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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 000-25311
VITALWORKS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-2248411
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
239 ETHAN ALLEN HIGHWAY, RIDGEFIELD, CONNECTICUT 06877
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (203) 894-1300
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 $.001
RIGHTS TO PURCHASE SERIES B PREFERRED STOCK
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. | |
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 (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 $.001 per share, as reported on the Nasdaq National Market on such date)
was approximately $335 million. 42,939,771 shares of common stock were
outstanding as of March 28, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for the 2003 Annual Meeting of
Stockholders, expected to be held on June 11, 2003, are incorporated herein by
reference.
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VITALWORKS INC.
FORM 10-K
CONTENTS
PAGE
PART I
Item 1. Business.......................................................... 2
Item 2. Properties........................................................ 22
Item 3. Legal Proceedings................................................. 23
Item 4. Submission Of Matters To A Vote Of Security Holders............... 24
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder 24
Matters...........................................................
Item 6. Selected Consolidated Financial Data.............................. 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 40
Item 8. Financial Statements and Supplementary Data....................... 40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 40
PART III
Item 10. Directors and Executive Officers of the Registrant................ 41
Item 11. Executive Compensation............................................ 41
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 41
Item 13. Certain Relationships and Related Transactions.................... 41
PART IV
Item 14. Controls and Procedures........................................... 41
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.. 41
Signatures................................................................. 74
Certifications............................................................. 75
VitalWorks and Radconnect are registered trademarks of VitalWorks Inc. All other
trademarks and company names mentioned are the property of their respective
owners.
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PART I
ITEM 1. BUSINESS
GENERAL
VitalWorks Inc. is a leading provider of information management technology
and services targeted to healthcare practices and organizations throughout the
United States. We provide IT-based solutions for general medical practices and
have specialty-specific products and services for practices such as radiology,
anesthesiology, ophthalmology, emergency medicine, plastic surgery, and
dermatology. We also offer enterprise-level systems designed for large physician
groups and networks. Our range of software solutions, which include workflow
features related to patient encounters, automate the administrative, financial,
and clinical information management functions for physicians and other
healthcare providers. We provide our clients with ongoing software support,
implementation, training, electronic data interchange, or EDI, services for
patient billing and claims processing, and a variety of Web-based services.
We were incorporated in Delaware in November 1996. Prior to July 10, 1997,
we conducted no significant operations and generated no revenue. On July 10,
1997, we completed our initial public offering. During the remainder of 1997
through 1999, we completed acquisitions of 16 medical companies. In addition,
during the period July 10, 1997 through 2000, we acquired 19 companies that made
up our former dental software business.
On March 5, 2001, we spun-off our dental software business through a pro
rata distribution to our shareholders of all the outstanding common stock (the
"Distribution") of our previously wholly-owned subsidiary, PracticeWorks, Inc.
("PracticeWorks"). As a result of the Distribution, PracticeWorks became an
independent public company operating what was formerly our dental business,
which included the dental, orthodontic, and oral and maxillofacial surgery
business lines. Accordingly, PracticeWorks has been accounted for as
discontinued operations. All information contained in this report, unless
otherwise indicated, has been restated to reflect the Distribution. We
relocated our executive offices to Connecticut and began doing business as
"VitalWorks" following the Distribution. The material terms of the
Distribution are described herein.
INDUSTRY BACKGROUND
Healthcare spending in the United States has risen dramatically over the
past two decades, amounting to approximately $1.3 trillion in 2000, according to
the Center for Medicare and Medicaid Services, and is expected to grow to $2.0
trillion in 2006. Federal and state governments, insurance carriers and other
third-party payors have taken actions to control these rising costs. As a
result, physicians are under increasing pressure to reduce costs and operate
their practices more efficiently. One of the ways in which third-party payors
have managed rising costs has been to employ alternative reimbursement models to
replace the fee-for-service reimbursement model, which has been the traditional
basis for payment for healthcare services. Such alternative reimbursement models
include managed care, fixed-fee, and capitated models of reimbursement. The
result of these generally more restrictive reimbursement models has been a
dramatic increase in the complexity of accounting, billing, and payment
collection for healthcare services.
The privacy and security rules adopted by the Health Insurance Portability
and Accountability Act of 1996, or HIPAA, are also serving as a driver for
expanded information management tools, especially in the areas of clinical
information. Practices will be required to ensure confidentiality of patient
healthcare information, and to better control access to this information.
In addition, physicians are under increased pressure to control the
quality of the care they deliver. In 1999, the Institute of Medicine reported
that up to 98,000 Americans die each year from preventable medical mistakes
experienced during hospitalization. Coalitions such as The Leapfrog Group have
formed to help ensure that consumers are properly informed to make the most
educated decisions about the medical care they need, and that
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physicians are practicing medicine at the highest possible levels of care and
safety. A key factor for a physician to achieve this level of care is the
accuracy and availability of patient healthcare information.
To address these challenges, healthcare providers are increasingly using
information technology, including practice management and clinical information
systems. Practice management systems include a range of software products and
services for physicians and other providers of healthcare services. Most
practice management systems provide several common functions, including practice
administration functions such as patient scheduling, and financial functions
such as insurance billing, patient billing and receivables management. Clinical
information systems include electronic medical records, clinical charting,
electronic prescribing, patient tracking and patient workflow systems.
The continued evolution of information and telecommunication technologies
has led to the development of a variety of electronic tools that can be
integrated with practice management systems, helping to improve healthcare
practices' cash flow. Among these is EDI, which expedites the submission of
healthcare insurance claims to third-party payors and expedites the receipt of
reimbursement. Paper claims require more time and are significantly more
expensive to prepare, file, and process than electronically submitted claims.
EDI transactions, on the other hand, can be processed directly with third-party
payors or channeled through processing clearinghouses at significantly lower
costs to the provider and the payor. Because of these significant cost savings,
some payors are beginning to require practitioners to submit reimbursement
claims electronically. In addition, new regulations mandated by HIPAA require
the industry to move to a single electronic format accepted by all payors. We
believe this will simplify the process of electronically exchanging information
and thereby enhance the utilization of electronic claim submission and open the
doors to many other types of EDI services, such as electronic remittance advice,
determination of eligibility, claim status checks, and referral authorizations.
PRODUCTS AND SERVICES
We offer a wide range of practice management and clinical software
products to healthcare providers in targeted specialty markets. These products
are designed to automate the administrative, financial, and clinical information
management functions of office-based physician practices, hospital-based
physician practices, and large healthcare enterprises, clinics and
organizations.
Types of Products
Each of our products addresses the management of healthcare data in one or
more of several different areas. These areas include:
- - Financial management, including patient billing, insurance processing,
receivables and collections management.
- - Administrative management, including appointment scheduling, patient
registration, patient correspondence, referral analysis, and document
imaging and management.
- - Clinical data management, including complete documentation of patient
visits, prescription writing, patient medical history, and treatment
planning.
- - EDI, including electronic processing of insurance claims and patient
statements.
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Targeted Specialties
In addition to addressing the needs of primary care and general medical
practices and clinics, many of our software products have been designed to
address the specific needs of specialty practices. For example,
anesthesiologists are required to bill their services on the basis of time
units, and radiologists require specialized scheduling, film tracking, image
delivery and workflow capabilities. Our targeted specialties include:
Hospital-based physician specialties:
- - Radiology
- - Anesthesiology
Enterprise-level groups:
- - Large physician groups
- - Emergency departments
- - Physician networks
- - Clinics
- - Service bureaus
- - Management Service Organizations
- - Independent Physician Associations
Office-based physician specialties:
- - Ophthalmology
- - Dermatology
- - Plastic Surgery
- - Podiatry
Principal Products
Our principal products are the main practice management and clinical
information products used by our clients. Each principal product falls into one
of two categories: "core" products or "classic" products. Our core products
offer advanced functionality and operate with the latest generation of operating
systems and hardware platforms offered by us. In addition, core products are the
primary products offered to our targeted practice areas. Classic products, while
continuing to offer adequate functionality, typically lack advanced practice
management features and are not designed for the latest generation of operating
systems. We actively market eight core products and support 20 classic products.
We believe that there is a significant opportunity to provide system upgrades to
those clients using classic and other non-core products by providing a migration
path to our core products. While we primarily market our core products, we will
continue to provide customer support for our classic products until we determine
that it is no longer cost effective or practically possible to do so. We are
actively promoting the migration of classic product clients to newer products.
We believe that while desktop systems will continue to be based primarily
on some version of the Microsoft Windows family of operating systems, a
significant number of physician, patient, and office functions will require
Internet connectivity and demand a more platform-neutral approach. Consequently,
our research and development efforts for new products are centered around
building platform-independent applications using proven technologies.
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Ancillary Products
In addition to our principal practice management and clinical products, we
offer a variety of ancillary products. While some of these products may operate
on a stand-alone basis, these are typically add-on modules to our principal
products. Ancillary products allow us to leverage our client base for additional
sales revenue, as well as generate interest and competitive advantage for our
core products. These ancillary products include:
- - Decision support tools - We offer several different decision support tools
designed to supplement the analytical features of our practice management
software products. These tools enable physicians to access, sort, and
display data according to user-selected criteria, including payor,
referral source, reimbursement rate, time interval, and other variables.
- - Document imaging and management - Our integrated document imaging and
management tools enable practices to electronically capture, store, and
manage all patient documents, as well as automate and streamline workflow.
- - Wireless data entry - Physicians using wireless data entry can enter and
review data from a handheld computing device, via wireless transmission.
- - Palm integration - Palm integration allows physicians to download data to
Palm-compatible handheld computing devices, for easy data access while
away from the office.
- - Web-based services - Web-based services include radiology image and report
distribution, patient and office staff communication, appointment and
prescription refill requests, and patient account inquiry.
- - Product interfaces - We provide connectivity between our principal
products and a variety of third-party products, such as hospital
information systems, lab information systems, coding systems, and picture
archive and communication systems, or PACS.
EDI Services
Our core software products offer transaction-based EDI functions,
including patient billing and insurance claims submission and remittance. The
use of EDI can improve a healthcare practice's cash flow by enabling more
accurate and rapid submission of claims to third-party payors and more rapid
receipt of corresponding reimbursements. We generate revenues by facilitating
EDI transactions, currently processing approximately five million EDI
transactions each month. Current EDI services include:
- - RapidBill(TM) - Provides comprehensive, automated patient statement
processing services.
- - RapidCollect(TM) - Provides collection letter processing.
- - RapidReminder(TM) - Provides appointment reminder notification processing.
- - RapidClaim(TM) - Provides electronic submission of insurance claims, and
available claims scrubbing.
- - RapidRemit(TM)- Provides electronic remittance of insurance payments and
automatically posts explanation of benefits data into the practice
management system.
- - RapidEligibility(TM)- Provides electronic access to insurance and managed
care plans to determine a patient's eligibility and covered benefits.
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Other Services
We believe that a high level of customer service is important to the
successful marketing and sale of our products. We provide a comprehensive suite
of training, consulting and technical support services to implement and support
our products including:
- - Software Maintenance - Under the terms of our standard maintenance
arrangement, customers pay a periodic (i.e., monthly, quarterly, annually)
maintenance fee. The fee charged is generally a fixed percentage
of the list price at time of contract signing of the licensed
software used by customers. This fee entitles customers to technical
support and to any maintenance updates for their software, if and when
updates are released.
- - Hardware Maintenance - Similar to software maintenance, customers may
contract with us for maintenance of their hardware. In return for periodic
maintenance fees, the customer is provided comprehensive telephone
diagnostic support and on-site field service support. We subcontract with
various third-party hardware maintenance professionals to provide a
significant amount of our on-site field service support.
- - Consulting and Training Services - We offer consulting, training, and
implementation services on a time and materials basis. Based on a
customer's technical and application knowledge, the customer can customize
a program with us that provides the customer with the appropriate level of
upfront and ongoing consulting and training support. Typically customers
who purchase new or add-on systems will utilize our implementation
and installation services.
Our services and support organization consisted of 332 employees as of
December 31, 2002.
Future Products
In 2002, we released our first products based on our Ingenuity(TM)
platform, which included RadConnect Results and our first version of RadConnect
RIS.
Our Ingenuity(TM) platform utilizes a server side Java, or J2EE,
application paired with a zero-client browser-based front end (true Web-based
technology). Standard SQL databases can be used for data storage.
In February 2003, we completed our first upgrade of RadConnect RIS, which
included major enhancements including mammography tracking. For the balance of
2003 and through 2004, we plan to focus on developing a variety of products
based on our Ingenuity(TM) platform, including radiology, anesthesiology, and
medical practice management systems as well as an enterprise level electronic
medical records, or EMR, system targeted to the ambulatory healthcare market.
RESEARCH AND DEVELOPMENT
Our development efforts are focused on new products based on our Web-based
Ingenuity(TM) platform, as well as maintaining the stability and competitiveness
of our current product offerings. We augment our development staff with
third-party developers. These third-party resources are focused on new and next
generation product development. Historically, our research and development
efforts have principally involved the incorporation of the best technologies
from each acquired product into our core practice management systems. While we
continue to incorporate the best functionality from our acquired products, this
is only one of the tasks that our development staff is charged with. Our
research and development department is also responsible for coordinating the
activities of developers and product managers on all cross-specialty development
efforts. These activities include researching emerging technologies in both the
healthcare and technology sectors, carefully evaluating each for their ability
to enable physicians to deliver better healthcare to their patients more
efficiently,
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and establishing best practices for our development efforts. Our research and
development organization consisted of 150 employees as of December 31, 2002, and
is currently co-located with our support staff primarily in three locations:
Daytona, Florida; Birmingham, Alabama; and Minneapolis, Minnesota. This
co-location of staff helps to keep staff focused on industry specific
applications and provide cross communication between the support staff who,
in turn, are in regular communication with customers, thus providing the
best quality products for our customers' needs.
In 2002, 2001 and 2000, our research and development expenses were $13.5
million, $10.9 million and $13.8 million, or 11.8%, 10.2% and 13.6% of total
revenues, respectively. In addition, in 2002 and 2001, we incurred $4.8 million
and $4.6 million, respectively, of third-party programmer fees that we
capitalized in conformity with Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed."
SALES AND MARKETING
We market and sell our products in the United States primarily through a
direct sales force, composed of 74 sales and marketing personnel as of December
31, 2002. We have sales offices located in Ridgefield, Connecticut; Birmingham,
Alabama; Daytona, Florida; Minneapolis, Minnesota; Portland, Oregon; and
Cincinnati, Ohio. Product support, training and implementation services are
also available through many of these offices. In addition, many of our sales
representatives are based from their home offices throughout the United States.
We organize our sales force by medical specialty and product platform. All
members of our sales organization participate in sales training, which among
other things, enables them to understand the specialty-specific needs of our
prospective customers.
Within our existing customer base, we promote and sell system upgrades,
product add-ons, ancillary products, maintenance services and EDI services. In
addition, we target new customers principally through direct mail campaigns,
telemarketing, seminars, webinars, trade shows and advertisements in various
publications. Moreover, senior personnel and members of management assist in
sales and marketing initiatives to larger and more technically advanced
prospective customers. Sales cycles generally range from an average of three to
four months for small office-based physician systems to as much as six to
eighteen months for clinical and larger scale systems.
For each of the past three fiscal years, no one customer has accounted
for more than 10% of total revenues.
INTELLECTUAL PROPERTY
We rely primarily on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
intellectual property and proprietary rights. These laws and procedures afford
only limited protection.
Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or to obtain and use
information that we regard as proprietary. Policing unauthorized use of our
products is difficult, and such problems may persist. There can be no assurance
that our means of protecting our proprietary rights will be adequate or that
competitors will not independently develop similar technology.
Some of our programs aimed at the radiology market have been delivered
along with their applicable source code, which is protected by contractual
provisions. In other cases, we have entered into source code escrow agreements
with a limited number of our customers requiring release of source code under
certain limited conditions, including any bankruptcy proceeding by or against
us, cessation of our business or our failure to meet our contractual
obligations.
We rely upon certain software that is licensed from third parties,
including software that is integrated with some of our internally developed
software and/or is used with some of our products to perform certain functions.
In some cases, we private label third party software for relicensing. There can
be no assurance that these third party software licenses will continue to be
available to us on commercially reasonable terms, which could
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adversely affect our business, operating results and financial condition. In
addition, there can be no assurance that third parties will not claim
infringement by us with respect to our products or enhancements thereto.
We distribute our software under software license agreements that grant
customers a nonexclusive, nontransferable license to our products and contain
terms and conditions prohibiting the unauthorized reproduction or transfer of
our products.
COMPETITION
Our principal competitors include both national and regional practice
management and clinical systems vendors. Currently, the practice management and
clinical systems industry in the United States is characterized by a large
number of relatively small, regionally focused companies, comprising a highly
fragmented industry with only a few national vendors. We believe that the
larger, national vendors are broadening their markets to include both small and
large healthcare providers. In addition, we compete with national and regional
providers of computerized billing, insurance processing, and record management
services to healthcare practices. As the market for our products and services
expands, additional competitors are likely to enter this market. We believe that
the primary competitive factors in our markets are:
- - product features and functionality;
- - ongoing product enhancements;
- - customer service, support and satisfaction;
- - the reputation and stability of the vendor; and
- - price.
We have experienced, and we expect to continue to experience, increased
competition from current and potential competitors, many of whom have
significantly greater financial, technical, marketing and other resources than
us. Such competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of their products than us. Also, certain
current and potential competitors have greater name recognition or more
extensive customer bases that could be leveraged, thereby gaining market share
to our detriment. We expect additional competition as other established and
emerging companies enter into the practice management and clinical software
markets and as new products and technologies are introduced. Increased
competition could result in price reductions, fewer customer orders, reduced
gross margins and loss of market share, any of which would materially adversely
affect our business, operating results, cash flows and financial condition.
Current and potential competitors may make strategic acquisitions or
establish cooperative relationships among themselves or with third parties,
thereby increasing the ability of their products to address the needs of our
existing and prospective customers. Further competitive pressures, such as those
resulting from competitors' discounting of their products, may require us to
reduce the price of our software and complementary products, which would
materially adversely affect our business, operating results, cash flows and
financial condition. There can be no assurance that we will be able to compete
successfully against current and future competitors, and the failure to do so
would have a material adverse effect upon our business, operating results, cash
flows and financial condition.
PRIVACY ISSUES
Because our customers use our applications and services to transmit and
manage 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 medical information, we utilize advanced technology
designed to ensure a high degree of security. This technology generally
includes:
- - security that requires both user IDs and passwords to access our systems
locally or remotely, with the potential of requiring digital certificates
for remote, Internet-based access, should such measures be
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required;
- - encryption of data relating to our ASP applications transmitted over the
Internet; and
- - use of a mechanism for preventing outsiders from improperly accessing
private data resources on our internal network and our ASP applications,
commonly referred to as a "firewall."
The level of data encryption used by our products is in compliance with
the encryption guidelines set forth in the proposed rule regarding security and
electronic signature standards in connection with HIPAA. We also encourage our
customers to implement their own firewall and security procedures to protect the
confidentiality of information being transferred into and out of their computer
networks.
Internally, we work to ensure the safe handling of confidential data by
employees in our electronic services department by:
- - using individual user names and passwords for each employee handling
electronic data; and
- - requiring each employee to sign an agreement to comply with all Company
policies, including our policy regarding handling of confidential
information.
We monitor proposed regulations that might affect our applications and
services to ensure our compliance with such regulations when and if they are
implemented.
HEALTHCARE REGULATION
The healthcare industry is highly regulated and is subject to changing
political, regulatory and other influences. As a participant in the healthcare
industry, our operations and relationships are subject to regulation by federal
and state laws and regulations and enforcement by federal and state governmental
agencies. Sanctions may be imposed for violation of these laws. We review our
practices in an effort to ensure compliance with applicable laws. However, laws
governing healthcare are both broad and, in some respects, vague. As a result,
it is often difficult or impossible to determine precisely how laws will be
applied, particularly to new products or to services similar to ours. Any
determination by a state or federal regulatory agency that any of our practices
violate any of these laws could subject us to civil or criminal penalties,
require us to change or terminate some portions of our business, and have a
material adverse effect on our business.
The relevant healthcare laws are:
HIPAA. The administrative simplification provisions of HIPAA and the
various regulations, which have been proposed and enacted to implement the
administrative simplification provisions, include five healthcare-related
standards governing, among other things:
- - electronic transactions involving healthcare information,
- - privacy of individually identifiable health information, and
- - security of healthcare information and electronic signatures.
The regulations governing the electronic exchange of information establish
a standard format for the most common healthcare transactions, including claims,
remittances, eligibility, and claims status. The regulations required compliance
by October 16, 2002, unless a covered entity submitted a compliance plan by such
date requesting an extension for compliance until October 16, 2003. We intend to
ensure our compliance with the regulations, as applicable. Many of our customers
are subject to the transaction standards and the standards will
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affect our processing of healthcare transactions among physicians, payors,
patients, and other healthcare industry participants.
The regulations promulgated pursuant to HIPAA establish national privacy
standards for the protection of individually identifiable health information by
certain healthcare organizations. Most healthcare entities covered by the rule
must comply by April 14, 2003. A substantial part of our activities involve the
receipt or delivery of confidential health information concerning patients of
our customers in connection with the processing of healthcare transactions and
the provision of technical services to participants in the healthcare industry.
The regulations may restrict the manner in which we transmit and use certain
information.
The proposed security regulations enacted pursuant to HIPAA establishing
security and electronic HIPAA signature standards were recently finalized. The
security regulations will be effective April 21, 2003, and most covered entities
will have until April 21, 2005 to comply with the standards. The regulations
will require certain healthcare organizations to implement administrative
safeguards, physical safeguards, technical security services, and technical
security mechanisms with respect to information that is electronically
maintained or transmitted in order to protect the confidentiality, integrity,
and availability of individually identifiable health information. The security
standards may require us to enter into agreements with certain of our customers
and business partners restricting the dissemination of health information and
requiring implementation of specified security measures.
Overall, HIPAA may require substantial changes to many of our
applications, services, policies, and procedures that could require us to make
significant financial investments, may require us to charge higher prices to our
customers and may also affect our customers' purchasing practices.
See further discussion regarding HIPAA below in "Forward-Looking
Statements and Risk Factors."
Other Privacy Requirements. In addition to the privacy rule under HIPAA,
most states have enacted or are considering enacting patient confidentiality
laws, which would further prohibit the disclosure of confidential medical
information. HIPAA establishes minimum standards and preempts conflicting state
laws, which are less restrictive than HIPAA regarding health information
privacy, but does not preempt conflicting state laws that are more restrictive
than HIPAA. The Federal Trade Commission and various state attorneys general
have applied federal and state consumer protection laws to privacy issues.
FDA. The Food and Drug Administration, or FDA, is responsible for assuring
the safety and effectiveness of medical devices under the 1976 Medical Device
Amendments to the Food, Drug and Cosmetic Act. Computer applications and
software are generally subject to regulation as medical devices requiring
registration with the FDA, application of detailed record-keeping and
manufacturing standards, and FDA approval or clearance prior to marketing when
such products are intended to be used in the diagnosis, cure, mitigation,
treatment, or prevention of disease. If the FDA were to decide that our products
and services should be subject to FDA regulation or if in the future, we
expanded our application and service offerings into areas that may subject us to
FDA regulation, the costs of complying with FDA requirements could be
substantial. Application of the approval or clearance requirements could create
delays in marketing, and the FDA could require supplemental filings or object to
certain of these products. Our compliance efforts could prove to be time
consuming, burdensome and expensive on the basis of the novel application of the
FDA to us, and this could have a material adverse effect on our ability to
introduce new applications or services in a timely manner and may require us to
charge higher prices.
The Federal Anti-Kickback Law. The federal Anti-Kickback Law includes a
prohibition against the direct or indirect payment or receipt of any
remuneration in order to induce the referral of business or patients
reimbursable under Medicare, Medicaid, and certain other federal healthcare
programs. Violations of the federal Anti-Kickback Law may result in criminal
liability, a felony conviction punishable by a maximum fine of $125,000,
imprisonment up to five years, or both, exclusion from the government programs,
and civil monetary sanctions. Many states also have similar anti-kickback laws
that are not limited to items or services for which payment is made by a federal
or state healthcare program, such as Medicare or Medicaid. The Federal
Anti-
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Kickback Law has been in effect since 1977 and applies broadly to all kinds of
providers and suppliers. If the activities of a customer of ours or other entity
with which we have a business relationship were found to violate the Federal
Anti-Kickback Law or other similar anti-kickback or anti-referral laws, and we,
as a result of the provision of products or services to such customer or entity,
were found to have knowingly and willfully participated in such activities, we
could be subject to sanction or liability under such laws.
Stark Law. The federal Stark Law restricts referrals by physicians of
Medicare, Medicaid, and other government-program patients to providers of a
broad range of designated health services with which they have ownership or
certain other financial arrangements. Many states have adopted or are
considering similar legislative proposals to prohibit the payment or receipt of
remuneration for the referral of patients and physician self-referrals
regardless of the source of the payment for the care. These laws and regulations
are extremely complex, and little judicial or regulatory interpretation exists.
If the activities of a customer of ours or other entity with which we have a
business relationship were found to constitute a violation of anti-referral
laws, and we were found to have knowingly participated in such activities, we
could be subject to sanction or liability under such law.
The Federal Civil False Claims Act and the Medicare/Medicaid Civil Money
Penalties. Federal regulations prohibit, among other things, the filing of
claims for services that were not provided as claimed, were not medically
necessary, or which were otherwise false or fraudulent. Violations of these laws
may result in civil penalties, including treble damages. In addition, Medicare,
Medicaid, and other federal statutes provide for criminal penalties for such
false claims. If, during the course of providing services to our customers, we
provide assistance with the filing of such claims, and we were found to have
knowingly participated, or participated with reckless disregard, in such
activities, we could be subject to sanction or liability under such laws.
EMPLOYEES
As of December 31, 2002, we employed 651 persons, including 74 in sales
and marketing, 332 in customer support and services, 150 in research and
development and 95 in administration, human resources, information technology,
finance and senior management. None of our employees is subject to a collective
bargaining arrangement. We consider our relations with our employees to be
satisfactory.
Our executive officers are:
Joseph M. Walsh
Joseph M. Walsh, age 43, has served as our President and Chief Executive
Officer and as a director since March 2001 and Chairman since June 2001. From
April 2000 until March 2001, Mr. Walsh served as president of our medical
software division. From 1987 until April 2000, Mr. Walsh served as president and
chief executive officer of Micro-Designs Software Corporation, a healthcare
practice management company specializing in oral and maxillofacial, and plastic
surgery practices. We acquired Micro-Designs in 1998.
Stephen N. Kahane
Stephen N. Kahane, M.D., M.S., age 45, has served as our Vice Chairman and
Chief Strategy Officer and as a director since March 2001. From November 1999
until March 2001, Dr. Kahane served as President of E-Health and then as Chief
Strategy Officer, of our medical software division. From October 1996 until
November 1999, he served as president and chief executive officer of Datamedic
Holding Corp., a practice management and clinical software company specializing
in ophthalmology and general medical practices. We acquired Datamedic in 1999.
Prior to joining Datamedic, Dr. Kahane was a co-founder and senior executive at
a clinical software company, Clinical Information Advantages, Inc. Dr. Kahane
also trained and served on the faculty at The Johns Hopkins Medical Center.
11
Michael A. Manto
Michael A. Manto, age 44, has served as our Executive Vice President and
as a director since March 2001, and as our Chief Financial Officer since April
2001. From July 2000 until March 2001, he served as Executive Vice President of
our medical software division. From 1991 until 2000, Mr. Manto was with Hyperion
Solutions Corporation, a multinational business software company, where he
served as vice president and corporate controller. Mr. Manto also served as
interim chief financial officer of Hyperion Software Corporation. Prior to
joining Hyperion, Mr. Manto, a certified public accountant, was with Ernst &
Young.
Kevin M. Silk
Kevin M. Silk, age 39, has served as our Vice President of Finance and
Business Development since March 2001, and was Vice President of Finance of our
medical software division between October 2000 and March 2001. From 1995 to
2000, Mr. Silk was with Hyperion Solutions Corporation, a multinational business
software company, where he served in the capacities of Director of Business
Development and Senior Director of Financial Planning and Analysis. Prior to
joining Hyperion, Mr. Silk, a certified public accountant, was with Seavex LTD
and Ernst & Young.
C. Daren Mccormick
C. Daren McCormick, age 41, has served as our Chief Operations Officer
since March 2001. He was Chief Operations Officer of our medical software
division between April 2000 and March 2001. From July 1999 until April 2000, he
served as our Vice President of Systems Engineering and from October 1998 until
July 1999, he served as our Vice President of Business Development. From 1995
until October 1998, he served as Senior Manager of Research and Development of
the Healthcare Systems Division of Reynolds and Reynolds, a healthcare practice
management company. We acquired the Healthcare Systems Division of Reynolds and
Reynolds in October 1998.
Stephen Hicks
Stephen Hicks, age 44, has served as our Vice President and General
Counsel since March 2001. He was Vice President of our medical software division
between August 2000 and March 2001. Prior to joining us, he was First Deputy
Commissioner at the New York State Division of Housing from January 1999, and
worked from February 1995 to December 1998 on the executive staff of Dennis C.
Vacco, the New York State Attorney General. From 1983 until 1995, Mr. Hicks
worked for McCullough, Goldberger and Staudt, a New York law firm.
Eric A. Montgomery
Eric A. Montgomery, age 48, has served as our Corporate Vice President of
Sales since November 2002. From 1999 to 2002, he acted as Vice President of
Sales and Business Development for OutlookSoft Corporation, a venture-backed
software company specializing in the area of business intelligence. From 1997
to 1999, he served as Vice President of Sales at Information Management
Associates. Prior positions included Senior Sales Director at Hyperion
Software Corporation, as well as various sales and marketing positions at
Citicorp's Information Division and Comshare, Inc.
In April and May 2002, each of our executive officers entered into an
individual stock trading plan, or a so-called Rule 10b5-1 plan. These plans
specify trading periods that generally extend for up to one year, number of
shares to be sold, and prices at which shares may be sold. If all conditions of
the plans are met, the total number of shares that may be sold under the plans
would equal 19.9% of the aggregate number of shares, including unvested option
shares, then held by the executive officers. More specifically, the Rule 10b5-1
plan of Joseph M. Walsh, our president and chief executive officer, provides for
the sale of not more than 90,000 shares on-average per quarter over the twelve
months ending May 30, 2003, which began with the announcement of our
12
operating results for the June 2002 quarter. The aggregate number of shares that
may be sold under this plan represents 11.3% of the number of shares, including
unvested option shares, then held by Mr. Walsh. Since March 6, 2001,
approximately 11.6% of the aggregate holdings of the executive officers was
sold.
THE DISTRIBUTION
On March 5, 2001, or the Distribution Date, we completed the Distribution
of PracticeWorks to our stockholders in a tax-free distribution. The spin-off of
PracticeWorks was effected by way of a pro rata dividend of all of the issued
and outstanding shares of common stock of PracticeWorks to our stockholders of
record as of February 21, 2001. This resulted in PracticeWorks becoming an
independent, publicly-traded company. Immediately prior to the Distribution, we
effectively transferred to PracticeWorks the division's assets and liabilities
and, thereby, distributed $28.5 million of net assets, as adjusted, in
connection with the Spin-Off. Our stockholders received one share of
PracticeWorks common stock for every four shares of our common stock owned as of
the record date. No proceeds were received by us in connection with the
Distribution.
For purposes of governing certain of the ongoing relationships between
PracticeWorks and us, and to provide for an orderly transition to the status of
two independent companies, we and PracticeWorks entered into various agreements.
Among other things, these agreements define the ongoing relationship between the
parties after the Distribution. Because these agreements were negotiated while
PracticeWorks was a wholly-owned subsidiary of ours, they are not the result of
negotiations between independent parties, although we and PracticeWorks set
pricing terms for interim services believed to be comparable to what would have
been achieved through arm's-length negotiations. Following the Distribution,
additional or modified agreements, arrangements and transactions were entered
into between PracticeWorks and us and such agreements and transactions were
determined through arm's-length negotiations. In connection with the
Distribution, both companies have indemnified the other, and either may incur
obligations with respect to certain representations, warranties, commitments,
and/or contingencies of the other entered into on or prior to the Distribution
Date. A brief description of certain of the material agreements follows:
Distribution Agreement
Prior to the Distribution Date, we and PracticeWorks entered into the
Distribution Agreement, which provided for, among other things, the principal
corporate transactions required to effect the Distribution and other agreements
relating to the continuing relationship between PracticeWorks and us after the
Distribution. Pursuant to the Distribution Agreement, we transferred to
PracticeWorks all of the assets and liabilities relating to our information
management technology business for dentists, orthodontists and oral and
maxillofacial surgeons.
Pursuant to the Distribution Agreement and effective as of the
Distribution Date, PracticeWorks assumed, and agreed to indemnify us against,
all liabilities, litigation, and claims, including related insurance costs,
arising out of PracticeWorks' business. We retained, and agreed to indemnify
PracticeWorks against, all liabilities, litigation, and claims, including
related insurance costs, arising out of our business. The foregoing obligations
do not entitle an indemnified party to recovery to the extent any such liability
is covered by proceeds received by such party from any third party insurance
policies.
The Distribution Agreement provides that each of PracticeWorks and us will
be granted access to certain records and information in the possession of the
other, and will require the retention by each of PracticeWorks and us for a
period of eight years following the Distribution Date of all of this information
in its possession. Also, the Distribution Agreement provides for a three-year
period during which neither PracticeWorks nor we may solicit pre-existing
customers or employees of the other party.
Transition Services Agreement
We and PracticeWorks entered into the Transition Services Agreement on the
Distribution Date. Pursuant to this agreement, in exchange for specified fees,
we provided to PracticeWorks services including insurance-related services and
employee benefit services, and PracticeWorks provided to us services including
the
13
preparation of tax returns, maintenance of the general ledger, preparation of
financial statements, corporate record-keeping, and payroll for a fee of $.4
million in 2001. The fees paid pursuant to the Transition Services Agreement
were agreed upon between the parties. This agreement terminated on December 31,
2001. Management believes that the terms and conditions were as favorable to us
as those available from unrelated parties for a comparable arrangement.
Tax Disaffiliation Agreement
We and PracticeWorks entered into the Tax Disaffiliation Agreement on the
Distribution Date which identifies each party's rights and obligations with
respect to deficiencies and refunds, if any, of federal, state, local, or
foreign taxes for periods before and after the Distribution and related matters
such as the filing of tax returns and the handling of Internal Revenue Service
matters and other audits. Under the Tax Disaffiliation Agreement, PracticeWorks
will indemnify us for any tax liability attributable to PracticeWorks or its
affiliates for any period. PracticeWorks will also indemnify us for all taxes
and liabilities incurred solely because (i) PracticeWorks breaches a
representation or covenant given to the law firm King & Spalding in connection
with rendering its tax opinion in the Distribution, which breach contributes to
an Internal Revenue Service determination that the Distribution was not
tax-free, or (ii) a post-Distribution action or omission by PracticeWorks or any
affiliate of PracticeWorks contributes to an Internal Revenue Service
determination that the Distribution was not tax-free. We will indemnify
PracticeWorks for all taxes and liabilities incurred solely because (i) we
breach a representation or covenant given to King & Spalding in connection with
rendering its tax opinion in the Distribution, which breach contributes to an
Internal Revenue Service determination that the Distribution was not tax-free,
or (ii) a post-Distribution action or omission by us or any affiliate
contributes to an Internal Revenue Service determination that the Distribution
was not tax-free. If the Internal Revenue Service determines that the
Distribution was not tax-free for any other reason, we and PracticeWorks will
indemnify each other against 50% of all taxes and liabilities.
PracticeWorks will also indemnify us for any taxes resulting from any
internal realignment undertaken to facilitate the Distribution on or before the
Distribution Date.
Employee Benefits and Compensation Allocation Agreement
We and PracticeWorks entered into the Employee Benefits and Compensation
Allocation Agreement on the Distribution Date, which contains provisions
relating to employee compensation, benefits and labor matters and the treatment
of options to purchase our common stock held by our employees who became
PracticeWorks employees. This agreement provides that our options held by our
employees who became PracticeWorks employees immediately following the
Distribution may be replaced by PracticeWorks options. PracticeWorks employees
whose VitalWorks options were fully vested as of the Distribution Date had the
right to surrender their vested VitalWorks options for options to purchase
PracticeWorks common stock for a period of 30 days following the Distribution
Date, or April 4, 2001. Any of our employees who became PracticeWorks employees
who chose not to surrender their vested VitalWorks options during this time
period continued to hold VitalWorks options which expired generally within 30 to
90 days from the Distribution Date. PracticeWorks employees who were not fully
vested in VitalWorks options as of the Distribution Date had their VitalWorks
options exchanged for PracticeWorks options as of the Distribution Date (see
Note I of the accompanying financial statements for further discussion).
FORWARD-LOOKING STATEMENTS AND RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Except for the historical information contained in this Annual Report on
Form 10-K, the matters discussed herein contain "forward-looking statements"
within the meaning of the federal securities laws. Statements regarding future
events and developments and our future performance, as well as our management's
expectations, beliefs, intentions, plans, estimates or projections relating to
the future, are forward-looking statements within the meaning of these laws. Our
management believes that these forward-looking statements are reasonable and are
based on reasonable assumptions and forecasts. However, these forward-looking
statements
14
are subject to a number of risks and uncertainties. As a result, actual results
may vary materially from those anticipated by the forward-looking statements.
Among the important factors that could cause actual results to differ
materially are the risk factors described below. You should read these factors
and the other cautionary statements made in this document as being applicable to
all related forward-looking statements wherever they appear in this Annual
Report on Form 10-K.
You are cautioned not to place undue reliance on the forward-looking
statements, which speak only as of the date of this report. Except as required
by law, we undertake no obligation to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You should carefully consider the following risk factors. Any of the
following risks could seriously harm our business, financial condition, cash
flows, and results of operations and cause the value of our common stock to
decline. The risks and uncertainties described below are those that we currently
believe may materially affect us. Additional risks and uncertainties that we are
currently unaware of or that we currently consider to be immaterial may also
become important factors that affect us.
OUR OPERATING RESULTS WILL VARY FROM PERIOD TO PERIOD. IN ADDITION, WE HAVE
EXPERIENCED LOSSES IN THE PAST AND MAY NEVER ACHIEVE OR MAINTAIN CONSISTENT
PROFITABILITY.
Our operating results will vary significantly from quarter to quarter and
from year to year. In addition, prior to the first quarter of 2002, we have
experienced net losses. Our net loss was $(27.8) million for the year ended
December 31, 2001 and $(78.1) million for the year ended December 31, 2000.
Our operating results have been and/or may be influenced significantly by
factors such as:
- - release of new products, product upgrades and services, and the rate of
adoption of these products and services by new and existing customers;
- - timing of and costs related to development of our products;
- - length of sales and delivery cycles;
- - size and timing of orders for our products and services;
- - availability of specified computer hardware for resale;
- - deferral and/or realization of deferred software license and system
revenues according to contract terms;
- - interpretations of accounting regulations, principles or concepts that are
or may be considered relevant to our business arrangements and practices;
- - changes in customer purchasing patterns;
- - competition, including alternative product and service offerings, and
price pressure;
- - timing of and charges or costs associated with acquisitions or other
strategic events or transactions, completed or not completed;
- - timing and levels of advertising and promotional expenditures;
- - changes of accounting estimates and assumptions used to prepare the prior
periods' financial statements and accompanying notes, and management's
discussion and analysis of financial condition and results of operations
(e.g., our valuation of assets and estimation of liabilities); and
- - uncertainties concerning pending and new litigation against us, including
related professional services fees.
In addition, we operate with a minimal amount of software licensing and
system sales backlog. Therefore, quarterly and annual revenues and operating
results are highly dependent on the volume and timing of the signing of license
agreements and product deliveries during each quarter. A significant portion of
our quarterly sales of software product licenses and computer hardware is
concluded in the last month of the fiscal quarter, generally with a
concentration of our quarterly revenues earned in the final ten business days of
that month. Also, our projections for revenues and operating results include
significant sales of new product and service offerings, including our new
radiology information system, or RIS, and sales and services related to the
implementation of
15
HIPAA, which may not be realized. Due to these and other factors, our revenues
and operating results are very difficult to forecast. A major portion of our
costs and expenses, such as personnel and facilities, is of a fixed nature and,
accordingly, a shortfall or decline in quarterly and/or annual revenues
typically results in lower profitability or losses. As a result, comparison of
our period-to-period financial performance is not necessarily meaningful and
should not be relied upon as an indicator of future performance. Due to the many
variables in forecasting our revenues and operating results, it is likely that
our results for a particular reporting period(s) will not meet our expectations
or the expectations of public market analysts or investors. Failure to attain
these expectations would likely cause the price of our common stock to decline.
OUR COMPETITIVE POSITION COULD BE SIGNIFICANTLY HARMED IF WE FAIL TO PROTECT OUR
INTELLECTUAL PROPERTY RIGHTS FROM THIRD-PARTY CHALLENGES.
Our ability to compete depends in part on our ability to protect our
intellectual property rights. We rely on a combination of copyright, trademark,
and trade secret laws and restrictions on disclosure to protect the intellectual
property rights related to our software applications. Our software technology is
not patented and existing copyright laws offer only limited practical
protection. In addition, in the past we have not generally entered into
confidentiality agreements with our employees. Although current practices
require all new employees to sign confidentiality agreements, not all existing
employees have signed agreements. We cannot assure you that the legal
protections that we rely on will be adequate to prevent misappropriation of our
technology.
Further, we may need to bring lawsuits or pursue other legal or
administrative proceedings in order to enforce our intellectual property rights.
Generally, lawsuits and proceedings of this type, even if successful, are
costly, time consuming and could divert our personnel and other resources away
from our business, which could harm our business.
Moreover, these protections do not prevent independent third-party
development of competitive technology or services. Unauthorized parties may
attempt to copy or otherwise obtain and use our technology. Monitoring use of
our technology is difficult, and we cannot assure you that the steps we have
taken will prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US COULD BE COSTLY TO DEFEND
AND COULD DIVERT OUR MANAGEMENT'S ATTENTION AWAY FROM OUR BUSINESS.
As the number of software products and services in our target markets
increases and as the functionality of these products and services overlaps, we
may become increasingly subject to the threat of intellectual property
infringement claims. Any infringement claims alleged against us, regardless of
their merit, can be time consuming and expensive to defend. Infringement claims
may also divert our management's attention and resources and could also cause
delays in the delivery of our applications to our customers. Settlement of any
infringement claims could require us to enter into royalty or licensing
agreements on terms that are costly or cost-prohibitive. If a claim of
infringement against us were successful and if we were unable to license the
infringing or similar technology or redesign our products and services to avoid
infringement, our business, financial condition, cash flows, and results of
operations could be harmed.
WE RECENTLY INSTITUTED A STOCK REPURCHASE PROGRAM, WHICH MAY INVOLVE THE USE OF
SIGNIFICANT CASH RESOURCES.
In October 2002, our board of directors authorized the repurchase of up to
$15 million of our common stock from time to time. The timing and amount of any
share repurchases are determined by management based on our evaluation of market
conditions and other factors. The repurchase program may be suspended or
discontinued at any time. Repurchased shares are available for use in connection
with stock plans and for other corporate purposes. The repurchase program is
funded using our existing cash resources. Spending under this
16
program may in turn limit our ability to invest in our core business activities
or undertake acquisitions, if any. In addition, there are a number of important
factors that could cause us not to repurchase shares including, among others,
the market price of our common stock, the nature of other investment
opportunities available to us, our cash flows from operations, general economic
conditions, and other factors identified in this report. As of March 24, 2003,
we repurchased 1,873,002 shares of our common stock under the program for an
aggregate cost of $6.0 million.
WE MAY UNDERTAKE ACQUISITIONS, WHICH MAY INVOLVE SIGNIFICANT UNCERTAINTIES AND
MAY INCREASE COSTS, DIVERT MANAGEMENT RESOURCES FROM OUR CORE BUSINESS
ACTIVITIES, OR FAIL TO REALIZE ANTICIPATED BENEFITS OF SUCH ACQUISITIONS.
We may undertake acquisitions if we identify companies with complementary
applications, services, businesses or technologies. We may not achieve any of
the anticipated synergies and other benefits that we expected to realize from
these acquisitions. In addition, software companies depend heavily on their
employees to maintain the quality of their software offerings and related
customer services. If we were unable to retain the acquired companies' personnel
or integrate them into our operations, the value of the acquired products,
technology, and/or client base could be compromised. The amount and timing of
the expected benefits of any acquisition are also subject to other significant
risks and uncertainties. These risks and uncertainties include:
- - our ability to cross-sell products and services to customers with which we
have established relationships and those with which the acquired business
had established relationships;
- - diversion of our management's attention from our existing business;
- - potential conflicts in customer and supplier relationships;
- - our ability to coordinate organizations that are geographically diverse
and may have different business cultures;
- - dilution to existing stockholders if we issue equity securities;
- - assumption of liabilities or other obligations in connection with the
acquisition; and
- - compliance with regulatory requirements.
Further, our profitability may also suffer because of acquisition-related
costs and/or amortization or impairment of intangible assets.
IF OUR NEW PRODUCTS, INCLUDING PRODUCT UPGRADES, AND SERVICES DO NOT ACHIEVE
SUFFICIENT MARKET ACCEPTANCE, OUR BUSINESS, FINANCIAL CONDITION, CASH FLOWS, AND
OPERATING RESULTS WILL SUFFER.
The success of our business will depend in part on the market acceptance
of:
- - new products and services, such as our radiology information system, or
RIS, products and services; and
- - enhancements to our existing products and services.
There can be no assurance that our clients will accept any of these
products, product upgrades, or services. In addition, there can be no assurance
that any pricing strategy that we implement for any of our new products, product
upgrades, or services will be economically viable or acceptable to our target
markets. Failure to achieve significant penetration in our target markets with
respect to any of our new products, product upgrades, or services could have a
material adverse effect on our business prospects.
Achieving market acceptance for our new products, product upgrades and
services is likely to require substantial marketing and service efforts and
expenditure of significant funds to create awareness and demand by participants
in the healthcare industry. In addition, deployment of new or newly integrated
products or product upgrades may require the use of additional resources for
training our existing sales force and customer service personnel and for hiring
and training additional sales and customer service personnel. There can be no
assurance
17
that the revenue opportunities for our new products, product upgrades and
services will justify the amounts that we spend for their development, marketing
and rollout.
TECHNOLOGY SOLUTIONS MAY CHANGE FASTER THAN WE ARE ABLE TO UPDATE OUR
TECHNOLOGY, WHICH COULD CAUSE A LOSS OF CUSTOMERS AND HAVE A NEGATIVE IMPACT ON
OUR REVENUES.
The information management technology market in which we compete is
characterized by rapidly changing technology, evolving industry standards,
emerging competition and the frequent introduction of new services, software and
other products. Our success depends partly on our ability to:
- - develop new or enhance existing products and services to meet our
customers' changing needs in a timely and cost-effective way; and
- - respond effectively to technological changes, new product offerings,
product enhancements and new services of our competitors.
We cannot be sure that we will be able to accomplish these goals. Our
development of new and enhanced products and services may take longer than
originally expected, require more testing than originally anticipated and
require the acquisition of additional personnel and other resources. In
addition, there can be no assurance that the products and/or services we develop
or license will be able to compete with the alternatives available to our
customers. Our competitors may develop products or technologies that are better
or more attractive than our products or technologies, or that may render our
products or technology obsolete. If we do not succeed in adapting our products,
technology and services or developing new products, technologies and services,
our business could be harmed.
THE NATURE OF OUR PRODUCTS AND SERVICES EXPOSES US TO PRODUCT LIABILITY CLAIMS
THAT MAY NOT BE ADEQUATELY COVERED BY INSURANCE OR CONTRACTUAL INDEMNIFICATION.
As a product and service provider in the healthcare industry, we operate
under the continual threat of product liability claims being brought against us.
For example, if patient information processed through our systems is incorrect,
patients may receive inadequate or inapplicable medical treatment, which could
subject us to significant liability. Errors or malfunctions with respect to our
products or services could also result in product liability claims. Although we
believe that we carry adequate insurance coverage against product liability
claims, we cannot assure you that claims in excess of our insurance coverage
will not arise. In addition, our insurance policies must be renewed annually.
Although we have been able to obtain what we believe to be adequate insurance
coverage at an acceptable cost in the past, we cannot assure you that we will
continue to be able to obtain adequate insurance coverage at an acceptable cost.
In many instances, our agreements have provisions requiring the other
party to the agreement to indemnify us against certain liabilities. However, any
indemnification of this type is limited, as a practical matter, to the
creditworthiness of the indemnifying party. If the contractual indemnification
rights available under our agreements are not adequate or inapplicable to the
product liability claims that may be brought against us, then, to the extent not
covered by our insurance, our business, operating results, cash flows and
financial condition could be materially adversely affected.
OUR BUSINESS COULD SUFFER IF OUR PRODUCTS AND SERVICES CONTAIN ERRORS,
EXPERIENCE FAILURES, RESULT IN LOSS OF OUR CUSTOMERS' DATA OR DO NOT MEET
CUSTOMER EXPECTATIONS.
The products and services that we offer are inherently complex. Despite
testing and quality control, we cannot be certain that errors will not be found
in prior versions, current versions or future versions or enhancements of our
products and services. We also cannot assure you that our products and services
will not experience partial or complete failure, especially our new product or
service offerings. It is also possible that as a result of any of these errors
and/or failures, our customers may suffer loss of data. The loss of business,
medical or patient data or the loss of the ability to process data for any
length of time may be a
18
significant problem for some of our customers who have time-sensitive or
mission-critical practices. We could face breach of warranty or other claims or
additional development costs if our software contains errors, if our customers
suffer loss of data or are unable to process their data, if our products and/or
services experience failures, do not perform in accordance with their
documentation, or do not meet the expectations that our customers have for
them. Even if these claims do not result in liability to us, investigating and
defending against them could be expensive and time consuming and could divert
management's attention away from our operations. In addition, negative
publicity caused by these events may delay or reduce market acceptance of our
products and services, including unrelated products and services. Such errors,
failures or claims could materially adversely affect our business, revenues,
operating results, cash flows and financial condition.
WE MAY BE SUBJECT TO CLAIMS RESULTING FROM THE ACTIVITIES OF OUR STRATEGIC
PARTNERS.
We rely on third parties to provide services critical to our business. For
example, we use national clearinghouses in the processing of insurance claims
and we outsource some of our hardware maintenance services and the printing and
delivery of patient billings for our customers. We also have relationships with
certain third parties where these third parties serve as sales channels through
which we generate a portion of our revenues. Due to these third-party
relationships, we could be subject to claims as a result of the activities,
products, or services of these third-party service providers even though we were
not directly involved in the circumstances leading to those claims. Even if
these claims do not result in liability to us, defending and investigating these
claims could be expensive and time-consuming, divert personnel and other
resources from our business and result in adverse publicity that could harm our
business.
WE ARE SUBJECT TO GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES, THE COMPLIANCE
WITH WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
HIPAA
Federal regulations have been adopted, and others have been proposed, that
impact the manner in which we conduct our business. We will be required to
expend resources to comply with regulations under HIPAA. The total extent and
amount of resources to be expended is not yet known. Because these regulations
are new, there is uncertainty as to how they will be interpreted and enforced.
In addition, the delay in adopting final security regulations creates
uncertainties as to what security requirements ultimately will be imposed, to
what extent we will be required to comply with those requirements, and what the
deadline for compliance will be.
Although we will make a good faith effort to ensure that we comply with,
and that our go-forward products enable compliance with, applicable HIPAA
requirements, we may not be able to conform all of our operations and products
to such requirements in a timely manner, or at all. The failure to do so could
subject us to civil liability when we are the business associate of a covered
entity, and could subject us to civil liability and criminal sanctions to the
extent we are regulated directly as a covered entity. 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 and our business could
be harmed by the implementation of HIPAA regulations.
Other E-commerce Regulations
We may be subject to additional federal and state statutes and regulations
in connection with offering services and products via the Internet. On an
increasingly frequent basis, federal and state legislators are proposing laws
and regulations that apply to Internet commerce and communications. Areas being
affected by these regulations include user privacy, pricing, content, taxation,
copyright protection, distribution, and quality of products and services. To the
extent that our products and services are subject to these laws and regulations,
the sale of our products and services could be harmed.
19
CHANGES IN STATE AND FEDERAL LAWS RELATING TO CONFIDENTIALITY OF PATIENT MEDICAL
RECORDS COULD LIMIT OUR CUSTOMERS' ABILITY TO USE OUR SERVICES.
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 and
regulations patient confidentiality rights are evolving rapidly. In addition to
the obligations being imposed at the state level, there is also legislation
governing the dissemination of medical information at the federal level. The
federal regulations may require holders of this information to implement
security measures, which could entail substantial expenditures on our part.
Adoption of these types of legislation or other 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. These
kinds of restrictions would likely decrease the value of our applications to our
customers, which could materially harm our business.
CHANGES IN THE REGULATORY AND ECONOMIC ENVIRONMENT IN THE HEALTHCARE INDUSTRY
COULD CAUSE US TO LOSE REVENUE AND INCUR SUBSTANTIAL COSTS TO COMPLY WITH NEW
REGULATIONS.
The healthcare industry is highly regulated and is subject to changing
political, economic and regulatory influences. These factors affect the
purchasing practices and operations 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 or in the revocation of endorsement of our services by
our strategic partners and others. Federal and state legislatures have
periodically considered programs to reform or amend the U.S. healthcare system
at both the federal and state level. 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.
LARGER COMPETITORS AND CONSOLIDATION OF COMPETITORS COULD CAUSE US TO LOWER OUR
PRICES OR TO LOSE CUSTOMERS.
Our principal competitors include both national and regional
practice management and clinical systems vendors. Currently, the practice
management and clinical systems industry in the United States is characterized
by a large number of relatively small, regionally focused companies,
comprising a highly fragmented industry with only a few national vendors.
Until recently, larger, national vendors have targeted primarily large
healthcare providers. We believe that the larger, national vendors may broaden
their markets to include both small and large healthcare providers. In
addition, we compete with national and regional providers of computerized
billing, insurance processing and record management services to healthcare
practices. As the market for our products and services expands, additional
competitors are likely to enter this market. We believe that the primary
competitive factors in our markets are:
- - product features and functionality;
- - customer service, support and satisfaction;
- - price;
- - ongoing product enhancements; and
- - the reputation and stability of the vendor.
We have experienced, and we expect to continue to experience, increased
competition from current and potential competitors, many of which have
significantly greater financial, technical, marketing and other resources than
us. Such competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of their products than us. Also, certain
current and potential competitors have greater name recognition or more
extensive customer
20
bases that could be leveraged, thereby gaining market share to our detriment. We
expect additional competition as other established and emerging companies enter
into the practice management and clinical software markets and as new products
and technologies are introduced. Increased competition could result in price
reductions, fewer customer orders, reduced gross margins and loss of market
share, any of which would materially adversely affect our business, operating
results, cash flows and financial condition.
Current and potential competitors may make strategic acquisitions or
establish cooperative relationships among themselves or with third parties,
thereby increasing the ability of their products to address the needs of our
existing and prospective customers. Further competitive pressures, such as those
resulting from competitors' discounting of their products, may require us to
reduce the price of our software and complementary products, which would
materially adversely affect our business, operating results, cash flows and
financial condition. There can be no assurance that we will be able to compete
successfully against current and future competitors, and the failure to do so
would have a material adverse effect upon our business, operating results, cash
flows and financial condition.
WE DEPEND ON PARTNERS/SUPPLIERS FOR DELIVERY OF ELECTRONIC DATA INTERCHANGE
(INSURANCE CLAIMS PROCESSING AND INVOICE PRINTING SERVICES), COMMONLY REFERRED
TO AS EDI, HARDWARE MAINTENANCE SERVICES AND SALES LEAD GENERATION. ANY FAILURE,
INABILITY OR UNWILLINGNESS OF THESE SUPPLIERS TO PERFORM THESE SERVICES COULD
NEGATIVELY IMPACT CUSTOMER SATISFACTION AND REVENUES.
We use various third-party suppliers to provide our customers with EDI
transactions and on-site hardware maintenance. EDI revenue would be particularly
vulnerable to a supplier failure because EDI revenues are earned on a daily
basis. Although other vendors are available in the marketplace to provide these
services, it would take time to switch suppliers. If these suppliers were unable
to perform such services or the quality of these services declined, 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 EDI services and Internet
solutions depends on the confidence of our customers in our ability to securely
transmit confidential information. Our EDI services and Internet solutions 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 our, or our customers', operations. In addition, our
EDI and Internet solutions 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, damage our reputation in the market
making it difficult to obtain new customers.
IF THE MARKETPLACE DEMANDS SUBSCRIPTION PRICING AND/OR APPLICATION SERVICE
PROVIDER, OR ASP, DELIVERED OFFERINGS, OUR REVENUES MAY BE ADVERSELY IMPACTED.
We currently derive substantially all of our revenues from traditional
software license, maintenance and service fees, as well as the resale of
computer hardware. Today, customers pay an initial license fee for the use of
our products, in addition to a periodic maintenance fee. If the marketplace
demands subscription pricing and/or ASP-delivered offerings, we may be forced to
adjust our strategy accordingly, by offering a higher percentage of our products
and services through these means. Shifting to subscription pricing and/or
ASP-delivered offerings could materially adversely impact our financial
condition, cash flows and quarterly and annual revenues and results of
operations, as our revenues would initially decrease substantially. We cannot
assure you that the marketplace will not embrace subscription pricing and/or
ASP-delivered offerings.
WE STRUCTURED THE SPIN-OFF OF PRACTICEWORKS AS A TAX-FREE TRANSACTION AND
PRACTICEWORKS AGREED TO INDEMNIFY US FOR ANY TAX LIABILITIES ARISING OUT OF THE
TRANSACTION. IF THE SPIN-OFF DOES NOT QUALIFY AS A TAX-FREE TRANSACTION, WE MAY
BE SUBJECT TO LIABILITIES AND WE CANNOT ASSURE YOU THAT PRACTICEWORKS WILL HONOR
ITS INDEMNIFICATION OBLIGATIONS.
The spin-off of PracticeWorks was structured to qualify as a tax-free
distribution under Section 355 of the Internal Revenue Code of 1986. Section 355
places certain requirements that must be complied with in order to qualify for
tax-free treatment. Failure to comply with those restrictions could cause us to
incur significant liabilities. PracticeWorks has generally agreed to indemnify
us under certain circumstances to the extent any
21
action or omission on its part contributes to a determination by the Internal
Revenue Service that the spin-off was not a tax-free transaction. However, we
cannot assure you that PracticeWorks will have sufficient resources to fulfill
its indemnification obligations and even if it had the resources, we cannot
assure you that PracticeWorks will not refute its indemnifications altogether.
In either case, if we are not indemnified, we may incur substantial liabilities,
which could have a material adverse effect on our business, financial condition,
cash flows and results of operations.
OUR GROWTH COULD BE LIMITED IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.
We believe that our success depends largely on our ability to attract and
retain highly skilled technical, managerial and sales personnel to develop, sell
and implement our products and services. Individuals with the information
technology, managerial and selling skills we need to further develop, sell and
implement our products and services are in short supply and competition for
qualified personnel is particularly intense. We may not be able to hire the
necessary personnel to implement our business strategy, or we may need to pay
higher compensation for employees than we currently expect. We cannot assure you
that we will succeed in attracting and retaining the personnel we need to
continue to grow and to implement our business strategy. In addition, we depend
on the performance of our executive officers and other key employees. The loss
of any member of our senior management team could negatively impact our ability
to execute our business strategy.
IF OUR INTERPRETATION OF THE ACCOUNTING PRONOUNCEMENTS REGARDING REVENUE
RECOGNITION IS NOT CORRECT OR IF THE REGULATORS OF ACCOUNTING STANDARDS MODIFIES
OR ISSUES NEW PRONOUNCEMENTS, THEN OUR BUSINESS AND FINANCIAL STATEMENTS COULD
BE ADVERSELY AFFECTED.
Based on our reading and interpretations of Statement of Positions 81-1,
97-2 and 98-9 and related or relevant guidance, principles or concepts, issued
by, among other authorities, the American Institute of Certified Public
Accountants, the Financial Accounting Standards Board, and the United States
Securities and Exchange Commission (e.g., Staff Accounting Bulletin No. 101), we
believe our current sales and licensing contract terms and business arrangements
have been properly reported. However, there continue to be issued
interpretations and guidance for applying the relevant standards to a wide range
of sales and licensing contract terms and business arrangements that are
prevalent in the software industry. Future interpretations or changes by the
regulators of existing accounting standards or changes in our business practices
could result in future changes in our revenue recognition accounting policies
and practices that could have a material adverse effect on our business,
financial condition, cash flows, revenues and results of operations.
* * * * * *
ACCESS TO OUR FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION
Our Internet address is www.vitalworks.com. The information on our website
is not a part of, or incorporated into, this Annual Report on Form 10-K. We make
our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 available, without
charge, on our website as soon as reasonably practicable after they are filed
electronically with, or otherwise furnished to, the Securities and Exchange
Commission.
ITEM 2. PROPERTIES
We currently occupy and lease nine facilities. These facilities are
located in: Atlanta, Georgia; Beaverton, Oregon; Birmingham, Alabama;
Minneapolis and Rochester, Minnesota; Daytona Beach, Florida; Carlsbad,
California; Ridgefield, Connecticut; and Fairfield, Ohio. We believe that our
existing facilities are adequate for our current needs; however, if additional
space is needed in the future, we believe that suitable additional or
alternative space will be available on commercially reasonable terms as needed.
22
ITEM 3. LEGAL PROCEEDINGS
From time to time, in the normal course of business, various claims are
made against us. Except for proceedings described below, there are no material
proceedings to which we are a party, and management is unaware of any material
contemplated actions against us.
On February 27, 2003, a purported class action complaint was filed in the
United States District Court for the District of Connecticut against VitalWorks
Inc. and three of our executive officers. The action was brought by plaintiff
Bernard Frazier, on behalf of purchasers of our securities between April 24,
2002 and October 23, 2002 (the "Class Period"). The complaint alleges, among
other things, violations of Section 10(b) of the Securities Exchange Act of
1934, Rule 10b-5 promulgated thereunder and breach of fiduciary duties. The
complaint alleges that the defendants made misleading statements and omissions
regarding our business and operations, principally in press releases and public
conference calls in April 2002 and July 2002, which allegedly had the effect of
artificially inflating the market price of our common stock during the Class
Period, and that six of our officers, including the defendant officers, sold
shares of our common stock during the Class Period. The plaintiff seeks recovery
of an unstated amount of compensatory damages, attorneys' fees and costs. We
understand that an additional lawsuit or lawsuits containing substantially
similar causes of action as the above referenced matter has been filed against
us, although we have not yet been served with any complaint.
On April 19, 2001, a lawsuit styled David and Susan Jones v. InfoCure
Corporation (now known as VitalWorks Inc.), et al., was filed in Boone County
Superior Court in Indiana. The defendants removed the case to the United States
District Court for the Southern District of Indiana. The complaint alleges state
securities law violations, breach of contract, and fraud claims against the
defendants. The complaint does not specify the amount of damages sought by
plaintiffs, but seeks rescission of a transaction that the plaintiffs value at
$5 million, as well as punitive damages and reimbursement for the plaintiffs'
attorneys' fees and associated costs and expenses of the lawsuit. In a decision
from the Court dated October 15, 2001, the plaintiffs' request for a preliminary
injunction to preserve their remedy of rescission was denied, part of their
complaint was dismissed and the case was transferred to the Northern District
Court of Georgia. On October 26, 2001, the plaintiffs filed a notice of appeal
with the 7th Circuit Court of Appeals. On November 8, 2002, the 7th Circuit
Court affirmed the denial of the preliminary injunction and dismissed the
remainder of the appeal. The case is now pending in the Northern District Court
of Georgia and the plaintiffs have obtained leave of the Court to file an
amended complaint.
While management believes that we have meritorious defenses in each of the
foregoing matters and we intend to pursue our positions vigorously, litigation
is inherently subject to many uncertainties. Thus, the outcome of these matters
is uncertain and could be adverse to us. However, even if the outcome of these
cases is adverse, we do not believe that the outcome of these cases,
individually or in the aggregate, will have a material adverse effect on our
financial position. However, depending on the amount and timing of an
unfavorable resolution(s) of the contingencies, it is possible that our future
results of operations or cash flows could be materially affected in a particular
reporting period(s).
We were named as a defendant as successor to CDL Healthcare Systems, Inc.
("CDL"), a company acquired by us in December 1999, in a complaint filed in the
Circuit Court of the Eleventh Judicial Circuit in Dade County, Florida on
February 27, 2001 by Sonia Abutog, individually, Angelo Abutog, individually,
and Sonia and Angelo Abutog, as parents and next best friends to Aaron Abutog, a
minor. Gary Weiner, former President of CDL, and his daughter, Elisha Weiner,
were also named as defendants. Plaintiffs alleged that they were injured at a
time, prior to the merger between us and CDL, when a motor vehicle operated by
Elisha Weiner collided with plaintiff Sonia Abutog, a pedestrian. The plaintiff
contended that she and her unborn child suffered severe personal injuries as a
result of the accident and sought to recover damages in an unspecified amount in
excess of $15,000, plus interest and costs. Our motion for final summary
judgment dismissing the action against us was granted by order of the Court
dated July 9, 2002. The plaintiffs did not file a Notice of Appeal of this
decision and the time to do so has expired.
23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In the fourth quarter of the year covered by this report, no matter was
submitted to a vote of security holders through the solicitation of proxies or
otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
On March 6, 2001, we changed our trading symbol on the Nasdaq National
Market to "VWKS." From January 29, 1999 until March 5, 2001, our common stock
was traded on the Nasdaq National Market under the trading symbol "INCX." From
July 10, 1997 until January 29, 1999, our common stock was traded on the
American Stock Exchange under the symbol "INC." On March 24, 2003, the last
reported sale price of our common stock on the Nasdaq National Market was $4.05
and there were 1,295 record holders of our common stock. The following table
sets forth the high and low sales price per share of our common stock for the
periods indicated, as reported on the Nasdaq National Market.
YEAR ENDED DECEMBER 31, 2001 HIGH LOW
- ------------------------------------------------------------ ----- -----
First Quarter .............................................. $4.88 $ .94
Second Quarter ............................................. 2.50 1.10
Third Quarter .............................................. 3.40 2.00
Fourth Quarter ............................................. 5.97 2.20
YEAR ENDED DECEMBER 31, 2002 HIGH LOW
- ------------------------------------------------------------ ----- -----
First Quarter .............................................. $6.45 $4.25
Second Quarter ............................................. 9.00 5.31
Third Quarter .............................................. 8.55 5.68
Fourth Quarter ............................................. 8.20 2.82
2003 HIGH LOW
- ------------------------------------------------------------ ----- -----
First quarter (through March 24) ........................... $4.39 $3.60
Dividend Policies. We have never declared or paid any cash dividends on
our common stock. We currently intend to retain all available funds and any
future earnings for use in the operation and expansion of our business and do
not anticipate declaring or paying any cash dividends 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. In addition, our credit
agreement with Foothill Capital Corporation, a wholly-owned subsidiary of Wells
Fargo & Company, prohibits payment of dividends.
Sales of Unregistered Shares. In April 2002, we issued 26,434 unregistered
shares of our common stock, and in May 2002, we issued 145,293 unregistered
shares of our common stock. These shares were issued in connection with the
exercise of outstanding warrants. The unregistered shares were issued in
reliance upon the exemption from registration under Section 3(a)(9) of the
Securities Act of 1933, as amended.
24
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(In thousands, except per share data)
STATEMENTS OF OPERATIONS DATA
REVENUES
Maintenance and services ............................. $ 84,808 $ 85,181 $ 79,984 $ 87,127 $ 46,575
Software licenses and system sales ................... 30,003 21,872 21,682 61,916 39,783
--------- --------- --------- --------- ---------
Total revenues .......................................... 114,811 107,053 101,666 149,043 86,358
--------- --------- --------- --------- ---------
COSTS AND EXPENSES
Cost of revenues: ....................................... 19,255
Maintenance and services ............................. 21,970 19,401 19,861 16,799
Software licenses and system sales, includes
amortization of product development costs
of $911 in 2002 .................................... 8,749 6,267 8,886 23,160
Selling, general and administrative ..................... 49,716 54,371 70,688 76,104 42,586
Research and development ................................ 13,535 10,871 13,833 11,470 13,861
Depreciation and amortization ........................... 2,572 26,207 27,966 11,206 4,110
Loss on headquarters building held for sale ............. 1,375
Impairment charges (credits) and other nonrecurring costs (6,000) 8,252 6,632 4,743
Restructuring costs (credits) ........................... (501) (425) 9,338 4,124 843
Merger costs ............................................ 3,105 54
Purchased research and development ...................... 9,000
Compensatory stock awards ............................... 1,003
--------- --------- --------- --------- ---------
90,041 126,319 157,204 151,714 89,709
--------- --------- --------- --------- ---------
OPERATING INCOME (LOSS) ................................. 24,770 (19,266) (55,538) (2,671) (3,351)
Interest expense, net ................................... (458) (3,170) (2,978) (2,178) (2,863)
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS,
BEFORE INCOME TAXES AND EXTRAORDINARY ITEM ........... 24,312 (22,436) (58,516) (4,849) (6,214)
Provision (benefit) for income taxes .................... 162 (9,843) (1,610) (1,910)
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS ................ 24,150 (22,436) (48,673) (3,239) (4,304)
Income (loss) from discontinued operations,
net of (benefit) provision for income taxes ......... (5,384) (29,440) 2,308 (2,495)
Extraordinary item, net of income taxes ................. (2,863)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ....................................... $ 24,150 $ (27,820) $ (78,113) $ (3,794) $ (6,799)
========= ========= ========= ========= =========
EARNINGS (LOSS) PER SHARE - BASIC
Continuing operations, before extraordinary item .... $ 0.58 $ (0.60) $ (1.45) $ (0.12) $ (0.22)
Discontinued operations ............................. (0.14) (0.88) 0.08 (0.13)
Extraordinary item .................................. (0.10)
--------- --------- --------- --------- ---------
$ 0.58 $ (0.74) $ (2.33) $ (0.14) $ (0.35)
========= ========= ========= ========= =========
EARNINGS (LOSS) PER SHARE - DILUTED
Continuing operations, before extraordinary item .... $ 0.49 $ (0.60) $ (1.45) $ (0.12) $ (0.22)
Discontinued operations ............................. (0.14) (0.88) 0.08 (0.13)
Extraordinary item .................................. (0.10)
--------- --------- --------- --------- ---------
$ 0.49 $ (0.74) $ (2.33) $ (0.14) $ (0.35)
========= ========= ========= ========= =========
CASH PROVIDED BY OPERATING ACTIVITIES ................... $ 20,758 $ 18,230 $ 12,756 $ 3,421 $ 5,101
25
DECEMBER 31,
-------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(In thousands)
BALANCE SHEET DATA
Cash and cash equivalents ............................... $ 39,474 $ 12,988 $ 5,969 $ 14,309 $ 8,669
Working capital (deficit) ............................... 27,220 (914) (11,144) 25,993 (2,564)
Total assets ............................................ 117,131 92,949 145,994 196,271 196,940
Total long-term debt .................................... 18,941 30,553 37,784 32,142 69,961
Convertible, redeemable preferred stock issuable ........ 10,000 8,501
Stockholders' equity .................................... 60,433 26,060 58,450 135,339 22,772
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Please see Part I, Item 1 above for an important discussion about
forward-looking statements and risk factors that may affect future results.
OVERVIEW
VitalWorks Inc. is a leading provider of information management technology
and services targeted to healthcare practices and organizations throughout the
United States. We provide IT-based solutions for general medical practices and
have specialty-specific products and services for practices such as radiology,
anesthesiology, ophthalmology, emergency medicine, plastic surgery, and
dermatology. We also offer enterprise-level systems designed for large physician
groups and networks. Our range of software solutions, which include workflow
features related to patient encounters, automate the administrative, financial,
and clinical information management functions for physicians and other
healthcare providers. We provide our clients with ongoing software support,
implementation, training, electronic data interchange, or EDI, services for
patient billing and claims processing, and a variety of Web-based services.
Software license fees and system revenues are derived from the sale of
software product licenses and computer hardware. Maintenance and services
revenues come from providing ongoing product support, implementation, training
and transaction processing services. Approximately 60% of our total revenues are
of a recurring nature.
We market our products and services primarily to three types of physician
practices:
- - ambulatory imaging centers and radiology practices, as well as
anesthesiology practices;
- - large general and emergency medicine practices, such as physician
networks, clinics and management service organizations that include ten or
more doctors; and
- - small group practices of fewer than ten doctors that serve a local
community, including ophthalmology, dermatology and general medicine
practices.
In 2002, approximately 40% of our revenues were derived from the
radiology/anesthesiology market and 30% from each of our other markets.
Approximately an equal amount of revenues was derived from each of these three
markets in 2001. Revenues from the small group market are skewed more toward
maintenance and services.
26
RESULTS OF OPERATIONS
REVENUES
Year Ended December 31,
--------------------------------------------------
2002 CHANGE 2001 CHANGE 2000
------- ------ ------- ------ -------
(Dollars in thousands)
Maintenance and services $84,808 (0.4)% $85,181 6.5% $79,984
Percentage of total revenues 73.9% 79.6% 78.7%
Software licenses and system sales $30,003 37.2% $21,872 0.9% $21,682
Percentage of total revenues 26.1% 20.4% 21.3%
We recognize software license revenues and system (computer hardware)
sales upon execution of the sales contract and delivery of the software
(off-the-shelf application software) and/or hardware. In all cases, however, the
fee must be fixed or determinable, collection of any related receivable must be
considered probable, and no significant post-contract obligations of ours shall
be remaining. Otherwise, we defer the sale until all of the requirements for
revenue recognition have been satisfied. Maintenance fees for routine client
support and unspecified product updates are recognized ratably over the term of
the maintenance arrangement. Training, implementation and EDI services revenues
are recognized as the services are performed. Most of our sales and licensing
contracts involve multiple elements, in which case, we allocate the total value
of the customer arrangement to each element based on the relative fair values of
the respective elements. The residual method is used to determine revenue
recognition with respect to a multiple element arrangement when specific
objective evidence of fair value exists for all of the undelivered elements
(e.g., implementation, training and maintenance services), but does not exist
for one or more of the delivered elements of the contract (e.g., computer
software or hardware). The fair value of an element is determined by the average
price charged when that element is sold separately (e.g., the fair value of
maintenance services is determined based on the average renewal price charged to
clients for continued maintenance). If evidence of fair value cannot be
established for the undelivered element(s) of an arrangement, the total value of
the customer arrangement is deferred until the undelivered element(s) is
delivered or until objective evidence of fair value is established. In our
contracts and arrangements with our customers, we generally do not include
acceptance provisions, which would give the customer the right to accept or
reject the product after we ship it. However, if an acceptance provision is
included, revenue is recognized upon the customer's acceptance of the product,
which occurs upon the earlier of receipt of a written customer acceptance or
expiration of the acceptance period. We provide allowances for estimated future
returns and discounts (recorded as contra-revenue), as well as bad debts, upon
recognition of revenues.
Recognition of revenues in conformity with generally accepted accounting
principles requires management to make judgments that affect the timing and
amount of reported revenues.
If we were to adopt new, or change our current, business practices in
response to a preference from the market or otherwise, then our revenue
recognition practices may be subject to significant change to comply with the
requisite accounting principles. For example, subscription type arrangements and
practices strictly for software services and support would result in the
recognition of revenues ratably over the term of the arrangement.
Excluding EDI services revenues of $1.6 million recognized in 2001 in
connection with the settlement of a contract dispute with an EDI supplier,
maintenance and services revenues in 2002 increased $1.2 million. The increase
is primarily attributable to (i) an increase in training and implementation
services revenues of $2.5 million, corresponding to the favorable trend in sales
of software licenses and systems, and (ii) additional EDI revenues, net of
customer attrition, of approximately $2.4 million, which reflect the conversion
of a number of customer accounts to direct billing by us for printing services
performed by certain third parties that, in the first
27
nine months of 2001, had been billed directly by the printing vendors. Our
revised agreements with these printers now call for us to bill our physician
practices directly for printing services and, in turn, remit a specified dollar
amount per page to the printer. Accordingly, based on the amended agreements, we
recognize 100% of our direct billings as revenue, compared to an amount that
previously was net of the printers' fees. Moreover, the increases were partly
offset by (i) the loss of revenues totaling $2.8 million earned in 2001 under
agreements to promote third-party product and services, which agreements were
terminated in 2001, and (ii) a $.9 million decline in maintenance revenues
related to customer attrition.
The increase in maintenance and services revenues in 2001 is mainly
attributable to (i) EDI services revenues of $1.6 million recognized in July
2001 in connection with the contract settlement referred to above, (ii) an
increase in maintenance fees of approximately $.7 million resulting from price
increases that took effect primarily in the second half of the year, and (iii)
additional EDI revenues of approximately $1.4 million that arose primarily in
the fourth quarter from the conversion of a number of customer accounts to
direct billing by us for printing services performed by certain third parties
that in prior periods had been billed directly by the printing vendors.
Software license and system revenues rose in 2002 primarily as a result of
an increase in the number of licenses and systems sold (unit volume versus, for
example, price increases). This increase was led by software sales made
primarily to ambulatory imaging centers and radiology practices.
We operate with a minimal amount of software licensing and system sales
backlog. Therefore, quarterly and annual revenues and operating results are
highly dependent on the volume and timing of the signing of license agreements
and product deliveries during each quarter. A significant portion of our
quarterly sales of software product licenses and computer hardware is concluded
in the last month of the fiscal quarter, generally with a concentration of our
quarterly revenues earned in the final ten business days of that month. Also,
our projections for revenues and operating results include significant sales of
new product and service offerings, including our new radiology information
system, or RIS, and sales and services related to the implementation of HIPAA,
which may not be realized. Due to these and other factors, our revenues and
operating results are very difficult to forecast. As a result, comparison of our
period-to-period financial performance is not necessarily meaningful and should
not be relied upon as an indicator of future performance.
In 2001, software license and system revenues rose slightly primarily due
to an increase in the number of licenses and systems sold. The unit volume
increase was realized in the last three quarters of the year. In the first
quarter, we experienced a decline in the number of licenses and systems sold,
which was the near-term result of management's reorganization and redeployment
of the sales force and redirection of our marketing focus that was initiated in
fiscal 2000.
28
COST OF REVENUES
Year Ended December 31,
--------------------------------------------------
2002 CHANGE 2001 CHANGE 2000
------- ------ ------- ------ -------
(Dollars in thousands)
Maintenance and services $21,970 13.2% $19,401 (2.3)% $19,861
Percentage of maintenance and services revenues 25.9% 22.8% 24.8%
Software licenses and system sales $ 8,749 39.6% $ 6,267 (29.5)% $ 8,886
Percentage of software licenses and system sales 29.2% 28.7% 41.0%
Cost of maintenance and services revenues consists primarily of the cost
of EDI claims processing, outsourced hardware maintenance and billing and
statement printing services, and postage. The increase in 2002 principally
reflects additional costs of EDI services incurred in connection with the
conversion of a number of customers to direct billing for printing services, as
discussed above regarding EDI revenues. In addition, in 2001 we recovered
certain EDI processing costs and recognized a credit of $.6 million in
connection with the contract settlement referred to above.
The decrease in the cost of maintenance and services revenues in 2001
primarily reflects the recovery of certain EDI processing costs of $.6 million
referred to above, a decline in hardware maintenance costs of approximately $.6
million, and reductions in the per transaction cost of providing patient
statement, invoicing and claims processing services. The decreases were
partially offset by additional costs of EDI services of approximately $.9
million incurred primarily in the fourth quarter in connection with the
conversion of a number of customers to direct billing by us for printing
services, as discussed above regarding EDI revenues.
Cost of software license and system revenues consists primarily of costs
incurred to purchase computer hardware, third-party software and other items for
resale in connection with sales of new systems and software and, in 2002,
amortization of product development costs. The increase in 2002 is mainly
attributable to $1.2 million in additional costs associated with an increase in
the number of computer hardware units sold, and amortization of product
development costs of $.9 million.
In 2001, the decrease in the cost of software licenses and system revenues
principally reflects a decline in the number of computer hardware units sold
which generally yield lower margins compared to software sales.
29
OPERATING EXPENSES
Year Ended December 31,
---------------------------------------------------
2002 CHANGE 2001 CHANGE 2000
------- ------ ------- ------ -------
(Dollars in thousands)
Selling, general and administrative $49,716 (8.6)% $54,371 (23.1)% $70,688
Percentage of total revenues 43.3% 50.8% 69.5%
Research and development $13,535 24.5% $10,871 (21.4)% $13,833
Percentage of total revenues 11.8% 10.2% 13.6%
Depreciation and amortization $ 2,572 (90.2)% $26,207 (6.3)% $27,966
Percentage of total revenues 2.2% 24.5% 27.5%
Selling, general and administrative expenses include fixed and variable
compensation and benefits of all personnel other than research and development
personnel, facilities, travel, communications, bad debt, legal, marketing,
insurance and other administrative expenses. The decreases in both 2002 and 2001
are related to the savings that resulted from a major restructuring plan that we
initiated in August 2000. We closed 14 offices, the last five of which were
closed in March and April 2001, and our employee-base average was reduced to 639
for 2002, from 671 for 2001 and 882 for 2000. The decrease in 2002 also reflects
declines in legal fees of $2.0 million, bad debt expense of $.6 million and
contract labor costs of $.5 million.
The increase in research and development expenses in 2002 is mainly
attributable to additional personnel costs and third-party software developer
fees associated with our expanded product research and development activities.
In 2002 and 2001, we capitalized $4.8 million (or 26.1% of total research and
development expenditures) and $4.6 million (or 29.7% of total research and
development expenditures) of third-party programmer fees, respectively, in
conformity with Statement of Financial Accounting Standards No. 86, "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed."
The amounts capitalized relate to our development of Web-based applications,
including a radiology information system, or RIS, which is a workflow solution
for medical imaging centers. We amortize capitalized software development costs
over the estimated economic life of the products. Depending on the nature and
success of the product, we generally expect to amortize these deferred costs
over a three to five-year period. Amortization commences when the product is
made commercially available. Two of the five products under development were
made commercially available in 2002. We expect the remaining products to become
commercially available in 2003. The decrease in research and development
expenses in 2001 reflects the reduction in staff that commenced in August 2000
as part of the restructuring plan.
In 2001 and 2000, depreciation and amortization expense consisted mainly
of $23.1 million and $23.2 million of goodwill amortization, respectively. The
decrease in depreciation and amortization expense in 2002 is due primarily to
the cessation of goodwill amortization in conformity with Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets." In 2001,
the Financial Accounting Standards Board issued Statement 142, which provides
that, upon adoption, we shall no longer amortize our goodwill assets. Rather, we
are required to test these assets for impairment of value on at least an annual
basis. Pursuant to Statement 142, we discontinued amortizing goodwill on January
1, 2002. The adoption of Statement 142 has not had a negative impact on our
financial statements. The decrease in depreciation and amortization expense in
2001 pertains to the closing of office facilities in connection with the
restructuring plan.
Loss On Headquarters Building Held for Sale. In 2001, we recorded an
impairment charge of $1.4 million relating to our former headquarters building
in Atlanta. We sold the building in August 2002 for proceeds of $6.3 million,
after closing costs. A portion of the proceeds from the sale was used to repay
the $5.5 million mortgage
30
loan on the building. Approximately $.4 million of the proceeds is being held in
escrow to partially guarantee to the new owner the monetary performance of
PracticeWorks, Inc., a tenant of the building, through December 2003 under their
lease agreement. We spun-off PracticeWorks in March 2001. In connection with the
sale, we entered into a market rate lease with the new owner of the building
ending December 2003 for approximately 3,900 square feet of office space, or
less than 5% of the building. In 2002, we recognized a gain of $.1 million from
the sale of the building (included in selling, general and administrative
expenses). The amount held in escrow has been deferred and may be recognized in
2003.
Impairment Charges (Credits) and Other Nonrecurring Costs. In the June and
September 2002 quarters, we received final payments from three former directors
satisfying their outstanding loans from us, including interest. Consequently, we
recorded a credit of $6.0 million, reflecting a complete reversal of the
allowance for loan losses established in March 2001.
In 2001, we recognized impairment charges and incurred other nonrecurring
costs of $8.3 million. These costs and expenses included the $6.0 million
provision for loan losses relating to the notes receivable from former
directors, $.9 million for unused equity financing (paid in 2002), $.8 million
of executive severance for separation benefits paid to our former chairman
pursuant to the terms of a mutual separation agreement and a pre-existing
employment agreement, and retention bonuses of $.2 million for terminated
employees. As of March 31, 2001, management determined that collection was
doubtful with respect to approximately $6 million of the outstanding balance of
the director loans and, accordingly, we recorded a valuation allowance and
ceased accruing interest on the loans.
In 2000, concurrent with the 2000 restructuring plan, we recognized
impairment charges and incurred other nonrecurring costs of $6.6 million
consisting of (i) $3.5 million relating to fixed assets that were abandoned due
to the closing of facilities; (ii) $1.1 million to write-down computer hardware
held for resale to its estimated net realizable value based on a planned bulk
lot disposal as a result of our decision to discontinue selling hardware and
hardware support in certain of our business lines; (iii) $1.3 million for
compensation and other termination benefits; (iv) $.4 million for other asset
write-downs; and (v) $.3 million for professional services and other related
costs.
Restructuring Costs (Credits). On August 1, 2000, we announced our
intention to restructure our operations through a plan of employee reductions
and consolidation of office facilities. Since then, we closed 14 facilities and
terminated approximately 400 employees. The offices that were closed are subject
to operating leases that expire at various dates through 2005. Accordingly, in
2000 we incurred restructuring charges of $9.3 million primarily associated with
employee severance and other termination benefits, and facility closure costs.
In 2001, we recorded $.4 million resulting from credits for changes in
accounting estimates relating to facility closure and employee severance costs
incurred in 2000. In 2002, we recognized an additional credit of $.5 million
reflecting a savings in connection with the early termination of an office lease
for a facility closed in March 2001 as part of the restructuring.
31
INTEREST INCOME (EXPENSE)
Year Ended December 31,
------------------------------------------------
2002 CHANGE 2001 CHANGE 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Interest income $1,480 163.3% $ 562 (19.3)% $ 696
Interest expense (1,938) (48.1)% (3,732) 1.6% (3,674)
The increase in interest income in 2002 reflects interest of $1.1 million
not previously recognized on the notes receivable from former directors. In the
June and September 2002 quarters, we received final payments from the former
directors satisfying their outstanding loans, including interest.
Interest expense consists primarily of interest costs incurred in
connection with our outstanding term loan and real estate mortgage loans. As of
August 2002, the mortgage loans have been repaid in full. The decrease in
interest expense in 2002 is due to a decline in both the outstanding principal
balances and associated interest rates under our credit agreement.
INCOME TAXES
For 2002, we recorded an income tax provision of $.2 million. No income
tax provision or benefit was recognized in 2001. Due to the significant loss
generated in 2000, we recognized an income tax benefit of $9.8 million.
Management has assessed the realizable value of our deferred tax assets of
$55.4 million and determined that a valuation allowance of $25.3 million was
necessary as of December 31, 2002 to, along with deferred tax liabilities of
$3.3 million, reduce the net deferred tax asset to $26.8 million, an amount
which we believe is more likely than not to be realized. In reaching this
conclusion, management noted that internal projections indicate that we will
generate sufficient taxable income to realize the net deferred tax assets within
three to four years.
Our effective income tax rate was less than 2% for 2002 and is expected to
remain at less than 2% for 2003 due primarily to utilization of net operating
loss carryforwards.
LOSS FROM DISCONTINUED OPERATIONS
Discontinued operations represent the results of PracticeWorks, Inc., a
provider of practice management software for dental and oral surgery practices,
through March 5, 2001. On that date, we distributed 100% of the common stock of
PracticeWorks to our stockholders. For the period January 1, 2001 to March 5,
2001 and for the year ended December 31, 2000, our net loss from discontinued
operations was $5.4 million and $29.4 million, respectively. For further details
regarding the distribution of shares of PracticeWorks to our stockholders, see
Note C of the accompanying financial statements.
NET INCOME (LOSS)
As a result of the above factors, our operating results for 2002 increased
to net income of $24.2 million from a net loss of $(27.8) million in 2001 and a
net loss of $(78.1) million in 2000.
To date, the overall impact of inflation on us has not been material.
32
LIQUIDITY AND CAPITAL RESOURCES
To date, we have financed our business through positive cash flows from
operations and proceeds from the issuance of common stock and long-term
borrowings. For 2002, 2001 and 2000, we generated positive cash flows from
operations of $20.8 million, $18.2 million and $12.8 million, respectively.
Days sales outstanding (calculated as accounts receivable, net of
allowances, divided by annual revenues multiplied by 365 days) for 2002 was 45
days, up from 43 days for 2001 and down from 52 days for 2000. Looking forward,
assuming license and systems sales increase, we would expect our days sales
outstanding to range from 50 to 60 days.
Cash provided by investing activities amounted to $2.5 million for 2002.
This total includes net proceeds of $7.3 million from the sale of office
buildings and $.3 million related to the spin-off of PracticeWorks, offset
partially by $4.3 million used for software development costs and $.8 million
used primarily for purchases of computer equipment and software.
Financing activities for 2002 provided cash of $3.2 million, consisting
of: proceeds of $27.5 million received in connection with a new four-year credit
agreement, $11.0 million of loan payments received from former directors, and
$10.0 million of payments received in connection with the exercise of stock
options by employees, partly offset by $38.6 million of principal payments of
long-term debt and $6.0 million of cash used to repurchase our common stock.
As of December 31, 2002, we had cash and cash equivalents of $39.5 million
and $18.9 million of total long-term debt. Cash equivalents are comprised
primarily of investment-grade commercial paper, time deposits, and U.S. federal,
state and political subdivision obligations with varying terms of three months
or less. In March 2002, we entered into a new four-year credit agreement with
Foothill Capital Corporation, a wholly-owned subsidiary of Wells Fargo &
Company. The new agreement included a term loan of $22.0 million at an interest
rate of prime plus 2%, and a mortgage loan of $5.5 million. We repaid the
mortgage loan in August 2002 in connection with the sale of our Atlanta
property. Subject to achieving certain specified earnings targets, the margin by
which our interest rate on the term loan exceeds prime may be reduced by as much
as 1.1% over the life of the loan. Interest is payable monthly in arrears.
Principal is payable over the life of the agreement, including a balloon payment
in March 2006. Should we decide to prepay the term loan in full prior to year
four, we would incur a prepayment fee equal to 2% in year two and 1% in year
three of the then outstanding principal balance of the term loan. The prepayment
fee may be reduced should the loan be prepaid in connection with a change of
control of VitalWorks. The loans, which are collateralized by substantially all
of our assets and intellectual property rights, subject us to certain
restrictive covenants, including (i) the required maintenance of minimum levels
of recurring revenues and earnings, as defined, (ii) an annual limit on the
amount of capital expenditures, and (iii) the prohibition of dividend payments
to shareholders.
33
The following table summarizes, as of December 31, 2002, the general
timing of future payments under our outstanding loan agreement and under lease
agreements that include noncancellable terms.
PAYMENTS DUE BY PERIOD
---------------------------------------------------------
TOTALS 2003 2004 2005 2006 THEREAFTER
------- ------ ------ ------ ------- ----------
(In thousands)
Long-term debt ..... $18,250 $3,750 $2,500 $12,000
Operating leases ... 8,234 2,557 1,881 $1,352 1,341 $ 1,103
Capital leases ..... 691 550 127 14
------- ------ ------ ------ ------- ----------
$27,175 $6,857 $4,508 $1,366 $13,341 $ 1,103
======= ====== ====== ====== ======= ==========
In May 2002, we entered into a five-year agreement with a third-party
provider of EDI services for patient claims processing. For the first year of
the agreement, we are committed to pay $.5 million for processing services.
Thereafter, the annual services fee will range from $.5 million to $.8 million
based on our volume usage in the last month of the preceding year.
In connection with our employee savings plan, we have committed, for the
2003 plan year, to contribute to the plan. Our matching contribution, estimated
to be approximately $.8 million, will be made half in cash and half in shares of
our common stock.
In October 2001, we expanded our August 2000 agreement with National Data
Corporation, or NDC, for outsourcing much of our patient statement and invoice
printing work. We will continue, for a fee, to provide printing services for our
physicians under the subcontracting arrangement with NDC. The amended
arrangement, which extends for a period of up to seven and a half years,
provides for, among other things, the attainment of certain quarterly
transaction processing volume levels during the term. In exchange, we received
$7.9 million in cash (in connection with the August agreement, we received $8.8
million in 2000), which represent unearned discounts (see accompanying balance
sheet) that are recognized as an offset to cost of maintenance and services
revenues as the minimum volume commitments are fulfilled.
We anticipate capital expenditures of approximately $5 million for 2003,
including software development costs of approximately $3 million. We intend to
review potential strategic acquisitions and other business alliances.
In October 2002, our board of directors authorized the repurchase of up to
$15 million of our common stock from time to time. The timing and amount of any
shares repurchased are determined by management based on our evaluation of
market conditions and other factors. The repurchase program may be suspended or
discontinued at any time. Repurchased shares are available for use in connection
with stock plans and for other corporate purposes. The repurchase program is
funded using our existing cash resources. As of March 24, 2003, we repurchased
1,873,002 shares of our common stock under the program for an aggregate cost of
$6.0 million.
From time to time, in the normal course of business, various claims are
made against us. Except for proceedings described below, there are no material
proceedings to which we are a party, and management is unaware of any material
contemplated actions against us.
34
On February 27, 2003, a purported class action complaint was filed in the
United States District Court for the District of Connecticut against VitalWorks
Inc. and three of our executive officers. The action was brought by plaintiff
Bernard Frazier, on behalf of purchasers of our securities between April 24,
2002 and October 23, 2002 (the "Class Period"). The complaint alleges, among
other things, violations of Section 10(b) of the Securities Exchange Act of
1934, Rule 10b-5 promulgated thereunder and breach of fiduciary duties. The
complaint alleges that the defendants made misleading statements and omissions
regarding our business and operations, principally in press releases and public
conference calls in April 2002 and July 2002, which allegedly had the effect of
artificially inflating the market price of our common stock during the Class
Period, and that six of our officers, including the defendant officers, sold
shares of our common stock during the Class Period. The plaintiff seeks recovery
of an unstated amount of compensatory damages, attorneys' fees and costs. We
understand that an additional lawsuit or lawsuits containing substantially
similar causes of action as the above referenced matter has been filed against
us, although we have not yet been served with any complaint.
On April 19, 2001, a lawsuit styled David and Susan Jones v. InfoCure
Corporation (now known as VitalWorks Inc.), et al., was filed in Boone County
Superior Court in Indiana. The defendants removed the case to the United States
District Court for the Southern District of Indiana. The complaint alleges state
securities law violations, breach of contract, and fraud claims against the
defendants. The complaint does not specify the amount of damages sought by
plaintiffs, but seeks rescission of a transaction that the plaintiffs value at
$5 million, as well as punitive damages and reimbursement for the plaintiffs'
attorneys' fees and associated costs and expenses of the lawsuit. In a decision
from the Court dated October 15, 2001, the plaintiffs' request for a preliminary
injunction to preserve their remedy of rescission was denied, part of their
complaint was dismissed and the case was transferred to the Northern District
Court of Georgia. On October 26, 2001, the plaintiffs filed a notice of appeal
with the 7th Circuit Court of Appeals. On November 8, 2002, the 7th Circuit
Court affirmed the denial of the preliminary injunction and dismissed the
remainder of the appeal. The case is now pending in the Northern District Court
of Georgia and the plaintiffs have obtained leave of the Court to file an
amended complaint.
While management believes that we have meritorious defenses in each of the
foregoing matters and we intend to pursue our positions vigorously, litigation
is inherently subject to many uncertainties. Thus, the outcome of these matters
is uncertain and could be adverse to us. However, even if the outcome of these
cases is adverse, we do not believe that the outcome of these cases,
individually or in the aggregate, will have a material adverse effect on our
financial position. However, depending on the amount and timing of an
unfavorable resolution(s) of the contingencies, it is possible that our future
results of operations or cash flows could be materially affected in a particular
reporting period(s).
We were named as a defendant as successor to CDL Healthcare Systems, Inc.
("CDL"), a company acquired by us in December 1999, in a complaint filed in the
Circuit Court of the Eleventh Judicial Circuit in Dade County, Florida on
February 27, 2001 by Sonia Abutog, individually, Angelo Abutog, individually,
and Sonia and Angelo Abutog, as parents and next best friends to Aaron Abutog, a
minor. Gary Weiner, former President of CDL, and his daughter, Elisha Weiner,
were also named as defendants. Plaintiffs alleged that they were injured at a
time, prior to the merger between us and CDL, when a motor vehicle operated by
Elisha Weiner collided with plaintiff Sonia Abutog, a pedestrian. The plaintiff
contended that she and her unborn child suffered severe personal injuries as a
result of the accident and sought to recover damages in an unspecified amount in
excess of $15,000, plus interest and costs. Our motion for final summary
judgment dismissing the action against us was granted by order of the Court
dated July 9, 2002. The plaintiffs did not file a Notice of Appeal of this
decision and the time to do so has expired.
We believe that our current cash and cash equivalent balances, together
with the funds we expect to generate from our operations, will be sufficient to
finance our business for the next twelve months, including the repurchase, as
the case may be (see discussion above regarding our stock repurchase program),
of up to $9 million of our outstanding common stock.
35
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements and accompanying
notes, which we believe have been prepared in conformity with generally accepted
accounting principles. The preparation of these financial statements requires
management to make estimates, assumptions and judgments that affect the amounts
reported in the financial statements and accompanying notes. On an ongoing
basis, we evaluate our estimates, assumptions and judgments, including those
related to revenue recognition, allowances for future returns, discounts and bad
debts, tangible and intangible assets, deferred costs, income taxes,
restructurings, commitments, contingencies, claims and litigation. We base our
judgments and estimates on historical experience and on various other
assumptions that we believe are reasonable under the circumstances. However, our
actual results could differ from those estimates.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our financial
statements.
Revenue Recognition. We recognize software license revenues and system (computer
hardware) sales upon execution of the sales contract and delivery of the
software (off-the-shelf application software) and/or hardware. In all cases,
however, the fee must be fixed or determinable, collection of any related
receivable must be considered probable, and no significant post-contract
obligations of ours shall be remaining. Otherwise, we defer the sale until all
of the requirements for revenue recognition have been satisfied. Maintenance
fees for routine client support and unspecified product updates are recognized
ratably over the term of the maintenance arrangement. Training, implementation
and EDI services revenues are recognized as the services are performed. Most of
our sales and licensing contracts involve multiple elements, in which case, we
allocate the total value of the customer arrangement to each element based on
the relative fair values of the respective elements. The residual method is used
to determine revenue recognition with respect to a multiple element arrangement
when specific objective evidence of fair value exists for all of the undelivered
elements (e.g., implementation, training and maintenance services), but does not
exist for one or more of the delivered elements of the contract (e.g., computer
software or hardware). The fair value of an element is determined by the average
price charged when that element is sold separately (e.g., the fair value of
maintenance services is determined based on the average renewal price charged to
clients for continued maintenance). If evidence of fair value cannot be
established for the undelivered element(s) of an arrangement, the total value of
the customer arrangement is deferred until the undelivered element(s) is
delivered or until objective evidence of fair value is established. In our
contracts and arrangements with our customers, we generally do not include
acceptance provisions, which would give the customer the right to accept or
reject the product after we ship it. However, if an acceptance provision is
included, revenue is recognized upon the customer's acceptance of the product,
which occurs upon the earlier of receipt of a written customer acceptance or
expiration of the acceptance period. We provide allowances for estimated future
returns and discounts (recorded as contra-revenue), as well as bad debts, upon
recognition of revenues.
Recognition of revenues in conformity with generally accepted accounting
principles requires management to make judgments that affect the timing and
amount of reported revenues.
Accounts Receivable. Our accounts receivable are customer obligations due under
normal trade terms carried at their face value, less allowances for estimated
future returns and discounts, as well as bad debts. We evaluate the carrying
amount of our accounts receivable on an ongoing basis and establish a valuation
allowance based on a number of factors, including specific customer
circumstances, historical rate of write-offs and the past due status of the
accounts. At the end of each fiscal quarter, the allowance is reviewed and
analyzed for adequacy and is often adjusted based on the findings. The allowance
is increased through a reduction of revenues, an increase in bad debt expense
and/or recovery of amounts previously written-off. The allowance is reduced by
write-offs of amounts deemed uncollectible and adjustments to revenue and/or bad
debt expense, if any, based on management's determination as to the adequacy of
the recorded allowance.
36
Goodwill Assets and Business Combinations. Goodwill represents the excess of
cost over the fair value of net assets of businesses acquired and accounted for
as purchase transactions. In 2001, the Financial Accounting Standards Board, or
the FASB, issued Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets." Statement 142 provides that, upon adoption, we
shall no longer amortize our goodwill assets. Rather, we are required to test
our goodwill for impairment of value on at least an annual basis. Pursuant to
Statement 142, we discontinued amortizing goodwill on January 1, 2002. The
adoption of Statement 142 has not had a negative impact on our financial
statements.
Excluding goodwill amortization of $23.1 million and $23.2 million for the
years ended December 31, 2001 and 2000, our net loss would have been $(4.7)
million, or $(0.13) per share, and $(54.9) million, or $(1.64) per share,
respectively, compared to net income of $24.2 million, or $.49 per diluted
share, for 2002.
Also in 2001, the FASB issued Statement 141, "Business Combinations."
Statement 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interests method of accounting for business
combinations. Statement 141 also requires that we recognize acquired intangible
assets apart from goodwill if the acquired intangible assets meet certain
criteria. Statement 141 applies to all business combinations initiated after
June 30, 2001.
Our business combinations were completed prior to 2000 and were accounted
for using both the pooling-of-interests and purchase methods. The
pooling-of-interests method does not result in the recognition of acquired
goodwill or other intangible assets. As a result, the adoption of Statements 141
and 142 did not affect the results of past transactions accounted for under the
pooling-of-interests method. However, all future business combinations would be
accounted for under the purchase method, which may result in the recognition of
goodwill and other intangible assets, some of which would be recognized through
operations, either by amortization or impairment charges, in the future.
Product Development Costs. We begin capitalizing product development costs,
exclusively third-party programmer fees, only after establishing commercial and
technical viability. Annual amortization of these costs represents the greater
of the amount computed using (i) the ratio that current gross revenues for the
product(s) bear to the total current and anticipated future gross revenues of
the product(s), or (ii) the straight-line method over the remaining estimated
economic life of the product(s); generally, depending on the nature and success
of the product, such deferred costs are amortized over a three to five-year
period. Amortization commences when the product is made commercially available.
Two of the five products under development were made commercially available in
2002.
Stock-based Compensation. Statement 123, "Accounting for Stock-Based
Compensation," as amended by Statement 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123," provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, Statement 148 amends the disclosure requirements of Statement 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results.
We account for stock option grants and stock awards, based on their
intrinsic value, in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations. Under
the intrinsic value method, compensation expense is only recognized if the
exercise price of the employee stock option is less than the market price of the
underlying stock on the date of grant. The weighted-average estimated grant date
fair value, as defined by Statement 123, of options granted in 2002, 2001 and
2000 was $2.34, $1.61 and $2.97, respectively, as calculated using the
Black-Scholes option valuation model. We price our stock options at fair market
value on the date of grant, and therefore, under Opinion 25, no compensation
expense is recognized for stock options granted. The following table illustrates
the effect on income (loss) from continuing operations and the related earnings
per share if we had applied the fair value
37
recognition provisions of Statement 123, as amended, to stock-based employee
compensation (In thousands, except per share data):
YEAR ENDED DECEMBER 31,
-------- -------- --------
2002 2001 2000
-------- -------- --------
Income (loss) from continuing operations,
as reported $ 24,150 $(22,436) $(48,673)
Less: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (5,320) (10,374) (6,415)
-------- -------- --------
Pro forma income (loss) from continuing operations $ 18,830 $(32,810) $(55,088)
======== ======== ========
Earnings (loss) per share - continuing operations:
Basic - as reported $ 0.58 $ (0.60) $ (1.45)
======== ======== ========
Basic - pro forma $ 0.45 $ (0.88) $ (1.64)
======== ======== ========
Diluted - as reported $ 0.49 $ (0.60) $ (1.45)
======== ======== ========
Diluted - pro forma $ 0.39 $ (0.88) $ (1.64)
======== ======== ========
The fair value of our employee stock options was estimated at the date of
grant using the Black-Scholes option valuation model with the following weighted
average assumptions:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
Risk-free interest rate ............................. 2.6% 4.0% 5.2%
Expected dividend yield ............................. 0.0 0.0 0.0
Expected stock price volatility ..................... 78.7 75.4 76.7
Weighted average expected life (in years) ........... 4 4 4
The Black-Scholes option valuation model was not developed for use in
valuing employee stock options. Instead, this model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable, which differ significantly from our stock option
awards. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility.
Income Taxes. We provide for taxes based on current taxable income, and the
future tax consequences of temporary differences between the financial reporting
and income tax carrying values of our assets and liabilities (deferred income
taxes). Quarterly, management assesses the realizable value of deferred tax
assets based on, among other things, estimates of future taxable income, and
adjusts the related valuation allowance as necessary.
38
Earnings Per Share. The following table sets forth the computation of basic and
diluted earnings (loss) per share ("EPS") (In thousands, except per share data):
YEAR ENDED DECEMBER 31,
-------- -------- --------
2002 2001 2000
-------- -------- --------
Numerator--income (loss):
Continuing operations $ 24,150 $(22,436) $(48,673)
Discontinued operations (5,384) (29,440)
-------- -------- --------
$ 24,150 $(27,820) $(78,113)
======== ======== ========
Denominator:
Basic EPS--weighted-average shares 41,592 37,477 33,537
Effect of dilutive securities, stock option
and warrant rights 7,258
-------- -------- --------
Diluted EPS--adjusted weighted-average
shares and assumed conversions 48,850 37,477 33,537
======== ======== ========
Basic EPS:
Continuing operations $ 0.58 $ (0.60) $ (1.45)
Discontinued operations (0.14) (0.88)
-------- -------- --------
$ 0.58 $ (0.74) $ (2.33)
======== ======== ========
Diluted EPS:
Continuing operations $ 0.49 $ (0.60) $ (1.45)
Discontinued operations (0.14) (0.88)
-------- -------- --------
$ 0.49 $ (0.74) $ (2.33)
======== ======== ========
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.1 million common shares with exercise prices ranging from
$6.14 to $17.31 per share were excluded from the diluted EPS calculation for
2002. For the same reason, all options and warrants were excluded from the
diluted calculation for years 2001 and 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board, or the FASB,
issued Statement of Financial Accounting Standards No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities." Statement 146 requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. Examples of costs covered by Statement 146 include lease termination costs
and certain employee severance costs that are associated with a restructuring,
discontinued operation, facility closing, or other exit or disposal activity.
Statement 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002.
In April 2002, the FASB issued Statement 145, "Rescission of FASB
Statements No. 4, 44 and 62, Amendment of FASB Statement No. 13 and Technical
Corrections." For most companies, Statement 145 will require gains and losses on
extinguishments of debt to be classified as income or loss from continuing
operations rather than as extraordinary items as previously required under
Statement 4. Extraordinary treatment will be required for certain
extinguishments as provided in Accounting Principles Board Opinion No. 30.
Statement 145 also amends Statement 13 for certain sales-leaseback and sublease
accounting. We are required to adopt the provisions of Statement 145 in January
2003. Except for a reclassification with respect to our 1999 statement of
operations, we believe the adoption of Statement 145 will not have a significant
impact on our financial statements.
In 2001, the FASB issued Statement 141, "Business Combinations." Statement
141 requires the use of the purchase method of accounting and prohibits the use
of the pooling-of-interests method of accounting for business combinations.
Statement 141 also requires us to recognize acquired intangible assets apart
from
39
goodwill if the acquired intangible assets meet certain criteria. Statement 141
applies to all business combinations initiated after June 30, 2001. It also
requires that, upon adoption of Statement 142, "Goodwill and Other Intangible
Assets" (adoption of Statement 142 is discussed in the operating expenses
section above), we reclassify the carrying amounts of intangible assets and
goodwill based on the criteria in Statement 141.
Our business combinations were completed prior to 2000 and were accounted
for using both the pooling-of-interests and purchase methods. The
pooling-of-interests method does not result in the recognition of acquired
goodwill or other intangible assets. As a result, the adoption of Statements 141
and 142 did not affect the results of past transactions accounted for under the
pooling-of-interests method. However, all future business combinations would be
accounted for under the purchase method, which may result in the recognition of
goodwill and other intangible assets, some of which would be recognized through
operations, either by amortization or impairment charges, in the future.
Also in 2001, the FASB issued Statement 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The adoption of Statement 144 has
not had a negative impact on our financial statements.
Statement 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, establishes accounting and reporting standards for
derivative instruments, such as foreign currency and interest rate swaps,
options, forwards, futures, collars, and warrants, and for hedging activities.
We do not hold derivative securities and have not entered into contracts
embedded with derivative instruments either to hedge existing risks or for
speculative purposes.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk consists of fluctuations in the "prime rate" of
interest announced from time to time by Wells Fargo Bank N.A. Approximately
$18.3 million of our outstanding debt at December 31, 2002 related to long-term
indebtedness under our credit agreement with Foothill Capital Corporation, a
wholly-owned subsidiary of Wells Fargo & Company. We expect interest on the
outstanding balance of the loan to be charged based on a variable rate related
to the prime rate. Thus, our interest expense is subject to market risk in the
form of fluctuations in the prime rate of interest. The effect of a hypothetical
one hundred basis point increase across all maturities of variable rate debt
would result in an annual decrease of approximately $.2 million in pre-tax
operating results assuming no further changes in the amount of our borrowings
subject to variable rate interest from amounts outstanding at December 31, 2002.
We do not hold derivative securities and have not entered into contracts
embedded with derivative instruments, such as foreign currency and interest rate
swaps, options, forwards, futures, collars, and warrants, either to hedge
existing risks or for speculative purposes.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements listed on page 45 of this report are filed as
part of this report on the pages indicated.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Certain information required by Part III of this Form 10-K is omitted
because the Company will file a definitive proxy statement pursuant to
Regulation 14A with respect to the 2003 Annual Meeting of Stockholders expected
to be held on June 11, 2003 (the "Proxy Statement"), not later than 120 days
after the end of the fiscal year covered by this Form 10-K, and certain
information to be included therein is incorporated herein by reference.
40
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is contained in part under the caption
"Employees" in Part I hereof, and the remainder is contained in the Proxy
Statement under the caption "Election of Directors", and is incorporated herein
by reference. Information relating to delinquent filings of Forms 3, 4, and 5
of the Company is contained in the Proxy Statement under the caption "Compliance
with Section 16(a) of the Securities Exchange Act of 1934", and is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is contained in the Proxy Statement under the
captions "Compensation of Directors", "Executive Compensation and Related
Information", "Option Grants in Last Fiscal Year", "Aggregate Option Exercises
in Last Fiscal Year and Year-End Option Values", and "Employment Contracts and
Change of Control Arrangements", and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is contained in the Proxy Statement in part
under the caption "Stock Ownership of Certain Beneficial Owners and Management"
and in part under the caption "Equity Compensation Plan Information" and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is contained in the Proxy Statement under the
captions "Certain Transactions" and "Compensation Committee Interlocks and
Insider Participation" and is incorporated herein by reference.
PART IV
ITEM 14. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their
evaluation of our disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date
within 90 days of the filing date of this Annual Report on Form 10-K, our chief
executive officer and chief financial officer have concluded that our disclosure
controls and procedures are designed to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms and are operating in an effective manner.
(b) CHANGES IN INTERNAL CONTROLS. There were no significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their most recent evaluation.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements. The financial statements listed on page 45 of
this report are filed as part of this report on the pages indicated.
(a)(2) Financial Statement Schedules. The applicable financial statement
schedules required under Regulation S-X have been included beginning on page 72
of this report, as follows:
Report of Independent Certified Public Accountants on Financial
Statement Schedule ............................................ 72
Schedule II--Valuation and Qualifying Accounts ...................... 73
41
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are
listed below.
EXHIBIT
NO. DESCRIPTION
- -------- --------------------------------------------------------------------
2.1 -- Agreement and Plan of Merger by and among Datamedic Holding Corp.,
Certain Principal Shareholders of Datamedic Holding Corp., InfoCure
Corporation and InfoCure Systems, Inc. dated September 3, 1999
(incorporated by reference to Appendix A to InfoCure's Registration
Statement on Form S-4 (Registration No. 333-87867) filed on
September 27, 1999).
2.2 -- Agreement and Plan of Distribution, dated as of February 21, 2001,
by and between InfoCure Corporation and PracticeWorks, Inc.
(incorporated by reference to Exhibit 2.1 to the Registrant's
Current Report on Form 8-K, filed with the Commission on March 20,
2001).
3.1 -- Certificate of Incorporation of InfoCure Corporation with all
amendments (incorporated by reference to Exhibit 3.1 to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1999).
3.2 -- Second Amended and Restated Bylaws of InfoCure (incorporated by
reference to Exhibit 3.2 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1999).
4.1 -- See Exhibits 3.1 and 3.2 for provisions of the Certificate of
Incorporation, as amended, and Bylaws of InfoCure defining rights of
the holders of common stock of InfoCure.
4.2 -- Specimen Certificate for shares of common stock (incorporated by
reference to Exhibit 4.2 to InfoCure's Registration Statement on
Form SB-2) (Registration No. 333-18923).
10.1 -- InfoCure Corporation 1996 Stock Option Plan (incorporated by
reference to Exhibit 10.1 filed with InfoCure's Registration
Statement on Form SB-2) (Registration No. 333-18923).
10.2 -- Form of Incentive Stock Option Agreement of InfoCure Corporation
(incorporated by reference to Exhibit 10.2 filed with InfoCure's
Registration Statement on Form SB-2) (Registration No. 333-18923).
10.3 -- InfoCure Corporation 1997 Directors' Stock Option Plan (incorporated
by reference to Exhibit 10.48 filed with InfoCure's Annual Report on
Form 10-KSB on April 1, 1998).
10.4 -- InfoCure Corporation Length-of-Service Nonqualified Stock Option
Plan (incorporated by reference to Exhibit 10.49 filed with
InfoCure's Annual Report on Form 10-KSB on April 1, 1998).
10.5 -- Amendment to InfoCure Corporation 1996 Stock Option Plan
(incorporated by reference to Exhibit 10.15 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999).
10.6 -- Amendment to InfoCure Corporation Length-of-Service Nonqualified
Stock Option Plan (incorporated by reference to Exhibit 10.16 to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1999).
10.7 -- Amendment to InfoCure Corporation Employee Stock Purchase Plan
(incorporated by reference to Exhibit 10.17 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999).
10.8 -- InfoCure Corporation Employee Stock Purchase Plan (incorporated by
reference to Exhibit 10.50 filed with InfoCure's Annual Report on
Form 10-KSB on April 1, 1998).
10.9 -- Form of Stock Option Grant Certificate and schedule of recipients of
such options (incorporated by reference to Exhibit 10.22 to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1999).
10.10 -- Form of Stock Option Grant Certificate and schedule of recipients of
such options (incorporated by reference to Exhibit 10.23 to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1999).
42
EXHIBIT
NO. DESCRIPTION
- -------- --------------------------------------------------------------------
10.11 -- Tax Disaffiliation Agreement, dated as of March 5, 2001, by and
between InfoCure Corporation and PracticeWorks, Inc. (incorporated
by reference to Exhibit 10.1 to the Registrant's Current Report on
Form 8-K, filed with the Commission on March 20, 2001).
10.12 -- Employee Benefits and Compensation Allocation Agreement, dated as of
March 5, 2001, by and between InfoCure Corporation and
PracticeWorks, Inc. (incorporated by reference to Exhibit 10.4 to
the Registrant's Current Report on Form 8-K, filed with the
Commission on March 20, 2001).
10.13 -- Intellectual Property License Agreement, dated as of March 5, 2001,
by and between InfoCure Corporation and PracticeWorks Systems, LLC
(incorporated by reference to Exhibit 10.5(a) to the Registrant's
Current Report on Form 8-K, filed with the Commission on March 20,
2001).
10.14 -- Intellectual Property License Agreement, dated as of March 5, 2001,
by and between InfoCure Corporation and PracticeWorks Systems, LLC
(incorporated by reference to Exhibit 10.5(b) to the Registrant's
Current Report on Form 8-K, filed with the Commission on March 20,
2001).
10.15 -- Assignment of Copyrights, dated as of March 5, 2001, by and between
InfoCure Corporation and PracticeWorks Systems, LLC (incorporated by
reference to Exhibit 10.5(c) to the Registrant's Current Report on
Form 8-K, filed with the Commission on March 20, 2001).
10.16 -- Assignment of Trademarks, dated as of March 5, 2001, by and between
InfoCure Corporation and PracticeWorks Systems, LLC (incorporated by
reference to Exhibit 10.5(d) to the Registrant's Current Report on
Form 8-K, filed with the Commission on March 20, 2001).
10.17 -- Employment Agreement, dated July 24, 2000, by and between InfoCure
Corporation and Joseph M. Walsh (incorporated by reference to
Exhibit 10.6(a) to the Registrant's Current Report on Form 8-K,
filed with the Commission on March 20, 2001).
10.18 -- Employment Agreement, dated July 24, 2000, by and between InfoCure
Corporation and Steven N. Kahane (incorporated by reference to
Exhibit 10.6(c) to the Registrant's Current Report on Form 8-K,
filed with the Commission on March 20, 2001).
10.19 -- Employment Agreement, dated July 24, 2000, by and between InfoCure
Corporation and Michael A. Manto (incorporated by reference to
Exhibit 10.6(d) to the Registrant's Current Report on Form 8-K,
filed with the Commission on March 20, 2001).
10.20 -- InfoCure Corporation 2000 Broad-Based Stock Plan (incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2000).
10.21 -- Amended and Restated Warrant, originally issued to Crescent
International Ltd. on September 28, 1998, as amended and restated on
March 6, 2001 (incorporated by reference to Exhibit 10.44 to the
Registrant's Annual Report on Form 10-K, filed with the Commission
on April 2, 2001).
10.22 -- SubLease Agreement, dated February 28, 2001, by and between InfoCure
Corporation and Southern Company Services, Inc. (incorporated by
reference to Exhibit 10.2 to the Registrant's Quarterly Report on
Form 10-Q, filed with the Commission on May 16, 2001).
10.23 -- Lease Agreement, dated March 13, 2001, by and between InfoCure
Corporation and Joseph V. Fisher, LLC (incorporated by reference to
Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q,
filed with the Commission on May 16, 2001).
10.24 -- Separation Agreement by and between InfoCure Corporation, and
Frederick L. Fine, dated June 6, 2001 (incorporated by reference to
Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed
with the Commission on June 6, 2001).
43
EXHIBIT
NO. DESCRIPTION
- -------- --------------------------------------------------------------------
10.25 -- Loan and Security Agreement by and among VitalWorks Inc. as
Borrower, and Foothill Capital Corporation as Lender, dated March 8,
2002 (incorporated by reference to Exhibit 10.32 to the Registrant's
Annual Report on Form 10-K, filed with the Commission on March 29,
2002).
10.26 -- VitalWorks Inc. 401(k) Profit Sharing Plan (incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on
Form 10-Q, filed with the Commission on August 13, 2002).
10.27 -- VitalWorks Inc. 2002 Employee Stock Purchase Plan (incorporated by
reference to Exhibit 10.2 to the Registrant's Quarterly Report on
Form 10-Q, filed with the Commission on August 13, 2002).
10.28 -- Rights Agreement, dated as of December 5, 2002 (the "Rights
Agreement"), between VitalWorks Inc. and StockTrans, Inc., as Rights
Agent, including as Exhibit B, the form of Rights Certificate and
Election to Exercise (incorporated by reference to Exhibit 4 to the
Registrant's Current Report on Form 8-K, filed with the Commission
on December 9, 2002).
10.29 -- Form of Letter to Stockholders (incorporated by reference to Exhibit
20 to the Registrant's Current Report on Form 8-K, filed with the
Commission on December 9, 2002).
10.30 -- Form of Certificate of Designations of Series B Preferred Stock,
included in Exhibit C to the Rights Agreement (incorporated by
reference to Exhibit 3 to the Registrant's Report on Form 8-A12B,
filed with the Commission on January 3, 2003).
*21.1 -- List of Subsidiaries.
*23.1 -- Consent of BDO Seidman, LLP, independent certified public
accountants.
24.1 -- Powers of Attorney (included on signature page).
*99.1 -- Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed herewith
(b) Reports On Form 8-K. We filed the following reports on Form 8-K
during the quarter ended December 31, 2002:
(i) Current Report on Form 8-K filed with the Securities and
Exchange Commission on November 6, 2002 with respect to our
announcement that our Board of Directors has authorized the
repurchase of up to $15 million of our common stock from time
to time.
(ii) Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 9, 2002 with respect to our
announcement that we adopted a Stockholder Rights Plan and
declared a dividend of one Right on each share of our common
stock.
44
VITALWORKS INC.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
FINANCIAL STATEMENTS:
Report of Independent Certified Public Accountants ..................... 46
Consolidated Balance Sheets as of December 31, 2002 and 2001 ........... 47
Consolidated Statements of Operations for the years ended December 31,
2002, 2001 and 2000 .............................................. 48
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2002, 2001 and 2000 ................................. 49
Consolidated Statements of Cash Flows for the years ended December 31,
2002, 2001, and 2000 ............................................. 50
Notes to Consolidated Financial Statements ............................. 51
45
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
VitalWorks Inc.
We have audited the accompanying consolidated balance sheets of
VitalWorks Inc. and Subsidiaries as of December 31, 2002 and 2001 and
the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 2002. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of VitalWorks Inc. and Subsidiaries as of December 31, 2002
and 2001 and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note B to the consolidated financial statements,
effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
BDO Seidman, LLP
New York, New York
January 20, 2003, February 27, 2003 for Note H
46
VITALWORKS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
DECEMBER 31,
----------------------
2002 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ..................................................... $ 39,474 $ 12,988
Accounts receivable, net of allowances of $1,900 and $1,800 ................... 14,130 12,693
Computer hardware held for resale ............................................. 629 323
Deferred income taxes, net .................................................... 1,578 3,376
Prepaid expenses and other current assets ..................................... 1,660 946
Headquarters buildings held for sale, at fair value ........................... 7,184
--------- ---------
TOTAL CURRENT ASSETS ........................................................... 57,471 37,510
Property and equipment, at cost, less accumulated depreciation and
amortization of $9,026 and $6,294 .......................................... 4,542 6,435
Goodwill, less accumulated amortization of $55,898 through 2001 ................ 20,256 20,256
Product development and deferred finance costs, less accumulated
amortization of $1,049 and $905 ............................................ 9,049 4,739
Deferred income taxes, net ..................................................... 25,172 23,358
Other assets ................................................................... 641 651
--------- ---------
Total assets .................................................................... $ 117,131 $ 92,949
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ......................................... $ 10,630 $ 10,503
Accrued employee compensation and benefits .................................... 4,636 2,862
Accrued restructuring costs ................................................... 1,107 2,900
Deferred revenue, including unearned discounts of $1,478 and $1,701 ........... 9,578 8,096
Current portion of long-term debt ............................................. 4,300 14,063
--------- ---------
TOTAL CURRENT LIABILITIES ...................................................... 30,251 38,424
Long-term debt ................................................................. 14,641 16,490
Other liabilities, primarily unearned discounts re: outsourced printing services 11,806 11,975
COMMITMENTS AND CONTINGENCIES-NOTES C AND H
Stockholders' equity:
Preferred stock $.001 par value; 2,000,000 shares authorized; none issued.....
Common stock $.001 par value, 200,000,000 shares authorized,
44,605,944 and 39,001,771 shares issued ..................................... 45 39
Additional paid-in capital .................................................... 203,173 191,585
Notes receivable from former directors, net of allowance of $6,000 in 2001 .... (4,632)
Accumulated deficit ........................................................... (136,313) (160,463)
Treasury stock, at cost, 1,985,502 and 112,500 shares ......................... (6,472) (469)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY ..................................................... 60,433 26,060
--------- ---------
Total liabilities and stockholders' equity ..................................... $ 117,131 $ 92,949
========= =========
See accompanying notes.
47
VITALWORKS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
-------- -------- --------
REVENUES
Maintenance and services ................................... $ 84,808 $ 85,181 $ 79,984
Software licenses and system sales ......................... 30,003 21,872 21,682
-------- -------- --------
Total revenues ................................................ 114,811 107,053 101,666
-------- -------- --------
COSTS AND EXPENSES
Cost of revenues:
Maintenance and services ................................... 21,970 19,401 19,861
Software licenses and system sales, includes amortization of
product development costs of $911 in 2002 ............... 8,749 6,267 8,886
Selling, general and administrative ........................... 49,716 54,371 70,688
Research and development ...................................... 13,535 10,871 13,833
Depreciation and amortization, includes $23,135 and
$23,228 of goodwill amortization in 2001 and 2000 .......... 2,572 26,207 27,966
Loss on headquarters building held for sale ................... 1,375
Impairment charges (credits) and other nonrecurring costs ..... (6,000) 8,252 6,632
Restructuring costs (credits) ................................. (501) (425) 9,338
-------- -------- --------
90,041 126,319 157,204
-------- -------- --------
OPERATING INCOME (LOSS) ....................................... 24,770 (19,266) (55,538)
Interest income ............................................... 1,480 562 696
Interest expense .............................................. (1,938) (3,732) (3,674)
-------- -------- --------
INCOME (LOSS) FROM CONTINUING OPERATIONS, BEFORE INCOME TAXES . 24,312 (22,436) (58,516)
Provision (benefit) for income taxes .......................... 162 (9,843)
-------- -------- --------
INCOME (LOSS) FROM CONTINUING OPERATIONS ...................... 24,150 (22,436) (48,673)
Loss from discontinued operations, net of
income tax benefit of $4,399 in 2000 .................... (5,384) (29,440)
-------- -------- --------
NET INCOME (LOSS) ............................................. $ 24,150 $(27,820) $(78,113)
======== ======== ========
EARNINGS (LOSS) PER SHARE
Basic:
Continuing operations .................................... $ 0.58 $ (0.60) $ (1.45)
Discontinued operations .................................. (0.14) (0.88)
-------- -------- --------
$ 0.58 $ (0.74) $ (2.33)
======== ======== ========
Diluted:
Continuing operations .................................... $ 0.49 $ (0.60) $ (1.45)
Discontinued operations .................................. (0.14) (0.88)
-------- -------- --------
$ 0.49 $ (0.74) $ (2.33)
======== ======== ========
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic ....................................................... 41,592 37,477 33,537
Diluted ..................................................... 48,850 37,477 33,537
See accompanying notes.
48
VITALWORKS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
SHARES
----------------------- ADDITIONAL
COMMON TREASURY COMMON PAID-IN
STOCK STOCK STOCK CAPITAL
---------- ---------- ------ ----------
Balance at December 31, 1999 .................. 32,202,099 $ 32 $ 189,837
Issuance of common stock, net of related
expense for:
2000 acquisition attributed to
PracticeWorks ............................. 127,660 2,386
Earnout commitments ....................... 35,384 1,100
Payment of obligations .................... 68,563 418
Exercise of stock options and warrants .... 1,723,911 2 1,588
Matching contribution 401(k) plan ......... 97,508 1,469
Tax benefit from the exercise of options ...... 1,413
1999 acquisition escrow closure ............... (18,890) (390)
Treasury stock received in exchange for sale of
license agreement ......................... (112,500)
Purchase price protection of previous share
issuance .................................. (500)
Receipt of note from former directors for
exercise of stock options plus accrued interest 6,564
Issuance of promissory note from former
directors plus accrued interest, net of
repayment ..................................
Other ......................................... 74
Net loss ......................................
---------- ---------- ------ ----------
Balance at December 31, 2000 .................. 34,236,235 (112,500) 34 203,959
Issuance of common stock, net of related
expense for:
1998 acquisition of unit of Reynolds &
Reynolds ................................... 500,000 1 127
Matching contribution 401(k) plan .......... 462,352 1,965
Conversion of rights to preferred stock of
subsidiary ................................. 1,929,012 2 9,998
Exercise of stock options and warrants ..... 974,645 1 1,882
1999 acquisition attributed to PracticeWorks 887,715 1 2,327
Other ...................................... 11,812 254
Dividend of subsidiary, PracticeWorks ......... (28,927)
Allowance for loan losses .....................
Loan payments, net ............................
Net loss ......................................
---------- ---------- ------ ----------
Balance at December 31, 2001 .................. 39,001,771 (112,500) 39 191,585
Issuance of common stock, net of related
expense for:
Matching contribution 401(k) plan .......... 222,012 1 1,110
Exercise of stock options and warrants ..... 5,382,161 5 10,077
Repurchases of common stock ................... (1,873,002)
Dividend of subsidiary, PracticeWorks,
adjustment .................................... 401
Allowance for loan losses (reversed) ..........
Loan payments, net ............................
Net income ....................................
---------- ---------- ------ ----------
BALANCE AT DECEMBER 31, 2002 .................. 44,605,944 (1,985,502) $ 45 $ 203,173
========== ========== ====== ==========
NOTES
RECEIVABLE -
FORMER ACCUMULATED TREASURY
DIRECTORS DEFICIT STOCK TOTAL
------------ ----------- -------- --------
Balance at December 31, 1999 .................. $ (54,530) $135,339
Issuance of common stock, net of related
expense for:
2000 acquisition attributed to
PracticeWorks ............................. 2,386
Earnout commitments ....................... 1,100
Payment of obligations .................... 418
Exercise of stock options and warrants .... 1,590
Matching contribution 401(k) plan ......... 1,469
Tax benefit from the exercise of options ...... 1,413
1999 acquisition escrow closure ............... (390)
Treasury stock received in exchange for sale of
license agreement ......................... $ (469) (469)
Purchase price protection of previous share
issuance .................................. (500)
Receipt of note from former directors for
exercise of stock options plus accrued interest $ (6,974) (410)
Issuance of promissory note from former
directors plus accrued interest, net of
repayment .................................. (5,457) (5,457)
Other ......................................... 74
Net loss ...................................... (78,113) (78,113)
------------ ----------- -------- --------
Balance at December 31, 2000 .................. (12,431) (132,643) (469) 58,450
Issuance of common stock, net of related
expense for:
1998 acquisition of unit of Reynolds &
Reynolds ................................... 128
Matching contribution 401(k) plan .......... 1,965
Conversion of rights to preferred stock of
subsidiary ................................. 10,000
Exercise of stock options and warrants ..... 1,883
1999 acquisition attributed to PracticeWorks 2,328
Other ...................................... 254
Dividend of subsidiary, PracticeWorks ......... (28,927)
Allowance for loan losses ..................... 6,000 6,000
Loan payments, net ............................ 1,799 1,799
Net loss ...................................... (27,820) (27,820)
------------ ----------- -------- --------
Balance at December 31, 2001 .................. (4,632) (160,463) (469) 26,060
Issuance of common stock, net of related
expense for:
Matching contribution 401(k) plan .......... 1,111
Exercise of stock options and warrants ..... 10,082
Repurchases of common stock ................... (6,003) (6,003)
Dividend of subsidiary, PracticeWorks,
adjustment .................................... 401
Allowance for loan losses (reversed) .......... (6,000) (6,000)
Loan payments, net ............................ 10,632 10,632
Net income .................................... 24,150 24,150
------------ ----------- -------- --------
BALANCE AT DECEMBER 31, 2002 .................. $ -- $ (136,313) $ (6,472) $ 60,433
============ =========== ======== ========
See accompanying notes.
49
VITALWORKS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
-------- -------- --------
OPERATING ACTIVITIES
Income (loss) from continuing operations .......................................... $ 24,150 $(22,436) $(48,673)
Adjustments to reconcile income (loss) from continuing operations to cash
provided by operating activities:
Loss on headquarters building held for sale .................................... 1,375
Restructuring and other nonrecurring costs and impairment charges (credits) .... (6,501) 6,903 5,447
Depreciation and amortization, primarily goodwill in 2001 and 2000 ............. 2,572 26,207 27,966
Provisions for bad debts, returns and discounts ................................ 2,815 3,196 1,883
Tax benefit from the exercise of options ....................................... 1,413
Gain on release of pension liability ........................................... (550)
Amortization of deferred finance costs, charged to interest expense ............ 277 638 217
Amortization of product development costs ...................................... 911
Deferred income taxes .......................................................... (11,886)
Other .......................................................................... 255
Changes in operating assets and liabilities:
Accounts receivable ......................................................... (4,252) (2,031) 13,580
Computer hardware held for resale, prepaid expenses and other ............... (802) 218 1,074
Accounts payable, accrued costs and expenses ................................ 1,536 (1,982) 9,208
Income taxes payable ........................................................ 3,256
Deferred revenue ............................................................ 1,344 (971) 1,961
Unearned discounts re: outsourced printing services ........................ (1,292) 6,503 8,215
Interest payments (income) on notes receivable from former directors .............. 610 (610)
-------- -------- --------
CASH PROVIDED BY OPERATING ACTIVITIES ...................................... 20,758 18,230 12,756
-------- -------- --------
INVESTING ACTIVITIES
Product development costs ..................................................... (4,345) (4,601)
Proceeds from sale of office buildings ........................................ 7,310 800
Proceeds from sale of equipment ............................................... 220 146
Purchases of property and equipment ........................................... (771) (1,203) (4,770)
Cash received from (advanced to) PracticeWorks, Inc. .......................... 333 (344) (24,658)
Other ......................................................................... (17) 738
-------- -------- --------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES ............................. 2,527 (5,145) (28,544)
-------- -------- --------
FINANCING ACTIVITIES
Long-term debt:
(Payments) .................................................................. (38,597) (9,154) (6,442)
Proceeds ................................................................... 27,450 194 8,038
Exercise of stock options and warrants ........................................ 10,017 1,804 1,590
Loan payments from (loans to) former directors ................................ 10,991 1,215 (5,238)
Repurchases of common stock ................................................... (6,003)
Proceeds from convertible, redeemable preferred stock issuable ................ 10,000
Cash paid for price protection of shares issued re: a 1998 business acquisition (500)
Deferred finance costs and other .............................................. (657) (125)
-------- -------- --------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ............................. 3,201 (6,066) 7,448
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .................................. 26,486 7,019 (8,340)
Cash and cash equivalents at beginning of year .................................... 12,988 5,969 14,309
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR .......................................... $ 39,474 $ 12,988 $ 5,969
======== ======== ========
See accompanying notes.
50
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS
VitalWorks Inc. ("VitalWorks" or the "Company") is a leading provider of
information management technology and services targeted to healthcare practices
and organizations throughout the United States. The Company provides IT-based
solutions for general medical practices and has specialty-specific products and
services for practices such as radiology, anesthesiology, ophthalmology,
emergency medicine, plastic surgery, and dermatology. VitalWorks also offers
enterprise-level systems designed for large physician groups and networks. The
Company's range of software solutions, which include workflow features related
to patient encounters, automate the administrative, financial, and clinical
information management functions for physicians and other healthcare providers.
VitalWorks provides its clients with ongoing software support, implementation,
training, electronic data interchange ("EDI") services for patient billing and
claims processing, and a variety of Web-based services.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
and its subsidiaries, all of which were wholly-owned and merged into VitalWorks
Inc. during 2001. All significant intercompany accounts and transactions have
been eliminated.
Reclassification of Financial Statement Balances
Certain amounts in the accompanying financial statements for 2001 and 2000
have been reclassified to conform to the 2002 presentation.
Revenue Recognition
Software license revenues and system (computer hardware) sales are
recognized upon execution of the sales contract and delivery of the software
(off-the-shelf application software) and/or hardware. In all cases, however, the
fee must be fixed or determinable, collection of any related receivable must be
considered probable, and no significant post-contract obligations of the Company
shall be remaining. Otherwise, the sale is deferred until all of the
requirements for revenue recognition have been satisfied. Maintenance fees for
routine client support and unspecified product updates are recognized ratably
over the term of the maintenance arrangement. Training, implementation and EDI
services revenues are recognized as the services are performed. Most of the
Company's sales and licensing contracts involve multiple elements, in which
case, the Company allocates the total value of the customer arrangement to each
element based on the relative fair values of the respective elements. The
residual method is used to determine revenue recognition with respect to a
multiple element arrangement when specific objective evidence of fair value
exists for all of the undelivered elements (e.g., implementation, training and
maintenance services), but does not exist for one or more of the delivered
elements of the contract (e.g., computer software or hardware). The fair value
of an element is determined by the average price charged when that element is
sold separately (e.g., the fair value of maintenance services is determined
based on the average renewal price charged to clients for continued
maintenance). If evidence of fair value cannot be established for the
undelivered element(s) of an arrangement, the total value of the customer
arrangement is deferred until the undelivered element(s) is delivered or until
objective evidence of fair value is established. In the Company's contracts and
arrangements with its customers, the Company generally does not include
acceptance provisions, which would give the customer the right to accept or
reject the product after the Company ships it. However, if an acceptance
provision is included, revenue is recognized upon the customer's acceptance of
the product, which occurs upon the earlier of receipt of a written customer
acceptance or expiration
51
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
of the acceptance period. Allowances for estimated future returns and discounts
(recorded as contra-revenue), as well as bad debts, are provided upon
recognition of revenues.
Recognition of revenues in conformity with generally accepted accounting
principles requires management to make judgments that affect the timing and
amount of reported revenues.
Current Assets, and Liabilities
The Company considers highly liquid investment instruments with varying
terms of three months or less to be cash equivalents and those with varying
terms greater than three months but no more than a year would be considered
short-term investments. Cash equivalents are comprised primarily of
investment-grade commercial paper, time deposits, and U.S. federal, state and
political subdivision obligations.
The Company's accounts receivable are customer obligations due under
normal trade terms carried at their face value, less allowances for estimated
future returns and discounts, as well as bad debts. The Company evaluates the
carrying amount of its accounts receivable on an ongoing basis and establishes a
valuation allowance based on a number of factors, including specific customer
circumstances, historical rate of write-offs and the past due status of the
accounts. At the end of each fiscal quarter, the allowance is reviewed and
analyzed for adequacy and is often adjusted based on the findings. The allowance
is increased through a reduction of revenues, an increase in bad debt expense
and/or recovery of amounts previously written-off. The allowance is reduced by
write-offs of amounts deemed uncollectible and adjustments to revenue and/or bad
debt expense, if any, based on management's determination as to the adequacy of
the recorded allowance.
All current assets and current liabilities, because of their short-term
nature, are stated at cost or face value, which approximates market value. The
carrying amount of the Company's long-term debt, which provides for interest at
floating rates, approximates market value (see Note G).
Computer Hardware Held for Resale
Computer hardware held for resale includes computer equipment and related
peripherals, which are valued at the lower of cost or realizable value. Cost is
principally determined by either the first-in first-out or average cost methods.
Goodwill Assets and Business Combinations
Goodwill represents the excess of cost over the fair value of net assets
of businesses acquired and accounted for as purchase transactions. In 2001, the
Financial Accounting Standards Board (the "FASB") issued Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets." Statement
142 provides that, upon adoption, the Company shall no longer amortize its
goodwill assets. Rather, the Company is required to test its goodwill for
impairment of value on at least an annual basis. Pursuant to Statement 142, the
Company discontinued amortizing goodwill on January 1, 2002. The adoption of
Statement 142 has not had a negative impact on the Company's financial
statements.
Excluding goodwill amortization of $23.1 million and $23.2 million for the
years ended December 31, 2001 and 2000, the net loss would have been $(4.7)
million, or $(0.13) per share, and $(54.9) million, or $(1.64) per share,
respectively, compared to net income of $24.2 million, or $.49 per diluted
share, for 2002.
Also in 2001, the FASB issued Statement 141, "Business Combinations."
Statement 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interests method of accounting for business
combinations. Statement 141 also requires that the Company recognize acquired
intangible assets apart
52
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
from goodwill if the acquired intangible assets meet certain criteria. Statement
141 applies to all business combinations initiated after June 30, 2001.
The Company's business combinations were completed prior to 2000 and were
accounted for using both the pooling-of-interests and purchase methods. The
pooling-of-interests method does not result in the recognition of acquired
goodwill or other intangible assets. As a result, the adoption of Statements 141
and 142 did not affect the results of past transactions accounted for under the
pooling-of-interests method. However, all future business combinations would be
accounted for under the purchase method, which may result in the recognition of
goodwill and other intangible assets, some of which would be recognized through
operations, either by amortization or impairment charges, in the future.
Product Development and Deferred Finance Costs
The Company begins capitalizing product development costs, exclusively
third-party programmer fees, only after establishing commercial and technical
viability. Annual amortization of these costs represents the greater of the
amount computed using (i) the ratio that current gross revenues for the
product(s) bear to the total current and anticipated future gross revenues of
the product(s), or (ii) the straight-line method over the remaining estimated
economic life of the product(s); generally, depending on the nature and success
of the product, such deferred costs are amortized over a three to five-year
period. Amortization commences when the product is made commercially available.
Two of the five products under development were made commercially available in
2002.
Deferred finance costs ($.6 million and $.1 million, net of accumulated
amortization, as of December 31, 2002 and 2001), which include charges, fees and
expenses directly associated with loan origination and underwriting, are
recognized as interest expense over the expected life of the respective loan at
an amortization rate per annum that approximates the interest method.
Depreciation/amortization
Depreciation and amortization are computed principally using the
straight-line method over the estimated economic or useful lives of the
applicable assets. Leasehold improvements are amortized over the lesser of the
remaining life of the lease or the useful life of the improvements.
Stock-based Compensation
Statement 123, "Accounting for Stock-Based Compensation," as amended by
Statement 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123," provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, Statement 148
amends the disclosure requirements of Statement 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results.
The Company accounts for stock option grants and stock awards, based on
their intrinsic value, in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" and related interpretations.
Under the intrinsic value method, compensation expense is only recognized if the
exercise price of the employee stock option is less than the market price of the
underlying stock on the date of grant. The weighted-average estimated grant date
fair value, as defined by Statement 123, of options granted in 2002, 2001 and
2000 was $2.34, $1.61 and $2.97, respectively, as calculated using the
Black-Scholes option valuation model. The Company prices its stock options at
fair market value on the date of grant, and therefore, under Opinion 25, no
compensation expense is recognized for stock options granted. The following
table illustrates the effect on income (loss) from continuing operations and the
related earnings per share if the Company had applied the fair
53
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
value recognition provisions of Statement 123, as amended, to stock-based
employee compensation (In thousands, except per share data):
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
-------- -------- --------
Income (loss) from continuing operations,
as reported $ 24,150 $(22,436) $(48,673)
Less: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (5,320) (10,374) (6,415)
-------- -------- --------
Pro forma income (loss) from continuing operations $ 18,830 $(32,810) $(55,088)
======== ======== ========
Earnings (loss) per share - continuing operations:
Basic - as reported $ 0.58 $ (0.60) $ (1.45)
======== ======== ========
Basic - pro forma $ 0.45 $ (0.88) $ (1.64)
======== ======== ========
Diluted - as reported $ 0.49 $ (0.60) $ (1.45)
======== ======== ========
Diluted - pro forma $ 0.39 $ (0.88) $ (1.64)
======== ======== ========
The fair value of the Company's employee stock options was estimated at
the date of grant using the Black-Scholes option valuation model with the
following weighted average assumptions:
YEAR ENDED DECEMBER 31,
----------------------
2002 2001 2000
---- ---- ----
Risk-free interest rate ............................. 2.6% 4.0% 5.2%
Expected dividend yield ............................. 0.0 0.0 0.0
Expected stock price volatility ..................... 78.7 75.4 76.7
Weighted average expected life (in years) ........... 4 4 4
The Black-Scholes option valuation model was not developed for use in
valuing employee stock options. Instead, this model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable, which differ significantly from the Company's stock
option awards. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility.
Income Taxes
The Company provides for taxes based on current taxable income, and the
future tax consequences of temporary differences between the financial reporting
and income tax carrying values of its assets and liabilities (deferred income
taxes).
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
54
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings (loss) per share ("EPS") (In thousands, except per share data):
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
-------- -------- --------
Numerator--income (loss):
Continuing operations $ 24,150 $(22,436) $(48,673)
Discontinued operations (5,384) (29,440)
-------- -------- --------
$ 24,150 $(27,820) $(78,113)
======== ======== ========
Denominator:
Basic EPS--weighted-average shares 41,592 37,477 33,537
Effect of dilutive securities, stock option
and warrant rights 7,258
-------- -------- --------
Diluted EPS--adjusted weighted-average
shares and assumed conversions 48,850 37,477 33,537
======== ======== ========
Basic EPS:
Continuing operations $ 0.58 $ (0.60) $ (1.45)
Discontinued operations (0.14) (0.88)
-------- -------- --------
$ 0.58 $ (0.74) $ (2.33)
======== ======== ========
Diluted EPS:
Continuing operations $ 0.49 $ (0.60) $ (1.45)
Discontinued operations (0.14) (0.88)
-------- -------- --------
$ 0.49 $ (0.74) $ (2.33)
======== ======== ========
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.1 million common shares with exercise prices ranging from
$6.14 to $17.31 per share were excluded from the diluted EPS calculation for
2002. For the same reason, all options and warrants were excluded from the
diluted calculation for years 2001 and 2000.
Comprehensive Income
Comprehensive income is a measure of all changes in equity of an
enterprise that results from recognized transactions and other economic events
of a period other than transactions with owners in their capacity as owners. For
the Company, comprehensive income (loss) is equivalent to its consolidated net
income (loss).
Derivative Instruments and Hedging Activities
The Company does not hold derivative instruments such as foreign currency
and interest rate swaps, options, forwards, futures, collars, and warrants and
has not entered into contracts embedded with derivative instruments either to
hedge existing risks or for speculative purposes.
C. DISTRIBUTION OF PRACTICEWORKS COMMON STOCK
On March 5, 2001 (the "Distribution Date"), VitalWorks completed the
distribution of the common stock of its PracticeWorks, Inc. subsidiary
("PracticeWorks" or "Division"), a provider of practice management software for
dental and oral surgery practices, to the Company's stockholders in a tax-free
distribution. The spin-off of PracticeWorks was effected by way of a pro rata
dividend (the "Distribution" or "Spin-Off") of all of the
55
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
issued and outstanding shares of common stock of PracticeWorks to VitalWorks'
stockholders of record as of February 21, 2001 (the "Record Date"). This
resulted in PracticeWorks becoming an independent, publicly-traded company.
Immediately prior to the Distribution, VitalWorks effectively transferred to
PracticeWorks the Division's assets and liabilities and, thereby, distributed
$28.5 million of net assets, as adjusted, in connection with the Spin-Off.
VitalWorks' stockholders received one share of PracticeWorks common stock for
every four shares of VitalWorks common stock owned as of the Record Date. No
proceeds were received by VitalWorks in connection with the Distribution.
Accordingly, the accompanying 2001 and 2000 consolidated statements of
operations reflect the results of operations of PracticeWorks as discontinued
operations. For years 2001 and 2000, revenues included in the loss from
discontinued operations were $6.6 million (i.e., through the Distribution Date)
and $40.0 million, respectively.
For purposes of governing certain of the ongoing relationships between
PracticeWorks and the Company, and to provide for an orderly transition to the
status of two independent companies, PracticeWorks and the Company entered into
various agreements. Among other things, these agreements define the ongoing
relationship between the parties after the Distribution. Because these
agreements were negotiated while PracticeWorks was a wholly-owned subsidiary of
the Company, they are not the result of negotiations between independent
parties, although the Company and PracticeWorks set pricing terms for interim
services believed to be comparable to what would have been achieved through
arm's-length negotiations. Following the Distribution, additional or modified
agreements, arrangements and transactions were entered into between the Company
and PracticeWorks and such agreements and transactions were determined through
arm's-length negotiations. In connection with the Distribution, both companies
have indemnified the other, and either may incur obligations with respect to
certain representations, warranties, commitments, and/or contingencies of the
other entered into on or prior to the Distribution Date. A brief description of
certain of the material agreements follows:
Distribution Agreement
Prior to the Distribution Date, the Company and PracticeWorks entered into
the Distribution Agreement, which provided for, among other things, the
principal corporate transactions required to effect the Distribution and other
agreements relating to the continuing relationship between PracticeWorks and the
Company after the Distribution. Pursuant to the Distribution Agreement, the
Company transferred to PracticeWorks all of the assets and liabilities relating
to the Company's information management technology business for dentists,
orthodontists and oral and maxillofacial surgeons.
Pursuant to the Distribution Agreement and effective as of the
Distribution Date, PracticeWorks assumed, and agreed to indemnify the Company
against, all liabilities, litigation and claims, including related insurance
costs, arising out of PracticeWorks' business. The Company retained, and agreed
to indemnify PracticeWorks against, all liabilities, litigation and claims,
including related insurance costs, arising out of the Company's business. The
foregoing obligations do not entitle an indemnified party to recovery to the
extent any such liability is covered by proceeds received by such party from any
third party insurance policies.
The Distribution Agreement provides that each of the Company and
PracticeWorks will be granted access to certain records and information in the
possession of the other, and will require the retention by each of the Company
and PracticeWorks for a period of eight years following the Distribution Date of
all of this information in its possession. Also, the Distribution Agreement
provides for a three-year period during which neither the Company nor
PracticeWorks may solicit pre-existing customers or employees of the other
party.
Transition Services Agreement
The Company and PracticeWorks entered into the Transition Services
Agreement on the Distribution
56
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Date. Pursuant to this agreement, in exchange for specified fees, the Company
provided to PracticeWorks services including insurance-related services and
employee benefit services, and PracticeWorks provided to the Company services
including the preparation of tax returns, maintenance of the general ledger,
preparation of financial statements, corporate record-keeping, and payroll for a
fee of $.4 million in 2001. The fees paid pursuant to the Transition Services
Agreement were agreed upon between the parties. This agreement terminated on
December 31, 2001. Management believes that the terms and conditions were as
favorable to the Company as those available from unrelated parties for a
comparable arrangement.
Tax Disaffiliation Agreement
The Company and PracticeWorks entered into the Tax Disaffiliation
Agreement on the Distribution Date which identifies each party's rights and
obligations with respect to deficiencies and refunds, if any, of federal, state,
local or foreign taxes for periods before and after the Distribution and related
matters such as the filing of tax returns and the handling of Internal Revenue
Service matters and other audits. Under the Tax Disaffiliation Agreement,
PracticeWorks will indemnify the Company for any tax liability attributable to
PracticeWorks or its affiliates for any period. PracticeWorks will also
indemnify the Company for all taxes and liabilities incurred solely because (i)
PracticeWorks breaches a representation or covenant given to the law firm King &
Spalding in connection with rendering its tax opinion in the Distribution, which
breach contributes to an Internal Revenue Service determination that the
Distribution was not tax-free, or (ii) a post-Distribution action or omission by
PracticeWorks or any affiliate of PracticeWorks contributes to an Internal
Revenue Service determination that the Distribution was not tax-free. The
Company will indemnify PracticeWorks for all taxes and liabilities incurred
solely because (i) the Company breaches a representation or covenant given to
King & Spalding in connection with rendering its tax opinion in the
Distribution, which breach contributes to an Internal Revenue Service
determination that the Distribution was not tax-free, or (ii) a
post-Distribution action or omission by the Company or any affiliate contributes
to an Internal Revenue Service determination that the Distribution was not
tax-free. If the Internal Revenue Service determines that the Distribution was
not tax-free for any other reason, the Company and PracticeWorks will indemnify
each other against 50% of all taxes and liabilities.
PracticeWorks will also indemnify the Company for any taxes resulting from
any internal realignment undertaken to facilitate the Distribution on or before
the Distribution Date.
Employee Benefits and Compensation Allocation Agreement
VitalWorks and PracticeWorks entered into the Employee Benefits and
Compensation Allocation Agreement on the Distribution Date, which contains
provisions relating to employee compensation, benefits and labor matters and the
treatment of options to purchase VitalWorks common stock held by VitalWorks
employees who became PracticeWorks employees. This agreement provides that
VitalWorks options held by VitalWorks employees who became PracticeWorks
employees immediately following the Distribution may be replaced by
PracticeWorks options. PracticeWorks employees whose VitalWorks options were
fully vested as of the Distribution Date had the right to surrender their vested
VitalWorks options for options to purchase PracticeWorks common stock for a
period of 30 days following the Distribution Date, or April 4, 2001. Any
VitalWorks employees who became PracticeWorks employees who chose not to
surrender their vested VitalWorks options during this time period continued to
hold VitalWorks options which expired generally within 30 to 90 days from the
Distribution Date. PracticeWorks employees who were not fully vested in
VitalWorks options as of the Distribution Date had their VitalWorks options
exchanged for PracticeWorks options as of the Distribution Date.
57
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
D. NONRECURRING CHARGES (Credits)
Restructuring Costs (Credits)
The 2000 Plan. On August 1, 2000, VitalWorks announced its intention to
restructure its operations through a plan of employee reductions and
consolidation of office facilities. Since then, the Company closed 14 facilities
and terminated approximately 400 employees. The offices that were closed are
subject to operating leases that expire at various dates through 2005.
The 1999 Plan. In the fourth quarter of 1999, VitalWorks decided to change
its product strategy to begin development of ASP applications and Internet
solutions, and begin a transition to subscription based-pricing and completed
three acquisitions. Concurrently, management committed to a plan of
restructuring and reorganization related to acquisitions completed in 1999,
which was completed in the second quarter of 2000, to consolidate certain
facilities and eliminate staffing redundancies involving approximately 50
employees.
A description of the nature and amount of restructuring costs (credits)
and other charges incurred with respect to the 2000 and 1999 Plans is as follows
(In thousands):
COSTS
APPLIED
BALANCE AT ADDITIONS AGAINST BALANCE AT
DECEMBER 31, 1999 TO ACCRUAL ACCRUAL DECEMBER 31, 2000
----------------- ----------- ------- -----------------
Facility closure and consolidation ................. $1,339 $4,785 $(1,521) $4,603
Employee severance and other termination benefits .. 515 4,145 (2,429) 2,231
Other asset write-downs and costs .................. 235 408 (643) --
----------------- ----------- ------- -----------------
2000 and 1999 Plans Total .......................... $2,089 $9,338 $(4,593) $6,834
================= =========== ======= =================
COSTS
APPLIED
ADJUSTMENTS AGAINST BALANCE AT
TO ACCRUAL ACCRUAL DECEMBER 31, 2001
----------- ------- -----------------
Facility closure and consolidation ................. $(205) $(1,612) $2,786
Employee severance and other termination benefits .. (220) (1,897) 114
Other asset write-downs and costs ..................
----------- ------- -----------------
2000 and 1999 Plans Total .......................... $(425)(a) $(3,509) $2,900
=========== ======= =================
COSTS
APPLIED
ADJUSTMENTS AGAINST BALANCE AT
TO ACCRUAL ACCRUAL DECEMBER 31, 2002
----------- ------- -----------------
Facility closure and consolidation ................. $(501) $(1,178) $1,107
Employee severance and other termination benefits .. (114) --
Other asset write-downs and costs ..................
----------- ------- -----------------
2000 and 1999 Plans Total .......................... $(501)(b) $(1,292) $1,107(c)
=========== ======= =================
- ----------
(a) credits resulting from changes in accounting estimates relating to
facility closure and employee severance costs incurred in 2000 in
connection with the 2000 Plan
(b) savings in connection with the early termination of an office lease for a
facility closed in March 2001 as part of the 2000 Plan
(c) primarily amounts accrued for outstanding lease commitments relating to
the 2000 Plan
58
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities."
Statement 146 requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Examples of costs covered by Statement
146 include lease termination costs and certain employee severance costs that
are associated with a restructuring, discontinued operation, facility closing,
or other exit or disposal activity. Statement 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002.
Impairment Charges (Credits) and Other Nonrecurring Costs
In the June and September 2002 quarters, VitalWorks received final
payments from three former directors satisfying their outstanding loans from the
Company, including interest. Consequently, the Company recorded a credit of $6.0
million, reflecting a complete reversal of the allowance for loan losses
established in March 2001, and related interest income of $1.1 million.
In 2001, the Company recognized impairment charges and incurred other
nonrecurring costs of $8.3 million. These costs and expenses included the $6.0
million provision for loan losses relating to the notes receivable from former
directors, $.9 million for unused equity financing (paid in 2002), $.8 million
of executive severance for separation benefits paid to the Company's former
chairman pursuant to the terms of a mutual separation agreement and a
pre-existing employment agreement, and retention bonuses of $.2 million for
terminated employees.
In 2000, concurrent with the 2000 Plan, the Company recognized impairment
charges and incurred other nonrecurring costs of $6.6 million consisting of (i)
$3.5 million relating to fixed assets that were abandoned due to the closing of
facilities; (ii) $1.1 million to write-down computer hardware held for resale to
its estimated net realizable value based on a planned bulk lot disposal as a
result of the Company's decision to discontinue selling hardware and hardware
support in certain of its business lines; (iii) $1.3 million for compensation
and other termination benefits; (iv) $.4 million for other asset write-downs;
and (v) $.3 million for professional services and other related costs.
In 2001, the FASB issued Statement 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The adoption of Statement 144 has not had a
negative impact on the Company's financial statements.
E. PROPERTY AND EQUIPMENT, AND BUILDINGS HELD FOR SALE
Major classes of property and equipment consist of the following:
DEPRECIATION/ DECEMBER 31,
AMORTIZATION -----------------
PERIOD 2002 2001
------------- ------- -------
(Years) (In thousands)
Equipment, primarily computers, and software .... 3-5 $10,338 $ 9,439
Equipment under capital lease obligations ....... 3-5 2,718 2,718
Furniture and other ............................. 3-7 512 572
------- -------
13,568 12,729
Less accumulated depreciation and amortization .. 9,026 6,294
------- -------
$ 4,542 $ 6,435
======= =======
59
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Depreciation and amortization expense of these assets totaled $2.6
million, $2.9 million and $3.7 million for 2002, 2001 and 2000, respectively.
In August 2002, the Company completed the sale of a former headquarters
building in Atlanta for proceeds of $6.3 million, after closing costs. A portion
of the proceeds from the sale was used to repay the $5.5 million mortgage loan
on the building (see Note G). Approximately $.4 million of the proceeds is being
held in escrow to partially guarantee to the new owner the monetary performance
of PracticeWorks, Inc., a tenant of the building, through December 2003 under
their lease agreement. The Company spun-off PracticeWorks in March 2001 (see
Note C). In connection with the sale, the Company entered into a market rate
lease with the new owner of the building ending December 2003 for approximately
3,900 square feet of office space, or less than 5% of the building. In 2002, the
Company recognized a gain of $.1 million from the sale of the building (included
in selling, general and administrative expenses). The amount held in escrow has
been deferred and may be recognized in 2003.
In January 2002, the Company completed the sale of its other office
building in Atlanta for $1.4 million, after closing costs.
F. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following:
DECEMBER 31,
--------------------
2002 2001
------- -------
(In thousands)
Cost of providing EDI services ....................... $ 2,894 $ 2,208
Trade accounts payable ............................... 1,930 872
Legal, including settlement costs, and other
professional services fees ........................ 1,428 2,253
Other accrued expenses ............................... 4,378 5,170
------- -------
$10,630 $10,503
======= =======
G. LONG-TERM DEBT
Long-term debt consists of the following:
DECEMBER 31,
--------------------
2002 2001
------- -------
(In thousands)
Term loan with Foothill Capital Corporation .......... $18,250
Finova Capital Corporation:
Term loan ........................................ $21,882
Real estate mortgage loans ....................... 6,850
Capital leases (see Note H) .......................... 691 1,713
Other ................................................ 108
------- -------
18,941 30,553
Less current portion ................................. 4,300 14,063
------- -------
$14,641 $16,490
======= =======
All loan amounts with Finova were repaid in March 2002 in connection with
a new four-year credit
60
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
agreement entered into by the Company with Foothill Capital Corporation, a
wholly-owned subsidiary of Wells Fargo & Company. The new agreement included a
term loan of $22.0 million at an interest rate of prime plus 2% (6.25% at
December 31, 2002), and a mortgage loan of $5.5 million. The Company repaid the
mortgage loan in August 2002 in connection with the sale of the Atlanta property
(see Note E). Subject to the Company achieving certain specified earnings
targets, the margin by which the Company's interest rate on the term loan
exceeds prime may be reduced by as much as 1.1% over the life of the loan.
Interest is payable monthly in arrears. Principal is payable over the life of
the agreement, including a balloon payment in March 2006. Should the Company
decide to prepay the term loan in full prior to year four, it would incur a
prepayment fee equal to 2% in year two and 1% in year three of the then
outstanding principal balance of the term loan. The prepayment fee may be
reduced should the loan be prepaid in connection with a change of control of the
Company. The loans, which are collateralized by substantially all of the
Company's assets and intellectual property rights, subject the Company to
certain restrictive covenants, including (i) the required maintenance of minimum
levels of recurring revenues and earnings, as defined, (ii) an annual limit on
the amount of capital expenditures, and (iii) the prohibition of dividend
payments to shareholders.
Maturities of long-term debt are as follows: $4.3 million in 2003, $2.6
million in 2004, and $12.0 million in 2006.
In April 2002, the FASB issued Statement 145, "Rescission of FASB
Statements No. 4, 44 and 62, Amendment of FASB Statement No. 13 and Technical
Corrections." For most companies, Statement 145 will require gains and losses on
extinguishments of debt to be classified as income or loss from continuing
operations rather than as extraordinary items as previously required under
Statement 4. Extraordinary treatment will be required for certain
extinguishments as provided in Accounting Principles Board Opinion No. 30.
Statement 145 also amends Statement 13 for certain sales-leaseback and sublease
accounting. The Company is required to adopt the provisions of Statement 145 in
January 2003. The Company believes the adoption of Statement 145 will not have a
significant impact on its financial statements.
H. COMMITMENTS AND CONTINGENCIES
The Company leases office and research facilities, and certain computer
and other equipment under various operating and capital lease agreements. The
leases expire at various dates through 2008.
Future minimum lease payments under all operating and capital leases with
noncancellable terms in excess of one year are as follows:
YEAR CAPITAL OPERATING
- ---- ------- ---------
(In thousands)
2003 .................................................... $ 571 $ 2,557
2004 .................................................... 132 1,881
2005 .................................................... 14 1,352
2006 .................................................... 1,341
2007 .................................................... 766
Thereafter ............................................... 337
------- ---------
717 8,234
Less amounts included in accrued restructuring costs ..... 959
------- ---------
717 $ 7,275
=========
Less amounts representing interest ....................... 26
-------
Present value of net minimum lease payments .............. 691
Less current portion ..................................... 550
-------
Long-term obligations under capital leases ............... $ 141
=======
61
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In addition, certain of the office leases provide for contingent payments
based on building operating expenses. Rental expenses for years 2002, 2001 and
2000 under all lease agreements totaled $2.6 million, $2.5 million and $4.4
million, respectively.
In May 2002, the Company entered into a five-year agreement with a
third-party provider of EDI services for patient claims processing. For the
first year of the agreement, the Company is committed to pay $.5 million for
processing services. Thereafter, the annual services fee will range from $.5
million to $.8 million based on the Company's volume usage in the last month of
the preceding year.
In connection with the Company-sponsored employee savings plan (discussed
in Note I), the Company has committed, for the 2003 plan year, to contribute to
the plan. The Company's matching contribution, estimated to be approximately $.8
million, will be made half in cash and half in VitalWorks common stock.
In October 2001, the Company expanded its August 2000 agreement with
National Data Corporation ("NDC") for outsourcing much of the Company's patient
statement and invoice printing work. The Company will continue, for a fee, to
provide printing services for its physicians under the subcontracting
arrangement with NDC. The amended arrangement, which extends for a period of up
to seven and a half years, provides for, among other things, the attainment of
certain quarterly transaction processing volume levels during the term. In
exchange, the Company received $7.9 million in cash (in connection with the
August agreement, the Company received $8.8 million in 2000), which represent
unearned discounts that are recognized as an offset to cost of maintenance and
services revenues as the minimum volume commitments are fulfilled.
From time to time, in the normal course of business, various claims are
made against the Company. Except for proceedings described below, there are no
material proceedings to which the Company is a party, and management is unaware
of any material contemplated actions against the Company.
On February 27, 2003, a purported class action complaint was filed in the
United States District Court for the District of Connecticut against VitalWorks
Inc. and three of its executive officers. The action was brought by plaintiff
Bernard Frazier, on behalf of purchasers of securities of the Company between
April 24, 2002 and October 23, 2002 (the "Class Period"). The complaint alleges,
among other things, violations of Section 10(b) of the Securities Exchange Act
of 1934, Rule 10b-5 promulgated thereunder and breach of fiduciary duties. The
complaint alleges that the defendants made misleading statements and omissions
regarding the Company's business and operations, principally in press releases
and public conference calls in April 2002 and July 2002, which allegedly had the
effect of artificially inflating the market price of the Company's common stock
during the Class Period, and that six officers of the Company, including the
defendant officers, sold shares of Company common stock during the Class Period.
The plaintiff seeks recovery of an unstated amount of compensatory damages,
attorneys' fees and costs. The Company understands that an additional lawsuit
or lawsuits containing substantially similar causes of action as the above
referenced matter has been filed against VitalWorks, although the Company has
not yet been served with any complaint.
On April 19, 2001, a lawsuit styled David and Susan Jones v. InfoCure
Corporation (now known as VitalWorks Inc.), et al., was filed in Boone County
Superior Court in Indiana. The defendants removed the case to the United States
District Court for the Southern District of Indiana. The complaint alleges state
securities law violations, breach of contract, and fraud claims against the
defendants. The complaint does not specify the
62
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
amount of damages sought by plaintiffs, but seeks rescission of a transaction
that the plaintiffs value at $5 million, as well as punitive damages and
reimbursement for the plaintiffs' attorneys' fees and associated costs and
expenses of the lawsuit. In a decision from the Court dated October 15, 2001,
the plaintiffs' request for a preliminary injunction to preserve their remedy of
rescission was denied, part of their complaint was dismissed and the case was
transferred to the Northern District Court of Georgia. On October 26, 2001, the
plaintiffs filed a notice of appeal with the 7th Circuit Court of Appeals. On
November 8, 2002, the 7th Circuit Court affirmed the denial of the preliminary
injunction and dismissed the remainder of the appeal. The case is now pending in
the Northern District Court of Georgia and the plaintiffs have obtained leave of
the Court to file an amended complaint.
While management believes that the Company has meritorious defenses in
each of the foregoing matters and the Company intends to pursue its positions
vigorously, litigation is inherently subject to many uncertainties. Thus, the
outcome of these matters is uncertain and could be adverse to the Company.
However, even if the outcome of these cases is adverse, management does not
believe that the outcome of these cases, individually or in the aggregate, will
have a material adverse effect on the financial position of the Company.
However, depending on the amount and timing of an unfavorable resolution(s) of
the contingencies, it is possible that the Company's future results of
operations or cash flows could be materially affected in a particular reporting
period(s).
The Company was named as a defendant as successor to CDL Healthcare
Systems, Inc. ("CDL"), a company acquired by VitalWorks in December 1999, in a
complaint filed in the Circuit Court of the Eleventh Judicial Circuit in Dade
County, Florida on February 27, 2001 by Sonia Abutog, individually, Angelo
Abutog, individually, and Sonia and Angelo Abutog, as parents and next best
friends to Aaron Abutog, a minor. Gary Weiner, former President of CDL, and his
daughter, Elisha Weiner, were also named as defendants. Plaintiffs alleged that
they were injured at a time, prior to the merger between the Company and CDL,
when a motor vehicle operated by Elisha Weiner collided with plaintiff Sonia
Abutog, a pedestrian. The plaintiff contended that she and her unborn child
suffered severe personal injuries as a result of the accident and sought to
recover damages in an unspecified amount in excess of $15,000, plus interest and
costs. The Company's motion for final summary judgment dismissing the action
against the Company was granted by order of the Court dated July 9, 2002. The
plaintiffs did not file a Notice of Appeal of this decision and the time to do
so has expired.
I. STOCKHOLDERS' EQUITY
Stockholder Rights Plan
In December 2002, the Company adopted a stockholder rights plan (the
"Rights Plan") and declared a dividend of one right (the "Right") on each share
of VitalWorks common stock. The dividend was paid on December 27, 2002, to
stockholders of record on December 27, 2002. The Rights Plan was approved and
recommended to the Company's board of directors (the "Board") by a special
committee of the Board consisting of three outside members of the Board. The
Rights Plan is designed to enable all VitalWorks stockholders to realize the
full value of their investment and to provide for fair and equal treatment of
all VitalWorks stockholders if there is an unsolicited attempt to acquire
control of the Company. The adoption of the Rights Plan is intended as a means
to guard against abusive takeover tactics and is not in response to any specific
effort to acquire control of the Company.
Initially, the Rights will trade with the common stock of VitalWorks and
will not be exercisable. The Rights will separate from the common stock and
become exercisable upon the occurrence of events typical of stockholder rights
plans. In general, such separation will occur when any person or group, without
the Board's approval, acquires or makes an offer to acquire 15% or more of
VitalWorks' common stock. Thereafter, separate right certificates will be
distributed and each Right will entitle its holder to purchase one
one-thousandth of a
63
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
share of VitalWorks' Series B Junior Preferred Stock (the "Preferred Stock") for
an exercise price of $20.00 (the "Exercise Price"). Each one one-thousandth of a
share of Preferred Stock has economic and voting terms equivalent to those of
one share of VitalWorks' common stock.
Subject to the specific terms of the Rights Plan, in the event that any
person or group, without the Board's approval, actually acquires 15% or more of
VitalWorks' common stock, then each holder of a Right (other than such person or
group) shall thereafter have the right to receive upon exercise of such Right
and payment of the Exercise Price, shares of Preferred Stock having a value
equal to twice the Exercise Price. Also, if the Company is involved in a merger
or sells more than 50% of its assets or earning power, each Right, unless
previously redeemed by the Board, will entitle its holder (other than the
acquiring person or group) to purchase shares of common stock of the acquiring
company having a market value of twice the Exercise Price.
The Rights Plan is not intended to prevent a takeover of the Company at a
full and fair price. However, the Rights Plan may cause substantial dilution to
a person or group that, without prior Board approval, acquires 15% or more of
VitalWorks' common stock, or unless the Rights are first redeemed by the Board.
The Rights may be redeemed by the Board for $0.005 per Right and will otherwise
expire on December 5, 2012.
The Rights Plan contains an independent directors review provision whereby
a committee of independent members of the Board will review the Rights Plan at
least every three years and, if a majority of the members of the independent
committee deems it appropriate, may recommend to the Board the continued
maintenance, modification or termination of the Rights Plan.
The Rights Plan does not weaken the Company's financial strength or
interfere with its business plans. The issuance of the Rights has no dilutive
effect, will not affect reported earnings per share, is not taxable to the
Company or its stockholders and will not change the way VitalWorks' shares are
traded.
Stock Repurchase Program
In October 2002, the Company's board of directors authorized the
repurchase of up to $15 million of the Company's common stock from time to time.
The timing and amount of any shares repurchased are determined by the Company's
management based on its evaluation of market conditions and other factors. The
repurchase program may be suspended or discontinued at any time. Repurchased
shares are available for use in connection with stock plans and for other
corporate purposes. The repurchase program is funded using the Company's
existing cash resources. As of December 31, 2002, the Company repurchased
1,873,002 shares of its common stock under the program.
Employee Savings Plan
The Company maintains an employee savings plan that qualifies as a cash or
deferred salary arrangement under Section 401(k) of the Internal Revenue Code.
Through 2002, participating employees could defer up to 15% of their pre-tax
compensation, but not more than $11,000 per calendar year. The Company may make
matching and/or profit-sharing contributions to the plan at its sole discretion.
In 2002, 2001 and 2000, the Company authorized matching contributions of $1.1
million, $1.1 million and $1.3 million, respectively, to the plan, representing
up to 6% of pre-tax compensation. Except for a cash contribution of $.3 million
made in 2003 with respect to the 2002 plan year, the contributions were made in
VitalWorks common stock in the following year.
Effective January 1, 2003, the Company amended the plan and has committed,
for the 2003 plan year, to make a quarterly matching contribution equal to
two-thirds of each participant's contribution, not to exceed 4% of the
participant's pre-tax compensation for the quarter. The Company's matching
contribution will be made half
64
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
in cash and half in VitalWorks common stock. Employees now become fully vested
with respect to Company contributions after three years of service. The vesting
term had been five years. Participating employees may now defer up to 50% of
their pre-tax compensation, but not more than $12,000 per calendar year.
Employee Stock Purchase Plan
The Company's 2002 Employee Stock Purchase Plan (the "ESPP"), as approved
by the Company's shareholders in June 2002, permits eligible employees to
purchase VitalWorks common stock at a discounted price through periodic payroll
deductions of up to 15% of their cash compensation. Generally, each offering
period will have a maximum duration of six months and shares of common stock
will be purchased for each participant at the conclusion of each offering
period. The price at which the common stock is purchased under the ESPP is equal
to 85% of the lower of (i) the closing price of the common stock on the first
business day of the offering period, or (ii) the closing price on the last
business day of the offering period. Under the ESPP, .5 million shares of common
stock of the Company have been reserved and were available for issuance at
December 31, 2002. In 2002, 2001 and 2000, a total of 56,404, 62,948 and 107,725
shares, respectively, were issued under the Company's prior employee stock
purchase plan.
Stock Option Plans
The Company has stock option plans that provide for the grant of incentive
and nonqualified options to purchase the Company's common stock to selected
officers, other key employees, directors and consultants. These plans include
the VitalWorks Inc. 2000 Broad Based Stock Plan, the VitalWorks Inc. 1996 Stock
Option Plan, the VitalWorks Inc. Length-of-Service Nonqualified Stock Option
Plan and the VitalWorks Inc. Directors Stock Option Plan. The Company has also
assumed the stock options of six medical software businesses that merged with
VitalWorks in 1999. Such options were converted at the applicable rates used to
issue the Company's common stock in the mergers. The shares reserved under the
Company's stock option plans were adjusted in connection with the Distribution
(see Note C), using a conversion ratio of 2.11667, in accordance with the terms
of the respective plans.
The VitalWorks Inc. 2000 Broad Based Stock Plan (the "2000 Plan") has 21.2
million shares of common stock of the Company reserved for nonqualified option
grants, stock appreciation right grants, or stock grants to directors and
employees. The option price for each share of stock subject to an option or
stock appreciation right may not be less than the fair market value of a share
of stock on the date the option or right is granted. Options or rights granted
under this plan generally vest over a three to four-year period and expire ten
years from the date of grant. At December 31, 2002, there were 12.1 million
shares available for grant under the 2000 Plan.
Under the VitalWorks Inc. 1996 Stock Option Plan (the "1996 Plan"), 12.7
million shares of common stock of the Company have been reserved for option
grants to directors, officers, other key employees, and consultants. Employees
of the Company may be granted incentive stock options ("ISOs") within the dollar
limitations prescribed under Section 422(d) of the Internal Revenue Code. The
exercise price of ISOs shall not be less than the fair market value of the
common stock as of the option grant date (110% of such value for 10%
stockholders). Nonqualified stock options may be granted to directors and
consultants. Options generally vest ratably over a three to four-year period and
expire ten years from the date of grant. At December 31, 2002, there were 5.1
million shares available for grant under the 1996 Plan.
Under the VitalWorks Inc. Length-of-Service Nonqualified Stock
Option Plan (the "LOSSO Plan"), 2.1 million shares of common stock of the
Company have been reserved for issuance to employees of the Company. Employees
are granted nonqualified stock options based on years of service with the
Company. The exercise price of options issued pursuant to this plan shall be no
less than the fair market value of the common stock as of the grant date.
Options granted under the LOSSO Plan vest four years and expire ten years from
the date of grant.
65
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Effective July 1, 2002, the Company discontinued granting options under the
LOSSO Plan.
Under the VitalWorks Inc. Directors Stock Option Plan (the "Director
Plan"), .4 million shares of common stock of the Company have been reserved for
issuance as nonqualified stock options to non-employee directors of the Company.
Upon appointment to the board of directors, a director receives an option grant
of 20,000 shares and an additional option grant of 2,500 shares on each
anniversary date. A director may also receive additional option grants from time
to time. One half of the options granted pursuant to this plan vest after one
year of service following the grant date and the other half vests after two
years of service following the grant date. At December 31, 2002, there were .3
million shares available for grant under the Director Plan.
A summary of stock option activity, and related information for the years
ended December 31 is as follows (Shares in thousands):
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
------- --------
Outstanding at December 31, 1999 ...................... 7,989 $ 10.78
Granted ............................................. 11,920 4.95
Exercised ........................................... (1,627) 4.72
Forfeited or canceled ............................... (2,388) 9.28
-------
Outstanding at December 31, 2000 ...................... 15,894 6.66
Granted ............................................. 761 2.77
Exercised ........................................... (871) 2.14
Forfeited or canceled ............................... (10,217) 7.31(a)
Conversion in order to preserve intrinsic value ..... 9,271 (a)
-------
Outstanding at December 31, 2001 ...................... 14,838 2.49
Granted ............................................. 324 3.97
Exercised ........................................... (5,153) 1.91
Forfeited or canceled ............................... (481) 3.95
-------
Outstanding at December 31, 2002 ...................... 9,528 $ 2.79
=======
Options exercisable at December 31, 2000 .............. 1,882 $ 8.27
Options exercisable at December 31, 2001 .............. 6,997 $ 2.24
Options exercisable at December 31, 2002 .............. 5,503 $ 2.61
- ----------
(a) In connection with the Spin-Off of PracticeWorks in March 2001, VitalWorks
and PracticeWorks entered into an Employee Benefits and Compensation
Allocation Agreement, which contains provisions relating to employee
compensation, benefits and labor matters including the treatment of
options to purchase VitalWorks common stock as a result of the
Distribution (see Note C for further discussion). PracticeWorks employees
exchanged approximately 7.4 million VitalWorks stock options with a
weighted average exercise price of $7.74 for PracticeWorks stock options,
thereby canceling the VitalWorks stock options. Stock options of
approximately 8.4 million with a weighted average exercise price of
approximately $7.20 held by VitalWorks employees prior to the
Distribution, who did not become PracticeWorks employees subsequent to the
Distribution, were converted to approximately 17.7 million options with an
average price of approximately $3.40 in order to preserve the intrinsic
value of the options.
66
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table summarizes information about the Company's outstanding
stock options at December 31, 2002 (Shares in thousands):
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED ----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ---------------- ----------- ----------- -------- ----------- --------
(Years)
$ 0.98 - 2.50 7,400 7.6 $2.05 4,389 $2.07
2.51 - 5.00 1,118 7.2 3.26 691 3.18
5.01 - 7.50 634 6.9 6.74 359 6.95
7.51 - 17.31 376 6.7 9.15 64 9.11
----------- -----------
$ 0.36 - 17.31 9,528 7.5 $2.79 5,503 $2.61
=========== ===========
Warrants
The following table summarizes information about the Company's outstanding
and exercisable warrants at December 31, 2002 (Shares in thousands):
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE
EXERCISE PRICES OF WARRANTS LIFE PRICE
- --------------- ----------- ----------- --------
(Years)
$ 0.79 - 6.89 358 5.1 $4.49
6.90 - 17.84 203 3.2 7.05
-----------
$ 0.79 - 17.84 561 4.4 $5.42
===========
There was no significant impact on the Company's financial statements
related to warrants in 2002, 2001 and 2000.
67
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
J. INCOME TAXES
The Company's provision (benefit) for income taxes for 2002 and 2000 is as
follows (for 2001, the Company did not record a provision or benefit for income
taxes due to its operating losses and the change in the valuation allowance for
deferred tax assets):
YEAR ENDED DECEMBER 31,
-----------------------
2002 2000
-------- --------
(In thousands)
Current:
Federal .......................................... $ 1,608
State ............................................ 351
-------- --------
1,959
-------- --------
Deferred:
Federal........................................... (1,608) $(12,248)
State ............................................ (189) (1,994)
-------- --------
(1,797) (14,242)
-------- --------
$ 162 $(14,242)
======== ========
In 2000, the Company did not record a current provision or benefit for
income taxes as a result of its operating losses.
The provision (benefit) for income taxes included in the accompanying
statements of operations for 2002 and 2000 is as follows:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2000
-------- --------
(In thousands)
Continuing operations ............................... $ 162 $ (9,843)
Discontinued operations ............................. (4,399)
-------- --------
$ 162 $(14,242)
======== ========
The deferred income tax benefit attributable to income from continuing
operations for 2000 consists of a federal benefit of $8.5 million and a state
benefit of $1.4 million.
68
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and their tax bases. Significant components of deferred income tax
assets and liabilities are as follows:
DECEMBER 31,
-----------------
2002 2001
------- -------
(In thousands)
Deferred income tax assets:
Allowance for doubtful accounts .......................... $ 1,422 $ 1,390
Goodwill amortization .................................... 8,795 10,041
Accrued expenses ......................................... 1,030 1,426
Unearned discounts re: outsourced printing services ...... 4,700 5,095
Net operating loss and credit carryforwards .............. 38,823 31,303
Notes receivable from former directors ................... 2,517
Other .................................................... 598 194
------- -------
55,368 51,966
Less valuation allowance ............................... 25,271 23,001
------- -------
$30,097 $28,965
======= =======
Deferred income tax liabilities:
Product development costs ................................ $ 3,347 $ 1,777
Other .................................................... 454
------- -------
3,347 2,231
------- -------
Net deferred income tax asset .............................. $26,750 $26,734
======= =======
The provision (benefit) for income taxes attributed to continuing
operations differed from the amounts computed by applying the statutory U.S.
federal income tax rate as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
-------- -------- --------
(In thousands)
Expected taxes at federal statutory rate ...................... $ 8,509 $ (7,628) $(19,895)
State income taxes, net of federal benefit .................... 107 (773) (2,692)
Nondeductible goodwill amortization ........................... 3,091 3,223
Retained net operating losses from discontinued operations .... (1,034) (7,362)
Other, net .................................................... (178) (162) 388
Change in valuation allowance ................................. (8,276) 6,506 16,495
-------- -------- --------
Provision (benefit) for income taxes--continuing operations ... $ 162 $ -- $ (9,843)
======== ======== ========
As of December 31, 2002, the Company has net operating loss carryforwards
for income tax purposes of approximately $93.2 million, which expire at various
dates through 2022. Included in the $93.2 million is approximately $25.8
million, the benefit of which when realized, will be recorded as a credit to
additional paid-in capital, and approximately $19.0 million resulting from
preacquisition tax attributes of subsidiaries, utilization of which is subject
to substantial limitations attributable to the change in ownership provisions of
the Internal Revenue Code and similar state authority.
Management has assessed the realizable value of the Company's deferred tax
assets of $55.4 million and determined that a valuation allowance of $25.3
million was necessary as of December 31, 2002 to, along with deferred tax
liabilities of $3.3 million, reduce the net deferred tax asset to $26.8 million,
an amount which management believes is more likely than not to be realized. In
reaching this conclusion, management noted that internal projections indicate
that the Company will generate sufficient taxable income to realize the net
deferred tax assets within three to four years.
69
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
K. SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NONCASH ACTIVITIES
Cash payments for interest amounted to $2.2 million, $2.1 million and $.6
million for 2002, 2001, and 2000, respectively. The Company made cash payments
for income taxes of $21,000 in 2002. The Company received net tax refunds of $.1
million and $3.3 million in 2001 and 2000, respectively.
In 2001, the Company distributed $28.5 million of net assets, as adjusted,
in connection with the Spin-Off of PracticeWorks (see Note C).
In 2001 and 2000, the Company acquired certain property and equipment with
an aggregate value of $.2 million and $1.1 million, respectively, in exchange
for indebtedness including mortgage and capital lease obligations.
In 2001, the Company settled a note payable and price protection feature
relating to the 1998 acquisition of the Healthcare Systems unit of the Reynolds
and Reynolds Company by issuing 500,000 shares of VitalWorks common stock.
In 2002, 2001, and 2000, the Company authorized contributions of $.8
million (plus $.3 million in cash), $1.1 million and $1.3 million, respectively,
to the employee savings plan, which were made in VitalWorks common stock in the
following year.
In 2000, pursuant to a February 2000 agreement with the Company, WebMD
Corporation exercised its rights to preferred stock of a wholly-owned subsidiary
of the Company into 1,929,012 shares of VitalWorks common stock. The shares of
common stock were issued on March 2, 2001.
In 2000, the Company received notes receivable of approximately $6.6
million from certain then-directors of the Company related to the exercise of
stock options. In addition, the Company received 112,500 shares of its common
stock into treasury in exchange for the grant of a license agreement for one of
the Company's products.
L. SEGMENT INFORMATION
The Company has identified two reportable operating segments: software
licenses and system sales, and maintenance and services. Software license fees
and system revenues are derived from the sale of software product licenses and
computer hardware. Maintenance and services revenues come from providing ongoing
product support, training and transaction processing services.
The Company's president and chief executive officer evaluates performance
based on measures of segment revenues, gross profit and company-wide operating
results. Employee headcount and operating costs and expenses are managed by
functional areas, rather than by revenue segments. Moreover, the Company does
not account for or report to the president and CEO its assets or capital
expenditures by segments.
The accompanying statements of operations and related notes disclose the
financial information of the Company's reportable segments for the three years
ended December 31, 2002.
The Company markets its products and services primarily to three types of
physician practices: ambulatory imaging centers and radiology practices, as well
as anesthesiology practices; large general and emergency medicine practices,
such as physician networks, clinics and management service organizations that
include ten or more doctors; and small group practices of fewer than ten doctors
that serve a local community, including ophthalmology, dermatology and general
medicine practices.
70
VITALWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
M. QUARTERLY RESULTS OF OPERATIONS (Unaudited)
The following is a tabulation of the unaudited quarterly results of
operations for the two years ended December 31, 2002:
THREE MONTHS ENDED
------------------------------------------------------------ YEAR ENDED
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 DECEMBER 31
-------- -------- ------------ ----------- -----------
(In thousands, except per share data)
2002
Total revenues .............................. $ 28,208 $ 28,902 $ 28,656 $ 29,045 $ 114,811
Gross profit ................................ 21,070 21,319 20,899 20,804 84,092
Net income .............................. $ 7,631(a) $ 8,299(a) $ 4,135 $ 4,085 $ 24,150
======== ======== ============ =========== ===========
Average number of shares outstanding
Basic ................................... 39,136 40,865 43,284 43,354 41,592
Diluted ................................. 47,211 49,690 50,385 47,727 48,850
Earnings per share
Basic ................................... $ 0.19 $ 0.20 $ 0.10 $ 0.09 $ 0.58
======== ======== ============ =========== ===========
Diluted ................................. $ 0.16 $ 0.17 $ 0.08 $ 0.09 $ 0.49
======== ======== ============ =========== ===========
2001
Total revenue ............................... $ 25,678 $ 25,924 $ 27,259(c) $ 28,192 $ 107,053
Gross profit ................................ 19,213 19,464 21,753(c) 20,955 81,385
Loss from continuing operations ............. (13,672)(b) (4,877) (1,668)(c) (2,219)(d) (22,436)
Loss from discontinued operations ........... (5,384) (5,384)
-------- -------- ------------ ----------- -----------
Net loss ................................ $(19,056) $ (4,877) $ (1,668) $ (2,219) $ (27,820)
======== ======== ============ =========== ===========
Average number of shares outstanding
Basic and diluted ....................... 35,406 37,202 38,327 38,907 37,477
Earnings (loss) per share - basic and diluted
Continuing operations ................... $ (0.39) $ (0.13) $ (0.04) $ (0.06) $ (0.60)
Discontinued operations ................. (0.15) (0.14)
-------- -------- ------------ ----------- -----------
$ (0.54) $ (0.13) $ (0.04) $ (0.06) $ (0.74)
======== ======== ============ =========== ===========
- ----------
(a) In the June 2002 quarter and in July 2002, the Company received final
payments from three former directors satisfying their outstanding loans
from VitalWorks, including interest. Consequently, the Company recorded a
credit of $6.0 million ($3.0 million each in the March and June quarters)
reflecting a complete reversal of the allowance for loan losses
established in March 2001, and related interest income of $1.1 million
($.5 million and $.6 million in the March and June quarters,
respectively). The June quarter also reflects a savings of $.5 million in
connection with the early termination of an office lease for a facility
closed in March 2001.
(b) In the quarter, the Company recognized impairment charges and incurred
other nonrecurring costs of $7.7 million consisting primarily of the $6.0
million provision for loan losses, $.9 million for unused equity
financing, and retention bonuses of $.4 million for terminated employees.
(c) In the quarter, the Company recognized $1.6 million of EDI transaction
revenues, and recovered certain EDI processing costs and legal fees of
$1.0 million in connection with the settlement of a contract dispute with
an EDI supplier.
(d) In the quarter, the Company incurred and accrued settlement costs,
including legal fees, of $1.4 million in connection with a legal
proceeding.
71
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
Board of Directors and Stockholders
VitalWorks Inc.
The audits referred to in our report dated January 20, 2003, February 27,
2003 for Note H, relating to the consolidated financial statements of VitalWorks
Inc., and Subsidiaries, which is contained in Item 8 of this Form 10-K, included
the audits of the schedule listed under Item 15(a)(2). This financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on this financial statement schedule based on our
audits.
In our opinion, such schedule presents fairly, in all material respects,
the information set forth therein.
BDO Seidman, LLP
New York, New York
January 20, 2003
72
ITEM 15(a)(2). FINANCIAL STATEMENT SCHEDULE
VITALWORKS INC.
SCHEDULE II -
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED BALANCE AT
BEGINNING COSTS AND TO OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
- ------------------------------------------------------ ---------- ---------- -------- ---------- ----------
ALLOWANCE FOR DOUBTFUL ACCOUNTS,
RETURNS AND DISCOUNTS
Year ended December 31, 2002 $ 1,800 1,371 1,444(a) (2,715)(b) $ 1,900
Year ended December 31, 2001 1,936 2,296 900(a) (3,332)(b) 1,800
Year ended December 31, 2000 3,183 1,883 (3,130)(b) 1,936
DEFERRED TAX ASSET VALUATION
ALLOWANCE
Year ended December 31, 2002 $ 23,001 10,546(d) (8,276)(e) $ 25,271
Year ended December 31, 2001 16,495 6,506(c) 23,001
Year ended December 31, 2000 16,495(c) 16,495
ALLOWANCE FOR NOTES RECEIVABLES
FROM FORMER DIRECTORS
Year ended December 31, 2002 $ 6,000 $ (6,000)(f)
Year ended December 31, 2001 6,000 6,000
Year ended December 31, 2000
- ----------
(a) Charged to revenues
(b) Write-offs, returns and discounts, net of recoveries
(c) Net operating loss carryforwards
(d) Net operating loss carryforwards relating to the exercise of employee
stock options, and other adjustments of $565
(e) Recognition of deferred tax assets
(f) Credit due to change in accounting estimate
All financial statement schedules not listed are omitted because they are
inapplicable or the requested information is shown in the financial statements
of the registrant or in the accompanying notes.
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on this 27th day of
March, 2003.
VitalWorks Inc.
By: /s/ MICHAEL A. MANTO
------------------------------------
Michael A. Manto
Executive Vice President and Chief
Financial Officer
By: /s/ JOSEPH M. WALSH
------------------------------------
Joseph M. Walsh
Chairman and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Joseph M. Walsh and Michael A. Manto, and each of
them, his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Annual Report on Form
10-K, and all documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or his or
their substitute or substitutes, may lawfully do or cause to be done by virtue
hereof. Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JOSEPH M. WALSH President, Chief Executive March 27, 2003
- -------------------------------- Officer and Chairman of the
Joseph M. Walsh Board of Directors
(Principal Executive
Officer)
/s/ MICHAEL A. Manto Executive Vice President, March 27, 2003
- -------------------------------- Chief Financial Officer and
Michael A. Manto Director (Principal
Financial and Accounting
Officer)
/s/ STEPHEN N. KAHANE M.D., M.S. Chief Strategy Officer, Vice March 27, 2003
- -------------------------------- Chairman and Director
Stephen N. Kahane M.D., M.S.
/s/ KENNETH R. ADAMS Director March 27, 2003
- --------------------------------
Kenneth R. Adams
/s/ STEPHEN J. DENELSKY Director March 27, 2003
- --------------------------------
Stephen J. DeNelsky
/s/ DAVID B. SHEPHERD Director March 27, 2003
- --------------------------------
David B. Shepherd
74
CERTIFICATIONS
I, Joseph M. Walsh, Chairman and Chief Executive Officer of the Company, certify
that:
1. I have reviewed this annual report on Form 10-K of VitalWorks Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Joseph M. Walsh March 27, 2003
------------------------------------ --------------
Joseph M. Walsh Date
Chairman and Chief Executive Officer
(principal executive officer)
75
I, Michael A. Manto, Executive Vice President and Chief Financial Officer of the
Company, certify that:
1. I have reviewed this annual report on Form 10-K of VitalWorks Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Michael A. Manto March 27, 2003
------------------------------------ --------------
Michael A. Manto Date
Executive Vice President and Chief
Financial Officer
(principal financial officer)
76