**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**(MARK ONE)**

 

| **ý****        QUARTERLY REPORT PURSUANT TO SECTION  13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                              |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                            |   |   |
| **FOR THE QUARTERLY PERIOD ENDED  JUNE 30, 2003**                                                                                                                                                                          |
|                                                                                                                                                                                                                            |   |   |
| **OR**                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                            |   |   |
| o         **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                 |
|                                                                                                                                                                                                                            |   |   |
| **for the transition period from                   to                 .** |
|                                                                                                                                                                                                                            |   |   |
| **COMMISSION FILE  NUMBER:     0-30859**                                                                                                                                                               |

 

**CARESCIENCE, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

| **PENNSYLVANIA**                                                |   | **23-2703715**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (STATE OR OTHER JURISDICTION  OF INCORPORATION OR ORGANIZATION) |   | (I.R.S. EMPLOYER  IDENTIFICATION NO.) |

 

**3600 MARKET STREETPHILADELPHIA, PA 19104**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

(ZIP CODE)

 

**(215) 387-9401**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDINGAREA CODE)

 

 (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,

IF CHANGED SINCE LAST REPORT)

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý No o

 

Indicated by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes o Noý

 

The number of shares of the registrant’s Common Stock outstanding, asof August 7, 2003 was 13,291,461.

 

 

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CARESCIENCE, INC.

 

FORM 10-Q

 

JUNE 30, 2003

 

INDEX

 
| PART  I.  FINANCIAL INFORMATION                                                                                         |
|------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                         |
| Item  1.  Financial Statements                                                                                          |
|                                                                                                                         |
| Consolidated  Balance Sheets—June 30, 2003 and December 31, 2002 (unaudited)                                  |
|                                                                                                                         |
| Consolidated Statements of Operations—Three  and Six Months Ended June 30, 2003 and June 30, 2002 (unaudited) |
|                                                                                                                         |
| Consolidated Statements  of Cash Flows—Six Months Ended June 30, 2003 and June 30, 2002  (unaudited)          |
|                                                                                                                         |
| Notes  to Consolidated Financial Statements                                                                                  |
|                                                                                                                         |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations                   |
|                                                                                                                         |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                                    |
|                                                                                                                         |
| Item  4.  Controls and Procedures                                                                                       |
|                                                                                                                         |
|                                                                                                                         |
| PART  II.  OTHER INFORMATION                                                                                            |
|                                                                                                                         |
| Item 1.   Legal Proceedings                                                                                             |
|                                                                                                                         |
| Item  2.  Changes in Securities and Use of  Proceeds                                                                    |
|                                                                                                                         |
| Item 5.   Other Information                                                                                             |
|                                                                                                                         |
| Item 6.  Exhibits and Reports on Form 8-K                                                                               |
|                                                                                                                         |
| Signatures                                                                                                                   |

 

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PART I. FINANCIALINFORMATION

 

ITEM 1.  Financial Statements

 

**CARESCIENC**E, INC. ANDSUBSIDIARYCONSOLIDATED BALANCE SHEETS

** **
|                                                                                                                                                                                                                |   | **June  30,  2003** |       | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-----------------------------|--------|
|                                                                                                                                                                                                                |   | **(unaudited)**          |       |
| **ASSETS**                                                                                                                                                                                                          |   |                     |       |                        |   |
| Current  assets:                                                                                                                                                                                                    |   |                     |       |                        |   |
| Cash and  cash equivalents                                                                                                                                                                                          |   | $                        | 8,636,209  |                        | $      | 11,677,225 |   |
| Short-term  investments                                                                                                                                                                                             |   | 5,989,790                |       | 5,489,095                   |   |
| Interest  receivable                                                                                                                                                                                                |   | 7,358                    |       | 15,244                      |   |
| Accounts  receivable, net of allowance for doubtful   accounts of  $85,000 and  $79,370, respectively                                                                                                     |   | 2,021,106                |       | 2,388,204                   |   |
| Prepaid  expenses and other                                                                                                                                                                                         |   | 850,781                  |       | 434,244                     |   |
| Total  current assets                                                                                                                                                                                               |   | 17,505,244               |       | 20,004,012                  |   |
| Property and  equipment:                                                                                                                                                                                            |   |                     |       |                        |   |
| Computer  equipment                                                                                                                                                                                                 |   | 5,592,629                |       | 5,536,460                   |   |
| Office  equipment                                                                                                                                                                                                   |   | 517,387                  |       | 546,857                     |   |
| Leasehold  improvements                                                                                                                                                                                             |   | 197,500                  |       | 169,956                     |   |
| Furniture  and fixtures                                                                                                                                                                                             |   | 504,086                  |       | 516,059                     |   |
|                                                                                                                                                                                                                |   | 6,811,602                |       | 6,769,332                   |   |
| Less—Accumulated  depreciation and amortization                                                                                                                                                                |   | (5,015,444               | )          | (4,644,588                  | )      |
| Net property  and equipment                                                                                                                                                                                         |   | 1,796,158                |       | 2,124,744                   |   |
| Other assets                                                                                                                                                                                                        |   | 247,519                  |       | 263,557                     |   |
| Total assets                                                                                                                                                                                                        |   | $                        | 19,548,921 |                        | $      | 22,392,313 |   |
|                                                                                                                                                                                                                |   |                     |       |                        |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                       |   |                     |       |                        |   |
| Current  liabilities:                                                                                                                                                                                               |   |                     |       |                        |   |
| Current  portion of capital lease obligations and   notes payable                                                                                                                                              |   | $                        | 152,601    |                        | $      | 248,162 |   |
| Accounts  payable                                                                                                                                                                                                   |   | 292,554                  |       | 524,504                     |   |
| Accrued expenses                                                                                                                                                                                                    |   | 1,271,364                |       | 965,738                     |   |
| Deferred  revenues                                                                                                                                                                                                  |   | 5,080,180                |       | 4,061,859                   |   |
| Total  current liabilities                                                                                                                                                                                          |   | 6,796,699                |       | 5,800,263                   |   |
| Capital  lease obligations                                                                                                                                                                                          |   | 71,347                   |       | 116,612                     |   |
| Notes  payable                                                                                                                                                                                                      |   | 183,760                  |       | 215,837                     |   |
| Commitments  and contingencies                                                                                                                                                                                      |   |                     |       |                        |   |
| Shareholders’  equity:                                                                                                                                                                                         |   |                     |       |                        |   |
| Preferred  stock, no par value, 20,000,000 shares authorized,  no shares issued or   outstanding                                                                                                          |   | —                   |       | —                      |   |
| Common  stock, no par value, 100,000,000 shares authorized,  14,731,461 shares issued and 13,291,461 shares outstanding,  and;  14,721,461 shares issued and  13,281,461 shares outstanding, respectively |   | 60,266,226               |       | 60,263,726                  |   |
| Additional  paid-in capital                                                                                                                                                                                         |   | 4,771,046                |       | 4,777,128                   |   |
| Deferred  compensation                                                                                                                                                                                              |   | (523,155                 | )          | (935,281                    | )      |
| Accumulated  other comprehensive income                                                                                                                                                                             |   | 13,227                   |       | 24,136                      |   |
| Accumulated  deficit                                                                                                                                                                                                |   | (51,084,229              | )          | (46,705,442                 | )      |
| Subscriptions  receivable                                                                                                                                                                                           |   | (46,000                  | )          | (264,666                    | )      |
| Treasury  stock, at cost, 1,440,000 shares                                                                                                                                                                          |   | (900,000                 | )          | (900,000                    | )      |
| Total  shareholders’ equity                                                                                                                                                                                    |   | 12,497,115               |       | 16,259,601                  |   |
| Total  liabilities and shareholders’ equity                                                                                                                                                                    |   | $                        | 19,548,921 |                        | $      | 22,392,313 |   |

 

The accompanying notes are an integral partof these statements.

 

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**CARESCIENCE, INC.AND SUBSIDIARYCONSOLIDATED STATEMENTS OF OPERATIONS**

** **

 
|                                  |   | **For the Three Months Ended  June 30,** |       | **For the Six Months Ended  June  30,** |   |
|---------------------------------------|--------|-----------------------------------------------|------------|----------------------------------------------|--------|
|                                  |   | **2003**                                      |       | **2002**                                     |   | **2003** |   | **2002** |   |
|                                  |   | **(unaudited)**                               |       | **(unaudited)**                              |   |
| Revenues                              |   | $                                             | 3,152,203  |                                         | $      | 3,536,062 |   | $ | 6,308,745 |   | $ | 6,812,630 |   |
| Cost of  revenues                     |   | 1,574,084                                     |       | 1,668,239                                    |   | 3,183,173 |   | 3,388,476 |   |
| Gross profit                          |   | 1,578,119                                     |       | 1,867,823                                    |   | 3,125,572 |   | 3,424,154 |   |
| Operating  expenses:                  |   |                                          |       |                                         |   |   |   |   |   |
| Research and  development             |   | 1,194,438                                     |       | 628,634                                      |   | 2,447,559 |   | 1,354,380 |   |
| Selling,  general and administrative  |   | 2,873,989                                     |       | 2,383,623                                    |   | 5,142,407 |   | 4,809,697 |   |
| Total  operating expenses             |   | 4,068,427                                     |       | 3,012,257                                    |   | 7,589,966 |   | 6,164,077 |   |
| Operating  loss                       |   | (2,490,308                                    | )          | (1,144,434                                   | )      | (4,464,394 | ) | (2,739,923 | ) |
| Interest  income                      |   | (30,365                                       | )          | (74,116                                      | )      | (101,832 | ) | (182,852 | ) |
| Interest  expense                     |   | 5,811                                         |       | 10,438                                       |   | 16,225 |   | 21,279 |   |
| Net loss                              |   | $                                             | (2,465,754 | )                                            | $      | (1,080,756 | ) | $ | (4,378,787 | ) | $ | (2,578,350 | ) |
| Net loss per  common share:           |   |                                          |       |                                         |   |   |   |   |   |
|                                  |   |                                          |       |                                         |   |   |   |   |   |
| Basic and  diluted                    |   | $                                             | (0.19      | )                                            | $      | (0.08 | ) | $ | (0.33 | ) | $ | (0.19 | ) |
| Weighted  average shares outstanding: |   |                                          |       |                                         |   |   |   |   |   |
|                                  |   |                                          |       |                                         |   |   |   |   |   |
| Basic and  diluted                    |   | 13,291,461                                    |       | 13,300,391                                   |   | 13,289,748 |   | 13,293,749 |   |

 

The accompanying notes are an integral partof these statements.

 

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**CARESCIENCE, INC.AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
|                                                                                     |   | **For the Six Months Ended  June  30,** |       |
|------------------------------------------------------------------------------------------|--------|----------------------------------------------|------------|
|                                                                                     |   | **2003**                                     |       | **2002** |   |
|                                                                                     |   | **(unaudited)**                              |       |
|                                                                                     |   |                                         |       |   |   |
| Cash flows  from operating activities:                                                   |   |                                         |       |   |   |
| Net loss                                                                                 |   | $                                            | (4,378,787 | ) | $ | (2,578,350 | ) |
| Adjustments  to reconcile net loss to net cash used   in operating activities— |   |                                         |       |   |   |
| Depreciation  and amortization                                                           |   | 663,633                                      |       | 642,226 |   |
| Loss on  disposal of property and equipment                                              |   | 53,960                                       |       | — |   |
| Provision  for bad debts                                                                 |   | 30,198                                       |       | 6,000 |   |
| Stock-based  compensation                                                                |   | 406,044                                      |       | 527,215 |   |
| Changes in  assets and liabilities—                                                 |   |                                         |       |   |   |
| (Increase)  decrease in—                                                            |   |                                         |       |   |   |
| Interest  receivable                                                                     |   | 7,886                                        |       | 53,893 |   |
| Accounts  receivable                                                                     |   | 336,900                                      |       | (149,238 | ) |
| Prepaid  expenses and other                                                              |   | (416,537                                     | )          | 143,122 |   |
| Other assets                                                                             |   | 16,038                                       |       | 4,146 |   |
| Increase  (decrease) in—                                                            |   |                                         |       |   |   |
| Accounts  payable and accrued expenses                                                   |   | 292,342                                      |       | 146,832 |   |
| Deferred  revenues                                                                       |   | 1,018,321                                    |       | (568,360 | ) |
| Net cash  used in operating activities                                                   |   | (1,970,002                                   | )          | (1,772,514 | ) |
|                                                                                     |   |                                         |       |   |   |
| Cash flows  from investing activities:                                                   |   |                                         |       |   |   |
| Purchases of  short-term investments                                                     |   | (6,973,543                                   | )          | (10,891,159 | ) |
| Proceeds  from the redemption of short-term investments                                  |   | 6,461,939                                    |       | 9,943,100 |   |
| Purchases of  property and equipment                                                     |   | (389,007                                     | )          | (332,024 | ) |
| Net cash  used in)  investing activities                                            |   | (900,611                                     | )          | (1,280,083 | ) |
|                                                                                     |   |                                         |       |   |   |
| Cash flows  from financing activities:                                                   |   |                                         |       |   |   |
| Proceeds  from the exercise of common stock options                                      |   | 2,500                                        |       | 26,644 |   |
| Payments on  capital lease obligations and notes payable                                 |   | (172,903                                     | )          | (126,584 | ) |
| Proceeds  from note payable                                                              |   | —                                       |       | 325,000 |   |
| Net cash  (used in)  provided by  financing activities                         |   | (170,403                                     | )          | 225,060 |   |
| Net decrease  in cash and cash equivalents                                               |   | (3,041,016                                   | )          | (2,827,537 | ) |
| Cash and  cash equivalents, beginning of  period                                    |   | 11,677,225                                   |       | 8,860,436 |   |
|                                                                                     |   |                                         |       |   |   |
| Cash and  cash equivalents, end of period                                                |   | $                                            | 8,636,209  |   | $ | 6,032,899 |   |

 

The accompanying notes are an integral partof these statements.

 

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CARESCIENCE, INC. AND SUDSIDIARY

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(1)          SUMMARY OF SIGNIFICANTACCOUNTING POLICIES

 

Organization and Basis of Presentation

 

CareScience,Inc. (the “Company”) is primarily a provider of care management services tohospitals and health systems. As a company specializing in clinical knowledge,the Company supplies the people and technology to facilitate the delivery ofquality care. The Company also has provided limited technology and services tothe pharmaceutical and biotechnology industry. The Company’s offerings in the pharmaceuticaland biotechnology marketplace have included data analysis, consulting servicesand customized research and strategic development support. These services havebeen refocused to data and data analysis to leverage the Company’s expertise incare management.

 

The consolidated balance sheet as of June 30, 2003, theconsolidated statements of operations for the three and six months endedJune 30, 2003 and 2002 and the consolidated statements of cash flows forthe six months ended June 30, 2003 and 2002 have been prepared by theCompany without audit.  In the opinionof management, all adjustments, consisting of normal and recurring adjustments,necessary to present fairly the financial position, results of operations andcash flows as of June 30, 2003 and for all periods presented have beenmade.

 

Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States have been condensed or omitted.   These financial statements should be readin conjunction with the financial statements and notes thereto included in theAnnual Report on Form 10-K as filed with the Securities and ExchangeCommission.  The results of operationsfor the three and six months ended June 30, 2003 are not necessarilyindicative of the operating results for the full year.

 

Principles ofConsolidation

 

Theaccompanying consolidated financial statements include the accounts ofCareScience, Inc. and its subsidiary. All significant intercompany transactions and balances have beeneliminated.

 

Cash and CashEquivalents and Short-term Investments

 

The Companyinvests excess cash in highly liquid investment-grade marketable securitiesincluding corporate commercial paper and U.S. government agency bonds.  For financial reporting purposes, theCompany considers all highly liquid investment instruments purchased with anoriginal maturity of three months or less to be cash equivalents.  All investment instruments with maturitiesgreater than three months are available for use in current operations andaccordingly are classified as current assets. All investments are considered available-for-sale and accordingly,unrealized gains and losses are included in a separate component of shareholders’equity.

 

As ofJune 30, 2003 cash and cash equivalents and short-term investments at costand fair market value consisted of the following:

* *
|                       |   | **June 30, 2003** |       |
|----------------------------|--------|------------------------|------------|
|                       |   | **Original  Cost**     |       | **Unrealized  Gains** |   | **Fair  Market  Value** |   |
| Cash and  cash equivalents |   | $                      | 8,636,209  |   | $ | — |   | $ | 8,636,209 |   |
|                       |   |                   |       |   |   |   |   |   |   |   |
| Short-term  investments    |   | 5,976,563              |       | 13,227 |   | 5,989,790 |   |
|                       |   |                   |       |   |   |   |   |
|                       |   | $                      | 14,612,772 |   | $ | 13,227 |   | $ | 14,625,999 |   |

 

----

 

As ofJune 30, 2003 short-term investments consisted of six debt instrumentsmaturing between July 15, 2003 and September 26, 2003.

 

SupplementalCash Flow Information

 

The Companypaid interest of $16,225 and $21,279 for the six months ended June 30,2003 and 2002, respectively.

 

RevenueRecognition

 

The Companygenerates revenue from subscriptions to its Internet-based proprietarytechnology applications and hosting of customer data, as well as developmentagreements, consulting services and staffing arrangements.

 

The Company’sagreements for its internet based tools provide to customers, among other things,a software license, project management services, data management services, datastorage and computer server maintenance and software support andmaintenance.  These agreements typicallycover an initial period of three-to-five years and are typically fixed priced.Revenues under these contracts are recognized ratably over the contract period.Any additional consulting fees, outside of the initial contract, are recognizedas the service is delivered.

 

The Companyhas also historically supported development agreements, with periods typicallyranging from three-to-five years that provided for customer funding for thedevelopment of new solutions and services. In accordance with Staff AccountingBulletin (SAB) No. 101, “Revenue Recognition in Financial Statements”, theCompany has treated revenue on those agreements as a single element contractand recognized revenue on a cost-to-cost basis over the entire agreementperiod.

 

The Company’svarious consulting services are delivered either as a single program or as aproject whose completion normally occurs over a multi-month period.  Consulting revenues from program servicesare recorded as the program is completed. Consulting revenues from projects are recorded on a percentage ofcompletion basis over the term of the project.   Staffing arrangement revenues are recognized ratably over thecontract period.

 

MajorCustomers

 

The Company’soperations are conducted in one business segment and sales are primarily madeto health care payors and providers. Two customers accounted for 23% and 27%, respectively, of total revenuesfor the three months and six months ended June 30, 2003,respectively.   Two different customersaccounted for 24% of total revenues for both the three and six months endedJune 30, 2002.

 

The Companyhad three customers as of  June 30,2003, which accounted for 47% of total accounts receivable.

 

ComprehensiveIncome

 

Accumulatedother comprehensive income consists of unrealized gains and losses on availablefor sale securities as follows:

 
| Balance,  December 31, 2002 |   | $       | 24,136 |   |
|----------------------------------|--------|---------|--------|--------|
| Current-period  change           |   | (10,909 | )      |
| Balance,  June 30, 2003     |   | $       | 13,227 |   |

 

Stock-BasedCompensation

 

The Companyaccounts for all stock-based plans under APB Opinion No. 25, “Accountingfor Stock Issued to Employees”, and related Interpretations, under whichcompensation expense is recognized based on the amount by which the fair valueof the underlying common stock exceeds the exercise price of the stock optionson the measurement date. For financial reporting purposes, the Company hasdetermined that the deemed fair market value on the measurement date forcertain stock options was in excess of the exercise price. This amount has beenrecorded as deferred compensation and is being amortized over the

 

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vesting period of theapplicable options, which range between four and seven years. The Companyrecorded deferred compensation of $5,624,839 and $120,683 during the yearsended December 31, 1999 and 2000.

 

Hadcompensation expense for all options issued been determined consistent withStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation,” the Company’s net loss, basic EPS and dilutedEPS would have been equal to the pro forma amounts indicated below:

 
|                                                                                                                  |   |        |   | **For the Three Months Ended  June 30,** |       | **For the Six Months Ended  June  30,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|-------------|--------|-----------------------------------------------|------------|----------------------------------------------|--------|
|                                                                                                                  |   |        |   | **2003**                                      |       | **2002**                                     |   | **2003** |   | **2002** |   |
| Net loss applicable to common shareholders                                                                            |   | As reported |   | $                                             | (2,465,754 | )                                            | $      | (1,080,756 | ) | $ | (4,378,787 | ) | $ | (2,578,350 | ) |
| Add – Stock-based employee compensation  included in Net Loss                                                    |   |        |   | 203,022                                       |       | 261,788                                      |   | 406,043 |   | 527,215 |   |
| Less – Total  stock-based employee compensation expense determined under fair value-based  method for all awards |   |        |   | (304,833                                      | )          | (411,173                                     | )      | (608,939 | ) | (820,748 | ) |
| Net loss  applicable to common shareholders                                                                           |   | Pro forma   |   | $                                             | (2,567,565 | )                                            | $      | (1,230,141 | ) | $ | (4,581,683 | ) | $ | (2,871,883 | ) |
|                                                                                                                  |   |        |   |                                          |       |                                         |   |   |   |   |   |   |   |   |   |
| Basic and  diluted EPS                                                                                                |   | As reported |   | $                                             | (0.19      | )                                            | $      | (0.08 | ) | $ | (0.33 | ) | $ | (0.19 | ) |
|                                                                                                                  |   |        |   |                                          |       |                                         |   |   |   |   |   |   |   |   |   |
|                                                                                                                  |   | Pro forma   |   | $                                             | (0.19      | )                                            | $      | (0.09 | ) | $ | (0.34 | ) | $ | (0.22 | ) |

 

Use ofEstimates

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual amounts could differ from those estimates.

 

New AccountingStandards Adopted

 

The Companyadopted the following accounting standards as of January 1, 2003:

 

SFAS  No. 143, “Accounting for Asset RetirementObligations”, SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64,Amendment of FASB Statement No.13 and Technical Corrections”, SFAS No.146,“Accounting for Costs Associated with Exit or Disposal Activities “ and FASBInterpretation No.45 “Guarantors Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness to Others”.  The impact of adopting the standards did nothave a material effect on the Company’s results of operations or financialposition.

 

InDecember 2002, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure.”  SFAS No. 148 amends SFASNo. 123, “Accounting for Stock-Based Compensation”, and is effective for fiscalyears ending after December 15, 2002. SFAS No. 148 amends the disclosure requirements of SFAS No. 123 torequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reported results. Disclosure requirements for interim financial statements are effectivefor interim periods beginning after December 15, 2002.  The Company has adopted these disclosurerequirements and these disclosures are included in the notes to theconsolidated financial statements.  Inaddition, SFAS No. 148 provides alternative methods of transition for a voluntarychange to a fair value based method of accounting for stock-based employeecompensation.  The Company has notcompleted its evaluation of the alternative methods of transition, and thus hasnot yet made a determination on whether it will adopt the fair value method ofaccounting for

 

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stock-based employeecompensation under the transition guidance of SFAS No. 148.  As such, the Company is not yet able todetermine what impact, if any, the adoption of this statement will have itsfinancial position or results of operations.

 

Reclassifications

 

Certainamounts have been reclassified in the prior years consolidated financialstatements to conform to the 2003 presentation.

 

RecentAccounting Pronouncements

 

InJanuary 2003, the Emerging Issues Task Force issued Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables.”  Issue No. 00-21 primarily addresses certain aspects of theaccounting by a vendor for arrangements under which it will perform multiple revenue-generatingactivities.  Specifically, it addresseshow to determine whether an arrangement involving multiple deliverablescontains more than one unit of accounting. In applying Issue No. 00-21, separate contracts with the same entity orrelated parties that are entered into at or near the same time are presumed tohave been negotiated as a package and should, therefore, be evaluated as asingle arrangement in considering whether there are one or more units ofaccounting.  That presumption may be overcomeif there is sufficient evidence to the contrary.  Issue No. 00-21 also addresses how arrangement considerationshould be measured and allocated to the separate units of accounting in thearrangements.  The provisions of IssueNo. 00-21 are effective for revenue arrangements entered into in fiscal periodsbeginning after June 15, 2003. Management believes that the impact of adopting this statement will nothave a material impact on our financial position or results of operations.

 

(2)          NET LOSSPER SHARE

 

Net loss pershare is calculated utilizing the principles of SFAS No. 128, “Earningsper Share” (“EPS”). Basic EPS excludes potentially dilutive securities and iscomputed by dividing net income available to common shareholders by theweighted-average number of common shares outstanding for the period. DilutedEPS is computed assuming the conversion or exercise of all dilutive securitiessuch as options and warrants.

 

Under SFASNo. 128, the Company’s granting of certain stock options resulted inpotential dilution of basic EPS. The number of incremental shares from theassumed exercise of stock options is calculated applying the treasury stockmethod. Stock options convertible into common shares were excluded from thecalculations as they were anti-dilutive due to the net loss.  Stock options to purchase 1,804,199 sharesof common stock at exercise prices ranging from $0.25 to $12.00 wereoutstanding as of June 30, 2003, but were excluded from the computation ofdiluted net loss per share since the inclusion would be anti-dilutive due tothe net loss.

 

(3)          COMMITMENTS ANDCONTINGENCIES

 

Litigation

 

The Company and certain of its officers are defendants in a purportedclass action litigation pending in the United States District Court for theEastern District of Pennsylvania. The complaints purport to bring claims onbehalf of all persons who allegedly purchased Company common stock betweenJune 29, 2000 and November 1, 2000, for alleged violations of thefederal securities laws, including Sections 11, 12(a)(2) and 15 of the SecuritiesAct of 1933 by issuing a materially false and misleading Prospectus andRegistration Statement with respect to the initial public offering of Companycommon stock.  On July 25, 2003,the Court dismissed all claims under Section 12(a)(2) of the Securities Act,but allowed the claims under Sections 11 and 15 of the Securities Act tocontinue.  Specifically, the complaintsallege, among other things, that the Company’s Prospectus and RegistrationStatement misrepresented and omitted to disclose material facts concerning theCompany’s competitors, two of the Company’s prospective products and theCompany’s contract with the California HealthCare Foundation.  The actions seek compensatory and otherdamages, and costs and expenses associated with litigation. Although the Companycannot predict the ultimate outcome of the case or estimate the range of anypotential loss that may be incurred in

 

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the litigation, managementbelieves the lawsuits are frivolous and without merit, strenuously denies allallegations of wrongdoing asserted by plaintiffs, and believes it hasmeritorious defenses to plaintiffs’ claims. The Company intends to vigorouslydefend the lawsuits.  Managementbelieves that the resolution of this litigation will not have a material effecton the Company’s consolidated financial position, results of operations orliquidity.

 

(4)          INCOME TAXES

 

The Companyhas incurred operating losses and generated a significant accumulated deficitthrough June 30, 2003, therefore, no tax provisions have been recorded. Asof June 30, 2003 the Company had federal net operating loss carryforwardsof approximately $37.4 million, which expire from 2010 through 2023.  As of June 30, 2003 and June 30,2002, a valuation allowance was recorded for 100% of the Company’s deferred taxasset as realization of the tax benefit was not considered more likely than notunder the provisions of SFAS No. 109.

 

The Tax ReformAct of 1986 contains certain provisions that limit the utilization of netoperating losses and tax credit carryforwards if there has been a cumulativeownership change greater than 50% within a three-year period. Such limitationcould result in the expiration of the net operating losses before such lossesare fully utilized.

 

(5)          RESTRUCTURING COSTS

 

InDecember 2002, the Company decided to minimize the pharmaceuticalresources associated with the Strategic Outcomes Services operations and moveany remaining resources from pharmacoeconomic consulting to data analysis andother activities consistent with its core care management business.  In accordance with FASB No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities”, the Companyrecognized  $180,000 of expense,included in selling, general and administrative expense, during the threemonths ended March  31, 2003 related to the estimated future leasecommitment for a vacated office lease. In addition, the Company recognized $422,000 of expense included inselling, general and administrative expense, during the three months ended June 30, 2003 related to theconclusion of employment for the Company’s former Chairman and Chief ExecutiveOfficer and costs associated with the closing of offices in California andNorth Carolina, including moving costs and the disposal of property andequipment.  Of these costs, $30,000 werepaid during the six months ended June 30,2003.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

This reportincludes a number of forward-looking statements that reflect our current viewswith respect to future events and financial performance. We use words such asanticipates, believes, expects, future, intends, and similar expressions toidentify forward-looking statements. For these statements we claim theprotection of the safe harbor for forward-looking statements contained in thePrivate Securities Litigation Reform Act of 1995. There are important factorsthat could cause actual results to differ materially from those expressed orimplied by such forward-looking statements, including:

 

•             the difficulty inevaluating our business because we operate in a new industry and our operatinghistory is limited;

•             we have a history oflosses and expect our losses to continue;

•             the proprietarytechnology we own or license may be subjected to infringement claims ordisagreements with the licensor which could be costly or impossible to resolve;

•             we depend on keycustomers;

•             the expiration inOctober 2002 of our consulting and development contract with theCalifornia HealthCare Foundation resulted in and may continue to result in asignificant, negative impact on revenue compared to  prior quarters;

•             we depend on anexclusive license with the University of Pennsylvania and an exclusive licensewith the California HealthCare Foundation for some of our technology, and theloss of these licenses would impair our ability to support, maintain anddevelop our business;

•             we could be liablefor information retrieved from our Web sites and incur significant costs fromresulting claims;

 

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•             we may experiencesystem failures which could interrupt our service and damage our customerrelationships;

•             the health careindustry may not accept our solutions or buy our services which would adverselyaffect our financial results;

•             our quarterlyfinancial results may fluctuate significantly, which could adversely affect theprice of our stock;

•             because our revenuesare dependent on a limited number of services, the failure of any one of theseservices would significantly decrease our revenues;

•             failure to managechanges in our business conditions would adversely affect our operations;

•             we face intensecompetition and may be unable to compete successfully which would adverselyaffect our financial results;

•             the loss of any ofour key personnel could adversely affect our operations and the recentconclusion of our prior Chief Executive Officer’s employment could have anegative impact on us and/or our customers;

•             our continuingfailure to develop strategic relationships could adversely affect our abilityto develop new services;

•             our failure to usenew technologies effectively or to adapt emerging industry standards wouldadversely affect our ability to compete;

•             our failure to adaptour technology to our customers’ needs or to handle high levels of customeractivity would adversely affect our ability to increase revenue;

•             failure by ourservice providers could interrupt our business and damage our customerrelationships;

•             we may need to obtainadditional capital and failure to do so may limit our growth;

•             our officers, directorsand affiliated entities have significant control over us and their interestsmay differ from your interests;

•             health information issubject to government regulation and legal uncertainties and changes mayrequire us to alter our business;

•             changes in the healthcare industry could adversely affect our operations;

•             our business willsuffer if commercial users do not accept Internet solutions;

•             our industry isevolving and we may not adapt successfully;

•             our common stock maycontinue to experience substantial fluctuations;

•             future sales ofshares could adversely affect our stock price;

•             our common stockcould be delisted from The NASDAQ SmallCap Market; and

•             the outcome of legalproceedings in which we are or may become involved could have an adverse effecton our business, results of operations, profitability and liquidity.

 

Overview

 

CareScience,Inc. is primarily a provider of care management services to hospitals andhealth systems. As a company specializing in clinical knowledge, we supply thepeople and technology to facilitate the delivery of quality care. Our missionis to make quality the way of life in health care by providing innovative caremanagement solutions to the health care industry. We help hospitals and healthsystems improve quality by building organizational support for change,addressing underlying barriers to improved clinical performance, and byexpanding the role of care management. We work with health care providers andhealth systems to manage clinical processes surrounding the point of care sothat fundamental reductions can be achieved in operating costs, clinicalinefficiencies and medical errors. We collect, share, store and analyzeclinical data generated by widely used health information systems and providethe care management services and staffing required to drive the realization ofunderlying clinical performance opportunities. We enable customers to applytheir clinical data to enhance patient safety and to the management of care,including quality monitoring, performance improvement, credentialing,profiling, error tracking, case management and evidence based medicine. We alsoprovide consulting services to health care providers that support strategicplanning and clinical operations.

 

We also haveprovided limited technology and services to the pharmaceutical andbiotechnology industry. Our offerings have included data analysis, consultingservices and customized research and strategic development support. Theseservices have been refocused to data and data analysis to leverage ourexpertise in care management and data analysis.

 

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Over the pastdecade, we have pioneered and commercialized several clinical informationtechnologies. We developed one of the nation’s first online quality measurementand management tools, commercialized one of the first clinically based outcomerisk assessment algorithms, became established as one of the first health careapplication service providers, and, most recently, developed the firstpeer-to-peer clinical data sharing technology.

 

CareSciencewas incorporated in 1992.  In 1993, weexclusively licensed the intellectual property underlying our core analytictechnology in a 30-year agreement with the University of Pennsylvania. In 1996,we launched our first Internet-based commercial solution based on thisproprietary technology through our Care Management SystemTM.  In 1999, we initiated development of theCare Data Exchange, ®(1) in October 2000, we licensed the coreclinical data exchange technology from the California HealthCare Foundation andon March 7, 2000, we changed our name from Care Management ScienceCorporation to CareScience, Inc.

 

In the fall of2002 due to a lack of perceived interest in the pharmaceutical marketplace, wediscontinued the active sale of our Lifecycle Decision System.  No significant revenue was ever generatedfrom the Lifecycle Decision System.  Wemay at some point in the future again decide to offer for sale the LifecycleDecision System; however, there are no plans at this time to do so.  Our significant consulting and developmentcontract with the California HealthCare Foundation for the Care Data Exchangeexpired in October 2002.  Althoughwe have entered into a limited extension contract with the CaliforniaHealthCare Foundation, that extension was for significantly less revenue thanthe initial consulting and development agreement and it is unlikely that thiscontract will be renewed and it may not continue.

 

OnJanuary 12, 2001, we acquired substantially all of the assets and certainliabilities of Strategic Outcomes Services, Inc., a pharmacoeconomic consultingcompany located in North Carolina.  Thetotal purchase price was approximately $1.3 million, which included a cashpayment of $1.1 million and 250,000 shares of our common stock.  The purchase agreement also provided foradditional contingent payments based on achieving revenue and profitabilitymilestones that are highly unlikely to be achieved.  No such contingent payments were accrued in 2001 or 2002 as therequired milestones were not met. The transaction was accounted for using thepurchase method of accounting. In December 2002, a goodwill impairmentcharge of $1,245,687 was recognized for the writedown of the goodwillassociated with the Strategic Outcomes Services operations, representing thedifference between the carrying amount of the unit and its fair value (asdetermined by using the expected present value of the expected future cashflows). Beginning in December 2002, we decided to minimize our remainingresources dedicated to the pharmaceutical marketplace and have since movedthose remaining resources from pharmacoeconomic consulting to data analysis andother activities consistent with our core care management business.

 

We generaterevenues from subscriptions to our Internet-based proprietary technologyapplications and hosting of customer data, as well as from consulting servicesand business process outsourcing, and from time to time, developmentagreements. We sell our solutions individually or as an integrated suite ofsolutions and services.  We price oursubscription services on a per-encounter basis, such as the number of ahospital’s patient admissions or outpatient visits.

 

Oursubscription agreements typically cover an initial three-year to five-yearperiod with provisions for automatic renewals. We recognize training andimplementation fees, as well as subscriptions and related hosting revenues, ona pro-rata basis over the life of the contract. We similarly recognize businessprocess outsourcing fees on a pro-rata basis over the life of the contract. Werecognize consulting fees as the program or service is delivered anddevelopment revenues on a cost-to-cost basis over the entire agreementperiod.  Staffing arrangement revenuesare recognized ratably over the contract period.

 

Our contractsgenerally provide for payment in advance of services rendered. Therefore, werecord these payments as deferred revenues and recognize these payments whenearned in accordance with our revenue recognition policy. Our deferred revenuebalances were $5.1 million and $4.1 million as of June 30, 2003and December 31, 2002, respectively.

 

More than 170health care organizations subscribe to our services.

 

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(1)  Care Data Exchange is a registered servicemark of the CaliforniaHealthCare Foundation.

 

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We have incurred substantial research and developmentcosts since inception and have also invested in our corporate infrastructure tosupport our long-term growth strategy. We expect that our operating expenseswill continue at historic or greater levels as we further our productdevelopment and sales and marketing efforts as we focus more highly on our corebusiness. Accordingly, we expect to continue to incur quarterly net losses forthe foreseeable future.

 

## Since inception, we have incurred cumulative net losses for federal andstate tax purposes and have not recognized any tax provision or benefit. As ofDecember 31, 2002, we had net operating loss carryforwards ofapproximately $37.4 million for federal income tax purposes. The net operatingloss carryforwards, if not utilized, expire from 2010 through 2023. Federal taxlaws impose significant restrictions on the utilization of net operating losscarryforwards in the event of an ownership change as defined inSection 382 of the Internal Revenue Code.

##  

## Critical Accounting Policies and Estimates

##  

Management’s Discussion and Analysis of the Company’s financialcondition and results of operations is based on the consolidated financialstatements and accompanying notes that have been prepared in accordance withthe accounting principles generally accepted in the United States.  The preparation of these financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

Thesignificant accounting policies of the Company are described in Note 1 to theconsolidated financial statements and the critical accounting policies andestimates are described in the Management’s Discussion and Analysis included inthe 2002 annual report on Form 10-K. Information concerning the Company’s implementation and impact of newaccounting standards issued by the Financial Accounting Standards Board(“FASB”) is included in the notes to the consolidated financialstatements.  Otherwise, the Company didnot adopt an accounting policy in the current period that had a material impacton the Company’s financial condition, change in financial condition, liquidityor results of operations.

 

## Results of Operations

##  

***ThreeMonths Ended June 30, 2003 and June 30, 2002***

*** ***

### *Revenues*

### * *

Total revenues decreased 11% to $3.2 million for thethree months ended June 30, 2003 from $3.5 million for the three monthsended June 30, 2002. The decrease was due primarily to the expiration ofdevelopment contracts with the California HealthCare Foundation and the associatedparticipants in the Santa Barbara County Care Data Exchange project that endedon October 1, 2002 and to a decline in pharmaceutical consultingrevenue.  Revenues from our developmentcontracts and our pharmaceutical consulting activities decreased from $1.3million  for the three months endedJune 30,  2002 to $23,000 inrevenues for the three months ended June 30, 2003.  This reduction more than offset an increaseof $891,000 in our core care management technology and service revenue from$2.2 million for the three months ended June 30, 2002 to $3.1 million forthe three months ended June 30, 2003.

 

Unrecognized revenues related to customer contracts(backlog) as of June 30, 2003 totaled $33.2 million.   This amount represents the Company’s unrecognizedrevenue on signed customer contracts and the associated future cashcollections, less deferred revenue, on those signed customer contracts.

 

### *Costof Revenues*

### * *

Cost of revenues includes customer and service-relatedcosts including personnel and facility costs, depreciation and maintenance.Cost of revenues for the three months ended June 30, 2003 was $1.6 milliona decrease of $94,000 or 6% compared to $1.7 million for the three months endedJune 30,  2002.

 

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*Gross Profit*

 

Our gross profit margin decreased from 53% for thethree months ended June 30, 2002, to 50% for the three months endedJune 30, 2003.  The decrease ingross profit margin is primarily due to the decrease of revenues spread over apartially fixed cost base.  We  expect our gross profit margin to increasein the future, to the extent that revenues from our core care managementtechnology and service  business  increase over the partially fixed cost base.  Gross profit margin will also be impacted bythe actual mix of technology and service revenues in current and futureagreements.

 

### *Researchand Development*

### * *

Research and development costs include technology andproduct development costs. Research and development costs for the three monthsended June 30, 2003 were $1.2 million, an increase of $566,000 orapproximately 90%, compared to $629,000 for the three months endedJune 30, 2002. This increase is primarily due to the expiration of ourfunded development contracts compared to the year ago period when the researchand development costs associated with funded development contracts were included in cost of  revenues .

 

As a percentage of revenues, research and developmentcosts were 38% for the three months ended June 30, 2003 as compared to 18%for the three months ended June 30, 2002. Although the actual expense mayincrease over 2003, we expect that these costs will decrease gradually as apercentage of revenue as our revenues increase in the future without matchingincreases in research and development costs.

 

### *Selling,General and Administrative Expenses*

### * *

Selling, general and administrative expenses includecosts associated with our sales, marketing, finance, human resource andadministrative functions. Selling, general and administrative expenses for thethree months ended June 30, 2003 were $2.9 million, an increase of$490,000, or 21% compared to $2.4 million for the three months endedJune 30, 2002.  The increase wasprimarily related to $422,000 in expense related to both the conclusion ofemployment for the Company’s former chairman and chief executive officer andcosts associated with the closing of offices in California and North Carolina,including moving costs and the disposal of property and equipment.

 

As a percentage of revenues, selling, general, andadministrative expenses were 91% for the three months ended June 30, 2003as compared to 67% for the three months ended June 30, 2002. We expectselling, general and administrative costs as a percentage of revenues todecrease in the future as we have completed the conclusion of employment forthe Company’s former chief executive officer and closed our offices inCalifornia and North Carolina.

 

### *InterestIncome and Expense*

### * *

Net interest income for the three months endedJune 30, 2003 was $25,000, a decrease of $39,000, compared to $64,000 forthe three months ended June 30, 2002.  The decrease is primarily due to lower investable cash balances, thetiming of certain securities sales and a decrease in investment interest rates.

 

***SixMonths Ended June 30, 2003 and June 30, 2002***

*** ***

### *Revenues*

### * *

Total revenues decreased 7% to $6.3 million for thesix months ended June 30, 2003 from $6.8 million for the six months endedJune 30, 2002. The decrease was due primarily to the expiration ofdevelopment contracts with the California HealthCare Foundation and theassociated participants in the Santa Barbara County Care Data Exchange projectthat ended on October 1, 2002 and to a decline in pharmaceuticalconsulting revenue. Revenues from our development contracts and ourpharmaceutical consulting activities decreased from  $2.6 million  for the sixmonths ended June 30, 2002 to $261,000 for the six months endedJune 30, 2003.  This reduction morethan offset an increase of $1.8 million in our core care management technologyand service revenue which increased from $4.2 million in revenue for the sixmonths ended June 30, 2002 to $6.0 million in revenue for the six monthsended June 30, 2003.

 

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Unrecognized revenues related to customer contracts(backlog) as of June 30, 2003 totaled $33.2 million.  This amount represents the Company’s  unrecognized revenue on signed customercontracts and the future associated cash collections, less deferred revenue, onthose signed customer contracts.

 

### *Costof Revenues*

### * *

Cost of revenues includes customer and service-relatedcosts including personnel and facility costs, depreciation and maintenance.Cost of revenues for the six months ended June 30, 2003 was $3.2 million adecrease of $205,000 or 6% compared to $3.4 million for the six months endedJune 30, 2002.  As revenuesincrease we expect our cost of revenues to increase.

 

### *GrossProfit*

### * *

Our gross profit margin was 50% for both the sixmonths ended June 30, 2003 and 2002. We expect our gross profit margin to increase in the future, to theextent that revenues from our core care management technology and servicebusiness continue to increase over a partially fixed cost base. Gross profitmargin will also be impacted by the actual mix of technology and servicerevenues in current and future agreements.

 

### *Researchand Development*

### * *

Research and development costs include technology andproduct development costs. Research and development costs for the six monthsended June 30, 2003 were $2.5 million, an increase of $1.1 million orapproximately 81%, compared to $1.4 million for the six months endedJune 30, 2002. This increase is primarily due to the expiration of ourfunded development contracts compared to the year ago period when the researchand development costs associated with the funded development contracts wereincluded in the cost of revenues.

 

As a percentage of revenues, research and developmentcosts were 39% for the six months ended June 30, 2003 as compared to 20%for the six months ended June 30, 2002. Although the actual expense mayincrease over 2003, we expect that these costs will decrease gradually as apercentage of revenues as our revenues increase in the future withoutincremental increases in research and development costs.

 

### *Selling,General and Administrative Expenses*

### * *

Selling, general and administrative expenses includecosts associated with our sales, marketing, finance, human resource andadministrative functions. Selling, general and administrative expenses for thesix months ended June 30, 2003 were $5.1 million, an increase of $333,000,or 7% compared to $4.8 million for the six months ended June 30,2002.  The increase was primarilyrelated to $602,000 in expense related to the conclusion of employment for theCompany’s former chairman and chief executive officer and costs associated withthe closing of offices in California and North Carolina, including moving costsand the disposal of property an equipment.

 

As a percentage of revenues, selling, general, andadministrative expenses were 82% for the six months ended June 30, 2003 ascompared to 71% for the six months ended June 30, 2002. We expect selling,general and administrative costs as a percentage of revenues to decrease in thefuture as we have completed the conclusion of employment for the Company’sformer chief executive officer and closed our offices in California and NorthCarolina.

 

### *InterestIncome and Expense*

### * *

Net interest income for the six months endedJune 30, 2003 was $86,000, a decrease of $76,000, compared to $162,000 forthe six months ended June 30, 2002.  The decrease is primarily due to lower investable cash balances and adecrease in investment interest rates.

 

***Liquidityand Capital Resources - June 30, 2003***

*** ***

Since inception, we have financed our operations andfunded our capital expenditures through the public offering and private sale ofequity securities, supplemented by private debt and equipment leases.  We believe that current capital resourceswill be sufficient to fund anticipated capital expenditures and

 

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working capital requirementsthrough at least 2004.  As ofJune 30, 2003, we had $14.6 million in cash and cash equivalents andshort-term investments and working capital of $10.7 million.

 

Net cash used in operating activities was $2.0 millionfor the six months ended June 30, 2003 and $1.8 million for the six monthsended June 30, 2002.  For thoseperiods, net cash used in operating activities was primarily to fund lossesfrom operations offset by changes in current assets and liabilities.

 

Net cash used in investing activities was $901,000 forthe six months ended June 30, 2003 and $1.3 million for the six months ended June 30, 2002 and consistedprimarily of the purchases of short-term investments, net of proceeds, andpurchases of property and equipment

 

Net cash used in financing activities was $170,000 forthe six months ended June 30, 2003 and consisted of payments on capitallease obligations and notes payable net of the proceeds from the exercise ofcommon stock options.  Net cash providedby financing activities was $225,000 for six months ended June 30, 2002,and consisted of proceeds from a note payable and the exercise of common stockoptions offset by payments on capital lease obligations and notes payable.

 

As we execute our strategy, we expect our operatingexpenses  to increase over time as wefund the development and sales and marketing of current and new servicelines.  Presently, we anticipate thatour existing capital resources will meet our operating and investing needsthrough at least 2004.  After that time,additional funding may not be available on acceptable terms or at all.  If we require additional capital resourcesto grow our business, execute our operating plans or acquire complementarybusinesses at any time in the future, we may seek to sell additional equity ordebt securities or secure additional lines of credit, which may result inownership dilution to our shareholders.

 

ContractualObligations and Commercial Commitments

 

The Company is obligated to make future payments undervarious contracts such as debt agreements, lease agreements and softwarelicensing agreements.  There have beenno material changes to Contractual Obligations and Commercial Commitments asreflected in the Managements Discussion and Analysis in the Company’s 2002 annualreport on Form 10-K.  Refer to Notes 6and 7 to the consolidated financial statements in the Company’s 2002 annualreport on Form 10-K for additional information on long-term debt and capitalleases and Note 8 for information on commitments and contingencies

 

RecentAccounting Pronouncements

 

InJanuary 2003, the Emerging Issues Task Force issued Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables.”  Issue No. 00-21 primarily addresses certain aspects of theaccounting by a vendor for arrangements under which it will perform multiplerevenue-generating activities. Specifically, it addresses how to determine whether an arrangementinvolving multiple deliverables contains more than one unit of accounting.  In applying Issue No. 00-21, separatecontracts with the same entity or related parties that are entered into at ornear the same time are presumed to have been negotiated as a package andshould, therefore, be evaluated as a single arrangement in considering whetherthere are one or more units of accounting. That presumption may be overcome if there is sufficient evidence to thecontrary.  Issue No. 00-21 alsoaddresses how arrangement consideration should be measured and allocated to theseparate units of accounting in the arrangements.  The provisions of Issue No. 00-21 are effective for revenuearrangements entered into in fiscal periods beginning after June 15,2003.  Management believes that theimpact of adopting this statement will not have a material impact on ourfinancial position or results of operations.

 

InDecember 2002, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure.”  SFAS No. 148 amends SFASNo. 123, “Accounting for Stock-Based Compensation, “ and is effective forfiscal years ending after December 15, 2002.  SFAS No. 148 amends the disclosure requirements of  SFAS No. 123 to  require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based  employee compensation and the effect of themethod used on reported results. Disclosure requirements for interim financial statements are effectivefor interim periods beginning after December 15,2002.  The Company has adopted these disclosurerequirements and these disclosures are included in the notes to theconsolidated financial statements.  Inaddition,, SFAS No. 148 provides alternative methods of transition for avoluntary change to a fair value based method of accounting for stock–based  employee

 

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compensation.  The Company has not completed its evaluationof the alternative methods of transition, and thus has not yet made adetermination on whether it will adopt the fair value method of accounting forstock-based employee compensation under the transition guidance of SFAS No.148.  As such, the Company is not yetable to determine what impact, if any, the adoption of this statement will haveits financial position or results of operations.

 

ITEM 3.   QUANTITIATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our cash equivalents, short-term investments, notepayable and capital lease obligations are at fixed interest rates and thereforethe fair market value of these instruments is affected by changes in marketinterest rates.  As of June 30,2003 all of our short-term investments mature within 3 months and we had theability to immediately liquidate our investments.  Therefore, we believe that we are exposed to immaterial levels ofmarket risk.

 

ITEM 4.   CONTROLS AND PROCEDURES

 

a.               We carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s President and Chief Executive Officer alongwith our Controller, our principal accounting officer, of the effectiveness ofthe design and operation of our disclosure controls and procedures as of theend of the period covered by this report pursuant to Exchange Act Rules13a-14(c) and 15d-14(c). Based upon that evaluation, the Company’s Chairman andChief Executive Officer along with our Controller concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to the Company (including its consolidated subsidiary)required to be included in our periodic SEC filings.

 

b.              There have been nosignificant changes in our internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date our President andChief Executive Officer along with our Controller carried out this evaluation.

 

PART II.  OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We and certain of our officers are defendants in apurported shareholder class action lawsuit litigation pending in the UnitedStates District Court for the Eastern District of Pennsylvania described belowfor alleged violations of federal securities laws. Although we cannot predictthe ultimate outcome of the case or estimate the range of any potential lossthat may be incurred in the litigation, we believe the lawsuits are frivolousand without merit, strenuously deny all allegations of wrongdoing asserted byplaintiffs, and believe we have meritorious defenses to plaintiffs’ claims. Weintend to vigorously defend the lawsuits.

 

The class action litigation is the result of severalcomplaints filed with the court beginning on October 17, 2001.  These actions were consolidated onNovember 16, 2001. The court approved the selection of the lead plaintiffin the litigation on March 12, 2002. We filed a motion to dismiss theconsolidated complaint on August 7, 2002. These complaints purport to bring claims on behalf of all persons whoallegedly purchased our common stock between June 29, 2000 andNovember 1, 2000, for alleged violations of the federal securities laws,including Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 by issuinga materially false and misleading Prospectus and Registration Statement withrespect to the initial public offering of our common stock.  Specifically, the complaints allege, amongother things, that our Prospectus and Registration Statement misrepresented andomitted to disclose material facts concerning our competitors, two of ourprospective products and our contract with the California HealthCareFoundation. On July 25, 2003, the Judge granted our motion to dismiss theclaims under Section 12(a)(2) of the Securities Act, but denied our motion todismiss the claims under Sections 11 and 15 of the Securities Act.  The actions seek compensatory and otherdamages, and costs and expenses associated with litigation.

 

At this time, we are not involved in any other legalproceedings that either individually or taken as a whole would have a materialadverse effect on our business, financial condition or results of operations.

 

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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

 

Use of Proceeds

### * *

On June 28,2000 the Securities and Exchange Commission declared effective our RegistrationStatement on Form S-1 (File number 333-32376), relating to the initial publicoffering of our Common Stock, no par value per share. The net offering proceedsto us after total expenses were $43.4 million. As of June 30, 2003, wehave used approximately $29.8 million of the net proceeds from our initialpublic offering of which approximately $17.2 million was used for workingcapital and other general corporate purposes, including expansion of our salesand marketing efforts as well as development of our solutions and services,approximately $6.5 million was used for dividends on and the redemption ofpreferred stock, approximately $3.9 million was used for the purchase of propertyplant and equipment , including technology and equipment expenditures requiredto support our product development infrastructure,  $1.0 million was used for the repayment of indebtness and $1.1million was used for the acquisition of Strategic Outcomes Services, Inc.

 

None of the net proceeds from the offering were usedto pay, directly or indirectly, directors, officers, persons owning ten percentor more of the Company’s equity securities, or affiliates of the Company.

 

ITEM 5.  OTHER EVENTS

 

On June 24, 2003, we entered into a SeparationAgreement with our former chief executive officer, David J. Brailer pursuant towhich Dr. Brailer concluded his employment as our chief executive officer andagreed to provide transition services in return for payments by us.  A copy of the Separation Agreement isattached as Exhibit 10.1 to this quarterly report on Form 10-Q and the terms ofthe Separation Agreement are incorporated by reference herein.

 

ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K

 

(a)          Exhibits

 

See Exhibit Index

 

(b)         Reports onForm 8-K

 

May 1, 2003 to report Results of Operations and FinancialInformation and Exhibits under Item 12 of Form 8-K.

 

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Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
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|   |                |   |                                  |
|   |                |   |                                  |
| Date:  | August 7, 2003 | By:    | /s/  Ronald Paulus                    |   |
|   |                |   | Ronald Paulus                         |
|   |                |   | President and Chief Executive Officer |
|   |                |   |                                  |
| Date:  | August 7, 2003 | By:    | /s/  Kurt Palek                       |   |
|   |                |   | Kurt Palek                            |
|   |                |   | Controller and Treasurer              |
|        |                     |        |                                       |  |  |

 

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EXHIBIT INDEX

 
| **Exhibit  No.** |   | **Description**                                                                                                    |
|------------------|--------|--------------------------------------------------------------------------------------------------------------------|
| 10.1             |   | Separation Agreement, dated as of June 24,  2003, between the Registrant and David J. Brailer.                |
|             |   |                                                                                                               |
| 31.1             |   | Certification of President and Chief Executive  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|             |   |                                                                                                               |
| 31.2             |   | Certification Controller and Treasurer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                 |
|             |   |                                                                                                               |
| 32.1             |   | Certification of President and Chief Executive  Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|             |   |                                                                                                               |
| 32.2             |   | Certification of Controller and Treasurer pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.              |

 

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