to
$14.5 million. Amortization of intangibles increased $952,000 for the nine
months ended September 30, 1998, related to the amended amounts for the IPR&D.
Company management believes that the amended IPR&D charge of $14.5 million
is valued consistently with the SEC staff's current views regarding valuation
methodologies. There can be no assurance, however, that the SEC will not take
issue with any of the assumptions used in the Company's allocations and require
the Company to further revise the amount allocated to IPR&D. The Company
amended its quarterly earnings on Form 10-Q for the first, second, and third
quarters of 1998 (see below). The following table depicts the adjustments made
to the values ascribed to IPR&D during the year ended December 31, 1998 (in
thousands):
ACQUISITION AS REPORTED AS RESTATED
Velox $ 4,800 $ 1,500
Cabot Marsh 6,200 4,200
Medicus (43.3%) 17,146 4,763
Other acquisitions 4,585 4,031
------- -------
Total $32,731 $14,494
======= =======
(in thousands, except per share data)
As Reported As Amended As Reported As Amended As Reported As Amended
For the quarters ended: March 31, March 31, June 30, June 30, September 30, September 30,
Total Revenues $17,086 $17,086 $ 34,384 $34,384 $43,794 $43,794
Net Loss (9,441) (4,141) (19,860) (7,245) (3,880) (4,510)
Basic and Diluted Net
Loss Per Share $(0.77) $(0.34) $ (1.23) $ (0.45) $ (0.20) $ (0.24)
72
EXHIBIT INDEX
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2 Consent of Deloitte & Touche LLP, Independent Auditors.
24.1 Power of Attorney (set forth in the signature page hereto).
27.1 Financial Data Schedule for the Year Ended 12/31/1998.