<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1996
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ___________ to ____________
Commission file number 0-27502.
HEALTH SYSTEMS DESIGN CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-3235734
State or other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
1330 BROADWAY, OAKLAND, CALIFORNIA 94612
(Address of principal executive offices) (Zip code)
(510) 763-2629
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which registered
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK
(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 reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
As of November 29, 1996, 6,434,666 shares of the registrant's common stock
were outstanding. The aggregate market value of the common stock held by
non-affiliates of the registrant on that date was approximately $8.75.
Exhibit index is located on page 21
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PART I
ITEM 1. BUSINESS
OVERVIEW. Health Systems Design Corporation is a leading provider of
managed care information systems software to payors and providers of managed
care products and services. The Company's DIAMOND product line consists of
DIAMOND 725B, DIAMOND 950C/S and DIAMOND 725Q, formerly known as DIAMOND BBx,
DIAMOND Client/Server and DIAMOND Quick Start, respectively. The DIAMOND
products manage information about members, employer groups, providers, health
plan and provider contracts, referrals and authorizations and health care
services for accurate provider reimbursement, risk pool accounting and health
care cost management. DIAMOND 950C/S is one of the first core administrative
client/server products offered to the managed care industry. HSD markets its
products primarily through its direct sales force. In addition, the Company has
a marketing relationship with Shared Medical Systems Corporation ("SMS"), a
major supplier of information processing systems and services to health care
organizations with total revenues in 1995 in excess of $650 million. SMS
markets, implements and supports the DIAMOND products as its exclusive core
administrative managed care solution.
The DIAMOND products are UNIX-based software which operate on a
variety of hardware platforms. While the products incorporate similar
functionality, each is designed to meet the requirements of different types
of managed care organizations. DIAMOND 725B provides a system for mid-size
managed care organizations, whereas DIAMOND 950C/S, which employs an
open system architecture and incorporates a graphical user interface and
relational database, is designed for organizations seeking advanced
technology, particularly larger organizations with high transaction
requirements and more complex networks. The Company's most recent product,
DIAMOND 725Q, provides a system for smaller managed care organizations
which do not require all of the functionality of DIAMOND 725B. HSD provides
its customers with implementation, training, modification, support and other
services to ensure that its customers maximize the benefits of the Company's
DIAMOND products. A significant portion of the Company's revenues are derived
from providing these services to its customers.
As a result of the industry shift toward managed care, the Company's
marketing relationship with SMS and the Company's introduction of DIAMOND
950C/S and DIAMOND 725Q, the Company has experienced significant
growth in its customer base. Of the Company's 82 customers at September 30,
1996, 27 were added during fiscal 1996.
The Company was founded and incorporated in California in July 1988 to
provide managed care information systems to payors and providers of managed
care services. In February 1996, the Company was reorganized as a Delaware
holding company. Unless the context otherwise requires, references in this
Form 10-K to HSD and the Company include both Health Systems Design
Corporation, a Delaware corporation, and its wholly-owned subsidiary, Health
Systems Design Corp., a California corporation. The Company's
principal executive offices are located at 1330 Broadway, Oakland, California
94612, and its telephone number is (510) 763-2629.
Substantially all of the Company's operations are in one industry
segment - developing and selling managed care information systems. Therefore,
no separate industry segment information is presented.
INDUSTRY BACKGROUND. As a result of the traditional fee-for-service
model of payment for medical services, health care delivery costs in the
United States have increased dramatically in recent years. Payors such as
employers, health maintenance organizations ("HMOs"), preferred provider
organizations ("PPOs"), traditional indemnity insurers and third party
administrators ("TPAs") are responding to these escalating health care costs
by shifting, generally under capitated payment arrangements, a portion of the
financial risk associated with the delivery of health care to providers such
as physicians, hospitals and integrated health care delivery systems. This
shift has caused providers to form groups or networks and to affiliate with
independent practice associations ("IPAs"), management service organizations
and physician hospital organizations, and has provided an impetus for
consolidation among hospitals and resulted in the proliferation of integrated
health care delivery systems. As a result, providers are being required to
manage financial risk and enhance their understanding of treatment costs,
variability of costs and cost control measures while demonstrating their
ability to provide quality care. Demand has intensified for health care
information systems for use by payors and providers that have assumed
financial risk as pressure to control health care costs has increased.
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Information systems software, which manages complex benefit and risk
plans and provides data to analyze cost-effective patterns of medical
practice, has become integral to the operation of managed care organizations.
Many of the existing payor and provider information systems were designed for
a fee-for-service model of medical practice and reimbursement and incorporate
older software and hardware technologies. These systems were focused on
billing and claim payments rather than healthcare utilization and financial
risk management. Today, managed care providers require information systems
that are able to account for increasingly sophisticated capitation schemes,
coordinate multiple contracts between payors and providers, maintain
eligibility databases, incorporate electronic data interchange, use complex
algorithms for utilization management and provide greater efficiency and
improved service.
PRODUCTS. The Company's DIAMOND product line consists of DIAMOND 725B
(formerly known as DIAMOND BBx), DIAMOND 950C/S (formerly known as DIAMOND
Client/Server) and DIAMOND 725Q (formerly known as DIAMOND Quick Start). The
Company's DIAMOND products manage information about members, employer groups,
providers, health plan and provider contracts, referrals and authorizations
and health care services for accurate provider reimbursement, risk pool
accounting and health care cost management. The DIAMOND products are
UNIX-based and operate on a variety of hardware systems, enabling the Company
to market them as flexible systems compatible with many of the hardware
platforms favored by existing and potential customers.
DIAMOND MODULES
MODULE DESCRIPTION
- --------------------------------------------------------------------------------
Members and Groups Supports enrollment processes
Maintains eligibility, benefit and member-level
provider assignment information
Electronic Data Interchange Receives enrollment and claims data in
electronic form
Allows batch processing of enrollment and
claims data
Provider Contracting and
Network Management Defines and manages multiple provider networks
and affiliations, and specific provider
reimbursement arrangements
Authorizations Processes referrals, authorizations and hospital
precertifications
Interfaces with claims so that adjudication
results can vary by authorization status
Claims Pricing and Adjudication Calculates price for services rendered
Applies benefits and eligibility information
Applies duplicate checking and other
transaction logic
Interfaces with clinical editors
Capitation and Risk Pool
Management Calculates capitated reimbursement
Debits budgeted dollars or funds with
utilization
Applies stoploss limits
Accounts Payable Supports claims and capitation payables plan
Generates full 1099 reporting
Premium Billing and Accounts Supports premium billing and in-bound
Receivable capitation
Reporting Generates standard utilization and cost
reporting
Includes correspondence generation
Supports AD HOC reporting
Customer Service Tracks communication and correspondence
between a health plan and its customers
Medicaid and Medicare
Interfaces Interfaces to federal and state governments
for eligibility information
Manages capitated reimbursement for providers
with Medicare contracts and Medicaid contracts
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DIAMOND 725B is the Company's initial internally developed managed care
information system. Introduced in 1992, DIAMOND 725B is designed to address
the needs of a wide spectrum of payor and provider organizations. The
functionality provided by DIAMOND 725B supports the critical operational tasks
of managed health care organizations ranging from start-up companies to
mid-sized mature companies seeking an established managed care information
system that is cost effective and easy to support.
DIAMOND 950C/S was released in 1995 as an information system for
large managed care organizations and for other managed care organizations
demanding advanced technologies. DIAMOND 950C/S employs an open system
architecture and incorporates the Oracle relational database, PowerBuilder
application development tools and a Microsoft Windows graphical user
interface. The advantages of DIAMOND 950C/S include broad scalability,
a high degree of information access using Structured Query Language ("SQL")
reporting tools, and a wide range of architectural options in deploying
system resources across geographically dispersed organizations, centralized
processing, and other topologies. The Windows-compliant front-end provides
DIAMOND 950C/S with the advantages of Microsoft's Windows technology.
The Company believes that DIAMOND 950C/S represents a significant
advantage for those organizations that are positioning themselves to respond
to a data-driven health care environment. DIAMOND 950C/S can be
integrated with other products in a two-tier or three-tier architecture and
incorporates SQL accessibility and application program interfaces. Its
capitation function supports cascading capitation and multi-layered risk fund
arrangements, increasingly required by sophisticated managed care
organizations.
DIAMOND 725Q, released in 1996, offers an entry-level system
solution for start up managed care organizations. With all standard files
pre-defined, DIAMOND 725Q offers a shorter implementation timeframe,
simplified system set-up, and an emphasis on user and operations training.
It provides an opportunity for organizations to make a smaller initial
investment that will be protected when the organization migrates to other
DIAMOND products as it grows.
License fee levels for the Company's direct customers are determined by
the number of users, with customers paying additional license and support
fees as the number of licensed users increases. The Company's direct
customers pay minimum license fees of $192,000, $320,000 and $85,000 for
DIAMOND 725B, DIAMOND 950C/S and DIAMOND 725Q, respectively.
Actual license fees can be substantially higher depending on the number of
concurrent system users.
IMPLEMENTATION, SERVICES AND SUPPORT. IMPLEMENTATION. HSD's
implementation services consist primarily of analysis of the hardware,
software, interfaces, networking, data conversion and personnel needs of its
customers, installation and testing of the software and detailed,
client-specific training at the customers' sites. Implementation of DIAMOND
725B and DIAMOND 725Q range from three to six months. DIAMOND
950C/S implementations are nine to twelve months in duration.
TRAINING PROGRAM. HSD provides a comprehensive training program to its
customers. Training classes are offered primarily through in-house facilities
at the Company's headquarters in Oakland, California and in Atlanta, Georgia.
SUPPORT. To ensure the most effective use of its products, HSD requires
each of its direct customers to enter into a minimum 24-month support
contract with the Company. The Company's software support services include
scheduled software releases, telephone and dial-up support and on-site
reviews. All software licensed by SMS to end-users pursuant to the SMS
Agreement is typically installed and supported by SMS. HSD provides training
services to SMS to enable SMS personnel to offer software support services to
its customers.
MODIFICATIONS. Because systems requirements of managed care
organizations vary, some clients request specific modifications to the
standard DIAMOND product. HSD provides these modification services to its
clients for an additional fee. Modifications requested by clients are
typically incorporated in the standard DIAMOND product.
SALES AND MARKETING. HSD markets its products primarily through its
direct sales force. In addition, the Company has a marketing relationship
with SMS. As of September 30, 1996, the Company's direct sales force
consisted of twelve account executives and two regional sales managers
located in the Company's Oakland, California; Atlanta, Georgia and Oak Brook,
Illinois offices, all under the direction of
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the Company's Vice President, Sales and Marketing. In addition to this sales
force, HSD employs an 18-person marketing, sales support and product
specialist team. To increase market share in other segments not fully
addressed by HSD directly, the Company is also seeking to develop additional
strategic relationships.
The sales cycle typically ranges from four to nine months and consists
of several steps which include initial contact and lead qualification, site
visits, response to requests for proposals, analysis of business
requirements, preparation of final bid and contract negotiations. Members of
HSD's engineering, implementation and client support departments assist the
Company's direct sales force in making presentations to, and preparing
comprehensive proposals for potential customers. To support the Company's
sales efforts, HSD conducts a variety of programs intended to market and
position its product line and services. These programs include trade journal
advertising, direct mailings, public relations activities and trade show
participation.
RELATIONSHIP WITH SMS. In January 1994, the Company entered into the
SMS Agreement, under which SMS markets, implements and supports the Company's
products to the SMS customer base. SMS has the worldwide, exclusive right to
market and license the DIAMOND products to its clients, other than certain
payor organizations. SMS also has the worldwide, non-exclusive right to
market and license the Diamond products to provider organizations. The SMS
Agreement has an initial term of five years and provides for automatic
renewal for successive two year periods unless either party provides prior
written notice of termination not less than one year prior to the end of the
then-current term.
During the term of the SMS Agreement, (i) HSD has agreed not to enter
into a marketing agreement for the DIAMOND products with any SMS competitor
and (ii) SMS has agreed not to develop a managed care application, or license
any managed care software from any third-party, that has the same or
substantially similar functionality as the DIAMOND products.
During fiscal 1996 and 1995, approximately 11% and 25%, respectively,
of the Company's total revenues were generated by SMS. All of the customers
generated by SMS in fiscal 1995 and some of the customers generated in fiscal
1996 represented licenses that had been prepaid at a discounted rate under
the terms of the SMS Agreement. For those licenses which were not prepaid,
SMS will pay the Company a percentage of the license fee charged to the
end-user. SMS must also pay HSD a percentage of all support fees paid to SMS
by its end-users.
CUSTOMERS. The Company's customers include HMOs, PPOs, integrated
delivery systems, health insurance companies, TPAs and managed Medicaid and
Medicare risk plans.
The following chart, showing the total number of customers added by the
Company and SMS in each of the last six fiscal years, illustrates the
growing diversity of the current customers for the Company's DIAMOND products:
<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL FISCAL FISCAL FISCAL
CUSTOMER 1991 1992 1993 1994 1995 1996 TOTAL
- -------- ------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
HMOs _ 1 1 6 _ 7 15
Provider organizations _ _ 1 1 8 13 23
PPOs 1 _ _ 2 4 2 9
TPAs _ 2 3 2 4 0 11
Managed Medicaid and
Medicare risk plans _ _ 3 6 10 5 24
Total systems 1 3 8 17 26 27 82
</TABLE>
PRODUCT DEVELOPMENT. To date, the Company has concentrated its product
development efforts on DIAMOND 725B, DIAMOND 950C/S and DIAMOND 725Q. The
Company has used object-oriented technologies that simplify the development,
maintenance and customization of its products. At September 30, 1996, the
Company had 46 employees in the engineering department, which is responsible
for product development and technical services. During fiscal 1996, 1995 and
1994, the Company's product development expenses were approximately
$3,443,000, $1,811,000, and $874,000, respectively. In most cases, product
enhancements and modifications funded by customers are subsequently
incorporated into the
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Company's products. To the extent that customers continue to request complex
custom enhancements, it may become increasingly difficult to meet these
requests and maintain standardized product releases. Although to date the
Company has been successful in accommodating customer requests for
enhancements while maintaining a standard product line, there can be no
assurance that it will be able to do so in the future.
The Company intends to continue to invest in product development and
expects that its product development expenses will continue to increase. The
Company's product development plans include (i) enhancing system reporting
capabilities with additional pre-programmed reports and new AD HOC reporting
packages, including an executive information system and a supporting data
warehouse, (ii) exploring the application of new technologies, such as image
processing, multi-dimensional databases for executive information systems and
high speed communication capabilities and (iii) increasing the functionality
of the DIAMOND products and developing additional interfaces with third-party
software to target specific market segments. There can be no assurance that
any product development efforts will be successfully completed or that future
products will be available on a timely basis or achieve market acceptance.
COMPETITION. The market for managed care information systems is highly
competitive, and the Company expects competition to intensify in the future.
The Company faces direct competition from a number of companies that offer
similar systems, such as AMISYS Managed Care Systems, Inc., Computer Science
Corporation, Erisco (a division of The Dun & Bradstreet Corporation),
Resource Information Management Systems, EDS and Health Systems Integration,
Inc. (a subsidiary of The Compucare Company). HSD also faces competition
from companies offering products with less advanced functionality to the
lower-end of the market, such as Fred Rothenberg & Associates, Mariner,
Physmark, QMACS and Sunquest. In addition, the Company competes with in-house
systems developed by large managed care organizations. Several of the
Company's competitors have significantly greater financial, technical,
product development and marketing resources than the Company. HSD competes on
the basis of functionality, technology, product quality, product features
(scalability, flexibility, performance and ease of use), price, customer
service and support. In the future, additional competitors could enter the
market, including providers of information systems to other segments of the
health care industry, and compete with the Company. Most of the Company's
sales are derived from competitive procurement processes managed directly by
sophisticated clients or consultants that require specific, highly detailed
presentations from several qualified vendors. There can be no assurance that
the Company will be able to compete successfully with existing or new
competitors. The failure of the Company to compete successfully would have a
material adverse effect on the Company's business, operating results and
financial condition.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. The Company
currently relies on a combination of trade secret and copyright laws,
software security measures, license agreements and nondisclosure agreements
to establish and protect its proprietary rights. The Company currently has no
domestic or foreign patents or patent applications pending. Despite the
Company's precautions, it may be possible for unauthorized third parties to
copy aspects of, or otherwise obtain and use, the Company's software products
and technology without authorization. The Company's practice of providing its
customers with the source code to the Company's software may increase this
risk. In addition, the Company cannot be certain that others will not develop
substantially equivalent or superior proprietary technology, or that
equivalent products will not be marketed in competition with the Company's
products, thereby substantially reducing the value of the Company's
proprietary rights. Furthermore, there can be no assurance that any
confidentiality agreements between the Company and its employees and
consultants or any license agreements with its customers will provide
meaningful protection for the Company's proprietary information in the event
of any unauthorized use or disclosure of such proprietary information.
The Company is not aware that any of its products infringes the
proprietary rights of third parties. Nonetheless, there can be no assurance
that the Company will not become the subject of infringement claims or legal
proceedings by third parties with respect to current or future products and
that such claims or proceedings will not have a material adverse effect on
the Company's business, financial condition or results of operations.
Moreover, an adverse outcome in litigation or similar adversarial proceedings
could subject the Company to significant liabilities to third parties,
require expenditure of significant resources to develop non-infringing
technology, require disputed rights to be licensed from others or require the
Company to cease the marketing or use of certain products, any of which
events could have a material adverse effect on the Company's business,
operating results and financial condition. As the number of software products
in the industry increases and the functionality of these products further
overlaps, the
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Company believes that software developers may become increasingly subject to
infringement claims. To the extent the Company wishes or is required to
obtain licenses to patents or proprietary rights of others, there can be no
assurance that any such licenses will be made available on terms acceptable
to the Company, if at all.
EMPLOYEES. As of September 30, 1996, the Company employed 139 people
on a full-time basis, including 46 in engineering, 33 in sales and marketing,
11 in client support, 26 in client services and 23 in administration and
finance. Competition for highly skilled employees with technical, management,
marketing, sales, product development and other specialized training is
intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. The employees and the Company are
not parties to any collective bargaining agreements, and the Company believes
that its relations with its employees are good.
EXECUTIVE OFFICERS OF THE COMPANY. The executive officers of the
Company and their ages as of September 30, 1996, are as follows:
NAME AGE POSITION
- ---- --- --------
Richard C. Auger 52 Chief Executive Officer and Chairman of the Board
Catherine C. Roth 46 President, Chief Operating Officer, Secretary and
Director
Richard E. Malone 31 Vice President, Finance and Chief Financial Officer
Richard C. Auger, a co-founder of the Company, has been Chief Executive
Officer and Chairman of the Board of the Company since August 1988. In
addition, Mr. Auger served as President of the Company from August 1988 to
January 1996. Prior to joining the Company, Mr. Auger was founder and
president of Worth, Auger & Associates, one of the first managed care systems
companies. Mr. Auger holds a B.A. and an M.A. degree in Economics from the
University of California, Davis.
Catherine C. Roth, a co-founder of the Company, has served as President
of the Company since January 1996, Chief Operating Officer of the Company
since April 1994 and Secretary and a Director of the Company since 1988. In
addition, Ms. Roth served as Executive Vice President of the Company from
1988 to January 1996. Prior to joining the Company, Ms. Roth was Director,
Client Services at Worth, Auger & Associates. Ms. Roth holds a B.A. degree
from Oakland University and an M.P.P. degree from the University of
California, Berkeley.
Richard E. Malone has served as Chief Financial Officer of the Company
since February 1994. From June 1992 to February 1994, Mr. Malone was Finance
Manager of the Company. Mr. Malone worked as senior consultant specializing
in health care information systems for Andersen Consulting from August 1987
to August 1990. Mr. Malone holds a B.A. degree in Economics from Harvard
University and an M.B.A. degree from the University of California, Berkeley.
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ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, customer
support and research and development facility is located in approximately
28,500 square feet of office space in Oakland, California. This facility is
leased to the Company under a lease that expires in October 1999. The Company
also has branch offices in Atlanta, Georgia and Oak Brook, Illinois. The
Company believes its facilities are adequate for its current operations.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Inapplicable
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock commenced trading on the NASDAQ National
Market on March 5, 1996 under the symbol HSDC. The following table presents
the high and low closing sale prices for the Company's common stock as
reported by the NASDAQ National Market.
Fiscal 1996 High Low
- ----------- ------ ------
Second Quarter (from March 5, 1996) 19 3/4 13 3/4
Third Quarter 21 1/2 13
Fourth Quarter 16 3/8 9 1/2
As of November 29, 1996, there were approximately 61 holders of record of
the Company's common stock.
The Company has never paid cash dividends, currently intends to retain
any earnings for use in its business and does not anticipate paying any cash
dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction
with the Company's Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere herein. The selected financial data presented below have
been derived from the Company's financial statements.
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<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
1996 1995 1994 1993 1992
--------- --------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
System sales $ 10,639 $ 5,560 $ 4,513 $ 2,180 $ 1,512
Services and other 1,813 1,217 520 214 156
--------- --------- --------- --------- ---------
Total revenues 12,452 6,777 5,033 2,394 1,668
Cost of revenues 3,699 2,538 1,667 844 643
--------- --------- --------- --------- ---------
Gross margin 8,753 4,239 3,366 1,550 1,025
--------- --------- --------- --------- ---------
Operating expenses:
General and administrative 3,806 2,147 1,575 858 543
Sales and marketing 2,750 1,059 706 473 214
Product development 3,444 1,811 874 172 152
--------- --------- --------- --------- ---------
Total operating expenses 10,000 5,017 3,155 1,503 909
--------- --------- --------- --------- ---------
Income (loss) from operations (1,247) (778) 211 47 116
Interest, net 40 (72) (42) (42) (29)
--------- --------- --------- --------- ---------
Income (loss) before provision for income taxes (1,207) (850) 169 5 87
Benefit (provision) for income taxes (1) 97 (4) (1) (21)
--------- --------- --------- --------- ---------
Income (loss) before cumulative effect of
change in accounting for income taxes (1,208) (753) 165 4 66
Cumulative effect of change in accounting
for income taxes 0 0 (32) 0 0
--------- --------- --------- --------- ---------
Net income (loss) $ (1,208) $ (753) $ 133 $ 4 $ 66
========= ========= ========= ========= =========
Net income (loss) per share $ (0.21) $ (0.16) $ 0.03 $ - $ 0.02
========= ========= ========= ========= =========
Weighted average shares outstanding 5,737 4,760 4,756 4,756 4,247
SEPTEMBER 30,
1996 1995 1994 1993 1992
--------- --------- --------- -------- ---------
(IN THOUSANDS)
Balance Sheet Data:
Working capital (deficit) $ 18,168 $ (1,145) $ (101) $ 83 $ 202
Total assets 23,757 3,652 2,686 1,262 828
Short-term borrowings 4 954 627 311 110
Long-term borrowings - 520 147 100 163
Total stockholders' equity (deficit) 21,112 (273) 477 344 331
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company was founded in July 1988 to provide managed care
information systems software to health care organizations that use managed
care techniques to deliver services, manage financial risk and control costs.
Since inception, the Company has invested substantially all of its operating
cash flow in product and business development. The Company introduced its
first internally developed product, DIAMOND 725B (formerly known as DIAMOND
BBx), in fiscal 1992, followed by DIAMOND 950C/S (formerly known as DIAMOND
Client/Server) in fiscal 1995 and DIAMOND 725Q (formerly known as DIAMOND
Quick Start) in fiscal 1996.
The Company's revenues to date have been derived from licensing the
DIAMOND products, providing the associated implementation, modification,
support and consulting services, and, to a lesser extent, reselling
third-party software and hardware. Software licenses typically are granted on
a perpetual basis, although the Company may also grant multi-year,
non-cancelable term licenses. License fees are determined according to the
number of users licensed. HSD requires each of its direct customers to enter
into a minimum 24-month support contract with the Company. From time to time,
customers request that the Company provide third-party hardware in connection
with system sales. Such sales of third-party hardware accounted for less than
1%, 3%, and 9% of the Company's total revenues in fiscal 1996, 1995 and 1994,
respectively.
The Company expects that license fee and service revenues associated
with DIAMOND 725B, DIAMOND 950C/S and DIAMOND 725Q will account
for substantially all of the Company's revenues for the foreseeable future.
As a result, the Company's financial performance will depend largely on the
continued growth in demand for operational managed care information systems
and the tools to implement such systems.
License revenues are recognized on a percentage of completion basis
based on the labor hours required to implement the system. The length of the
implementation process depends on factors outside of the Company's control,
including customers' ability to allocate internal resources to the
installation process and, with respect to certain customers, the need to
obtain necessary governmental approvals. In addition, substantially all of
the Company's license agreements may be terminated under certain
circumstances. The termination of license agreements could have a material
adverse effect on the Company's business, financial condition and results of
operations. Therefore, the Company is unable to predict accurately the amount
of revenues it expects to recognize from license fees in any particular
period. Implementation, modification and support fees are billed either on an
hourly or monthly basis and are recognized as services are rendered.
Third-party software and hardware fees are typically billed and recognized as
revenues when delivered to the customer.
In fiscal 1994, the Company entered into a marketing agreement with
SMS. Pursuant to this agreement, SMS prepaid the first 30 software licenses
for resale. As of September 30, 1996, all 30 licenses have been executed.
For these 30 licenses, the Company recognized DIAMOND 725B license fees when a
DIAMOND 725B contract between SMS and the end-user was executed, and will
recognize DIAMOND 950C/S license fees upon successful implementation
of the system at the site of an SMS end-user. For SMS sales after the 30th
sale, the Company recognizes revenues ratably over the term of the license
agreement between SMS and the end-user, which term typically extends five to
seven years. The SMS relationship accounted for 11%, 25% and 21% of total
revenues in fiscal 1996, 1995 and 1994, respectively.
The Company capitalizes software costs for internally developed
software. These costs relate primarily to the development of either new
products or significant enhancements to existing products which enable the
products to penetrate new markets. Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed," requires capitalization of certain software
development costs subsequent to the establishment of technological
feasibility. Based on the Company's product development process,
technological feasibility is established upon completion of a working model.
The capitalized costs are amortized on a straight-line basis over the
estimated useful lives (not exceeding three years), commencing when each
product or significant enhancement is available to the market.
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<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the fiscal periods indicated,
certain statement of operations data expressed as a percentage of total
revenues:
FISCAL YEAR ENDED SEPTEMBER 30,
-------------------------------
1996 1995 1994
--------- --------- --------
Revenues:
System sales 85.4% 82.0% 89.7%
Services and other 14.6 18.0 10.3
--------- --------- --------
Total revenues 100.0 100.0 100.0
Cost of revenues 29.7 37.4 33.1
--------- --------- --------
Gross margin 70.3 62.6 66.9
--------- --------- --------
Operating expenses:
General and administrative 30.6 31.8 31.3
Sales and marketing 22.1 15.6 14.0
Product development 27.6 26.7 17.4
--------- --------- --------
Total operating expenses 80.3 74.1 62.7
Income (loss) from operations (10.0) (11.5) 4.2
Interest expense, net 0.3 (1.0) (0.8)
--------- --------- --------
Income (loss) before provision for
income taxes (9.7) (12.5) 3.4
Benefit (provision) for income taxes -- 1.4 --
--------- --------- --------
Income (loss) before cumulative effect
of change in accounting for income
taxes (9.7) (11.1) 3.4
Cumulative effect of change in accounting
for income taxes -- -- (0.8)
--------- --------- --------
Net income (loss) (9.7)% (11.1)% 2.6%
========= ========= ========
REVENUES
Total revenues were $12,452,000, $6,777,000 and $5,033,000 in fiscal
1996, 1995 and 1994, respectively, representing increases of 84% from fiscal
1995 to fiscal 1996 and 35% from fiscal 1994 to fiscal 1995. The growth in
total revenues is attributable primarily to DIAMOND 950C/S, as
revenues from DIAMOND 725B remained relatively constant. The Company's
relationship with Blue Cross and Blue Shield of Florida, which commenced in
November 1995, accounted for revenues of $4,156,000 in fiscal 1996. The SMS
marketing relationship accounted for revenues of $1,402,000, $1,722,000 and
$1,031,000 in fiscal 1996, 1995 and 1994, respectively. License fees per
customer increased as the Company expanded product functionality and licensed
its products to customers with a greater number of end-users.
SYSTEM SALES. System sales revenues were $10,639,000, $5,560,000 and
$4,513,000 in fiscal 1996, 1995 and 1994, respectively, representing
increases of 91% from fiscal 1995 to fiscal 1996 and 23% from fiscal 1994 to
fiscal 1995. Revenues associated with reselling third-party software and
hardware represented 5%, 11% and 9% of total revenues in fiscal 1996, 1995
and 1994, respectively, of which revenues associated with sales of
third-party hardware represented 0.3%, 3% and 7% in fiscal 1996, 1995 and
1994, respectively. In fiscal 1996, DIAMOND 725B accounted for 34% of systems
sales revenues, DIAMOND 950C/S accounted for 64% of system sales revenues,
and DIAMOND 725Q accounted for 2% of systems sales revenue. Revenues
associated with DIAMOND 950C/S sales were responsible for the majority of the
increase in systems sales revenues, with significant increases in DIAMOND
950C/S license, implementation and modification fees. The Company expects
that DIAMOND 950C/S will continue to represent a significant portion of
systems sales revenues over the next several years due to the higher systems
sales revenues per client associated with sales of DIAMOND 950C/S. As a
result, the Company's financial performance will depend largely on the market
acceptance of DIAMOND 950C/S.
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System sales revenues consist of license fees for the Company's products,
implementation and modification fees, and revenues associated with reselling
third-party software and hardware.
SERVICES AND OTHER. Services and other revenues were $1,813,000,
$1,217,000 and $520,000 in fiscal 1996, 1995 and 1994, respectively,
representing increases of 49% from fiscal 1995 to fiscal 1996 and 134% from
fiscal 1994 to fiscal 1995. Support fees continued to account for the
majority of services and other revenues. The increase in services and other
revenues was due primarily to the expansion of the installed base for Diamond
725B. Services and other revenues are comprised of system support, consulting
and training revenues.
COST OF REVENUES. The cost of revenues was $3,699,000, $2,538,000 and
$1,667,000 in fiscal 1996, 1995 and 1994, respectively, representing
increases of 46% from fiscal 1995 to fiscal 1996 and 52% from fiscal 1994 to
fiscal 1995. Cost of revenues increased in absolute terms primarily as a
result of the increased number of personnel, both HSD employees and
independent contractors, required to implement and support the larger client
base. The cost of system sales as a percentage of total revenues is dependent
upon the mix of license, service and third-party software and hardware
revenues, and may fluctuate over time as the mix of total system sales
revenues changes. The cost of system sales consists of expenses directly
related to sales of software licenses, associated implementation,
modification services and third party hardware and software.
OPERATING EXPENSES
GENERAL AND ADMINISTRATIVE. General and administrative expenditures were
$3,806,000, $2,147,000 and $1,575,000 in fiscal 1996, 1995 and 1994,
respectively, representing increases of 77% from fiscal 1995 to fiscal 1996
and 36% from fiscal 1994 to fiscal 1995. The increase in general and
administrative expenditures was due primarily to staff additions and
infrastructure to support the Company's expanded operations as well as
fulfilling the requirements of being a public company. The Company believes
that the level of general and administrative expenses will continue to
increase as the Company expands its staff to support a larger client base.
General and administrative expenses include the salaries and benefits
associated with general management, finance and administration, as well as
costs associated with recruiting and facilities.
SALES AND MARKETING. Sales and marketing expenditures were $2,750,000,
$1,059,000 and $706,000 in fiscal 1996, 1995 and 1994, respectively,
representing increases of 160% from fiscal 1995 to fiscal 1996 and 50% from
fiscal 1994 to fiscal 1995. The increase in sales and marketing expenses was
attributable to the growth of the Company's sales force, associated support
personnel and increased marketing and promotional activities. During fiscal
1996, HSD aggressively expanded its direct sales force and enhanced its
marketing capabilities. Sales and marketing expenses primarily include the
salaries and benefits of the Company's direct sales force and the cost of
product marketing, advertising, travel and product literature.
PRODUCT DEVELOPMENT. Product development expenditures, net of software
capitalization costs, were $3,444,000, $1,811,000 and $874,000 in fiscal
1996, 1995 and 1994, respectively, representing increases of 90% from fiscal
1995 to fiscal 1996 and 107% from fiscal 1994 to fiscal 1995. The increase in
product development expenditures, net of software capitalization costs, was
attributable to significant costs associated with the DIAMOND 950C/S
development effort, including increased staffing and the hiring of
independent technical consultants to assist such efforts. The Company
believes that research and development expenditures are essential to
maintaining its competitive position and expects these costs to continue to
constitute a significant percentage of total revenues in the near future. The
Company capitalized $277,000, $314,000 and $57,000 in product development
costs in fiscal 1996, 1995 and 1994, respectively. Product development
expenses primarily include the salaries and benefits associated with the
product development staff as well as an allocation of indirect costs.
INTEREST INCOME (EXPENSE), NET
Interest income, net of interest expense, was $40,000, ($71,000) and
($41,000) in fiscal 1996, 1995 and 1994, respectively. The Company recorded
approximately $508,000 in interest income in fiscal 1996, and had no interest
income in fiscal 1995 and 1994. The interest income in fiscal 1996 was the
result
13
<PAGE>
of the cash proceeds from the initial public offering completed in
March, 1996, offset by an increase in interest expense, due primarily to a
non-cash charge of approximately $350,000 associated with the repayment of
$2,000,000 of Notes issued by the Company in December 1995. Interest income
represents interest earned on the Company's excess cash balances, which are
generally placed in short term investments, money market funds, and government
securities. Interest expense consists primarily of interest on short and long
term debt and capital leases.
INCOME TAXES
The Company's benefit (provision) for income taxes was ($1,000),
$97,000 and $(4,000) in fiscal 1996, 1995 and 1994, respectively. Effective
October 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes," whereby income
taxes are accounted for under the liability method. For financial reporting
purposes, a valuation allowance at September 30, 1996 of approximately
$807,000 has been recorded to offset the deferred tax assets recognized under
SFAS 109. A 100% valuation allowance has been established given that the
Company has historically not achieved significant levels of profitability.
ADOPTION OF ACCOUNTING PRONOUNCEMENTS
The Company is required to adopt SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for the Long-Lived Assets to be Disposed
of" beginning October 1, 1996. The Company is also required to adopt SFAS No.
123, "Accounting for Stock-Based Compensation" beginning October 1, 1996. The
Company believes the adoption of these pronouncements will not have a
material impact on the financial statements of the Company taken as a whole.
LIQUIDITY AND CAPITAL RESOURCES
In March 1996, the Company completed an initial public offering of its
common stock, raising $21,723,000 net of expenses. Net cash provided by
(used in) operating activities was ($3,472,000), $306,000 and $293,000 in
fiscal 1996, 1995, and 1994, respectively. Net cash provided by operating
activities in fiscal 1994 consisted primarily of an increase in unearned
revenue offset by an increase in accounts receivable. In fiscal 1995, net
cash provided by operating activities consisted primarily of an increase in
unearned revenue and accounts payable offsetting the net loss for the year.
Net cash used in operating activities in fiscal 1996 consisted primarily of
the net loss for the year and an increase in accounts receivable, unbilled
revenues and prepaid expenses, partially offset by an increase in accrued
liabilities. The increase in accounts receivable in fiscal 1996 was due
primarily to both the execution of several contracts at the end of the period
as well as an overall increase in the sales volume of the Company. The
increase in accrued liabilities was due primarily to the accrual of royalties
due third parties.
Net cash used in investing activities was $2,180,000, $1,004,000 and
$333,000 in fiscal 1996, 1995, and 1994, respectively, and consisted
primarily of acquisitions of computer equipment and furniture, as well as the
capitalization of software development costs. The investment in computer
equipment and furniture was directly related to the increase in the number of
employees and the acquisition of computers for software development. Cash
used for capitalized software development costs increased from approximately
$57,000 in fiscal 1994 to $314,000 in fiscal 1995 and $277,000 in fiscal 1996
as a result of the relative increase in overall research and development
costs and slight changes in the amount of research and development
capitalized.
Net cash provided by financing activities was $20,752,000, $703,000 and
$165,000 in fiscal 1996, 1995 and 1994, respectively. Financing activities
consisted primarily of capital lease payments, lines of credit,
stockholder loans, a $500,000 long-term note in fiscal 1995, $2,000,000 in
Notes in fiscal 1996 and an initial public offering of the Company's common
stock in fiscal 1996.
As of September 30, 1996, 1995 and 1994, the Company had cash in the
amount of $15,254,000, $149,000 and $144,000.
The Company believes that available funds and cash flow from operations
will be adequate to fund its presently anticipated working capital
requirements for at least the next 12 months.
14
<PAGE>
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements in this report concerning the future results of operations,
financial condition and business of the Company are "forward-looking"
statements as defined in the Securities Act of 1933 and the Securities
Exchange Act of 1934. Investors are cautioned that information contained in
these forward-looking statements is inherently uncertain, and that actual
performance and results may differ materially due to numerous risk factors,
including but not limited to the following, as well as other risks which are
described in the Company's other filings with the Securities and Exchange
Commission:
DEPENDENCE UPON SINGLE PRODUCT LINE. The Company derives substantially all
of its revenues from licensing its DIAMOND software products and providing
the associated implementation, modification, support and consulting services
to its customers. The Company intends to broaden its product line through the
development and introduction of new products and through product
acquisitions. However, there can be no assurance that the Company will be
able to broaden its product line successfully, and any factor adversely
affecting the market for any of the Company's current products could have a
material adverse effect on the Company's business, financial condition and
results of operations.
MARKET ACCEPTANCE, IMPLEMENTATION AND SUPPORT OF DIAMOND 950C/S (formerly
known as DIAMOND Client/Server). In fiscal 1996, the Company introduced
DIAMOND 950C/S, which is based on client/server technology. The market for
information systems based on client/server technology is continuing to evolve
and the success of DIAMOND 950C/S is dependent in part upon the market
acceptance of managed care information systems using client/server
technology. Although initial customer implementation of DIAMOND 950C/S began
in fiscal 1995, DIAMOND 950C/S was not used in live production by the
Company's customers until the second quarter of fiscal 1996. Therefore, there
can be no assurance that these customers will not experience operational or
technical problems which could result in the termination of customer
contracts. The Company faces greater challenges in installing and supporting
DIAMOND 950C/S because of the complexity of client/server technology. Prior
to DIAMOND 950C/S, the Company had limited experience in installing and
supporting products with client/server technology and there can be no
assurance that the Company can obtain the necessary resources to install and
support DIAMOND 950C/S in an efficient, cost effective and competitive
manner. The failure of DIAMOND 950C/S to achieve market acceptance for any
reason could have a material adverse effect on the Company's business,
financial condition and results of operations.
VARIABILITY OF OPERATING RESULTS; LENGTH OF SALES CYCLES. The Company's
revenues and operating results may vary significantly from quarter to quarter
as a result of a number of factors, including the number and timing of
systems sales, the relatively large dollar amounts of customer contracts, the
length of the sales cycles and delays in the implementation process. The
Company has typically experienced sales cycles of four to nine months. As a
result, the Company's results of operations are subject to significant
fluctuations and its results of operations for any particular quarter or
fiscal year may not be indicative of results of operations for future
periods. A significant portion of the Company's operating expenses are fixed,
and planned expenditures are based primarily on sales forecasts. Any
inability of the Company to reduce spending or to compensate for any failure
to meet sales forecasts or receive anticipated revenues could magnify the
adverse impact of such events on the Company's operating results. Further,
the commencement of one or more major implementations could generate a large
increase in revenues and net income for any given quarter or fiscal year,
which increase may prove anomalous when compared to changes in revenues and
net income in other periods. The Company's ability to complete implementation
of its systems and recognize revenues is dependent on certain factors outside
the control of the Company, including its customers' ability to allocate
internal resources to the implementation process and, with respect to certain
customers, the need to obtain necessary governmental approvals. In addition,
substantially all of the Company's license agreements may be terminated under
certain circumstances upon 30 to 120 days notice. In the second quarter of
fiscal 1994 and the second quarter of fiscal 1996, the Company experienced
terminations of license agreements. The termination of license agreements
could result in the refund of license fees and could have a material adverse
effect on the Company's business, financial condition and results of
operations.
PRODUCT DEVELOPMENT AND ENHANCEMENT. The market for the Company's products
is characterized by frequent new product introductions and enhancements,
rapid technological advances and rapid changes in customer requirements and
preferences. Accordingly, the Company's future success will depend on its
ability to enhance its existing products and to develop and market new
products on a timely basis that respond to evolving customer requirements,
achieve market acceptance and keep pace with technological
15
<PAGE>
developments. There can be no assurance that the Company will be successful
in developing, introducing on a timely basis and marketing such products or
enhancements, that its software will not contain errors that would delay
product introduction, shipment or implementation, or that any such new
products or enhancements will be accepted by the market. Because the
Company's products are important to the successful operation of its
customers' managed care organizations, errors or delays in product
development and enhancement may have a material adverse effect on the
continued market acceptance of the Company's products and may expose the
Company to claims from customers and third parties.
RELATIONSHIP WITH SHARED MEDICAL SYSTEMS. In January 1994, the Company
entered into an agreement under which SMS markets, implements and supports
the Company's DIAMOND products to the SMS customer base (the "SMS
Agreement"). During fiscal 1996, approximately 11% of the Company's total
revenues were generated by SMS. There can be no assurance that SMS will
continue to sell the DIAMOND products successfully, or that SMS will be able
to provide the level of service and support required to maintain its customer
base. The initial term of the SMS Agreement will continue through January
1999 with automatic renewals for successive two year periods unless either
party provides prior written notice of termination not less than one year
prior to the end of the then-current term. SMS has the right to terminate the
SMS Agreement prior to its expiration in the event of a material breach of
the SMS Agreement by the Company or under certain other circumstances. The
termination of the SMS Agreement could have a material adverse effect on the
Company's business, financial condition and results of operations.
MANAGEMENT OF GROWTH. The Company is currently experiencing a period of
rapid growth and expansion which has placed, and will continue to place, a
significant strain on the Company's managerial, technical, financial and
other resources. The Company's growth has resulted in an increase in the
level of responsibility for both existing and new management personnel. The
Company has sought to manage its current and anticipated growth through the
recruitment of additional management, sales and marketing and technical
personnel, and through continued enhancement of internal systems and
controls. The failure to manage growth effectively could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON KEY PERSONNEL; ABILITY TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL. The Company's future performance is substantially dependent upon
the retention of key senior management, sales and marketing and technical
personnel, particularly Richard C. Auger, its Chief Executive Officer, and
Catherine C. Roth, its President and Chief Operating Officer. The Company's
success will also depend on its ability to attract, retain and motivate
highly skilled managerial, sales and marketing, and technical personnel,
including project managers, software programmers and systems architects
skilled in the environments in which the Company's products operate.
Competition for such personnel in the software and information services
industries is intense and is likely to remain so for the foreseeable future.
The loss of one or more of its key management, sales and marketing and
technical personnel or the inability to attract, retain and motivate other
qualified personnel could have a material adverse effect on the Company's
business, financial condition and results of operations.
COMPETITION. The market for managed care information systems is highly
competitive. The Company's competitors vary in the size, scope and breadth of
the products and services they offer. There can be no assurance that
competitors will not develop or offer products with superior functionality,
including client/server technology, or that other features of competitive
products will not be preferred by the Company's customers. Several of the
Company's competitors have significantly greater financial, technical,
product development and marketing resources than the Company. In the future,
additional competitors could enter the market, including providers of
information systems to other segments of the health care industry, and
compete with the Company. Most of the Company's sales are derived from
competitive procurement processes managed directly by sophisticated clients
or consultants that require specific, highly detailed presentations from
several qualified vendors. There can be no assurance that future competition
will not have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON MANAGED CARE INDUSTRY. All of the Company's revenues in fiscal
1996 and 1995 were derived from the sale of software products and services
to payors and providers that offer managed care products and services. The
Company's success is dependent on continued demand for software and related
services in that industry. The Company's growth is therefore dependent on the
growth of that industry. Consolidation in the managed care industry could
have a material adverse effect on the Company, due to the decrease in the
number of potential purchasers of the Company's products and services or the
acquisition of
16
<PAGE>
one or more of the Company's customers by an acquiror that uses a different
managed care information system. 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 be materially changed.
Legislative or market-driven reforms could have unpredictable effects on the
Company's business, financial condition and results of operations.
PROPRIETARY RIGHTS. The Company's success is dependent to a significant
extent on its ability to maintain the proprietary and confidential software
incorporated in its products. The Company currently relies on a combination
of trade secret and copyright laws, software security measures, license
agreements and nondisclosure agreements to establish and protect its
proprietary rights. However, there can be no assurance that the legal
protections and the precautions taken by the Company will be adequate to
prevent misappropriation of the Company's technology. In addition, these
protections and precautions do not prevent independent third-party
development of competitive technology or products. The Company's practice of
providing its customers with the source code to the Company's software may
increase the risk of unauthorized use of such software. Any infringement or
misappropriation of the Company's proprietary software could adversely affect
the Company's ability to retain and attract new clients in a highly
competitive market and could cause the Company to lose revenues or incur
substantial litigation expense to enforce the Company's proprietary rights.
The Company is not aware that any of its products infringes the
proprietary rights of third parties. Nonetheless, there can be no assurance
that the Company will not become the subject of infringement claims or legal
proceedings by third parties with respect to current or future products and
that such claims or proceedings will not have a material adverse effect on
the Company's business, financial condition or results of operations.
Moreover, an adverse outcome in litigation or similar adversarial proceedings
could subject the Company to significant liabilities to third parties,
require expenditure of significant resources to develop non-infringing
technology, require disputed rights to be licensed from others or require the
Company to cease the marketing or use of certain products, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. As the number of software products in the industry
increases and the functionality of these products further overlaps, the
Company believes that software developers may become increasingly subject to
infringement claims. To the extent the Company wishes or is required to
obtain licenses to patents or proprietary rights of others, there can be no
assurance that any such licenses will be made available on terms acceptable
to the Company, if at all.
RECENT LOSSES; ACCUMULATED DEFICIT; STOCKHOLDERS' DEFICIT. The Company
incurred net losses of approximately $1,208,000 and $753,000 for the fiscal
years ended September 30, 1996 and 1995, respectively. As of September 30,
1996, the Company had an accumulated deficit of approximately $1,649,000. The
Company has yet to achieve significant levels of profitability and there can
be no assurance that the Company will be profitable in the future.
RISKS OF ACQUISITIONS. The Company intends to grow in part through
acquisitions of complementary products, technologies and businesses.
Acquisitions involve a number of risks that could adversely affect the
Company's operating results, including the diversion of management's
attention, the assimilation of the operations and personnel of the acquired
companies, the amortization of acquired intangible assets and the potential
loss of key employees. The Company's ability to expand successfully through
acquisitions depends on many factors, including the successful identification
and acquisition of products, technologies or businesses and management's
ability to integrate the acquired products, technologies or businesses
effectively. There can be no assurance that the Company will be successful in
acquiring or integrating any such products, technologies or businesses or
that any such acquisition will enhance the Company's business.
PRODUCT LIABILITY. While the Company's products primarily provide
operational functions, they also provide applications that relate to patient
medical information. Any failure by the Company's products to provide
accurate information could result in product liability claims against the
Company by its customers or their patients. A product liability claim brought
against the Company could result in expensive litigation and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
POSSIBLE VOLATILITY OF STOCK PRICE. Prior to March 5, 1996, there was no
public market for the Common Stock, and there can be no assurance that an
active trading market will be sustained or that the market price of the
Common Stock will not decline below its current price. The stock market
historically has experienced volatility which has affected the market price
of securities of many companies and which has
17
<PAGE>
sometimes been unrelated to the operating performance of such companies. The
trading price of the Common Stock could also be subject to significant
fluctuations in response to variations in quarterly results of operations,
announcements of new products or acquisitions by the Company or its
competitors, governmental regulatory action, other developments or disputes
with respect to proprietary rights, general trends in the industry and
overall market conditions, and other factors. The market price of the
Common Stock may be significantly affected by factors such as
announcements of new products by the Company's competitors, as well as
variations in the market conditions in the medical cost containment or
software industries in general. The market price may also be affected by
movements in prices of equity securities in general.
18
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements: Page
----
Report of Independent Public Accountants F-1
Consolidated Balance Sheets as of September 30, 1996 and 1995 F-2
Consolidated Statements of Operations for the fiscal years ended
September 30, 1996, 1995 and 1994 F-3
Consolidated Statements of Stockholders' Equity for
the fiscal years ended September 30, 1996, 1995 and 1996 F-4
Consolidated Statements of Cash Flows for the fiscal years ended
September 30, 1996, 1995 and 1994 F-5
Notes to Consolidated Financial Statements F-6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
19
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference from
the information set forth under the captions, "Election of Directors" and
"Section 16(a) Information" of the registrant's definitive Proxy Statement
relating to the Annual Meeting of Stockholders to be held March 3, 1997. See
also Item 1 above.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from
the information set forth under the caption, "Compensation of Executive
Officers," of the registrant's definitive Proxy Statement relating to the
Annual Meeting of Stockholders to be held March 3, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from
the information set forth under the caption, "Ownership of Management and
Principal Stockholders," of the registrant's definitive Proxy Statement
relating to the Annual Meeting of Stockholders to be held on March 3, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from
the information set forth under the captions, "Compensation Committee
Interlocks and Insider Participation" and "Transactions With the Company," of
the registrant's definitive Proxy Statement relating to the Annual Meeting of
Stockholders to be held on March 3, 1997.
20
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) See Index to Consolidated Financial Statements at Item 8. of this report.
EXHIBIT DESCRIPTION
------- -----------
3.1 Certificate of Incorporation of the Registrant, as amended
(Incorporated by reference from Exhibit 3.1 to Registration
Statement No. 333-0094)
3.2 By-laws of the Registrant (Incorporated by reference from
Exhibit 3.2 to Registration Statement No. 333-0094)
4.1 Specimen Common Stock Certificate (Incorporated by reference
from Exhibit 4.1 to Registration Statement No. 333-0094)
10.1 Office building lease, dated February 24, 1994, as amended, for
the Registrant's principal executive offices (Incorporated by
reference from Exhibit 10.1 to Registration Statement
No. 333-0094)
10.2 1994 Equity Incentive Plan (Incorporated by reference from
Exhibit 3.1 to Registration Statement No. 333-0094)*
10.3 1996 Omnibus Equity Incentive Plan (Incorporated by reference
from Exhibit 10.3 to Registration Statement No. 333-0094)*
10.4 Marketing Agreement dated January 31, 1994 between the
Registrant and Shared Medical Systems Corporation
(Incorporated by reference from Exhibit 10.4 to Registration
Statement No. 333-0094)+
10.6 Promissory Note, dated May 31, 1995, issued by the Registrant
to SVB (Incorporated by reference from Exhibit 10.6 to
Registration Statement No. 333-0094)
10.7 Commercial Security Agreement, dated May 31, 1995, between the
Registrant and SVB (Incorporated by reference from Exhibit 10.7
to Registration Statement No. 333-0094)
10.8 Commercial Guaranty, dated May 31, 1995, made by J. Matthew
Mackowski for the benefit of SVB (Incorporated by reference
from Exhibit 10.8 to Registration Statement No. 333-0094)
10.9 Commercial Guaranty, dated May 31, 1995, made by Catherine C.
Roth for the benefit of SVB (Incorporated by reference from
Exhibit 10.9 to Registration Statement No. 333-0094)
10.10 Commercial Guaranty, dated May 31, 1995, made by Richard C.
Auger for the benefit of SVB (Incorporated by reference from
Exhibit 10.10 to Registration Statement No. 333-0094)
10.11 Commercial Guaranty, dated May 31, 1995, made by David M. Roth
for the benefit of SVB (Incorporated by reference from
Exhibit 10.11 to Registration Statement No. 333-0094)
10.12 Business Loan Agreement, effective August 22, 1995, between the
Registrant and SVB (Incorporated by reference from Exhibit 10.12
to Registration Statement No. 333-0094)
10.13 Promissory Note, dated August 15, 1995, issued by the Registrant
to SVB (Incorporated by reference from Exhibit 10.13 to
Registration Statement No. 333-0094)
10.14 Commercial Security Agreement, dated August 15, 1995, between
the Registrant and SVB (Incorporated by reference from
Exhibit 10.14 to Registration Statement No. 333-0094)
10.15 Loan Modification Agreement, dated January 4, 1996, to
SVB Business Loan Agreement (Incorporated by reference from
Exhibit 10.15 to Registration Statement No. 333-0094)
10.16 Promissory Note, dated May 6, 1994, issued by the Registrant
to Wells Fargo Bank, National Association (Incorporated by
reference from Exhibit 10.16 to Registration
Statement No. 333-0094)
10.17 Note and Warrant Purchase Agreement dated December 14, 1995
between the Registrant and the Purchasers listed on Exhibit A
thereto (Incorporated by reference from Exhibit 10.17 to
Registration Statement No. 333-0094)
10.23 Advisory Agreement dated July 18, 1995 between the Registrant
and Mackowski & Shepler (Incorporated by reference from
Exhibit 10.23 to Registration Statement No. 333-0094)
10.24 Form of Indemnification Agreement between the Registrant and
its directors and executive officers (Incorporated by reference
from Exhibit 10.24 to Registration Statement No. 333-0094)
10.25 Registrant's 401(k) Plan, as amended (Incorporated by reference
from Exhibit 10.25 to Registration Statement No. 333-0094)
10.26 License Agreement, dated March 25, 1996 between the Registrant
and Blue Cross/Blue Shield of Florida (Incorporated by reference
from Exhibit 10.26 to Registration Statement No. 333-0094)+
11.1 Computation of net loss per share
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP
21
<PAGE>
+ Confidential treatment has been granted with respect to portions of this
exhibit.
* Indicates, as required by Item 14(a)(3), a management contract or
compensation plan required to be filed as an exhibit to this Form 10-K.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of fiscal 1996.
(c) See attached Exhibit Index.
(d) The following financial statement schedules are filed as part of this
report on page S-2.
Schedule II - Valuation of Qualifying Accounts
All other schedules required by Form 10-K Annual Report have been omitted
because they were not applicable, were included in the notes to the
consolidated financial statements, or were otherwise not required under
the instructions contained in Regulation S-X.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Health Systems Design Corporation
By: /s/ RICHARD C. AUGER
--------------------------------
Richard C. Auger,
Chairman and Chief Executive
Officer
Date: 12/27/96
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE DATE NAME & TITLE
--------- ---- ------------
/s/ RICHARD C. AUGER 12/27/96 Richard C. Auger, Chairman and
__________________________ __________ Chief Executive Officer
(principal executive officer)
/s/ CATHERINE C. ROTH 12/27/96
__________________________ __________ Catherine C. Roth, Director
/s/ RICHARD E. MALONE 12/27/96 Richard E. Malone, Chief Financial
__________________________ __________ Officer (principal fnancial officer
and accounting officer)
/s/ J. MATTHEW MACKOWSKI 12/27/96
__________________________ __________ J. Matthew Mackowski, Director
/S/ ARTHUR M. SOUTHAM, M.D. 12/27/96
__________________________ __________ Arthur M. Southam, M.D., Director
23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Health Systems Design Corporation:
We have audited the accompanying consolidated balance sheets of Health
Systems Design Corporation (a Delaware corporation) and subsidiary as of
September 30, 1996 and 1995, and the related consolidated statements of oper-
ations, changes in stockholders' equity (deficit) and cash flows for each of
the three years in the period ended September 30, 1996. These financial
statements are the responsibility of the Company's management. Our respon-
sibility is to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Health Systems
Design Corporation and subsidiary as of September 30, 1996 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 1996, in conformity with generally accepted
accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in Item 14 of
Form 10-K 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 the 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.
ARTHUR ANDERSEN LLP
Oakland, California
November 8, 1996
F-1
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------------
1996 1995
------------- -------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 15,254,042 $ 149,218
Accounts receivable, net of allowance for
doubtful accounts of
$100,000 and $50,000 at September 30, 1996 and 1995,
respectively 3,661,984 1,419,309
Unbilled revenue 1,469,533 650,204
Prepaid expenses 427,586 41,416
------------ ------------
Total current assets 20,813,145 2,260,147
------------ ------------
Property and equipment:
Computer equipment 2,454,204 1,049,607
Office furniture and other 865,725 442,517
------------- -------------
Total property and equipment 3,319,929 1,492,124
Less: Accumulated depreciation (765,203) (531,107)
------------- -------------
Net property and equipment 2,554,726 961,017
Deposits and other assets 83,211 166,186
Software development costs, net of accumulated
amortization of $390,508 and $155,507 at
September 30, 1996 and 1995, respectively 305,970 264,159
------------- -------------
Total assets $ 23,757,052 $ 3,651,509
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Line of credit $ - $ 508,427
Current portion of notes payable - 94,004
Current portion of capital lease obligations 3,505 26,904
Accounts payable 693,269 671,185
Accrued liabilities 746,358 214,589
Unearned revenue 1,201,913 1,564,505
Advances from stockholder - 325,000
------------- -------------
Total current liabilities 2,645,045 3,404,614
Notes payable, net of current portion - 516,092
Capital lease obligations, net of current portion - 3,505
------------- -------------
Total liabilities 2,645,045 3,924,211
------------- -------------
Stockholders' equity (deficit):
Preferred stock, $.001 par value, 1,000,000 shares
authorized, none outstanding - -
Common stock, $.001 par value, 20,000,000 shares
authorized, 6,433,766 shares issued at
September 30, 1996; 4,442,600 shares issued
and outstanding at September 30, 1995 6,434 247,165
Additional paid-in capital 22,842,130 -
Treasury stock, 2,054 shares (28,500) -
Deferred compensation (59,039) (78,795)
Retained deficit (1,649,018) (441,072)
------------- -------------
Total stockholders' equity (deficit) 21,112,007 (272,702)
------------- -------------
Total liabilities and stockholders' equity (deficit) $ 23,757,052 $ 3,651,509
============= =============
</TABLE>
The accompanying notes are an integral part of these statements
F-2
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
------------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
System sales $ 10,639,298 $ 5,560,022 $ 4,512,578
Services and other 1,812,528 1,217,215 520,454
------------ ------------ ------------
Total revenues 12,451,826 6,777,237 5,033,032
Cost of revenues 3,699,316 2,537,892 1,667,257
------------ ------------ ------------
Gross margin 8,752,510 4,239,345 3,365,775
------------ ------------ ------------
Operating expenses:
General and administrative 3,805,863 2,147,239 1,574,666
Sales and marketing 2,749,946 1,059,165 706,283
Product development 3,443,301 1,810,897 874,274
------------ ------------ ------------
Total operating expenses 9,999,110 5,017,301 3,155,223
------------ ------------ ------------
Income (loss) from operations (1,246,600) (777,956) 210,552
Interest income (expense), net 39,454 (71,335) (41,302)
------------ ------------ ------------
Income (loss) before provision for
income taxes (1,207,146) (849,291) 169,250
Benefit (provision) from income taxes (800) 96,537 (3,578)
------------ ------------ ------------
Income (loss) before cumulative effect of
change in accounting for income taxes (1,207,946) (752,754) 165,672
Cumulative effect of change in accounting
for income taxes - - (32,530)
------------ ------------ ------------
Net income (loss) $ (1,207,946) $ (752,754) $ 133,142
============ ============ ============
Net income (loss) per share $ (0.21) $ (0.16) $ 0.03
============ ============ ============
Weighted average common and common
equivalent shares outstanding 5,737,504 4,759,635 4,756,347
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements
F-3
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ADDITIONAL RETAINED TOTAL
COMMON PAID-IN DEFERRED TREASURY EARNINGS STOCKHOLDERS'
SHARES STOCK CAPITAL COMPENSATION STOCK (DEFICIT) EQUITY (DEFICIT)
------------ ------------ ------------- ------------ ----------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1993 4,432,000 $ 165,189 $ - $ - $ - $ 178,540 $ 343,729
Net income - - - - 133,142 133,142
------------ ------------ ------------- ------------ ----------- ------------ ----------------
Balance, September 30, 1994 4,432,000 165,189 - - - 311,682 476,871
Exercise of common stock
options 10,600 3,181 - - - - 3,181
Grant of stock options - 78,795 - (78,795) - - -
Net loss - - - - - (752,754) (752,754)
------------ ------------ ------------- ------------ ----------- ------------ ----------------
Balance, September 30, 1995 4,442,600 247,165 - (78,795) - (441,072) (272,702)
Issuance of warrants to
purchase common stock - - 350,000 - - - 350,000
Excersice of warrants to
purchase common stock 95,000 95 474,905 - - - 475,000
Exercise of common stock
options 43,220 43 57,387 - - 57,430
Amortization of deferred
compensation - - (3,996) 19,756 - - 15,760
Initial public offering,
net of issuance costs 1,855,000 1,855 21,721,110 - - - 21,722,965
Transfer of par value upon
reincorporation (242,724) 242,724 -
Purchase of treasury stock (2,054) - - - (28,500) - (28,500)
Net loss - - - - (1,207,946) (1,207,946)
------------ ------------ ------------- ------------ ----------- ------------ ----------------
Balance, September 30, 1996 6,433,766 $ 6,434 $ 22,842,130 $ (59,039) $ (28,500) $(1,649,018) $ 21,112,007
------------ ------------ ------------- ------------ ----------- ------------ ----------------
------------ ------------ ------------- ------------ ----------- ------------ ----------------
</TABLE>
The accompanying notes are an integral part of these statements
F-4
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
------------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income (loss) $(1,207,946) $ (752,754) $ 133,142
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Cumulative effect of change in accounting principle - - 32,530
Depreciation and amortization 630,085 337,717 167,101
Gain on sale of asset (2,975) - -
Amortization of deferred compensation 15,760 - -
Deferred taxes - (97,337) 2,768
Write off of debt discount 350,000 - -
Changes in current assets and liabilities:
Accounts receivable (2,242,675) 248,696 (1,010,148)
Unbilled revenue (819,329) (567,503) 83,841
Prepaids (386,170) 24,297 (7,927)
Accounts payable 22,084 474,290 119,464
Accrued liabilities 531,769 135,204 (82,207)
Unearned revenue (362,592) 503,589 854,870
------------ ------------ ------------
Net cash provided by (used in) operating activities (3,471,989) 306,199 293,434
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (2,019,119) (570,989) (255,356)
Proceeds from sale of property and equipment 33,301 15,494 -
Capitalization of software development costs (276,812) (314,041) (56,755)
Deposits and other assets 82,975 (134,052) (20,692)
------------ ------------ ------------
Net cash used in investing activities (2,179,655) (1,003,588) (332,803)
------------ ------------ ------------
Cash flows from financing activities:
Borrowings from line of credit 450,000 508,427 250,335
Payments under line of credit (958,427) (500,000) -
Borrowings from notes payable 1,500,000 514,420 -
Payments under notes payable and capital lease obligations (2,162,000) (148,413) (85,592)
Proceeds from issuance of common stock, net of issuance costs 21,722,965 - -
Advances from stockholder 175,000 325,000 -
Purchase of treasury stock (28,500) - -
Proceeds from exercise of common stock options and warrants 57,430 3,181 -
------------ ------------ ------------
Net cash provided by financing activities 20,756,468 702,615 164,743
------------ ------------ ------------
Net increase in cash 15,104,824 5,226 125,374
Cash and cash equivalents at beginning of year 149,218 143,992 18,618
------------ ------------ ------------
Cash and cash equivalents at end of year $15,254,042 $ 149,218 $ 143,992
============ ============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 105,965 $ 69,735 $ 51,978
Taxes paid $ 800 $ 2,454 $ 800
Supplemental disclosure of noncash transactions:
Purchase of equipement under capital lease obligations
and notes payable $ - $ - $ 198,758
Warrants exercised in exchange for cancellation
of notes payable $ 475,000 $ - $ -
Deferred compensation recorded related to stock
option grants $ - $ 78,795 $ -
Cancellation of deferred compensation related to stock
option cancellations $ 3,996 $ - $ -
</TABLE>
The accompanying notes are an integral part of these statements
F-5
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION:
Health Systems Design Corp. was incorporated in the State of California
on July 1, 1988. In February 1996, the Company was reorganized as Health
Systems Design Corporation (the "Company"), a Delaware holding corporation
which owns 100% of the stock of Health System Design Corp., the California
corporation. The Company is a provider of managed care information systems
software to payors and providers of managed care services. The Company
introduced its first internally developed product, DIAMOND 725B, in fiscal
1992 followed by DIAMOND 950C/S in fiscal 1995 and DIAMOND 725Q in fiscal
1996.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CASH
The Company considers cash to be all highly liquid investments with an
original maturity less than three months from the date of purchase.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of accounts receivable.
The Company believes it has addressed this risk through its credit approval
process.
ADOPTION OF ACCOUNTING PRONOUNCEMENTS
The Company is required to adopt SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for the Long-Lived Assets to be Disposed
of" beginning October 1, 1996. The Company is also required to adopt SFAS No.
123, "Accounting for Stock-Based Compensation" beginning October 1, 1996. The
Company believes the adoption of these pronouncements will not have a
material impact on the financial statements of the Company taken as a whole.
MANAGEMENT'S USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. Actual results could differ from those estimates. Such
estimates include the Company's calculation of percentage of completion for
its system implementation projects, which includes recognition of license
revenues, and an allowance for doubtful accounts.
REVENUE RECOGNITION
The Company licenses its internally developed software products and
other software products to health care organizations under the terms of
product license contracts. Individual sales may include, among others, a
combination of software license, implementation, program modifications,
training, and support. Contracts with customers may be terminated under
certain circumstances and revenues recognized could be refundable upon
termination in certain cases, including breach of contract. The termination
of customer contracts could have a material adverse effect on the Company's
business, financial condition, or results of operations.
In December 1991, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 91-1, "Software Revenue Recognition." The
Company's revenue recognition policy is in compliance with the provisions of
this SOP.
License revenue is recognized on a percentage of completion basis based
on the labor hours required to implement the system. Implementation,
modification and support fees are billed either on an hourly or monthly basis
and are recognized as services are rendered. Revenue recognized in excess of
billings is recorded as an asset (unbilled revenue). Billings in excesss of
recognized revenue is recorded as a liability (unearned revenue). Third
party software and hardware are typically billed and recognized as revenue
when delivered to the client. In January 1994, the Company entered into a
marketing agreement with another company, whereby the other company markets
certain of the Company's products to its customer base. Prepaid license fees
under this agreement are recognized when a contract between the other company
and the end-user is executed for DIAMOND 725B and are recognized for DIAMOND
950C/S upon successful implementation of the system at the other company's
end-user site. Licenses which are not prepaid are recognized ratably over
the client's contract term. Fees for support and other services are
recognized as services are rendered.
F-6
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
Costs incurred prior to the establishment of technological feasibility
are charged to expense as incurred. When technological feasibility of a
software product or significant enhancement to a software product has been
established, software development costs are capitalized. Capitalization
begins upon the establishment of a working model. Capitalization ceases when
the product is considered available for general release to customers.
Capitalized software development costs are amortized to direct costs over the
estimated economic lives of the software products based on actual sales
experience and product life expectancy. Generally, estimated economic lives
of the software products do not exceed 3 years. Capitalized software
development cost amortization was $235,001, $93,573 and $44,724 in fiscal
1996, 1995 and 1994, respectively.
PROPERTY AND EQUIPMENT
Computer equipment and office furniture are recorded at cost and are
depreciated using the straight-line method over their estimated useful lives
of five and seven years, respectively. The cost of assets retired or
otherwise disposed of and the related accumulated depreciation are removed
from the accounts, and any gain or loss is included in the results of
operations. Maintenance and repairs that do not improve or extend the life of
assets are expensed as incurred.
The Company also has entered into several capital lease arrangements for
computer and office equipment. Depreciation on this equipment is taken using
the straight-line method over the estimated life of the equipment or term of
the lease, whichever is shorter.
STOCK SPLITS
In July 1994, the Company effected a 40-for-1 common stock split. In
January 1995, the Company effected a 2-for-1 common stock split. All common
stock data in the accompanying financial statements for all years presented
have been retroactively adjusted to reflect the stock splits.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," issued in
February 1992. Under the liability method specified by SFAS No. 109, deferred
taxes are determined based on the difference between the financial statement
and tax bases of assets and liabilities as measured by the effective tax
rates. The Company is currently on the cash basis for tax reporting purposes.
The cumulative effect of the adoption of SFAS No. 109 was recorded in the
statement of operations in the amount of $32,530 for the year ended
September 30, 1994.
NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed using the weighted average
number of shares outstanding. Common equivalent shares from stock options and
warrants are excluded from the computation as their effect is not material in
fiscal 1994 and is antidilutive in fiscal 1995 and 1996, except that,
pursuant to the Securities and Exchange Commission (SEC) Staff Accounting
Bulletins, stock options and warrants issued during the 12-month period prior
to the proposed initial public offering at prices below the assumed public
offering price have been included in the calculation as if they were
outstanding for all periods prior to and through the period ended December
31, 1995, (using the treasury stock method).
RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial
statements to conform to the current year presentation.
F-7
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. LINE OF CREDIT:
In May 1995, the Company entered into a line of credit agreement with a
bank. Under the terms of the agreement, as amended, the outstanding balance
could not exceed $750,000, and interest was calculated at the bank's
reference rate plus 1.5 percent (10.25 percent at September 30, 1995).
Borrowings were limited to 70 percent of eligible accounts receivable, as
defined. The outstanding balance under the line of credit was $508,427 at
September 30, 1995. The line of credit agreement also contained restrictions
on the Company's ability to pay dividends. Repayments under the line of
credit were guaranteed by three stockholders of the Company, and were secured
by substantially all the assets of the Company. The agreement expired May
30, 1996, by which time all outstanding balances were repaid.
4. NOTES PAYABLE:
The Company's notes payable consisted of:
SEPTEMBER 30,
------------------
1996 1995
-------- --------
Bank Term Note for $500,000, secured, interest at the
bank's reference rate plus 2.75 percent (11 percent
at September 30, 1995), due in monthly installments of
$8,333 plus accrued interest through August 2000;
guaranteed by three stockholders of the Company -- $500,000
Equipment Note to borrow up to $150,000, interest rates
ranging from 10.15 percent to 11.20 percent, as determined
on the advance date; due June 1997 through March 1998;
guaranteed by three stockholders of the Company -- 110,096
-------- --------
610,096
Less: current portion -- 94,004
-------- -------
-- $516,092
======== ========
The notes payable were repaid with the proceeds of the March 5, 1996
initial public offering (See Note 11).
5. ADVANCES FROM STOCKHOLDER:
During fiscal 1996 and 1995, a stockholder of the Company made advances
to the Company totaling $175,000 and $325,000, respectively. All advances
were due upon demand, but no later than one year from the date of the advance
and bore interest at rates ranging from 5.9 to 6.1 percent. The impact of
imputing interest at the market rate is not material. The advance was repaid
with the proceeds of the March 5,1996 initial public offering (See Note 11).
F-8
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. LEASE COMMITMENTS:
The Company is obligated under certain operating leases for office space
and certain equipment. Future minimum lease payments for fiscal years ending
September 30, are as follows:
1997 $ 985,574
1998 964,930
1999 967,735
2000 214,630
2001 73,676
----------
$3,206,545
Rent expense under these operating leases was approximately $665,999,
$338,000 and $194,000 in fiscal 1996, 1995, 1994, respectively.
7. INCOME TAXES:
The provision for income taxes consisted of the following:
1996 1995 1994
------ ------ ------
FISCAL YEAR ENDED SEPTEMBER 30,
-------------------------------
Current:
Federal $ - $ - $ -
State 800 800 800
Deferred:
Federal (398,899) (362,570) 13,532
State (11,467) (131,356) (10,754)
Valuation allowance 410,366 396,589 -
--------- --------- -------
Total $ 800 $ (96,537) $ 3,578
Deferred tax liabilities and assets under FAS 109, which result from
temporary differences in the recognition of certain revenues and expenses for
financial and income tax reporting purposes, consisted of the following:
SEPTEMBER 30,
--------------------
1996 1995
-------- --------
Cash to accrual basis differences $1,263,304 -
Capitalized software costs 132,485 118,645
Depreciation 160,953 70,909
Other 38,759 -
----------- --------
Gross deferred tax liabilities 1,595,501 189,554
----------- --------
Cash to accrual basis differences - 130,960
Research and development credit carryforwards 516,874 334,012
Net operating loss carryforwards 1,885,582 116,413
Other - 4,758
---------- --------
Gross deferred tax assets 2,402,456 586,143
Deferred tax valuation allowance (806,955) (396,589)
---------- --------
Net deferred tax asset (liability) $ - $ -
========== ========
The provision for income taxes differed from the amount computed using
the statutory federal income tax rate of 34 percent as follows:
F-9
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEAR ENDED SEPTEMBER 30,
-------------------------------
1996 1995 1994
--------- --------- ---------
Statutory U.S. tax rate (34)% (34)% 34%
State taxes (6) 3 6
Research and development credit carryforwards (15) (25) (42)
Other 21 (2) 4
Valuation allowance 34 47 -
--------- --------- ---------
-% (11)% 2%
========= ========= =========
At September 30, 1996, the Company has approximately $4,914,000 and
$285,000 of federal tax net operating loss carryforwards and research and
development tax credits, respectively, which are available to reduce future
taxable income of the Company, if any. These carryforwards begin to expire in
fiscal 2007. Provisions under the Tax Reform Act of 1986 may limit the
federal net operating loss carryforwards and credits available to be used in
any given year in the event of a significant change in ownership, including the
March 5, 1996 initial public offering.
The Company has approximately $2,309,000 and $232,000 of California tax
net operating loss carryforwards and research and development tax credits,
respectively, which are available to reduce future taxable income of the
Company, if any. The carryforwards begin to expire in fiscal 2010.
8. SALES TO MAJOR CUSTOMERS:
In March, 1996, the Company executed an agreement with a health plan
which granted a perpetual license to use Diamond 950C/S along with
providing implementation services and modifications to the product. The
Company also agreed to pay royalties to the plan for modifications developed
as part of the agreement. Royalties will be based on a percentage of the
Diamond 950C/S licenses paid by the Company's clients which meet
certain criteria.
The Company recognized revenues under the Agreement of approximately
$4,156,000 in fiscal year 1996. This was approximately 33 percent of total
revenues in fiscal 1996. Billed accounts receivable under the Agreement were
approximately $1,752,000 at September 30, 1996. Unbilled revenue under the
Agreement was approximately $158,000 at September 30, 1996. Unearned revenue
under the agreement was approximately $87,000 at September 30, 1996.
In January 1994, the Company entered into a five-year marketing
agreement (the "Agreement") that grants to another company worldwide
marketing rights to certain of the Company's products for sales to providers
and combined provider/payor organizations. Under the terms of the Agreement,
the Company provides to the other company initial modifications, training,
product development, support, and marketing assistance. Payments to the
Company under the Agreement relate to sub-licensing of the product to
end-users, the performance of a set of initial software changes by the
Company, and the provision of support, marketing and training services to the
other company. Under the licensing provisions, the Company granted up to 30
licenses to the other company for sub-licensing. The Company recognized
revenues for DIAMOND 725B licenses upon execution of an end-user license by
the other party. DIAMOND 950C/S licenses are recognized upon successful
implementation at end-users. License revenue beyond the original 30 granted
will be recognized ratably over the term of the contract with the end-user.
Under the development provisions, the Company is obligated to perform a set
of software enhancements for which the Company will be paid upon the
achievement of certain milestones. The Company is recognizing revenues from
this development arrangement under the percentage-of-completion method. The
costs incurred under the development arrangement are included in product
development in the accompanying statements of operations.
The Company recognized revenues under the Agreement of approximately
$1,402,000, $1,722,000 and $1,031,000 in fiscal year 1996, 1995 and 1994,
respectively. This was approximately 11 percent, 25 percent and 21 percent of
total revenues in fiscal 1996, 1995 and 1994, respectively. Accounts
receivable under the Agreement were approximately $374,000 and $522,000 at
September 30, 1996 and 1995, respectively. Billings under the Agreement are
made upon the achievement of certain performance milestones. Unbilled revenue
under the Agreement was approximately $687,000 and $340,000 at
F-10
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996 and 1995, respectively. Unearned revenue under the
Agreement was approximately $345,000 at September 30, 1996.
For the year ended September 30, 1996, revenues under the
above-mentioned Agreements, combined with revenues from the three next
largest customers (none of which individually accounted for greater than 10
percent of Company revenues) were 56 percent of the Company's revenues. No
other single customer accounted for more than 10 percent of total revenues in
fiscal 1996, 1995 and 1994.
9. RETIREMENT PLAN:
The Company maintains a 401(k) retirement plan (the "Plan") for
full-time employees. The plan year is from January 1 to December 31, and the
discretionary employer contribution is established at the end of the plan
year. Participants become fully vested after four years of service, although
they vest incrementally on an annual basis until the four-year period is
completed. No contributions were made during the fiscal years ended
September 30, 1996 and 1995.
10. STOCK OPTION PLAN AND WARRANTS;
Effective August 5, 1994, the Company implemented a stock option plan. The
plan allows incentive stock options to be granted to employees only, while
nonstatutory stock options may be granted to both employees and consultants.
Under the terms of the plan, incentive stock options to purchase shares of
the Company's common stock must be granted at a price equal to the market
price of the stock at the date of grant except for employees who, prior to
the grant, own more than 10 percent of the voting power of all stock. The
exercise price for such employees must be no less than 110 percent of the
market price. For nonstatutory stock options, the exercise price for both
employees and consultants will be no less than 85 percent of the market
price. Both incentive stock options and nonstatutory stock options may be
exercised within ten years from the date of grant, except for employees and
consultants who own more than 10 percent of the voting power of all classes
of stock, in which case the options may be exercised within a five-year
period. Options generally vest over a five-year period. The Company has
reserved 500,000 shares of stock for grants.
On January 2, 1996, the Board of Directors authorized the 1996 Omnibus
Equity Incentive Plan, under which the Company is authorized to grant up to
500,000 shares of common stock to employees and consultants of the Company.
The stock option activity under the Stock Option and Equity Incentive
Plans during the fiscal years ended September 30, 1996, 1995, and 1994, was
as follows:
NUMBERS EXERCISE
OF SHARES PRICE VESTED
----------- ------------ ------------
Granted 133,800 $ 0.30
----------- -------------
Outstanding, September 30, 1994 133,800 $ 0.30 -
Granted 431,000 $ 1.80-$ 5.00 -
Exercised (10,600) $ 0.30 -
Canceled (66,700) $ 0.30-$ 1.80 -
----------- -------------
Outstanding, September 30, 1995 487,500 $ 0.30-$ 5.00 26,760
Granted 217,250 $14.75-$17.75 -
Exercised (43,220) $ 0.30-$ 5.00 -
Canceled (27,180) $ 1.80-$14.75 -
----------- -------------
Outstanding, September 30, 1996 634,350 $ 0.30-$17.75 111,040
=========== =============
At September 30, 1996 and 1995, there were 311,830 and 1,900 shares,
respectively, reserved and unissued under the plan.
F-11
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company records deferred compensation based on the difference
between the estimated fair value of the common stock and the exercise price
at the date of grant. In connection with options granted during fiscal 1995,
the Company recorded deferred compensation of $78,795. The deferred
compensation will be amortized to expense over the vesting period of five
years. Amortization expense of $15,760 and $0 was recorded for the fiscal
year ended September 30, 1996 and 1995, respectively.
In a December 1995 private placement, the Company issued $2,000,000 in
notes with warrants to purchase 200,000 shares of the Company's common stock
at $5.00 per share. Upon repayment of the notes, the noteholders executed
95,000 warrants. At September 30, 1996, 105,000 warrants were outstanding.
11. PUBLIC OFFERING
On March 5, 1996, the Company sold 1,855,000 shares of its common stock
through an initial public offering. As a result, the Company received net
proceeds of $21,722,965. A portion of the proceeds was immediately used to
retire short-term and long-term indebtedness to banks and other creditors. In
connection with the repayment of the private placement notes payable of
$2,000,000 of which $600,000 was paid to a stockholder, the Company recorded
a one-time, non-cash charge to interest expense of approximately $333,000 in
the second quarter of fiscal 1996 to reflect the write-off of deferred
interest. A $17,000 non-cash charge to interest expense was recorded in the
first quarter of fiscal 1996.
F-12
<PAGE>
EXHIBIT 11.1
HEALTH SYSTEMS DESIGN CORPORATION
COMPUTATION OF NET LOSS PER SHARE
<TABLE>
<CAPTION>
------------ ---------- ----------
1996 1995 1994
------------ ---------- ----------
<S> <C> <C> <C>
Net income (loss) $ (1,207,946) $ (752,754) 0 $ 133,142
============ ========== ==========
Weighted average common shares outstanding 5,656,413 4,435,288 4,432,000
Common shares, options, and warrants granted
(using the treasury stock method assuming an
initial public offering price of $13.00) since
March 16, 1995 included pursuant to Securities
and Exchange Commission Rules 81,086 324,347 324,347
------------ ---------- ----------
Weighted average common and common equivalent
shares outstanding 5,737,499 4,759,635 4,756,347
============ ========== ==========
Net income (loss) per common and common
equivalent share $ (0.21) $ (0.16) $ 0.03
============ ========== ==========
</TABLE>
S-1
<PAGE>
SCHEDULE II
HEALTH SYSTEMS DESIGN CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
<TABLE>
<CAPTION>
Additions
Balance at Charged to Balance at
Beginning of Costs and End of
Description Period Expenses Deductions Period
- -------------------------------------- ------------ ---------- ----------- ----------
<S> <C> <C> <C> <C>
For year ended September 30, 1996:
Allowance for doubtful accounts $ 50,000 $ 63,767 $ 13,767 $ 100,000
=========== ========== =========== ==========
For year ended September 30, 1995:
Allowance for doubtful accounts $ 50,000 $ 30,690 $ 30,690 $ 50,000
=========== ========== =========== ==========
For year ended September 30, 1994:
Allowance for doubtful accounts $ 50,000 $ 61,186 $ 61,186 $ 50,000
=========== ========== =========== ==========
</TABLE>
S-2
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> SEP-30-1996
<CASH> 15,254,042
<SECURITIES> 0
<RECEIVABLES> 3,761,984
<ALLOWANCES> 100,000
<INVENTORY> 0
<CURRENT-ASSETS> 20,813,145
<PP&E> 3,319,929
<DEPRECIATION> 765,203
<TOTAL-ASSETS> 23,757,052
<CURRENT-LIABILITIES> 2,645,045
<BONDS> 0
0
0
<COMMON> 6,434
<OTHER-SE> 21,105,573
<TOTAL-LIABILITY-AND-EQUITY> 23,757,052
<SALES> 0
<TOTAL-REVENUES> 12,451,826
<CGS> 0
<TOTAL-COSTS> 3,699,316
<OTHER-EXPENSES> 9,999,110
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (39,454)<F1>
<INCOME-PRETAX> (1,207,146)
<INCOME-TAX> 800
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,207,946)
<EPS-PRIMARY> (0.21)
<EPS-DILUTED> (0.21)
<FN>
<F1>NET OF INTEREST (INCOME)
</FN>
</TABLE>
