<PAGE>   1
                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

          [X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED OCTOBER 31, 1999
                                       OR
          [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                         COMMISSION FILE NUMBER: 0-20946

                         HEALTH MANAGEMENT SYSTEMS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

               NEW YORK                                      13-2770433
     (STATE OR OTHER JURISDICTION OF                     (I.R.S. EMPLOYER)
      INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)

          401 PARK AVENUE SOUTH                             10016
            NEW YORK, NEW YORK                            (ZIP CODE)
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                 (212) 685-4545
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
                        --------------------------------

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                                         NAME OF EACH EXCHANGE
       TITLE OF EACH CLASS                                 ON WHICH REGISTERED
            NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                                  COMMON STOCK
                                (Title of Class)

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. [ ]

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                               Yes  X     No  ___

The aggregate market value of the registrant's common stock held by
non-affiliates as of January 7, 2000 was $114,203,376 based on the closing price
on the Nasdaq National Market System on that day.

Number of shares outstanding of the registrant's common stock, $.01 par value,
on January 7, 2000 was 17,435,522.

                      DOCUMENTS INCORPORATED BY REFERENCE:

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<CAPTION>
    DOCUMENT                                              WHERE INCORPORATED
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<S>                                                       <C>
    PROXY STATEMENT FOR THE ANNUAL MEETING                PART III
    TO BE  HELD ON MARCH 14, 2000
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                                TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                      Page
Contents                                                                             Number
--------                                                                             ------
<S>                                                                                  <C>
Cover Page ........................................................................     i
PART I
     Item 1.  Business ............................................................     1
     Item 2.  Properties ..........................................................    11
     Item 3.  Legal Proceedings ...................................................    11
     Item 4.  Submission of Matters to a Vote of Security Holders .................    13
PART II
     Item 5.  Market for Registrant's Common Equity and Related Shareholder Matters    13
     Item 6.  Selected Financial Data .............................................    14
     Item 7.  Management's Discussion and Analysis of Financial Condition and
              Results of Operations ...............................................    15
     Item 7A. Quantitative and Qualitative Disclosures About Market Risks .........    24
     Item 8.  Financial Statements and Supplementary Data .........................    24
     Item 9.  Changes in and Disagreements with Accountants on Accounting and
              Financial Disclosure ................................................    24
PART III
     Item 10. Directors and Executive Officers of the Registrant ..................    25
     Item 11. Executive Compensation ..............................................    25
     Item 12. Security Ownership of Certain Beneficial Owners and Management ......    25
     Item 13. Certain Relationships and Related Transactions ......................    25
PART IV
     Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ....    25
     Signatures ...................................................................    26
     Exhibit Index ................................................................    54
</TABLE>



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                SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS


         EXCEPT FOR THE HISTORICAL FINANCIAL INFORMATION CONTAINED HEREIN, THE
MATTERS DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K MAY BE CONSIDERED
"FORWARD-LOOKING" STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED. SUCH STATEMENTS INCLUDE DECLARATIONS REGARDING THE INTENT, BELIEF OR
CURRENT EXPECTATIONS OF THE COMPANY AND ITS MANAGEMENT. PROSPECTIVE INVESTORS
ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF
FUTURE PERFORMANCE AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES AND THAT
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH
FORWARD-LOOKING STATEMENTS. AMONG THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING
STATEMENTS INCLUDE THOSE RISKS IDENTIFIED IN "ITEM 7 - MANAGEMENT'S DISCUSSION
AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION CERTAIN FACTORS
THAT MIGHT AFFECT FUTURE OPERATING RESULTS" AND OTHER RISKS IDENTIFIED IN THIS
FORM 10-K AND FROM TIME TO TIME IN THE COMPANY'S REPORTS AND REGISTRATION
STATEMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

PART I

ITEM 1. BUSINESS

OVERVIEW

         Health Management Systems, Inc. (the "Company" or "HMSY") furnishes
proprietary information management, data processing, and software (including
consulting) services to healthcare providers and payors, including government
health service agencies. These services address the various types of data
generated by the interaction of the participants in the healthcare delivery
process: the providers of care, the third-party payors, and the patients.
Through its product and service offerings, the Company acts as an outsourcer of
information management functions addressing the operational, administrative,
financial, and clinical data that result from the rendering of healthcare
services to patients. The Company's product and service offerings benefit its
clients by enhancing revenue (achieved through improved reimbursability,
profitability, and/or collectability), accelerating cash flow, reducing
operating and administrative costs (by supplying advanced information
analytics), and improving decision-making capabilities (via the provision of
useful information regarding cost and quality of care).

         Healthcare providers receive payment for services from patients,
third-party payors, or a combination thereof. Third-party payors include
commercial insurance companies, governments or their fiscal agents and
intermediaries, health maintenance organizations, preferred provider
organizations, third-party administrators for self-insured companies, and
managed care companies. Although patients generally retain primary
responsibility for payment for all healthcare services, third-party payors bear
the preponderance of the responsibility for many charges for care. Obtaining
reimbursement from third-party payors has become increasingly difficult for
providers because of frequent changes in reimbursement formulae and contractual
requirements for pre-admission certification and utilization review, and
administrative procedures instituted by third-party payors in an effort to
control costs. To be successful in obtaining payment from third-party payors,
hospitals and other healthcare providers require regulatory knowledge and
technical skills to manage complex data collection, integration, analysis, and
accounts receivable management functions. To ensure that program costs are not
greater than necessary, third party payors require knowledge and skills
analogous to those required by providers.

         Using the operational, financial, administrative, and clinical data
generated as part of the healthcare delivery process, HMSY applies proprietary
software and other analytical tools to transform data into valuable information
that clients use to (i) minimize operating and administrative costs while
improving profitability, (ii) measure the quality of care, and (iii) increase
revenue by optimizing the outcome of the transfer payment processes linking
payors, providers, and patients. The Company believes its customers benefit from
the Company's unique understanding of the healthcare delivery and associated
transfer payment processes, from the perspective of both providers and payors.



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COMPANY HISTORY

         In fiscal year 1999, each of the Company's subsidiaries adopted use of
the corporate name, Health Management Systems, as part of an initiative to
strengthen the corporate identity. As well, the Company changed the designation
of its business segments in order to more appropriately describe the functions
being performed. The table below cross-references the current nomenclature to
that used in prior years.

         A healthcare information systems and services enterprise, the Company
is organized into two divisions: the Revenue Services Division ("Revenue
Services Division") and the Software Systems and Services Division ("Software
Division"). The Revenue Services Division comprises two business units: the
Provider Revenue Services Group and the Payor Revenue Services Group. The
Company's Software Division also comprises two business units: the Decision
Support Group and the Payor Systems Group.



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        CURRENT NOMENCLATURE                                 PRIOR NOMENCLATURE
        --------------------                                 ------------------
<S>                                                  <C>
Revenue Services Division                            Transfer Payment Division
 -  Provider Revenue Services Group                   -  Provider Transfer Payment Unit
 -  Payor Revenue Services Group                      -  Payor Transfer Payment Unit
Software Systems and Services Division               Software Systems and Services Division
 -  Decision Support Group                            -  Decision Support Systems or DSS Unit
 -  Payor Systems Group                               -  Managed Care Information Systems or MCIS
                                                          Unit
</TABLE>


         Within the Revenue Services Division, the Provider Revenue Services
Group has delivered Retroactive Claims Reprocessing ("RCR")(SM) services since
1974 and began to deliver Comprehensive Account Management Services ("CAMS")(SM)
in 1986 and Electronic Data Interchange ("EDI") services with the acquisition in
1990 of Quality Medi-Cal Adjudication, Incorporated ("QMA"). QMA provides
electronic billing and automated denial reprocessing services. In 1997, the
Company acquired a computerized medical record-based processing system for
managed care public health and ambulatory care facilities as part of its
purchase of substantially all the assets of Global Health Systems, Inc. and GHS
Management Services, Inc. (collectively "Global"). In 1997 the Company formed a
Business Office Outsourcing unit and in 1998 consolidated this unit with the
remainder of what is currently entitled the Provider Revenue Services Group. In
1999, the Company's Quality Standards in Medicine, Inc. ("QSM") subsidiary
acquired substantially all of the assets and specified liabilities of Health
Receivables Management, LLC ("Old HRM"), an Illinois based company that
furnishes Medicaid applications service, electronic billing, eligibility
verification, accounts receivable management, and collections services to
providers. In connection with the transaction, QSM changed its name to Health
Receivables Management, Inc. ("HRM"). The Company offers pre-collection and
collections services through HRM. HRM's results are included in the Provider
Revenue Services Group. The Revenue Services Division's Payor Revenue Services
Group began delivery of Third Party Liability Recovery ("TPLR")(SM) services in
1985 and augmented its product line in 1996 with the acquisition of CDR
Associates, Inc. ("CDR"). CDR is a provider of hospital-based claim audits to
payors, principally Blue Cross and Blue Shield organizations.

         The Company entered the software business in 1995, merging with Health
Care microsystems, Inc. ("HCm"), a company furnishing microcomputer-based
distributed decision support software systems and services (including
consulting) to healthcare providers and payors. HCm now constitutes the Decision
Support Group. In 1996, the Decision Support Group acquired QSM and integrated
QSM's clinical information systems with HCm's decision support offerings. In
1997 the Company, which had owned a 43% equity interest in Health Information
Systems Corporation ("HISCo"), acquired from Welsh, Carson, Anderson & Stowe
("WCAS") and various of its affiliates, independent investors, and from certain
of the Company's executive officers and directors, the remaining 57% of HISCo's
equity. At the time of acquisition, HISCo merged with its sole operating
subsidiary, Health Systems Architects, Inc., and was renamed HSA Managed Care
Systems, Inc. ("HSA"). This entity now constitutes the Payor Systems Group


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and furnishes automated business and information solutions, including software
systems and services, to healthcare providers and payors.

         The HCm, CDR, and QSM mergers were accounted for using the pooling of
interest method, while the QMA, HISCo, Global, and HRM acquisitions were
accounted for using the purchase method.

                    HEALTHCARE REFORM AND REGULATORY MATTERS

         The healthcare reimbursement landscape continues to change. Federal,
state, and local governments, as well as other third-party payors, have
initiated policies to reduce the rate of increase in healthcare expenditures.
Many of these policy initiatives have contributed to the complex and
time-consuming nature of obtaining healthcare reimbursement for medical
services.

         Changes occurring in the healthcare industry, most notably the
evolution of healthcare towards the present managed care model characterized by
the formation of large integrated delivery systems and capitated reimbursement,
have created an increasingly complex reimbursement environment that impacts both
providers and payors. This environment is made even more complex as the
historical distinction between providers and payors becomes less clear. The
consolidation of healthcare into integrated delivery systems has broken down
traditional organizational barriers that once supported a clear delineation
between the manner in which providers and payors utilized operational,
financial, administrative, and clinical information. Today, emphasis is placed
on improving the level of provider and payor accountability for both the
delivery and the utilization of healthcare services. Providers must ensure that
they are properly reimbursed by third-party payors for healthcare services
rendered in accordance with pre-established contracts. Likewise, payors must
ensure that they are making payments for only those services for which they are
responsible and in the dollar amounts specified by these pre-established
contracts.

         Although the Company cannot predict the nature of future healthcare
reforms that will be adopted by federal, state, and local governments, the
Company believes that the shifting of traditional insurance risk to providers of
care, the consolidation of providers, and the resulting additional information
management requirements placed on providers and payors should increase the
demand for the Company's offerings. Moreover, the Company believes that
providers, payors, and patients -- both separately and together -- will benefit
from the Company's integration of cost and other financial and clinical data,
enabling identification and management by all participants (providers, payors,
and patients) of the outcomes (benefits and costs) achieved.

         The Company observes the continuing intensification of interest in
ensuring compliance by providers and payors with the statutory, regulatory, and
contractual requirements of managed care. The Company believes that the
intensifying concern regarding compliance has increased its costs, as the
Company seeks to ensure its own compliance and that of its customers. At the
same time, the Company believes that the increased focus on compliance creates a
potential market for its products and services.

         The Company's services also are subject to regulations pertaining to
billing services, which primarily involve recordkeeping requirements and other
provisions designed to prevent fraud. The Company believes that it operates in a
manner consistent with such regulations, the enforcement of which is
increasingly more stringent.

         The Medicare program is administered by the Health Care Financing
Administration ("HCFA"), an agency of the United States Department of Health and
Human Services. HCFA currently contracts with numerous intermediaries and fiscal
agents to process regional claims for reimbursement. Although HCFA has
established the regulatory framework for Medicare claims administration,
Medicare intermediaries have the authority to develop independent procedures for
administering the claims reimbursement process. The Medicaid program is subject
to regulation by HCFA, but is administered by state governments. State
governments provide for Medicaid claims reimbursement either through the
establishment of state-owned and operated processing centers or through
contractual arrangements with third-party fiscal agents who own and operate
their own processing centers. The requirements and procedures for reimbursement
implemented by Medicaid differ from state to state. Similar to the claims
administration processes of Medicare and Medicaid, many national health
insurance companies and self-insured employers administer reimbursement of


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claims through local or regional offices. Consequently, because guidelines for
the reimbursement of claims are generally established by third-party payors at
local or regional levels, hospital and other provider reimbursement managers
must remain current with the local procedures and requirements of third-party
payors.

         The ownership and operation of hospitals is subject to comprehensive
federal and state regulation, which affects hospital reimbursement. Since
adoption, the Medicare and Medicaid programs have undergone significant and
frequent changes, and it is realistic to expect additional changes in the
future. Specifically, Congress recently passed the Balanced Budget Refinement
Act of 1999. This legislation provides relief of approximately $17 billion to
the healthcare industry over the next five years. The bill was enacted to
partially restore funds that were reduced as a result of the Balanced Budget Act
of 1997. The Balanced Budget Act of 1997 was originally estimated to reduce
Medicare spending by approximately $106 billion over five years. Today,
estimates of the reduction in Medicare outlays due to the Balanced Budget Act of
1997 exceed $200 billion, more than double the original government projections.
The recent legislation may indicate an acknowledgment that the reductions were
too pervasive and that hardship has been placed on many healthcare providers as
a result of Medicare cuts associated with the Balanced Budget Act of 1997. While
the Balanced Budget Act of 1997, as modified by the Balanced Budget Refinement
Act of 1999, could still have an adverse effect on the operations of hospitals
and other providers of healthcare, and consequently reduce the amount of the
Company's revenue, the Company believes that healthcare organizations can use
the Company's products and services to reduce costs while maintaining or
improving the quality of care (thereby compensating, in part or whole, for
losses in revenue due to the Balanced Budget Act of 1997).

         In addition, the Social Security Act imposes certain requirements on
the Company with regard to confidentiality and disclosure of Medicare and
Medicaid provider and beneficiary data. Specifically, the Company is prohibited
from disclosing information that is obtained by or from the Department of Health
and Human Services except as otherwise provided by regulations or other federal
law. Generally, the Company is required to maintain standards of confidentiality
that are comparable to those of an agency administering the Medicare or Medicaid
program when the Company uses data obtained from such programs.

         Finally, the Health Insurance Portability and Accountability Act of
1996 ("HIPAA") requires the Secretary of Health and Human Services to adopt
national standards for certain types of electronic health information
transactions and the data elements used in such transactions and to adopt
standards to ensure the integrity and confidentiality of health information. All
providers, payors, and clearinghouses will be mandated to use HIPAA standards
when electronically exchanging health data covered by HIPAA. Any material
restriction on the ability of healthcare providers and payors to obtain or
disseminate health information could adversely affect the Company's business,
financial condition, and results of operations. While HIPAA could also have an
adverse affect on the operations of providers and payors and consequently reduce
the amount of the Company's revenue, the Company believes it possesses technical
and managerial knowledge and skills that could benefit healthcare organizations
seeking to establish compliance with HIPAA requirements.

         The Company believes that the rapidity of consolidation within the
healthcare industry will continue to create opportunities for the Company in its
role as a data consolidator. Yet the rapidity of change suggests that some of
the consolidation may have been overdone and may be undone over the next several
years, as providers downsize and integrated delivery networks ("IDN's") begin to
unbundle. The Company believes these dynamics constitute both a risk to its
existing business relationship with Columbia/HCA Healthcare Corporation
("Columbia"), the Company's largest client, and an opportunity for new business
in the future.

                         PRINCIPAL PRODUCTS AND SERVICES

PROVIDER REVENUE SERVICES GROUP

          The Company's Provider Revenue Services Group offers information
management solutions across the accounts receivable spectrum, with offerings
performed on retroactive, concurrent, and prospective bases. Fees are tailored
to the particular configuration of service furnished to the client, with the


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preponderance of the Company's remuneration based upon contingent fee
arrangements. The Company recognizes revenue at the time the work on a
particular bill submission, claim, recovery, or cost report has been completed
and accepted by the client for purposes of initiating the revenue recovery
process.

PROVIDER REVENUE SERVICES GROUP: SAFETY-NET SERVICES

         The Company's first product, RCR, entails the retroactive recovery of
third-party payments due provider healthcare organizations, including large
public and voluntary hospitals and schools. RCR services are used by a hospital
(most commonly for its emergency room and outpatient clinics) to realize
third-party revenue from patient accounts after the hospital has expended its
own best efforts at billing and collection, but before the accounts are referred
to a collection agency. The Company's specialized data aggregation, data
purification, data editing, and electronic claim preparation and transmission
routines are designed to facilitate the reimbursement of accounts that remain
unpaid because necessary billing information was missing or because third-party
coverage was not known. RCR services require the hospital to provide the Company
with copies of existing data files, demand minimal hospital staff support, and
generally involve no patient contact. Through the application of the Company's
proprietary technology, the Company's RCR services produce, for its hospital
clients, incremental revenue which otherwise would remain uncollected. RCR
services have evolved from a strictly background process to a process frequently
concurrent and integrated with clients' internal processes, entailing onsite
support, designed to generate the maximum results through targeted review,
analysis, and opportunity identification.

         Using database-driven methodologies developed in connection with RCR,
the Provider Revenue Services Group offers a range of additional safety-net
retroactive recovery services to healthcare providers. In conjunction with the
Decision Support Group, the Provider Revenue Services Group provides Managed
Care Recovery Services (formerly referred to as "underpayment recovery
services") to assist healthcare providers in the recovery of underpayments due
from managed care payors. The Company is paid on a contingent fee basis for
these services, and recognizes revenue at the time the work has been completed
and is accepted by the client.

         This Group also offers Cost Report reimbursement services, including
Medicare Bad Debt Recovery, in which the Company assists providers in isolating
coinsurance and deductible amounts that qualify for Bad Debt reimbursement, and
Disproportionate Share services, as part of which the Company identifies and
recalculates improperly classified claims that are eligible for Federal
Financial Participation. The Group also supports clients' substantiation of
future claims for Medicare Bad Debt by establishing appropriate concurrent
operating processes. In addition, the Company performs Supplemental Security
Income ("SSI") identification and recovery services in order to secure
reimbursement from Medicaid for services rendered to recipients approved for SSI
upon conclusion of the lengthy SSI application review process.

PROVIDER REVENUE SERVICES GROUP: BUSINESS OFFICE SERVICES

         As a result of the technology and expertise developed in providing RCR
services, the Company is able to provide customized institutional data
processing, computer software, and operations support services to hospitals,
public health clinics, outpatient treatment facilities, and companies that serve
the healthcare industry. In contrast to RCR services, which retrospectively
reprocess patient accounts receivable data, CAMS, delivered to healthcare
providers, provides concurrent third-party claim identification, editing, claim
preparation, electronic claims submission, bill follow-up, denial reprocessing,
and remittance management services. The Company integrates data derived from the
hospital's disparate data collection systems and manages the electronic
interfaces between the hospital and the transfer payment agencies upon which the
hospital is dependent for reimbursement. CAMS is designed to provide an
integrated and comprehensive solution to a hospital's accounts receivable
liquidation requirements by combining (i) an intimate familiarity with the
principal in-house data collection and patient accounting systems found in large
urban hospitals with (ii) expertise in the management and liquidation of
accounts receivable, thereby offering a hospital a unique opportunity to improve
the effectiveness (enhanced revenue and accelerated cash flow) of its accounts
receivable management program while decreasing its administrative costs.



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         Through its RCR and CAMS offerings, the Company has developed the
capability to submit healthcare claims data and to receive remittance data
electronically from a diverse array of third-party payors. In addition, the
Company provides electronic billing and follow-up services for claims submitted
by providers to Medi-Cal (the California Medicaid program) and the Illinois
Medicaid program. The Company also provides stand-alone EDI services to clients
in Illinois, New York, and Pennsylvania. The Company's strategy includes the
continued development of EDI services as an integral component of its business
office services.

         Using its EDI capability and medical record-based processing system
acquired from Global, the Provider Revenue Services Group is also able to
provide products and services on a concurrent basis as part of its Business
Office Outsourcing offering. The Company created this offering in 1997 to
provide a lower-cost alternative to its CAMS offering for hospitals, physician
groups, faculty practices, public and private clinic systems, and other
healthcare organizations. As part of its Business Office Outsourcing offering,
the Company integrates its software, staff, and processes to enable providers,
including those bearing financial risk, to manage their data and transfer
payment processes. Components of the Company's Business Office Outsourcing
offering include pre-treatment patient registration and admission; treatment
authorization; claim preparation and billing; account follow-up; and reporting.
For providers at financial risk, the Company's Business Office Outsourcing
offering includes membership services, claims administration, provider services,
risk administration, and management information.

         The Provider Revenue Services Group also furnishes Comprehensive
Accounts Receivable Services ("CARS"), through which the Company liquidates aged
accounts from a client's outgoing patient accounting system before a new patient
accounting system is installed. CARS also assists providers in liquidating aged
accounts before they are transferred to a collection agency.

         With the acquisition of the assets and specified liabilities of Old HRM
in 1999, the Company offers Medicaid Application Services, which assist eligible
patients in properly enrolling in public aid, ensuring that providers receive
reimbursement for care rendered to indigent patients. The Company also provides
pre-collection and collections services to providers through HRM.

PAYOR REVENUE SERVICES GROUP

         In 1985, the Company began to offer TPLR services principally to state
Medicaid agencies, as a means of identifying third parties with prior liability
for Medicaid claims. As part of its TPLR offering via its 1996 acquisition of
CDR, the Company provides hospital-based claims audits on behalf of payors, for
the purpose of recovering credit balances and duplicate payments. The Company
provides services to state Medicaid agencies as well as to Medicaid HMO's and to
Blue Cross/Blue Shield organizations and commercial insurers (including managed
care payors).

         The Payor Revenue Services Group applies its proprietary information
management and coordination of benefits methodologies used in TPLR to examine
paid claims datasets in order to identify duplicate payments, overpayments,
compliance-related erroneous payments, and other inappropriate payments on
behalf of payor organizations.

         TPLR contracts generally have one to three year terms and provide for
contingent fees calculated as a percentage of the amounts recovered for the
client. The Company recognizes revenue at the time the work on a particular
recovery or disallowance has been submitted to the client or its third-party
payors or intermediaries and accepted by the client for purposes of initiating
the recovery process. The Group's fiscal fourth quarter is traditionally its
strongest quarter, within which it executes a number of once a year recovery
projects.

DECISION SUPPORT GROUP

          The growth of managed care and the consolidation of healthcare
institutions is significantly increasing the complexity of the industry and the
associated demand for decision support systems. In the managed care environment,
the Company believes decision support to be the linchpin for integrating,
analyzing, and understanding key operational, financial, administrative, and
clinical data obtained from institutions' transaction-based healthcare



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information systems. As such, decision support systems and services are
increasingly being relied upon to guide the management practices of providers
(in areas ranging from managed care contracting and clinical pathways
development to physician profiling) to ensure the success and financial and
operational viability of their organizations. The current clients for the
Decision Support Group include more than 500 hospitals and IDN's located
primarily in the United States. These hospitals range in size from 50 to more
than 1,000 beds, and include many of the most progressive and complex health
systems in the country, as well as some of the largest multi-site hospital
chains, managed care organizations, and long-term care institutions.

         Developed in collaboration with several major healthcare organizations,
the Company's suite of decision support software and related consulting
services, called Alliance for Decision Support(TM) ("Alliance"), was released to
the market in June 1998. Alliance enables healthcare providers to perform
contract modeling and net revenue management, costing and clinical financial
analytics, and physician profiling and quality management from the perspective
of the provider, payor, and/or third-party administrator. Employing advanced
systems integration, data validation, and distribution methods, Alliance
supports evolving data warehousing and information systems initiatives. Alliance
was built with an open system architecture, running on a variety of platforms
that support client server processing and World Wide Web applications. In
addition to purchasing the Company's software, customers have the option of
partnering with the Company or outsourcing part or all of the operation of the
Alliance system to the Company. The Company continues to integrate clinical
quality measures within Alliance.

          In partnering relationships, the Company dedicates considerable
resources to providing a wide variety of related consulting applications,
including decision support planning and implementation services, decision
support outsourcing and management, and data warehouse planning and
implementation.

         The Decision Support Group provides clients with prospective,
concurrent, and retroactive decision support applications and services,
including a concurrent managed care contract profiler and payment calculator
system and data warehouse services for a substantial number of Columbia
facilities. As a result, proper calculation of anticipated contractual
allowances are now provided as an integrated component of the managed care
reimbursement process for a substantial number of Columbia facilities. In
addition, the Decision Support Group provides a substantial number of Columbia
facilities with prospective decision support applications for reimbursement
management.

         Through Alliance for Financial Management(TM) ("FM"), the Decision
Support Group offers healthcare organizations an enterprise-wide financial
analysis and modeling application, with capabilities including employee-level
budget and productivity support, operating and capital budget support, and
long-range strategic planning. FM version 6.2 was released during fiscal year
1999, and incorporates web publishing and a Microsoft(R) Excel spreadsheet
add-in for ease of use and quicker access to data. The application also
incorporates multi-dimensional, on-line analytical processing technology,
integrated with electronic mail applications and standard spreadsheet tools to
support communications and analysis. The Decision Support Group provides related
application consulting services, focusing on analysis and development of cost
accounting, contract management, budgeting, business lines, and treatment
patterns.

PAYOR SYSTEMS GROUP

         The Payor Systems Group provides large-scale transaction processing
systems and services to large and medium-sized commercial payors and managed
care plans, including some large Blue Cross/Blue Shield organizations.

         Both public and private entities have been embracing managed care
health plans as a means of providing and managing the delivery and cost of
healthcare services. With this increased demand, the number of existing payors,
the number of start-up entities, and the number of IDN's seeking to offer
managed care products has greatly increased. To support their businesses, these
payors require systems to: manage patient membership, provider contracts, and
networks; process and adjudicate claims; manage risk; and perform medical
management.



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         The four principal offerings of the Payor Systems Group are
ProAlliance(TM); CapAlliance(TM); Alliance for Managed Care(TM) (formerly called
"HES"), and Alliance for Claims Outsourcing(TM) ("ACO") formerly called
("Service Bureau"). ProAlliance is a data repository of integrated information,
enabling proactive management of complex processes such as credentialing,
accreditation, and pricing arrangements. In the past two years, in conjunction
with development partners and on its own, the Company has migrated various of
its Payor Systems Group offerings to an open system architecture, running on
platforms that support client server and world wide web applications.
CapAlliance, the Company's stand-alone capitation offering, manages the payment
to providers of pre-negotiated per capita amounts. Alliance for Managed Care is
a risk management solution for payors seeking a strategy to manage their own
health plans and market their own products, providing data processing for plans
offering a full spectrum of products, from traditional indemnity coverage
through complete managed care programs. Comprised of modular systems, Alliance
for Managed Care automates four major areas of healthcare administration:
membership and billing, provider administration, capitation, and benefits and
claims. In fiscal year 1999, the Payor Systems Group consummated a multi-year
strategic partnership with Medical Mutual of Ohio for the design and development
of Alliance for Managed Care, which will expand the current functionality of the
Company's existing managed care systems to incorporate graphical and web
interfaces, a component-based architecture, and the use of relational database
technology. Through its ACO offering, the Company provides its managed care
functionality, including hardware and software, in an outsourcing or
applications service provider mode. In fiscal year 1999, ACO was upgraded for
the "Year 2000 ("Y2K") computer issue" to afford home host information
technology services processing to clients, and to afford enhanced electronic
claims and referral authorization control. Membership was approximately 44,000
members at October 31, 1999.

         The Company's Payor Systems Group offerings are sold on a stand-alone
basis, or can be integrated into existing systems, the latter option enabling
payors to preserve their investments in information technology. The Company
believes that these offerings dramatically reduce the cost of processing claims
through auto-adjudication.

                                    CUSTOMERS

         The Company's client base includes hospitals, IDN's, multi-hospital
systems, the country's largest public health systems, long-term care facilities,
large commercial payors, Blue Cross/Blue Shield organizations, and state
Medicaid agencies. The Company also has a limited number of overseas clients.
Among the Company's domestic clients are the nation's three largest public
health systems and the largest proprietary hospital corporation.

         No single client of the Company accounted for 10% or more of the
Company's total revenue in fiscal year 1999. The Company's largest client is
Columbia, a customer of the Decision Support Group. This client accounted for
9%, 10%, and 12% of the Company's total revenue in fiscal years 1999, 1998, and
1997, respectively. The Company provides its services to Columbia primarily
pursuant to annual work order agreements. There is no assurance that any of
these agreements will be renewed.

         The clients constituting the Company's ten largest clients change
periodically. The concentration of revenue in such accounts has decreased;
accounting for approximately 48%, 50%, and 53% of the Company's revenue in
fiscal years 1999, 1998, and 1997, respectively. In many instances, including
governmental clients, the Company provides its services pursuant to agreements
subject to competitive re-procurement. All of these agreements periodically
expire, and will have reached their terms by the end of fiscal year 2004. There
is no assurance that any of these agreements will be renewed and, if renewed,
that the fee rates will be equal to those currently in effect.

         The Company works with selected customers and other development
partners in the research, development, and testing of its software products and
services.



                                       8
<PAGE>   11
                           MARKET TRENDS/OPPORTUNITIES

         The healthcare industry continues to face unrelenting financial
pressure, as provider reimbursement is constrained and payor costs are under
pressure. Thus, information relating to reimbursement, costs, and quality of
care is of increasing importance. Administrative costs within the healthcare
industry remain high and constitute a continuing target of opportunity for the
Company.

         The demands of managing the delivery of patient care with ever
increasing qualitative and quantitative rigor will continue to drive the need
for increased amounts of operational, financial, administrative, and clinical
information. The Company believes that it possesses the data content, analytic
tools, technology, communications, and process management skills required to
respond to the current and anticipated needs of provider and payor clients for
tools and services to manage this evolving complexity.

         Cost pressures continue to drive horizontal and vertical integration of
providers and payors alike. Consolidation among healthcare organizations is
creating larger healthcare delivery systems, with greater regional market power.
This phenomenon is creating a new market for the Company's products, with fewer
but larger client prospects. Despite some recent analyses suggesting that the
rapidity of this change may be undone over the next several years, as providers
are downsized and IDN's begin to unbundle, the Company believes that it has the
opportunity to leverage its products and services across larger enterprises,
making the Company's products and services more cost effective for clients. As
well, the shifting of financial risk from payors to providers creates the
opportunity for the Company to provide its payor software offerings to
providers.

         A certain portion of the accounts receivable against which the
Company's traditional receivables management services were focused has been
capitated and is no longer subject to recovery through the primary RCR offering.
Capitation and other forms of managed care reimbursement, however, have created
an opportunity for the Company to augment its RCR offering with managed care
recovery services, enabling providers to ensure proper reimbursement under
capitated and other managed care contracts. In addition, providers' commercial
insurance portfolios are becoming more problematic. Providers are increasingly
seeking assistance from vendors to optimize recovery of commercial insurance
claims, which are frequently rejected erroneously as managed care claims. In
addition, the Company expects that there will be a growing trend toward
outsourcing by healthcare provider organizations in the future.

         The World Wide Web is a readily available means of enhancing
communications among the various participants in the healthcare delivery
process. Previously disenfranchised consumers, or patients, may now connect
readily with their providers of healthcare and the payors for care. Previously
isolated individual and small practitioners may now connect readily with larger
providers and with their payors. In the short term, the enhanced connectivity
should render various types of data more readily available, while in the longer
term the enhanced connectivity has the potential to facilitate partial or full
amelioration of existing inefficiencies in the clinical, operational, financial,
and administrative aspects of healthcare. The Company views the Internet as a
conduit for additional data, thereby enabling the Company to increase its
value-added impact on the marketplace.

                                   COMPETITION

         Although the Company's products and services involve various
proprietary aspects, its business is highly competitive and competition has been
consolidating rapidly. While the Company believes that no one company competes
with all aspects of its business, several companies, some of which may be larger
and have greater financial resources than the Company, compete with the Company
in providing one or more of the Company's offerings. The Company also encounters
competition from companies attempting to expand the scope of their products and
services within or into the healthcare information management services industry.


                                       9
<PAGE>   12
PROVIDER REVENUE SERVICES GROUP

          The Company's Provider Revenue Services Group competes with systems
integration companies (such as Electronic Data Systems Corporation ("EDS")),
hospital computer systems vendors (such as McKesson HBOC, Inc. ("MCK") and
Shared Medical Systems Corporation ("SMS")), EDI companies (such as National
Data Corporation ("NDC"), Healtheon/WebMD ("HLTH"), and QuadraMed Corporation
("QMDC")), and national public accounting firms. The Company competes on the
basis of its proprietary systems, existing relationships, long-standing
reputation in the provider market segment, and pricing.

PAYOR REVENUE SERVICES GROUP

         The Company's Payor Revenue Services Group targets federal and state
healthcare agencies and large commercial payors, and competes primarily with
national public accounting firms (especially Deloitte & Touche LLP and Public
Consulting Group). The Company competes on the basis of its proprietary systems,
historically high recovery rates, and pricing.

DECISION SUPPORT GROUP

         The Company's Decision Support Group competes with products provided by
Eclypsis Corporation ("ECLP"), MCK, QMDC, Kreg Information Systems, and SRC
Software. Companies that offer general-purpose financial management products,
including Hyperion Software and PeopleSoft, Inc., are also competitors. The
Company competes on the basis of its proprietary software and quality,
value-added management consulting services.

PAYOR SYSTEMS GROUP

         The Company's Payor Systems Group competes against multiple companies,
including Health Systems Design Corporation and ERISCO, Inc. ("ERISCO"), as well
as with in-house systems development groups. The Company sells its products to
large provider organizations, and also views IDN's as a potential market for its
existing products and services. In the provider market, competition comes from
large hospital computer systems vendors, such as MCK and SMS, which offer
managed care information systems as part of their solutions.

         In the traditional indemnity health insurance market, the Company's
payor systems offerings compete with claims adjudication and provider management
products from ERISCO, Synertech, a subsidiary of Highmark, Inc., Resource
Information Management Systems, Inc. and QMDC. As the Company enters the IDN
market, it will compete with MCK's Amisys Division and SMS. CSC Healthcare, a
subsidiary of Computer Sciences Corporation, has also been investing in and may
emerge as a strong competitor in the IDN information systems market.

         The Company's Payor Systems Group competes on the basis of its
proprietary software, healthcare software development expertise, and large-scale
project management capabilities.

                            RESEARCH AND DEVELOPMENT

         The Company's performance in the healthcare information technology and
services arenas requires it to devote resources to research and development to
continue the acceptance of the Company's products in the marketplace. See Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations Risk Factors - New Product Development and System Enhancement.

                                BUSINESS STRATEGY

         Given the severity of the budgetary constraints impinging upon
providers and payors of healthcare alike, and the high procurement and
conversion costs associated with the implementation of new systems, there is a
great deal of attractiveness to a paradigm that enables a client to access the
requisite applications software and data by means of communications technology
via the World Wide Web, with the vendor providing associated software and data
maintenance functions as an applications services provider, and associated
business functionality as a business services provider.


                                       10
<PAGE>   13
         The Company's business strategy is to accelerate growth in the second
half of fiscal year 2000 and thereafter, once client reluctance to make
decisions regarding implementation of new software during their internal Y2K
concerns abates. Management believes the Company is well positioned as a leading
source of analytic and operational software and services to providers and payors
within the healthcare industry. The Company expects to continue to leverage its
existing software and service offerings to enhance its outsourcing offerings and
to provide, as a single package World Wide Web connectivity, software
applications, and related applications and business services for a monthly
service fee. Key components of the Company's strategy include: (i) continuing
its investment in product research and development, (ii) enhancing its
capabilities as an outsourcer or business services provider, (iii) continuing
its investment in its data warehousing infrastructure, (iv) leveraging its
existing relationships with large clients through the provision of augmentative
products and services, and (v) expanding its strategic development partnerships
with provider and payor organizations for all aspects of the Company's business.

         Additionally, the Company seeks to acquire companies that supply
healthcare providers and/or payors with information management software,
systems, or services if the offerings of the Company or such companies would
benefit from access to the other's technology, software applications, or client
base. The Company believes that such acquisition opportunities exist due, in
part, to competitive pressures on local service businesses that lack adequate
capital, technical, and management resources.

                                    EMPLOYEES

         As of October 31, 1999, the Company employed approximately 900
employees. No employees are covered by a collective bargaining agreement or are
represented by a labor union.

                  FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

         Specific financial information with respect to the Company's industry
segments is provided in Note 13, Segment and Geographical Information, of Notes
to Consolidated Financial Statements, on page 46 on this Form 10-K.

ITEM 2. PROPERTIES

         The Company's New York City offices consist of approximately 149,000
square feet. In addition, the Company leases approximately 169,000 square feet
of office space in approximately 23 locations throughout the United States.
Information regarding the Company's leases is included in Note 14, Commitments,
of Notes to Consolidated Financial Statements, on page 48 of this Form 10-K.

ITEM 3. LEGAL PROCEEDINGS

         In April and May 1997, five purported class action lawsuits were
commenced in the United States District Court for the Southern District of New
York against the Company and certain of its present and former officers and
directors alleging violations of the Securities Exchange Act of 1934 in
connection with certain allegedly false and misleading statements. These
lawsuits, which sought damages in an unspecified amount, were consolidated into
a single proceeding captioned In re Health Management Systems, Inc. Securities
Litigation (97 CIV-1965 (HB)) and a Consolidated Amended Complaint was filed.
Defendants made a motion to dismiss the Consolidated Amended Complaint, which
was submitted to the Court on December 18, 1997 following oral argument. On May
27, 1998, the Consolidated Amended Complaint was dismissed by the Court for
failure to state a claim under the federal securities laws, with leave for the
plaintiffs to replead. On July 17, 1998, a Second Consolidated Amended Complaint
was filed in the United States District Court for the Southern District of New
York, which reiterated plaintiffs' allegations in their prior Complaint. On
September 11, 1998, the Company and the other defendants filed a motion to
dismiss the Second Consolidated Amended Complaint. The motion was fully briefed
in late November 1998, at which time the motion was submitted to the Court.


                                       11
<PAGE>   14
The consolidated proceeding was reassigned to another Judge. The Court heard
oral argument on the motion to dismiss on June 11, 1999. Prior to rendering its
decision on the motion to dismiss, the Court ordered the parties to attempt to
settle the case, and meetings toward that end were conducted. On December 20,
1999, the parties reached a tentative agreement on the principal terms of
settlement of the litigation against all defendants. Pursuant to this
understanding, without admitting any wrongdoing, certain of the defendants have
agreed to pay, in complete settlement of this lawsuit, the sum of $4,500,000,
not less than 75 percent of which will be paid by the Company's insurance
carriers. For the fiscal year ended October 31, 1999, the Company has recorded a
charge of $845,000 related to this proposed settlement which is included as a
component of other cost of services. The proposed settlement is subject to
execution of a final settlement agreement and Court approval. On December 22,
1999, the Judge issued an Order dismissing, without prejudice, the pending
motion to dismiss, as moot. In the event a final settlement is not consummated,
the Company intends to resubmit a motion to dismiss the Second Consolidated
Amended Complaint and to continue its vigorous defense of the lawsuit. See Note
17 of Notes to Consolidated Financial Statements and Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations.

         On June 1, 1998, MedE America Corp. commenced a lawsuit against the
Company and others in the United States District Court for the Southern District
of New York. In its complaint, plaintiff alleged copyright infringement and
other violations of its rights relating to the Company's development and sale of
certain computer software, known as the Universal Billing Platform, which was
developed for the Company by certain former employees of plaintiff, who are also
defendants in the action, acting as independent contractors. Plaintiff, among
other relief, sought (i) to restrain the Company from continuing to market and
sell the alleged infringing software, and (ii) monetary damages in excess of
$10,000,000. Over a period of in excess of nine months prior to the filing of
the complaint, the parties engaged in an extensive exchange of communications,
as a result of which the Company concluded, after investigation, that
plaintiff's claims were without merit. On July 22, 1998, the Company answered
the complaint, denying the material allegations of the complaint. After the
commencement of discovery and pursuant to the Rules of the Court, this matter
was referred to a Court-appointed Mediator, who, in the context of non-binding
mediation and independent of the Court proceeding, met with the parties over a
period of months. The Mediator assisted in negotiating a settlement of this
case, which entails no payment by the Company, dismissal of the Complaint with
prejudice, and an acknowledgement by MedE that, after review and access to
additional information, the copyright and trademark infringement claims were
without merit.

         On June 28, 1998, eight holders of promissory notes (the "Notes") of
HHL Financial Services, Inc. ("HHL") commenced a lawsuit against the Company and
others in the Supreme Court of the State of New York, County of Nassau, alleging
various breaches of fiduciary duty on the part of the defendants against HHL.
The complaint alleges that, as a result of these breaches of duty, HHL was
caused to make substantial unjustified payments to the Company which,
ultimately, led to defaults on the Notes and to HHL's filing for Chapter 11
bankruptcy protection. On June 30, 1998, the same Note holders commenced a
virtually identical action (the "Adversary Proceeding") in the United States
Bankruptcy Court for the District of Delaware, where HHL's Chapter 11 proceeding
is pending. The Adversary Proceeding alleges the same wrongdoing as the New York
State Court proceeding and seeks the same damages, i.e., $2,300,000 (the unpaid
amount of the Notes) plus interest. Plaintiffs have moved in the Bankruptcy
Court to have the Court abstain from hearing the Adversary Proceeding in
deference to the New York State Court action. The Company has opposed
plaintiffs' motion for abstention and on September 15, 1998 filed a motion in
the Bankruptcy Court to dismiss the Adversary Proceeding. This motion was
briefed in December 1998. Oral argument on the motions was heard by the Court on
April 22, 1999 and the motions are now sub judice. The Company intends to
continue its vigorous defense of this lawsuit. Management believes the risk of
loss is not probable and accordingly has not recognized any accrued liability
for this matter. Although the outcome of this matter cannot be predicted with
certainty, the Company believes that any liability that may result will not, in
the aggregate, have a material adverse effect on the Company's financial
position or cash flows, although it could be material to the Company's operating
results in any one accounting period.



                                       12
<PAGE>   15
         Other legal proceedings to which the Company is a party, in the opinion
of the Company's management, are not expected to have a material adverse effect
on the Company's financial position, results of operations, or liquidity.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         Not Applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

         The Company's common stock is included in the NASDAQ-AMEX National
Market System (symbol: HMSY). As of the close of business on December 30, 1999,
there were approximately 9,500 holders of the Company's common stock, including
the individual participants in security position listings. The Company has not
paid any cash dividends on its common stock and does not anticipate paying cash
dividends in the foreseeable future. The Company's current intention is to
retain earnings to support the future growth of its business. The Company's
credit agreement with its bank contains limitations on the Company's ability to
pay cash dividends.

         The table below summarizes the high and low sales prices per share for
the Company's common stock for the fiscal year periods indicated, as reported on
the NASDAQ-AMEX National Market System.


<TABLE>
<CAPTION>
                     First       Second        Third      Fourth
                    Quarter      Quarter      Quarter     Quarter
                    -------      -------      -------     -------
<S>               <C>            <C>          <C>         <C>
     1999:
       High       $   10.13       8.00         6.63        6.09
       Low             6.13       4.13         4.44        3.81

     1998:
       High       $    7.63      13.38        13.12        9.25
       Low             5.25       7.25         7.75        3.94
</TABLE>






                                       13
<PAGE>   16
ITEM 6. SELECTED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL DATA (a)
  ($ In Thousands, Except Per Common Share Data)

<TABLE>
<CAPTION>
Years Ended October 31,                                      1999           1998           1997            1996            1995
-----------------------                                  ---------      ---------      ---------       ---------       ---------
<S>                                                      <C>            <C>            <C>             <C>             <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
  Revenue Services Division
      Provider Revenue Services Group                    $  41,536      $  34,987      $  39,007       $  55,410       $  55,128
      Payor Revenue Services Group                          26,414         22,251         16,849          26,406          19,479
                                                         ---------      ---------      ---------       ---------       ---------
                                                            67,950         57,238         55,856          81,816          74,607
  Software Division
      Decision Support Group                                22,542         25,499         24,873          19,510          15,888
      Payor Systems Group                                   23,563         22,515          8,788               0               0
                                                         ---------      ---------      ---------       ---------       ---------
                                                            46,105         48,014         33,661          19,510          15,888
                                                         ---------      ---------      ---------       ---------       ---------
                                                           114,055        105,252         89,517         101,326          90,495
Cost of services                                           102,918         95,628         88,355          87,873          73,035
                                                         ---------      ---------      ---------       ---------       ---------
  Operating margin before amortization of intangibles       11,137          9,624          1,162          13,453          17,460
Amortization of intangibles (b)                                840          1,964          1,331             204             243
                                                         ---------      ---------      ---------       ---------       ---------
  Operating income (loss)                                   10,297          7,660           (169)         13,249          17,217
Net interest income                                          1,277          1,700          2,755             987             942
Other income (loss)                                              0            597           (856)(c)      (1,371)(d)      (1,045)(e)
                                                         ---------      ---------      ---------       ---------       ---------
  Income before income taxes                                11,574          9,957          1,730          12,865          17,114
Income tax expense (benefit)                                 4,091          3,869           (351)          5,574           8,152
                                                         ---------      ---------      ---------       ---------       ---------
  Net income                                                 7,483          6,088          2,081           7,291           8,962
                                                         ---------      ---------      ---------       ---------       ---------
PER COMMON SHARE DATA:

Diluted earnings per share                               $    0.43      $    0.34      $    0.12       $    0.39       $    0.51
Weighted average common shares and
  common share equivalents                                  17,419         17,833         17,979          18,494          17,579
                                                         ---------      ---------      ---------       ---------       ---------
</TABLE>

<TABLE>
<CAPTION>
As of October 31,                                            1999           1998           1997            1996            1995
-----------------                                        ---------      ---------      ---------       ---------       ---------
<S>                                                      <C>            <C>            <C>             <C>             <C>
BALANCE SHEET DATA:

Cash and short-term investments                            $33,817         28,402         39,080          39,521          30,112
Working capital                                             58,437         56,703         53,799          54,753          41,413
Total assets                                               130,921        117,802        109,694         109,643          88,101
Common shareholders' equity                                 91,232         83,269         79,806          74,612          58,203
</TABLE>


NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA

(a)     Included in each respective year's amounts are the revenue and costs
        associated with the following acquisitions, accounted for using the
        purchase method of accounting (see Note 2 of Notes to Consolidated
        Financial Statements): HRM, since June 1999 acquisition; Global, since
        July 1997 acquisition; and HISCo, since March 1997 acquisition. In
        accordance with the pooling method of accounting, financial data for the
        fiscal years 1996 and 1995 has been restated to reflect the merger with
        QSM in fiscal year 1997; financial data for the fiscal year 1995 has
        been restated to reflect the merger with HCm in fiscal year 1996.

(b)     Intangible assets were principally recorded in connection with the
        Company's fiscal year 1989 recapitalization, its acquisition of QMA in
        fiscal year 1990, its HISCo and Global acquisitions in fiscal year 1997,
        and its HRM acquisition in fiscal year 1999. The amortization of
        software related to the HISCo acquisition was completed during fiscal
        year 1999. See Notes 1(e) and 6 of Notes to Consolidated Financial
        Statements.


                                       14
<PAGE>   17
(c)      Includes costs associated with the Company's merger with QSM, and
         acquisition of the remaining outstanding shares of HISCo not already
         owned by the Company. See Notes 2(c) and 2(d) of Notes to Consolidated
         Financial Statements.

(d)      Includes costs associated with the Company's merger with CDR.

(e)      Includes costs associated with the Company's merger with HCm.



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

FISCAL YEARS ENDED OCTOBER 31, 1999 AND 1998

         Consolidated revenue for the fiscal year ended October 31, 1999 was
$114,055,000, an increase of $8,803,000 or 8.4% over prior year revenue of
$105,252,000.

         The Revenue Services Division, comprised of the Provider Revenue
Services Group and the Payor Revenue Services Group, achieved revenue of
$67,950,000, an increase of $10,712,000 or 19% from the prior year. Of these
amounts, the Provider Revenue Services Group produced revenue of $41,536,000,
including the $1,800,000 in revenue growth attributable to the HRM acquisition
in July 1999, an increase of $6,549,000 or 19% from the prior year. The Payor
Revenue Services Group produced revenue of $26,414,000, an increase in revenue
of $4,163,000 or 19% from the prior year. Other than the revenue growth
attributable to the HRM acquisition, the balance of the revenue growth realized
by each of the two groups comprising the Revenue Services Division was
internally generated from both (1) "new clients," defined as clients generating
revenue in the fiscal year 1999 who did not generate revenue in fiscal year
1998, and (2) delivery of services of expanded scope to "existing clients,"
defined as clients who generated revenue in the comparable prior period.

          Revenue from the Software Division was $46,105,000, a decrease of
$1,909,000 or 4% compared with the prior year. Revenue from the Decision Support
Group was $22,542,000, a decrease of $2,957,000 or 11.6% from the prior year,
while revenue from the Payor Systems Group increased $1,048,000 to $23,563,000,
an increase of 5% from the prior period. Overall, the increased revenue realized
in the Payor Systems Group was offset by the decrease in revenue from the
Decision Support Group. The decrease in this Division's revenue was the result
of an elongated sales cycle, attributable to clients' reluctance to make
decisions regarding the implementation of new software while facing their own
internal Y2K conversion, partially offset by the revenue earned from the
Company's recurring base of clients and implementation of its sales backlog.

         Cost of services for the fiscal year ended October 31, 1999 was
$102,918,000, an increase of $7,290,000 or 8% from the prior year. The increase
was attributable to higher compensation costs, and direct project
subcontractors, partially offset by lower data processing, occupancy, and other
employee related operating expenses. Compensation expense, the largest component
of cost of services, was $64,253,000 for the fiscal year ended October 31, 1999,
reflecting an increase of $4,965,000 or 8% over the prior year. As a percentage
of total revenue, compensation expense remained constant at 56% of total revenue
in the fiscal years ended October 31, 1999 and 1998, respectively. Increased
compensation expense was principally attributable to increases in average
salaries to reflect prevailing market conditions, and an increase in personnel
associated with the acquisition of HRM. Data processing expense for the fiscal
year ended October 31, 1999 was $7,061,000, a decrease of $1,710,000 from the
prior year. The decrease was primarily attributable to the Company's continued
consolidation of its data processing platforms, reduced support of older
versions of the Company's systems, products and services, the capitalization of
additional software development costs incurred to enhance existing products, and
the timing differences associated with amortization of multiple-period
maintenance and software license fees. Direct project costs were $11,240,000 for
the fiscal year ended October 31, 1999, reflecting an increase of $6,172,000
over the prior year, primarily attributable to the Company's increased use of
revenue-generating subcontractor services to support the growth in the Revenue
Services Division. Other operating expenses were $10,987,000 for the fiscal year
ended October 31, 1999 including $845,000 reserved for settlement of the
Company's class action litigation, reflecting a decrease of $1,851,000 over the


                                       15
<PAGE>   18
prior year. The change was primarily attributable to lower professional fees and
employee related costs, including recruiting costs.

         Principally as a result of the above factors, operating margin before
amortization of intangible assets for the fiscal year ended October 31, 1999 was
$11,137,000, an increase of $1,513,000 or 16% from the $9,624,000 realized in
fiscal year 1998. The Company's operating margin rate before amortization of
intangible assets was 10%, compared to 9% in the years ended October 31, 1999
and 1998, respectively.

         Amortization of intangible assets for the fiscal year ended October 31,
1999 was $840,000, a decrease of $1,124,000 from the prior year. This decrease
was due primarily to completion, in fiscal year 1999, of the amortization of the
excess purchase price related to the HISCo acquisition in fiscal year 1997
allocated to certain revenue contracts.

         Net interest and other income for the fiscal year ended October 31,
1999 was $1,277,000, a decrease of $1,020,000 over the prior year, based upon
the combination of lower cash balances and interest rates, the HRM acquisition
transaction, and a $600,000 capital gain on investment recorded in the prior
fiscal year.

         The Company's income tax expense for the fiscal year ended October 31,
1999 was $4,091,000, resulting in an effective tax rate of approximately 35.3%.
This compared to an income tax expense of $3,869,000 and an effective tax rate
of approximately 38.9% for fiscal year 1998. The increased income tax expense
was due primarily to the Company's higher pre-tax profit, offset by a more
favorable effective tax rate realized from the Company's ability to file
consolidated state tax returns in specific jurisdictions and from the newly
enacted provision of the tax code pertaining to utilization of existing prior
year net operating tax loss carryforwards, for which the Company had previously
provided a valuation allowance. The Company reduced its valuation allowance by
$372,000 related to this matter.

         Principally as a result of the above factors, net income for the fiscal
year ended October 31, 1999 increased to $7,483,000, an increase of $1,395,000
or 23% from the prior year. Resultant diluted earnings per share was $0.43 in
fiscal year 1999, compared to $0.34 in fiscal year 1998.

FISCAL YEARS ENDED OCTOBER 31, 1998 AND 1997

         The results of operations discussed below include certain editorial
changes to conform the years ended October 31, 1998 and 1997 to current business
unit naming and segment conventions.

         Consolidated revenue for the fiscal year ended October 31, 1998 was
$105,252,000, an increase of $15,735,000 or 18% from prior year revenue of
$89,517,000.

         The Revenue Services Division, comprised of the Provider Revenue
Services Group and the Payor Revenue Services Group, achieved revenue of
$57,238,000, an increase of $1,382,000 or 2% from the prior year. Of these
amounts, the Provider Revenue Services Group had revenue of $34,987,000, a
decrease of $4,020,000 or 10% from the prior year, while the Payor Revenue
Services Group had revenue of $22,251,000, an increase in revenue of $5,402,000
or 32% over the prior period.

         Revenue from the Software Division was $48,014,000, an increase of
$14,353,000 or 43% over the prior year. Revenue from the Decision Support Group
was $25,499,000, an increase of $626,000 or 3% from the prior year, while the
Payor Systems Group had revenue of $22,515,000 reflecting an increase of
$13,727,000 or 156% from the prior year. This increase was primarily
attributable to the inclusion of the Payor Systems results for the entirety of
the fiscal year in 1998 but for only two-thirds of the fiscal year (March 18
through October 31) in 1997.

         Cost of services for the fiscal year ended October 31, 1998 was
$95,628,000, an increase of $7,273,000 or 8% from the prior year, which included
only partial year costs for the Payor Systems Group in fiscal year 1997 and
partial year costs for the Global acquisition consummated by the Company in July
1997 and reported as part of the Provider Revenue Services Group in fiscal


                                       16
<PAGE>   19
year 1998. In summary, increased costs in the Software Division of $11,045,000
(of which $8,962,000 were attributable to the Payor Systems Group) were offset
by diminished costs of approximately $3,772,000 in the Revenue Services
Division. As a percentage of total revenue, cost of services declined to 91%
from 99% of total revenue for the fiscal years ended October 31, 1998 and 1997,
respectively.

         Compensation expense, the largest component of cost of services, was
$59,288,000 or 56% of total revenue for the fiscal year ended October 31, 1998,
an increase of $6,927,000 or 13% over the prior year, when compensation cost was
58% of total revenue. Increased compensation expense was attributable in large
part to the addition of full year compensation costs for the Payor Systems Group
and the full year effect of the Global acquisition, offset by lower compensation
expense in the remainder of Revenue Services Division due to reduction in
average headcount and decreased deferred compensation benefits. Data processing
expense for the fiscal year ended October 31, 1998 was $8,771,000, an increase
of $1,178,000 or 16% from the prior year. The increase was due primarily to full
year costs of operations in fiscal year 1998 associated with the acquisitions
completed during the course of fiscal year 1997. Occupancy expense for the
fiscal year ended October 31, 1998 was $9,663,000, a decrease of $720,000 or 7%
from the prior year. The decrease was attributable to the subletting of two
floors at the Company's New York City offices, offset by increases associated
with the acquisitions completed during the course of fiscal year 1997. Other
operating expense for the fiscal year ended October 31, 1998 was $17,906,000, a
decrease of $112,000 or 1% from the prior year. This decrease was attributable
to cost reductions in the Revenue Services Division, offset in part by full year
costs in fiscal year 1998 for the acquisitions completed during the course of
fiscal year 1997.

         Operating margin before amortization of intangible assets for the
fiscal year ended October 31, 1998 was $9,624,000, an increase of $8,462,000 or
728% from the $1,162,000 realized in fiscal year 1997. The Company's operating
margin rate before amortization of intangible assets was 9.1%, compared to 1.3%
in the prior year.

         Amortization of intangible assets for the fiscal year ended October 31,
1998 was $1,964,000, an increase of $633,000 from the prior year. This increase
was attributable to a full year of amortization of intangibles for both the
Global and HSA acquisitions.

         Net interest and other income for the fiscal year ended October 31,
1998 was $2,297,000, an increase of $398,000 over the prior year. Fiscal year
1998 other income included $597,000 in capital gains compared to a loss of
$9,000 in the prior year. The prior year also included $877,000 in interest
expense reversal resulting from a favorable Internal Revenue Service audit
resolution, merger expense of $537,000 and equity losses in HISCo of $310,000,
none of which events occurred in fiscal year 1998. Finally, fiscal year 1998
interest income declined by $178,000 from the prior year due to lower interest
rates and lower cash balances.

         The Company's income tax expense for the fiscal year ended October 31,
1998 was $3,869,000, resulting in an effective tax rate of approximately 38.9%.
This compared to an income tax benefit of $351,000 for fiscal year 1997. The
fiscal year 1998 tax rate of 38.9% was lower than the Company's normal rate of
slightly under 42%. This decrease was attributable to available "capital loss
carry forwards" which sheltered the entirety of a $593,000 long term capital
gain, both for tax and financial statement purposes. The effective tax rate for
fiscal year 1998 exclusive of the benefit of the tax-sheltered capital gain was
41.3%, compared to an equivalent effective tax rate of 42.9% in fiscal year
1997. The tax benefit in fiscal year 1997 was primarily due to a reversal of
$1,093,000 in accrued taxes arising from the favorable resolution of an Internal
Revenue Service audit.

         Net income for the fiscal year ended October 31, 1998 was $6,088,000,
an increase of $4,007,000 or 193% from the prior year. Resultant diluted
earnings per share were $0.34 in fiscal year 1998, compared to $0.12 in fiscal
year 1997. Included in the fiscal year 1998 earnings per share were $0.03
resulting from $593,000 in fully sheltered long-term capital gains; included in
fiscal year 1997 earnings per share were $0.06 attributable to non-recurring
events, which consisted of a $310,000 loss in earnings due to the Company's
(then) equity interest in HISCo, $537,000 in merger related costs, offset by a
one-time benefit from the reversal of a $877,000 reserve for interest expense
and $1,093,000 in accrued taxes resulting from a favorable resolution of an
Internal Revenue Service audit concluded fiscal year 1997. Earnings per share
without the one-time and unusual events increased from $0.06 in fiscal year 1997
to $0.31 in fiscal year 1998, an increase of $0.25 per share.



                                       17
<PAGE>   20

LIQUIDITY AND CAPITAL RESOURCES

         At October 31, 1999, the Company had $58,437,000 in net working
capital, an increase of $1,734,000 or 3% from the level at October 31, 1998. The
Company's principal sources of liquidity at October 31, 1999 consisted of cash,
cash equivalents, and short-term investments aggregating $33,817,000, and net
accounts receivable of $58,662,000. Accounts receivable at October 31, 1999
reflected an increase of $3,669,000 or 7% from the balance at October 31, 1998,
of which approximately $2,561,000 was attributable to the HRM acquisition
transaction.

         As of December 30, 1999, the Company amended its unsecured revolving
credit facility to extend the existing term through February 15, 2000. No other
terms of the existing credit facility have changed. Although the Company is in
the process of securing a new credit facility with its financial institution,
there can be no assurance that the Company will be able to do so on terms that
are consistent with the current credit facility or terms that are acceptable to
the Company.

         On May 28, 1997, the Board of Directors authorized the Company to
repurchase such number of shares of its Common Stock that have an aggregate
purchase price not in excess of $10,000,000. The Company may repurchase these
shares from time to time on the open market or in negotiated transactions at
prices deemed appropriate by the Company. Repurchased shares are deposited in
the Company's treasury and used for general corporate purposes. Since the
inception of the repurchase program in June 1997, the Company has repurchased in
the open market 1,049,000 shares having an aggregate purchase price of
$7,750,000. No shares were repurchased in fiscal year 1999.

         In fiscal year 1999, the Company utilized a portion of its excess
capital to again become an opportunistic acquirer, completing the HRM
acquisition transaction. The Company continues to seek to acquire companies that
supply healthcare providers and/or payors with information management software,
systems, or services if the offerings of the Company or such companies would
benefit from access to the other's technology, software applications, or client
base. The Company believes that such acquisition opportunities exist due, in
part, to competitive pressures on local service businesses that lack adequate
capital, technical, and management resources.

INFLATION

         Historically, inflation has not been a material factor affecting the
Company's revenue, and general operating expenses have been subject to normal
inflationary pressure. Notwithstanding, the Company's business is labor
intensive. Wages and other employee-related expenses increase during periods of
inflation and when shortages in the skilled labor market occur. Although the
moderate inflation rates of the past several years have not imposed significant
problems for the Company, in light of current shortages in the skilled labor
market, the Company has implemented selective wage increases in fiscal year 1999
to assure retention of qualified personnel in key areas of its operations.

RISK FACTORS

                PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
                        SAFE HARBOR COMPLIANCE STATEMENT
                         FOR FORWARD-LOOKING STATEMENTS

         In passing the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"), Congress encouraged public companies to make "forward-looking
statements" by creating a safe harbor to protect companies from securities law
liability in connection with forward-looking statements. The Company intends to
qualify both its written and oral forward-looking statements for protection
under the Reform Act and any other similar safe harbor provisions.



                                       18
<PAGE>   21
         "Forward-looking statements" are defined by the Reform Act. Generally,
forward-looking statements include expressed expectations of future events and
the assumptions on which the expressed expectations are based. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they are subject to
numerous known and unknown risks and uncertainties which could cause actual
events or results to differ materially from those projected. Due to those
uncertainties and risks, prospective investors are urged not to place undue
reliance on written or oral forward-looking statements of the Company. The
Company undertakes no obligation to update or revise this safe harbor compliance
statement for forward-looking statements to reflect future developments. In
addition, the Company undertakes no obligation to update or revise
forward-looking statements to reflect changed assumptions, the occurrence of
unanticipated events or changes to future operating results over time.

         The Company provides the following risk factor disclosure in connection
with its continuing effort to qualify its written and oral forward-looking
statements for the safe harbor protection of the Reform Act and any other
similar safe harbor provisions. Important factors currently known to management
that could cause actual results to differ materially from those in
forward-looking statements include the following:

VARIABILITY OF OPERATING RESULTS; LENGTH OF SALES CYCLES; TERMINABILITY OF
CUSTOMER CONTRACTS.

         The Company's revenue 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 termination of, or a reduction in, offerings of the
Company's products and services; the loss of customers due to consolidation in
the healthcare industry; the length of the sales cycles and delays in the
implementation process; the timing of periodic revenue enhancement projects; and
general economic conditions. The Company experiences sales cycles of three to
eighteen 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 revenue and net
income for any given quarter or fiscal year, which increase may prove anomalous
when compared to changes in revenue and net income in other periods, and which
may not provide a valid basis for future projections. The Company's ability to
complete implementation of its systems and recognize revenue 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 approvals upon
completion of work but prior to customer acceptance. In addition, many of the
Company's agreements with its customers may be terminated under certain
circumstances upon 30 to 90 days notice. The termination of customer agreements,
if not replaced, could have a material adverse effect on the Company's business,
financial condition and results of operations.

NEW PRODUCT DEVELOPMENT AND SYSTEM ENHANCEMENT

         The Company's future performance will depend in large part upon the
Company's ability to provide the increasing functionality required by its
customers through the timely development and successful introduction of new
products and enhancements to its existing suite of products. The Company has
historically devoted increasingly more resources to product enhancements and
research and development and believes that significant continuing development
efforts will be necessary to adapt to changing marketplace requirements, to
sustain its operations, and to integrate the products and technologies of
acquired businesses. There can be no assurance that the Company will
successfully or in a timely manner develop, acquire, integrate, introduce, and
market new product enhancements or products, or that product enhancements or new
products developed by the Company will meet the requirements of hospitals or
other healthcare providers and payors and achieve or sustain market acceptance.





                                       19
<PAGE>   22
LIMITED PROPRIETARY RIGHTS; RISK OF INFRINGEMENT

         The Company's success is dependent to a significant extent on its
ability to maintain the proprietary and confidential aspects of its data
processing and computer software technology. The Company relies on a combination
of trade secrets, copyright and trademark laws, nondisclosure and other
contractual provisions to protect its proprietary rights. There can be no
assurance that the measures taken by the Company to protect its intellectual
property will be adequate or that the Company's competitors will not
independently develop products and services that are substantially equivalent or
superior to those of the Company.

         Substantial litigation regarding intellectual property rights exists in
the software industry, and the Company expects that software products may be
increasingly subject to third-party infringement claims as the number of
competitors in the Company's industry segment grows and the functionality of
products overlaps. Although the Company believes that its products do not
infringe upon the proprietary rights of third parties, there can be no assurance
that third parties will not assert infringement claims against the Company in
the future or that a license or similar agreement will be available on
reasonable terms in the event of an unfavorable ruling on any such claim. In
addition, any claim may require the Company to incur substantial litigation
expenses or subject the Company to significant liabilities and could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be
successful in its defense of any such claims.

RISK OF PRODUCT DEFECTS; FAILURE TO MEET PERFORMANCE CRITERIA

         Products and services such as those offered by the Company at times
contain errors or failures, especially when initially introduced or when new
versions are released or processes implemented. Although the Company conducts
extensive testing, software errors are sometimes discovered in certain
enhancements and products and services after their introduction. There can be no
assurance that, despite testing by the Company and by current and potential
customers, errors or performance failures will not occur in products and
services under development or in other enhancements or products after
commencement of commercial shipments or implementations, resulting in loss of
revenue and customers, delay in market acceptance, diversion of development
resources, damage to the Company's reputation or increased service and warranty
costs, any of which could have a material adverse effect upon the Company's
business, financial condition and results of operations.

ACQUISITIONS AND EXPANSION

         The Company's strategy includes the expansion of its business through
selective acquisitions. In pursuing such acquisitions, the Company competes with
other prospective acquirors, some of which may have greater financial resources
than the Company. There can be no assurance that suitable acquisition
opportunities will be identified or that acquisitions can be consummated or
integrated successfully into the Company's operations. In addition, future
acquisitions by the Company could result in potentially dilutive issuances of
equity securities, the incurrence of debt and contingent liabilities and
amortization expenses related to goodwill and other tangible assets, any of
which could materially adversely affect the Company's operating results and
financial position.

         Growth through acquisition entails certain risks in that acquired
operations could be subject to unanticipated business uncertainties or legal
liabilities. The Company seeks to minimize these risks through investigation and
evaluation of the operations proposed to be acquired and through transaction
structure and indemnification. The various risks associated with the
acquisitions and operational integration of future acquisitions and the
subsequent performance of such acquired operations may adversely affect the
Company's results of operations. The ability of the Company to acquire
additional operations may depend upon its ability to obtain appropriate
financing and personnel.



                                       20
<PAGE>   23
COMPETITION

         The business of providing information management and data processing
products and services to hospitals and other healthcare providers and to
government health service agencies and other healthcare payors 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, 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 healthcare industry,
and compete with the Company. A substantial amount 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.

HEALTHCARE PAYMENT COMPLEXITY

         The complexity of the healthcare transfer payment process, and the
experience of the Company in offering services that improve the ability of its
customers to recover incremental revenue through that process, have been
contributing factors to the success of the Company's service offerings.
Complexities of the healthcare transfer payment process include multiple payors,
the coordination and utilization of clinical, operational, financial and/or
administrative review instituted by third-party payors in an effort to control
costs and manage care. If the payment processes associated with the healthcare
industry are simplified, the need for services such as those offered by the
Company could be reduced, and there could be a resulting adverse effect on the
Company's business, results of operations or financial condition.

HEALTHCARE REGULATION AND REFORM

         The healthcare industry in the United States is subject to changing
political, economic and regulatory influences that may affect the procurement
practices and operations of healthcare organizations. The Company's products are
designed to function within the structure of the healthcare financing and
reimbursement system currently being used in the United States. During the past
several years, the healthcare industry has been subject to increasing levels of
governmental regulation of, among other things, reimbursement rates, certain
capital expenditures, and data confidentiality and privacy. From time to time,
certain proposals to reform the healthcare system have been considered by
Congress. These proposals, if enacted, may increase government involvement in
healthcare, lower reimbursement rates and otherwise change the operating
environment for the Company's clients. Healthcare organizations may react to
these proposals and the uncertainty surrounding such proposals by curtailing or
deferring investments, including those for the Company's products and services.
The Company cannot predict with any certainty what impact, if any, such
proposals or healthcare reforms might have on its results of operations,
financial condition or business.

DEPENDENCE UPON KEY PERSONNEL

         As the Company's success depends upon the continued contributions of
its senior management, the loss of services of certain of the Company's
executive officers could have an adverse effect on the Company's business.
Accordingly, although the Company does not have long term service agreements
with most of its executive officers, the Company does have confidentiality,
non-compete and non-solicitation agreements with most of its management and
certain other key employees. In general, such agreements (i) require the
employee to protect the confidential and proprietary information of the Company
and (ii) preclude the employee from soliciting other employees of the Company or
competing with the Company for periods of up to three years following
termination of employment. In addition, the Company believes that its continued
success also will depend in large part on its ability to attract and retain
highly-skilled management, technology, marketing, and sales personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company will be successful in attracting and retaining such personnel as


                                       21
<PAGE>   24
necessary. Furthermore, the Company's ability to manage change and growth
successfully will require the Company to continue to improve its management
expertise as well as its financial systems and controls. Additions of new
personnel, and departures of existing skilled employees, can be disruptive and
could have a material adverse effect on the Company's business, financial
condition and results of operations.

POSSIBLE VOLATILITY OF STOCK PRICES

         The market price of the Company's common stock has been subject in the
past and could be subject in the future to significant fluctuations in response
to variations in the Company's quarterly operating results and other factors,
such as announcements of technological innovations or new products by the
Company or by the Company's competitors, adoption of new or amended government
regulations, challenges to or changes in patent or other proprietary rights, and
developments in the Company's relationships with its customers. In addition, the
stock market has in recent years experienced and continues to experience
significant price fluctuations. These fluctuations often have been unrelated to
the operating performance of the specific companies whose stock is traded. Broad
market fluctuations, as well as fluctuating economic conditions generally, may
adversely affect the market price of the Company's common stock.

CERTAIN ANTI-TAKEOVER PROVISIONS

         The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 5,000,000 shares of "blank check" preferred stock with such
designations, rights and preferences as may be determined by the Company's Board
of Directors. Accordingly, the Company's Board of Directors is empowered,
without shareholder approval, to issue preferred stock with dividend,
liquidation, conversion, voting or other rights, which could adversely affect
the voting power or, other rights of holders of the Company's common stock. In
the event of issuance, preferred stock could be utilized, under certain
circumstances, as a method of discouraging, delaying or preventing a change in
control of the Company. Although the Company has no present intention to issue
any shares of preferred stock, there can be no assurance that the Company will
not do so in the future. In addition, the Company's by-laws provide for a
classified Board of Directors, which provision could also have the effect of
discouraging a change of control of the Company.

LITIGATION

         The Company is a party to various proceedings as described under Item
3, "Legal Proceedings," of this Report, which description is incorporated herein
by reference. Although the Company believes that it has meritorious defenses to
the claims of liability or for damages in the actions against the Company, there
can be no assurance that an outcome favorable to the Company will be reached in
any of these litigations or that additional lawsuits will not be filed against
the Company. Further, there can be no assurance that these lawsuits will not
have a disruptive effect upon the operations of the business, that the defense
of the lawsuits will not consume the time and attention of the senior management
of the Company, or that the resolution of the lawsuits will not have a material
adverse effect upon the Company, including without limitation, the Company's
results of operations, financial position and cash flow.

YEAR 2000

         In common with many other organizations, the Y2K computer issue creates
risks for the Company. To address these Y2K issues, the Company formulated a
plan and began work at the end of 1997. The Company put in place a working
committee to track implementation of the plan. Activities included in this plan
intended to encompass all major categories of systems in use by the Company,
including those entailed in the performance of product development, operations,
sales, finance, and human resources. Interactions with major suppliers of
products and services were identified and continue to be monitored to ensure
uninterrupted delivery to the Company of the requisite products and services.



                                       22
<PAGE>   25
         The Company is also continuing to work with its clients to ensure a
smooth Y2K transition. As well, the Company responded to the enactment of the
Y2K Information and Disclosure Act ("Y2K Act") on October 19, 1998. The purpose
of the Y2K Act is to encourage and promote disclosure regarding Y2K issues and
to provide limitations for claims on tort liability.

         Contingency plans for all potential single points of disruption were
developed and implemented. It is expected that assessment and remediation will
be completed in sufficient time to ensure the Company's provision of service
without interruption due to the onset of the year 2000. No event has surfaced
through the time of filing of this Form 10-K to materially impact the Company's
results of operations. The Company has completed its Y2K remediation work in
accordance with a schedule which is responsive to the time sensitivity of the
clients, seeking first to complete work on engagements where the Company's
interactions with the clients are on a concurrent (in contrast to a
retrospective) basis. To the extent that the Company has not developed an
adequate plan for any particular contingency, the Company believes its capacity
to stage, resequence and reschedule much of its operational processing work
should enable mitigation, in whole or part, of the potential long-term negative
impact on its clients and the Company.

         The Company has designed and tested the most current versions of its
products for Y2K compliance. The Company has finished migrating to its most
current versions those of the Company's products running on versions not Y2K
compliant. The Company is utilizing the migration to Y2K compliant systems as
the catalyst for a consolidation of various of the Company's disparate systems
-- thereby reducing the number of product versions which require updating for
the Y2K problem. Each business group has had its Y2K remediation tested, with
the exception of the Provider Revenue Services Group. Progress continues to be
made in the substantial conversion work for the Provider Revenue Services Group,
though not all of it was concluded by the end of 1999. As well, a number of the
Company's customers are running product versions that are not Y2K compliant.
While the Company has provided its clients with viable plans for migration to
Y2K compliant versions and has been encouraging such customers to adopt such
plans, it is possible that various of the Company's clients will not adopt the
recommended plan of migration, potentially entailing either increased costs to
the Company or loss of revenue by the Company. Moreover, the revenue stream and
financial stability of existing customers may be adversely impacted by Y2K
problems, which could cause fluctuations or diminution in the Company's revenue.
In addition, there can be no assurances that the Company's current products do
not contain undetected errors or defects associated with Y2K date functions that
could result in material, additional future costs to the Company. Moreover,
assessment of whether a complete system will operate correctly depends on the
capabilities and interoperability of the hardware and software components
comprising the system; for most end-users, this will include hardware and
software provided by companies other than the Company. Except as specifically
provided for in the limited warranty accompanying the current versions of its
products, the Company does not believe it is legally responsible for costs
incurred by customers related to ensuring their Y2K capability. Nevertheless,
the Company is incurring various costs to provide customer support and customer
satisfaction services regarding Y2K issues and it is anticipated that these
expenditures would continue through 2000.

         The costs incurred to date related to these programs are difficult to
isolate but are estimated at approximately $2,100,000. The Company currently
expects that the total cost of these programs, including both incremental
spending and redeployed resources, will not exceed $2,500,000. The total cost
estimate does not include potential costs related to any customer claims, other
claims or the cost of internal software and hardware replaced in the normal
course of business, nor does this estimate include the costs associated with the
consolidation (to the maximum practicable extent) by the two Groups comprising
the Revenue Services Division of their respective product versions into a
consolidated version for each group. In some instances, the installation
schedule of new software and hardware in the normal course of business is being
accelerated to afford a timely solution to Y2K capability issues. Because the
factors involved are complex and frequently not readily separable, it is
difficult to determine which of the Company's multiple development activities
are properly allocable to the solution of Y2K problems. The Company's cost
estimates are based on an assessment of the current situation and are subject to
future revision.



                                       23
<PAGE>   26
         The expenses incurred by the Company to identify and address the Y2K
matters discussed above, or the expenses or liabilities to which the Company may
become subject as a result of such matters, could have a material adverse effect
on the Company's business, financial condition and results of operation. In
addition, there can be no assurance that failure to ensure Y2K capability by a
supplier, client or another third party would not have a material adverse effect
on the Company.

NEW ACCOUNTING PRONOUNCEMENTS

         In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives will be reported in the statement of operations or as a deferred
item, depending on the use of the derivatives and whether they qualify for hedge
accounting. The key criteria for hedge accounting is that the derivative must be
highly effective in achieving offsetting changes in fair value or cash flows of
the hedged items during the term of the hedge. The effective date of SFAS No.
133 was delayed to fiscal 2001 by the issuance of SFAS No. 137. The Company has
not yet determined the effect, if any, of adopting this new standard.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

         The Company's holdings of financial instruments are comprised of
federal, state and local government debt, and corporate debt. All such
instruments are classified as securities available for sale. The Company does
not invest in portfolio equity securities or commodities or use financial
derivatives for trading purposes. The Company's debt security portfolio
represents funds held temporarily, pending use in the Company's business and
operations. The Company manages these funds accordingly. The Company seeks
reasonable assuredness of the safety of principal and market liquidity by
investing in rated fixed income securities while, at the same time, seeking to
achieve a favorable rate of return. The Company's market risk exposure consists
principally of exposure to changes in interest rates. The Company's holdings are
also exposed to the risks of changes in the credit quality of issuers. The
Company typically invests in the shorter-end of the maturity spectrum or highly
liquid investments.

         The table below presents the historic cost basis, and the fair value
for the Company's investment portfolio as of October 31, 1999, and the related
weighted average interest rates by year of maturity:

<TABLE>
<CAPTION>
                                                                   Fiscal year
                                  Fiscal year     Fiscal year         2005 and
                                      2000             2001         thereafter           Total        Fair value
                                  ----------      -----------      -----------     ------------      ------------
<S>                               <C>             <C>              <C>             <C>               <C>
Fixed income assets
  Governmental Securities         $ 5,137,000     $ 5,756,000      $ 6,383,000     $ 17,276,000      $ 17,005,000
  Average interest rate                 5.06%           5.01%            5.52%

  Corporate debt                                                                        500,000           502,000
  Average interest rate                                                                   4.55%
                                  -----------     -----------      -----------     ------------      ------------
                                  $ 5,137,000     $ 5,756,000      $ 6,383,000     $ 17,776,000      $ 17,507,000
                                  -----------     -----------      -----------     ------------      ------------
</TABLE>


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The information required by Item 8 is found on pages 29 to 53 of this
         report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

         Not Applicable.





                                       24
<PAGE>   27
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The information required by Item 10 will be included in the Company's
Proxy Statement for the 2000 Annual Meeting of Shareholders (the "Proxy
Statement"), which will be mailed within 120 days after the close of the
Company's fiscal year ended October 31, 1999, and is hereby incorporated herein
by reference to such Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

         The information required by Item 11 will be included in the Proxy
Statement, which will be mailed within 120 days after the close of the Company's
fiscal year ended October 31, 1999, and is hereby incorporated herein by
reference to such Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by Item 12 will be included in the Proxy
Statement, which will be mailed within 120 days after the close of the Company's
fiscal year ended October 31, 1999, and is hereby incorporated herein by
reference to such Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by Item 13 will be included in the Proxy
Statement, which will be mailed within 120 days after the close of the Company's
fiscal year ended October 31, 1999, and is hereby incorporated herein by
reference to such Proxy Statement.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

         A.       Financial Statements:
                      See Index to Consolidated Financial Statements on page 27

         B.       Schedule:
                      Schedule II - Valuation and Qualifying Accounts on page 53

         C.       Reports on Form 8-K:
                      None

         D.       Exhibits:
                      See Exhibit Index on page 54


                                       25
<PAGE>   28
                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                   HEALTH MANAGEMENT SYSTEMS, INC.
                                   -------------------------------
                                            (REGISTRANT)


                                   BY:  /s/ PAUL J. KERZ
                                      -------------------------------
                                        Paul J. Kerz
                                        President and Chief Executive Officer


                                   DATE:    January 24, 2000

         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.

<TABLE>
<CAPTION>
Signatures                               TITLE                                       Date
----------                                                                           ----

<S>                                      <C>                                         <C>
/s/ PAUL J. KERZ                         Chairman, President,                        January 24, 2000
-------------------------                Chief Executive Officer,
Paul J. Kerz                             and Director


/s/ ALAN L. BENDES                       Senior Vice President and                   January 24, 2000
-------------------------                Chief Financial Officer
Alan L. Bendes


/s/ ERNEST W. D'AMBROSE                  Corporate Controller                        January 24, 2000
-------------------------
Ernest W. D'Ambrose


/s/ RANDOLPH G. BROWN                    Director                                    January 24, 2000
-------------------------
Randolph G. Brown


/s/ ROBERT V. NAGELHOUT                  Director, and President of Software         January 24, 2000
-------------------------                Systems and Services Division
Robert V. Nagelhout


/s/ WILLIAM W. NEAL                      Director                                    January 24, 2000
-------------------------
William W. Neal


/s/ GALEN D. POWERS                      Director                                    January 24, 2000
-------------------------
Galen D. Powers


/s/ ELLEN A. RUDNICK                     Director                                    January 24, 2000
-------------------------
Ellen A. Rudnick


/s/ DONALD J. STAFFA                     Director                                    January 24, 2000
--------------------------
Donald J. Staffa


/s/ RICHARD H. STOWE                     Director                                    January 24, 2000
-------------------------
Richard H. Stowe
</TABLE>


                                       26
<PAGE>   29
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                   PAGE
CONSOLIDATED FINANCIAL STATEMENTS:                                                                NUMBER
-----------------------------------                                                               ------
<S>                                                                                               <C>
Independent Auditors' Report                                                                        28

Consolidated Balance Sheets as of October 31, 1999 and 1998                                         29

Consolidated Statements of Operations for the Years Ended October 31, 1999, 1998, and 1997          30

Consolidated Statements of Comprehensive Income for the Years Ended October 31, 1999,
   1998, and 1997                                                                                   31

Consolidated Statements of Shareholders' Equity for the Years Ended October 31, 1999,
   1998, and 1997                                                                                   32

Consolidated Statements of Cash Flows for the Years Ended October 31, 1999, 1998, and 1997          33

Notes to Consolidated Financial Statements                                                          34


FINANCIAL STATEMENT SCHEDULE:

Schedule II - Valuation and Qualifying Accounts                                                     53
</TABLE>





                                       27
<PAGE>   30
                          INDEPENDENT AUDITORS' REPORT









The Board of Directors and Shareholders
Health Management Systems, Inc.:

         We have audited the accompanying consolidated financial statements of
Health Management Systems, Inc. and subsidiaries as listed in the accompanying
index. In connection with our audits of the consolidated financial statements,
we also have audited the financial statement schedule as listed in the
accompanying index. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Health
Management Systems, Inc. and subsidiaries as of October 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the years in
the three-year period ended October 31, 1999 in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.


                                                 /s/ KPMG LLP


New York, New York
December 1, 1999, except for
 paragraph 1 of footnote 17
 which is as of December 20, 1999




                                       28
<PAGE>   31
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                   ($ In Thousands, Except Per Share Amounts)

<TABLE>
<CAPTION>
                                                                                                             October 31,
                                                                                                   ------------------------------
                                                                                                         1999               1998
                                                                                                   -----------       ------------
<S>                                                                                                <C>                <C>
                                                               Assets
Current assets:
  Cash and cash equivalents                                                                        $    16,310        $    13,883
  Short-term investments                                                                                17,507             14,519
  Accounts receivable, billed, net                                                                      17,001             28,792
  Accounts receivable, unbilled, net                                                                    41,661             26,201
  Income tax receivable                                                                                    588              2,340
  Prepaid expenses and other current assets                                                              3,928              4,021
                                                                                                   -----------       ------------
      Total current assets                                                                              96,995             89,756

Property and equipment, net                                                                              7,766              6,687
Capitalized software costs, net                                                                          7,286              4,203
Goodwill, net                                                                                           12,762             11,742
Deferred income taxes                                                                                    3,797              3,303
Notes receivable from officer                                                                              900                750
Other assets                                                                                             1,415              1,361
                                                                                                   -----------       ------------

         Total assets                                                                              $   130,921        $   117,802
                                                                                                   ===========       ============


                                              Liabilities and Shareholders' Equity

Current liabilities:
  Accounts payable and accrued expenses                                                            $    18,050        $    15,420
  Deferred revenue                                                                                       4,541              6,326
  Deferred income taxes                                                                                 15,967             11,307
                                                                                                   -----------        -----------
      Total current liabilities                                                                         38,558             33,053

Other  liabilities                                                                                       1,131              1,480
                                                                                                   -----------        -----------
      Total liabilities                                                                                 39,689             34,533
                                                                                                   -----------        -----------


Shareholders' equity:
  Preferred stock - $.01 par value; 5,000,000 shares authorized; none issued
     and outstanding                                                                                         0                  0
  Common stock - $.01 par value; 45,000,000 shares authorized;
     18,450,737 shares issued and 17,401,737 shares outstanding at October 31, 1999;
     18,332,367 shares issued and 17,283,367 shares outstanding at October 31, 1998                        184                183
  Capital in excess of par value                                                                        71,714             71,134
  Retained earnings                                                                                     27,078             19,595
  Accumulated other comprehensive income                                                                     6                107
                                                                                                   -----------        -----------
                                                                                                        98,982             91,019
  Less treasury stock, at cost (1,049,000 shares at October 31, 1999 and October 31, 1998)              (7,750)            (7,750)
                                                                                                   -----------        -----------
      Total shareholders' equity                                                                        91,232             83,269
                                                                                                   -----------        -----------

         Total liabilities and shareholders' equity                                                $   130,921        $   117,802
                                                                                                   ===========        ===========
</TABLE>


See accompanying notes to consolidated financial statements.



                                       29
<PAGE>   32
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                            STATEMENTS OF OPERATIONS
                   ($ In Thousands, Except Per Share Amounts)


<TABLE>
<CAPTION>
                                                                                               Years ended October 31,
                                                                                 ------------------------------------------------
                                                                                        1999              1998              1997
                                                                                 ------------      ------------      ------------
<S>                                                                              <C>               <C>               <C>
Revenue:                                                                         $    114,055      $    105,252      $     89,517
                                                                                 ------------      ------------      ------------

Cost of services:
    Compensation                                                                       64,253            59,288            52,361
    Data processing                                                                     7,061             8,771             7,593
    Occupancy                                                                           9,377             9,663            10,383
    Direct project costs                                                               11,240             5,068             6,034
    Other                                                                              10,987            12,838            11,984
                                                                                 ------------      ------------      ------------
                                                                                      102,918            95,628            88,355
                                                                                 ------------      ------------      ------------
        Operating margin before amortization of intangibles                            11,137             9,624             1,162

    Amortization of intangibles                                                           840             1,964             1,331
                                                                                 ------------      ------------      ------------

        Operating income (loss)                                                        10,297             7,660              (169)
                                                                                 ------------      ------------      ------------

Other income:
     Interest income, net                                                               1,277             1,700             2,755
     Other income (loss), net                                                               0               597              (856)
                                                                                 ------------      ------------      ------------
                                                                                        1,277             2,297             1,899
                                                                                 ------------      ------------      ------------

        Income before income taxes                                                     11,574             9,957             1,730

Income tax expense (benefit)                                                            4,091             3,869              (351)
                                                                                 ------------      ------------      ------------

        Net income                                                               $      7,483      $      6,088      $      2,081
                                                                                 ============      ============      ============

Earnings per share data:
    Basic:
          Basic earnings per share                                               $       0.43      $       0.35      $       0.12
                                                                                 ============      ============      ============
          Weighted average common shares outstanding                                   17,357            17,366            17,611
                                                                                 ============      ============      ============

    Diluted:
          Diluted earnings per share                                             $       0.43      $       0.34      $       0.12
                                                                                 ============      ============      ============
          Weighted average common shares and common share equivalents                  17,419            17,833            17,979
                                                                                 ============      ============      ============
</TABLE>




See accompanying notes to consolidated financial statements.




                                       30
<PAGE>   33
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                ($ IN THOUSANDS)




<TABLE>
<CAPTION>
                                                                                            Years ended October 31,
                                                                               ------------------------------------------------
                                                                                   1999              1998             1997
                                                                               ------------    ---------------    -------------
<S>                                                                            <C>             <C>                <C>
Net income                                                                     $     7,483      $       6,088     $      2,081

Other comprehensive income, net of tax:
    Change in net unrealized appreciation (depreciation)
       on short-term investments                                                      (101)              (574)             210
                                                                               ------------    ---------------    -------------

Comprehensive income                                                           $     7,382     $        5,514     $      2,291
                                                                               ============    ===============    =============
</TABLE>



See accompanying notes to consolidated financial statements.




                                       31
<PAGE>   34
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                ($ IN THOUSANDS)



<TABLE>
<CAPTION>
                                               Common Stock
                                           -------------------                             Accumulated                 Total
                                            Number of            Capital In                     Other                 Share-
                                              Shares      Par     Excess Of     Retained  Comprehensive  Treasury    holders'
                                           Outstanding   Value    Par Value     Earnings       Income      Stock       Equity
                                           ----------   ------    ---------    ---------       ------    --------    --------
<S>                                       <C>          <C>       <C>         <C>          <C>         <C>           <C>
Balance at October 31, 1996                17,520,991   $  175     $ 62,541     $ 11,426     $    471   $       0    $ 74,613

  Net income                                        0        0            0        2,081            0           0       2,081
  Stock option activity                        69,480        1          333            0            0           0         334
  Employee stock purchase plan activity        95,332        1          708            0            0           0         709
  Stock issued to retire QSM debt              87,850        1        1,434            0            0           0       1,435
  Stock issued to non-employees                     0        0           98            0            0           0          98
  Disqualifying dispositions                        0        0        2,190            0            0           0       2,190
  Treasury stock acquisition                 (314,500)       0            0            0            0      (1,863)     (1,863)
  Change in net unrealized appreciation
   on short-term investments                        0        0            0            0          210           0         210

                                           ----------   ------    ---------    ---------       ------    --------     -------
Balance at October 31, 1997                17,459,153      178       67,304       13,507          681      (1,863)     79,807

  Net income                                        0        0            0        6,088            0           0       6,088
  Stock option activity                       440,316        4        2,713            0            0           0       2,717
  Employee stock purchase plan activity       118,398        0          515            0            0           0         515
  Treasury stock acquisition                 (734,500)       1            0            0            0      (5,887)     (5,886)
  Disqualifying dispositions                        0        0          602            0            0           0         602
  Change in net unrealized depreciation
   on short-term investments                        0        0            0            0         (574)          0        (574)

                                           ----------   ------    ---------    ---------       ------    --------    --------
Balance at October 31, 1998                17,283,367      183       71,134       19,595          107      (7,750)     83,269

  Net income                                        0        0            0        7,483            0           0       7,483
  Stock option activity                        41,247        0          210            0            0           0         210
  Employee stock purchase plan activity        77,123        1          337            0            0           0         338
  Disqualifying dispositions                        0        0           33            0            0           0          33
  Change in net unrealized depreciation
   on short-term investments                        0        0            0            0         (101)          0        (101)

                                           ----------   ------    ---------    ---------       ------    --------    --------
Balance at October 31, 1999                17,401,737   $  184     $ 71,714    $  27,078       $    6    $ (7,750)   $ 91,232
                                           ==========   ======    =========    =========       ======    ========    ========
</TABLE>











See accompanying notes to consolidated financial statements.


                                       32
<PAGE>   35
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                ($ IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                                       Years ended October 31,
                                                                                                 ----------------------------------
                                                                                                    1999         1998        1997
                                                                                                 --------     --------     --------
<S>                                                                                              <C>          <C>          <C>
Operating activities:
     Net income                                                                                  $  7,483     $  6,088     $  2,081
       Adjustments to reconcile net income to net cash provided by (used in)
         operating activities:
           Depreciation and amortization of capitalized software                                    3,755        3,520        3,811
           Amortization of intangibles                                                                840        1,964        1,331
           Provision for doubtful accounts                                                            690          838          538
           Loss on disposal of assets                                                                   0            0           17
           Deferred tax expense (benefit)                                                           4,166        4,022       (1,635)
           Equity in loss of affiliate                                                                  0            0          310
           Stock options issued to non-employees                                                       33            0           98
           Changes in assets and liabilities:
             (Increase) decrease in accounts receivable                                            (2,496)     (15,474)       5,008
             (Increase) decrease in income tax receivable                                           1,752       (1,830)         200
             (Increase) decrease in prepaid expenses and other current assets                         133       (1,147)       3,937
             Increase (decrease) in accounts payable and accrued expenses                             491         (289)      (2,910)
             Decrease in amounts payable to affiliates                                                  0            0         (747)
             Increase (decrease) in deferred revenue                                                 (401)         754         (575)
             Decrease in other assets                                                                (477)        (747)      (1,531)
                                                                                                 --------     --------     --------
                      Net cash provided by (used in) operating activities                          15,969       (2,301)       9,933
                                                                                                 --------     --------     --------
Investing activities:
     Software capitalization                                                                       (4,107)      (3,138)      (1,498)
     Capital asset expenditures                                                                    (2,720)      (1,263)      (2,462)
     Net proceeds from (purchases of) short-term investments                                       (3,089)       3,295         (964)
     Acquisition of net assets of Health Receivables Management, LLC, net of cash acquired         (4,024)           0            0
     Acquisition of remainder of Health Information Systems Corporation, net of cash acquired           0            0       (3,689)
     Acquisition of assets of subsidiaries of GHS, Inc.                                                 0            0       (2,146)
     Increase in notes receivable from officer                                                       (150)        (750)           0
                                                                                                 --------     --------     --------
                      Net cash used in investing activities                                       (14,090)      (1,856)     (10,759)
                                                                                                 --------     --------     --------
Financing activities:
     Proceeds from issuance of common stock                                                           210          515          709
     Proceeds from exercise of stock options                                                          338        2,717          334
     Common stock repurchases                                                                           0       (5,886)      (1,863)
                                                                                                 --------     --------     --------
                     Net cash provided by (used in) financing activities                              548       (2,654)        (820)
                                                                                                 --------     --------     --------

                     Net increase (decrease) in cash and cash equivalents                           2,427       (6,811)      (1,646)

Cash and cash equivalents at beginning of period                                                   13,883       20,694       22,340

                                                                                                 --------     --------     --------
Cash and cash equivalents at end of period                                                       $ 16,310     $ 13,883     $ 20,694
                                                                                                 ========     ========     ========
</TABLE>


See accompanying notes to consolidated financial statements.


                                       33
<PAGE>   36
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Health Management Systems, Inc. (the "Company") furnishes proprietary
information management, data processing, and software (including consulting)
services to healthcare providers and payors, including government health service
agencies. The Company is organized into two divisions: the Revenue Services
Division ("Revenue Services Division") and the Software Systems and Services
Division ("Software Division"). The Revenue Services Division comprises two
business units: the Provider Revenue Services Group and the Payor Revenue
Services Group. The Company's Software Division also comprises two business
units: the Decision Support Group and the Payor Systems Group.

         In fiscal year 1999, each of the Company's subsidiaries adopted use of
the corporate name, Health Management Systems ("HMS"), as part of an initiative
to strengthen the corporate identity. As well, the Company changed the
designation of its business segments in order to more appropriately describe the
functions being performed. The table below cross-references fiscal year 1999
nomenclature to that used in prior years.



<TABLE>
<CAPTION>
          CURRENT NOMENCLATURE                                 PRIOR NOMENCLATURE
          --------------------                                 ------------------
<S>                                                  <C>
Revenue Services Division                            Transfer Payment Division
 -  Provider Revenue Services Group                   -  Provider Transfer Payment Unit
 -  Payor Revenue Services Group                      -  Payor Transfer Payment Unit
Software Systems and Services Division                Software Systems and Services Division
 -  Decision Support Group                            -  Decision Support Systems or DSS Unit
 -  Payor Systems Group                               -  Managed Care Information Systems or MCIS
                                                         Unit
</TABLE>



         (a)   Principles of Consolidation
         The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.

         (b)   Cash and Cash Equivalents
         For purposes of financial reporting, the Company considers all highly
liquid investments purchased with an original maturity of three months or less
(including money market instruments of $3,871,000 and $6,231,000 at October 31,
1999 and 1998, respectively) to be cash equivalents.

         (c)   Short-Term Investments
         Short-term investments are recorded at fair value. Included in
short-term investments are investments classified as available for sale and
carried at fair value. Debt securities that the Company does not have the intent
and ability to hold to maturity are classified either as "available for sale" or
as "trading" and are carried at fair value. Unrealized gains and losses on
securities classified as available for sale are carried as a separate component
of shareholders' equity. Unrealized gains and losses on securities classified as
trading are reported in earnings. Management determines the appropriate
classification of its investments in debt and equity securities at the time of
purchase and reevaluates such determination at each balance sheet date.

         At October 31, 1999 and 1998, the Company recorded cumulative
unrealized appreciation of $6,000 and $107,000, respectively, on short-term
investments classified as available for sale.







                                       34
<PAGE>   37
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


         (d)   Depreciation and Amortization of Property and Equipment
         Property and equipment are recorded at cost. Depreciation is provided
over the estimated useful lives of the property and equipment utilizing the
straight-line method. Amortization of leasehold improvements is provided over
the estimated useful lives of the assets or the terms of the leases, whichever
is shorter, utilizing the straight-line method. The estimated useful lives are
as follows:

<TABLE>
<S>                                                  <C>
                  Equipment                          3-5 years
                  Leasehold improvements             5-8 years
                  Furniture and fixtures             5-7 years
</TABLE>

         (e)   Intangible Assets
         Intangible assets have been recorded primarily as a result of the
recapitalization of the Company in 1989, the acquisition of Quality Medi-Cal
Adjudication, Incorporated ("QMA") in 1990, the acquisition of the remaining
shares of Health Information Systems Corporation ("HISCo") in March 1997, the
acquisition of the assets of Global Health Systems, Inc. and GHS Management
Services, Inc. (collectively "Global") in July 1997, and the acquisition of the
assets of Health Receivables Management, LLC ("Old HRM") in July 1999.
Intangible assets consist of software and goodwill, which are being amortized on
a straight-line basis over three years, three years and between ten and forty
years, respectively.

         (f)   Software Development Costs
         The Company capitalizes software development costs (related to software
developed for resale) incurred subsequent to the establishment of technological
feasibility of the product, including costs incurred to develop upgrades
subsequent to the commercial release of the product. Amortization of software
development costs is calculated on a straight-line basis over the expected
economic life of the product, generally estimated to be 36-48 months. Software
development costs are stated at original cost of $11,000,000 and $6,893,000 less
accumulated amortization of $3,714,000 and $2,690,000 at October 31, 1999 and
1998, respectively. Amortization expense for the years ended October 31, 1999,
1998, and 1997 was $1,024,000, $956,000, and $992,000, respectively.

         (g)   Revenue Recognition
         The Company generally recognizes revenue for financial reporting
purposes when billings are submitted to clients or their third-party payors or
intermediaries as a consequence of completion and acceptance of services
performed by the Company for a client. Accounts receivable, unbilled, net,
represents amounts recognized for services rendered but not yet invoiced and is
based on the Company's estimate of the fees that will be invoiced upon receipt
of remittance data. Accounts receivable, billed, net, represents amounts
invoiced to clients. Several client contracts contain periodic fee limitations
that the Company believes will be exceeded in the normal course of business. As
a result, the fees allowable under these contracts are recognized on a
straight-line basis over the fee limitation period as services are performed,
and amounts billed in excess of revenue recognized are deferred. Other contracts
have sliding fee scales for which revenue is fairly predictable. For these, the
Company recognizes revenue, at the estimated effective fee rate, ratably over
the client's contract year. Finally, certain contracts are subject to fixed-fee
arrangements covering specified periods, which the Company realizes on a
straight-line basis over the corresponding periods.

         The Company recognizes revenue from consulting services as the services
are provided. Revenue from software products sold to customers under license
agreements is deferred and recognized as revenue upon software installation and
satisfaction of significant Company obligations, if any, and when collection of
the resulting receivable is reasonably assured. Revenue from ongoing maintenance
agreements is deferred and recognized as revenue on a straight-line basis over
the periods of the respective maintenance agreements.





                                       35
<PAGE>   38
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


         (h)   Income Taxes
         Income taxes are accounted for under the asset and liability method.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized as income in the period that includes the enactment date.

         (i)   New Accounting Pronouncements
         In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives will be reported in the statement of operations or as a deferred
item, depending on the use of the derivatives and whether they qualify for hedge
accounting. The key criteria for hedge accounting is that the derivative must be
highly effective in achieving offsetting changes in fair value or cash flows of
the hedged items during the term of the hedge. The effective date of SFAS No.
133 was delayed to fiscal 2001 by the issuance of SFAS No. 137. The Company has
not yet determined the effect, if any, of adopting this new standard.

         (j)   Net Income Per Common Share
         Basic earnings per share is based on the net income for the relevant
period divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is based on the net income for the
relevant period divided by the weighted average number of common shares and
common stock equivalents outstanding during the period. The Company had weighted
average common shares and common stock equivalents outstanding during fiscal
years 1999, 1998, and 1997 of 17,357,000, 17,366,000, and 17,611,000 and of
62,000, 467,000, and 368,000, respectively. The Company's common stock
equivalents consist of stock options. As of October 31, 1999, the Company had
3,335,928 potentially dilutive common shares outstanding that could have an
effect on future calculations of diluted earnings per share.

         (k)   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 affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenue and
expenses during the reported period. The actual results could differ from those
estimates.

         (l)   Reclassifications
         Certain reclassifications were made to prior year amounts to conform to
the current presentation.

         (m)   Fair Value of Financial Instruments
         The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties.
The carrying amounts of the Company's financial instruments included in the
accompanying consolidated balance sheets approximate estimated fair value as of
October 31, 1999 and 1998.

         (n)   Stock-Based Compensation
         The Company accounts for its stock option plan in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees", and related interpretations. As such,
compensation expense would be recorded on the date of grant only if the current
market price of the underlying stock exceeded the exercise price. On October 31,
1997, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation", which permits entities to recognize as expense over the vesting


                                       36
<PAGE>   39
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro-forma net income and pro-forma
earnings per share disclosures for employee stock option grants made in fiscal
1996 and future years as if the fair-value based method defined in SFAS No. 123
had been applied. The Company has elected to continue to apply the provisions of
APB Opinion No. 25 and provide the pro-forma disclosure provisions of SFAS No.
123. See Note 12 - Stock Based Compensation Plans.

         (o)   Accounting for the Impairment of Long-Lived Assets
         The Company reviews its long-lived assets, certain identifiable
intangibles, and goodwill for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amounts of the assets exceed the fair value of the assets.

2.       BUSINESS COMBINATIONS

         (a)   Acquisition of the Assets of Health Receivables Management, LLC.
         In June 1999, the Company's Quality Standards in Medicine, Inc. ("QSM")
subsidiary acquired substantially all of the assets and assumed specified
liabilities of Old HRM for $4,024,000, net of cash acquired and subject to
certain purchase price adjustments. In connection with the transaction, QSM
changed its name to Health Receivables Management, Inc. ("HRM"). HRM currently
furnishes Medicaid application services, electronic billing, eligibility
verification, accounts receivable management and collection services to
healthcare providers, principally in the State of Illinois.

         The acquisition was accounted for using the purchase method of
accounting and, accordingly, the results of operations of HRM from the date of
acquisition through October 31, 1999 are included in the accompanying
consolidated financial statements. Its results are included in the Provider
Revenue Services Group. The $1,618,000 excess of the purchase price over the
fair market value of the identifiable assets acquired was recorded as goodwill
and is being amortized over a period not to exceed 15 years.

         The following unaudited pro forma financial information presents the
combined results of operations of the Company and HRM as if the acquisition had
occurred as of the beginning of fiscal years 1999 and 1998, after giving effect
to certain adjustments. The pro forma financial information does not necessarily
reflect the results of operations that would have occurred had the Company and
HRM constituted a single entity during such periods.

<TABLE>
<CAPTION>
                                                            (Unaudited)
                                                       Year ended October 31,
                                                     1999                  1998
                                                     ----                  ----
<S>                                            <C>                    <C>
Revenue                                        $ 119,209,000          $ 113,066,000
Net income                                         7,556,000              5,571,000
                                               -------------          -------------
Basic earnings per share                                0.41                   0.32
                                               -------------          -------------
Diluted earnings per share                     $        0.40          $        0.31
                                               -------------          -------------
</TABLE>


         (b)   Acquisition of the Assets of Global Health Systems Inc. and GHS
               Management Services, Inc.
         In July 1997, the Company acquired substantially all the assets of
Global for $2,146,000. Global provides computerized record-based processing
systems and services for managed care, public health and ambulatory care
facilities.

         The acquisition was accounted for using the purchase method and
accordingly the results of operations for Global from the date of acquisition
through October 31, 1998 are included in the accompanying consolidated


                                       37
<PAGE>   40
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


financial statements. Its results are included in the Provider Revenue Services
Group. The $1,701,000 excess of the purchase price over the fair market value of
the identifiable assets acquired was recorded as goodwill and is being amortized
over a period not to exceed 20 years.

         (c)   Acquisition of Health Information Systems Corporation
         In March 1997, the Company, which owned 43% of the equity of HISCo,
acquired the remaining 57% of HISCo's equity for $3,689,000, net of cash
acquired from Welsh, Carson, Anderson & Stowe ("WCAS"), a limited partnership
affiliated with WCAS, other affiliates of WCAS, independent investors, and
certain of the Company's executive officers and directors. HISCo was
subsequently renamed HSA Managed Care Systems, Inc. ("HSA"). HSA provides
automated business and information solutions, including software systems and
services, to healthcare providers and payors.

         The acquisition was accounted for using the purchase method and
accordingly the results of operations of HSA from the date of acquisition
through October 31, 1998 are included in the accompanying consolidated financial
statements. Its results comprise the results of the Payor Systems Group. The
$2,309,000 excess of the purchase price over the fair market value of the
identifiable net assets acquired was recorded as goodwill and is being amortized
over a period not to exceed 20 years.

         The following unaudited pro forma financial information presents the
combined results of operations of the Company and HSA as if the acquisition had
occurred as of the beginning of fiscal year 1997, after giving effect to certain
adjustments. The pro forma financial information does not necessarily reflect
the results of operations that would have occurred had the Company and HSA
constituted a single entity during such period.

<TABLE>
<CAPTION>
                                                              (Unaudited)
                                                         Year ended October 31,
                                                                 1997
                                                         ----------------------

<S>                                                      <C>
Revenue                                                       $ 94,582,000
Net income                                                       1,671,000
                                                              ------------
Basic earnings per share                                              0.09
                                                              ------------
Diluted earnings per share                                    $       0.09
                                                              ------------
</TABLE>


         (d)   Merger with Quality Standards in Medicine, Inc.

         In November 1996, the Company completed the acquisition of QSM, a
Boston-based company providing clinical quality management systems, for 260,000
shares of the Company's common stock. This transaction was accounted for using
the pooling of interests method. Accordingly, the accompanying consolidated
financial statements have been retroactively restated through 1995 for periods
presented to include the financial position, results of operations, and cash
flows of QSM. Founded in 1986, QSM provides hospitals with sophisticated systems
and consulting services to help define and measure the quality of care. QSM has
clients located primarily in 13 states and the District of Columbia.

3.       MARKETABLE SECURITIES
         The Company's holdings of financial instruments are comprised of
federal, state and local government debt, and corporate debt. All such
instruments are classified as securities available for sale. The Company does
not invest in portfolio equity securities or commodities or use financial
derivatives for trading purposes. The Company's debt security portfolio
represents funds held temporarily, pending use in the Company's business and
operations. The Company manages these funds accordingly. The Company seeks
reasonable assuredness of the safety of principal and market liquidity by
investing in rated fixed income securities while, at the same time, seeking to
achieve a favorable rate of return. The Company's market risk exposure consists
principally of exposure to changes in interest rates. The Company's holdings are
also exposed to the risks of changes in the credit quality of issuers. The
Company typically invests in the shorter-end of the maturity spectrum or highly



                                       38
<PAGE>   41
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

liquid investments.

         The table below presents the historic cost basis, and the fair value
for the Company's investment portfolio as of October 31, 1999:

<TABLE>
<CAPTION>
                                                                  Fiscal year
                                  Fiscal year     Fiscal year        2005 and
                                      2000            2001         thereafter        Total           Fair value
                                  -----------     -----------     -----------    ------------       ------------
<S>                               <C>             <C>             <C>            <C>                <C>
Fixed income assets
  Governmental Securities         $ 5,137,000     $ 5,756,000     $ 6,383,000    $ 17,276,000        $ 17,005,000
  Corporate debt                                                                      500,000             502,000
                                  -----------     -----------     -----------    ------------        ------------
                                  $ 5,137,000     $ 5,756,000     $ 6,383,000    $ 17,776,000        $ 17,507,000
                                  ===========     ===========     ===========    ============        ============
</TABLE>


4.       ACCOUNTS RECEIVABLE
         Accounts receivable are reflected net of an allowance for doubtful
accounts of $1,823,000 and $1,853,000 at October 31, 1999 and 1998,
respectively.

5.       PROPERTY AND EQUIPMENT
         Property and equipment as of October 31, 1999 and 1998 consisted of the
following:

<TABLE>
<CAPTION>
                                                         1999               1998
                                                    ------------       ------------
<S>                                                 <C>                <C>
Equipment                                           $ 19,022,000       $ 15,411,000
Leasehold improvements                                 6,161,000          6,035,000
Furniture and fixtures                                 5,192,000          5,119,000
                                                    ------------       ------------
                                                      30,375,000         26,565,000
Less accumulated depreciation and amortization       (22,609,000)       (19,878,000)
                                                    ------------       ------------
Property and equipment, net                         $  7,766,000       $  6,687,000
                                                    ============       ============
</TABLE>


         Depreciation and amortization expense related to property and equipment
charged to operations for the years ended October 31, 1999, 1998, and 1997 was
$2,731,000, $2,564,000, and $2,819,000, respectively.

6.       GOODWILL AND OTHER INTANGIBLE ASSETS
         Goodwill and other intangible assets as of October 31, 1999 and 1998
consisted of the following:


<TABLE>
<CAPTION>
                                        1999               1998
                                   ------------       ------------
<S>                                <C>                <C>
Goodwill                           $ 15,916,000       $ 14,298,000
Less accumulated amortization        (3,154,000)        (2,556,000)
                                   ------------       ------------
Goodwill, net                        12,762,000         11,742,000
                                   ------------       ------------

Other intangible assets               1,443,000          7,036,000
Less accumulated amortization          (973,000)        (6,325,000)
                                   ------------       ------------
Other intangible assets, net       $    470,000       $    711,000
                                   ------------       ------------
</TABLE>


         Amortization expense related to intangible assets charged to operations
for the years ended October 31, 1999, 1998, and 1997, was $840,000, $1,964,000,
and $1,331,000, respectively. During 1999, software in the amount of $5,593,000
became fully amortized.



                                       39
<PAGE>   42
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.       ACCOUNTS PAYABLE AND ACCRUED EXPENSES
         Accounts payable and accrued expenses as of October 31, 1999 and 1998
consisted of the following:

<TABLE>
<CAPTION>
                                      1999             1998
                                  -----------      -----------
<S>                               <C>              <C>
Accounts payable                  $ 5,922,000      $ 4,485,000
Accrued compensation                5,113,000        6,390,000
Accrued direct project costs        3,112,000        1,763,000
Accrued other expenses              3,903,000        2,782,000
                                  -----------      -----------
                                  $18,050,000      $15,420,000
                                  ===========      ===========
</TABLE>


8.       CREDIT FACILITY
         The Company's unsecured $30,000,000 revolving credit facility with a
major money center financial institution carries an unused commitment fee of 20
basis points, and bears interest at the institution's prime lending rate, or
LIBOR plus 5/8%, at the Company's option. The revolving credit facility
contains, among other things, restrictions on additional borrowings, capital
expenditures, leases, sales of assets, and payments of dividends. The revolving
credit facility also contains covenants that require the Company to maintain
minimum tangible consolidated shareholders' equity and limit debt-to-equity and
debt-to-asset relationships as defined in the agreement. The Company had an
available balance under this credit facility of $30,000,000 at both October 31,
1999 and October 31, 1998. See Note 16(c) Related Party Transactions. Subsequent
to the fiscal year ended October 31, 1999, the Company amended the credit
facility to extend the existing term through February 15, 2000. No other terms
of the existing credit facility have changed. Although the Company is in the
process of securing a new credit facility with its financial institution, there
can be no assurance that the Company will be able to do so on terms that are
consistent with the current credit facility or terms that are acceptable to the
Company.

         Cash interest payments including bank charges attributable to the
aforementioned credit facility for the years ended October 31, 1999, 1998, and
1997 were $105,000, $102,000, and $80,000, respectively.

9.       INCOME TAXES
         Income tax expense (benefit) for the years ended October 31, 1999,
1998, and 1997 was comprised of the following:

<TABLE>
<CAPTION>
                                              1999                1998               1997
                                         -----------         -----------         -----------
<S>                                      <C>                 <C>                 <C>
Current tax expense (benefit):
   Federal                               $  (145,000)        $  (577,000)        $   716,000
   State and local                            70,000             423,000             568,000
                                         -----------         -----------         -----------
                                             (75,000)           (154,000)          1,284,000
                                         -----------         -----------         -----------

Deferred tax expense (benefit):
   Federal                                 3,254,000           3,505,000          (1,136,000)
   State and local                           912,000             518,000            (499,000)
                                         -----------         -----------         -----------
                                           4,166,000           4,023,000          (1,635,000)
                                         -----------         -----------         -----------
Income tax expense (benefit), net        $ 4,091,000         $ 3,869,000         $  (351,000)
                                         -----------         -----------         -----------
</TABLE>





                                       40
<PAGE>   43
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         A reconciliation of the income tax expense (benefit) to the applicable
federal statutory rates follows:

<TABLE>
<CAPTION>
                                          1999                       1998                         1997
                                     -----------                  -----------                  -----------
<S>                                  <C>           <C>           <C>           <C>           <C>            <C>
Income tax expense (benefit):
Computed at federal statutory rate   $ 3,951,000   34.1%         $ 3,386,000   34.0%         $   588,000    34.0%
State and local tax expense, net of      647,000    5.6              621,000    6.2               46,000     2.7
   federal benefit
Amortization of goodwill                  56,000    0.5               83,000    0.8               70,000     4.0
Municipal interest                      (199,000)  (1.7)            (181,000)  (1.8)            (258,000)  (14.9)
Decrease in valuation allowance         (372,000)  (3.2)                   0    0.0                    0     0.0
Merger related costs                           0    0.0                    0    0.0              183,000    10.6
Equity loss in affiliate                       0    0.0                    0    0.0               88,000     5.1
IRS audit resolution                           0    0.0                    0    0.0           (1,093,000)  (63.2)
Amortization of software                       0    0.0              104,000    1.0               24,000     1.4
Tax contingency                                0    0.0             (261,000)  (2.6)                   0     0.0
Other, net                                 8,000    0.0              117,000    1.3                1,000     0.0
                                     -----------   ----          -----------   ----          -----------   -----
Total income tax expense (benefit)   $ 4,091,000   35.3%         $ 3,869,000   38.9%         $  (351,000)  (20.3)%
                                     ===========   ====          ===========   ====          ===========   =====
</TABLE>


         Deferred income taxes are recognized for the future tax consequences of
temporary differences between the financial statement and tax bases of assets
and liabilities. The types of temporary differences that give rise to the
deferred tax liability, and the effect on the deferred income tax expense
(benefit) of changes in those temporary differences, are as follows:

<TABLE>
<CAPTION>
                                                             1999                 1998                 1997
                                                         -----------          -----------        -----------
<S>                                                      <C>                  <C>                <C>
Accounts receivable                                      $ 5,900,000          $ 5,351,000        $(2,131,000)
Allowance for doubtful accounts                               61,000             (265,000)           104,000
 Fees held in escrow                                        (130,000)            (105,000)          (128,000)
Depreciable and amortizable assets                           272,000           (1,112,000)          (674,000)
Capitalized research and development costs                 1,229,000            1,119,000            316,000
Unbilled costs                                                58,000               32,000           (242,000)
Accounts payable and other accrued expenses                  (78,000)             122,000          1,248,000
Deferred revenue                                             214,000               92,000            106,000
Deferred rent                                                355,000              (65,000)          (138,000)
Contract termination contingency                                   0                    0         (1,093,000)
HHL one-time charges                                               0                    0          1,310,000
Federal and state net operating loss                      (3,780,000)          (1,251,000)          (434,000)
Other                                                         65,000              105,000            121,000
                                                         -----------          -----------        -----------
Deferred income tax expense (benefit)                    $ 4,166,000          $ 4,023,000        $(1,635,000)
                                                         ===========          ===========        ===========
</TABLE>


         The tax effect of temporary differences that give rise to a significant
portion of the deferred tax assets and deferred tax liabilities at October 31,
1999 and 1998 were as follows:




                                       41
<PAGE>   44
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                      1999              1998
                                                                  ------------      ------------
<S>                                                               <C>               <C>
Deferred tax assets:
    Accounts receivable/deferred items                            $    193,000      $    408,000
    Allowance for doubtful accounts                                    777,000           838,000
    Property and equipment                                           3,732,000         3,904,000
    HHL one-time charges                                               325,000           399,000
    Accounts payable and accrued expenses                              203,000           202,000
    Federal and state net operating loss carryforward                7,261,000         3,321,000
    Minimum tax credit                                                 572,000                 0
    Other                                                              684,000           756,000
                                                                  ------------      ------------
         Total deferred tax assets before valuation allowance       13,747,000         9,828,000
    Less: Valuation allowances                                      (1,024,000)       (1,396,000)
                                                                  ------------      ------------
         Total deferred tax assets after valuation allowance      $ 12,723,000      $  8,432,000
                                                                  ============      ============

Deferred tax liabilities:
    Accounts receivable/deferred items                            $ 18,446,000      $ 12,121,000
    Capitalized research and development cost                        3,194,000         1,965,000
    Federal impact of states net operating losses                    1,207,000           674,000
    Other                                                            2,046,000         1,676,000
                                                                  ------------      ------------
        Total deferred tax liabilities                            $ 24,893,000      $ 16,436,000
                                                                  ============      ============
        Total net deferred tax liabilities                        $(12,170,000)     $ (8,004,000)
                                                                  ============      ============

Net current deferred tax liabilities                              $(15,967,000)     $(11,307,000)
Net noncurrent deferred tax assets                                   3,797,000         3,303,000
                                                                  ------------      ------------
        Total net deferred tax liabilities                        $(12,170,000)     $ (8,004,000)
                                                                  ============      ============
</TABLE>



         The valuation allowances for the fiscal years ended October 31, 1999,
1998, and 1997 were $1,024,000, $1,396,000 and $1,396,000, respectively. At
October 31, 1999, the Company had a net operating loss carryforward of
$10,000,000 and $16,000,000, which is available to offset future federal and
state/city taxable income, respectively. Of the federal amount, $3,998,000 is
subject to annual limitation of $266,000 under Internal Revenue Code Section
382. The federal and state/city net operating loss carryforwards expire between
fiscal years 2012 through 2019, and fiscal years 2012 through 2014,
respectively. The federal minimum tax credit has no expiration period. The
Company's management believes that the utilization of certain net operating loss
carryforward is not more likely than not to be realized, and therefore has
maintained a valuation allowance of $1,024,000.

         Cash payments attributable to income taxes for the years ended October
31, 1999, 1998, and 1997 were $522,000, $2,412,000, and $1,263,000,
respectively.

         The Company has had disqualifying disposition transactions during the
three years ended October 31, 1999. Disqualifying dispositions are non-cash
transactions and are excluded from the statements of cash flows. The tax benefit
derived from disqualifying dispositions increased shareholders' equity by
$33,000, $602,000, and $2,190,000 during the fiscal years ended October 31,
1999, 1998, and 1997, respectively.

10.      EQUITY
         On May 28, 1997, the Board of Directors authorized the Company to
repurchase such number of shares of its common stock that have an aggregate
purchase price not in excess of $10,000,000. The Company is authorized


                                       42
<PAGE>   45
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to repurchase these shares from time to time on the open market or in negotiated
transactions at prices deemed appropriate by the Company. Repurchased shares are
deposited in the Company's treasury and used for general corporate purposes. In
fiscal year 1998, the Company repurchased a total of 734,500 shares of common
stock at an average price of $8.01 per share, for an aggregate purchase price of
$5,887,000. Since the inception of the repurchase program in June 1997, the
Company has repurchased in the open market 1,049,000 shares of common stock at
an average price of $7.39 per share having an aggregate purchase price of
$7,750,000.

         The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 5,000,000 shares of "blank check" preferred stock with such
designations, rights and preferences as may be determined by the Company's Board
of Directors.

11.      PROFIT SHARING AND 401(K) PLAN
         The Company had a discretionary defined contribution profit sharing
plan in which a substantial number of its employees participated. For the years
ended October 31, 1999, 1998, and 1997, profit sharing expense was $0, $0, and
$197,000 respectively.

         Effective January 1, 1992, the Company amended its profit sharing plan
to include a 401(k) plan, which permits an employee to contribute a portion of
the employee's compensation, subject to certain limitations. At its discretion,
the Company may make annual contributions to the 401(k) plan for the benefit of
participating employees. For the years ended October 31, 1999, 1998, and 1997,
401(k) plan expense was $1,102,000, $959,000, and $804,000, respectively.

         Effective October 31, 1997, the Company terminated its profit sharing
plan, including the 401(k) plan. A replacement, but identical, 401(k) plan was
established as of November 1, 1997. Having obtained approval by the Internal
Revenue Service, an initial distribution of the assets of the terminated profit
sharing plan was completed on December 18, 1998, the majority of the individual
accounts were distributed in March 1999, and the Company expects to distribute
the remainder in fiscal year 2000.

12.      STOCK-BASED COMPENSATION PLANS
         At October 31, 1999, the Company had three stock-based compensation
plans, which are described below. The Company has adopted the disclosure-only
provisions of SFAS 123 and applies APB Opinion No. 25 and related
Interpretations in accounting for its plans. Accordingly, no employee
compensation costs have been recognized for its stock purchase plan and stock
option plans. Had compensation costs for the Company's three stock-based
compensation plans been determined consistent with fair value method prescribed
by SFAS 123, the Company's net income and earnings per share would have been
adjusted to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                         1999          1998          1997
                                                                        ------        ------        ------

<S>                                        <C>                          <C>           <C>           <C>
Net income                                 As reported                  $7,483        $6,088        $2,081
                                           Pro forma                     6,325         2,189           837

Net income per basic share                 As reported                    0.43          0.35          0.12
                                           Pro forma                      0.36          0.13          0.05

Net income per diluted share               As reported                    0.43          0.34          0.12
                                           Pro forma                     $0.36         $0.12         $0.05
</TABLE>



                                       43
<PAGE>   46
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The effect noted above by applying the disclosure-only provisions of
SFAS 123 may not be representative of the pro forma effect in future years.

         The fair value of the stock options granted in 1999, 1998, and 1997 is
estimated at the grant date using the Black-Scholes option-pricing model with
the following assumptions: dividend yield of 0% (the Company does not pay
dividends); expected volatility of 58.3%, 48.9%, and 51.4%; a risk-free interest
rate of 4.7%, 5.7%, and 5.8%; and expected lives of 4.76, 4.91, and 4.90 years,
respectively.

         Effective March 9, 1999, the shareholders of the Company approved the
Health Management Systems, Inc. 1999 Long-Term Incentive Stock Plan (the
"Plan"), which replaced the Health Management Systems, Inc. Stock Option and
Restricted Stock Purchase Plan terminated in May 1999. The primary purposes of
the Plan are (i) to promote the interests of the Company and its shareholders by
strengthening the Company's ability to attract and retain highly competent
individuals to serve as officers and other key employees and (ii) to provide a
means to encourage stock ownership and proprietary interest by such persons in
the Company. The Plan provides for the grant of (a) options to purchase shares
of the Company's common stock at an exercise price no less than 100% of the
estimated fair market value of the Company's common stock; (b) stock
appreciation rights ("SAR") representing the right to receive a payment, in
cash, shares of common stock, or a combination thereof, equal to the excess of
the fair market value of a specified number of shares of the Company's common
stock on the date the SAR is exercised over the fair market value of such shares
on the date the SAR was granted; or (c) stock awards made or valued, in whole or
in part, by reference to shares of common stock. The Plan authorizes the
issuance of up to 4,751,356 shares of common stock. The Plan expires in January
2009.

         The stock options become exercisable and expire at various dates
through November 2009. As of October 31, 1999, no SAR's or stock purchase awards
had been granted. Effective November 30, 1999 (the "Grant Date"), the Company
awarded 367,500 stock options. Of the total options, 234,000 options are subject
to a performance based accelerated vesting schedule. These options vested 25
percent on the Grant Date and the remaining 75 percent will vest on October 31,
2003, subject to accelerated vesting of all or a portion of the total options
upon realization of certain annual performance measures. All options whose
vesting has not otherwise been accelerated pursuant to the foregoing will vest
on October 31, 2003, subject only to the continued employment by the Company of
the optionee.

         The Company's 1995 Non-Employee Director Stock Option Plan (the "NEDP")
was adopted by the Board of Directors on November 30, 1994, which action was
subsequently approved by shareholders at the Annual Meeting of Shareholders held
on March 7, 1995. Under the NEDP, directors of the Company who are not employees
of the Company or its subsidiaries are granted options to purchase 1,500 shares
of common stock of the Company during the fourth fiscal quarter of each year
commencing with fiscal year 1995. Options for the purchase of up to 112,500
shares of common stock may be granted under the NEDP and the Company will
reserve the same number of shares for issuance. The options available for grant
are automatically increased to the extent any granted options expire or
terminate unexercised.




                                       44
<PAGE>   47
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Presented below is a summary of the stock option plans for the years
ended October 31, 1999, 1998, and 1997:

<TABLE>
<CAPTION>
                                     1999                       1998                        1997
                            ---------------------      ---------------------       ----------------------
                                         Weighted                  Weighted                     Weighted
                                          average                   average                      average
                                         exercise                  exercise                     exercise
                              Shares      Price          Shares      price           Shares       price
                            ---------    --------      ---------   ---------       ---------    ---------
<S>                         <C>          <C>           <C>         <C>             <C>          <C>
Options outstanding at      1,801,098    $   7.50      1,925,856   $    7.82       1,962,752    $   12.47
   Beginning of year
Granted                     1,965,250        6.16        541,504        6.57       1,573,294         9.09
Exercised                     (41,247)       5.09       (440,316)       6.17         (69,424)        3.90
Cancelled                    (389,173)       6.58       (225,946)      10.63      (1,540,766)       15.22
                            ---------    --------      ---------   ---------       ---------    ---------
Options outstanding at
   end of year              3,335,928    $   6.85      1,801,098   $    7.50       1,925,856    $    7.82
                            =========    ========      =========   =========       =========    =========

Weighted average
   Grant-date fair value
   of options granted
(Black-Scholes)                          $   2.30                  $    3.17                    $    4.63
                                         ========                  =========                    =========
</TABLE>

         The following table summarizes information for stock options
outstanding at October 31, 1999:

<TABLE>
<CAPTION>
                                   Total Outstanding Options                 Outstanding Exercisable Options
                        ---------------------------------------------        -------------------------------
                                             Weighted
                                              average         Weighted                            Weighted
            Range             Number        remaining          average                             average
      of exercise        outstanding      contractual         exercise             Number         exercise
           prices     as of 10/31/99             life            price        exercisable            price
-----------------     --------------      -----------      -----------        -----------        ---------
<S>                   <C>                 <C>              <C>                <C>                   <C>
   $ 0.58 -  5.69            360,869             8.43      $     4.28             71,744         $    2.84

     5.88 -  6.03            482,994             7.60            5.88            359,994              5.88

     6.32 -  7.00          2,044,028             8.56            6.43            529,280              6.45

     8.16 - 10.06            306,652             4.97            9.30            271,652              9.26

    15.31 - 23.00            141,101             6.21           17.20            131,590             17.34

    70.51 - 70.51                284             6.18           70.51                172             70.51
-----------------     --------------      -----------      -----------        -----------        ---------
   $ 0.58 - 70.51          3,335,928             7.98      $     6.85          1,364,432         $    7.73
-----------------     --------------      -----------      -----------        -----------         ---------
</TABLE>



         On May 28, 1997, the Board of Directors authorized a stock option
exchange program for employee participants in the Plan. Eligible employees who
held stock options ("Old Options") with exercise prices in excess of $10.00 per
share were able to exchange them for stock options ("New Options") exercisable
for a lesser number of shares with an exercise price of $5.88 per share, the
average price of the Company's common stock on the NASDAQ-Amex National Market
System on June 2, 1997 ("Grant Date"). Approximately 1,600,000 Old Options were
eligible to be exchanged for 900,000 New Options. At the end of the exchange
program, 1,288,000 Old Options were exchanged for 609,000 New Options. The New
Options received in the exchange entailed a new vesting schedule where one
quarter vested immediately on the Grant Date, with an additional quarter vesting
on each of November 1, 1998, 1999, and 2000, respectively. To the extent that
the fair market value of the Company's common stock exceeded $12.50 on each day
for ten consecutive trading days, the vesting of all New Options not otherwise
vested would become accelerated and 100% fully vested. On March 30, 1998, these
New Options became fully vested as a consequence of the fair market value of the
Company's common stock having exceeded $12.50 for the requisite ten consecutive
trading day period.



                                       45
<PAGE>   48
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         On May 28, 1993, the Board of Directors adopted the Health Management
Systems, Inc. Employee Stock Purchase Plan (the "ESPP"), which was subsequently
approved by shareholders at the Annual Meeting of Shareholders held on February
28, 1994. The Company has reserved for issuance up to 1,125,000 shares of common
stock pursuant to the ESPP, which is intended to qualify as an "employee stock
purchase plan" within the meaning of Section 423 of the Internal Revenue Code of
1986. The ESPP provides that all full-time employees of the Company and its
subsidiaries may elect to participate in the ESPP without regard to length of
service if their customary employment is a minimum of 20 hours per week. For the
years ended October 31, 1999, 1998, and 1997, the Company had sold 77,123,
118,531, and 95,332 shares, respectively, of common stock pursuant to the ESPP
for aggregate consideration of $337,000, $516,000, and $709,000, respectively,
which activity is reflected in the accompanying consolidated financial
statements. The weighted-average fair value of those purchase rights granted in
1999, 1998, and 1997, respectively, based on the Black-Scholes model was $2.35,
$3.52, and $10.68 respectively.

13.      SEGMENT AND GEOGRAPHICAL INFORMATION
         In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of An Enterprise and Related Information." SFAS No. 131 established standards
for reporting information about operating segments in annual financial
statements and in interim financial reports issued to stockholders.

         (a)   Segment Information
         The Company measures the performance of its operating segments through
"Operating Income" as defined on the accompanying consolidated statements of
operations.







                                       46
<PAGE>   49
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                TOTAL     Provider     Payor
                                               REVENUE    Revenue     Revenue           TOTAL     Decision     Payor
                              TOTAL            SERVICES   Services   Services          SOFTWARE    Support    Systems
($ in Thousands)               HMS             DIVISION     Group      Group           DIVISION     Group      Group
----------------            ---------          ---------  ---------  ---------         ---------  ---------  ---------
<S>                         <C>                 <C>        <C>        <C>                  <C>        <C>        <C>
1999

Revenue                     $ 114,055          $  67,950  $  41,536  $  26,414         $  46,105  $  22,542  $  23,563
Operating income (loss)        10,297              2,150     (2,988)     5,138             8,147      4,328      3,819
Total assets                  130,921             84,186     51,155     32,631            46,735     21,536     25,199
Depreciation and
 amortization                   4,595              1,865      1,368        497             2,730      1,584      1,146
Capital expenditures and
 software capitalization        6,827              2,177      1,562        615             4,650      3,165      1,485
                            ---------          ---------  ---------  ---------         ---------  ---------  ---------
1998

Revenue                       105,252             57,238     34,987     22,251            48,014     25,499     22,515
Operating income (loss)         7,660              1,481     (1,620)     3,101             6,179      4,645      1,534
Total assets                  117,802             73,857     46,106     27,751            43,945     19,939     24,006
Depreciation and
 amortization                   5,484              2,343      1,559        786             3,141      1,285      1,856
Capital expenditures and
 software capitalization        4,401                687        420        267             3,714      2,941        773
                            ---------          ---------  ---------  ---------         ---------  ---------  ---------
1997

Revenue                        89,517             55,856     39,007     16,849            33,661     24,873      8,788
Operating income (loss)          (169             (3,824)      (704)    (3,120)            3,655      4,628       (973)
Total assets                  109,694             73,304     46,630     26,674            36,390     17,359     19,031
Depreciation and
 amortization                   5,142              2,531      1,814        717             2,611      1,059      1,552
Capital expenditures and
 software capitalization    $   3,960          $   1,519  $   1,055  $     464         $   2,441  $   2,182  $     259
                            ---------          ---------  ---------  ---------         ---------  ---------  ---------
</TABLE>


         (b)   Geographic Information
         The Company operates within the continental United States. The Company
also has a limited number of overseas clients. Substantially, all identifiable
assets of the Company are located and safeguarded throughout the continental
United States.

         (c)   Major Customers
         No single client of the Company accounted for 10% or more of the
Company's total revenue in fiscal year 1999. The Company's largest client is
Columbia/HCA Healthcare Corporation ("Columbia"), a customer of the Decision
Support Group. This client accounted for 9%, 10%, and 12% of the Company's total
revenue in fiscal years 1999, 1998, and 1997, respectively. The Company provides
its services to Columbia primarily pursuant to annual work order agreements.
There is no assurance that any of these agreements will be renewed.

         (d)   Concentration of Revenue
         The clients constituting the Company's ten largest clients change each
year. The concentration of revenue in such accounts has decreased; accounting
for approximately 48%, 50%, and 53% of the Company's revenue in fiscal years
1999, 1998, and 1997, respectively. In many instances, including governmental
clients, the Company provides its services pursuant to agreements subject to
competitive re-procurement. All of these agreements periodically expire,


                                       47
<PAGE>   50
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

and will have reached their terms by the end of fiscal year 2004. There is no
assurance that any of these agreements will be renewed and, if renewed, that the
fee rates will be equal to those currently in effect.

14.      COMMITMENTS
         The Company leases office space and data processing equipment under
operating leases which expire at various dates through 2006. The lease
agreements provide for rent escalations. Rent expense, net of sublease income,
for the years ended October 31, 1999, 1998, and 1997, including escalations, was
$6,806,000, $6,801,000, and $7,634,000, respectively. Sublease income was
$1,401,000, $751,000 and $0, for the years ended October 31, 1999, 1998, and
1997, respectively.

         Minimum annual lease payments for each of the next five years ending
October 31 and thereafter are as follows:

<TABLE>
<CAPTION>
        Year                                                 Payments
        ----                                            --------------
<S>                                                     <C>
        2000                                            $    4,795,838
        2001                                                 4,427,404
        2002                                                 4,350,503
        2003                                                 3,417,561
        2004                                                 2,519,253
        Thereafter                                           4,138,669
                                                        --------------
        Total                                           $   23,649,228
                                                        ==============
</TABLE>



15.      RELATED PARTY TRANSACTIONS
         (a)  HHL Financial Services, Inc.
         Effective January 31, 1992, the Company entered into a management and
data processing services agreement ("Management Agreement") with HHL Financial
Services, Inc. ("HHL"). Under the Management Agreement, the Company provided HHL
with executive management, data processing, and technical support services
through June 30, 1996, subject to certain termination and renewal provisions.

         Effective July 1, 1993, the Management Agreement was amended
("Outsourcing Amendment") to include the Company's provision of comprehensive
data processing and information management services to HHL. The five-year term
of the Outsourcing Amendment called for fixed annual fees that range from
$6,700,000 to $9,500,000, subject to upward adjustment in the event of material
changes in the scope of service and/or growth in HHL revenue in excess of 7%
annually.

         On August 21, 1996, the Company announced a one-time charge and revenue
reversal pertaining to its relationship with HHL, which was in default of the
Outsourcing Amendment. The Company's one-time charge related to (i) the full
reservation of prior period accounts receivable of $2,881,000, (ii) accrual of
net costs to be incurred in excess of anticipated revenue relating to the
Company's continued contractual obligation with HHL of $3,823,000, and (iii) the
write-off of its investment in HHL of $927,000, resulting in a total one-time
charge of $7,631,000. Additionally, revenue of $2,180,000 earned and initially
recorded in the third quarter of 1996 was reversed. The result of the total
write-off and revenue reversal recognized in the third quarter of 1996 of
$9,811,000 translated to an after-tax impact of $5,563,000, or $0.30 per share.

         On October 29, 1996, the Company entered into an agreement with HHL and
HHL's primary financial creditor providing for mutual general releases and the
cessation of all claims. The Company also settled its liabilities due to HHL of
$1,950,000 for a payment of $870,000 resulting in the reversal of $1,080,000 in
liabilities as an offset to other operating expenses. In addition, the Company
agreed to provide, for a period of up to 18 months, a reduced level of service


                                       48
<PAGE>   51

                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to HHL in exchange for payment in advance. During this 18-month period, HHL had
the right and elected to lower the level of service requested and therefore
lower the amount paid in advance. Also, HHL had the right and in certain
instances cancelled the service on 30 days prior written notice.

         During 1997, the Company had incurred and offset $2,739,000 in net
expenses for its contractual obligations with HHL. During 1998 and 1999, the
Company had offset $200,000 and $130,000, respectively, of a contractual
obligation to a third party. The remaining accrual liability of $389,000 at
October 31, 1999, is scheduled to be offset over the next three years against a
contractual obligation of the Company to a third party.

         During the years ended October 31, 1999, 1998, and 1997, the Company
received approximately $0, $0, and $1,849,000 in fees from HHL related to these
agreements and in connection with jointly executed client projects. During the
same periods, HHL charged the Company expenses for services totaling $0, $0, and
$250,000, respectively, in connection with work done on jointly executed client
projects.

         (b)  HISCo
         The Company and HISCo entered into an agreement, dated as of October
31, 1995 (the "HISCo Agreement"), pursuant to which the Company was to provide
HISCo with certain services ("Basic Services"), including executive, acquisition
support, and corporate support services. For these Basic Services, the Company
was entitled to receive a fee, payable monthly, calculated at the Company's then
current standard hourly rates established for internal allocations plus 20%. The
term of the HISCo Agreement was to continue until the later of (i) June 30, 2000
or (ii) the expiration of any outstanding work order related to additional
services. The Company believes that the terms of the HISCo Agreement were fair
and reasonable and were no less favorable to the Company than those that could
have been obtained with respect to comparable engagements with independent third
parties. In fiscal year 1997, the Company received approximately $331,000 in
fees from HISCo for services provided pursuant to the HISCo Agreement.

         In March 1997, the Company, which owned 43% of HISCo's equity, acquired
the remaining 57% of HISCo's equity for $3,689,000, net of cash acquired. In
connection with this acquisition, the HISCo agreement was terminated and HISCo
merged with its sole operating subsidiary, Health Systems Architects, Inc. and
was renamed HSA Managed Care Systems, Inc. This entity is currently known as the
Company's Payor Systems Group, and provides automated business and information
solutions, including software and services, to healthcare providers and payors.
The acquisition was accounted for using the purchase method and accordingly the
results of operations of HSA from the date of acquisition through October 31,
1999 are included in the accompanying financial statements. The $2,309,000
excess of the purchase price over fair market value of the identifiable net
assets acquired was recorded as goodwill and is being amortized over a period of
20 years.

         In connection with the sale of their respective equity interests in
HISCo to the Company, certain of the Company's current and former officers and
directors derived gross proceeds as follows: Paul J. Kerz, $101,000; Laurence B.
Simon, $62,000; Donald J. Staffa, $31,000; Russell L. Carson, $79,000; and
Richard H. Stowe, $30,000.

         The Company's total revenue from related parties was $0, $0, and
$331,000 in fiscal years 1999, 1998, and 1997, respectively.

         (c)  Robert V. Nagelhout
         In April 1997, the Company guaranteed a loan by The Chase Manhattan
Bank (the "Bank") in the original principal amount of $1,600,000 to Robert V.
Nagelhout, the then Chief Operating Officer and a director of the Company. Mr.
Nagelhout granted the Company a security interest in 500,000 shares of the
Company's common stock as collateral for its guarantee. On June 11, 1998, Mr.
Nagelhout repaid the loan in its entirety, the Bank released the Company's

                                       49
<PAGE>   52

                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

guaranty, and the available balance under the Company's line of credit with the
Bank was restored by $1,600,000 to $30,000,000.

         (d) Paul J. Kerz
         During October 1998, the Company's HSA subsidiary, a Delaware
corporation, made two loans to Paul J. Kerz, an officer and director of HSA, who
is also the Company's Chairman and Chief Executive Officer. One loan, in the
principal amount of $500,000, was secured by a pledge of 162,666 shares of the
Company's common stock owned by Mr. Kerz, while the other loan, in the principal
amount of $250,000, was unsecured. Both loans bore interest at the rate of
5.3125% per annum, payable semi-annually commencing April 30, 1999, and were due
as to principal and all then accrued but unpaid interest on October 31, 2000.
During October 1999, HSA (i) extended the due date of both loans to December 31,
2001 and (ii) increased the total principal amount of the unsecured loan to
$1,000,000 of which a total of $400,000 was outstanding as of October 31, 1999.
During November 1999, Mr. Kerz drew down the remaining $600,000 of the unsecured
loan. In addition, the interest rate on the amended loans was increased to
5.9686% per annum. The amendments to the loans were unanimously approved by the
Board of Directors of HSA and the Company as the sole stockholder of HSA,
following the recommendation of the Compensation Committee of the Company's
Board of Directors that the amendment to the loans were in the best interest of
HSA and the Company, and the unanimous approval of the amendment to the loans by
the independent members of the Company's Board of Directors.

16.      QUARTERLY FINANCIAL DATA (UNAUDITED)
         The table below summarizes the Company's unaudited quarterly operating
results for its last two fiscal years.

<TABLE>
<CAPTION>
                                                                First       Second        Third        Fourth
($ In Thousands, Except Earnings Per Common Share)             Quarter      Quarter      Quarter       Quarter
--------------------------------------------------             -------      -------      -------       -------
<S>                                                            <C>          <C>          <C>           <C>
1999:
Revenue                                                        $ 27,369     $ 28,857     $ 27,655      $ 30,174
Operating income                                                  2,415        2,831        2,844         2,207
Net income                                                        1,606        1,803        2,068         2,006
Basic earnings per share                                           0.09         0.10         0.12          0.12
Diluted earnings per share                                         0.09         0.10         0.12          0.12
                                                               --------     --------     --------      --------
1998:
Revenue                                                          25,037       25,636       26,736        27,843
Operating income                                                  1,010        1,609        1,960         3,081
Net income                                                          879        1,185        1,388         2,636
Basic earnings per share                                           0.05         0.07         0.08          0.15
Diluted earnings per share                                     $   0.05     $   0.07     $   0.08      $   0.15
                                                               --------     --------     --------      --------
</TABLE>


17.      LEGAL
         In April and May 1997, five purported class action lawsuits were
commenced in the United States District Court for the Southern District of New
York against the Company and certain of its present and former officers and
directors alleging violations of the Securities Exchange Act of 1934 in
connection with certain allegedly false and misleading statements. These
lawsuits, which sought damages in an unspecified amount, were consolidated into
a single proceeding captioned In re Health Management Systems, Inc. Securities
Litigation (97 CIV-1965 (HB)) and a Consolidated Amended Complaint was filed.
Defendants made a motion to dismiss the Consolidated Amended Complaint, which
was submitted to the Court on December 18, 1997 following oral argument. On May
27, 1998, the Consolidated Amended Complaint was dismissed by the Court for
failure to state a claim under the federal securities laws, with leave for the
plaintiffs to replead. On July 17, 1998, a Second Consolidated Amended Complaint
was filed in the United States District Court for the Southern District of New
York, which reiterated plaintiffs' allegations in their prior Complaint. On
September 11, 1998, the Company and the other defendants filed a motion


                                       50
<PAGE>   53

                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to dismiss the Second Consolidated Amended Complaint. The motion was fully
briefed in late November 1998, at which time the motion was submitted to the
Court. The consolidated proceeding was reassigned to another Judge. The Court
heard oral argument on the motion to dismiss on June 11, 1999. Prior to
rendering its decision on the motion to dismiss, the Court ordered the parties
to attempt to settle the case, and meetings toward that end were conducted. On
December 20, 1999, the parties reached a tentative agreement on the principal
terms of settlement of the litigation against all defendants. Pursuant to this
understanding, without admitting any wrongdoing, certain of the defendants have
agreed to pay, in complete settlement of this lawsuit, the sum of $4,500,000,
not less than 75 percent of which will be paid by the Company's insurance
carriers. For the fiscal year ended October 31, 1999, the Company has recorded a
charge of $845,000 related to this proposed settlement which is included as a
component of other cost of services. The proposed settlement is subject to
execution of a final settlement agreement and Court approval. On December 22,
1999, the Judge issued an Order dismissing, without prejudice, the pending
motion to dismiss, as moot. In the event a final settlement is not consummated,
the Company intends to resubmit a motion to dismiss the Second Consolidated
Amended Complaint and to continue its vigorous defense of the lawsuit.

          On June 1, 1998, MedE America Corp. commenced a lawsuit against the
Company and others in the United States District Court for the Southern District
of New York. In its complaint, plaintiff alleged copyright infringement and
other violations of its rights relating to the Company's development and sale of
certain computer software, known as the Universal Billing Platform, which was
recently developed for the Company by certain former employees of plaintiff, who
are also defendants in the action, acting as independent contractors. Plaintiff,
among other relief, sought (i) to restrain the Company from continuing to market
and sell the alleged infringing software, and (ii) monetary damages in excess of
$10,000,000. Over a period of in excess of nine months prior to the filing of
the complaint, the parties engaged in an extensive exchange of communications,
as a result of which the Company concluded, after investigation, that
plaintiff's claims were without merit. On July 22, 1998, the Company answered
the complaint, denying the material allegations of the complaint. After the
commencement of Discovery and pursuant to the Rules of the Court, this matter
was referred to a Court-appointed Mediator, who, in the context of non-binding
mediation and independent of the Court proceeding, met with the parties over a
period of months. The Mediator assisted in negotiating a settlement of this
case, which entails no payment by the Company, dismissal of the Complaint with
prejudice, and an acknowledgement by MedE that, after review and access to
additional information, the copyright and trademark infringement claims were
without merit.

         On June 28, 1998, eight holders of promissory notes (the "Notes") of
HHL commenced a lawsuit against the Company and others in the Supreme Court of
the State of New York, County of Nassau, alleging various breaches of fiduciary
duty on the part of the defendants against HHL. The complaint alleges that as a
result of these breaches of duty, HHL was caused to make substantial unjustified
payments to the Company which, ultimately, led to defaults on the Notes and to
HHL's filing for Chapter 11 bankruptcy protection. On June 30, 1998, the same
Note holders commenced a virtually identical action (the "Adversary Proceeding")
in the United States Bankruptcy Court for the District of Delaware, where HHL's
Chapter 11 proceeding is pending. The Adversary Proceeding alleges the same
wrongdoing as the New York State Court proceeding and seeks the same damages,
i.e., $2,300,000 (the unpaid amount of the Notes) plus interest. Plaintiffs have
moved in the Bankruptcy Court to have the Court abstain from hearing the
Adversary Proceeding in deference to the New York State Court action. The
Company has opposed plaintiffs' motion for abstention and on September 15, 1998
filed a motion in the Bankruptcy Court to dismiss the Adversary Proceeding. This
motion was briefed in December 1998. Oral argument on the motions was heard by
the Court on April 22, 1999 and the motions are now sub judice. The Company
intends to continue its vigorous defense of this lawsuit. Management believes
the risk of loss is not probable and accordingly has not recognized any accrued
liability for this matter. Although the outcome of this matter cannot be
predicted with certainty, the Company believes that any liability that may
result will not, in the aggregate, have a material adverse effect on the
Company's financial position or cash flows, although it could be material to the
Company's operating results in any one accounting period.



                                       51
<PAGE>   54

                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Other legal proceedings to which the Company is a party, in the opinion
of the Company's management, are not expected to have a material adverse effect
on the Company's financial position, results of operations, or liquidity.








                                       52
<PAGE>   55
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS




<TABLE>
<CAPTION>
Allowance for doubtful accounts:

<S>                                                  <C>
Balance, October 31, 1996                            $     1,682,000
         Provision                                           538,000
         Recoveries                                                -
         Charge-offs                                        (792,000)
                                                     ---------------
Balance, October 31, 1997                                  1,428,000
         Provision                                           838,000
         Recoveries                                                -
         Charge-offs                                        (413,000)
                                                     ---------------
Balance, October 31, 1998                                  1,853,000
         Provision                                           690,000
         Recoveries                                                -
         Charge-offs                                        (720,000)
                                                     ---------------
BALANCE, OCTOBER 31, 1999                            $     1,823,000
                                                     ===============
</TABLE>





                                       53
<PAGE>   56
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER

<S>            <C>
2.1            Agreement and Plan of Merger dated as of January 18, 1995 among
               Health Management Systems, Inc., HCm Acquisition Corp., and all
               the shareholders of Health Care microsystems, Inc., as amended
               (Incorporated by reference to Exhibit 10.18 to the Company's
               Annual Report on Form 10-K for the year ended October 31, 1994
               and to Exhibit 10.2 to the Company's Registration Statement on
               Form S-3, file no. 33-91518)

2.2            Agreement and Plan of Merger, dated as of April 29, 1996 among
               Health Management Systems, Inc., CDR Acquisition Corp., CDR
               Associates, Inc., and all the shareholders of CDR Associates,
               Inc. (Incorporated by reference to Exhibit 10.1 to the Company's
               Current Report on Form 8-K dated April 29, 1996)

2.2(i)         First Amendment to Agreement and Plan of Merger, dated as of
               April 29, 1996, among Health Management Systems, Inc., CDR
               Acquisition Corp., CDR Associates, Inc., and all the shareholders
               of CDR Associates, Inc. (Incorporated by reference to Exhibit
               2.2(i) to the Company's Annual Report on Form 10-K for the year
               ended October 31, 1996 (the 1996 Form 10-K)

2.3            Agreement and Plan of Merger, dated as of September 3, 1996, by
               and among Health Management Systems, Inc., QSM Acquisition
               Corporation and Quality Standards in Medicine, Inc. (Incorporated
               by reference to Exhibit 2.1 to the Company's Registration
               Statement on Form S-4, File No. 333-13513 (the S-4))

2.3(i)         Amendment to Agreement and Plan of Merger, dated as of November
               20, 1996, by and among Health Management Systems, Inc., QSM
               Acquisition Corporation, and Quality Standards in Medicine, Inc.
               (Incorporated by reference to Exhibit 10.1 to Post-Effective
               Amendment No. 1 to the S-4)

2.4            Agreement and Plan of Merger, dated as of March 18, 1997, by and
               among Health Management Systems, Inc., HISCo Acquisition Corp.,
               Health Information Systems Corporation and HSA Managed Care
               Systems, Inc. (Incorporated by reference to Exhibit 2.1 to the
               Company's Quarterly Report on Form 10-Q for the quarter ended
               April 30, 1997 (the April 1997 Form 10-Q))

2.5            Asset Purchase Agreement, dated as of March 10, 1997, by and
               among GHS, Inc., Global Health Systems, Inc. GHS Management
               Services, Inc., Health Management Systems, Inc. and Global Health
               Acquisition Inc. (Incorporated by reference to Exhibit 2.1 to the
               Company's Quarterly Report on Form 10-Q for the quarter ended
               July 31, 1997 (the July 1997 Form 10-Q))

2.5(i)         Assignment and Assumption Agreement, dated as of July 15, 1997,
               between Global Health Acquisition Corp. and HSA Managed Care
               Systems, Inc. (Incorporated by reference to Exhibit 2.2 to the
               July 1997 Form 10-Q)

2.6            Asset Purchase Agreement, dated as of June 30, 1999, by and among
               ARC Ventures, LLC, and Health Receivables Management, LLC and
               Health Management Systems, Inc., and Quality Standards In
               Medicine, Inc. (Incorporated by reference to Exhibit 2 to the
               Company's Quarterly Report on Form 10-Q for the quarter ended
               July 31, 1999 (the "July 1999 Form 10-Q"))
</TABLE>



                                       54
<PAGE>   57
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER

<S>            <C>
3.1            Amended and Restated Certificate of Incorporation of Health
               Management Systems, Inc. (Incorporated by reference to Exhibit
               3.1 to Amendment No. 1 (Amendment No. 1) to the Company's
               Registration Statement on Form S-1, File No. 33-4644 (the
               Registration Statement) and Exhibit 3(i) to the Company's
               Quarterly Report on Form 10-Q for the quarter ended January 31,
               1996 (the January 1996 Form 10-Q))

3.2            By-Laws of Health Management Systems, Inc. (Incorporated by
               reference to Exhibit 3.2 to Amendment No. 1)


10.2(ii)       Amendment, dated as of September 1, 1995, to Master Software
               License, dated June 29, 1992, by and between Health Care
               microsystems, Inc. and Columbia/HCA. (Incorporated by reference
               to Exhibit 10.2(ii) to the 1997 Form 10-K)

10.3(i)        Health Management Systems, Inc. Stock Option and Restricted Stock
               Purchase Plan, as amended (Incorporated by reference to Exhibit
               10.3 to the Registration Statement, to Exhibit 10.3 to Amendment
               No. 2 (Amendment No. 2) to the Registration Statement, Exhibit
               10.1 to the Company's Quarterly Report on Form 10-Q for the
               quarter ended January 31, 1994 (the January 1994 Form 10-Q) and
               Exhibit 10 to the January 1996 Form 10-Q)

10.3(ii)       Amendment No. 6, dated as of December 2, 1997, to the Health
               Management Systems, Inc., Stock Option and Restricted Stock
               Purchase Plan. (Incorporated by reference to Exhibit 10.3(iii) to
               the 1997 Form 10K)

10.3(iii)      Health Management Systems, Inc. Employee Stock Purchase Plan, as
               amended (Incorporated by reference to Exhibit 10.2 to the January
               1994 Form 10-Q and to Exhibit 10.1 to the Company's Quarterly
               Report on Form 10-Q for the quarter ended January 31, 1995 (the
               January 1995 Form 10-Q))

10.3(iv)       Health Management Systems, Inc. 1995 Non-Employee Director Stock
               Option Plan (Incorporated by reference to Exhibit 10.2 to the
               January 1995 Form 10-Q)

10.3(v)        Health Management Systems, Inc. Profit Sharing Plan (Incorporated
               by reference to Exhibit 10.3(iv) to the Company's Annual Report
               on Form 10-K for the year ended October 31, 1995 (the 1995 Form
               10-K))

10.3(vi)       Health Management Systems, Inc. Profit Sharing Plan, as amended
               (Incorporated by reference to Exhibit 10.3(vi) to the 1995 Form
               10-K)

10.3(vii)      Health Management Systems, Inc. 1999 Long-Term Incentive Stock
               Plan (Incorporated by reference to Exhibit 4 to the Company's
               Registration Statement on Form S-8, File No. 333-77121)
</TABLE>



                                       55
<PAGE>   58
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER

<S>            <C>
 10.4(i)       Credit Agreement and Guaranty Among Health Management Systems,
               Inc., as Borrower, Accelerated Claims Processing, Inc., Quality
               Medi-Cal Adjudication, Incorporated, Health Care microsystems,
               Inc., and CDR Associates, Inc., as Guarantors, and The Chase
               Manhattan Bank, as Bank (Incorporated by reference to Exhibit
               10.1 to the Company's Quarterly Report on Form 10-Q for the
               quarter ended July 31, 1996 (the July 1996 Form 10-Q))

 10.4(ii)      First Amendment to Credit Agreement and Waiver (Incorporated by
               reference to Exhibit 10.1(i) to the July 1996 Form 10-Q)

 10.4(iii)     Guaranty Agreement, dated as of April 16, 1997, between Health
               Management Systems, Inc. and The Chase Manhattan Bank
               (Incorporated by reference to Exhibit 10.1 to the April 1997 Form
               10-Q)

 10.4(iv)      Second Amendment to Credit Agreement and Guaranty, dated as of
               April 16, 1997, among Health Management Systems, Inc.,
               Accelerated Claims Processing, Inc., Quality Medical
               Adjudication, Incorporated, Health Care microsystems, Inc., CDR
               Associates, Inc., and The Chase Manhattan Bank (Incorporated by
               reference to Exhibit 10.1 to the July 1997 Form 10-Q)

 10.4(v)       Third Amendment to Credit Agreement and Guaranty, dated as of
               June 30, 1997, among Health Management Systems, Inc., Accelerated
               Claims Processing, Inc., Quality Medical Adjudication,
               Incorporated, Health Care Microsystems, Inc., CDR Associate,
               Inc., HSA Managed Care Systems, Inc., Quality Standards in
               Medicine, Inc. and The Chase Manhattan Bank (Incorporated by
               reference to Exhibit 10.1 to the July 1997 Form 10-Q)

 10.4(vi)      Fourth Amendment To Credit Agreement And Guaranty, dated as of
               July 15, 1999 among Health Management Systems, Inc., Accelerated
               Claims Processing, Inc., Quality Medi-Cal Adjudication,
               Incorporated, Health Care Microsystems, Inc., CDR Associates
               Inc., HSA Managed Care Systems, Inc., Quality Standards In
               Medicine, Inc. and The Chase Manhattan Bank (Incorporated by
               reference to Exhibit 2 to the July 1999 Form 10-Q)

*10.4(vii)     Fifth Amendment To Credit Agreement And Guaranty, dated as of
               September 30, 1999, among Health Management Systems, Inc.,
               Accelerated Claims Processing, Inc., Quality Medi-Cal
               Adjudication, Incorporated, Health Care Microsystems, Inc., CDR
               Associates Inc., HSA Managed Care Systems, Inc., Health
               Receivables Management, Inc. and The Chase Manhattan Bank

*10.4(viii)    Sixth Amendment to Credit Agreement and Guaranty, dated as of
               December 30, 1999, among Health Management Systems, Inc.,
               Accelerated Claims Processing, Inc., Quality Medi-Cal
               Adjudication, Incorporated, Health Care Microsystems, Inc., CDR
               Associates Inc., HSA Managed Care Systems, Inc., Health
               Receivables Management, Inc. and The Chase Manhattan Bank

 10.5(i)       Leases, dated February 1, 1980, September 24, 1981, September 24,
               1982, and January 6, 1986, as amended, between 401 Park Avenue
               South Associates and Health Management Systems, Inc.
               (Incorporated by reference to Exhibit 10.13 to the Registration
               Statement and to Exhibit 10.5 to the Company's Quarterly Report
               on Form 10-Q for the quarter ended January 31, 1994)
</TABLE>



                                       56
<PAGE>   59
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER

<S>            <C>
 10.5(ii)      Lease, dated as of March 15, 1996, by and between 387 PAS
               Enterprises, as Landlord, and Health Management Systems, Inc., as
               Tenant (Incorporated by reference to Exhibit 10.2 to the July
               1996 Form 10-Q)

 10.6          Lease, dated September 1996, by and between Pacific Corporate
               Towers LLC, Health Management Systems, Inc., and Health Care
               microsystems, Inc. (Incorporated by reference to Exhibit 10.13 to
               the 1996 Form 10-K)

 10.7          Services Agreement, dated as of October 31, 1995, between Health
               Information Systems Corporation and Health Management Systems,
               Inc. (Incorporated by reference to Exhibit 10.19(iv) to the 1995
               Form 10-K)

 10.8          Agreement and Release of Claims dated as of October 29, 1996, by
               and among HHL Financial Services, Inc., Health Management
               Systems, Inc., and the First National Bank of Chicago
               (Incorporated by reference to Exhibit 10.12 to the 1996 Form
               10-K)

 10.9          Security Agreement, dated as of April 16, 1997, by and between
               Robert V. Nagelhout and Health Management Systems, Inc.
               (Incorporated by reference to Exhibit 10.3 to the April 1997 Form
               10-Q)

 10.10         Promissory note, dated as of April 16, 1997, by and between
               Robert V. Nagelhout and The Chase Manhattan Bank. (Incorporated
               by reference to Exhibit 10.4 to the April 1997 Form 10-Q)

 10.11         Sublease Agreement, dated December 23, 1997, between Health
               Management Systems, Inc. and Shandwick USA, Inc. (Incorporated by
               reference to Exhibit 10.1 to the company's Quarterly Report on
               Form 10-Q for the quarter ended January 31, 1998 (the January
               1998 Form 10-Q))

 10.12         Consent to Sublease, dated December 23, 1997, by 387 P.A.S.
               Enterprises to the subletting by Health Management Systems, Inc.
               to Shandwick USA, Inc. (Incorporated by reference to Exhibit 10.2
               to the January 1998 Form 10-Q)

 10.13         Promissory note, dated as of October 15, 1998, in the principal
               amount of $500,000 between Paul J. Kerz and HSA Managed Care
               Systems, Inc. (Incorporated by reference to Exhibit 10.16 to the
               Company's Annual Report on Form 10-K for the year ended October
               31, 1998 (the "1998 Form 10-K")

 10.14         Promissory note, dated as of October 15, 1998, in the principal
               amount of $250,000 between Paul J. Kerz and HSA Managed Care
               Systems, Inc. (Incorporated by reference to Exhibit 10.17 to the
               1998 Form 10-K)

 10.15         Security Agreement, dated as of October 15, 1998, between Paul J.
               Kerz and HSA Managed Care Systems, Inc. (Incorporated by
               reference to Exhibit 10.18 to the 1998 Form 10-K)

*10.16         Amended and restated promissory note, dated as of October 1999,
               in the principal amount of $500,000 between Paul J. Kerz and HSA
               Managed Care Systems, Inc.

*10.17         Amended and restated promissory note, dated as of October 1999,
               in the principal amount of $1,000,000 between Paul J. Kerz and
               HSA Managed Care Systems, Inc.
</TABLE>



                                       57
<PAGE>   60
                HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER

<S>            <C>
*11            Computation of Earnings per Share

*21            List of subsidiaries of Health Management Systems, Inc.

*23            Consent of KPMG LLP, independent certified public accountants

*27            Financial Data Schedule, which is submitted electronically to the
               Securities and Exchange Commission for informational purposes
               only
</TABLE>


* Filed herewith





                                       58