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The following is an excerpt from a 10-K SEC Filing, filed by TRIZETTO GROUP INC on 3/16/2007.
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TRIZETTO GROUP INC - 10-K - 20070316 - PART_I

PART I

 

Item 1—Business

OVERVIEW

TriZetto is distinctly focused on accelerating healthcare payers’ ability to lead the industry’s transformation by providing information technology solutions that enhance revenue growth, drive administrative efficiency and improve the cost and quality of care for their members. We offer a broad portfolio of proprietary information technology products and services targeted to the payer industry, which is comprised of health insurance plans and third party benefits administrators. These include:

 

 

 

Enterprise core administration software, including Facets ® , Facts , QicLink and QNXT, including add-on modules such as Workflow, HealthWeb ® , HIPAA Privacy, CDH Account Management and FXI to provide enhanced functionality for advanced automation, web-based e-business, HIPAA regulations, consumer functionality and inoperability, respectively;

 

 

 

Cost and quality of care solutions, including our NetworX suite of products for provider network management and CareAdvance suite of care management solutions for both traditional and advanced care management;

 

   

Revenue enhancement software and administrative efficiency solutions for payers that service members in Medicare Advantage, Medicare Part D and Medicaid plans;

 

   

Software hosting services and select business process outsourcing services; and

 

   

Strategic, installation, and optimization consulting services.

In the U.S. healthcare system, payers effectively balance the demands of all the different constituents in the healthcare system including employers, providers, consumers and brokers. As a result, payers are the central aggregation point for data from across the systems and payers are information-intensive businesses. New government regulations, shifting market trends and competition constantly pressure these payers to change their product offerings, business policies and processes. To enable these changes, payers must continually upgrade their information technology systems. Many payers, especially the largest, have traditionally developed their own information systems in-house. But, increasingly in recent years, payers have utilized commercial systems to reduce information technology and business costs, and accelerate their time-to-market for new products and enhanced efficiency.

TriZetto’s large footprint of payers and their members provides unique opportunities to develop and accelerate the adoption of new information technology solutions that will help payers respond and to capitalize on market changes. Including the company’s recent acquisitions, TriZetto technology touches approximately 120 million lives, or nearly half the insured population of the U.S.

We provide products and services to 362 unique customers, including our recent acquisitions, in the health plan and benefits administrator markets. In 2006, these markets represented 90% and 10% of our total revenue, respectively.

The TriZetto Group, Inc. was incorporated in Delaware in May 1997 with the merger of two organizations: System One, a provider of online electronic-funds transfer technology, and Margolis Health Enterprises, a provider of technology consulting to healthcare organizations. The combination created a company dedicated to healthcare information technology products and services. Initially, we focused upon providing hosted software services addressed primarily to the provider market. From 1998 to 2003, we increased our focus on the payer industry. In 2003, we initiated a strategic plan to concentrate exclusively on the payer market and to wind-down our provider business. We completed this plan in 2005 and no longer provide services to the provider market.

We completed our initial public offering in October 1999 and, since that time, have acquired 10 companies: Novalis Corporation, Finserv Health Care Systems, Inc., Healthcare Media Enterprises, Inc., Erisco Managed Care Technologies, Inc. (“Erisco”), Resource Information Management Systems, Inc. (“RIMS”), Infotrust Company, Diogenes, Inc., CareKey, Inc. (“CareKey”), Plan Data Management, Inc. (“PDM”), and Quality Care Solutions, Inc. (“QCSI”).

 

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Of the 10 acquisitions, the Erisco and RIMS acquisitions completed in the fourth quarter of 2000, the CareKey acquisition completed in the fourth quarter of 2005, and the QCSI acquisition completed in the first quarter of 2007 were our most significant. Erisco’s main product, Facets ® and QCSI’s main product, QNXT, are the leading administrative systems for managed health plans in the country. QicLink , developed by RIMS, is the leading automated claims-processing system for benefits administrators. With these acquisitions, TriZetto obtained a customer base with more than 120 million enrollees (48% of the U.S. insured population) and attained a leadership position in two market segments of the payer industry, health plans and benefits administrators. The products developed by CareKey are proven applications and solutions for the rapidly growing consumer-directed healthcare segment.

FINANCIAL INFORMATION

Please refer to Item 6, “Selected Financial Data,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a review of revenue, net income, and total assets for the last three years.

OUR STRATEGY

Rising healthcare costs and health insurance premiums are causing employers, as well as federal and state government programs, to shift more of the cost of healthcare benefits to consumers in the form of higher premium contributions, deductibles, co-insurance and co-payments. Since 2000, average premiums for family coverage in the United States increased 59%, while wages grew only 12%. Typical family out-of-pocket healthcare costs now exceed 10% of the average annual wage. As a result of increased personal spending on healthcare, healthcare consumers (i.e., employees and their family members, individuals, and retirees) are demanding better service, efficiency, and value from their health plan. This includes improved information regarding health care benefit and insurance coverage options, better information to determine the most efficient methods to fund out-of-pocket costs, real-time information regarding benefits eligibility and accessibility, accurate information at the point-of-service regarding out-of-pocket costs (i.e., patient or consumer financial responsibility), real-time information regarding healthcare fund balances and claims payment status, and increased comparative data and intelligence regarding healthcare provider cost (i.e., pricing) and quality.

We believe that payers will play a central and leading role in the evolution of the U.S. healthcare industry. We also believe that most health plans and benefits administrators must evolve and improve their technology infrastructures, software applications, and business processes to compete in this changing healthcare marketplace. We recognize that the evolution of the healthcare industry to a more retail-like environment may be gradual or in steps. Our strategy, therefore, is to protect our existing customers’ investment in our products and services through ongoing research and development that allows for systematic upgrades of existing capabilities, while providing both existing and new payer customers with innovative information technology products and services that help them strengthen their IT capabilities, and transform their businesses to prosper in this more consumer-centric environment. Key elements of our strategy include:

 

   

Help customers anticipate change and migrate toward a successful future. In 2006, we continued to articulate our vision of the future for health plans and benefits administrators. In 2003, we launched and named these “futures” concepts Health Plan 5.0 and Benefits Administrator 5.0. “5.0” continues to be the centerpiece of our sales strategy, supported by TriZetto’s extensive portfolio of solutions and a clear migration path for customers. Over the course of 2006, we introduced additional products and services that provide our customers with the solution components to achieve level or version “5.0.”

 

   

Offer a compelling value proposition. We are focused on offering a quantified, compelling value proposition that includes such advantages as enhancing payers’ revenue growth, driving their administrative efficiency and improving the cost and quality of care for their members. Other benefits include reduced and more predictable information technology costs, more cost effective business processes, lower administrative costs, lower medical costs, less risk and more rapid return on investment, and faster business transformation. Our internal estimates, based on industry benchmarks and customer data, show that return on investment increases with the use of our proprietary software in combination with one or more of our outsourced services.

 

 

 

Offer market-leading enterprise administration software for health plans and benefits administrators. As some of the most information-intensive businesses in the U.S., payers spend about 11% of the premiums they collect on administration activities. Efficient and accurate enterprise administration systems are critical to success. In 2003, we introduced new versions of both Facets Extended Enterprise (or Facets e 2 ) and QicLink Extended Enterprise (QicLink e 2 ) to the marketplace. Facets e 2 represented a major expansion of our flagship Facets ® enterprise administration software for health plans. Facets e 2 provides significant new business and technology enhancements aimed at helping health plans meet emerging market demands, including customer-driven market requirements, integrated e-business functionality, regulatory compliance, and advanced open architecture and web services technologies. QicLink e 2 represented a new generation of our leading QicLink administration software for third-party benefits administrators, with similar consumer-centric enhancements, as well as an enhanced user interface. In 2006, new releases of these systems included new features, functionality and benefits for payers. These products continue to be our flagship core

 

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enterprise solutions. The acquisition of QCSI’s QNXT in January 2007 further expands TriZetto’s enterprise administration solutions.

 

 

 

Offer innovative enterprise cost and quality of care application. Payers spend an average of 86% of premiums collected on the cost of care for members. As the economics of running a plan started to shift in 2005 and 2006, payers began looking to new ways to cut waste and improve care. In early 2004, TriZetto partnered with CareKey, Inc. to offer new cost and quality of care solutions to its payer customers. In December 2005, TriZetto acquired CareKey. Today, the company is unique in offering integrated solutions that address both the unit cost of care as well as the volume usage. TriZetto’s suite of cost and quality of care solutions are complementary to our enterprise software solutions and allow us to help payers address the vast majority of healthcare medical costs not focused solely on health plan administration activities. TriZetto’s NetworX Pricer and NetworX Modeler applications allow health plans to improve the provider contracting process, as well as to automate the administration of these provider contracts to reduce the aggregate unit cost of care. Our CareAdvance Enterprise suite of advanced care management solutions addresses traditional utilization, case and disease management, as well as provides secure, portable and personalized health records to facilitate proactive population management. By improving patient wellness, these solutions better control the total usage of healthcare resources and reduce payers’ aggregate usage-driven costs of care for members. While these applications are architecturally engineered to most easily integrate with other TriZetto products such as Facets ® , they are also of high value to customers who run enterprise administration systems not developed by TriZetto.

 

   

Enhance the value of our core enterprise technology with a variety of add-on software solutions and a continuum of services. In addition to offering leading enterprise administration and care solutions, TriZetto has created a number of high-value add-on systems that increase the performance of TriZetto systems and extend the value and return on investment for customers. TriZetto’s enterprise systems are very large applications that require significant work to install and optimize. Like many other enterprise software companies, TriZetto offers complementary services that assist customers in achieving business success, including: professional services, or consulting, for installation and optimization of the company’s software. For customers who desire to reduce their data center or overall processing costs, TriZetto also offers software hosting services and business process outsourcing services. These typically are sold as add-ons following the sale of TriZetto software.

 

   

Organize products and services around the customer’s main business cycles. Our solutions are aligned with the way our customers operate internally. Our individual products and services, and complete solutions address the main business cycles of a health plan, which are: product development, revenue management, reimbursement management, customer service, network management, care management, risk management, and general finance and administration. Benefits administrators have largely similar business cycles.

 

   

Leverage our strategic relationships. We leverage our current strategic relationships and enter into new relationships to expand our customer base and service offerings. We have established co-marketing and sales arrangements with third-party systems integrators and software vendors. As our customer base grows, we intend to expand and strengthen these relationships.

 

   

Selectively pursue acquisitions. We continually evaluate acquisitions of companies that could expand our market share, product offerings or our technical capabilities. Since our initial public offering in 1999, we have made 10 acquisitions. We may pursue additional acquisitions that we believe create shareholder value.

OUR PRODUCTS AND SERVICES

TriZetto’s mission is to be the premier technology provider focused on healthcare payers. We have historically been a leading core administration company, and through acquisitions have expanded our capabilities. We have targeted five strategic areas that will drive healthcare changes including enterprise core administration, care management, network management, consumer retail healthcare and government programs.

In 2006, we derived approximately 47% of our total revenue from license and maintenance fees for our proprietary enterprise core administration software. Our Facets ® , Facts and QicLink applications are recognized in their respective markets for providing advanced solutions that enhance revenue growth, drive administrative efficiencies and improve the cost and quality of care.

Out of our total revenue in 2006, 2005, and 2004, we spent 15%, 14%, and 14% respectively, on software development (expensed and capitalized), primarily for our proprietary software products.

Enterprise Core Administration Software

Facets ® . Facets ® is a comprehensive, flexible, scalable, production-proven, enterprise-wide core administration solution for healthcare payers. Facets ® provides a functionally rich set of modules that allow health care payers to meet their comprehensive business requirements—across claims processing, claims re-pricing, capitation/risk fund accounting, premium billing, provider

 

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network management, group/membership administration, referral management, hospital and medical pre-authorization, case management, customer service, and electronic data interchange.

Facets ® can also be combined with complementary software to address the enterprise-wide needs of a managed care organization. Facets ® has been expanded through alliances with complementary solutions for physician credentialing, document imaging, workflow management, data warehousing, and decision support.

Facets ® is available to customers on a hosted or non-hosted basis; it includes core functionality and add on modules that provide the following features and benefits for health plans:

 

   

Flexible, integrated technology to support multiple lines of business and in-depth functionality which provide for the essentials of health plan administration;

 

   

Simplified entry of benefit plan information;

 

   

Enhanced views of customer service data;

 

   

Integrated HIPAA functionality to satisfy standard electronic transactions and privacy regulations;

 

   

Consumer directed healthcare, Medicare and Managed Medicaid solutions;

 

   

Functions to support complex provider contracts and automated pricing of claims;

 

   

Integrated Workflow for claims, customer service and group administration

 

   

Extended integration tools to enable customers to access key business logic

 

   

Extensive use of Service-Oriented Architecture (SOA) that emphasizes Web-enabled interoperability to simplify integration of third-party applications; and

 

   

Choice of leading databases — Oracle, Microsoft SQL and Sybase.

At December 31, 2006, we had 74 implementations of Facets ® at customers comprising approximately 80 million member lives under contract. Many customers have purchased or are updating to Facets ® 4.3 and 4.4 to support consumer directed health plans, changes in NPI and workflow improvements. These upgrades are included in customers’ annual release fees. In addition, unspecified upgrades generate opportunities to sell consulting and other services to assist with the upgrades, as well as add-on modules that work exclusively with this new version of Facets ® . In 2006, TriZetto Professional Services created a new Upgrade Service exclusively focused on helping health plans upgrade Facets ® to a newer version to take advantage of the new capabilities.

Facts . Introduced in 1980, Facts is designed for the indemnity insurance market, specifically managed indemnity, and group insurance. Facts software, which we acquired in our acquisition of Erisco, is a legacy software application which is used for the essential administrative transactions of an indemnity plan, including enrollment, rating and premium calculation, billing, and claims processing. At December 31, 2006, we had 33 Facts customers totaling more than 48.5 million lives.

QicLink . We believe that QicLink is the nation’s most widely-used automated claims administration technology for benefits administrators. Its flexible design is well suited for third party administrators, as well as organizations that self-fund or self-administer their health benefits. QicLink is a full-functioned enterprise system that handles enrollment, customer service, claims adjudication, billing and accounts receivable, re-pricing, and payment process, and is available to customers on a licensed or hosted basis. Recent product releases include functionality improvements designed for the consumer-directed market, debit card processing expanded auto adjudication and web customer service, and technology improvements such as the introduction of the Microsoft.NET framework. At December 31, 2006, we had 135 QicLink customers, totaling more than 7.6 million lives.

Workflow. The add-on Workflow application for Facets e 2™ automates manual processes and streamlines workflows, helping health plans to reduce claims turnaround times, improve customer response and facilitate the creation of employer groups. With Facets e 2™ Workflow, claims are prioritized and routed automatically according to rules established by the plan’s business staff. Faster claims turnaround times allow health plans to realize lower overall operating costs, as well as nearly immediate return on investment through prompt-pay discounts. Facets e 2™ Workflow functionality for Customer Service focuses on the management of work items that are not resolved upon initial contact with customer service representative. Facets e 2™ Workflow functionality for Group Administration allows customers to administer the creation of new groups and facilitates the group renewal process. The application gives health plans a competitive advantage: faster, more accurate claims adjudication and reduced customer response time, which translates directly into improved service for plan members and providers.

 

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DirectLink . DirectLink was added to TriZetto’s component offerings in November 2004, built around technology from the acquisition of Diogenes, Inc. DirectLink helps payers reduce their dependence on clearinghouses and exchange transactions with providers, employers, and other constituents directly over the Internet – at a fraction of the cost of clearinghouse fees. The technology provides point-to-point connectivity and cutting-edge security features, including encryption, authentication, and tamper protection, which exceed the government’s HIPAA security guidelines. DirectLink is designed to be easy to use and can be remotely deployed and installed via the Internet, right to the desktop.

Cost and Quality of Care. As cost and quality of care issues move to center stage, for health plans, the ability to automate care and provider management becomes key to improving care outcomes and decrease costs. TriZetto offers solutions for both care management and network management.

Care management

Health plans are recognizing that care management will quickly become a required competency for connecting to members in an increasingly consumer-retail world of healthcare. The ability to keep the well from getting sick, to keep the sick out of the hospital and to help the hospitalized recover quickly will reduce overall medical costs. TriZetto offers CareAdvance Enterprise to address both personal health records for the consumers and health management for the health plans.

CareAdvance Enterprise . Until 2004, the majority of TriZetto’s solutions focused on payers’ administrative costs. In 2004, TriZetto partnered with CareKey to offer the CareAdvance suite of care management solutions. TriZetto completed its acquisition of CareKey in December 2005 and began marketing the CareAdvance suite as TriZetto CareAdvance Enterprise . TriZetto CareAdvance Enterprise automates all aspects of care management, including: member identification and assessment; guideline-based care planning; member and provider communications; task and team management; ongoing member monitoring, education and care coaching; and multi-stakeholder granular reporting for a variety of constituents. The system integrates with TriZetto’s Facets ® administrative system as well as other core administration systems to provide real-time access to member administrative data including claims, eligibility, benefits and authorizations. CareAdvance Enterprise extends effective care to more members and allows a health plan to serve all its members’ medical management needs on one platform, including catastrophic care coordination, chronic disease management, wellness, and family care.

Health plans can license and host the care management enterprise software themselves or have it hosted through TriZetto’s Hosting Services. Health plans can also use TriZetto Professional Services to implement and optimize their care management operations. Specific services include: implementation, business process engineering, health program development and launch, and technology and application optimization.

Network management

As cost and quality issues move to center stage for health plans, the ability to automate provider networks, including the contracting and payment cycle becomes key to reducing care costs. Changes to a provider contract by 1% can result in net increases or decreases of millions to a health plan’s bottom line. Increasingly complex contracts and intense financial pressures have made network management critical to a health plan’s success.

NetworX . NetworX was the first enterprise-wide management system and claims re-pricing solution for preferred provider organizations. The NetworX product line has been expanded to include a suite of products that addresses the pricing needs of not only PPOs, but also the requirements of health plans for automated pricing of complex facility claims and modeling of contracts. NetworX Pricer is a specialized component application, which automates the claims pricing process for health plans. This product is sold as a separate application that can be interfaced to legacy administration systems, as well as to Facets e2 . The NetworX Modeler product is a standalone application to support the automated modeling and analysis of contracts to help health plans negotiate with providers in their network. NetworX Pricer and NetworX Modeler have an innovative interface, which allows users to share contract data between the two systems. NetworX complements ClaimsExchange , a hosted application service, which provides Internet connections that allow preferred provider organizations and healthcare claims payers to exchange claim information online.

Health plans can license the network management software or host it through TriZetto’s Hosting Services. Health plans can also use TriZetto Professional Services to implement their network management operations. Specific services include implementation, contract loading third-party interface development, and optimization.

 

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Market Solutions

Two pervasive market drivers are driving dramatic changes in healthcare today:

 

   

A surge in government healthcare programs as baby boomers drop out of private plans and into Medicare programs while the Medicaid-eligible population grows

 

   

Continued pressure on the consumer to pay more of individual healthcare costs to offset the rapidly increasing costs

TriZetto has formed two market solutions groups to help drive the technological transformation needed to support government and consumer programs.

Retail Healthcare Solutions

A change that started with high deductible health plans, the retail healthcare movement is rapidly changing how payers interact with their consumer, provider, broker and employer constituents. TriZetto’s Consumer Retail Healthcare Solutions combine our traditional technology solutions with services and third-party applications. Specific retail healthcare solutions include:

Fund Management. Combining Facets ® CDH Account Management Module, Metavante’s Benefits Card Platform and financial services, TriZetto’s Fund Management solution enables Facets ® users to administer FSA, HRA and HSA plans on the Facets ® platform. Our pre-integrated solutions enables debit card access for FSA, HRA and HSA accounts via a single card. Through Metavante, the fund management solution provides integration with ACS/Mellon, HAS Bank, and other preferred financial institutions, for “one-step” HAS account management. Members can track HSA account spending and manage fund investments while benefiting from the health plan’s education, online services and enrollment capabilities.

HealthWeb ® . HealthWeb ® allows health plans to exchange information and conduct business with physician groups, members, employers, and brokers on a secure basis over the Internet. HealthWeb ® is installed on the health plan’s web servers or offered on a hosted basis and then configured according to customer preferences. The HealthWeb ® applications are easy to use and personalized for each customer, providing access to the business applications and content needed to perform typical healthcare tasks. HealthWeb ® modules are designed to manage online eligibility, authorizations, referrals, benefit verification, claims status, claims adjudication, and many other transactions benefiting physician offices. The modules also support enrollment, billing, benefit cost modeling, demographic changes, primary care physician selection, identification card requests, and other transactions for employers, brokers, and health plan members.

Provider POS Direct. Health plans can use this integrated software solution to enable providers to calculate real-time patient liability or fully adjudicate a claim in real-time before the patient leaves the provider’s office. Provider POS Direct helps providers reduce costs associated with growing accounts receivable and collections by allowing the provider to collect true payment at the time of service.

Professional Services. TriZetto offers a suite of services specifically for Retail Healthcare including Retail Readiness, Implementation and Optimization. Retail Readiness Services combine strategic planning, business process engineering and implementation services to help a health plan ready its operations to support retail solutions, expanding beyond pure technology implementation.

Government Programs

TriZetto offers solutions that assist payers as they compete in the rapidly growing Government programs marketplace. With the influx of new members through the aging of the baby-boomers and the passage of the Medicare Modernization Act providing prescription drug coverage for seniors, plans have entered this marketplace in large numbers. TriZetto government solutions, which are built on our core products, allow our customers to expand their offerings to include Medicare Part D, Medicare Advantage and Managed Medicaid.

Medicare and Medicare Part D. Building on its Facets ® Core Administration platform, TriZetto offers targeted solutions for Managed Medicare and Medicare Part D. TriZetto provides core administration software along with Care Management and Network management tools to assist a plan’s efforts to control their administrative costs while providing high quality and cost effective care for their seniors. Our FastTrak solution integrates Facets ® , Hosting Services and BPO to implement a Medicare or Medicare Part D solution in six months. In addition to implementing and optimizing Facets ® for the Medicare and Medicare Part D business lines, TriZetto also offers a CMS Monitoring Service in which Medicare-knowledgeable TriZetto professionals monitor daily changes in CMS requirements and identify the ramifications of those changes on the health plan’s operations.

Medicaid. TriZetto’s Medicaid solutions can efficiently handle claims processing as well as enrollment, medical-management and workflow processes for Medicaid membership. We continue to enhance our solution to accommodate the evolving Medicaid

 

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reporting requirements and other administrative demands. Health plans can purchase these solutions in a license, hosted or BPO option, including an integrated solution—FastTrak—that implements in six months.

PDM. In 2006, TriZetto acquired Plan Data Management, the leading business solutions company to the Medicare Advantage industry. PDM provides four key Medicare Advantage solutions including enrollment, data validation and submission, reconciliation, and revenue optimization. Solutions include:

E*ENRL. Includes the steps required to enroll and disenroll members including interfacing to the CMS system for Medicare Advantage and Part D business lines.

E*DATA Module 1 . Part of the Data Validation and Submission suite, E*DATA Module 1 submits, tracks and provides the tools to correct and resubmit medical data and encounter data.

E*DATA Module 2 . Identifies, from claims data, diagnoses that may indicate the presence of other conditions that may ultimately affect CMS payment and supplies the necessary reporting to allow a payer to submit additional confirmed diagnoses to CMS.

E*RxEVENT . Part of the Data Validation and Submission suite, E*RxEVENT submits, tracks and provides the tools to correct and resubmit pharmacy event data to CMS.

Outsourced Business Services

In 2006, we derived approximately 25% of our total revenue from outsourced business services. Our outsourced business services fall into two categories, software hosting and application management and business process outsourcing, both of which are described in more detail below.

Software Hosting and Application Management. TriZetto Hosting Services include integrating, hosting, monitoring, and managing our proprietary software applications alongside other software applications from third party vendors. We deliver software on a cost-predictable subscription basis, through multi-year contracts that include service levels.

TriZetto Hosting Services include implementing, hosting and supporting Facets ® , CareAdvance Enterprise , HealthWeb ® , NetworX , QicLink and the third-party applications with which these systems interface. Dedicated teams provide deep knowledge in technical architecture, application support, performance and tuning, operations and release management. The data center operates 24x7x365 and offers a Class 5 (highest level) data center that includes disaster recovery capabilities that support HIPAA and internal control requirements.

Whether adding new members, or adding care and network management capability, TriZetto’s hosting customers turn to us to help them align their strategic and business initiatives. Using TriZetto’s Hosting Services, health plans can deliver new products to market faster and better manage capacity fluctuations, provide higher service levels and focus IT resources on strategic initiatives rather than day-to-day operations.

TriZetto’s hosted solutions provide complete, professionally managed application management and customization that includes desktop and network connections, software applications, specialized third-party software, information management access and sophisticated reporting capabilities to aid in data analysis and decision making. Customers can choose the combination of our products and services to best meet their business requirements including:

Hosting. A comprehensive solution that works for health plans of all sizes. TriZetto Hosting Services include best-practice implementation, and management and support of TriZetto’s products. Standard packages include monitoring and reporting of customers’ equipment, telecommunications, network services and disaster recovery. Also included is the management of daily batch scheduling, reporting, and interfaces to business-critical third-party applications.

On Demand Environments. These services provide pre-configured environments run by experienced Facets ® professionals—to help customers jumpstart their product configuration, testing and training activities, and deliver more features to the market this year than current resources allow.

Disaster Recovery . Because compliance is key to any health plan’s operations, TriZetto also offers multiple disaster recovery options including a Class 5 (highest level) data center. This facility incorporates advanced technology to ensure the maximum possible disaster preparedness. It includes features such as redundant connectivity, cooling, power sources, generator and fuel systems. TriZetto data centers are staffed 24x7x365 by Facets ® experts who know how to recover Facets ® more quickly and efficiently than companies that provide only equipment and floor space.

 

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InfoTrust ® . The TriZetto Cyber Site also incorporates its powerful InfoTrust ® methodology to allow health plans to use recovery equipment as a pre-production model environment for application testing. With InfoTrust ® , TriZetto provides servers and applications as a non-production environment. If a disaster occurs, TriZetto fails over to these environments to recover customers’ applications in committed recovery times. This “double use” methodology provides a more cost effective solution for health plans because it minimizes equipment needs.

Vendor Partner Relationships. In order to provide our customers with accessibility to other specialty software applications that run integrated and alongside TriZetto solutions, we have acquired rights to license and/or deploy numerous commercially available software applications from a variety of healthcare and other software vendors. These relationships range from perpetual, reusable software licenses and contracts to preferred installer agreements to informal co-marketing arrangements. We enter into relationships with software vendors in order to offer our customers a variety of solutions tailored to their unique information technology needs. Our relationships with our vendor partners are designed to provide both parties with numerous mutual benefits.

Business Process Outsourcing (BPO). To complement our software hosting services, we also provide health plans and benefits administrators with transaction processing services for typical back office functions, including claims, billing, and enrollment. Customers typically outsource to us for the following reasons: to improve or maintain service, for more predictable costs, to take advantage of our larger scale, to reduce risk through our performance guarantees, to gain access to our technical and healthcare business expertise, to increase speed-to-market, to ensure business continuity, and to become HIPAA compliant.

Our business process outsourcing services include:

 

   

Benefit and Provider Configuration Rule Set-Up . We configure, and can maintain, the customer’s software according to the customer’s specific benefit plans and provider payment arrangements.

 

   

Document Imaging/Electronic Data Interchange (EDI) Processing. We accept and process claim forms, enrollment documents and other documents submitted via paper or EDI, and scan all images for electronic retrieval.

 

   

Medical, Dental, and Specialty Claims Processing. We process claims submitted for services under a variety of products and lines of business, adjust payments, and coordinate benefits. We also generate, print, and distribute claims payment checks and remittance notices to appropriate claimants and to health plan members.

 

   

Membership and Enrollment Processing. We set up employer group and individual membership information and process transactions regarding benefit plan selection, assignment of primary care physicians, and membership changes. We also issue member identification cards and perform other related administrative tasks.

 

   

Premium Billing. We generate, print, and mail invoices, post payments received on behalf of the health plan, and reconcile employer group and individual member accounts against billed amounts.

 

   

Print and Mailing Services. We print and mail functional area output documents such as enrollment cards, claims payment checks, remittance notices, premium invoices, broker commission checks, and capitation payments along with supporting documentation.

 

   

Business Continuity Services. We have facilities and personnel available to assist customers using our proprietary products to meet business processing requirements in the event of a loss of a customer site.

Health plans can purchase these services on a retainer or project basis. These business process outsourcing services are generally provided in our centralized processing locations. Approximately 200 employees are located at our various processing sites, providing services for customers using our Facets ® , QicLink , and other proprietary and third-party software systems.

Professional Services

We derived approximately 28% of our revenue from professional services in 2006, mainly from consulting and implementations associated with our proprietary software, software hosting, and other outsourcing contracts. As of December 31, 2006, we employed approximately 250 professional services personnel. Our professional services team helps our customers enhance revenue growth, drive administrative efficiencies and improve the cost and quality of care by implementing and optimizing TriZetto solutions. Our team provides expertise in all aspects of TriZetto’s proprietary software products, especially Facets ® , CareAdvance , QicLink , HealthWeb ® , HIPAA Gateway, and NetworX , through onsite services, remote support, and customer training in four key areas:

Product Installation . Product Installation includes a set of pre-bundled services to help a health plan install a TriZetto application. Services include: product training, environment setup, product installation, and project planning and configuration design. Often this phase includes assessments for third-party interface development, business process engineering and data conversion. The by-

 

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product of this phase is a correctly installed product, and a realistic implementation plan that identifies all of the critical success factors and resource constraints to take a technology from installation through operational use.

Customization . To take full advantage of TriZetto applications, health plans typically customize them to meet their unique operational needs. Customization services include software development (design, coding and testing) of interfaces and extensions to third-party applications; Facets ® configuration; application and technology architecture integration planning; test planning, report development and additional product training. TriZetto professional services team members are experienced in both our applications and healthcare operations. This experience drives faster and more accurate customizations, saves time and money, and reduces the risk of a complex system implementation.

Deployment . In the Deployment phase, health plans move our applications into operations. This typically requires converting legacy data to our new applications, testing the application, training the trainer, training end users and managing the operational turnover. To assist with these tasks, our Professional Services organization has developed a library of toolkits and shortcuts to make operational transition smooth and to increase internal user adoption rates.

Optimization . Once operational, our customers use our Optimization services to increase the effectiveness and efficiencies of our applications. Services include: Business Process Engineering to help our customers engineer their existing operations to achieve higher business performance; data management and warehousing strategies and implementation to help our customers improve information access and build business reports that drive intelligent business decisions; optimization of hardware, software and data exchange capabilities to leverage technology and network investments and maximize data center operations; product optimization, and user effectiveness training. These services optimize existing applications, enable the health plan to scale operations quickly and efficiently and add new lines of business.

SALES AND MARKETING

Our primary sales and marketing approach is to utilize our direct sales force to promote TriZetto as the single source for comprehensive healthcare information technology products and services to payers. As of December 31, 2006, we had approximately 70 sales, sales support, account management and marketing employees throughout the United States. Our professional sales force sells our entire range of offerings to current and prospective customers, including enterprise core administration software, network management and care management, outsourced hosting and business services, and consulting services. We also have specialized sales personnel who focus exclusively on our care management applications. Separate sales teams have been established for the health plan and benefits administration markets. Our solutions architecture team supports application and service sales while our sales support team provides in-depth technical information, provides product demonstrations and negotiates contracts with our customers and prospects. To support the overall sales process, multi-disciplinary pursuit teams are established for each major prospect, spearheaded by a member of executive management.

Our marketing team includes five key areas: Integrated Marketing, Marketing Communications and Events, Sales Channel Programs, Solutions Marketing and Product Marketing. Key functions of Integrated Marketing include branding and naming, integrated marketing planning, market intelligence, relationship marketing, analyst relations, employee communications and the Intranet and Internet. Marketing Communications and Events produces our advertising, collateral and lead generation material, as well as plans and executes TriZetto conferences and trade shows. Sales Channel Programs include customer analytics, loyalty programs, customer satisfaction and customer councils. The Solutions Marketing and Product Marketing teams are responsible for driving a presence in new markets including developing value propositions, sales tools, application beta management, product roadmaps and segmentation planning.

CUSTOMER SERVICE

We believe that personalized support is necessary to maintain long-term relationships with our customers. Because we support multiple applications and technology solutions, our functional and technical support staff are grouped and trained by specific application and by application type. These focused staff groups have concentrated expertise that we can deploy as needed to address customer needs. We cross-train employees to support multiple applications and technology solutions and create economies-of-scale in our support staff.

We further leverage the capabilities of our support staff through the use of sophisticated software that tracks solutions to common computer and software-related problems. This allows our support staff to learn from the experience of other people within the organization and reduces the time it takes to solve problems. In addition, we provide customer support for our business process outsourcing services.

Hosted clients interact most directly with TriZetto’s customer delivery management (CDM) business unit. The CDM provides ongoing customer support and “customer-facing” functions for TriZetto’s hosted customers and reports directly to the senior vice president of Enterprise Infrastructure (i.e., hosting operations). In addition to providing the customer support services identified above, the CDM is primarily responsible for managing service level commitments and supervising the delivery of

 

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customer’s specific production processing services (e.g., batch processing, online availability, file transfers, connectivity, issue resolution) for hosted customers. This service-oriented business unit is composed of TriZetto’s Customer Support Help Desk and a dedicated customer delivery team composed of customer leads and a customer delivery executive (CDE).

COMPETITION

The market for healthcare information technology services is intensely competitive, rapidly evolving, highly fragmented and subject to rapid technological change. By using proprietary technologies and methods, we develop, integrate and deliver packaged enterprise and component software applications, connectivity solutions for both Internet and direct communication, application hosting, infrastructure outsourced business services and IT consulting services. Our competitors provide some or all of the services that we provide. Our competitors can be categorized as follows:

 

   

information technology and outsourcing companies, such as Perot Systems Corporation, IBM, Affiliated Computer Services, DST (who acquired the healthcare division of Computer Sciences Corporation), Electronic Data Systems Corporation and Infocrossing;

 

   

healthcare information software vendors, including the newly combined DST/Amisys Synertech Inc., Perot Systems Corporation, Electronic Data Systems Corporation, and Plexis in the health plan market, as well as Eldorado and SBPA in the benefits administration market, and MMC 2020, Gorman and Dynamics in the Medicare Advantage market;

 

   

healthcare information technology consulting firms, such as First Consulting Group, Inc., Proxicom (ACS) and the consulting divisions or former affiliates of the major accounting firms, such as Deloitte Consulting and Accenture;

 

   

healthcare e -commerce and portal companies, such as Emdeon Corporation (formerly WebMD Corporation), Healthnation, HealthTrio, Avolent, edocs and BenefitFocus;

 

   

enterprise application integration vendors such as Vitria, SeeBeyond, TIBCO, Fuego and M2;

 

   

care management software and service companies such as HealthTrio, MEDecision, McKesson, Emdeon, HealthAtoZ and Click4Care;

 

   

consumer retail software and services companies such as CareGain and FiServ; and

 

   

health plans, themselves, some of whom are providing hosting and BPO services to the marketplace and leveraging capabilities across the aggregated membership of multiple organizations.

Each of these types of companies can be expected to compete with us within various segments of the healthcare information technology market. Furthermore, major software information systems companies and other entities, including those specializing in the healthcare industry that are not presently offering applications that compete with our products and services, may enter our markets. In addition, some of our third-party software vendors compete with us from time to time by offering their software on a licensed or hosted basis.

We believe companies in our industry primarily compete based on performance, price, software functionality, ease of implementation, level of service, and track record of successful customer installations. Although our competitive position is difficult to characterize due principally to the variety of current and potential competitors and the evolving nature of our market, we believe that we presently compete favorably with respect to all of these factors. While our competition comes from many industry segments, we believe no other single company offers the integrated, single-source solution that we provide to our customers.

To be competitive, we must continue to enhance our products and services, as well as our sales, marketing, and distribution channels to respond promptly and effectively to:

 

   

changes in the healthcare industry, including consolidation;

 

   

constantly evolving standards and government regulation affecting healthcare transactions;

 

   

the challenges of technological innovation and adoption;

 

   

evolving business practices of our customers;

 

   

our competitors’ new products and services;

 

   

new products and services developed by our vendor partners and suppliers; and

 

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challenges in hiring and retaining information technology professionals.

BACKLOG

Our total backlog is defined as the revenue we expect to generate in future periods from existing customer contracts. Our 12-month backlog is defined as the revenue we expect to generate from existing customer contracts over the next 12 months. Most of the revenue in our backlog is derived from multi-year service revenue contracts (including software hosting, business process outsourcing, IT outsourcing, and software maintenance with periods up to seven years) and consulting contracts. Consulting revenue is included in the backlog when the revenue from such a consulting contract is expected to be recognized over a period exceeding 12 months.

Backlog can change due to a number of factors, including unforeseen changes in implementation schedules, contract cancellations (subject to penalties paid by the customer), or customer financial difficulties. In such event, unless we enter into new customer agreements that generate enough revenue to replace or exceed the revenue that is recognized in any given quarter, our backlog will decline. Our backlog at any date may not indicate demand for our products and services and may not reflect actual revenue for any period in the future.

Our total backlog at December 31, 2006 was approximately $858.2 million compared to $703.4 million at December 31, 2005. The 12-month backlog at December 31, 2006 was approximately $213.3 million compared to $185.1 million at December 31, 2005.

INTELLECTUAL PROPERTY

Our intellectual property is important to our business. We rely on certain developed software assets and internal methodologies for performing customer services. Our consulting services group develops and utilizes information technology life-cycle methodology and related paper-based and software-based toolsets to perform customer assessments, planning, design, development, implementation, and support services. We rely primarily on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures, and contractual provisions to protect our intellectual property.

Our efforts to protect our intellectual property may not be adequate. Our competitors may independently develop similar technology or duplicate our products or services. Unauthorized parties may infringe upon or misappropriate our products, services or proprietary information. In addition, the laws of some foreign countries do not protect proprietary rights as well as the laws of the United States. In the future, litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation could be time consuming and costly.

We could be subject to intellectual property infringement claims as we expand our product and service offerings and the number of competitors increases. Defending against these claims, even if not meritorious, could be expensive and divert our attention from operating our company. If we become liable to third parties for infringing upon their intellectual property rights, we could be required to pay a substantial damage award and be forced to develop non-infringing technology, obtain a license or cease using the applications that contain the infringing technology or content. We may be unable to develop non-infringing technology or content or obtain a license on commercially reasonable terms, or at all.

We also rely on a variety of technologies that are licensed from third parties to perform key functions. These third-party licenses are an essential element of our hosted solutions business. These third-party licenses may not be available to us on commercially reasonable terms in the future. The loss of or inability to maintain any of these licenses could delay the introduction of software enhancements and other features until equivalent technology can be licensed or developed. Any such delay could materially adversely affect our ability to attract and retain customers.

SIGNIFICANT CUSTOMERS

As of December 31, 2006 we were providing services to 320 unique customers. One of our customers, The Regence Group, accounted for more than 10% of our consolidated revenue in 2006. No single customer accounted for more than 10% of our accounts receivable in 2006. In 2005, one of our customers, The Regence Group, accounted for more than 10% of our accounts receivable and two of our customers, The Regence Group and United Healthcare Services, Inc., each accounted for more than 10% of our consolidated revenue. No single customer accounted for more than 10% of our accounts receivable and consolidated revenues in 2004.

EMPLOYEES

As of December 31, 2006, we had approximately 1,600 employees. Our employees are not subject to any collective bargaining agreements, and we generally have good relations with our employees.

 

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AVAILABLE INFORMATION

Our website is located at www.trizetto.com . We make available free of charge through this website all of our SEC filings including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after those reports are electronically filed with the SEC.

Item 1A—RISK FACTORS

We cannot predict if we will be able to sustain our positive net income.

We may not be able to sustain our current level of revenue or increase our revenue in the future. We currently derive our revenue primarily from providing hosted solutions, software licensing and maintenance, and other services such as consulting. We depend on the continued demand for healthcare information technology and related services. We plan to continue investing in administrative infrastructure, research and development, sales and marketing, and acquisitions. If we are not able to sustain our current levels of revenue or maintain our profitability, our operations may be adversely affected.

Revenue from a limited number of customers comprises a significant portion of our total revenue, and if these customers terminate or modify existing contracts or experience business difficulties, it could adversely affect our earnings.

As of December 31, 2006, we were providing services to 320 unique customers. One of our customers, The Regence Group, represented approximately 12% of our consolidated revenue for the year ended December 31, 2006.

Although we typically enter into multi-year customer agreements, a majority of our customers are able to reduce or cancel their use of our services before the end of the contract term, subject to monetary penalties which are not significant. We also provide services to some hosted customers without long-term contracts. In addition, many of our contracts are structured so that we generate revenue based on units of volume, which include the number of members, number of workstations or number of users. If our customers experience business difficulties and the units of volume decline or if a customer ceases operations for any reason, we will generate less revenue under these contracts and our operating results may be materially and adversely impacted.

Our operating expenses are relatively fixed and cannot be reduced on short notice to compensate for unanticipated contract cancellations or reductions. As a result, any termination, significant reduction or modification of our business relationships with any of our significant customers could have a material adverse effect on our business, financial condition, operating results and cash flows.

Our business is changing rapidly, which could cause our quarterly operating results to vary and our stock price to fluctuate.

Our quarterly operating results have varied in the past, and we expect that they will continue to vary in future periods. Our quarterly operating results can vary significantly based on a number of factors, such as:

 

   

our mix of products and services revenue;

 

   

our ability to add new customers and renew existing accounts;

 

   

selling additional products and services to existing customers;

 

   

long and unpredictable sales cycles;

 

   

meeting project milestones and customer expectations;

 

   

seasonality in information technology purchases;

 

   

the timing of new customer sales; and

 

   

general economic conditions.

Variations in our quarterly operating results could cause us to not meet the earnings estimates of securities analysts or the expectations of our investors, which could affect the market price of our common stock in a manner that may be unrelated to our long-term operating performance.

We base our expense levels in part upon our expectations concerning future revenue, and these expense levels are relatively fixed in the short-term. If we do not achieve our expected revenue targets, we may not be able to reduce our short-term spending in response. Any shortfall in revenue would have a direct impact on our results of operations.

The intensifying competition we face from both established entities and new entries in the market may adversely affect our revenue and profitability.

The market for our technology and services is highly competitive and rapidly changing and requires potentially expensive technological advances. Many of our competitors and potential competitors have significantly greater financial, technical, product development, marketing and other resources, and greater market recognition than we have. Many of our competitors also have, or

 

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may develop or acquire, substantial installed customer bases in the healthcare industry. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion, and sale of their applications or services than we can devote.

Our competitors can be categorized as follows:

 

   

information technology and outsourcing companies, such as Perot Systems Corporation, IBM, Affiliated Computer Services, DST (who acquired the healthcare division of Computer Sciences Corporation), Electronic Data Systems Corporation and Infocrossing;

 

   

healthcare information software vendors, including the newly combined DST/Amisys Synertech Inc., Perot Systems Corporation and Electronic Data Systems Corporation and Plexis in the health plan market, as well as Eldorado and SBPA in the benefits administration market and MMC 2020, Gorman and Dynamics in the Medicare Advantage market;

 

   

healthcare information technology consulting firms, such as First Consulting Group, Inc., Proxicom (ACS) and the consulting divisions or former affiliates of the major accounting firms, such as Deloitte Consulting and Accenture;

 

   

healthcare e -commerce and portal companies, such as Emdeon Corporation (formerly WebMD Corporation), HealthTrio, Avolent, edocs and BenefitFocus;

 

   

enterprise application integration vendors such as Vitria, SeeBeyond, TIBCO, Fuego and M2;

 

   

care management software and service companies such as HealthTrio, MEDecision, McKesson, Emdeon, HealthAtoZ and Click4Care;

 

   

consumer retail software and services companies such as, CareGain and FiServ; and

 

   

health plans, themselves, some of whom are providing hosting and BPO services to the marketplace and leveraging capabilities across the aggregated membership of multiple organizations.

Further, other entities that do not presently compete with us may do so in the future, including major software information systems companies and financial services entities.

We believe our ability to compete will depend in part upon our ability to:

 

   

enhance our current technology and services;

 

   

respond effectively to technological changes;

 

   

introduce new capabilities for current and new market segments; and

 

   

meet the increasingly sophisticated needs of our customers.

 

   

maintain and continue to develop partnerships with vendors;

Increased competition may result in price reductions, reduced margins, and loss of market share, any of which could have a material adverse effect on our results of operations. In addition, pricing, margins, and market share could be negatively impacted further as a greater number of available products in the marketplace increases the likelihood that product and service offerings in our markets become more fungible and price sensitive.

Our sales and implementation cycles are long and unpredictable.

We have experienced and continue to experience long and unpredictable sales cycles, particularly for contracts with large customers, or customers purchasing multiple products and services. Enterprise software typically requires significant capital expenditures by customers, and the decision to outsource IT-related services is complicated and time-consuming. Major purchases by large payer organizations typically range from nine to 12 months or more from initial contact to contract execution. The prospects currently in our pipeline may not sign contracts within a reasonable period of time or at all.

In addition, our implementation cycle has ranged from 12 to 24 months or longer from contract execution to completion of implementation. During the sales cycle and the implementation cycle, we will expend substantial time, effort, and financial resources preparing contract proposals, negotiating the contract, and implementing the solution. We may not realize any revenue to offset these expenditures, and, if we do, accounting principles may not allow us to recognize the revenue during corresponding periods, which could harm our future operating results. Additionally, any decision by our customers to delay implementation may adversely affect our revenues.

Consolidation of healthcare payer organizations and benefits administrators could decrease the number of our existing and potential customers.

There has been and continues to be acquisition and consolidation activity among healthcare payers and benefits administrators. Mergers or consolidations of payer organizations in the future could decrease the number of our existing and potential customers. The acquisition of a customer could reduce our revenue and have a negative impact on our results of operations

 

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and financial condition. A smaller overall market for our products and services could also result in lower revenue and margins. In addition, healthcare payer organizations are increasing their focus on consumer directed healthcare, in which consumers interact directly with health plans through administrative services provided by health plans to employer groups. These services compete with the services provided by benefits administrators and could result in additional consolidation in the benefits administration market.

Some of our significant customers may develop their own software solutions, which could decrease the demand for our products.

Some of our customers in the healthcare payer industry have, or may seek to acquire, the financial and technological resources necessary to develop software solutions to perform the functions currently serviced by our products and services. Additionally, consolidation in the healthcare payer industry could result in additional organizations having the resources necessary to develop similar software solutions. If these organizations successfully develop and utilize their own software solutions, they may discontinue their use of our products or services, which could materially and adversely affect our results of operations.

We depend on our software application vendor relationships, and if our software application vendors terminate or modify existing contracts or experience business difficulties, or if we are unable to establish new relationships with additional software application vendors, it could harm our business.

We depend, and will continue to depend, on our licensing and business relationships with third-party software application vendors. Our success depends significantly on our ability to maintain our existing relationships with our vendors and to build new relationships with other vendors in order to enhance our services and application offerings and remain competitive. Although most of our licensing agreements are perpetual or automatically renewable, they are subject to termination in the event that we materially breach such agreements. We may not be able to maintain relationships with our vendors or establish relationships with new vendors. The software, products or services of our third-party vendors may not achieve or maintain market acceptance or commercial success. Accordingly, our existing relationships may not result in sustained business partnerships, successful product or service offerings or the generation of significant revenue for us.

Our arrangements with third-party software application vendors are not exclusive. These third-party vendors may not regard our relationships with them as important to their own respective businesses and operations. They may reassess their commitment to us at any time and may choose to develop or enhance their own competing distribution channels and product support services. If we do not maintain our existing relationships or if the economic terms of our business relationships change, we may not be able to license and offer these services and products on commercially reasonable terms or at all. Our inability to obtain any of these licenses could delay service development or timely introduction of new services and divert our resources. Any such delays could materially adversely affect our business, financial condition, operating results and cash flows.

Our licenses for the use of third-party software applications are essential to the technology solutions we provide for our customers. Loss of any one of our major vendor agreements may have a material adverse effect on our business, financial condition, operating results and cash flows.

We rely on third-party software vendors for components of our software products.

Our software products contain components developed and maintained by third-party software vendors, and we expect that we may have to incorporate software from third-party vendors in our future products. We may not be able to replace the functions provided by the third-party software currently offered with our products if that software becomes obsolete, defective, or incompatible with future versions of our products or is not adequately maintained or updated. Any significant interruption in the availability of these third-party software products or defects in these products could harm the sale of our products unless and until we can secure or develop an alternative source. Although we believe there are adequate alternate sources for the technology currently licensed to us, such alternate sources may not be available to us in a timely manner, may not provide us with the same functions as currently provided to us or may be more expensive than products we currently use.

We have sustained rapid growth, and our inability to manage this growth could harm our business.

We have rapidly and significantly expanded our operations since inception and may continue to do so in the future. This growth has placed, and may continue to place, a significant strain on our managerial, operational, and financial resources, and information systems. If we are unable to manage our growth effectively, it could have a material adverse effect on our business, financial condition, operating results, and cash flows.

Our acquisition strategy may disrupt our business and require additional financing.

Since our initial public offering in October 1999, we have made ten acquisitions. A significant portion of our historical growth has occurred through acquisitions and we may continue to seek strategic acquisitions as part of our growth strategy. We compete with other companies to acquire businesses, making it difficult to acquire suitable companies on favorable terms or at all.

 

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Acquisitions may require significant capital, typically entail many risks, and can result in difficulties integrating operations, personnel, technologies, products and information systems of acquired businesses.

We may be unable to successfully integrate companies that we have acquired or may acquire in the future in a timely manner. If we are unable to successfully integrate acquired businesses, we may incur substantial costs and delays or other operational, technical or financial problems. In addition, the integration of our acquisitions may divert our management’s attention from our existing business, which could damage our relationships with our key customers and employees.

To finance future acquisitions, we may issue equity securities that could be dilutive to our stockholders. We may also incur debt and additional amortization expenses related to goodwill and other intangible assets as a result of acquisitions. The interest expense related to this debt and additional amortization expense may significantly reduce our profitability and have a material adverse effect on our business, financial condition, operating results and cash flows. Acquisitions may also result in large one-time charges as well as goodwill and intangible assets and impairment charges in the future that could negatively impact our operating results.

Our need for additional financing is uncertain as is our ability to raise capital if required.

If we are not able to sustain our positive net income, we may need additional financing to fund operations or growth. We may not be able to raise additional funds through public or private financings at any particular point in the future or on favorable terms. Future financings could adversely affect our common stock and debt securities.

Our business will suffer if our software products contain errors.

The proprietary and third party software products we offer are inherently complex. Despite our testing and quality control procedures, errors may be found in current versions, new versions or enhancements of our products. Significant technical challenges may also arise with our products because our customers purchase and deploy those products across a variety of computer platforms and integrate them with a number of third-party software applications and databases. If new or existing customers have difficulty deploying our products or require significant amounts of customer support, our costs would increase. Moreover, we could face possible claims and higher development costs if our software contains undetected errors or if we fail to meet our customers’ expectations. As a result of the foregoing, we could experience:

 

   

loss of or delay in revenue and loss of market share;

 

   

loss of customers;

 

   

damage to our reputation;

 

   

failure to achieve market acceptance;

 

   

diversion of development resources;

 

   

increased service and warranty costs;

 

   

legal actions by customers against us which could, whether or not successful, increase costs and distract our management; and

 

   

increased insurance costs.

We could lose customers and revenue if we fail to meet contractual obligations including performance standards and other material obligations.

Many of our service agreements contain performance standards and other post contract obligations. Our failure to meet these standards or breach other material obligations under our agreements could trigger remedies for our customers including termination, financial penalties and refunds that could have a material adverse effect on our business, financial condition, operating results and cash flows.

If our ability to expand our network and computing infrastructure is constrained in any way, we could lose customers and damage our operating results.

We must continue to expand and adapt our network and technology infrastructure to accommodate additional users, increased transaction volumes, changing customer requirements and technological obsolescence. We may not be able to accurately project the rate or timing of increases, if any, in the use of our hosted solutions or be able to expand and upgrade our systems and infrastructure to accommodate such increases. We may be unable to expand or adapt our network infrastructure to meet additional demand or our customers’ changing needs on a timely basis, at a commercially reasonable cost or at all. Our current information systems, procedures and controls may not continue to support our operations while maintaining acceptable overall performance and may hinder our ability to exploit the market for healthcare applications and services. Service lapses could cause our users to switch to the services of our competitors, which could have a material adverse effect on our business, financial condition, operating results and cash flows.

 

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Performance or security problems with our systems could damage our business.

Our customers’ satisfaction and our business could be harmed if we, or our customers, experience any system delays, failures, or loss of data.

Although we devote substantial resources to avoid performance problems, errors may occur. Errors in the processing of customer data may result in loss of data, inaccurate information, and delays. Such errors could cause us to lose customers and be liable for damages. We currently process a substantial number of our customers’ transactions and data at our data centers in Colorado. Although we have safeguards for emergencies and we have contracted backup processing for our customers’ critical functions, the occurrence of a major catastrophic event or other system failure at any of our facilities could interrupt data processing or result in the loss of stored data. In addition, we depend on the efficient operation of telecommunication providers that have had periodic operational problems or experienced outages.

A material security breach could damage our reputation or result in liability to us. We retain confidential customer and federally protected patient information in our data centers. Therefore, it is critical that our facilities and infrastructure remain secure and that our facilities and infrastructure are perceived by the marketplace to be secure. Despite the implementation of security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties, or similar disruptive problems.

Our services agreements generally contain limitations on liability, and we maintain insurance with adequate coverage limits for general liability and professional liability to protect against claims associated with the use of our products and services. However, the contractual provisions and insurance coverage may not provide adequate coverage against all possible claims that may be asserted. In addition, appropriate insurance may be unavailable in the future at commercially reasonable rates. A successful claim in excess of our insurance coverage could have a material adverse effect on our business, financial condition, operating results, and cash flows. Even unsuccessful claims could result in litigation or arbitration costs and may divert management’s attention from our existing business.

Our success depends on our ability to attract, retain and motivate management and other key personnel.

Our success will depend in large part on the continued services of management and key personnel. Competition for personnel in the healthcare information technology market is intense, and there are a limited number of persons with knowledge of, and experience in, this industry. We do not have employment agreements with most of our executive officers, so any of these individuals may terminate his or her employment with us at any time. The loss of services from one or more of our management or key personnel, or the inability to hire additional management or key personnel as needed, could have a material adverse effect on our business, financial condition, operating results, and cash flows. Although we currently experience relatively low rates of turnover for our management and key personnel, the rate of turnover may increase in the future. In addition, we expect to further grow our operations and our needs for additional management and key personnel will increase. Our continued ability to compete effectively in our business depends on our ability to attract, retain, and motivate these individuals.

We rely on an adequate supply and performance of computer hardware and related equipment from third parties to provide services to larger customers and any significant interruption in the availability or performance of third-party hardware and related equipment could adversely affect our ability to deliver our products to certain customers on a timely basis.

As we offer our hosted solution services and software to a greater number of customers and particularly to larger customers, we may be required to obtain specialized computer equipment from third parties that can be difficult to obtain on short notice. Any delay in obtaining such equipment may prevent us from delivering large systems to our customers on a timely basis. We also may rely on such equipment to meet required performance standards. We may have no control over the resources that third parties may devote to service our customers or satisfy performance standards. If such performance standards are not met, we may be adversely impacted under our service agreements with our customers.

Any failure or inability to protect our technology and confidential information could adversely affect our business.

Our success depends in part upon proprietary software and other confidential information. The software and information technology industries have experienced widespread unauthorized reproduction of software products and other proprietary technology. We rely on a combination of copyright, patent, trademark and trade secret laws, confidentiality procedures, and contractual provisions to protect our intellectual property. However, these protections may not be sufficient, and they do not prevent independent third-party development of competitive products or services.

We execute confidentiality and non-disclosure agreements with certain employees and our suppliers, as well as limit access to and distribution of our proprietary information. The departure of any of our management and technical personnel, the breach of their confidentiality and non-disclosure obligations to us, or the failure to achieve our intellectual property objectives could have a material adverse effect on our business, results of operations and financial condition. We have had, and may continue to have, employees leave us and go to work for competitors. If we are not successful in prohibiting the unauthorized use of our proprietary

 

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technology or the use of our processes by a competitor, our competitive advantage may be significantly reduced which would result in reduced revenues.

Our products may infringe the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products.

We cannot be certain that our products do not infringe issued patents or other intellectual property rights of others. In addition, because patent applications in the United States and many other countries are not publicly disclosed until a patent is issued, applications covering technology used in our software products may have been filed without our knowledge. We may be subject to legal proceedings and claims from time to time, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us or our licensees in connection with their use of our products. Intellectual property litigation is expensive and time-consuming and could divert our management’s attention away from running our business and seriously harm our business. If we were to discover that our products violated the intellectual property rights of others, we would have to obtain licenses from these parties in order to continue marketing our products without substantial reengineering. We might not be able to obtain the necessary licenses on acceptable terms or at all, and if we could not obtain such licenses, we might not be able to reengineer our products successfully or in a timely fashion. If we fail to address any infringement issues successfully, we would be forced to incur significant costs, including damages and potentially satisfying indemnification obligations that we have with our customers, and we could be prevented from selling certain of our products.

If our consulting services revenue does not grow substantially, our revenue growth could be adversely impacted.

Our consulting services revenue represents a significant component of our total revenue and we anticipate that it will continue to represent a significant percentage of total revenue in the future. The level of consulting services revenue depends upon the healthcare industry’s demand for outsourced information technology services and our ability to deliver products that generate implementation and follow-on consulting services revenue. Our ability to increase services revenue will depend in part on our ability to increase the capacity of our consulting group, including our ability to recruit, train and retain a sufficient number of qualified personnel.

The insolvency of our customers or the inability of our customers to pay for our services could negatively affect our financial condition.

Healthcare payers are often required to maintain restricted cash reserves and satisfy strict balance sheet ratios promulgated by state regulatory agencies. In addition, healthcare payers are subject to risks that physician groups or associations within their organizations become subject to costly litigation or become insolvent, which may adversely affect the financial stability of the payer. If healthcare payers are unable to pay for our services because of their need to maintain cash reserves or failure to maintain balance sheet ratios or solvency, our ability to collect fees for services rendered would be impaired and our financial condition could be adversely affected.

Changes in government regulation of the healthcare industry could adversely affect our business.

During the past several years, the healthcare industry has been subject to increasing levels of government regulation of, among other things, reimbursement rates and certain capital expenditures. In addition, proposals to substantially reform Medicare, Medicaid, and the healthcare system in general have been or are being considered by Congress. These proposals, if enacted, may further increase government involvement in healthcare, lower reimbursement rates, and otherwise adversely affect the healthcare industry which could adversely impact our business. The impact of regulatory developments in the healthcare industry is complex and difficult to predict, and our business could be adversely affected by existing or new healthcare regulatory requirements or interpretations.

Participants in the healthcare industry, such as our payer customers, are subject to extensive and frequently changing laws and regulations, including laws and regulations relating to the confidential treatment and secure transmission of patient medical records, and other healthcare information. Legislators at both the state and federal levels have proposed and enacted additional legislation relating to the use and disclosure of medical information, and the federal government is likely to enact new federal laws or regulations in the near future. Pursuant to the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), the Department of Health and Human Services (“DHHS”) has issued a series of regulations setting forth security, privacy and transactions standards for all health plans, clearinghouses, and healthcare providers to follow with respect to individually identifiable health information. DHHS has issued final regulations mandating the use of standard transactions and code sets, which became effective October 16, 2003. DHHS has also issued final HIPAA privacy regulations, which required Covered Entities to be in compliance by April 14, 2003, and final HIPAA security regulations, which required Covered Entities to be in compliance by April 20, 2005. Many of our customers will also be subject to state laws implementing the federal Gramm-Leach-Bliley Act, relating to certain disclosures of nonpublic personal health information and nonpublic personal financial information by insurers and health plans.

Our payer customers must comply with HIPAA, its regulations, and other applicable healthcare laws and regulations. In addition, we may be deemed to be a covered entity subject to HIPAA because we offer our customers products that convert data to a

 

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HIPAA compliant format. Accordingly, we must comply with certain provisions of HIPAA and in order for our products and services to be marketable, they must contain features and functions that allow our customers to comply with HIPAA and other healthcare laws and regulations. We believe our products currently allow our customers to comply with existing laws and regulations. However, because HIPAA and its regulations have yet to be fully interpreted, our products may require modification in the future. If we fail to offer solutions that permit our customers to comply with applicable laws and regulations, our business will suffer.

We perform billing and claims services that are governed by numerous federal and state civil and criminal laws. The federal government in recent years has imposed heightened scrutiny on billing and collection practices of healthcare providers and related entities, particularly with respect to potentially fraudulent billing practices, such as submissions of inflated claims for payment and upcoding. Violations of the laws regarding billing and coding may lead to civil monetary penalties, criminal fines, imprisonment, or exclusion from participation in Medicare, Medicaid and other federally funded healthcare programs for our customers and for us. Any of these results could have a material adverse effect on our business, financial condition, operating results, and cash flows.

In addition, laws governing healthcare payers are often not uniform among states. This could require us to undertake the expense and difficulty of tailoring our products in order for our customers to be in compliance with applicable state and local laws and regulations.

Part of our business is subject to government regulation relating to the Internet that could impair our operations.

The Internet and its associated technologies are subject to increasing government regulation. A number of legislative and regulatory proposals are under consideration by federal, state, local, and foreign governments, and agencies. Laws or regulations may be adopted with respect to the Internet relating to liability for information retrieved from or transmitted over the Internet, on-line content regulation, user privacy, taxation and quality of products and services. Many existing laws and regulations, when enacted, did not anticipate the methods of the Internet-based hosted, software and information technology solutions we offer. We believe, however, that these laws may be applied to us. We expect our products and services to be in substantial compliance with all material federal, state and local laws and regulations governing our operations. However, new legal requirements or interpretations applicable to the Internet could decrease the growth in the use of the Internet, limit the use of the Internet for our products and services or prohibit the sale of a particular product or service, increase our cost of doing business, or otherwise have a material adverse effect on our business, results of operations and financial conditions. To the extent that we market our products and services outside the United States, the international regulatory environment relating to the Internet and healthcare services could also have an adverse effect on our business.

Increased leverage as a result of our convertible note offering may harm our financial condition and results of operations.

On October 5, 2005, we completed a private placement of $100.0 million aggregate principal amount of our 2.75% Convertible Senior Notes due 2025 (“Notes”). The indebtedness under the Notes constitutes senior unsecured obligations and will rank equally with all of our existing and future unsecured indebtedness. The Notes were issued pursuant to an Indenture dated October 5, 2005 (the “Indenture”) with Wells Fargo Bank, National Association, as trustee.

As of December 31, 2006, our total consolidated long-term debt was $114.0 million. In addition, the Indenture does not restrict our ability to incur additional indebtedness, and we may choose to incur additional debt in the future. Our level of indebtedness could have important consequences to you, because:

 

   

it could affect our ability to satisfy our debt obligations under the Notes or our credit facility;

 

   

a substantial portion of our cash flows from operations will have to be dedicated to interest and principal payments of our debt obligations and may not be available for operations, expansion, acquisitions or other purposes;

 

   

it may impair our ability to obtain additional financing in the future;

 

   

it may limit our flexibility in planning for, or reacting to, changes in our business and industry; and

 

   

it may make us more vulnerable to downturns in our business, our industry or the economy in general.

Our ability to make payments of principal and interest on our indebtedness depends upon our future performance, which will be subject to our success in marketing our products and services, general economic conditions and financial, business and other factors affecting our operations, many of which are beyond our control. If we are not able to generate sufficient cash flow from operations in the future to service our indebtedness, we may be required, among other things:

 

   

to seek additional financing in the debt or equity markets;

 

   

to refinance or restructure all or a portion of our indebtedness;

 

   

to sell assets; and/or

 

   

to reduce or delay planned expenditures on research and development and/or commercialization activities.

 

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Such measures might not be sufficient to enable us to service our debt. In addition, any such financing, refinancing or sale of assets might not be available on economically favorable terms or at all.

We have certain repurchase and payment obligations under the Notes and we may not be able to repurchase such Notes or pay the amounts due upon conversion of the Notes when necessary.

On each of October 1, 2010, 2015 and 2020, holders of certain of the Notes may require us to purchase, for cash, all or a portion of their Notes at 100% of their principal amount, plus any accrued and unpaid interest. If a fundamental change occurs, as defined in the Indenture, including a change in control transaction, holders of such Notes may also require us to repurchase, for cash, all or a portion of their Notes. In addition, upon conversion of such Notes if we have made an irrevocable election to settle conversion in cash, we would be required to satisfy our conversion obligation up to the principal amount of the Notes in cash. Our ability to repurchase the Notes and settle the conversion of the Notes in cash is effectively subordinated to our senior credit facility and may be limited by law, by the Indenture, by the terms of other agreements relating to our senior debt and by indebtedness and agreements that we may enter into in the future which may replace, supplement or amend our existing or future debt. Our failure to repurchase the Notes or make the required payments upon conversion would constitute an event of default under the Indenture, which would in turn constitute a default under the terms of our senior credit facility and other indebtedness at that time.

Our common stock price has been, and may continue to be, volatile and our shareholders may not be able to resell shares of our stock at or above the price paid for such shares.

The price for shares of our common stock has exhibited high levels of volatility with significant volume and price fluctuations, which makes our common stock unsuitable for many investors. For example, for the year ended December 31, 2006, the closing price of our common stock ranged from a high of $19.15 to a low of $11.96. The fluctuations in price of our common stock have occasionally been related to our operating performance. These broad fluctuations may negatively impact the market price of shares of our common stock. The price of our common stock has also been influenced by:

 

   

fluctuations in our results of operations or the operations of our competitors or customers;

 

   

failure of our results of operations to meet the expectations of stock market analysts and investors;

 

   

changes in stock market analyst recommendations regarding us, our competitors or our customers; and

 

   

the timing and announcements of new products or financial results by us or our competitors.

Future issuances of common stock may depress the trading price of our common stock.

Any future issuance of equity securities, including the issuance of shares upon conversion of the Notes, could dilute the interests of our existing stockholders and could substantially decrease the trading price of our common stock. We may issue equity securities in the future for a number of reasons, including to finance our operations and business strategy, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options or for other reasons.

Our stockholder rights plan and charter documents could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders.

Our stockholder rights plan and certain provisions of our certificate of incorporation and Delaware law are intended to encourage potential acquirers to negotiate with us and allow our Board of Directors the opportunity to consider alternative proposals in the interest of maximizing shareholder value. However, such provisions may also discourage acquisition proposals or delay or prevent a change in control, which in turn, could harm our stock price.

Item 1B—Unresolved Staff Comments

Not applicable.

Item 2—Properties

Facilities

As of December 31, 2006, we were leasing a total of 14 facilities located in the United States. Our principal executive and corporate office is located in Newport Beach, California. Our data center that we use to serve customers is located in Greenwood Village, Colorado. Our leases have expiration dates ranging from 2007 to 2016. We believe that our facilities are adequate for our current operations and that additional leased space can be obtained, if needed.

Item 3—Legal Proceedings

In September 2004, McKesson Information Solutions LLC (“McKesson”) filed a lawsuit against us in the United States District Court for the District of Delaware. In its complaint, McKesson alleged that we made, used, offered for sale, and/or sold a clinical editing software system that infringed McKesson’s United States Patent No. 5,253,164, entitled “System And Method For

 

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Detecting Fraudulent Medical Claims Via Examination Of Services Codes.” McKesson sought injunctive relief and substantial monetary damages, including treble damages for willful infringement. On April 4, 2006, in response to our motion for summary judgment, the court ruled, as a matter of law, that our software products did not infringe 12 of the 15 claims of McKesson’s patent that were involved in this dispute, leaving claims 1, 2 and 16. On April 17, 2006, a jury trial commenced on the first phase of this case to determine the issue of infringement of the remaining three claims. On April 26, 2006, the jury found that our Facets ® , QicLink and ClaimFacts ® software products infringed claims 1 and 2, but not claim 16 of the patent. On May 4, 2006, the court scheduled the second phase of the trial to commence on October 3, 2006 on the issues of our validity, estoppel and laches defenses and on the issue of McKesson’s damages, if any.

On September 7, 2006, we entered into a Settlement Agreement with McKesson to settle the lawsuit. As part of the Settlement Agreement, we agreed to pay McKesson a one-time royalty fee of $15.0 million for a license in the patent that covers past and future use of our products and services by all existing customers. The $15.0 million, payable in two equal installments on September 30, 2006 and September 30, 2007, was expensed in the third quarter of 2006. Our customers with maintenance agreements also will continue to receive software version upgrades that include clinical editing capabilities. Going forward, we may continue to include our clinical editing functionality in versions of Facets ® sold to new health plan customers with 100,000 or fewer members and in versions of QicLink sold to any new customers. We have agreed to pay McKesson a royalty fee of 5% of the net licensing revenue received from new sales of Facets ® and QicLink containing our clinical editing functionality. However, pursuant to the terms of the Settlement Agreement, we will no longer include clinical editing functionality in versions of Facets ® sold to new customers with more than 100,000 members, beginning November 1, 2006. In these cases, new customers may choose their clinical editing solution from available third-party providers.

In addition to the matters described above, we are involved in litigation from time to time relating to claims arising out of our operations in the normal course of business. Except as discussed above, as of the filing date of this annual report on Form 10-K, we were not a party to any other legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our results of operations, financial position and/or cash flows.

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

No matters were submitted to a vote of our stockholders during the quarter ended December 31, 2006.

 

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