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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002,

or

Commission file number: 0-30859

CareScience, Inc.
(Exact Name of Registrant as Specified in its Charter)

(215) 387-9401
(Registrant's Telephone Number, Including Area Code)

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

        None

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

        Common Stock, no par value

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

        Indicate by check mark if disclosure of delinquent filers purstuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / /

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes / /    No /x/

        The aggregate market value of voting Common Stock held by non-affiliates of the registrant based on the closing price for the Common Stock on the NASDAQ National Market on June 28, 2002 was approximately $5,351,190. As of March 24, 2003, 13,291,461 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Certain sections of the Proxy Statement to be filed in connection with the 2003 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K where indicated.

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

Overview

        CareScience, Inc. is primarily a provider of care management services to hospitals and health systems. As a company specializing in clinical knowledge, we supply the people and technology to facilitate the delivery of quality care throughout the health care system. For over 10 years, we have helped hospitals and health systems improve their performance and prevent complications and deaths by employing a systematic business approach to quality. We call this approach "care management." The primary goals of care management are to deliver patient care in the correct setting and to have patients receive "error-free" access to the best treatment choices.

        Our mission is to make quality the way of life in health care by providing innovative care management solutions to the health care industry. We help hospitals and health systems improve quality by building organizational support for change, addressing underlying barriers to improved clinical performance, and by expanding the role of care management. We work with health care providers and health systems to manage clinical processes surrounding the point of care so that fundamental reductions can be achieved in operating costs, clinical inefficiencies and medical errors. We collect, share, store and analyze clinical data generated by widely used health information systems and provide the care management services and staffing required to drive the realization of underlying clinical performance opportunities. We enable customers to apply their clinical data to enhance patient safety and to the management of care, including quality monitoring, performance improvement, credentialing, profiling, error tracking, case management and evidence based medicine. We also provide consulting services to health care providers that support strategic planning and clinical operations.

        We also have provided limited technology and services to the pharmaceutical and biotechnology industry. Our offerings have included data analysis, consulting services and customized research and strategic development support. These services are now being refocused to leverage our expertise in care management and data analysis.

        Over the past decade, we have pioneered and commercialized several clinical information technologies. We developed one of the nation's first online quality measurement and management tools, commercialized one of the first clinically based outcome risk assessment algorithms, became established as one of the first health care application service providers, and, most recently, developed the first peer-to-peer clinical data sharing technology.

        CareScience was incorporated in 1992. In 1993, we exclusively licensed the intellectual property underlying our core analytic technology in a 30-year agreement with the University of Pennsylvania. In 1996, we launched our first Internet-based commercial solution based on this proprietary technology through our Care Management System™. In 1999, we initiated development of the Care Data Exchange,®⁽¹⁾ in October 2000, we licensed the core clinical data exchange technology from the California HealthCare Foundation and on March 7, 2000, we changed our name from Care Management Science Corporation to CareScience, Inc.

        Our executive offices are located at 3600 Market Street, Philadelphia, Pennsylvania 19104 and our telephone number is (215) 387-9401. We maintain an Internet website at www.carescience.com.

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Care Data Exchange is a registered servicemark of the California HealthCare Foundation.

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Industry Background

Health Care Market and Information Technology Sub-Sector

        Health care is the largest single sector in the United States economy. According to the Centers for Medicare and Medicaid Services, or CMS, annual health care spending in the United States grew 8.7% to $1.4 trillion in 2001, an accelerating growth rate that resulted in health care accounting for 14.1% of the country's gross domestic product. The 2001 increase follows growth of 7.4% in 2000 and 6.1% in 1999 and marks the fifth consecutive year of increased spending on health care. CMS projects national health care expenditures will increase to $2.4 trillion by 2008, a compounded annual growth rate of greater than 8.0%.

        The health care information technology market is one of the strongest sub-sectors of the overall information technology market, in part driven by the increased focus on quality care. The health care information technology market is estimated to have grown 2.5% to $17.6 billion in 2002 according to International Data Corporation. In 2003, spending on health care information technology is projected to increase by 9.0%, resulting in a projected $19.2 billion in spending in 2003.

Clinical Costs are Large and Growing

        Medical costs have continued to increase at rates far greater than baseline inflation in the economy despite efforts to change administrative and financial processes, reduce systems costs, and adopt certain clinical information interventions such as computerized physician order entry systems. Even if successful, most of these efforts do not address many of the issues that cause complications, inappropriate treatments, duplicative tests and other forms of waste and inefficiency. The costs associated with waste and inefficiency comprise a large portion of spending in the health care industry. As inefficiencies within the health care system continue to consume enormous resources and pose medical risks to consumers, many constituents within the health care industry are seeking results—through cost-effective solutions, including services, information and tools to improve the quality and efficiency of care delivery.

Concerns about Clinical Quality and Medical Errors Remain High

        The delivery of clinical care usually involves complex procedures, multiple treatments and subjective judgments. Even appropriate clinical decisions are often difficult to implement and analyze because of uncontrolled operational systems. Health care organizations have been seeking to gain control of and measure clinical processes to increase accountability and efficiency and to improve care.

        Quality problems within the health care industry have received increased attention over the past few years because of advances in the ability to measure medical errors and complications and increasing concern about clinical care among policy-makers and the public. In addition to being the eighth-leading cause of death in the United States according to the Institute of Medicine's 1999 report "To Err is Human," medical errors add substantial costs to and drive consumer dissatisfaction with the delivery of care. More recently, the Institute of Medicine's 2001 report "Crossing the Quality Chasm: A New Health System for the 21^st Century" called for widespread adoption of technology and managerial methods focused upon process improvement, to substantially reduce the occurrence of medical errors and complications. In addition to the efforts being put forward by the Institute of Medicine, the Leapfrog Group, an employer consortium, has been pressuring hospitals and health systems to improve quality by implementing improved information technology and better care processes. Further, the Patient Safety Improvement Act was recently passed by the United States House of Representatives. Among other things, the Act calls for the adoption of voluntary national standards to promote the interoperability of clinical information systems and provides for a grant program to facilitate the adoption of information technology in health care.

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        Despite this increasing focus on quality of care in the United States, there remains a gap in the definition and pursuit of quality in the health care environment. Since hospitals use disparate systems to track information from a single patient, including lab systems, radiology systems, surgery systems, and other systems, the integration of data into a usable form is a significant challenge for health care providers as they respond to these outside pressures.

        Medical errors and complications result in unnecessary events including emergency room visits, hospitalizations, specialist referrals and laboratory studies, all of which are used to evaluate complications and manage the consequences they create. We believe that many of the current efforts to reduce administrative waste and improve financial performance do not address the core processes that result in clinical inefficiencies and errors. Health care delivery systems, physicians, health plans, the government and employers are seeking information regarding clinical quality and medical errors as well as tools to enhance clinical efficiency.

Technological and Data Fragmentation Leads to Inefficient Use of Clinical Data

        In order to efficiently deliver care, information must flow within and between health care constituents. For example, in order to diagnose and treat a patient properly, physicians need access to clinical information such as medical history data, laboratory results, x-rays and prescriptions from various hospitals, laboratories and other providers. Health care constituents have not historically coordinated their information technology investments due to the high cost, the number of different constituents, the lack of common technical, data and vocabulary standards, the complexity of health care encounters and lingering concerns over confidentiality and related implications of the Health Insurance Portability and Accountability Act of 1996.

        This failure to coordinate information has resulted in the current technology infrastructure in health care remaining captive to numerous incompatible and proprietary systems, including mainframe and client/server systems that store information in isolated databases using non-standardized formats. Thus, providers must typically request information by phone, fax and/or patient survey and those requests may be delayed due to disparate paper-based systems maintained by many constituents. Furthermore, the lack of timely access to accurate clinical information, particularly in an urgent-care situation, may lead to poor clinical outcomes and excess costs in various ways including inaccurate diagnoses, redundant test, therapies and admissions and an increased risk for medical errors or clinical complications. As a result of this geographic, organizational and technological fragmentation, current information exchange is often incomplete or redundant, thus creating the need for a comprehensive technology solution.

        In addition to this technological fragmentation, much of the clinical information important to understanding patterns of care and overall clinical and economic performance remains isolated in separate databases (e.g., laboratory, pharmacy, etc.). Traditional processes focused upon individual case review supplemented with chart abstracts to collect information are too labor-intensive and otherwise costly to apply broadly and therefore are not reliable for measuring and monitoring clinical or economic performance trends within or across organizations. Moreover, both the volume and underlying complexity of this data make it difficult to utilize beneficially in the absence of advanced methods and techniques for data standardization, normalization and analysis.

The CareScience Solution

        We offer the people and the technology required to make quality a reliable result of health care operations. Our solution focuses on care management because we believe that it is fundamental to delivering improved quality. We work with our clients to gain executive support, physician involvement, business planning, change management and results accountability. We do this by offering specialized

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technology and expert people who work closely with our clients to drive organizational change and return on investment.

Our People

        We offer specialized experts in care improvement, data analysis, quality procedures and technology management that supplement our client's in-house expertise. Our support ranges from consulting and education, to staffing or complete outsourcing of organization-wide care management functions. Our clinician-led team of executives has expertise in patient throughput, medical evidence, patient safety and documentation. We also employ clinicians and consultants who have highly specialized knowledge in clinical processes, business accountability, and statistical analysis. We work with our clients in the following ways:

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Consulting: Engagements of episodic projects that enable customers to fill short-term gaps, or handle complex change management or analysis challenges. Our consultants have a broad range of skills that can support many clinical improvement or data analysis projects.



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Staffing: Long-term staffing or management of an overall performance improvement program to facilitate the completion of strategic organizational goals. Our staffing helps clients create an integrated care management infrastructure with a results-oriented clinical leadership culture.



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Care Management Strategic Sourcing: A unique partnership opportunity that allows a hospital or health system to strategically source the operation of its entire care management and quality function to us. The partnership includes a complete set of on-site staff, management leadership, specialized technologies and data management and analytic capabilities.

Our Technology

        Our main product offering, the Care Management System is an Internet-based suite of tools that help to automate information flow and analysis throughout the care process. Our technology currently offers robust analytical techniques on risk-adjusted data for performance improvement measurement and monitoring and the ability to exchange real-time clinical information within and across organizations, and it is expected to offer in the future:

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up-to-the-minute care monitoring and real-time management of key events in the care process;



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customizable workflow that allows users to share important information on patients and patient populations; and



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intelligently generated alerts and reminders that are based on evidence-based medicine and clinical knowledge.

        Our range of Internet-based tools that support effective care management help health care professionals to:

        Access Comprehensive Patient Data More Efficiently.    Our technologies provide information to influence diagnostic and treatment decisions by enabling secure information sharing among authorized health care constituents. We believe that health care providers who can access clinical information immediately and securely at the point of care will become the standard-bearers of informed care. Since much information is not currently available at the point of care, we have developed and are refining an Internet-based peer-to-peer technology that allows health care organizations to share patient information across locations—allowing providers direct access to patient data when and where it is most needed—at the point of care. This peer-to-peer technology provides secure, real-time Internet access to clinical results, patient demographics, medical records and other critical data from the original source.

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        Analyze Comprehensive Patient Data More Effectively.    Our proprietary analytic methodologies were developed at the University of Pennsylvania School of Medicine and The Wharton School. Our algorithms allow us to normalize clinical information across many different parameters using sophisticated statistical analysis to provide an online evaluation of clinical performance. Unlike benchmarking, which simply compares performance to designed protocols or averages of broad populations across a limited number of criteria, our algorithms help users understand the underlying basis for their clinical performance. For example, when a patient experiences a clinical complication, we can help determine the likelihood that the complication was attributable to the patient's condition rather than the physician's decisions or the hospital's operations, and for any of these, help identify which specific treatment patterns may have contributed to the complication so that care processes can be targeted for evaluation or change.

        Apply Clinical Knowledge for Better Health Quality and Reduced Medical Expenses.    The collection, standardization and analysis of clinical data is complicated, time intensive and requires specialized capabilities. Our solutions are designed to collect and analyze comprehensive clinical data in order to improve the delivery of care. As an application service provider, we offer our customers cost-effective access to remotely hosted data supported by sophisticated processing technology and analysis methods.

        Drive Clinical and Economic Return on Investment.    Our implementation, support and consulting services seek to ensure that organizations realize the clinical and economic opportunities that our care management technologies identify. For clients that require greater assistance with the design, implementation or execution of effective care management strategies, we offer customized consulting services, full-time staffing or complete care management outsourcing.

Our Value Proposition

        Our solution helps clients prevent and solve real-world clinical problems. Specifically, we help clients:

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improve patient throughput;



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reduce complications and medical errors;



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improve compliance with evidence-based medicine; and



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improve documentation and information handling.

        Improving Patient Throughput: Helping Hospitals with Patient Flow Congestion.    Our tools and services help get patients in the right place for their treatment, track placement-related quality or efficiency problems, identify treatment delays and avoid capacity constraints and other problems that result in throughput inefficiencies. As many of the nation's hospitals face significant capacity constraints that impede proper patient care and block revenue growth, the focus on enhancing patient throughput has gained increasing attention. Hospitals and health systems also face daily challenges with patient flow congestion that result from inefficient patient placement. This may cause them to have difficulty moving patients out of the intensive care unit to a step-down or general bed or to divert emergency room patients to other hospitals because there are no available beds in the event a hospital admission would be required. This may further extend length of stay and produce poorer patient outcomes, higher costs and lower revenue. We work with clients to help improve patient throughput by:

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facilitating placement of patients in the correct site of care, and in the correct level of care;



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identifying patterns of critical capacity constraints; and



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identifying critical resource constraints (e.g., bottlenecks).

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        Reducing Complications and Medical Errors:    Identifying Opportunities for Improvement and Care Process Breakdowns. Our tools and services help identify high-risk patients, detect medical and surgical complications of care, link complication problems to underlying care processes and provide risk-adjusted comparative performance information for regulatory reporting and clinical performance improvement efforts. Because the typical complication adds thousands of dollars to the cost of care, drives quality problems and reduces patient and clinician satisfaction, we believe that reducing complications and process errors can produce significant improvements in organizational performance. Widespread focus on medical errors by the Institute of Medicine and other organizations has only increased the attention surrounding this area. We work with clients to reduce medical errors and complications by:

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identifying when medical and surgical complications occur;



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monitoring professional competence and volume of treatments provided by physicians and facilities;



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providing risk-adjusted comparative, physician performance information for regulatory reporting and credentialing; and



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enabling physicians to access and compare their pattern of care to others.

        Improving Compliance with Evidence-based Medicine.    Our tools and services help our clients improve their compliance with evidence-based medicine by identifying compliant and non-compliant care patterns and tracking the resulting outcomes for each, by reporting on required evidence-based clinical events to regulatory agencies and by tracking changes in those patterns over time. Although we have not developed and do not intend to develop the evidence-based rules ourselves, we expect to develop a flexible environment where evidence-based treatment rules can be housed and alerts or indicators can be triggered based upon those rules. Many hospitals and health systems have set guidelines and treatment protocols for care but are unable to get their clinical staff to adopt and comply with their identified best practices. These failures result in unnecessary treatment variations and a lack of standardized care processes that contribute to poor patient outcomes. We work with clients to help develop strategies and tactics to improve compliance with evidence-based medicine by:

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identifying compliant and non-compliant treatment patterns and the resulting outcomes for each; and



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providing comprehensive patient data through cross-enterprise results reporting so that duplicative orders, redundant tests, and unnecessary treatments are reduced.

We also expect to support these efforts by:

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providing a flexible structure to support third-party (including client) developed treatment rules that we intend to trigger alerts and other actions in new releases of the product; and



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using pre-programmed and customized alerts and reminders that we intend to inform clinicians and care managers of the absence of an accepted, evidence-based treatment.

        Improving Documentation and Information Handling: Helping Clinicians Get Timely Access to Clinical Information at the Point of Care.    We are developing our tools and services to help our clients improve information access and documentation by integrating both internal and cross-enterprise clinical information in a common manner. In so doing, our solutions reduce the need for manual data collection and for manual tracking of clinical events. Further, because our solutions are vendor neutral and operate over the Internet, we enable our customers to realize substantial incremental value from their historical investment in legacy information systems.

        Historically, a heavy reliance on paper-based medical records, enterprise-wide legacy systems that do not integrate with one another, and competitive business arrangements have prevented hospitals and

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health systems from sharing patient data at the point of care. This type of patient data fragmentation contributes to medical errors, redundant testing, and inadequate care. We work with our clients to improve documentation and information handling by:

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facilitating real-time management of patient records, lab results, pharmacy data, admission, discharge and transfer information, and hospital-based ambulatory care reports;



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reducing the likelihood of data transfer errors due to better integration with standard practices;



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providing access to a wider and more complete range of data for clinical analysis and data sharing;



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enabling organizations to track their clinical performance; including near-term tracking of quality performance;



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improving patient consent compliance by employing an audit trail that logs transactions between providers who have viewed patient records; and



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supporting regulatory efforts such as core measures data collection and reporting.

        In addition, all of these value propositions provide an insight and understanding of clinical processes that enable direct insight into the role, use and clinical and economic benefits of drug use within the clinical process. Those insights are made available to our pharmaceutical customers through our data analysis and consulting services.

Our Strategy

        Our mission is to make quality a way of life in health care. We will attempt to accomplish that mission by leading the industry in care management technology, services, and partnerships and by enabling our clients to manage the complete care management process, from the individual patient to entire patient populations. In so doing, our objective is to become the leading provider of care management solutions to facilitate improvements in health care quality and efficiency. The primary components of our strategy include:

        Provide a Care Management Solution that Drives Substantial Return on Investment for Clients.    Our primary focus is to effectively support the care management efforts of our clients with a complete solution offering—the technology, services and staff required to realize significant returns on investment from core care management functions. We believe that there is a strong business case for quality in that perceived quality of care drives both payer preference and consumer loyalty. In addition, there is evidence that improved quality of care lowers costs and enhances revenue. For too long, quality improvement efforts have been divorced from the strategic needs and goals of the organization. By linking these together, and by taking accountability for the technology, services staff, or all three, we provide a solution that is directly relevant to the strategic goals of our client organizations and that is directly tied to return on investment. It is that return on investment that determines our success and the success of our clients.

        Develop New Solutions Based on Our Proprietary Knowledge and Data Assets.    We have developed a substantial and rapidly growing proprietary online data asset encompassing millions of care encounters. We maintain proprietary, rigorously validated clinical algorithms. Our data and knowledge bases are differentiated because of our methods, the level of clinical detail and our linkage to ongoing relationships with active customers. We are leveraging our proprietary database to develop and introduce other Internet-based solutions. For example, in the spring of 2002, we introduced our National Comparatives database that enables users to compare their detailed patterns of treatment and resulting outcomes to those of other client organizations. Currently, we are developing the second generation of our Care Management System that we expect to take advantage of real-time client data

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feeds and provide workflow linkages between care managers, quality managers, clinicians and executives.

        Leverage our Technology Platform.    Our solutions benefit from a common technology platform, including the architecture, data structures, analytic processing tools, clinical algorithms and telecommunication protocols. Additionally, our solutions frequently integrate with a variety of other vendors' products or enable direct interactions among those products. By serving as a centralized application service provider, we believe that our solution provides significant value to our customers. Furthermore, since our solutions are technologically intensive and connect disparate industry segments, customers cannot replicate our solutions without incurring substantial costs.

        Pursue Targeted Strategic Relationships.    We intend to pursue strategic relationships that could expand our care management service offerings to customers or bolster our distribution channels. As organizations begin to better understand that core care management functions encompass a broader range of activities, including regulatory reporting, credentialing, performance improvement, throughput management, case management and loss prevention, we believe that targeted relationships with other care management specialty providers will be beneficial as they help to expand our ability to offer a more comprehensive solution without the need to develop each and every component internally.

        In executing those components of our strategy, we attempt to leverage our organizational assets to:

        Gain clinician buy-in.    Health systems have trouble translating potential quality improvement opportunities into real changes in the care delivery process because they lack physician engagement and involvement. We believe successful care management is led by clinicians because they are the best positioned to analyze and apply clinical and financial information to their decisions. Our analytic methods and technologies support and streamline clinical operations:

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our proven analytic techniques have been published in clinically relevant peer-reviewed literature;



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our risk-assessment and complication-identification methodologies help drive clinical predictions that are considered important predictors of patient outcomes;



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our clinical vocabulary is standardized so that treatments can be tracked and compared; and



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we employ clinician executives and clinical consultants that help drive organizational support of quality improvement efforts at the executive and physician executive level.

        Establish a proven track record.    We have been in business for over 10 years and have become a trusted provider of care management solutions to the health systems sector. Our track record is evidenced by the following:

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over 160 hospital facilities currently use our technology and/or services;



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since inception, we have performed several hundred consulting projects; and



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since inception, our customer renewal rate has been greater than 90% across all hospital and health system customers.

        Employ advanced technologies.    Our technology is designed by clinicians and executives who have real world, clinical operations expertise. We offer customizable data integration and analysis tools, and expect to offer workflow communication tools to help customers manage the entire care management process. Our technology embeds our unique knowledge of research methodologies and clinical operations expertise. We offer:

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risk assessment methodologies developed at the University of Pennsylvania's School of Medicine and the Wharton School of Business that overcome biases inherent in traditional categorical severity methods;



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complication identification methodologies that can distinguish between newly occurring complications and pre-existing conditions and identify when complications occur unexpectedly, giving clients the ability to target and prevent costly, systemic errors;



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throughput algorithms that help customers develop customized patient placement maps;



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vocabulary standardization that is based on the widely accepted Unified Medical Language System maintained by the National Library of Medicine and promotes more accurate performance comparisons by mapping facility-specific terms to standardized clinical vocabulary for easier analyses; and



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controlled data access and data sharing across enterprise organizations that offer data owners the ability to restrict and control data access using a peer-to-peer data sharing protocol.

        Remain cost effective.    There is a great deal of interest in how technology can address the challenges that hospitals and health care systems face. However, many technologies require enormous capital and operating investments in order to succeed. Our solutions are designed to leverage existing information system investments so they can be used more effectively.

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As an application service provider, we offer our clients cost-effective access to hosted data, data processing, analysis methods and browser-based interfaces.



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We offer a cheaper and more cost effective way to share patient information across enterprise organizations via peer-to-peer networking which requires no central infrastructure.



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We have been able to secure unique partnerships with philanthropies and academic institutions to lower our development costs.

        Align ourselves with our customers' needs.    In addition to supplying technology, we also work closely with our clients to define mutually agreed upon strategic goals and metrics. These jointly established incentives and metrics foster an active partnership with our clients and tie our own success with that of our clients. We offer:

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on-site staffing and outsourcing that enable us to work side-by-side with our clients to achieve mutually agreed upon goals;



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at-risk contracting to align a portion of our payment with client success metrics;



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ongoing education and training so that our customers are involved in the latest care management techniques; and



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long-term partnerships with our pharmaceutical clients and offer hospitals and health systems partnering opportunities with pharmaceutical companies to help accelerate improvements in their patient outcomes.

Health Care Provider Services and Solutions

        We provide an integrated suite of Internet-based solutions designed to access, analyze and apply clinical information to improve the processes surrounding the point of care. Our customers use these solutions to improve the quality and delivery of clinical care. To date, we have deployed solutions for both health care providers and for pharmaceutical and biotechnology companies. For health care providers, we currently offer our Care Management System, Care Data Exchange, consulting services, staffing and care management outsourcing.

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        An overview of our health care provider solution offerings and their future direction can be seen below:

Care Management System

        Our Care Management System applies cutting-edge analysis methods to clinical data in order to help health care provider organizations improve their clinical performance by allowing users to:

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improve patient throughput;



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reduce medical errors and complications;



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improve compliance with evidence-based medicine; and



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improve documentation and information handling.

        The Care Management System helps health care provider organizations take advantage of the vast data resources that often remain trapped or underused within organizations. The Care Management System's Internet-based interface is intended to enable medical officers, clinical analysts, physicians and health care professionals to perform their jobs more effectively.

        We typically sell the Care Management System pursuant to three- to five-year contracts. Contract pricing is based upon a per-encounter basis with services, staffing or outsourcing priced on an as configured basis. Customers typically have unlimited access to data and are supported by an array of telephone and email help, data validation and management, training classes and ad-hoc services.

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Key Product Benefits

        The key benefits of the Care Management System are its robust analytical techniques. Specifically, the Care Management System uses proven risk assessment techniques on retrospective data for performance improvement. Our risk-assessment methodologies overcome intrinsic limitations and biases inherent in categorical severity methods. These methods were developed at the University of Pennsylvania via collaboration between the School of Medicine and the Wharton School of Business. The Care Management System is one of the only available products that can distinguish between newly occurring complications and pre-existing or comorbid conditions across a broad range of medical and surgical diagnoses and identifies when complications occur unexpectedly, giving clients the ability to target and prevent costly, systemic errors.

Current Features

        Features of the Care Management System include:

        Query Ad Hoc Reporting—A tool is embedded into the Care Management System that allows users to generate customizable clinical and business reports that probe virtually any element in the database using a set of common-language terms. It supplies drill-down, interactive reporting for a faster response to clinical analyses and more insightful clinical inquiry.

        National Comparatives—A module is offered within the Care Management System that allows users to compare their clinical and financial outcomes and resource patterns against national norms. The module offers a quick and simple method to assess a client's resource utilization and practice patterns, and provides users with a national, patient data sample to use as a benchmark for outcomes and resource comparison.

        Select Practice™—As a built-in feature of the Care Management System, the Select Practice function allows users to view outcome reports based on comparisons to the performance of a select group of hospitals with excellent outcomes for both clinical outcomes (mortality, complication frequency and complication morbidity) and length of stay measures. For each disease grouping, hospitals are ranked for quality and efficiency separately. To be classified "Select Practice" for a given disease area, a facility must be ranked in the top two quintiles of both rankings, resulting in approximately 16% of facilities nationwide achieving Select Practice for each separate disease area.

        Core Measures Reporting Solution—The Core Measures Reporting Solutions is a data abstraction, processing, and reporting solution that allows hospitals to comply with the Core Measure reporting requirements of the Joint Commission on Accreditation of Healthcare Organizations. Core Measures reporting offers clients a flexible data extraction platform, immediate access to data, and rigorous data validation through an online validation data management tool. The reporting tool offers greater flexibility for data abstraction and submission of core measure indicators by offering both flat file and real-time Web-based submission of data. Data can be submitted from anywhere in the hospital using a secure Internet connection. This reporting solution also provides customized reporting via an ad hoc query tool.

Future Enhancements

        We are currently developing enhancements to the Care Management System that we expect to provide the following future benefits:

        Real-time or Batch Access to Clinical Data:    We are developing real-time clinical data access in order to monitor patient events and/or interventions as they occur.

        User-specific Portals:    We currently offer tools specialized for use by quality managers for population analyses, and clinicians and consumers for clinical data access via the Care Data Exchange.

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We are in the process of beginning to integrate these functions together and expect that over time, the Care Management System will offer five specialized user portals with customizable functionality for efficient and effective communication supported by institution-specific workflow. The system is intended to meet the needs of disparate users within a health care organization by making cross-departmental data available to help streamline and coordinate the entire care management process so that patients receive the highest quality of care.

        Embedded Clinical Knowledge and Best Practice Identification:    Future enhancements are expected to provide alerts and reminders that incorporate support for evidence-based protocols and best practices as defined in the literature or through other sources that clients deem to be appropriate for their care delivery processes. Currently, the Care Management System provides analytic tools to help clients define their own facility-specific best practices and compare them to a large national sample.

        Patient-Centric Clinical Results Delivery:    Future enhancements are expected to offer a truly patient-centric view of clinical results from multiple sources using a peer-to-peer network data-sharing model. A patient's clinical results will be able to be extracted from multiple information systems within the enterprise.

Care Data Exchange

        The Care Data Exchange is a regional clinical data-sharing solution that is designed to provide a patient-centric view of clinical information from multiple, disparate data sources using a peer-to-peer data-sharing model. The Care Data Exchange securely indexes, locates, and provides access to clinical data from original source systems across enterprise boundaries.

Key Product Benefits

        The key benefits of the Care Data Exchange are:

        Automation of the Sharing of Patient Information:    It automates the sharing of patient data without building a costly centralized data repository.

        Regional or Cross-Enterprise Data Sharing:    It offers a lower cost solution to enterprise and cross-enterprise/regional data sharing.

        Comprehensive View of Patient Data:    It brings the full patient experience to the point of care, providing a patient-centric view of clinical results from multiple data sources using a network data-sharing model.

        Controlled Data Access:    It provides access to results, but source data remains within the health care organization that stewards it.

        Inexpensive/Low Cost Availability:    It uses public Internet connectivity and peer-to-peer architecture/file-sharing to access results and offers a low cost alternative to software integration.

        Health Insurance Portability and Accountability Act of 1996 Enabler:    It supports policies and procedures for setting up cross-enterprise data-sharing contracts that are compliant with the rules and regulations promulgated under the Health Insurance Portability and Accountability Act of 1996.

        The Care Data Exchange gives individual health care organizations the ability to store and manage their own data while making it accessible to all authorized users within a designated network locally, regionally or nationally. This peer-to-peer approach reduces the cost of data sharing while minimizing the competitive issues surrounding data ownership and access privileges. The Care Data Exchange was developed and is currently being deployed in Santa Barbara County, California, a result of a project funded by the California HealthCare Foundation, a non-profit philanthropic organization.

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Consulting for Health Care Providers

        Our consulting services lead and anchor the technology component of our solutions and drive the linkage between strategic goals, care management initiatives, clinical process and return on investment. We are helping health care leaders build customized care management functions and processes to enable the continuous generation of clinical performance change. We do this through customized consulting engagements, long-term dedicated staffing, and recently, through complete departmental business process outsourcing where we provide all staff, technology and management for a fixed fee and an opportunity to earn bonus payments if our clients hit targeted success metrics.

        We approach each client from a multidisciplinary perspective to evaluate that organization's strategic quality plan, establish specific goals, targets and metrics that link care management strategies to that strategic plan, assess data availability and care management tool usage, identify organizational capability gaps in achieving the strategic plan and then setting a step-wise plan for filling those gaps in order to achieve the strategic quality plan. As described above, we support implementation of our Care Management System, with or without the cross-enterprise data sharing capabilities of our Care Data Exchange product, and provide ongoing consulting services as desired by the client.

        We have also provided feasibility assessment services related to community-wide clinical data sharing initiatives in several communities and offer implementation services including business rules, technology assessment and business structure for those initiatives.

Pharmaceutical and Biotechnology Organization Services and Solutions

        In the fall of 2002, due to lack of perceived interest in the pharmaceutical marketplace, we discontinued the active sale of our Lifecycle Decision System™. We may at some point in the future again decide to offer the Lifecycle Decision System for sale; however, there are no plans at this time to do so. In addition, we believe that competitive pressures and consolidation in the pharmaceutical marketplace have reduced the demand for and profitability of pharmacoeconomic consulting services and as a result, we have elected to minimize the remaining pharmaceutical consulting resources and move those resources from pharmacoeconomic consulting to data analysis and other activities consistent with our core care management business.

Customers

        We have entered into long term relationships with over 160 hospitals and health systems and more than 40 pharmaceutical and biotechnology companies. Representative customers for our solutions and services include:

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Ascension Health;

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Bon Secours Hampton Roads Health System;

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MedStar Health;

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Providence Health System;

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Rush System for Health;

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Sansum-Santa Barbara Medical Foundation Clinic;

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Santa Barbara Regional Health Authority;

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Sisters of Mercy Health System; and

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University of Pennsylvania Health System.

        Our operations are conducted in one business segment and sales are primarily made to health care providers. During the years ended December 31, 2001 and 2000, we generated 12% and 20%, respectively, of our revenue from our contract with the California HealthCare Foundation. No other customer comprised 10% or more of our revenues during the last three fiscal years.

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        We had one customer as of December 31, 2002 and 2001, respectively, which accounted for 18% and 12%, respectively, of our total accounts receivable.

Technology

        We have developed a technology platform and approach that underlies all of our solutions. The core asset of all of our applications is the clinical data that supports the effective delivery of care. Therefore, the direction of our technological advances is aimed at the efficient organization, handling and delivery of data. The three major areas of our technology infrastructure are:

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data hosting and storage;

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data movement and normalization; and

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data access, analysis and reporting.

Data Hosting and Storage

        We use large volumes of data in our clinical analysis and applications. Much of this data is supplied by our clients and we transform that data into information that can be applied to improve patient throughput, reduce complications and medical errors, improve compliance with evidence based medicine and improve documentation and information handling. To support those functions, we enable the aggregation of several years of patient records to support querying for both user-defined patient populations and individual cases at a given organization and entire disease classes across a group of hospitals from multiple markets. When we couple this data with the business rules from our client organizations regarding the handling of data, our data processing and storage strategy must be precise yet flexible. Our approach to this challenge has two primary thrusts:

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centralized hosting and storage of data; and

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distributed storage of data in clinical data repositories.

        Our data center is organized for managing and storing terabytes of data entrusted to us from our clients. We maintain separate environments for data storage during processing and production access including a mixture of direct attached storage and storage area networks that allow us to keep data in the most appropriate and cost-effective manner for its particular processing stage. As data move through our processing steps and is transformed toward its end-use, our level of data preservation escalates in terms of the amount of disk and server redundancy used to increase its availability and preservation. Our storage solutions utilize what we believe are best-of breed vendors to achieve configurations that are compliant with common industry standards. Our central hosting environment is scalable to handle growth in data volume as our business environment evolves. We employ a number of security measures to protect data, including protecting against unauthorized discovery, corruption, access disruption, and loss. This data hosting model is employed for the vast majority of our clients, including all of our Care Management System clients, who contract with us to warehouse their data within our hosting facility.

        By contrast, the nature of the business relationships and technology model established in our peer-to-peer Care Data Exchange relationships necessitates more flexibility in the hosting model. We accommodate these unique needs by adding distributed data storage to our offering in addition to our standard centralized storage model. We, therefore, have a standard clinical data repository, which allows us to aggregate data remotely, with an indexing service for performing remote queries. We maintain the required infrastructure by creating a server "appliance" that we provide to organizations to install and use without the need for them to provide material storage configuration and tuning in order to support our applications. These server-appliances contain a scaled version of our Clinical Information Architecture, allowing us to integrate remote data sources into our integrated application suite.

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Data Movement and Normalization

        We have developed a strategy and supporting technologies that enable the acquisition of data from different source systems. This technology, called the Clinical Information Architecture, is a computer-to-computer interface that uses standard Internet protocols, such as HTTPS. The Clinical Information Architecture enables the secure transfer of clinical and administrative data from originating systems to us in both batch and real time modes. The Clinical Information Architecture supports interfacing to a wide variety of systems that can provide updates to the Care Management System and Care Data Exchange.

        The Clinical Information Architecture can collect all required data and can be customized to fit a particular organization's infrastructure needs by being deployed in one of two primary methods:

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Hosted Relay Model—A relay interface installed at a customer's site collects the data directly from an integration engine, or customer source system. It then sends the encrypted information, via the Internet, to our data center. A secure server validates the inbound data, applies any analytic processing or other transformation steps and then adds it to the Care Management System database. This method is typically employed in a streaming data configuration, sending patient data in a transactional manner.

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Secure Transfer Model—A secure staging server, installed in our data center, accepts the transmission of data files in a batch format. This is useful if a batch extract of data is more practical than a message-based interface, either as a supplement or an alternative to real time data transfer.

        The Clinical Information Architecture includes a data management utility, which applies a data validation process to incoming data. As the data is fed through the Clinical Information Architecture, the data management utility checks data for proper format, content errors, and omissions and also reports data related issues, if any, back to the customer. The data management utility also allows the customer to correct data errors using a browser-based interface. In addition, we apply standard vocabularies across clinical organizations to standardize data for comparative and analytic reasons. In Care Data Exchange implementations, patient identities are reconciled in an attempt to eliminate duplication of those different identities for the same person across multiple organizations.

Data Access, Analysis and Reporting

        Ultimately, clients use our tools to change their care processes, with information supplied via reports, alerts and other means. To that end, we have developed a combination of methods to make information accessible to our customers. Retrospective analytic reports deliver clinical insight for populations of patients to support the hospital quality measurement, monitoring and improvement functions. These reports are accessed using a standard Internet browser. We also integrate an ad-hoc query function that makes use of an industry-leading business-intelligence engine to provide full-client application capabilities against our centrally-hosted data repository. Our ongoing movement to real time data integration is anticipated to enable online analytic processing to be extended beyond these population-based objectives and to enable the support of clinical care directly. We expect these to include alerts incorporating web alarms, email to critical staff, and escalation across multiple user roles to deliver information in time-critical situations. We believe that this integration of multiple user agendas will become an enabler for improved hospital workflow focused around care management.

Strategic Relationships

        We have developed strategic relationships with organizations that supply important inputs into our solutions. We have a long-standing license relationship with the University of Pennsylvania related to our core analytic methods. The University and CareScience management began a relationship in 1987 which has grown over time as several new methods and properties have been added to our portfolio. From time to time, faculty of the University of Pennsylvania have provided informal advice and consultation regarding refinement of our existing methodologies and/or advice regarding potential areas

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of new development. This informal advice is not material to our results of operations. The University of Pennsylvania Health System is also a non-material customer of CareScience. Also, the University owns less than one percent of our common stock. The University does not have the ability to direct or influence our operations, except as licensor under the license agreement. We are not aware of any agreements among the University and any other parties, such as other shareholders, to influence our management or operations. We have no agreements with the University, informal or formal, other than a non-material customer agreement and the license agreement.

        We entered into our license agreement with the University on July 1, 1993 and amended it effective on April 1, 1995 and May 1, 1997. That agreement expires on March 31, 2025, unless sooner terminated by the University upon our default or sooner terminated by us upon 90 days' notice to the University. Under the license agreement, the University grants a royalty-bearing, worldwide, exclusive license to us for the use of the software code which forms the basis for the proprietary analytic routines which were used to create the Care Management System software, as well as the right to sublicense the software, to create derivative works from the software and to enter into end-user agreements with our customers. We pay the University royalties for the license in an amount equal to a percentage of fees we receive for allowing others to use or to sublicense the technology. We are obligated to pay the University a minimum level of $75,000 per year in royalties, regardless of the fees we collect, or a higher amount if our fees exceed minimum thresholds. If we fail to pay the minimum level of royalty fees every year, the University has the option to convert our exclusive license to a non-exclusive license. The University retains the right to publish the material we license, although the University must notify us in advance of their intention to publish in order that a filing for intellectual property protection of such material may be made. In the event of such publication, to the extent that intellectual property protection is not available for such material, the University agrees to negotiate with us in good faith as to whether the disclosure can be appropriately modified or withheld, although we do not have a right to prevent any such disclosure. The University has not disclosed any information about the licensed material and, to our knowledge, the University has no plans to do so. Pursuant to the license agreement, we agree to indemnify and hold the University harmless against claims which arise out of the use of the licensed material by us or parties with which we contract.

        We entered into a consulting agreement with California HealthCare Foundation for a term beginning October 1, 1999 that ended September 30, 2002. In October 2002, the term of the consulting agreement was extended for a one year period ending October 1, 2003; however the remaining payments under the consulting agreement are immaterial to the results of our operations. The original work plan included the development and oversight of a local business model for the Internet-based cooperative sharing of clinical health information that may then be replicated in other localities. The Foundation owns all intellectual property rights with respect to the project, subject to a license between us and the Foundation as described below. Either party may terminate the agreement due to the other's breach that is not cured within 45 days after written notice from the non-breaching party.

        We entered into a license agreement with the Foundation on October 2, 2000. That agreement expires on October 2, 2030, unless sooner terminated by the Foundation upon our default or sooner terminated by us upon 90 days' notice to the Foundation. Under the license agreement, the Foundation grants a royalty-bearing, worldwide, exclusive license to us for the use of the software code which forms the basis for the Care Data Exchange, as well as the right to sublicense the software, to create derivative works from the software and to enter into end-user agreements with our customers. We pay the Foundation royalties for the license in an amount equal to a percentage of fees we receive for allowing others to use or to sublicense the technology. We are obligated to pay the Foundation a minimum level of $57,500, $73,750 and $90,000 per year in royalties for the year 2003, 2004 and 2005 and each year after 2005, respectively, regardless of the fees we collect. If we fail to pay the minimum level of royalty fees every year, the Foundation has the option to convert our exclusive license to a non-exclusive license. Pursuant to the license agreement, we agree to indemnify and hold the

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Foundation harmless against claims which arise out of the use of the licensed material by us or parties with which we contract.

Marketing and Sales

        We sell our solutions and services through a geographically distributed consulting and sales force. We have positioned ourselves as a leader in the provision of care management solutions to improve the quality and efficiency of health care. We market our solutions and services by:

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providing consulting activities aimed at solving important management problems faced by health system executive including care management design studies and clinical data exchange feasibility analyses;

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developing a consulting and client services staff with strong clinical, management and analytic expertise;

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on a limited basis, customizing data analysis studies for pharmaceutical and biotechnology companies;

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conducting research about clinical decision making and other important methodological frontiers and publishing our research in academic journals;

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securing speaking engagements for our clinical executives and consulting experts at leading industry conferences attended by health industry leaders;

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hosting periodic client conferences to provide clients, industry leaders and other key constituents with an opportunity for focused discussion and education on new trends in care management;

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exhibiting at leading industry conferences and trade shows in the care management and clinical information sectors;

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securing public relations opportunities to promote our clients' success and the success of our solutions; and

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advertising in trade publications aimed at health industry executives, clinicians and technicians.

Product Development

        Over the years, we have focused on changes in the analysis and application of information to support patient care. Our technology is based on research in risk assessment, outcomes measurement, care-process analysis, medical-language processing and data integration and validation at the University of Pennsylvania, beginning in the late 1980s. Researchers have published more than ten scientific manuscripts about the methodologies underlying our solutions and other publications are underway at this time regarding new advances, which we intend to commercialize in the future.

        From this research base, we have commercialized advances in clinical management and information-sharing solutions. We have accomplished this commercialization by nurturing technology transfer-relationships with scientists, from which we can acquire and commercialize new technologies. Our development is coordinated by our research center, which is staffed with our employees and by academic scientists and which can balance the academic needs of scientists with proprietary requirements. Our research center works closely with our engineers to prototype new innovations.

        In addition to the design of our solutions in the laboratory, we refine our solutions in demonstration projects. For example, we tested our Care Management System in a group of health systems, and our consulting services for health care providers in two major health systems before commercialization. We are currently deploying our Care Data Exchange in Santa Barbara, California.

Competition

        Each of our service lines faces different competitors, although we believe that our total solution as a whole has no single competitor. We now have many Internet-based competitors, and Internet-based competition is increasing and many more off-line organizations are adding Internet capabilities. We

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believe that competition in our industry is based, among other factors, on the performance, utility, price and level of comprehensiveness of solutions and services.

        Care Management System.    Although competition is intense, we do not believe that there is a dominant care-management firm serving the hospital, health system or physician markets. Fundamental changes and growth along with the demand for a new generation of care-management tools opened this market sector in the late 1990s to new entrants. At present, most Care Management System competition arises from clinical information system companies that offer data warehousing or from benchmarking firms. The clinical information system firms with which we compete offer large-scale transactional databases and applications, but their current data warehouses do not generally use risk adjustment methodologies to analyze clinical data on a retrospective basis nor do they have the ability to change the way that health care constituents interact with each other and with physicians or consumers. Although the benchmarking firms with which we compete have moved away from being administratively oriented and now offer some clinical analysis, these firms focus primarily on external comparisons rather than the internal management of care. Although our Care Management System may be offered at a higher price level than some of our competitors, we believe that our solution orientation, our clinical analysis methodologies and our strong service offerings have enabled us to continue to expand our customer base.

        Care Data Exchange.    The Care Data Exchange faces a diverse array of competitors, including consulting firms, technology vendors, and local community and regional data sharing efforts. Most vendors offer a within enterprise results reporting approach rather than allowing customers to obtain data from beyond their organization. Furthermore, most result reporting solutions mandate the use of a centralized database, which requires redundant stores of proprietary data that are costly and difficult to maintain for an enterprise. Centralized databases are also politically problematic for cross-enterprise data sharing initiatives because they require data replication and storage outside the boundaries of the organization that creates the initial data. Additionally, many of these solutions and services are aimed primarily at the flow of claims and financial data, rather than clinical data. Large consulting firms have begun implementing plans for new activities in data sharing. However, their core business model is to focus on application implementation, not data sharing. In addition, these consulting firms tend to have long-standing relationships with large hospital information system vendors that prevent them from being vendor-neutral, and they have not yet been able to fully adapt their value proposition to the Internet. Moreover, several vendors are now offering solutions that are directly competitive with the Care Data Exchange, but none of those vendors has established significant market share.

        Pharmaceutical Consulting Services.    The market for pharmaceutical consulting services is large and fragmented. Competitors range from very small consulting organizations to large contract research organizations, benchmarking firms and other pharmaceutical data suppliers. In addition, many pharmaceutical organizations and some biotechnology firms maintain their own internal consulting staff. Our competitors typically have access to ambulatory care data, but less frequently have access to detailed comprehensive in-patient data. The benchmarking firms that compete with our Care Management System offer the most comparable types of in-patient data. In view of the recent limitation on and refocusing of our pharmaceutical business, we expect to continue to differentiate our limited services based on our analytic and consulting capabilities and our understanding of the clinical processes that the data represent.

Government Regulation

        The collection, storage and transmission of personal information about an individual, especially health care information, is extensively regulated by federal and state governmental authorities in the United States. A variety of federal and state laws protect a person's medical records and information as confidential, including the Health Insurance Portability and Accountability Act of 1996. In addition, several federal and state privacy laws have strict requirements governing the treatment of particularly sensitive health data, such as information regarding an individual's HIV status, mental health, or

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substance abuse problems. Widespread access to the Internet, and the high speed at which data is transferred over the Internet, make this medium especially vulnerable to breaches of confidentiality.

        As required by the Health Insurance Portability and Accountability Act of 1996, the U.S. Department of Health and Human Services has promulgated final regulations to protect the confidentiality of individually identifiable health information that is stored or transmitted electronically. This information is referred to as "protected health information." The regulations became effective on April 14, 2001 and all affected organizations are required to be compliant by April 14, 2003. The Health Insurance Portability and Accountability Act of 1996 privacy regulation prohibits health care providers, health insurance plans and health care clearinghouses, referred to as "covered entities," from using or disclosing protected health information without the individual's authorization, except as permitted by the proposed regulations. Additionally, the regulation requires a covered entity to protect an individual's medical records from unauthorized disclosure for the life of the individual plus two years after the individual's death.

        The regulation also outlines procedures and policies that covered entities must establish regarding the collection, storage and dissemination of protected health information. Finally, the privacy regulation also governs business associates of a covered entity who receive protected health information from a covered entity.

        We will be subject to the Health Insurance Portability and Accountability Act of 1996 privacy regulation as a business associate of a covered entity. Consequently, our internal policies and procedures will need to meet the requirements of the regulation. Our business relationships with persons who share information with us, and with whom we share information, also will need to meet the requirements of the regulations. Under the final regulation, in many situations our exchange of protected health information will not require a patient's authorization under the regulation. However, even in these situations we must be very careful to safeguard the information against receipt by persons other than the intended recipient. We will need to implement technical safeguards to ensure that information in our systems can only be accessed by authorized persons. We do not expect to significantly modify our solutions and services or business operations or materially increase our expenses in response to currently proposed regulations.

        We will be subject to periodic reviews by the federal government to verify our compliance with the regulations. If we are found not to be in compliance, we may have to pay penalties. Additionally, if we are found to have misused any protected health information, we may face substantial monetary penalties and our management or employees could face imprisonment.

        Under the Health Insurance Portability and Accountability Act of 1996, the privacy regulation sets a federal standard for the privacy of protected health information; however, the Health Insurance Portability and Accountability Act of 1996 provides that state medical privacy laws will preempt the federal standard if the state law is not contrary to and is more stringent than the federal standard. Therefore, we will still be subject to provisions of state laws to the extent that they preempt the federal standard. Some state laws establish strict requirements for the maintenance and dissemination of an individual's health records, especially when those records contain particularly sensitive data such as HIV status, mental health information or substance abuse information.

Intellectual Property

        We have licensed intellectual property from the University of Pennsylvania and from the California HealthCare Foundation. The intellectual property underlying our online analytic processing software is licensed exclusively to us by the University of Pennsylvania in a 30-year agreement, which include payments by us of royalties or sublicense fees. The intellectual property used in our Care Data Exchange software is licensed exclusively to us by the California HealthCare Foundation in a 30-year agreement, which requires payments by us of royalties or sublicense fees. We consider the core technology we own and license to be fundamental to the success of our operations.

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        Excluding externally-funded development contracts, we have spent approximately $3.0 million, $3.9 million and $4.7 million in the years ended December 31, 2002, 2001 and 2000, respectively, on research and development activities.

        We own proprietary software that we have developed and used in our operations which we consider to be trade secrets. In addition, we have filed a patent with the United States Patent and Trademark Office to protect the Care Data Exchange® technology that we license from the California HealthCare Foundation.

Employees

        As of December 31, 2002, we employed 105 people, including 29 in research and development, 12 in sales and marketing, 44 in professional services and 20 in administration.

ITEM 2. PROPERTIES

        Our headquarters and application service provider operations are located in Philadelphia, Pennsylvania, where we lease approximately 21,000 square feet of office space. We also lease approximately 5,000 square feet of office space in San Francisco, California, and approximately 4,000 square feet of office space in Research Triangle Park, North Carolina.

ITEM 3. LEGAL PROCEEDINGS

        We and certain of our officers are defendants in a purported shareholder class action lawsuit litigation pending in the United States District Court for the Eastern District of Pennsylvania described below for alleged violations of federal securities laws. Although we cannot predict the ultimate outcome of the case or estimate the range of any potential loss that may be incurred in the litigation, we believe the lawsuits are frivolous and without merit, strenuously deny all allegations of wrongdoing asserted by plaintiffs, and believe we have meritorious defenses to plaintiffs' claims. We intend to vigorously defend the lawsuits.

        The class action litigation is the result of several complaints filed with the court beginning on October 17, 2001. These actions were consolidated on November 16, 2001. The court approved the selection of the lead plaintiff in the litigation on March 12, 2002. We filed a motion to dismiss the consolidated complaint on August 7, 2002 and we are currently awaiting action by the Judge presiding over the case on this motion. These complaints purport to bring claims on behalf of all persons who allegedly purchased our common stock between June 29, 2000 and November 1, 2000, for alleged violations of the federal securities laws, including Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 by issuing a materially false and misleading Prospectus and Registration Statement with respect to the initial public offering of our common stock. Specifically, the complaints allege, among other things, that our Prospectus and Registration Statement misrepresented and omitted to disclose material facts concerning our competitors, two of our prospective products and our contract with the California HealthCare Foundation. The actions seek compensatory and other damages, and costs and expenses associated with litigation. For additional discussion of legal proceedings, see "Risk Factors—Risks Related to Our Common Stock—The outcome of legal proceedings in which we are or may become involved could have an adverse effect on our business, results of operations and profitability."

        We are not involved in any other legal proceedings that either individually or taken as a whole would have a material adverse effect on our business, financial condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2002.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Price Range of Common Stock

        Since January 6, 2003, our common stock is quoted on the NASDAQ SmallCap Market under the symbol CARE. Previously, our common stock had been quoted on the NASDAQ National Market under the symbol CARE. As of March 24, 2003, we had approximately 53 holders of record of our common stock. The following table sets forth the range of high and low closing prices of our common stock as reported by the NASDAQ National Market for each period indicated:

Dividend Policy

        We have never paid cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business. Therefore, we do not anticipate paying any cash dividends in the foreseeable future.

Sales of Unregistered Securities

        We did not sell any unregistered securities during our fiscal year ended December 31, 2002.

Use of Proceeds

        On June 28, 2000 the Securities and Exchange Commission declared effective our Registration Statement on Form S-1 (File number 333-32376), relating to the initial public offering of our Common Stock, no par value per share. The net offering proceeds to us after total expenses were $43.4 million. As of December 31, 2002, we have used approximately $27.2 million of the net proceeds from our initial public offering of which approximately $15.2 million was used for working capital and other general corporate purposes, including expansion of our sales and marketing efforts as well as development of our solutions and services, approximately $6.5 million was used for dividends on and the redemption of preferred stock, approximately $3.6 million was used for the purchase of property plant and equipment, including technology and equipment expenditures required to support our product development infrastructure, $888,000 was used for the repayment of indebtedness and $1.1 million was used for the acquisition of Strategic Outcomes Services, Inc.

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ITEM 6. SELECTED FINANCIAL DATA

(in thousands, except per share data)

        The following table sets forth our selected consolidated financial information as of and for the years ended December 31, 1998, 1999, 2000, 2001 and 2002. You should read the data set forth below together with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes in the "Notes to Consolidated Financial Statements" in this Form 10-K.