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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
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 of (I.R.S. Employer
incorporation or organization) Identification No.)
239 ETHAN ALLEN HIGHWAY, RIDGEFIELD, CT 06877
(Address of principal executive offices, including zip code)
(203) 894-1300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES |X| NO | |
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES |X| NO | |
As of May 12, 2003 there were 42,980,159 shares of the registrant's common
stock, $.001 par value, outstanding.
VITALWORKS INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (unaudited)
Report of Independent Certified Public Accountants......................... 2
Condensed Balance Sheets --
March 31, 2003 and December 31, 2002..................................... 3
Condensed Statements of Income --
Three Months Ended March 31, 2003 and 2002............................... 4
Condensed Statements of Cash Flows --
Three Months Ended March 31, 2003 and 2002............................... 5
Notes to Condensed Financial Statements --
March 31, 2003.......................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk............ 29
Item 4. Controls and Procedures .............................................. 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 29
Item 5. Other Information..................................................... 30
Item 6. Exhibits and Reports on Form 8-K...................................... 30
SIGNATURES.................................................................... 32
CERTIFICATIONS ............................................................... 33
For further information, refer to the VitalWorks Inc. annual report on
Form 10-K filed on March 31, 2003. VitalWorks and RadConnect are
registered trademarks of VitalWorks Inc. All other trademarks and company
names mentioned are the property of their respective owners.
Report of Independent Certified Public Accountants
Board of Directors and Stockholders
VitalWorks Inc.
We have reviewed the condensed balance sheet of VitalWorks Inc. as of
March 31, 2003 and the related condensed statements of income and cash flows for
the three-month periods ended March 31, 2003 and 2002, included in the
accompanying Securities and Exchange Commission Form 10-Q for the period ended
March 31, 2003. These financial statements are the responsibility of the
Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the condensed financial statements referred to above for them
to be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with auditing standards
generally accepted in the United States of America, the balance sheet as of
December 31, 2002, and the related statements of income, stockholders' equity
and cash flows for the year then ended (not presented herein); and in our report
dated January 20, 2003, and February 27, 2003 for Note H, we expressed an
unqualified opinion on those financial statements. In our opinion, the
information set forth in the accompanying condensed balance sheet as of December
31, 2002 is fairly stated in all material respects in relation to the balance
sheet from which it has been derived.
/s/ BDO Seidman, LLP
New York, New York
April 21, 2003
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VitalWorks Inc.
Condensed Balance Sheets
(in thousands, except share data)
MARCH 31, DECEMBER 31,
2003 2002
----------- -----------
ASSETS (unaudited) (Note)
Current assets:
Cash and cash equivalents $ 39,552 $ 39,474
Accounts receivable, net of allowances of $1,700 and $1,900 12,897 14,130
Computer hardware held for resale 1,068 629
Deferred income taxes, net 1,578 1,578
Prepaid expenses and other current assets 1,616 1,660
--------- ---------
TOTAL CURRENT ASSETS 56,711 57,471
Property and equipment, at cost, less accumulated
depreciation and amortization of $9,626 and $9,026 4,335 4,542
Goodwill 20,256 20,256
Product development and deferred finance costs, less
accumulated amortization of $1,522 and $1,049 8,965 9,049
Deferred income taxes, net 25,172 25,172
Other assets 921 641
--------- ---------
Total assets $ 116,360 $ 117,131
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 11,654 $ 10,630
Accrued employee compensation and benefits 1,854 4,636
Accrued restructuring costs 981 1,107
Deferred revenue, including unearned discounts of $1,586 and $1,478 8,709 9,578
Current portion of long-term debt 4,172 4,300
--------- ---------
TOTAL CURRENT LIABILITIES 27,370 30,251
Long-term debt 13,357 14,641
Other liabilities, primarily unearned discounts re: outsourced printing services 11,335 11,806
COMMITMENTS AND CONTINGENCIES - NOTE E
Stockholders' equity:
Preferred stock $.001 par value; 2,000,000 shares authorized;
none issued
Common stock $.001 par value; 200,000,000 shares authorized;
44,925,273 and 44,605,944 shares issued 45 45
Additional paid-in capital 204,320 203,173
Accumulated deficit (133,595) (136,313)
Treasury stock, at cost, 1,985,502 shares (6,472) (6,472)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 64,298 60,433
--------- ---------
Total liabilities and stockholders' equity $ 116,360 $ 117,131
========= =========
Note: The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date.
See accompanying notes.
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VitalWorks Inc.
Condensed Statements of Income (unaudited)
(in thousands, except per share data)
THREE MONTHS ENDED
MARCH 31,
2003 2002
-------- --------
REVENUES
Maintenance and services $ 22,530 $ 21,165
Software licenses and system sales 6,043 7,043
-------- --------
Total revenues 28,573 28,208
-------- --------
COSTS AND EXPENSES
Cost of revenues:
Maintenance and services 6,206 5,544
Software licenses and system sales, includes
amortization of product development costs
of $428 and $122 2,719 1,594
Selling, general and administrative 12,248 12,614
Research and development 3,847 3,175
Depreciation and amortization 555 604
Credit for loan losses (3,000)
-------- --------
25,575 20,531
-------- --------
OPERATING INCOME 2,998 7,677
Interest income 91 570
Interest expense (321) (591)
-------- --------
INCOME BEFORE INCOME TAXES 2,768 7,656
Provision for income taxes 50 25
-------- --------
NET INCOME $ 2,718 $ 7,631
======== ========
EARNINGS PER SHARE
Basic $ 0.06 $ 0.19
Diluted $ 0.06 $ 0.16
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 42,716 39,136
Diluted 46,391 47,211
See accompanying notes.
-4-
VitalWorks Inc.
Condensed Statements of Cash Flows (unaudited)
(in thousands)
THREE MONTHS ENDED
MARCH 31,
2003 2002
-------- --------
OPERATING ACTIVITIES
Net income $ 2,718 $ 7,631
Adjustments to reconcile net income to cash provided by
operating activities:
Credit for loan losses (3,000)
Depreciation and amortization 555 604
Provisions for bad debts, returns and discounts 507 678
Amortization of deferred finance costs, charged to interest expense 45 151
Amortization of product development costs 428 122
Changes in operating assets and liabilities:
Accounts receivable 726 (2,085)
Computer hardware held for resale, prepaid expenses and other (514) 15
Accounts payable, accrued costs and expenses (723) 173
Deferred revenue (977) (197)
Unearned discounts re: outsourced printing services (342) (311)
Interest income on notes receivable from former directors (514)
-------- --------
CASH PROVIDED BY OPERATING ACTIVITIES 2,423 3,267
-------- --------
INVESTING ACTIVITIES
Product development costs (715) (751)
Proceeds from sale of office buildings 90 1,369
Purchases of property and equipment (343) (124)
Security deposit (308)
-------- --------
CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (1,276) 494
-------- --------
FINANCING ACTIVITIES
Long-term debt:
(Payments) (1,413) (28,900)
Proceeds 27,450
Loan payments from former directors 1,528
Exercise of stock options by employees 344 300
Deferred finance costs (533)
-------- --------
CASH USED IN FINANCING ACTIVITIES (1,069) (155)
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 78 3,606
Cash and cash equivalents at beginning of period 39,474 12,988
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 39,552 $ 16,594
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid, net of refunds $ 127 $ 51
Interest paid 196 865
See accompanying notes.
-5-
VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
March 31, 2003
A. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
only of normal recurring accruals, considered necessary for a fair presentation
have been included in the accompanying unaudited financial statements. Operating
results for the three-month period ended March 31, 2003 are not necessarily
indicative of the results that may be expected for the full year ending December
31, 2003. For further information, refer to the financial statements and
footnotes thereto for the year ended December 31, 2002 included in the
VitalWorks Inc. (the "Company" or "VitalWorks") annual report on Form 10-K filed
on March 31, 2003. Certain prior period amounts in the condensed statement of
income have been reclassified to conform to the 2003 presentation.
B. STOCK-BASED COMPENSATION
The Company accounts for employee 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 and the number of
shares is fixed. The weighted-average estimated grant date fair value, as
defined by Financial Accounting Standards Board Statement 123, of options
granted in the three-month period ended March 31, 2003 was $2.30, 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 net income and the related earnings
per share for the three-month period ended March 31, 2003 if the Company had
applied the fair value recognition provisions of Statement 123, as amended, to
stock-based employee compensation (in thousands, except per share data):
Net income, as reported $ 2,718
Less: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (1,085)
---------
Pro forma net income $ 1,633
=========
Earnings per share:
Basic - as reported $ 0.06
=========
Basic - pro forma $ 0.04
=========
Diluted - as reported $ 0.06
=========
Diluted - pro forma $ 0.04
=========
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 for the three-month period ended March
31, 2003:
Risk-free interest rate.................................... 2.5%
Expected dividend yield.................................... 0.0%
Expected stock price volatility............................ 77.3%
Weighted average expected life (in years).................. 4
-6-
VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
March 31, 2003
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.
C. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share ("EPS") (in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31,
2003 2002
------- -------
Numerator:
Net income $ 2,718 $ 7,631
======= =======
Denominator:
Basic EPS - weighted-average shares 42,716 39,136
Effect of dilutive securities, stock option
and warrant rights 3,675 8,075
------- -------
Diluted EPS - adjusted weighted-average
shares and assumed conversions 46,391 47,211
======= =======
Basic EPS $ 0.06 $ 0.19
Diluted EPS $ 0.06 $ 0.16
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.6 million common shares with exercise prices ranging from
$3.90 to $17.84 per share were excluded from the diluted EPS calculation for the
three-month period ended March 31, 2003.
D. 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 is equivalent to its net income.
-7-
VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
March 31, 2003
E. COMMITMENTS AND CONTINGENT MATTERS
In April 2003, VitalWorks entered into an agreement to acquire program
source code, object code, and engineering services from an independent software
development firm. A monthly fee of approximately $.3 million ($3 million per
annum) for development services will be incurred during the term ending January
2006. Also, during the term, the Company is obligated to pay royalty fees of up
to $5 million based on related software license sales.
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 (see accompanying balance sheets) that are recognized as an
offset to cost of maintenance and services revenues as the minimum volume
commitments are fulfilled. In April 2003, the Company's arrangement with NDC was
amended such that commencing in June 2003, the quarterly minimum volume
commitments will be reduced. In turn, the Company agreed to refund $4.3 million
of unearned discounts. The new quarterly commitment approximates 60% of the
Company's current aggregate transaction level.
From time to time, in the normal course of business, various claims are
made against the Company. Except for the 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. Three additional complaints containing substantially
similar causes of action as the above referenced matter were served against
VitalWorks on April 30, 2003.
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.
-8-
VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
March 31, 2003
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).
F. ACCRUED RESTRUCTURING COSTS
In August 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 nature of the restructuring accrual as of December 31, 2002 and March
31, 2003 was primarily the total cost of future payments that remained
outstanding under lease commitments regarding certain of the offices that were
closed. In the quarter ended March 31, 2003, lease payments of $.1 million were
applied against the accrual.
G. STOCKHOLDERS' EQUITY AND NONCASH ACTIVITIES
In the quarter ended March 31, 2003, the Company issued 319,329 shares of
its common stock, consisting of 120,267 shares in connection with the exercise
of stock options by certain employees, and 199,062 shares with respect to the
Company-sponsored employee savings plan. As a result, the Company recognized
$1.1 million as a credit to additional paid-in capital.
H. 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, implementation, training and transaction processing services.
The accompanying statements of income disclose the financial information of the
Company's reportable segments for the three-month periods ended March 31, 2003
and 2002. The Company does not account for or report its assets or capital
expenditures by segments.
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
generally include ten or more doctors; and small group practices of generally
fewer than ten doctors that serve a local community, including ophthalmology,
dermatology and general medicine practices.
-9-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Except for the historical information contained in this Quarterly Report
on Form 10-Q, 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, including the assumption that
there will be no further deterioration in the IT-spending environment. However,
these forward-looking statements 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 Quarterly
Report on Form 10-Q. You should also consider the forward-looking statements
contained in this document in light of the cautionary language contained in our
other filings with the Securities and Exchange Commission, including our 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;
- changes in the mix of products and or services sold;
- 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
-10-
our business arrangements and practices;
- changes in customer purchasing patterns;
- changing economic, political and regulatory conditions, particularly
with respect to the IT-spending environment;
- competition, including alternative product and service offerings,
and price pressure;
- customer attrition;
- 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, which are very difficult
to forecast. 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 certain requirements of the Health
Insurance Portability and Accountability Act of 1996, or 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
-11-
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 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 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 May 12, 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;
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- 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 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
TECHNOLOGIES, 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 technologies 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.
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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 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.
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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 additional 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, any 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 and or deliver services that would
enable HIPAA compliance for our current and prospective customers could put us
at a significant disadvantage in the marketplace. Accordingly, our business, and
the sale of our products and services, could be materially harmed by failures
with respect to 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.
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
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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 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.
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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 THAT ARE ATTRIBUTABLE TO ITS ACTIONS. 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.
In March 2001, we spun-off our former dental practice management software
business, PracticeWorks, Inc. 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
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
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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 MODIFY
OR ISSUE 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.
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.
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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
generally include ten or more doctors; and
- small group practices of generally fewer than ten doctors that serve
a local community, including ophthalmology, dermatology and general
medicine practices.
In the first quarter of 2003 and in 2002, approximately 40% of our
revenues were derived from the radiology/anesthesiology market and 30% from each
of our other markets. Revenues from the small group market are skewed more
towards maintenance and services.
RESULTS OF OPERATIONS
REVENUES
First Quarter Ended
March 31, 2003 CHANGE 2002
- --------- ---- ------ ----
(dollars in thousands)
Maintenance and services $22,530 6.4% $21,165
Percentage of total revenues 78.9% 75.0%
Software licenses and system sales $ 6,043 (14.2)% $ 7,043
Percentage of total revenues 21.1% 25.0%
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.
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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.
The increase in maintenance and services revenues is mainly attributable
to an increase in implementation and training services revenues of $1.7 million,
including $.9 million relating to HIPAA compliance. The increase was partially
offset by a $.5 million decline in maintenance revenues related to customer
attrition.
Software license and system revenues declined primarily as a result of a
decrease in the number of licenses and systems sold (unit volume versus, for
example, price decreases), particularly software products marketed to larger
physician 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, which are very difficult to
forecast. 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 certain requirements 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.
COST OF REVENUES
First Quarter Ended
March 31, 2003 CHANGE 2002
- --------- ---- ------ ----
(dollars in thousands)
Maintenance and services $6,206 11.9% $5,544
Percentage of maintenance and services
revenue 27.5% 26.2%
Software licenses and system sales $2,719 70.6% $1,594
Percentage of software licenses and
system sales 45.0% 22.6%
Cost of maintenance and services revenues consists primarily of the cost
of EDI insurance claims processing, outsourced hardware maintenance and EDI
billing and statement printing services, and postage. The increase principally
reflects additional costs incurred with respect to an arrangement with an EDI
supplier.
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 amortization of
product development costs. The increase is largely attributable to $.3 million
of additional software royalties and an increase in amortization of product
development costs of $.3 million.
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OPERATING EXPENSES
First Quarter Ended
March 31, 2003 CHANGE 2002
- --------- ---- ------ ----
(dollars in thousands)
Selling, general and administrative $12,248 (2.9)% $12,614
Percentage of total revenues 42.9% 44.7%
Research and development $ 3,847 21.2% $ 3,175
Percentage of total revenues 13.5% 11.3%
Depreciation and amortization $ 555 (8.1)% $ 604
Percentage of total revenues 1.9% 2.1%
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. Selling, general and administrative
expenses declined slightly primarily due to a decrease in variable compensation
expense of $.3 million and bad debt expense of $.3 million. Our employee-base
average has remained substantially unchanged.
The increase in research and development expenses is mainly attributable
to additional personnel costs and third-party software developer fees associated
with our expanded product research and development activities. For the three
months ended March 31, 2003 and 2002, we capitalized $.4 million (or 9.2% of
total research and development expenditures) and $.8 million (or 19.1% 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.
The decrease in depreciation and amortization expense reflects the fact
that certain assets became fully depreciated in 2002.
In April 2002, we received payments from a former officer and director
totaling $6.2 million satisfying his outstanding loans from us, including
interest. Consequently, we recorded a credit of $3.0 million in March 2002
reflecting a reduction of the allowance for loan losses established a year
earlier.
INTEREST INCOME (EXPENSE)
First Quarter Ended
March 31, 2003 CHANGE 2002
- --------- ---- ------ ----
(dollars in thousands)
Interest income $ 91 (84.0)% $570
Interest expense (321) (45.7)% (591)
The decrease in interest income reflects $.5 million of interest
recognized in 2002 in connection with the recovery of the notes receivable from
a former officer and director.
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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 is due to a decline in both the outstanding principal balances
and associated interest rates under our credit agreement.
INCOME TAXES
For the three-month periods ended March 31, 2003 and 2002, we recorded
income tax provisions of $50,000 and $25,000, respectively. Management has
assessed the realizable value of our deferred tax assets of $54.2 million and
determined that a valuation allowance of $24.1 million was necessary as of March
31, 2003 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 is expected to remain at less than 2% for
the rest of 2003 due primarily to utilization of net operating loss
carryforwards.
NET INCOME
As a result of the above factors, net income for the three-month period
ended March 31, 2003 decreased to $2.7 million from $7.6 million for the
corresponding period of 2002.
To date, the overall impact of inflation on us has not been material.
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 the three months ended March 31, 2003, and for fiscal years
2002, 2001 and 2000, we generated positive cash flows from operations of $2.4
million, $20.8 million, $18.2 million and $12.8 million, respectively.
Days sales outstanding (calculated as accounts receivable, net of
allowances, divided by quarterly revenues multiplied by 90 days) for the first
quarter of 2003 was 41 days, down from 45 days for the corresponding March 2002
quarter. Looking forward, assuming license and systems sales increase, we would
then expect our days sales outstanding to range from 50 to 60 days.
Investing activities for the three months ended March 31, 2003 resulted in
a use of cash of $1.3 million. This total includes $.7 million used for software
development costs, $.3 million used primarily for purchases of computer
equipment and software, and a $.3 million security deposit.
Cash used in financing activities for the three months ended March 31,
2003 amounted to $1.1 million consisting of $1.4 million of principal payments
of long-term debt, partly offset by $.3 million of payments received in
connection with the exercise of stock options by employees.
As of March 31, 2003, we had cash and cash equivalents of $39.6 million
and $17.5 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
-22-
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.
The following table summarizes, as of March 31, 2003, the general timing
of future payments under our outstanding loan agreement, lease agreements that
include noncancellable terms, and other long-term contractual obligations.
PAYMENTS DUE BY PERIOD
------------------------------------------------------------------------------------
TOTALS 2003 2004 2005 2006 THEREAFTER
------- ------- ------- ------- ------- ----------
(in thousands)
Long-term debt................... $17,000 $ 2,500 $ 2,500 $12,000
Operating leases................. 7,717 1,896 1,927 $ 1,395 1,384 $ 1,115
Capital leases................... 528 387 127 14
Other long-term liabilities...... 623 162 321 130 10
------- ------- ------- ------- ------- -------
$25,868 $ 4,783 $ 4,716 $ 1,730 $13,514 $ 1,125
======= ======= ======= ======= ======= =======
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 for the
remainder of 2003, estimated to be approximately $.5 million, will be made half
in cash and half in shares of our common stock.
In April 2003, we entered into an agreement to acquire program source
code, object code, and engineering services from an independent software
development firm. A monthly fee of approximately $.3 million ($3 million per
annum) for development services will be incurred during the term ending January
2006. Also, during the term, we are obligated to pay royalty fees of up to $5
million based on related software license sales.
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
sheets) that are recognized as an offset to cost of maintenance and services
revenues as the minimum volume commitments are fulfilled. In April 2003, our
arrangement with NDC was amended such that commencing in June 2003, the
quarterly minimum volume commitments will be reduced. In turn, we agreed to
refund $4.3 million of unearned discounts. The new quarterly commitment
approximates 60% of our current aggregate transaction level.
-23-
We anticipate capital expenditures of approximately $4 million for the
remainder of 2003, including software development costs of approximately $2
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. We did not repurchase any shares in
the first quarter of 2003. As of May 12, 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 the 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. Three
additional complaints containing substantially similar causes of action as the
above referenced matter were served against us on April 30, 2003.
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).
-24-
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.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based on our 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
-25-
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.
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.
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.
Stock-based Compensation. We account for employee 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 and the
number of shares is fixed. The weighted-average estimated grant date fair value,
as defined by Statement 123, of options granted in the three-month period ended
March 31, 2003 was $2.30, 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 net income
and the related earnings per share for the three-month period ended March 31,
2003 if we had applied the fair value recognition provisions of Statement 123,
as amended, to stock-based employee compensation (in thousands, except per share
data):
-26-
Net income, as reported $ 2,718
Less: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (1,085)
---------
Pro forma net income $ 1,633
=========
Earnings per share:
Basic - as reported $ 0.06
=========
Basic - pro forma $ 0.04
=========
Diluted - as reported $ 0.06
=========
Diluted - pro forma $ 0.04
=========
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 for the three-month period ended March 31, 2003:
Risk-free interest rate..................................... 2.5%
Expected dividend yield..................................... 0.0%
Expected stock price volatility............................. 77.3%
Weighted average expected life (in years)................... 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.
-27-
VitalWorks Inc.
Earnings Per Share. The following table sets forth the computation of
basic and diluted earnings per share ("EPS") (in thousands, except per share
data):
THREE MONTHS ENDED
MARCH 31,
2003 2002
------- -------
Numerator:
Net income $ 2,718 $ 7,631
======= =======
Denominator:
Basic EPS - weighted-average shares 42,716 39,136
Effect of dilutive securities, stock option
and warrant rights 3,675 8,075
------- -------
Diluted EPS - adjusted weighted-average
shares and assumed conversions 46,391 47,211
======= =======
Basic EPS $ 0.06 $ 0.19
Diluted EPS $ 0.06 $ 0.16
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.6 million common shares with exercise prices ranging from
$3.90 to $17.84 per share were excluded from the diluted EPS calculation for the
three-month period ended March 31, 2003.
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 adopted the provisions of Statement 145 in January 2003. Except
for a reclassification with respect to our 1999 statement of operations, the
adoption of Statement 145 did not have an impact on our financial statements.
-28-
VitalWorks Inc.
ITEM 3. 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 $17
million of our outstanding debt at March 31, 2003 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 March 31, 2003. 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 4. 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 Quarterly Report on Form 10-Q, 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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, in the normal course of business, various claims are
made against us. Except for the 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. Three
additional complaints containing substantially similar causes of action as the
above referenced matter were served against us on April 30, 2003.
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
-29-
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).
ITEM 5. OTHER INFORMATION
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 operating
results for the June 2002 quarter. The aggregate number of shares that may be
sold under Mr. Walsh's plan represents 11.3% of the number of shares, including
unvested option shares, then held by him. The plans of all other executive
officers have expired. Since March 6, 2001, approximately 11.7% of the aggregate
holdings of the executive officers was sold.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Description
- ----------- -----------
15 Letter regarding unaudited interim financial information from
BDO Seidman, LLP, independent certified public accountants.
-30-
VitalWorks Inc.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
We filed the following report on Form 8-K during the quarter
ended March 31, 2003:
Current Report on Form 8-K filed with the Securities and
Exchange Commission on March 5, 2003 with respect to our
announcement that a purported class action complaint was filed
in the United States District Court for the District of
Connecticut against us and three of our executive officers.
-31-
VitalWorks Inc.
Form 10-Q for the Three-month Period Ended March 31, 2003
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VitalWorks Inc.
/s/ Michael A. Manto 5/14/03
-----------------------------------------------
Michael A. Manto Date
Executive Vice President and
Chief Financial Officer
/s/ Joseph M. Walsh 5/14/03
-----------------------------------------------
Joseph M. Walsh Date
Chairman and Chief Executive Officer
-32-
VitalWorks Inc.
Form 10-Q for the Three-month Period Ended March 31, 2003
CERTIFICATIONS
I, Joseph M. Walsh, Chairman and Chief Executive Officer of the Company, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of VitalWorks
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 we 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 quarterly 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 quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly 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 quarterly 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 5/14/03
-----------------------------------------------
Joseph M. Walsh Date
Chairman and Chief Executive Officer
(principal executive officer)
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VitalWorks Inc.
Form 10-Q for the Three-month Period Ended March 31, 2003
I, Michael A. Manto, Executive Vice President and Chief Financial Officer of the
Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of VitalWorks
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 we 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 quarterly 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 quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly 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 quarterly 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 5/14/03
--------------------------------------------
Michael A. Manto Date
Executive Vice President
and Chief Financial Officer
(principal financial officer)
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