Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

COMMISSION FILE NUMBER 001-16079

PracticeWorks, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:    (770) 850-5006

Securities registered pursuant to Section 12(b) of the Act:    None

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

Common Stock, par value $0.01

Series B Convertible Preferred Stock, par value $0.01

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.    x

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

The aggregate market value of the common equity held by non-affiliates of the Registrant (16,198,373 shares, assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the Registrant) as of June 28, 2002 (based on the closing sale price of the Registrant’s common stock, par value $0.01 per share, $18.45 per share, as reported on the American Stock Exchange on such date) was $298,859,982. 17,603,821 shares of common stock were outstanding as of March 1, 2003.

Table of Contents

TABLE OF CONTENTS

Table of Contents

Item 1.     Business

General

We are the premier provider of software-based information management technology systems and related services for dentists, orthodontists and oral and maxillofacial surgeons in the United States, and, through our Trophy subsidiary, we are the world’s leading provider of digital and conventional radiology equipment for dental applications. Our product offerings include practice management applications, digital radiography systems, cosmetic imaging systems, electronic data interchange (EDI) and other e-commerce services and conventional x-ray equipment. We also offer ongoing maintenance, support and training related to our practice management software products. Our business is divided into segments as follows: (i) our information management technology systems and related services business, which is in turn divided into a domestic and an international segment; and (ii) our Trophy radiology business.

PracticeWorks, Inc. was incorporated in Delaware in August 2000 and operated as a division of VitalWorks Inc. until March 5, 2001, when it became an independent company as a result of a spin-off to the shareholders of the former parent.

Our Strategy

Our objective for our information management business is to enhance our position as the premier provider of software-based information technology systems for the dental services industry in our markets. Our objectives for our Trophy radiology business are to enhance Trophy’s position as the world’s leading provider of digital and conventional radiography systems in Europe and Japan and to become the premier provider of such products in the United States. Our principal strategies to meet these objectives are:

Promoting Our Practice Management Applications to New and Existing Customers.    In addition to promoting our applications to new customers, we actively offer existing customers using our older classic applications the opportunity to upgrade to our core technologies and subscribe to new products. These core technologies offer advanced functionality and operate with the latest generation of operating systems and hardware platforms. Based on our experience in the information technology industry, we believe providers traditionally upgrade to new practice management systems approximately every five to seven years. These upgrades should result in continued new revenue for us.

Increasing Trophy’s Market Presence.    We believe that the demand for digital radiography will continue to gain momentum as providers continue to move to an automated office environment and a digital solution continues to gain acceptance as a better, more efficient alternative to conventional x-ray film. We believe that Trophy’s reputation for superior digital imaging systems, combined with the integration that exists between Trophy’s digital imaging products and our practice management applications will make us the preferred and logical choice of our large customer base in the United States as it converts from conventional x-ray film to digital, as well as the preferred choice for new customers seeking new or better solutions for their practice automation and modernization needs. Although Trophy has long been a premier provider in Europe and Japan, the United States, the largest dental market in the world, represents only about ten percent of Trophy’s revenues. We intend to aggressively promote Trophy’s products in the United States and to continue to promote Trophy in its traditional markets of Europe and Japan as well as the rest of the world.

Providing Additional Products and Services.    As we have done in the recent past with the addition of new products such as cosmetic imaging and digital radiography, we expect to continue to develop new products and services that will benefit our customers’ practices. Furthermore, we believe that existing customers will take advantage of our EDI and other electronic services, because of the efficiencies that these services can provide. We also intend to continue to promote our maintenance and support services to customers who operate with one of our practice management software products, but who may engage third-party providers for support, training and maintenance.

1

Table of Contents

Generating Recurring Revenues from Subscription Pricing.    In addition to our historical practice of selling licenses to our information management systems for a one-time fee plus ongoing maintenance and support fees, we also offer our information management systems on a subscription basis. This pricing methodology bundles the license fee with ongoing maintenance and support for a consolidated monthly charge. Since beginning this pricing methodology in the last two years, approximately 70% of our new information management system sales have been through subscription pricing, and 9% of our total information management customer base is currently under subscription pricing. Although recurring revenue will decrease as a percentage of total revenue as a result of the Trophy acquisition, because Trophy digital systems are more often acquired outright through a purchase rather than through subscription, we intend to increase the percentage of customers using our subscription-pricing model for our non-Trophy products and services in order to enhance the reliability and consistency of our revenues. We will continue to market subscription pricing to existing customers primarily in conjunction with our efforts to upgrade those customers to our core information management applications. New customers will be offered subscription pricing for all of our products and services, although we expect these customers will also prefer to purchase rather than subscribe to Trophy digital systems.

Creating a Strong Brand Identity for PracticeWorks and Trophy.    We have implemented programs designed to create a strong brand identity for PracticeWorks, and we will expand those efforts to also create a strong brand identity for Trophy in the United States. Our marketing programs include direct mailings, advertising, participation in trade shows, promotions at user group meetings and seminar programs that enable us to meet face-to-face with existing and potential customers in major U.S. cities. Through our various marketing programs, we will continue to stress the benefits of our offerings and the reasons a provider should choose our products over those of a competitor.

Information Management Business

Overview

We provide software-based information technology systems for dentists, orthodontists and oral and maxillofacial surgeons. Our applications and services are designed to automate dental practices, resulting in greater efficiency, lower costs and higher quality care. As of December 31, 2002, we had an installed base of approximately 77,000 providers, including approximately 52,000 dentists, 5,000 orthodontists and 6,000 oral and maxillofacial surgeons in the United States and approximately 14,000 providers primarily in Sweden and the United Kingdom. Our large installed customer base provides us with recurring revenues from our maintenance, support and other services and applications offered under our subscription-pricing model. It also gives us the opportunity to pursue growth through sales of emerging information technology products and other services such as cosmetic imaging software and Trophy digital radiography systems to our existing customers.

Our practice management applications assist our customers in virtually every aspect of their practices, including administrative, financial and clinical functions. The administrative and financial applications include appointment scheduling, patient registration, correspondence, management reporting, insurance billing, patient billing and accounts receivable management. Clinical applications include documentation of patient visits, patient billing and treatment planning. We also offer cosmetic imaging software and digital radiography systems that provide our customers the opportunity to operate more efficiently, market new services and generate incremental revenue. Similarly, the electronic data interchange, or EDI, component of our applications can improve a practice’s cash flow by enabling more accurate and rapid submission of claims to third-party payors and more efficient processing of patient statements. In addition, we offer other electronic services to our customers that we believe provide opportunities for future growth.

Another significant component of our business is providing ongoing maintenance, support and training to new and existing customers. Our maintenance services include monitoring and developing enhancements to our software products, which we make available to our support and maintenance customers. Our support services are provided primarily by our staff of well-trained telephone support personnel. We provide on-site and remote training to all of our new customers as well as to our existing customers who request it.

2

Table of Contents

In the United States, we offer our products and services on a 36-month subscription basis, which reduces the initial cash outlay that the purchase of software licenses and practice applications often requires. If they desire, our customers may purchase our products in the traditional manner by paying a one-time license fee plus a recurring monthly support and maintenance fee. Our customers’ reliance on our systems and high level of support and maintenance for the mission-critical aspects of their practices keeps us in close contact with them and leads to additional sales opportunities. This reliance and proximity, combined with the difficulty in transferring data to competitive systems, accounts for our historically low customer turnover. In addition, our regular interaction with our customers gives us opportunities to upgrade our customers to our most advanced applications as well as to market our full suite of products and services.

We expect our growth in the United States to continue in part from sales of additional products and services to our existing customer base. We also believe there is potential for growth of our information management business in Europe both organically and through acquisitions. Through our existing operations in the United Kingdom and Sweden, we have established much of the infrastructure we expect to need for this expansion, including a Europe-based management team focused solely on international operations.

Practice Management Applications and Services

Application Features.    Our practice management applications are designed to automate the administrative, financial and clinical information management functions for dental, orthodontic and oral and maxillofacial surgery practices. Our applications are also scalable, providing the flexibility to serve practices of all sizes and with multiple locations. Our applications include the following standard features and functions that are essential to our customers’ practices:

In addition to providing standard practice management features, our specialty-specific applications offer advanced features that serve orthodontic and oral and maxillofacial surgery practices. Some of these advanced features are summarized in the following chart:

Current Applications.    We classify our existing practice management applications as either core or classic. Core applications are those we currently market to new and existing customers and are the focus of our ongoing product development efforts. Core applications offer advanced functionality and operate with the latest

3

Table of Contents

generation of operating systems and hardware platforms. Classic applications, while continuing to offer adequate functionality, may lack the most advanced practice management features and may not be designed for the latest generation of operating systems. We have designated as “classic” some of our applications that offer advanced functionality and operate on the latest generation of operating systems, because we have a core application that we believe better serves the same market.

As of December 31, 2002, approximately 57% of our customers used core applications, while approximately 43% used classic applications. We believe there is a significant opportunity to upgrade those customers utilizing classic applications to our core applications. As part of our strategy to upgrade our customers to our core applications, we no longer actively market our classic applications. We will, however, continue to provide support for those applications until we determine, on a case-by-case basis, that it is no longer cost-effective to do so.

Subscription Pricing.    Under our subscription-pricing model, our customers pay a fixed, monthly subscription fee for our practice management applications, maintenance and support. The subscription fee is based on the practice specialty and number of authorized system users, which may include practitioners and support staff. The subscription fee is set by a contract that is typically 36 months in length. Subscription pricing also provides our customers with protection against application obsolescence because we provide our customers with upgrades for no additional charge as we expand the functionality of our applications.

Electronic Data Interchange

By using the EDI component of our practice management applications in conjunction with our electronic gateway, customers are able to (1) determine patient insurance eligibility, (2) submit insurance claims to independent national clearinghouses that then forward the claims to payors and (3) submit patient billing information to clearinghouses that process, print and mail patient statements and provide billing reports to the customer. The use of our EDI services can improve a practice’s cash flow by enabling both more accurate and rapid submission of claims to third-party payors and more efficient generation of patient statements. Furthermore, our EDI application is an integrated component of most of our practice management applications, enabling customers to submit information to clearinghouses via our gateway without the need to access a separate system or re-enter data. Customers pay for this service on a per-transaction basis.

Dicom Cosmetic Imaging

The Dicom Digital Imaging Suite of software applications includes imagExplorer^™, imagEditor^™, imagSimulator^™ and Whitener modules. This digital imaging system for dentists is an easy-to-use add-on module for our dental practice management products. It provides powerful image management, editing, annotation and treatment simulation capabilities for dentists and their staff. The Dicom Digital Imaging Suite also provides a powerful communications tool that benefits dentists, dental laboratories and insurance companies due to its strong functionality and ease of use.

Internet Services

PW Exchange.    PW Exchange, our e-commerce application accessible on the Internet, is designed to reduce administrative effort and increase the efficiency of the procurement function of a practice by enabling online purchasing of dental and orthodontic supplies, office supplies and promotional materials at competitive prices from a single source. PW Exchange features an electronic catalog of the supplies offered by our e-commerce suppliers and permits them to promote special offerings. Customers create orders by selecting products from this catalog, and PW Exchange sends the order to be fulfilled by one of our e-commerce suppliers. PW Exchange also offers an inventory management function that can automatically generate practice-specific supply orders for orthodontic supplies based on the pre-determined needs of the practice.

4

Table of Contents

Other Electronic Services.    Healthcare practices are increasingly establishing their own websites to market their services and provide information about their practices over the Internet. To serve this growing demand, we offer SiteBuilder, our Internet-based personalized website development application. SiteBuilder easily and economically allows a provider to create a personalized website using templates and available graphics. Through communications functionality, known as e-Link, currently available in our core practice management applications, our customers’ websites may be integrated with their practice management application that enables them to provide an interactive, secure, encrypted communication link for their patients. This functionality provides our customers with the option to allow patients to request an appointment, receive confirmation of an appointment, obtain account information, update their demographic data and communicate with the customer via email.

In addition, we continue to develop our Internet portal, or website, whereby customers will be able to access PW Exchange and SiteBuilder. Our portal will feature Internet-based training and support services and a customer service application.

Sales and Marketing

Sales

In the United States, we offer both our information management products and services and Trophy radiology systems primarily through a direct sales force that is organized by geographic territory and consisted of approximately 70 sales representatives as of December 31, 2002. Each of our representatives has been trained and is able to sell all of our products and services offering to all dental providers within their assigned territory. Some of our representatives focus and specialize, however, on promoting specific products and services. We utilize software that provides our sales force with tools for remote generation of proposals and quotes and provides our sales management tools for lead tracking, sales forecasting and customer base forecasting.

We focus our sales efforts on the following initiatives:

Marketing

We have committed resources to a focused marketing program. We believe we were successful in continuing the branding of the PracticeWorks name in 2002. We are continuing programs that will promote market awareness of our brands. Our marketing program includes the following components:

5

Table of Contents

We target our customers principally through customer referrals, participation in trade shows, our seminar program, direct mailings and advertising.

Customers

As of December 31, 2002, our information management business had an installed customer base of approximately 63,000 providers in the United States, including 52,000 dentists, 5,000 orthodontists and 6,000 oral and maxillofacial surgeons. We have systems installed in all 50 states.

In addition, as of December 31, 2002, we had an installed customer base of approximately 14,000 providers outside of the United States, primarily in Europe, approximately half of which were in the United Kingdom and half in Sweden.

Customer Service, Support and Training

Our support staff provides a wide range of customer support functions. As of December 31, 2002, we employed approximately 300 functional and technical support personnel who work directly with our customers to resolve technical, operational and application problems or questions.

Our support staff also assists with the implementation process. Implementation consists of training, hardware integration and, with respect to new customers or existing customers that are upgrading from our classic systems, data conversion. We train providers and their staffs on the use of our products through remote and on-site training, and we regularly offer seminar training in major U.S. cities. Data conversion is generally performed while providers are using their existing practice management systems so that the day-to-day operations of their practices are not interrupted. We have established a centralized data conversion center, which we believe will enable us to more efficiently and effectively perform customer data conversions. Hardware support is generally provided directly by the manufacturer or its authorized reseller, although we provide the first level of telephone support and dispatch the service call to the appropriate vendor.

We also have centralized our support service for our applications. We believe this is a more cost-effective way to offer a higher level of support to our customers. We plan to utilize the capabilities of our support staff through the implementation and use of sophisticated computer software that keeps track of solutions to common computer and software-related problems. Use of this software will allow our support staff to learn from the experience of other personnel within our company and is expected to reduce the time required to respond to support requests.

We recently have introduced remote training via the telephone and Internet. We are also developing Internet-based maintenance and support services. Remote training enables us to deliver training to a customer without the significant disruption of their normal business routine that on-site training requires. Internet-based training allows our customers and their office staff to learn to utilize their practice management systems as needed and on a more consistent basis than periodic on-site training or seminars.

Product Development

We focus our product development efforts on our core applications, including integration of our practice management and imaging systems, as well as our classic products. Our product development staff develops additional functionality for our applications by regularly communicating with our customers, our customer service and support staff and our sales representatives to ensure our applications continue to meet evolving market demands and by assessing the best attributes of our classic applications. Through our Thought Leaders program, whose members are selected from leaders in the various fields of dentistry, we have formalized our efforts to seek and receive input on our products and services and the needs of practitioners. In addition, we actively seek feedback from our customers through end user group meetings.

6

Table of Contents

As of December 31, 2002, we had approximately 35 employees performing product development functions and 15 performing quality assurance checks on our information management products. We spent approximately $3.4 million, $2.2 million and $3.5 million on research and development activities on our information management business, net of amounts eligible for treatment as capitalized software development costs, during the years ended December 31, 2002, 2001 and 2000, respectively.

Technology

Operating Systems

We believe that PC-based practice management systems are standardizing on the Windows family of operating systems. Our PC-based core applications use industry standard relational database software and Microsoft Corporation’s operating system software, such as Windows 98, Windows 2000 and Windows XP.

Privacy Issues

Because our applications and services are utilized to manage and transmit highly sensitive and confidential health information, we must address the security and confidentiality concerns of our customers and their patients. To enable the use of our applications and services for the transmission of sensitive and confidential personal health information, we utilize advanced technology designed to ensure a high degree of security. This technology generally includes:

The level of data encryption utilized by our products is in compliance with the encryption guidelines set forth in the final rule regarding security standards published on February 20, 2003 and the proposed rule regarding electronic signature standards in connection with HIPAA. We also encourage each of our customers to implement their own firewall to protect the confidentiality of information being transferred into and out of their computer network.

Internally, we work to ensure the safe handling of confidential data by employees in our electronic services department by:

We monitor proposed regulations that might affect our applications and services in order to ensure that we are in compliance with such regulations when and if they are promulgated.

Employees

As of December 31, 2002, we employed approximately 700 full-time employees in our information management business, none of whom is covered by a collective bargaining agreement. From time to time we employ a small number of part-time personnel.

Competition

The market for software-based information management technology systems for the dental services industry is competitive, rapidly evolving, highly fragmented and subject to swift technological change. Our primary

7

Table of Contents

competitors are national, regional and local practice management application providers, including Dentrix Dental Systems, Inc. and Easy Dental Systems, both subsidiaries of Henry Schein, Inc., as well as EagleSoft, a subsidiary of Patterson Dental Company. Each of these companies can be expected to compete with us within various segments of the market for information technology for dentists, orthodontists and oral and maxillofacial surgeons.

Furthermore, major software information systems companies and other entities, including those specializing in the healthcare industry that are not presently offering applications that compete with our applications and services, may enter our markets. We believe that the primary competitive factors in our industry are:

We believe that we compete favorably with respect to all of these factors.

Trophy Radiology Business

Overview

In December 2002, we acquired Trophy Radiologie S.A., a developer and manufacturer of a complete line of radiology equipment for dental applications, including its flagship RVG^TM digital imaging sensor and related software, high performance computer controlled digital panoramic imaging systems and intra-oral cameras. In addition to being a premier manufacturer of conventional x-ray systems, Trophy pioneered the development of intra-oral digital imaging systems that allow traditional x-ray equipment to generate x-ray images instantly without film or other consumables. We believe Trophy’s RVG digital sensors and software make Trophy the first and only digital intra-oral system that has equaled or exceeded the performance of x-ray film. Prior to the acquisition, we had been a preferred distributor of Trophy’s digital sensor products in the United States since early 2002. We acquired Trophy in order to take full advantage of the growing demand for and acceptance of digital imaging products worldwide. Digital solutions are used in the most successful dental practices to improve time management and increase productivity per chair. Trophy’s digital imaging systems allow a dentist to obtain a high resolution x-ray image in a more versatile, useable electronic format with added benefits of reduced radiation exposure to the patient and elimination of chemicals and film. Office productivity is enhanced from the elimination of traditional film development processing.

Trophy Products

Digital Imaging.    Trophy offers a full line of digital radiography systems covering all intra-oral procedures. Dental radiology equipment typically consists of an x-ray generator and an electronic control unit. In 1983, Trophy pioneered the development of its RVG digital imaging system which allows conventional x-ray equipment to generate x-ray images instantly without requiring film or other consumables and offers better diagnostic capabilities than conventional film. Digital systems also require significantly less x-ray radiation exposure than conventional x-ray equipment. As dental providers continue to move to an automated office environment and digital imaging continues to gain acceptance as a better and more efficient alternative to conventional x-ray film, we expect increasing demand for Trophy’s digital products. All of Trophy’s digital products are integrated with our core practice management applications and bridged both to our classic practice management applications and to those of our primary competitors. Trophy’s digital imaging products include the following:

8

Table of Contents

Conventional X-Ray.    Trophy also manufactures and sells two models of conventional x-ray generator units, both of which are fully compatible with the RVG digital imaging system.

Sales and Marketing

Sales

In Europe, we offer Trophy products primarily through a well-established network of approximately 550 distributors supported by local Trophy sales offices in France, the United Kingdom, Belgium, Germany, Italy and Spain. These distributors sell both digital and conventional systems primarily on a non-exclusive basis. In the U.S., we sell Trophy’s digital radiology products exclusively through our information management products sales force while we sell its conventional radiology products through independent non-exclusive dealers. In Japan, we sell our Trophy products through an exclusive distribution arrangement with a Japanese dental products manufacturer. In the rest of the world, Trophy generally uses one dealer per country, typically on a non-exclusive basis. In France, Trophy also has an in-house sales and service team that supports its dealer network and pursues large orders in Eastern Europe, Asia, the Middle East and South America. During fiscal year 2002, no Trophy distributor represented more than five percent of Trophy’s revenue except for Trophy’s exclusive distributor in Japan, which represented 8% of Trophy’s revenues.

9

Table of Contents

Marketing

In the United States, we are committed to a marketing program designed to create strong brand identity and brand awareness for Trophy. This program will be part of and work in conjunction with the marketing program for our information management business described elsewhere in this report. In Europe, the Trophy brand name is well known, and we market Trophy brand products throughout Europe in a variety of ways, including by attending trade shows and advertising in industry publications.

Customer Service, Support and Training

Our distributor network is supported by Trophy’s sales and support staff of approximately 100 employees located in its offices in France and at its international sales subsidiary locations.

Product Development

We focus our product development efforts on our digital imaging, software and conventional x-ray systems as well as new products. These efforts concentrate on exploring alternative imaging technology and improving ergonomics and ease of operation and installation, all while maintaining or improving our image quality. We also devote a considerable amount of resources to continually improve processing techniques, comply with regulatory requirements and improve ease of use.

As of December 31, 2002, we had approximately 30 employees performing product development functions. Research and development expenditures are anticipated to be $3.0 million for 2003.

Manufacturing

We have one manufacturing facility for our Trophy products, which is located near Paris, France. This facility also serves as the principal business office for our Trophy operations.

Trophy currently utilizes three production lines and one distribution line in the manufacture of its dental products. The three production lines are organized for (i) the manufacture of conventional dental products (Irix and Elitys), (ii) the manufacture of dental imaging products (RVG, STV, DigiPan) and (iii) the manufacture of TrophyPan units.

Trophy is one of only a few manufacturers worldwide that are capable of the complete manufacture of x-ray generators: winding operations, oil filling of x-ray head containers and x-ray tube fabrication. Trophy also manufactures the major components of the RVG sensor and the TrophyPan and DigiPan units. Trophy’s production staff is highly skilled and capable as a result of internal training programs and long length of service.

Trophy operates on a just-in-time production schedule. Trophy utilizes various subcontractors for sheet metal parts production, painting, mechanical works and most PC-board devices. Main subcontractors are located in France and all operations and components are made according to Trophy’s specifications. For all purchased components, suppliers are required to send quality reports certifying the conformity of their products to Trophy’s norms and requirements. Components are checked by a Trophy team upon taking delivery. During the manufacturing process, quality control is maintained at each and every level both by the working operators and the team managers. All finished products are checked for quality control purposes before packing, according to checklists, and a delivery report must be issued before any product is permitted to leave Trophy’s facility.

10

Table of Contents

In March 1998, Trophy became an ISO 9001 certified company. All Trophy’s products involving ionizing x-ray radiation, such as Irix, Elitys, and Digital Panoramic (class Iib) units, are subject to CE Marking, pursuant to European Directives 93/42/EEC, annexes III and V. The other non-active dental products, such as RVG, STV, and DigiPan (class I), are subject to CE Marking, pursuant to the same above Directives, annex VII. New products under development will be submitted to CE Marking, under annex II.

Employees

As of December 31, 2002, we employed approximately 280 full-time employees in our Trophy business, primarily in France and other European countries. As required by French law, the employees of Trophy are represented by a Labor Council of ten members. One of these members represents Confédération française et démocratique du travail, and another represents Confédération générale des travailleurs, two unions. In addition, our employees in Europe have significant rights provided by their respective government’s employment regulations. We consider our relations with our Trophy employees to be good.

Competition

The market for dental radiology systems is intensely competitive and includes a number of companies, both within and outside the United States. Trophy’s primary competitors vary by product category. In conventional x-ray systems, our primary competitors are Gendex (a subsidiary of DENTSPLY International in the United States), Sirona of Germany, and Planmeca and Instrumentarium-Soredex, both of Finland, and there are as well other smaller companies who compete in this product category, primarily in developing countries. In digital radiology, including panoramic systems, our primary competitors are three U.S.-based companies, Schick Technologies, Inc., Gendex and Dexis. Primary competitive factors include integration with practice management applications, image quality, ease of operation, product features and functionality and price. We believe we compete favorably with respect to all of these factors.

The Dental Industry

Overview

According to the Centers for Medicare & Medicaid Services, spending on dental services in the United States reached approximately $65.6 billion in 2001. Dental services are expected to grow at a compounded rate of 5.5% annually through the year 2012, when total dental care would account for approximately $118.0 billion of healthcare expenditures in the United States. Based on our experience in the industry, we believe the primary drivers of growth in dental services include the aging population, natural teeth being retained longer, changing dental procedures and preventative care trends, general population growth and an increase in private dental insurance. According to Dorland Healthcare Information, a healthcare industry research firm, orthodontic services were estimated to have represented $4.4 billion of total dental services expenditures in 2000, an increase of 7.3% over the previous year. Information about the oral and maxillofacial surgery market is not available and is not included in the dental services industry data discussed above.

The dental services industry in Europe differs notably from the current market in the United States in two major respects. First, in contrast with the United States, where we believe a substantial majority of practices are automated or computerized, we believe that roughly half of the practices in Europe are currently automated or computerized. Second, in most European countries, the market for practice management software applications in the dental services industry is fragmented, with no clear leader.

Information Technology

Information from the American Dental Association indicates that dental practitioners are increasingly utilizing information technology, including practice management applications, in their day-to-day operations to more efficiently manage their practices and control costs. Practice management applications include a range of

11

Table of Contents

software products for dentists and other dental healthcare providers that are used throughout the business day. Most practice management applications provide several common functions considered mission critical, including:

Information technology and the Internet are becoming increasingly important and commercially viable means to reduce the current cost burden in the healthcare industry. Because of its size, fragmentation and dependence on information exchange, we believe the dental, orthodontic and oral and maxillofacial surgery markets are ideally suited to benefit from increased use of technology to control costs and manage complex data requirements. We believe a significant opportunity exists for companies like ours that have experience in delivering information technology systems to dental providers.

Digital Radiology

Dentists typically perform their own radiology work and, as a result, represent, as a group, one of the largest consumers of radiology products in the world. Until recently, conventional x-ray equipment using film was the only means available to dental providers. However, as digital technology has evolved to the point where image quality equals or exceeds conventional film while at the same time reducing radiation exposure, eliminating processing time and increasing overall efficiency, providers are increasingly migrating to digital, notwithstanding its higher initial cost. According to Business Communications Company, dental digital radiology has grown from an estimated $32 million industry in 1998 to an estimated $233 million in 2002, a compound annual rate of 64%. We believe that the worldwide market for digital radiology will continue to grow with a potential market that includes all dental providers practicing today and in the future. We believe the business is being driven by major demographic and socioeconomic trends as well.

Intellectual Property and Proprietary Rights

Our success and ability to compete depend in part on our ability to protect our proprietary intellectual property rights to our applications and services. To protect these rights, we rely primarily on a combination of patent, copyright, trade secret, service mark and trademark laws, confidentiality agreements with third parties, and protective contractual provisions such as those contained in agreements with companies with which we have business relationships, vendors and customers. In addition, our employees are expected to sign an agreement to comply with our corporate policies and procedures, including our policy regarding non-disclosure of confidential information, but we may not have entered into these agreements in every case. Despite our efforts to protect our proprietary information, unauthorized parties may attempt to obtain and use our proprietary information. Policing unauthorized use of our proprietary information is difficult, and the steps we have taken might not prevent misappropriation, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the United States. In addition, competitors may independently develop applications and services similar to ours.

PracticeWorks, Trophy, RVG, SoftDent, Irix 70, Elitys, TrophyPan and DigiPan, among others, are trademarks owned by us to which we have registration rights, common law rights, or both.

Government Regulation

As a participant in the healthcare industry, our operations and relationships are subject to regulation by foreign, federal and state laws and regulations and enforcement by foreign, federal and state governmental agencies. Sanctions may be imposed for violation of these laws. We believe our operations are in compliance with existing laws that are material to our operations.

12

Table of Contents

HIPAA.    The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) required the Secretary of the Department of Health and Human Services, referred to as the Secretary, to promulgate rules for, among other things, electronic transactions and protection of the privacy and security of individually identifiable health information.

A significant portion of our activities involves the receipt, delivery and potential use and disclosure of individually identifiable health information concerning patients of the dentists, orthodontists and oral and maxillofacial surgeons with whom we have direct contractual relationships. For example, we transfer individually identifiable health information to national healthcare clearinghouses through our EDI services, and we will transmit individually identifiable health information over the Internet in connection with our application service provider offerings. Additionally, we may receive certain types of individually identifiable health information when we convert a provider’s entire database in connection with the installation of new software or when we remotely access a customer’s computers to resolve hardware or software issues.

On December 28, 2000, the Secretary published a final rule, which was amended on May 31, 2002 and August 14, 2002, setting standards to limit the permissible use and disclosure of individually identifiable health information by healthcare providers, health plans and healthcare clearinghouses, known collectively as “covered entities” (the “Final Privacy Rule”). The Final Privacy Rule regulates so-called protected health information, or PHI, which encompasses all individually identifiable health information that is transmitted or maintained by a covered entity in electronic media or any other form or medium. The Final Privacy Rule establishes a complex regulatory framework on a variety of subjects, including (1) disclosure and use of PHI, (2) individuals’ rights to access and amend their PHI, and (3) individuals’ rights to an accounting of disclosures of PHI. The Final Rule generally prohibits any disclosure or use of PHI except as authorized either by the rule or by the patient under standards set by the rule. Most covered entities must be in compliance with the Final Privacy Rule on or before April 14, 2003. We are taking steps to ensure that our operations and contracts will be in compliance with the Final Privacy Rule and any revisions thereto on or before that date.

Although we are not a healthcare provider or a health plan, we offer certain electronic claims and billing services to our dental customers, which include the conversion and consolidation of certain healthcare claims data from non-standard to standard formats for submission to third-party payors or claims processing entities. As such, we may be considered a healthcare clearinghouse under the Final Privacy Rule. As a covered entity, we will need to comply with certain components of the Final Privacy Rule, including the implementation of new policies, procedures and employee training to protect the privacy of any PHI that we may receive from our customers when performing these types of clearinghouse services.

Certain requirements of the Final Privacy Rule also extend to so-called “business associates” of covered entities. Because we likely would be considered a “business associate” when receiving PHI to facilitate a client’s data conversion or when remotely accessing a client’s computers or providing other similar functions, our clients need to ensure that they have in place with us a contractual relationship that includes certain requirements to protect the privacy of any PHI that we may receive in the course of our relationship. Among other requirements, the contracts must specify that the business associate will: (1) only use or disclose PHI as permitted under the agreement and not in a manner that would violate the Final Privacy Rule; (2) use appropriate safeguards to prevent further use or disclosure of PHI except as permitted by the agreement; (3) report any known misuse of PHI to the covered entity; (4) make an accounting of any disclosures of PHI available to individuals as required by the Final Privacy Rule; (5) return or destroy any PHI at the termination of the relationship; and (6) require that the contract be terminated, if feasible, where it is determined that the business associate has materially violated it. In our conduct of certain clearinghouse and other services, we are considered a covered entity, and therefore we will enter into a business associate agreement with certain of our vendors as well.

In addition to the Final Privacy Rule, on August 17, 2000, the Secretary issued final rules for financial and administrative transactions and data elements for certain types of healthcare transactions that are transmitted electronically (the “Final Transaction Rule”), which were modified on February 20, 2003. Specifically, the Final

13

Table of Contents

Transaction Rule establishes standards and data elements for eight financial and administrative transactions including: (1) healthcare claims or equivalent encounter information; (2) eligibility for a health plan; (3) referral certification and authorization; (4) healthcare claims status; (5) enrollment and disenrollments in a health plan; (6) healthcare payment and remittance advice; (7) health plan premium payments; and (8) coordination of benefits. Testing for the eight transactions covered by the rule must begin no later than April 16, 2003. Because of the complexity of these new requirements, we are in the process of reviewing all applications in an effort to ensure that the content and edits will conform to the Final Transaction Rule for our customers that submit any of the eight transactions electronically. While we will incur costs to become compliant with the Final Transaction Rule, management believes they will not have a significant overall impact on the Company’s financial results or operations.

Lastly, on February 20, 2003, the Secretary issued final regulations addressing security standards regarding electronic transmission of PHI under HIPAA. The security standards address various areas, including, administrative procedures, physical safeguards, technical security services and technical security mechanisms. Security standards may require us to enter into agreements and/or amendments to existing agreements with certain of our customers restricting the dissemination of PHI and requiring implementation of specified security measures. The deadline for compliance with the security regulations is April 21, 2005.

State Privacy Laws.    In addition to the Final Privacy Rule, most states have enacted patient confidentiality laws which prohibit the disclosure of confidential medical information and many are considering further legislation in this area. The Final Privacy Rule establishes minimum standards and would preempt conflicting state laws that are less restrictive than HIPAA but would not preempt conflicting state laws that are more stringent than any rules issued by the Secretary under HIPAA. As a result, both the Final Privacy Rule and state privacy laws may require changes to our applications and services, policies and procedures.

FDA Regulation.    The U.S. Food and Drug Administration, or FDA, has the authority to regulate “medical devices,” including x-ray and certain computer applications, when such devices are indicated, labeled or intended to be used in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment or prevention of disease, or are intended to affect the structure or function of the body. The FDA regulates the marketing, manufacturing, labeling, packaging, advertising, sale and distribution of “medical devices”, as do various foreign authorities in their respective jurisdictions. The FDA enforces additional regulations regarding the safety of equipment utilizing x-rays. Various states also impose similar regulations on the use of x-ray producing equipment by healthcare professionals.

Expansion of our application and service offerings through the acquisition of Trophy subjected us to FDA regulation for the first time. In addition to our Trophy radiology products, however, there is always the possibility that the FDA could assert regulatory jurisdiction over other aspects of our business. FDA jurisdiction over Trophy products is well established, as discussed below. FDA’s extending jurisdiction to other aspects of our applications and services could materially affect our ability to introduce new applications and services in a timely manner because of the FDA approval process. In addition, compliance with FDA regulations could be expensive.

Radiological and imaging products that Trophy is currently manufacturing or has in developmental stages are subject to governmental clearance, including marketing clearance by the FDA. FDA approval typically requires extended evaluation to confirm that a medical device is safe and effective for its intended use. Medical devices cannot be legally marketed in the United States without FDA marketing clearance. There are no assurances that any product developed by us in the future will be given clearance by FDA or that additional regulations will not be adopted or current regulations amended in such a manner as to adversely affect the marketing and sale of our products.

The FDA, under authority of the Federal Food, Drug and Cosmetic Act (“FFDCA”) classifies medical devices intended for human use as: Class I, Class II, and Class III devices. Class I devices are products which the

14

Table of Contents

FDA may be reasonably assured are safe and effective by maintaining general controls over manufacturing, relating to such matters as adulteration, misbranding, registration, notification, records and reports. The STV Stomavision is a Class I device.

Class II devices require special controls such as promulgation of performance standards, post-market surveillance, patient registries or such other actions as the FDA deems to provide a reasonable assurance of safety and efficacy. With the exception of the STV Stomavision, all Trophy radiology products are Class II devices.

Class III devices are life-supporting, life-sustaining, of substantial importance in preventing impairment of human health, or present a potential unreasonable risk of illness or injury. Class III devices require extensive pre-market review by FDA prior to approval. None of our existing products are Class III medical devices.

Unless they fall into a narrow category of exempt devices, medical devices may not be commercially distributed in the United States unless they have been cleared by the FDA. Medical devices can receive such clearance in accordance with a Section 510(k) procedure or by Pre-Market Approval (“PMA”). A medical device that has been cleared by FDA for one particular purpose may not be marketed for applications that have not been cleared by FDA.

Under the 510(k) procedure, a manufacturer submits to the FDA a pre-market notification that it intends to begin marketing the device and provides information demonstrating that the device is substantially equivalent to another legally marketed product. The FDA will clear the device for marketing if the applicant can show that it has the same intended use and that it is as safe and effective as a legally marketed device and does not raise questions of safety and effectiveness. The FDA may require a 510(k) notification to include data from human clinical studies.

Once the FDA issues a clearance letter confirming substantial equivalence to an already legally marketed device, marketing may commence. FDA is required by regulation to respond to a 510(k) notification within 90 days, but there are no assurances that the agency will provide a timely response, or that a finding of substantial equivalence will be made.

Pre-Market Approval (“PMA”) must be obtained for medical devices that do not qualify for the 510(k) procedure, because they are not substantially equivalent to a legally marketed device (or fall into the Class III device category), before they can be legally marketed in the United States.

The objective of the PMA application is to confirm that the medical device is safe and effective. PMA applications are complex submissions that include the results of clinical studies. FDA’s review of PMAs may be lengthy and the agency can request additional data. The FDA may take 180 days to review a PMA application, but the review is subject to extension. There are no assurances that the FDA will approve a PMA application.

The Trophy products marketed in the U.S. all have been cleared under the 510(k) procedure.

Medical device manufacturers and distributors are subject to continuing oversight by the FDA, including annual reporting and annually providing FDA with a list of commercially distributed medical devices. Medical device manufacturers must also comply with labeling requirements and manufacture their products and maintain their documents in a prescribed manner with respect to manufacturing, testing, and quality control activities.

The Medical Device Reporting regulations subject medical devices to post-market reporting requirements pertaining to instances where death or injury occurred, or malfunctions occurred in a manner that would be likely to cause a death or serious injury.

15

Table of Contents

We are currently developing new products and making improvements to existing products. We expect to file 510(k) applications with the FDA in connection with our future products. There are no assurances that the clearance process will not be encumbered by requirements for additional data that may substantially delay the 510(k) process and result in substantial additional expense.

FDA clearance, if obtained, may further be subject to conditions on the marketing or manufacturing of the medical device which could impede our ability to manufacture and/or market the device. There are no assurances that products we may develop will be approved by or receive marketing clearance from applicable governmental authorities. The inability to obtain regulatory approval for and market new devices and enhancements to existing devices, could have a material adverse effect on our business.

FDA regulations are enforced by a variety of sanctions. Non-compliance can result in fines, injunctions, civil penalties, suspensions or loss of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. It is also possible that new government regulations may be promulgated that could prevent or delay regulatory clearance of our products. Delays in clearance, failure to receive clearance or the loss of clearance previously obtained could have a material adverse effect on our business.

Available Information

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, available free of charge on our website, located at http://www.practiceworks.com as soon as reasonably practicable after they are filed with or furnished to the SEC.

Risk Factors

We have a history of losses, and we may never achieve or maintain profitability.

We had net losses of $7.1 million for the year ended December 31, 2002. Our accumulated deficit as of December 31, 2002 was $32.5 million. We were not profitable during the last three fiscal years, and although we expect to be profitable in fiscal 2003, uncertainties still exist regarding our attainment of profitability.

Management and integration of the Trophy business may task our executive management, which could adversely affect our business.

We believe that the Trophy acquisition will allow us to remain at the forefront of developing trends in the modern dental practice and permit us to provide a complete digital solution for our customers. However, Trophy operations, which we anticipate will represent a significant portion of our overall business, include manufacturing operations conducted in France, where we have not previously had any experience conducting business. Although we have had success maintaining a European business presence in the past, our international business before Trophy did not approach the magnitude that Trophy represents, and U.S. management may face unexpected challenges related to having such a large part of its business conducted at such a remote distance from the U.S. operations. In addition, Trophy has added to our company an entirely new business segment of manufacturing. U.S. management personnel are not experienced in manufacturing on this scale and will necessarily rely on existing management at Trophy for the day-to-day operations of that segment. Trophy has a world-wide distribution network for its products and manages that distribution through a number of foreign subsidiaries. Most of those subsidiaries are located in jurisdictions in which our company has not previously had experience conducting business. The Trophy business may require additional management resources that may not be available in the company, and it may divert current executive management’s attention and efforts from our day-to-day operations in the U.S., including those related to our information management business, which could adversely affect our business.

16

Table of Contents

We may be unable to set subscription fees at levels that will enable us to achieve profitability.

The success of our subscription pricing model for information management products depends upon our ability to set subscription fees for our applications and services at rates that will allow us to achieve profitability in our information management business. Under our subscription-pricing model, our customers pay a fixed, monthly subscription fee for our practice management applications, maintenance and support. The subscription fee is based on the practice specialty and number of authorized system users. The market for delivery of applications and services like ours on a subscription fee basis is not well developed. In addition, we expect to enter into multi-year agreements with subscribers pursuant to which subscription fees are typically locked in for 36 months, limiting our ability to increase our subscription fees for those subscribers. If we fail to appropriately price our subscription fees, achieving profitability in our information management business could take longer than expected, or we may never achieve profitability in that business segment. In addition, although we expect recurring revenues to continue to increase in amount, we expect them to decrease as a percentage of total revenues as a result of the Trophy acquisition.

We may not be able to achieve widespread recognition of our brand name, which would make it difficult to implement our business strategy.

Achieving market acceptance for our new applications and services and for our Trophy products in the United States will require continuous and substantial sales and marketing efforts and the expenditure of significant funds to increase awareness and demand by our current and prospective customers. The PracticeWorks name is relatively new and we expect to invest significant amounts on programs that will promote market awareness and identity of our brand. The same is true of the Trophy name in the United States. If we fail to successfully create a recognized brand name for PracticeWorks and Trophy in the United States, our ability to obtain new customers and retain current customers could suffer.

Our cosmetic imaging systems, digital radiography systems, and certain electronic services are new product offerings that may not achieve significant near-term adoption, and a lack of growth from these offerings may adversely affect our business model.

Our new cosmetic imaging and Trophy digital radiology systems have not yet achieved widespread market acceptance. We will need to devote substantial marketing efforts in order to drive market adoption of these products. We also intend to grow by encouraging dentists, orthodontists and oral and maxillofacial surgeons to place orders with suppliers over the Internet using our PW Exchange application and to access other services on our Internet portal. If these efforts are not successful and our customers do not utilize these products and services as we anticipate, our growth could be inhibited.

Technology systems may change faster than we are able to update our products, which could affect our ability to grow our business.

Although the healthcare industry, including dental, orthodontic and oral and maxillofacial surgery practices, historically has been slow to respond to technological advances, many vendors are introducing technologically advanced products in anticipation of growing demand. As a result, the healthcare industry is increasingly characterized by rapidly changing technology, evolving industry standards, emerging competition and the frequent introduction of new applications and services. Our success depends partly on our ability to:

If our competitors develop products or technologies that are better or more attractive than ours, or technological advancements render our applications and services obsolete, our business could be harmed.

17

Table of Contents

Our Trophy products expose us to the risk of product liability, recalls and similar claims which may result in substantial damage awards and other costs which could have a material adverse effect on our business and results of operations.

Due to the nature of our Trophy products, we are subject to the risk of product liability, recalls and other claims in the event that the use of our products results in personal injury or other claims. Trophy has conducted recalls and other corrective actions, and experienced claims for property damage and/or personal injury (generally only minor in nature), with respect to the scissor arms of certain conventional x-ray machines manufactured prior to 1998. Although these recalls and corrective actions have generally been completed, certain claims and legal proceedings are still pending and the termination of these recalls and corrective actions may not necessarily preclude future product failures, recalls and additional claims for property damage and/or personal injury. Although we maintain insurance coverage related to product liability claims and, in connection with the Trophy acquisition, Trophy’s former parent agreed to indemnify us, subject to certain limits, for scissor arm claims related to products manufactured prior to 1998, there can be no assurance that product liability or other claims or costs related thereto will not exceed our insurance coverage limits or be subject to indemnity.

The markets we serve are highly competitive, and we may be unable to compete with businesses that may have greater resources than we have.

The market for providing information technology and radiology equipment to dentists, orthodontists and oral and maxillofacial surgeons is competitive. In our information management business, our primary competitors include national, regional and local practice management application providers, including Dentrix Dental Systems, Inc. and Easy Dental Systems, both subsidiaries of Henry Schein, Inc., as well as EagleSoft, a subsidiary of Patterson Dental Company. In our Trophy radiology business, our competitors include European and United States companies, including Gendex (United States), Sirona (Germany) and Planmeca and Instrumentarium-Sordex (both in Finland) in conventional x-ray, and Schick Technologies, Inc., Gendex and Dexis (all U.S.-based) in digital radiology. Furthermore, major software and radiology companies and other entities, including those specializing in the healthcare industry that are not currently offering applications, services or digital equipment that compete with our applications and products, may enter our markets.

Some of our competitors may have substantially greater financial, technical and marketing resources, longer operating histories, greater name recognition and more established relationships in the healthcare information technology and radiology markets than we have. We may not have the resources or expertise to compete successfully in the future. If we are unable to develop and expand our applications, services and products or adapt to changing customer needs as well as our current or future competitors are able to do, we may experience reduced profitability and a loss of market share.

We may need additional capital to finance existing obligations and to fund our operations and growth, and we may be unable to obtain additional capital under terms acceptable to us or at all.

We have certain obligations that may have to be refinanced. As of December 31, 2002, the principal balance of our Bank of America credit facility was approximately $39.0 million out of $45.0 million available under the facility. The credit facility has a three-year term and matures on December 23, 2005. In addition, if our series B convertible preferred stock is not converted prior to August 8, 2006, we would be required to redeem this preferred stock at a redemption price equal to the liquidation preference, $5.2 million as of December 31, 2002, plus accrued and unpaid dividends ($451,000 as of December 31, 2002). In addition to the foregoing, unanticipated events could cause our revenues to be lower and our costs to be higher than expected, therefore creating the need for additional capital. We cannot assure you that we will have sufficient funds available to pay our credit or redemption obligations or that we will be able to refinance these obligations or obtain capital to finance operations on favorable terms or at all. If we are unable to do so, we may have to delay or abandon some or all of our development and expansion plans or otherwise forego market opportunities, any of which could harm our business.

18

Table of Contents

We have recorded, and may continue to record, a significant amount of goodwill in connection with our acquisition strategy.

As a result of our acquisitions, goodwill accounted for $78.2 million, or 42%, of our total assets as of December 31, 2002. We may record additional goodwill related to future acquisitions, if any. In 2002, we recorded goodwill of approximately $32.8 million related to the purchase price allocations of acquisitions. Under newly adopted generally accepted accounting principles, we will no longer amortize any goodwill. However, we will perform an annual impairment analysis on the carrying value of our goodwill. If the financial benefits of our acquisitions do not ultimately exceed the associated costs, including any dilution to our stockholders resulting from the issuance of shares of our common stock in connection with our acquisitions, we could be required to write down some or all of the unamortized goodwill. As a result, our results of operations would be adversely affected.

The exercise of options or warrants may result in dilution to you.

In connection with the redemption in June 2002 of our series A convertible preferred stock, we issued a warrant to the holder of such stock to purchase up to 450,000 shares of common stock with an exercise price equal to $15.50. Those warrants may be exercised at any time up to seven years from the date of issuance. In addition, approximately 5.8 million shares of common stock are subject to issuance upon exercise of outstanding stock options. These shares have been registered and may be sold immediately after exercise. As of December 31, 2002, options and warrants to purchase approximately 1.6 million of the shares were exercisable at a weighted average exercise price of $10.41. Accordingly, your ownership may be diluted by the exercise of outstanding stock options and warrants.

Our failure or inability to comply with recent privacy or other regulations to which we are or may be subject in the future could have a material adverse effect on our business.

Federal regulations, such as HIPAA, have been adopted, and others proposed, that will impact the manner in which we conduct our business.

A significant portion of our activities involves the receipt, delivery and potential use and disclosure of individually identifiable health information. Although we are not a healthcare provider or a health plan, we offer certain electronic billing services to our customers, which include the conversion and consolidation of certain healthcare claims data from non-standard to standard formats for submission to third-party payors or claims processing entities. As such, we may be considered a healthcare clearinghouse under the final privacy rules issued by the Secretary under HIPAA in December 2000 and amended on May 31, 2002 and August 14, 2002.

Additionally, from time to time, we receive individually identifiable health information from our customers. For example, we may receive certain types of individually identifiable health information when we convert a provider’s entire database in connection with the installation of new software or when we remotely access a customer’s computers to resolve hardware or software issues. In providing this service to our dental customers, we likely would be considered a business associate of a covered entity and will be required to amend existing contracts to ensure compliance with these requirements.

In addition to the final privacy provisions, the Secretary also has adopted final rules for financial and administrative transactions and data elements for certain types of healthcare transactions which are transmitted electronically. These transaction rules will likely require changes to our software applications to comply with these requirements.

These final regulations issued by the Secretary pursuant to HIPAA may require us to expend significant resources to comply with these requirements. We may need to implement new policies, procedures, and technical security measures. We must take additional steps to make sure that we comply with the final transaction standards adopted by the Secretary. Because these regulations are new and evolving, there is some uncertainty as to how certain provisions will be interpreted and/or enforced.

19

Table of Contents

While we have taken a number of steps to bring our operations into compliance with these new mandates, in the event we are unable to conform our operations and products to the requirements of HIPAA, we could be subject to civil monetary penalties and/or criminal sanctions. In addition, delay in developing or failure to develop products that would enable HIPAA compliance for our current and prospective customers could put us at a significant disadvantage in the marketplace. Accordingly, the sale of our products could be harmed and our business could be adversely affected by the implementation and enforcement of HIPAA regulations.

Changes in state and federal laws relating to confidentiality of patient medical records could limit our customers’ ability to use our services.

Changes to state or federal laws could materially affect or restrict the ability of healthcare providers to submit information from patient records using our products and services. Any such restrictions would inevitably decrease the value of our applications to our customers, which could materially harm our business. The confidentiality of patient records and the circumstances under which records may be released are already subject to substantial regulation by state governments. Although compliance with these laws and regulations is principally the responsibility of the healthcare provider under these current laws, statutes and regulations governing patient confidentiality rights are evolving rapidly. In addition to the obligations being imposed at a state level, legislation governing the dissemination of medical information is being passed at the federal level. The legislation may require holders of this information to implement additional security measures, which could entail substantial expenditures on our part. Consequently, the sale of our products could be harmed and our business could be adversely affected.

Changes in the regulatory and economic environment in the healthcare industry could adversely affect our business.

The healthcare industry is highly regulated and subject to changing political, economic and regulatory influences. These factors affect the purchasing practices and operation of healthcare organizations. Changes in current healthcare financing and reimbursement systems could require us to make unplanned enhancements of applications or services, or result in delays or cancellations of orders. Federal and state legislatures periodically consider programs to reform or amend the U.S. healthcare system. These programs may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates, or otherwise change the environment in which healthcare industry participants operate. Healthcare industry participants may respond by reducing their investments or postponing investment decisions, including investments in our applications and services. As a consequence, our business could be adversely affected.

In addition to the adopted and proposed requirements under HIPAA, the FDA is vested with the responsibility for ensuring the safety and efficacy of medical devices under the Federal Food, Drug and Cosmetic Act. Computer applications and software are considered as medical devices for purposes of this Act and, as such, are subject to regulation by the FDA when they are indicated, labeled or intended to be used in the diagnosis of disease or other conditions or in the cure, mitigation, treatment or prevention of disease, or they are intended to affect the structure or function of the body. We do not believe that any of our current information management products or services are subject to FDA regulation as medical devices. However, the products that Trophy currently manufacturers or has in developmental stages are subject to FDA clearance. Although we have obtained the necessary clearances for all Trophy products that we currently sell, there are no assurances that any information management or Trophy products developed by us in the future will be given clearance by FDA or that additional regulations will not be adopted or current regulations amended in such a manner as to adversely affect, delay or prevent the marketing and sale of our products, all of which could have a material adverse effect on our business.

20

Table of Contents

We plan to expand rapidly and we may be unable to manage our growth.

We intend to rapidly grow our business. However, we cannot be sure that we will successfully manage our growth. In order to successfully manage our growth, we must:

Continued growth could place a strain on our management, operations and financial resources. The same is true about our recent Trophy acquisition and our ownership and operation of a substantial business and manufacturing operation in France. Our business plan will also place additional demands on our sales, marketing, information systems and administrative resources as we offer new applications, products and services and expand our target markets and customers. We cannot assure you that our infrastructure, facilities and personnel will be adequate to support our integration of the Trophy business, our future operations or to effectively adapt to future growth. If we cannot manage our growth effectively, our business may be harmed.

We may have difficulty integrating acquisitions into our business.

We may from time to time acquire other companies or their businesses. As a result, we may be exposed to several risks relating to integrating these additional businesses, including those risks listed below, any of which may adversely affect our business or operating results and all of which also exist with respect to acquisitions completed during fiscal 2002, including Trophy:

We are dependent upon our executive officers and other key employees, and the loss of these personnel could disrupt our growth.

Our success depends on the continued services and performance of our executive officers and key employees both in the United States and in France and we cannot guarantee that we will be able to retain those individuals. The loss of the services of one or more of our executive officers could seriously impair our ability to continue to develop our product and service offerings, and manage and expand our businesses. We do not maintain key person life insurance.

21

Table of Contents

If we are unable to protect our intellectual property rights from third party challenges, it may significantly impair our competitive position.

Our success and ability to compete depend in part on our ability to protect our intellectual property rights, which consist primarily of our software applications and Trophy digital technology. Any failure to adequately protect our intellectual property rights could result in our competitors offering similar products or services, which could impair our competitive advantage and decrease our revenues. To protect our intellectual property rights, we rely primarily on a combination of copyright, patent, trademark, service mark and trade secret laws and contractual confidentiality provisions in agreements with third parties. In addition, we expect our employees to sign an agreement to comply with our corporate policies and procedures, including our policy regarding non-disclosure of confidential information, but we may not have entered into these agreements in every case. These contractual arrangements or the other steps we have taken to protect our intellectual property may not prove sufficient to prevent illegal use of our proprietary information and technology or to deter independent third party development of similar technologies. In addition, the laws of foreign countries in which we do or seek to do business may not protect our proprietary rights to the same extent as do the laws of the United States.

Asserting, defending and maintaining our intellectual property rights could be difficult and costly and failure to do so may diminish our ability to compete effectively and may harm our operating results.

We may need to pursue lawsuits or legal action in the future to enforce and protect our intellectual property rights, and to determine the validity and scope of the proprietary rights of others. If third parties prepare and file applications for trademarks and domain names used or registered by us, we may oppose those applications and be required to participate in proceedings to determine priority of rights to the trademarks and domain names. Similarly, competitors may have filed applications for patents, may have received patents and may obtain additional patents and proprietary rights relating to products or services that block or compete with ours. We may have to participate in interference proceedings to determine the priority of invention and the right to a patent or other proprietary right for the application or service. Litigation and interference proceedings, even if they are successful, are expensive to pursue and are time consuming, and we could have to use a substantial amount of our financial and technical personnel resources in either case.

We may face third-party claims alleging infringement of their intellectual property rights, which could result in significant expense to us and loss of significant rights.

From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies that are used in and are important to our business. This risk may increase as the number of entrants to our market increases and we improve the functionality of our applications and services, potentially causing an overlap with the applications and services of other companies. Any claims against us or companies with which we have business relationships, asserting that our applications or services infringe or may infringe proprietary rights of third parties, whether with or without merit, could be time consuming, result in costly litigation, divert the efforts of our technical and management personnel, and disrupt our relationships with our customers or require us to enter into royalty or licensing agreements, any of which could have a negative impact upon our operating results. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. If a claim against us is successful and we cannot obtain a license to the relevant technology on acceptable terms, license a substitute technology, or redesign our applications or services to avoid infringement, our business and financial results could be harmed.

We are dependent on partners/suppliers for delivery of EDI transactions, radiology products and other products and services, and any inability or failure of these suppliers to perform in a timely and cost-effective manner could negatively impact customer satisfaction and revenue.

We utilize various third party suppliers to provide our customers with EDI transactions, and other products and services. We also rely on third party suppliers to provide certain components necessary to manufacture our

22

Table of Contents

radiology products. Although other vendors are available in the marketplace to provide most of these products and services, it would take time to switch suppliers and the cost would likely be higher. If these suppliers were unable to provide such products or perform such services or the quality of these products or services declined or the cost increase, it could have a negative impact on customer satisfaction and ultimately result in a decrease in our revenues.

Our systems may be vulnerable to security breaches and viruses.

The success of our strategy to offer our applications and services depends in part on the confidence of our customers in our ability to securely transmit confidential information. Our systems and services rely on encryption, authentication and other security technology licensed from third parties to achieve secure transmission of confidential information. We may not be able to stop unauthorized attempts to gain access to or disrupt the transmission of communications by our customers. Anyone who is able to circumvent our security measures could misappropriate confidential user information or interrupt us, or our customers’ operations. In addition, our applications and services may be vulnerable to viruses, physical or electronic break-ins, and similar disruptions. Any failure to provide secure electronic communication services could result in a lack of trust by our customers causing them to seek out other vendors, and/or, tarnish our reputation in the market, making it difficult to obtain new customers.

Provisions of our certificate of incorporation, bylaws, shareholder rights plan and state law may discourage takeovers that would otherwise be in the best interest of our stockholders.

Our certificate of incorporation, bylaws and shareholder rights plan contain provisions that may make more difficult or expensive or otherwise discourage a tender offer, change in control or takeover attempt that is opposed by our board of directors. In particular, our certificate of incorporation, bylaws and shareholder rights plan include provisions that, among other things:

In addition, Section 203 of the Delaware General Corporation Law provides certain restrictions on business combinations between us and any party acquiring a 15% or greater interest in our voting stock other than in a transaction approved by our board of directors and in certain cases by our stockholders. These provisions of our certificate of incorporation and bylaws and Delaware law could discourage potential acquisition proposals and could delay or prevent a change in control of PracticeWorks, even if our stockholders support such proposals. These provisions could also make it more difficult for third parties to remove and replace the members of our board of directors. Moreover, these provisions could diminish the opportunities for stockholders to participate in

23

Table of Contents

certain tender offers, including tender offers at prices above the then-current market value of our common stock, and may also inhibit increases in the trading price of our common stock that could result from takeover attempts or speculation.

Our quarterly operating results may fluctuate and could fall below expectations of securities analysts and investors, which could cause our stock price to fluctuate.

Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors that are outside of our control. Some of these factors include:

In addition, the following factors that are within our control may cause our revenue and operating results to vary significantly from quarter to quarter:

Any change in one or more of these or other factors could cause our annual or quarterly operating results to fluctuate. If our operating results do not meet market expectations, our stock price will likely decline.

Future sales of shares by existing stockholders could affect our stock price.

If our existing stockholders sell substantial amounts of our common stock in the public market or if there is a perception that they may do so, the market price of our common stock could decline. As of December 31, 2002, we have 17,547,589 shares of common stock outstanding, all of which are freely tradable (subject to volume limitation for those held by affiliates), except for approximately 970,000 shares which will not be freely tradable. In addition, approximately 2.1 million shares are subject to outstanding options and warrants that may immediately be exercised as of December 31, 2002, approximately 5.8 million shares are subject to options that have been granted under our 2000 stock option plan and will become exercisable from time to time and approximately 2.2 million shares reserved for further issuance pursuant to this plan. All of these shares will become available for sale immediately upon the exercise of those options.

24

Table of Contents

The market price of our common stock has been volatile and may continue to be volatile, and the value of your investment may decline.

The market price of our common stock has been volatile in the past and may continue to be volatile in the future. This volatility may cause precipitous drops in the price of our common stock on the Nasdaq National Market. These drops may cause your investment in our common stock to lose significant value. The market price is affected by:

This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to their operating performance. Therefore, we cannot predict the market price for our common stock after the offering.

Tax requirements and indemnification obligations undertaken by us in connection with the spin-off restrict our ability to issue new shares to finance acquisitions or raise capital, may delay or prevent takeovers which would otherwise be in your best interest as a stockholder and may subject us to substantial liability.

The spin-off was structured to qualify as a tax-free distribution under Section 355 of the Internal Revenue Code. Tax-free treatment is conditioned on compliance with several requirements, the failure of which would cause VitalWorks to recognize significant tax liabilities. We have generally agreed to indemnify VitalWorks under certain circumstances to the extent any action or omission on our part contributes to a determination by the Internal Revenue Service that the spin-off was not tax-free. This indemnification obligation, if triggered, could therefore be substantial. In addition, under regulations that govern corporations filing a consolidated tax return, each member of VitalWorks’ consolidated group, including us with respect to tax periods before the spin-off, is jointly and severally liable for any tax liability incurred by VitalWorks prior to the spin-off or in connection with it.

One of the conditions of Section 355 for tax free treatment of the spin-off provides that the spin-off would be treated as a taxable transaction if one or more persons acquire directly or indirectly 50% or more of our or VitalWorks’ stock, measured by stock or value, as part of a plan that is, or series of related transactions that are, linked to the spin-off under the rules of Section 355. For this purpose, any acquisition of our stock within two years before or after March 5, 2001 is presumed to be part of such a plan, although we may be able to rebut that presumption on the basis that the acquisition is unrelated to the business reasons for the spin-off. If such an acquisition of our stock results in the spin-off becoming taxable, under our indemnification agreement with VitalWorks, we would be required to indemnify VitalWorks for the resulting tax, which could be substantial. This obligation might discourage, delay, or prevent takeovers which would otherwise be in your best interest as a stockholder. We have already consummated certain transactions involving issuance of our common stock. These issuances, together with other issuances in the future, could result in a determination that there has been an acquisition of 50% or greater interest in PracticeWorks in the four-year period. In addition to the potential for significant tax liability, the restrictions and obligations related to the spin-off therefore limit our ability to issue stock to finance acquisitions or raise capital, which could impact our growth and liquidity.

25

Table of Contents

FORWARD-LOOKING STATEMENTS

This report contains statements about future events and expectations which are characterized as forward-looking statements. Forward-looking statements are based on management’s beliefs, assumptions and expectations of our future economic performance, taking into account the information currently available to them. These statements are not statements of historical fact. Forward-looking statements involve risks and uncertainties that may cause our actual results, performance or financial condition to differ materially from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. Factors that could contribute to these differences include those discussed in “Risk Factors” above and in other sections of this report. The words “believe,” “may,” “will,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “strive” or similar words, or the negatives of these words, identify forward-looking statements. We qualify any forward-looking statements entirely by these cautionary factors.

Item 2.     Properties

Our principal executive offices and primary business offices and operations facility are located in 74,000 square feet of leased space in one building in metropolitan Atlanta, Georgia. We hold that space under a long-term lease agreement. Our Trophy manufacturing facility is located near Paris, France in 110,000 square feet of leased space in one building. That space is held under a long-term lease that expires in 2005, and has favorable, renewable three-year terms. We have additional small offices in leased spaces in Hunt Valley, Maryland, Indianapolis, Indiana and Danbury Connecticut, as well as in the United Kingdom, Sweden, Spain, Germany, Italy, Japan, Belgium, Canada and Australia. The U.S. leases have expiration dates ranging from June 2002 to December 2008. We believe that our facilities are adequate for our current operations and that additional leased space can be obtained if needed.

Item 3.     Legal Proceedings

From time to time, we are involved in various legal proceedings incident to the ordinary course of our business. We are not a party to any legal proceedings that we believe to be material, and we are unaware of any contemplated material actions against us. During the course of the Trophy acquisition, we became aware that Trophy had conducted recalls and other corrective actions, and experienced product liability claims for generally minor property damage and personal injury, with respect to purported failures of scissor arms in conventional x-ray products manufactured by Trophy prior to 1998. While the recalls and corrective actions have generally been completed, certain claims and legal proceedings related to such purported failures are ongoing and still pending and the termination of the recalls and corrective actions do not preclude future product failures and additional claims for property damage and/or personal injury. We maintain insurance coverage related to product liability claims and, in connection with the Trophy acquisition, Trophy’s former parent agreed to indemnify us, subject to certain limits and other conditions, for product liability claims related to scissor arms manufactured prior to 1998. As a result, our management believes that neither pending nor future claims or legal proceedings related to scissor arms manufactured prior to 1998 will have a material adverse effect on our financial condition, liquidity or operating results.

Item 4.     Submission of matters to a vote of Security Holders

No matters were submitted to a vote of our security holders during the last three months of the period of this report.

26

Table of Contents

PART II

Item 5.     Market for Registrant’s Common Equity and Related Stockholder Matters

On October 1, 2002, our common stock commenced trading on the Nasdaq National Market under the trading symbol “PRWK.” Prior to October 1, 2002, our common stock traded on the American Stock Exchange. The table below sets forth the range of high and low bid prices per share as reported by Nasdaq National Market and the low and high sales prices of our common stock on the American Stock Exchange.

The number of record holders of PracticeWorks, Inc. common stock as of March 1, 2003 was 1,407 (excluding individual participants in nominee security position listings).

Dividend Policies

Our dividend policy is set by our board of directors. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and have not to date and do not anticipate declaring or paying any cash dividends on our common stock in the foreseeable future. Any future determination as to the declaration and payment of dividends will be at the discretion of our board of directors and will depend on then existing conditions, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors that our board of directors considers relevant. Dividends on common stock may not be paid unless accumulated dividends on our series B convertible redeemable preferred stock have been paid. In addition, our credit facility with Bank of America prohibits payment of cash dividends on our common stock.

Holders of series B convertible redeemable preferred stock are entitled to receive cumulative dividends at an annual rate of 6.0% of the liquidation preference when declared, payable quarterly in arrears. The initial liquidation preference was $5.44 per preferred share. Dividend payments may be made in cash or shares of our common stock. If a dividend is not declared and paid in full for any quarterly period, then the amount payable, but not paid, will automatically be added to the liquidation preference of the shares and will no longer be payable, but will be deemed paid.

Item 6.     Selected Financial Data

You should read the following selected financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002 and the related notes appearing elsewhere in this annual report. The consolidated statement of operations data for the year ended December 31, 2002 and the consolidated balance sheet as of December 31, 2002 are derived from, and qualified by reference to, the consolidated financial statements included elsewhere in this annual report that

27

Table of Contents

have been audited by Ernst & Young LLP, independent auditors. The consolidated statement of operations data for each of the two years in the period ended December 31, 2001, and the consolidated balance sheet data as of December 31, 2001 are derived from, and qualified by reference to, the consolidated financial statements included elsewhere in this annual report that have been audited by BDO Seidman, LLP, independent certified public accountants. The consolidated statement of operations data for each of the two years in the period ended December 31, 1999 and the consolidated balance sheet data as of December 31, 2000, 1999 and 1998 are derived from, and qualified by reference to, the consolidated financial statements audited by BDO Seidman, LLP, not included in this annual report. For all periods presented prior to March 5, 2001 we operated as a division of VitalWorks. On March 5, 2001, VitalWorks completed the spin-off of all of the outstanding shares of PracticeWorks common stock to VitalWorks stockholders.

From July 10, 1997 through December 31, 2000, VitalWorks completed 18 acquisitions that were attributed to us in the spin-off. Subsequent to March 5, 2001 through December 31, 2002, we completed eight additional acquisitions. During the second quarter of 2000 we introduced a subscription-based revenue model that was different than the traditional license model we had offered historically. We are also developing new products, applications and services, including digital radiography and cosmetic imaging which we began offering in 2002. Further, in December 2002 we completed the acquisition of Trophy Radiologie SA, the world’s leading provider of dental digital and conventional radiology equipment for dental practices. As a result, the financial information included in this section may not be indicative of our future results of operations, financial position and cash flows. In addition, this financial information may not reflect the financial results we would have achieved if we had been a separate stand-alone entity during the periods prior to March 5, 2001.

28

Table of Contents

The financial statements for all periods presented give retroactive effect to poolings of interests treatment for five acquisitions completed during 1999 attributed to us by VitalWorks in the spin-off and include the results of operations for all purchase acquisitions attributed to us by VitalWorks from the respective acquisition date.

29

Table of Contents

30

Table of Contents

Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the “Selected Financial Data” and the consolidated financial statements and related notes included elsewhere in this annual report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this annual report.

Overview

We provide software-based information technology systems for dentists, orthodontists and oral and maxillofacial surgeons. Prior to March 5, 2001, we operated as a division of VitalWorks Inc. On March 5, 2001, VitalWorks completed the pro rata distribution of all of the outstanding shares of PracticeWorks common stock to VitalWorks stockholders. In addition, through our recently acquired Trophy subsidiary (discussed below), we are the world’s leading manufacturer and distributor of radiology equipment for dental applications.

Acquisitions

A substantial part of our growth has been achieved through acquisitions. From July 10, 1997 through December 31, 2000, VitalWorks completed 18 acquisitions that were attributed to us in the spin-off. Subsequent to the spin-off we have completed eight acquisitions through 2002. Given the significant number of acquisitions in each of the periods presented, the results of operations from period to period may not necessarily be comparable.

On December 23, 2002, we completed the acquisition of Trex Medical France SA and its subsidiaries, principally Trophy Radiologie SA (“Trophy”), the world’s leading provider of digital and conventional radiology

31

Table of Contents

equipment for dental practices. Trophy offers conventional x-ray generator equipment and industry leading digital radiography systems to over 200,000 customers worldwide who are served by over 550 independent distributors. Total consideration paid was $50.7 million in cash, which includes the agreed upon purchase price, a net working capital adjustment and transaction costs and is net of acquired cash. The initial allocation of fair values was based on a preliminary valuation of tangible and intangible assets, developed technologies, in-process research and development charges, and total liabilities assumed. We recorded goodwill of $19.7 million. We also recorded a one-time charge of $12.3 million to recognize the value of in-process research and development for new products and modifications to existing products that had not reached technological feasibility, were not ready for commercial production and have no future alternate use. Subsequent adjustments may be recorded upon the completion of the valuation and the final determination of the purchase price allocation. Pursuant to the purchase agreement we estimate a final payment of approximately $2.1 million for final working capital adjustments which is payable during the first quarter of 2003 and is included in accounts payable in our consolidated balance sheet.

During 2002, we completed three other acquisitions that were also accounted for as purchases. In connection with these acquisitions, we paid cash consideration aggregating $11.3 million. The purchase price was allocated based on a valuation of tangible and intangible assets, developed technologies and total liabilities assumed. We recorded goodwill of approximately $6.7 million.

On March 7, 2001, we completed the acquisition of SoftDent, LLC, a practice management software subsidiary of DENTSPLY International, Inc. (“DENTSPLY”). This subsidiary, also referred to as InfoSoft, develops and provides dental practice management software systems, which we now market as our SoftDent^® software product. At the time of acquisition, InfoSoft was party to approximately 23 value added reseller, or VAR, agreements. As of December 31, 2002, all of these agreements had expired or been terminated. We acquired the support business of some of the former VARs at the time their reseller agreements ended. The estimated fair value of the total consideration, including acquisitions of certain business assets from VARs through December 31, 2002, was approximately $27.1 million, represented by 32,000 shares of our series A convertible redeemable preferred stock valued at $21.0 million (net of discount of $11.0 million), cash consideration of $2.5 million, notes payable of approximately $2.4 million, and transaction costs of $1.2 million. Of these amounts, approximately $1.5 million of the aggregate consideration was incurred in 2002, consisting of cash consideration of $1.2 million and a note payable of approximately $300,000. We recorded total goodwill of $25.6 million. The series A preferred stock was redeemed in June 2002.

During the second quarter of 2001, we completed two acquisitions that were also accounted for as purchases. In connection with these acquisitions, we paid cash consideration aggregating $1.6 million, issued a non-interest bearing note payable in the amount of approximately $600,000 and assumed net liabilities of approximately $500,000. The purchase prices were allocated based on estimates of fair values to tangible and intangible assets, developed technology and total liabilities assumed. We recorded goodwill of approximately $2.9 million, inclusive of approximately $166,000 in transaction costs.

On August 8, 2001, we acquired all of the outstanding equity interests of Medical Dynamics, Inc., a dental practice management company, for which the aggregate consideration was approximately $9.6 million represented by approximately 222,000 shares of PracticeWorks common stock, 977,000 shares of PracticeWorks series B convertible redeemable preferred stock, 888,000 shares of VitalWorks common stock and $19,000 in cash. Additionally, we assumed $3.0 million in liabilities and incurred approximately $1.2 million in transaction costs. The purchase price was allocated based on a valuation of fair values to tangible and intangible assets and total liabilities assumed. We recorded goodwill of approximately $8.3 million. We have accounted for VitalWorks’ issuance of its common stock as a capital contribution.

VitalWorks acquired six dental information technology companies that were accounted for as purchases during the year ended December 31, 2000. The aggregate consideration for these acquisitions was $13.4 million in cash and $2.4 million in VitalWorks common stock. Goodwill of approximately $15.7 million was recorded

32

Table of Contents

for these transactions. VitalWorks acquired four dental information technology companies that were accounted for as purchases during the year ended December 31, 1999. The aggregate consideration for these acquisitions was $8.3 million in cash and $2.0 million in VitalWorks common stock. Goodwill of $10.5 million was recorded for these transactions. The 2000 and 1999 acquisitions were attributed to the Company in the spin-off.

Restructuring and Non-recurring Charges

Due to the significant number of acquisitions we have completed, we announced and implemented restructuring plans in 2001 and 2000 to integrate and consolidate the acquired operations into our existing facilities. We recorded the costs in accordance with Emerging Issues Task Force Issue (“EITF”) No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring).” Liabilities incurred as a result of exiting an activity of acquired companies are recorded in accordance with the guidance of EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.”

Significant Accounting Policies

We have three accounting policies we believe are significant to our financial condition and results of operations that require judgments and estimates about matters. These policies are:

Revenue Recognition

We base our revenue recognition policies for sales of software on the provisions of the American Institute of Certified Public Accountants’ Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” as amended. Revenue from maintenance and support services and subscriptions, which typically have contract terms varying from one to three years in length, is recognized ratably over the life of the contract. Revenue from electronic services is recognized as the service is provided. Revenue from the sale of software licenses is recognized when persuasive evidence of an arrangement exists; delivery has occurred or training has been provided, whichever is later; fees are fixed or determinable; and collectibility is probable. Revenue from hardware sales is recognized upon product shipment, terms of which are typically FOB shipping point. Revenue from training and implementation services is recognized as the service is provided. Revenue from Trophy equipment sales is recognized when no significant vendor obligation remains, title to the equipment passes (depending on terms, either upon shipment or delivery), and the customer has the intent and ability to pay in accordance with contract payment terms that are fixed and determinable. Outside of the United States, Trophy sells to a network of third party distributors. Revenue is recognized at the time of delivery to the distributor as title passes and no right of return exists. Amounts received from customers in advance of product shipment or service periods are recorded as deferred revenue.

Capitalized Costs of Computer Software to be Sold, Leased or Otherwise Marketed

Costs incurred, such as planning, designing, coding and testing, for computer software to be sold, leased or otherwise marketed are expensed as incurred prior to establishing the technological feasibility of a product. Technological feasibility is generally achieved when the detailed program design or a working model has been completed. For the period between the establishment of technological feasibility and the time a product is available for general release, such costs are capitalized. Capitalized software costs are amortized using the straight-line method over the estimated lives of the related products (generally 48 months). Capitalized costs for each project are reviewed periodically to determine that the estimated useful lives are appropriate and carrying values are recoverable based on estimated future cash flows and revisions to estimated lives or impairment charges are recorded as necessary.

33

Table of Contents

Goodwill and Other Intangible Assets

Goodwill represents the excess purchase price of net tangible and intangible assets acquired in business combinations over their estimated fair value. In 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires goodwill and other acquired intangible assets that have an indefinite useful life to no longer be amortized; however, these assets must undergo an initial impairment test and be reviewed for impairment at least annually thereafter. We adopted certain provisions of SFAS No. 142 effective July 1, 2001 and the remaining provisions effective January 1, 2002. Concurrent with the adoption effective January 1, 2002, we performed the initial impairment test using an income approach, the results of which yielded no impairment. We also completed the annual impairment test as of October 1, 2002 (the “Measurement Date”), the results of which indicated that there was no impairment of goodwill and other acquired intangible assets as of the Measurement Date. Additionally, no events have occurred subsequent to the Measurement Date that would indicate impairment.

Segment and Market Information

SFAS No. 131 establishes standards for the way in which public companies are to disclose certain information about operating segments in their financial reports. It also establishes standards for related disclosures about products and services, geographic areas, and major customers.

We historically reported results from operations in two segments: recurring revenue and non-recurring revenue. Concurrent with the adoption of SFAS No. 141 and No. 142, the completion of several acquisitions in the United Kingdom in 2002 and the acquisition of Trophy in December 2002, we revised and restated the segment reporting to more closely align with how our Chief Operating Decision Maker manages the Company. The results from operations are now reported using three segments: Information Technology—United States (“IT—United States”), Information Technology—International (“IT—International”) and Manufactured Products. The IT—United States and IT—International segments will include the operations of our historical information management technology systems and related services including Trophy products sold by PracticeWorks sales representatives, broken down by geographic region and the Manufactured Products segment will include the worldwide operations of Trophy’s traditional and digital x-ray business, excluding sales made by PracticeWorks sales representatives. The IT-International segment consists primarily of operations in the United Kingdom and to a much lesser extent, Sweden. The Manufactured Products segment consists primarily of operations in France.

Our Chief Operating Decision Maker evaluates performance based on measures of segment revenues and operating results.

34

Table of Contents

Information about our operations by operating segment is as follows (in thousands):