References to "fiscal" in this discussion pertain to the Partnership's fiscal years that begin January 1 and end December 31. References to "Footnotes" pertain to footnotes to the Consolidated Financial Statements.
The Partnership's products include a claims administration system, workers' compensation medical bill repricing system, an incident reporting system, data conversion services, a disability claims administration system, and risk information reporting.
Operating revenues for fiscal 1996 decreased $4.32 million (9 percent) over the same period in 1995.
Special project fees revenue decreased $3.23 million (26 percent) mainly due to the near completion of a one-time project in 1996 of product development performed under a contract for a customer that was in progress throughout 1995. This project produced $.45 million and $1.78 million of revenue in fiscal 1996 and 1995, respectively, which accounts for a decrease of $1.32 million. Another one-time project generated $1.5 million of revenue for the Partnership's research and development efforts on the teleclaim product during fiscal 1995.
mainly due to additional revenue totaling $.82 million generated during 1995 by one customer that increased its volume of bills to catch up on its backlog. Another component of risk management claims administration services that decreased was service fees by $.43 million in 1996 over the same period in 1995 due to continued competitive considerations and certain contract price concessions given to customers purchasing stand-alone systems and terminating existing service agreements with the Partnership. These decreases were somewhat offset by increases in risk information reporting service fees of $.25 million in fiscal 1996 over the same period in 1995.
During fiscal 1996, installations and programming revenue were up $.37 million (15 percent) from the same period in 1995 partly due to new sales to the existing client base of the Partnership's new product, CS KnowlEDGE that increased the total by $.16 million. The remainder of the increase is due to programming and file construction fee increase of $.26 million over the same period in 1995. The increase is offset by a decrease of $.05 million in license fees generated from sales of other products.
Operating expenses decreased $3.97 million (11 percent) in fiscal 1996 as compared to fiscal 1995. However, as a percent of operating revenues, operating expenses remained flat in 1996 compared to the same period in 1995 at approximately 90 percent.
Net new product development decreased $1.62 million mainly due to the completion of the teleclaim project during 1996.
Selling, general, and administrative expenses increased $1.71 million (29 percent) in fiscal 1996 over the same period in 1995. The increase can mainly be attributed to increased costs incurred for professional fees ($.49 million) related to internal restructuring, legal and acounting costs related to the legal form of the organization.
Depreciation expense and occupancy costs increased in fiscal 1996 by $.29 million over the same period in 1995 mainly due to the new customer service building. Other expense categories increasing include compensation ($.25 million), property taxes ($.18 million), and sales tax ($.23 million).
YEAR ENDED DECEMBER 31, 1995, COMPARED TO THE YEAR ENDED DECEMBER 31, 1994
Growth in risk management claims administration services was attributed to increases in the volume of risk management claims administration services, as well as the Partnership's ability to obtain several new significant customer contracts during fiscal 1995. The volume of medical cost management bills processed increased due to one customer catching up on its backlog during the year increasing this customer's revenue by $1.96 million over the same period in 1994. Also included in this component is revenue generated from the Partnership's teleclaim product, which showed an increase of $.24 million over the same period in 1994.
develop a set of software programs designed specifically for that entity and within the scope of the Partnership's expertise. The Partnership receives these project requests and secures the business on an ad hoc basis and does not anticipate revenues from this source in its annual planning process. For the year ended December 31, 1995, revenue generated from these contracts was $3.27 million compared to $2.11 million during the same period in 1994.
Operating Expenses increased $6.82 million (20 percent) in fiscal 1995 as compared to fiscal 1994. As a percent of operating revenues, operating expenses increased for fiscal 1995 as compared to fiscal 1994 to approximately 90 percent from 87 percent.
Additional increases in operating expenses are primarily related to new product development, which includes research and development and product development performed under contracts for others. When the effects of new product development activity is removed from both years, operating income as a percent of revenue increased to 21 percent for fiscal 1995 as compared to 19 percent for fiscal 1994.
Research and development expenditures, net of amounts reimbursed by customers, for the year ended December 31, 1995 and 1994, were $4.08 million and $2.13 million, respectively. The total amount of new product development, which includes development performed under contracts for others, research and development expenditures, and other development costs, totaled $7.71 million and $4.18 million in fiscal 1995 and 1994, respectively. The increase in new product development expenses is in support of the Partnership's new and existing product development initiatives. New product development costs are expensed as incurred and are reflected primarily as components of cost of services in the financial statements. The following table sets forth the amounts related to new product development included in the financial statements under the following captions:
YEAR YEAR ENDED ENDED DECEMBER 31, DECEMBER 31, 1995 1994 ------------ ------------
Accounts receivable decreased $1.81 millin at December 31, 1996, from December 31, 1995. Such decrease resulted in an improvement in the percentage of accounts due within 60 days of 93 percent at December 31, 1996, from 57 percent at December 31, 1995.
The Partnership has several noncancelable operating leases for equipment and office space that expire over the next three years. The Partnership has several operating leases for certain computer equipment that required monthly rental payments that are charged to operations as incurred.
Effective in 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which encouraged, but did not require, a method of accounting for employee equity-based awards which results in compensation expense being recognized when awards are granted based on their fair value. Entities which elect not to adopt the new method for the financial statements are required to disclose in the notes to the financial statements the pro forma effect on net income and earnings per share as if the fair value method of accounting had been applied. The Partnership will continue to account for the equity-based awards using the requirements of Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Appropriate disclosures have been added to the notes to the 1996 consolidated financial statements.
Balance Sheet as of December 31, 1996 . . . . . . . . . . . . . . . . 17
Note to Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . 18
Consolidated Statements of Income for each of the years in the three-year period ended December 31, 1996. . . . . 22
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . 26
We have audited the accompanying balance sheet of Corporate Systems Holding, Inc. as of December 31, 1996. This financial statement is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the balance sheet is free of material misstatement. An audit of a balance sheet includes examining, on a test basis, evidence supporting the amounts and disclosures in that balance sheet. An audit of a balance sheet also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audit of the balance sheet provides a reasonable basis for our opinion.
Shareholder's equity: Common stock, $.001 par value, 20,000,000 shares authorized, 1 share issued and outstanding $ - Additional paid-in capital 1,000 ------
Corporate Systems Holding, Inc. (the Company), a Nevada corporation, was incorporated on August 7, 1996 and conducted no business activity through December 31, 1996.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Corporate Systems, Ltd. and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in notes 1 and 6, the Partnership adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS effective January 1, 1995.
General Limited Partner Partners Total ----------- ----------- ----------- Partners' equity, December 31, 1993 $ 1,767,705 $ 2,913,186 $ 4,680,891 Net earnings 2,453,004 2,881,887 5,334,891 Distributions to partners (1,306,017) (1,534,361) (2,840,378) ----------- ----------- ----------- Partners' equity, December 31, 1994 2,914,692 4,260,712 7,175,404 Net earnings 1,952,931 2,324,184 4,277,115 Distributions to partners (1,786,670) (2,149,088) (3,935,758) Sale of partnership units (76,683 units) - 384,665 384,665 ----------- ----------- ----------- Partners' equity, December 31, 1995 3,080,953 4,820,473 7,901,426 Net earnings 2,090,676 2,543,942 4,634,618 Distributions to partners (1,600,003) (1,953,685) (3,553,688) Sale of partnership units (46,548 units) - 232,740 232,740 ----------- ----------- ----------- Partners' equity, December 31, 1996 $ 3,571,626 $ 5,643,470 $ 9,215,096 ----------- ----------- ----------- ----------- ----------- -----------
Through January 1997, the Partnership operated under a Texas limited partnership agreement which provided for an initial term of 30 years, beginning in 1976. Under the agreement, the maximum amount of any limited partner's individual liability could not exceed the contributions of such partner plus related undistributed profits. Profits and losses of the Partnership were allocated among the partners in proportion to the Partnership units owned by each partner. The Partnership had 6,000,000 units authorized at December 31, 1996, 1995 and 1994 and 5,922,814, 5,876,266 and 5,799,583 outstanding at December 31, 1996, 1995 and 1994, respectively.
- Establishment of a net deferred tax asset resulting from temporary differences in the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. As a corporation, income will be subject to taxation and income taxes will be provided in accordance with Statement of Financial Accounting Standards No. 109, "ACCOUNTING FOR INCOME TAXES" (SFAS No. 109). Based on the historical ability to generate future taxable income exclusive of reversing temporary differences, management believes it is more likely than not that the Company will realize the benefits of the net deferred tax asset in future periods.
- Establishment of a leveraged employee stock ownership plan (ESOP) through the purchase of 592,281 shares from existing shareholders financed through bank debt of $4,738,248. Additionally, 350,000 shares with a value equivalent to $2,800,000 were issued from authorized shares through the issuance of bank debt. The proceeds received were used to repay the interim construction loan (see note 4). Due to the establishment of the ESOP, the Company will not continue to make contributions to the existing profit sharing plan (see note 5) and will use such funds to repay the debt associated with the ESOP.
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of the Partnership and its wholly owned subsidiary, Diagnostic Profiles, Inc. (DPI). All significant intercompany transactions and balances have been eliminated in consolidation.
Purchased computer software is included in property, plant and equipment and is capitalized at cost and amortized using the straight-line method over the estimated useful life of the software which generally ranges from one to five years.
Effective January 1, 1996, the Partnership adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF (Statement 121). Statement 121 addresses the accounting for the impairment of long-lived assets, certain identifiable intangibles and goodwill when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is evaluated by estimating future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, an impairment loss
Revenue from risk management claims administration services, computer access and equipment rentals, special project fees, software support agreements and reimbursed costs are generally recognized at the time services are performed or ratably over the contract period during which the services are performed.
Revenue from software licensing fees that have insignificant vendor obligations remaining are recognized on delivery of the software. The remaining obligations are accounted for by
deferring a pro rata portion of the revenue and recognizing it either ratably as the obligations are fulfilled or on completion of performance. For software licensing fees that have significant vendor obligations remaining, revenue is not recognized until delivery has occurred and other remaining vendor obligations are no longer significant. Postcontract customer support is generally recognized upon delivery of the software, with the cost of providing postcontract customer support charged to operations as incurred or accrued and charged to operations at the time revenue is recognized, whichever occurs first.
Cash equivalents of $3,200,000 at December 31, 1995 consist of investments in U.S. Treasury Notes and money market funds. The Partnership periodically invested overnight in U.S. Treasury Notes. There were no such cash equivalents at December 31, 1996.
Research and development costs of new products are expensed currently as required by SFAS No. 2, ACCOUNTING FOR RESEARCH AND DEVELOPMENT COSTS. Costs charged to expenses for 1996, 1995 and 1994 were approximately $2,451,000 $4,081,000 and $2,129,000, respectively.
Certain amounts in the 1995 and 1994 consolidated financial statements have been reclassified to conform to the 1996 method of presentation.
Capital Operating Year ending December 31: leases leases ------- ---------- 1997 $22,554 $2,737,412 1998 - 1,724,870 1999 - 33,660 ------- ---------- Total minimum lease payments 22,554 $4,495,942 ---------- ---------- Less amount representing interest (819) ------- Present value of net minimum capital lease payments 21,735 Less current maturities of obligations under capital leases 21,735 ------- $ - ------- -------
Certain computer equipment leased by the Partnership under long-term leases is subleased to its customers on a month-to-month basis.
Subsequent to December 31, 1996, the Company obtained a promissory note from a bank in the amount of $7,500,000 secured by 942,281 shares of the Company's common stock sold to the ESOP (see note 1). Such loan bears interest at the bank's base rate less .5% and requires annual principal payments of $1,071,429 plus accrued interest. A portion of the proceeds obtained from this note were used to pay off the interim construction loan.
Additionally, at December 31, 1996, the Partnership has a commitment from the Amarillo Economic Development Corporation to lend approximately $1,400,000. Such borrowings would be secured by certain facilities.
The Partnership has a profit sharing plan that provides certain retirement, disability, death and termination benefits for eligible employees and owner-employees (employees who own more than 10% of the capital interest in the Partnership). Additionally, the Plan was amended to provide for a 401(k) arrangement whereby each participant may elect to contribute a portion of their salary to the Plan beginning in 1994. Each plan year, the Partnership may contribute an amount of matching contributions determined at the Partnership's discretion. Such matching contributions are allocated to participants based on the Plan's provisions. Additional discretionary Partnership contributions may also be made. Participant after-tax contributions are not allowed. The provision for the Partnership's matching contributions for 1996, 1995 and 1994 was approximately $272,000, $237,000 and $253,000, respectively. The provision for discretionary profit sharing contributions was approximately $850,000, $682,000 and $1,000,000 for 1996, 1995 and 1994, respectively. As described in note 1, the Partnership does not anticipate making future contributions to the profit sharing plan due to the establishment of the ESOP in 1997.
Effective in 1996, the Financial Accounting Standards Board issued SFAS No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION (Statement 123), which encourages, but does not require, a method of accounting for employee equity-based awards which results in compensation expense being recognized when awards are granted based on their fair value. Entities which elect not to adopt the new method for the financial statements are required to disclose in the notes to the financial statements the pro forma effect on net income and earnings per share as if the fair value method of accounting had been applied. The Partnership will continue to account for the equity-based awards using the requirements of Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.
The Partnership applies APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, in accounting for its unit options and, accordingly, no compensation cost has been recognized for its unit options in the consolidated financial statements. Had the Partnership determined compensation cost based on the fair value at the grant date for its unit options under Statement No. 123, there would not have been a significant impact on the Partnership's net earnings as noted above and therefore, no pro forma disclosure has been made.
Summary information on the Partnership's plan as of and for the years ended December 31, 1996 and 1995 is as follows:
A summary of the service cost and interest cost components for the Partnership's plan for 1996 and 1995 and the effect of a one-percentage- point increase for 1996 in the assumed health care cost trend rate is as follows:
1996 1995 --------------------------- ------------ Current Current Medical Current Medical Trend Assumptions Trend Assumptions Plus 1% Assumptions ----------- ----------- ----------- Service cost $ 70,082 $ 84,000 $55,165 Interest cost 45,000 50,000 43,000 -------- -------- ------- $115,082 $134,000 $98,165 -------- -------- ------- -------- -------- -------
The Partnership's customers are located throughout the United States. Revenues which individually represent more than five percent of total operating revenues during the years ended December 31 are as follows: