##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K (MARK ONE) þ
    
    ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the fiscal year ended: December 31, 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 0-21485 SUPERIOR CONSULTANT HOLDINGS CORPORATION  Delaware
(State or Other Jurisdiction of
Incorporation or Organization)17570 West Twelve Mile Road, Southfield, Michigan
(Address of Principal Executive Offices)
    
    38-3306717
(I.R.S. Employer
Identification No.)48076
(Zip Code)
 Registrants telephone number, including area code: (248) 386-8300 Securities registered pursuant to section 12(b) of the act: None Securities pursuant to section 12(g) of the act:
Common Stock, par value $.01 per share
(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
filings requirements for the past 90 days. Yes x No o 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. o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Act). Yes o No x The aggregate market value of voting stock held by non-affiliates of the
registrant based upon the closing sale price of the stock as reported on the
NASDAQ National Market on the last business day of the registrants most
recently completed second quarter, June 30, 2003, was
$9,487,044. At March 29, 2004,
10,407,399 shares of the registrants Common Stock were outstanding, excluding
treasury shares. DOCUMENTS INCORPORATED BY REFERENCE The registrants definitive proxy statement for the annual meeting of
stockholders, to be held in July 2004, expected to be filed with the Commission
not later than April 29, 2004, is incorporated by reference into Part III of
this Form 10-K.




---



TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERSITEM 6. SELECTED CONSOLIDATED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESPART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KINDEX TO CONSOLIDATED FINANCIAL STATEMENTSREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTSCONSOLIDATED BALANCE SHEETSSIGNATURESINDEX TO EXHIBITSAmend. to Employment Agmt. of Richard P. SaslowEmployment Agreement for George S. HuntzingerAmend. to Employment Agmt. of Richard R. SorensenSubsidiariesCertification of Chief Executive OfficerCertification of Chief Financial Officer906 Certification of CEO and CFO    Table of Contents  
 PART I 
 ITEM 1. BUSINESS Summary Superior Consultant Holdings Corporation (Superior or the Company) is
a leading national provider of Digital Business Transformation
services to the healthcare industry that enable
our clients to thrive in the information-driven economy and help them plan and
execute better business strategies to meet their fiscal challenges while
advancing clinical quality. Through our primary operating subsidiary,
Superior Consultant Company, Inc., we offer business process and
information technology (IT) outsourcing, management and
consulting services and assistance to healthcare organizations, including health
plans and technology providers, with special emphasis on hospital systems and
integrated delivery networks. When we use the terms
Company or Superior, we are referring
collectively to the Company together with Superior Consultant
Company, Inc. We have deep proficiency in clinical, financial and
administrative systems consulting, including planning, selection and
implementation. With extensive industry application knowledge and experience,
and specialists in business process improvement, we apply critical industry
context and expertise to our engagements. Our best practices
outsourcing model includes a full range of flexible business process and IT
solutions, data center services, including 24/7/365 network monitoring and help
desk services through our network control center, facility management, interim
management, and application outsourcing services. By participating in our
world-class processing center, clients gain the benefits of purchasing power,
application integration and shared initiatives in addition to consistent
service levels and a single source of accountability. In order to address the increased industry-wide focus on patient safety,
clinical excellence, compliance with security regulations and financial
performance, our services and solutions are designed to give the healthcare
industry the tools and strategies they need to serve their customers
effectively, improve the quality and safety of clinical care, secure and
authenticate online healthcare transactions, reduce cost and ensure compliance
with evolving government and industry requirements, including the Health
Insurance Portability and Accountability Act (HIPAA) and bar
coding mandates. From education, visioning and planning to implementation and outsourcing,
we provide the following services and solutions that are designed to help
client organizations perform better: Outsourcing  
    
    Business Process Outsourcing
    
    Full-service IT Outsourcing
    
    Processing Center
    
    Network Control Center with Remote Network Monitoring, Management and Help Desk Services 24/7/365
    
    Outsourcing Consortium
    
    Facilities Management
    
    Application Management
    
    Interim Management Consulting  
    
    Strategy Formulation 2




---



##### Table of Contents




    
    Financial Systems
    
    Application Delivery - Clinical Information Systems
    
    Application Delivery - Revenue Cycle Information Systems
    
    Application Delivery - Administrative, Decision Support and
other Healthcare Information Systems
    
    Systems Integration Because of our deep knowledge of the healthcare industry and our clients
needs, and our extensive experience with a broad range of healthcare operations
and workflow, IT and clinical systems, we are able to work with clients to
enable them to leverage their existing legacy information system investments
and accelerate their return on those investments by connecting them to
web-based or other technologies. We believe that our long-term relationships,
in-depth knowledge of the healthcare industry and our clients needs coupled
with our range of service offerings endow us with significant advantages over
our competitors in marketing additional services and winning new engagements.
We believe we are well positioned to help healthcare providers bridge
traditional services to a digital environment and capitalize on inherent
market, care delivery and business efficiency benefits. Our goal is to be the
preferred, if not sole, provider of a broad range of outsourcing and consulting
solutions for each of our clients. Industry Background General Healthcare providers today face external and internal pressures to meet
the competitive demands of the marketplace, pursue their strategic initiatives
and comply with increasing government regulations, while also improving their
bottom line. The United States healthcare industry continues to undergo rapid,
profound change. In recent years, healthcare expenditures have increased at
approximately twice the rate of inflation. In 2002, healthcare spending rose
9.3% to $1.6 trillion and accounted for 14.9% of the nominal gross domestic
product, the largest share on record. Healthcare expenditures are expected to
outpace GDP growth by an average of 2.0% per year from 2003 to 2013, double
2002 levels, according to a CMS Office of the Actuary report published in
Health Affairs. There is a greater emphasis placed on issues of patient safety
and the prevention of medical errors, competition in clinical care quality and
IT innovation, as well as heightened awareness of the urgency to implement
electronic medical records, digital security measures and compliance
strategies, as well as bar coding technologies. We believe that these factors,
combined with changes in federal, state and commercial/private payer
reimbursement, slowed growth of Medicare payments, the aging of the U.S.
population and the growing acceptance of the Internet and web-based
technologies, and spurred by the increasingly vocal demands of consumers for
quality care, will result in continued dramatic change in the healthcare
industry. Healthcare Information Technology The healthcare IT environment is increasingly complex and costly.
Healthcare IT must address the challenges inherent in deploying new
technologies, maintaining or integrating older systems and deploying an IT
function capable of meeting new objectives. Healthcare IT services must help
to improve clinical quality and patient safety, achieve regulatory compliance
and ensure secure digital transactions while at the same time improving
business operations and the revenue cycle as well as reducing supply costs.
With all of these pressures, healthcare organizations must become more
efficient and effective. As a result, we believe that the healthcare industry
will increase the percentage of its budget devoted to IT solutions. Integrating
web-based or Internet technology, computerized practitioner order entry, or
CPOE, electronic medical records systems, bar coding and other technologies
into the healthcare delivery process can enable organizations to improve their
financial performance. These technologies can help healthcare organizations
reduce costs through clinical and supply chain efficiencies, enhance
communications with physicians, patients, payers and other constituencies,
improve care delivery and patient safety and streamline activities such as
claims processing, eligibility verification and billing. With the increased move to digital communications by virtually all
segments of the industry  providers, payers, consumers, health plans,
suppliers, employers and employees  all participants have the opportunity to
effectively address the cost-containment pressures of federal, state,
commercial/private payers and to meet strict privacy mandates and regulations.
Our extensive experience with all major healthcare software vendors along with
a multitude of other applications, enables our company to implement and
integrate best practices IT solutions to improve our clients performance and
leverage their existing IT investments. 3




---



##### Table of Contents



We believe that healthcare participants will continue to turn to outside
consultants, external management of internal information systems, application
support and full outsourcing arrangements as a means of coping with the
financial and technical demands of information systems management and
integration of web-based solutions. Superior responds to these demands by
providing information technology and management consulting services and
solutions along with flexible business process and information technology
outsourcing solutions. Clients can choose any combination of support, including
full outsourcing with data center consolidation, 24/7/365 network monitoring
and help desk through our network control center, as well as facility
management, application unification, application outsourcing and interim
management of business process and IT operations. Through outsourcing, clients
can achieve their business process and information technology goals while
remaining focused on expanding their primary businesses and reducing related
capital outlay. Outsourcing We believe that the competitive, technical, clinical and economic
challenges facing healthcare providers today will spur those providers, in
increasing numbers, to consider outsourcing of their business processes and/or
information technology functions. With the range of business process,
management and information technology outsourcing solutions that we offer, we
can assist clients to address many of the challenges they face while allowing
them to focus on their primary business objectives. Our outsourcing solutions
offer clients cost effective operation of their business processes and
information technology functions and potential reduction in related capital
outlay. We deliver to our outsourcing clients best practice solutions and the
technical advances and expertise that Superior develops through its outsourcing
and consulting services. Our flexible continuum of outsourcing solutions allows
our clients to select the level of support most suitable to their situation. We
offer full business process and IT management and operations outsourcing,
including data center consolidation in our world-class processing center. We
also offer 24/7/365 network monitoring and help desk support from our network
control center. Our outsourcing solutions enable clients to meet critical
completion timetable needs by providing availability of the expertise resident
in our nationally deployed specialists, thus allowing clients to pursue a
greater number of IT initiatives concurrently. Further, our experience and
expertise in the implementation and operation of various applications provides
our outsourcing clients with ever-evolving, best practices operational models.
We offer other outsourcing alternatives, including facility management,
application unification, application outsourcing and interim management of
business process and IT operations. Consulting The changing business environment has also produced an evolving range of
strategic and operating options for healthcare entities. In response,
healthcare participants are formulating and implementing new strategies and
tactics, redesigning business processes and workflows, acquiring better
technology to improve operations and patient care, integrating legacy systems
with web-based technologies, developing e-commerce abilities and adopting or
remodeling customer service, patient care and marketing programs. We believe
that healthcare participants will continue to turn to outside consultants to
assist in this vast array of initiatives for several reasons: the pace of
change is eclipsing the capacity of their own internal resources to identify,
evaluate and implement the full range of options; consultants enable healthcare
participants to develop better solutions in less time and can be more cost
effective. By employing outside expertise, healthcare providers can often
improve their ability to compete by more rapidly deploying new processes. In 2003, the healthcare consulting industry was highly fragmented and
consisted primarily of:  
    
    Larger systems integration firms, including the consulting divisions
of the national accounting firms and their spin-offs, which may or may
not have a particular healthcare focus or offer healthcare consulting as
one of several specialty areas;
    
    Healthcare information systems vendors that focus on services
relating to the software solutions they offer;
    
    Healthcare consulting firms, many of which focus on selected
specialty areas, such as strategic planning or vendor-specific
implementation;
    
    Large general management consulting firms that may or may not
specialize in healthcare consulting and/or do not offer systems
implementation; and
    
    Boutique firms that offer one or two specialized services, or who
service a particular geographic market. 4




---



##### Table of Contents



We believe that, increasingly, the competitive advantage in healthcare
consulting will be gained by those consulting firms which:  
    
    Are able to coordinate the necessary expertise and resources to offer
comprehensive skill sets and packaged solutions to clients;
    
    Have the vision, strength and consistency to advise clients along the
entire service continuum, from strategy to selection to implementation
to operation;
    
    Offer the flexibility to meet the challenges of the rapidly changing
healthcare, digital business communication and IT environment; and
    
    Have assets to bring total solutions including offerings that address
the clients need for market expansion and capital replacement. The Superior Solution Our outsourcing and consulting services provide all segments of the
healthcare industry, including health plans and technology providers,
with special emphasis on hospital systems and integrated delivery
networks, with the critical tools and strategies needed to
effectively serve customers, manage patient care and workflows, enhance
financial performance, improve patient safety, and capitalize on
digital business communication and
other new technology opportunities while ensuring digital security. We offer
custom-tailored services and packaged solutions based on an assessment of each
clients needs. Our continuum of solutions includes: strategy formulation, information
technology and digital business communication planning and capital resources planning; operations
and revenue cycle management, organizational change and business process
redesign and outsourcing; automation of workflows, computerized practitioner
order entry, clinical transformation and patient records; information
technology design and construction, application implementation, information
systems implementation and integration; and IT interim management, application
unification, application support, network monitoring and help desk, business
process and information technology outsourcing. For each client and engagement,
we structure a project team that understands the impact of the changing
healthcare environment on that particular client and can address the
management, operational and technical ramifications of change and improvement.
In structuring an engagement, we draw upon our solutions framework to bring our
clients the most efficient, cost effective solution to meet their needs. Our
nationally deployed professionals are aided by instant access, via our
proprietary information and communication system, to our knowledge and client
resource databases and to collaboration with colleagues. Our unified team
approach helps to ensure high quality, consistent and geographically seamless
client service. Outsourcing Our outsourcing offers a variety of solutions designed to meet client
needs, which include complete or partial business process and/or IT
outsourcing, interim management and remote network support. We provide clients
with a complete solution for effective management of information and technology
and IT cost control. Our best practices outsourcing model includes a full range
of flexible business process and IT solutions, including 24/7/365 network
monitoring and help desk services, facility management, interim management, and
application outsourcing services. By participating in our common processing
center, clients gain the benefits of purchasing power, application integration
and shared initiatives in addition to consistent service levels. Clients can choose one or any combination of:  Full-Service Business Process and IT Outsourcing  We offer single-source
accountability and a state-of-the-art processing center to help clients
achieve higher performance and lower costs. Our outsourcing clients may join a
consortium of healthcare organizations that offers them an opportunity to
drive down the cost of information systems through resource and systems
sharing including hardware, software and infrastructure.NetLinc  Remote Network Monitoring and Help Desk Services 24/7/365  Our
NetLinc control center offers solutions designed specifically as an element of
clients IT functions, such as help desk and network management, application
support and development, and network monitoring. 5




---



##### Table of Contents



Facilities Management  We become the clients full technology partner by
operating IT (hardware and application functions) and managing/transitioning
staff on the clients site or remotely.Application Management  We provide ongoing services to support the efficient
operation of critical applications.Interim Management  We provide senior-level technology executives to guide
the operations and initiatives of clients IT functions, including interim
privacy/security officers. Consulting Our services are the building blocks of every solution we offer,
integrating management consulting and technology expertise to meet the entire
range of clients needs as they deal with the financial challenges and
operational issues all healthcare providers face today. Our services and
solutions  from boardroom strategy planning to implementation to fine-tuning
of technical and operational project details  enable clients to maximize and
build upon their existing IT investments and leverage digital technology for
future growth. Strategy Formulation  Combining the knowledge of healthcare managers,
consultants, clinicians and renowned futurists, we help clients to better
understand the competitive market within which they operate and to develop and
execute business strategies that address market dynamics, quality of care,
financial performance, technology development and resource allocation across
their entire organizations. Our multi-disciplinary approach integrates
strategic/business planning, operations redesign and clinical and financial
analysis, as well as reconfiguration of existing technology architecture to
achieve clinical transformation and desired outcomes in quality, cost
reduction, clinical productivity and increased satisfaction among
patients, physicians and employees. Superior's
Clinical Transformation Management program is a structured,
culturally sensitive process to redesign work flows, implement best
practices and adopt technologies that integrate resources and
standardize operations in support of specified improvements in
clinical, operational and economic objectives. From readiness assessments to strategic planning to implementation, we
help clients to take advantage of new technologies and processes to improve
digital proficiency and security and comply with HIPAA, CMS, JCAHO and other
applicable regulations. Financial Systems  Our resource planning solutions promote
enterprise-wide integration and help organizations respond to changing market
conditions. We assess infrastructure needs (financial, human resources and
materials management), reengineer business processes to optimize infrastructure
operations and ROI, and implement appropriate financial systems. We manage the revenue cycle  from redesigning business processes to
installing or troubleshooting information systems  to actually managing and
performing accounts receivable collection activities for our clients, to help
clients accelerate cash flow and positively affect their bottom line. We work
closely with client staff to reduce accounts receivable, re-deploy assets and
improve operational efficiencies. Application Delivery  We specialize in selecting, customizing, and
implementing all major healthcare software applications. Services include
pre-implementation planning, system implementation and integration, patient
accounting and business improvement, and system optimization. Our integrated solutions are designed to automate, track and assure the
quality of the medication process to dramatically reduce medication errors -
the most common and costly of medical mistakes. By combining clinical
discovery, assessment, benchmarking, troubleshooting and decision support
tools, and integrating technologies such as CPOE, electronic medical records
and bar coding, we help clients create optimal care models and methodologies
that reduce medical mishaps and improve clinical outcomes. To assist our clients in achieving the optimal strategic, clinical,
operational, IT and digital business communication solutions for their business needs, we draw upon
our expertise with the products of a vast array of vendors. Through this
in-depth product knowledge, we are able to fully assess the advantages and
disadvantages of each particular strategic, clinical, operational, IT and
digital business communication solution in the context of the individual clients needs.
Additionally, through select alliances and relationships, we are able to bring
an aggregation of products and services packaged to suit client needs. We have
experience with the products of hundreds of vendors. Systems Integration  We have a national focus on promoting the use of
electronic information exchange to address the opportunities and challenges of
the healthcare industry. We assist our clients with network and
telecommunication design and 6




---



##### Table of Contents



acquisition, enterprise messaging, intranet and web strategies and design,
workgroup technology, as well as software and application development
solutions. We provide a bridge between existing and emerging technologies by
supplying vendors with needed knowledge to develop innovations focused on the
changing needs of the marketplace and by assisting healthcare industry
participants to assess, select and implement new technologies. This enables us
to help our clients take advantage of the opportunities presented by
technologies such as the Internet and intranets, local and wide area
communication networks and network medicine. Developments in 2003 Superior achieved several financial and business developments during 2003,
including:  
    
    Receiving the 2003 Best Bang for the Buck Award from Frost &
Sullivan, a global leader in growth consulting. Superior has been
awarded this distinction for providing the highest value to cost ratio
in its outsourcing and consulting services and solutions. Superior is
only the second company ever to receive this prestigious award from
Frost & Sullivan.
    
    Signing two new multi-year, multi-million dollar outsourcing
agreements representing a base value of over $77 million.
    
    Adding over 100 new clients in 2003.
    
    Achieving positive earnings before interest, taxes, depreciation,
and amortization (EBITDA) of $4.2 million for the year ended December
31, 2003. (Refer to Item 6 Selected Consolidated Financial
Data for a reconciliation of net loss to EBITDA.)
    
    Generating positive cash flow from operations of $1.8 million for the year ended December 31, 2003.
    
    Increasing outsourcing net revenue by 24% over the prior year.
    
    Issuing Subordinated Notes and Warrants to private institutional
investors for an aggregate investment of $8,000,000.
    
    Completion of a modified Dutch Auction tender to repurchase 355,782 shares of
our common stock at a price of $3.60 per share, and additional open
market purchases of 76,500 shares. Employees We believe that one of our key strengths lies in our ability to attract,
develop, motivate and retain a talented, creative and highly skilled work force
of senior-level professionals who are specialists in one or more areas of
healthcare, information technology and digital business communication. Our consultants are highly
experienced and many have established their credentials as healthcare
executives and senior management of healthcare organizations, senior technical
officers, business office managers, medical records administrators, nurse
administrators, nurses, laboratory technicians, physician assistants, medical
technologists, physicians, pharmacists, hospital admissions directors and
information management and information systems technical personnel. As of
December 31, 2003, we employed 609 employees, 484 of whom were
consultants or outsourcing personnel. Of
the 125 remaining personnel, a significant number of our senior and middle
management perform a variety of line functions, including sales and
marketing, client billable
consulting and advisory services. We believe we have a unique corporate culture built upon open
communication across geographic regions and Competency Centers fostered by our
proprietary information and communications system, which currently runs on a
robust intranet, and a motivational and interactive work environment that
features professional development opportunities and productivity incentives. 7




---



##### Table of Contents



An integral part of the on-going education process at Superior takes place
through our communications system. This allows our consultants to continue to
upgrade their skills while remaining deployed in the field. We also maintain a
formal and active network of former employees. These alumni provide expertise
on projects, introduce us to new client leads and in many cases have returned
to Superior from experiences elsewhere in the healthcare industry. Sales and Marketing Our executive leadership and our client relationship leadership (Client
Partner Organization leaders) focus intensely on client development strategies,
geographic market penetration, cross-selling, and on securing larger and more
profitable engagements. Business development is an integral part of the formal
responsibilities at all levels of our management, including Competency Center
leaders, and we set business development goals on both a departmental and
individual basis. We utilize a sales methodology which is successfully employed
by many Fortune 500 companies. Our senior executives lead the companys
outsourcing sales program and manage specialized outsourcing sales teams as
well as prospecting, proposal development, negotiation, transition and
delivery. Our business development efforts focus primarily on identifying key
decision makers in the healthcare industry, determining the value we can bring
to each potential client and then managing the sales process to completion
through a sophisticated sales program and proprietary client resource database,
developed and maintained internally. Our client resource database enables our
personnel to access information on our efforts with respect to a client or
client prospect, identify other Superior contacts with that client and
highlight the particular needs expressed by the client. We further our business development efforts through our reputation in the
marketplace, the personal contacts and networking of our professionals, direct
industry marketing programs, trade shows, our Internet web site (located at
www.superiorconsultant.com), and the industry presence maintained by our
professionals. Our marketing profile within the healthcare industry is enhanced
by our employees speaking engagements and publications on topics affecting
healthcare. Our views on a wide range of healthcare and IT topics are
frequently solicited and quoted for articles in major industry journals and
books. Our healthcare consultants have been published extensively on current
and emerging topics in healthcare information and management and have
participated in external speaking engagements and presentations to industry
associations and client audiences internationally. We operate our healthcare outsourcing and consulting businesses through a
combination of our national presence, regional relationships and our Competency
Centers. Each Competency Center offers a selected variety of our healthcare
consulting services and often two or more of these areas work synergistically
together and with other industry leaders to develop and package repeatable
solutions or market offerings for clients. Each Competency Center is managed by
a leader who is responsible for achieving performance-based goals for the
specific area and is responsible for its growth. We actively market the
subject-matter expertise of our Competency Centers through the focus of our
Client Partner Organizations. Each Client Partner Organization is responsible
for developing and enhancing knowledge of local regulation and market factors,
as well as developing and nurturing relationships with specific client and
partner organizations. This enables us to combine the expertise of our
Competency Centers to form customized, as well as repeatable packaged solutions
that are responsive to local conditions and of value to specific clients. We provide a compensation system designed to foster an active focus on
growth and business development at all levels within the organization.
Management has the potential to earn incentive compensation on a quarterly
and/or annual basis based on individual, group and company-wide performance
goals. 8




---



##### Table of Contents



Competition The market for our services is highly fragmented, highly competitive and
is subject to rapid change. We believe that we currently compete principally
with systems integration firms, national consulting firms, including the
consulting divisions of the national accounting firms and their spin-offs,
outsourcers, information system vendors, service groups of computer equipment
companies, facilities management companies, general management consulting firms
and regional and specialty consulting firms. Many of our competitors have
significantly greater financial, technical and marketing resources than we
have, generate greater revenue and have greater name recognition than we have.
Moreover, those competitors that sell or license their own software may in the
future attempt to limit or eliminate the use of third party consultants, such
as Superior, to implement and/or customize such software. In addition, vendors
whose systems may enjoy wide market acceptance and large market share could
enter into exclusive or restrictive agreements with other consulting firms
which could eliminate or substantially reduce our implementation work for those
systems. There are relatively low barriers to entry into our markets (other
than outsourcing) and we have faced and expect to continue to face additional
competition from new entrants into our markets. In addition, combinations and
consolidations in the consulting and outsourcing industry may give rise to
larger competitors, whose relative strengths we cannot predict. We also compete
with our clients internal resources, particularly where these resources
represent a fixed cost to the client. This internal client competition may
heighten as consolidation of healthcare providers creates organizations large
enough to support internal information management capabilities. We compete with
new entrants and other smaller companies which often compete very aggressively
on price, and at the same time we compete, particularly on outsourcing and
other large engagements, with companies that enjoy greater financial and
technical resources than our own, as well as greater brand recognition and
marketing resources. We believe that the principal competitive factors in our market include
reputation, corporate commitment to the healthcare market, size and capital
resources, highly experienced workforce, industry expertise, full array of
offerings, project management expertise, price, quality of service,
responsiveness, speed of implementation and delivery, assured performance and
willingness to share risk. There can be no assurance that we will be able to
compete effectively on pricing or other requirements with current and future
competitors or that competitive pressures faced by us will not cause our
revenue or operating margins to decline, or otherwise materially adversely
affect our business, financial condition and results of operations. Intellectual Property and Other Proprietary Rights Our success is in part dependent upon our proprietary internal information
and communications systems, databases, services and market offerings, best
practices, tools and the methods and procedures that we have developed
specifically to serve our clients. In addition, we have and will continue to
develop proprietary groupware/collaborative tools and applications. Through
acquisitions, we have acquired numerous development tools and methodologies. We
have no patents or registered copyrights and, consequently, we rely on a
combination of non-disclosure and other contractual arrangements and copyright,
trademark and trade secret laws to protect our proprietary systems, information
and procedures. There can be no assurance that the steps taken by us to protect
our proprietary rights will be adequate to prevent misappropriation of such
rights or that we will be able to detect unauthorized use and take appropriate
steps to enforce our proprietary rights. We believe that our systems and
procedures and other proprietary rights do not infringe upon the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not assert infringement claims against us in the future or that any such
claims will not require us to enter into materially adverse license
arrangements or result in protracted and costly litigation, regardless of the
merits of such claims. Risk Factors Some of the information in this report contains forward-looking statements
that involve substantial risks and uncertainties. You can identify these
statements by forward-looking words such as may, will, expect,
anticipate, believe, estimate, intend, promise, should,
conditioned upon, project, predict, continue and similar words. You
should read statements that contain these words carefully because they discuss
our future expectations, contain projections of our future results of
operations or of our financial condition or state other forward-looking
information. We believe it is important to communicate our expectations to our
investors. However, there will be events in the future that we are not able to
accurately predict or over which we will have no control. The risk factors
listed in this section, as well as any other cautionary language in this
report, provide examples of just a few of the many risks, uncertainties and
events that may cause our actual results to differ materially from the
expectations we describe in our forward-looking statements. You should be aware
that the occurrence of the events described in the following risk factors and
elsewhere in this report, or in our other 9




---



##### Table of Contents



publicly filed reports which we may file from time to time, could have a
material adverse effect on our business, operating results and financial
condition. In that event, the market price of our common stock could decline,
and you could lose all or part of your investment. Other risks not currently
known to us, or which we believe to not be material, may also have a material
adverse effect on our business. In addition, any one or more of these risks,
including those outlined below could have a greater or lesser impact on our
business at any particular point in time and you should not give any greater or
lesser emphasis or weight to any single factor merely by virtue of the order of
its presentation or the depth of its discussion in this report. A Variety Of Factors Can Cause Our Revenue, Income Or Loss To Fluctuate In recent years, we have experienced significant quarterly fluctuations in
our operating results. Variations in our revenue and operating results may
continue from quarter to quarter as a result of a number of factors, including,
but not limited to:  
    
    The relatively longer sales cycle in obtaining new clients and
larger contracts, including outsourcing;
    
    Fluctuations in sales of our services and solutions and in
consultant billing and utilization rates;
    
    Client and employee retention;
    
    The failure to secure and deliver new client contracts at the
budgeted rate and the resulting negative impact on utilization of our
consultants;
    
    Industry spending patterns and market conditions that may adversely
affect the buying decisions of our current and prospective clients;
    
    Government funding of healthcare;
    
    The number and significance of active client engagements during a
quarter;
    
    Increased investment by us in new services, implementation of new
client relationships and other strategic initiatives;
    
    The decision of clients to defer commitments on new projects;
    
    Client budgetary cycles and pressures;
    
    Timing and collection of client payments;
    
    The award or loss or reduction in scope of significant client
assignments;
    
    Significant write-offs of billable time, reimbursable expenses or accounts
receivable;
    
    Unforeseen disruptions in transportation, communications or other
infrastructure components;
    
    Use and reductions in our available cash and other operating capital
resources; and
    
    General economic conditions and adverse developments in the
financial condition of our clients. Our existing consulting clients can generally reduce the scope of or
cancel their use of our services without penalty and with little or no notice.
If a client defers, modifies or cancels an engagement or chooses not to retain
us for additional phases of a project, our financial performance will suffer
unless we are able to rapidly redeploy our employees to other engagements in
order to minimize underutilization of employees. Because a substantial percentage of our expenses, particularly personnel,
facilities and technology, are relatively fixed in advance of any particular
quarter, variations in the size or number of client assignments or the timing
of the initiation or the completion of client assignments can cause significant
variations in operating results from quarter to quarter. Given the possibility
of such fluctuations, we believe that comparisons of our results of operations
for preceding quarters are not 10




---



##### Table of Contents



necessarily meaningful and that you should not rely upon the results for
one quarter as an indication of future performance. Based on the preceding
factors, or others, it is possible that we may experience a shortfall in
revenue or earnings from expected levels or otherwise fail to meet expectations
of securities analysts or the market in general. In such event, the price of
our common stock could be materially adversely affected. Our success in sustaining and increasing revenue will be dependent upon,
among other factors, timely sales, the type, range and quality of our services
and solutions, competitive rates, growth and improvement in proposal acceptance
rates in outsourcing and consulting, and our successful competition in the
marketplace. We have experienced a consistently uneven market in recent
quarters. This trend could continue if healthcare organization spending levels
remain low, leading to continued unpredictability in the market for consulting
services. If we are unsuccessful in increasing or sustaining our revenue, for
these or for other reasons, we may fail to meet the public markets
expectations of financial performance and operating results, which could have a
material adverse effect on our common stock price. Finally, we have reported net losses over the past several years, and we
cannot predict with certainty to what extent we will achieve positive earnings
in the future. If we are unable to maintain consistent profitability on a
quarterly or annual basis, the market price of our common stock could be
adversely affected and our financial condition would suffer. Our Long Sales And Project Delivery Cycles Expose Us To Potential Losses Our sales process for outsourcing, network-related and other large scale
projects is often subject to delays associated with the lengthy approval
process that typically accompanies significant capital expenditures by our
clients. During this process, we expend substantial time, effort and expense
marketing our services, preparing contract proposals and negotiating contracts.
Any failure or delay in obtaining a signed contract and receiving payment for
our services after expending significant time, effort and resources could
materially and adversely affect our revenue and financial condition. Expenses
incurred in the pursuit and winning of a large scale contract must be recovered
over the life of the contract. If the contract is terminated prior to its
scheduled expiration, we may not be able to recover expenses incurred in
procuring the contract. As we place increasing focus and emphasis on the sale
of outsourcing, network-related and other large scale engagements, these
potential adverse effects of the longer sales and delivery cycles can be
magnified. Moreover, outsourcing, network-related and other related large scale
projects generate more intense competition and competition from larger and
better financed competitors. This contributes to lengthening the sales cycle
and also makes the winning of the engagements more difficult. Any failure of
the Company to close and perform its budgeted number of large scale
transactions on its budgeted schedule could contribute to a shortfall in
revenue or earnings from expected levels and a failure to meet expectations of
securities analysts or the market in general. In such an event, the price of
our common stock could be materially adversely affected. Short Term Consulting
Projects Add Risk to Our Business Market
demand for our consulting services has been uneven for the last
several quarters. It is difficult to predict with certainty
developments in the market for our consulting services. Each quarter,
a portion of our consulting revenues is prospected, bid and
oftentimes completely or partially delivered, with the revenue
recognized appropriately, during the quarter. These shorter-term
engagements are often the result of rapid responses to client
requests, and as such, are difficult to forecast with certainty. If
market demand or other factors result in fewer shorter-term
consulting projects than we anticipate, or if the projects are of
insufficient size to meet our expectations, then our business will
incur increased risk. Costs of sale as a percentage of revenue may
increase, as more sales cycles may be required to keep our
consultants engaged over a given period of time. Short term consulting
projects may also make it more difficult to plan resource deployment
and maintain consultant utilization at optimum levels. It also may
become more difficult to match available skill sets within our
resource pool to market demand. Based on the preceding factors, or
others, it is possible that we may experience a shortfall in revenue
or earnings from expected levels or otherwise fail to meet expectations
of securities analysts or the market in general. In such event, the
price of our common stock could be materially adversely affected. Continued Investment In Outsourcing Contracts, Coupled With The Potential for
Further Losses, May Place Pressure On Our Available Cash Resources The nature, amount and timing of our long-term capital needs can be
affected by a number of factors. For example, our strategic plan includes a
heightened focus on the development of our outsourcing business and the winning
of large contracts. Implementation of a new outsourcing contract has and can
involve the need for capital investment, including the hiring of new personnel
and the acquisition of a clients information technology assets, including
hardware and software. An additional element of our outsourcing business
strategy includes offering data center consolidation to our clients, which has
and will continue to require investment by us in data or processing center
hardware and software as we sign additional contracts. The timing, number and scale of potential future outsourcing contracts
can impact our need for long-term and short-term capital resources. In addition, our future
capital needs will be affected by the timing of our market and service
offerings, in addition to outsourcing, and the degree and timing of success
enjoyed by our service offerings in the market. If our new service offerings
do not meet success in the market and/or if we cannot generate additional
revenue from existing offerings and client relationships, and if we cannot
adequately adjust our operating expenses to an appropriate level commensurate
with operating revenue, our capital resources will be reduced and our financial
condition will be adversely affected. If our available funds and cash generated from operations are insufficient
to satisfy our long-term liquidity requirements, or if we are either restricted
from further borrowings and/or required to repay all outstanding indebtedness
under our credit agreement, we may need to seek additional sources of funding,
such as selling additional equity or debt securities or obtaining additional
lines of credit. We could also, in such event, face the need to delay or
reduce the development of services or the pursuit of contracts that would
require significant investment to complete. We could also face the need to
reduce staffing levels and related expenses or potentially to liquidate or
mortgage selected assets. 11




---



##### Table of Contents



If our management decides that it is in our best interest to raise cash
for operations, investments to strengthen our balance sheet, or for any other
reason, we may decide to issue equity or debt, even if all of our current
funding sources remain available. If we issue additional securities to raise
funds, those securities may have rights, preferences, or privileges senior to
those of our common stock and our stockholders may experience dilution. We
cannot be certain that additional financing will be available on favorable
terms when required, or at all. Our inability to obtain additional financing
when needed could impair our ability to develop products and services for the
market; to implement our business strategies; and may otherwise materially and
adversely affect our financial condition. Our Client Base Is Heavily Concentrated In The Healthcare Industry We derive the substantial majority of our revenue from clients involved in
the healthcare industry. As a result of our focus on healthcare outsourcing and
consulting, our business, financial condition and results of operations are
influenced by conditions affecting this industry. In recent years the
healthcare industry has experienced a slow-down in consulting expenditures as
fiscal constraints imposed by factors such as the applicable regulations and
changes in the private reimbursement environment combined forces to dampen
overall industry demand for new information technology service consulting
projects. These forces continued to hamper demand for our services in 2003 and
may continue to do so in the future. Furthermore, these forces and others may
continue to adversely effect the financial stability of healthcare industry
participants and their demand for professional services of the type offered by
us. Some of these factors are discussed in more detail below: Regulatory Change. Federal, state and commercial payer changes
resulted in substantial limitations on capital expenditures and investments
in the healthcare industry. In addition, many federal and state legislators
have announced that they intend to propose programs to reform the United
States healthcare system at both the federal and state level and government
agencies have intensified efforts to monitor fraud and abuse in healthcare
programs reimbursed by federal and state agencies. Further, HIPAA and other
mandates require that providers and other healthcare participants comply
with a complex set of regulations. Although these efforts could increase
demand for our services, they could also adversely affect our clients,
result in lower reimbursement rates and change the environment in which
providers operate and could otherwise adversely affect service providers
such as ourselves. The ongoing impact of federal, state and commercial
payer reimbursement changes on our healthcare industry clients cannot be
predicted with certainty. Reduced revenue to the healthcare industry could
adversely affect service providers like us. In addition, ongoing change in
government regulation of the healthcare industry can affect us in a number
of ways. Government regulation can affect the ways in which our healthcare
clients procure and pay for services such as those that we offer.
Regulation can also have significant effects on the operations of our
healthcare clients. If we are unsuccessful in developing and maintaining
our ability to assist and serve our clients in the evolving environment of
government regulation, our ability to win and retain clients may suffer,
which could materially and adversely effect our business. Cost Pressure. Large private purchasers of healthcare services are
placing increasing cost pressure on providers. Healthcare providers have
and may continue to react to these cost pressures and other uncertainties
by curtailing or deferring investments, including investments in our
services. The impact of these developments in the healthcare industry is difficult
to predict. Some of them have had and some or all of them may continue to have
a material adverse effect on our business. We Face Risks In Providing Outsourcing Services We provide healthcare business process and information technology
outsourcing solutions which include any combination of support from full
outsourcing with data center consolidation, 24/7/365 network monitoring and
help desk, facility management, application unification, application
outsourcing, business process and interim management. These solutions may
involve personnel acquisition and/or the transfer of a clients information
system assets  hardware/software and human resources  from an internal
business function to an outsourced service. We incur significant expense in the pursuit, development and negotiation
of large outsourcing contracts. Moreover, to implement our outsourcing
program, we are required to make substantial investments in equipment and
personnel in order to perform under the contracts. We must then recover such
expenses over the life of the contract. Insufficient access to capital 12




---



##### Table of Contents



could prevent us from entering into or executing new outsourcing
contracts, which could materially and adversely affect our business. We may
also be dependent upon our ability to hire and retain some or all of an
outsourcing clients former information technology staff or certain business
operations in order to provide appropriate service levels. We cannot predict
whether we will in each instance be able to either assess accurately the
investment required for an outsourcing contract or negotiate and perform any of
our outsourcing contracts in a profitable manner. Some of our agreements call
for penalties, or allow for early termination in the event we fail to meet
certain service levels. If we fail to meet required performance standards in
our outsourcing, or other engagements, we could incur contractual penalties, or
the agreements could terminate before we are able to recover the investments we
made in the pursuit and initiation of the engagement. In either event, we
could suffer adverse financial consequences, as well as damage to our
reputation in the industry, which could adversely and materially affect our
business, financial condition, result of operations and the price of our common
stock. We anticipate that competitors will continue to increase their focus on
this outsourcing market. Our ability to increase revenue depends in significant
part upon our ability to secure new outsourcing contracts in the face of this
competition. As mentioned elsewhere, many of these competitors have advantages
over us. The increased focus from competitors has to date and may continue to
adversely affect our ability to obtain new outsourcing contracts as well as the
profitability of any such contracts. In addition, one key to the success of the expansion of our outsourcing
business is to build and operate one or more data centers to run the data
processing, network management and monitoring and other information technology
functions of our outsourcing clients. Our ability to achieve optimum economies
of scale is dependent upon our ability to win outsourcing and network
management engagements of a sufficient number and size. Unless we are able to
fill our data centers with sufficient billable work we may not recover our
development and operation costs. Further, a demonstrated ability to
successfully close and execute outsourcing engagements is critical to the
development of increasing recognition and credibility in the marketplace which,
in turn, is important to the future growth of the outsourcing business. An
inability to successfully win, execute and manage outsourcing and network
management engagements could have a material adverse affect on our business and
on the price of our common stock. Our Results Will Be Adversely Impacted If We Cannot Properly Anticipate And
Respond To Shifts In Market Demand As
healthcare and other sectors move increasingly to Internet and
web-based technologies and applications and as we continue to
innovate services and solutions to develop and capitalize on this
market, we will incur risks related to our participation in such
untested opportunities, markets and quickly evolving lines of
business. Such risks can include, but are not limited to, new and
unforeseen technologies superseding development of the Internet
and/or the systems integration platforms and other technologies in
which we invest; potential government regulation of the Internet;
slowness of traditional healthcare clients to adopt new technologies;
and increased competition for consultant talent in the digital
business communication field, increasing
our cost of providing services. As
a result of the financial and technological pressures that face the
healthcare industry, and as result of the rapid rate of evolution in
technology, the technical solutions and marketing initiatives in which
we invest may fail to gain acceptance in the marketplace.
Consequently, we may be forced to abandon certain initiatives without
having recouped our costs of development. In addition, solutions and
market offerings invested in by us may encounter competitive products
in the marketplace that enjoy competitive pricing advantages, better
brand recognition or other advantages over solutions offered by us. A
failure by us to invest in and develop successful market offerings
could have a material adverse affect on our business and the price of
our common stock. In response to shifts in market demand and in an effort to better align
our business with our markets, we have restructured our business units in
recent years. This restructuring has included hiring persons with appropriate
skills, including salespersons, and reductions in force in service areas
experiencing less demand. These market conditions and restructuring efforts
have placed new and increased demands on our management personnel, technical
and operational resources and on our information systems. Our consultants are
generally employed on a full-time basis. Therefore, in the short run we incur
substantially all of our employee-related costs even during periods of low
utilization, as the majority of employment costs of these personnel are fixed.
In addition, we have and may from time to time discontinue lines of business
which can result in lower margins, as there may not be immediate opportunities
for the reassignment of personnel, or there may be costs associated with the
separation of personnel from us. As we previously have responded to the
diminishing demand for certain of our consulting services by contracting
operations and reducing costs, we have and may again incur costs associated
with business contractions, and may also lose the ability to recover
investments made in personnel, equipment, office space and 13




---



##### Table of Contents



other assets associated with the service lines that are reduced or
eliminated. In the event that office space is closed by us, there can be no
assurance that we will be able to sublease that space, or that sublease rents
will offset our obligations under its prime lease(s). In addition, there can
be no assurance that any sublessees will not default in their rent or other
obligations. Default by our sublessees, or an inability of us to sublease
excess office space could have a material adverse effect on our financial
condition. We Face Risks in the Performance of Projects in our Business Many of our engagements, including but not limited to our outsourcing and
network management engagements, involve projects which are critical to the
operations of our clients business and which provide benefits that may be
difficult to measure. For example, we perform data processing and other
information system functions through our processing centers that are critical
to our clients operations. Any failure to successfully perform these
operations could harm our clients and could result in early termination,
contractual penalties, legal liabilities and damage to our business reputation,
all of which could adversely affect our business. Beyond actual execution
failure, other perceived or actual failures to meet a clients expectations in
the performance of our services could damage our reputation and adversely
affect our ability to attract new business with that client or with others. We
could incur substantial costs and expend significant resources working to
ensure client satisfaction even in situations where our services met contract
requirements. A negative impact on client relationships could materially and
adversely affect our business whether or not we bear any responsibility, legal
or otherwise, for the occurrence of those problems. A successful legal claim
against us could damage our reputation in the industry and have a material
adverse effect on our business. We attempt to limit liability contractually,
but there can be no assurance that such limitations will be effective. We also
maintain insurance against such claims, but there can be no assurance that our
insurance will provide adequate coverage for successful claims against us. We May Fail To Perform Fixed Price Contracts In A Profitable Manner As a result of obtaining additional outsourcing contracts and introducing
and selling repeatable, pre-packaged solutions, an increasing portion of our
projects are billed on a fixed-fee basis as opposed to time and materials. Our
inability to estimate accurately the resources and related expenses required
for a fixed-fee project or failure to complete our contractual obligations in a
manner consistent with the project plan upon which our fixed-fee contract was
based could result in cost overruns that could materially and adversely affect
our business. We May Not Be Able To Effectively Recruit Or Retain Required Personnel Our business involves the delivery of professional services and is
labor-intensive. Our success depends in large part upon our ability to attract,
develop, motivate and retain highly skilled sales, management, administrative
and technical personnel. Other consulting firms, healthcare providers and
other healthcare industry participants, including health information systems
vendors, clients, systems integrators and many other enterprises, compete with
us for employees with the skills required to perform the services we offer. If
we are unable to recruit and retain consultants to perform new and existing
client engagements, our reputation in the industry and our ability to generate
revenue will both suffer, which could have a material adverse effect on our
business, financial condition and on the price of our common stock. Moreover,
our consultants are often key to our client relationships. Loss of key
consultants could impair client relationships and adversely affect our ability
to gain recurring engagements, which could adversely affect our financial
condition. Loss Of One Or More Large Clients Could Harm Our Business We derive a significant portion of our revenue from a relatively limited
number of clients. A substantial portion of our revenue is derived from
services provided to our existing clients. Except for our outsourcing
contracts, which typically are for more than one year, clients engage us on an
assignment-by-assignment basis and a client can generally terminate an
assignment at any time without penalty. In addition, the level of our
consulting services required by any individual client can diminish over the
life of our relationship with us and we cannot give any assurance that we will
be successful in establishing relationships with new clients as this occurs.
Moreover, we cannot give any assurance that our existing clients will continue
to engage us for additional projects or do so at the same revenue level. The
loss of any significant client or significant contract (such as a large
outsourcing agreement) could materially and adversely affect our business.
Significant write-offs or the insolvency of a significant client could
materially and adversely affect our business. Additionally, if we fail to
generate additional revenue from our existing clients, it may materially
adversely affect our business and financial condition. 14




---



##### Table of Contents



A Large Part Of Our Consulting Work Is Concentrated In The Systems Of A
Relatively Small Number Of Major Vendors The healthcare industry can choose among numerous healthcare information
systems solutions. Vendors of these products come into and out of favor
depending on a variety of factors. Although our consultants have expertise with
the information systems developed by numerous healthcare information system
vendors, we have historically experienced periodic revenue concentration from
client projects involving the products of an evolving but relatively small
group of vendors. We believe that this concentration generally reflects the
current preference of the healthcare industry participants that we serve.
Should any one or more of these vendors (or any other vendors with whose
products we have substantial involvement) lose favor in the healthcare
industry, we would be required to refocus our efforts on alternative
information systems products of other vendors. Moreover, vendors may in the
future attempt to limit or eliminate the use of third party consultants, such
as ourselves, to implement and/or customize such software. In addition, vendors
with whom we currently do substantial work could enter into exclusive or
restrictive agreements with other consulting firms which could eliminate or
substantially reduce our implementation work for those systems. The loss of a
major portion of our business with respect to any one of these vendors could
materially and adversely affect our business. The Loss Of One Or More Members Of Management Could Harm Our Business Our success is highly dependent upon the efforts, abilities and business
generation capabilities of our senior management team. Although we manage
client relationships at many levels, the unplanned loss of the services of one
or more of our key executives for any reason could adversely affect our
business. Moreover, certain client and industry relationships and areas of
expertise depend on the efforts, abilities and business generation capabilities
of other members of our management team. The loss of any of these management
team members could materially and adversely affect our business. We May Not Be Able To Effectively Compete The market for our services is highly fragmented, highly competitive and
is subject to rapid change. We believe that we currently compete principally
with a variety of companies, including but not limited to:  
    
    outsourcing firms;
    
    systems integration firms;
    
    national consulting firms;
    
    general management consulting firms;
    
    regional and specialty consulting firms;
    
    web development and e-commerce firms;
    
    information system vendors;
    
    service groups of computer equipment companies; and
    
    facilities management companies. Many of our competitors have significantly greater financial, technical
and marketing resources, generate greater revenue and have larger customer
bases and greater name recognition than we do. Moreover, those competitors that
sell or license their own software may in the future attempt to limit or
eliminate the use of third party consultants, such as ourselves, to implement
and/or customize such software. In addition, vendors whose systems may enjoy
wide market acceptance and large market share could enter into exclusive or
restrictive agreements with other consulting firms which could eliminate or
substantially reduce our implementation work for those systems. Entry barriers
into our markets are relatively low, except for outsourcing, and we have faced
and expect to face additional competition from new entrants into the healthcare
consulting industry. Our competitors may prove better able to leverage their
financial and technological resources to develop and market their competitive
services; to introduce innovative solutions to the market; and to compete on
price and other factors with the products and services offered by us. As a
result, there is no certainty that we will be able to retain or expand our
existing base of clients. In addition, combinations and consolidations in the
consulting industry will give rise to larger competitors whose relative
strengths we cannot predict. We also compete with our clients internal
resources, particularly where these resources represent a fixed cost to the
client. This internal client competition may heighten as consolidation of
healthcare providers creates organizations large enough to support more
sophisticated internal information management capabilities. Our inability to
compete effectively with current and future competitors and competitive
pressures facing us may reduce our revenue or operating margins or otherwise
materially and adversely affect our business and the price of our common stock. 15




---



##### Table of Contents



Management Of Growth We may identify opportunities to expand our geographic presence, industry
expertise and technical scope through strategic acquisitions and alliances with
companies that provide additional and complementary products, services or
skills or have strategic client relationships. If suitable acquisition
candidates are identified, we may not be able to acquire such companies on
suitable terms. Moreover, many other companies are competing for acquisition
candidates, which could increase the price of acquisition targets and decrease
the number of attractive companies available for acquisition. Acquisitions also
involve a number of special risks, including but not limited to: (1) adverse
effects on our reported operating results including increased interest expense;
(2) diversion of management attention; (3) risks associated with unanticipated
problems, liabilities or contingencies; (4) difficulties related to the
integration and management of the acquired business; (5) risks of entering
markets in which we have limited or no direct expertise; and (6) the potential
loss of key employees of the acquired companies. In addition, acquisitions may require us to spend significant funds. An
acquisition may not result in long-term benefits and management may not be able
to manage effectively the resulting business. The occurrence of some or all of
the events described in these risks could have a material adverse effect on our
business. Our Business Is Highly Dependent Upon Continued Availability Of Business Travel During 2001, the events of September 11 and resulting disruptions in air
travel adversely affected our business. In addition, the aftermath of
September 11, including increased federal spending on defense and homeland
security, could adversely affect the federal and state governments spending on
Medicare, Medicaid and other healthcare initiatives, which could adversely
affect our clients revenue and cause them to defer or cancel projects that
would create demand for our services. In addition, our consultants often
perform services at the clients site, away from their own city or state of
residence. We are therefore highly dependent upon effective air travel for the
performance of a majority of our client engagements. If, as a result of
terrorist attacks, the outbreak of military hostilities or other domestic or
global disturbances, air travel becomes increasingly costly, time consuming,
limited or unreliable, or should our employees become reluctant to travel, it
could harm our ability to timely and cost effectively perform our client
engagements, which could have a material adverse effect on our financial
condition and results of operations. We Have Only Limited Protection Of Proprietary Systems And Procedures Our success depends in part upon our information and communication
systems, databases, service and market offerings, best practices, tools and the
methods and procedures that we have developed specifically to serve our
clients. In addition, we offer enterprise-wide communications services and will
continue to develop groupware/collaboration tools and applications. Because we
have no patents or registered copyrights, we rely on a combination of
nondisclosure and other contractual arrangements and copyright, trademark and
trade secret laws to protect our proprietary systems, information and
procedures. We can offer no assurance that the steps we have taken to protect
these rights will be adequate to prevent theft or detect unauthorized use and
we may not take appropriate steps to enforce our proprietary rights. We believe
that our systems and procedures and other proprietary rights do not infringe
upon the rights of third parties. However, if a party sues us in the future
claiming that our business or systems infringe on their intellectual property,
we may have to enter into expensive litigation regardless of the merits of such
claims. In addition, any infringement claim that causes us to discontinue use
of, or having to acquire licenses for, applications, tools, systems or software
used or marketed by us, could have a material adverse affect on our business. Our Insiders Have Effective Control Over Most Significant Matters Requiring
Stockholder Approval As
of March 29, 2004, our principal stockholder and Chief Executive Officer, Richard D. Helppie,
Jr., beneficially owns approximately 35% of our outstanding shares of common
stock, excluding treasury shares. As of March 29, 2004, our directors and executive officers
beneficially collectively own approximately 58% of our outstanding common
stock, excluding treasury shares. As a result, Mr. Helppie acting alone, and
our officers and directors as a group, possess the voting power to exercise
effective control over the outcome of many of the matters requiring a
stockholder vote, including the election of directors and the approval of
significant corporate matters such as mergers, sales of all or substantially
all of our assets, and authorization and issuance of additional shares of stock. 16




---



##### Table of Contents



Stock Price Volatility The trading price of our common stock has fluctuated widely. In addition,
in recent years the stock market has experienced extreme price and volume
fluctuations. The overall market and the price of our common stock may continue
to fluctuate greatly in the future. Our common stock has been publicly traded since our initial public
offering of common stock to the public in 1996. In 2003, the sale price ranged
from a low of $1.98 per share to a high of $5.65 per share. The market price of
our common stock could continue to fluctuate substantially due to a variety of
factors, including, but not limited to:  
    
    Announcements concerning our financial performance, prospects and
business developments;
    
    Acquisition or loss of material outsourcing contracts and other
material engagements;
    
    Changes in the healthcare and information technology consulting
environments;
    
    The size of the trading market for our common stock;
    
    Announcements of key developments by competitors;
    
    Changes in earnings estimates by analysts;
    
    Sales of common stock by existing holders;
    
    General economic or market conditions;
    
    Loss of key personnel; and
    
    Impact of any adverse events (including those described in the Risk
Factors Section). The market price for our common stock has and could also be affected by
our ability to meet analysts expectations. Failure to meet such expectations
has in the past, and could in the future, have a material adverse effect on the
market price of our common stock. In addition, the stock market is subject to
extreme price and volume fluctuations. This volatility has had a significant
effect on the market prices of securities issued by many companies for reasons
unrelated to the operating performance of these companies. In the past,
following periods of volatility in the market price of a companys securities,
securities class action litigation has often been instituted against such a
company. If similar litigation were instituted against us, it could result in
substantial costs and a diversion of our managements attention and resources,
which could have a material adverse effect on our business, operating results
and financial condition. Impact Of Anti-Takeover Provisions And Other Factors On Our Stock Price Our certificate of incorporation and by-laws and the Delaware General
Corporation Law include provisions that may be deemed to have anti-takeover
effects and may delay, defer or prevent a takeover attempt that stockholders
might consider in their best interests. Our board of directors is divided into
three classes, each of which is elected for staggered, three-year terms. Our
by-laws contain provisions under which only the chairman of the board, a
majority of the board of directors or stockholders owning at least 50% of our
capital stock may call meetings of stockholders and which require certain
advance notice procedures for nominating candidates for election to the board
of directors. Our board of directors is empowered to issue up to 1,000,000
shares of preferred stock and to determine the price, rights, preferences and
privileges of such shares, without any further stockholder action. The
existence of this blank-check preferred stock could make more difficult or
discourage an attempt to obtain control of the Company by means of a tender
offer, merger, proxy contest or otherwise. In addition, this blank check
preferred stock and an issuance thereof, may have an adverse effect on the
market price of our common stock. Furthermore, we are subject to the
anti-takeover provisions of Section 203 of the Delaware General Corporation Law
that prohibit us from engaging in a business combination with an interested
stockholder for a period of three years after the date of the transaction in
which the person first becomes an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203
and certain other provisions of the certificate of incorporation could also
have the effect of delaying or preventing a change of control of the Company,
which could adversely affect the market price of our common stock. EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers are as follows: Richard
D. Helppie, Jr. (age 48) has served as our Chief Executive Officer
since he founded Superior in 1984. He also served as our President from May
1984 to January 1999, and as Chairman from May 1984 to October 2000. Mr.
Helppie also currently serves as a Director of the Company. Mr. Helppie has
more than 29 years of experience in the healthcare and information systems
industries. He currently serves as a director of Neoforma, Inc. and Med-i-Bank
Inc. 17




---



##### Table of Contents



George S. Huntzinger (age 54) has served as our President and Chief
Operating Officer since October 2000. Previously, Mr. Huntzinger served in
senior management roles for several healthcare organizations, including a
12-year term as President of CSC Healthcare. He is a member of numerous
national organizations and associations and previously served on the boards of
several healthcare and financial organizations and has served the healthcare
industry for over 30 years. Charles O. Bracken (age 54) has served as a Director since January 1999
and has served as our Executive Vice President since joining Superior in March
1987. Mr. Bracken has more than 30 years of experience in the healthcare and
information systems industries. Prior to joining Superior, Mr. Bracken spent
three years as Vice President of Marketing of a healthcare information software
firm, preceded by 14 years of related experience in healthcare information
systems management, including positions as Chief Information Officer for single
and multi-hospital corporations. Richard
R. Sorensen (age 48) has provided his financial expertise to
Superior in an advisory capacity since our inception in 1984. He joined
Superior as Controller in August of 1998 and became Chief Financial Officer in
October 2000. Previously, he served as an audit partner with Plante & Moran,
LLP. He is a Certified Public Accountant. 
 ITEM 2. PROPERTIES Our headquarters is located in approximately 24,000 square feet of owned
office space in Southfield, Michigan. We also lease an aggregate of
approximately 152,000 square feet of additional office space in Alpharetta,
Georgia; San Diego, California; Woodland Hills, California; Ann Arbor,
Michigan; Dearborn, Michigan; Cheshire, Connecticut; and Pittsburgh,
Pennsylvania. Of our total space described above, we have sublet approximately
66,000 square feet. After giving effect to space reductions from our recent
restructurings, we believe that our facilities are adequate for our current
needs and that additional facilities can be leased or acquired to meet future
needs. We continue to consolidate offices and have undertaken initiatives to
sublet office space in Woodland Hills, California, Cheshire, Connecticut,
Ann Arbor, Michigan and Southfield, Michigan. 
 ITEM 3. LEGAL PROCEEDINGS We are a party to litigation from time to time. However, we are not now a
party to, and are not aware of, any pending or threatened litigation that we
currently anticipate would have a material adverse effect on us. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. 
 PART II 
 ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is traded on the NASDAQ National Market under the symbol
SUPC. The following table shows high and low closing prices as reported by
NASDAQ for the fiscal years 2002 and 2003. HIGH
    
    LOWFISCAL 2002First Quarter
    
    $
    8.86
    
    
    $
    5.41Second Quarter
    
    
    7.00
    
    
    
    5.00Third Quarter
    
    
    5.70
    
    
    
    2.80Fourth Quarter
    
    
    3.29
    
    
    
    1.77FISCAL 2003First Quarter
    
    $
    3.26
    
    
    $
    2.41Second Quarter
    
    
    3.52
    
    
    
    1.98Third Quarter
    
    
    5.50
    
    
    
    2.85Fourth Quarter
    
    
    5.65
    
    
    
    4.00
 At
March 26, 2004, we had 105 stockholders of record. 18




---



##### Table of Contents





We have not paid cash dividends to the holders of our common stock. It is
our present intention to retain earnings for use in the growth of our business.
Accordingly, we do not anticipate that cash dividends will be paid in the
foreseeable future.




ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

You should read the following selected financial data in conjunction with
our consolidated financial statements, the related notes and Managements
Discussion and Analysis of Financial Condition and Results of Operations,
included elsewhere in this report. The selected financial data as of December
31, 2001, 2002 and 2003 have been derived from our audited consolidated
financial statements included elsewhere in this report (except for
our audited consolidated balance sheet for the year ended December
31, 2001, which is not included elsewhere in this report). The selected financial
data as of December 31, 1999 and 2000 have been derived from our audited
consolidated financial statements not included elsewhere in this report.

YEAR ENDED DECEMBER 31,1999(1)
    
    2000
    
    2001
    
    2002
    
    2003(IN THOUSANDS, EXCEPT PER SHARE DATA)STATEMENT
OF OPERATIONS DATA:Net revenue
    
    $
    149,349
    
    
    $
    99,237
    
    
    $
    86,721
    
    
    $
    84,108
    
    
    $
    91,941Net cost of services
    
    
    91,714
    
    
    
    77,674
    
    
    
    56,721
    
    
    
    59,131
    
    
    
    66,775Selling, general and administrative expenses
    
    
    65,597
    
    
    
    73,278
    
    
    
    40,833
    
    
    
    32,816
    
    
    
    26,253Costs
incurred in connection with new business initiative
    
    
    4,840
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restructuring (recovery) charges, net
    
    
    
    
    
    
    4,165
    
    
    
    3,112
    
    
    
    3,308
    
    
    
    (193
    )Impairment of assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    571
    
    
    
    Impairment of goodwill
    
    
    
    
    
    
    10,221
    
    
    
    
    
    
    
    8,223
    
    
    
    Loss from operations
    
    
    (12,802
    )
    
    
    (66,101
    )
    
    
    (13,945
    )
    
    
    (19,941
    )
    
    
    (894
    )Other income (expense), net
    
    
    1,874
    
    
    
    6,056
    
    
    
    (3,620
    )
    
    
    176
    
    
    
    (861
    )Loss before income taxes
    
    
    (10,928
    )
    
    
    (60,045
    )
    
    
    (17,565
    )
    
    
    (19,765
    )
    
    
    (1,755
    )Benefit for income taxes
    
    
    (3,967
    )
    
    
    (2,492
    )
    
    
    
    
    
    
    (2,301
    )
    
    
    Net loss
    
    $
    (6,961
    )
    
    $
    (57,553
    )
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Net loss per share  basic
    
    $
    (0.67
    )
    
    $
    (5.48
    )
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Net loss per share  diluted
    
    $
    (0.67
    )
    
    $
    (5.48
    )
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Shares used in calculating net
loss per share  basic
    
    
    10,340
    
    
    
    10,511
    
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595Shares used in calculating net
loss per share  diluted
    
    
    10,340
    
    
    
    10,511
    
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595


AT DECEMBER 31,BALANCE
SHEET DATA:
    
    1999
    
    2000
    
    2001
    
    2002
    
    2003Working capital
    
    $
    61,811
    
    
    $
    29,622
    
    
    $
    19,033
    
    
    $
    14,046
    
    
    $
    11,080Total assets
    
    
    186,597
    
    
    
    78,632
    
    
    
    58,607
    
    
    
    43,656
    
    
    
    53,853Total debt
    
    
    
    
    
    
    5,125
    
    
    
    2,925
    
    
    
    4,318
    
    
    
    16,552Total stockholders equity
    
    
    150,935
    
    
    
    58,340
    
    
    
    42,224
    
    
    
    25,167
    
    
    
    22,916


YEAR ENDED DECEMBER 31,EBITDA CALCULATION:
    
    1999
    
    2000
    
    2001
    
    2002
    
    2003Net loss
    
    $
    (6,961
    )
    
    $
    (57,553
    )
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Depreciation and amortization
    
    
    7,155
    
    
    
    6,493
    
    
    
    4,832
    
    
    
    4,451
    
    
    
    5,080Interest (income) expense, net
    
    
    (1,900
    )
    
    
    (1,376
    )
    
    
    (700
    )
    
    
    (176
    )
    
    
    861Income tax benefit
    
    
    (3,967
    )
    
    
    (2,492
    )
    
    
    
    
    
    
    (2,301
    )
    
    
    EBITDA
    
    $
    (5,673
    )
    
    $
    (54,928
    )
    
    $
    (13,433
    )
    
    $
    (15,490
    )
    
    $
    4,186


(1) Statement of operations data for fiscal 1999 includes results of acquired businesses.




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

OVERVIEW

We are organized into the two business segments of outsourcing and
consulting. The outsourcing segment helps healthcare providers simplify their
management agendas, improve their return on information systems investments and
strengthen their technology management by taking on responsibility for managing
and operating all or part of the clients IT function. We deploy specialized
resources to deliver higher quality IT functionality at lower cost and help
clients avoid or reduce certain capital expenses. The outsourcing segment
offers the client an array of services, functions and economic elements that
can be tailored to the specific client agenda, including business process
management, IT management, IT planning and budgeting, applications support,
applications implementation, IT operations, data center consolidation in our
processing center, 24/7/365 network monitoring and help desk in our network
control center, financial management and risk sharing, facility management,
application unification, application outsourcing and interim management. The
consulting segment provides information technology, as well as strategic and
operations management consulting and solutions, and application support to a
broad cross-section of healthcare industry participants and information systems
vendors. The consulting segment also provides tools, strategies and solutions
designed to transform clinical operations and improve patient

19



---



##### Table of Contents



safety, enhance financial performance, and promote secure and private
Health Insurance Portability and Accountability Act (HIPAA) compliant
transactions. In recent years, we have expanded our outsourcing and solution sales
capabilities. As healthcare and other sectors implement web-based technologies
and applications, we may incur risks related to participation in such
opportunities, markets and quickly evolving lines of business. Such risks can
include, but are not limited to: new and unforeseen technologies superseding
development of web-based applications and/or the systems integration platforms
and other technologies in which we have invested; increased competition in the
outsourcing business from larger and better capitalized competitors who may
also enjoy better name recognition and other competitive advantages; the
potential advent of foreign competition from markets with lower cost
structures; failure by us to develop and offer new services and solutions
demanded by the market; failure of our services and solutions to generate
sufficient demand in the market; potential government regulation of the
Internet; slowness of traditional healthcare clients to adopt new technologies;
and increased competition for consultant talent, increasing our cost of
providing services. We derive substantially all of our revenue from fees for professional
services. We establish standard-billing guidelines based on the type and level
of service offered. Actual billing rates are established on a
project-by-project basis and may vary from the standard guidelines. Billings
for time and materials engagements are generally contracted to be made on a
bi-weekly basis to monitor client satisfaction and manage outstanding accounts
receivable balances. Revenue on time and materials contracts is recognized as
the services are provided. Fixed-fee projects, pre-packaged solution sales and
outsourcing contracts are billed by deliverable or on a periodic basis,
typically monthly. We generally recognize revenue on fixed-fee projects and
pre-packaged solution sales based on progress toward project milestones.
Revenue on outsourcing contracts is generally recognized ratably over
annual periods within our multi-year contracts. As of December 31, 2003, we have seven significant contracts
to provide healthcare IT outsourcing services. We also provide help desk and
call center support, which are typically billable on a per seat per month
basis, and we have a managed trust (digital security) contract, which is
billed annually and recognized ratably over the life of the contract.
On occasion, we may collect payment prior to providing services. These
payments are recorded as deferred revenue and reflected as a liability on our
consolidated balance sheet. There can be no assurance that we will be able to achieve profit margins
on existing and new contracts, which are consistent with our historical levels
of profitability. In addition, profit margins on outsourcing and support
contracts are generally lower than profits margins on traditional consulting engagements.
Increased use of fixed-fee contracts subjects us to increased risks, including
cost overruns. Moreover, we incur significant expense in the process of
seeking, developing and negotiating large fixed-fee contracts, such as
outsourcing contracts. In addition, the implementation of certain outsourcing
contracts requires significant initial investment by us in the hiring of
personnel and the acquisition of software applications and equipment to perform
the contract. Such expenses are expected to be recovered over the life of the
agreement. Some of our agreements call for penalties, or allow for early
termination in the event we fail to meet certain service levels. If we fail to
meet required performance standards in our outsourcing, or other engagements,
we could incur contractual penalties, or the agreements could terminate before
we are able to recover the investments we made in the pursuit and initiation of
the engagement. In either event, we could suffer adverse financial
consequences, as well as damage to our reputation in the industry, which could
adversely and materially affect our business, financial condition, results of
operations and the price of our common stock. With the addition of new outsourcing contracts, we may require additional
capital for the acquisition of hardware and software with which to perform the
contracts. If our capital resources or access to capital are restricted, we
may be unable to pursue or complete new outsourcing contracts, which could
adversely and materially affect our business, financial condition, results of
operations and the price of our common stock. We seek to increase revenue through various means, including an increased
emphasis on outsourcing contracts, an increase in the value and duration of
projects for existing and new clients, as well as continued additions to our
recurring revenue base. In addition, we seek to increase revenue by expanding
our range of specialty services with a focus on opportunities arising from the
demand for clinical quality and patient safety, financial improvement, digital
communications and system security and privacy. We manage our client
development efforts through our internal Client Partner Organizations (CPO)
having specific geographic responsibility and focus. Within a geographical
area, our CPO members develop relationships and pursue opportunities with
strategic clients, maintain relationships with various stakeholders (buyers,
suppliers and advisors) and develop other business opportunities. Our success
in increasing our revenue will be dependent upon, among other factors, timely
sales, the type, range and quality of our services and solutions, competitive
prices, growth and improvement in proposal acceptance rates in outsourcing and
consulting, and successful competition in 20




---



##### Table of Contents



the marketplace. Many of the entities with whom we compete have greater
name recognition and financial resources, larger customer bases and greater
technical and sales and marketing resources, which may adversely impact our
ability to compete against them successfully. In addition, our revenue has and
can be adversely affected by unforeseen disruptions in transportation,
communications or other infrastructure components. Should we be unsuccessful
in increasing or sustaining our revenue, for these or for other reasons, we may
fail to meet the public markets expectations of our financial performance and
operating results, which could have a material adverse effect on our common
stock price. Our most significant expense is cost of services, which consists primarily
of consultant compensation expense and operating costs associated with our full
outsourcing contracts. Historically, consultant compensation expense has grown faster than
consultant billing rates. We have sought to address the consultant
compensation issue by adding a variable portion of compensation payable upon
the achievement of measurable performance goals. In addition, we have sought
to address compensation expense pressures through increased use of stock
options as an overall part of our compensation package. These efforts have
been hampered in the past by the impact of our stock price and could be
affected in the future depending upon market conditions. The market in which
we compete for our talented and highly skilled consultant work force is highly
competitive. Many of the entities with whom we compete for employees have
greater financial and other resources than we do, and may be able to offer more
attractive compensation packages to candidates than we can, including salary,
benefits, stock and stock options. Our ability to successfully operate our
business and compete in our market is dependent upon our ability to recruit and
retain skilled and motivated sales, management, administrative and technical
personnel. If we are unable to recruit and retain consultants to perform new
and existing client engagements, our reputation in the industry and our ability
to generate revenue will both suffer, which could have a material adverse
effect on our business, financial condition and on the price of our common
stock. Moreover, our consultants are often key to our client relationships.
Loss of key consultants could impair client relationships and adversely affect
our ability to gain recurring engagements, which could adversely affect our
financial condition. Our operating costs associated with the full outsourcing contracts have
and will continue to increase as additional clients are serviced.
Additionally, as we continue to migrate clients to the processing center, we
expect to incur incremental costs, which will be offset with savings
over time as additional clients are added and we are able to leverage our
investment. These costs consist primarily of, but are not limited to:
equipment lease costs, depreciation, telecommunication and facility related
expenditures. We expect to recover our investment in our processing and
network management centers through the performance of multiple outsourcing
contracts and network management (NetLinc) contracts utilizing processing
center resources. If we are unsuccessful in winning sufficient new outsourcing
and NetLinc contracts, or if the terms of outsourcing or NetLinc contracts are
not sufficiently favorable to us, or if any of the existing outsourcing or
NetLinc contracts were to be terminated early for any reason, our ability to
recover our processing center investments would be impaired, which could have a
material adverse effect on our financial condition. In addition, we will be
performing data processing and other client information systems functions
through our processing centers. Any failure by us to successfully perform our
processing center functions could adversely affect our clients operations,
which could result in contractual performance penalties to us, early
termination of one or more contracts, potential legal liabilities and damage to
our reputation in the industry, any or all of which could have a material
adverse effect on our financial condition, results of operations and the price
of our common stock. Our net cost of services as a percentage of net revenue is primarily
driven by how efficiently we utilize our consultant resources and deliver our
consulting and outsourcing services and solutions. We attempt to optimize
efficient deployment of our consultants through initial engagement planning and
by continuously monitoring project requirements, timetables, and service and
solution deliveries. The number of consultants assigned to a project will vary
according to the type, size, complexity, duration and demands of the project.
Project terminations, completions and scheduling delays, and incremental costs
associated with the full outsourcing contracts have and can continue to cause
us to experience lower gross margins. In recent years the healthcare industry has experienced a slow-down in
consulting expenditures as fiscal constraints imposed by federal, state and
commercial/private payers, have dampened overall industry demand for new IT
service consulting projects. Some of these forces and others have continued to
hamper demand for certain of our services in 2003. Furthermore, changes in
federal, state and commercial/private payer reimbursement may continue to
adversely affect the financial stability and viability of our clients and may
impact their ability to contract for and pay for professional services such as
those offered by us. We record a provision for estimated uncollectible amounts
based on prior collection experience. 21




---



##### Table of Contents



During 2001, the events of September 11 and resulting disruptions in air
travel adversely affected our business. In addition, the aftermath of
September 11, including increased federal spending on defense, homeland
security and the Iraq War, as well as federal tax cuts, could adversely affect
the federal and state governments spending on Medicare, Medicaid and other
healthcare initiatives. In addition, state budget deficits could adversely
affect our clients revenues and cause them to defer or cancel projects that
would create demand for our services. In addition, our consultants often
perform services at the clients site, away from their own city or state of
residence. We are, therefore, highly dependent upon effective air travel for
the performance of a majority of our client engagements. If, as a result of
terrorist attacks, conflicts in the Middle East and other unsettling world
events, air travel becomes increasingly costly, time consuming, limited or
unreliable, or should our employees become reluctant to travel, it could harm
our ability to timely and cost effectively perform our client engagements,
which could have a material adverse effect on our financial condition and
results of operations. In addition, our establishment of new services and market offerings and
hiring of consultants in peak hiring periods have and can from time to time
adversely affect margins. Also, seasonal factors, such as vacation days,
holidays and total business days in a quarter have and can affect margins.
Variations in services and market offering solution sales, longer outsourcing
sales cycles, uneven deployment of resources and failure to secure large
engagements can also result in quarterly variability of our net cost of
services as a percentage of net revenue. Our consultants are generally
employed on a full-time basis and therefore we will, in the short run, incur
substantially all of our employee-related costs even during periods of low
utilization, as the majority of employment costs of these personnel are fixed.
In addition, we have and may from time to time discontinue service offerings
that have not been successful in the market. Exiting a service offering can
result in lower margins, as there may not be immediate opportunities for the
reassignment of personnel, or there may be costs associated with the separation
of personnel from us. In addition, as we have responded to the diminishing
demand for certain of our consulting services by contracting operations and
reducing costs, we have and may again incur costs associated with business
contractions, and may also lose the ability to recover investments made in
personnel, equipment, office space and other assets associated with the service
lines that are reduced or eliminated. In the event that we close office space, there can be no assurance that we will be able to sublease that space,
or that sublease rents will offset our obligations under our prime lease(s).
In addition, there can be no assurance that existing sublessees under our
leases will not default in their rent or other obligations. Default by our
sublessees, or an inability by us to sublease excess office space could have an
adverse effect on our financial condition. Selling, general and administrative expenses include the costs of
recruiting, training and re-training, continuing education, technology, sales
and marketing, facilities, administration, corporate insurance expense, outside
professional fees and depreciation. In November 2001, the Financial Accounting Standards Board issued Staff
Announcement Topic No. D-103, Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses Incurred, which states that
reimbursements received for out-of-pocket expenses should be characterized as
revenue in the income statement. The application of Staff Announcement Topic
No. D-103 does not have an impact on current or previously reported net
earnings (loss) or earnings (loss) per share. We will continue to use net
revenue (revenue before out-of-pocket reimbursements) and net cost of services
(cost of services before out-of-pocket reimbursements) to compute percentage
and margin calculations, as well as for purposes of comparing the results of
operations for the year ended December 31, 2003, to the year ended December 31,
2002, and the year ended December 31, 2002, to the year ended December 31,
2001. We believe excluding out-of-pocket reimbursements, although a non-GAAP
financial measure, provides investors a better comparison from period to period
by removing the impact of fluctuations in out-of-pocket reimbursements that do
not reflect on operating performance. Critical Accounting Policies and Estimates The preparation of consolidated financial statements and related
disclosures in conformity with accounting principles generally accepted in the
United States of America, requires us to make judgments, assumptions and
estimates that affect the amounts reported in our consolidated financial
statements and the accompanying notes to consolidated financial statements.
Our estimates are based on prior experience, current business and market
conditions, as well as various other assumptions we believe are necessary to
form a basis for making judgments related to the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenue and
expenses during the reporting period. Significant judgments, assumptions and
estimates made by us include, but are not limited to: the allowance for
doubtful accounts and restructuring charges. Actual results could differ from
these estimates. The following critical accounting policies reflect our more
significant judgments, assumptions and estimates used 22




---



##### Table of Contents



in the preparation of the consolidated financial statements. Refer to our
audited consolidated financial statements and notes thereto for the years ended
December 31, 2001, 2002 and 2003 included herein, for information regarding our
significant accounting policies. Accounts Receivable Valuation. Substantially all of our accounts
receivable are due from companies in the healthcare industry. Credit is
extended based on evaluation of a customers financial condition and,
generally, collateral is not required. Accounts receivable are due within 30
days and are stated at amounts due from customers net of an allowance for
doubtful accounts. We determine our allowance by considering a number of
factors, including the length of time trade accounts receivable are past due,
our previous loss history, the customers current ability to pay its obligation
to us, and the condition of the general economy and the industry as a whole.
We write-off accounts receivable when they become uncollectible, and payments
subsequently received on such receivables are credited to the allowance for
doubtful accounts. We typically have not assessed interest on past due
accounts. Restructuring Charges. Prior to 2003, we accrued for restructuring
charges when we were specifically able to identify actions that needed to be
taken in response to a change in our strategic plan, product demand, increased
costs or other business factors. Effective January 1, 2003, we adopted the
provisions of Statement of Financial Accounting Standards No. 146, Accounting
for Costs Associated with Exit or Disposal Activities. This statement
requires entities to recognize costs associated with exit or disposal
activities when liabilities are incurred rather than when the entity commits to
an exit or disposal plan. We routinely evaluate the prior restructuring
accruals and make any necessary adjustments to reflect any changes in the costs
of the restructuring activities. During the year ended December 31, 2003, we
recorded a reduction to the 2002 accrual for future lease obligations, as the
result of subletting office space during 2003, which was previously included in
the accrual. Estimates are based on anticipated costs to exit such activities
and are subject to change. As of December 31, 2003, the restructuring-related accrual amounted to
approximately $1.5 million, which represents the present value of future
operating lease obligations for facilities no longer used by us, but not sublet
or sublet at amounts less than our obligation, as well as severance costs
related to our organizational restructuring. Our restructuring accrual may be
adjusted in the future, based on our actual success in subleasing compared to
our estimate. Our key accounting estimates and policies are reviewed with our auditors
and the Audit Committee of our Board of Directors. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, selected
statement of operations data expressed as a percentage of net revenue. The
trends illustrated in the following table may not necessarily be indicative of
future results. PERCENTAGE OF NET REVENUEYEAR ENDED DECEMBER 31,2001
    
    2002
    
    2003Net revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Net cost of services
    
    
    65.4
    %
    
    
    70.3
    %
    
    
    72.6
    %Selling, general and
administrative expenses
    
    
    46.2
    %
    
    
    39.0
    %
    
    
    28.6
    %Amortization of goodwill
    
    
    0.9
    %
    
    
    0.0
    %
    
    
    0.0
    %Restructuring (recovery) charges, net
    
    
    3.6
    %
    
    
    3.9
    %
    
    
    (0.2
    %)Impairment of assets
    
    
    0.0
    %
    
    
    0.7
    %
    
    
    0.0
    %Impairment of goodwill
    
    
    0.0
    %
    
    
    9.8
    %
    
    
    0.0
    %Loss from operations
    
    
    (16.1
    %)
    
    
    (23.7
    %)
    
    
    (1.0
    %)Other income (expense), net
    
    
    (4.2
    %)
    
    
    0.2
    %
    
    
    (0.9
    %)Loss before income tax benefit
    
    
    (20.3
    %)
    
    
    (23.5
    %)
    
    
    (1.9
    %)Income tax benefit
    
    
    0.0
    %
    
    
    (2.7
    %)
    
    
    0.0
    %Net loss
    
    
    (20.3
    %)
    
    
    (20.8
    %)
    
    
    (1.9
    %)
 23




---



##### Table of Contents



2003 COMPARED TO 2002 Net Revenue. Consulting. Net revenue in this segment increased by $0.7 million or
1.2%, to $54.3 million for the year ended December 31, 2003, as compared to
$53.6 million for the year ended December 31, 2002. Outsourcing. Net revenue in this segment increased by $7.2 million, or
23.6%, to $37.7 million for the year ended December 31, 2003, as compared to
$30.5 million for the year ended December 31, 2002. The revenue increase was
primarily the result of the signing of two new full outsourcing contracts
subsequent to December 31, 2002. Net Cost of Services. Consulting. Net cost of services in this segment increased by $0.2
million, or 0.6%, to $33.3 million for the year ended December 31, 2003, as
compared to $33.1 million for the year ended December 31, 2002. Net cost of
services as a percentage of net revenue for this segment was consistent at
61.4% for the year ended December 31, 2003, as compared to
61.8% for the year ended December 31, 2002. Outsourcing. Net cost of services in this segment increased by $7.4
million, or 28.6%, to $33.4 million for the year ended December 31, 2003, as
compared to $26.0 million for the year ended December 31, 2002. The increase
was primarily due to the costs incurred as the result of the signing of two new
outsourcing contracts subsequent to December 31, 2002, as well
as incurring a full year of operating costs associated with our new processing center. Net cost of services as a
percentage of net revenue for this segment increased to 88.8% for the year
ended December 31, 2003, as compared to 85.3% for the year ended December 31,
2002. The increase was primarily due to the costs incurred as the result of
the signing of two new outsourcing contracts subsequent to December 31, 2002,
as well as incurring a full year of operating costs associated with our new processing center. Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $6.5 million, or 20.0%, to $26.3 million
for the year ended December 31, 2003, as compared to $32.8 million for the year
ended December 31, 2002. The decrease was primarily attributable to reductions
in: personnel and related costs, depreciation and facility expenditures;
partially offset by increased corporate insurance expense. Selling, general
and administrative expenses as a percentage of net revenue decreased to 28.6%
for the year ended December 31, 2003, as compared to 39.0% for the year ended
December 31, 2002. The decrease was primarily attributable to: reductions in
personnel and related costs, increased operating efficiencies as a result of
our disciplined cost controls and an increased revenue base. Other income and expense. Other expense was $861,000 for the year ended
December 31, 2003, as compared to other income of $176,000 for the year ended
December 31, 2002. The change was primarily the result of interest expense
incurred on our long-term obligations, including the amortization of the costs
and warrant value associated with our senior subordinated debentures, as well
as reduced interest earned on our short-term investments during the year ended
December 31, 2003. 2002 COMPARED TO 2001 Net Revenue. Consulting. Net revenue in this segment decreased by $3.8 million or 6.7%,
to $53.6 million for the year ended December 31, 2002, as compared to $57.4
million for the year ended December 31, 2001. The revenue decrease was
primarily due to a decline in demand for this segments services. Outsourcing. Net revenue in this segment increased by $1.2 million, or
4.2%, to $30.5 million for the year ended December 31, 2002, as compared to
$29.3 million for the year ended December 31, 2001. The revenue increase was
primarily the result of the signing of a new outsourcing agreement during late
2001 and two new outsourcing agreements during 2002, partially offset by the
planned completion of two outsourcing agreements during 2001. Net Cost of Services. Consulting. Net cost of services in this segment decreased by $2.3
million, or 6.6%, to $33.1 million for the year ended December 31, 2002, as
compared to $35.4 million for the year ended December 31, 2001. The decrease
was due primarily to reductions in personnel and related costs in this segment.
Net cost of services as a percentage of net revenue for this segment 24




---



##### Table of Contents



was consistent at 61.8% for the year ended December 31, 2002, as compared
to 61.7% for the year ended December 31, 2001. Outsourcing. Net cost of services in this segment increased by $4.7
million, or 22.3%, to $26.0 million for the year ended December 31, 2002, as
compared to $21.3 million for the year ended December 31, 2001. The increase
was primarily due to costs related to new contracts. Net cost of services as a
percentage of net revenue for this segment increased to 85.3% for the year
ended December 31, 2002, as compared to 72.6% for the year ended December 31,
2001. The increase was primarily attributable to the initial costs associated
with the signing of the new full outsourcing contracts, including costs
associated with the opening of our new processing center. Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $8.0 million, or 19.6%, to $32.8 million
for the year ended December 31, 2002, as compared to $40.8 million for the year
ended December 31, 2001. The decrease was primarily attributable to reductions
in: personnel and related costs, facility, technology, communication and
marketing expenditures, goodwill amortization and charges related to the
accounts receivable allowance, litigation and claims, as well as efficiencies
achieved in continuing education programs. Selling, general and administrative
expenses as a percentage of net revenue decreased to 39.0% for the year ended
December 31, 2002, as compared to 47.1% for the year ended December 31, 2001.
The decrease was primarily attributable to increased operating efficiencies as
a result of our disciplined cost controls. Restructuring charges. Restructuring charges were $3.3 million for the
year ended December 31, 2002, as compared to $3.1 million for the year ended
December 31, 2001. Restructuring charges recorded during the year ended
December 31, 2002, consisted primarily of costs associated with the termination
of a business alliance, which included the accelerated lease costs related to
office space we determined was no longer necessary and were unable to sublet as
of December 31, 2002, as well as the write-off of leasehold improvements and
capitalized software development costs. The restructuring charges also included
severance costs related to our continued organizational restructuring and the
write-off of property and equipment, partially offset by a reduction to the
accrual for restructuring costs as of December 31, 2001. Restructuring charges
recorded during the year ended December 31, 2001, consisted primarily of costs
incurred as a result of the acceleration of lease costs associated with office
space we determined was no longer necessary based on our current business model
and had been unable to sublet as of December 31, 2001, or sublet at amounts
less than our obligations. The restructuring charges also consisted of the
write-off of property and equipment associated with closed office facilities,
the write-off of leasehold improvements related to closed or sublet office
space and severance costs related to our continued organizational
restructuring, partially offset by a reduction to the accrual for restructuring
costs included in accrued liabilities as of December 31, 2000. Refer to Note 11
(Restructurings) of our consolidated financial statements included herein,
for further details on the components of the restructuring charges. Impairment of assets. During the year ended December 31, 2002, we recorded
an impairment loss of approximately $0.6 million to write-down the carrying
value of non-essential real estate that we decided to sell during the quarter
ended December 31, 2002, in order to reduce operating costs and improve
liquidity, to its current fair value. We listed the real estate, an office
building and undeveloped land adjacent to the building, with an agent during
the fourth quarter of 2002, and sold the real estate in February 2003. The fair
value of the real estate was determined based on the ultimate sale price less
costs to sell. Impairment of goodwill. During the year ended December 31, 2002, we
completed our annual impairment assessment and concluded, based on market
capitalization, the expected present value of future cash flows and other
available information, that goodwill was fully impaired and as a result,
recorded an impairment loss of approximately $8.2 million. Other income and expense. Other income was $176,000 for the year ended
December 31, 2002, as compared to other expense of $3.6 million for the year
ended December 31, 2001. The change was primarily the result of the $4.1
million loss recognized on the sale of our remaining investment securities
during the year ended December 31, 2001, as well as the reduced interest earned
on our short-term investments during the year ended December 31, 2002. 25




---



##### Table of Contents



Quarterly Results The following table sets forth certain unaudited quarterly operating
information for each of the last eight quarters. QUARTER ENDEDMAR. 31,
    
    JUNE 30,
    
    SEPT. 30,
    
    DEC. 31,
    
    MAR. 31,
    
    JUNE 30,
    
    SEPT. 30,
    
    DEC. 31,2002
    
    2002
    
    2002
    
    2002
    
    2003
    
    2003
    
    2003
    
    2003(IN THOUSANDS, EXCEPT PER SHARE DATA)Net revenue
    
    $
    21,257
    
    
    $
    22,021
    
    
    $
    20,826
    
    
    $
    20,004
    
    
    $
    21,891
    
    
    $
    22,886
    
    
    $
    22,589
    
    
    $
    24,575Net cost of services
    
    
    14,190
    
    
    
    14,626
    
    
    
    14,992
    
    
    
    15,323
    
    
    
    15,884
    
    
    
    16,566
    
    
    
    16,342
    
    
    
    17,983Selling, general and
administrative expenses
    
    
    8,467
    
    
    
    8,396
    
    
    
    8,007
    
    
    
    7,946
    
    
    
    6,815
    
    
    
    6,555
    
    
    
    6,493
    
    
    
    6,390Restructuring (recovery) charges, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,308
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (193
    )Impairment of assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,223
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Earnings (loss) from operations
    
    
    (1,400
    )
    
    
    (1,001
    )
    
    
    (2,173
    )
    
    
    (15,367
    )
    
    
    (808
    )
    
    
    (235
    )
    
    
    (246
    )
    
    
    395Other income (expense), net
    
    
    72
    
    
    
    57
    
    
    
    50
    
    
    
    (3
    )
    
    
    (79
    )
    
    
    (150
    )
    
    
    (344
    )
    
    
    (288
    )Earnings (loss) before income
tax benefit
    
    
    (1,328
    )
    
    
    (944
    )
    
    
    (2,123
    )
    
    
    (15,370
    )
    
    
    (887
    )
    
    
    (385
    )
    
    
    (590
    )
    
    
    107Income tax benefit
    
    
    (2,301
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss)
    
    $
    973
    
    
    $
    (944
    )
    
    $
    (2,123
    )
    
    $
    (15,370
    )
    
    $
    (887
    )
    
    $
    (385
    )
    
    $
    (590
    )
    
    $
    107Net earnings (loss) per share
- basic
    
    $
    0.09
    
    
    $
    (0.09
    )
    
    $
    (0.20
    )
    
    $
    (1.43
    )
    
    $
    (0.08
    )
    
    $
    (0.04
    )
    
    $
    (0.06
    )
    
    $
    0.01Net earnings (loss) per share
- diluted
    
    $
    0.08
    
    
    $
    (0.09
    )
    
    $
    (0.20
    )
    
    $
    (1.43
    )
    
    $
    (0.08
    )
    
    $
    (0.04
    )
    
    $
    (0.06
    )
    
    $
    0.01Shares used in calculating net
earnings (loss) per share -
basic
    
    
    10,733
    
    
    
    10,748
    
    
    
    10,758
    
    
    
    10,765
    
    
    
    10,765
    
    
    
    10,765
    
    
    
    10,478
    
    
    
    10,377Shares used in calculating net
earnings (loss) per share -
diluted
    
    
    11,513
    
    
    
    10,748
    
    
    
    10,758
    
    
    
    10,765
    
    
    
    10,765
    
    
    
    10,765
    
    
    
    10,478
    
    
    
    11,363
 Revenue and operating results fluctuate from quarter to quarter due to
several factors, such as the number and significance of client engagements
commenced and completed during a quarter, delays incurred in connection with
projects, fluctuations in sales of our market offerings, slow adoption rate of
new solutions, and deployment of resources. The timing of revenue varies from
quarter to quarter because our sales cycle can be relatively long and may
depend on factors such as the size and scope of assignments, the general
ability of clients to terminate engagements without penalty, long outsourcing
sales cycles and general economic conditions. In addition, the timing of the
establishment of new Competency Centers, services and market offerings,
geographic expansion and the hiring of key individuals have and can adversely
affect margins. Seasonal factors such as vacation days, total business days in
a quarter or the business practices of clients, such as deferred commitments on
new projects until after the end of the calendar or the clients fiscal year,
have and can affect margins. Because a significant percentage of our expenses
are relatively fixed, a variation in the number or size of client assignments
or the timing of the initiation or the completion of client assignments can
cause significant variations in operating results from quarter to quarter. As a result of the factors above, and others, period-to-period comparison
of our revenue and operating results may not be meaningful. You should not rely
on these comparisons as indicators of future performance as no assurances can
be given that quarterly results will not fluctuate, causing a material adverse
effect on our operating results and financial conditions. LIQUIDITY AND CAPITAL RESOURCES In connection with our restructuring activities, we recorded restructuring
charges of approximately $3.3 million during the year ended December 31, 2002.
These charges consisted primarily of costs associated with the termination of a
business alliance, which included the accelerated expense associated with a
certain lease obligation and the write-off of leasehold improvements and
capitalized software development costs. The restructuring charges also
included severance costs related to our organizational restructuring and the
write-off of property and equipment, partially offset by a reduction to the
2001 accrual for restructuring costs. During the year ended December 31, 2003,
we recorded restructuring recoveries of approximately $193,000, which consisted
primarily of a reduction to the 2002 accrual for future lease obligations,
partially offset by severance costs related to our organizational
restructuring. Refer to Note 11 (Restructurings") of our consolidated
financial statements included herein, for further details on the components of
the restructuring (recoveries) charges. During the year ended December 31,
2003, we had cash outflows associated with these restructuring items of
approximately $1.4 million, of which approximately $1.1 million related to
certain lease obligations, which were accrued for as of December 31, 2002, and
approximately $257,000 related to severance costs, of which $239,000 was
accrued for as of December 31, 2002 26




---



##### Table of Contents



and $18,000 was included in additional charges recorded during 2003. The
current accrued liability for additional cash outflows, related to severance
costs and certain lease obligations, is approximately $1.5 million and will be
payable as follows: $590,000 during 2004, $474,000 during 2005, $235,000 during
2006 and $169,000 during 2007. During 2003, we entered into an unsecured financing arrangement for $8.5
million for software and professional fees related to the implementation of a
new healthcare application platform for an existing outsourcing client. The
agreement provides for sixty monthly payments in the amount of $170,046,
including interest at an annual rate of 7.35%, commencing February 2003 and
continuing through January 2008. As of December 31, 2003, we have capitalized
approximately $6.2 million related to software and professional services we
have received through that date. The liability associated with the capitalized
software and professional fees is $4.9 million as of December 31, 2003. We
currently anticipate the implementation project should be completed during the
first half of 2005 and we will continue to capitalize the remaining $2.3
million of software and professional fees throughout the project as those costs
are incurred. During 2003, we have also capitalized approximately $255,000 of
interest related to the project. Our outstanding contractual obligations as of December 31, 2003, which
include approximately $2.3 million of additional costs related to the above
financing arrangement, are summarized as follows: Operating
    
    Long-Term
    
    SeniorSubordinatedYears Ending December 31,
    
    Leases
    
    Obligations
    

Debentures
    
    Total2004
    
    $
    5,405
    
    
    $
    3,429
    
    
    $
    
    
    
    $
    8,8342005
    
    
    5,333
    
    
    
    2,926
    
    
    
    
    
    
    
    8,2592006
    
    
    2,532
    
    
    
    2,058
    
    
    
    8,000
    
    
    
    12,5902007
    
    
    1,071
    
    
    
    2,041
    
    
    
    
    
    
    
    3,1122008
    
    
    623
    
    
    
    170
    
    
    
    
    
    
    
    793Thereafter
    
    
    187
    
    
    
    
    
    
    
    
    
    
    
    187Total
    
    $
    15,151
    
    
    $
    10,624
    
    
    $
    8,000
    
    
    $
    33,775
 As of December 31, 2003, we have a line of credit arrangement with Fifth
Third Bank allowing for borrowings of up to $8.0 million, based on qualifying
accounts receivable and other operating metrics. Based on the eligibility
provisions and accounts receivable at December 31, 2003, we could have borrowed
$5.0 million. At December 31, 2003, $1.9 million was
outstanding. Borrowings under the line mature in May 2004. Borrowings bear
interest at the prime rate less 0.25%. The interest rate at December 31, 2003,
was 3.75%. The line is collateralized by accounts receivable, any deposits
held by the bank, equipment and other personalty. We were in compliance with
all financial covenants as of December 31, 2003. In addition, we have letters
of credit outstanding of approximately $1.9 million issued by various banks, of
which, approximately $0.9 million is secured by bank deposits and $1.0 million
is covered by our line of credit. In June and July 2003, we agreed to issue Senior Subordinated Debentures
(the Debentures) and warrants (the Warrants) to purchase 860,800 shares of
our $0.01 par value common stock (the common stock), in exchange for a cash
investment of $8.0 million from investors pursuant to the Securities Purchase
Agreement dated as of June 9, 2003, by and between us and the Purchasers
thereto (the Purchase Agreement). The unsecured Debentures have an initial
maturity date of June 9, 2006, with an option to extend the term for one
additional year to June 9, 2007, at our sole option, subject to certain
conditions. Pursuant to the terms of the Debentures, we are required to make
quarterly interest payments at the rate of (i) 7.2% per annum commencing on
July 1, 2003, until repayment in full, and (ii) if we elect to extend the
maturity date, 12% per annum from June 9, 2006 through June 9, 2007. We are
entitled, at any time, to make up to three partial prepayments of the
Debentures in the amount of at least 33% of the total initial indebtedness,
which if the Debentures are pre-paid in full, would result in a reduction to
the number of outstanding Warrants as provided for in the Warrant Agreement.
As of December 31, 2003, $8.0 million was outstanding on the debt. Under the Purchase Agreement, we agreed not to incur additional
indebtedness while the Debentures remain outstanding except for (a) capital
leases, purchase money indebtedness, mortgage debt, performance bonds and
similar instruments in the ordinary course of business, and (b) other
indebtedness for borrowed money not to exceed the greater of $8.0 million or
ten times EBITDA for the most recent quarter. Depending upon the
circumstances, these restrictions may make it difficult for us to make
acquisitions or grow our business and may restrict our access to needed
capital. 27




---



##### Table of Contents



Our Board of Directors approved the repurchase of up to 650,000 shares of
our common stock. A portion of these shares were repurchased in our Dutch
Auction Tender Offer, which commenced on June 16, 2003 and expired on July 14,
2003. During the tender offer, 355,782 shares of our common stock were
properly tendered at $3.60 per share, resulting in payments, including
expenses, of approximately $1.3 million. During the year ended December 31,
2003, we also repurchased 76,500 shares of our common stock on the open market
for approximately $331,000. Our primary capital needs have been, and will be, to fund our outsourcing
and solution sales initiatives, as well as our capital expenditures. We
believe after giving effect to the restructuring plan, and assuming appropriate
cost control initiatives and revenue consistent with recent levels, that our
current cash and cash equivalents, cash generated from operations, recent funds
received from the private placement of senior subordinated debentures, plus
available credit under our current and/or anticipated credit agreements with
our lenders, will be sufficient to finance our working capital and capital
expenditure requirements for at least the next twelve months. The nature,
amount and timing of our long-term capital needs can be affected by a number of
factors. For example, our strategic plan includes a heightened focus on the
development of our outsourcing business and the securing of large contracts.
Implementation of a new outsourcing contract has and can involve the need for
capital investment by us, including the hiring of new personnel and the
acquisition of a clients IT assets, including hardware and software. An
additional element of our outsourcing business strategy includes offering data
center consolidation to our clients, which has and will continue to require
investment by us in data or processing center hardware and software
as we sign additional contracts. The timing, number and
scale of potential future outsourcing contracts can impact our need for capital
resources. In addition, our future long-term capital needs will be affected by
the nature and timing of our market and service offerings, in addition to
outsourcing, and the degree and timing of success enjoyed by such offerings in
the market. A failure of our offerings to meet success in the market, and our
inability to adjust our operating expenses to an appropriate level commensurate
with operating revenue, can also affect our need for capital resources. For
all of these reasons and those identified in the other risk factors discussed
herein, our ability to project long-term revenue levels and capital needs is
subject to substantial uncertainty. If our available funds and cash generated from operations are insufficient
to satisfy our long-term liquidity requirements, or if we do not obtain other
expected credit agreements, or if an event of default occurs under our current
and/or anticipated credit agreements with our lenders and we are required to
repay all outstanding indebtedness under the credit agreements, we may need to
seek additional sources of funding, such as selling additional equity or debt
securities or obtaining additional lines of credit. We could also, in such
event, face the need to delay or reduce the development of services or the
pursuit of contracts that would require significant investment to complete. We
could also face the need to reduce staffing levels and related expenses or
potentially to liquidate or mortgage selected assets. If we decide that it is in our best interest to continue to raise cash to
strengthen our balance sheet, broaden our investor base, increase the liquidity
of our pool of publicly traded stock or for any other reason, we may decide to
issue additional equity or debt, notwithstanding that our currently available
funds are sufficient to meet our anticipated needs for working capital and
capital expenditures through the next twelve months. We may decide to continue
entering into such transactions to raise cash even if all of our current
funding sources remain available to us. If we issue additional securities to
raise funds, those securities may have rights, preferences, or privileges
senior to those of our common stock and our stockholders may experience
dilution. We cannot be certain that additional financing will be available to
us on favorable terms when required, or at all. Our inability to obtain
additional financing when needed could impair our ability to develop products
and services for the market; to enter into or implement new outsourcing
contracts; to implement our business strategies; and may otherwise materially
and adversely affect our financial condition. At December 31, 2003, we had cash and cash equivalents of $12.7 million
and working capital of $11.1 million, as compared with cash and cash
equivalents of $14.6 million and working capital of $14.0 million at December
31, 2002. Our net cash provided by operations increased to $1.8 million for the year
ended December 31, 2003, compared with $1.2 million for the year ended December
31, 2002. The increase in net cash provided by operations was due to
our improved operating results and the increase in depreciation and amortization during the year ended December
31, 2003, as compared to the year ended December 31, 2002, which
was partially off-set by the changes in our operating assets and liabilities. Net cash of $6.6 million used in investing activities during the year
ended December 31, 2003, consists of additions to property, equipment and
software, which primarily relate to the new full outsourcing contracts,
partially offset by the proceeds received from the sale of real estate. 28




---



##### Table of Contents



Net cash of $2.9 million provided by financing activities during the year
ended December 31, 2003, was the result of proceeds received from our senior
debentures and principal payments on our stockholders notes receivable,
partially offset by the repurchase and retirement of our common stock and
payments on our long-term obligations and line of credit. We do not believe that inflation has had a material effect on the results
of our operations. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to interest rate change market risk in connection with our
credit facilities with our bank. The interest rates on these facilities are
tied to the banks prime rate, and changes in the variable rate will have an
impact on our interest expense. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements are annexed to this Report as pages F-2 through
F-21. An index to such statements appears on page F-1. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 
 ITEM 9A. CONTROLS AND PROCEDURES As of the end of the period covered by this report, our management, under
the supervision of our Chief Executive Officer and Chief Financial Officer,
carried out an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Rule 13a-15(b) of the
Securities Exchange Act of 1934 (the Exchange Act). We do not expect that
our disclosure controls and procedures will prevent all errors and fraud. A
control system, irrespective of how well it is designed and operated, can only
provide reasonable assurance, and cannot guarantee, that it will succeed in its
stated objectives. Based upon their evaluation, our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures are effective in alerting them timely to material information
required to be included in our Exchange Act filings. There have not been any significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of the evaluation referred to above. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT We are incorporating the information required by this item with respect to
our directors by reference from our definitive proxy statement, which we expect
to file with the Commission on or prior to April 29, 2004. We have set forth
information regarding executive officers in Part I of this report. 
 ITEM 11. EXECUTIVE COMPENSATION We are incorporating the information required by this item by reference
from our definitive proxy statement, which we expect to file with the
Commission on or prior to April 29, 2004. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT We are incorporating the information required by this item by reference
from our definitive proxy statement, which we expect to file with the
Commission on or prior to April 29, 2004. 29




---



##### Table of Contents



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We are incorporating the information required by this item by reference
from our definitive proxy statement, which we expect to file with the
Commission on or prior to April 29, 2004. 
 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES We are incorporating the information required by this item by reference
from our definitive proxy statement, which we expect to file with the
Commission on or prior to April 29, 2004. 
 PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The financial statements filed as part of this report are listed in the
accompanying Index to Consolidated Financial Statements. The exhibits filed as
part of this report are listed in the accompanying Index to Exhibits. We will
furnish a copy of any exhibit listed to requesting stockholders upon payment of
our reasonable expenses in furnishing those materials. On October 24, 2003, we furnished a Current Report on Securities and
Exchange Commission Form 8-K reporting the press release issued by us that
announced our results of operations for the third quarter of 2003. 30




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGEReport of Independent Certified Public Accountants
    
    
    F-2Consolidated Balance Sheets as of December 31, 2002 and 2003
    
    
    F-3Consolidated Statements of Operations for the years ended December 31, 2001, 2002 and 2003
    
    
    F-4Consolidated Statements of Stockholders Equity for the years ended December 31, 2001, 2002 and 2003
    
    
    F-5Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2002 and 2003
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7




---



##### Table of Contents



REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors
Superior Consultant Holdings Corporation We have audited the accompanying consolidated balance sheets of Superior
Consultant Holdings Corporation (a Delaware corporation) and Subsidiaries as of
December 31, 2002 and 2003, and the related statements of operations,
stockholders equity and cash flows for each of the three years in the period
ended December 31, 2003. These 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 auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated 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 consolidated financial position
of Superior Consultant Holdings Corporation and Subsidiaries as of December 31,
2002 and 2003, and the results of their consolidated operations and their
consolidated cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America. As discussed in Note 5 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assetson January 1, 2002. /s/ GRANT THORNTON LLP Southfield, Michigan
February 17, 2004 F-2




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS December 31,2002
    
    2003(In thousands)Current assetsCash and cash equivalents
    
    $
    14,575
    
    
    $
    12,688Accounts receivable, net
    
    
    11,959
    
    
    
    12,592Accrued interest receivable and prepaid expenses
    
    
    3,139
    
    
    
    3,852Refundable income taxes
    
    
    238
    
    
    
    148Total current assets
    
    
    29,911
    
    
    
    29,280Property and equipment, net
    
    
    12,737
    
    
    
    24,235Real estate held for sale
    
    
    991
    
    
    
    Other long-term assets
    
    
    17
    
    
    
    338Total Assets
    
    $
    43,656
    
    
    $
    53,853LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesNotes payable to bank
    
    $
    2,925
    
    
    $
    1,900Current portion of long-term obligations
    
    
    455
    
    
    
    2,793Accounts payable
    
    
    7,449
    
    
    
    8,829Accrued liabilities, principally compensation
    
    
    2,842
    
    
    
    2,758Deferred revenue
    
    
    2,194
    
    
    
    1,920Total current liabilities
    
    
    15,865
    
    
    
    18,200Senior subordinated debentures, net
    
    
    
    
    
    
    7,552Long-term obligations
    
    
    938
    
    
    
    4,307Other long-term liabilities
    
    
    1,686
    
    
    
    878Commitments and contingencies (Note 16)
    
    
    
    
    
    
    Stockholders equityPreferred stock; authorized, 1,000,000 shares of $.01 par value; no shares issued
as of December 31, 2002 and December 31, 2003
    
    
    
    
    
    
    Common stock; authorized, 30,000,000 shares of $.01 par value; issued, 11,116,991 shares
as of December 31, 2002 and 10,801,630 shares as of December 31, 2003
    
    
    111
    
    
    
    108Additional paid-in capital
    
    
    116,154
    
    
    
    115,520Stockholders notes receivable
    
    
    (1,221
    )
    
    
    (749
    )Treasury stock  at cost; 352,100 shares as of December 31, 2002
and 428,600 shares as of December 31, 2003
    
    
    (3,270
    )
    
    
    (3,601
    )Accumulated deficit
    
    
    (86,607
    )
    
    
    (88,362
    )Total stockholders equity
    
    
    25,167
    
    
    
    22,916Total Liabilities and Stockholders Equity
    
    $
    43,656
    
    
    $
    53,853
 The accompanying notes are an integral part of the consolidated financial statements. F-3




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31,2001
    
    2002
    
    2003(In thousands, except per share data)RevenueRevenue before reimbursements (net revenue)
    
    $
    86,721
    
    
    $
    84,108
    
    
    $
    91,941Out-of-pocket reimbursements
    
    
    10,485
    
    
    
    8,517
    
    
    
    7,599Total revenue
    
    
    97,206
    
    
    
    92,625
    
    
    
    99,540Operating costs and expensesCost of services before reimbursements (net cost of services)
    
    
    56,721
    
    
    
    59,131
    
    
    
    66,775Out-of-pocket reimbursements
    
    
    10,485
    
    
    
    8,517
    
    
    
    7,599Total cost of services
    
    
    67,206
    
    
    
    67,648
    
    
    
    74,374Selling, general and administrative expenses
    
    
    40,833
    
    
    
    32,816
    
    
    
    26,253Restructuring (recovery) charges, net
    
    
    3,112
    
    
    
    3,308
    
    
    
    (193
    )Impairment of assets
    
    
    
    
    
    
    571
    
    
    
    Impairment of goodwill
    
    
    
    
    
    
    8,223
    
    
    
    Total operating costs and expenses
    
    
    111,151
    
    
    
    112,566
    
    
    
    100,434Loss from operations
    
    
    (13,945
    )
    
    
    (19,941
    )
    
    
    (894
    )Other income (expense), net
    
    
    (3,620
    )
    
    
    176
    
    
    
    (861
    )Loss before income tax benefit
    
    
    (17,565
    )
    
    
    (19,765
    )
    
    
    (1,755
    )Income tax benefit
    
    
    
    
    
    
    (2,301
    )
    
    
    Net loss
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Net loss per shareBasic
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Diluted
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Weighted average number of common shares outstandingBasic
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595Diluted
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595
 The accompanying notes are an integral part of the consolidated financial statements. F-4




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY Preferred Stock
    
    Common Stock
    
    AdditionalPaid-In
    
    StockholdersNotesShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Receivable(In thousands)Balance at January 1, 2001
    
    
    1
    
    
    $
    
    
    
    
    11,075
    
    
    $
    111
    
    
    $
    116,003
    
    
    $
    (1,553
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net unrealized gain on investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total comprehensive lossTax benefit relating to stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    16
    
    
    
    Purchase of 267,100 shares of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancellation of shares issued in connection with acquisition
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    Compensation expense recognized for fair value of stock
options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38
    
    
    
    Payment on stockholders notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Balance at December 31, 2001
    
    
    
    
    
    
    
    
    
    
    11,080
    
    
    
    111
    
    
    
    116,062
    
    
    
    (1,536
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Tax benefit relating to stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    37
    
    
    
    
    
    
    
    115
    
    
    
    Reversal of compensation expense recognized during 2001 for
fair value of stock options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50
    )
    
    
    Payments on stockholders notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    315Balance at December 31, 2002
    
    
    
    
    
    
    
    
    
    
    11,117
    
    
    
    111
    
    
    
    116,154
    
    
    
    (1,221
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Tax benefit relating to stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    41
    
    
    
    
    
    
    
    118
    
    
    
    Purchase of 76,500 shares of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Repurchase and retirement of 355,782 shares
    
    
    
    
    
    
    
    
    
    
    (356
    )
    
    
    (3
    )
    
    
    (1,302
    )
    
    
    Warrants issued in connection with
senior subordinated debentures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    526
    
    
    
    Payments on stockholders notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    472Balance at December 31, 2003
    
    
    
    
    
    $
    
    
    
    
    10,802
    
    
    $
    108
    
    
    $
    115,520
    
    
    $
    (749
    )
 AccumulatedTreasury
    
    
    
    
    
    OtherStock
    
    Accumulated
    
    ComprehensiveAmount
    
    Deficit
    
    Income (Loss)
    
    TotalBalance at January 1, 2001
    
    $
    (2,270
    )
    
    $
    (51,578
    )
    
    $
    (2,373
    )
    
    $
    58,340Net loss
    
    
    
    
    
    
    (17,565
    )
    
    
    
    
    
    
    (17,565
    )Net unrealized gain on investment securities
    
    
    
    
    
    
    
    
    
    
    2,373
    
    
    
    2,373Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,192
    )Tax benefit relating to stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16Purchase of 267,100 shares of treasury stock
    
    
    (1,000
    )
    
    
    
    
    
    
    
    
    
    
    (1,000
    )Cancellation of shares issued in connection with acquisition
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Compensation expense recognized for fair value of stock
options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38Payment on stockholders notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Balance at December 31, 2001
    
    
    (3,270
    )
    
    
    (69,143
    )
    
    
    
    
    
    
    42,224Net loss
    
    
    
    
    
    
    (17,464
    )
    
    
    
    
    
    
    (17,464
    )Tax benefit relating to stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115Reversal of compensation expense recognized during 2001 for
fair value of stock options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50
    )Payments on stockholders notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    315Balance at December 31, 2002
    
    
    (3,270
    )
    
    
    (86,607
    )
    
    
    
    
    
    
    25,167Net loss
    
    
    
    
    
    
    (1,755
    )
    
    
    
    
    
    
    (1,755
    )Tax benefit relating to stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118Purchase of 76,500 shares of treasury stock
    
    
    (331
    )
    
    
    
    
    
    
    
    
    
    
    (331
    )Repurchase and retirement of 355,782 shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,305
    )Warrants issued in connection with
senior subordinated debentures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    526Payments on stockholders notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    472Balance at December 31, 2003
    
    $
    (3,601
    )
    
    $
    (88,362
    )
    
    $
    
    
    
    $
    22,916
 The accompanying notes are an integral part of the consolidated financial statements. F-5




---



##### Table of Contents





SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|---------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                                                                                   |  | Year Ended December 31,
|                                                                                   |  | 2001                    |         | 2002 |  | 2003
|                                                                                   |  | (In thousands)         
|Cash flows from operating activities:                                              |  |                         |         |      |  |      |         |   |  |   |        |  
|Net loss                                                                           |  | $                       | (17,565 | )    |  | $    | (17,464 | ) |  | $ | (1,755 | )
|Adjustments to reconcile net loss to net                                           |  |                         |         |      |  |      |         |   |  |   |        |  
|cash provided by operating activities:                                             |  |                         |         |      |  |      |         |   |  |   |        |  
|Depreciation and amortization of property and equipment                            |  |                         | 4,083   |      |  |      | 4,451   |   |  |   | 5,080  |  
|Goodwill amortization                                                              |  |                         | 749     |      |  |      |        |   |  |   |       |  
|Impairment of goodwill                                                             |  |                         |        |      |  |      | 8,223   |   |  |   |       |  
|Bad debt expense                                                                   |  |                         | 395     |      |  |      |        |   |  |   |       |  
|Impairment of assets                                                               |  |                         |        |      |  |      | 571     |   |  |   |       |  
|Restructuring charge  write-off of property and equipment                         |  |                         | 527     |      |  |      | 55      |   |  |   |       |  
|Restructuring charge  write-off of leasehold improvements                         |  |                         | 305     |      |  |      | 888     |   |  |   |       |  
|Restructuring charge  write-off of capitalized software development costs         |  |                         |        |      |  |      | 586     |   |  |   |       |  
|Restructuring charge  future lease obligations                                    |  |                         | 2,231   |      |  |      | 1,429   |   |  |   |       |  
|Gain on sale of investment securities                                              |  |                         | 4,081   |      |  |      |        |   |  |   |       |  
|Non-cash interest expense                                                          |  |                         |        |      |  |      |        |   |  |   | 161    |  
|Options and warrants issued to non-employees                                       |  |                         | 38      |      |  |      | (50     | ) |  |   |       |  
|Changes in operating assets and liabilities:                                       |  |                         |         |      |  |      |         |   |  |   |        |  
|Accounts receivable                                                                |  |                         | 4,915   |      |  |      | 2,205   |   |  |   | (633   | )
|Accrued interest receivable and prepaid expenses                                   |  |                         | (128    | )    |  |      | 505     |   |  |   | (483   | )
|Refundable income taxes                                                            |  |                         | 5,399   |      |  |      | 495     |   |  |   | 114    |  
|Accounts payable                                                                   |  |                         | (1,295  | )    |  |      | (2,545  | ) |  |   | 531    |  
|Accrued liabilities, deferred bonuses and compensation                             |  |                         | (1,021  | )    |  |      | 90      |   |  |   | (84    | )
|Deferred revenue                                                                   |  |                         | (1,624  | )    |  |      | 53      |   |  |   | (274   | )
|Other long-term liabilities                                                        |  |                         |        |      |  |      | 1,686   |   |  |   | (808   | )
|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|Net cash provided by operating activities                                          |  |                         | 1,090   |      |  |      | 1,178   |   |  |   | 1,849  |  
|Cash flows from investing activities:                                              |  |                         |         |      |  |      |         |   |  |   |        |  
|Proceeds from sale of investment securities                                        |  |                         | 571     |      |  |      |        |   |  |   |       |  
|Purchase of property and equipment                                                 |  |                         | (1,747  | )    |  |      | (3,836  | ) |  |   | (7,627 | )
|Proceeds from sale of real estate                                                  |  |                         |        |      |  |      |        |   |  |   | 991    |  
|Changes in other long-term assets                                                  |  |                         | (670    | )    |  |      |        |   |  |   |       |  
|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|Net cash used in investing activities                                              |  |                         | (1,846  | )    |  |      | (3,836  | ) |  |   | (6,636 | )
|Cash flows from financing activities:                                              |  |                         |         |      |  |      |         |   |  |   |        |  
|Repayment of line of credit                                                        |  |                         | (2,200  | )    |  |      |        |   |  |   | (1,025 | )
|Payments on long-term obligations                                                  |  |                         |        |      |  |      | (99     | ) |  |   | (2,534 | )
|Proceeds from senior subordinated debentures                                       |  |                         |        |      |  |      |        |   |  |   | 8,000  |  
|Costs associated with senior subordinated debentures                               |  |                         |        |      |  |      |        |   |  |   | (495   | )
|Principal payments on stockholders notes receivable                               |  |                         | 17      |      |  |      | 315     |   |  |   | 472    |  
|Exercise of stock options                                                          |  |                         | 16      |      |  |      | 115     |   |  |   | 118    |  
|Stock repurchased                                                                  |  |                         | (1,000  | )    |  |      |        |   |  |   | (331   | )
|Repurchase and retirement of common stock                                          |  |                         |        |      |  |      |        |   |  |   | (1,305 | )
|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|Net cash provided by (used in) financing activities                                |  |                         | (3,167  | )    |  |      | 331     |   |  |   | 2,900  |  
|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|Net decrease in cash and cash equivalents                                          |  |                         | (3,923  | )    |  |      | (2,327  | ) |  |   | (1,887 | )
|Cash and cash equivalents, beginning of period                                     |  |                         | 20,825  |      |  |      | 16,902  |   |  |   | 14,575 |  
|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|Cash and cash equivalents, end of period                                           |  | $                       | 16,902  |      |  | $    | 14,575  |   |  | $ | 12,688 |  
|                                                                                   |  |                         |         |      |  |      |         |   |  |   |        |  
|Supplemental
disclosure of cash flow information:                                  |  |                         |         |      |  |      |         |   |  |   |        |  
|Cash paid for income taxes                                                         |  | $                       | 6       |      |  | $    | 73      |   |  | $ | 3      |  
|Cash paid for interest                                                             |  |                         | 281     |      |  |      | 160     |   |  |   | 993    |  
|Non-Cash Transactions:                                                             |  |                         |         |      |  |      |         |   |  |   |        |  
|Net unrealized gain on investments, net of deferred income taxes                   |  | $                       | 2,373   |      |  | $    |        |   |  | $ |       |  
|Tax benefit from exercise of stock options                                         |  |                         | 6       |      |  |      | 27      |   |  |   | 24     |  
|Purchase of property and equipment financed by long-term obligations               |  |                         |        |      |  |      | 1,492   |   |  |   | 8,102  |  
|Purchase of property and equipment included in accounts payable                    |  |                         |        |      |  |      |        |   |  |   | 849    |  
|Purchase of a support and maintenance agreement financed by a long-term obligation |  |                         |        |      |  |      |        |   |  |   | 139    |  

The accompanying notes are an integral part of the consolidated financial statements.

F-6



---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts
of Superior Consultant Holdings Corporation and its wholly-owned
subsidiaries. All material intercompany accounts and transactions have been
eliminated. Business Activities and Reportable Segments We are organized into the two business segments of consulting and
outsourcing. The consulting segment provides information technology, as well
as strategic and operations management consulting and solutions, and
application support to a broad cross-section of healthcare industry
participants and information systems vendors. The outsourcing segment helps
healthcare providers simplify their management agendas, improve their return
on information systems investment and strengthen their technology management
by taking on responsibility for managing and operating all or part of the
clients information technology functions. Cash and Cash Equivalents For purposes of the statement of cash flows, we consider all highly
liquid investments purchased with a maturity of three months or less to be
cash equivalents. At December 31, 2002 and 2003, we have $1,572,000 and
$932,000 of cash restricted for letters of credit, respectively. Accounts Receivable Substantially all of our accounts receivable are due from companies in
the healthcare industry. Credit is extended based on evaluation of a
customers financial condition and, generally, collateral is not required.
Accounts receivable are due within 30 days and are stated at amounts due from
customers net of an allowance for doubtful accounts. We determine our
allowance by considering a number of factors, including the length of time
trade accounts receivable are past due, our previous loss history, the
customers current ability to pay its obligation to us, and the condition of
the general economy and the industry as a whole. We write-off accounts
receivable when they become uncollectible, and payments subsequently received
on such receivables are credited to the allowance for doubtful accounts. We
typically have not assessed interest on past due accounts. Property and Equipment Property and equipment are stated at cost. Expenditures for renewals and
improvements that extend the useful life of property and equipment are
capitalized. Expenditures for maintenance and repairs are charged to expense
as incurred. Depreciation is provided over the estimated useful lives of
depreciable assets using the straight-line method. F-7




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Investment Securities We follow Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities (SFAS
115). Under SFAS 115, debt and marketable equity securities must be
classified in one of three categories: trading, available-for-sale, or held
to maturity. A decline in the market value of an available-for-sale security
below cost that is deemed other than temporary would be charged to earnings
and result in the establishment of a new cost basis for the security.
Realized gains and losses are determined on the specific identification
method and reflected in earnings. Income Taxes We account for income taxes using the asset and liability approach.
Deferred income taxes are provided for the differences between the tax bases
of assets or liabilities and their reported amounts in the financial
statements. This method also requires the recognition of future tax benefits
such as net operating loss carryforwards, to the extent that realization of
such benefits is more likely than not. The tax benefit from the exercise of
certain stock options reduces our accrued income tax liability and increases
additional paid-in capital. Use of Estimates The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from these
estimates. Fair Value of Financial Instruments The carrying value of the cash equivalents approximates their estimated
fair values based upon quoted market prices. The fair value of stockholders
notes receivables and subordinated debt approximates their carrying values
based on current rates for instruments with similar characteristics. Revenue Recognition We recognize revenue on time and materials engagements as the services
are provided. For fixed-fee projects and pre-packaged solution sales, we
generally recognize revenue based on progress toward project milestones. We
generally recognize revenue from our outsourcing contracts, help desk and
call center support agreements, managed trust (digital security)
contracts and
support and maintenance agreements ratably over annual periods within
our multi-year contracts.
Deferred revenue represents collections made in advance of services being
performed. Reimbursements for out-of-pocket expenses are recorded as revenue. Revenue Concentration For the year ended December 31, 2003, revenue recognized from one client
represented approximately 10.3% of our total net revenue. For the years
ended December 31, 2001 and 2002, no clients exceeded 10.0% of our total net
revenue. F-8




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Stock-Based Compensation Our incentive plan is described more fully in Note 10 Stock Options and
Warrants. We apply the intrinsic value method under APB Opinion 25,
Accounting for Stock Issued to Employeesand its related interpretations,
for options granted to employees and Board members. No compensation expense
is recognized because we award options at the fair market value on the date
of grant. For options and warrants to non-employees, we apply Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation(SFAS 123), and accordingly, recognize expense using a fair
market value method. The following table illustrates the effect if we had applied the fair
value recognition provisions of SFAS 123 to options and warrants issued to
employees and Board members, using the assumptions described in Note 10. Year Ended December 31,2001
    
    2002
    
    2003Net loss, as reported
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Deduct stock-based employee compensation expense
determined under the fair value-based method for
awards granted, modified, or settled, net of related
tax effects
    
    
    (7,483
    )
    
    
    (5,260
    )
    
    
    (4,167
    )Pro forma net loss
    
    $
    (25,048
    )
    
    $
    (22,724
    )
    
    $
    (5,922
    )Loss per share:Basic and diluted  as reported
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Basic and diluted  pro forma
    
    $
    (2.29
    )
    
    $
    (2.11
    )
    
    $
    (0.56
    )
 Comprehensive Income (Loss) Comprehensive loss, which is included as a component of stockholders
equity, includes net unrealized gains and losses on investments in marketable
equity and debt securities. We sold our remaining holdings of marketable
equity securities during the year ended December 31, 2001. The total
comprehensive loss is summarized as follows: Year Ended December 31,2001
    
    2002
    
    2003Net loss
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Other comprehensive income, net of tax:Unrealized holding losses on securities arising
during the period
    
    
    (55
    )
    
    
    
    
    
    
    Less:
    
    Reclassification adjustment for realized
losses on securities included in net
loss, net of tax benefit of $1,653, $0 and $0
for the years ended December 31, 2001,
2002 and 2003, respectively
    
    
    (2,428
    )
    
    
    
    
    
    
    Other comprehensive income, net of tax
    
    
    2,373
    
    
    
    
    
    
    
    Total comprehensive loss
    
    $
    (15,192
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )
 F-9




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) New Accounting Pronouncements Derivative Instruments and Hedging Activities.In April 2003, the
Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities(SFAS 149). SFAS 149 clarifies various
derivative implementation issues, and is generally effective for new
contracts entered into or modified after June 30, 2003. We currently do not
enter into derivative transactions, and therefore the adoption of SFAS 149
had no impact on our consolidated financial statements. Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity.In May 2003, the FASB issued Statement of
Financial Accounting Standards No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity(SFAS
150). Under SFAS 150, a mandatorily redeemable financial instrument is
classified as a liability unless the redemption is required to occur only
upon the liquidation or termination of the entity, and is measured at fair
market value. Changes in the fair value or redemption amount are recognized
in earnings. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003. For financial instruments issued on or before
May 31, 2003, SFAS 150 is effective July 1, 2003. The adoption of SFAS 150
had no impact on our consolidated financial statements. Consolidation of Variable Interest Entities.In January 2003, the FASB
issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable
Interest Entities.The objective of this interpretation is to provide
guidance on how to identify a variable interest entity (VIE) and determine
when the assets, liabilities, non-controlling interests and results of
operations of a VIE need to be included in a companys consolidated financial
statements. A company that holds variable interests in an entity will need
to consolidate the entity if the companys interest in the VIE is such that
the company will absorb a majority of the VIEs expected losses and/or
receive a majority of the VIEs expected residual returns, if they occur.
FIN 46 also requires additional disclosures by primary beneficiaries and
other significant variable interest holders. The provisions of this
interpretation apply at the reporting period ending after March 15, 2004
(i.e., March 31, 2004) to VIEs in which a company holds a variable interest
that it acquired before February 1, 2003. We believe the adoption of FIN 46
will have no impact on our consolidated financial statements. Revenue Recognition.In November 2002, the Emerging Issues Task Force
(EITF) reached a consensus opinion on EITF Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables(EITF 00-21). The consensus
provides that revenue arrangements with multiple deliverables should be
divided into separate units of accounting if certain criteria are met. The
consideration for the arrangement should be allocated to the separate units
of accounting based on their relative fair values, with different provisions
if the fair value of all deliverables are not known or if the fair value is
contingent on delivery of specified items or performance conditions.
Applicable revenue recognition criteria should be considered separately for
each separate unit of accounting. EITF 00-21 is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
Entities may elect to report the change as a cumulative effect adjustment in
accordance with APB Opinion 20, Accounting Changes.During 2003, we
performed an assessment of our outsourcing contract terms and
deliverables, and concluded that the adoption of EITF 00-21 had no
impact on our consolidated financial statements. Reclassifications Certain reclassifications were made to the 2002 consolidated financial
statements to conform to 2003s presentation. F-10




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 2. ALLOWANCE FOR DOUBTFUL ACCOUNTS A summary of activity in connection with the allowance for doubtful
accounts follows: Year Ended December 31,2001
    
    2002
    
    2003Allowance for doubtful accounts at beginning of year
    
    $
    6,375
    
    
    $
    5,200
    
    
    $
    3,988Write-offs
    
    
    (1,570
    )
    
    
    (1,212
    )
    
    
    (1,192
    )Charged to bad debt expense
    
    
    395
    
    
    
    
    
    
    
    Allowance for doubtful accounts at end of year
    
    $
    5,200
    
    
    $
    3,988
    
    
    $
    2,796
 3. PROPERTY AND EQUIPMENT Property and equipment consists of the following: December 31,
    
    Range ofUseful2002
    
    2003
    
    LivesOffice furniture and equipment
    
    $
    6,024
    
    
    $
    6,096
    
    
    5-7 YearsComputer equipment
    
    
    11,725
    
    
    
    18,212
    
    
    3-5 YearsComputer software
    
    
    6,712
    
    
    
    16,512
    
    
    3-5 YearsBuilding
    
    
    2,825
    
    
    
    2,825
    
    
    40 YearsLeasehold improvements
    
    
    1,616
    
    
    
    1,835
    
    
    2-7 Years28,902
    
    
    
    45,480Less: accumulated depreciation and amortization
    
    
    (16,185
    )
    
    
    (21,265
    )Land
    
    
    20
    
    
    
    20Property and equipment, net
    
    $
    12,737
    
    
    $
    24,235
 The property and equipment classification includes approximately
$1,492,000 and $9,850,000 of items under capital leases as of December 31,
2002 and 2003, respectively. As of December 31, 2002 and 2003, accumulated
amortization of approximately $50,000 and $517,000, respectively, was
recorded on these assets. 4. REAL ESTATE HELD FOR SALE We recognized an impairment loss of approximately $571,000 on real
estate in 2002. During the quarter ended December 31, 2002, we decided to
sell non-essential real estate in order to reduce operating costs and improve
liquidity. We listed the real estate, an office building and undeveloped land
adjacent to the building, with an agent in the fourth quarter of 2002, and
sold the real estate in February 2003. The fair value of the real estate,
approximately $991,000, was based on the ultimate sale price less costs to
sell. 5. GOODWILL AND GOODWILL IMPAIRMENT Effective January 1, 2002, we adopted the provisions of Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible
Assets(SFAS 142), issued by the Financial Accounting Standards Board.
SFAS 142 addresses how intangible assets that are acquired should be
accounted for upon acquisition. SFAS 142 specifies, among other things, that
goodwill is not subject to amortization. During 2002, in accordance with SFAS
142, we ceased the
amortization of goodwill. The following table shows on a comparative
basis what net loss and net loss per share would have been exclusive of
amortization expense (including any related tax effects): F-11




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 5. GOODWILL AND GOODWILL IMPAIRMENT (CONTINUED) Year Ended December 31,2001
    
    2002
    
    2003Reported net loss
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Add: goodwill amortization
    
    
    749
    
    
    
    
    
    
    
    Adjusted net loss
    
    $
    (16,816
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Basic and diluted net loss per share:Reported net loss per share
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Add: goodwill amortization
    
    
    0.07
    
    
    
    
    
    
    
    Adjusted net loss per share
    
    $
    (1.54
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )
 As of January 1, 2002, we had recorded goodwill of approximately $22.8
million and accumulated amortization of approximately $14.6 million. In
addition, as a result of ceasing the amortization of goodwill, we are
required under SFAS 142 to perform an impairment assessment at least
annually. During the fourth quarter ended December 31, 2002, we performed our
annual assessment. We estimated fair value using market capitalization, the
expected present value of future cash flows, and other available information.
Based on our findings, we concluded that goodwill was fully impaired, and
recorded approximately $8.2 million of impairment losses. The following are changes in the carrying amount of goodwill for the year
ended December 31, 2002: Consulting
    
    OutsourcingSegment
    
    Segment
    
    TotalBalance as of January 1, 2002
    
    
    6,014
    
    
    
    2,209
    
    
    
    8,223Impairment losses
    
    
    (6,014
    )
    
    
    (2,209
    )
    
    
    (8,223
    )Balance as of December 31, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
 6. NOTES PAYABLE TO BANK As of December 31, 2002, borrowings under a line of credit bear interest
at the greater of the prime rate or 1% plus the Federal funds effective rate.
The interest rate at December 31, 2002 was 4.25%. The line is collateralized
by accounts receivable and any deposits held by the bank. There are no
compensating balance requirements. The loan agreement contains covenants,
including financial ratios concerning liquidity, working capital and
operating results. We did not meet certain financial operating covenants as
of December 31, 2002, and repaid the outstanding balance subsequent to
year-end. In addition, at December 31, 2002, we had letters of credit of
approximately $1.6 million issued by a bank, secured by bank deposits. As of December 31, 2003, we have a line of credit with a bank allowing
for borrowings of up to $8.0 million, based on qualifying accounts receivable
and other operating metrics. Based on the eligibility provisions and
accounts receivable at December 31, 2003, we could have borrowed
$5.0 million. At December 31, 2003, $1.9 million was
outstanding. Borrowings under the line mature in May 2004. Borrowings bear
interest at the prime rate less 0.25%. The interest rate at December 31,
2003, was 3.75%. The line is collateralized by accounts receivable, any
deposits held by the bank, equipment and other personalty. The loan
agreement contains financial covenants, including working capital and ratios
concerning liquidity and debt coverage. We were in compliance with all
financial covenants as of December 31, 2003. In addition, we have letters of
credit outstanding of approximately $1.9 million issued by various banks, of
which, approximately $0.9 million is secured by bank deposits and $1.0
million is covered by our line of credit. F-12




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 7. LONG-TERM OBLIGATIONS During 2003, we entered into an unsecured financing arrangement for $8.5
million for software and professional fees related to the implementation of a
new healthcare application platform for an existing outsourcing client. The
agreement provides for sixty monthly payments in the amount of $170,046,
including interest at an annual rate of 7.35%, commencing February 2003 and
continuing through January 2008. As of December 31, 2003, we have
capitalized approximately $6.2 million related to software and professional
services we have received through that date. The liability associated with
the capitalized software and professional fees is $4.9 million as of December
31, 2003. We currently anticipate the implementation project should be
completed during the first half of 2005 and we will continue to
capitalize the remaining $2.3 million of software and professional fees
throughout the project as those costs are incurred. The principal maturities
related to this obligation are included in the table below. During 2003, we
have also capitalized approximately $255,000 of interest related to the
project. We lease and have financing arrangements for computer equipment under
various agreements that expire through 2008 (amounts to be repaid during 2007
and 2008 have yet to be capitalized  see paragraph above). The leases have
been accounted for as capital leases for financial reporting purposes, and
include interest at rates ranging from 4.6% to 11.7% per annum. Future
minimum payments under the lease and financing arrangements consist of the
following: LeaseYears Ending December 31,
    
    Payments
    
    Principal2004
    
    $
    3,429
    
    
    $
    2,7932005
    
    
    2,926
    
    
    
    2,5092006
    
    
    2,058
    
    
    
    1,798Total minimum lease payments
    
    
    8,413
    
    
    $
    7,100Less: amounts representing interest
    
    
    1,313Net minimum lease payments
    
    $
    7,100
 8. SENIOR SUBORDINATED DEBENTURES In June and July 2003, we entered into an Agreement (the Purchase
Agreement) whereby we agreed to issue Senior Subordinated Debentures (the
Debentures) and Warrants (the Warrants) to purchase 860,800 shares of our
$0.01 par value common stock (the common stock), in exchange for a cash
investment of $8.0 million from two investors. The unsecured Debentures
mature three years from the date of their issuance (the Issuance Date),
with an option to extend the term for one additional year at our sole
option, subject to certain conditions. Pursuant to the terms of the
Debentures, we are required to make quarterly interest payments at the rate
of (i) 7.2% per annum until repayment in full, and (ii) if we elect to extend
the maturity date, 12% per annum during the extension period. We are
entitled, at any time, to make up to three partial prepayments of the
Debentures in the amount of at least 33% of the total initial indebtedness,
which if the Debentures are pre-paid in full, would result in a reduction to
the number of outstanding Warrants as provided for in the Warrant Agreement.
As of December 31, 2003, $8.0 million was outstanding on the debt. The Warrants to purchase up to 860,800 shares of our common stock have
an exercise price of $3.046 per share, subject to certain anti-dilution
adjustments. All Warrants were immediately available for exercise. The
Warrants expire during 2008, or, if earlier, two (2) years after the
repayment of the Debentures in full. In addition, Warrants may be cancelled
as follows: in the event of prepayment of the debentures in full prior to the
second anniversary of issuance, seventeen percent (17%) of the Warrants will
be cancelled; or in the event of prepayment of the debentures in full after
the second anniversary of issuance and before the third anniversary of
issuance, a pro rata portion of seventeen percent
(17%) of the Warrants will be cancelled based on the number of full
months between the prepayment and the third anniversary of issuance. F-13




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 8. SENIOR SUBORDINATED DEBENTURES (CONTINUED) In accordance with APB Opinion No. 14, Accounting for Convertible Debt
and Debt Issued with Stock Purchase Warrantswe allocated the proceeds
received to the debt instruments and detachable warrants on a relative fair
value basis. An external valuation firm completed an independent valuation
of the Warrants, which resulted in $526,000 of proceeds allocated to the
Warrants and additional paid-in capital, with the remaining $7,474,000
intially allocated to debt. The $526,000 allocated to the value of the
Warrants is treated as a debt discount and is being amortized to interest
expense over the initial term of the debt. As of December 31, 2003, the
un-amortized discount is approximately $448,000. We incurred investment banking and legal costs associated with these
transactions totaling approximately $520,000. The costs are being amortized
to interest expense over the initial term of the debt. Under the Purchase Agreement, we agreed not to incur additional
indebtedness while the Debentures remain outstanding except for (a) capital
leases, purchase money indebtedness, mortgage debt, performance bonds and
similar instruments in the ordinary course of business, and (b) other
indebtedness for borrowed money not to exceed the greater of $8.0 million or
ten times EBITDA for the most recent quarter. Our Board of Directors approved the repurchase of up to 650,000 shares
of our common stock. A portion of these shares were repurchased in our
Dutch Auction Tender Offer (Tender Offer), which commenced on June 16,
2003 and expired on July 14, 2003. During the Tender Offer, 355,782 shares
of our common stock were properly tendered at $3.60 per share, resulting in
payments, including expenses, of approximately $1.3 million. 9. ACCRUED LIABILITIES Accrued liabilities consist of the following: December 31,2002
    
    2003Payroll and withholding taxes
    
    $
    1,858
    
    
    $
    1,462Commissions
    
    
    567
    
    
    
    747Bonuses
    
    
    379
    
    
    
    549Other
    
    
    38
    
    
    
    Total accrued liabilities
    
    $
    2,842
    
    
    $
    2,758
 F-14




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 10. STOCK OPTIONS AND WARRANTS Pursuant to our Long-Term Incentive Plan (Incentive Plan), a maximum
of 4,000,000 shares of common stock are reserved for the granting of
incentive, nonstatutory or formula options, restricted stock grants and other
equity based compensation. The options, other than the director formula
options, may have terms not exceeding ten years when granted. The exercise
price of each option equals the market price of our stock on the date of
grant. Pursuant to our Nonstatutory Stock Option Plan (Nonstatutory Plan),
a maximum of 1,000,000 shares of common stock are reserved for issuance.
Under the Nonstatutory Plan, we may grant stock options in connection with
our acquisitions and other special circumstances. The Nonstatutory Plan has
substantially the same form, terms and substance as our Incentive Plan,
except that grants issued under the Nonstatutory Plan will not qualify as
incentive stock options for tax purposes, and our directors and executive
officers are not eligible to receive grants under the Nonstatutory Plan. In
addition, as of December 31, 2003, we have 1,160,800 stock warrants
outstanding, 860,800 will expire in 2008, and 300,000 in 2009. For purposes of pro forma disclosures in Note 1 Summary of Significant
Accounting Policies, the estimated fair values of the stock options are
amortized to expense over the options vesting period. The fair value of
these stock options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions: Year Ended December 31,2001
    
    2002
    
    2003Risk free interest rate
    
    
    3.95
    %
    
    
    3.16
    %
    
    
    2.82
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility factor
    
    
    .93
    
    
    
    .88
    
    
    
    .60Expected option term life in years
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0
 A summary of the status of our options and warrants as of December 31,
2001, 2002 and 2003, and changes during the years then ended, is presented
below: 2001
    
    2002
    
    2003Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    Average
    
    
    
    
    
    AverageShares
    
    Exercise
    
    Shares
    
    Exercise
    
    Shares
    
    Exercise(000)
    
    Price
    
    (000)
    
    Price
    
    (000)
    
    PriceOutstanding at beginning of year
    
    
    2,924
    
    
    $
    24.42
    
    
    
    3,370
    
    
    $
    14.02
    
    
    
    3,627
    
    
    $
    13.46Granted
    
    
    1,483
    
    
    $
    3.32
    
    
    
    633
    
    
    $
    6.21
    
    
    
    1,463
    
    
    $
    3.01Exercised
    
    
    (5
    )
    
    $
    3.18
    
    
    
    (37
    )
    
    $
    3.10
    
    
    
    (40
    )
    
    $
    2.93Forfeited
    
    
    (1,032
    )
    
    $
    26.51
    
    
    
    (339
    )
    
    $
    5.88
    
    
    
    (435
    )
    
    $
    9.52Outstanding at year-end
    
    
    3,370
    
    
    $
    14.02
    
    
    
    3,627
    
    
    $
    13.46
    
    
    
    4,615
    
    
    $
    10.26Exercisable at year-end
    
    
    1,678
    
    
    $
    20.65
    
    
    
    2,231
    
    
    $
    17.59
    
    
    
    3,629
    
    
    $
    11.51
 The weighted-average grant date fair value of grants during 2001, 2002 and
2003 were $2.43, $4.35 and $2.97, respectively. The following information applies to options and warrants outstanding at
December 31, 2003: Number
    
    Weighted-Average
    
    Weighted-AverageRange of Exercise Prices
    
    Outstanding
    
    Exercise Price
    
    Remaining Life$1.75 - $10.31
    
    
    3,142
    
    
    $
    3.63
    
    
    6.9 Years$11.75 - $24.75
    
    
    745
    
    
    $
    14.50
    
    
    5.4 Years$28.00 - $35.75
    
    
    453
    
    
    $
    32.31
    
    
    1.6 Years$36.00 - $45.13
    
    
    275
    
    
    $
    38.31
    
    
    4.9 Years4,615
 F-15




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 11. RESTRUCTURINGS During 1999 through late 2003, we experienced a decline in demand for
our services as compared to prior years. Beginning in 2000, we implemented
restructuring plans, endorsed by our Board of Directors, aimed at improving
future overall financial performance through operating cost reductions and
optimization of our workforce. As a result, we recorded restructuring charges
(recoveries) of approximately $3,112,000, $3,308,000 and $(193,000) during
the years ended December 31, 2001, 2002 and 2003, respectively. The
restructuring items are summarized as follows: Year Ended December 31,2001
    
    2002
    
    2003Severance costs
    
    $
    215
    
    
    $
    350
    
    
    $
    22Write-off of property and equipment
    
    
    527
    
    
    
    55
    
    
    
    Write-off of leasehold improvements
    
    
    305
    
    
    
    888
    
    
    
    Write-off of capitalized software development costs
    
    
    
    
    
    
    586
    
    
    
    Closing of various office facilities
    
    
    (30
    )
    
    
    
    
    
    
    Future lease obligations
    
    
    2,231
    
    
    
    1,728
    
    
    
    Reduction of accrual related to estimated future
lease obligations initially recorded during 2001
    
    
    
    
    
    
    (299
    )
    
    
    Reduction of accrual related to estimated future
lease obligations initially recorded during 2002
    
    
    
    
    
    
    
    
    
    
    (215
    )Reduction of accrual related to estimated severance
costs initially recorded during 2000
    
    
    (136
    )
    
    
    
    
    
    
    Total restructuring (recovery) charges, net
    
    $
    3,112
    
    
    $
    3,308
    
    
    $
    (193
    )
 A summary of the activity of the restructuring-related liabilities,
included in accounts payable, is as follows: Liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    Liabilitiesas of
    
    
    
    
    
    
    
    
    
    2002
    
    as ofJanuary 1,
    
    2002
    
    2002
    
    Change in
    
    December 31,2002
    
    Additions
    
    Payments
    
    Estimate
    
    2002Severance
    
    $
    
    
    
    $
    350
    
    
    $
    (111
    )
    
    $
    
    
    
    $
    239Future lease obligations
    
    
    2,231
    
    
    
    1,728
    
    
    
    (840
    )
    
    
    (299
    )
    
    
    2,820Total
    
    $
    2,231
    
    
    $
    2,078
    
    
    $
    (951
    )
    
    $
    (299
    )
    
    $
    3,059
 Liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    Liabilitiesas of
    
    
    
    
    
    
    
    
    
    2003
    
    as ofJanuary 1,
    
    2003
    
    2003
    
    Change in
    
    December 31,2003
    
    Additions
    
    Payments
    
    Estimate
    
    2003Severance
    
    $
    239
    
    
    $
    22
    
    
    $
    (257
    )
    
    $
    
    
    
    $
    4Future lease obligations
    
    
    2,820
    
    
    
    
    
    
    
    (1,141
    )
    
    
    (215
    )
    
    
    1,464Total
    
    $
    3,059
    
    
    $
    22
    
    
    $
    (1,398
    )
    
    $
    (215
    )
    
    $
    1,468
 The 2001 and 2002 expense for future lease obligations represents the
present value of our operating lease commitments for facilities no longer
being used by us, but not sublet or sublet at amounts less than our
obligation. This obligation is payable as follows: $586,000 during 2004,
$474,000 during 2005, $235,000 during 2006 and $169,000 during 2007. We
anticipate the remaining severance liabilities will be paid during 2004. F-16




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 12. OTHER INCOME Other income (expense) consists of the following: Year Ended December 31,2001
    
    2002
    
    2003Interest income
    
    $
    951
    
    
    $
    325
    
    
    $
    181Net realized loss on sale of investment securities
    
    
    (4,081
    )
    
    
    
    
    
    
    Interest expense
    
    
    (251
    )
    
    
    (149
    )
    
    
    (1,042
    )Sundry
    
    
    (239
    )
    
    
    
    
    
    
    $
    (3,620
    )
    
    $
    176
    
    
    $
    (861
    )
 13. INCOME TAXES The income tax benefit consists of the following: Year Ended December 31,2001
    
    2002
    
    2003Current federal income tax benefit
    
    $
    
    
    
    $
    (2,236
    )
    
    $
    Deferred federal income taxes
    
    
    (5,805
    )
    
    
    (4,259
    )
    
    
    (524
    )Current state income taxes
    
    
    
    
    
    
    (65
    )
    
    
    (6
    )Deferred state income taxes
    
    
    (1,070
    )
    
    
    (842
    )
    
    
    (118
    )Tax benefit from exercise of stock options credited
directly to additional paid-in capital
    
    
    6
    
    
    
    27
    
    
    
    24Increase in valuation allowance
    
    
    6,869
    
    
    
    5,074
    
    
    
    624$
    
    
    
    $
    (2,301
    )
    
    $
    
 The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31 are as follows: 2002
    
    2003Deferred tax assets:Deferred compensation
    
    $
    676
    
    
    $
    544Allowance for bad debts
    
    
    1,615
    
    
    
    1,132Deferred revenue
    
    
    889
    
    
    
    778Options or warrants issued to non-employees
    
    
    1,318
    
    
    
    1,350Impairment of goodwill
    
    
    7,470
    
    
    
    7,470Net
operating loss carryforward and other
    
    
    22,035
    
    
    
    23,612Total deferred tax assets
    
    
    34,003
    
    
    
    34,886Deferred tax liabilities:Depreciation
    
    
    (1,426
    )
    
    
    (1,685
    )Other
    
    
    (17
    )
    
    
    (17
    )Total deferred tax liabilities
    
    
    (1,443
    )
    
    
    (1,702
    )Deferred tax asset valuation allowance
    
    
    (32,560
    )
    
    
    (33,184
    )Total net deferred tax asset
    
    $
    
    
    
    $
    
 F-17




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 13. INCOME TAXES (CONTINUED) A reconciliation of the provision for income taxes follows: Year Ended December 31,2001
    
    2002
    
    2003Expected benefit at the statutory rate
    
    $
    (5,972
    )
    
    $
    (6,720
    )
    
    $
    (597
    )Permanent differences and other
    
    
    173
    
    
    
    252
    
    
    
    226State income tax benefit
    
    
    (1,070
    )
    
    
    (907
    )
    
    
    (253
    )Change in valuation allowance
    
    
    6,869
    
    
    
    5,074
    
    
    
    624Total income tax benefit
    
    $
    
    
    
    $
    (2,301
    )
    
    $
    
 We
have net operating and capital loss carryforwards for federal income tax purposes
of approximately $55.1 million, the last of which will expire in 2023 if not
utilized. 14. PROFIT-SHARING We have a profit-sharing plan which qualifies under Section 401(a) of
the Internal Revenue Code. Eligible employees may contribute up to the
maximum allowable under tax regulations. Company contributions are fully
discretionary. There were no Company contributions made during the years
ended December 31, 2001, 2002 and 2003. 15. NET LOSS PER SHARE Loss per share data was computed as follows: Year Ended December 31,2001
    
    2002
    
    2003Basic:Net loss
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Weighted-average common shares outstanding
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595Basic loss per share
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )Diluted:Net loss
    
    $
    (17,565
    )
    
    $
    (17,464
    )
    
    $
    (1,755
    )Weighted-average common shares outstanding
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595Dilutive effect of stock options
    
    
    
    
    
    
    
    
    
    
    Weighted-average shares assuming dilution
    
    
    10,920
    
    
    
    10,751
    
    
    
    10,595Diluted loss per share
    
    $
    (1.61
    )
    
    $
    (1.62
    )
    
    $
    (0.17
    )
 Options and warrants to purchase approximately 3,370,000, 3,627,000 and
4,615,000 shares of common stock with a weighted average exercise price of
$14.02, $13.46 and $10.26 were outstanding at December 31, 2001, 2002 and
2003, respectively, but were excluded from the computation of diluted net
loss per share because to do so would have been antidilutive for the periods
presented. F-18




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 16. COMMITMENTS AND CONTINGENCIES We lease office facilities, certain equipment and vehicles under lease
agreements classified as operating leases. Future minimum lease payments
under such non-cancelable operating leases as of December 31, 2003 are
summarized as follows: Related
    
    All
    
    SubleaseYears Ending December 31,
    
    Party
    
    Other
    
    Income
    
    Total2004
    
    $
    580
    
    
    $
    4,825
    
    
    $
    (1,108
    )
    
    $
    4,2972005
    
    
    580
    
    
    
    4,753
    
    
    
    (1,114
    )
    
    
    4,2192006
    
    
    242
    
    
    
    2,290
    
    
    
    (403
    )
    
    
    2,1292007
    
    
    
    
    
    
    1,071
    
    
    
    (159
    )
    
    
    9122008
    
    
    
    
    
    
    623
    
    
    
    
    
    
    
    623Thereafter
    
    
    
    
    
    
    187
    
    
    
    
    
    
    
    187Total future minimum lease payments
    
    $
    1,402
    
    
    $
    13,749
    
    
    $
    (2,784
    )
    
    $
    12,367
 Net rent expense amounted to approximately $3,819,000, $2,655,000 and
$2,234,000 for the years ended December 31, 2001, 2002 and 2003,
respectively, and has been included in selling, general and administrative
expenses in the accompanying consolidated statements of operations. The rent
expense was offset by sublease income of approximately $1,031,000, $1,252,000
and $1,299,000 for the years ended December 31, 2001, 2002 and 2003,
respectively. We have committed to approximately $2.3 million of additional costs for
software and professional fees relating to the implementation of a new
healthcare application platform for an existing outsourcing client. We
currently anticipate the implementation project should be completed during
the first half of 2005 and we will continue to capitalize the remaining
software and professional fees throughout the project as those costs are
incurred. Effective July 1, 2001, we are required to pay a business partner a
royalty of approximately 3.4% of a certain portion of our systems integration
revenue. The royalty, up to a cumulative maximum amount of $5.7 million, will
be payable in the years the related revenue is recognized. Royalty expense
was $27,000, $26,000 and $54,000 for the years ended December 31, 2001, 2002
and 2003, respectively. We are involved in various legal proceedings, including business and
employment matters of a nature considered normal to our operations. We accrue
for amounts related to these legal matters if it is probable that a liability
has been incurred and an amount is reasonably estimable. In our opinion,
although the outcome of any legal proceeding cannot be predicted with
certainty, our ultimate liability in connection with our current legal
proceedings will not have a material adverse effect on our financial position
or results of operations. 17. RELATED PARTY TRANSACTIONS We lease an office facility from an entity partially owned by two
stockholders. Net rent expense for this lease was approximately $450,000,
$411,000 and $397,000 for the years ended December 31, 2001, 2002 and 2003,
respectively. The rent expense was offset by sublease income of approximately
$107,000, $190,000 and $220,000 for the years ended December 31, 2001, 2002
and 2003, respectively. F-19




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(TABULAR AMOUNTS ARE IN THOUSANDS, EXCEPT SHARE DATA) 17. RELATED PARTY TRANSACTIONS (CONTINUED) During 2000, we sold 600,000 shares of our common stock for fair market
value to three newly hired executives, in exchange for cash and promissory
notes totaling $916,620. The original notes bore interest at 9.5% per annum
and required payment of all accrued interest and principal in October 2002.
Effective July 25, 2002, two of the promissory notes were amended to reduce
the interest rate of the notes to a per annum rate equal to the prime rate
plus 1% and extend the payment due date of all unpaid accrued interest and
principal to December 31, 2003. The effective interest rate at December 31,
2003 was 5.00%. During the years ended December 31, 2002 and 2003, two of the
original promissory notes were repaid, including accrued interest. During
January 2004, the remaining promissory note was repaid, including accrued
interest. During 1995, we issued 658,833 shares of our common stock to two
stockholders in exchange for promissory notes totaling $750,000, and the
cancellation of outstanding stock options. The notes bear interest at 7.71%
per annum and require periodic cash payments. Interest income on all notes
totaled approximately $104,000, $117,000, and $76,000 for the years ended
December 31, 2001, 2002 and 2003, respectively. We charter aircraft from an entity owned by an officer/stockholder.
Payments to the entity were approximately $71,000, $20,000 and $54,000 for
the years ended December 31, 2001, 2002 and 2003, respectively. During the year ended December 31, 2001, we recognized revenue of
approximately $1,587,000, from an entity in which we had an equity interest.
During the years ended December 31, 2002 and 2003, we no longer held equity
interests in any entities. 18. SEGMENT FINANCIAL INFORMATION See Note 1 Summary of Significant Accounting Policiesfor a
description of our segments. Our reportable segments are business units that
offer and provide different services through different means. Our training,
information technology, accounting and finance, facilities, sales and
marketing, legal, senior management and other selling, general and
administrative (SG&A) functions are combined into the unallocated SG&A
expenses. Unallocated assets consist principally of cash, accrued interest
receivable and prepaid expenses. We evaluate segment performance and allocate resources based on gross
profit. Intrasegment services are provided at cost. The accounting policies
of the reportable segments are the same as those described in the summary of
significant accounting policies in Note 1. F-20




---



##### Table of Contents



SUPERIOR CONSULTANT HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
     (TABULAR AMOUNTS ARE IN THOUSANDS,
EXCEPT SHARE DATA) 18. SEGMENT FINANCIAL INFORMATION (CONTINUED) The following is a summary of certain financial information by segment for
the years ended December 31, 2001, 2002 and 2003: Year Ended December 31,2001
    
    2002
    
    2003RevenueConsultingRevenue before reimbursements (net revenue)
    
    $
    57,463
    
    
    $
    53,634
    
    
    $
    54,279Out-of-pocket reimbursements
    
    
    8,827
    
    
    
    7,997
    
    
    
    7,036Total consulting revenue
    
    
    66,290
    
    
    
    61,631
    
    
    
    61,315OutsourcingRevenue before reimbursements (net revenue)
    
    
    29,258
    
    
    
    30,474
    
    
    
    37,662Out-of-pocket reimbursements
    
    
    1,658
    
    
    
    520
    
    
    
    563Total outsourcing revenue
    
    
    30,916
    
    
    
    30,994
    
    
    
    38,225Consolidated revenue
    
    $
    97,206
    
    
    $
    92,625
    
    
    $
    99,540Gross Profit and Statement of Operations ReconciliationConsulting
    
    $
    21,993
    
    
    $
    20,500
    
    
    $
    20,945Outsourcing
    
    
    8,007
    
    
    
    4,477
    
    
    
    4,221Consolidated gross profit
    
    
    30,000
    
    
    
    24,977
    
    
    
    25,166Impairment of goodwillConsulting
    
    
    
    
    
    
    6,014
    
    
    
    Outsourcing
    
    
    
    
    
    
    2,209
    
    
    
    Consolidated impairment of goodwill
    
    
    
    
    
    
    8,223
    
    
    
    UnallocatedSelling, general and administrative expenses
    
    
    40,833
    
    
    
    32,816
    
    
    
    26,253Restructuring (recovery) charges, net
    
    
    3,112
    
    
    
    3,308
    
    
    
    (193
    )Impairment of assets
    
    
    
    
    
    
    571
    
    
    
    Other (income) expense, net
    
    
    3,620
    
    
    
    (176
    )
    
    
    861Subtotal
    
    
    47,565
    
    
    
    36,519
    
    
    
    26,921Consolidated loss before income tax benefit
    
    $
    (17,565
    )
    
    $
    (19,765
    )
    
    $
    (1,755
    )Depreciation and amortizationConsulting
    
    $
    4,637
    
    
    $
    4,131
    
    
    $
    2,386Outsourcing
    
    
    195
    
    
    
    320
    
    
    
    2,694Consolidated depreciation and amortization
    
    $
    4,832
    
    
    $
    4,451
    
    
    $
    5,080Identifiable assetsConsulting
    
    $
    31,082
    
    
    $
    17,477
    
    
    $
    15,489Outsourcing
    
    
    6,982
    
    
    
    6,783
    
    
    
    25,207Unallocated
    
    
    20,543
    
    
    
    19,396
    
    
    
    13,157Consolidated total assets
    
    $
    58,607
    
    
    $
    43,656
    
    
    $
    53,853Expenditures for long-term assetsConsulting
    
    $
    1,747
    
    
    $
    1,440
    
    
    $
    1,429Outsourcing
    
    
    
    
    
    
    3,888
    
    
    
    15,149Consolidated expenditures for long-term assets
    
    $
    1,747
    
    
    $
    5,328
    
    
    $
    16,578
 F-21




---



##### Table of Contents



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. SUPERIOR CONSULTANT HOLDINGS CORPORATIONMarch 30, 2004
    
    By:
    
    /s/ RICHARD D. HELPPIE, JR.Richard D. Helppie, Jr.Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. SIGNATURES
    
    TITLE
    
    DATERonald V. Aprahamian
    
    Director
    
    March 30, 2004/s/ REGINALD M. BALLANTYNE III
Reginald M. Ballantyne III
    
    Director
    
    March 30, 2004/s/ CHARLES O. BRACKEN
Charles O. Bracken
    
    Executive Vice President
and Director
    
    March 30, 2004/s/ RICHARD D. HELPPIE, JR.
Richard D. Helppie, Jr.
    
    Chief Executive Officer
(Principal Executive
Officer) and
Director
    
    March 30, 2004/s/ DOUGLAS S. PETERS
Douglas S. Peters
    
    Director
    
    March 30, 2004/s/ RICHARD P. SASLOW
Richard P. Saslow
    
    Vice President,
General Counsel
and Director
    
    March 30, 2004/s/ JOHN L. SILVERMAN
John L. Silverman
    
    Chairman
    
    March 30, 2004/s/ RICHARD R. SORENSEN
Richard R. Sorensen
    
    Chief Financial
Officer (Principal
Financial and
Accounting Officer)
    
    March 30, 2004/s/ SATISH K. TYAGI
Satish K. Tyagi
    
    Director
    
    March 30, 2004




---



##### Table of Contents



INDEX TO EXHIBITS EXHIBITNUMBER
    
    DESCRIPTION
    
    PAGE3.1
    
    Amended and Restated Certificate of Incorporation of the Company, as amended
    
    
    (5
    )3.2
    
    Form of By-Laws of the Company
    
    
    (2
    )4.1
    
    Specimen Common Stock Certificate
    
    
    (3
    )4.2
    
    Securities Purchase Agreement dated as of June 9, 2003 by and among Superior Consultant Holdings
Corporation, Superior Consultant Company, Inc., and the Purchasers named herein
    
    
    (9
    )4.3
    
    Form of Debenture of Superior Consultant Holdings Corporation and Superior Consultant Company
Inc., as co-borrowers
    
    
    (9
    )4.4
    
    Warrant Agreement dated as of June 9, 2003 by and between Superior Consultant Holdings
Corporation as Issuer and the Warrant holders named therein
    
    
    (9
    )10.1
    
    Form of Indemnification Agreement between the Company and each of its directors and officers
    
    
    (2
    )10.2
    
    Form of Long-Term Incentive Compensation Plan
    
    
    (2
    )10.3
    
    Amendment to Long-Term Incentive Plan
    
    
    (4
    )10.4
    
    Second Amendment to Long-Term Incentive Plan
    
    
    (6
    )10.5
    
    Lease dated March 21, 1996 between PMTC Limited Partnership and Superior
    
    
    (1
    )10.6
    
    Compensation Agreement dated January 5, 1998, as amended, between Richard D. Helppie, Jr. and the
Company
    
    
    (5
    )10.7
    
    Amendment effective January 4, 1999, to Compensation Agreement dated January 5, 1998, between
Richard D. Helppie, Jr. and the Company
    
    
    (8
    )10.8
    
    Employment Agreement dated January 5, 1998, as amended, between Charles O. Bracken and the Company
    
    
    (5
    )10.9
    
    Amendment effective January 4, 1999, to Employment Agreement dated January 5, 1998, between
Charles O. Bracken and the Company
    
    
    (8
    )10.10
    
    Employment Agreement dated January 20, 1997, as amended, between Richard P. Saslow and the Company
    
    
    (5
    )10.11
    
    Amendment effective January 4, 1999, to Employment Agreement dated January 20, 1997, between
Richard P. Saslow and the Company
    
    
    (8
    )10.12
    
    Amendment effective January 7, 2001, to Employment Agreement dated January 20, 1997, between
Richard P. Saslow and the Company
    
    
    (8
    )10.13
    
    Amendment effective October 13,
2002, to Employment Agreement dated January 20, 1997, between Richard
P. Saslow and the Company.
    
    
    *10.14
    
    Employment Agreement dated September 25, 2003, between George S. Huntzinger and the Company
    
    
    *10.15
    
    Employment Agreement dated
August 10, 1998, as amended January 7, 2001, between Richard R. Sorensen and the Company
    
    
    (7
    )10.16
    
    Amendment effective February 28,
2002, to Employment Agreement dated August 10, 1998, between Richard
R. Sorensen and the Company
    
    
    *10.17
    
    Promissory Note dated April 20, 1995, executed by Charles O. Bracken in favor of the Company
    
    
    (2
    )10.18
    
    Pledge Agreement dated April 20, 1995, between Charles O. Bracken and the Company
    
    
    (2
    )10.19
    
    Shareholder Agreement, dated May 4, 2001, by and between Ronald V. Aprahamian and the Company
    
    
    (8
    )10.20
    
    Amended and Restated Promissory Note dated May 4, 2001, executed by Ronald V. Aprahamian in favor
of the Company
    
    
    (8
    )10.21
    
    Revolving Credit and Security Agreement, dated May 14, 2003, by and among Superior Consultant
Company, Inc., Superior Consultant Holdings Corporation, ComTrust, LLC and Fifth Third Bank
    
    
    (11
    )10.22
    
    Revolving Line of Credit Note, dated May 14, 2003, made by Superior Consultant Company, Inc. in
favor of Fifth Third Bank
    
    
    (11
    )




---



##### Table of Contents



EXHIBITNUMBER
    
    DESCRIPTION
    
    PAGE10.23
    
    Guaranty and Commercial Security Agreement, dated May 14, 2003, by and between Superior
Consultant Holdings Corporation and Fifth Third Bank
    
    
    (11
    )10.24
    
    Guaranty and Commercial Security Agreement, dated May 14, 2003, by and between ComTrust, LLC and
Fifth Third Bank
    
    
    (11
    )21.1
    
    Subsidiaries of Superior Consultant Holdings Corporation
    
    
    *31.1
    
    Certification by our Chief Executive Officer with respect to our Form 10-K for the year ended
December 31, 2003, pursuant to Rule 13A-14 or 15D-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
    
    
    *31.2
    
    Certification by our Chief Financial Officer with respect to our Form 10-K for the year ended
December 31, 2003, pursuant to Rule 13A-14 or 15D-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
    
    
    *32.1
    
    Certification by our Chief Executive Officer and Chief Financial Officer with respect to our Form
10-K for the year ended December 31, 2003, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
    
    
    *99.1
    
    Guaranty Agreement by and between the Subsidiaries of Superior Consultant Holdings Corporation
named therein, Superior Consultant Holdings Corporation, Superior Consultant Company, Inc. and
the Purchasers named therein
    
    
    (10
    )99.2
    
    Investor Rights Agreement dated as of June 9, 2003 by and between Superior Consultant Holdings
Corporation, the Holders named therein and certain other parties
    
    
    (9
    )
   *
    
    Filed herewith.(1)
    
    Incorporated by reference from the Registrants Form S-1 Registration
Statement No. 333-10213 as filed on August 15, 1996.(2)
    
    Incorporated by reference from the Registrants Amendment No. 1 to Form
S-1 Registration Statement No. 333-10213 as filed on September 20, 1996.(3)
    
    Incorporated by reference from the Registrants Amendment No. 2 to Form
S-1 Registration Statement No. 333-10213 as filed on October 4, 1996.(4)
    
    Incorporated by reference from the Registrants Information Statement on
Form 14C as filed on November 7, 1997.(5)
    
    Incorporated by reference from the Registrants Form 10-K as filed on
March 31, 1999.(6)
    
    Incorporated by reference from the Registrants Information Statement on
Form 14A as filed April 9, 1999.(7)
    
    Incorporated by reference from the Registrants Form 10-K as filed on
April 2, 2001.(8)
    
    Incorporated by reference from the Registrants Form 10-K as filed on
April 1, 2002.(9)
    
    Incorporated by reference from the Registrants Form 8-K as filed on June
13, 2003.(10)
    
    Incorporated by reference from the Registrants Form 8-K as filed on July
29, 2003.(11)
    
    Incorporated by reference from the Registrants Form 10-Q as filed on
August 14, 2003.