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 (FEE REQUIRED)

                   For the fiscal year ended December 31, 1996

                                       OR

        [ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

                For the transition period from _______ to _______

                         Commission file number 0-25378

                                   HCIA Inc.
             (Exact name of registrant as specified in its charter)


           Maryland                                      52-1407998
(State or other jurisdiction of
incorporation or organization)              (I.R.S. employer identification no.)

300 East Lombard Street, Baltimore, MD                      21202
(Address of Principal executive offices)                  (Zip Code)

Registrant's telephone number, including area code (410) 895-7470

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:



                          Common Stock, $.01 par value
                                (Title of class)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.   Yes  X     No
                                                ---       ---

<PAGE>

         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. [ ]

         The aggregate market value of the Common Stock, $.01 par value, held by
non-affiliates  of the registrant based on the closing sales price of the Common
Stock as quoted on the National Association of Securities Dealers, Inc. National
Market System as of February 28, 1997 was $396,075,220.

         The number of shares of the registrant's  Common Stock, $.01 par value,
outstanding as of February 28, 1997 was 11,833,656.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions  of the  registrant's  Proxy  Statement  for the  1997  Annual
Meeting of Stockholders are incorporated by reference into Part III.

                                      -2-

<PAGE>

                                     PART I

Item 1.           Business.

Background

                  HCIA  Inc.  ("HCIA"  or the  "Company")  was  incorporated  in
Maryland in 1985.  In 1988,  all of the then  outstanding  capital  stock of the
Company  was  acquired by  Citicorp  Financial  Guaranty  Holdings,  Inc.  which
subsequently transferred the stock to AMBAC Inc. ("AMBAC").  AMBAC is a publicly
held holding company that through its affiliates  provides  financial  guarantee
insurance and financial  services to both public and private clients.  From 1988
until HCIA's initial public  offering,  AMBAC  provided  additional  capital and
financing  for  the  growth  of  the  Company.  In  March  1992,  HCIA  acquired
substantially  all of the  assets  of the  Information  Strategies  division  of
McGraw-Hill,  Inc. and certain assets of the commercial products division of the
SysteMetrics subsidiary of McGraw-Hill, Inc. (collectively, "MHI"). The business
of MHI  acquired by the  Company had revenue for the fiscal year ended  December
31, 1991 of approximately $4.8 million.  In April 1992, the Company acquired all
of the  outstanding  capital  stock  of  Healthcare  Knowledge  Resources,  Inc.
("HKR"),  a health care  information  company  with  revenue for the fiscal year
ended June 30, 1991 of  approximately  $12.2  million.  The  acquisition  of HKR
provided the Company with a perpetual and exclusive  license (subject to certain
conditions) to the International Classification of Clinical Services System (the
"ICCS System"), a proprietary  classification  system for tracking and measuring
the use of medical  resources,  and the database  developed by the Commission on
Professional  and  Hospital  Activities  ("CPHA").   See  "--  Decision  Support
Systems."  During the first quarter of 1995,  HCIA  completed an initial  public
offering of  approximately  2.0 million  newly  issued  shares of Common  Stock.
Subsequent  to the  offering,  in April 1995,  the Company  acquired  all of the
outstanding  capital  stock of Datis  Corporation,  a  health  care  information
company  with  revenue  for  the  twelve  months  ended  December  31,  1994  of
approximately  $6.9 million.  In August 1995, HCIA sold 1.5 million newly issued
shares and AMBAC sold approximately 1.1 million shares of Common Stock at $28.50
per share in a combined public offering.

                  In December 1995, the Company acquired the assets constituting
the CHAMP unit of William M. Mercer,  Incorporated  ("CHAMP"),  which provides a
database  service for the analysis of health care costs to employers,  for $17.5
million  in  cash.  In  May  1996,  the  Company  acquired  Response  Healthcare
Information  Management,  Inc. ("Response"),  a patient-centered data collection
company,  for  approximately  $6.3 million in cash. In August 1996,  the Company
acquired LBA Health Care  Management,  Inc.  ("LBA"),  a health care information
company combining data collection,  benchmarking and decision support tools with
a clinical  implementation  management team, for  approximately  $128.8 million,
$100.1  million of which was paid in cash and $28.7 million of which was paid by
the delivery of Common Stock. In December 1996, the Company  acquired all of the
capital stock of  HealthChex,  Inc.  ("HealthChex"),  which  provides  physician
profiling and medical claims review systems to health care providers and payors,
for $11.5 million in cash. In addition to the acquisitions  described above, the
Company has also  acquired a number of smaller  companies  and  business  lines,
including several acquisitions in Europe. During 1996, the Company completed two
additional  public  offerings.  In May 1996,  AMBAC sold the remaining shares of
Common  Stock it held,  and the Company  sold an  additional  261,951  shares of
Common Stock,  at a per share price of $51.00.  In August 1996, the Company sold
approximately  2.0  million  shares of  Common  Stock,  at a per share  price of
$54.125, to repay bank indebtedness  incurred in connection with the acquisition
of LBA.

                                      -3-

<PAGE>

General

                  HCIA is a leading health care information content company that
develops and markets integrated clinical  information systems and products.  The
Company's  systems and  products  range from  standardized  databases  to highly
focused  decision  support  systems that assist its customers in evaluating  the
efficacy  and  economics  of health  care  delivery.  HCIA  currently  sells its
decision  support  systems  to more  than 470  customers,  including  hospitals,
integrated delivery systems,  self-insured employers,  pharmaceutical  companies
and managed care  organizations.  The Company's  syndicated products are sold to
over 7,000  customers.  During 1996,  revenue from the sale of decision  support
systems  represented  82% of revenue and  syndicated  products  represented  the
remaining 18% of revenue.  As a result of its unique ability to integrate health
care data collected from numerous sources and across varied treatment  settings,
the Company believes that it is well positioned to offer the information systems
and  products  necessary  to continue to increase  average  revenue per customer
through  the  sale of more  sophisticated  and  comprehensive  decision  support
systems.

                  By  utilizing  its  core   collection  of   proprietary   data
standardization  methodologies,   value-added  clinical  measurement  tools  and
databases,  including the ICCS  System(TM),  HCIA creates  clinical  information
systems and products  from its many large and disparate  data streams.  The ICCS
System(TM)  allows for the  standardization  and comparison of detailed clinical
data across a broad range of data  sources.  The Company's  proprietary  disease
management  methodologies link the costs,  quality,  utilization and outcomes of
medical  services  delivered  to patients in various  clinical  settings.  These
methodologies  and technical  resources permit the Company to provide a level of
clinical  information  which  is  substantially  more  detailed  and  useful  in
modifying  clinical practice patterns than information  derived from traditional
health care data sources.

Decision Support Systems

                  HCIA offers a range of  decision  support  systems,  which are
utilized  by  each  of  the  three  major  health  care  market  constituencies.
Providers, such as hospitals,  physician groups and integrated delivery systems,
use the Company's  decision  support systems to measure and analyze the cost and
quality of medical  interventions.  The Company's  entry-level  systems  provide
customers  with  competitor  specific   information  such  as  market  share  by
specialty,  local market  utilization  rates compared with regional and national
norms and  customer  specific  analyses  of  product  line and  physician  level
resource consumption.  High-end decision support systems incorporate  benchmarks
for specific  medical  resource  consumption  and are designed to help providers
understand the best practice for a medical intervention. Buyers, such as managed
care organizations,  indemnity insurers and self-insured employers,  utilize the
information and analyses on medical resource usage and outcomes derived from the
Company's  decision  support  systems to select and monitor the  performance  of
network  providers,   channel  specific  types  of  patients  towards  the  most
clinically  effective  providers,  and  negotiate  fair  prices and  appropriate
utilization  criteria,  as well as to  manage  the  overall  health  status of a
covered population. Suppliers, such as pharmaceutical, biotechnology and medical
supply and device companies,  utilize the Company's  decision support systems in
market   analysis,    product   positioning   and   pharmacoeconomic   analysis.
Pharmacoeconomic  analysis provides suppliers with information needed to measure
the specific  benefit/cost and outcome of an individual product against those of
competing  products,  alternative  therapies  or,  in the  case of a new drug or
product, the status quo therapy.

                                      -4-

<PAGE>

                  The Company's  entry-level  systems are generally  priced from
$25,000  annually,  while high-end systems are generally priced from $250,000 to
more  than  $1.0  million  annually.  HCIA has  also  entered  into a number  of
strategic relationships with state hospital associations, business partners such
as HBO & Company ("HBOC") and Cerner Corporation ("Cerner"),  and large users of
data such as Cigna Healthcare, Amgen Inc. and Columbia/HCA.

                  Most  of  HCIA's  decision  support  systems  are  based  on a
combination  of the  Company's  Databridge(TM)  collection of databases and data
handling technologies,  Solesource(TM) desktop analytical software, and clinical
implementation management team.

                  Databridge(TM).   Databridge(TM)  is  HCIA's   collection   of
proprietary databases and data-handling technologies. A typical decision support
system  customer  submits data in an electronic,  computer-readable  format.  In
creating the interface for the customer's data stream, HCIA enables the transfer
of customer data and the  subsequent  application  of the Company's  proprietary
software algorithms and data-standardization  technologies to the incoming data,
transforming   the  data   into   HCIA's   proprietary   standardized   formats.
Databridge(TM) has several components, including:

                  Database.  A large number of the Company's  customers are also
its data  suppliers.  Most of the Company's  decision  support system  contracts
provide  that as the Company  extracts  data from the  customer  (as part of the
process of  delivering  a system to the  customer),  the data become part of the
Company's database.  The Company supplements its database with data it purchases
or licenses from federal and state governments,  trade groups and other industry
sources.  The Company  maintains  more than a terabyte of live health care data,
including data from medical records,  laboratory,  pharmacy, imaging, outpatient
clinics,  physician's  offices,  insurance  claims,  managed care encounters and
point-of-care  member  patient  surveys.  The  Company's  database  resides in a
relational  database structure that utilizes a network of large Sun Microsystems
servers.  The Company believes that its current software and hardware  platforms
are scaleable and provide it with a cost and flexibility advantage.  The Company
has made a significant  investment in an open-network  architecture  which links
its several  geographical  locations and provides customers with leased-line and
dial-up  access.  The Company  supports  most of the major  relational  database
platforms.  The  Company  has  personnel  drawn from  several  key  health  care
disciplines (e.g.,  pharmacists,  clinical nurses and medical technologists) who
are responsible for the auditing,  editing and standardizing of its database, as
well as the upgrading and  maintaining  of its core  methodologies.  The Company
believes that its database  provides more  clinical  detail and better  outcomes
measurement  capabilities than competitive  systems.  Furthermore,  the detailed
medical   content  of  the  data  and  HCIA's   experience  in  collecting   and
standardizing this information provide additional  competitive  advantages.  The
acquisitions of the CHAMP and Response databases have significantly expanded the
Company's   outpatient  and  episode-of-care   capabilities.   As  a  result  of
acquisitions and its internal growth, the Company believes that it has built one
of the  largest  and most  sophisticated  collections  of  integrated  clinical,
financial and labor/productivity data in the health care industry.

                  ICCS  System(TM). The Company  holds a perpetual and exclusive
license to the ICCS System(TM),  subject only to the Company's obligation to use
all commercially reasonable efforts to maintain and upgrade the system. The ICCS
System(TM)  assigns a discrete and  clinically  detailed  12-digit code to every
product and service consumed in the treatment of patients.  The Company believes
that the ICCS System(TM) is the health care  industry's most widely  implemented
uniform  classification  system for  tracking and  measuring  the use of medical
resources (e.g.,  drugs,  devices,  laboratory  tests,  blood units,  diagnostic
imaging and clinical services) across health care providers. The ICCS System(TM)
allows  for the  standardization  and  comparison  of  detailed  clinical  data,
regardless of the original source of the data (e.g., medical records,  insurance
claims,  laboratory  or pharmacy  systems).  The ICCS  System(TM) is used

                                      -5-

<PAGE>

by the Company to create the most  clinically  detailed  portion of its
database.  The Company develops a set of proprietary software interfaces with
each customer who is a supplier of such data.  The interfaces are built by a
series of proprietary "data-mapping" applications that incorporate the ICCS
System(TM) and a series of algorithms  that  allow the  mapping  applications
to  "learn"  each time a new clinical  item is  encountered.  In  doing  so,
the  applications  are  able to automatically  standardize  more data each time
a new interface is created.  Set forth below is an  illustration of the
application of the ICCS System(TM) to the delivery of a common anti-infective
drug.

ICCS Code             ICCS Structure                           Example

4                     Service Type                             Pharmacy
41                    General Therapeutic Category             Anti-infective
412                   Specific Therapeutic Category            Cephalosporin
412020                Generic Drug Type                        Cefazolin
412020.2              Route of Administration                  Parenteral
412020.232            Dosage Form                              IV Piggy Back
412020.23279          Dosage Strength                          500
412020.232792         Dosage Unit                              Milligrams


                  SoleSource(TM).  SoleSource(TM) is the  Company's  workstation
that provides customers with access to and analyses of information obtained with
a decision support system.  SoleSource(TM) utilizes Microsoft Foundation Classes
Software and accesses a variety of database configurations,  including Microsoft
SQL  Server,  Microsoft  Access and  Informix.  As the Company has worked with a
variety of different  health care  organizations  during the last several  years
(e.g., hospitals,  managed care organizations and pharmaceutical  companies), it
has  developed  an  extensive  library  of  proprietary   health  care  database
applications.  In addition, as a result of its recent acquisitions,  the Company
has  expanded,   and  will  continue  to  expand,  the  scope  of  its  database
applications.  Depending  on the  customer,  the  size of the  database  and the
sophistication  of the decision  support system,  the Company  licenses  various
SoleSource(TM) applications to customers as part of a decision support system.

                  Clinical Improvement  Methodology and Management.  In addition
to  providing  databases  and  application  software,  the  Company,   utilizing
proprietary methodologies, assists customers with the implementation of clinical
solutions.  The Company's  knowledge-based  clinical  improvement  methodologies
allow HCIA to leverage its ICCS-level  information and enable clients to realize
improved  clinical  outcomes and lower costs through the modification of medical
and behavioral  practice patterns.  The Company's  methodologies link the costs,
quality,  utilization and outcomes of medical services  delivered to patients in
various  clinical  settings  and focus on  episodes  of  illness  that offer the
greatest  opportunity  for improving  outcomes and reducing  costs.  The Company
utilizes  database   analyses,   clinical   improvement   methodologies  and  an
implementation management team to assist customers in reducing clinical resource
consumption and improving outcomes in major specialties, including:

   o  invasive cardiovascular                o  vascular
   o  orthopaedics                           o  neurosciences
   o  oncology                               o  pulmonary
   o  medical cardiology                     o  women's services

                                      -6-

<PAGE>

Syndicated Products

                  Syndicated  products  include  publications  and  standardized
databases  which are  generally  priced  between  $100 to $2,000,  with  certain
products priced up to $25,000. The products are developed from specific portions
of  the  Company's  database,  and  feature  particular  industry  niches.  Most
syndicated  products  are  sold  as  annually  renewable   subscriptions  or  as
multi-year contracts. Syndicated products range from database directories (e.g.,
health  care   industry   professionals,   nursing   homes  and   managed   care
organizations)  to more complex analyses (e.g.,  cost and outcome  summaries for
each U.S. hospital).  HCIA also markets to managed care clients a number of more
sophisticated  syndicated  products  containing  national and regional normative
data on length of stay, costs and medical  necessity.  The Company markets these
products  directly to managed care  organizations,  and through  alliances  with
information systems vendors,  third-party administrators and other entities that
process data streams for managed care organizations and payors. These syndicated
products generally are used for utilization management,  claims adjudication and
actuarial forecasting and generally result in annual revenue of $100,000 or more
per customer.

Customers

                  The Company's  customers include numerous health care industry
participants  located  throughout the United  States,  United Kingdom and Spain,
including major provider and provider groups,  managed care  organizations,  and
pharmaceutical,  biotechnology and medical device companies.  As of December 31,
1996, the Company had more than 470 decision  support system  customers and more
than 7,000 syndicated  product  customers.  In 1995 and 1996, no single customer
accounted for 10% or more of the Company's revenue. HCIA's ten largest customers
accounted  for  approximately  36% and 28% of its revenue  during 1995 and 1996,
respectively.

Sales and Marketing

                  HCIA markets its  information  systems and products  through a
variety  of  means  that are  designed  to  enhance  its  name  recognition  and
facilitate  the  marketing  of  additional  systems and products to its customer
base. The Company's marketing personnel are organized into market focused units.
The Company utilizes a direct sales approach with the existing  customer base to
market its  decision  support  systems  and seeks to present  proposals  to both
existing and potential clients in face-to-face  meetings at the executive level.
The Company's field sales force is highly  specialized  and frequently  draws on
the Company's  clinical  implementation  management team. In addition,  HCIA has
entered into  agreements  with  companies  such as HBOC,  Cerner and  Transition
Systems,  whereby the Company's  systems are marketed  through their  respective
sales   forces.   The  Company  also   approaches   each  of  the  major  market
constituencies  through the sale of lower-priced  syndicated  products.  Many of
these products,  such as the 100 Top Hospitals study, are specifically  designed
to  increase  the  visibility  of the Company as an  industry-leading  source of
health care  information.  The Company uses both  telemarketing  and direct-mail
efforts  in the  sales  of  its  syndicated  products.  HCIA  continually  seeks
opportunities  to create name  recognition as a leading  provider of health care
information.  As part of this  strategy,  the  Company  is widely  quoted in the
media,  including  publications  such as The  Wall  Street  Journal  and  Modern
Healthcare,  and its senior  officers are frequently  asked to speak at industry
conferences  and serve on the  editorial  boards  of  industry  newsletters  and
publications.

                                      -7-

<PAGE>

Competition

                  The market for health care  information  products and services
is intensely  competitive.  The Company believes that the principal  competitive
factors in the health  care  information  market are the  breadth and quality of
system  and  product   offerings,   access  to  proprietary  data,   proprietary
methodologies and technical resources,  price and the effectiveness of marketing
and sales efforts.  In addition,  the Company believes that the speed with which
information  companies can  anticipate  and respond to the evolving  health care
industry  structure and identify  information needs is an important  competitive
factor.  The Company believes that it competes favorably with respect to each of
these factors. Competitors vary in size and in the scope and breadth of products
and  services  offered,  and the  Company  competes  for the sale of systems and
products and the resulting  access to data with  different  companies in each of
its target markets. Many of the Company's competitors have significantly greater
financial,  technical,  product development,  marketing and other resources than
the  Company.  Furthermore,  other major  information  companies  not  presently
offering  clinical  health care  information  services  may enter the markets in
which  the  Company  competes.   The  Company's  potential  competitors  include
specialty health care information companies,  health care information system and
software  vendors and large data processing and information  companies.  Many of
these competitors have substantial  installed  customer bases in the health care
industry and the ability to fund significant product development and acquisition
efforts.

Intellectual Property

                  HCIA  considers  its  methodologies,   computer  software  and
databases  to be  proprietary.  The  Company  seeks to protect  its  proprietary
information through confidentiality agreements with its employees. The Company's
policy is to have employees  enter into  confidentiality  agreements  containing
provisions  prohibiting  the  disclosure of  confidential  information to anyone
outside the Company,  requiring  employees to  acknowledge,  and, if  requested,
assist in  confirming  the Company's  ownership of any new ideas,  developments,
discoveries or inventions conceived during employment,  and requiring assignment
to the Company of  proprietary  rights to such  matters  that are related to the
Company's  business.  The Company also relies on a combination  of trade secret,
copyright  and  trademark  laws,   contractual  provisions  in  agreements  with
customers and technical measures to protect its rights in various methodologies,
systems  and  products  and  databases.  The  Company  has only filed one patent
application,  and no copyright registration applications,  covering its software
technology. Due to the nature of its software applications, the Company believes
that  patent,   trade  secret  and  copyright   protection  are  generally  less
significant than the Company's  ability to further  develop,  enhance and modify
its current systems and products.

Government Regulation

                  The FDA has  promulgated a draft policy for the  regulation of
certain  computer  products as medical  devices.  Although it is not possible to
anticipate the final form of the FDA's policy with regard to computer  software,
the Company expects that, whether or not the draft policy is finalized,  the FDA
is likely to become  increasingly active in regulating computer software that is
intended for use in health care  settings.  The  Company's  products and product
development activities,  therefore, could become subject to extensive regulation
by the FDA. The FDA regulates the introduction of new medical devices as well as
activities such as manufacturing,  labeling and recordkeeping for such products.
To the extent that computer  software is a medical device under FDA  regulations
or policy,  the Company would be required,  depending on the product,  to comply
with regulations, to (i) register and list the product with

                                      -8-

<PAGE>

the FDA, (ii) notify the FDA and demonstrate  substantial equivalence to other
products on the market before  marketing  such  products or (iii) obtain FDA
approval by  demonstrating safety and effectiveness before marketing a product.
In addition,  such products would be subject to the FDA's general controls,
including those relating to good manufacturing practices and adverse experience
reporting.

         The process of obtaining  clearance from the FDA can be costly and time
consuming, and there can be no assurance that, if required, such clearance would
be granted for the  Company's  existing  and future  systems  and  products on a
timely basis,  if at all, or that FDA review will not include  delays that would
adversely affect the Company's  ability to market new systems and products or to
expand permitted uses of existing systems and products. The FDA could also limit
or prevent the manufacture or distribution of the Company's systems and products
and has the power to  require  the  recall of such  systems  and  products.  FDA
regulations depend heavily on administrative and scientific interpretation,  and
there can be no assurance that future  interpretations  made by the FDA or other
regulatory bodies, with possible prospective and retroactive  effects,  will not
adversely affect the Company.

         The  confidentiality  of patient  records and the  circumstances  under
which  records may be released  for  inclusion  in the  Company's  databases  is
subject to  substantial  regulation by state  governments.  These state laws and
regulations  govern both the disclosure and use of confidential  patient medical
record  information.  Although  compliance  with these laws and  regulations  is
principally the  responsibility of the hospital,  physician or other health care
provider  supplying the data to the Company,  the Company's  databases have been
designed to enable  health  care  providers  to comply with the  confidentiality
requirements of state law. The Company believes that its procedures  comply with
the  laws  and   regulations   regarding  the  collection  of  patient  data  in
substantially all jurisdictions.  However,  additional legislation governing the
dissemination of medical record  information has been proposed at both the state
and federal level.  This  legislation may require holders of such information to
implement  security  procedures  that may  result  in  substantial  costs to the
Company.  There can be no  assurance  that changes to state or federal laws will
not  materially  restrict  the  ability  of  health  care  providers  to  submit
information from patient records to the Company.

Employees

         As of December 31, 1996, the Company had 820  employees,  including 100
in sales and  marketing,  408 in health care data,  178 in technology and 134 in
finance and administration. None of the Company's employees are represented by a
union  or  other   collective   bargaining   group.  The  Company  believes  its
relationships with its employees to be satisfactory.

Risk Factors; Forward-Looking Statements

CERTAIN  STATEMENTS  CONTAINED HEREIN REGARDING  MATTERS THAT ARE NOT HISTORICAL
FACTS ARE FORWARD-LOOKING  STATEMENTS (AS SUCH TERM IS DEFINED IN THE SECURITIES
ACT OF 1933,  AS AMENDED (THE  "SECURITIES  ACT"),  AND BECAUSE SUCH  STATEMENTS
INVOLVE RISKS AND UNCERTAINTIES, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
EXPRESSED  OR IMPLIED BY SUCH  FORWARD-LOOKING  STATEMENTS.  FACTORS  THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED BELOW.

                  Acquisitions.  The Company  has, in large part,  expanded  its
systems  and  products  through  the  acquisition  of  health  care  information
companies, product lines and data resources. The Company intends to continue the
acquisition  of  methodological,  analytical  and technical  resources that will
further enhance and expand the Company's systems and products.

                                      -9-

<PAGE>

                  Acquisitions involve numerous risks, including difficulties in
the   assimilation   of  operations   and   products,   the  ability  to  manage
geographically remote units, the diversion of management's  attention from other
business  concerns,  the risks of  entering  markets  in which the  Company  has
limited or no direct  expertise and the  potential  loss of key employees of the
acquired  companies.  In addition,  acquisitions  may involve the expenditure of
significant funds and the incurrence of significant  charges associated with the
amortization  of goodwill or other  intangible  assets,  write-offs  of acquired
in-process  research and  development  costs and/or  future  write-downs  of the
recorded  values  of  assets  acquired.  There  can  be no  assurance  that  any
acquisition will result in long-term  benefits to the Company or that management
will be able to manage effectively the resulting business.

                  Management of Growth. The Company is currently  experiencing a
period of rapid growth and expansion  which could place a significant  strain on
the Company's  personnel and resources.  The Company's growth has resulted in an
increase in the level of  responsibility  for both  existing and new  management
personnel.  Many of the Company's  management  personnel  have had limited or no
experience in managing companies as large as the Company. The Company has sought
to manage  its  current  and  anticipated  growth  through  the  recruitment  of
additional management and technical personnel and the implementation of internal
systems and controls.  However,  the failure to manage growth  effectively could
materially and adversely affect the Company's operating results.

                  Dependence  on  Key  Personnel.   The  Company  depends  to  a
significant  extent on key management,  technical and marketing  personnel.  The
Company's  growth and future success will depend in large part on its ability to
attract,  motivate and retain highly qualified  personnel,  including management
personnel of acquired companies. Except for an agreement with George D. Pillari,
its Chairman of the Board,  President and Chief Executive  Officer,  the Company
does not have employment agreements with any of its executive officers. The loss
of key personnel or the inability to hire or retain  qualified  personnel  could
have a material adverse effect on the Company.

                  Variations in Quarterly  Results.  The Company has experienced
and expects to continue to experience  variations in quarterly  results.  Recent
quarterly variations are primarily due to the effect of one-time charges related
to acquired in-process research and development costs and the timing of contract
executions.  Quarterly  results are also  influenced by the timing of release of
certain  systems  and  products  as a result of the  annual  release  of certain
external  data  sources.  The  Company's  operating  results for any  particular
quarterly or annual period may not be indicative of results for future periods.

                  Dependence on Intellectual  Property  Rights.  The Company has
made  significant  investments in the  development  and  maintenance of its core
collection  of  proprietary  data  standardization  methodologies,   value-added
clinical  measurement  tools and technical  resources that are used to transform
its many large and disparate data streams into clinically  relevant  information
products.  The Company relies largely on its license  agreements  with customers
and  its  own  security   systems,   confidentiality   procedures  and  employee
nondisclosure  agreements  to  maintain  the trade  secrecy  of its  proprietary
information.   There  can  be  no  assurance  that  the  legal  protections  and
precautions taken by the Company will be adequate to prevent misappropriation of
the Company's  proprietary  information.  In addition,  these protections do not
prevent  independent  third-party  development  of  functionally  equivalent  or
superior systems, products or methodologies.

                  Competition.  The health care information  market is intensely
competitive and rapidly  changing.  The Company competes for the sale of systems
and products and the resulting  access to data with different  companies in each
of its target markets.  Competitors vary in size and in the scope and breadth of
the  products and  services  offered.  Many of the  Company's  competitors  have
significantly

                                      -10-

<PAGE>

greater financial,  technical,  product development and marketing resources than
the Company.  There can be no assurance that future  competition, or any
significant loss of access to data resulting  therefrom,  will not have a
material adverse effect on the Company.

                  Major  Customers.  During  1995 and 1996,  the  Company's  ten
largest customers accounted for approximately 36% and 28%, respectively,  of the
Company's  revenue.  Many of the  Company's  contractual  arrangements  with its
customers  are  subject  to  annual  renewal.  The  loss  of one or  more of the
Company's largest customers could have a material adverse effect on the Company.

                  Integrity  and  Reliability  of Data.  The  Company's  success
depends  significantly on the integrity of its data.  Although the Company tests
data for completeness and consistency, it does not conduct independent audits of
the information provided by its customers.  Moreover, while the Company believes
that the  benchmarking  and other  clinical,  cost and  performance  information
contained  in its  database  is  representative  of the  operational  aspects of
various  types of health care industry  participants,  there can be no assurance
that such  information is appropriate for  comparative  analysis in all cases or
that the databases  accurately  reflect general or specific trends in the health
care  market.  If the  information  contained  in the data were  found,  or were
perceived, to be inaccurate,  or if such information were generally perceived to
be unreliable,  the Company's business and operating results could be materially
and adversely affected.

                  Potential Cost of Performance  Guarantees.  As part of certain
of its decision  support  systems,  the Company  guarantees that a customer will
achieve or identify a certain  level of cost  savings at least equal to the fees
the  customer  pays for the  system.  To the extent  such cost  savings  are not
achieved,  the  Company  may be  subject to claims  related to such  guarantees.
Although the Company has never  incurred a claim under these  guarantees,  there
can be no assurance that this will continue to be the case.  Liabilities related
to such claims could have a material  adverse  effect on the Company's  business
and operating results.

                  Volatility of Stock Price.  The stock market  historically has
experienced volatility which has affected the market price of securities of many
companies and which has sometimes been unrelated to the operating performance of
such  companies.  The  trading  price of the  Common  Stock  may be  subject  to
significant fluctuations in response to general market conditions and to factors
specific to the Company,  such as variations in quarterly results of operations,
announcements  of  acquisitions,  new  systems or products by the Company or its
competitors, governmental regulatory action, other developments or disputes with
respect to proprietary rights, general trends in the industry and overall market
conditions, and other factors.

                  Changes in the Health Care Industry.  The health care industry
is subject to changing  political,  economic and regulatory  influences that may
affect  the  procurement   practices  and  operation  of  health  care  industry
participants  generally.  During the past several  years,  the U.S.  health care
industry has been subject to an increase in  governmental  regulation  of, among
other things,  reimbursement  rates and certain  capital  expenditures.  Various
programs have been proposed to reform the U.S. health care system. Many of these
programs contain proposals to increase governmental  involvement in health care,
lower reimbursement rates and otherwise change the operating environment for the
Company's  customers.  Health  care  industry  participants  may  react to these
proposals  and the  uncertainty  surrounding  such  proposals by  curtailing  or
deferring  investments,  including those for the Company's systems and products.
The Company cannot  predict what impact,  if any, such factors might have on its
business,  financial  condition  and results of  operations.  In addition,  many
health care  providers are  consolidating  to create larger health care delivery
enterprises  with greater  regional  market  power.  As a

                                      -11-

<PAGE>

result,  the remaining enterprises could have greater bargaining power, which
may lead to price erosion of the Company's systems and products.

                  Government  Regulation.  The U.S. Food and Drug Administration
(the "FDA") has promulgated a draft policy  addressing the regulation of certain
computer  products as medical devices under the Federal Food, Drug, and Cosmetic
Act.  The FDA could  determine in the future that  certain  applications  of the
Company's  systems and  products  are  clinical  decision  tools  subject to FDA
regulation as medical devices. In addition,  the Company could become subject to
future regulation of the manufacture and marketing of medical devices and health
care software  systems,  or to  legislation  or regulation  regarding the use of
patient  records  or of  access  to  health  care  data.  Compliance  with  such
legislation  and regulation  could be burdensome,  time consuming and expensive.
The  Company  cannot  predict  the effect of  possible  future  legislation  and
regulation.

WHEN USED IN THIS FORM 10-K, IN ANY FUTURE  FILINGS BY HCIA WITH THE  SECURITIES
AND EXCHANGE COMMISSION,  IN THE COMPANY'S PRESS RELEASES AND IN ORAL STATEMENTS
MADE WITH THE APPROVAL OF AN AUTHORIZED  EXECUTIVE OFFICER, THE WORDS OR PHRASES
"WILL LIKELY  RESULT,"  "ARE EXPECTED TO," "WILL  CONTINUE,"  "IS  ANTICIPATED,"
"ESTIMATE,"   "PROJECTED"  OR  SIMILAR  EXPRESSIONS  ARE  INTENDED  TO  IDENTIFY
"FORWARD-LOOKING  STATEMENTS"  WITHIN THE MEANING OF THE  SECURITIES  ACT.  SUCH
STATEMENTS  ARE  SUBJECT TO CERTAIN  RISKS AND  UNCERTAINTIES  THAT COULD  CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM HISTORICAL EARNINGS AND THOSE PRESENTLY
ANTICIPATED  OR  PROJECTED.  HCIA  WISHES TO CAUTION  READERS NOT TO PLACE UNDUE
RELIANCE ON ANY SUCH FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE
MADE.  HCIA  UNDERTAKES  NO OBLIGATION  TO PUBLICLY  UPDATE ANY  FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.

Item 2.           Properties.

                  The  Company's  executive  offices are  located in  Baltimore,
Maryland,  in approximately  65,000 square feet of leased office space,  under a
lease that  expires on December 31,  2002,  and which  includes an option for an
additional  term of up to five  years.  The Company  also  leases  approximately
46,500  square feet of office  space in Ann Arbor,  Michigan,  under leases that
expire on March 31,  2000,  and 42,000  square  feet of office  space in Denver,
Colorado,  under a lease that  expires  on August 31,  2001.  The  Company  also
maintains offices in Fairport,  New York,  Waltham,  Massachusetts,  Louisville,
Kentucky,  Concord,  California,  Olympia,  Washington,  East  Greenwich,  Rhode
Island,  Windsor,  Connecticut,   Deerfield,  Illinois,  Alcester,  England  and
Barcelona,  Spain. The Company believes that its facilities are adequate for its
current operations.

Item 3.           Legal Proceedings.

                  The  Company  is a  defendant  from  time to time in  lawsuits
incidental to its business. The Company is not currently a party to, and none of
its properties is subject to, any material legal proceedings.

Item 4.           Submission of Matters to a Vote of Security Holders.

                  Not applicable.

                                      -12-

<PAGE>


Item 4A. Executive Officers of the Company.

                  Executive  officers  are  elected  annually  by the  Board  of
Directors and serve at the  discretion  of the Board of  Directors.  Information
regarding  the  executive  officers of the Company who are not  directors  is as
follows:

       Name             Age                     Position
       ----             ---                     --------

Sachi J. Morishige       30      Senior Vice President-Corporate Development

Barry C. Offutt          35      Senior Vice President and Chief Financial
                                      Officer

Jean Chenoweth           50      Senior Vice President-Industry Relations

Charles A. Berardesco    38      Senior Vice President, General Counsel and
                                      Secretary

Donald S. Good, Jr.      34      Senior Vice President-Commercial Markets

EJay Lockwood            34      Senior Vice President-Managed Care Markets

Kevin J. Hicks           37      Senior Vice President-Provider Markets

                  Ms.  Morishige  has been  employed by the  Company in  various
capacities  since  its  founding in 1985,  and currently  serves as Senior  Vice
President-Corporate Development.

                  Mr.  Offutt served as a Vice  President  from April 1992 until
September 1995, when he was appointed a Senior Vice President, and has served as
Chief Financial  Officer since October 1992. He is a certified public accountant
and was  employed by Arthur  Andersen & Co. in various  capacities  from 1984 to
March 1992.

                  Ms.  Chenoweth  served as Vice President - Industry  Relations
from April 1992 until her  appointment  as Senior Vice  President  in  September
1995. She served in various senior management  positions,  including  President,
with HKR and its predecessor from 1989 through April 1992.

                  Mr. Berardesco  served as Vice President,  General Counsel and
Secretary  from May 1996 until  September  1996,  when he was appointed a Senior
Vice  President.  Prior  to May  1996,  he was a  partner  with  the law firm of
Whiteford, Taylor & Preston L.L.P., counsel to the Company.

                  Mr.  Good  served  as a Vice  President  from May  1996  until
September 1996, when he was appointed Senior Vice President-Commercial  Markets.
Prior to May 1996, he was a healthcare consultant with Arthur Andersen & Co.

                  Mr.  Lockwood has been  employed by the Company  since January
1996, having served as Vice  President-Commercial  Markets until his appointment
as a Senior Vice  President  in February  1996.  Prior to January  1996,  he was
employed by CIGNA Healthcare in various capacities.

                                      -13-

<PAGE>

                  Mr.  Hicks  has  served  as  Senior  Vice   President-Provider
Markets, since joining the Company in August 1996. Prior to that time, he served
in various senior management positions,  including chief executive officer, with
LBA.

                                      -14-

<PAGE>

                                     PART II

Item 5.           Market for the Company's Common Equity and Related Stockholder
                  Matters.

                  The  Company's  Common Stock has been  publicly  traded on the
NASDAQ  National  Market System since February 22, 1995 under the symbol "HCIA."
The following table sets forth, for the quarterly period indicated, the high and
low closing sale price per share of Common Stock as reported by NASDAQ:

                           1995                             1996
                      High        Low                High          Low
                    -------------------            ----------------------
First Quarter       $25         $17-5/8            $55-3/4       $41-7/8
Second Quarter       31-5/8      21                 67-7/8        45-5/8
Third Quarter        31-1/4      24-1/2             67-3/8        50-1/16
Fourth Quarter       46-3/4      22-3/4             36-1/8        23-1/4

                  As of February  28,  1997,  there were 72 holders of record of
the Company's Common Stock.  The number of record holders is not  representative
of the number of beneficial  holders since many shares are held by depositories,
brokers or other nominees.

Dividends

                  The  Company has never paid any cash  dividends  on its Common
Stock and does not anticipate  paying any cash dividends on the Common Stock for
the foreseeable future. The Company currently intends to retain future earnings,
if any, to fund the development and growth of its business.

Sales of Unregistered Securities

                  In connection  with the acquisition of LBA, the Company issued
a total of  492,961  shares of Common  Stock to the then  stockholders  of LBA's
parent company.  The foregoing issuances were exempt from registration  pursuant
to Section 4(2) of the Securities Act as they did not involve a public offering.
In issuing the shares,  the Company  relied upon the status of the  stockholders
(or their  representatives)  as officers or  directors  of LBA and that each had
such  knowledge  and  experience  in financial  and  business  matters that such
stockholder  was capable of evaluating  the merits and risks of an investment in
the Company's Common Stock.

Item 6.           Selected Financial Data.

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31,
                                                                      1992        1993          1994      1995(1)       1996(1)
                                                                    -------      -------      -------     --------     --------
                                                                                  (in thousands, except per share data)
<S><C>
STATEMENTS OF OPERATIONS DATA:
  Revenue                                                           $19,470      $28,111      $30,711     $ 48,015     $ 73,520
  Salaries, wages and benefits                                        9,431       14,168       15,457       21,932       32,688
  Other operating expenses                                            7,499        8,611        8,625       12,055       17,058
  Depreciation and amortization                                       3,204        4,595        4,826        6,864       12,670
  Write-off of acquired in-process research and development costs        --           --           --       12,152       48,065
                                                                    -------      -------      -------     --------     --------
      Operating income (loss)                                          (664)         737        1,803       (4,988)     (36,961)
  Interest income                                                        --           --          111        1,290        1,110
  Interest expense                                                      625          111          131          187          530
                                                                    -------      -------      -------     --------     --------
      Income (loss) before income taxes, minority interest in
      loss (income) of consolidated subsidiaries and cumulative
      effect of change in accounting for income taxes                (1,289)         626        1,783       (3,885)     (36,381)
  Provision (benefit) for income taxes                                 (330)         362          759       (1,554)       5,886
  Minority interest in loss (income) of consolidated subsidiaries       (45)          90           (3)         (74)          --
                                                                    -------      -------      -------     --------     --------
      Income (loss) before cumulative effect of change in
      accounting for income taxes                                    (1,004)         354        1,021       (2,405)     (42,267)
  Cumulative effect of change in accounting for income taxes             --         (142)          --           --           --
                                                                    -------      -------      -------     --------     --------
      Net income (loss)                                             $(1,004)     $   212      $ 1,021     $ (2,405)     (42,267)
                                                                    =======      =======      =======     ========     ========
  Net income (loss) per share                                                                 $  0.19     $  (0.31)    $  (4.19)

  Shares used in per share calculation                                                          5,518        7,733       10,096
                                                                    =======      =======      =======     ========     ========

BALANCE SHEET DATA:
  Working capital                                                   $   454      $ 3,852      $ 5,620     $ 35,671     $ 36,996
  Total assets                                                       37,643       41,122       40,865      108,401      223,196
  Long-term liabilities, excluding current installments               1,298        2,136        1,835          699        2,305
  Stockholders' equity                                               28,907       32,762       34,371       98,044      202,407
</TABLE>

(1) In connection with various acquisitions, the Company has recorded charges
related to acquired in-process research and development costs. Exclusive of such
charges and related income tax effects, net income per share would have been
$0.60 and $0.68 for 1995 and 1996, respectively.


<PAGE>

Item 7.           Management's  Discussion  and Analysis of Financial  Condition
                  and Results of Operations.

OVERVIEW

HCIA Inc. ("HCIA" or the "Company") is a health care information content company
that develops and markets integrated clinical  information systems and products.
The Company's systems and products range from  standardized  databases to highly
focused  decision  support  systems that assist its customers in evaluating  the
efficacy and economics of health care delivery.  The Company's customers include
hospitals,  integrated delivery systems, self-insured employers,  pharmaceutical
companies  and  managed  care  organizations.  In 1991,  HCIA  began a series of
acquisitions  of  health  care  information  companies,  product  lines and data
resources.  In connection  with certain of these  acquisitions,  the Company has
recorded   one-time  charges  related  to  acquired   in-process   research  and
development  costs. Such charges totaled  approximately  $12.2 million and $48.1
million during 1995 and 1996,  respectively.  As a result of these charges,  the
Company  recorded net losses for each of these years.  The Company has accounted
for all of its  acquisitions  using  the  purchase  method  of  accounting  and,
accordingly, has included the results of the acquired entities since the date of
acquisition. See Note 1 of the Notes to Consolidated Financial Statements.

The Company has made a substantial investment in the acquisition and development
of  its  core  collection  of  methodologies,  clinical  measurement  tools  and
technical  resources.  The  Company's  strategy is to leverage  these  resources
across  substantially  all of its systems and  products,  thereby  giving it the
ability  to  increase   revenue   generated  from  these  resources   without  a
commensurate   increase  in  expenses.  In  addition  to  its  internal  product
development  efforts,  the Company  seeks to continue the  acquisition  of other
health care information companies, product lines and data resources, and intends
to integrate and leverage these assets into  product-line  extensions across its
markets.  The Company does not track profitability by product line since many of
the Company's resources are utilized throughout its systems and products.

The Company's internal product  development  efforts are generally in connection
with  customer  contracts,  and the related costs are included as a component of
operating expenses in the year incurred.  The Company  capitalizes costs related
to  internal  product  development  which is not in  connection  with a specific
customer  contract from the point of  technological  feasibility to the point of
general availability.

As a result of its  acquisitions of health care information  companies,  product
lines and data resources,  the Company has acquired  intangible assets, the cost
of which it amortizes  over various useful lives.  In addition,  the Company has
capitalized  internal  development  costs and  acquired  assets  relating to the
development  of   methodologies,   clinical   measurement  tools  and  technical
resources,  including  its  database,  of $3.4  million,  $6.9 million and $14.4
million during 1994, 1995 and 1996, respectively.  Consequently, the Company has
recorded  amortization  expense of $3.9 million,  $5.2 million and $10.1 million
during 1994, 1995 and 1996, respectively.  See Notes 1, 2, and 4 of the Notes to
Consolidated Financial Statements.

As a result of its unique  ability to integrate  health care data collected from
numerous sources and across varied treatment settings, the Company believes that
it is well positioned to offer the information systems and products necessary to
continue  to increase  average  revenue  per  customer  through the sale of more
sophisticated   and  comprehensive   systems  and  products.   With  respect  to
entry-level systems and products,  pricing is relatively fixed and is influenced
by  competitive  systems and  products.  With  respect to  high-end  systems and
products, pricing is often negotiated with the customer and is based on a number
of factors, including the value attributed by the customer to the system.


                                       8

<PAGE>



The Company's  revenue is comprised of both recurring revenue from the Company's
installed  customer base as well as from first-time  sales. The Company seeks to
generate  recurring  revenue from decision  support systems  through  multi-year
agreements (typically two to three years) and through renewals of its syndicated
products,  which are updated annually. The Company defines its recurring revenue
percentage  as revenue  recognized  during the period from a sale of a system or
product to a customer  who  purchased  a similar  system or product in the prior
period,  divided  by the  Company's  total  revenue  in  the  prior  period.  In
determining  its  recurring  revenue  percentage,  the  Company  includes in its
revenue  the  revenue  of  entities  acquired  during  the  period  as  if  such
acquisitions had occurred at the beginning of the prior period. The Company does
not classify revenue as recurring to the extent that it exceeds the revenue from
a  similar  system  or  product  purchase  in the prior  period.  The  Company's
recurring revenue percentage was 69% and 66% in 1995 and 1996, respectively.


RESULTS OF OPERATIONS

The following table sets forth, for the fiscal periods indicated,  certain items
from the  statements of  operations of the Company  expressed as a percentage of
revenue:

<TABLE>
<CAPTION>
                                                                                  YEAR ENDED DECEMBER 31,
                                                                             1994          1995        1996
                                                                            -----         ------      ------
<S><C>
Revenue                                                                      100%          100%        100%
Salaries, wages and benefits                                                  50            46          45
Other operating expenses                                                      28            25          23
Depreciation and amortization                                                 16            14          17
Write-off of acquired in-process research and development costs               --            25          65
  Operating income (loss)                                                      6           (10)        (50)
Net interest income                                                           --             2           1
  Income (loss) before income taxes and minority interest in loss (income)
     of consolidated subsidiaries                                              6            (8)        (49)
Provision (benefit) for income taxes                                           3            (3)          8
Net income (loss)                                                              3%           (5)%       (57)%
</TABLE>

                                       9

<PAGE>


1996 Compared to 1995

Revenue

Revenue for 1996 was $73.5  million,  an  increase of $25.5  million or 53% over
1995. The increase was the result of increased sales of the Company's decision
support systems.  Revenue from the sales of decision support systems
represented 82% of revenue  for 1996 and  syndicated  products  represented  the
remaining  18% of revenue.

The  decision  support  systems  revenue  increase was  primarily  the result of
increased  sales to providers  and managed  care  customers,  particularly  as a
result of acquisitions, as well as increased penetration of the supplier market.

Salaries, Wages and Benefits

Salaries,  wages and benefits  decreased to 45% of revenue for 1996 from 46% for
1995.  This decrease was a result of the  continued  leveraging of the Company's
historical  investments  in  technology  and  basic  infrastructure  as  revenue
increased.

Other Operating Expenses

Other  operating  expenses,  which  include  occupancy,   travel  and  marketing
expenses,  decreased to 23% of revenue for 1996 from 25% for 1995. This decrease
was a result of certain of these expenses growing at a slower rate than revenue.

Depreciation and Amortization

Depreciation and amortization increased to 17% of revenue for 1996 from 14% for
1995. This increase was a result of the additional  amortization associated with
certain  acquisitions  and  capitalized  internal  development  costs as well as
depreciation of other acquired assets.

Write-Off of Acquired In-Process Research and Development Costs

In connection with four acquisitions completed during 1995 and 1996, the Company
acquired  ongoing  research and  development  activities.  The Company  recorded
one-time  charges totaling $12.2 million and $48.1 million during 1995 and 1996,
respectively,  resulting from the write-off of the acquired  in-process research
and  development  costs.  The amount of the  one-time  charges  was equal to the
estimated current fair value, based on the discounted  risk-adjusted cash flows,
of specifically identified technologies for which technological  feasibility had
not yet been established pursuant to Statement of Financial Accounting Standards
No. 86,  "Accounting  for the Costs of Computer  Software to be Sold,  Leased or
Otherwise  Marketed," ("SFAS No. 86") and for which future  alternative uses did
not exist.

Interest Income and Expense

Net interest  income was $580,000 for 1996 compared with net interest  income of
$1.1 million for 1995. The decrease was the result of higher interest expense in
1996 related to debt incurred in connection with certain acquisitions.

Income Taxes

The Company's effective tax rate was 16% for 1996 compared with (39)% for 1995.
The  change  was  primarily  the  result  of  non-deductible  goodwill  and  the
non-deductible  write-off  of the  in-process  research  and  development  costs
resulting from certain acquisitions during 1996.


                                       10

<PAGE>


1995 Compared to 1994

Revenue

Revenue for 1995 was $48.0  million,  an  increase of $17.3  million or 56% over
1994.  The increase was  primarily  the result of a 77% increase in revenue from
the sale of decision support systems.  Revenue from the sale of decision support
systems represented 80% of revenue for 1995 and Syndicated Products  represented
the remaining 20% of revenue.

The  decision  support  systems  revenue  increase was  primarily  the result of
increased  sales of decision  support  systems to providers,  particularly  as a
result of acquisitions during the year, and to a lesser extent, due to increased
sales  through  CHKS  Ltd.,  the  Company's  English  subsidiary.  Sales  of the
Company's  systems to the supplier  market also  increased.  In particular,  the
Company met several  performance  milestones pursuant to its contract with CIGNA
Healthcare during the year.

Salaries, Wages and Benefits

Salaries,  wages and benefits  decreased to 46% of revenue for 1995 from 50% for
1994.  This decrease was a result of the leveraging of the Company's  historical
investments in technology and basic infrastructure as revenue increased.

Other Operating Expenses

Other  operating  expenses,  which  include  occupancy,   travel  and  marketing
expenses,  decreased to 25% of revenue for 1995 from 28% for 1994. This decrease
was a result of certain of these expenses growing at a slower rate than revenue.

Depreciation and Amortization

Depreciation and amortization decreased to 14% of revenue for 1995 from 16% of
revenue for 1994.  The  decrease  was the result of the fixed  nature of a large
component of the  depreciation and  amortization,  which was the result of prior
acquisitions, being measured against a larger revenue base.

Write-Off of Acquired In-Process Research and Development Costs

In connection  with an  acquisition  during 1995, the Company  acquired  ongoing
research and development activities. At the time of the acquisition, the Company
recorded a one-time  $12.2 million  charge  resulting  from the write-off of the
acquired  in-process  research and development costs. The amount of the one-time
charge was equal to the estimated current fair value, based on the risk-adjusted
cash flows,  of specifically  identified  technologies  for which  technological
feasibility had not yet been  established  pursuant to SFAS No. 86 and for which
future alternative uses did not exist.

Interest Income and Expense

Net interest income was $1.1 million for 1995 compared with net interest expense
of $20,000 for 1994.  The  increase in net  interest  income was the result of a
portion of the proceeds of the  Company's  public  offerings  being  utilized to
repay the amount due under the  Company's  credit  agreement  with the Company's
former majority stockholder,  AMBAC Inc.  (approximately $1.9 million), with the
balance being invested in cash equivalents and short-term investments.

Income Taxes

The Company's effective income tax rate was (39)% for 1995 compared with 43% for
1994. The change was a result of the Company recording a net loss in 1995.


                                       11

<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

During 1995 and 1996,  the Company  completed  several  public  offerings of its
Common  Stock.  The  net  proceeds  to  the  Company  from  the  offerings  were
approximately $182.3 million.

In August 1996,  the Company  obtained  from First Union  National Bank of North
Carolina ("First Union") a credit facility totaling $100 million,  consisting of
a $50 million term loan and a $50 million revolving line of credit.  The Company
incurred a one-time  facility fee of $520,000.  The Company  borrowed the entire
$50 million term loan and  approximately  $36 million of the  revolving  line of
credit in connection  with the  acquisition of LBA Healthcare  Management,  Inc.
("LBA") and repaid  such  borrowings  with a portion of the net  proceeds to the
Company from a public offering of the Company's common stock.

The Company  currently  maintains the $50 million (subject to certain  borrowing
limitations) revolving line of credit for general corporate purposes,  including
future   acquisitions   and  working   capital   requirements.   Borrowings  are
collateralized  by  substantially  all of the Company's  assets.  The Company is
required to pay a  commitment  fee on the average  daily  unused  portion of the
facility  at a rate  ranging  from 0.25% to 0.375% per annum,  depending  on the
Company's debt/cash flow ratio.  Borrowings bear interest at varying rates based
on an index tied to First  Union's  prime rate or LIBOR  (6.25% at December  31,
1996). The credit facility also contains financial covenants applicable to HCIA,
including a debt/cash  flow ratio and ratios of debt to capital.  As of December
31, 1996, the Company was in compliance  with all such  financial  covenants and
had a maximum  borrowing  capacity of $50 million,  and there were no borrowings
outstanding under the facility.  The credit facility reduces to $37.5 million in
July 1999, $25 million in July 2000 and expires on July 31, 2001.

During 1994,  1995 and 1996, the Company  generated net cash from  operations of
approximately $4.4 million, $3.1 million and $11.4 million, respectively. During
1995 and 1996,  approximately  $7.1 million and $12.1 million of cash  generated
from  operations  was used to fund the  increase  in  accounts  receivable.  The
increases in accounts receivable were primarily the result of revenue growth, as
well as the timing of receipt of payments from certain major customers. Net cash
provided by financing  activities  during 1994, 1995 and 1996 was  approximately
$568,000, $66.2 million and $143.6 million, respectively,  primarily as a result
of the Company's  public offerings of its common stock. The net cash provided by
operations and financing activities has been utilized primarily for acquisitions
and capital expenditures.

The Company made capital  expenditures  (including  capitalized leases) totaling
$1.6  million,  $3.1  million  and $6.4  million  during  1994,  1995 and  1996,
respectively.  As of December 31, 1996,  the Company had net working  capital of
$37.0 million,  including cash, cash  equivalents and short-term  investments in
the  amount of $13.8  million,  and did not have any  material  commitments  for
capital expenditures.


                                       12


<PAGE>

In April 1995, the Company  completed the  acquisition of all of the outstanding
capital stock of Datis Corporation ("Datis"). The purchase price for the capital
stock  of  Datis  was  approximately  $14.6  million  in  cash,  which  included
approximately  $14.25 million funded by the Company and $386,000 funded with the
proceeds  received from the exercise of certain options to purchase Datis stock.
In addition,  the Company repaid  approximately  $900,000 of outstanding debt of
Datis.  In  December  1995,  the Company  acquired  the CHAMP unit of William M.
Mercer,  Incorporated  ("CHAMP") for $17.5 million in cash and, in May 1996, the
Company completed the acquisition of Response Healthcare Information Management,
Inc.  ("Response") for  approximately  $6.3 million in cash. In August 1996, the
Company acquired LBA for a total purchase price of approximately $128.8 million,
$100.1  million of which was paid in cash and $28.7 million of which was paid by
the  delivery  of HCIA  common  stock.  The  Company  utilized  $86  million  in
borrowings  under the First Union credit  facility  discussed  above to fund the
cash  portion of the  purchase  price,  which was  subsequently  repaid from the
proceeds of a public  offering of Common Stock.  In December  1996,  the Company
acquired HealthChex,  Inc. ("HealthChex") from Equifax Inc. for $11.5 million in
cash.  Each of these  acquisitions  has been  accounted  for using the  purchase
method of  accounting  and,  accordingly,  the assets  have been valued at their
estimated fair market value.

The Company  expects to incur  additional  costs of $6 to $9 million to complete
the development  efforts related to systems and products  obtained in connection
with the acquisitions of CHAMP, Response,  LBA and HealthChex,  and to integrate
these  products with the Company's  other  products.  Such costs are expected to
consist  of direct  labor and  contracted  labor  costs and are  expected  to be
incurred over the next two to three years.

                                       13

<PAGE>

Item 8.           Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT AUDITORS

THE BOARD OF DIRECTORS
HCIA INC.:

We have audited the  accompanying  consolidated  balance sheets of HCIA Inc. and
subsidiaries  as of  December  31, 1995 and 1996,  and the related  consolidated
statements of  operations,  changes in  stockholders'  equity and cash flows for
each of the years in the  three-year  period  ended  December  31,  1996.  These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We  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 HCIA Inc.  and
subsidiaries  as of  December  31,  1995  and  1996,  and the  results  of their
operations and their cash flows for each of the years in the  three-year  period
ended  December  31,  1996 in  conformity  with  generally  accepted  accounting
principles.

                                                           KPMG PEAT MARWICK LLP

Baltimore, Maryland
January 23, 1997


                                       14

<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(in thousands, except per share data)

HCIA INC. AND SUBSIDIARIES

<TABLE>
<CAPTION>

                                                                                           1994          1995          1996
                                                                                         -------       -------       --------
<S><C>
Revenue                                                                                  $30,711       $48,015       $ 73,520
Salaries, wages and benefits                                                              15,457        21,932         32,688
Other operating expenses                                                                   8,625        12,055         17,058
Depreciation                                                                                 957         1,619          2,567
Amortization                                                                               3,869         5,245         10,103
Write-off of acquired in-process research and development costs                               --        12,152         48,065
                                                                                         -------       -------       --------
  Operating income (loss)                                                                  1,803        (4,988)       (36,961)
Interest income                                                                              111         1,290          1,110
Interest expense                                                                             131           187            530
                                                                                         -------       -------       --------
  Income (loss) before income taxes and minority interest in income of consolidated
     subsidiaries                                                                          1,783        (3,885)       (36,381)
Provision (benefit) for income taxes                                                         759        (1,554)         5,886
Minority interest in income of consolidated subsidiaries                                      (3)          (74)            --
                                                                                         -------       -------       --------
  Net income (loss)                                                                      $ 1,021       $(2,405)      $(42,267)
                                                                                         =======       =======       ========
Net income (loss) per share                                                              $  0.19       $ (0.31)      $  (4.19)
                                                                                         =======       =======       ========
Shares used in per share calculation                                                       5,518         7,733         10,096
                                                                                         =======       =======       ========
</TABLE>

See accompanying notes to consolidated financial statements.


                                       15

<PAGE>


CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
(in thousands)

HCIA INC. AND SUBSIDIARIES


<TABLE>
<CAPTION>
                                                                                                         1995               1996
                                                                                                       --------           --------
<S><C>
ASSETS
Current assets:
  Cash and cash equivalents                                                                            $  3,190           $ 13,302
  Short-term investments                                                                                 23,280                510
  Trade accounts receivable, net of allowance for doubtful accounts
     of $454 in 1995 and $1,042 in 1996                                                                  16,623             32,122
  Prepaid expenses and other current assets                                                               2,236              3,886
  Income tax receivable                                                                                      --                339
  Deferred compensation funds held in trust                                                                  --              5,321
                                                                                                       --------           --------
            Total current assets                                                                         45,329             55,480
Furniture and equipment, net                                                                              6,576             12,188
Computer software costs, net                                                                             11,012             20,425
Other intangible assets, net                                                                             42,338            115,601
Net deferred tax asset                                                                                    3,090             17,074
Other                                                                                                        56                123
Deferred compensation funds held in trust                                                                    --              2,305
                                                                                                       --------           --------
            Total assets                                                                               $108,401           $223,196
                                                                                                       ========           ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                                                                     $    732           $  1,315
  Accrued salaries, benefits and other liabilities                                                        4,222              7,957
  Capital lease obligations                                                                                 174                121
  Notes payable                                                                                           2,265              1,718
  Income taxes payable                                                                                    1,098                 --
  Deferred revenue                                                                                        1,167              2,052
  Acquired deferred compensation liability                                                                   --              5,321
                                                                                                       --------           --------
            Total current liabilities                                                                     9,658             18,484
Notes payable                                                                                               699                 --
Acquired deferred compensation liability                                                                     --              2,305
                                                                                                       --------           --------
            Total liabilities                                                                            10,357             20,789
                                                                                                       --------           --------
Stockholders' equity:
  Preferred stock--$0.01 par value; authorized 500,000 shares; no shares issued and outstanding              --                 --
  Common stock--$0.01 par value; authorized 50,000,000 shares; issued and
   outstanding 8,955,932 as of December 31, 1995 and 11,781,458 as of December 31, 1996                      90                118
  Additional paid-in capital                                                                            102,882            249,591
  Accumulated deficit                                                                                    (4,953)           (47,220)
  Cumulative unrealized appreciation of short-term investments                                               44                  4
  Cumulative effect of currency translation adjustment                                                      (19)               (86)
                                                                                                       --------           --------
            Total stockholders' equity                                                                   98,044            202,407
                                                                                                       --------           --------
 Total liabilities and stockholders' equity                                                            $108,401           $223,196
                                                                                                       ========           ========
</TABLE>

See accompanying notes to consolidated financial statements.


                                       16

<PAGE>

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(in thousands)

HCIA INC. AND SUBSIDIARIES


<TABLE>
<CAPTION>
                                                                                                                     Cumulative
                                                                                                                     Unrealized
                                                                                                                    Appreciation/
                                 Preferred   Preferred  Preferred    Total             Additional                  (Depreciation)
                                   Stock       Stock      Stock    Preferred  Common    Paid-In     Accumulated    of Short-Term
                                 Series A    Series B   Series C     Stock     Stock    Capital       Deficit       Investments
                                 ---------   ---------  ---------  ---------  ------   ----------   -----------    --------------
<S><C>
BALANCE AT
  DECEMBER 31, 1993              $ 10,662    $ 5,500    $ 6,400    $ 22,562    $ 30    $ 11,319     $ (1,155)             --
Capital contributions                  --         --         --          --      --         605           --              --
Conversion of preferred stock     (10,662)    (5,500)    (6,400)    (22,562)     24      24,952       (2,414)             --
Net income                             --         --         --          --      --          --        1,021              --
Effect of currency
  translation adjustment               --         --         --          --      --          --           --              --
                                 --------    -------    -------    --------    ----    --------     --------            ----
BALANCE AT
  DECEMBER 31, 1994                    --         --         --          --      54      36,876       (2,548)             --
Sale of common stock
  to the public                        --         --         --          --      36      66,006           --              --
Net loss                               --         --         --          --      --          --       (2,405)             --
Effect of currency
  translation adjustment               --         --         --          --      --          --           --              --
Unrealized appreciation of
  short-term investments               --         --         --          --      --          --           --              44
                                 --------    -------    -------    --------    ----    --------     --------            ----
BALANCE AT
  DECEMBER 31, 1995                    --         --         --          --    $ 90    $102,882     $ (4,953)           $ 44
Exercise of stock options              --         --         --          --      --         638           --              --
Sale of common stock to
  the public                           --         --         --          --      23     116,233           --              --
Tax benefits related to exercise
  of stock options                     --         --         --          --      --       1,128           --              --
Issuance of stock in connection
  with an acquisition                  --         --         --          --       5      28,710           --              --
Net loss                               --         --         --          --      --          --      (42,267)             --
Effect of currency
  translation adjustment               --         --         --          --      --          --           --              --
Unrealized depreciation of
  short-term investments               --         --         --          --      --          --           --             (40)
                                 --------    -------    -------    --------    ----    --------     --------            ----
BALANCE AT
  DECEMBER 31, 1996              $     --    $    --    $    --    $     --    $118    $249,591     $(47,220)           $  4
                                 ========    =======    =======    ========    ====    ========     ========            ====
</TABLE>


                                            Cumulative
                                             Effect of
                                             Currency         Total
                                            Translation    Stockholders'
                                             Adjustment       Equity
                                            -----------    -------------
BALANCE AT
  DECEMBER 31, 1993                             $  6        $ 32,762
Capital contributions                             --             605
Conversion of preferred stock                     --              --
Net income                                        --           1,021
Effect of currency
  translation adjustment                         (17)            (17)
                                                ----        --------
BALANCE AT
  DECEMBER 31, 1994                              (11)         34,371
Sale of common stock
  to the public                                   --          66,042
Net loss                                          --          (2,405)
Effect of currency
  translation adjustment                          (8)             (8)
Unrealized appreciation of
  short-term investments                          --              44
                                                ----        --------
BALANCE AT
  DECEMBER 31, 1995                             $(19)       $ 98,044
Exercise of stock options                         --             638
Sale of common stock to
  the public                                      --         116,256
Tax benefits related to exercise
  of stock options                                --           1,128
Issuance of stock in connection
  with an acquisition                             --          28,715
Net loss                                          --         (42,267)
Effect of currency
  translation adjustment                         (67)            (67)
Unrealized depreciation of
  short-term investments                          --             (40)
                                                ----        --------
BALANCE AT
  DECEMBER 31, 1996                             $(86)       $202,407
                                                ====        ========

See accompanying notes to consolidated financial statements.



                                       17

<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(in thousands)

HCIA INC. AND SUBSIDIARIES

<TABLE>
<CAPTION>

                                                                           1994             1995             1996
                                                                         --------        ---------        ----------
<S><C>
Cash flows from operating activities:
  Net income (loss)                                                      $ 1,021         $ (2,405)        $ (42,267)
  Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
      Depreciation and amortization                                        4,826            6,864            12,670
      Write-off of acquired in-process research and development costs         --           12,152            48,065
      Income tax benefit related to stock options                             --               --             1,128
      Deferred tax provision                                                (338)          (3,625)            5,606
      Changes in operating assets and liabilities:
         Accounts receivable                                                (349)          (7,078)          (12,057)
         Income taxes payable/receivable                                   1,097              973            (1,637)
         Prepaid expenses                                                   (234)          (1,505)             (328)
         Accounts payable                                                   (853)             215            (1,247)
         Accrued salaries, benefits and other liabilities                   (771)            (816)              812
         Deferred revenue                                                     40           (1,714)              674
         Minority interest                                                     3               75                --
                                                                         -------         --------         ---------
            Net cash provided by operating activities                      4,442            3,136            11,419
                                                                         -------         --------         ---------
Cash flows from investing activities:
  Purchases of furniture and equipment                                    (1,568)          (3,145)           (6,357)
  Cost of acquisitions, net of cash acquired                                  --          (35,271)         (146,765)
  Computer software costs purchased or capitalized                        (2,603)          (6,151)          (12,671)
  Other intangible assets purchased or capitalized                          (779)            (716)           (1,742)
  Purchases of short-term investments                                         --          (69,312)          (59,640)
  Proceeds from disposals of short-term investments                           --           46,077            82,370
  Payments on note receivable                                                108            1,551                --
  Other                                                                      (40)             104               (67)
                                                                         -------         --------         ---------
            Net cash used in investing activities                         (4,882)         (66,863)         (144,872)
                                                                         -------         --------         ---------
Cash flows from financing activities:
  Proceeds from exercise of stock options                                     --               --               638
  Proceeds from public offerings                                              --           66,042           116,256
  Proceeds from issuance of preferred stock                                  605               --                --
  Issuance of stock in connection with an acquisition                         --               --            28,715
  Acquisition related borrowings                                              --               --            86,000
  Repayment of acquisition related borrowings                                 --               --           (86,000)
  Fees paid to establish credit facilities                                    --               --              (520)
  Borrowing from related party                                             1,400            2,915                --
  Repayments of notes payable                                                 --             (513)           (1,246)
  Repayments of related party borrowings                                  (1,250)          (1,900)               --
  Principal payments on capital leases                                      (187)            (315)             (211)
                                                                         -------         --------         ---------
            Net cash provided by financing activities                        568           66,229           143,632
                                                                         -------         --------         ---------
Impact of currency fluctuations on cash and cash equivalents                 (17)              (8)              (67)
                                                                         -------         --------         ---------
Increase in cash and cash equivalents                                        111            2,494            10,112
Cash and cash equivalents -- beginning of year                               585              696             3,190
Cash and cash equivalents -- end of year                                 $   696         $  3,190         $  13,302
                                                                         =======         ========         =========
Supplemental cash flow information
           -- cash paid during the year for interest                     $   137         $     89         $     461
                                                                         =======         ========         =========
           -- cash paid during the year for income taxes                 $    --         $  1,088         $     790
                                                                         =======         ========         =========
</TABLE>

See accompanying notes to consolidated financial statements.

                                       18

<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994, 1995, AND 1996

HCIA INC. AND SUBSIDIARIES

(1) BACKGROUND

(a) Description of Business
HCIA Inc. ("HCIA" or the "Company") is a health care information content company
that develops and markets integrated clinical  information systems and products.
The Company's systems and products range from  standardized  databases to highly
focused  decision  support  systems that assist its customers in evaluating  the
efficacy and economics of health care delivery.  The Company's customers include
hospitals,  integrated delivery systems, self-insured employers,  pharmaceutical
companies and managed care organizations.

(b) Public Offerings
During  February  1995,  the Company  completed  an initial  public  offering of
approximately 2.0 million shares of common stock at $14.00 per share.

In August 1995, the Company  completed a public  offering of  approximately  2.6
million  shares at $28.50 per share,  consisting of 1.5 million shares issued by
the Company and  approximately  1.1 million  shares sold by the  Company's  then
largest stockholder, AMBAC Inc. ("AMBAC").

In May 1996, approximately 4.2 million shares of the Company's common stock were
sold by AMBAC in a public offering.  In connection with the offering the Company
sold 261,951 shares of common stock at $51.00 per share.

In August 1996,  approximately  2.2 million shares of the Company's common stock
were sold at $54.125 per share in a public  offering.  Of these shares,  216,696
were sold by  certain  stockholders.  The  Company  did not  receive  any of the
proceeds from the sale of shares by the selling stockholders.

Net  proceeds  to  the  Company  from  the   offerings   discussed   above  were
approximately $182.3 million.

(c) Acquisitions
Certain  information  regarding the Company's major  acquisitions in the periods
covered by these financial statements is summarized below:

<TABLE>
<CAPTION>
                                   Datis                  CHAMP                Response                   LBA
                          ----------------------  ---------------------  ---------------------  -----------------------
                                        Life of                Life of               Life of                   Life of
                                         Asset                  Asset                 Asset                     Asset
                                        -------                -------               -------                   -------
<S><C>
Purchase Price            $14,250,000             $17,500,000            $6,261,000             $128,829,000
Assets Acquired
  Current Assets          $ 1,338,000             $   175,000            $1,274,000             $  4,681,000
  Furniture & Equipment   $ 1,092,000  3-5 years           --            $  293,000  3-5 years  $  1,533,000  3-5 years
  Other Assets                $25,000                      --                    --                       --
  Deferred tax asset               --                      --            $  221,000             $ 18,534,000
  Software                $   233,000    5 years  $   859,000   5 years  $  255,000    5 years            --
  Trade Name                       --             $ 1,266,000  12 years          --                       --
  Customer base                    --             $   595,000  12 years $   393,000   12 years  $  5,135,000   10 years
  Methodologies                    --                      --                    --             $ 12,843,000    6 years
  Assembled Workforce              --             $ 1,102,000  12 years $   133,000   12 years  $  4,080,000   10 years
  Goodwill                $16,503,000   20 years  $ 1,351,000  12 years $   304,000   15 years  $ 43,859,000   20 years
  In-process research
    & development                  --             $12,152,000           $ 4,309,000             $ 41,507,000
Liabilities assumed       $ 4,941,000                      --           $   921,000             $  3,343,000
</TABLE>


                                              HealthChex
                                        ----------------------
                                                      Life of
                                                       Asset
                                                      -------
Purchase Price                          $11,503,000
Assets Acquired
  Current Assets                        $   508,000
  Furniture & Equipment                 $   590,000  3-5 years
  Other Assets                                   --
  Deferred tax asset                    $   835,000
  Software                                       --
  Trade Name                                     --
  Customer base                         $   599,000   10 years
  Methodologies                         $ 1,628,000    5 years
  Assembled Workforce                   $   715,000   10 years
  Goodwill                              $ 5,107,000   20 years
  In-process research
    & development                       $ 2,249,000
Liabilities assumed                     $   728,000



                                       19


<PAGE>



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HCIA INC. AND SUBSIDIARIES

On April 28, 1995, the Company acquired all of the capital stock of Datis
Corporation ("Datis") for $14,250,000 in cash. Datis provided databases and
related analyses to hospitals and hospital systems. The goodwill amortization
period is based on the nature of Datis' products and markets and the historical
rates of change in the products and markets.

On December 15, 1995,  the Company  acquired the assets  constituting  the CHAMP
unit of William M. Mercer, Incorporated ("CHAMP") for $17,500,000 in cash. CHAMP
provides database and analytical reporting services to large employers to assist
them in the management of their healthcare costs.

On May 15, 1996, the Company  acquired all of the outstanding  stock of Response
Healthcare  Information  Management,  Inc.  ("Response") for $6,261,000 in cash.
Response  develops and markets  information  products  which capture and analyze
point-of-care,  patient-centered  data  relating  to  disease-specific  outcomes
measurement and member/patient satisfaction.

On  August  9,  1996,  the  Company  acquired  all of the  capital  stock of LBA
Holdings,  Inc. (formerly  HealthVision,  Inc.) and its operating subsidiary LBA
Health Care Management,  Inc. ("LBA"). The purchase price including  acquisition
expenses  was  $128,829,000,   of  which  $100,114,000  was  paid  in  cash  and
$28,715,000  was paid  through the delivery of 492,961  shares of the  Company's
common  stock.  LBA develops and markets  information  products that analyze and
benchmark detailed clinical and productivity  outcomes.  The cash portion of the
purchase  price was funded  primarily  through a credit  facility  obtained from
First Union  National Bank of North  Carolina  ("First  Union")  consisting of a
$50,000,000 term loan and a $36,000,000 draw on a $50,000,000  revolving line of
credit (see note 9). These loans were repaid with a portion of the proceeds from
the Company's August 1996 public offering.

On December 2, 1996,  the Company  purchased all of the capital stock of Equifax
Health Analytical  Services,  Inc.  ("HealthChex")  for $11,503,000 in cash. The
parties  have  agreed  to make an  election  under  Internal  Revenue  Code Sec.
338(h)(10)  to treat this  acquisition  as an asset  purchase for tax  purposes.
HealthChex  provides  physician  profiling and medical  claims review systems to
health care providers and payors.

The  values  and lives of the  intangible  assets and  in-process  research  and
development  costs  obtained  in  the  CHAMP,   Response,   LBA  and  HealthChex
acquisitions were determined by an independent  appraiser.  The lives and values
of the intangible assets were based on, among other things,  employee  retention
rates,  customer  retention  rates  and the  historical  rates of  change in the
products  and  markets.  The  current  fair  value of  in-process  research  and
development  costs was  determined,  based on the  risk-adjusted  cash flows (at
discount rates of 19% to 22%), of specifically identified technologies for which
technological  feasibility had not yet been established pursuant to Statement of
Financial  Accounting  Standards No. 86,  "Accounting  for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed" ("SFAS No. 86") and for which
future   alternative   uses  did  not  exist.   Consideration  of  technological
feasibility for purposes of these  calculations  was given on a basis consistent
with that normally utilized by the Company (see note 2d).  Non-recurring charges
to write off these costs were  recorded on the date of each  acquisition.  These
charges are  recorded as  operating  expenses on the  accompanying  consolidated
statements of operations.

During  November 1995,  the Company  acquired an additional 36% interest in CHKS
Limited ("CHKS").  As a result of this  acquisition,  CHKS became a wholly owned
subsidiary  of the  Company.  The  Company  issued  notes  payable to the former
shareholders  in the  principal  amount  of  $2,795,000.  This  acquisition  was
accounted for using the purchase method of accounting and resulted in additional
goodwill of  $2,709,000.  The  goodwill is being  amortized  over its  estimated
useful life of 15 years. The estimate of the amortization period is based on the
nature of the products and markets of CHKS and the historical  rate of change in
the products and markets.


                                       20



<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HCIA INC. AND SUBSIDIARIES

Also  during  1995,  the Company  acquired  certain  assets and assumed  certain
liabilities of John Froehlich  Associates,  MetriCor Inc. and MetaGenerics.  The
aggregate  purchase price for these  acquisitions was $1,677,000,  consisting of
cash of $1,166,000 and notes payable of $511,000. These acquisitions resulted in
increases in furniture and equipment of $75,000,  increases in other  intangible
assets of $1,938,000 and increases in current liabilities of $336,000. The other
intangible   assets  consist  of  goodwill   which  is  being   amortized  on  a
straight-line  basis over estimated useful lives of 10 to 15 years. The estimate
of each  amortization  period is based on the nature of the products and markets
of the acquired  entities and the historical  rate of change in the products and
markets.

During 1996 the Company also acquired all of the stock of IASIST S.A. and all of
the interests in Managed  Marketing LLC. The aggregate  purchase price for these
acquisitions was $2,713,000 and was paid in cash. These acquisitions resulted in
increases in current  assets of $496,000,  furniture  and  equipment of $85,000,
software of $303,000 and  goodwill of  $2,159,000,  offset by increased  current
liabilities  of  $330,000.  The goodwill is being  amortized on a  straight-line
basis  over  its  estimated  useful  life  of 15  years.  The  estimate  of each
amortization  period is based on the nature of the  products  and markets of the
acquired  entities  and the  historical  rates of  change  in the  products  and
markets.

Unless  otherwise  noted,  funding  for the  acquisitions  discussed  above  was
provided  from the  proceeds of the  Company's  public  offerings.  All of these
acquisitions were accounted for using the purchase method of accounting.

Unaudited pro forma  combined  results of the  operations of the Company for the
years  ended  December  31,  1995 and 1996 are  presented  below  and have  been
prepared  assuming  that the  acquisitions  discussed  above had been made as of
January 1, 1995.

                                    1995               1996
                                  -------            -------
                                          (unaudited)

Revenue                           $79,456            $93,568
Net income                        $ 2,146            $ 7,192
Net income per share              $  0.20            $  0.59


The pro forma  results  include the  historical  accounts of the Company and the
acquired  entities  adjusted  to reflect  the  effects of the  depreciation  and
amortization of the acquired  identifiable  tangible and intangible assets based
on the new cost  basis  of the  assets  acquired,  additional  interest  expense
related to notes payable  issued in connection  with certain  acquisitions,  the
reversal of the  non-recurring  write-off  of acquired  in-process  research and
development  costs recorded in connection with certain  acquisitions and related
income tax effects.  The pro forma  results are not  necessarily  indicative  of
actual  results which might have occurred had the  operations  and management of
the Company and the acquired entities been combined in 1995 and 1996.



                                       21


<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation
The accompanying  financial  statements  include the accounts of the Company and
its subsidiaries. The minority interest of CHKS for the periods before it became
wholly owned is stated separately on the financial statements. All significant
intercompany transactions have been eliminated in consolidation.

(b) Cash Equivalents and Short-Term Investments
Cash equivalents consist of highly liquid securities with original maturities of
three months or less at the date  acquired by the Company.  At December 31, 1995
and 1996,  the  Company's  short-term  investments,  which are  classified as an
available for sale securities portfolio, consist of the following:

<TABLE>
<CAPTION>

                                              1995                                 1996
                                 -----------------------------         -------------------------
                                   Fair Value          Cost            Fair Value         Cost
                                 -------------     -----------         ----------       --------
<S><C>
Auction Market Preferred Stock   $ 7,000,000       $ 7,000,000         $     --         $     --
Variable Rate Debentures           5,500,000         5,500,000               --               --
Municipal Bonds                   10,780,000        10,736,000          510,000          506,000
                                 -----------       -----------         --------         --------
     Total                       $23,280,000       $23,236,000         $510,000         $506,000
                                 ===========       ===========         ========         ========
</TABLE>


The portfolio is carried at fair value in accordance with Statement of Financial
Accounting  Standards No. 115,  "Accounting for Certain  Investments in Debt and
Equity  Securities." All securities  mature within one year.  Realized gains and
losses are recorded using the specific  identification basis to determine costs.
During 1995 and 1996,  proceeds from sales of the securities totaled $46,077,000
and $82,370,000,  respectively.  Gross realized gains and losses on sales of the
securities were immaterial in 1995 and 1996.

(c) Furniture and Equipment
Furniture and equipment are stated at cost.  Included in furniture and equipment
are computer hardware, furniture and fixtures and leasehold improvements.  These
costs are being  depreciated on the  straight-line  method over their  estimated
useful lives of three to five years.

(d) Computer Software Costs
Computer  software costs include the cost of internally  developed  software and
the fair  market  value  assigned  to  computer  software  obtained  in purchase
transactions.  Costs  for  internally  developed  software  are  capitalized  in
accordance  with SFAS No. 86.  These costs  relate  primarily to the building of
production  systems  and  extending  existing  applications  to new  markets  or
platforms  using existing  technologies  and  programming  methods.  The Company
capitalizes only those costs incurred after a detailed program design or, in the
absence of such, a working  prototype has been developed.  The Company generally
develops its applications in connection with customer contracts and includes the
related costs as a component of operating  expenses in the period incurred.  The
Company  capitalized  or  purchased  a  total  of  $2,603,000,   $7,260,000  and
$13,229,000  of computer  software costs in 1994,  1995 and 1996,  respectively,
including   $1,092,000  in  1995  and  $558,000  in  1996  related  to  business
acquisitions.

Capitalized costs are amortized,  beginning with market  availability,  over the
economic  useful life of the product.  Typically,  this life is five years.  The
annual amortization  expense is the greater of the amount computed using (a) the
ratio that current  gross  revenues for a product  bears to the total of current
and anticipated  future gross revenues for that product or (b) the straight-line
method over the remaining  estimated  economic life of the product including the
period  being  reported.   Amortization   expense  for  computer   software  was
$1,456,000,  $2,048,000 and $3,816,000 during 1994, 1995 and 1996, respectively.
Accumulated amortization for computer software was $6,510,000 and $10,326,000 at
December 31, 1995 and 1996, respectively.

The Company  evaluates,  on a quarterly basis, the recoverability of capitalized
software  costs on the basis of whether  such costs are fully  recoverable  from
projected  undiscounted  cash flows of individual  system and product lines.


                                       22



<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(e) Revenue Recognition
Revenue  from  license  fees for  access to the  Company's databases is
recognized  when access to the  database is made  available to the customer.
Revenue from custom system or database development and implementation contracts
is  recognized  on  a  percentage  of  completion   basis  using  the
cost-to-cost method. This method of accounting has resulted in unbilled accounts
receivable  of  $3,073,000  and  $3,686,000  at  December  31,  1995  and  1996,
respectively.  On a quarterly  basis,  the Company  assesses whether the current
estimate of total contract costs for each of these contracts indicates a loss is
expected  and accrues any such  losses on the entire  contract in that  quarter.
Where the Company has  contracted  to provide both access to a Company  database
and development of a custom  database,  the contract value is segmented into its
discrete elements  according to their relative values, and revenue is recognized
separately on each element in accordance with the above.

Revenue from group data  contracts,  which obligate the Company to process data,
produce reports and update databases on periodic intervals, is recognized as the
contracted obligations are fulfilled.

Revenue  from  licensing  of software  products  is  recognized  upon  shipment,
provided that no vendor obligations remain outstanding. While the Company has no
significant  post-contract  support ("PCS") obligations,  any revenue related to
insignificant  PCS  obligations on software  licenses is deferred and recognized
over the  contract  term.  The  Company  determines  the  component  of  revenue
applicable to PCS  obligations  based upon its  experience  in  fulfilling  such
obligations.

Revenue on all other products is recognized when the product is shipped.

During  1994,  one  customer  accounted  for 12% of the  Company's  revenue.  At
December  31,  1994,  receivables  from  that  customer  represented  12% of the
Company's  trade  accounts  receivable.   Consistent  with  Company  policy,  no
collateral  or other  security  was held with  respect  to such  trade  accounts
receivable.  During 1995 and 1996, no single customer  accounted for 10% or more
of the Company's revenue or trade accounts receivable.

(f) Foreign Currency Translation
The assets and liabilities of the Company's foreign operations are translated at
year-end  exchange  rates,  while  revenue and expenses are  translated at rates
prevailing during the period.  Accordingly,  translation  adjustments that arise
due to  fluctuations  in exchange  rates are excluded  from  operations  and are
reported as a separate component of stockholders' equity.

(g) Income Taxes
Prior to the  completion of the Company's  initial  public  offering in February
1995,  the Company was party to a federal  tax-sharing  agreement with AMBAC and
was included in AMBAC's  consolidated federal income tax return. The tax-sharing
agreement  provided for the determination of tax expense or benefit based on the
contribution of the Company to AMBAC's tax liability,  computed substantially as
if the Company filed a separate  income tax return.  The tax liability due AMBAC
was settled quarterly,  with a final settlement taking place after the filing of
the consolidated  federal tax return.  Commencing February 22, 1995, the Company
was no longer  included on a consolidated  basis for tax purposes with AMBAC and
is responsible for filing its own federal income tax return.

The  Company  uses the asset and  liability  method  required  by  Statement  of
Financial  Accounting  Standards  No.  109,  "Accounting  For Income  Taxes," to
account for deferred income taxes. Under this method,  deferred income taxes are
recognized for temporary  differences  between the financial  reporting bases of
assets and liabilities and their respective tax bases and for operating loss and
tax credit  carryforwards  based on enacted rates  expected to be in effect when
such  amounts are  realized  or  settled.  The effects of changes in tax laws or
rates on deferred tax assets and  liabilities  are recognized in the period that
includes the enactment date.

(h) Earnings Per Share
Earnings per share has been calculated based upon the weighted average number of
shares  outstanding  and using the treasury stock method for  outstanding  stock
options.  The number of shares  used in this  calculation  has been  adjusted to
reflect a  one-for-three  reverse stock split and the  conversion of Class A and
Class B common  stock into a single  class of common  stock  (see note 10).  For
1994, the fair market value per share for the purpose of the  calculation of the
weighted  average  shares  outstanding  was assumed to be $11.00,  which was the
mid-point of the Company's initial public offering price range.


                                       23



<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(i) Accounting for Stock Options
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," ("APB No. 25") in accounting for its stock options.
Additional information required by Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123") is
discussed in Note 10.

(j) Use Of Estimates
Management  of the  Company  has  made a number  of  estimates  and  assumptions
relating  to the  reporting  of assets and  liabilities  and the  disclosure  of
contingent  assets and  liabilities  to prepare  these  financial  statements in
conformity with generally accepted accounting  principles.  Actual results could
differ from those estimates.

(k) Reclassifications
Certain  amounts  for 1994 and 1995 have been  reclassified  to  conform  to the
presentation for 1996.

(3) FURNITURE AND EQUIPMENT

Furniture and equipment consist of the following at December 31:

                                          1995             1996
                                      ------------     ------------
Computer equipment                    $ 8,629,000      $15,274,000
Office furniture and equipment          1,398,000        1,881,000
Other                                     392,000          516,000
                                      -----------      -----------
                                       10,419,000       17,671,000
Less accumulated depreciation          (3,843,000)      (5,483,000)
                                      -----------      -----------
                                      $ 6,576,000      $12,188,000
                                      ===========      ===========

(4) OTHER INTANGIBLE ASSETS

Other intangible assets at December 31, 1996 consist of the following:

<TABLE>
<CAPTION>
                                       Capitalized    Accumulated     Carrying      Weighted
                                          Cost       Amortization      Value      Average Life
                                     -------------   ------------  -------------  ------------
<S><C>
Databases                            $  7,788,000    $ 4,778,000   $  3,010,000         5
CPHA license and prepaid royalties     14,031,000      3,886,000     10,145,000        17
Goodwill                               79,467,000      4,777,000     74,690,000        19
Customer bases                          6,722,000        290,000      6,432,000        10
Methodologies                          14,471,000        919,000     13,552,000         6
Assembled workforce                     6,030,000        276,000      5,754,000        10
Other                                   2,274,000        256,000      2,018,000        13
                                     ------------    -----------   ------------
                                     $130,783,000    $15,182,000   $115,601,000
                                     ============    ===========   ============
</TABLE>

Other intangible assets at December 31, 1995 consist of the following:

<TABLE>
<CAPTION>
                                       Capitalized   Accumulated      Carrying      Weighted
                                          Cost      Amortization       Value      Average Life
                                     -------------  ------------  -------------   ------------
<S><C>
Databases                             $ 5,888,000    $3,711,000    $ 2,177,000         5
CPHA license and prepaid royalties     14,031,000     3,061,000     10,970,000        17
Goodwill                               27,536,000     2,231,000     25,305,000        17
Customer bases                            595,000            --        595,000        12
Assembled workforce                     1,102,000            --      1,102,000        12
Other                                   2,274,000        85,000      2,189,000        13
                                      -----------    ----------    -----------
                                      $51,426,000    $9,088,000    $42,338,000
                                      ===========    ==========    ===========
</TABLE>

Databases  consist of the fair market value of various acquired  databases,  the
cost of acquiring data and internal  development costs (direct labor and related
overhead)  incurred  in  standardizing  data  for  use in  internally  developed
databases.  These assets are being amortized on a straight-line basis over their
estimated  useful lives of five years.  Amortization  expense for  databases was
approximately  $839,000,  $962,000 and  $1,067,000  during 1994,  1995 and 1996,
respectively.

                                       24


<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

During 1992, the Company acquired an exclusive  license to access and  sell  the
databases  and  certain  other  assets  of  the   Commission  on Professional
and Hospital Activities ("CPHA").  This license was recorded at its estimated
fair  value of  $8,073,000  at the date of  acquisition  and is being amortized
on a straight-line  basis over 17 years. The  amortization  period was
determined to be the estimated  economic life cycle of the licensed  properties,
as corroborated by an independent appraisal,  and reflected the remainder of the
existing  term of the license at the date of  acquisition  plus one renewal term
provided under the terms of the agreement.  Under the terms of the license,  the
Company paid royalties to CPHA based on revenues  earned  utilizing the licensed
assets.  Subsequent to the acquisition,  the Company and CPHA entered into a new
license  agreement.  Under  the terms of the new  agreement,  the  Company  paid
$5,958,000  to CPHA in  lieu of  future  royalty  obligations.  The  payment  is
recorded as prepaid CPHA  royalties  and is being  amortized on a  straight-line
basis over 17 years, consistent with the estimated economic life of the licensed
properties.

Goodwill  represents the excess of the purchase price over the fair value of net
assets acquired. Goodwill is being amortized on a straight-line basis over 10 to
20 years.  Such  amortization  periods are estimated  based on the nature of the
products  and markets of the  acquired  companies  and the  historical  rates of
changes in these products and market areas.

Customer bases, methodologies and assembled workforces were obtained through the
CHAMP, Response, LBA and HealthChex acquisitions.  The values and lives of these
assets were  determined  by an  independent  appraiser  based on factors such as
going concern value, employee turnover and historical customer retention rates.

Other intangibles  consist of a trade name obtained in the CHAMP acquisition and
certain  non-competition  agreements.  The value and life of the  tradename  was
determined by an  independent  appraiser.  The  non-competition  agreements  are
amortized  over their 1 to 2 year terms  commencing  with the date the employees
are no longer employed by the Company.

(5) ACCRUED SALARIES, BENEFITS AND OTHER LIABILITIES

Accrued salaries, benefits and other liabilities consist of the following at
December 31:


                                          1995                1996
                                       ----------          ----------
Accrued salaries                       $1,108,000          $2,220,000
Accrued benefits                          304,000             477,000
Accrued vacation                          562,000             681,000
Other                                   2,248,000           4,579,000
                                       ----------          ----------
                                       $4,222,000          $7,957,000
                                       ==========          ==========

(6) LEASES

The Company leases office space and certain  equipment under  operating  leases.
Rent expense for these leases was  $1,527,000,  $2,286,000  and 3,563,000 net of
rental income of $0, $0 and $412,000 during 1994,  1995 and 1996,  respectively.
The  minimum  rental  commitments  under  noncancelable  operating  leases as of
December 31, 1996, are as follows:

Year Ending December 31:
  1997                                $ 4,619,000
  1998                                  4,042,000
  1999                                  3,910,000
  2000                                  2,906,000
  2001                                  2,274,000
  Thereafter                            1,400,000
                                      -----------
     Gross minimum payments required  $19,151,000
  Sublease Income                        (949,000)
                                      -----------
    Net minimum payments required     $18,202,000
                                      ===========

                                       25


<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(7)  SAVINGS INCENTIVE PLAN

The Company  maintains the HCIA Inc.  Savings  Incentive  Plan, a profit sharing
plan qualified under Section 401(a) of the Internal  Revenue Code. All employees
of the  Company  who  have  completed  one  year  of  service  are  eligible  to
participate  in  the  Plan.   Subject  to  certain   limitations  on  individual
contributions   and  allocations  and  Company   deductions,   the  Plan  allows
participants to defer up to 15% of their pay on a pre-tax basis and up to 10% of
their pay on an after-tax basis.  The Company also makes matching  contributions
equal to 50% of the amount a  participant  defers up to 6% of the  participant's
pay. The Plan also provides for discretionary  contributions by the Company. All
participants  are  fully  vested  in all of  their  accounts  in the  Plan.  The
Company's   contributions   to  the  Plan  during  1994,   1995  and  1996  were
approximately $167,000, $194,000 and $397,000, respectively.

(8) INCOME TAXES

The income tax expense (benefit) relating to the operations of the Company
consists of the following:


<TABLE>
<CAPTION>
                                                  1994            1995             1996
                                              -----------     ------------      ----------
<S><C>
Federal and state:
  Current                                     $1,097,000      $ 2,071,000       $  280,000
  Deferred                                      (338,000)      (3,625,000)       5,606,000
                                              ----------      -----------       ----------
     Total income tax expense (benefit)       $  759,000      $(1,554,000)      $5,886,000
                                              ==========      ===========       ==========
</TABLE>


The  tax  provisions  in  the  accompanying  financial  statements  differ  from
prevailing federal corporate rates. A reconciliation of this difference follows:

<TABLE>
<CAPTION>

                                                      1994                     1995                        1996
                                                Amount      %          Amount         %            Amount          %
                                              -----------------    -----------------------     ------------------------
<S><C>
Computed expected tax expense
  (benefit) at statutory rate                 $623,000    35.0%    $(1,346,000)    (34.0)%     $(12,370,000)    (34.0)%
Goodwill amortization                           44,000     2.5         220,000       5.6            637,000       1.8
Tax-exempt interest                                 --      --        (234,000)     (5.9)          (216,000)     (0.6)
State tax, net of federal benefit               93,000     5.2        (224,000)     (5.7)        (1,609,000)     (4.4)
Acquired in-process research and development        --      --              --        --         19,226,000      52.8
Other, net                                      (1,000)     --          30,000       0.7            218,000       0.6
                                              ----------------     ---------------------       ----------------------
Provision (benefit) for income taxes          $759,000    42.7%    $(1,554,000)    (39.3)%     $  5,886,000      16.2%
                                              ================     =====================       ======================
</TABLE>

                                       26



<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The tax effects of temporary differences that give rise to significant portions
of the deferred tax liabilities and deferred tax assets at December 31, 1995 and
1996, are presented below:

                                                    1995                1996
                                                 ----------         -----------

Deferred tax assets:
  Operating accruals                             $  403,000         $   881,000
  Basis difference in intangibles                 6,297,000          10,091,000
  Bonus accrual                                          --           2,005,000
  Net operating loss carryforwards                       --          11,457,000
                                                 ----------         -----------
  Gross deferred tax assets                       6,700,000          24,434,000
  Valuation allowance                                    --                  --
                                                 ----------         -----------
  Net deferred tax assets                         6,700,000          24,434,000
                                                 ----------         -----------
Deferred tax liabilities:
  Capitalized software                            3,005,000           6,226,000
  Fixed assets                                      605,000           1,134,000
                                                 ----------         -----------
Total deferred tax liabilities                    3,610,000           7,360,000
                                                 ----------         -----------

Net deferred tax assets                          $3,090,000         $17,074,000
                                                 ==========         ===========


The  valuation  allowance  for  deferred  tax  assets as of  January 1, 1995 and
December  31,  1995 and 1996 was $0.  Therefore,  there was no net change in the
valuation allowance for 1995 and 1996.

The Company has net operating loss  carryforwards of $41,600,000 at December 31,
1996, which expire between 2002 and 2011.

(9) CREDIT AGREEMENT

In August 1996 the Company  obtained a credit facility from First Union totaling
$100,000,000,  consisting of a $50,000,000 term loan and a $50,000,000 revolving
line of  credit.  The  Company  incurred  a one-time  facility  fee and  related
expenses of  $520,000  which is being  amortized  over the five year term of the
line of  credit.  The  Company  borrowed  the entire  $50,000,000  term loan and
approximately  $36,000,000  of the line of  credit  in  connection  with the LBA
acquisition  (see note 1(c)).  These  borrowings  were repaid by August 31, 1996
with a portion of the proceeds from the Company's August 1996 public offering of
its  common  stock  (see  note  1(b)).  The  Company  currently   maintains  the
$50,000,000  line of  credit  (subject  to  borrowing  limitations)  and made no
additional borrowings against it during 1996.

The line of credit bears interest at rates ranging from First Union's prime rate
to prime plus 0.5% or LIBOR (5.5% at December 31, 1996) plus 0.75% to LIBOR plus
1.75%,  depending on the Company's  debt to cash flow ratio.  The Company pays a
commitment fee on the unused portion of the line of credit at rates ranging from
0.25% to 0.375%  depending on the Company's debt to cash flow ratio. The line of
credit is subject to financial covenants including debt to cash flow and debt to
capital ratios.  As of December 31, 1996, the Company was in compliance with all
such covenants and had a maximum borrowing  capacity of $50,000,000.  The credit
facility  reduces  to  $37,500,000  in July 1999,  $25,000,000  in July 2000 and
expires on July 31, 2001.




                                       27


<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(10) STOCKHOLDERS' EQUITY

(a) Capital Amendment
Effective  February 14, 1995,  the Company filed an amendment to its articles of
incorporation which effected:  (i) a one-for-three reverse stock split; (ii) the
conversion of the Class A and Class B common stock into a single class of common
stock;  and (iii) the  authorization  of a total of 15,000,000  shares of common
stock and 500,000 shares of preferred stock, each having a par value of $.01 per
share.  All  references  to common  stock and stock  options in these  financial
statements have been adjusted to reflect the  one-for-three  reverse stock split
as if it had occurred prior to January 1, 1994.  Effective  August 12, 1996, the
Company  filed an  amendment  to its articles of  incorporation  increasing  the
authorized number of shares of common stock to 50,000,000.

(b) Common and Preferred Stock
The preferred stock may be issued from time to time by the board of directors as
shares of one or more series.  The  description  of the shares of each series of
preferred  stock is established by the board of directors  prior to the issuance
of the series of shares.

During  1994,  the Company  issued  2,378,672  shares of common stock to AMBACin
exchange for the 225,621 shares of preferred stock then outstanding.

During 1995, the Company issued  3,512,500  shares of common stock in connection
with its public offerings.

During 1996, the Company issued  2,261,591  shares of common stock in connection
with its public  offerings and 492,961 shares in connection with its acquisition
of LBA.

(c) Options
At December 31, 1994, 1995 and 1996, the Company had  outstanding  stock options
as follows:

Stock options outstanding pursuant to:

                                          1994            1995            1996
                                        -------         -------        ---------

HCIA Stock Option Plan                       --         169,933          956,266
Directors' Option Plan                       --          22,500           57,000
Other options                           374,226         507,800          451,111
                                        -------         -------        ---------
Total stock options outstanding         374,226         700,233        1,464,377
                                        =======         =======        =========



                                       28



<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The HCIA Stock Option Plan provides  that up to 1,350,000  options may be issued
to employees of the Company. Options granted to date under this plan vest over a
period of three or four  years and  expire  ten  years  from date of grant.  The
Directors'  Option  Plan  provides  that up to 200,000  options may be issued to
outside  directors of the Company.  Options granted to date under this plan vest
over  periods  of one to two years and  expire ten years from the date of grant.
The Company has also issued  non-plan  options which generally vest over periods
of two or three  years  and  expire  six to ten years  from  date of  grant.  In
February  1995,  the  Company  issued a non-plan  option to its chief  executive
officer  which was fully  vested on the date of grant and expires ten years from
date of grant.  All stock  options  issued by the Company have been granted with
exercise  prices equal to or greater than the estimated fair market value of the
common stock on the date of grant.  Stock option  transactions are summarized as
follows:

<TABLE>
<CAPTION>
                                            1994                1995                  1996
                                     -----------------    -----------------  -------------------
                                              Weighted             Weighted             Weighted
                                               Average              Average              Average
                                              Exercise             Exercise             Exercise
                                      Shares    Price      Shares    Price     Shares     Price
                                     -------  --------    -------  --------  ---------  --------
<S><C>
Outstanding at beginning of year     164,997   $ 6.00     374,226   $ 8.62     700,233   $13.80
Granted                              217,563   $10.50     357,433   $18.99   1,524,000   $45.61
Exercised                                 --       --      (6,427)  $10.50     (62,605)  $ 9.27
Cancelled                             (8,334)  $ 6.00     (24,999)  $11.20    (697,251)  $58.35
Outstanding at end of year           374,226   $ 8.62     700,233   $13.80   1,464,377   $25.89
Options exercisable at end of year        --       --     186,867   $13.50     345,215   $13.13
</TABLE>

The  following  summarizes  information  about stock options  outstanding  as of
December 31, 1996:

<TABLE>
<CAPTION>
                                    Options Outstanding                            Options Exercisable
                      -----------------------------------------------         ---------------------------
                        Number        Weighted Avg.       Weighted              Number        Weighted
   Range of           Outstanding       Remaining          Average            Exercisable      Average
Exercise Prices       at 12/31/96   Contractual Life   Exercise Price         at 12/31/96  Exercise Price
---------------       -----------   ----------------   --------------         -----------  --------------
<S><C>
      $6                126,097            3.5           $ 6.00                 47,766         $ 6.00
  $10 to $15            367,848            7.8            12.43                265,215          12.83
  $25 to $30            797,932            9.7            28.30                 32,234          26.17
  $48 to $51             29,500            9.1            48.65                     --             --
    $59.88              143,000            9.6            59.88                     --             --
                      ---------            ---           ------                -------         ------
                      1,464,377            8.7           $25.89                345,215         $13.13
                      =========            ===           ======                =======         ======
</TABLE>

The Company applies APB No. 25 and related interpretations in accounting for its
stock  options.  Accordingly,  no  compensation  expense has been  recognized in
connection with its stock options.  Had  compensation  expense for the Company's
stock options been  determined  consistent  with SFASNo.  123, the Company's net
income and earnings  per share would have been reduced to the pro forma  amounts
indicated below:

                                          1994            1995            1996
                                         ------         --------       ---------
Net Income              As reported      $1,021         $(2,405)       $(42,267)
                          Pro forma      $  812         $(2,996)       $(43,795)
Earnings per share      As reported      $ 0.19         $ (0.31)       $  (4.19)
                          Pro forma      $ 0.15         $ (0.39)       $  (4.34)

The fair value of the options for purposes of the above pro forma disclosure was
calculated  using the  Black-Scholes  option  pricing  model  and the  following
assumptions:  a risk-free interest rate of 6.58%, weighted average expected life
of six to seven years, no dividend  payments and a volatility of 31.29% based on
the annualized 10 year industry average. The effects of applying SFAS No. 123 in
the pro forma net income and earnings per share for 1994,  1995 and 1996 may not
be representative of the effects on such pro forma information for future years.



                                       29


<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(11) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying  amount of cash and cash  equivalents,  trade accounts  receivable,
other  current  assets,  accounts  payable,  accrued  expenses and capital lease
obligations  approximates fair value because of the short-term maturity of these
instruments.  The fair value of  short-term  investments  is estimated  based on
quoted  market  prices for these or similar  investments.  The Company has notes
payable to individuals relating to certain of its business  acquisitions.  It is
not  practicable  to  estimate  the fair value of these notes since they are not
traded, no quoted values are readily available for similar financial instruments
and the Company believes it is not cost-effective to have valuations  performed.
However,  management  believes  that there has been no  permanent  change in the
value of such notes.


                                       30



<PAGE>

Item 9.           Changes in and  Disagreements  with  Accountants on Accounting
                  and Financial Disclosure.

                  Not applicable.

                                      -16-

<PAGE>

                                    PART III

Item 10. Directors and Executive Officers.

                  The  information  required  by this Item is  contained  in the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders  under the
headings  "Election of Directors" and  "Additional  Information -- Section 16(a)
Beneficial Ownership Reporting Compliance," and in Item 4A of this Form 10-K.

Item 11. Executive Compensation.

                  The  information  required  by this Item is  contained  in the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders  under the
heading "Executive Compensation and Other Information."

Item 12. Security Ownership of Certain Beneficial Owners and Management.

                  The  information  required  by this Item is  contained  in the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders  under the
heading "Security Ownership of Management and Certain Beneficial Owners."

Item 13. Certain Relationships and Related Transactions.

                  The  information  required  by this Item is  contained  in the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders  under the
heading "Certain Transactions."

                                      -17-

<PAGE>

                                     PART IV

Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K.

         (a)      The following documents are filed as a part of this Report:

                  1. The following report and financial  statements are included
in Item 8 of this Report:


                     Independent Auditors' Report
                     Consolidated Balance Sheets
                     Consolidated Statements of Operations
                     Consolidated Statements of Changes in Stockholders' Equity
                     Consolidated Statements of Cash Flows
                     Notes to Consolidated Financial Statements

         (b)      Form 8-Ks:

                  1. On October 1, 1996,  the Company filed a Form 8-K enclosing
a press  release  announcing  the  preliminary  results  for the  quarter  ended
September 30, 1996.

                  2. On October 23, 1996,  the Company  filed a Form 8-K/A-2 (i)
enclosing a press release  announcing the results for the quarter ended June 30,
1996 and (ii)  including  the  following  financial  statements  relating to the
previously announced acquisition of LBA:

                     Financial Statements of Datis Corporation
                     Financial Statements of William M. Mercer, Incorporated
                        National Health Analysis Unit (CHAMP)
                     Financial Statements of HealthVISION, Inc.
                     Financial Statements of LBA Health Care Management, Inc.
                     Pro Forma Financial Statements

         (c)      Financial Statement Schedules:

                     Independent Auditors' Report on Schedule
                     Schedule II -- Valuation and Qualifying Accounts

                  All other  schedules  to the  financial  statements  for which
provision  is made  in the  accounting  regulations  of the  Commission  are not
applicable,  not  required  or the  information  is  included  in the  financial
statements or notes thereto and therefore have been omitted.

         (d)      Exhibits:

                                      -18-

<PAGE>

<TABLE>
<CAPTION>
       Exhibit
        Number                                   Description
       -------                                   -----------
<S> <C>
          3.1       ***      Articles of Incorporation of the Registrant, as amended to date.
          3.2                Bylaws of the Registrant, as amended to date.
         10.1       *        Employment Agreement dated as of January 1, 1995 by and between the
                             Registrant and George D. Pillari.
        10.1.1               First Amendment to Employment Agreement.
         10.2                HCIA Inc. 1994 Stock and Incentive Plan, as amended to date.
         10.3       **       Agreement dated December 4, 1992 by and among Healthcare Knowledge
                             Resources, Inc., the Registrant and the Commission on Professional and
                             Hospital Activities.
         10.4                HCIA Inc. 1995 Non-Employee Directors Stock Option Plan, as amended to
                             date.
         10.5       **       Tax Sharing Agreement by and among AMBAC Inc., AMBAC Indemnity
                             Corporation,   American   Municipal   Bond  Holding
                             Company  and the  Registrant  dated  as of July 18,
                             1991.
         10.6       ***      Form of Management Retention Agreement.
         10.7       *        Registration Rights Agreement, dated August 10, 1995, by and among the
                             Registrant, George D. Pillari, AMBAC Inc. and AMBAC Indemnity
                             Corporation.
         10.8       ***      Registration Rights Agreement, dated August 9, 1996, by and among the
                             Registrant and certain stockholders.
         10.9       ***      Credit Agreement,  dated August 8, 1996, by and
                             between   First  Union   National   Bank  of  North
                             Carolina, as Agent, and the Registrant.
         11.1                Statement regarding Computation of Per Share Earnings.
         21.1                Subsidiaries of the Registrant.
         23.1                Consent of KPMG Peat Marwick LLP.
         27.1                Financial Data Schedule
</TABLE>

------------
*        Incorporated by reference to the Registrant's Registration Statement on
         Form S-1. (File No. 33-94946).
**       Incorporated by reference to the Registrant's Registration Statement on
         Form S-1. (File No. 33-88226).
***      Incorporated by reference to the Registrant's Registration Statement on
         Form S-3. (File No. 333-08639).

                                      -19-

<PAGE>

                                   SIGNATURES

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

                                       HCIA INC.


                                       By:  /s/ George D. Pillari
                                            ----------------------------------
                                            George D. Pillari
                                            Chairman of the Board, President &
                                            CEO

                  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 in the capacities and on the dates indicated.

         Signature                     Title                           Date
         ---------                     -----                           ----

/s/ George D. Pillari          Chairman of the Board,             March 28, 1997
---------------------------    President and Chief
George D. Pillari              Executive Officer
                               (principal executive
                                officer)

/s/ Barry C. Offutt            Senior Vice President              March 28, 1997
---------------------------    and Chief Financial Officer
Barry C. Offutt                (principal financial and]
                                accounting officer)

/s/ Phillip B. Lassiter        Director                           March 28, 1997
---------------------------
Phillip B. Lassiter

/s/ Richard Dulude             Director                           March 28, 1997
---------------------------
Richard Dulude

/s/ Richard Berman             Director                           March 28, 1997
---------------------------
Richard Berman

/s/ W. Grant Gregory           Director                           March 28, 1997
---------------------------
W. Grant Gregory

/s/ Mark C. Rogers             Director                           March 28, 1997
---------------------------
Mark C. Rogers

/s/ Carl J. Schramm            Director                           March 28, 1997
---------------------------
Carl J. Schramm


<PAGE>

                                  Exhibit Index

<TABLE>
<CAPTION>
                                                                                             Page No.
<S> <C>
3.1  ***      Articles of Incorporation of the Registrant, as amended to date................
3.2           Bylaws of the Registrant, as amended to date...................................
10.1 *        Employment Agreement dated as of January 1, 1995 by and between the
              Registrant and George D. Pillari...............................................
10.1.1        First Amendment to Employment Agreement........................................
10.2          HCIA Inc. 1994 Stock and Incentive Plan, as amended to date....................
10.3 **       Agreement dated December 4, 1992 by and among Healthcare Knowledge
              Resources, Inc., the Registrant and the Commission on Professional and
              Hospital Activities............................................................
10.4          HCIA Inc. 1995 Non-Employee Directors Stock Option Plan, as amended to date....
10.5 **       Tax Sharing  Agreement by and among AMBAC Inc., AMBAC Indemnity
              Corporation,  American  Municipal  Bond  Holding  Company  and the
              Registrant dated as of July 18, 1991...........................................
10.6 ***      Form of Management Retention Agreement.........................................
10.7 *        Registration Rights Agreement, dated August 10, 1995, by and among the
              Registrant, George D. Pillari, AMBAC Inc. and AMBAC Indemnity Corporation......
10.8 ***      Registration Rights Agreement, dated August 9, 1996, by and among the
              Registrant and certain stockholders............................................
10.9 ***      Credit Agreement, dated August 8, 1996, by and between First Union National
              Bank of North Carolina, as Agent, and the Registrant...........................
11.1          Statement regarding Computation of Per Share Earnings..........................
21.1          Subsidiaries of the Registrant.................................................
23.1          Consent of KPMG Peat Marwick LLP...............................................
27.1          Financial Data Schedule........................................................
</TABLE>

*        Incorporated by reference to the Registrant's Registration Statement on
         Form S-1 (File No. 33-94946).
**       Incorporated by reference to the Registrant's Registration Statement on
         Form S-1. (File No. 33-88226).
***      Incorporated by reference to the Registrant's Registration Statement on
         Form S-3. (File No. 333-08639).


<PAGE>

                          Independent Auditors' Report




The Board of Directors and Stockholders
HCIA Inc.:

Under date of January 23, 1997, we reported on the  consolidated  balance sheets
of HCIA Inc. and Subsidiaries  (the  Company) as of December  31, 1995 and 1996,
and the related consolidated  statements of operations, stockholders' equity and
cash  flows  for  each  of the years in the three-year period ended December 31,
1996, as contained in the annual  report on  Form 10-K  for  the year  1996.  In
connection  with  our  audits  of  the  aforementioned   consolidated  financial
statements,  we  also  audited  the  related  consolidated  financial  statement
schedule  in  the  Form  10-K.  This  financial   statement   schedule   is  the
responsibility of the Company's  management. Our  responsibility  is to  express
an  opinion  on  this  consolidated  financial  statement  schedule based on our
audits.

In our opinion, such consolidated 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.

                                       KPMG PEAT MARWICK LLP

Baltimore, Maryland
January 23, 1997


<PAGE>

                SCHEDULE II --- VALUATION AND QUALIFYING ACCOUNTS

                                 (In thousands)

<TABLE>
<CAPTION>
                                      Balance at    Charged to    Deductions    Balance
                                      Beginning     Costs and                      at
Description                           of Period      Expenses                    End of
<S> <C>                                                                          Period
Allowance for Doubtful Accounts
    Year ended December 31, 1994.....    $499           $87       $(227)(A)        $359
    Year ended December 31, 1995.....     359           214        (119)(A)         454
    Year ended December 31, 1996.....     454           560          28 (A)       1,042
</TABLE>


(A)      Accounts receivable write-offs and recoveries