NDCHEALTH CORP - 10-Q Quarterly Report

(Former name, former address and former fiscal year, if changed since last report)

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

NDCHealth Corporation, which may be referred to in this Report as the “Company”, “NDCHealth”, “we”, “our”, or “us”, provides network based information processing services and systems to healthcare providers and payers; and information management products and solutions primarily to pharmaceutical manufacturers. We classify our business into two reportable segments: Network Services and Systems and Information Management.

We have prepared the financial statements included herein, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although we believe the disclosures are adequate to make the information presented not misleading. In addition, certain reclassifications have been made to the fiscal 2003 consolidated financial statements to conform to the fiscal 2004 presentation.

You should read these financial statements in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K/A for the fiscal year ended May 30, 2003.

In the opinion of management, these financial statements reflect all adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods presented. All such adjustments are of a normal recurring nature. Because of the seasonality inherent in our business, our interim results are not necessarily indicative of our anticipated results for the full fiscal year.

In accordance with Securities and Exchange Commission guidance, those accounting policies that management believes are the most critical and require complex management judgment are discussed below. Further discussion of the application of these critical accounting policies can be found under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K/A for the fiscal year ended May 30, 2003.

Revenue – In accordance with criteria set forth in Staff Accounting Bulletin (“SAB”) No. 104, Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” and other authoritative literature, we recognize revenue when persuasive evidence of an agreement exists, delivery and performance has occurred, there is a fixed and determinable sales price, and collectibility is reasonably assured. Additionally, we have adopted the provisions of Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements with Multiple Deliverables,” which addresses certain aspects of the accounting for arrangements under which companies will perform multiple revenue-generation activities and requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting.

Within the Network Services and Systems segment, the primary source of revenue is transaction fees charged for network services. This revenue is recognized at the time services are rendered. In instances where we host web browser-based applications for our customers, fees charged per transaction include the use of the application software, network, and other value added services. Additionally, we receive revenue from the sale of software licenses and subscription fees from related maintenance and support agreements. Revenue related to software utilized by the customer to process transactions through our

network is recognized ratably over the estimated life of the network services relationship beginning on the date of customer acceptance of the software. In instances where revenue is recognized over the term of a contract, or we have contractual minimums, and we incur discrete incremental installation or other costs, we defer these costs and recognize them ratably over the contract term. Revenue related to customer installed software with stand alone functionality (meaning that connection to our network is not required for the software to be functional) is recognized when the product is shipped. Revenue related to software with stand alone functionality that is installed by us or one of our affiliates is recognized upon the date that the software is in operation at the customer site where vendor specific objective evidence (“VSOE”) has been established for the undelivered elements of the customer contract, which typically are maintenance and customer support. In these cases, the maintenance and customer support revenue is recognized over the term of the contract. Where VSOE cannot be established for undelivered elements within the contract, the revenue is recognized upon acceptance over the remaining term of the contract.

In many cases, our physician systems are sold indirectly through value added resellers, or VARs. Because the VARs provide many of the services that we would otherwise provide (such as contract support, advertising, etc.), we provide them allowances to cover their cost of providing these services. In these cases, we record revenue in accordance with EITF Issue No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products,” which requires that certain allowances be treated as reductions in revenue and allows other allowances, for which we receive separable, identifiable and quantifiable benefits, to be recorded as revenue and operating expense.

Within the Information Management segment, we have two primary sources of revenue: database information reporting and consulting services. Database information reporting typically involves the delivery of data providing pharmaceutical information. Revenue for our database information reporting products and services delivered over a period of time with multiple deliverables is recognized ratably over the term of the contract, typically using a straight-line model. Typically, the terms of these database information reporting contracts average 1 to 3 years. When we are able to support the fair value of the elements of the arrangement, and the undelivered elements are not essential to the delivered elements, revenue for these separable deliverable products and services is recognized based on the delivery of those elements. Revenue for single deliverable products and services is recognized when obligations to the customer have been fulfilled, which is typically upon delivery. Consulting services are typically structured as fixed price service contracts. Revenue for these services is recognized over the contract term as performance milestones specified in the contract are achieved. If it is determined that we will incur a loss on a contract, the loss is recognized at the time of determination. Typically, these service contracts average 3 to 12 months.

Capitalized software – In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” capitalization of costs begins when technological feasibility has been established, and ends when the product is available for general release to customers. Completed projects capitalized under SFAS No. 86 are amortized after reaching the point of general availability using the greater of the amount computed using the straight-line method or the ratio that current revenues bear to the total of current and anticipated revenues, based on the estimated useful life of the software, normally five years. The net realizable value of software capitalized under SFAS No. 86 is monitored to confirm that the investment will be recovered through the future sales of products.

In accordance with 98-1, “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use,” capitalization of costs begins when the application development phase has been initiated and ends when the product is available for general use. Completed projects capitalized under SOP 98-1 are amortized using the straight-line method, normally over five years. The net realizable value of software capitalized under SOP 98-1 is monitored to ensure that the investment will be recovered through its future use.

Investments – In a rapidly changing technology industry, we consider and selectively enter into a variety of alliances, joint ventures and investments. We maintain investments in both publicly traded and privately held entities. Investments in publicly traded entities are classified as available-for-sale securities and are reported at fair value. Unrealized gains and losses are reported, net of taxes, as a component of stockholders’ equity. In accordance with SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” unrealized losses are charged against income when a decline in fair value is determined to be other than temporary. The specific identification method is used to determine the cost of securities sold. Realized gains and losses on investments are included in other income (expense) when realized.

Investments in privately held entities are accounted for under either the cost, equity, or consolidation method, whichever is appropriate for the particular investment. The appropriate method is determined by our ability to exercise significant influence over the investee, through either voting stock or other means. These investments are regularly reviewed for impairment issues and propriety of current accounting treatment. In accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 18, “Equity Method of Accounting for Investments in Common Stock,” transition from the cost to equity method, due to changes in our ability to influence the investee or the level of investment, would require retroactive restatement of previously issued financial statements as if we had always accounted for the investment under the equity method. If our level of investment increases to a level such that we directly or indirectly control the entity, the entity’s results would be consolidated into our consolidated financial statements.

Intangible assets - Intangible assets represent goodwill, customer base, data access rights, and proprietary technology acquired in connection with acquisitions. Customer base acquired is amortized over the estimated useful life ranging from 5 to 15 years. Data access rights are currently amortized over 7 years which is the estimated useful life. Proprietary technology is amortized over the estimated useful life ranging from 3 to 7 years. Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets.

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS 141 eliminates pooling of interests accounting and requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. SFAS 142 deals with, among other things, the elimination of amortization of goodwill. We adopted these new standards in the first quarter of fiscal 2002. SFAS 142 requires that goodwill no longer be amortized but be reviewed for impairment at least annually. In accordance with SFAS 142, we conduct our annual impairment tests during the second quarter of each fiscal year. Additionally, we test at other times if events or circumstances occur that would more likely than not impact the fair value of a reporting unit. The goodwill impairment test has two steps. First, we compare the fair value of the reporting unit with its book value. If the fair value of the reporting unit exceeds its carrying value, the second step is not necessary. If the carrying value exceeds its fair value, the second step calculates the possible impairment by comparing the implied fair value of goodwill with the carrying amount. If the implied value of goodwill is less than the carrying amount, a write-down would be required.

We regularly evaluate whether events and circumstances have occurred that indicate the carrying amount of other intangibles may warrant revision or may not be recoverable. When factors indicate that intangibles with finite lives should be evaluated for possible impairment, we compare the estimated fair

value to the carrying value in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” If such evaluation indicates a potential impairment, cash flows discounted using our internal borrowing rate or a risk free rate are used to measure fair value in determining the amount of these assets that should be written off.

In management’s opinion, goodwill and identifiable intangible assets were appropriately valued at February 27, 2004 and May 30, 2003.

Use of estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make other estimates and assumptions in addition to those discussed above. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reported period. Actual results could differ from these estimates.

Allowance for doubtful accounts - Allowance for doubtful accounts reflects management’s estimate of probable losses based principally on historical experience and specific review and analysis. All accounts or portions thereof deemed to be uncollectible or to require excessive collection costs are written off against the allowance.

Data costs – We purchase data from a variety of sources primarily for use in our information products and services. These costs are typically held in deferred cost at the time of purchase and expensed during one, or over several months as products utilizing the data are delivered to customers. Occasionally product offerings are expanded by modifying current products for a new market. In these cases, additional or new types of data costs may be incurred in developing the database for these new products over several months during which the product cannot be sold and the additional data costs are deferred. These data costs are then amortized, beginning when sales of the new products commence, over the expected life of the customer relationships established around these new products, in all cases not to exceed three years.

Stock options - We have chosen the disclosure option under SFAS No. 123, “Accounting for Stock Based Compensation” and SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123,” and continue to apply APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for our equity compensation plans. Accordingly, no compensation cost has been recognized for options granted under the plans. The weighted average fair value of options granted during the third quarter of fiscal 2004 and 2003 was $14.16 and $9.09, respectively. The weighted average fair value of options granted during the first nine months of fiscal 2004 and 2003 was $9.87 and $10.72, respectively. Had compensation cost for these plans been recognized based on the fair value of the options at the grant dates for awards under the plans consistent with the method of SFAS No. 123, the effect on our net income and earnings per share would have been as follows:

On December 31, 2003, through an agreement whereby we acquired all fixed assets and employees and obtained a seven year exclusive license to certain of its assets, we acquired the continuing operations of ArcLight Systems LLC, an information management company. The purchase price included 381,098 shares of unregistered NDCHealth common stock with a market value as of the date of issuance of $10.0 million and a five-year warrant to purchase

an additional 381,098 shares of NDCHealth common stock at an exercise price of $26.24 per share with an estimated value as of the date of issuance using the Black-Scholes option pricing model of $4.4 million. The assumptions used in estimating the warrant’s value were a risk-free interest rate of 3.3%, an expected dividend yield of 0.6%, an expected life of five years, and expected volatility of 48%.

Additionally, the acquisition required the recording of transaction and lease termination costs totaling $3.1 million and a $0.7 million receivable for future cash payments from the remaining ArcLight business to NDCHealth relating to a previous agreement between the two parties ArcLight made a transition payment of $2.0 million to NDCHealth at closing. The transition payment resulted in a reduction in the consideration we paid for ArcLight’s business. Future cash payments from ArcLight to NDCHealth relating to the previous agreement will reduce the net purchase price in subsequent periods.

Additionally, we will pay ArcLight royalties on our future product sales utilizing ArcLight data and the agreement to use certain data may be extended for three additional years if certain financial and business objectives are met. If the agreement is extended for an additional three years, ArcLight will have the option to receive an additional $10.0 million in either cash or NDCHealth common stock.

The net purchase price of $12.4 million has been allocated as follows. We determined that $0.4 million of the assets acquired represented in process research and development, the cost of which were appropriately expensed in the third quarter as required by FASB Interpretation No. (“FIN”) 4, “Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method” as a component of sales, general and administrative expense.

ArcLight’s results have been consolidated into our financial statements as of December 31, 2003, the date of the agreement. The following unaudited pro forma information for the ArcLight acquisition has been prepared as if the acquisition had been completed as of the beginning of each period presented. The information is based on historical results of the separate companies and may not necessarily be indicative of the results that would have been achieved or of results that may occur in the future. The pro forma information includes the expense for amortization of intangible assets, other than goodwill, resulting from the acquisition, the elimination of inter-company revenues and expenses previously recorded, and a $0.4 million charge for in-process research and development discussed above. The pro forma information does not reflect any synergies or operating cost reductions that may be achieved from the combined operations.

Basic earnings per share is computed by dividing reported net earnings available to common stockholders by weighted average shares outstanding during the period. Diluted earnings per share is computed by dividing reported net earnings available to common stockholders by weighted average shares outstanding during the period and the impact of securities that, if exercised, and convertible debt that, if converted, would have a dilutive effect on earnings per share. Our convertible debt was retired on December 26, 2002 and therefore can no longer be converted. All options with an exercise price less than the average market share price for the period have a dilutive effect on earnings per share.

The following table sets forth the computation of basic and diluted earnings (loss):

Outstanding options to purchase 543,000 shares of the Company’s common stock were not included in the computation of diluted earnings per share for the three months ended February 27, 2004 because the options’ exercise prices were greater than the average market price of NDCHealth common stock during the period and therefore were antidilutive. In the three months ended February 28, 2003, outstanding options to purchase 4,207,000 shares of the Company’s common stock were not included in the computation of diluted earnings (loss) per share because the effect would be antidilutive due to the operating loss. Outstanding options to purchase 1,302,000 and 1,960,000 shares of the Company’s common stock were excluded for the nine months ended February 27, 2004 and February 28, 2003, respectively, because they were antidilutive. For the three months ended February 27, 2004 and February 28, 2003 dividends declared per common share were $0.04. For the nine months ended February 27, 2004 and February 28, 2003, dividends declared per common share were $0.12.

The aggregate amortization expense for the three and nine months ended February 27, 2004 and estimated amortization expense for the next five fiscal years is as follows:

The changes in the carrying amount of goodwill for the nine months ended February 27, 2004 are as follows:

Segment information for the three and nine months ended February 27, 2004 and February 28, 2003 is presented below. We operate our business as two reportable segments: Network Services and Systems and Information Management. Network Services and Systems provides electronic connectivity to the NDCHealth intelligent network and system solutions throughout the healthcare industry. Information Management provides management information, research, and consulting services to pharmaceutical manufacturers, pharmacy chains and hospitals. Other includes certain portions of fiscal 2004 Restructuring, impairment and other charges, losses related to investments, and charges related to the early extinguishment of debt. There has been no significant change in the composition of the reportable segments from the presentation of fiscal 2003 segment information included in our Annual Report on Form 10-K/A for the fiscal year ended May 30, 2003.

The following presents information about our operations from different geographic regions for and as of the three months ended February 27, 2004 and February 28, 2003:

The following presents information about our operations from different geographic regions for and as of the nine months ended February 27, 2004 and February 28, 2003:

Several independent pharmacies filed a lawsuit on December 23, 2002 in the Twentieth Judicial Circuit Court, St. Clair County, Illinois, against IMS Health, Inc., or IMS, and sixty-two other defendants, including us (collectively the computer systems vendors). We were served with the lawsuit in May 2003. The pharmacies, Douglas & Ogden Medical Center Pharmacy, Inc. d/b/a Douglas Main Pharmacy, Timmerman & Associates, Inc. d/b/a Comprehensive Care Pharmacy, and John Hartman d/b/a Bittles Drug Store allege that IMS violated the Illinois Trade Secrets Act and breached alleged contracts it had with the computer systems vendors by reselling what the plaintiffs claim to be proprietary drug information to a competing prescription drug provider. The plaintiffs have also alleged that the computer systems vendors, including us, violated the Illinois Trade Secrets Act and breached alleged contracts with the plaintiffs by providing what they claim to be proprietary pharmacy data to IMS. On February 17, 2004, all claims, including any obligations to pay any of the damages, sought in this case against us were dismissed with prejudice. Furthermore, IMS Health has also agreed to pay our reasonable attorneys’ fees incurred in connection with the defense of this case.

We currently provide pharmaceutical information services solutions to our European customers, pharmaceutical companies, through our German business. In this regard we deliver the wholesale data we receive from our data suppliers in a variety of products to our customers to assist them in operating their businesses. We deliver this data to our customers in an electronic format. The specific electronic format within which such data is actually delivered to such pharmaceutical companies in Germany is the subject matter of the current litigation both before the European Commission and the German courts with IMS Health.

In the proceedings before the European Commission instituted by us on December 19, 2000, we are alleging that to the extent this format is copyrighted by IMS Health, the format constitutes an industry standard and an essential facility to competition and must be made available to competitors of IMS Health. We obtained a ruling as to our request for Interim Relief from the European Commission whereby they ordered IMS Health to license its structure for organizing pharmaceutical sales data to us. However, subsequent to this decision, the Court of First Instance and later the European Court Of Justice stayed this decision pending a complete review of the underlying substantive matters. Those matters are still proceeding. The European Commission has recently withdrawn its ruling as to our request for Interim Relief finding that since the German Court of Appeals had found that IMS Health had no right to enforce any existent copyright in the structure that we could sufficiently compete in the marketplace.

format. On August 13, 2002, the Frankfurt Court of Appeals ruled in our favor by dismissing the preliminary injunction against our use of the industry standard data structure. This decision is final and is not subject to further appeal by IMS Health. On September 17, 2002 the Frankfurt Court of Appeals issued a judgment in the main proceedings against PI. While validating a copyright in the structure, the Court held that IMS Health has no standing to sue to enforce the copyright. The Court also determined that IMS Health does not own the copyright. The Court further denied IMS Health’s claims under the EU Database Directive for protection of the data structure involved. Finally, the Court found that PI breached the German Act Against Unfair Trade Practices (UGW) by reason of identically copying the data structure. We have not sold or used the data structure initially used by PI. We do not own PI and PI is no longer actively conducting business. The case against us remains pending before the Frankfurt Regional Court at this time.

On October 14, 2003, we filed suit in the 96th Judicial District Court, Tarrant County, Texas, against 1-Rex, Inc., FDS, Inc., Healthcare Computer Corporation, Freedom Drug Stores, Inc., Freedom Data Services, Inc. and William Rex Akers (collectively the “Defendants”) for breach of contract, misappropriation of trade secrets, fraud, and negligent misrepresentation, seeking millions of dollars in damages for Defendants’ wrongful conduct. On March 5, 2004, Defendants filed a counterclaim against us, asserting claims for tortious interference with a prospective contract, violations of Section 15.05(b) of the Texas Business and Commerce Code, civil conspiracy, and seeking a declaratory judgment in connection with various claims made by us. Defendants seek over $25 million in damages, plus attorneys’ fees, pre-judgment and post-judgment interest, and punitive damages. We intend to vigorously prosecute our causes of action against the Defendants, have denied all liability and damages sought in the counterclaim, and are vigorously defending the claims asserted against us.

On April 7, 2004, a putative securities class-action lawsuit was filed in the United States District Court for the Northern District of Georgia against the Company and Messrs. Hoff and Hutto. The complaint addresses the Company’s April 1, 2004 announcement that it would delay the release of fiscal third-quarter results pending a review of certain practices and procedures relating to the timing of revenue recognition of sales to the value-added reseller channel in the Company’s Physician business unit. The complaint generally alleges, among other things, that members of a purported class of stockholders who purchased common stock between October 1, 2003 and March 31, 2004 were damaged as a result of purported accounting irregularities, the Company’s previously issued financial statements were materially false and misleading, thereby causing the prices of the Company’s common stock to be inflated artificially. The complaint further alleges that, as a result defendants violated Section 10(b) and 20(a) of the Securities Exchange of 1934, and Rule 10b-5 promulgated thereunder. The action seeks unspecified monetary damages and other relief. The Company intends to vigorously defend itself. The Company has not been served.

We are also aware that, on April 14, 2004, a press release was issued by the law firm of Federman & Sherwood stating that a complaint was filed in the United States District Court for the Northern District of Georgia against the Company. At this time we have neither been served with, nor seen a copy of the complaint.

Additionally, we are party to a number of other claims and lawsuits incidental to our business. We believe that the ultimate outcome of such matters, in the aggregate, will not have a material adverse impact on our financial position, liquidity or results of operations.

In the fourth quarter of fiscal 2003, in conjunction with the completion of the TechRx acquisition, we began a review of the entirety of NDCHealth to identify opportunities for increased operational efficiencies. This ongoing review includes an assessment of our organizational structure as well as our physical operating locations. We have taken several actions in the first nine months of fiscal 2004 as a result of this review.

In the Network Services and Systems segment, we have begun to streamline the management organizations of our pharmacy services and systems businesses and the application development organization in our hospital business. We completed the first step of the streamlining, in which we eliminated 16 positions, in the first quarter. In connection with the first step, we recorded approximately $1.0 million in severance related costs in the first quarter. Approximately $0.1 million of this severance cost was a non-cash charge related to modified stock options. We completed additional steps of this streamlining in the second quarter with the elimination of an additional 14 positions. In connection with the additional streamlining, we recorded approximately $1.5 million in severance related costs in the second quarter. Also in the second quarter, we recorded a charge of approximately $0.2 million for the impairment of a note receivable we received as partial consideration for the sale of a non-core operation in the second quarter of fiscal 2001.

During the first quarter of fiscal 2004, we made a decision to combine the sales organizations and streamline the development organizations within the Information Management segment. As a result of this reorganization, during the first quarter we eliminated 28 positions and reduced the size of two locations. Accordingly, we recorded approximately $0.4 million in severance related costs and $0.1 million of expense related to lease terminations in the first quarter. The reorganization of these sales organizations is substantially complete.

Kingdom pharmacy systems business. In connection with the first step, we recorded charges of approximately $0.7 million for lease termination costs and impairment of assets and approximately $0.1 million in severance related costs in the second quarter.

We expect to continue to review alternatives to reduce costs, including strategies to improve our profitability in Europe and efficiencies gained through the acquisition of ArcLight, in the remaining period of fiscal 2004.

Our restructuring, impairment and other charges are shown in tabular form below.

In fiscal year 2003, we issued $200 million aggregate principal amount of 10 1/2% senior subordinated notes due 2012. Our wholly-owned, material subsidiaries, which include NDC Health Information Services (Arizona) Inc. and NDC of Canada, Inc., have fully and unconditionally guaranteed the notes on a joint and several basis.

Presented below is our consolidating financial data, including the combined financial data for our subsidiary guarantors and our subsidiary non-guarantors.

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. We do not have arrangements which would meet the disclosure or consolidation requirements of FIN 46.

On March 31, 2004, a special committee of NDCHealth’s Board of Directors comprised of the members of its Audit Committee, each of whom is an independent director, and independent legal and accounting advisors retained by the Special Committee, initiated a review of practices and procedures relating to the timing of revenue recognition of sales to the value-added reseller (VAR) channel in the company’s physician business unit. On April 16, 2004, the Special Committee completed its review and analysis. After a discussion of the results of the review with the company’s outside auditors, it was also concluded based on the review that there was no impact on any reported prior period results. The company did, however, implement a change that had the impact of delaying revenue recognition of $2.3 million of third quarter sales to VARs, which resulted in a decrease in net income of $0.8 million, or $0.02 per diluted share.

On April 8, 2004, we announced our acquisition of the OmniLink pre-and post-editing business from McKesson Corporation for approximately $14 million in cash to complement our existing pharmacy network services business and expand our comprehensive suite of edits for customers of both organizations.

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements. Actual results could differ materially from those encompassed within such forward-looking statements as a result of various factors, including those set forth herein under the caption “Forward-Looking Information.”

For an understanding of the significant factors that influenced our results, the following discussion should be read in conjunction with the condensed consolidated financial statements and related notes appearing elsewhere in this report.

Healthcare represents the largest segment of the United States economy. The U.S. government estimates that healthcare spending in the United States will reach $3.1 trillion in 2012, up from $1.6 trillion in 2002 (14.9% of GDP), and that approximately 25% of total healthcare expenditures in 2002 was spent on administrative overhead. We believe NDCHealth plays an increasingly important role in providing automation, transaction processing and information solutions to improve the efficiency and effectiveness of healthcare.

In July 2003, we outlined an eight-quarter plan of our key business strategies and goals for fiscal years 2004 and 2005. We have a number of new initiatives underway to allow us to realize the still very large untapped potential for our solutions in our existing markets. Execution focus is critical to our success in achieving this plan. As part of our 2005 planning process, we will update our plan through fiscal 2006 and will describe that plan in our Annual Report on Form 10-K for the fiscal year ending May 28, 2004.

There are three key elements to our strategy: to increase revenue per claim through value added transactions; to grow claims volume as healthcare grows and through gains in market share; and to take full advantage of our extensive claims processing resources in our information management business in order to be well positioned for a rebound in the pharmaceutical manufacturing industry.

Our strategy starts with the fundamental transaction in healthcare’s revenue cycle – the submission of claims from providers to third party payers. We estimate that we process more than 45% of all electronic healthcare claims in the United States. Our revenue increases as we gain market share and provide advanced edit processing and other real-time transaction related products and services to add significant value for customers. We are generally able to price incrementally for these additional products and services in addition to the pricing for the base claim. Further, due to an aging population and legislation requiring Medicare to pay for many drugs, our claims volume and related revenue should grow.

From our network, we capture the claim and related transaction information and, where we have the right to use the data, combine that information with data we purchase and create information solutions for pharmaceutical manufacturers and providers, such as pharmacies. Our information strategy is to continue to aggregate and integrate data from our processing network to create unique new products which build additional streams of revenue and expand margins. Today, we provide products and services to four major areas of the healthcare industry:

As the healthcare marketplace continues to evolve, our goal is to expand our customer base to include payers, employers and consumers, thereby reducing our effective cost per unit of data.

We are executing a business strategy to evolve from a value-added intelligent network and information products provider to an integrated healthcare information solutions company. Our strategy is to continue to expand our markets and add new products and services as we offer our customers high quality, quantifiable, value-added information solutions in healthcare. We seek to achieve this strategy by leveraging the assets of our two business segments, Network Services and Systems and Information Management, and growing a sustainable business model with a consistent base of recurring revenues.

To execute this strategy, we developed an eight-quarter plan (through fiscal 2005) which has three key priorities: focus on revenue growth, control operational and administrative costs to realize margin improvement, and generate significant cash flow to pay down debt and reduce interest expense. We

believe this strategy, properly executed, will allow us to generate revenue growth even though our pharma revenue growth is expected to be relatively slow over the eight quarter plan, with expected accelerating revenue and earnings growth toward the end of the period.

In the third quarter, our Network Services and Systems segment showed solid revenue growth. We believe we are now seeing solid evidence of accelerating growth in our pharmacy and hospital businesses as new systems are installed and transaction volumes build. In this segment, we have made significant changes to our sales force this year to focus on selling complete, integrated business solutions. While the full potential from these changes will take time to be realized, we believe our sales and operating results clearly indicate we are gaining traction in the marketplace.

Our Information Management segment grew slowly, as we expected. Given the future prospects of this business we remain very committed to it, despite this segment’s low single-digit growth rate in the quarter. We are continuing to make investments to accelerate future growth, including the development of what we believe will be the largest diagnosis-to-drug linked database. We expect these investments will begin to contribute to future growth and profitability in our fiscal year ended May 2005.

Also in the quarter, we began to reduce our debt by prepaying a portion of our term loan using cash flow generated this year. Further, we continued to fuel our future growth plans by investing in developing and launching a number of new products and services.

At the same time, there are unique challenges we are managing. We believe the market demand for information in the pharma industry continues to be constrained. We expect it will be later in calendar 2005 before this will change significantly. In addition, our transition to a recurring revenue model delays revenue recognition of this year’s strong new sales of certain long-term contracts and it slows our current revenue growth rates. However, we believe this is very positive for our business longer term and should improve our revenue quality and visibility as these sales build future recurring revenue streams.

Over the past two years, we believe we have done extremely well in creating long-term business arrangements with major pharmacy chains. However, we now need to focus on accelerating sales of our value-added Network editing solutions into regional chains and independent pharmacies. We have also seen dramatic revenue growth in our Pharma business in Germany. We now must eliminate the losses associated with this business.

We continue to feel very positive about our capabilities to expand the spectrum of opportunity for NDCHealth. We believe we are a leading provider of network-based information products and services across healthcare today, and our business investments and organizational and personnel changes are aimed at accelerating our growth.

We completed a re-evaluation of our previously disclosed strategy over the last few months, which included an assessment by our Board of Directors. We concluded that our strategy is appropriate and does not require any fundamental change. That being said, we are constantly reviewing each of our business units to ensure that we are properly focused on the business opportunities that offer the best outlook for revenue, profit and cash flow growth. This is why we are taking steps to mitigate the negative impact of certain businesses on our financial performance. Even more importantly, we are focused on executing on our strategies to accelerate the rollout of new pharmacy and hospital solutions, integrate the ArcLight business and develop new information solutions for the pharmaceutical industry.

Our strategy continues to be centered on building our “electronic highway” for healthcare. The electronic highway utilizes the strength of our existing scale and solutions to automate workflow to reduce our customers’ labor needs, provides connectivity to optimize our customers’ revenue and cash flow, allows for informational transparency so they may better understand cause and effect of healthcare

decisions and provides for HIPAA-compliant electronic messaging at the point of care. Overall, it helps to improve the quality and efficiency of healthcare.

We believe the concept is well developed and a number of applications have already been implemented. For example, a few months ago we announced the National Community Pharmacy Network, or NCPN. Through NCPN, we work with other pharmacy vendors and are able to use our extensive network capabilities to create a virtual chain of regional and independent pharmacies giving these pharmacies the opportunity to aggregate data to create new business and profit opportunities otherwise unavailable to them.

We expect that the ability to provide messaging sponsored by pharmaceutical manufacturers directly to pharmacies and their customers at the point-of-care could be a significant electronic highway opportunity for NDCHealth. Such messages can improve persistency and compliance to prescriptions thereby enhancing the quality of healthcare. We currently have four messaging programs sponsored by pharmaceutical manufacturers that are under contract and operational, and more than a dozen additional programs that are under discussion.

Our electronic healthcare highway is already a reality and represents the type of creative investments we are making to ensure future growth. We believe it is this type of innovation that will allow NDCHealth to continue its leadership role in healthcare.

In the quarter, we continued to invest in future growth areas including Europe, e-prescribing and our new pharmacy systems, as well as the combination of our Intelligent Health Repository with ArcLight to build next generation pharma products. These investments impacted our diluted per share results by $0.06 in the quarter, including the $0.02 related to ArcLight mentioned above. We expect these products will enhance our overall business strength, especially as we implement specific action plans to eliminate the loss associated with each of these investments during fiscal 2005.

Capital expenditures were approximately $10.2 million in the third quarter and $33.6 million for the first nine months of this fiscal year. We expect full-year capital expenditures to be approximately $45 million as we continue the development of new products and solutions during the remainder of fiscal 2004.

Net cash provided by operating activities was $70.4 million for the nine months ended February 27, 2004, as compared to $70.3 million for the same period last year. This year we have experienced improved management of working capital which was, however, offset by an additional $21.3 million in cash interest paid this fiscal year as compared to the same period last year, and $8.0 million in pharma receivables that were not collected due to ongoing contract renewal or extension negotiations, leaving cash flow at a similar level as compared to last year. The negotiations have now been concluded, and the receivables have been collected. Because a number of these large pharma customers normally pay in advance of revenue recognition, the timing of receivables and collections from these few pharma customers also impacted the current portion of the Deferred revenue line on our Balance sheet.

Free cash flow, defined as Net cash provided by operating activities less Capital expenditures and Dividends paid, was $32.5 million year-to-date. We also received an additional $5.8 million in cash from stock option-related activities during our fiscal third quarter which is not reflected in free cash flow. In accordance with Regulation G, a reconciliation of free cash flow to our GAAP financials was provided in the Form 8-K filed with the Securities and Exchange Commission on April 19, 2004.

Our days sales outstanding, or DSO, was 59 days at the end of the third quarter, a decrease of 3 days from the same period last year. This DSO improvement was partially offset by a temporary increase in receivables from the few large pharma customers mentioned above. At February 27, 2004, we had outstanding Information Management receivables of approximately $8.0 million that normally would have been paid in the third quarter, all of which have been collected since the end of the fiscal third quarter.

The greater collection challenges are in our physician and hospital businesses, and we have activated a number of programs to improve collections of these accounts. As we analyzed our collection trends, we recorded $0.9 million in incremental reserves in the quarter to cover deterioration in physician receivables. Cash management and improvements in collections will continue to be an area of focus across the entire company.

In December 2003, we announced the renegotiation of our $225 million credit facility, which increases our financial flexibility and will lower our future net interest expense by approximately $525,000 per quarter. This reduction in interest expense is before the effect of any loan prepayments we may make in future periods.

Using our free cash flow, we paid down our senior debt by $14.5 million since the end of the second quarter, further improving our debt-to-capital ratio, which is down approximately 500 basis points from 52.4% at the end of fiscal 2003. In the first month of our fiscal fourth quarter, we reduced our senior debt by an additional $5 million and also paid off a $2.3 million mortgage,

Third quarter revenue in our Network Services and Systems segment increased by 9.1% to $74.2 million from $68.0 million in the third quarter of fiscal 2003 as we continued to generate strong sales and began to install our new solutions into customers. Revenue from our pharmacy unit grew substantially faster than revenue from both the hospital and physician units. Operating income margin in our Network Services and Systems segment declined to 20.6% from the 20.9% reported in last year’s third quarter. Our pharmacy systems business, formerly TechRx, continued to contribute to operating profitability.

We continued to experience success in our network services business in our fiscal third quarter. Total network transaction volume, which is comprised of base claims and pre- and post-edit transactions, increased 11.9% year-over-year and 4.5% sequentially. Over the last couple of years, we have made significant progress in selling into the largest pharmacy chains, and the volume increases inherent in these sales have now been realized. Going forward, year-over-year increases in total transaction volume should be at a solid, projectable run rate.

Our base pharmacy claims volume in the quarter grew 10.0% over the third quarter of fiscal 2003, which was faster than our estimate of the market’s overall script growth of approximately 4.0%. We continued to gain share and have had good success in gaining further penetration of our value-adding editing services as our total pharmacy editing transaction grew approximately 16.0% year-over-year. Further, our pharmacy revenue per claim continued to increase sequentially.

In our hospital business, we continued to enjoy success with our NDC ePREMIS revenue cycle management solution. We sold an additional 50 units in our third fiscal quarter, bringing the total to more than 500 units sold in the first nine months of this year. We experienced a very high level of initial unit sales in the first nine months of the year due primarily to sales to large organizations, each of which has multiple facilities. We were pleased with our third quarter sales, as they were about double last year’s third quarter sales. In addition, this quarter’s sales were generally to larger individual facilities, which should mean greater claims volume per facility. We anticipate our rate of unit sales, which are measured by the number of hospital facilities, should remain at a solid double-digit level for the next few quarters.

Due to the increased features and functionality of NDC ePREMIS, our revenue per claim on new units sold should be 20 to 25% higher than our current revenue per claim within our legacy hospital customer base. Overall hospital revenue per claim should begin to increase as transaction volumes grow following NDC ePREMIS installations in the next several quarters. Our hospital unit is still in the relatively early stages of the product introduction and installation of our NDC ePREMIS solution, and over the next several quarters, we intend to focus our efforts on converting current hospital customers to NDC ePREMIS, which should help to increase this business unit’s profit margins.

In our physician business unit, we introduced our NDCMedisoft^™ product upgrade at a VAR conference in late January 2004, and sales of our NDCMedisoft and NDCLytec^™ products were positive in the quarter. We are also working with our value-added resellers to market and sell our transaction processing solutions.

In our physician electronic commerce division, our physician claims volume grew by 35% over claims volume in the third quarter last year. We are anticipating improved transaction growth as we sell our physician claims processing capabilities. In the area of e-prescribing, the number of electronic transactions from physicians continued to increase, however the adoption rate of electronic connectivity by physicians continues to be modest. Physicians continue to lag in their acceptance and implementation of e-prescribing solutions in their practices.

We believe there are unequivocal benefits to e-prescribing, and market indications are that accelerated adoption will occur. E-prescribing can greatly improve patient safety and quality of care while reducing costs. We believe we will be a leader in the electronic prescriptions market, and we are focusing our efforts around connecting physician practices to pharmacies through business alliances with trade association partners, technology partners, and practice management systems and scriptwriter vendors.

Third quarter revenue in our Information Management segment grew 2.2% to $41.9 million from $41.0 million in the third quarter of fiscal 2003. Our 12 largest U.S. pharma customers represent about half of our Information Management segment’s revenue. While the majority of our larger pharma customers increased their spending with us at a double-digit rate versus the third quarter last year, we experienced

revenue declines from a few of these customers. The single-digit revenue growth this quarter in this segment is the net result of these factors.

This slower revenue growth had an impact on our profitability which, when coupled with the additional data expense in Europe, reduced this segment’s operating margin to 15.0% from 22.4% margin in last year’s third quarter.

Revenue from the sale of our Insight and Impact product solutions in the U.S. increased sequentially and rose close to 100% over last year, albeit off a small base. Our German business also delivered another solid quarter of 100% revenue growth over last year.

Based on our progress during the first three quarters of our eight-quarter plan, we continue to believe the execution of our strategy will increase our Revenue, Net income and Net cash from operating activities during the next several quarters.

In the Network Services and Systems segment, where we serve pharmacy, hospital and physician providers, we expect the key drivers of future revenue growth to be:

We have already created and introduced a number of new and innovative system solutions for both the pharmacy and hospital market. We are in the midst of our most active product development and introduction cycle ever, and these new solutions are being very well received. As we move through the remainder of our eight quarter plan, to the end of fiscal 2005, we will place even greater emphasis on installing these new solutions. Our primary focus will be to improve gross profit margin, so our sales efforts over the next few quarters will be directed at our existing customer base, with particular emphasis on converting our current hospital and pharmacy customers to our new technology platforms.

We expect to leverage our market presence, increase revenue per claim, further improve gross profit, and expand our operating profit margins and cash flow. As we transition to more of a recurring revenue model, we believe it will strengthen our quarterly growth.

In our network services business, we have been very successful in growing our pharmacy transaction processing market share, particularly with national chain pharmacies, and it has given us a leading market position. It is important to understand that, due to volume-based rate structures, these large chain pharmacies pay a lower per-transaction fee than the independent and small regional pharmacies. As a result, while average revenue per claim in pharmacy has been increasing, changes in volume mix can impact average revenue per claim and the rate of increase. It also points to our need to continue to further penetrate our value-adding transaction services in the independent and regional pharmacy market, in which our pre-and post editing is currently utilized less frequently. This is now a major area of sales emphasis for us. We have recently upgraded our pharmacy sales force and have them very focused on selling value-added solutions to regional chains and independent pharmacies.

We will place greater emphasis on gaining further penetration of our value-adding transaction services in the independent and regional pharmacy market, since it would have positive implications in terms of higher revenue per claim. We also expect the inherent industry growth in prescription volume and

a continuing market shift to adjudicated claims from cash transactions should increase our claims volume and help enable us to continue to grow market share.

An important facet of our pharmacy marketing strategy is to leverage partnerships with industry leaders. On April 8, 2004, we announced that we acquired the OmniLink pre- and post-editing business from McKesson Corporation for approximately $14 million in cash to complement our existing pharmacy network services business and expand our comprehensive suite of edits for customers of both organizations. We expect this acquisition to be accretive as we intend to move to rapidly integrate OmniLink into NDCHealth’s existing pharmacy services infrastructure. Complementing our goal to improve margins and accelerate the growth of our business, we also entered into a strategic alliance with McKesson to jointly market NDCHealth’s value-adding pharmacy transaction processing services into McKesson’s systems customer base of 2,300 pharmacies.

We are on track to process more than 4.7 billion total transactions in fiscal 2004 versus approximately 3.9 billion transactions in 2003, more than a 20% increase. We expect to reap an immediate benefit from the OmniLink pre- and post-editing acquisition. Both the OmniLink transaction and our alliance with McKesson should be accretive in fiscal 2005 and beyond as we gain additional share of the pharmacy transaction processing market and add new editing and information solution revenue streams.

Our relationship with McKesson and our strong, pre-existing relationship with Cardinal Health are a key part of our efforts to further penetrate the regional and independent pharmacy market, where we receive a higher price per transaction, with our value-added solutions. As these relationships begin to show results, revenue and revenue per claim should increase.

We have been engaged by one new customer to refine the functional requirements that we expect will lead to a long-term agreement for our new enterprise pharmacy mail order system. We are also continuing to negotiate several other significant agreements that we are working to complete this calendar year. These agreements, when finalized and in combination with the national chain, regional and independent customers already under contract, could provide NDCHealth with a pharmacy system revenue opportunity that exceeds $300 million spread over the next 5-to-10 years. As our system is rolled out and implemented, we expect the demonstrated performance and financial benefits of this solution for our pharmacy customers will lead to a number of new sales to additional customers over the next several quarters and beyond.

Both the short- and long-term business and financial success of our new pharmacy solution is dependent upon finalizing product development and our customers’ roll-out timelines, as well as the timing of revenue recognition associated with each of these contracts. The roll out of our independent and regional pharmacy system should accelerate as we begin the installations of our regional product into Kerr Drugs’ stores in the next three months. The product being installed at Kerr has the functionality required by regional chains. Now that we have this functionality, we anticipate stronger sales of our new pharmacy system into the smaller regional chain market.

Our enterprise solution for national chains is scheduled to be delivered in July for customer beta testing and piloting, and we expect customer implementations could commence by the end of this calendar year. In November 2003, we received the Borland Software Customer Application of the Year Award based on the product development process of this enterprise solution for national chain pharmacies. Further, we expect to be able to repackage and implement this very same set of application software very cost-effectively on a single PC. We expect the enterprise solution will be followed next by our mail order pharmacy solution.

In addition, we are developing a significant system upgrade for our Canadian pharmacy customers, and are rolling out our pre- and post-editing services throughout Canada.

We believe we have a solid pipeline for pharmacy sales that should help to enhance our growth. With our new pharmacy solutions improving our customers’ cash flow and profitability, we expect our pharmacy revenue per claim should continue to increase as we sell and install these solutions to existing customers and add new customers. We expect the demonstrated performance and financial benefits of our solution for our pharmacy customers will lead to additional, significant, new sales to potential customers over the next several quarters.

We believe our hospital business is very well positioned for future success with a solid sales pipeline and installation schedule. As we enter our fiscal fourth quarter, we are very focused on customer conversions and installations from the strong sales performance we have had this year. Our profit in this business is solid, and revenue per claim and resulting profit margins should begin to grow as transaction volumes at higher average per claim rates increase following installations of ePREMIS over the next few quarters.

In our physician business unit, as a result of the issues discussed earlier, we are currently cautious with regard to our fourth quarter revenue in our physician unit. The last phase of HIPAA, the new security requirements addressing physical, administrative and technical safeguards, should help drive more sales as we build these new regulations, with which physicians must comply, into next year’s releases.

In our Information Management business, there continues to be cyclically low demand for information in the U.S. as pharmaceutical manufacturers continue to tightly constrain discretionary spending, particularly in the early quarters of this calendar year. Nonetheless, our customers have been receptive to our Insight and Impact product suites as these unique solutions are providing new ways for pharma companies to market their products, target physicians and evaluate the results of their business decisions.

During the third quarter and month of March, we signed contract renewals or extensions with our largest pharma customers, and we are encouraged by the continuing growth from many of our accounts, particularly considering the overall spending constraints in the pharma industry. As we look past the next few quarters, we believe the customers who are increasing their spending with NDCHealth will generally continue to do so. We understand the number of new drug approvals is expected to accelerate from 17 in 2003 to approximately 50 per year in each of 2005, 2006 and 2007, according to some industry estimates. As a result, we believe our customers should begin to increase their spending as they roll out their new drugs that are today in the FDA review process.

On December 31, 2003, we entered into a seven-year exclusive license agreement with ArcLight Systems LLC, an information management company owned by a number of major participants in the pharmacy industry, including Alberton’s Inc., CVS Corporation, Cardinal Health, Inc., Kmart Corporation, and Wal-Mart Stores, Inc. As consideration for this exclusive license to certain of ArcLight’s assets, we issued 381,098 shares of unregistered NDCHealth common stock and a five-year warrant to purchase an additional 381,098 shares of NDCHealth common stock at an exercise price of $26.24 per share. We will also pay ArcLight royalties on product sales utilizing ArcLight data. The agreement may be extended for three additional years if certain financial and business objectives are met. If the agreement is extended for an additional three years, then ArcLight will receive an additional $10.0 million in either cash or NDCHealth common stock at ArcLight’s option.

We believe that the pharma industry will look for innovative ways to utilize new solutions to increase sales efficiency and revenue growth. To this end, we expect the business we purchased from ArcLight, when combined with our pharmacy and hospital systems and network connectivity, will become a key market differentiator for NDCHealth. This is the next step in our strategy to build next-generation pharma products. Because of ArcLight and our provider solutions, first we will be able to offer a broader database and more accurate data at a granular level for compensation and targeting purposes. Further, we expect to be positioned to offer the pharma industry the largest HIPAA-compliant, privacy-protected

diagnosis-to-drug linked database of information and connectivity to help change the way pharmaceutical manufacturers do business.

In terms of our ArcLight action plan, we are on track with the integration. We’ve validated our new product opportunities with pharma customers and are moving toward an active development and delivery timeline. As we developed the transition and integration plan, we identified some additional costs, the bulk of which were non-cash or fully reimbursed, that, in conjunction with amortization of the license, impacted third quarter EPS by $0.02.

On March 15, 2004, we filed a Current Report on Form 8-K with the Securities and Exchange Commission containing ArcLight’s historical financial statements. Because we received the systems, facilities, data rights and certain employees, in accordance with Generally Accepted Accounting Principles (GAAP) we were required to treat this transaction as a business combination. While we did assume some increased amortization in connection with the assets and some transaction costs, the majority of the ArcLight costs reflected in the Form 8-K are not a continuing expense to NDCHealth as we are integrating ArcLight’s data assets and technology into our existing operations. Therefore, we continue to expect that ArcLight will be a positive contributor to our Information Management segment beginning in the second quarter of fiscal 2005.

Our European operations continued to experience solid growth. However, our cost of historical data for new products overseas keeps us from showing a current profit. Our focus is on eliminating the approximately $0.02 per share quarterly loss we have in Europe as we gain critical mass. We are actively reviewing alternatives to eliminate losses associated with our European business within the balance of our eight-quarter plan. We expect this review of alternatives and appropriate actions will be substantially completed in the fourth quarter.

We believe our Information Management business is well positioned for the new wave of drugs expected to receive FDA approval in the next few years. We expect our customers’ discretionary spending levels to increase as new drugs are approved and introduced into the market, stimulating growth in this segment. We also expect to continue to generate additional revenue streams as our customers gain a greater understanding of how to leverage our new Insight and Impact solutions to improve their profitability and move beyond the traditional sales and compensation product lines.

Longer term, we believe the future is bright for our Information segment. We will continue to generate additional revenue streams as our customers gain a greater understanding of how they can use our new Insight and Impact solutions to improve their profitability as we move beyond the traditional sales and compensation product lines. As pharmaceutical manufacturers begin to accelerate the introduction of new drugs later in calendar 2005, we believe that pharma discretionary spending will increase and that our revenue growth in this segment will accelerate. Operating income margins can also expand longer term through a re-acceleration of revenue in this fixed cost business, tight cost controls, and elimination of losses in our international operations.

Management is revising its financial guidance for fiscal 2004. Full-year revenue is expected to be in the range of $460 million to $466 million, which reflects, among other things, the company’s shift in sales strategy to a solution-based approach, the continued constraints due to pressure on discretionary spending from U.S. pharmaceutical manufacturers, and the possibility of a near-term reduction in sales due to increased inventory levels at VARs in the physician business unit.

The company is not providing earnings and cash flow guidance at this time due to the undetermined professional fees and expenses, and possible sales impact in the physician unit related to the independent review noted above. In the fourth quarter ending May 28, 2004, the company expects to incur charges related to the conclusion of activities to eliminate losses in Europe. Additional actions taken in the U.S. to

reduce headcount are expected to result in a decrease of approximately $6.0 million in annualized compensation-related costs. This expense reduction is expected to be used to fund the sales and marketing of recently introduced and other new products to accelerate future growth.

Management continues to believe NDCHealth will achieve its eight-quarter plan objectives, and is focused on executing on key business strategies to accelerate the rollout and drive the sale of new pharmacy and hospital solutions, integrate the ArcLight assets and develop new information solutions for the pharmaceutical industry.

Although there are risks in our business plan as outlined in our Annual Report on Form 10-K for the fiscal year ended May 30, 2003, a number of favorable macroeconomic trends in healthcare may benefit NDCHealth. Most important, there continues to be a significant need to improve pharmacy, hospital and physician automation, and we believe NDCHealth is very well positioned with our existing systems and information solutions to address many of the challenges healthcare providers currently face. While we expect the macro trends in healthcare to continue to present new opportunities to grow our business, some or all of these opportunities may not materialize.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions. Critical accounting policies are those policies that can have a significant impact on our financial position and results of operations and require complex judgments and the most significant use of these subjective estimates and assumptions. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Specific risks inherent in our application of these critical policies are described below. For all of these policies, we caution that future events rarely develop exactly as forecasted, and the best estimates routinely require adjustment. These policies also often require difficult judgments on complex matters that may be subject to multiple sources of authoritative guidance. Additional information concerning our accounting policies can be found in Note 1 to our condensed consolidated financial statements.

Although we have several sources of revenue, in all cases, we recognize revenue when persuasive evidence of an arrangement exists, the sales price is fixed or determinable, delivery and performance has occurred, and collectibility is probable. The most variable of these factors between our various businesses is determining when delivery and performance has occurred. In accordance with criteria set forth in SAB No. 104, SOP No. 97-2, “Software Revenue Recognition,” and other authoritative literature, we recognize revenue when persuasive evidence of an agreement exists, delivery and performance has occurred, there is a fixed and determinable sales price, and collectibility is reasonably assured. Additionally, we have adopted the provisions of EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables,” which requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting.

In our Network Services and Systems segment, the primary source of revenue is fees charged for network services. We provide these services to our pharmacy, hospital, physician, and payer customers. These fees are generally based on the volume of services we provide to each individual customer. In most instances, this fee is charged per transaction and type of transaction while in some instances, these services are provided to large customers for a fixed monthly fee, regardless of each month’s actual transaction volume for a portion of the contract term. We have begun the rollout of hosted web browser based applications for our hospital and pharmacy customers. The per transaction charge for these services includes charges for the use of the application software, network, and other value added services. Revenue for these services is recognized each month as the services are rendered.

In our systems businesses, we also receive revenue from software licenses and related maintenance and support agreements. The American Institute of Certified Public Accountants issued SOP No. 97-2, “Software Revenue Recognition” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” These SOP’s provide guidance on applying accounting principles generally accepted in the United States for software revenue recognition transactions. Based on these authoritative statements, we recognize revenue as follows:

Revenues from the sale of software licenses and implementation services are recognized on the date that the software is in operation at the customer site where vendor specific objective evidence, or VSOE, has been established for the undelivered elements of the customer contract, which typically is maintenance. In these cases, the maintenance revenue is recognized over the term of the maintenance contract. Where VSOE cannot be established for undelivered elements within the contract, the revenue related to license fees and implementation services are deferred and recognized upon acceptance over the remaining term of the contract, typically two or three years.

The software we license to our customers is generally one of two types. The most common software type performs functions such as scheduling and billing and is used by our customers to manage their businesses and connect to our network. Because this type of software has stand alone functionality (meaning that connection to our network is not required for the software to be functional), we recognize revenue for sales of products of this type that are customer installed when the product is shipped. For products of this type that are installed by us or one of our affiliates, we recognize revenue when the software is installed. The other type of software is used by our customers to process transactions through our network. Because this software provides value to our customers only to the extent that they are utilizing our network services, revenue is recognized over the estimated life of the network services contract rather than when the software is installed. In instances where revenue is recognized over the term of a contract, or we have contractual minimums, and we incur discrete incremental costs in providing the initial deliverable, we defer these costs and recognize them ratably over the contract term.

We provide software maintenance and customer support to our customers on both an as needed and long-term basis. Services provided outside a maintenance contract are on an as requested basis and revenue is recognized as the services are provided. Revenue for services provided on a long-term basis is recognized ratably over the terms of the contract.

Many of our physician systems are sold indirectly through value added resellers, or VARs. Because the VARs provide many of the services that we would otherwise provide (such as contract support, advertising, etc.), we provide them allowances to cover their cost of providing these services. We record revenue in accordance with EITF Issue No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products,” which requires that certain allowances be treated as reductions in revenue and allows other allowances, for which we receive separable, identifiable and quantifiable benefits, to be recorded as revenue and operating expense.

In our Information Management segment, we have two primary sources of revenue: database information reporting and consulting services. Database information reporting typically involves the delivery of products providing pharmaceutical information. These include products with a single

delivery and products where multiple deliveries are made over a period of time. Revenue for products involving a single delivery is recognized when obligations to the customer have been fulfilled, which is typically upon delivery. Products with multiple deliveries over a period of time, usually 1 to 3 years, are generally unique in nature and therefore require more complex judgment to determine appropriate revenue recognition. In most cases, information of a similar type is delivered at equal intervals over a fixed period of time in which case revenue is recognized over the term of the contract using a straight-line model.

Our consulting services are typically provided for a fixed fee over a specific period of time. Because the terms of these contracts generally include multiple performance milestones, revenue for these services is recognized over the contract term as performance milestones specified in the contract are achieved. If we determine that we will incur a loss on a contract, we recognize the loss at the time the determination is made. These contracts typically average 3 to 12 months.

Internally developed software held as property on our balance sheet consists of two types: software that we develop for sale to our customers and software that we develop that is for internal use in providing services to our customers. The costs associated with developing this software are capitalized differently depending on whether the software is for sale or for internal use. In each instance, in accordance with SFAS 86 or SOP 98-1, costs are capitalized only when the project has reached the point of technological feasibility or the application development stage. Costs incurred prior to this point are charged to earnings as research and development expense.

For software sold to our customers, in accordance with SFAS 86 we capitalize both direct and indirect development costs such as programmers’ salaries and benefits, outside contractor costs, computer time, and allocated facility costs. Completed projects capitalized under SFAS 86 are amortized after reaching the point of general availability using the greater of the amount computed using the straight-line method or the ratio that current revenues bear to the total of current and anticipated revenues, based on the estimated useful life of the project, normally five years. The life used for amortization is based on the projected period of time that we will either sell the product or use the product to provide services, typically five years.

For software used internally, in accordance with SOP 98-1 direct development costs such as programmers’ salaries and benefits, and fees paid to others for development are capitalized. Completed projects capitalized under SOP 98-1 are amortized using the straight-line method. The life used for amortization is based on the projected period of time that we will use the software to provide services, typically five years.

The actual useful life of the product or software may be longer or shorter than the estimated useful life. If the actual life is longer, we would continue to realize value from the asset while no longer recognizing a corresponding expense. If the actual life is shorter or we determine that the investment will not be recovered through the future sales of products or services, the remaining carrying amount may need to be amortized over a shorter period or a non-cash charge to earnings could be required. The net realizable value of capitalized software is monitored on a periodic basis to confirm that the investment will be recovered through the future sale of products or in the case of internal software, through use.

We consider and selectively enter into a variety of alliances, joint ventures and investments. As such, we maintain investments in both privately held and publicly traded entities.

Our investments in privately held entities are accounted for under either the cost, equity, or consolidation method, whichever is appropriate for the particular investment. The appropriate method is determined by our ability to exercise significant influence over the investee, through either quantity of voting stock or other means. We regularly review our investments for impairment issues and propriety of current accounting treatment. The primary method we use to determine whether or not an impairment issue exists is to compare the valuation of our investment with the underlying value of the entity in which we have an investment. We determine the underlying value of the entity based on a number of factors, including: the execution of business strategy and the steps that it has and is taking in the execution of that strategy, and the entity’s subsequent financing activity. If we determine that an impairment issue exists, we would realize the loss in other income (expense) in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” If we determine that our accounting treatment should change from the cost to equity method, in accordance with the provisions of Accounting Principles Board Opinion No. 18, “Equity Method of Accounting for Investments in Common Stock,” we would retroactively restate our previously issued financial statements as if we had always accounted for the investment under the equity method. If our level of investment increased to a level such that we directly or indirectly controlled the entity, we would consolidate the entity’s results into our consolidated financial statements.

Our investments in publicly traded entities are classified as available-for-sale securities and are reported at fair value and unrealized gains and losses are reported, net of taxes, as a component of stockholders’ equity. For example, if the market price of our investment has declined but we believe that the decline is only temporary because the underlying value of the business is higher than the market indicates, we will report the value of our investment at the price indicated by the market and report any change in the investment’s value as an unrealized holding loss. When a decline is determined to be other than temporary, we realize the gain or loss in other income (expense).

Intangible assets are created when the purchase price of an acquired business exceeds the value of its tangible assets. For any significant business we acquire, we obtain a valuation from an independent specialist which assists in the identification of any specific intangibles and provides assistance in our determination of an estimated value and life for each. Goodwill exists where our purchase price exceeds the value of tangible assets plus these specifically identified intangible assets.

Specifically identified intangible assets primarily represent proprietary technology, customer relationships, and data access rights. Identified intangibles are assigned a value, generally that which was estimated in the valuation, and amortized over the estimated life. Because of the complexity of assumptions and judgment used in estimating the value and life of these assets, there is significant risk that their actual value and life may vary from the original estimate. We periodically evaluate whether events and circumstances have occurred that indicate the carrying amount of intangibles may warrant revision or may not be recoverable. When factors indicate that an intangible should be evaluated for possible impairment, we estimate the present value of future cash flows associated with the asset over its remaining life. We may determine that an intangible asset has diminished or has no remaining value prior to it being fully amortized. In this instance, we would be required to record a charge to earnings to account for impairment of the asset.

SFAS 142, “Goodwill and Other Intangible Assets,” requires that goodwill no longer be amortized but be reviewed for impairment on a regular basis. The goodwill impairment test has two steps. The first step is to compare the fair value of each reporting unit with its book value. Our reporting units are defined as our Pharmacy, Hospital, and Physician businesses in our Network Services and

Systems segment plus our total Information Management segment. If the estimated current value of future cash flows of any reporting unit is calculated as being lower than its book value, the second step would be to calculate the possible impairment by comparing the implied fair value of goodwill with the carrying amount. Any impairment would require a non-cash charge to earnings in the period in which the impairment was identified.

We completed our annual impairment testing during the second quarter of fiscal 2004. For each of our reporting units, we found that the estimated fair value exceeded the net book value of the unit and therefore the second step was not necessary. We will conduct these same tests going forward at least annually during our second fiscal quarter to determine that goodwill carried on our Balance Sheet is properly valued.

We operate our business as two fundamental segments: Network Services and Systems, and Information Management. Network Services and Systems provides electronic connectivity to our NDCHealth Intelligent Network and system solutions throughout the healthcare industry. Information Management provides management information, research, and consulting services to pharmaceutical manufacturers and pharmacy chains. Other operating income includes restructuring, impairment and other charges in fiscal 2004. More information concerning segments can be found in Note 5 of the Notes to our Condensed Consolidated Financial Statements.

Total revenue increased $7.1 million, or 6.5%, to $116.1 million in the third quarter of fiscal 2004 from $109.0 million in the third quarter of fiscal 2003. On a segment basis, Network Services and Systems revenue grew $6.2 million, or 9.1%, to $74.2 million in the third quarter of fiscal 2004 from $68.0 million in the third quarter of fiscal 2003. Information Management revenue grew $0.9 million, or 2.2%, to $41.9 million in the third quarter of fiscal 2004 from $41.0 million in the third quarter of fiscal 2003. The increases in revenue are due to the reasons discussed previously in “Fiscal Third Quarter Financial Review.”

Total revenue for the first nine months of fiscal 2004 increased $25.8 million, or 8.2% to $340.2 million from $314.4 million in the first nine months of fiscal 2003. On a segment basis, Network Services and Systems revenue grew $17.0 million, or 8.5%, to $216.7 million in the first nine months of fiscal 2004 from $199.7 million in the first nine months of fiscal 2003. Information Management revenue grew $8.8 million, or 7.7%, to $123.5 million in the first nine months of fiscal 2004 from $114.7 million in the first nine months of fiscal 2003. Revenue in this period grew due to increased transactions volume and greater market share in our Network Services and Systems business, and growth in our German and domestic business in our Information Management segment.

Our significant expenses are compensation, data costs, depreciation and amortization, and communications expense. Together, exclusive of restructuring, impairment and other charges, these expenses represented 64% of our operating expenses in the third quarter of fiscal 2004, and 65% in the third quarter of fiscal 2003. For the first nine months of fiscal 2004, exclusive of restructuring, impairment and other charges, these expenses represented 63% of our operating expenses compared to 65% for the first nine months of fiscal 2003. Cost of service includes certain compensation, computer operations, data costs, consulting services, telecommunications, customer support, and application maintenance expenses. Sales, general and administrative expense includes certain compensation, sales, marketing, administration, and corporate overhead expenses.

As a service organization, compensation is our largest expense and we continue to monitor it closely. In general, we are not always able to pass our inflationary cost increases on to our customers. As our costs go up, we must find new ways to operate our business in order to reduce costs and improve productivity. This includes addressing under-performing projects, products and people.

As a percent of revenue, compensation expense, exclusive of restructuring, impairment and other charges, which includes incentive pay, commissions, and related fringe benefits, and is net of capitalized labor, increased in the third quarter of fiscal 2004 over the third quarter of fiscal 2003. The increase was a result of a lower rate of capitalization of labor as new products are placed into service and increased expense related to non-cash compensation. Compensation expense as a percent of revenue decreased in the first nine months of fiscal 2004 from the first nine months of fiscal 2003. This decrease is due to increased productivity as a result of our training initiatives and cost control efforts as well as the scalability of our business model and the rate of capitalization of labor in the first half of the year related to product development. We have also achieved compensation savings through the streamlining of our Pharmacy Services & Systems, Hospital, and Information Management businesses begun in the first quarter. We will continue to look for ways to improve efficiencies, including centralization, in our businesses.

Cost of service, or COS, includes certain compensation, computer operations, data costs, consulting services, telecommunications, customer support, and application maintenance expenses. COS increased $5.8 million, or 10.9%, to $58.9 million in the third quarter of fiscal 2004 from $53.1 million in the third quarter of fiscal 2003. In the first nine months of fiscal 2004, COS increased $14.3 million, or 9.1%, to $171.2 million from $156.9 million in the first nine months of 2003. The increase was due primarily to increased data costs discussed below and variable costs related to increased revenue. As a percent of revenue, during the third quarters of fiscal 2004 and 2003 COS expense was 50.7% and 48.7%, respectively. During the first nine months of fiscal 2004 and 2003 COS expense as a percent of revenue was 50.3% and 49.9%, respectively. We expect that COS, as a percent of revenue, will be similar for the remainder of fiscal 2004.

We buy data from various sources to supplement our own data collection efforts. Data costs increased $2.1 million, or 14.4%, to $16.7 million in the third quarter of fiscal 2004 from $14.6 million in the third quarter of fiscal 2003. Data costs increased $8.4 million, or 21.6%, to $47.3 million in the first nine months of fiscal 2004 from $38.9 million in the first nine months of fiscal 2003. The increase was due to the purchase of additional data types for our new German informatics products, an increase in volume of other data purchased, and an increase in the costs of such data. As a percent of revenue, data costs increased from fiscal 2003 to fiscal 2004. We are actively pursuing programs to continue to contain data costs, including exploring new areas of opportunity where data is less costly.

Communications costs decreased as a percent of revenue to 3.4% in the third quarter of fiscal 2004 from 3.6% in the third quarter of fiscal 2003 and decreased as a percent of revenue to 3.6% in the first nine months of fiscal 2004 from 4.0% in the first nine months of fiscal 2003. This reduction in costs as a percent of revenue results from our conversion to new technologies that allow us to provide superior service to our customers at reduced cost. Because competition in the telecommunications industry has resulted in historically low communications costs, we do not expect significant future reductions in communications costs.

The primary engine of growth for NDCHealth is the creation of new and enhanced products. Software costs are related to the development of new products and maintenance and enhancement of existing products. As such, software costs are an investment in the growth engine of the company and are essentially our investment in future growth. Our approach, which we believe is succeeding, is to learn what the market needs and correlate these needs with the disciplined development of products. As these new products are sold and installed, we expect to grow revenue, gross profit (defined as revenue less cost of service) and increase cash flow. We capitalize the cost of developing software held for sale to our customers as well as software used internally to provide services to our customers. Depreciation expense associated with capitalized software is discussed below under depreciation and amortization. Our current focus is on developing products such as our new pharmacy systems, ePREMIS for hospitals, NDC Prescriber, NDC Dynamic Claims Analyzer, NDC FutureRx, Retail Insight and Payment Insight, as well as Canadian pre- and post editing, long-term care prescription sales compensation, injectible prescription tracking and point-of-sale messaging capabilities.

Development costs capitalized as a percent of total development costs decreased to 74.1% in the third quarter of fiscal 2004 from 79.1% in the second quarter of fiscal 2004 and 81.7% in the third quarter of fiscal 2003. For the first nine months of fiscal 2004, development costs capitalized as a percent of total development costs declined to 74.8% from 80.2% in the first nine months of fiscal 2003.

Total costs associated with software development for our new pharmacy system was $5.4 million in the third quarter of fiscal 2004 versus $4.0 million in the third quarter of fiscal 2003. Approximately $4.6 million of these development costs were capitalized resulting in net development expense associated with our new pharmacy system of approximately $0.8 million in the third quarter of fiscal 2004. For the first nine months of fiscal 2004, total costs associated with software development for our new pharmacy system were $14.8 million versus $11.6 million in the first nine months of fiscal 2003. Approximately $12.2 million of these development costs were capitalized resulting in net development expense associated with our new pharmacy system of approximately $2.6 million in the first nine months of fiscal 2004. Pharmacy system software maintenance expense was $0.5 million in the third quarter of fiscal 2004. For the first nine months of fiscal 2004 pharmacy system software maintenance expense was $1.4 million.

Sales, general and administrative, or SG&A, expense consists primarily of salaries, wages and expenses relating to sales, marketing, administrative and management employees, employee training costs, and occupancy of leased space directly related to these functions. SG&A expense increased $3.6 million, or 16.1%, to $25.9 million in the third quarter of fiscal 2004 from $22.3 million in the third quarter of fiscal 2003. In the first nine months of fiscal 2004, SG&A increased $9.3 million, or 14.4%, to $73.9 million from $64.6 million in the first nine months of 2003. As a percent of revenue, during the third quarters of fiscal 2004 and 2003 SG&A expense was 22.3% and 20.5%, respectively. During the first nine months of fiscal 2004 and 2003 SG&A expense as a percent of revenue was 21.7% and 20.5%,

respectively. The increase was due to increases in governance and other corporate costs. Additionally, we incurred additional bad debt expense of $0.9 million as a result of a review of our allowance for doubtful accounts in our physician business unit during the third quarter of fiscal 2004 which increased SG&A expense. We expect that SG&A expense, as a percent of revenue, will be similar for the remainder of fiscal 2004 due to increased corporate governance expenses and continued new investment in our sales and marketing programs to support the rollout of new products.

Depreciation and amortization expense increased in the third quarter of fiscal 2004 from the third quarter of fiscal 2003, and increased in the first nine months of fiscal 2004 from the first nine months of fiscal 2003. The increase was due to increased amortization related to the second step of the TechRx acquisition completed in May 2003, the rollout of new products, and amortization of intangible assets acquired in the ArcLight transaction. Depreciation and amortization expense will increase in the remainder of fiscal 2004 as newly developed products are placed in service and intangible assets acquired in the TechRx and ArcLight acquisitions are amortized.

Operating income decreased $1.8 million, or (7.7%), to $21.6 million in the third quarter of fiscal 2004 from $23.4 million in the third quarter of fiscal 2003. Operating income decreased $5.1 million, or (7.5%), to $62.6 million in the first nine months of fiscal 2004 from $67.7 million in the first nine months of fiscal 2003. Operating income decreased in the first nine months due to restructuring, impairment and other charges of $4.0 million, increased depreciation and amortization, increased data costs, higher corporate costs, additional bad debt expense, and expenses associated with ArcLight. $2.9 million of the $4.0 million restructuring, impairment and other charges in the first nine months of fiscal 2004 is in Other operating income, and $1.1 million is in Network Services and Systems.

eliminated 16 positions, in the first quarter. In connection with the first step, we recorded approximately $1.0 million in severance related costs in the first quarter. Approximately $0.1 million of this severance cost was a non-cash charge related to modified stock options. We completed additional steps of this streamlining in the second quarter with the elimination of an additional 14 positions. In connection with the additional streamlining, we recorded approximately $1.5 million in severance related costs in the second quarter. Also in the second quarter, we recorded a charge of approximately $0.2 million for the impairment of a note receivable we received as partial consideration for the sale of a non-core operation in the second quarter of fiscal 2001.

During the second quarter of fiscal 2004, we began the consolidation of our European operations. In the first step we began to streamline the management organization, and realign the focus, of our United Kingdom pharmacy systems business. In connection with the first step, we recorded charges of approximately $0.7 million for lease termination costs and impairment of assets in the second quarter that are not aligned with the current focus of our United Kingdom business. In connection with additional streamlining, we recorded approximately $0.1 million in severance related costs in the second quarter.

We expect to continue to review alternatives to reduce costs, including strategies to eliminate losses in Europe and efficiencies gained through the acquisition of ArcLight, in the remaining period of fiscal 2004.

Our estimated effective tax rate in the first nine months of fiscal 2004 was 37.5% compared to 44.4% in the first nine months of fiscal 2003. The tax rate for fiscal 2003 was higher due to certain capital losses that were not deductible in fiscal 2003.

Interest and other expense consists of interest expense, amortization of debt issuance costs and other miscellaneous non-operating expense. Interest and other expense as a percent of revenue decreased to 6.0% in the third quarter of fiscal 2004 from 7.1% in the third quarter of fiscal 2003. The decrease was a result of a lower rate on our term loan as discussed in Liquidity and Capital Resources, repayment of principal in the third quarter of fiscal 2004, and increased interest expense during the third quarter of fiscal 2003 in which $200 million of 10 ½% Senior Subordinated Notes Due 2012 and the 5% convertible subordinated notes due November 2003 were both outstanding. Interest and other expense as a percent of revenue increased to 6.6% in the first nine months of fiscal 2004 from 4.7% in the first nine months of fiscal 2003. The increase was a result of increased debt levels.

Payments from our customers are our greatest source of liquidity. Additional sources of liquidity include our credit facility, financing under capital lease arrangements, vendor financing, and issuances of

common stock and other instruments. The cash provided by these sources has a variety of uses. Most importantly, we must pay our employees and vendors for the services and materials they supply. Additional uses include, among other things, expenditures for new capital equipment, development of additional products, investments in alliances, acquisitions, payment of taxes, payment of dividends, extension of credit to our customers, and to generally fund our operations.

Our operating cash requirements are generally satisfied with our customer receipts because we receive a higher level of cash from our customers than we expend for payments of salaries and other recurring operating costs. Excess cash that we generate after satisfying all of our continuing operating requirements is shown on our statement of cash flows as net cash provided by operating activities. This measure takes into account items such as non-cash expenses included in our operating income, cash used to extend credit to our customers, and cash provided by our vendors extending credit to us.

Net cash provided by operating activities was $70.4 million for the first nine months of fiscal 2004, an increase of $0.1 million from $70.3 million in the first nine months of fiscal 2003. Net income adjusted for non-cash items including equity in losses of affiliated companies, non-cash portion of restructuring, impairment and other charges, non-cash in-process research and development charges, non-cash early extinguishment of debt charges, loss related to investments, and depreciation and amortization was $56.3 million in the first nine months of fiscal 2004 compared to $62.5 million in the first nine months of fiscal 2003. As a result of our acquisition of TechRx, in the first three months of fiscal 2004 we began to recognize the benefit of net operating loss carry-forwards, or NOLs, previously generated by TechRx, with a net tax benefit of approximately $17 million. We expect to utilize approximately $7 million of this benefit in fiscal 2004 with the balance carried forward into fiscal 2005. The utilization of these NOLs positively impacts net cash provided by operating activities by reducing our current cash tax payments.

While net cash provided by operating activities was at similar levels in the first nine months of fiscal 2004 and fiscal 2003, there were significant differences in several items. These differences included accounts receivable, prepaid expenses and other assets, accounts payable and accrued liabilities, and accrued interest on long-term debt. Accounts receivable used $6.1 million of cash in the first nine months of fiscal 2004 and used $5.3 million of cash in the first nine months of fiscal 2003. Even though DSO decreased by three days from the same period last year, accounts receivable increased because increased sales required more working capital in order to extend credit to our customers. Prepaid expenses and other assets used $1.7 million of cash in the first nine months of fiscal 2004 and used $8.6 million of cash in the first nine months of fiscal 2003. Accounts payable and accrued liabilities provided $7.3 million of cash in the first nine months of fiscal 2004 and used $1.3 million of cash in the first nine months of fiscal 2003. This difference was the result of management’s increased focus in 2004 on minimizing working capital requirements. Accrued interest on long-term debt used $6.2 million of cash in the first nine months of fiscal 2004 and provided $6.5 million of cash in the first nine months of fiscal 2003. This difference was the result of differences between the cash payment of interest on our Senior Subordinated Notes and other credit facilities and the accrual of expense for the next required payment. Another difference between the first nine months of fiscal 2004 and the first nine months of fiscal 2003 was changes in deferred revenue. These changes in deferred revenue used $1.5 million of cash in the first nine months of fiscal 2004 and used $3.9 million of cash in the first nine months of fiscal 2003. In our Network Services and Systems segment, our strategy is to market a complete set of solutions rather than individual products that we emphasized in the past. As a result, more of our network contracts are subject to EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” The impact is an increase in deferred revenue as the customer remits payment in advance and revenue is recognized in future periods.

The nature of an information services business is such that it requires a substantial continuing investment in technology equipment and product development in order to expand the business. Creation of new and enhanced products is the engine of growth for NDCHealth and we continue to invest in our future growth through focus on product development. We are generally able to fund these investments internally from excess cash generated from operations. Historically we have also expanded our business through acquisitions and strategic investments in other businesses. The cash we use to expand our business is shown as net cash used in investing activities. Capital expenditures, which reflect our investment in equipment and product development such as software costs discussed above, were $33.6 million in the first nine months of fiscal 2004, including $24.4 million in capitalized software costs and $2.2 million in capitalized interest; and $31.8 million in the first nine months of fiscal 2003, including $21.9 million in capitalized software costs and $1.1 million in capitalized interest. Capital expenditures were funded from cash from operations in both years. As we continue the rollout of new products and solutions during fiscal 2004, we expect to reduce the capital expenditure run rate while also improving our revenue growth, gross profit and ultimately, cash flow. In addition, capital expenditures in the first nine months of fiscal 2004 included some costs that we would not expect to repeat. As a result, the level of capital expenditures in the first nine months of fiscal 2004 is not indicative of the expected full-year capital expenditure level, which is expected to be approximately $45 million, including approximately $31.0 million in capitalized software costs.

We used $7.1 million of cash in the first nine months of fiscal 2004 for other investing activities, primarily the payment of transaction costs related to the completion of our acquisition of TechRx at the end of fiscal 2003 and additional investment in InstantDx, a provider of technology that allows physicians to write electronic prescriptions using mobile phones, desktop computers, and other web-enabled devices. During the first nine months of fiscal 2003, we used cash totaling $13.8 million for the payment of merger related costs associated with our acquisition of a controlling interest in TechRx at the end of fiscal 2002 and for the acquisition of German pharmaceutical data related to the development of a new informatics product. During the first nine months of fiscal 2004, proceeds from the sale of equipment provided cash of $2.1 million.

We currently have in place a $225 million senior credit facility, consisting of a $100 million five-year revolving credit facility and a $125 million six-year term loan, and have $200 million in senior subordinated notes outstanding. Details of our indebtedness are discussed below. We believe that our current level of cash on hand, future cash flows from operations, and our credit facility are sufficient to meet our operating needs in fiscal 2005.

In November 2002, we completed a refinancing that included a new $225 million senior secured credit facility and the issuance of $200 million of 10 ½% Senior Subordinated Notes due 2012 in an unregistered offering pursuant to Rule 144A and Regulation S under the Securities Act of 1933. On September 2, 2003 we completed an exchange offer whereby we exchanged all of the unregistered notes for substantially identical registered senior subordinated notes. As of February 27, 2004, the fair market value of the notes was approximately $223.3 million.

On December 19, 2003, the credit facility was amended to reduce the interest rate and relax certain covenants to provide us added flexibility. As of February 27, 2004, $109 million was outstanding under the term loan, which bore interest at a weighted average annual interest rate equal to 4.4% during the third quarter. The $100 million revolving credit facility is available for working capital and general corporate purposes and has a variable interest rate based on market rates. As of February 27, 2004 there were no borrowings outstanding under the revolving credit facility. The credit facility contains certain financial and non-financial covenants customary for financings of this nature. As of February 27, 2004, we were in compliance with all restrictive covenants and expect to remain in compliance with the amended covenants in the foreseeable future.

Borrowings under the amended credit facility bear interest, at our option, at a rate based on either (1) the applicable margin plus the base rate, which is the higher of the per annum rate, which the administrative agent publicly announces from time to time to be its prime lending rate, and the federal funds rate, as published by the Federal Reserve Bank of New York, plus 0.5%, or (2) the applicable margin plus a 1, 2, 3 or 6 month “LIBOR” rate. The amended credit facility eliminates the LIBOR minimum of 2.00% for term loan borrowings contained in the original facility. The applicable margin with respect to term loan borrowings is a percentage per annum equal to 1.75% for base rate borrowings and 2.75% for LIBOR borrowings. The applicable margin with respect to borrowings under the revolving credit facility is a percentage per annum equal to 1.50% for base rate borrowings and 2.50% for LIBOR borrowings. The applicable margin is subject to adjustments based on our financial performance. Under the credit agreement there is no cap on the interest rate applicable to the term loan or the revolving credit facility.

We intend to reduce our level of senior debt during fiscal 2004 and 2005, and believe that free cash flow, defined as net cash provided by operating activities less capital expenditures and dividends paid, is a meaningful measure of our ability to generate cash for this use. Free cash flow is not a GAAP measurement and may not be comparable to free cash flow reported by other companies. Free cash flow decreased to $32.5 million in the first nine months of fiscal 2004 from $34.3 million in the first nine months of fiscal 2003 due to increased capital expenditures in the first nine months of fiscal 2004.

The table below reconciles free cash flow for the nine months ended February 27, 2004 and February 28, 2003 to our results determined under GAAP.

Stock activities provide us an additional source of liquidity. Stock activities are primarily related to the exercises of employee stock options and issuances under the employee stock purchase plan. In the first nine months of fiscal 2004, issuance of shares of our common stock generated $8.4 million versus $1.3 million in the first nine months of fiscal 2003. Although the issuance of additional shares provides us with liquidity, it results in a dilution of each individual stockholder’s equity. Another use of cash is the payment of dividends, which totaled $4.3 million in the first nine months of fiscal 2004 and $4.2 million in the first nine months of fiscal 2003.

Discontinued operations used $1.5 million in the first nine months of fiscal 2004, primarily in the settling of liabilities, versus $4.4 million in the first nine months of fiscal 2003. Net operating loss carry-forwards related to our discontinued operations allowed us to reduce our cash tax payments by $6.1 million in the first nine months of fiscal 2003.

This report contains forward-looking statements. The statements related to the Company’s expected business outlook and the Company’s guidance for fiscal year 2004 are forward-looking statements. In general, forward-looking statements may include statements preceded by, followed by or that include the words “may,” “could,” “would,” “should,” “believe,” “expect,” “anticipate,” “plan,” “estimate,” “target,” “project,” “intend,” or similar expressions. These statements involve risks and uncertainties that may cause actual results to differ materially from those set forth in the forward-looking statements. Among other things, the Company’s business outlook and the projected results for the remainder of fiscal year 2004 are based on preliminary estimates, assumptions and projections that management believes to be reasonable at this time, but are beyond management’s control. Some of management’s assumptions that underlie the Company’s forward-looking statements include, among others, assumptions regarding demand for the Company’s products, the cost and timing of product upgrades and new product introductions, gains in market share, industry conditions affecting the Company’s customers, expected pricing levels, expected growth of revenue and net income, the timing and cost of planned capital expenditures, any regulatory action, outcomes of pending or threatened litigation, the aging of accounts receivable from the company’s value-added resellers and levels of inventory purchased by these VARs, as well as recognition of VAR revenue and the adequacy of associated VAR accounts-receivable reserves and expected synergies relating to acquisitions, joint ventures and alliances.

Additional factors that could cause results to materially differ from current expectations include, but are not limited to, the following:

For further discussion of the factors noted above and other relevant factors, please see the information set forth under the caption “Additional Factors That May Affect Future Performance” in Item 7 of our Annual Report on Form 10-K/A for the fiscal year ended May 30, 2003, which are incorporated herein by this reference.

Forward-looking statements speak only as of the date they are made, and the Company disclaims any obligation to update or amend these statements in light of new information, future events or otherwise. Forward-looking statements are only predictions and are not guarantees of performance.

There have been no significant changes in our market risk from that disclosed in our Annual Report on Form 10-K/A for the year ended May 30, 2003.

Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of February 27, 2004. Based on that evaluation, our chief executive officer and our chief financial officer have concluded that, as of February 27, 2004, our disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

There has been no change in our internal control over financial reporting during the quarter ended February 27, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In proceedings before the German courts instituted by IMS Health on December 21, 2000, IMS Health has alleged copyright infringement against each of Pharma Intranet Information AG, or PI, the company from whom we purchased certain assets of our German business, and us, and we each have contested the validity of IMS Health’s alleged copyright. In these proceedings, IMS Health obtained an injunction from the Frankfurt Regional Court to prevent each of PI and us from distributing data in the contested format. On August 13, 2002, the Frankfurt Court of Appeals ruled in our favor by dismissing the preliminary injunction against our use of the industry standard data structure. This decision is final and is not subject to further appeal by IMS Health. On September 17, 2002 the Frankfurt Court of Appeals issued a judgment in the main proceedings against PI. While validating a copyright in the structure, the Court held that IMS Health has no standing to sue to enforce the copyright. The Court also determined that IMS Health does not own the copyright. The Court further denied IMS Health’s claims under the EU Database Directive for protection of the data structure involved. Finally, the Court found that PI breached the German Act Against Unfair Trade Practices (UGW) by reason of identically copying

the data structure. We have not sold or used the data structure initially used by PI. We do not own PI and PI is no longer actively conducting business. The case against us remains pending before the Frankfurt Regional Court at this time.

We issued 381,098 unregistered shares of NDCHealth common stock with an estimated value as of the date of issuance of $10.0 million to ArcLight Systems LLC, an information management company with administrative offices in Westerville, Ohio, on December 31, 2003. These shares were issued in a private placement pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. The shares were issued in partial consideration for our acquisition of all fixed assets and employees and a seven year exclusive license to its assets. We also issued a five-year warrant to purchase an additional 381,098 shares of NDCHealth common stock at an exercise price of $26.24 per share with an estimated value as of the date of issuance of $4.4 million.

There were no defaults upon our senior securities during the quarter ended February 27, 2004.

(b) Reports on Form 8-K were filed during the quarter ending February 27, 2004. The items reported, any financial statements filed, and the dates of any such reports are listed below.

(i) NDCHealth Corporation’s Current Report on Form 8-K filed on January 7, 2004, reporting as an exhibit under Item 7 the Company’s press release dated January 7, 2004; under Item 9 Management’s discussion of its’ business position and strategy; and under Item 12 the Company’s release of financial results for the quarter ended November 28, 2003.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


NDCHealth Corporation
(Registrant)

By:		/s/ Randolph L.M. Hutto
		Randolph L.M. Hutto
		Chief Financial Officer
		(Authorized Signing Officer and Principal Financial Officer)


DELAWARE		58-0977458
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

NDC Plaza, Atlanta, Georgia		30329-2010
(Address of principal executive offices)		(Zip Code)


	Three Months Ended
	February 27, 2004			February 28, 2003
Revenues	$	116,113		$	109,007

Operating expenses:
Cost of service		58,914			53,130
Sales, general and administrative		25,863			22,341
Depreciation and amortization		9,761			7,842
Restructuring, impairment and other charges		—			2,283

		94,538			85,596

Operating income		21,575			23,411

Other income (expense):
Interest and other income		126			343
Interest and other expense		(6,980	)		(7,766	)
Minority interest in losses		776			185
Loss related to investments		—			(14,955	)
Early extinguishment of debt charges		—			(1,438	)

		(6,078	)		(23,631	)

Income (loss) before income taxes and equity in losses of affiliated companies		15,497			(220	)
Provision for income taxes		5,811			3,121

Income (loss) before equity in losses of affiliated companies		9,686			(3,341	)
Equity in losses of affiliated companies		(410	)		(359	)

Net income (loss)	$	9,276		$	(3,700	)

Basic earnings (loss) per share:	$	0.26		$	(0.11	)

Diluted earnings (loss) per share:	$	0.26		$	(0.11	)


	Nine Months Ended
	February 27, 2004			February 28, 2003
Revenues	$	340,238		$	314,375

Operating expenses:
Cost of service		171,248			156,881
Sales, general and administrative		73,871			64,555
Depreciation and amortization		28,519			22,952
Restructuring, impairment and other charges		3,999			2,283

		277,637			246,671

Operating income		62,601			67,704

Other income (expense):
Interest and other income		450			1,088
Interest and other expense		(22,296	)		(14,682	)
Minority interest in losses		1,399			1,216
Loss related to investments		—			(14,955	)
Early extinguishment of debt charges		—			(2,359	)

		(20,447	)		(29,692	)

Income before income taxes and equity in losses of affiliated companies		42,154			38,012
Provision for income taxes		15,797			16,886

Income before equity in losses of affiliated companies		26,357			21,126
Equity in losses of affiliated companies		(993	)		(984	)

Net income	$	25,364		$	20,142

Basic earnings per share:	$	0.73		$	0.58

Diluted earnings per share:	$	0.71		$	0.58


	Nine Months Ended
	February 27, 2004			February 28, 2003
Cash flows from operating activities:
Net income	$	25,364		$	20,142
Adjustments to reconcile net income to cash provided by operating activities:
Equity in losses of affiliated companies		993			984
Non-cash portion of restructuring, impairment and other charges		1,049			2,283
Non-cash in process research and development charges		350			—
Non-cash early extinguishment of debt charges		—			1,217
Loss related to investments		—			14,955
Depreciation and amortization		28,519			22,952
Deferred income taxes		17,709			12,072
Provision for bad debts		3,246			2,115
Other, net		2,211			5,333
Changes in assets and liabilities which provided (used) cash, net of the effects of acquisitions:
Accounts receivable, net		(6,092	)		(5,307	)
Prepaid expenses and other assets		(1,728	)		(8,612	)
Accounts payable and accrued liabilities		7,312			(1,304	)
Accrued interest on long-term debt		(6,207	)		6,490
Deferred revenue		(1,499	)		(3,896	)
Income taxes		(862	)		857

Net cash provided by operating activities		70,365			70,281

Cash flows from investing activities:
Capital expenditures		(33,633	)		(31,767	)
Proceeds from the sale of equipment		2,148			—
Investing activities and other non-current assets		(7,077	)		(13,831	)

Net cash used in investing activities		(38,562	)		(45,598	)

Cash flows from financing activities:
Net repayments under lines of credit		—			(91,000	)
Net principal payments under capital lease arrangements and other long-term debt		(16,559	)		(1,888	)
Net cash from refinancing activities		(395	)		168,070
Net proceeds from stock activities		8,431			1,283
Dividends paid		(4,254	)		(4,170	)

Net cash (used in) provided by financing activities		(12,777	)		72,295

Cash flows from discontinued operations:
Cash provided by tax benefits of discontinued operations		—			6,106
Cash used in discontinued operations		(1,527	)		(4,393	)

Net cash (used in) provided by discontinued operations		(1,527	)		1,713

Increase in cash and cash equivalents		17,499			98,691
Cash and cash equivalents, beginning of period		16,103			13,447

Cash and cash equivalents, end of period	$	33,602		$	112,138


	February 27, 2004			May 30, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	33,602		$	16,103
Accounts receivable		82,720			78,988
Allowance for doubtful accounts		(8,555	)		(6,785	)

Accounts receivable, net		74,165			72,203

Income tax receivable		2,050			1,199
Deferred income taxes		10,022			21,663
Prepaid expenses and other current assets		31,862			34,304

Total current assets		151,701			145,472

Property and equipment, net		128,494			116,678
Intangible assets, net		492,078			479,234
Deferred income taxes		—			5,018
Debt issuance cost		13,476			12,756
Investments		17,979			15,662
Other		15,669			12,432

Total Assets	$	819,397		$	787,252

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	6,037		$	6,558
Current portion of obligations under capital leases		1,019			1,028
Accounts payable and accrued liabilities		67,993			61,211
Accrued interest		7,074			13,281
Deferred revenue		37,444			38,137

Total current liabilities		119,567			120,215

Long-term debt		305,666			321,262
Obligations under capital leases		124			558
Deferred revenue		8,794			9,461
Deferred income taxes		742			—
Other long-term liabilities		30,557			30,225

Total liabilities		465,450			481,721

Commitments and contingencies

Minority interest in equity of subsidiaries		7,620			9,019

Stockholders’ equity:
Preferred stock, par value $1.00 per share; 1,000,000 shares authorized, none issued		—			—
Common stock, par value $.125 per share; 200,000,000 shares authorized; 35,961,257 and 34,888,753 shares issued, respectively.		4,495			4,361
Capital in excess of par value		242,423			216,156
Retained earnings		100,338			79,228
Deferred compensation and other		(5,722	)		(4,301	)
Other comprehensive income		4,793			1,068

Total stockholders’ equity		346,327			296,512

Total Liabilities and Stockholders’ Equity	$	819,397		$	787,252


*(In thousands, except per share data)*	Three Months Ended,
	February 27, 2004			February 28, 2003
Net income (loss):
As reported	$	9,276		$	(3,700	)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		394			217
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		(2,299	)		(1,750	)

Pro forma	$	7,371		$	(5,233	)

Basic earnings (loss) per share:
As reported	$	0.26		$	(0.11	)
Pro forma	$	0.21		$	(0.15	)
Diluted earnings (loss) per share:
As reported	$	0.26		$	(0.11	)
Pro forma	$	0.20		$	(0.15	)

*(In thousands, except per share data)*	Nine Months Ended,
	February 27, 2004			February 28, 2003
Net income:
As reported	$	25,364		$	20,142
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		1,248			636
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		(6,751	)		(5,516	)

Pro forma	$	19,861		$	15,262

Basic earnings per share:
As reported	$	0.73		$	0.58
Pro forma	$	0.57		$	0.44
Diluted earnings per share:
As reported	$	0.71		$	0.58
Pro forma	$	0.56		$	0.44


Assets:
Prepaid and other current assets	$	822
Property and equipment		857
In process R&D (expensed concurrently)		350
Intangible assets – Data Access Rights		10,409
Intangible assets – Proprietary Technology		1,500
Intangible assets - Goodwill		2,377

Total Assets	$	16,315

Liabilities:
Accounts payable and accrued liabilities assumed	$	3,934

Total Liabilities	$	3,934

Net purchase price (including transaction costs and transition payments)	$	12,381


*(In thousands, except per share data)*	Three Months Ended
	February 27, 2004					February 28, 2003
	Income		Shares	Per Share		Income			Shares	Per Share
Basic EPS:
Income	$	9,276	35,232	$	0.26	$	(3,700	)	34,623	$	(0.11	)

Effect of dilutive securities:
Stock options and restricted stock		—	1,052				—		—

		9,276	36,284				(3,700	)	34,623

Diluted EPS:
Income plus assumed conversions	$	9,276	36,284	$	0.26	$	(3,700	)	34,623	$	(0.11	)


*(In thousands, except per share data)*	Nine Months Ended
	February 27, 2004					February 28, 2003
	Income		Shares	Per Share		Income			Shares	Per Share
Basic EPS:
Income	$	25,364	34,934	$	0.73	$	20,142		34,561	$	0.58

Effect of dilutive securities:
Stock options and restricted stock		—	738				—		362

		25,364	35,672				20,142		34,923

Diluted EPS:
Income plus assumed conversions	$	25,364	35,672	$	0.71	$	20,142		34,923	$	0.58


*(In thousands)*	As of February 27, 2004							As of May 30, 2003
	Gross Carrying Amount		Accumulated Amortization			Total		Gross Carrying Amount		Accumulated Amortization			Total
Amortized intangible assets
Customer base	$	68,332	$	(20,616	)	$	47,716	$	67,213	$	(15,163	)	$	52,050
Proprietary technology		33,529		(13,709	)		19,820		32,029		(11,702	)		20,327
Data access rights		10,409		(244	)		10,165		—		—			—
Other		900		(279	)		621		900		(167	)		733

Total		113,170		(34,848	)		78,322		100,142		(27,032	)		73,110

Unamortized intangible assets
Goodwill		413,756		—			413,756		406,124		—			406,124

Total Intangible Assets	$	526,926	$	(34,848	)	$	492,078	$	506,266	$	(27,032	)	$	479,234


Aggregate Amortization Expense *(In thousands)*
For the three months ended February 27, 2004	$	2,400
For the nine months ended February 27, 2004		6,825

Estimated Amortization Expense
For year Ending May 28, 2004	$	9,508
For year Ending May 27, 2005		12,070
For year Ending June 02, 2006		11,755
For year Ending June 01, 2007		11,152
For year Ending May 30, 2008		11,012


Goodwill *(In thousands)*	Network Services and Systems		Information Management		Total
Balance as of May 30, 2003	$	331,635	$	74,489	$	406,124
Translation adjustment		2,086		1,982		4,068
Purchase price adjustments		1,187		—		1,187
ArcLight acquisition		—		2,377		2,377

Balance as of February 27, 2004	$	334,908	$	78,848	$	413,756


Quarter Ended February 27, 2004 *(In thousands)*	Network Services and Systems		Information Management		Other		Totals
Revenues	$	74,241	$	41,872	$	—	$	116,113
Income (loss) before income taxes and equity in losses of affiliated companies		10,879		4,618		—		15,497
Depreciation and amortization		6,123		3,638		—		9,761
Segment assets		679,418		139,979		—		819,397


Quarter Ended February 28, 2003 *(In thousands)*	Network Services and Systems		Information Management		Other			Totals
Revenues	$	67,987	$	41,020	$	—		$	109,007
Income (loss) before income taxes and equity in losses of affiliated companies		9,424		6,749		(16,393	)		(220	)
Depreciation and amortization		5,313		2,529		—			7,842
Segment assets		623,137		147,655		—			770,792


*(In thousands)*	2004		2003
Revenues:
United States	$	108,099	$	104,038
All other		8,014		4,969

Total revenues	$	116,113	$	109,007

Long-lived assets:
United States	$	124,539	$	113,550
All other		3,955		3,140

Total long-lived assets	$	128,494	$	116,690


Nine months Ended February 27, 2004 *(In thousands)*	Network Services and Systems		Information Management		Other			Totals
Revenues	$	216,715	$	123,523	$	—		$	340,238
Income (loss) before income taxes and equity in losses of affiliated companies		31,722		13,353		(2,921	)		42,154
Depreciation and amortization		18,008		10,511		—			28,519
Segment assets		679,418		139,979		—			819,397

Nine months Ended February 28, 2003 *(In thousands)*	Network Services and Systems		Information Management		Other			Totals
Revenues	$	199,681	$	114,694	$	—		$	314,375
Income (loss) before income taxes and equity in losses of affiliated companies		36,972		18,354		(17,314	)		38,012
Depreciation and amortization		8,030		14,922		—			22,952
Segment assets		623,137		147,655		—			770,792


Restructuring, impairment and other charges *(In thousands)*	Cash		Non-cash		Total
Impairment of assets	$	—	$	855	$	855
Closing of facilities		221		—		221
Severance and related costs		2,729		194		2,923

Total restructuring, impairment and other charges	$	2,950	$	1,049	$	3,999


Statement of Operations for the Three Months Ended February 27, 2004 *(In thousands)*	NDCHealth Corporation			Subsidiary Guarantors		Subsidiary Non- Guarantors			Consolidated
Revenues	$	60,363		$	43,116	$	12,634		$	116,113

Cost of service		22,899			25,145		10,870			58,914
Other operating expenses		20,628			11,908		3,088			35,624

Operating income (loss)		16,836			6,063		(1,324	)		21,575

Other income (expense)		(6,654	)		56		520			(6,078	)

Income (loss) before income taxes and equity in losses of affiliated companies		10,182			6,119		(804	)		15,497
Provision for income taxes		3,818			2,295		(302	)		5,811

Income (loss) before equity in losses of affiliated companies		6,364			3,824		(502	)		9,686
Equity in losses of affiliated companies		—			—		(410	)		(410	)

Net income (loss)	$	6,364		$	3,824	$	(912	)	$	9,276


Statement of Operations for the Nine Months Ended February 28, 2003 *(In thousands)*	NDCHealth Corporation			Subsidiary Guarantors			Subsidiary Non- Guarantors			Eliminations			Consolidated
Revenues	$	133,910		$	172,900		$	20,211		$	(12,646	)	$	314,375

Cost of service		45,911			100,272			16,175			(5,477	)		156,881
Other operating expenses		27,540			59,875			7,096			(4,721	)		89,790

Operating income (loss)		60,459			12,753			(3,060	)		(2,448	)		67,704

Other income (expense)		(35,433	)		36,604			1,071			(31,934	)		(29,692	)

Income (loss) before income taxes and equity in losses of affiliated companies		25,026			49,357			(1,989	)		(34,382	)		38,012
Provision for income taxes		12,212			7,089			(2,212	)		(203	)		16,886

Income (loss) before equity in losses of affiliated companies		12,814			42,268			223			(34,179	)		21,126
Equity in losses of affiliated companies		(984	)		—			—			—			(984	)

Net income (loss)	$	11,830		$	42,268		$	223		$	(34,179	)	$	20,142


Statement of Cash Flows for the Nine months Ended February 27, 2004 *(In thousands)*	NDCHealth Corporation			Subsidiary Guarantors			Subsidiary Non- Guarantors			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	18,287		$	10,106		$	(1,970	)	$	(1,059	)	$	25,364

Adjustments to reconcile net income (loss) to cash provided by operating activities:		41,352			8,952			4,081			(308	)		54,077
Changes in assets and liabilities which provided (used) cash, net of the effects of acquisitions:		1,228			(14,647	)		2,976			1,367			(9,076	)

Net cash provided by (used in) operating activities		60,867			4,411			5,087			—			70,365

Cash flows from investing activities:		(30,811	)		(4,229	)		(3,522	)		—			(38,562	)

Cash flows from financing activities:		(12,727	)		(537	)		487			—			(12,777	)

Cash flows from discontinued operations:		—			—			(1,527	)		—			(1,527	)

Increase (decrease) in cash and cash equivalents		17,329			(355	)		525			—			17,499
Cash and cash equivalents, beginning of period		12,698			1,491			1,914			—			16,103

Cash and cash equivalents, end of period	$	30,027		$	1,136		$	2,439		$	—		$	33,602


Balance Sheet as of May 30, 2003 *(In thousands)*	NDCHealth Corporation		Subsidiary Guarantors			Subsidiary Non-Guarantors			Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	12,698	$	1,491		$	1,914		$	—		$	16,103
Accounts receivable		48,570		20,053			3,580			—			72,203
Income taxes		23,111		(252	)		3			—			22,862
Prepaid expenses and other current assets		24,936		12,825			5,053			(8,510	)		34,304

Total current assets		109,315		34,117			10,550			(8,510	)		145,472

Property and equipment, net		79,332		33,841			3,505			—			116,678
Intangible assets, net		391,590		39,012			54,011			(5,379	)		479,234
Investments		47,847		263			10,670			(43,118	)		15,662
Intercompany receivables (payables)		94,579		(26,901	)		(18,296	)		(49,382	)		—
Other		43,739		—			5,355			(18,888	)		30,206

Total Assets	$	766,402	$	80,332		$	65,795		$	(125,277	)	$	787,252

Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt	$	6,809	$	663		$	5,889		$	(5,775	)	$	7,586
Accounts payable and accrued liabilities		38,034		8,780			8,768			5,629			61,211
Accrued interest		12,541		—			740			—			13,281
Deferred revenue		17,709		18,347			2,081			—			38,137

Total current liabilities		75,093		27,790			17,478			(146	)		120,215

Long-term liabilities		378,591		2,225			7,943			(27,253	)		361,506

Total liabilities		453,684		30,015			25,421			(27,399	)		481,721

Minority interest in equity of subsidiaries		—		—			9,019			—			9,019

Stockholders’ equity		312,718		50,317			31,355			(97,878	)		296,512

Total Liabilities and Stockholders’ Equity	$	766,402	$	80,332		$	65,795		$	(125,277	)	$	787,252


*(In millions, except per share data)*	Third Quarter Ended,
	February 27, 2004			February 28, 2003			Change
Revenue:
Network Services and Systems	$	74.2		$	68.0		$	6.2		9.1	%
Information Management		41.9			41.0			0.9		2.2	%

Total revenue	$	116.1		$	109.0		$	7.1		6.5	%

Operating income:
Network Services and Systems	$	15.3		$	14.2		$	1.1		7.7	%
Information Management		6.3			9.2			(2.9	)	(31.5	)%

Total operating income	$	21.6		$	23.4		$	(1.8	)	(7.7	)%

Net income (loss)	$	9.3		$	(3.7	)	$	13.0		—

Diluted earnings (loss) per share	$	0.26		$	(0.11	)	$	0.37		—

*(In millions, except per share data)*	Nine Months Ended,
	February 27, 2004			February 28, 2003			Change
Revenue:
Network Services and Systems	$	216.7		$	199.7		$	17.0		8.5	%
Information Management		123.5			114.7			8.8		7.7	%

Total revenue	$	340.2		$	314.4		$	25.8		8.2	%

Operating income:
Network Services and Systems	$	46.1		$	45.8		$	0.3		0.7	%
Information Management		19.4			21.9			(2.5	)	(11.4	)%
Other		(2.9	)		—			(2.9	)	—

Total operating income	$	62.6		$	67.7		$	(5.1	)	(7.5	)%

Net income	$	25.4		$	20.1		$	5.3		26.4	%

Diluted earnings per share	$	0.71		$	0.58		$	0.13		22.4	%


*(In millions)*	Third Quarter Ended,
	February 27, 2004			February 28, 2003
Compensation expense, net of capitalized labor	$	30.3		$	27.7
Revenue	$	116.1		$	109.0
Percent of revenue		26.1	%		25.4	%

*(In millions)*	Nine Months Ended,
	February 27, 2004			February 28, 2003
Compensation expense, net of capitalized labor	$	85.1		$	84.0
Revenue	$	340.2		$	314.4
Percent of revenue		25.0	%		26.7	%


(in thousands)	Nine months ended February 27, 2004			Nine months ended February 28, 2003
Net cash provided by operating activities	$	70,365		$	70,281
Capital expenditures		(33,633	)		(31,767	)
Dividends paid		(4,254	)		(4,170	)

Free cash flow	$	32,478		$	34,344


Exhibit Numbers		Description
10(i)		Letter Amendment No. 4 to Credit Agreement dated as of January 22, 2004 by and among the Registrant, Merrill Lynch Capital, and the Lenders and agents from time to time party thereto.

31(i)		Rule 13a-14(a)/15d-14(a) Certification of Walter M. Hoff

31(ii)		Rule 13a-14(a)/15d-14(a) Certification of Randolph L.M. Hutto

32		Section 1350 Certification