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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to ________________
Commission file number 0-13801
QUALITY SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
California 95-2888568
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
17822 East 17th Street, Tustin, California 92780
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (714) 731-7171
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Name of each exchange on
Title of each class which registered:
-------------------------------------- ------------------------
Common Stock, par value $.01 per share NA
Common Stock Purchase Rights NA
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
State the aggregate market value of the voting stock held by non-affiliates
of the registrant as of May 30, 1997: $ 32,915,000.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of May 30, 1997: 5,998,712.
Page 1 of 77
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DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of the Form 10-K is
incorporated by reference from Registrant's Definitive Proxy Statement
for its 1997 annual meeting which is to be filed with the Commission
on or before July 29, 1997.
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PART I
Item 1. BUSINESS.
---------
Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K, including discussions of the
Company's product development plans and business strategies and market
factors influencing the Company's results, are forward-looking statements
that involve certain risks and uncertainties. Actual results may differ
from those anticipated by the Company as a result of various factors, both
foreseen and unforeseen, including, but not limited to, the Company's
ability to continue to develop new products and increase systems sales in
markets characterized by rapid technological evolution, consolidation, and
competition from larger, better capitalized competitors. Many other
economic, competitive, governmental and technological factors could impact
the Company's ability to achieve its goals and interested persons are urged
to review the risks described below under "Item 1. Business. Risk
Factors." and in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation." set forth below, as well as in the
Company's other public disclosures and filings with the Securities and
Exchange Commission.
GENERAL
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiary, Clinitec
International, Inc. ("Clinitec"), (collectively the "Company") develop and
market health care information systems that automate medical and dental
group practices, physician hospital organizations ("PHO's"), management
service organizations ("MSOs"), health maintenance organizations ("HMOs")
and community health centers. In response to the growing need for more
comprehensive, cost-effective information solutions for physician and
dental practice management, the Company's systems provide clients with the
ability to redesign patient care and other workflow processes, to improve
productivity and reduce information processing and administrative costs and
to provide multi-site access to patient information. The Company's
proprietary software systems include general patient information and
summary medical records, appointment scheduling, billing, insurance claims
submission and processing, managed care plan implementation and referral
management, treatment outcome studies, treatment planning, drug
formularies, patient electronic medical records, word processing and
accounting. In addition to providing fully integrated information
solutions to its clients, the Company provides comprehensive hardware and
software installation, maintenance and support services, system training
services and electronic insurance claims submission services.
The Company currently has an installed base of more than 500 operating
health care information systems serving PHOs, MSOs, HMOs, group practices,
specialty practices, dental schools and other health care organizations,
each of which consists of one to 120 physicians or dentists. The Company
believes that as health care providers are increasingly required to reduce
costs while maintaining the quality of health care, the Company will be
able to capitalize on its strategy of providing fully integrated
information systems and superior customer service.
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QSI is a California corporation formed in 1974 and was founded with an
early focus on providing information systems and services primarily for
dental group practices. QSI's initial "turnkey" systems were designed to
improve productivity while reducing information processing costs and
personnel requirements. In the mid-1980's, QSI capitalized on the
opportunity presented by the increasing pressure of cost containment on
physicians and health care organizations and further expanded its
information processing systems into the broader medical market. Today, QSI
develops and provides integrated UNIX-based* health care information
systems for both the medical and dental markets. These systems operate on
a stand-alone basis or in a networked environment and are expandable to
accommodate client needs.
Augmenting its practice management software, QSI added Clinitec's
electronic medical records software to its product line in 1995 and
completed its acquisition of Clinitec in May 1996. Clinitec's principal
product, NextGen**, permits scanning, annotation, retrieval and analysis of
medical records in all formats, from documents to photographs and X-rays.
NextGen has been developed using a client/server platform, a graphical user
interface for compatibility with UNIX, Microsoft Windows***, Windows NT***
and Windows 95*** operating systems, and a relational database for
flexibility in screen customization, reporting and logic flow. The Company
is also in the process of designing an alternative client/server version of
its products utilizing a graphical user interface ("GUI") with the intent
of enabling a more seamless integration of the QSI and NextGen
applications. With the addition of NextGen, the Company is able to provide
its clients with a comprehensive information management solution. NextGen,
in conjunction with QSI's practice management software, was first installed
at a beta site in August 1995 and is currently being installed in
additional sites.
Further augmenting its product line, the Company purchased substantially
all of the assets of MicroMed Healthcare Information Systems, Inc.
("MicroMed") in May 1997. MicroMed develops proprietary medical practice
management systems that utilize a client/server platform, a graphical user
interface for compatibility with Windows 95 and Windows NT operating
systems, and a relational database that is ANSI SQL-compliant in contrast
with the Company's existing practice management systems which are primarily
character based. MicroMed was formed in 1993 and, as of the acquisition
date, MicroMed had six installed customer sites which include a medical
center with more than 70 doctors, 20 locations and nearly 100 simultaneous
users. (See "Item 1. Business. MicroMed.")
* UNIX is a registered trademark of AT&T Corporation.
** NextGen is a registered trademark of Clinitec International, Inc.
*** Microsoft Windows, Windows NT and Windows 95 are registered
trademarks of Microsoft Corporation.
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INDUSTRY BACKGROUND
To compete in the changing health care environment, physicians and other
outpatient care providers are increasingly joining and affiliating with
other physicians, managed care organizations, hospitals and others
enterprises to form larger health care organizations such as PHOs, MSOs and
HMOs. These organizations are designed to take advantage of economies of
scale associated with managing health care services for large patient
populations across inpatient and outpatient settings, while achieving
improved quality, reduced costs and strengthened negotiating positions with
managed care entities. In the managed care environment, health care
organizations are increasingly entering into contracts which define the
terms under which care is administered. The expansion in the number of
managed care and third-party payor organizations, as well as additional
government regulation and changes in reimbursement models, has greatly
increased the complexity of pricing policies, billing procedures and
reimbursement policies impacting medical practices. In addition, to
operate effectively, health care organizations must efficiently manage
patient care and other workflow processes which may extend across multiple
care locations and business entities.
To compete under the constraints of managed care while maintaining quality
of services, health care organizations have placed increasing demands on
their information systems. Initially, these information systems automated
financial and administrative functions. As it became necessary to manage
patient flow processes, the need arose to integrate much "back-office" data
with clinical information such as patient test results and office visits.
Particularly for larger organizations and group practices, the Company
believes information systems must allow enterprise-wide exchange of patient
information incorporating administrative, financial and clinical
information from multiple entities, while focusing on the physician as the
primary care giver. In addition, large health care organizations
increasingly require information systems that can deliver high-performance
in environments with multiple concurrent computer users.
Many existing health care information systems, including systems designed
for physicians and small group practices, were designed for limited
administrative tasks such as billing and scheduling and can neither
accommodate multiple computing environments nor operate effectively across
multiple locations and entities. As the health care industry continues to
evolve, physician groups and health care organizations will increasingly
require systems that compile structured clinical information from multiple
sources and enable measurement of treatment outcomes and management of
clinical processes. Such systems must be integrated with financial and
administrative information systems in order to maintain patient flow while
continuing to reduce costs and improve quality of care. The Company
believes that systems which integrate patient clinical data with
administrative, financial and other practice management data are best
positioned to succeed in the current managed care environment.
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As health care organizations transition to new computer platforms and newer
technologies, they will be migrating toward the implementation of
enterprise-wide, patient-centered computing systems embedded with automated
patient medical records. These organizations cannot afford significant
downtime or re-education, nor can they prudently risk choosing a system
which has not proven its ability to handle high volume processing with
continuous dependability. The Company believes that successful systems
vendors in the market will have a sufficient installed base and adequate
resources to offer high quality, fully integrated products and the value-
added services needed to expand and support clients throughout this
evolution process.
Similarly, the dental industry has seen consolidation of dental practices
in recent times. This consolidation, as with the physician marketplace,
has created business organizations which require more sophisticated
computer information systems.
THE QSI SOLUTION
In response to the growing need for more comprehensive, cost-effective
health care information solutions for physician and dental practice
management, the Company's systems provide clients with the ability to
redesign patient care and other workflow processes and improve productivity
through multi-site and multi-entry access to patient information.
Utilizing proven third-party hardware solutions combined with the Company's
proprietary software configured to maximize the efficiency of a health care
organization's information processing requirements, the Company's solutions
enable an integration of a variety of administrative and patient
information operations. With the addition of Clinitec's product line, the
Company provides clients with an integrated medical records management
system as part of a total information management solution. Leveraging over
20 years of experience in the health care information services industry,
the Company believes that it continues to distinguish its solutions by
providing its clients with sophisticated, full-featured software systems
along with comprehensive systems implementation, maintenance and support.
QSI's systems automate many aspects of group practice management, including
the retention of general patient information, appointment scheduling,
billing, insurance claims submission and processing, managed care plan
implementation and referral management, treatment outcome studies,
treatment planning, drug formularies, word processing and accounting. QSI
primarily uses the IBM RS6000* central processing unit and IBM'S AIX**
version of the UNIX operating system as a platform for its application
software, which enables QSI to continue providing a wide range of flexible
and functional systems to accommodate clients from solo practitioner to
large group practices.
* RS6000 is a registered trademark of International Business Machines
Corporation.
** AIX is a registered trademark of International Business Machines
Corporation.
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PRODUCTS
QSI's health care information systems consist primarily of proprietary
software applications and third-party hardware and software. The systems
range in capacity from one to hundreds of users, allowing the Company to
address the needs of both small and large clients. The software
configuration of a typical system includes a basic medical or dental
application and additional software applications. A typical system also
consists of third party hardware components, including a UNIX-based central
processing unit, disk drives, a magnetic tape unit, video display
terminals, PCs, one or more printers, and telecommunications equipment.
The systems are modular in design and may be expanded to grow with changing
client requirements.
QSI purchases all the hardware components of its systems as well as the
requisite operating system licenses from manufacturers or distributors of
those components. It assembles and tests the hardware components and
incorporates QSI's proprietary application software and other third party
software into completed systems. QSI provides systems tailored to
accommodate particular client requirements. QSI continually evaluates the
hardware components of its systems with a view to utilizing hardware that
is functional, reliable and cost-effective.
QSI's systems include application and system software modules that provide
comprehensive solutions for physician and dental practices. Clients
typically purchase a base medical or dental application and add on
additional applications as desired. Add-on applications include such
modules as managed care, electronic medical records, patient eligibility,
electronic claims and patient statements processing, various proprietary
and third party accounting and word processing packages. Systems have
ranged in price from approximately $10,000 to over $900,000 depending upon
size of group practice, number of system users and number of sites.
QSI continues to make enhancements to its hardware and software packages to
provide increased functionality and flexibility to its clients. Recent
enhancements include additional interfaces for electronic claims submission
and insurance payments, increased ability to implement managed care plans
and fees, electronic patient eligibility verification, applications for
community health centers, drug formulary tracking, enhanced patient
scheduling, and software to support paperless collections. QSI has
continued to take advantage of new releases in the IBM RS6000 family, as
well as new PC-based products utilizing the SCO* UNIX operating system. In
addition, QSI has added enhanced telecommunications and new peripheral
products.
* SCO is a registered trademark of Santa Cruz Operation, Inc.
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CLINITEC
In April 1995, the Company entered into a strategic relationship with
Clinitec, a developer of electronic medical records software systems. In
May 1995 as part of this relationship, the Company acquired a 25% equity
interest in Clinitec for $1.0 million. In May 1996, the Company acquired
the remaining 75% of Clinitec for approximately $4.9 million in cash plus
309,846 shares of QSI Common Stock. For purposes of the acquisition, the
shares were valued at approximately $6.9 million, or $22.25 per share, for
a total purchase price of approximately $11.8 million for this remaining
75% ownership interest. QSI continues to maintain Clinitec as a separate
subsidiary and sell Clinitec software products in conjunction with QSI
products, as well as on a stand-alone basis. For accounting purposes, the
acquisition was treated as a purchase transaction during the quarter ended
June 30, 1996. In connection with this accounting treatment, the Company
recorded an $8.3 million charge for purchased in-process research and
development during the June 30, 1996 quarter.
Clinitec was formed in January 1994 to develop and market electronic
medical records software systems. Clinitec's proprietary software products
are relatively new and Clinitec has sold only a limited quantity of these
products to date. There can be no assurance that Clinitec's products will
achieve broad market acceptance.
Clinitec's software product, NextGen, has been developed using a graphical
user interface client/server platform for compatibility with the UNIX,
Microsoft Windows, Windows NT and Windows 95 operating systems and a
relational database back end to permit flexibility in screen customization,
reporting and logic flow. NextGen operates in a client/server environment,
using a desktop, laptop or pen-based PC configuration. Medical records
data can include:
* User customized templates for data capture and automatic
document generation.
* Scanned or electronically acquired images, including X-rays
and photographs.
* Other records, documents and notes, including
electronically captured handwriting and annotations.
* Digital voice recordings embedded in documents.
In addition, specific templates designed into the system will permit
research and analysis of particular conditions and diagnoses, including the
interaction between various prescribed pharmaceuticals, and will allow for
extensive outcomes reporting.
Clinitec offers software applications that are complementary to those
offered by QSI. The key "back office" applications incorporated into QSI's
solutions such as practice management, eligibility, claims processing and
accounting can be augmented by the "front office" applications of the
NextGen software. Because QSI's products are UNIX-based, QSI is able to
add NextGen as part of an integrated system. To further address the
client/server technology oriented marketplace, the Company has acquired
substantially all of the assets of MicroMed (see "Item 1. Business.
9
MicroMed."). QSI is also in the process of designing alternative versions
of certain of its products for the client/server environment. In addition
to a graphical user interface, these client/server versions will include
screens and templates similar to those in NextGen to enable a more seamless
integration of the QSI and NextGen applications. The Company intends to
leverage its existing client base for sales of NextGen.
MICROMED
In May 1997, the Company purchased substantially all of the assets of
MicroMed, a developer and marketer of proprietary medical practice
management systems, for up to $10.8 million. The purchase price consists
of an initial cash payment of $4.8 million paid upon the May 1997 closing
of the transaction with an additional payment of up to $6.0 million due no
later than June 29, 1998. The additional payment will be determined using
a formula based primarily upon Revenues and Pre-Tax Operating Income, as
each is defined in the related Asset Purchase Agreement, for the twelve
month period ending March 31, 1998. Up to 15% of the additional payment,
if any, is payable in the Company's Common Stock at the sole election of
the Company with the balance of any such payment payable in cash. The
acquisition will be treated as a purchase for accounting purposes. In
connection with this treatment, the Company expects to allocate a
significant portion of the purchase price paid at the closing of the
transaction to purchased in-process research and development during the
quarter ending June 30, 1997.
MicroMed was formed in 1993 and, as of the acquisition date, MicroMed had
six installed customer sites which include a medical center with more than
70 doctors, 20 locations and nearly 100 simultaneous users. MicroMed's
proprietary software products are new and MicroMed has sold only a limited
quantity of these products to date. There can be no assurance that
MicroMed's products will achieve broad market acceptance.
MicroMed offers software applications that are complementary to NextGen and
expands the Company's practice management system product line which
historically has been primarily character-based software solutions.
MicroMed's software product has been developed using a GUI client/server
platform for compatibility with Windows 95 and Windows NT operating
systems, and a relational database that is ANSI SQL-compliant. MicroMed's
product, which has been designed initially for health care provider
networks, is scalable and includes a master patient index, enterprise-wide
appointment scheduling with referral tracking, clinical support, and
centralized or decentralized patient financial management based on either a
managed care or fee-for-service model. The system's three-tiered
architecture allows work to be performed on the database server, the
application server and the client workstation.
SALES AND MARKETING
The Company sells and markets its products nationwide through a direct
sales force operating from sales offices in California, Florida, Ohio, New
York, Pennsylvania and Texas. The Company's sales and marketing employees
identify and contact prospective clients by a variety of means, including
referrals from existing clients and contacts at professional society
meetings and seminars with persons involved in group practice as well as
trade journal advertising, direct mail advertising, and telemarketing.
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These sales employees are knowledgeable about medical and dental group
health care systems, as well as computer applications. Typically, these
employees make presentations to potential clients by demonstrating the
system and its capabilities on the prospective client's premises. In
addition, the Company performs remote demonstrations by utilizing a
prospective client's PC or by sending the prospective client a
telecommunications kit including a terminal.
The Company's sales cycle can vary significantly and typically ranges from
three to 12 months from initial contact to contract execution. Systems are
normally delivered to a customer within 30 to 60 days of receipt of a
system order, and therefore, the Company does not believe data pertaining
to backlog is meaningful. Standard payment terms include a 25% down
payment with the balance due when the hardware is installed, in certain
circumstances, or when the installed system is ready for training in other
circumstances. As part of the fees paid by its clients, the Company
receives up-front licensing fees and a monthly/quarterly service fee based
on client configuration.
QSI and Clinitec maintain separate sales forces. As appropriate, sales
leads for each other's products are passed between the two sales forces.
In certain instances, a joint sales team is utilized to sell combined
systems.
Several clients have purchased the Company's system and, in turn, are
providing time-share services to local single and group practice
practitioners. Under the time-share agreements, the client provides the
use of its system for a fee to one or more practitioners. Although the
Company does not receive a fee directly from the time-share client,
implementation of time-share arrangements has resulted in the purchase of
additional system capacity by the client offering the time-share services,
as well as new system purchases made by the time-share clients. The
Company continues to concentrate its sales and marketing efforts on medical
and dental practices, dental schools, physician clinics, MSOs, PHOs and
community health centers. MSOs and PHOs to which the Company has sold
systems provide use of the Company's software to those group and single
physician practices associated with the organization or hospital on either
a time-sharing basis or by directing the Company to contract with those
practices for the sale of stand-alone turnkey systems.
The Company has entered into marketing assistance agreements with certain
of its clients pursuant to which the clients allow the Company to
demonstrate to potential clients the use of systems on the existing
clients' premises. In addition, the Company has established certain of its
clients as dealers for its systems. Through this arrangement, the dealer
markets and sells QSI systems to prospects in a local territory. These
prospects are generally smaller health care facilities than those actively
pursued by the Company. QSI's PC-based products are well suited to this
dealer marketing. In addition, the dealer typically provides a variety of
ongoing services for its clients. Dealers are compensated based on system
size and profitability, and the services which they perform in lieu of the
Company.
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The Company often assists prospective clients in identifying third party
sources for financing the purchase of the Company's systems. The
financing usually is obtained by the client directly from institutional
lenders and typically takes the form of a loan from the institution secured
by the system to be purchased or a leasing arrangement. Most of the
clients purchasing QSI systems have been assisted by the Company in finding
sources of financing for such purchases.
The Company has numerous clients and does not believe that the loss of any
single client would have a material adverse effect on the Company. No
client accounted for ten percent or more of net revenues during fiscal
years ended March 31, 1997, 1996 or 1995.
CUSTOMER SERVICE AND SUPPORT
The Company believes its success is attributable in part to its exceptional
customer service and support. The Company offers support to its clients
seven days a week, 24 hours a day. All of QSI's systems have a dedicated
computer port for dial-up remote access, facilitating rapid response by QSI
technicians to system inquiries. Most inquiries can be resolved without the
need to dispatch QSI technicians. These support services also provide QSI
with the opportunity to monitor changes in each client's information
processing requirements and to recommend the purchase of system hardware or
software enhancements designed to satisfy these additional requirements.
The Company believes that its commitment to provide extensive support has
contributed significantly to the development of its business.
The Company offers clients support services for most system components,
including hardware and software maintenance, for a fixed monthly/quarterly
fee. The Company also subcontracts with IBM to perform specific hardware
maintenance tasks under the Company's direction. This arrangement has
provided the Company with economies of scale associated with IBM's service
infrastructure while still maintaining service standards.
The Company's continuing system support staff is comprised of specialists
who are knowledgeable in the area of hardware and software technology as
well as in the day-to-day operations of a group practice. QSI's on-line
access to all client systems enables the support staff to provide immediate
assistance to clients. This assistance ranges from correcting minor
procedural problems in the client's system to performing complex data base
reconstructions or software updates. QSI also utilizes an automated on-
line support system which assists clients in resolving minor problems and
facilitates automated electronic retrieval of problems along with symptoms
following a client's call to QSI's automated support system. Additionally,
the on-line support system maintains a complete call record at the client's
facility and QSI.
IMPLEMENTATION AND TRAINING
The Company provides implementation and training services and believes that
its system delivery, implementation and support services are key elements
of successful client relationships. When a client signs a contract for the
purchase of a QSI system, a client manager, trained in physician and/or
dental group practice procedures, is assigned to ensure that the client is
fully informed of system options and that the proper system configuration
is installed. This information is determined through discussions with the
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client and observation of the client's practice. Once the set of software
features is established, the software configuration unique to a given
client can be created in an automated fashion.
Before activation of the client's QSI system, QSI personnel typically
convert the relevant client data onto the system. Typically, QSI
interfaces electronically to convert the client's data from another
computer system, allowing for a quick, cost-effective and accurate
conversion. The system is then subjected to extensive testing which
includes processing representative data using the client's system
configuration. In some situations, the data may have been previously
maintained by the client on ledger cards or other hard copy. In such
situations, QSI typically uses its data entry staff to input the required
data.
One or more QSI trainers experienced in group practice procedures are
assigned to conduct an intensive training program for the client's
employees. The program includes a combination of computer assisted
instruction ("CAI"), remote training techniques and training classes
conducted by QSI staff at the client's office(s). CAI consists of
workbooks, computer interaction and personal instruction. CAI is also
offered to clients, for an additional charge, after the initial training
program is completed for the purpose of training new and additional
employees. Remote training allows a trainer at QSI's office to train one
or more people at a client site via telephone and computer connection, thus
allowing an interactive and office-specific mode of training without the
expense and time required for travel. QSI also provides ongoing training
through electronic classrooms where employees at different locations from
the same or different companies can simultaneously interact on-line with a
trainer. In addition, QSI's on-line "help" documentation feature
facilitates client training as well as ongoing support.
Similarly, when a client signs a contract for the purchase of a electronic
medical records system from Clinitec, Clinitec's customer support manager
creates, in conjunction with the client, a detailed system implementation
plan and an implementation specialist is assigned to the client. The
implementation specialist is experienced with the information flow within a
medical practice/organization. The specialist trains the client in the use
of the NextGen software and assists the client in tailoring the electronic
medical records system to meet the entity's specific needs. Training is
provided at the client's site. Throughout the implementation process, the
customer support manager monitors the implementation milestones to assure
timely training, installation and knowledge-base development.
COMPETITION
The market for medical group practice management systems is intensely
competitive and the Company faces significant competition from a number of
different sources. The industry is highly fragmented and includes numerous
competitors, none of which the Company believes dominates the overall
market for medical group practice management systems. In addition, several
of the Company's competitors have significantly greater financial,
technical, product development and marketing resources than the Company.
The Company believes its principal competitive advantages are the features
and capabilities of its products and services, its high level of customer
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support and its 20-year experience in the industry. To date, the Company
has not encountered substantial competition in the dental group practices
market of six or more dentists. The Company is anticipating that market
competition in the dental group practices market of six or more dentists
will increase as new competitors enter the marketplace. The Company
believes that numerous firms sell computerized data processing systems to
group dental practices consisting of five or fewer dentists.
The market for electronic medical records systems is highly competitive and
subject to rapid changes in technology. The Company expects that market
competition will increase as new competitors enter the marketplace. The
industry is highly fragmented and includes numerous competitors, none of
which the Company believes dominates the electronic medical records market.
Many of the Company's competitors have substantially greater name
recognition and technical, marketing and financial resources. The Company
believes its principal competitive advantages are the features and
flexibility of its NextGen products. There can be no assurance that future
competition or new product introductions in the electronic medical records
market will not have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the NextGen
software products are relatively new and only a limited quantity of these
systems have been sold to date. There can be no assurance that the NextGen
products will achieve broad market acceptance.
Furthermore, the Company also competes in all of its markets indirectly and
to varying degrees with other major health care related companies,
information management companies generally, and other software developers
which may more directly enter the markets in which the Company competes.
There can be no assurance that future competition will not have a material
adverse effect on the Company's business, financial condition and results
of operations. Competitive pressures and other factors, such as new
product introductions by the Company or its competitors, may result in
price erosion that could have a material adverse effect on the Company's
business, financial condition and results of operations.
PRODUCT ENHANCEMENT AND DEVELOPMENT
The health care information management and computer software and hardware
industries are characterized by rapid technological change requiring the
Company to engage in continuing efforts to improve its systems. During
fiscal years 1997, 1996 and 1995 the Company expended approximately $2.8
million, $1.9 million and $1.7 million, respectively, on research and
development activities including capitalized software amounts of $850,000,
$382,000 and $191,000, respectively. In addition, many of the Company's
product enhancements have resulted from software development work performed
under contracts with its clients. To the extent that the Company fails to
achieve technological advances comparable to those made by others in the
computer and health care information management industries, its products
and services may become obsolete.
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GOVERNMENTAL REGULATION
The health care industry is subject to changing political, economic and
regulatory influences that may affect the procurement processes and
operation of health care facilities. During the past several years, the
health care industry has been subject to an increase in governmental
regulation of, among other things, reimbursement rates and certain capital
expenditures. Certain legislators have announced that they intend to
examine proposals to reform certain aspects of the U.S. health care system
including proposals which may increase governmental involvement in health
care, lower reimbursement rates and otherwise change the operating
environment for the Company's clients. Health care providers may react to
these proposals and the uncertainty surrounding such proposals by
curtailing or deferring investments, including those for the Company's
systems and related services. On the other hand, changes in the regulatory
environment have increased and may continue to increase the needs of health
care organizations for cost-effective data management and thereby enhance
the marketability of the Company's systems and related services. The
Company cannot predict what impact, if any, such proposals or health care
reforms might have on the Company's business, financial condition and
results of operations.
The Company's software may be subject to regulation by the U.S. Food and
Drug Administration (the "FDA") as a medical device. Such regulation could
require the registration of the applicable manufacturing facility and
software and hardware products; application of detailed recordkeeping and
manufacturing standards; and, FDA approval or clearance prior to marketing.
An approval or clearance could create delays in marketing, and the FDA
could require supplemental filings or object to certain of these
applications.
EMPLOYEES
As of May 31, 1997, the Company, including MicroMed, employed 239 persons
of which 225 were full time employees. Systems analysts, programmers and
qualified sales and marketing personnel are in short supply and,
consequently, competition for such individuals is intense. The Company
believes that its future success depends in part upon recruiting and
retaining qualified marketing and technical personnel as well as other
employees. The Company considers its employee relations to be good.
RISK FACTORS
DEPENDENCE ON PRINCIPAL PRODUCT AND NEW PRODUCT DEVELOPMENT - The Company
currently derives substantially all of its net revenues from sales of its
health care information systems and related services. The Company believes
that a primary factor in the market acceptance of its systems has been its
ability to meet the needs of users of health care information systems. The
Company's future financial performance will depend in large part on the
Company's ability to continue to meet the increasingly sophisticated needs
of its clients through the timely development and successful introduction
of new and enhanced versions of its systems and other complementary
products. The Company has historically expended a significant amount of
its net revenues on product development and believes that significant
continuing product development efforts will be required to sustain the
Company's growth.
15
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing or new products, or that products or product
enhancements will be developed in a timely manner, meet the requirements of
health care providers or achieve market acceptance. If new products or
product enhancements do not achieve market acceptance, the Company's
business, operating results and financial condition could be adversely
affected. At certain times in the past, the Company has also experienced
delays in purchases of its products by clients anticipating the launch of
new products by the Company. There can be no assurance that material order
deferrals in anticipation of new product introductions will not occur.
COMPETITION - The market for health care information systems is intensely
competitive and the Company faces significant competition from a number of
different sources. The electronic medical records market, in particular,
is subject to rapid changes in technology and the Company expects that
competition in this portion of the market will increase as new competitors
enter the marketplace. In addition, several of the Company's competitors
have significantly greater name recognition as well as substantially
greater financial, technical, product development and marketing resources
than the Company.
The industry is highly fragmented and includes numerous competitors, none
of which the Company believes dominates the overall market for either group
practice management or electronic medical records systems. Furthermore, the
Company also competes indirectly and to varying degrees with other major
health care related companies, information management companies generally,
and other software developers which may more directly enter the markets in
which the Company competes.
There can be no assurance that future competition or new product
introductions will not have a material adverse effect on the Company's
business, financial condition and results of operations. Competitive
pressures and other factors, such as new product introductions by the
Company or its competitors, may result in price erosion that could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company believes that once a health care provider has chosen a
particular health care information system vendor, the provider will, for a
period of time, be more likely to rely on that vendor for its future
information system requirements. In addition, if the health care industry
continues to undergo further consolidation as it has recently experienced,
each sale of the Company's systems will assume even greater importance to
the Company's business, financial condition and results of operations. The
Company's inability to make initial sales of its systems to either newly
formed groups and/or health care providers that are replacing or
substantially modifying their health care information systems could have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, if new systems sales do not
materialize, maintenance service revenues can be expected to decrease over
time due to failure to capture new maintenance revenues therefrom and to
attrition of existing maintenance revenues associated with the Company's
existing clients whose systems become obsolete or are replaced by
competitor's products.
16
TECHNOLOGICAL CHANGE - The software market generally is characterized by
rapid technological change, changing customer needs, frequent new product
introductions and evolving industry standards. The introduction of
products incorporating new technologies and the emergence of new industry
standards could render the Company's existing products obsolete and
unmarketable. There can be no assurance that the Company will be
successful in developing and marketing new products that respond to
technological changes or evolving industry standards. New product
development depends upon significant research and development expenditures
which depend ultimately upon sales growth. Any material weakness in
revenues or research funding could impair the Company's ability to respond
to technological advances in the marketplace and remain competitive. If
the Company is unable, for technological or other reasons, to develop and
introduce new products in a timely manner in response to changing market
conditions or customer requirements, the Company's business, results of
operations and financial condition will be materially adversely affected.
In response to increasing market demand, the Company is currently
developing new generations of certain of its group practice management
software products that will be designed for the client/server and
Internet/intranet environments. There can be no assurance that the Company
will successfully develop these new software products or that these
products will operate successfully on the principal client/server operating
systems, which include UNIX, Microsoft Windows, Windows NT and Windows 95,
or that any such development, even if successful, will be completed
concurrently with or prior to introduction by competitors of products
designed for the client/server and Internet/intranet environments. Any
such failure or delay could adversely affect the Company's competitive
position or could make the Company's current practice management product
line designed for the UNIX environment obsolete.
FLUCTUATION IN QUARTERLY OPERATING RESULTS - The Company's revenues and
operating results have in the past fluctuated, and may in the future
fluctuate, from quarter to quarter and period to period as a result of a
number of factors including, without limitation: the size and timing of
orders from clients; the length of sales cycles and installation processes;
the ability of the Company's clients to obtain financing for the purchase
of the Company's products; changes in pricing policies or price reductions
by the Company or its competitors; the timing of new product announcements
and product introductions by the Company or its competitors; the
availability and cost of supplies; the financial stability of major
clients; market acceptance of new products, applications and product
enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements and to control costs; the
Company's success in expanding its sales and marketing programs; deferrals
of client orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with minimal backlog.
As a result, sales in any quarter are dependent on orders booked and
shipped in that quarter and are not predictable with any degree of
certainty. Furthermore, the Company's systems can be relatively large and
expensive and individual systems sales can represent a significant portion
17
of the Company's revenues for a quarter such that the loss of even one such
sale can have a significant adverse impact on the Company's quarterly
profitability. Clients often defer systems purchases until the Company's
quarter end, so quarterly results generally cannot be predicted and
frequently are not known until the quarter has concluded. The Company's
initial contact with a potential customer depends in significant part on
the customer's decision to replace, or substantially modify, its existing
information system. How and when to implement, replace or substantially
modify an information system are major decisions for health care providers.
Accordingly, the sales cycle for the Company's systems can vary
significantly and typically ranges from three to 12 months from initial
contact to contract execution/shipment and the installation cycle is
typically two to four months from contract execution/shipment to completion
of installation.
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can
cause significant variations in operating results from quarter to quarter.
As a result, the Company believes that interim period-to-period comparisons
of its results of operations are not necessarily meaningful and should not
be relied upon as indications of future performance. Further, the Company's
historical operating results are not necessarily indicative of future
performance for any particular period.
Due to all of the foregoing factors, it is possible that in some future
quarter the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially adversely affected.
PROPRIETARY TECHNOLOGY - The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely
on license agreements, confidentiality procedures and employee
nondisclosure agreements to protect its intellectual property. The
Company's software is not patented and existing copyright laws offer only
limited practical protection. There can be no assurance that the legal
protections and precautions taken by the Company will be adequate to
prevent misappropriation of the Company's technology or that competitors
will not independently develop technologies equivalent or superior to the
Company's. Further, the laws of some foreign countries do not protect the
Company's proprietary rights to as great an extent as do the laws of the
United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no
assurance that others will not assert infringement or trade secret claims
against the Company with respect to its current or future products or that
any such assertion will not require the Company to enter into a license
agreement or royalty arrangements with the party asserting the claim. As
competing health care information systems increase in complexity and
overall capabilities and the functionality of these systems further
overlaps, providers of such systems may become increasingly subject to
infringement claims. Responding to and defending any such claims may
distract the attention of Company management and have a material adverse
effect on the Company's business, financial condition and results of
operations. In addition, claims may be brought against third parties from
which the Company purchases software, and such claims could adversely
affect the Company's ability to access third party software for its
systems.
18
CLINITEC - A principal component of the Company's business strategy is the
May 1996 acquisition of Clinitec. The Company's future financial results
will depend in part on the Company's ability to achieve market acceptance
for Clinitec's products and successfully integrate Clinitec's business with
the Company's. There can be no assurance that the Company will be able to
successfully coordinate its business activities with those of Clinitec.
Furthermore, there can be no assurance that the Company will be successful
in fully integrating Clinitec's products with those of the Company or that
the acquisition of Clinitec will not have an adverse effect upon the
Company's operating results. In addition, Clinitec was formed in January
1994 to develop and market electronic medical records software systems.
Clinitec's proprietary software products are relatively new and Clinitec
has sold only a limited quantity of these products to date. There can be
no assurance that Clinitec's products will achieve broad market acceptance.
MICROMED - A principal component of the Company's business strategy is the
May 1997 acquisition of MicroMed. The Company's future financial results
will depend in part on the Company's ability to achieve market acceptance
for MicroMed's products and successfully integrate MicroMed's business with
the Company's. There can be no assurance that the Company will be able to
successfully coordinate its business activities with those of MicroMed.
Furthermore, there can be no assurance that the Company will be successful
in fully integrating MicroMed's products with those of the Company or that
the acquisition of MicroMed will not have an adverse effect upon the
Company's operating results. In addition, MicroMed was formed in February
1993 to develop and market medical practice management software systems.
MicroMed's proprietary software products are new and MicroMed has sold only
a limited quantity of these products to date. There can be no assurance
that MicroMed's products will achieve broad market acceptance.
ABILITY TO MANAGE GROWTH - The Company has recently experienced a period of
growth and increased personnel which has placed, and will continue to
place, a significant strain on the Company's resources. The Company
anticipates expanding its overall software development, marketing, sales,
client management and training capacity. In the event the Company is
unable to identify, hire, train and retain qualified individuals in such
capacities within a reasonable time-frame, such failure could have a
material adverse effect on the Company. In addition, the Company's ability
to manage future increases, if any, in the scope of its operations or
personnel will depend on significant expansion of its research and
development, marketing and sales, management and administrative, and
financial capabilities. The failure of the Company's management to
effectively manage expansion in its business could have a material adverse
effect on the Company's business, results of operations and financial
condition.
PRODUCT LIABILITY - Certain of the Company's products provide applications
that relate to patient medical information. Any failure by the Company's
products to provide accurate and timely information could result in claims
against the Company. The Company maintains insurance to protect against
claims associated with the use of its products, but there can be no
assurance that its insurance coverage would adequately cover any claim
asserted against the Company. A successful claim brought against the
Company in excess of its insurance coverage could have a material adverse
effect on the Company's business, financial condition and results of
operations. Even unsuccessful claims could result in the Company's
expenditure of funds in litigation and management time and resources.
19
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess
of its insurance coverage, that the Company's insurance will cover such
claims or that appropriate insurance will continue to be available to the
Company in the future at commercially reasonable rates. Such claims could
have a material adverse affect on the Company's business, financial
condition and results of operations.
UNCERTAINTY IN HEALTH CARE INDUSTRY; GOVERNMENT REGULATION - The health
care industry is subject to changing political, economic and regulatory
influences that may affect the procurement processes and operation of
health care facilities. During the past several years, the health care
industry has been subject to an increase in governmental regulation of,
among other things, reimbursement rates and certain capital expenditures.
Certain legislators have announced that they intend to examine proposals to
reform certain aspects of the U.S. health care system including proposals
which may increase governmental involvement in health care, lower
reimbursement rates and otherwise change the operating environment for the
Company's clients. Health care providers may react to these proposals and
the uncertainty surrounding such proposals by curtailing or deferring
investments, including those for the Company's systems and related
services. Cost-containment measures instituted by health care providers as
a result of regulatory reform or otherwise could result in greater
selectivity in the allocation of capital funds. Such selectivity could
have an adverse effect on the Company's ability to sell its systems and
related services. The Company cannot predict what impact, if any, such
proposals or health care reforms might have on its business, financial
condition and results of operations.
The Company's software may be subject to regulation by the U.S. Food and
Drug Administration (the "FDA") as a medical device. Such regulation could
require the registration of the applicable manufacturing facility and
software/hardware products, application of detailed recordkeeping and
manufacturing standards, and FDA approval or clearance prior to marketing.
An approval or clearance could create delays in marketing, and the FDA
could require supplemental filings or object to certain of these
applications.
DEPENDENCE UPON KEY PERSONNEL - The Company's future performance also
depends in significant part upon the continued service of its key technical
and senior management personnel, many of whom have been with the Company
for a significant period of time. Because the Company has a relatively
small number of employees when compared to other leading companies in the
same industry, its dependence on maintaining its employees is particularly
significant. The Company is also dependent on its ability to attract and
retain high quality personnel, particularly highly skilled software
engineers for applications development. The industry is characterized by a
high level of employee mobility and aggressive recruiting of skilled
personnel. There can be no assurance that the Company's current employees
will continue to work for the Company. Loss of services of key employees
could have a material adverse effect on the Company's business, results of
operations and financial condition. The Company does not maintain key man
life insurance on any of its employees. The Company may need to grant
additional stock options to key employees and provide other forms of
incentive compensation to attract and retain such key personnel.
20
Item 2. PROPERTIES.
-----------
The Company's principal administrative, data processing, marketing and
development operations are located in approximately 17,000 square feet of
leased space in Tustin, California under a lease which expires in March
2000. In addition, the Company leases approximately 13,000 square feet of
space in Santa Ana, California to house its assembly and warehouse
operations, approximately 15,000 square feet of space in Horsham,
Pennsylvania, the principal office for Clinitec, and an aggregate of 2,000
square feet of space in Florida, Kansas, New York, Texas and Washington to
house additional sales, training and service operations. These leases,
including options, have expiration dates ranging from month-to-month to
March 2000 and provide for aggregate annual rental payments of
approximately $542,000. The Company believes that its facilities are
adequate for its current needs and that suitable additional or substitute
space is available, if needed.
21
Item 3. LEGAL PROCEEDINGS.
------------------
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State
of California for the County of Orange, in which Mr. Caveny, on behalf of
himself and all others who purchased the Company's Common Stock between
June 26, 1995 and July 3, 1996, alleges that the Company, and Sheldon
Razin, Robert J. Beck, Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma
G. Carmona, John A. Bowers, Graeme H. Frehner, and Gordon L. Setran (all of
the foregoing individuals were either officers, directors or both during
the period from June 26, 1995 through July 3, 1996), as well as other
defendants not affiliated with the Company, violated California
Corporations Code Sections 25400 and 25500, California Civil Code Sections
1709 and 1710, and California Business and Professions Code Sections 17200
and 17500, et. seq., by issuing positive statements about the Company that
allegedly were knowingly false, in part, in order to assist the Company and
the individual defendants in selling Common Stock at an inflated price in
the Company's March 5, 1996 public offering and at other points during the
class period. The complaint seeks compensatory and punitive damages in
unspecified amounts, disgorgement, declatory and injunctive relief, and
attorneys' fees. The Company and each of the individual defendants deny
all allegations of wrongdoing made against them in the lawsuit.
On May 14, 1997, a second purported class action entitled WENDY WOO v.
QUALITY SYSTEMS, INC., ET AL. was filed in the same court. This complaint
essentially repeats the allegations in the Caveny lawsuit and seeks
identical relief. The Company and the individual defendants deny all
allegations of wrongdoing made against them in this lawsuit as well.
The Company and its named officers and directors deny all allegations of
wrongdoing made against them in these suits, consider the allegations
groundless and without merit, and intend to vigorously defend against these
actions.
The Company is a party to various other legal proceedings incidental to its
business, none of which are considered by the Company to be material.
22
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
----------------------------------------------------
No matter was submitted to a vote of security holders during the fourth
quarter of fiscal year 1997.
Executive Officers of the Registrant
- ------------------------------------
The executive officers of the Company as of March 31, 1997 were
as follows:
Name Age Position
---- --- --------
Sheldon Razin 59 Chairman of the Board, Chief
Executive Officer, President
and Director
Robert J. Beck 57 Executive Vice President
Patrick B. Cline 36 Executive Vice President,
Director, and President and
Chief Operating Officer
of Clinitec
Greg Flynn 39 Vice President - Sales and
Marketing
Abe LaLande 46 Vice President - Hardware
Research and Development
Robert G. McGraw 39 Vice President - Chief
Financial Officer
Donn Neufeld 40 Vice President - Software
and Operations
Janet Razin 57 Vice President, Corporate
Secretary and Director
Executive officers of the Company are elected by, and serve at the
discretion of, the Board of Directors. Additional information regarding
the Company's executive officers is set forth below.
23
Sheldon Razin is the founder of the Company and has served as Chairman of
the Board of Directors and Chief Executive Officer since the Company's
inception. He also has served as the Company's President since its
inception except for the period from August 1990 to August 1991.
Additionally, Mr. Razin served as Treasurer from the Company's inception
until October 1982. Prior to founding the Company, he held various
technical and managerial positions with Rockwell International Corporation
and was a founder of the Company's predecessor, Quality Systems, a sole
proprietorship engaged in the development of software for commercial and
space applications and in management consulting work. Mr. Razin holds a
B.S. degree in Mathematics from the Massachusetts Institute of Technology.
Mr. Razin is the husband of Janet Razin.
Robert J. Beck joined the Company, and has served as its Executive Vice
President, since April 1992. In this capacity, he is heavily involved in
the Company's sales and marketing efforts. Mr. Beck has been associated
with turnkey health care computing applications since 1975, holding a
variety of increasingly responsible management positions in several
companies. Prior to joining the Company, Mr. Beck served as Executive Vice
President of Sandata, a provider of DME and Home Health Care Turnkey
Systems. Mr. Beck's experience includes founding and running a
corporation, The Hamilton Computer Group, Inc., which was at one time a
major competitor to the Company. He holds a B.A. degree in Mathematics and
Statistics from Hunter College.
Patrick B. Cline has served as a Director and Executive Vice President
since May 1996. Mr. Cline is a co-founder of Clinitec and has served as
its President since its inception in January 1994 and as its Chief
Operating Officer since May 1996 when it was acquired by the Company. Mr.
Cline served as Clinitec's Chairman of the Board of Directors and Chief
Executive Officer from January 1994 until May 1996. Prior to co-founding
Clinitec, Mr. Cline served, from July 1987 to January 1994, as Vice
President of Sales and Marketing with Script Systems, a subsidiary of
InfoMed, a health care information systems company. From January 1994 to
May 1994, after the founding of Clinitec, Mr. Cline continued to serve, on
a part time basis, as Script Systems' Vice President of Sales and
Marketing. Mr. Cline has held senior positions in the health care
information systems industry since 1981.
Greg Flynn has served as the Company's Vice President Sales and Marketing
since January 1996 after serving as Vice President Administration since
June 1992. In these capacities, Mr. Flynn has been responsible for
numerous functions related to sales and the ongoing management of the
Company. Previously, Mr. Flynn served as the Company's Vice President
Corporate Communications. Since joining the Company in January 1982, Mr.
Flynn has held a variety of increasingly responsible management positions
within the organization. Prior to joining the Company, Mr. Flynn was a
scriptreader/script consultant for a film production company. He holds a
B.A. degree in English from the University of California, Santa Barbara.
24
Abe LaLande has served as the Company's Vice President Hardware Research
and Development since February 1989 except from January 1997 to March 1997
when he was employed at Toshiba America, Inc. From 1979 to 1982, he served
as the Company's senior field service engineer, and from 1982 to 1988, he
served as Vice President Field Service and Production. During fiscal 1989,
Mr. LaLande left the Company for three months to work for Toshiba America,
Inc. Prior to joining the Company, Mr. LaLande held various senior field
service engineering positions with Mini-Computer Systems (October 1978 to
April 1979), Varian Associates (February 1978 to October 1978) and General
Automation (July 1977 to February 1978), all of which are computer
manufacturing companies. He holds an A.A. degree in Electronic Engineering
from Fullerton College and an A.S. degree in Computer Science from Control
Data Institute.
Robert G. McGraw joined the Company in February 1996 as Chief Financial
Officer. Prior to joining the Company, Mr. McGraw was the Chief Financial
Officer of CVD Financial Corporation, an asset-based commercial lender,
from March 1994 to February 1996. He was an independent financial
consultant from August 1989 to February 1991 and from March 1992 to
February 1994. From March 1991 to February 1992, Mr. McGraw was Chief
Financial Officer of MGV International, Inc., a diversified middle market
company with a personal computer manufacturing plant and wholesale
distribution operations. Mr. McGraw is a Certified Public Accountant and
holds an M.B.A. from UCLA and a B.A. with highest honors in Business
Economics from the University of California, Santa Barbara.
Donn Neufeld has served as the Company's Vice President-Software and
Operations since January 1996 and as Vice President - Operations from June
1986 until January 1996. From April 1981 until June 1986, Mr. Neufeld held
the position of Manager of Customer Support. He joined the Company in
December 1980 as part of the System Generation Department. Prior to
joining the Company, Mr. Neufeld was a System Analyst/Programmer at Loma
Linda University Medical Center.
Janet Razin has served as a Director, Vice President and Corporate
Secretary since the Company's inception and served as the Company's
Controller until November 1981. She served as Vice President Chief
Financial Officer from October 1982 until October 1984. Prior to joining
the Company, she was a computer programmer for Rockwell International
Corporation. Mrs. Razin holds a B.A. degree in Mathematics from
Northeastern University. Mrs. Razin is the wife of Sheldon Razin.
25
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
---------------------------------------------------------
The Company's Common Stock is traded on the Nasdaq National Market
under the symbol "QSII". The following table sets forth for the
quarters indicated, the reported high and low closing sales prices as
reported by Nasdaq. The quotations reflect inter-dealer prices,
without retail markup, markdown, or commissions and may not
necessarily represent actual transactions.
Quarter Ended High Low
------------------ -------- --------
June 30, 1995 5.13 3.00
September 30, 1995 17.88 4.63
December 31, 1995 32.25 12.88
March 31, 1996 30.00 18.00
June 30, 1996 35.25 17.00
September 30, 1996 18.50 7.38
December 31, 1996 9.88 6.00
March 31, 1997 8.38 6.13
At May 31, 1997 there were approximately 189 holders of record. The
Company estimates the number of beneficial holders of its Common Stock to
be in excess of 1,400.
On May 17, 1996, in connection with the acquisition of Clinitec, the
Company issued 309,846 unregistered shares of its Common Stock and paid
$4.9 million in cash to the shareholders of Clinitec to purchase the
remaining 75% ownership interest in Clinitec that the Company did not
already own (see "Item 1. Business. Clinitec."). The shares of Common
Stock were valued at $6.9 million, or $22.25 per share.
Through May 31, 1997, the Company has not paid cash dividends on shares of
its Common Stock. The Company anticipates that all future earnings, if
any, will be retained for use in the Company's business and it does not
anticipate paying any cash dividends in the future. Payment of future
dividends, if any, will be at the discretion of the Company's Board of
Directors after taking into account various factors, including the
Company's financial condition, operating results, current and anticipated
cash needs and plans for expansion.
26
Item 6. SELECTED FINANCIAL DATA.
- ---------------------------------
The following selected financial data with respect to the Company's
consolidated statements of operations for each of the five years in the
period ended March 31, 1997 and the balance sheet data as of the end of
each such fiscal year are derived from the audited financial statements of
the Company. The following information should be read in conjunction with
the consolidated Financial Statements of the Company and the related notes
thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere herein.
Consolidated Statement of Operations Data
(In thousands, except for per share data)
Year Ended March 31,
---------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
Net Revenues $20,127 $16,732 $12,049 $11,752 $11,651
Cost of Products
and Services 10,089 7,929 6,060 6,527 6,992
------- ------- ------- ------- -------
Gross Profit 10,038 8,803 5,989 5,225 4,659
Selling, General
and Administrative 7,736 3,897 3,536 3,052 3,008
Research and Development 1,978 1,567 1,467 1,318 1,134
Purchased In-Process
Research and
Development(1) 8,300 - - - -
------- ------- ------- ------- -------
Income (Loss) from
Operations (7,976) 3,339 986 855 517
Interest and
Other Income 1,285 482 429 400 192
------- ------- ------- ------- -------
Income (Loss) before
Provision for Income
Taxes (6,691) 3,821 1,415 1,255 709
Provision for
Income Taxes(2) 784 1,528 453 349 86
------- ------- ------- ------- -------
Net Income (Loss) $(7,475)$ 2,293 $ 962 $ 906 $ 623
======= ======= ======= ======= =======
Net Income (Loss)
per Share(3) $ (1.26)$ 0.48 $ 0.21 $ 0.21 $ 0.15
======= ======= ======= ======= =======
Weighted Average
Shares Outstanding 5,937 4,788 4,606 4,342 4,187
======= ======= ======= ======= =======
27
Consolidated Balance Sheet Data
(In thousands)
March 31,
---------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
Cash and Cash Equivalents
and Short-Term
Investments(4) $22,735 $28,944 $ 7,322 $ 6,071 $ 4,778
Working Capital 25,613 30,196 8,032 6,857 5,204
Total Assets 37,866 37,272 12,668 11,094 9,596
Total Liabilities 5,596 4,571 3,480 3,054 3,074
Shareholders' Equity(4) $32,270 $32,701 $ 9,188 $ 8,040 $ 6,522
======= ======= ======= ======= =======
(1) In May 1996, the Company acquired Clinitec (see "Item 1. Business.
Clinitec.") which was treated as a purchase transaction for accounting
purposes. In connection with this treatment, the Company incurred an
$8.3 million charge for purchased in-process research and development
during the year ended March 31, 1997.
(2) The provision for income taxes for the year ended March 31, 1993 is
net of an extraordinary credit resulting from the tax benefit from
utilization of net operating loss carryforwards.
The provision for income taxes for the year ended March 31, 1997
differs from the Company's combined Federal and State statutory rates
primarily due to the non-deductible charge for purchased in-process
research and development incurred in connection with the acquisition
of Clinitec in May 1996.
(3) Net income (loss) per share reflects primary income (loss) per share
for all periods indicated. Primary and fully diluted net income
(loss) per share were the same for all periods except for the year
ended March 31, 1994, for which fully diluted net income per share was
$0.20.
(4) In March 1996, the Company completed a secondary public offering of
one million shares of Common Stock resulting in net cash proceeds of
$20.2 million.
28
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION.
-----------------------------------------------------------
Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K, including discussions of the
Company's product development plans and business strategies and market
factors influencing the Company's results, are forward-looking statements
that involve certain risks and uncertainties. Actual results may differ
from those anticipated by the Company as a result of various factors, both
foreseen and unforeseen, including, but not limited to, the Company's
ability to continue to develop new products and increase systems sales in
markets characterized by rapid technological evolution, consolidation, and
competition from larger, better capitalized competitors. Many other
economic, competitive, governmental and technological factors could impact
the Company's ability to achieve its goals and interested persons are urged
to review the risks described in "Item 1. Business. Risk Factors." and in
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" set forth below, as well as in the Company's other public
disclosures and filings with the Securities and Exchange Commission.
GENERAL
Since fiscal 1995, approximately one-half of the Company's revenues have
been derived from sales of computer systems, upgrades and supplies, with
the balance derived from systems maintenance agreements and other support
services. On sales of its systems, upgrades and supplies, the Company
generally recognizes its contract revenues upon shipment of its systems and
products so long as the estimated costs to complete the systems are
insignificant. If such estimates to complete are significant, revenues are
recognized on a percentage of completion basis. Maintenance revenues are
recognized ratably over the life of the related agreements.
In the last several years, the majority of the Company's clients have
elected to purchase the Company's maintenance and support services.
Revenues from systems maintenance are typically recognized ratably over the
life of the contract. In recent years, the Company's maintenance revenues
have been increasing and the Company anticipates that these revenues will
continue to increase if systems sales increase. However, there can be no
assurance that future purchasers of the Company's systems will also
purchase the Company's maintenance services. Furthermore, if new systems
sales do not materialize, maintenance service revenues can be expected to
decrease over time due to failure to capture new maintenance revenues
therefrom and to attrition of existing maintenance revenues associated with
the Company's existing clients whose systems become obsolete or are
replaced by competitors' products.
In the recent past, the Company's systems sales have been impacted by a
number of factors which have had the effect of reducing systems sales
revenues and systems upgrade revenues while at the same time increasing the
potential relative profitability in percentage terms of these sales. For
example, the costs of the hardware components used in the Company's systems
have declined while the performance and capacity of such components have
continually increased. Consistent with the marketplace, the Company has
adjusted its systems pricing to its clients to reflect these decreased
hardware costs. Furthermore, the Company increasingly encounters
prospective clients that already own, or desire to acquire from third
29
parties, significant quantities of hardware which may be utilized with the
Company's software. In such instances, the revenues generated from such
clients are lower than they otherwise would be. As a result of these
market changes, the Company has increasingly experienced a number of new
systems sales comprised of greater revenues as a percentage of the total
system sale from the software user licenses and services components with
reduced or no revenues from hardware components, and such systems sales
generally yield higher margins than those systems sales that also include
significant hardware components. There can be no assurance that these
trends will continue.
With the recent increase in the capacity of the hardware components which
the Company markets, the Company has experienced a significant market for
the sale of additional software user licenses to its existing clients
because such clients can often add more software user capacity to their
systems with minimal or no change to their current central processing unit.
Such clients frequently also purchase hardware peripherals from the Company
for use with the newly purchased software user licenses. However, there
can be no assurance that these trends will continue and the Company's
existing client base represents a finite market that will not generate new
sales indefinitely. This trend may also negatively impact the Company's
sales of hardware upgrades in the future. Ultimately, the Company's growth
depends on new client sales.
Health care providers, faced with economic pressures to reduce costs and
increase productivity, are increasingly aligning with health maintenance
organizations, hospitals and other health care organizations as well as
consolidating with other health care providers into larger, more efficient
business entities. This trend results in an increase in the number of
large and complex health care organizations that are potential clients for
the Company's sophisticated systems. In addition, the potential growth of
these organizations after they become clients of the Company presents the
potential for the Company to increase sales of upgrades and additional
software user licenses. The Company's ability to address the complex
software requirements of such newly forming or growing business entities,
in particular in the area of managed care, is a key to success in this
changing health care delivery environment. Furthermore, there can be no
assurance that the Company will be successful in its efforts to market its
systems to a significant number of these newly formed organizations and an
inability to do so can have a material adverse effect on the Company's
business, financial condition and results of operations.
The sales cycle for the Company's systems typically ranges from three to 12
months from initial contact to contract execution/shipment. The
installation cycle is typically two to four months from contract
execution/shipment to completion of installation. The Company's products
are generally shipped as orders are received and accordingly, the Company
has historically operated with minimal backlog. As a result, sales in any
quarter are dependent on orders booked and shipped in that quarter and are
not predictable with any degree of certainty. Furthermore, the Company's
systems can be relatively large and expensive, and individual systems sales
can represent a significant portion of the Company's revenues for a quarter
such that the loss of even one such sale can have a significant adverse
impact on the Company's quarterly profitability. Clients often defer
systems purchases until the Company's quarter end, so quarterly results
generally cannot be predicted and frequently are not known until the
30
quarter has concluded. Because a significant percentage of the Company's
expenses are relatively fixed, a variation in the timing of systems sales
and installations can cause significant variations in operating results
from quarter to quarter. Thus, the Company believes that interim period-
to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future
performance.
The Company's research and development expenses consist primarily of
personnel and equipment costs required to conduct the Company's product
development effort. The Company believes that significant investments in
research and development are required to remain competitive. As a
consequence, in recent years, the Company has increased the amount of its
expenditures on research and development mainly through the employment of
additional development personnel. While the Company's current cash
position supports research and development expenditures even during periods
with relatively low revenues or gross profits, ultimately the Company's
ability to continue development of new products depends upon its ability to
generate new revenues. Because new revenues depend to a significant degree
upon new products, any interruption in either revenues or research and
development efforts could adversely affect the Company.
Development costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as
incurred until technological feasibility has been established. After
technological feasibility is established, any additional development costs
are capitalized and generally are amortized over three years.
In April 1995, the Company entered into a strategic relationship with
Clinitec, a developer of electronic medical records software systems. In
May 1995, in connection with this relationship, the Company acquired a 25%
ownership interest in Clinitec for $1.0 million in cash. On May 17, 1996,
the Company acquired the remaining 75% of Clinitec for approximately $4.9
million in cash plus 309,846 shares of QSI Common Stock and is operating
Clinitec as a wholly-owned subsidiary. For purposes of the May 1996
acquisition, the QSI Common Stock was valued at approximately $6.9 million,
or $22.25 per share. For accounting purposes, the acquisition was treated
as a purchase transaction. In connection with this treatment, the Company
incurred an $8.3 million charge for purchased in-process research and
development during the quarter ended June 30, 1996.
Clinitec was formed in January 1994 to develop and market electronic
medical records software systems. The Clinitec software products are
complementary to the Company's existing medical and dental practice
management product solutions. Clinitec's software products have been
developed using a graphical user interface client/server platform utilizing
desktop, laptop or pen-based PC configurations for compatibility with the
UNIX, Microsoft Windows, Windows NT and Windows 95 operating systems
together with a relational database enabling flexibility in screen
customization, reporting and logic flow.
Clinitec was not operating profitably prior to the acquisition and the
absorption of Clinitec's operating costs since the acquisition has
adversely affected the Company's profitability. The Company anticipates
that increased sales of Clinitec's products, together with operational
synergies, will ultimately contribute to greater profitability. However,
31
Clinitec's proprietary software products are relatively new and Clinitec
has sold only a limited quantity of these products to date. There can be
no assurance that Clinitec's products will achieve broad market acceptance.
If Clinitec's products are not successful, the Clinitec operation will
continue to impair the Company's profitability.
In May 1997, the Company purchased substantially all of the assets of
MicroMed, a developer and marketer of proprietary medical practice
management systems, for up to $10.8 million. The purchase price consists
of an initial cash payment of $4.8 million paid upon the May 1997 closing
of the transaction with an additional payment of up to $6.0 million due no
later than June 29, 1998. The additional payment will be determined using
a formula based primarily upon Revenues and Pre-Tax Operating Income, as
each is defined in the related Asset Purchase Agreement, for the twelve
month period ending March 31, 1998. Up to 15% of the additional payment,
if any, is payable in the Company's Common Stock at the sole election of
the Company with the balance of any such payment payable in cash. The
acquisition will be treated as a purchase for accounting purposes. In
connection with this treatment, the Company expects to allocate a
significant portion of the purchase price paid at the closing of the
transaction to purchased in-process research and development during the
quarter ending June 30, 1997.
MicroMed offers software applications that are complementary to NextGen and
expands the Company's practice management system product line which
historically has primarily been character-based software solutions.
MicroMed's software product has been developed using a GUI client/server
platform for compatibility with Windows 95 and Windows NT operating
systems, and a relational database that is ANSI SQL-compliant.
MicroMed was formed in 1993 and immediately prior to the acquisition,
MicroMed was not operating profitably. The Company anticipates that
increased sales of MicroMed's products, together with operational
synergies, will ultimately contribute to greater profitability. However,
MicroMed's proprietary software products are new and MicroMed has sold only
a limited quantity to date. There can be no assurance that Micromed's
products will achieve broad market acceptance. If MicroMed's products are
not successful, the MicroMed operation will impair the Company's
profitability.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Consolidated Financial Statements and
related notes thereto included elsewhere herein. Historical results of
operations, percentage margin fluctuations and any trends that may be
inferred from the discussion below are not necessarily indicative of the
operating results for any future period.
32
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, the percentage of
net revenues represented by each item in the Company's consolidated
statements of operations. The consolidated statements of operations
include the operations of Clinitec from May 17, 1996 (the date of its
acquisition) through March 31, 1997.
Year Ended March 31,
----------------------
1997 1996 1995
------ ------ ------
Net Revenues:
Sales of computer systems,
upgrades and supplies 58.7% 57.5% 47.1%
Maintenance and other services 41.3 42.5 52.9
------ ------ ------
100.0 100.0 100.0
Cost of Products and Services 50.1 47.4 50.3
------ ------ ------
Gross Profit 49.9 52.6 49.7
Selling, General and
Administrative Expenses 38.5 23.3 29.3
Research and Development Costs 9.8 9.4 12.2
Purchased In-Process
Research and Development 41.2 - -
------ ------ ------
Income (Loss) from Operations (39.6) 19.9 8.2
Investment Income 6.5 3.2 3.6
Equity in Loss of Clinitec
International, Inc. (0.1) (0.3) -
------ ------ ------
Income (Loss) before Provision
for Income Taxes (33.2) 22.8 11.8
Provision for Income Taxes 3.9 9.1 3.8
------ ------ ------
Net Income (Loss) (37.1%) 13.7% 8.0%
====== ====== ======
33
FOR THE YEARS ENDED MARCH 31, 1997 AND 1996.
After recognizing an $8.3 million charge for purchased in-process research
and development in connection with the Clinitec acquisition, the Company
incurred a net loss of $(7.5) million, or $(1.26) per share on 5,937,000
weighted average shares outstanding, for the year ended March 31, 1997 as
compared to net income of $2.3 million, or $0.48 per share on 4,788,000
weighted average shares outstanding, for the year ended March 31, 1996.
Net Revenues. Net revenues for the year ended March 31, 1997 increased
20.3% to $20.1 million from $16.7 million for the year ended March 31,
1996. Sales of computer systems, upgrades and supplies for the year ended
March 31, 1997 increased 22.7% to $11.8 million from $9.6 million for the
year ended March 31, 1996 after the consolidation of Clinitec's net
revenues in fiscal 1997. Without the inclusion of Clinitec's revenues, the
Company's sales of computer systems, upgrades and supplies declined 23.2%
in fiscal 1997 as compared to fiscal 1996. Net revenues from maintenance
and other services during the year ended March 31, 1997 grew 17.0% to $8.3
million from $7.1 million for the year ended March 31, 1996 resulting
primarily from an increase in revenues from the Company's larger client
base for recurring maintenance and other services together with the
consolidation of Clinitec's revenues in fiscal 1997.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 1997 increased 27.2% to $10.1 million from $7.9 million for
the year ended March 31, 1996 while costs of products and services as a
percentage of net revenues increased to 50.1% from 47.4% during the
comparable periods. The increase in costs of products and services in both
amount and as a percentage of net revenues during the year ended March 31,
1997 as compared to the year ended March 31, 1996 resulted primarily from
increased customer service, support, and training personnel for QSI during
fiscal 1997 plus the addition of such costs for Clinitec's personnel. The
increase in the amount of costs of products and services also resulted from
the higher net revenues attained in fiscal 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended March 31, 1997 increased 98.5%
to $7.7 million from $3.9 million for the year ended March 31, 1996
representing 38.5% and 23.3% of net revenues, respectively. The increase
in selling, general and administrative expenses in both amount and as a
percentage of net revenues is primarily the result of the consolidation of
Clinitec's selling, general and administrative expenses during fiscal 1997
and amortization expense related to certain intangible assets acquired in
connection with the Clinitec acquisition during fiscal 1997 as well as
higher selling, general and administrative expenses resulting from an
increase in QSI's selling efforts, including sales personnel, and
administrative infrastructure. The increase in selling, general and
administrative expenses as a percentage of net revenues between the
comparable periods also resulted from the differing cost structure of
Clinitec as compared to QSI's cost structure prior to the acquisition as
well as QSI's decrease in revenues before the inclusion of the Clinitec
revenues.
34
Research and Development Costs. Research and development costs for the
year ended March 31, 1997 increased 26.2% to $2.0 million from $1.6 million
for the year ended March 31, 1996 primarily due to the consolidation of
Clinitec's research and development costs during fiscal 1997. Research and
development costs as a percentage of net revenues remained relatively
unchanged at 9.8% and 9.4%, respectively.
Purchased In-Process Research and Development. In connection with the
acquisition of Clinitec in May 1996, Clinitec's in-process research and
development for which technological feasibility had not been established
was valued at $8.3 million. In accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed," software development costs must
be expensed until technological feasibility has been established.
Accordingly, the value of the purchased in-process research and development
was expensed during the year ended March 31, 1997. There were no
comparable transactions during the year ended March 31, 1996.
Investment Income and Equity in Loss of Clinitec International, Inc.
Investment income for the year ended March 31, 1997 increased 146.9% to
$1.3 million from $533,000 for the year ended March 31, 1996 primarily as a
result of an increase in funds available for investment during fiscal 1997
arising from the Company's $20.2 million secondary public offering
completed in March 1996. The Company acquired a 25% ownership interest in
Clinitec in May 1995 which the Company increased to 100% in May 1996.
During the period that the Company owned 25% of Clinitec, its investment
was accounted for under the equity method of accounting whereby the Company
recorded its proportionate share of Clinitec's losses as equity in loss of
Clinitec. Commencing in May 1996 when the Company acquired the remaining
75% of Clinitec, the Company consolidated Clinitec's results with those of
its own operations. Accordingly, the equity in loss of Clinitec of
$(51,000) for the year ended March 31, 1996 reflects the Company's
proportionate share of Clinitec's net loss from the date the Company
acquired its 25% ownership interest in Clinitec in May 1995 through March
31, 1996. Correspondingly, the equity in loss of Clinitec of $(31,000) for
the year ended March 31, 1997 reflects the Company's proportionate share of
Clinitec's net loss from April 1, 1996 until the Company began
consolidating Clinitec's results in May 1996 when the Company acquired the
remaining 75% ownership interest in Clinitec.
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 1997 was $784,000 and differs from the combined Federal and
state statutory rates primarily due to the non-deductible charge for
purchased in-process research and development as well as non-deductible
amortization of certain intangibles acquired in the Clinitec purchase. The
provision for income taxes for the year ended March 31, 1996 was $1.5
million, yielding a combined Federal and state effective rate of 40.0%
which approximates the Company's combined statutory rates for that period.
35
FOR THE YEARS ENDED MARCH 31, 1996 AND 1995.
Net income for the year ended March 31, 1996 increased 138.4% to $2.3
million from $1.0 million for the year ended March 31, 1995. Similarly,
net income per share on a fully diluted basis increased to $0.48 from $0.21
based on weighted average shares outstanding of 4,788,000 and 4,606,000,
respectively.
Net Revenues. Net revenues for the year ended March 31, 1996 increased
38.9% to $16.7 million from $12.0 million for the year ended March 31,
1995. This increase was due primarily to sales of computer systems,
upgrades (including software user licenses) and supplies which in total
grew 69.4% to $9.6 million from $5.7 million. This growth resulted from an
increase in the number of larger systems and increased sales of upgrades.
Net revenues from maintenance and other services grew 11.6% to $7.1 million
from $6.4 million as a result of a growing client base for recurring
services and increased time and materials billings for additional services.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 1996 increased 30.8% to $7.9 million from $6.1 million for
the year ended March 31, 1995. This increase was due primarily to the
increases in systems sold and net revenues. As a percentage of net
revenues, costs of products and services decreased to 47.4% from 50.3% due
to an increase in the proportion of net revenues with higher gross margins.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended March 31, 1996 increased 10.2%
to $3.9 million from $3.5 million for the year ended March 31, 1995 as a
result of increases in selling efforts and sales personnel. However,
because net revenues grew more rapidly between fiscal 1996 and fiscal 1995
as compared to the growth in selling, general and administrative expenses
during the comparable period, selling, general and administrative expenses
as a percentage of net revenues declined to 23.3% in fiscal 1996 as
compared to 29.3% in fiscal 1995.
Research and Development Costs. Research and development costs for the
year ended March 31, 1996 increased 6.8% to $1.6 million from $1.5 million
for the year ended March 31, 1995. Total research and development costs
and capitalized software costs for the year ended March 31, 1996 increased
17.6% to $1.9 million from $1.7 million for the year ended March 31, 1995.
Investment Income. Investment income for the year ended March 31, 1996
increased 24.2% to $533,000 from $429,000 for the year ended March 31, 1995
primarily as a result of an increase in funds available for investment
during fiscal 1996 as compared to fiscal 1995. The increase in available
funds for investment was significantly augmented during March 1996 with the
receipt of $20.2 million in net proceeds from the completion of the
Company's secondary public offering.
36
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 1996 increased 237.3% to $1.5 million from $453,000 for the
year ended March 31, 1995. This increase in fiscal 1996 was due to
increased earnings before the provision for income taxes and an increase in
the Company's effective tax rate. The effective tax rates for fiscal 1996
and 1995 were 40.0% and 32.0%, respectively. The effective rate for fiscal
1995 was lower than the effective rate for fiscal 1996 due to utilization
in fiscal 1995 of a deferred tax valuation allowance related to net
operating loss carryforwards. All of the Company's net operating loss
carryforwards were utilized during fiscal 1995 and as such there were no
similar tax benefits available for use in fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $520,000, $2.7 million and
$1.2 million for the years ended March 31, 1997, 1996 and 1995,
respectively. Net cash provided by operations for the year ended March 31,
1997 consisted primarily of the Company's net loss adjusted for the
principal non-cash operating expenses of depreciation, amortization and the
$8.3 million charge for purchased in-process research and development
incurred in connection with the acquisition of Clinitec, offset by an
increase in accounts receivable. The increase in accounts receivable
during fiscal 1997 results primarily from increased sales and the timing of
sales in fiscal 1997. Net cash provided by operations for the year ended
March 31, 1996 consisted principally of net income before depreciation and
amortization and an increase in accounts payable offset by an increase in
accounts receivable. The increase in accounts receivable during fiscal
1996 results primarily from increased sales and the timing of sales in
fiscal 1996. Net cash provided by operations for the year ended March 31,
1995 consisted principally of net income before depreciation and
amortization.
Net cash provided by (used in) investing activities was $(6.6) million,
$(1.3) million and $3.6 million for the years ended March 31, 1997, 1996
and 1995, respectively. Net cash used in investing activities for the years
ended March 31, 1996 and 1997 was principally impacted by QSI's purchase of
a 25% ownership interest in Clinitec for $1.0 million in cash during fiscal
1996 and QSI's purchase of the remaining 75% ownership interest during
fiscal 1997 for $4.9 million in cash and 309,846 shares of Common Stock.
Net cash provided by (used in) investing activities for all three years
also consists of changes in short-term investments as well as additions to
equipment and improvements and capitalized software.
Net cash provided by financing activities was $61,000, $20.4 million and
$151,000 for the years ended March 31, 1997, 1996 and 1995, respectively.
Net cash provided by financing activities for the year ended March 31, 1996
consists of $20.2 million of net proceeds from the Company's March 1996
secondary public offering of one million shares of the Company's Common
Stock and $182,000 of proceeds from the exercise of employee stock options
during the year. Net cash provided by financing activities for the years
ended March 31, 1997 and 1995 consists of the proceeds from the exercise of
employee stock options.
37
At March 31, 1997, the Company had cash and cash equivalents of $21.9
million and short-term investments of $883,000. Short-term investments
include a $642,000 investment in a fund which trades in special situation
securities. There can be no assurance that the markets for these
securities will not change, causing a loss of principal.
In March 1996, QSI raised $20.2 million to be used for general corporate
purposes, including the financing of product sales growth, development of
new products, working capital requirements, an increase in its ownership
interest in Clinitec (which was completed in May 1996), and the possible
acquisitions of complementary businesses and technologies.
The Company continues to evaluate potential investment opportunities and in
May 1997 acquired substantially all of the assets of MicroMed (see "Item 1.
Business. MicroMed.") for an initial cash payment of $4.8 million with an
additional payment of up to $6.0 million due on or before June 29, 1998.
Except for the acquisition of MicroMed and the Company's intention to
expend funds on capitalized software in connection with complementary
products to its existing product line, alternative versions of certain of
its products for the client/server environment to take advantage of more
powerful technologies and to enable a more seamless integration of the
Company's products, the Company has no other significant capital
commitments and currently anticipates that additions to equipment and
improvements for fiscal 1998 will be comparable to fiscal 1997.
The Company believes that its cash and cash equivalents and short-term
investments on hand at March 31, 1997, together with the cash flows from
operations, if any, will be sufficient to meet its working capital and
capital expenditure requirements for the next year.
38
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
--------------------------------------------
The Financial Statements of the Company identified in the Index to
Financial Statements appearing under "Item 14. Exhibits, Financial
Statement Schedules, and Reports on Form 8-K" of this report are
incorporated by reference to Item 14.
39
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
----------------------------------------------------------
None.
40
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
---------------------------------------------------
Except for information concerning the Company's executive officers which is
included under the caption "Executive Officers of the Registrant" following
Part I, Item 4 of this report, the information required by Item 10 is
incorporated by reference from the Company's definitive proxy statement
scheduled to be filed with the Commission on or before July 29, 1997 for
the Company's 1997 annual shareholders' meeting.
41
Item 11. EXECUTIVE COMPENSATION.
-----------------------
The information required by Item 11 is incorporated herein by reference
from the Company's definitive proxy statement scheduled to be filed with
the Commission on or before July 29, 1997 for the Company's 1997 annual
shareholders' meeting.
42
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
---------------------------------------------------
The information required by Item 12 is incorporated herein by reference
from the Company's definitive proxy statement scheduled to be filed with
the Commission on or before July 29, 1997 for the Company's 1997 annual
shareholders' meeting.
43
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
-----------------------------------------------
The information required by Item 13 is incorporated herein by reference
from the Company's definitive proxy statement scheduled to be filed with
the Commission on or before July 29, 1997 for the Company's 1997 annual
shareholders' meeting.
44
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K. Page
-------------------------------------------- ------
(a) Documents filed as part of this report.
(1) Index to Financial Statements
Independent Auditors' Report F-1
Consolidated Balance Sheets at March 31, 1997
and 1996 F-2
Consolidated Statements of Operations for
the Years Ended March 31, 1997, 1996 and 1995 F-3
Consolidated Statements of Shareholders'
Equity for the Years Ended March 31, 1997,
1996 and 1995 F-4
Consolidated Statements of Cash Flows for
the Years Ended March 31, 1997, 1996 and 1995 F-6
Notes to Financial Statements F-8
(2) Financial Statement Schedule.
Schedule II - Valuation and Qualifying Accounts F-24
(3) Exhibits.
INDEX TO EXHIBITS
Sequential
Page
Exhibit No.
------- ----------
3.1 Articles of Incorporation of the Company,
as amended, are hereby incorporated by
reference to Exhibit 3.1 to the Registrant's
Annual Report on Form 10-K for the year ended
March 31, 1984, File No. 2-80056.
3.2 Bylaws of the Company, as amended, are
hereby incorporated by reference to Exhibit 3.3 to
the Company's Registration Statement on
Form S-1, File No. 2-80056.
3.2.1 Certificate of Amendment of Bylaws of the
Registrant is hereby incorporated by
reference to Exhibit 3.2.1 to the
Registrant's Registration Statement on
Form S-1, File No. 333-00161.
45
INDEX TO EXHIBITS
(Continued) Sequential
Page
Exhibit No.
------- ----------
3.2.2 Text of Sections 2 and 3 of Article II of
the Bylaws of the Registrant is hereby
incorporated by reference to Exhibit 3.2.2
to the Registrant's Quarterly report on
Form 10-QSB for the period ended
December 31, 1996, file No. 0-13801.
10.2* 1989 Incentive Stock Option Plan is hereby
incorporated by reference to Exhibit 4.1 to
the Registrant's Registration Statement on
Form S-8, File No. 33-31949.
10.2.1* Form of Incentive Stock Option Agreement is
hereby incorporated by reference to
Exhibit 10.2 to the Registrant's Registration
Statement on Form S-1, File No. 333-00161.
10.2.2* Form of Non-Qualified Stock Option Agreement
is hereby incorporated by reference to
Exhibit 10.3 to the Registrant's Registration
Statement on Form S-1, File No. 333-00161.
10.3* Form of Incentive Stock Option Agreement is
hereby incorporated by reference to
Exhibit 10.2 to the Company's Registration
Statement on Form S-1, File No. 2-80056.
10.4* 1993 Deferred Compensation Plan, is hereby
incorporated by reference to Exhibit 10.5
to the Registrant's Annual Report on
Form 10-KSB for the year ended March 31, 1994,
File No. 0-13801.
10.4.2* Profit Sharing and Retirement Plan, as
amended, is hereby incorporated by reference
to Exhibit 10.4.2 to the Registrant's Annual
Report on Form 10-KSB for the year ended
March 31, 1994, File No. 0-13801.
10.4.3* Profit Sharing and Retirement Plan, as
amended, amendments No. 2 and 3, are hereby
incorporated by reference to Exhibit 10.4.3
to the Registrant's Annual Report on
Form 10-KSB for the year ended March 31, 1996,
File No. 0-13801.
10.5 Lease Agreement dated March 11, 1993 between
the Registrant and Craig Development
Corporation, is hereby incorporated by
reference to Exhibit 10.35 to the
Registrant's Annual Report on Form 10-K
for the year ended March 31, 1993
File No. 0-13801.
46
INDEX TO EXHIBITS
(Continued) Sequential
Page
Exhibit No.
------- ----------
10.6 Lease agreement dated September 12, 1994
between the Registrant and Koll/Realty
Orangewood Business Center General
Partnership, is hereby incorporated by
reference to Exhibit 10.8 to the
Registrant's Annual Report on Form 10-KSB
for the year ended March 31, 1995,
File No. 0-13801.
10.7 Series "A" Convertible Preferred Stock
Purchase Agreement, as amended, dated
April 21, 1995 between the Registrant and
Clinitec International, Inc., is hereby
incorporated by reference to Exhibit 10.11
to the Registrant's Annual Report on
Form 10-KSB for the year ended March 31, 1995,
File No. 0-13801.
10.8 Form of Indemnification Agreement is hereby
incorporated by reference to Exhibit 10.10 to
the Registrant's Registration Statement on
Form S-1, File No. 333-00161.
10.9 Marketing agreement, as amended, dated
April 1, 1995 between the Registrant and
Clinitec International, Inc., is hereby
incorporated by reference to Exhibit 10.12
to the Registrant's Annual Report on
Form 10-KSB for the year ended March 31, 1995,
File No. 0-13801.
10.10 Agreement and Plan of Merger, dated
May 16, 1996, by and among Quality Systems,
Inc., CII Acquisition Corporation, Clinitec
International, Inc. and certain shareholders
of Clinitec International, Inc. and certain
exhibits is hereby incorporated by reference
to Exhibit 2 to the Registrant's Current
Report on Form 8-K, dated May 17, 1996 and
filed May 30, 1996.
10.11 Employment agreement dated May 16, 1996 by
and between CII Acquisition Corporation and
Patrick Cline is hereby incorporated by
reference to Exhibit 10.1 to the
Registrant's Current Report on Form 8-K/A
dated May 17, 1996 and filed June 21, 1996.
47
INDEX TO EXHIBITS
(Continued) Sequential
Page
Exhibit No.
------- ----------
10.12 Shareholder Rights Agreement, dated as of
November 25, 1996, by and between Quality
Systems, Inc. and U.S. Stock Transfer Corp.
is hereby incorporated by reference to the
Exhibit to the Registrant's registration
statement on Form 8-A, file No. 001-12537.
10.13 Asset Purchase Agreement, dated May 5, 1997,
by and among MicroMed Healthcare Information
Systems, Inc., MHIS Acquisition Corp., Quality
Systems, Inc., and certain shareholders of
MicroMed Healthcare Information Systems, Inc.
is hereby incorporated by reference to
Exhibit 2 of Registrant's Current Report on
Form 8-K, dated May 15, 1997 and filed
May 29, 1997, File No. 0-13801.
21 List of Subsidiaries. 74
23.1 Independent Auditor's Consent - Deloitte &
Touche LLP. 76
27.1 Financial Data Schedule, is filed herewith.
* This exhibit is a management contract or a compensatory
plan or arrangement.
48
(b) Reports on Form 8-K:
On March 11, 1997, the Registrant filed a Current Report on Form
8-K dated February 12, 1997 disclosing the authorization by
Registrant's Board of Directors for management to repurchase on
the open market up to ten percent of the outstanding shares of
the Registrant's Common Stock at various times through February
12, 1998, subject to applicable laws and regulations. The timing
and amount of any repurchase is at the discretion of the
Registrant's management based upon its view of prevailing
economic and market conditions. The Registrant's management
could, in the exercise of its judgment, decide not to effect any
repurchases, or to repurchase fewer shares than authorized,
whether as a result of market factors or because of applicable
laws and regulations. No financial statements were filed in
connection with the Current Report on Form 8-K dated February 12,
1997.
49
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QUALITY SYSTEMS, INC.
By: /s/SHELDON RAZIN Date: June 11, 1997
----------------------------- ---------------------------
SHELDON RAZIN
Chairman of the Board of
Directors and President
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/SHELDON RAZIN Chairman of the Board of
- -------------------------- Directors and President June 11, 1997
SHELDON RAZIN (Principal Executive
Officer)
/s/JANET RAZIN
- -------------------------- Vice President, June 11, 1997
JANET RAZIN Secretary and Director
/s/ROBERT MCGRAW
- -------------------------- Vice President, June 11, 1997
ROBERT MCGRAW Chief Financial Officer
(Principal Financial
and Accounting Officer)
/s/JOHN BOWERS, M.D.
- -------------------------- Director June 11, 1997
JOHN BOWERS, M.D.
/s/WILLIAM BOWERS
- -------------------------- Director June 11, 1997
WILLIAM BOWERS
/s/GEORGE BRISTOL
- -------------------------- Director June 11, 1997
GEORGE BRISTOL
/s/PATRICK CLINE
- -------------------------- Director June 11, 1997
PATRICK CLINE
/s/GRAEME FREHNER
- -------------------------- Director June 11, 1997
GRAEME FREHNER
/s/GORDON SETRAN
- -------------------------- Director June 11, 1997
GORDON SETRAN
50
INDEPENDENT AUDITORS' REPORT
----------------------------
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated balance sheets of Quality
Systems, Inc. and subsidiary as of March 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows
for each of the three years in the period ended March 31, 1997. Our audits
also included the financial statement schedule listed in the Index of Item
14.(a)(2). These financial statements and schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion
on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Quality Systems, Inc. and
subsidiary as of March 31, 1997 and 1996, and the results of their
operations and their cash flows for the three years in the period ended
March 31, 1997 in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Costa Mesa, California
June 11, 1997
F-1
51
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
March 31,
------------------------
ASSETS 1997 1996
----------- -----------
Current Assets:
Cash and cash equivalents $21,852,000 $27,872,000
Short-term investments 883,000 1,072,000
Accounts receivable, less allowance
for doubtful accounts of $297,000
and $126,000, respectively 6,574,000 4,751,000
Inventories 1,071,000 853,000
Other current assets 628,000 135,000
----------- -----------
Total current assets 31,008,000 34,683,000
Equipment and Improvements, net 1,391,000 572,000
Capitalized Software Costs, net 1,041,000 599,000
Investment in Clinitec International, Inc. - 976,000
Excess of Cost Over Net Assets of Acquired
Business, net of accumulated amortization
of $274,000 and $ - , respectively 2,868,000 -
Other Assets 1,558,000 442,000
----------- -----------
Total assets $37,866,000 $37,272,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,345,000 $ 1,706,000
Deferred service revenue 1,493,000 1,031,000
Estimated costs to complete
system installations 565,000 402,000
Other current liabilities 1,992,000 1,348,000
----------- -----------
Total current liabilities 5,395,000 4,487,000
Deferred Tax Liability 201,000 84,000
----------- -----------
Total liabilities 5,596,000 4,571,000
----------- -----------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $0.01 par value,
20,000,000 shares authorized, 5,997,462
and 5,653,491 shares issued and
outstanding, respectively 60,000 56,000
Additional paid-in capital 34,144,000 27,148,000
Unrealized loss on available-for-sale
securities - (44,000)
Retained earnings (accumulated deficit) (1,934,000) 5,541,000
----------- -----------
Total shareholders' equity 32,270,000 32,701,000
----------- -----------
Total liabilities and
shareholders' equity $37,866,000 $37,272,000
=========== ===========
See notes to consolidated financial statements.
F-2
52
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended March 31,
-----------------------------------
1997 1996 1995
----------- ----------- -----------
Net Revenues:
Sales of computer systems,
upgrades and supplies $11,809,000 $ 9,623,000 $ 5,681,000
Maintenance and other services 8,318,000 7,109,000 6,368,000
----------- ------------ ----------
20,127,000 16,732,000 12,049,000
Cost of Products and Services 10,089,000 7,929,000 6,060,000
----------- ------------ -----------
Gross Profit 10,038,000 8,803,000 5,989,000
Selling, General and
Administrative Expenses 7,736,000 3,897,000 3,536,000
Research and Development Costs 1,978,000 1,567,000 1,467,000
Purchased In-Process
Research and Development 8,300,000 - -
----------- ------------ -----------
Income (Loss) from Operations (7,976,000) 3,339,000 986,000
Investment Income 1,316,000 533,000 429,000
Equity in Loss of Clinitec
International, Inc. (31,000) (51,000) -
----------- ------------ -----------
Income (Loss) before Provision
for Income Taxes (6,691,000) 3,821,000 1,415,000
Provision for Income Taxes 784,000 1,528,000 453,000
----------- ------------ -----------
Net Income (Loss) $(7,475,000)$ 2,293,000 $ 962,000
=========== ============ ===========
Net Income (Loss) per Share $(1.26) $0.48 $0.21
====== ===== =====
See notes to consolidated financial statements.
F-3
53
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Unrealized
Common Loss on Retained
Shares Issued Additional Available- Earnings
------------------ Paid-in for-Sale (Accumulated)
Number Amount Capital Securities Deficit)
---------- ------- ----------- ---------- -----------
Balance at
April 1, 1994 4,445,116 $44,000 $ 5,789,000 $ (79,000) $ 2,286,000
Exercise of
stock options 90,750 1,000 150,000 - -
Tax benefit
resulting from
stock options - - 39,000 - -
Unrealized loss,
net of $3,000
tax benefit - - - (4,000) -
Net income - - - - 962,000
---------- ------- ---------- ----------- -----------
Balance at
March 31, 1995 4,535,866 45,000 5,978,000 (83,000) 3,248,000
Sale of stock
in secondary
offering 1,000,000 10,000 20,244,000 - -
Exercise of
stock options 117,625 1,000 181,000 - -
Tax benefit
resulting from
stock options - - 745,000 - -
Unrealized gain,
net of $29,000
tax provision - - - 39,000 -
Net income - - - - 2,293,000
--------- ------- ----------- ---------- -----------
Balance at
March 31, 1996 5,653,491 56,000 27,148,000 (44,000) 5,541,000
See notes to consolidated financial statements.
F-4
54
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued)
Unrealized
Common Loss on Retained
Shares Issued Additional Available- Earnings
---------------- Paid-in for-Sale (Accumulated)
Number Amount Capital Securities Deficit)
-------- ------ ---------- ---------- -------------
Shares issued
in acquisition
of Clinitec
International,
Inc. 309,846 3,000 6,891,000 - -
Exercise of
stock options 34,125 1,000 60,000 - -
Tax benefit
resulting
from stock
options - - 45,000 - -
Disposition
of available
for-sale
securities,
net of
$34,000 tax
provision - - - 44,000 -
Net loss - - - - (7,475,000)
--------- ------- ----------- --------- -------------
Balance at
March 31, 1997 5,997,462 $60,000 $34,144,000 $ - $(1,934,000)
========= ======= =========== ========= =============
See notes to consolidated financial statements.
F-5
55
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended March 31,
-----------------------------------
1997 1996 1995
----------- ----------- ----------
Cash Flows from Operating
Activities:
Net income (loss) $(7,475,000) $2,293,000 $ 962,000
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Purchased in-process research
and development 8,300,000 - -
Depreciation and amortization 1,139,000 496,000 418,000
Gain on sale of short-term
investments and
fixed assets (85,000) (88,000) (233,000)
Equity in loss of Clinitec
International, Inc. 31,000 51,000 -
Deferred income taxes 102,000 180,000 (62,000)
Changes, net of amounts
acquired, in:
Accounts receivable (1,594,000) (1,754,000) (267,000)
Inventories (202,000) (70,000) 112,000
Other current assets (208,000) 19,000 13,000
Accounts payable (613,000) 1,109,000 (252,000)
Deferred service revenue 401,000 79,000 76,000
Estimated costs to complete
system installations 123,000 185,000 (130,000)
Income taxes payable, and
taxes related to equity
accounts 291,000 163,000 515,000
Other current liabilities 310,000 25,000 66,000
---------- ---------- ----------
Net Cash Provided By
Operating Activities 520,000 2,688,000 1,218,000
---------- ---------- ----------
Cash Flows from
Investing Activities:
Proceeds from sales of
short-term investments 402,000 1,426,000 12,725,000
Purchases of short-term
investments (50,000) (1,114,000) (8,758,000)
Additions to equipment and
improvements, net (855,000) (240,000) (162,000)
Additions to capitalized
software costs (850,000) (382,000) (191,000)
Purchase of ownership interests
in Clinitec International, Inc.(4,946,000) (1,027,000) -
See notes to consolidated financial statements.
F-6
56
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years Ended March 31,
------------------------------------
1997 1996 1995
----------- ----------- ----------
Change in other assets (302,000) - 9,000
----------- ----------- ----------
Net Cash Provided By (Used In)
Investing Activities (6,601,000) (1,337,000) 3,623,000
----------- ----------- ----------
Cash Flows from Financing
Activities:
Proceeds from exercise of
stock options 61,000 182,000 151,000
Proceeds from issuance
of common stock, net - 20,254,000 -
----------- ----------- -----------
Net Cash Provided By
Financing Activities 61,000 20,436,000 151,000
----------- ----------- ----------
Net Increase (Decrease) in Cash
and Cash Equivalents (6,020,000) 21,787,000 4,992,000
Cash and Cash Equivalents,
beginning of year 27,872,000 6,085,000 1,093,000
----------- ----------- ----------
Cash and Cash Equivalents, end
of year $21,852,000 $27,872,000 $6,085,000
=========== =========== ==========
Supplemental Information - During fiscal 1997, 1996 and 1995 the
Company made income tax payments of $431,000, $1,146,000 and $10,000,
respectively.
Detail of business acquired in
purchase transaction:
In-Process Research
and Development $8,300,000
Fair Value of Assets Acquired
(net of previous investment) 3,999,000
Liabilities Assumed (459,000)
Common Stock Issued in the
Acquisition (6,894,000)
----------
Cash Paid for the Acquisition,
net of cash acquired $4,946,000
==========
See notes to consolidated financial statements.
F-7
57
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiary, Clinitec
International, Inc. ("Clinitec"), (collectively the "Company") develop and
market proprietary computer information systems for medical and dental
group practices, dental schools, physician hospital organizations,
management service organizations, health maintenance organizations and
community health centers. The Company's proprietary software systems
include summary medical records and general patient information,
appointment scheduling, billing, insurance claims submission and
processing, managed care plan implementation and referral management,
treatment outcome studies, treatment planning, drug formularies, electronic
medical records, word processing and accounting. In addition to providing
fully integrated solutions, the Company provides its clients with
comprehensive hardware and software maintenance and support services,
system training services and electronic claims submission services.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - QSI acquired a 100% ownership interest in
Clinitec on May 17, 1996 (see Note 11). Accordingly, the accompanying
consolidated financial statements include all of the accounts of QSI for
the periods presented and the accounts of Clinitec for the period
commencing May 17, 1996 through March 31, 1997. All significant
intercompany amounts have been eliminated.
Revenue Recognition - Licenses and sales of computer systems and system
upgrades revenues are recognized at the time the basic software and
hardware is shipped, if the estimated costs to complete the system are not
considered significant, in accordance with Statement of Position 91-1,
"Software Revenue Recognition." Estimated costs to complete the systems
are normally insignificant and are charged to expense in the period in
which the sales are recognized. These costs typically include labor and
travel costs associated with training, installation and data conversion
services. If estimated costs to complete a system are significant, revenue
is recognized on a percentage of completion basis.
Maintenance revenue is recognized ratably over the life of the contract.
Advance maintenance revenue billings are included in deferred service
revenue.
Cash Equivalents - The Company considers all highly liquid interest earning
deposits purchased with an original maturity of three months or less to be
cash equivalents.
F-8
58
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Short-term Investments - The Company classifies its short-term investments
into one of the following categories:
Held to maturity - Debt securities for which the Company has the
intent and the ability to hold to maturity.
Trading - Debt securities that do not meet the "intent-to-hold"
criteria and equity securities, both of which are bought and held
principally for the purpose of being sold in the near term.
Available-for-sale - Debt securities that do not meet the "intent-
to-hold" criteria and which are not classified as trading
securities, as well as all equity securities not otherwise
classified as trading securities.
Held to maturity securities are carried in the balance sheet at cost
(unless there are declines in the values of individual securities that are
not due to temporary declines), and realized gains and losses are recorded
in the statement of operations in the period that they are earned or
incurred. Trading securities are carried in the balance sheet at fair
market value and unrealized gains and losses are recorded in the statement
of operations. Available-for-sale securities are carried in the balance
sheet at fair market value; realized gains and losses are recorded in the
statement of operations when they are earned or incurred, and unrealized
gains and losses, net of tax effect, are recognized as a component of
shareholders' equity.
Realized gains and losses from investment transactions are determined on a
first-in, first-out basis.
Accounts Receivable - A majority of the Company's system sales
are financed by third-party sources while the Company provides credit
for most maintenance contract sales. The Company performs ongoing
credit evaluations of its customers and maintains reserves for
potential credit losses which reserves have been within management's
expectations.
Inventories - Inventories are valued at lower of cost (first-in, first-out)
or market. Certain inventories are maintained for customer support
pursuant to service agreements and are amortized over a five-year period
using the straight-line method.
Equipment and Improvements - Equipment and improvements are stated at cost
less accumulated depreciation and amortization. Depreciation and
amortization of equipment and improvements are provided over the estimated
useful lives of the assets, or the related lease terms if shorter, by the
straight-line method. Useful lives range from five to seven years.
F-9
59
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Software Development Costs - Development costs incurred in the research and
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established, any
additional development costs are capitalized in accordance with Statement
of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." Such costs
are generally amortized over the lesser of three years or the economic life
of the related product. The Company performs an annual review of the
recoverability of such capitalized software costs. At the time a
determination is made that capitalized amounts are not recoverable based on
the estimated cash flows to be generated from the applicable software, any
remaining capitalized amounts are written off.
Excess of Cost Over Net Assets of Acquired Business and Intangible Assets -
Excess of costs over net assets of acquired business and intangible assets
are being amortized using the straight-line method over ten years and five
years, respectively. The Company performs an annual review of the
recoverability of such unamortized amounts. At the time a determination is
made that any portion of such unamortized amounts are not recoverable based
on the estimated cash flows to be generated from such assets, the excess
amount is written off.
Income Taxes - Income taxes are provided for the tax effects of
transactions reported in the financial statements and consist of taxes
currently due plus deferred taxes related primarily to differences between
the basis of assets and liabilities for financial and tax reporting. The
deferred tax assets and liabilities represent the future tax return
consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.
Deferred taxes also are recognized for operating losses that are available
to offset future taxable income and tax credits that are available to
offset future income taxes. Valuation allowances are established as a
reduction of net deferred tax assets when management cannot determine that
the recoverability of such assets is probable.
Earnings per Share - The net loss per share for the year ended March 31,
1997 was computed using the weighted average number of shares outstanding
during the year of 5,937,000 and any common share equivalents were excluded
because their impact would be anti-dilutive. The difference between
primary and fully diluted net income per share for each of the years ended
March 31, 1996 and 1995 was not significant. Net income per share for each
of the years ended March 31, 1996 and 1995 was calculated using the
weighted average number of common shares and common share equivalents
outstanding of 4,788,000 and 4,606,000, respectively. Common share
equivalents consist of the effect of stock options calculated using the
treasury stock method.
F-10
60
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Stock-Based Compensation - In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123,
"Accounting For Stock-Based Compensation" ("SFAS No. 123"), which was
adopted by the Company beginning April 1, 1996. SFAS No. 123 requires
expanded disclosures of stock-based compensation arrangements with
employees and encourages (but does not require) compensation cost to be
measured based on the fair value of the equity instrument awarded.
Companies are permitted, however, to continue to apply Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25"), which recognizes compensation cost based on the intrinsic
value of the equity instrument awarded. The Company will continue to apply
APB No. 25 to its stock-based compensation awards to employees and will
disclose the required pro forma effect on net income (loss) and net income
(loss) per share.
New Accounting Pronouncement - In February 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 128,
"Earnings per Share (EPS)" ("SFAS No. 128"), which is effective for
financial statements for interim and annual periods ending after December
15, 1997. SFAS No. 128 requires the Company to report Basic EPS, as
defined therein, which excludes all common share equivalents from the
earnings per share computation, and Diluted EPS, as defined therein, which
is calculated similar to the Company's primary earnings per share
computation. The Company has determined that the adoption of this
statement would not have had a material impact on the earnings per share
calculations for the periods presented in the accompanying consolidated
financial statements.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results in future periods
could differ from those estimates made in the current year.
Reclassifications - Certain amounts in the accompanying financial
statements have been reclassified to conform with the March 31, 1997
presentation.
NOTE 3 - CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
At March 31, 1997 and 1996, the Company had cash equivalents of $21,155,000
and $27,079,000, respectively, invested in a major national brokerage
firm's institutional fund that specializes in U.S. government securities
and commercial paper with high credit ratings.
F-11
61
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Short-term investments consist of the following components:
March 31,
----------------------
1997 1996
---------- ----------
Trading securities $ 883,000 $ 758,000
Available-for-sale securities - 314,000
---------- ----------
$ 883,000 $1,072,000
========== ==========
Trading securities include an investment of $642,000 and $576,000 as of
March 31, 1997 and 1996, respectively, in a fund which trades in special
situation securities. The Company bears no off-balance sheet risk on its
investments.
The following is a summary of available-for-sale securities:
March 31,
-----------------------
1997 1996
---------- ----------
Aggregate market $ - $ 314,000
Gross unrealized holding losses - 78,000
---------- ----------
Amortized cost basis for debt
securities issued by foreign
governments, denominated in
U.S. dollars $ - $ 392,000
========== ==========
Investment income for each of the three years ended March 31, 1997 consists
of the following:
Years Ended March 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
Interest income $1,240,000 $ 433,000 $ 196,000
Net gains (losses) on
short-term investments --
Realized 102,000 (10,000) 151,000
Unrealized (26,000) 90,000 82,000
Other - 20,000 -
---------- ---------- ----------
$1,316,000 $ 533,000 $ 429,000
========== ========== ==========
F-12
62
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 4 - CAPITALIZED SOFTWARE COSTS
Capitalized software costs at March 31, 1997 and 1996 were net of
accumulated amortization of $1,275,000 and $867,000, respectively.
Information related to net capitalized software costs is as follows:
Years Ended March 31,
----------------------------------
1997 1996 1995
---------- --------- ---------
Beginning of year $ 599,000 $ 502,000 $ 509,000
Capitalized 850,000 382,000 191,000
Amortization (408,000) (285,000) (198,000)
---------- --------- ---------
End of year $1,041,000 $ 599,000 $ 502,000
========== ========= =========
NOTE 5 - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
March 31,
----------------------------
1997 1996
---------- ----------
INVENTORIES:
Computer systems
and components $ 750,000 $ 509,000
Replacement parts for
certain client systems, net
of accumulated amortization
of $1,079,000 and $1,015,000,
respectively 274,000 295,000
Miscellaneous parts
and supplies 47,000 49,000
---------- ----------
$1,071,000 $ 853,000
========== ==========
F-13
63
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
EQUIPMENT AND IMPROVEMENTS:
March 31,
----------------------------
1997 1996
------------- ----------
Computers and electronic
test equipment $2,110,000 $1,393,000
Furniture and fixtures 622,000 330,000
Vehicles 72,000 88,000
Leasehold improvements 120,000 117,000
---------- ----------
2,924,000 1,928,000
Accumulated depreciation
and amortization (1,533,000) (1,356,000)
---------- ----------
$1,391,000 $ 572,000
========== ==========
OTHER ASSETS:
March 31,
----------------------------
1997 1996
------------- ----------
Intangible assets, net of
accumulated amortization
of $156,000 and $ - ,
respectively $ 734,000 $ -
Other 824,000 442,000
---------- ----------
$1,558,000 $ 442,000
========== ==========
OTHER CURRENT LIABILITIES:
March 31,
----------------------------
1997 1996
------------- ----------
Accrued payroll and
related expenses $ 848,000 $ 498,000
Deferred compensation 454,000 370,000
Deferred tax liability - 34,000
Other accrued expenses 690,000 446,000
---------- ----------
$1,992,000 $1,348,000
========== ==========
F-14
64
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6 - INCOME TAXES
The income tax provision consists of the following components:
Years Ended March 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Federal-
Current taxes $ 523,000 $ 1,072,000 $ 414,000
Deferred taxes 81,000 109,000 (36,000)
----------- ----------- -----------
604,000 1,181,000 378,000
----------- ----------- -----------
State-
Current taxes 159,000 305,000 101,000
Deferred taxes 21,000 42,000 (26,000)
----------- ----------- -----------
180,000 347,000 75,000
----------- ----------- -----------
$ 784,000 $ 1,528,000 $ 453,000
=========== =========== ===========
The income tax provision differs from an amount computed at the Federal
statutory rate as follows:
Years Ended March 31,
--------------------------------------
1997 1996 1995
----------- ----------- ------------
Federal income tax provision
at statutory rate (34%) $(2,275,000) $ 1,299,000 $ 481,000
Increases (decreases)
resulting from:
Non-deductible purchased
in-process research and
development 2,822,000 - -
Non-deductible amortization
of purchased intangible
assets 120,000 - -
State income taxes 127,000 234,000 107,000
Change in
valuation allowance - - (86,000)
Other (10,000) (5,000) (49,000)
----------- ----------- -----------
$ 784,000 $ 1,528,000 $ 453,000
=========== =========== ===========
The change in valuation allowance in 1995 is related to benefits arising
from federal and state net operating loss carryforwards.
F-15
65
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The net deferred tax benefits in the accompanying balance sheets include
the following components:
March 31,
----------------------
1997 1996
--------- ---------
Deferred tax assets -
Accounts receivable $ 167,000 $ 55,000
Inventories 62,000 30,000
Other current assets - 46,000
Accumulated depreciation 5,000 5,000
Investment in Clinitec
International, Inc. - 22,000
Accrued vacation and sick leave 193,000 106,000
Accrued liability for
deferred compensation 195,000 169,000
State income taxes 46,000 51,000
Net operating loss carryforward 201,000 -
--------- ---------
869,000 484,000
--------- ---------
Deferred tax liabilities -
Short-term investments (30,000) (3,000)
Inventories (12,000) (17,000)
Accumulated depreciation (38,000) (21,000)
Capitalized software (364,000) (259,000)
Deferred revenue (334,000) (302,000)
--------- ---------
(778,000) (602,000)
--------- ---------
$ 91,000 $(118,000)
========= =========
The deferred tax assets and liabilities have been shown net in the
accompanying balance sheets based on the long-term or short-term nature of
the items which give rise to the deferred amount.
At March 31, 1997, Clinitec had net operating loss carryforwards of
$502,000 of which $241,000 and $261,000 expire in the fiscal years ending
March 31, 2011 and 2012, respectively, for Federal income tax purposes and
in the fiscal years ending March 31, 1998 and 2000, respectively, for state
income tax purposes.
F-16
66
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - EMPLOYEE BENEFIT PLANS
QSI has a profit sharing and retirement plan (the "Retirement Plan") for
the benefit of substantially all of its employees. The Retirement Plan was
amended during the fiscal year ended March 31, 1994 to add 401(k) features.
Participating employees may defer up to 15% of their compensation per year.
The Company's annual contribution is determined by the Company's Board of
Directors and the Retirement Plan may be amended or discontinued at the
discretion of the Board of Directors. Contributions of $25,000, $20,000
and $21,000 were made to the Retirement Plan for the fiscal years ended
March 31, 1997, 1996 and 1995, respectively.
During the fiscal year ended March 31, 1994, the Company initiated a
deferred compensation plan (the "Deferral Plan") for the benefit of
officers and key employees. Participating employees may defer all or a
portion of their compensation for a Deferral Plan year. In addition, the
Company may, but is not required to, make contributions into the Deferral
Plan on behalf of participating employees. Each participating employee's
deferred compensation and share of Company contributions has been invested
in a life insurance policy which has death benefit and mutual fund
features. Investment decisions are made by each participating employee
from a family of mutual funds. The Company is the owner and beneficiary of
the life insurance policies and has an obligation to pay the greater of the
death benefit or the net cash surrender value upon each employee's death or
termination. The net cash surrender value of the life insurance policies
and the related Company obligation for deferred compensation was $454,000
and $370,000 at March 31, 1997 and 1996, respectively. The Company made
contributions of $10,000, $11,000 and $10,000 to the Deferral Plan for the
fiscal years ended March 31, 1997, 1996 and 1995, respectively.
NOTE 8 - EMPLOYEE STOCK OPTION PLANS
1981 Stock Option Plan - Under a shareholder approved incentive
stock option plan (the "1981 Plan") for officers and employees,
365,384 shares of common stock were reserved for the issuance of
options to purchase shares of common stock at the fair market value at
the date of grant. On October 31, 1991, the 1981 incentive stock
option plan expired and no additional shares could be granted under
the plan. As of March 31, 1995, all outstanding shares under this
plan had been exercised.
1989 Stock Option Plan - During fiscal 1990, the Company's shareholders
approved a stock option plan (the "1989 Plan") under which 1,000,000 shares
of common stock have been reserved for the issuance of options. The 1989
Plan provides that salaried officers, key employees and non-employee
directors of the Company or its subsidiaries may, at the discretion of the
Plan Administrator, be granted options to purchase shares of Common Stock
at an exercise price not less than 85% of their fair market value on the
option grant date.
F-17
67
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Upon an acquisition of the Company by merger or asset sale, each
outstanding option will be subject to accelerated vesting under certain
circumstances. The 1989 Plan will terminate on May 30, 1999, unless sooner
terminated by the Board. At March 31, 1997, options for 43,000 shares were
exercisable and 425,000 shares were available for future grant under the
1989 Plan.
A summary of option transactions under the 1981 Plan and 1989 Plan for the
three years ended March 31, 1997 is as follows:
Weighted
Average
Number Exercise
of Shares Price
----------- ----------
Outstanding, March 31, 1994 305,500 $ 1.57
Granted 5,000 3.75
Exercised (90,800) 1.66
Cancelled - -
-----------
Outstanding, March 31, 1995
(73,250 exercisable at a weighted
average price of $1.54) 219,700 1.57
Granted (weighted average
fair value of $291,000) 30,000 14.87
Exercised (117,600) 1.55
Cancelled (2,000) 26.50
-----------
Outstanding, March 31, 1996
(21,625 exercisable at a weighted
average price of $1.57) 130,100 4.28
Granted (weighted average
fair value of $3,188,000) 279,500 18.80
Exercised (34,125) 1.77
Cancelled (107,975) 15.59
-----------
Outstanding, March 31, 1997 267,500 $15.20
=========== ==========
F-18
68
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The outstanding stock options vest ratably over a four-year period
commencing from the respective option grant dates. Stock options
outstanding at March 31, 1997 are summarized as follows:
Options Outstanding
Weighted
Average
Number Remaining Weighted
Range of Outstanding at Contractual Average
Exercise Prices March 31, 1997 Life (Yrs.) Exercise Price
- --------------- -------------- ----------- --------------
$ 1.38 - $ 4.88 64,500 1.4 $ 1.59
6.75 - 11.50 77,000 4.8 7.06
23.50 - 27.50 126,000 4.2 27.15
--------------
$ 1.38 - $27.50 267,500 3.7 $15.20
=============== ============== =========== ==============
Options Exercisable
Number Weighted
Range of Exercisable at Average
Exercise Prices March 31, 1997 Exercise Price
--------------- -------------- --------------
$ 1.38 - $ 4.88 40,250 $ 1.57
6.75 - 11.50 - -
23.50 - 27.50 2,750 23.50
--------------
$ 1.38 - $27.50 43,000 $ 2.98
=============== ============== =============
As discussed in Note 2, the Company continues to account for its stock-
based awards using the intrinsic value method in accordance with APB No.
25. No compensation expense has been recognized in the financial
statements for employee stock arrangements.
SFAS No. 123 requires the disclosure of pro forma net income and earnings
per share had the Company adopted the fair value method as of the beginning
of fiscal 1996. Under SFAS No. 123, the fair value of stock-based awards
to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models
also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the
calculated values.
F-19
69
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company's calculations were made using the Black-Scholes option pricing
model with the following assumptions: expected life, twelve months
following full vesting; stock volatility, ranging from 68% to 101% in
fiscal 1997 and ranging from 71% to 95% in fiscal 1996; risk free interest
rates, 6.50% in fiscal 1997 and 6.50% in fiscal 1996; and, no dividends
during the expected term. The Company's calculations are based on a single
option valuation approach and forfeitures are recognized as they occur. If
the computed fair values of the fiscal 1997 and 1996 awards had been
amortized to expense over the vesting period of the awards, the pro forma
net loss would have been $(7,991,000), or $(1.35) per share, in fiscal 1997
and pro forma net income would have been $2,274,000, or $0.47 per share, in
fiscal 1996. These amounts are based on calculated values for option
awards in fiscal 1997 and 1996 of $3,188,000 and $291,000, respectively.
The impact of stock options granted prior to fiscal 1996 has been excluded
from the pro forma calculation; accordingly, the fiscal 1997 and 1996 pro
forma adjustments are not indicative of future period pro forma
adjustments, when the calculation may apply to all applicable stock
options.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and offices under noncancelable operating
lease agreements expiring at various dates through March 2000. The Company
has rental commitments under these agreements in fiscal 1998, 1999 and 2000
of $500,000, $455,000 and $272,000, respectively. Total rental expense for
all operating leases was $451,000, $385,000 and $387,000 for the years
ended March 31, 1997, 1996 and 1995, respectively.
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of business. The Company believes such
matters are without merit, or involve such amounts that unfavorable
disposition would not have a material adverse effect on the Company's
financial statements. (Also see Note 14.)
NOTE 10 - RELATED PARTY TRANSACTION
During the year ended March 31, 1996, the Company sold a computer system
for $335,000 to an entity whose founder and chief executive officer is also
a QSI Director. In connection with this sale, the Company also entered
into an agreement to pay a license fee based upon future revenues, if any,
from certain software templates that may be developed by the entity. As of
March 31, 1997, no such license fees have been earned.
F-20
70
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11 - ACQUISITION OF CLINITEC INTERNATIONAL, INC.
In April 1995, QSI entered into a strategic relationship with Clinitec, a
developer of electronic medical records software systems. In May 1995 in
connection with this strategic relationship, QSI acquired a 25% ownership
interest in Clinitec for $1.0 million in cash. On May 16, 1996, QSI and
Clinitec executed an Agreement and Plan of Merger, which was effected on
May 17, 1996, whereby QSI acquired the remaining 75% of Clinitec that it
did not already own for $4.9 million in cash and 309,846 shares of QSI
Common Stock. For purposes of the acquisition, the shares were valued at
$6.9 million, or $22.25 per share, for a total purchase price of $11.8
million for this remaining 75% ownership interest. On May 17, 1996, in
accordance with the terms of the transaction, Clinitec was merged with and
into a newly formed, wholly-owned subsidiary of the Company.
The acquisition was recorded as a purchase transaction. In connection with
this treatment, the $11.8 million paid in May 1996 together with the
Company's then existing $1.0 million investment in Clinitec and $484,000 of
assumed Clinitec liabilities was allocated to $1.9 million of acquired
identified assets, $8.3 million of acquired in-process research and
development, and $3.1 million of purchase price in excess of assets
acquired. At the May 1996 acquisition date, the technological feasibility
of the acquired in-process research and development had not been
established and, accordingly, the allocated value was charged to operations
during the year ended March 31, 1997.
The following unaudited pro forma information presents the consolidated
results of operation for the year ended March 31, 1996 as if the
acquisition had been consummated as of the beginning of that fiscal year.
Similar amounts for the year ended March 31, 1997 are not presented as the
pro forma impact was insignificant.
Pro forma net revenues $18,225,000
Pro forma net income $ 1,425,000
Pro forma net income per share $ 0.28
===========
The pro forma information is not necessarily indicative of the results of
operations that would have occurred nor of future results of the combined
enterprise.
F-21
71
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SHAREHOLDER RIGHTS PLAN
Each share of the Company's Common Stock includes a Right to purchase from
the Company one share of Common Stock for $40, subject to adjustment. These
Rights expire on November 25, 2006 and may not be exercised and will not
detach or trade separately from the Common Stock except as described below.
The Rights will detach from the Common Stock and may be exercised only if a
person or group without prior consent of the Company's board becomes the
beneficial owner of 15% or more of the Common Stock ("Stock Acquisition").
Existing shareholder positions as of November 22, 1996 of 15% or more of
the outstanding Common Stock do not trigger the Rights unless they acquire
additional shares without prior board consent. If a Stock Acquisition
occurs, the Rights flip-in and each Right entitles its holder (other than
shareholders who have caused the Stock Acquisition) to purchase, at the
Right's then current exercise price, Common Stock (or, if the number of
shares of authorized common stock is insufficient to permit the full
exercise of the Rights, cash, property or other securities of the Company)
having a formula value equal to twice the Right's exercise price. In
addition, if at any time following a Stock Acquisition, (i) the Company is
acquired in a merger or other business combination transaction in which the
Company is not the surviving corporation, or (ii) 50% or more of the
Company's assets or earnings power is sold or transferred, the Rights flip-
over and each unexercised Right will entitle the holder to purchase, at the
Right's then current exercise price, common shares of the successor having
a formula value equal to twice the Right's exercise price. The Rights may
be redeemed by the Company at any time prior to ten days following the date
the Company's board becomes aware of a Stock Acquisition (which period may
be extended by the Company's Board of Directors at any time while the
Rights are still redeemable). Upon the occurrence of a flip-in or flip-
over event, if the Rights are not redeemed, the Rights would result in
substantial dilution to any person who has caused the Stock Acquisition or
who attempts to merge or consolidate with the Company. As a result, the
Rights may deter potential attempts to acquire control of the Company
without the approval of the Company's Board of Directors.
F-22
72
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - STOCK REPURCHASE PLAN
On February 12, 1997, the Company's Board of Directors authorized the
repurchase on the open market of up to 10% of the Company's outstanding
Common Stock at various times through February 1998, subject to compliance
with applicable laws and regulations. The timing and amount of any
repurchase is at the discretion of the Company's management. The Company's
management could, in the exercise of its judgment, decide not to effect any
repurchases, or to repurchase fewer shares than authorized. Repurchased
shares, if any, will be held as treasury stock available for future
issuance by the Company. As of March 31, 1997, no shares have been
repurchased.
NOTE 14 - SUBSEQUENT EVENTS
Litigation - On April 22, 1997, a purported class action was filed in
California Superior Court on behalf of all persons who purchased the
Company's Common Stock between June 26, 1995 and July 3, 1996. The
complaint alleges that the Company and certain of its officers and
directors, as well as other defendants not affiliated with the Company,
violated sections of the California Corporations Code by issuing positive
statements about the Company that allegedly were knowingly false, in part,
in order to assist the Company and certain of its officers and directors in
selling Common Stock at an inflated price in the Company's March 5, 1996
public offering and at other points during the period specified. On May
14, 1997, a second purported class action was filed in the same court
essentially repeating the allegations of the April 22, 1997 suit. The
Company and its named officers and directors deny all allegations of
wrongdoing made against them in these suits, consider the allegations
groundless and without merit, and intend to vigorously defend against these
actions.
Acquisition - On May 15, 1997, the Company acquired substantially all of
the assets of MicroMed Healthcare Information Systems, Inc. ("MicroMed"), a
developer and marketer of proprietary information systems utilizing a
graphical user interface client/server platform for medical group
practices. The purchase price consists of an initial cash payment of $4.8
million paid at the closing of the transaction and an additional payment of
up to $6.0 million due no later than June 29, 1998. The additional payment
will be determined using a formula based primarily upon Revenues and Pre-
Tax Operating Income of the MicroMed Business, each as defined in the
related Asset Purchase Agreement, for the twelve months ending March 31,
1998. Up to 15% of the additional payment, if any, is payable in the
Company's Common Stock at the sole election of the Company with the balance
of any such payment payable in cash. The acquisition will be treated as a
purchase for accounting purposes. In connection with this treatment, the
Company expects to allocate a significant portion of the purchase price
paid at the closing of the transaction to purchased in-process research and
development which will be charged against operations during the quarter
ending June 30, 1997.
F-23
73
QUALITY SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Column C - Additions
---------------------
(2) Column E
Column B (1) Charged to Balance
Balance at Charged to other Column D at end
Column A beginning of costs and accounts Deductions of
Description period expenses describe describe Period
- ------------------ ------------ ---------- ---------- ---------- --------
Fiscal Year Ended:
March 31, 1997 $126,000 $171,000 $ 85,000(I) $ 85,000 $297,000
March 31, 1996 77,000 71,000 - 22,000 126,000
March 31, 1995 $ 66,000 $ 28,000 - $ 17,000 $ 77,000
============ ========== ========== ========== ========
(I) Acquired in connection with the purchase of Clinitec International,
Inc. on May 17, 1996.
F-24
74
EXHIBIT 21
75
EXHIBIT 21
------------
QUALITY SYSTEMS, INC.
List of Subsidiaries
1. Clinitec International, Inc., a California Corporation, is a wholly-
owned subsidiary of Quality Systems, Inc.
2. MHIS Acquisition Corp., a California Corporation, is a wholly-owned
subsidiary of Quality Systems, Inc.
76
EXHIBIT 23.1
77
EXHIBIT 23.1
- ------------
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements
Number 2-82773 and 33-31949 on Form S-8 of our report dated June 11, 1997
appearing in this Annual Report on Form 10-K for Quality Systems, Inc. for
the year ended March 31, 1997.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Costa Mesa, California
June 11, 1997