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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, 1998
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
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 29, 1998: $36,609,000
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of May 29, 1998: 5,997,612.
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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 1998 annual
meeting which is to be filed with the Commission on or before July 29,
1998.
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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
Registrant's product development plans, business strategies and market
factors influencing the Registrant's results, are forward-looking
statements that involve certain risks and uncertainties. Actual results
may differ from those anticipated by the Registrant as a result of various
factors, both foreseen and unforeseen, including, but not limited to, the
Registrant's ability to continue to develop new products and increase
systems sales in markets characterized by rapid technological evolution;
consolidation within the Registrant's target marketplace and among the
Registrant's competitors; and, competition from larger, better capitalized
competitors. Many other economic, competitive, governmental and
technological factors could impact the Registrant's ability to achieve its
goals and interested persons are urged to review the risks described under
"Item 1. Business. Risk Factors." and in "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations." as well as
in the Registrant's other public disclosures and filings with the
Securities and Exchange Commission.
COMPANY OVERVIEW.
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiaries, Clinitec
International, Inc. ("Clinitec") and MicroMed Healthcare Information
Systems, Inc. ("MicroMed"), (collectively, the "Company") develop and
market healthcare information systems that automate medical and dental
group practices, physician hospital organizations ("PHOs"), management
service organizations ("MSOs"), and community health centers. In response
to the growing need for more comprehensive, cost-effective information
solutions for physician and dental practices, the Company's systems provide
its clients with the ability to redesign patient care and other workflow
processes, improve productivity, reduce information processing and
administrative costs, and provide multi-site access to patient information.
The Company's proprietary software systems include general patient
information, electronic medical records, appointment scheduling, billing,
insurance claims submission and processing, managed care plan
implementation and referral management, treatment outcome studies,
treatment planning, drug formularies, dental charting, and letter
generation. In addition to providing fully integrated software information
solutions to its clients, the Company offers comprehensive hardware and
software installation services, maintenance and support services, system
training services, and electronic insurance claims submission services.
The Company currently has an installed base of more than 500 healthcare
information systems serving PHOs, MSOs, group practices, specialty
practices, dental schools and other healthcare organizations, each of which
consists of from one to 250 physicians or dentists. The Company believes
that as healthcare providers are increasingly required to reduce costs
while maintaining the quality of healthcare, the Company will be able to
capitalize on its strategy of providing fully integrated information
systems and superior client 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 healthcare organizations and further expanded its
information processing systems into the broader medical market. Today, QSI
primarily develops and provides integrated character-based healthcare
information systems utilizing a UNIX* operating system for both the medical
and dental markets ("Legacy Product"). These expandable systems operate on
a stand-alone basis or in a networked environment.
Augmenting its medical practice management software system, QSI added
Clinitec's electronic medical records software, NextGen**, to its product
line in 1995 and completed its acquisition of Clinitec in May 1996 (see
"Item 1. Business. Acquisitions."). NextGen allows healthcare providers
to create and maintain medical records using a series of user-definable
clinical "templates". Data is generally captured using a light pen or a
mouse, and entries are then turned into sentences and/or paragraphs to
create documentation. NextGen also supports the scanning and annotation of
paper documents, photographs and X-rays, and contains many other advanced
features. NextGen is marketed both in conjunction with the Company's
practice management software offerings as well as on a stand-alone basis
where NextGen may interface with other practice management systems. With
the addition of NextGen, the Company believes that it currently provides a
comprehensive information management solution for the medical marketplace.
In September 1996, QSI entered into a software licensing and development
agreement to utilize and market a computerized oral health records system
for dental practitioners ("Charting Product"). QSI continues to modify and
expand the product's source code to meet the needs of large dental groups
and has interfaced this charting system with the dental Legacy Product.
The dental charting software incorporates specific clinical information
associated with tooth and perio charting, video image management (including
interfacing with digital X-ray equipment and intra-oral cameras),
periodontal screening and recording examination ("PSR") results and patient
education, and maintains chart notes in both text and audio form. The
system is being developed with a client/server architecture; a GUI design
utilizing either Windows 95 or Windows NT operating system platforms; and,
a platform independent relational database that is ANSI SQL-compliant. In
addition, the dental charting software can be integrated with components
from the NextGen electronic medical records system to form the base for a
chartless, paperless dental office environment.
Further augmenting its medical practice management system product line, the
Company purchased MicroMed in May 1997 (see "Item 1. Business.
Acquisitions."). MicroMed develops and markets proprietary medical
practice management systems. MicroMed's practice management system
("Windows Product") has been developed with a client/server architecture; a
GUI design utilizing either Windows 95 or Windows NT operating system
platforms; and, a platform independent relational database that is ANSI
SQL-compliant. MicroMed's product is designed to provide a flexible,
enterprise-wide solution employing a master patient index.
* 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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ACQUISITIONS.
CLINITEC.
Clinitec was formed in 1994 to develop and market electronic medical
records software systems. In April 1995, QSI entered into a strategic
relationship with Clinitec providing QSI with certain marketing rights to
Clinitec's products. In May 1995, as part of this relationship, QSI
acquired a 25% equity interest in Clinitec for $1.0 million in cash. In
May 1996, QSI 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 the remaining 75% ownership interest. For accounting purposes, the
acquisition was treated as a purchase transaction during the fiscal year
ended March 31, 1997. In connection with this accounting treatment, the
Company recorded an $8.3 million charge representing the value of
Clinitec's in-process research and development.
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.
MicroMed was formed in 1993 to develop and market medical practice
management software systems. In May 1997, the Company purchased
substantially all of the assets of MicroMed for $10.5 million. The
purchase price consisted of an initial cash payment of $4.8 million paid
upon the May 1997 closing of the transaction with an additional payment of
$5.7 million due no later than June 29, 1998. QSI anticipates paying $1.8
million of the additional payment in QSI Common Stock. For accounting
purposes the acquisition was treated as a purchase transaction during the
fiscal year ended March 31, 1998. In connection with this accounting
treatment, the Company recorded a $10.2 million charge representing the
value of MicroMed's in-process research and development.
MicroMed's proprietary software products are relatively 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
or will successfully compete with other Windows based practice management
software products.
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INDUSTRY BACKGROUND.
To compete in the changing healthcare environment, physicians and other
outpatient care providers are increasingly joining and affiliating with
other physicians, managed care organizations, hospitals and other
enterprises to form larger healthcare organizations such as PHOs, MSOs and
health maintenance organizations ("HMOs"). These organizations are
designed to take advantage of anticipated economies of scale associated
with managing healthcare services for large patient populations across
inpatient and outpatient settings while achieving improved quality, reduced
costs and strengthened negotiating positions with managed care entities.
Similarly, the dental profession has recently seen consolidation of dental
practices driven by many of the same factors as in the medical profession.
The consolidation occurring among medical and dental providers,
respectively, has created business organizations which require more
sophisticated computer information systems.
As the managed care environment continues to expand as many experts expect,
more healthcare provider organizations enter into contracts, and often
multiple 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 and dental practices. To operate effectively, healthcare provider
organizations must efficiently manage patient care and other workflow
processes which increasingly extend across multiple care locations and
business entities.
To compete under the constraints of managed care while maintaining quality
of services, healthcare provider 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 "back-office"
data with such clinical information 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 primary care
provider. In addition, large healthcare organizations increasingly require
information systems that can deliver high-performance in environments with
multiple concurrent computer users.
Many existing healthcare information systems, including numerous systems
currently utilized by the solo practitioner 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 healthcare
industry continues to evolve, physician and dental groups and other
healthcare organizations will increasingly require systems that compile
structured clinical information from multiple sources and enable
measurement of treatment outcomes and management of clinical processes.
The Company believes that systems which integrate this patient clinical
data with administrative, financial and other practice management data to
maintain patient flow while continuing to reduce costs and improve quality
of care are best positioned to succeed in the evolving managed care
environment.
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As healthcare organizations transition to new computer platforms and newer
technologies, experts believe such organizations 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,
therefore, that successful systems vendors in the market most likely will
have a sufficient installed base and adequate resources to offer high
quality, fully integrated products together with the value-added services
needed to expand and support growing clients throughout this evolutionary
process.
PRODUCTS.
In response to the growing need for more comprehensive, cost-effective
healthcare information solutions for physician and dental practices, the
Company's systems provide its clients with the ability to redesign patient
care and other workflow processes while improving productivity through
multi-site and multi-user access to patient information. Utilizing proven
third-party hardware solutions combined with the Company's proprietary
software configured to maximize the efficiency of a healthcare
organization's information processing requirements, the Company's solutions
enable an integration of a variety of administrative and clinical
information operations. Leveraging 25 years of experience in the
healthcare 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.
PRACTICE MANAGEMENT SYSTEMS.
The Legacy Product consists primarily of proprietary healthcare software
applications together with third-party hardware and other non-industry
specific software. The systems range in capacity from one to hundreds of
users, allowing the Company to address the needs of both small and large
organizations. The systems are modular in design and may be expanded to
grow with changing client requirements.
The software configuration for a typical Legacy Product system includes a
basic medical or dental application and additional software to meet
identified needs of each client. The basic Legacy Product software
automates many aspects of group practice management, including general
patient registration, appointment scheduling, billing, insurance claims
submission and processing, and treatment planning. Add-on applications
include such modules as outside referral management for managed care,
patient eligibility, electronic insurance claims and electronic patient
statements processing, and various proprietary and third party accounting
and word processing packages.
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A typical Legacy Product system also consists of third party hardware
components, including one or more central processing units, disk drives,
magnetic tape units, video display terminals, PCs, and printers together
with telecommunications equipment, which the client often purchases as a
turnkey system from the Company. The Legacy Product system 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 enabling a wide
range of flexible and functional systems. The hardware components, as well
as the requisite operating system licenses, are purchased from
manufacturers or distributors of those components. QSI assembles and tests
the hardware components and incorporates the Legacy Product software and
other third party packages into completed systems tailored to accommodate
particular client requirements. The Company continually evaluates the
hardware components of its systems with a view toward utilizing hardware
that is functional, reliable and cost-effective.
The Windows Product expands the Company's practice management system
product line which historically has been primarily character-based software
solutions as have most of the products offered by the Company's
competitors. The Windows 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.
The Windows Product, which has been designed initially for healthcare
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 Windows Product is designed to be used on any computer that supports
Windows 95 or Windows NT operating systems. The system's three-tiered
architecture allows work to be performed on the database server, the
application server and the client workstation. To date, the Company
generally has made hardware recommendations for the Windows Product to its
clients based upon information provided by each client. However, the
client is responsible for the ultimate selection, installation and
integration of the hardware which each client purchases directly from third
party suppliers other than the Company.
In December 1996, the Company announced the release of an Internet dental
practice management product, QSINET, that includes such features as patient
registration, scheduling, collections and receivables tracking, treatment
planning, and management reporting. QSINET connects dental groups to the
extensive and growing electronic commerce network enabling users to process
insurance claims and patient statements more rapidly and also allows the
practice to communicate with its patients via e-mail for appointment
reminders, treatment recalls, and other patient notifications. The system
can be accessed anywhere at any time using a personal computer with
Internet access. In addition, the Company has also provided an intranet
solution to one of its clients based on the QSINET product. The Company
does not generally provide any hardware in connection with its
Internet/intranet products.
* RS6000 is a registered trademark of International Business Machines
Corporation.
** AIX is a registered trademark of International Business Machines
Corporation.
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CLINICAL SYSTEMS.
Clinitec provides software applications that are complimentary to, and
interface with, the Company's medical practice management offerings. The
applications incorporated into the Company's practice management solutions
(such as scheduling, eligibility, billing and claims processing) are
augmented by clinical information captured by Clinitec's NextGen, including
services rendered and diagnoses used for billing purposes. NextGen was
developed with a client/server architecture and a graphical user interface
("GUI") utilizing Microsoft Windows 95 or Windows NT on each workstation
and either Windows NT, UNIX or Novell* on the server. NextGen maintains
data using an industry standard relational database engine such as
Microsoft SQL Server**, INFORMIX*** or Oracle****. The system is scaleable
from one to hundreds of workstations.
NextGen stores and maintains clinical data including:
* Data captured using user-customized input "templates";
* Scanned or electronically acquired images, including X-rays
and photographs;
* Data electronically acquired through interfaces with clinical
instruments;
* Other records, documents or notes, including electronically
captured handwriting and annotations; and,
* Digital voice recordings.
NextGen also offers a workflow module, prescription management, automatic
document and letter generation, patient education, referral tracking,
interfaces to billing and lab systems, physician alerts and reminders, and
powerful reporting and data analysis tools.
NextGen is sold either as a combination of software and services, or as a
turn-key system including computer hardware, which can include network
servers, PC workstations, tape back-up units, printers, scanners and
requisite operating system software. Computer hardware for turn-key
systems are purchased for resale by Company from third party manufacturers
or distributors.
* Novell is a registered trademark of Novell, Inc.
** Microsoft is a registered trademark and SQL Server is
a trademark of Microsoft Corporation.
*** INFORMIX is a registered trademark of Informix Corporation.
**** Oracle is a registered trademark of Oracle Corporation.
10
The Company added a recently developed dental charting software system, the
Charting Product, to its product line during the year ended March 31, 1998.
The Charting Product interfaces with the dental Legacy Product, and with
the anticipated integration with components of NextGen, the Company
believes it will provide a comprehensive solution to dental group
practices. The system is being developed with a client/server
architecture; a GUI design utilizing either Windows 95 or Windows NT
operating system platforms; and, a platform independent relational database
that is ANSI SQL-compliant.
The Charting Product enables the user to perform such tasks as:
* Electronic tooth, perio and PSR charting;
* Digital X-ray, intra-oral and extra-oral cameras, and
video image review;
* Treatment planning and presentations;
* Patient education;
* Clinical notation in voice, graphic and text format; and,
* Access to historical patient records and clinical notes.
The comprehensive dental solution offered by the Company will form the
basis for a chartless, and perhaps eventually paperless, dental office.
The Charting Product incorporates client/server technology consisting of
one or more file servers together with any combination of one or more
desktop, laptop, or pen-based PC workstations. It is anticipated that file
servers used in connection with the Charting Product will utilize a Windows
NT operating system and the hardware will typically be a PC with one or
more Pentium* or equivalent processors. Based on the server configuration
chosen, the Company anticipates that the Charting Product will be scalable
from one workstation to hundreds of workstations. A typical configuration
may also include one or more disk drives, magnetic tape units and printers
together with telecommunications equipment, intra-oral and extra-oral
cameras, and digital X-ray equipment. The hardware components, including
the requisite operating system licenses, are purchased from third party
manufacturers or distributors either directly by the customer or by the
Company for resale to the customer.
SALES AND MARKETING.
The Company sells and markets its products nationwide through a direct
sales force. 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 practices as well as trade journal
advertising, direct mail advertising, and telemarketing.
These sales employees are knowledgeable about medical and dental group
healthcare entities, as well as computer applications. Typically, sales
employees make presentations to potential clients by demonstrating the
system and its capabilities on the prospective client's premises. In
addition for certain of its products, the Company performs remote
demonstrations by utilizing a prospective client's PC or by sending the
prospective client a telecommunications kit including a terminal.
* Pentium is a registered trademark of Intel Corporation.
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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. As part of the fees paid by its clients, the
Company receives up-front licensing fees and a monthly or quarterly service
fee based on system configuration.
To date, the Company has maintained separate sales forces along product
lines. As appropriate, sales leads for each other's products are passed
between the sales forces. In certain instances, a joint sales team is
utilized to sell combined systems. Effective June 1, 1998, the Company
plans to substantially merge its medical Legacy Product and Windows Product
sales forces.
Several clients have purchased the Company's practice management system
and, in turn, are providing either time-share or billing services to local
single and group practice practitioners. Under the time-share or billing
service 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 client's customers, implementation of such arrangements
has resulted in the purchase of additional system capacity by the client
offering the services, as well as new system purchases made by the client's
customers should such customers decide to perform the practice management
functions in-house.
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 service basis or by directing the Company to contract with those
practices for the sale of stand-alone systems.
The Company has also 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 to date, the
dealer markets and sells the Legacy Product to prospects in a local
territory. These prospects are generally smaller healthcare facilities
than those actively pursued by the Company. The Company's PC-based Legacy
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 place of the Company.
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. Many of the
clients purchasing systems have been assisted by the Company in finding
sources of financing for such purchases.
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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, 1998, 1997 or 1996.
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 the Legacy Product systems have
a dedicated computer port for dial-up remote access facilitating rapid
response by technicians to system inquiries. Most inquiries can be resolved
without the need to dispatch technicians to the client location. These
support services also provide the Company 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'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. This system
support ranges from correcting minor procedural problems in the client's
system to performing complex database reconstructions or software updates.
The Company also utilizes an automated on-line support system for the
Legacy Product which assists clients in resolving minor problems and
facilitates automated electronic retrieval of problems and symptoms
following a client's call to the automated support system. Additionally,
this on-line support system maintains a complete call record at both the
client's facility and the Company.
The Company offers its clients support services for most system components,
including hardware (generally, except for the Windows Product to date) and
software maintenance, for a fixed monthly or quarterly fee. The Company
also subcontracts, in certain instances, 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.
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 system, a client manager/implementation specialist, trained
in medical and/or dental group practice procedures, is assigned to assure
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 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.
13
Before activation of the client's practice management system, Company
personnel typically convert, or assist in conversion of, the relevant
client data onto the system. Usually, the data is converted electronically
from another computer system enabling 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.
One or more Company trainers experienced in group practice procedures are
assigned to conduct an intensive training program for the client's
employees. The program may include a combination of computer assisted
instruction ("CAI") for certain of the Company's products, remote training
techniques and training classes conducted by Company staff at the client's
office(s). CAI consists of workbooks, computer interaction and self-paced
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 the
Company 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. The
Company also provides ongoing training for certain of its products through
electronic classrooms where employees at different locations from the same
or different clients can simultaneously interact on-line with a trainer.
In addition, the Company's on-line "help" documentation feature facilitates
client training as well as ongoing support.
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
support and its 25-year experience in the industry. The Windows Product is
relatively new and only limited numbers of Windows Product systems have
been sold to date. There can be no assurance that the Windows Product will
achieve broad market acceptance or will successfully compete with other
Windows based practice management software products.
To date, the Company has not encountered substantial competition for its
dental practice management and clinical products in the Company's primary
niche market of dental group practices consisting of six or more dentists.
The Company is anticipating that market competition in this dental group
practice niche market 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.
14
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 limited numbers of these
systems have been sold to date. There can be no assurance that the NextGen
products will achieve broad market acceptance.
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.
Furthermore, the Company also competes in all of its markets indirectly and
to varying degrees with other major healthcare related companies,
information management companies and systems integrators 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.
PRODUCT ENHANCEMENT AND DEVELOPMENT.
The healthcare 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 1998, 1997 and 1996 the Company expended approximately $4.9
million, $2.8 million and $1.9 million, respectively, on research and
development activities including capitalized software amounts of $1.9
million, $850,000 and $382,000, 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 healthcare information management industries, its
products and services may become obsolete.
GOVERNMENTAL REGULATION.
The healthcare industry is subject to changing political, economic and
regulatory influences that may affect the procurement processes and
operation of healthcare facilities. During the past several years, the
healthcare industry has been subject to an increase in governmental
regulation of, among other things, reimbursement rates and certain capital
expenditures. In the past, various legislators have announced that they
intend to examine proposals to reform certain aspects of the U.S.
15
healthcare system including proposals which may increase governmental
involvement in healthcare, lower reimbursement rates and otherwise change
the operating environment for the Company's clients. Healthcare 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 healthcare organizations for cost-effective data management and
thereby enhance the overall market for healthcare management information
systems. The Company cannot predict what impact, if any, such proposals or
healthcare reforms might have on the Company's business, financial
condition and results of operations.
In addition, 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, if the result of which could have a material
adverse effect on the Company's business, financial condition and results
of operations.
EMPLOYEES.
As of May 29, 1998, the Company, employed 228 persons of which 223 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.
COMPETITION.
The market for healthcare 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 clinical systems. Furthermore, the Company also
competes indirectly and to varying degrees with other major healthcare
related companies, information management companies generally, and other
software developers which may more directly enter the markets in which the
Company competes.
16
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.
In addition, the Company believes that once a healthcare provider has
chosen a particular healthcare 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. Furthermore, if the healthcare
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 healthcare providers that are
replacing or substantially modifying their healthcare information systems
could have a material adverse effect on the Company's business, financial
condition and results of operations. If new systems sales do not
materialize, maintenance service revenues can be expected to decrease over
time due to the effect of failure to capture new maintenance revenues
therefrom in combination with attrition of existing maintenance revenues
associated with the Company's current clients whose systems become obsolete
or are replaced by competitor's products.
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 system components; 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
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
17
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 healthcare 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.
Through March 31, 1998, the Company recognized revenue in accordance with
the provisions of the American Institute of Certified Public Accountants
("AICPA") Statement of Position No. 91-1, Software Revenue Recognition
("SOP 91-1"). The AICPA has recently adopted Statement of Position No. 97-
2, Software Revenue Recognition ("SOP 91-2"), that supersedes SOP 91-1 and
becomes effective for fiscal years beginning after December 15, 1997.
Although the Company has not yet determined the impact that SOP 97-2 will
have on its financial statements, there can be no assurance that
application and subsequent interpretations of this pronouncement by the
Company, its independent auditors or the Securities Exchange Commission
will not modify the Company's revenue recognition policies, or that such
modifications would not have a material adverse effect on the operating
results reported in any particular quarter. There can be no assurance that
the Company will not be required to adopt changes in its licensing or
services practices to conform to SOP 97-2, or that such changes, if
adopted, would not result in delays or cancellations of potential sales of
the Company's products.
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.
ACQUISITIONS.
During the past two years, the Company has made two significant
acquisitions of relatively new companies each of which has products
utilizing newer technology than the Company's Legacy Product and each
company having limited sales histories (see "Item 1. Business.
Acquisitions."). Acquisitions involve a number of special risks, including
possible adverse effects on the Company's operating results, diversion of
management's attention, failure to retain key acquired personnel,
amortization of acquired intangible assets, and risks associated with
unanticipated events or liabilities, some or all of which could have a
material adverse effect on the Company's business, results of operations
and financial condition. Customer dissatisfaction or performance problems
at a single acquired business can also have an adverse effect on the
reputation of the Company.
18
DEPENDENCE ON PRINCIPAL PRODUCT AND NEW PRODUCT DEVELOPMENT.
The Company currently derives substantially all of its net revenues from
sales of its healthcare 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 healthcare
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, successful introduction and implementation 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.
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 and implemented in a timely manner, meet the
requirements of healthcare 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.
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 its software products 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
19
affect the Company's competitive position or could make the Company's
current products obsolete.
YEAR 2000 COMPLIANCE.
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The
Year 2000 issue is whether the computer systems will properly recognize
date sensitive information when the year changes to 2000. This Year 2000
problem creates risk for the Company from unforeseen problems in its own
computer systems and from third parties with whom the Company deals on
financial transactions nationwide.
The Company's Windows Product, NextGen and Charting Product are designed to
be Year 2000 compliant. However, there can be no assurance that such
products do not contain undetected errors or defects associated with Year
2000 date functions. The Company is currently evaluating the impact of
Year 2000 issues upon its medical and dental Legacy Product software and,
pending the conclusion of its evaluation, the impact of such Year 2000
issues upon the Company and its financial performance is uncertain.
The Company has begun to review software used internally by the Company in
all support systems to determine whether they are Year 2000 compliant. The
Company plans to have formal Year 2000 initiatives developed to address any
conversion update or upgrade necessary to become Year 2000 compliant on
software currently used by the Company. Any new software or support
systems implemented in the future will be Year 2000 compliant or will have
updates or upgrades available before the Year 2000 to enable the system to
be Year 2000 compliant. Management is currently assessing the Year 2000
compliance expense and related potential effect on the Company's earnings.
LITIGATION.
The pending federal and state securities actions are in the early states of
procedure (see "Item 3. Legal Proceedings."). Consequently, at this time
it is not reasonably possible to estimate the damage, or the range of
damages, if any, that the Company might incur in connection with such
actions. However, the uncertainty associated with substantial unresolved
litigation may be expected to have an adverse impact on the Company's
business. In particular, such litigation could impair the Company's
relationships with existing customers and its ability to obtain new
customers. Defending such litigation will likely result in a diversion of
management's time and attention away from business operations, which could
have a material adverse effect on the Company's results of operations.
Such litigation may also have the effect of discouraging potential
acquirors from bidding for the Company or reducing the consideration such
acquirors would otherwise be willing to pay in connection with an
acquisition.
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
20
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 healthcare 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.
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 timeframe, 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.
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.
The Company does not maintain key man life insurance on any of its
employees. 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. Furthermore, 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.
21
PRODUCT LIABILITY.
Certain of the Company's products provide applications that relate to
patient clinical 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.
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 HEALTHCARE INDUSTRY; GOVERNMENT REGULATION.
The healthcare industry is subject to changing political, economic and
regulatory influences that may affect the procurement processes and
operation of healthcare facilities. During the past several years, the
healthcare industry has been subject to an increase in governmental
regulation of, among other things, reimbursement rates and certain capital
expenditures. In the past, various legislators have announced that they
intend to examine proposals to reform certain aspects of the U.S.
healthcare system including proposals which may increase governmental
involvement in healthcare, lower reimbursement rates and otherwise change
the operating environment for the Company's clients. Healthcare 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
healthcare 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 healthcare reforms might have on its business,
financial condition and results of operations.
The Company's software may be subject to regulation by 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, the result of which could have a material
adverse effect on the Company's business, financial condition and results
of operations.
22
Item 2. PROPERTIES.
-----------
The Company's principal administrative, data processing, marketing and
development operations are located in approximately 19,000 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, approximately 12,000
square feet in Atlanta, Georgia, the principal office for MicroMed, and an
aggregate of 5,000 square feet of space in California, Florida, Kansas,
Minnesota, Texas, Wisconsin and Washington to house additional sales,
training and service operations. These leases, including options, have
expiration dates ranging from month-to-month to June 2000. The Company
believes that its facilities are adequate for its current needs and that
suitable additional or substitute space is available, if needed, at
commercially reasonable rates.
23
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
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, declaratory and injunctive relief, and
attorneys' fees.
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,
which has been consolidated with the Caveny lawsuit, essentially repeats
the allegations in the Caveny lawsuit and seeks identical relief.
The Company and the other named defendants successfully demurred to the
plaintiffs' claim under California Civil Code Sections 1709 and 1710, and
that claim, which served as the only basis for plaintiffs' request for
punitive damages, has been dismissed from both actions.
The Company and its named officers and directors deny all remaining
allegations of wrongdoing made against them in these suits, consider the
allegations groundless and without merit, and intend to vigorously defend
against these actions.
On July 1, 1997, a third purported class action entitled WADE CHENEY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the United States District Court
of the Central District of California, Southern Division. The complaint
makes essentially the same factual allegations as in the Caveny and Woo
complaints, and purports to state claims under Section 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and under
Section 20(a) of said Act. By Court order dated August 13, 1997, this
action was stayed temporarily and the Court reserved jurisdiction to lift
the stay after all matters are final in the Caveny and Woo actions or if
otherwise appropriate, and on August 15, 1997 the case was removed from the
Court's active caseload. The Company denies all allegations of wrongdoing
made in this suit, considers the allegations groundless and without merit,
and if the stay is ever lifted, the Company intends to vigorously defend
against this action.
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.
24
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 1998.
Executive Officers of the Registrant.
- -------------------------------------
The executive officers of the Company as of March 31, 1998 were as follows:
Name Age Position
---- --- --------
Sheldon Razin 60 Chairman of the Board, Chief
Executive Officer, President
and Director
Patrick B. Cline 37 Executive Vice President and
Director; and, President and
Chief Operating Officer
of Clinitec
Greg Flynn 40 Vice President Sales and
Marketing
Robert G. McGraw 40 Vice President Chief
Financial Officer
Donn Neufeld 41 Vice President Software
and Operations
Stephen K. Puckett 33 Executive Vice President; and,
President and Chief Operating
Officer of MicroMed
David Razin 34 Vice President Business Development
Janet Razin 58 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.
25
Sheldon Razin is the founder of the Company and has served as its 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 and the father of David Razin.
Patrick B. Cline has served as a Director and Executive Vice President of
the Company 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 healthcare 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 healthcare
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. He holds a B.A. degree in English from the
University of California, Santa Barbara.
Robert G. McGraw joined the Company in February 1996 as its Vice President
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 the University of California, Los Angeles and a B.A.
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.
26
Stephen K. Puckett has served as an Executive Vice President of the Company
since May 1997. Mr. Puckett is the founder of MicroMed and has served as
its President since its inception in February 1993 and as its Chief
Operating Officer since May 1997 when it was acquired by the Company. Mr.
Puckett served as MicroMed's Chairman of the Board of Directors and Chief
Executive Officer from February 1993 until May 1997. Prior to founding
MicroMed, Mr. Puckett gained his healthcare expertise at Gerber Alley and
Andersen Consulting in Atlanta, Georgia. Mr. Puckett holds a B.S. degree
in Industrial Management from the Georgia Institute of Technology.
David Razin has served as Vice President Business Development of the
Company since August 1997. Before being named to this position, Mr. Razin
served from 1995 to 1997 as Director of Product Development. In that
position, Mr. Razin oversaw the development of the Company's Legacy
Products, EDI services network and Internet/intranet applications. From
1988 to 1995, Mr. Razin held the position of Manager of Client Managing and
Training. Prior to that, Mr. Razin held various positions in software
development from 1985 to 1988. David Razin is the son of Sheldon and Janet
Razin.
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 and the
mother of David Razin.
27
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 high and low 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, 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
June 30, 1997 7.75 5.50
September 30, 1997 7.75 6.00
December 31, 1997 9.13 5.63
March 31, 1998 8.56 5.94
At May 29, 1998, there were approximately 174 holders of record of the
Company's Common Stock. 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. Acquisitions."). The shares of Common
Stock were valued at $6.9 million, or $22.25 per share. The shares were
issued pursuant to an exception from registration provided by Regulation D
under the Securities Act of 1933, as amended, involving a sale to less than
35 nonaccredited investors.
In June 1998, in connection with the acquisition of MicroMed, the Company
anticipates issuing $1.8 million of unregistered shares of its Common Stock
as part of its final payment for this acquisition (see "Item 1. Business.
Acquisitions."). Any shares issued will be determined based upon the
formula set forth in the related Asset Purchase Agreement and it is
anticipated that the shares will be issued pursuant to an exception from
registration provided by Regulation D under the Securities Act of 1933, as
amended, involving a sale to less than 35 nonaccredited investors.
28
Through May 29, 1998, 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.
29
Item 6. SELECTED FINANCIAL DATA.
- ---------------------------------
The following selected financial data with respect to the Company's
Consolidated Statements of Operations Data for each of the five years in
the period ended March 31, 1998 and the Consolidated 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 "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations." included elsewhere
herein.
Consolidated Statements of Operations Data
(In thousands, except for per share data)
Year Ended March 31,
---------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Net Revenues $31,216 $20,127 $16,732 $12,049 $11,752
Cost of Products
and Services 13,509 10,089 7,929 6,060 6,527
------- ------- ------- ------- -------
Gross Profit 17,707 10,038 8,803 5,989 5,225
Selling, General
and Administrative 12,485 7,736 3,897 3,536 3,052
Research and Development 3,072 1,978 1,567 1,467 1,318
Purchased In-Process
Research and
Development (1) 10,200 8,300 - - -
------- ------- ------- ------- -------
Income (Loss) from
Operations (3) (8,050) (7,976) 3,339 986 855
Investment Income 971 1,285 482 429 400
------- ------- ------- ------- -------
Income (Loss) before
Provision for (Benefit
from) Income Taxes (3) (7,079) (6,691) 3,821 1,415 1,255
Provision for (Benefit
from) Income Taxes (2) (2,463) 784 1,528 453 349
------- ------- ------- ------- -------
Net Income (Loss) (3) $(4,616)$(7,475)$ 2,293 $ 962 $ 906
======= ======= ======= ======= =======
Net Income (Loss)
per Share:
$(0.77) $(1.26) $ 0.49 $ 0.22 $ 0.21
Basic (3) ======= ======= ======= ======= =======
$(0.77) $(1.26) $ 0.48 $ 0.21 $ 0.21
Diluted (3) ======= ======= ======= ======= =======
Weighted Average
Shares Outstanding:
5,981 5,937 4,640 4,472 4,218
Basic ======= ======= ======= ======= =======
5,981 5,937 4,776 4,606 4,342
Diluted ======= ======= ======= ======= =======
30
Consolidated Balance Sheet Data
(In thousands)
March 31,
---------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Cash and Cash Equivalents
and Short-Term
Investments(4) $17,080 $22,735 $28,944 $ 7,322 $ 6,071
Working Capital 15,453 25,613 30,196 8,032 6,857
Total Assets 40,916 37,866 37,272 12,668 11,094
Total Liabilities 13,475 5,596 4,571 3,480 3,054
Shareholders' Equity(4) $27,441 $32,270 $32,701 $ 9,188 $ 8,040
======= ======= ======= ======= =======
(1) In May 1996, the Company acquired Clinitec (see "Item 1. Business.
Acquisitions.") 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.
In May 1997, the Company acquired MicroMed (see "Item 1. Business.
Acquisitions.") which was treated as a purchase transaction for
accounting purposes. In connection with this treatment, the Company
incurred a $10.2 million charge for purchased in-process research and
development during the year ended March 31, 1998.
(2) 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) Includes a charge of $10.2 million and $8.3 million for purchased in-
process research and development for the years ended March 31, 1998
and 1997, respectively. Excluding the charge, on a pro forma basis,
income from operations and income before provision for (benefit from)
income taxes would have been $2.2 million and $3.1 million,
respectively, for fiscal 1998 and $324,000 and $1.6 million,
respectively for fiscal 1997. The income tax benefit related to the
charge for purchased in-process research and development for the years
ended March 31, 1998 and 1997 was $3.9 million and $0, respectively.
Excluding the charge and related income tax benefit, on a pro forma
basis, net income and basic and diluted income per share would have
been $1.7 million, $0.29 and $0.28, respectively, for fiscal 1998 and
$825,000, $0.14 and $0.14, respectively, for fiscal 1997.
(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.
31
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
-----------------------------------------------------------
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, 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 Operations." set forth below, as well as in the Company's other
public disclosures and filings with the Securities and Exchange Commission.
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, 1998 and the operations of MicroMed from May
15, 1997 (the date of its acquisition) through March 31, 1998.
Year Ended March 31,
------------------------
1998 1997 1996
------ ------ ------
Net Revenues:
Sales of computer systems,
upgrades and supplies 64.9% 58.7% 57.5%
Maintenance and other services 35.1 41.3 42.5
------ ------ ------
100.0 100.0 100.0
Cost of Products and Services 43.3 50.1 47.4
------ ------ ------
Gross Profit 56.7 49.9 52.6
Selling, General and
Administrative Expenses 40.0 38.5 23.3
Research and Development Costs 9.8 9.8 9.4
Purchased In-Process
Research and Development 32.7 41.2 -
------ ------ ------
Income (Loss) from Operations (25.8) (39.6) 19.9
Investment Income 3.1 6.4 2.9
------ ------ ------
Income (Loss) before Provision
for (Benefit from) Income Taxes (22.7) (33.2) 22.8
Provision for (Benefit from)
Income Taxes (7.9) 3.9 9.1
------ ------ ------
Net Income (Loss) (14.8)% (37.1)% 13.7%
====== ====== ======
33
FOR THE YEARS ENDED MARCH 31, 1998 AND 1997.
The Company incurred a net loss of $(4.6) million, or $(0.77) on a basic
and diluted per share basis, for the year ended March 31, 1998 as compared
to a net loss of $(7.5) million, or $(1.26) on a basic and diluted per
share basis, for the year ended March 31, 1997. During fiscal 1998, the
Company recognized a $6.3 million charge, net of the related $3.9 million
tax benefit, for purchased in-process research and development in
connection with the MicroMed acquisition. Similarly, during fiscal 1997,
the Company recognized an $8.3 million charge, net of the related $0 tax
benefit, for purchased in-process research and development in connection
with the Clinitec acquisition. Excluding the charge, net of the related
income tax benefit, for purchased in-process research and development, on a
pro forma basis, net income and basic and diluted income per share for
fiscal 1998 would have been $1.7 million, $0.29 and $0.28, respectively,
and $825,000, $0.14 and $0.14, respectively, for fiscal 1997.
Net Revenues. Net revenues for the year ended March 31, 1998 increased
55.1% to $31.2 million from $20.1 million for the year ended March 31,
1997. Sales of computer systems, upgrades and supplies for the year ended
March 31, 1998 increased 71.7% to $20.3 million from $11.8 million for the
year ended March 31, 1997 after the consolidation of MicroMed's net
revenues in fiscal 1998. Without the inclusion of MicroMed's revenues, the
Company's sales of computer systems, upgrades and supplies increased 36.6%
in fiscal 1998 as compared to fiscal 1997. Net revenues from maintenance
and other services during the year ended March 31, 1998 grew 31.6% to $10.9
million from $8.3 million for the year ended March 31, 1997 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 MicroMed's revenues in fiscal 1998.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 1998 increased 33.9% to $13.5 million from $10.1 million
for the year ended March 31, 1997 while costs of products and services as a
percentage of net revenues decreased to 43.3% from 50.1% during the
comparable periods. The increase in the amount of costs of products and
services during the year ended March 31, 1998 as compared to the year ended
March 31, 1997 resulted primarily from increased systems sales and an
increase in customer service, support, and training personnel during fiscal
1998 plus the addition of such costs for MicroMed's personnel. The
decrease in costs of products and services as a percentage of net revenues
resulted primarily from the inclusion of MicroMed in fiscal 1998. To date,
MicroMed's systems sales have not included any significant amount of
hardware content. Systems sales without significant hardware content
generally yield higher margins than systems sales that include a
significant amount of hardware content. The mixture of sales with and
without significant hardware content fluctuates from period to period and
there can be no assurance that the mixture of such sales attained in the
year ended March 31, 1998, which contributed materially to the decrease in
cost of products and services as a percentage of net revenues, will be
achieved in future periods. Without the inclusion of MicroMed, costs of
products and services increased 27.7% in fiscal 1998 over fiscal 1997 and
as a percentage of net revenues decreased to 48.1% from 50.1%. The
increase in the amount and decrease in percentage before the inclusion of
MicroMed results primarily from higher systems sales.
34
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended March 31, 1998 increased 61.4%
to $12.5 million from $7.7 million for the year ended March 31, 1997
representing 40.0% and 38.5% 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 an increase in the
Company's selling efforts, including sales personnel, and administrative
infrastructure together with the consolidation of MicroMed's selling,
general and administrative expenses during fiscal 1998. Without the
inclusion of MicroMed's selling, general and administrative expenses, such
expenses increased 32.7% over fiscal 1997 and decreased to 38.3% from 38.5%
as a percentage of net revenues. Before the inclusion of MicroMed, the
increase in the amount of selling, general and administrative expenses
resulted primarily from an increase in Clinitec's selling efforts,
including sales personnel, and administrative infrastructure together with
a smaller increase in such costs for QSI.
Research and Development Costs. Research and development costs for the
year ended March 31, 1998 increased 55.3% to $3.1 million from $2.0 million
for the year ended March 31, 1997 primarily due to an increase in such
efforts for QSI and Clinitec together with the consolidation of MicroMed's
research and development costs during fiscal 1998. Research and
development costs as a percentage of net revenues remained unchanged at
9.8% for both periods. Without the inclusion of MicroMed, such costs
increased 34.1% and remained relatively unchanged at 9.9% as a percentage
of net revenues.
Purchased In-Process Research and Development. In connection with the
acquisitions of MicroMed in May 1997 and Clinitec in May 1996, the purchase
price allocated to in-process research and development for which
technological feasibility had not been established was $10.2 million and
$8.3 million, respectively. 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 purchase price allocated to in-process research and
development in each of fiscal 1998 and 1997 was expensed during the
respective fiscal years.
Investment Income. Investment income for the year ended March 31, 1998
decreased 24.4% to $1.0 million from $1.3 million for the year ended March
31, 1997 primarily as a result of a decrease in funds available for
investment during fiscal 1998 after payment of the purchase price in
connection with the Company's MicroMed acquisition together with amounts
used to fund the growth of Clinitec and MicroMed.
Provision for (Benefit from) Income Taxes. The benefit from income taxes
for the year ended March 31, 1998 was $2.5 million, resulting in an
effective income tax rate of 34.8%. 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 non-taxable
Clinitec purchase transaction. The MicroMed acquisition was a taxable
transaction and, accordingly, the related purchased in-process research and
development is deductible for income tax purposes.
35
FOR THE YEARS ENDED MARCH 31, 1997 AND 1996.
The Company incurred a net loss of $(7.5) million, or $(1.26) on a basic
and diluted per share basis, for the year ended March 31, 1997, as compared
to net income of $2.3 million, of $0.49 per share and $0.48 per share on a
basic and diluted basis, respectively, for the year ended March 31, 1996.
During fiscal 1997, the Company recognized an $8.2 million charge, net of
the related $0 tax benefit, for purchased in-process research and
development in connection with the Clinitec acquisition. Excluding the
charge, net of the related income tax benefit, for purchased in-process
research and development, on a pro forma basis, net income and basic and
diluted income per share for fiscal 1997 would have been $825,000, $0.14
and $0.14, respectively. There was no similar charge during fiscal 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.
36
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. Investment income for the year ended March 31, 1997
increased 166.6% to $1.3 million from $482,000 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 offset in part by funds used for
the May 1996 Clinitec acquisition.
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 non-taxable Clinitec
purchase transaction. 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.
LIQUIDITY AND CAPITAL RESOURCES.
Net cash provided by operating activities was $2.2 million, $520,000 and
$2.7 million for the years ended March 31, 1998, 1997 and 1996,
respectively. Net cash provided by operations for the year ended March 31,
1998 consisted primarily of the Company's net loss adjusted for the
principal non-cash operating expenses of depreciation, amortization and the
$10.2 million charge for purchased in-process research and development
incurred in connection with the acquisition of MicroMed together with
decreases in deferred service revenue and other current liabilities offset
in part by an increase in accounts receivable and deferred income tax
benefits. 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. 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 each of the fiscal years results primarily from increased sales and
the timing of sales in each period.
37
Net cash used in investing activities was $7.8 million, $6.6 million, and
$1.3 million for the years ended March 31, 1998, 1997 and 1996,
respectively. Net cash used in investing activities for the year ended
March 31, 1998 was principally impacted by the $5.3 million paid to acquire
MicroMed during the year. 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 used for additions to equipment, improvements and
capitalized software for the years ended March 31, 1998, 1997 and 1996 were
$2.7 million, $1.7 million and $622,000, respectively, which were offset in
part for the years ended March 31, 1997 and 1996 by cash provided from net
sales of short-term investments of $352,000 and $312,000, respectively.
There were no short-term investment sales or purchases during the year
ended March 31, 1998.
Net cash used in financing activities for the year ended March 31, 1998 was
$223,000 consisting principally of $271,000 used to repurchase 40,100
shares of the Company's Common Stock. Net cash provided by financing
activities was $61,000 and $20.4 million for the years ended March 31, 1997
and 1996, 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. Net cash provided by financing activities for
the years ended March 31, 1998, 1997 and 1996 also includes the proceeds
from the exercise of employee stock options.
At March 31, 1998, the Company had cash and cash equivalents of $16.1
million and short-term investments of $1.0 million. Short-term investments
include a $762,000 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 (see "Item 1. Business. Acquisitions."), 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. Acquisitions.") for an initial cash payment of $4.8 million with
an additional payment of $5.7 million due on or before June 29, 1998. The
Company anticipates that the additional payment will be made with $3.9
million in cash with the balance to be paid in QSI Common Stock.
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 1999 will be comparable to fiscal 1998.
38
The Company believes that its cash and cash equivalents and short-term
investments on hand at March 31, 1998, 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.
YEAR 2000 COMPLIANCE.
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The
Year 2000 issue is whether the computer systems will properly recognize
date sensitive information when the year changes to 2000. This Year 2000
problem creates risk for the Company from unforeseen problems in its own
computer systems and from third parties with whom the Company deals on
financial transactions nationwide.
The Company's Windows Product, NextGen and Charting Product are designed to
be Year 2000 compliant. However, there can be no assurance that such
products do not contain undetected errors or defects associated with Year
2000 date functions. The Company is currently evaluating the impact of
Year 2000 issues upon its medical and dental Legacy Product software and,
pending the conclusion of its evaluation, the impact of such Year 2000
issues upon the Company and its financial performance is uncertain.
The Company has begun to review software used internally by the Company in
all support systems to determine whether they are Year 2000 compliant. The
Company plans to have formal Year 2000 initiatives developed to address any
conversion update or upgrade necessary to become Year 2000 compliant on
software currently used by the Company. Any new software or support
systems implemented in the future will be Year 2000 compliant or will have
updates or upgrades available before the Year 2000 to enable the system to
be Year 2000 compliant. Management is currently assessing the Year 2000
compliance expense and related potential effect on the Company's earnings.
39
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES
ABOUT MARKET RISK.
----------------------------------------
Not Applicable.
40
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 herein by reference to Item 14.
41
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
----------------------------------------------------------
None.
42
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 herein by reference from the Company's definitive proxy
statement scheduled to be filed with the Securities and Exchange Commission
on or before July 29, 1998 for the Company's 1998 annual shareholders'
meeting.
43
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 Securities and Exchange Commission on or before July 29, 1998 for the
Company's 1998 annual shareholders' meeting.
44
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 Securities and Exchange Commission on or before July 29, 1998 for the
Company's 1998 annual shareholders' meeting.
45
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 Securities and Exchange Commission on or before July 29, 1998 for the
Company's 1998 annual shareholders' meeting.
46
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, 1998
and 1997 F-2
Consolidated Statements of Operations for
the Years Ended March 31, 1998, 1997 and 1996 F-3
Consolidated Statements of Shareholders'
Equity for the Years Ended March 31, 1998,
1997 and 1996 F-4
Consolidated Statements of Cash Flows for
the Years Ended March 31, 1998, 1997 and 1996 F-6
Notes to Financial Statements F-8
(2) Financial Statement Schedule.
Schedule II - Valuation and Qualifying Accounts F-25
(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.
47
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.
48
INDEX TO EXHIBITS
(Continued) Sequential
Page
Exhibit No.
------- ----------
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.
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.
49
INDEX TO EXHIBITS
(Continued) Sequential
Page
Exhibit No.
------- ----------
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.
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 15, 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. 77
23.1 Independent Auditor's Consent - Deloitte &
Touche LLP. 79
27.1 Financial Data Schedule, is filed herewith.
* This exhibit is a management contract or a compensatory
plan or arrangement.
50
(b) Reports on Form 8-K:
On February 12, 1998, the Registrant filed a Current Report on
Form 8-K dated February 9, 1998 disclosing the extension of 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 9, 1999, 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 9, 1998.
51
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 9, 1998
----------------------------- ---------------------------
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 9, 1998
SHELDON RAZIN (Principal Executive
Officer)
/s/JANET RAZIN
- -------------------------- Vice President, June 9, 1998
JANET RAZIN Secretary and Director
/s/ROBERT MCGRAW
- -------------------------- Vice President, June 9, 1998
ROBERT MCGRAW Chief Financial Officer
(Principal Financial
and Accounting Officer)
/s/JOHN BOWERS, M.D.
- -------------------------- Director June 9, 1998
JOHN BOWERS, M.D.
/s/WILLIAM BOWERS
- -------------------------- Director June 9, 1998
WILLIAM BOWERS
/s/GEORGE BRISTOL
- -------------------------- Director June 9, 1998
GEORGE BRISTOL
/s/PATRICK CLINE
- -------------------------- Director June 9, 1998
PATRICK CLINE
/s/GORDON SETRAN
- -------------------------- Director June 9, 1998
GORDON SETRAN
52
INDEPENDENT AUDITORS' REPORT
----------------------------
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated balance sheets of Quality
Systems, Inc. and subsidiaries as of March 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended March 31, 1998.
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
subsidiaries as of March 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended March 31, 1998 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 5, 1998
F-1
53
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31,
----------------
ASSETS 1998 1997
------- -------
Current Assets:
Cash and cash equivalents $16,107 $21,852
Short-term investments 973 883
Accounts receivable, less allowance for doubtful
accounts of $521 and $297, respectively 9,946 6,574
Inventories 1,328 1,071
Other current assets 574 628
------- -------
Total current assets 28,928 31,008
Equipment and Improvements, net 1,790 1,391
Capitalized Software Costs, net 2,183 1,041
Deferred Tax Asset 3,105 -
Excess of Cost Over Net Assets of Acquired
Business, net of accumulated amortization
of $613 and $274, respectively 2,793 2,868
Other Assets 2,117 1,558
------- -------
Total assets $40,916 $37,866
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,327 $ 1,345
Acquisition obligation 5,676 -
Deferred service revenue 2,244 1,493
Estimated costs to complete
system installations 592 565
Other current liabilities 3,636 1,992
------- -------
Total current liabilities 13,475 5,395
Deferred Tax Liability - 201
------- -------
Total liabilities 13,475 5,596
------- -------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $0.01 par value,
20,000 shares authorized, 5,988
and 5,997 shares issued and
outstanding, respectively 60 60
Additional paid-in capital 33,931 34,144
Accumulated deficit (6,550) (1,934)
------- -------
Total shareholders' equity 27,441 32,270
------- -------
Total liabilities and
shareholders' equity $40,916 $37,866
======= =======
See notes to consolidated financial statements.
F-2
54
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended March 31,
------------------------------
1998 1997 1996
------- ------- --------
Net Revenues:
Sales of computer systems,
upgrades and supplies $20,273 $11,809 $ 9,623
Maintenance and other services 10,943 8,318 7,109
------- ------- -------
31,216 20,127 16,732
Cost of Products and Services 13,509 10,089 7,929
------- ------- -------
Gross Profit 17,707 10,038 8,803
Selling, General and
Administrative Expenses 12,485 7,736 3,897
Research and Development Costs 3,072 1,978 1,567
Purchased In-Process
Research and Development 10,200 8,300 -
------- ------- -------
Income (Loss) from Operations (8,050) (7,976) 3,339
Investment Income 971 1,285 482
------- ------- -------
Income (Loss) before Provision
for (Benefit from) Income Taxes (7,079) (6,691) 3,821
Provision for (Benefit from)
Income Taxes (2,463) 784 1,528
------- ------- -------
Net Income (Loss) $(4,616) $(7,475) $ 2,293
======= ======= =======
Net Income (Loss) per Share:
Basic $(0.77) $(1.26) $ 0.49
======= ======= =======
Diluted $(0.77) $(1.26) $ 0.48
======= ======= =======
See notes to consolidated financial statements.
F-3
55
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Unrealized
Common Loss on Retained
Shares Issued Additional Available- Earnings
----------------- Paid-in for-Sale (Accumulated)
Number Amount Capital Securities Deficit)
---------- ------ ---------- ---------- -------------
Balance at
April 1, 1995 4,536 $45 $ 5,978 $ (83) $ 3,248
Sale of stock
in secondary
offering 1,000 10 20,244 - -
Exercise of
stock options 117 1 181 - -
Tax benefit
resulting from
stock options - - 745 - -
Unrealized gain,
net of $29
tax provision - - - 39 -
Net income - - - - 2,293
--------- ------- ----------- ---------- -------------
Balance at
March 31, 1996 5,653 56 27,148 (44) 5,541
See notes to consolidated financial statements.
F-4
56
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued)
(in thousands)
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. 310 $ 3 $ 6,891 $ - $ -
Exercise of
stock options 34 1 60 - -
Tax benefit
resulting
from stock
options - - 45 - -
Disposition
of available
for-sale
securities,
net of $34 tax
provision - - - 44 -
Net loss - - - - (7,475)
-------- ------ ---------- ---------- -------------
Balance at
March 31, 1997 5,997 60 34,144 - (1,934)
Exercise of
stock options 31 - 48 - -
Tax benefit
resulting from
stock options - - 10 - -
Purchases of
Common Stock (40) - (271) - -
Net loss - - - - (4,616)
-------- ------ ---------- --------- -------------
Balance at
March 31, 1998 5,988 $ 60 $33,931 $ - $ (6,550)
======== ====== ========== ========= =============
See notes to consolidated financial statements.
F-5
57
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended March 31,
---------------------------------
1998 1997 1996
--------- ------- -------
Cash Flows from Operating
Activities:
Net income (loss) $(4,616) $(7,475) $ 2,293
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Purchased in-process research
and development 10,200 8,300 -
Depreciation and amortization 1,895 1,139 496
Gains on short-term
investments and other (90) (85) (88)
Equity in loss of Clinitec
International, Inc. - 31 51
Deferred income taxes (3,336) 102 180
Changes, net of amounts
acquired, in:
Accounts receivable (3,175) (1,594) (1,754)
Inventories (257) (202) (70)
Other current assets 116 (208) 19
Accounts payable (72) (613) 1,109
Deferred service revenue 590 401 79
Estimated costs to complete
system installations 27 123 185
Income taxes payable, and
taxes related to equity
accounts 397 291 163
Other current liabilities 563 310 25
------- ------- -------
Net Cash Provided By
Operating Activities 2,242 520 2,688
------- ------- -------
Cash Flows from
Investing Activities:
Proceeds from sales of
short-term investments - 402 1,426
Purchases of short-term
investments - (50) (1,114)
Additions to equipment and
improvements, net (810) (855) (240)
Additions to capitalized
software costs (1,861) (850) (382)
Purchase of ownership interests
in Clinitec International, Inc. - (4,946) (1,027)
Purchase of Net Assets of MicroMed
Healthcare Information
Systems, Inc. (5,327) - -
See notes to consolidated financial statements.
F-6
58
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
Years Ended March 31,
-----------------------------
1998 1997 1996
------- ------- -------
Change in other assets $ 234 $ (302) $ -
------- ------- -------
Net Cash Used In
Investing Activities (7,764) (6,601) (1,337)
------- ------- -------
Cash Flows from Financing
Activities:
Purchases of Common Stock (271) - -
Proceeds from exercise of
stock options 48 61 182
Proceeds from issuance
of common stock, net - - 20,254
------- ------- -------
Net Cash Provided By (Used In)
Financing Activities (223) 61 20,436
------- ------- -------
Net Increase (Decrease) in Cash
and Cash Equivalents (5,745) (6,020) 21,787
Cash and Cash Equivalents,
beginning of year 21,852 27,872 6,085
------- ------- -------
Cash and Cash Equivalents, end
of year $16,107 $21,852 $27,872
======= ======= =======
Supplemental Information - During fiscal 1998, 1997 and 1996 the Company
made income tax payments of $485, $431 and $1,146, respectively.
Detail of businesses acquired in
purchase transactions:
Years Ended March 31,
------------------------
1998 1997
------- ------
In-Process Research and Development $10,200 $8,300
Fair Value of Assets Acquired
(net of previous investment) 1,480 3,999
Liabilities Assumed (677) (459)
Common Stock Issued in the Acquisition - (6,894)
Acquisition Obligation (5,676) -
------- ------
Cash Paid for the Acquisition, net of
cash acquired $ 5,327 $4,946
======= ======
See notes to consolidated financial statements.
F-7
59
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiaries, Clinitec
International, Inc. ("Clinitec") and MicroMed Healthcare Information
Systems, Inc. ("MicroMed"), (collectively the "Company") develop and market
proprietary computer information systems for medical and dental group
practices, dental schools, physician hospital organizations, management
service organizations, and community health centers. The Company's
proprietary software systems include 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, dental charting and letter generation. 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 and MicroMed on May 15, 1997 (see Note 10).
Accordingly, the accompanying consolidated financial statements include all
of the accounts of QSI for the periods presented, the accounts of Clinitec
for the period commencing May 17, 1996 through March 31, 1998, and the
accounts of MicroMed for the period commending May 15, 1997 through March
31, 1998. All significant intercompany amounts have been eliminated.
Revenue Recognition - Licenses and sales of computer systems and system
upgrades 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
60
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 - Many 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
61
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 - In February 1997, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 128, "Earnings Per Share," ("SFAS No. 128").
This statement is effective for periods ending after December 15, 1997 and
requires restatement of all prior periods. The Statement redefines
earnings per share ("EPS") under generally accepted accounting principles,
making EPS comparable to international standards. SFAS No. 128 requires
dual presentation of "Basic" and "Diluted" EPS, by entities with complex
capital structures, replacing "Primary" and "Fully Diluted" EPS under
Accounting Principles Board ("APB") Opinion No. 15.
Basic EPS excludes dilution from common stock equivalents and is computed
by dividing income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution from common stock equivalents, similar to fully
diluted EPS, but uses only the average stock price during the period as
part of the computation.
F-10
62
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company has adopted the provisions of SFAS No. 128 in the accompanying
1998 consolidated financial statements and has restated prior periods to
reflect the adoption of SFAS No. 128.
The following table reconciles the weighted average shares outstanding for
basic and diluted income (loss) per share for the periods presented.
Years Ended March 31,
-----------------------------
1998 1997 1996
------- ------- -------
(in thousands except per share amounts)
Net income (loss) $(4,616) $(7,475) $ 2,293
------- ------- -------
Basic income (loss) per
common share:
Weighted average of common
shares outstanding 5,981 5,937 4,640
------- ------- -------
Basic income (loss) per
common share $(0.77) $(1.26) $ 0.49
======= ======= =======
Diluted income (loss) per share:
Weighted average of common shares
outstanding 5,981 5,937 4,640
Weighted average of common shares
equivalents:
Weighted average options
outstanding - - 136
------- ------- -------
Weighted average number of common
and common equivalent shares 5,981 5,937 4,776
------- ------- -------
Diluted income (loss) per
common share $(0.77) $(1.26) $ 0.48
======= ======= =======
Stock-Based Compensation - In October 1995, the FASB 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
F-11
63
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
Recently Issued Accounting Pronouncements - In June 1997, the FASB issued
SFAS No. 130, Reporting Comprehensive Income, ("SFAS No. 130"). This
statement establishes standards for the reporting of comprehensive income
and its components in a financial statement that is displayed with the same
prominence as other financial statements. Comprehensive income, as
defined, includes all changes in equity (net assets) during a period from
non-owner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency
translation adjustments and unrealized gain/loss on available-for-sale
securities. The Company has not yet determined the impact, if any, of
adopting this new standard. The disclosures prescribed by SFAS No. 130 are
effective for interim periods and fiscal years beginning after December 15,
1997.
In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information, ("SFAS No. 131"). This statement
establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes
standards for related disclosure about products and services, geographic
areas and major customers. The Company has not yet determined the impact,
if any, of adopting this new standard. The disclosures prescribed by SFAS
No. 131 are effective for fiscal years beginning after December 15, 1997.
In October 1997, the American Institute of Certified Public Accounts issued
Statement of Position ("SOP") 97-2, Software Revenue Recognition, which
supersedes SOP 91-1. SOP 97-2 provides guidance on when revenue should be
recognized and in what amounts for licensing, selling, leasing or otherwise
marketing computer software. The provisions of SOP 97-2 that impact the
Company are effective for financial statements for fiscal years beginning
after December 15, 1997. The Company will adopt SOP 97-2 in fiscal 1999
and has not yet determined its impact.
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, 1998
presentation.
F-12
64
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
At March 31, 1998 and 1997, the Company had cash equivalents of $14,733,000
and $21,155,000, 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.
At March 31, 1998 and 1997, all short-term investments consist of trading
securities which include an investment of $762,000 and $642,000,
respectively, in a fund which trades in special situation securities. The
Company bears no off-balance sheet risk on its investments.
Investment income for each of the three years ended March 31, 1998 consists
of the following:
Years Ended March 31,
----------------------------
1998 1997 1996
------ ------ ------
(in thousands)
Interest income $ 884 $1,240 $ 433
Net gains (losses) on
short-term investments --
Realized 146 102 (10)
Unrealized (58) (26) 90
Other (1) (31) (31)
------ ------ ------
$ 971 $1,285 $ 482
====== ====== ======
F-13
65
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 4 - CAPITALIZED SOFTWARE COSTS
Capitalized software costs at March 31, 1998 and 1997 were net of
accumulated amortization of $1,129,000 and $1,275,000, respectively.
Information related to net capitalized software costs is as follows:
Years Ended March 31,
------------------------------
1998 1997 1996
------ ------ ------
(in thousands)
Beginning of year $1,041 $ 599 $ 502
Capitalized 1,861 850 382
Amortization (719) (408) (285)
------ ------ ------
End of year $2,183 $1,041 $ 599
====== ====== ======
NOTE 5 - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
INVENTORIES:
March 31,
--------------------
1998 1997
------ ------
(in thousands)
Computer systems
and components $1,019 $ 750
Replacement parts for
certain client systems, net
of accumulated amortization
of $1,018 and $1,079,
respectively 260 274
Miscellaneous parts
and supplies 49 47
------ ------
$1,328 $1,071
====== ======
F-14
66
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
EQUIPMENT AND IMPROVEMENTS:
March 31,
--------------------
1998 1997
------ ------
(in thousands)
Computers and electronic
test equipment $2,540 $2,110
Furniture and fixtures 830 622
Vehicles 72 72
Leasehold improvements 196 120
------ ------
3,638 2,924
Accumulated depreciation
and amortization (1,848) (1,533)
------ ------
$1,790 $1,391
====== ======
OTHER ASSETS:
March 31,
--------------------
1998 1997
------ ------
Intangible assets, net of
accumulated amortization
of $490 and $156,
respectively $1,280 $ 734
Other 837 824
------ ------
$2,117 $1,558
====== ======
OTHER CURRENT LIABILITIES:
March 31,
--------------------
1998 1997
------ ------
(in thousands)
Accrued payroll and
related expenses $1,184 $ 848
Deferred compensation 685 454
Income taxes payable 553 166
Other accrued expenses 1,214 524
------ ------
$3,636 $1,992
====== ======
F-15
67
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6 - INCOME TAXES
The income tax provision (benefit) consists of the following components:
Years Ended March 31,
---------------------------------
1998 1997 1996
------- ------- -------
(in thousands)
Federal-
Current taxes $ 672 $ 523 $ 1,072
Deferred taxes (2,832) 81 109
------- ------- -------
(2,160) 604 1,181
------- ------- -------
State-
Current taxes 201 159 305
Deferred taxes (504) 21 42
------- ------- -------
(303) 180 347
------- ------- -------
$(2,463) $ 784 $ 1,528
======= ======= =======
The income tax provision (benefit) differs from an amount computed at the
Federal statutory rate as follows:
Years Ended March 31,
---------------------------------
1998 1997 1996
------- ------- -------
(in thousands)
Federal income tax provision
(benefit) at statutory rate (34%) $(2,407) $(2,275) $ 1,299
Increases (decreases)
resulting from:
Non-deductible purchased
in-process research and
development - 2,822 -
Non-deductible amortization
of purchased intangible
assets 144 120 -
State income taxes (201) 127 234
Other 1 (10) (5)
------- ------- -------
$(2,463) $ 784 $ 1,528
======= ======= =======
F-16
68
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,
-----------------------
1998 1997
-------- --------
(in thousands)
Deferred tax assets -
Accounts receivable $ 254 $ 167
Inventories 54 62
Accumulated depreciation 21 5
Purchased in-process
research and development 3,646 -
Intangible assets 39 -
Accrued vacation and sick leave 255 193
Accrued liability for
deferred compensation 241 195
Deferred revenue 19 -
State income taxes 42 46
Net operating loss carryforward - 201
-------- --------
4,571 869
-------- --------
Deferred tax liabilities -
Short-term investments (5) (30)
Inventories (16) (12)
Accumulated depreciation (64) (38)
Capitalized software (537) (364)
Deferred revenue (522) (334)
-------- --------
(1,144) (778)
-------- --------
$ 3,427 $ 91
======== ========
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.
F-17
69
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - EMPLOYEE BENEFIT PLANS
QSI and Clinitec each has a profit sharing and retirement plan (the
"Retirement Plans") for the benefit of substantially all of their
employees. 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 Plans may be amended or
discontinued at the discretion of the Board of Directors. Contributions of
$43,000, $33,000 and $20,000 were made to the Retirement Plans for the
fiscal years ended March 31, 1998, 1997 and 1996, respectively.
During the fiscal year ended March 31, 1994, QSI 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 $685,000
and $454,000 at March 31, 1998 and 1997, respectively. The Company made
contributions of $8,000, $10,000 and $11,000 to the Deferral Plan for the
fiscal years ended March 31, 1998, 1997 and 1996, respectively.
NOTE 8 - EMPLOYEE STOCK OPTION PLANS
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 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-18
70
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, 1998, 443,000 shares were available
for future grant under the 1989 Plan.
A summary of option transactions under the 1989 Plan for the three years
ended March 31, 1998 is as follows:
Weighted
Average
Number Exercise
of Shares Price
----------- ----------
Outstanding, April 1, 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
(43,000 exercisable at a
weighted average price
of $2.98) 267,500 15.20
Granted (weighted average
fair value of $1,214,000) 164,831 7.37
Exercised (30,250) 1.60
Cancelled (182,549) 21.08
-----------
Outstanding, March 31, 1998
(50,500 exercisable at a
weighted average price
of $3.45) 219,532 $ 6.31
=========== ==========
F-19
71
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, 1998 are summarized as follows:
Options Outstanding
Weighted
Average
Number Remaining Weighted
Range of Outstanding at Contractual Average
Exercise Prices March 31, 1998 Life (Yrs.) Exercise Price
- --------------- -------------- ----------- --------------
$ 1.50 - $ 4.88 34,250 0.5 $ 1.58
6.38 - 11.50 184,282 4.2 7.09
23.50 - 27.50 1,000 2.8 23.50
--------------
$ 1.50 - $27.50 219,532 3.6 $ 6.31
=============== ============== =========== ==============
Options Exercisable
Number Weighted
Range of Exercisable at Average
Exercise Prices March 31, 1998 Exercise Price
--------------- -------------- --------------
$ 1.50 - $ 4.88 33,625 $ 1.54
6.38 - 11.50 16,375 6.75
23.50 - 27.50 500 23.50
--------------
$ 1.38 - $27.50 50,500 $ 3.45
=============== ============== =============
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. Accordingly, 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 pro forma
income (loss) 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-20
72
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 47% to 59% in
fiscal 1998, ranging from 68% to 101% in fiscal 1997 and ranging from 71%
to 95% in fiscal 1996; risk free interest rates -- 5.9% in fiscal 1998,
6.5% in fiscal 1997 and 6.5% 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 1998, 1997 and 1996 awards had been
amortized to expense over the vesting period of the awards, the pro forma
net loss would have been $(4,771,000), or $(0.79) per share, in fiscal
1998; and $(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 1998, 1997 and 1996 of $1,214,000, $3,188,000 and $291,000,
respectively. The impact of stock options granted prior to fiscal 1996 has
been excluded from the pro forma calculations; accordingly, the fiscal
1998, 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
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. On July
1, 1997, a third purported class action was filed in the United States
District Court repeating essentially the same factual allegations as the
April 22, 1997 suit and purports to state claims under the Federal
securities laws. 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 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.
F-21
73
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Rental Commitments - The Company leases its facilities and offices under
noncancelable operating lease agreements expiring at various dates through
June 2000. The Company has rental commitments under these agreements in
fiscal 1999, 2000 and 2001 of $622,000, $281,000 and $2,000, respectively.
Total rental expense for all operating leases was $672,000, $451,000 and
$385,000 for the years ended March 31, 1998, 1997 and 1996, respectively.
NOTE 10 - ACQUISITIONS
Clinitec - 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:
Basic $ 0.29
Diluted $ 0.28
===========
F-22
74
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
MicroMed - On May 15, 1997, the Company acquired substantially all of the
assets of MicroMed, a developer and marketer of proprietary information
systems utilizing a graphical user interface client/server platform for
medical group practices. The purchase price consisted of an initial cash
payment of $4.8 million paid at the closing of the transaction and an
additional payment of $5.7 million due no later than June 29, 1998. The
Company anticipates paying $1.8 million of the additional payment in the
Company's Common Stock with the balance in cash.
The acquisition was recorded as a purchase transaction. In connection with
this treatment, the $10.6 million paid, and to be paid, by the Company,
including related acquisition costs, together with a $550,000 loan payable
by MicroMed to the Company as of the acquisition date and $677,000 of
assumed MicroMed liabilities was allocated to $1.3 million of acquired
identified assets, $10.2 million of acquired in-process research and
development, and $264,000 of purchase price in excess of assets acquired.
The technological feasibility of the acquired in-process research and
development had not been established at the dates the purchase price was
allocated and, accordingly, the allocated value was charged to operations
during the year ended March 31, 1998.
If the MicroMed acquisition had been consummated as of the beginning of the
year ended March 31, 1997, the impact on pro forma revenues, net loss and
net loss per share would not have been material for each of the years ended
March 31, 1997 and 1998.
NOTE 11 - 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)
F-23
75
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
NOTE 12 - 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. On February 9, 1998, the Company's
Board of Directors extended this authorization through February 9, 1999.
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 are immediately cancelled. As
of March 31, 1998, the Company has repurchased 40,100 shares at a cash cost
of $271,000.
F-24
76
QUALITY SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(in thousands)
Column C - Additions
---------------------
Column E
Column B (1) (2) Balance
Balance at Charged to Charged to at end
Column A beginning of costs and other Column D of
Description period expenses accounts Deductions Period
- ------------------ ------------ ---------- ---------- ---------- --------
Fiscal Year Ended:
March 31, 1998 $297 $339 $ - $115 $521
March 31, 1997 126 171 85(I) 85 297
March 31, 1996 $ 77 $ 71 $ - $ 22 $126
============ ========== ========== ========== ========
(I) Acquired in connection with the purchase of Clinitec International,
Inc. on May 17, 1996.
F-25
77
EXHIBIT 21
78
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. MicroMed Healthcare Information Systems, Inc., a California
Corporation, is a wholly-owned subsidiary of Quality Systems, Inc.
79
EXHIBIT 23.1
80
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 5, 1998
appearing in this Annual Report on Form 10-K for Quality Systems, Inc. for
the year ended March 31, 1998.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Costa Mesa, California
June 8, 1998