<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
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)
<TABLE>
<S> <C>
DELAWARE 94-3235734
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
</TABLE>
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:
<TABLE>
<CAPTION>
Name of each exchange on which
Title of each Class registered
<S> <C>
NONE NONE
</TABLE>
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. /X/
As of November 29, 1997, 6,534,807 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 $27,532,563.
Documents incorporated by reference: Definitive proxy statement for the
company's annual meeting of stockholders to be held on March 24, 1998--Part III
of this Form 10-K.
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<PAGE>
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 725, DIAMOND 950C/S and DIAMOND 725Q. 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 supplier of information
processing systems and services to health care organizations.
The DIAMOND products are UNIX-based 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 725 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 725. 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
introduction of DIAMOND 950C/S and other factors, the Company has experienced
continued growth in its customer base. Of the Company's 101 customers at
September 30, 1997, 19 were added during fiscal 1997.
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 ("MSOs") 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
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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.
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 725,
DIAMOND 950C/S and DIAMOND 725Q. 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
<TABLE>
<CAPTION>
MODULE DESCRIPTION
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
Members and Groups...................................... Supports enrollment processes
Maintains eligibility, benefit and member-level provider
assignment information
Electronic Data Interchange (EDI)....................... 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
Generates full 1099 reporting
Premium Billing and Accounts Receivable................. Supports premium billing and accounts receivable
</TABLE>
3
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<TABLE>
<CAPTION>
MODULE DESCRIPTION
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
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
</TABLE>
DIAMOND 725 is the Company's initial internally developed managed care
information system. Introduced in 1992, DIAMOND 725 is designed to address the
needs of a wide spectrum of payor and provider organizations. The functionality
provided by DIAMOND 725 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 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 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 725, 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 725 and DIAMOND 725Q range from four
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.
4
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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 rights to
receive unspecified product updates, upgrades and enhancements, telephone and
dial-up support and on-site reviews.
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, 1997, the Company's direct sales force consisted of 9 account
executives located in the Company's Oakland, California; Atlanta, Georgia; Oak
Brook, Illinois and Novi, Michigan offices. In addition to this sales force, HSD
employs a 17-person marketing, sales support and product specialist team. To
increase market share in other segments not fully addressed by HSD directly, the
Company has entered into strategic alliances with various service organizations,
third party hardware and software vendors. 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.
Pursuant to the SMS Agreement, SMS was granted 30 software licenses for
resale at a stated price. For these 30 licenses, the Company recognizes Diamond
725 license fees when a Diamond 725 contract between SMS and the end-user is
executed, and recognizes Diamond 950 C/S license fees upon successful
implementation of the system at the site of an SMS end-user. For term license
agreements, 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. For those licenses after the first 30 licenses under the original
agreement, SMS pays 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. During fiscal 1997 and 1996, approximately 2% and 11%,
respectively, of the Company's total revenues were generated by SMS.
In December 1997, the Company entered into an amendment to the SMS Agreement
for the purpose of resolving certain disagreements between the parties and
jointly pursuing opportunities in the European payor organization markets,
amongst other matters. The amendment provides for a $4 million credit pool
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against which SMS may charge billings for services rendered by the Company, as
well as future royalties payable by SMS to license the Diamond products in
Europe. Because of the credit pool, the Company is not expected to generate
significant revenues from SMS in the near future. In addition, the Company has
agreed to provide certain services and enhancements to the Diamond software for
SMS's payor markets. In return, SMS will undertake significant investments in
the European payor organization markets and has agreed not to initiate
litigation for certain matters, provided the Company satisfies specified
obligations. As a result of this amendment, the Company accrued approximately
$800,000 as of September 30, 1997 to cover anticipated costs related to
performance disagreements under the original SMS Agreement.
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
1992 AND FISCAL FISCAL FISCAL FISCAL FISCAL
CUSTOMER PRIOR 1993 1994 1995 1996 1997 TOTAL
- ---------------------------------------- -------- ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
HMOs.................................... 1 1 6 -- 7 10 25
Provider organizations.................. -- 1 1 8 13 8 31
PPOs.................................... 1 -- 2 4 2 -- 9
TPAs.................................... 2 3 2 4 -- -- 11
Managed Medicaid and Medicare risk
plans................................. -- 3 6 10 5 1 25
Total systems......................... 4 8 17 26 27 19 101
</TABLE>
PRODUCT DEVELOPMENT. To date, the Company has concentrated its product
development efforts on the DIAMOND products. The Company has used
object-oriented technologies that simplify the development, maintenance and
customization of its products. At September 30, 1997, the Company had 47
employees in the engineering department, which is responsible for product
development and technical services. During fiscal 1997, 1996 and 1995, the
Company's product development expenses, net of capitalized development expenses,
were approximately $5,023,655, $3,443,000, and $1,811,000, respectively. In most
cases, product enhancements and modifications funded by customers are
subsequently incorporated into the 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, (now part of HBOC Inc.), Computer
Science Corporation, Erisco (a division of the Cognizant Corporation formerly
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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 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, 1997, the Company employed 139 people on a
full-time basis, including 47 in engineering, 26 in sales and marketing, 12 in
client support, 29 in client services and 25 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.
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EXECUTIVE OFFICERS OF THE COMPANY. The executive officers of the Company
and their ages as of September 30, 1997, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------------------- --- ------------------------------------------
<S> <C> <C>
Richard C. Auger............................ 53 Chairman of the Board
Russell J. Harrison......................... 52 President and Chief Executive Officer
Steven J. Correia........................... 33 Acting Chief Financial Officer
</TABLE>
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
and Chief Executive Officer until August 1997. 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.
Russell J. Harrison has served as President and Chief Executive Officer
since August, 1997. Mr. Harrison was Vice President and Chief Information
Officer at Paris-based SITA Globetel Company S.C. from March 1996 to August
1997. Prior to his time at SITA Globetel, Mr. Harrison served as Chief Executive
Officer of 3Net Systems, a provider of client/server solutions to the healthcare
industry, from August 1993 to September 1995, and Chairman until November 1995,
and has also served as Chief Information Officer of McKesson Corporation from
September 1991 to August 1993. Mr. Harrison was also founding President of AMR
Information Systems, Inc., a wholly owned subsidiary of AMR Corporation, parent
of American Airlines from 1986 to 1991 and also served as Senior Vice President
at Bank of America 1975 to 1986.
Steven J. Correia has served as Acting Chief Financial Officer of the
Company since April 1997. From August 1994 to April 1997, Mr. Correia was
Accounting Manager of the Company. Mr. Correia worked as manager for a regional
public accounting firm from August 1986 to August 1994. Mr. Correia holds a B.S.
degree in Business Administration from California State University at Hayward
and is a Certified Public Accountant in the state of California.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, customer support
and research and development facility is located in approximately 60,000 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; Oak Brook, Illinois and Novi, Michigan. 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 during the fiscal year for the Company's common
stock as reported by the NASDAQ National Market.
<TABLE>
<CAPTION>
FISCAL 1996 HIGH LOW
- --------------------------------------------------------------------------------- ------- -------
<S> <C> <C>
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
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1997 HIGH LOW
- --------------------------------------------------------------------------------- ------- -------
<S> <C> <C>
First Quarter.................................................................... 12 7 3/4
Second Quarter................................................................... 9 5/8 6
Third Quarter.................................................................... 7 3/8 3 7/8
Fourth Quarter................................................................... 15 5 7/8
</TABLE>
As of November 29, 1997, there were approximately 55 registered 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.
At the effective date of the initial public offering, March 5, 1996
(Registration Statement #333-00094), the Company received $21,723,000, net of
expenses, as a result of the issuance of its common stock. The proceeds to date
have been used to pay off approximately $3,120,000 of short and long-term debt
and to purchase approximately $3,506,000 of furniture and equipment.
Approximately $3,900,000 has been used as working capital.
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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 has been derived
from the Company's financial statements.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
System sales................................................. $ 14,269 $ 10,639 $ 5,560 $ 4,513 $ 2,180
Services and other........................................... 2,497 1,813 1,217 520 214
--------- --------- --------- --------- ---------
Total revenues............................................. 16,766 12,452 6,777 5,033 2,394
Cost of revenues............................................... 6,804 3,699 2,538 1,667 844
--------- --------- --------- --------- ---------
Gross margin................................................... 9,962 8,753 4,239 3,366 1,550
--------- --------- --------- --------- ---------
Operating expenses:
General and administrative................................... 5,646 3,806 2,147 1,575 858
Sales and marketing.......................................... 3,821 2,750 1,059 706 473
Product development.......................................... 5,023 3,444 1,811 874 172
--------- --------- --------- --------- ---------
Total operating expenses................................... 14,490 10,000 5,017 3,155 1,503
--------- --------- --------- --------- ---------
Income (loss) from operations.............................. (4,528) (1,247) (778) 211 47
Interest, net.................................................. 673 40 (72) (42) (42)
--------- --------- --------- --------- ---------
Income (loss) before provision for income taxes............ (3,855) (1,207) (850) 169 5
Benefit (provision) for income taxes........................... (1) (1) 97 (4) (1)
--------- --------- --------- --------- ---------
Income (loss) before cumulative effect of change in
accounting for income taxes.............................. (3,856) (1,208) (753) 165 4
Cumulative effect of change in accounting for income taxes..... 0 0 0 (32) 0
--------- --------- --------- --------- ---------
Net income (loss).............................................. $ (3,856) $ (1,208) $ (753) $ 133 $ 4
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) per share.................................... $ (0.60) $ (0.21) $ (0.16) $ 0.03 $ --
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average shares outstanding............................ 6,479 5,737 4,760 4,756 4,756
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital (deficit)..................................... $ 13,347 $ 18,168 $ (1,145) $ (101) $ 83
Total assets.................................................. 22,077 23,757 3,652 2,686 1,262
Short-term borrowings......................................... -- 4 954 627 311
Long-term borrowings.......................................... -- -- 520 147 100
Total stockholders' equity (deficit).......................... 17,459 21,112 (273) 477 344
</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 725 (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 7%, 0.3%, and 3% of the Company's total revenues in
fiscal 1997, 1996 and 1995, respectively.
The Company expects that license fee and service revenues associated with
DIAMOND 725, 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 was granted 30 software licenses for resale at a
stated price. For these 30 licenses, the Company recognizes DIAMOND 725 license
fees when a DIAMOND 725 contract between SMS and the end-user is executed, and
recognizes DIAMOND 950C/S license fees upon successful implementation of the
system at the site of an SMS end-user. For term license agreements, 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. For those
licenses after the first 30 licenses under the original agreement, SMS pays the
Company a percentage of the license fee charged to its end-users. SMS must also
pay HSD a percentage of all support fees paid to SMS by its end-users. The SMS
relationship accounted for 2%, 11%, and 25% of total revenues in fiscal 1997,
1996 and 1995, respectively. Because of the amendment to the SMS Agreement, as
described in Item 1--RELATIONSHIP WITH SMS, revenues from SMS are expected to be
negligible in the near future, until the credit pool is exhausted.
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
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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.
YEAR 2000 ISSUES
In considering potential costs associated with modifying computer software
for the year 2000, the Company does not expect to incur any significant costs
for its internal computer systems or the systems it has developed and is
marketing to its customers.
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:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER
30,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Revenues:
System sales.............................................. 85.1% 85.4% 82.0%
Services and other........................................ 14.9 14.6 18.0
------- ------- -------
Total revenues.......................................... 100.0 100.0 100.0
Cost of revenues............................................ 40.6 29.7 37.4
------- ------- -------
Gross margin................................................ 59.4 70.3 62.6
------- ------- -------
Operating expenses:
General and administrative................................ 33.6 30.6 31.8
Sales and marketing....................................... 22.8 22.1 15.6
Product development....................................... 30.0 27.6 26.7
------- ------- -------
Total operating expenses................................ 86.4 80.3 74.1
Loss from operations.................................... (27.0) (10.0) (11.5)
Interest expense, net....................................... 4.0 0.3 (1.0)
------- ------- -------
Loss before provision for income taxes.................. (23.0) (9.7) (12.5)
Benefit (provision) for income taxes........................ -- -- 1.4
------- ------- -------
Net loss.................................................... (23.0)% (9.7)% (11.1)%
------- ------- -------
------- ------- -------
</TABLE>
REVENUES
Total revenues were $16,766,000, $12,452,000, and $6,777,000 in fiscal 1997,
1996 and 1995, respectively, representing increases of 35% from fiscal 1996 to
fiscal 1997 and 84% from fiscal 1995 to fiscal 1996. The growth in total
revenues is attributable primarily to increases in modification revenues for
DIAMOND 950C/S, increases in support revenues from an increased client base and
a larger portion of third party hardware and software sales. The Company's
relationship with Blue Cross and Blue Shield of Florida, which commenced in
November 1995, accounted for revenues of $3,799,000 in fiscal 1997. The
Company's relationship with another "Blue," Blue Cross and Blue Shield of North
Carolina, which commenced in January 1997, accounted for revenues of $1,922,000
in fiscal 1997. The SMS marketing relationship accounted for revenues of
$415,000, $1,402,000, and $1,722,000 in fiscal 1997, 1996 and 1995,
respectively. Revenues from this relationship are expected to be significantly
lower in the future due to the amendment
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described in Item 1. License fees per customer continued to increase 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 $14,269,000, $10,639,000, and
$5,560,000 in fiscal 1997, 1996 and 1995, respectively, representing increases
of 34% from fiscal 1996 to fiscal 1997 and 91% from fiscal 1995 to fiscal 1996.
Revenues associated with reselling third-party software and hardware represented
13%, 5%, and 11% of total revenues in fiscal 1997, 1996 and 1995, respectively,
of which revenues associated with sales of third-party hardware represented 7%,
0.3%, and 3% in fiscal 1997, 1996 and 1995, respectively. In fiscal 1997,
DIAMOND 725 accounted for approximately 36% of systems sales revenues, DIAMOND
950C/S accounted for approximately 62% of system sales revenues, and DIAMOND
725Q accounted for approximately 2% of systems sales revenue. 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. 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 $2,497,000,
$1,813,000, and $1,217,000 in fiscal 1997, 1996 and 1995, respectively,
representing increases of 38% from fiscal 1996 to fiscal 1997 and 49% from
fiscal 1995 to fiscal 1996. 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 725. Services
and other revenues are comprised of system support, consulting and training
revenues.
COST OF REVENUES. The cost of revenues was $6,804,000, $3,699,000, and
$2,538,000 in fiscal 1997, 1996 and 1995, respectively, representing increases
of 84% from fiscal 1996 to fiscal 1997 and 46% from fiscal 1995 to fiscal 1996.
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, as well as a
significant cost accrual related to the execution of the SMS amendment referred
to in Item 1. Cost of revenues as a percentage of total revenues was 40.6%,
29.7% and 37.4% for the years ended September 30, 1997, 1996 and 1995,
respectively. The cost of revenues 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 and was higher in fiscal 1997 due to the SMS accrual referred to in Note
12 of the financial statements. The cost of revenues 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
$5,646,000, $3,806,000, and $2,147,000 in fiscal 1997, 1996 and 1995,
respectively, representing increases of 48% from fiscal 1996 to fiscal 1997 and
77% from fiscal 1995 to fiscal 1996. The increase in general and administrative
expenditures was due primarily to staff additions and infrastructure to support
the Company's expanded operations. The Company believes that the level of
general and administrative expenses will continue to increase, although at a
slower rate 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 $3,821,000,
$2,750,000, and $1,059,000 in fiscal 1997, 1996 and 1995, respectively,
representing increases of 39% from fiscal 1996 to fiscal 1997 and 160% from
fiscal 1995 to fiscal 1996. The increase in sales and marketing expenses in
fiscal 1997 and 1996 was attributable to the growth of the Company's sales
force, associated support personnel and increased marketing and promotional
activities, although the rate of growth of these expenses decreased in fiscal
1997. During fiscal 1997 and 1996, HSD aggressively expanded its direct sales
force. Sales and marketing
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<PAGE>
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 $5,023,000 $3,444,000, and $1,811,000 in fiscal 1997,
1996 and 1995, respectively, representing increases of 46% from fiscal 1996 to
fiscal 1997 and 90% from fiscal 1995 to fiscal 1996. 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 $685,000, $277,000, and $314,000 in
product development costs in fiscal 1997, 1996 and 1995, 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 $673,000, $40,000, and
($72,000) in fiscal 1997, 1996 and 1995, respectively. The interest income in
fiscal 1997 and fiscal 1996 was the result of the cash proceeds from the initial
public offering completed in March 1996. 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 consisted 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), ($1,000),
and $97,000 in fiscal 1997, 1996 and 1995, respectively. Effective October 1,
1993, the Company adopted Statement of Financial Accounting Standards No. 109
("SFAS No. 109"), "Accounting for Income Taxes," whereby income taxes are
accounted for under the liability method. For financial reporting purposes, a
100% valuation allowance at September 30, 1997 has been recorded to offset the
deferred tax assets recognized under SFAS No. 109 because the Company has
historically not achieved significant levels of profitability, and there is
inherent uncertainty as to when the Company will achieve future profitability.
ADOPTION OF ACCOUNTING PRONOUNCEMENTS
The Company was 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 was also required to adopt SFAS No. 123,
"Accounting for Stock-Based Compensation" beginning October 1, 1996. The
adoption of these pronouncements did not have a material impact on the financial
statements of the Company taken as a whole.
For the year ending September 30, 1998, the Company will report its Earnings
per Share (EPS) based upon the recently issued Statement of Financial Accounting
Standards No. 128 (SFAS No. 128), "Earnings per Share." There is no pro forma
effect of this accounting change on the year ended September 30, 1997. For the
year ending September 30, 1999, the Company will report Comprehensive Income
based upon the recently issued Statement of Financial Standards No. 130 (SFAS
No. 130), "Comprehensive Income." There is no pro forma effect of this
accounting change on the year ended September 30, 1997.
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 ($2,030,000), ($3,472,000), and $306,000 in fiscal
1997, 1996, and 1995, respectively. Net cash provided by operating activities in
fiscal 1995 consisted primarily of an increase in unearned revenue and accounts
payable
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<PAGE>
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. Net cash used in operations in fiscal 1997
consisted primarily of a net loss and an increase in accounts receivable offset
by an increase in accounts payable and accruals and depreciation and
amortization.
Net cash used in investing activities was $2,214,000, $2,180,000, and
$1,004,000 in fiscal 1997, 1996, and 1995, 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 $277,000
in fiscal 1996 to $684,000 in fiscal 1997 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 $184,000, $20,752,000, and
$703,000 in fiscal 1997, 1996 and 1995, 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 and an
initial public offering of the Company's common stock in fiscal 1996, and
proceeds from exercise of common stock options in fiscal 1997.
As of September 30, 1997, 1996 and 1995, the Company had cash in the amount
of $11,195,000, $15,254,000, and $149,000.
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.
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 and has achieved limited acceptance to date.
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/
15
<PAGE>
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 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 1997, approximately 2% 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.
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In December 1997, the Company executed an amendment to the SMS Agreement for
the purpose of resolving certain disagreements between the parties and jointly
pursuing opportunities in the European payor organization markets, amongst other
matters. The amendment provides for a $4 million credit pool against which SMS
may charge billings for services rendered by the Company, as well as future
royalties payable by SMS to license the Diamond products in Europe. Because of
the credit pool, the Company is not expected to generate significant revenues
from SMS in the near future. In addition, the Company has agreed to provide
certain services and enhancements to the Diamond software for SMS's payor
markets. In return, SMS will undertake significant investments in the European
payor organization markets and has agreed not to initiate litigation for certain
matters, provided the Company satisfies specified obligations. As a result of
this amendment, the Company accrued approximately $800,000 as of September 30,
1997 to cover anticipated costs related to performance disagreements under the
original SMS Agreement.
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.
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 1997 and 1996 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 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
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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 $3,856,000, $1,208,000 and $753,000 for the
fiscal years ended September 30, 1997, 1996, and 1995 respectively. As of
September 30, 1997, the Company had an accumulated deficit of approximately
$5,505,000. 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.
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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 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.
19
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Financial Statements:
Report of Independent Public Accountants................................................................. 20
Consolidated Balance Sheets as of September 30, 1997 and 1996............................................ 21
Consolidated Statements of Operations for the fiscal years ended September 30, 1997, 1996 and 1995....... 22
Consolidated Statements of Stockholders' Equity for the fiscal years ended September 30, 1997, 1996 and
1995................................................................................................... 23
Consolidated Statements of Cash Flows for the fiscal years ended September 30, 1997, 1996 and 1995....... 24
Notes to Consolidated Financial Statements............................................................... 25
</TABLE>
20
<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, 1997 and 1996, and the related consolidated statements of
operations, changes in stockholders' equity (deficit) and cash flows for each of
the three years in the period ended September 30, 1997. These consolidated
financial statements and the schedules referred to below are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements and schedules 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, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended September 30, 1997, 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
San Francisco, California
November 13, 1997 (except with respect to the matter discussed in Note 12, as to
which the date is December 23, 1997)
21
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............. $11,194,757 $15,254,042
Accounts receivable, net of allowance
for doubtful accounts of $193,000
and $100,000 at September 30, 1997
and 1996, respectively.............. 5,208,056 3,661,984
Unbilled revenue...................... 994,421 1,469,533
Prepaid expenses...................... 568,266 427,586
----------- -----------
Total current assets................ 17,965,500 20,813,145
----------- -----------
Property and equipment:
Computer equipment.................... 3,636,153 2,454,204
Office furniture and other............ 1,149,701 865,725
----------- -----------
Total property and equipment........ 4,785,854 3,319,929
Less: Accumulated depreciation...... (1,599,767) (765,203)
----------- -----------
Net property and equipment.......... 3,186,087 2,554,726
Deposits and other assets............... 127,000 83,211
Software development costs, net of
accumulated amortization of $582,752
and $390,508 at September 30, 1997 and
1996, respectively.................... 798,540 305,970
----------- -----------
Total assets........................ $22,077,127 $23,757,052
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease
obligations......................... $ -- $ 3,505
Accounts payable...................... 1,202,704 693,269
Accrued liabilities................... 1,740,674 746,358
Unearned revenue...................... 1,675,265 1,201,913
----------- -----------
Total current liabilities........... 4,618,143 2,645,045
Stockholders' equity:
Preferred stock, $.001 par value,
1,000,000 shares authorized, none
outstanding......................... -- --
Common stock, $.001 par value,
20,000,000 shares authorized,
6,533,406 shares and 6,433,766
shares issued and outstanding at
September 30, 1997 and 1996,
respectively........................ 6,533 6,434
Additional paid-in capital.............. 23,029,552 22,842,130
Treasury stock, 2,054 shares............ (28,500) (28,500)
Deferred compensation................... (43,279) (59,039)
Retained deficit........................ (5,505,322) (1,649,018)
----------- -----------
Total stockholders' equity.............. 17,458,984 21,112,007
----------- -----------
Total liabilities and stockholders'
equity............................ $22,077,127 $23,757,052
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements
22
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
------------------------------------
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Revenues:
System sales.......................... $14,268,604 $10,639,298 $5,560,022
Services and other.................... 2,496,921 1,812,528 1,217,215
----------- ----------- ----------
Total revenues...................... 16,765,525 12,451,826 6,777,237
Cost of revenues........................ 6,803,611 3,699,316 2,537,892
----------- ----------- ----------
Gross margin........................ 9,961,914 8,752,510 4,239,345
----------- ----------- ----------
Operating expenses:
General and administrative............ 5,646,031 3,805,863 2,147,239
Sales and marketing................... 3,820,733 2,749,946 1,059,165
Product development................... 5,023,655 3,443,301 1,810,897
----------- ----------- ----------
Total operating expenses............ 14,490,419 9,999,110 5,017,301
----------- ----------- ----------
Loss from operations................ (4,528,505) (1,246,600) (777,956)
Interest income (expense), net.......... 673,251 39,454 (71,335)
----------- ----------- ----------
Loss before provision for income
taxes............................. (3,855,254) (1,207,146) (849,291)
Benefit (provision) for income taxes.... (1,050) (800) 96,537
----------- ----------- ----------
Net loss................................ $(3,856,304) $(1,207,946) $ (752,754)
----------- ----------- ----------
----------- ----------- ----------
Net loss per share...................... $ (0.60) $ (0.21) $ (0.16)
----------- ----------- ----------
----------- ----------- ----------
Weighted average common shares
outstanding........................... 6,478,789 5,737,504 4,759,635
----------- ----------- ----------
----------- ----------- ----------
</TABLE>
The accompanying notes are an integral part of these statements
23
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
ADDITIONAL RETAINED STOCKHOLDERS'
COMMON PAID-IN TREASURY DEFERRED EARNINGS EQUITY
SHARES STOCK CAPITAL STOCK COMPENSATION (DEFICIT) (DEFICIT)
--------- --------- ----------- ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
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
Exercise 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 (28,500) (59,039) (1,649,018) 21,112,007
Exercise of options and warrants to
purchase common stock................. 99,640 99 187,422 -- -- -- 187,521
Amortization of deferred compensation... -- -- -- -- 15,760 -- 15,760
Net loss................................ -- -- -- -- -- (3,856,304) (3,856,304)
--------- --------- ----------- ---------- ------------ ----------- -------------
Balance, September 30, 1997............. 6,533,406 $ 6,533 $23,029,552 $(28,500) $(43,279) $(5,505,322) $17,458,984
--------- --------- ----------- ---------- ------------ ----------- -------------
--------- --------- ----------- ---------- ------------ ----------- -------------
</TABLE>
The accompanying notes are an integral part of these statements
24
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net Loss.............................. $(3,856,304) $(1,207,946) $ (752,754)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Depreciation and amortization....... 1,036,032 630,085 337,717
(Gain) loss on sale of assets....... 9,809 (2,975) --
Amortization of deferred
compensation...................... 15,760 15,760 --
Deferred taxes...................... -- -- (97,337)
Write off of debt discount.......... -- 350,000 --
Changes in current assets and
liabilities:
Accounts receivable............... (1,546,072) (2,242,675) 248,696
Unbilled revenue.................. 475,112 (819,329) (567,503)
Prepaid expenses.................. (140,680) (386,170) 24,297
Accounts payable.................. 508,935 22,084 474,290
Accrued liabilities............... 994,316 531,769 135,204
Unearned revenue.................. 473,352 (362,592) 503,589
----------- ----------- -----------
Net cash provided by (used in)
operating activities.......... (2,029,740) (3,471,989) 306,199
----------- ----------- -----------
Cash flows from investing activities:
Purchases of property and equipment... (1,487,458) (2,019,119) (570,989)
Proceeds from sale of property and
equipment........................... 2,500 33,301 15,494
Capitalization of software development
costs............................... (684,814) (276,812) (314,041)
Deposits and other assets............. (43,789) 82,975 (134,052)
----------- ----------- -----------
Net cash used in investing
activities.................... (2,213,561) (2,179,655) (1,003,588)
----------- ----------- -----------
Cash flows from financing activities:
Borrowings from line of credit........ -- 450,000 508,427
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........... (3,505) (2,162,000) (148,413)
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................ 187,521 57,430 3,181
----------- ----------- -----------
Net cash provided by financing
activities.................... 184,016 20,756,468 702,615
----------- ----------- -----------
Net increase (decrease) in
cash.......................... (4,059,285) 15,104,824 5,226
Cash and cash equivalents at beginning
of year............................... 15,254,042 149,218 143,992
----------- ----------- -----------
Cash and cash equivalents at end of
year.................................. $11,194,757 $15,254,042 $ 149,218
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure of cash flow
information:
Interest paid......................... $ -- $ 105,968 $ 69,735
Taxes paid............................ $ 1,050 $ 800 $ 2,454
Supplemental disclosure of noncash
transactions:
Warrants exercised in exchange for
cancellation of note 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
25
<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 725, in fiscal 1992 followed by DIAMOND 950C/S in
fiscal 1995 and DIAMOND 725Q in fiscal 1996.
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPALS OF CONSOLIDATION
The Consolidated financial statements include the accounts of Health Systems
Design Corporation and its subsidiary. All intercompany accounts and
transactions have been eliminated.
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 BUSINESS RISKS
The market for the Company's products and services is characterized by
intense competition, rapid technological developments, frequent new product
introductions, and evolving industry standards. Accordingly, the Company is
required to continually improve the performance, features and reliability of its
products and develop and maintain strategic relationships with distributors and
with other service organizations. In addition, substantially all of the
Company's revenue is derived from its three principal products.
The Company operates in the United States, but has contracts in progress in
South Africa, New Zealand, Mexico and Greece. These contracts could be impacted
by the economic and political stability of these nations.
See Note 8 for discussion of sales to major customers.
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 contract approval process.
26
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
ADOPTION OF ACCOUNTING PRONOUNCEMENTS
For the year ending September 30, 1998, the Company will report its Earnings
per Share (EPS) based upon the recently issued Statement of Financial Accounting
Standards No. 128 (SFAS No. 128), "Earnings per Share". The pro forma effect of
this accounting change on the year ended September 30, 1997 is:
<TABLE>
<S> <C>
Primary EPS as reported................................... $ (0.60)
Pro forma effect of SFAS No. 128.......................... $ 0.00
Basic EPS pro forma....................................... $ (0.60)
Fully diluted EPS as reported............................. $ (0.60)
Pro forma effect of SFAS No. 128.......................... $ 0.00
Diluted EPS pro forma..................................... $ (0.60)
</TABLE>
For the year ending September 30, 1999, the Company will report
Comprehensive Income based upon the recently issued Statement of Financial
Accounting Standards No. 130 (SFAS No. 130), "Comprehensive Income". The pro
forma effect of this accounting change on the year ended September 30, 1997 is:
<TABLE>
<S> <C>
Net loss as reported...................................... $ (3,856,304)
Pro forma effect of SFAS No. 130.......................... $ 0
Comprehensive income pro forma............................ $ (3,856,304)
</TABLE>
The Company adopted 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 also adopted SFAS No. 123, "Accounting for
Stock-Based Compensation", beginning October 1, 1996. The adoption of these
pronouncements did not have a material impact on the consolidated financial
statements of the Company taken as a whole.
MANAGEMENT'S USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that effect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from those estimates.
Significant estimates made by management include revenue recognition under the
percentage-of-completion method for its license contracts which require extended
installation periods, determination of technological feasibility of software
under development and related research and development cost capitalization,
product life amortization periods for capitalized software costs, and allowance
for doubtful accounts receivable, and certain other reserves, including a
reserve for commitments under a marketing agreement (see Note 12).
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
27
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
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
(AICPA) 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. In October, 1997, the AICPA issued SOP 97-2, "Software Revenue
Recognition," which the Company is required to adopt as of October 1, 1998. The
Company believes that the adoption of this pronouncement will not have a
material impact on its revenue recognition policy nor on the financial
statements taken as a whole.
The Company generates revenues from licensing the rights to use its software
products directly to end users and indirectly through distributors. The Company
also generates revenues from sales of post-contract support, implementation and
modification services, and training services performed for customers who license
the Company's products.
If collection is probable, the Company generally recognizes license revenue
on a percentage of completion basis based on the labor hours required to
implement the system. If there are no significant post-delivery obligations and
if collection is probable, the Company recognizes license revenue upon shipment
of the software to end users. If a software license agreement provides for
acceptance criteria that extend beyond the published specifications of the
applicable product, then revenues are recognized upon the earlier of customer
acceptance or the expiration of the acceptance period. If discounts are granted
on purchase of future products, the discount is allocated pro rata over the
current and potential future product sale. In situations where there are
undelivered elements that are critical to functionality of the software product,
the entire license fee is deferred.
Implementation, modification and training fees are billed either on an
hourly or a monthly basis and are recognized as services are rendered. Third
party software and hardware are typically billed and recognized as revenue when
delivered to the end user.
Post-contract support services are billed on a monthly basis. Customers who
purchase post-contract support services under maintenance agreements have the
right to receive unspecified product updates, upgrades and enhancements.
Customers that do not purchase post-contract support must purchase product
updates, upgrades and enhancements under separate agreements that are subject to
the criteria of the Company's revenue recognition policy. Revenues from
post-contract support services are recognized ratably over the term of the
support period. If post-contract support services are included free or at a
discount in a license agreement, such amounts are allocated out of the license
fee at their fair market value based on the value established by independent
sale of such post-contract support services to customers.
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 (see Notes 8 and 12). License fees under this agreement are
recognized when a contract between the other company and the end-user is
executed for DIAMOND 725 and are recognized for DIAMOND 950C/S upon successful
implementation of the system at the other company's end-user site. Revenues
under term license agreements are recognized ratably over the client's contract
term. Fees for support and other services are recognized as services are
rendered.
Revenue recognized in excess of billing is recorded as an asset (unbilled
revenue). Billings in excess of recognized revenue is recorded as a liability
(unearned revenue).
28
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs in accordance with SFAS
No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or
otherwise financed." 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 $192,244, $235,001 and $93,573 in fiscal 1997, 1996 and 1995,
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
three 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.
INCOME TAXES
The Company provides 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
income 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. A valuation allowance is placed on the deferred tax assets to reduce
them to their net realizable value. The Company was on the cash basis of
accounting for tax reporting purposes during the fiscal years ended September
30, 1996 and 1995 and changed to the accrual basis of accounting as of October
1, 1996.
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 antidilutive in fiscal 1997 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 initial public
offering date (using the treasury stock method).
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
29
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. LINE OF CREDIT: (CONTINUED)
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 had been
repaid.
4. RELATED PARTY TRANSACTIONS:
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 was not material. The advance was repaid with the
proceeds of the March 5, 1996 initial public offering (See Note 10).
The Company paid approximately $90,000 in consulting fees to a shareholder
director during the years ended September 30, 1997 and 1996.
5. 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:
<TABLE>
<S> <C>
1998............................................................ $1,210,938
1999............................................................ 1,185,979
2000............................................................ 141,013
2001............................................................ 1,263
2002............................................................ 0
---------
$2,539,193
---------
---------
</TABLE>
Rent expense under these operating leases was approximately $1,140,330,
$665,999 and $338,000 in fiscal 1997, 1996, 1995, respectively.
6. ACCRUED EXPENSES
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Accrued royalties................................................. $ 169,452 $ 148,374
Accrued vacation.................................................. 215,629 209,568
Accrued commissions............................................... 30,412 --
Accrued professional and consulting fees.......................... 206,060 50,000
Accrual under SMS amendment (see Note 12)......................... 808,541
Other accrued expenses............................................ $ 310,580 338,416
------------ ------------
$ 1,740,674 $ 746,358
------------ ------------
------------ ------------
</TABLE>
30
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES:
The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
---------------------------------------
<S> <C> <C> <C>
1997 1996 1995
------------- ----------- -----------
Current:
Federal................................................................ $ -- $ -- $ --
State.................................................................. 1,050 800 800
Deferred:
Federal................................................................ (1,462,456) (398,899) (362,570)
State.................................................................. (244,722) (11,467) (131,356)
Valuation allowance...................................................... 1,707,178 410,366 396,589
------------- ----------- -----------
Total................................................................ $ 1,050 $ 800 $ (96,537)
------------- ----------- -----------
------------- ----------- -----------
</TABLE>
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:
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------
<S> <C> <C>
1997 1996
------------- ------------
Cash to accrual basis differences................................ $ 871,549 $ 1,263,304
Capitalized software costs....................................... 318,058 132,485
Depreciation..................................................... 265,279 160,953
Other............................................................ -- 38,759
------------- ------------
Gross deferred tax liabilities................................. 1,454,886 1,595,501
------------- ------------
Research and development credit carryforwards.................... 770,650 516,874
Net operating loss carryforwards................................. 2,859,723 1,885,582
Reserves not deductible for tax in the current year.............. 338,646 --
------------- ------------
Gross deferred tax assets...................................... 3,969,019 2,402,456
Deferred tax valuation allowance................................. (2,514,133) (806,955)
------------- ------------
Net deferred tax asset (liability)............................. $ -- $ --
------------- ------------
------------- ------------
</TABLE>
31
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES: (CONTINUED)
The provision for income taxes differed from the amount computed using the
statutory federal income tax rate of 34 percent as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30,
------------------
<S> <C> <C> <C>
1997 1996 1995
---- ---- ----
Statutory U.S. tax rate................. (34) (34)% (34)%
State taxes............................. (6) (6) 3
Research and development credit
carryforwards......................... (9) (15) (25)
Other................................... 5 21 (2)
Valuation allowance..................... 44 34 47
---- ---- ----
-- % -- % (11)%
---- ---- ----
---- ---- ----
</TABLE>
For financial reporting purposes, a 100% valuation allowance has been
recorded at September 30, 1997 to offset the deferred tax assets recognized
under SFAS No. 109 because the Company has historically not achieved significant
levels of profitability, and there is inherent uncertainty as to when the
Company will achieve future profitability.
At September 30, 1997, the Company has approximately $7,773,000 and $494,000
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 $3,717,000 and $277,000 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:
HEALTH PLANS
In March, 1996, the Company executed an agreement with a health plan (the
Plan) which granted a perpetual license to use Diamond 950 C/S, and provided for
implementation services and modifications to the product. The Company, in turn,
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 license
fees paid to the Company which meet certain criteria. The Company recognized
revenues under the Agreement of approximately $3,799,000 in fiscal year 1997.
This was approximately 23% of total revenues in fiscal 1997. The Company also
recorded royalty expense of $169,452 in fiscal year 1997.
In January 1997, the Company executed another agreement (the 1997 Agreement)
with a health plan which granted a perpetual license to use Diamond
Client/Server, along with providing implementation services and modifications to
the product. The Company recognized revenues under the 1997 Agreement of
approximately $1,922,000 in fiscal year 1997. This was approximately 11% of the
total revenues of the Company in fiscal year 1997.
32
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. SALES TO MAJOR CUSTOMERS: (CONTINUED)
SMS
In January 1994, the Company entered into a five-year marketing agreement
(the SMS Agreement) with Shared Medical Systems (SMS) that grants to SMS
worldwide marketing rights to certain of the Company's products for sales to
providers and combined provider/payor organizations. Under the terms of the SMS
Agreement, the Company provides to SMS initial modifications, training, product
development, support, and marketing assistance. Payments to the Company under
the SMS 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 SMS. Under the
licensing provisions, the Company granted up to 30 licenses to SMS for
sub-licensing. The Company recognizes revenues for DIAMOND 725 licenses upon
execution of license agreement between SMS and the end-user. DIAMOND 950C/S
licenses are recognized upon successful implementation of the system at end-user
sites. For term license agreements, the Company recognizes revenue ratability
over the term of the license agreement between SMS and the end-user, which term
typically extends five to seven years. For licenses after the first 30 licenses
under the original agreement, SMS pays 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. 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 SMS Agreement of approximately
$415,000, $1,402,000, and $1,722,000 in fiscal year 1997, 1996 and 1995,
respectively. This was approximately 2 percent, 11 percent, and 25 percent of
total revenues in fiscal 1997, 1996 and 1995, respectively. Accounts receivable
under the SMS Agreement were approximately $253,000 and $374,000 at September
30, 1997 and 1996, respectively. Billings under the Agreement are made upon the
achievement of certain performance milestones. Unbilled revenue under the SMS
Agreement was approximately $437,000 and $687,000 at September 30, 1997 and
1996, respectively. Unearned revenue was $0 and $345,000 at September 30, 1997
and 1996, respectively. Subsequent to year-end the Company entered into an
amendment to the SMS Agreement (see Note 12).
For the year ended September 30, 1997, revenues under the above-mentioned
agreements, combined with revenues from the next largest customer were 45
percent of the Company's revenues. No other single customer accounted for more
than 10 percent of total revenues in fiscal 1997, 1996 or 1995.
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, 1997 and
1996.
33
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTION PLAN AND WARRANTS:
Effective August 5, 1994, the Company implemented a stock option plan. The
Company has reserved 500,000 shares of stock for grants, but the plan is no
longer issuing options since the inception of the 1996 Ominbus Plan.
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
900,000 shares of common stock to employees and consultants of the Company. 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.
In October 1996 the Company's Board of Directors approved the issuance of
300,000 shares under the Health Systems Design Corporation Employee Stock
Purchase Plan. The Plan allows for employees to purchase the Company's common
stock at a 15% discount off the stock's market value as defined under the Plan.
The Company accounts for these plans under APB Opinion No. 25, under which
$78,795 was charged to deferred compensation in the year ended September 30,
1995 because certain options were granted at below the then fair market value of
the common stock. This deferred compensation is being amortized over the vesting
period of the related options. Amortization of Deferred Compensation was $15,760
for each of the years ended Sept. 30, 1997 and 1996 and no other compensation
cost has been recognized under APB Opinion No. 25 as all other options have been
granted at an option exercise price equal to the market value of common stock on
the date of grant. Had compensation cost for these plans been determined
consistent with SFAS No. 123, the Company's net loss in total and per share
would have been changed to the following pro forma amounts:
<TABLE>
<CAPTION>
YEAR ENDED SEPT. 30,
------------------------
<S> <C> <C> <C>
1997 1996
----------- -----------
Net Loss:......................................... As Reported (3,856,304) (1,207,946)
Pro Forma (4,180,109) (1,376,354)
Primary EPS:...................................... As Reported (0.60) (0.21)
Pro Forma (0.65) (0.24)
Fully Diluted EPS:................................ As Reported (0.60) (0.21)
Pro Forma (0.65) (0.24)
</TABLE>
Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to October 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
34
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTION PLAN AND WARRANTS: (CONTINUED)
The stock option activity under the Stock Option and Equity Incentive Plans
during the fiscal years ended September 30, 1997, 1996, and 1995, was as
follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE EXERCISABLE
NUMBER WEIGHTED AVERAGE FAIR VALUE OF AT END
OF SHARES EXERCISE PRICE OPTIONS GRANTED OF PERIOD
---------- ---------------- ----------------- -----------
<S> <C> <C> <C> <C>
----------
Outstanding, September 30, 1994..................... 133,800 0.30 --
Granted............................................. 431,000 3.39 --
Exercised........................................... (10,600) 0.30 --
Canceled............................................ (66,700) 0.93 --
----------
Outstanding, September 30, 1995..................... 487,500 2.95 -- 26,760
Granted............................................. 217,250 14.85 11.70
Exercised........................................... (43,220) 1.42 --
Canceled............................................ (27,180) 6.11 --
----------
Outstanding, September 30, 1996..................... 634,350 6.99 -- 111,040
Granted............................................. 819,450 7.05 5.55
Exercised........................................... (99,640) 1.85 --
Canceled............................................ (280,530) 10.90 --
----------
Outstanding, September 30, 1997..................... 1,073,630 6.50 -- 268,780
----------
----------
</TABLE>
At September 30, 1997, 1996 and 1995, there were 336,370, 311,830 and 1,900
shares, respectively, reserved and unissued under the Plans. Options outstanding
at September 30, 1997 consist of the following:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION EXERCISE EXERCISE REMAINING AVERAGE VESTED
SHARES PRICE RANGE PRICE CONTRACTURAL LIFE SHARES
- ------------- ----------- ------------- ------------------- ---------
<C> <S> <C> <C> <C>
263,880 0.30-5.00 4.47 7.87 263,880
769,250 5.50-8.25 7.14 9.60 --
38,500 9.00-17.75 15.21 8.67 4,900
- -------------
1,073,630
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997 and 1996, respectively: risk-free weighted
average interest rate of 6.11 and 6.55 percent, expected dividend yields of 0
percent, expected lives of 5 years from the date of grant and expected
volatility of 103%.
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 note holders executed warrants to
purchase 95,000 shares of the Company's common stock. At September 30, 1996 and
1997, warrants to purchase 105,000 shares of the Company's common stock were
outstanding.
35
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 $350,000 in
fiscal 1996 to reflect the write-off of deferred interest.
12. SUBSEQUENT EVENT
On December 23, 1997, the Company executed an amendment to the SMS Agreement
for the purpose of resolving certain disagreements between the parties and
jointly pursuing opportunities in the European payor organization markets,
amongst other matters. The amendment provides for a $4 million credit pool
against which SMS may charge billings for services rendered by the Company, as
well as future royalties payable by SMS to license the Diamond products in
Europe. Because of the credit pool, the Company is not expected to generate
significant revenues from SMS in the near future. In addition, the Company has
agreed to provide certain services and enhancements to the Diamond software for
SMS's payor markets. In return, SMS will undertake significant investments in
the European payor organization markets and has agreed not to initiate
litigation for certain matters, provided the Company satisfies specified
obligations. As a result of this amendment, the Company accrued approximately
$800,000 as of September 30, 1997 to cover anticipated costs related to
performance disagreements under the original SMS Agreement.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
36
<PAGE>
HEALTH SYSTEMS DESIGN CORPORATION
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 24, 1998. 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 24, 1998.
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 24, 1998.
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 24, 1998.
37
<PAGE>
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.
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- --------- -----------------------------------------------------------------------------------------------
<S> <C>
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)+
10.4.1 Amendment to HSD/SMS Marketing Agreement, dated December 19, 1997++
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)
</TABLE>
38
<PAGE>
<TABLE>
<S> <C>
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
27. Financial Data Schedule
</TABLE>
- ------------------------
+ Confidential treatment has been granted with respect to portions of this
exhibit.
++ Confidential treatment has been requested 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 1997.
(c) See attached Exhibit Index.
(d) The following financial statement schedules are filed as part of this
report on page F-15.
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.
39
<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/ RUSSELL J. HARRISON
---------------------------------------
Russell J. Harrison,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: December 29, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE & NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
President and Chief
/s/ RUSSELL J. HARRISON Executive Officer
- ------------------------------ (principal executive December 29, 1997
Russell J. Harrison officer)
/s/ RICHARD C. AUGER
- ------------------------------ Chairman of the Board of December 29, 1997
Richard C. Auger Directors
Acting Chief Financial
/s/ STEVEN J. CORREIA Officer
- ------------------------------ (principal financial December 29, 1997
Steven J. Correia officer
and accounting officer)
/s/ CATHERINE C. ROTH
- ------------------------------ Director December 29, 1997
Catherine C. Roth
/s/ J. MATTHEW MACKOWSKI
- ------------------------------ Director December 29, 1997
J. Matthew Mackowski
/s/ ARTHUR M. SOUTHAM M.D.
- ------------------------------ Director December 29, 1997
Arthur M. Southam M.D.
/s/ CHRISTOPHER HERRON
- ------------------------------ Director December 29, 1997
Christopher Herron
40
<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, 1997:
Allowance for doubtful accounts.............................. $ 100,000 $ 256,673 $ 163,673 $ 193,000
------------ ----------- ----------- ----------
------------ ----------- ----------- ----------
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
------------ ----------- ----------- ----------
------------ ----------- ----------- ----------
</TABLE>
<PAGE>
AMENDMENT TO SMS/HSD MARKETING AGREEMENT
This amendment (the "Amendment") is made as of the 19th day of December,
1997, between SHARED MEDICAL SYSTEMS CORPORATION, 51 Valley Stream Parkway,
Malvern, Pennsylvania 19355 ("SMS") and HEALTH SYSTEMS DESIGN CORP., 1330
Broadway #1210, Oakland, California ("HSD"). For ease of reference SMS and/or
HSD may be referred to individually as a "Party" or collectively as the
"Parties".
SMS and HSD agree to amend the Marketing Agreement between them dated
January 31, 1994, as amended (the "Agreement") to address and clarify aspects
of the Parties' ongoing relationship and to expand the scope of the Agreement
to include previously untapped opportunities in European Payor Organization
markets. This Amendment shall serve to modify the Agreement only as specified
hereinbelow with the understanding that in the event of any conflict between
the provisions of this Amendment and the Agreement, this Amendment shall
control.
1. FLEXIBLE CREDIT POOL. Effective on the date of this Amendment, HSD shall
create a credit account in the amount of $4,000,000 for the benefit of SMS (the
"Flexible Credit Pool"). It is agreed by the Parties that ninety percent (90%)
of the amount of all correct invoices sent to SMS by HSD (or as otherwise
specified herein) may, at SMS' discretion, be charged against the Flexible
Credit Pool. The remaining ten percent (10%) of all such payments shall be
paid by SMS to HSD pursuant to the payment provisions of the Agreement.
Credits may be taken against the Flexible Credit Pool as determined by SMS,
including without limitation the support of the Parties' efforts to address the
European Payor Organization market.
2. PAYOR ORGANIZATIONS.
2.1. HSD grants to SMS the non-exclusive right to license its Diamond
950C/S Software (referred to in the Agreement as the "Oracle version of the
Diamond") to European Payor Organizations. For purposes of this Amendment the
definition of Europe shall include the European continent and countries
comprising the former Soviet Union. The first license granted by SMS to a
European Payor Organization shall entitle HSD to a one-time combined
distribution/license fee of [ * ]. For subsequent licenses, SMS shall
pay HSD [ * ] of the license fee charged by SMS to licensee Payor Organizations,
provided that the minimum license fee for each such license shall not be deemed
less than [ * ] for purposes of calculating fees due HSD.
2.2. Support fees for support of the Software licensed in the European
Payor market will be $125 per hour.
2.3. Fees for licenses granted in the European Payor Organization market
shall be due and payable at the time Diamond 950C/S is first used in the live
operation of the licensee European Payor Organization (and/or in an Outsourcing
arrangement in that territory). Support fees shall be due quarterly in
arrears. The provisions of subsection 1, above, shall apply to all such
payments due in connection with SMS licensing to European Payor Organizations.
SMS' right to license to European Payor Organizations shall also include the
local equivalent of a Third Party Administrator (TPA) performing outsourcing
services for payors.
* Confidential portions omitted and filed separately with the Commission.
1
<PAGE>
2.4 HSD SUPPORT FOR DIAMOND 950C/S INTERNATIONALIZATION.
2.4.1 HSD will provide to SMS [ * ] the rights to use HSD's
internationalization software which enables Diamond 950C/S to utilize
multiple languages and multiple currencies and allow programmers to create
local country versions. This software shall be deemed a Deliverable
2.4.2 HSD will dedicate a minimum of the equivalent of two (2)
full time equivalent (FTE) employees for 18 months to create local country
versions of Diamond 950C/S according to SMS specifications. Tasks shall
include, without limitation, creating local versions for multi-lingual
support, multiple currency support, premium subsidy, and social program
support. Both FTEs will be experienced Diamond 950C/S technical resources.
HSD agrees to make these resources available to SMS upon 60 days prior
notice, and SMS shall have the right to preapprove such resources. Such
resources will be chargeable to SMS consistent with Section 7 of this
Amendment.
3. OUTSOURCING. HSD acknowledges SMS' continuing right to use Diamond 725
and the right to use Diamond 950C/S in SMS' Outsourcing Services Division
("OSD") operation at SMS remote processing centers. SMS' right to use Diamond
725 and/or 950C/S shall be non-exclusive, meaning that SMS may simultaneously
use and process any other managed care software solution in the provision of
services to end users via SMS remote processing facilities or any other
outsourcing or end user facility operated by SMS. SMS agrees to pay HSD the
following fees for the use of Diamond 725 at SMS remote processing facilities:
The following Diamond 725 fees are based on per-member per-month ("PMPM")
pricing. SMS shall pay HSD [ * ] of the rates listed below:
[ * ]
* Plan participant enrolled in the member file in Diamond.
The following Diamond 950C/S fees are based on per-member per-month
("PMPM") pricing. SMS shall pay HSD [ * ] of the rates listed below:
[ * ]
* Plan participant enrolled in the member file in Diamond.
* Confidential portions omitted and filed separately with the Commission.
2
<PAGE>
For purposes of measuring SMS' performance against the 50 user license
requirement in Section 6(a) of the Agreement, SMS shall be credited with one
license toward the 50 licenses as described in Section 6(a) of the Agreement
for each OSD customer that (i) processes a minimum of at least [ * ] lives
per month through Diamond and (ii) has an SMS contract of at least 36 months.
It is also expressly understood and agreed that SMS' right to use the
725 and/or 950C/S Software to provide services through OSD shall survive
expiration or termination of this Agreement, for a period not to exceed the
unexpired term of any outsourcing agreements that SMS enters into with
customers prior to any such expiration and/or termination. In addition, SMS
shall have surviving rights including the right to add new end users for
existing outsourcing customers and the right to renew/extend the terms of any
such existing customers. The surviving rights specified in this paragraph
shall be conditional upon SMS'continued payment of the above-specified
OSD-specific license fees to HSD for as long as SMS services such end
users/customers.
4. DIAMOND 725 LICENSE FEES. The license fees due HSD in consideration of
SMS licensing Diamond 725 shall be calculated as follows:
(a) The minimum perpetual license fee due HSD shall be [ * ] for
each Diamond 725 perpetual license (1-32 concurrent users) granted by SMS
beyond the first 30 Software licenses granted by SMS (Diamond 725 and 950C/S
combined).
(b) The minimum term license pricing for Diamond 725 shall be
calculated as follows: As to each Diamond 725 term license granted by SMS
beyond the first 30 Software licenses granted by SMS (Diamond 725 and 950C/S
combined) , SMS shall pay to HSD [ * ] of the Diamond 725 license fee net of
support fees, plus [ * ] of the support fees charged to that End User; provided
the minimum term license fee charged by SMS shall not be less than the
following:
[ * ]
For illustration purposes, a 32 concurrent user license with a [ * ]
annual support fee shall result in fees due HSD in the amount of [ * ] per
month.
* Confidential portions omitted and filed separately with the Commission.
3
<PAGE>
[ * ]
5. DIAMOND 950C/S LICENSE FEES. The license fees due HSD in consideration
of SMS licensing Diamond 950C/S shall be calculated as follows: The minimum
perpetual license fee due HSD shall be [ * ] for each Diamond 950C/S
perpetual license (1-32 concurrent users) granted by SMS. The parties' minimum
term pricing for Diamond 950C/S shall be calculated as follows: As to each
Diamond 950C/S term license granted by SMS, SMS shall pay to HSD [ * ] of the
Diamond 950C/S license fee net of support fees, plus [ * ] of the support fees
charged to that End User; provided the minimum gross license fee charged by SMS
shall not be less than the following:
[ * ]
6. BASIS LICENSES. HSD agrees to pay the BASIS International software
license fees for the following End Users to enable those End Users to use the
Diamond 725 Windows product without the payment of additional BASIS
International license fees; provided that the maximum payments by HSD under
this subsection shall not exceed [ * ]. These BASIS license payments will be
applied to the Flexible Credit Pool as and when HSD makes any such license fee
payments.
[ * ]
7. HSD PROFESSIONAL SERVICES. HSD agrees to perform the professional
services described below. HSD shall prioritize SMS' requests for all such
services consistent with the prioritization procedures of all other projects
undertaken by HSD, with the express understanding that SMS requests will not be
prejudiced by the fact that charges for such services may be credited against
the Flexible Credit Pool.
7.1 IMPLEMENTATION AND PROFESSIONAL SERVICES. Except for services
required to be provided by HSD under the terms of the Agreement for which no
additional compensation shall be paid by SMS to HSD (except as otherwise
provided in Section 9 of this Amendment), SMS agrees to pay HSD to perform
certain additional professional services as follows: HSD will perform
implementation and other professional services for End Users, under subcontract
to SMS, pursuant to the terms of the attached Engagement Program in Exhibit A,
in consideration of SMS paying HSD the professional service rate of [ * ] per
person per hour.
7.2 INTERFACES AND ENHANCEMENTS/SOFTWARE DEVELOPMENT SERVICES. HSD
shall commit to perform software development services requested by SMS at the
rate of [ * ] per person per hour, which services shall be predominantly focused
on services required to enable and support the Parties efforts with respect to
the European Payor Market or as otherwise determined by SMS.
* Confidential portions omitted and filed separately with the Commission.
4
<PAGE>
8. CONVERSIONS TO DIAMOND 950. HSD shall perform automated conversions from
Diamond 725 to Diamond 950C/S for the five End Users specified in Section 6 of
this Amendment, above for the fixed fee of [ * ] per End User for any such
conversion initiated within two (2) years from the date the conversion process
is first demonstrated to be operational at a customer site. It is mutually
understood and agreed that the fixed fee specified in the preceding sentence
shall apply to conversions from the base/unmodified version of the 725 Software
to a base/unmodified version of the 950C/S Software. In the event that the End
User requests other than a base/unmodified version of the 950C/S Software, HSD
will offer the additional required services at its then standard rates pursuant
to its applicable Software modification procedures. The [ * ] base
conversion fee referenced in the first sentence of this Section 8 shall be
credited against the Flexible Credit Pool at 100% (notwithstanding the 90% rule
in Section 1 above) for each such conversion that is completed by HSD. The
details and timeframes for each such conversion shall be agreed upon by SMS,
HSD and the subject End User. SMS shall also have the right at no charge to use
the conversion programs utilized by HSD and HSD shall provide conversion
program training to SMS at no charge; provided that SMS will be responsible for
the cost, if any, of any third party software components of the conversion
program.
9. DIAMOND 725 AND 950C/S ENHANCEMENTS.
9.1 HSD shall provide the Diamond 725 and 950C/S enhancements listed in
the attached Exhibit B. The enhancements listed in Exhibit B shall be free of
charge, except that as to any of the four enhancements listed directly below
that HSD objectively demonstrates are provided exclusively for SMS' benefit
(e.g., not for the benefit of any other HSD customer), SMS shall pay HSD at the
rate of [ * ] per hour which shall be credited at 100% (notwithstanding the
90% rule in Section 1 above) against the Flexible Credit Pool and HSD agrees to
design and implement such enhancements according to SMS' specifications.
[ * ]
A workplan for the implementation of Exhibit B enhancements is attached as
Exhibit C. It is understood that SMS' internal costs in support of the
development, testing and implementation of the Exhibit B enhancements will be
borne by SMS. For those Diamond 725 and 950C/S enhancements included in the
workplan, SMS shall have the authority to revise and approve the final
specifications of each such deliverable with the understanding that HSD shall
make the final decision--following discussions between HSD's CEO and SMS' Vice
President, Accounting Systems--on whether any such enhancements are added to
model software. SMS will review and provide feedback on all deliverables
within 10 days after receipt of the deliverable.
9.2 If HSD fails to deliver any of the above-described enhancements or
fails to achieve a milestone or phase of the detailed workplan on or before the
tenth (10th) day after the date scheduled in Exhibit C for general availability
or milestone/phase achievement of any such enhancement, then SMS shall be
entitled to withhold all payments due HSD under the Agreement until such
delivery occurs except to the extent that any such delay is attributable to a
force majeure event as described in Section 16 of the Agreement.
* Confidential portions omitted and filed separately with the Commission.
5
<PAGE>
9.3 If HSD fails to deliver any of the above-described enhancements or
fails to achieve a milestone or phase of the detailed workplan on or before the
ninetieth (90th) day after the date scheduled in Exhibit C for general
availability or milestone/phase achievement of any such enhancement, as
appropriate, then SMS shall be entitled to liquidated damages in the amount of
$1,000 per day for each day after the initial 90 days that delivery is delayed,
which may be taken by SMS--at SMS' election--in cash or as a credit against
future invoices.
9.4 To the extent a delivery delay results from changes to the
implementation schedules or scope of work in Exhibit C requested by SMS, or due
to the failure of SMS to provide feedback to HSD and such failure causes HSD to
be late, the delivery dates shall be adjusted accordingly without penalty to
HSD.
10. EXCLUSIVITY.
10.1 Notwithstanding anything to the contrary in the Agreement SMS may
license a managed care product that competes with, or replaces Diamond 725
and/or 950, provided that if SMS commences licensing any such competing or
replacement product (other than a relationship between SMS and CPU, Inc.
and/or for use at any SMS outsourcing center), HSD is relieved of its
exclusivity obligations under Section 6(d) of the Agreement. Also, if SMS
commences licensing a competing or replacement product in the standalone
Payor Organization market (other than outside the United States as provided
in Section 2 of this Amendment), then HSD may market and license Diamond to
SMS Core Application licensees notwithstanding the provisions of Section 6(a)
of the Agreement.
10.2 Prior to HSD commencing any marketing or licensing activities as
currently prohibited under Section 6(a) of the Agreement, HSD shall provide at
least 30 days advance written notice to SMS of such intention for purposes of
enabling the parties to decide, if a challenge exists, whether or not SMS has
licensed Diamond to a Payor Organization.
11. CREDIT FOR ENHANCEMENTS. Separate and apart from the $4,000,000 in the
Flexible Credit Account, HSD grants to SMS a credit equal to [ * ]
([ * ] for Diamond 950C/S enhancements paid-for, but not delivered by
HSD, less [ * ] already withheld in good faith by SMS), which credit shall be
applied to any correct invoice received by SMS from HSD.
12. STAFF FUNDING BY HSD. HSD will fund the cost, not to exceed [ * ]
each, for two (2) SMS employees to perform, for one year, SMS-specific
functions in support of SMS' licensing of the 725 and/or 950C/S Software and/or
as otherwise benefits the SMS/HSD undertakings described in this Amendment
including without limitation support of the opening of the European Payor
Organization market.One employee shall perform the responsibilities of a
Program Manager in the HSD Product Management organization. The other employee
will work on technical projects as directed by SMS.Their activities will be
directed by SMS and administered with the cooperation of HSD. SMS will
invoice HSD quarterly in advance for such payments. HSD commits that these
individuals will commence the above-described work no later than March 31,
1998. HSD shall at no charge also provide office space, equipment, and support
consistent with the space, equipment, and support HSD provides to its own
employees performing programming and development functions.
13. TERM. Notwithstanding anything to the contrary in Section 2 of the
Agreement, the Agreement may not be terminated by HSD prior to the retirement
of the Flexible Credit Pool. The Flexible Credit
* Confidential portions omitted and filed separately with the Commission.
6
<PAGE>
Pool may be retired by means of applying credits as described in this
Amendment and/or cash payments by HSD to SMS in the discretion of the Parties.
14. ADDITIONAL ITEMS.
14.1 Processing by Affiliated and Unaffiliated Physicians and Entities.
The parties agree that the letter attached as Exhibit F is the agreed upon
method for determining whether SMS' right to relicense Diamond includes the
right for End Users to use Diamond to process the data of affiliated and
unaffiliated physicians and entities.
14.2 DEFINITIONS. The definition of "Deliverables" shall be amended to
also include that third party software specified in Exhibit C, as amended, as a
component of the Software.
14.3 CLARIFICATION OF BILLING. The chart attached as Exhibit D shall
be used to determine whether or not services provided by HSD to SMS are
billable in the future.
15. RELEASE. Contingent on HSD performing all of its material contractual
obligations to SMS in a timely and correct manner, SMS agrees to refrain from
initiating litigation against HSD for claims arising prior to the date of
this AmendmentSMS waives no other rights or remedies available to SMS under
the Agreement, at law, or in equity. In the event HSD fails to perform its
material contractual obligations in a timely and correct manner and SMS
initiates litigation against HSD for claims arising prior to the date of this
Amendment, any potential recovery by SMS shall be reduced by amounts
correctly credited against the Flexible Credit Pool, plus amounts paid by HSD
to SMS pursuant to Section 12 of this Amendment.
16. ENTIRE UNDERSTANDING. This Amendment contains the entire understanding of
the Parties and superseds and prior understandings written or oral, respecting
the subjects discussed herein. Modifications may be made to this Amendment
only if in writing and when signed by both Parties.
17. GENERAL. This Amendment supersedes any contrary or inconsistent
provisions of the Agreement and any prior amendments. No provisions of any HSD
purchase order shall apply. As amended, the Agreement shall remain in full
force and effect.
IN WITNESS WHEREOF, intending to be legally bound hereby, SMS and HSD have
executed this Amendment as of the date and year first above mentioned.
SHARED MEDICAL SYSTEMS HEALTH SYSTEMS DESIGN
CORPORATION CORPORATION
By: /s/ Janet G. Fulton By: /s/ Russell J. Harrison
------------------------------- ------------------------------
Janet G. Fulton Russell J. Harrison
- ---------------------------------- ---------------------------------
Typed or Printed Name and Title Typed or Printed Name and Title
Vice President President & CEO
7
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CONFIDENTIAL
EXHIBIT A
ENGAGEMENT PROGRAM
ATTACHED IS SMS STANDARD ENGAGEMENT AGREEMENT USED BY SMS TO ENGAGE
SUBCONTRACTORS. THE PARTIES AGREE THAT NOTWITHSTANDING PROVISIONS IN THE
AMENDMENT THAT REQUIRE HSD TO PERFORM ACCORDING TO THE ATTACHED PROVISIONS, THE
PARTIES WILL NEGOTIATE IN GOOD FAITH ENGAGEMENT PROVISIONS USING THE ATTACHED
PROVISIONS AS A GUIDELINE.
1. GENERALLY. From time to time, SMS may wish to engage HSD to perform
implementation, support, and other services (an "Engagement"). This Exhibit
shall generally govern the relationship between SMS and HSD regarding such
Engagements. The particulars of such Engagements, such as the identity of
the SMS customer for whom the services are to be performed, the location of
the Engagement, the description of the precise nature of the services to be
performed, scheduling matters, the identification of project leaders, etc.,
shall be set forth in a written Engagement Letter which specifically refers
to this Exhibit and which is signed by both parties. The Engagement can be
extended by SMS within 20 days prior to its termination. If any provision in
an Engagement Letter is inconsistent with any provision in this Exhibit, the
former shall govern. SMS grants to HSD a non-transferable, non-exclusive
limited license to use Confidential Information (as hereinafter defined)
certain SMS' software licensed to the SMS customer, Documentation and other
Deliverables solely for the purpose of assisting an SMS customer identified
in an Engagement Letter and solely for the purpose and duration of such
engagement as set forth in the Engagement Letter and for no other purpose.
SMS shall offer HSD access to training in certain courses, if such training
is necessary for HSD to perform its obligations hereunder, at the current SMS
rates , to install SMS applications software/systems in SMS' customer
facilities according to SMS' policies, reporting guidelines and SMS'
proprietary methodologies and protocols. SMS shall be responsible for
implementation project management which includes, but is not limited to,
implementation workplan task definition, task assignment and scheduling,
staff utilization, and the development, implementation and enforcement of all
policies and procedures necessary to accomplish the implementation tasks in a
timely and efficient manner. SMS shall be solely responsible for the billing
of SMS' customer for all implementation tasks in accordance with the
application software/system agreement between SMS and SMS' customer. All
services provided by HSD employees under this Exhibit shall be performed in a
competent and workmanlike manner.
2. AMOUNTS PAYABLE BY SMS TO HSD. HSD shall submit to SMS, on a monthly
basis, one invoice detailing: the hours and reasonably incurred expenses
spent each week by each of its employees performing services described in
Section 1 of this Exhibit and in an Engagement Letter. Such invoice must be
submitted within thirty days from the end of the month in which the services
were rendered and will include a copy of the SMS Expense Report. HSD shall
also submit on a weekly basis, a SMS expense report detailing all
Professional Service time provided and reasonable expenses incurred. Such
report must be submitted within seven days from the end of the week in which
such services were rendered. SMS shall pay $00.00 per hour for services
performed by HSD employees, and shall pay the reasonably incurred expenses of
such HSD employees in accordance with the travel and living reimbursement
policy, as described in Exhibit A. The rate set forth in the preceding
sentence shall be effective for all new Engagements commencing after the
effective date hereof. SMS shall pay the amount invoiced by HSD within
thirty (30) days from the date of receipt of an invoice, subject to its right
to withhold payment of any portion of an invoice that is the subject of a
good faith dispute.
3. RELATION OF THE PARTIES. HSD is an independent consulting firm and all
HSD employees performing work pursuant to this Exhibit shall remain employees
solely of HSD and shall not be considered employees of
8
<PAGE>
CONFIDENTIAL
SMS for any purpose. HSD acknowledges that its employees will be performing
work for the benefit of SMS' customers and that HSD is responsible for the
performance of the work performed by its employees. HSD shall remain
responsible for payment of all wages and/or salaries and benefits due such
employees, and for all applicable federal, state and local tax liabilities
arising from its employees' work performed pursuant to this Exhibit. HSD
shall provide SMS with certificates of insurance evidencing that its
employees are covered by: (i) General Liability insurance with a minimum
limit of $1 million combined single limit bodily injury and property damage;
(ii) Worker's Compensation insurance in the state in which each HSD employee
is employed; and (iii) errors and omissions coverage with a minimum limit of
$500,000 per claim.
4. PROPRIETARY RIGHTS. HSD hereby assigns to SMS, without further
consideration, sole right, title and interest in and to all programming code,
documentation, documentation and other written product, methodologies,
processes, training materials, inventions, software, ideas and other
information and work product (collectively, "Work") developed or generated by
or on behalf of HSD during the performance of its obligations as a
subcontractor under this Exhibit, including any and all patents, copyrights,
trade secrets and other proprietary rights related thereto. All Work shall
be deemed " Work for Hire" within the meaning of the Copyright Act of 1976,
as amended. HSD agrees to execute and deliver, or cause to be executed and
delivered, all documents and instruments requested by SMS to evidence the
foregoing assignment. HSD represents and warrants that its performance under
this Exhibit and ownership or use of the Work by SMS will not constitute an
infringement of any third party proprietary right. Any trade secrets conveyed
to SMS by HSD shall be treated as "Confidential Information" as defined in
Section 6 hereof. HSD may offer usage of HSD's work product developed
outside the scope of this Exhibit which is not derivative of SMS intellectual
property without impairment of HSD's right of sole ownership of such work
product, so long as HSD makes no improper use of Confidential Information
5. TERM. The term of this Exhibit shall be coterminous with the term of the
Agreement; provided that SMS shall be entitled to terminate any Engagement
immediately upon any breach by HSD of Sections 1, 4 or 6 of this Exhibit.
Both parties shall make all reasonable efforts to cooperate in the timely
completion of any Engagements that remain pending at the termination of the
Agreement.
SMS shall be entitled to replace the HSD consultant or terminate an
Engagement if in SMS and/or its customer's reasonable opinion, the
consultant's work is unsatisfactory or his or her conduct is inappropriate.
The parties shall make all reasonable efforts to resolve any staffing issues
in such a way as to avoid adverse customer impact. Sections 4, 6, 7 and 8
shall survive any termination of the Agreement.
6. CONFIDENTIALITY.
(a) CONFIDENTIAL INFORMATION. HSD acknowledges that in order to perform
under this Exhibit, SMS must provide to HSD or HSD will become exposed to
certain confidential, proprietary information, including, but not limited to
existing SMS systems, programs, training, training materials, documentation,
methodologies and materials and those in development; SMS' prices, the
identity of SMS' customers or prospective customers; the terms, conditions
and prices of any contract, existing or proposed, between SMS and its
customers and prospective customers; confidential information of SMS'
customer facilities and all patient information; and any other information
identified by SMS as confidential or such as the reasonable person would
understand to be confidential under the circumstances including, without
limitation, this Exhibit ("Confidential Information"). This Exhibit imposes
no obligation upon a party who receives Confidential Information where such
Confidential Information (i) is in such party's (the "Recipient") possession
before receipt from the other party (the "Discloser"); (ii) is or becomes a
matter of public knowledge through no fault of the Recipient; (iii) is
rightfully received by the Recipient from a third party without a duty of
confidentiality; (iv) is independently developed by the Recipient; (v) is
disclosed by the
9
<PAGE>
CONFIDENTIAL
Recipient under operation of law, provided the Recipient gives the Discloser
prompt notice of the requirement to disclose and the opportunity to contest
such disclosure; or (vi) is disclosed by the Recipient with the Discloser's
prior written approval.
(b) NON DISCLOSURE. HSD agrees that: (i) it will hold the Confidential
Information in confidence, and will not, without SMS' written consent,
disclose any portion thereof to any third party; (ii) it will restrict
dissemination of the Confidential Information within HSD to those persons who
have a need to know such information in order to perform under this Exhibit;
(iii) it will take such actions as are necessary, including appropriate
agreements with or instructions to its employees, to enable HSD to perform
its obligations hereunder; and (iv) it will use the Confidential Information
for the purpose of performing its duties hereunder, and for no other purpose
and (v) any Confidential Information disclosed by SMS to HSD or its employees
prior to the date of the Agreement shall be subject to this Exhibit. HSD
will cause its members and/or employees participating in an Engagement to
acknowledge and comply with their obligations hereunder. At the expiration
or termination of the Agreement, all Confidential Information will be
returned to SMS.
(c) HSD ACTIVITIES OUTSIDE THIS EXHIBIT. The parties recognize that HSD
has been, and is, in the business of providing services to its healthcare
industry customers, which services include the installation and
implementation of software systems of various competitors of SMS. Except as
expressly provided herein, it is understood and agreed that: (i) services
provided by HSD to SMS are provided on a non-exclusive basis and that HSD
retains the right to continue to provide the same type of services, and any
other services, to any other of its customers, including competitors of SMS;
(ii) HSD retains the right to carry on and expand its business including
without limitation, that part of its business involved with the installation
and implementation of software systems that are similar to or in competition
with those of SMS, for HSD's present and future customers: (iii) during the
term of an Engagement and for a period of one year after phase 1 of an
implementation (as defined below), HSD will not provide or solicit to provide
to a SMS customer when HSD has been placed in an Engagement any direct
services that HSD could provide under this Exhibit, nor will HSD respond to
or solicit an SMS customer once SMS has identified that customer to HSD as
having requested services from SMS and customer has not previously contacted
HSD for this particular resource request prior to such customer being
identified by SMS to HSD. For purposes of this Section 6(c), "phase 1 of an
implementation" shall mean the date of first productive use of the particular
set of SMS software applications, as defined in the Workplan. Nothing in
this Exhibit shall be deemed in any way to prevent, restrict or limit HSD in
providing installation and implementation of software systems that are
similar to or in competition with those of SMS provided that Confidential
Information is not used in connection with such activities.
(d) HSD PRODUCT OFFERINGS. For the term of the Agreement and for a
period of 2 years from the date of termination of the last Engagement, HSD
will not compete with SMS by offering to a SMS customer or to SMS' customer
base any product that competes with a current SMS product or a SMS product
under development. If HSD desires to offer a product to a SMS customer or to
SMS' customer base, HSD will first notify SMS so that SMS can determine if
such product will compete with a SMS product. If SMS determines that the HSD
product will compete with a SMS product, and HSD decides that it still wishes
to offer the product to a SMS customer or to SMS' customer base, HSD will so
notify SMS in writing and at SMS' option, this Engagement Exhibit and any
current Engagements may be terminated. SMS' right to terminate this Exhibit
shall be in addition to any other rights and remedies available to SMS, in
law or at equity, for any breach of this Exhibit including, without
limitation a breach of Section 6 hereof.
10
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CONFIDENTIAL
EXHIBIT B
LIST OF DIAMOND 725 ENHANCEMENTS
PROJ ID PROJECT DESCRIPTION
20 Authorization - adjudication
60 Authorization - redesign of data flow
6 Authorization API
504 Benefits off of lesser of billed or allowed. Restrict copay/
coinsurance to 50% of allowed
24 Cascading Capitation
500/500b Eligibility API
510 Institutional Claims - add 2 char modifier
514 Med Defs expand field in BRULE
M3 MEEDI -- need separate report or file for MEEDI error messages
M1 MEEDI -- preprocessor errors report, with more useful sort
87 MEEDI performance improvements, allow for retro active changes for
multiple periods of eligibility and table driven member search logic.
138 Procedure code - expand field in professional claims to 12 characters
to allow NDC codes
40 Provider -- covering provider logic
177 Provider Par flag - expand to allow multiple levels of participation.
66 Provider reimbursement by location.
TBD Year 2000 compliance
TBD MS Windows compliant user interface with Release 4.3.
TBD Large file sizes of 4GB -- HSD will test and release large file
sizes available from BASIS within 30 days after the general
availability of the BASIS Kilauea release
TBD NT Server for Diamond 725 -- HSD will document and benchmark the
availability of running Diamond 725 using NT Server technology.
11
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CONFIDENTIAL
LIST OF DIAMOND 950C/S ENHANCEMENTS (ALL PROJECT IDS TO BE DETERMINED)
PROJECT DESCRIPTION
Eligibility API
Authorization API
Auth/Claim link
Capitation Adjustments
MEEDI performance improvements, allow for retro active changes for multiple
periods of eligibility
Add ability to define provider reimbursement by location.
Expand Par flag to allow multiple levels of participation.
Compute coinsurance on lessor of allowed or billed amount
Dental Claims
Standard Utilization Reports (comparable to Feedback function)
Integrated Letters
Mass Eligibility Update Utility
12
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CONFIDENTIAL
EXHIBIT C
ENHANCEMENTS -- IMPLEMENTATION WORKPLAN
DIAMOND 725 ENHANCEMENTS
<TABLE>
<CAPTION>
PROJECT DESCRIPTION GENERAL AVAILABILITY
<S> <C>
Year 2000 compliance March 1998
MS Windows compliant user interface with Release 4.3 March 1998
Large file sizes of 4GB -- HSD will test and release Within 30 days after
"large file sizes" available from BASIS. the general
availability of BASIS
Kilauea release.
NT Server for Diamond 725 -- HSD will document and benchmark
the availability of running Diamond 725 using NT Server technology. March 1998
</TABLE>
DIAMOND 950C/S ENHANCEMENTS
PROJECT DESCRIPTION GENERAL AVAILABILITY
DATE
Dental Claims Diamond 950C/S
Release 5.1
Standard Utilization Reports (comparable to Diamond 950C/S
Feedback function) Release 5.1
Integrated Letters Diamond 950C/S
Release 5.1
Mass Eligibility Update Utility Diamond 950C/S
Release 5.1
MEEDI performance improvements, allow for
retroactive changes for multiple periods of eligibility Feb. 1999
Add ability to define provider reimbursement by location. April 1998
Expand Par flag to allow multiple levels of participation. April 1998
Compute coinsurance on lessor of allowed or billed amount. April 1998
13
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CONFIDENTIAL
EXHIBIT D
RIGHT TO PROCESS THE DATA OF AFFILIATED AND NON-AFFILIATED PHYSICIANS
AND ENTITIES
14
<PAGE>
CONFIDENTIAL
EXHIBIT E
HSD BILLABLE AND NON-BILLABLE SERVICES
BY TOPIC, CALLER, AND PURPOSE
<TABLE>
<CAPTION>
BILLABLE?
CALLER TECHNICAL APPLICATION RELEASE MODIFICATION DIAMOND SALES AND CONF. ENHANCEMENT JOINT PRODUCT
SUPPORT SUPPORT INSTALL RELEASE PORTION OF MARKETING CALLS TRAINING DEVELOPMENT PLANNING / MANAGEMENT
SUPPORT SUPPORT SMS CALLS / SMS
INTEGRATION PROGRAMMING
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SMS N N N N N N N N N
CORPORATE
FOR SMS
CORPORATE
- -----------------------------------------------------------------------------------------------------------------------------------
Onsite Y
for
Prospect
demos and
presentations
- -----------------------------------------------------------------------------------------------------------------------------------
Onsite or N
conference
calls with
customers
for product
issues
resolution
- -----------------------------------------------------------------------------------------------------------------------------------
SMS N N N N N N N N
CORPORATE
FOR SMS
SUPPORT
CLIENTS
- -----------------------------------------------------------------------------------------------------------------------------------
SMS N N N N N N N N
CORPORATE
FOR SMS
INSTALL
CLIENTS
- -----------------------------------------------------------------------------------------------------------------------------------
SMS N/A N/A N/A N/A N/A N/A N/A N/A
SUPPORT
CLIENTS
- -----------------------------------------------------------------------------------------------------------------------------------
SMS N/A N/A N/A N/A N/A N/A N/A N/A
INSTALL
CLIENTS
- -----------------------------------------------------------------------------------------------------------------------------------
SMS FIELD N/A N/A N/A N N N/A N/A
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
15
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CONFIDENTIAL
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------------
STAFF OR
THIRD
PARTY
CONSULTANTS
CONTRACTED
BY SMS
- -----------------------------------------------------------------------------------------------------------------------------------
Related to N N
bugs,
clarifica
tion of
documenta
tion, or
review of
GSD's and
custom
development
- -----------------------------------------------------------------------------------------------------------------------------------
"HOW TO" Y Y
QUESTIONS
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- - N/A is indicated for conditions requiring support that will be routed
through an existing SMS organization or communication structure. For
example, Support and Install Clients experiencing problems should first
contact the appropriate internal support staff at SMS who will then resolve
the issue. Members of the Field Staff or Third-Party Consultants under
contract to SMS would likewise contact internal SMS resources first for the
client/issue combinations marked N/A in the above matrix. HSD will refer
those calls back to SMS.
- - Joint Development/SMS Programming does not include customer GSD's which
would be incorporated in the cost of the bid for the development.
16
<PAGE>
EXHIBIT 11.1
HEALTH SYSTEMS DESIGN CORPORATION
COMPUTATION OF NET LOSS PER SHARE
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- ------------
<S> <C> <C> <C>
Net loss.............................................................. $ (3,856,304) $ (1,207,946) $ (752,754)
------------- ------------- ------------
------------- ------------- ------------
Weighted average common shares outstanding............................ 6,478,789 5,656,413 4,435,288
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
------------- ------------- ------------
Weighted average common and common equivalent shares outstanding...... 6,478,789 5,737,499 4,759,635
------------- ------------- ------------
------------- ------------- ------------
Net loss per common and common equivalent share....................... $ (0.60) $ (0.21) $ (0.16)
------------- ------------- ------------
------------- ------------- ------------
</TABLE>
<PAGE>
Exhibit 23.1
CONSENT OF ARTHUR ANDERSEN LLP
As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K, into the Company's previously filed
Registration Statement on Form S-8.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
San Francisco, California
December 29, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 11,194,757
<SECURITIES> 0
<RECEIVABLES> 5,208,056
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 17,965,500
<PP&E> 4,785,854
<DEPRECIATION> 1,599,767
<TOTAL-ASSETS> 22,077,127
<CURRENT-LIABILITIES> 4,618,143
<BONDS> 0
0
0
<COMMON> 6,533
<OTHER-SE> 17,452,451
<TOTAL-LIABILITY-AND-EQUITY> 22,077,127
<SALES> 0
<TOTAL-REVENUES> 16,765,525
<CGS> 6,803,611
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 14,490,419
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (673,251)<F1>
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,856,304)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1> INTEREST INCOME (NET)
</FN>
</TABLE>
