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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 JUNE 30, 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 August 11, 2003 there were 43,180,542 shares of the registrant's
common stock, $.001 par value, outstanding.
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VITALWORKS INC.
FORM 10-Q
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INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (unaudited)
Report of Independent Certified Public Accountants.........................2
Condensed Balance Sheets--
June 30, 2003 and December 31, 2002......................................3
Condensed Statements of Income--
Three and Six Months Ended June 30, 2003 and 2002........................4
Condensed Statements of Cash Flows--
Six Months Ended June 30, 2003 and 2002..................................5
Notes to Condensed Financial Statements--
June 30, 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...........30
Item 4. Controls and Procedures .............................................30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................30
Item 4. Submission of Matters to a Vote of Security Holders..................31
Item 5. Other Information....................................................32
Item 6. Exhibits and Reports on Form 8-K.....................................32
SIGNATURES...................................................................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 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
June 30, 2003 and the related condensed statements of income for the three and
six-month periods ended June 30, 2003 and 2002, and cash flows for the six-month
periods ended June 30, 2003 and 2002, included in the accompanying Securities
and Exchange Commission Form 10-Q for the period ended June 30, 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
July 21, 2003
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VitalWorks Inc.
Condensed Balance Sheets
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2003 2002
-----------------------
ASSETS (UNAUDITED) (NOTE)
Current assets:
Cash and cash equivalents $ 36,720 $ 39,474
Accounts receivable, net of allowances of $1,900 12,788 14,130
Computer hardware held for resale 1,023 629
Deferred income taxes, net 1,682 1,578
Prepaid expenses and other current assets 2,396 1,660
-----------------------
TOTAL CURRENT ASSETS 54,609 57,471
Property and equipment, at cost, less accumulated
depreciation and amortization of $10,248 and $9,026 3,935 4,542
Goodwill 20,256 20,256
Product development and deferred finance costs, less
accumulated amortization of $1,995 and $1,049 8,780 9,049
Deferred income taxes, net 25,068 25,172
Other assets 797 641
-----------------------
Total assets $ 113,445 $ 117,131
=======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 10,493 $ 10,630
Accrued employee compensation and benefits 2,080 4,636
Accrued restructuring costs 771 1,107
Deferred revenue, including unearned discounts of $1,200 and $1,478 7,583 9,578
Current portion of long-term debt 4,909 4,300
-----------------------
TOTAL CURRENT LIABILITIES 25,836 30,251
Long-term debt 12,079 14,641
Other liabilities, primarily unearned discounts re: outsourced printing
services 6,600 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;
45,051,863 and 44,605,944 shares issued 45 45
Additional paid-in capital 204,716 203,173
Accumulated deficit (129,359) (136,313)
Treasury stock, at cost, 1,985,502 shares (6,472) (6,472)
-----------------------
TOTAL STOCKHOLDERS' EQUITY 68,930 60,433
-----------------------
Total liabilities and stockholders' equity $ 113,445 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
----------------------- -----------------------
REVENUES
Maintenance and services $ 22,569 $ 21,229 $ 45,099 $ 42,394
Software licenses and system sales 5,619 7,673 11,662 14,716
----------------------- -----------------------
Total revenues 28,188 28,902 56,761 57,110
----------------------- -----------------------
COSTS AND EXPENSES
Cost of revenues:
Maintenance and services 5,538 5,376 11,744 10,920
Software licenses and system sales, includes
amortization of product development costs
of $427, $265, $855 and $387 2,034 2,207 4,753 3,801
Selling, general and administrative 11,678 11,928 23,926 24,542
Research and development 3,850 3,565 7,697 6,740
Depreciation and amortization 573 630 1,128 1,234
Credit for loan losses -- (3,000) -- (6,000)
----------------------- -----------------------
23,673 20,706 49,248 41,237
----------------------- -----------------------
OPERATING INCOME 4,515 8,196 7,513 15,873
Interest income 73 649 164 1,219
Interest expense (302) (521) (623) (1,112)
----------------------- -----------------------
INCOME BEFORE INCOME TAXES 4,286 8,324 7,054 15,980
Provision for income taxes 50 25 100 50
----------------------- -----------------------
NET INCOME $ 4,236 $ 8,299 $ 6,954 $ 15,930
======================= =======================
EARNINGS PER SHARE
Basic $ 0.10 $ 0.20 $ 0.16 $ 0.40
Diluted $ 0.09 $ 0.17 $ 0.15 $ 0.33
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 42,998 40,865 42,858 40,006
Diluted 46,415 49,690 46,389 48,625
SEE ACCOMPANYING NOTES.
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VitalWorks Inc.
Condensed Statements of Cash Flows (unaudited)
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
2003 2002
-----------------------
OPERATING ACTIVITIES
Net income $ 6,954 $ 15,930
Adjustments to reconcile net income to cash provided by operating
activities:
Credit for loan losses -- (6,000)
Depreciation and amortization 1,128 1,234
Provisions for bad debts, returns and discounts 1,011 1,366
Amortization of deferred finance costs, charged to interest expense 90 194
Amortization of product development costs 855 387
Changes in operating assets and liabilities:
Accounts receivable 331 (4,271)
Computer hardware held for resale, prepaid expenses and other (1,595) (462)
Accounts payable, accrued costs and expenses (1,796) (475)
Deferred revenue (1,716) (570)
Unearned discounts re: outsourced printing services (5,002) (622)
-----------------------
CASH PROVIDED BY OPERATING ACTIVITIES 260 6,711
-----------------------
INVESTING ACTIVITIES
Product development costs (999) (2,380)
Proceeds from sale of office buildings 180 1,369
Purchases of property and equipment (512) (465)
Security deposit (308) --
-----------------------
CASH USED IN INVESTING ACTIVITIES (1,639) (1,476)
-----------------------
FINANCING ACTIVITIES
Long-term debt:
(Payments) (1,953) (30,321)
Proceeds -- 27,450
Loan payments from former directors -- 8,837
Exercise of stock options by employees 578 5,080
Deferred finance costs -- (523)
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CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,375) 10,523
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(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,754) 15,758
Cash and cash equivalents at beginning of period 39,474 12,988
---------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 36,720 $ 28,746
=====================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid, net of refunds $ 227 $ 61
Interest paid 450 1,297
SEE ACCOMPANYING NOTES.
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VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
June 30, 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 and six-month periods ended June 30, 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 second quarter and six months ended June 30, 2003 was $2.20 and
$2.24, 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 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):
SECOND QUARTER SIX MONTHS
ENDED ENDED
JUNE 30, 2003 JUNE 30, 2003
--------------------------------------------
Net income, as reported $4,236 $6,954
Less: total stock-based employee compensation
expense determined under fair value-based
method for all awards, net of related tax effects (1,096) (2,181)
---------------------- ---------------------
Pro forma net income $3,140 $4,773
====================== =====================
Earnings per share:
Basic - as reported $0.10 $0.16
====================== =====================
Basic - pro forma $0.07 $0.11
====================== =====================
Diluted - as reported $0.09 $0.15
====================== =====================
Diluted - pro forma $0.07 $0.11
====================== =====================
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VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
June 30, 2003
The fair value of the Company's employee stock options awarded in 2003
was estimated at the date of grant using the Black-Scholes option valuation
model with the following weighted average assumptions:
Risk-free interest rate.................................... 2.2% TO 2.5%
Expected dividend yield.................................... 0.0%
Expected stock price volatility............................ 75.4% TO 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 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):
SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
-------------------------------- --------------------------------
Numerator:
Net income $4,236 $8,299 $6,954 $15,930
================================ ================================
Denominator:
Basic EPS - weighted-average shares 42,998 40,865 42,858 40,006
Effect of dilutive securities, stock option
and warrant rights 3,417 8,825 3,531 8,619
-------------------------------- --------------------------------
Diluted EPS - adjusted weighted-average
shares and assumed conversions 46,415 49,690 46,389 48,625
================================ ================================
Basic EPS $0.10 $0.20 $0.16 $0.40
Diluted EPS $0.09 $0.17 $0.15 $0.33
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.7 million common shares (with exercise prices ranging from
$3.74 to $17.84 per share) and 1.6 million common shares (with exercise prices
ranging from $3.85 to $17.84 per share) were excluded from the diluted EPS
calculation for the three and six-month periods ended June 30, 2003,
respectively.
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.
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VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
June 30, 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 continues, for a fee, to
provide printing services for its physicians under the subcontracting
arrangement with NDC. The amended arrangement, which extends until April 2009,
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 2001 (in connection with the August 2000
agreement, the Company had received $8.8 million), 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 were
reduced. In turn, the Company refunded $4.3 million of unearned discounts. The
new quarterly commitment approximates 60% of the Company's current aggregate
transaction level. These discount amounts, received and refunded, have been
classified as cash provided by and used in operating activities.
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.
In August 2003, the Company was served with a summons and complaint as
part of a bankruptcy proceeding relating to a former business associate of the
Company. The complaint alleges that in 2001, the Company received a preference
payment from the business associate and seeks to avoid and recover the $.8
million payment made to 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. The Court has appointed a lead plaintiff and
lead attorney, and the Company's law firm was served with a consolidated
complaint on August 4, 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
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VitalWorks Inc.
Notes to Condensed Financial Statements (unaudited)
June 30, 2003
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. The plaintiffs have retained new counsel
and have served a second amended complaint upon the Company.
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
June 30, 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 six months ended June 30, 2003, the accrual was reduced by $.3
million consisting primarily of lease payments.
G. STOCKHOLDERS' EQUITY AND NONCASH ACTIVITIES
In the first half of 2003, the Company issued 445,919 shares of its
common stock, consisting of 213,428 shares in connection with the exercise of
stock options by certain employees, and 232,491 shares with respect to the
Company-sponsored employee savings plan. As a result, the Company recognized
$1.5 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 and six-month periods ended June 30,
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.
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VitalWorks Inc.
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:
o release of new products, product upgrades and services, and the rate of
adoption of these products and services by new and existing customers;
o timing of and costs related to development of our products;
o length of sales and delivery cycles;
o size and timing of orders for our products and services;
o changes in the mix of products and or services sold;
o availability of specified computer hardware for resale;
o deferral and/or realization of deferred software license and system
revenues according to contract terms;
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VitalWorks Inc.
o interpretations of accounting regulations, principles or concepts that are
or may be considered relevant to our business arrangements and practices;
o changes in customer purchasing patterns;
o changing economic, political and regulatory conditions, particularly with
respect to the IT-spending environment;
o competition, including alternative product and service offerings, and price
pressure;
o customer attrition;
o timing of and charges or costs associated with mergers, acquisitions or
other strategic events or transactions, completed or not completed;
o timing and levels of advertising and promotional expenditures;
o 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
o 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, our
Intuition(TM) product line of practice management and electronic medical records
systems, 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.
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VitalWorks Inc.
Moreover, these protections do not prevent independent third-party
development of competitive technology or services. Unauthorized parties may
attempt to copy or otherwise obtain and use our technology. Monitoring use of
our technology is difficult, and we cannot assure you that the steps we have
taken will prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US COULD BE COSTLY TO DEFEND
AND COULD DIVERT OUR MANAGEMENT'S ATTENTION AWAY FROM OUR BUSINESS.
As the number of software products and services in our target markets
increases and as the functionality of these products and services overlaps, we
may become increasingly subject to the threat of intellectual property
infringement claims. Any infringement claims alleged against us, regardless of
their merit, can be time consuming and expensive to defend. Infringement claims
may also divert our management's attention and resources and could also cause
delays in the delivery of our applications to our customers. Settlement of any
infringement claims could require us to enter into royalty or licensing
agreements on terms that are costly or cost-prohibitive. If a claim of
infringement against us was 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 August 11, 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 desirable
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:
o 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;
o diversion of our management's attention from our existing business;
o potential conflicts in customer and supplier relationships;
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VitalWorks Inc.
o our ability to coordinate organizations that are geographically diverse
and may have different business cultures;
o dilution to existing stockholders if we issue equity securities;
o assumption of liabilities or other obligations in connection with the
acquisition; and
o 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,
REVENUES AND OPERATING RESULTS WILL SUFFER.
The success of our business will depend in part on the market acceptance
of:
o new products and services, such as our radiology information system, or
RIS, and our Intuition(TM)product line, existing products and services;
and
o 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.
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.
Our inability to sell our new and next-generation software products to
healthcare providers that are in the market for healthcare information systems,
could have a material adverse effect on our business, revenues, operating
results, cash flows and financial condition. If new software sales do not
materialize, our maintenance and EDI services revenues can be expected to
decrease over time due to the combined effects of potential attrition of
existing clients and a shortfall in new client additions.
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:
o develop new or enhance existing products and services to meet our
customers' changing needs in a timely and cost-effective way; and
o respond effectively to technological changes, new product offerings,
product enhancements and new services of our competitors.
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VitalWorks Inc.
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.
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.
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VitalWorks Inc.
WE MAY BE SUBJECT TO CLAIMS RESULTING FROM THE ACTIVITIES OF OUR STRATEGIC
PARTNERS.
We rely on third parties to provide services critical to our business.
For example, we use national clearinghouses in the processing of insurance
claims and we outsource some of our hardware maintenance services and the
printing and delivery of patient billings for our customers. We also have
relationships with certain third parties where these third parties serve as
sales channels through which we generate a portion of our revenues. Due to these
third-party relationships, we could be subject to claims as a result of the
activities, products, or services of these third-party service providers even
though we were not directly involved in the circumstances leading to those
claims. Even if these claims do not result in liability to us, defending and
investigating these claims could be expensive and time-consuming, divert
personnel and other resources from our business and result in adverse publicity
that could harm our business.
WE ARE SUBJECT TO GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES, THE COMPLIANCE
WITH WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
HIPAA
Federal regulations have been adopted 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 and some are not
yet effective, there is uncertainty as to how they will be interpreted and
enforced.
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 our 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
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VitalWorks Inc.
expenditures on our part. Adoption of these types of legislation or other
changes to state or federal laws could materially affect or restrict the ability
of healthcare providers to submit information from patient records using our
products and services. These kinds of restrictions would likely decrease the
value of our applications to our customers, which could materially harm our
business.
CHANGES IN THE REGULATORY AND ECONOMIC ENVIRONMENT IN THE HEALTHCARE INDUSTRY
COULD CAUSE US TO LOSE REVENUE AND INCUR SUBSTANTIAL COSTS TO COMPLY WITH NEW
REGULATIONS.
The healthcare industry is highly regulated and is subject to changing
political, economic and regulatory influences. These factors affect the
purchasing practices and operations of healthcare organizations. Changes in
current healthcare financing and reimbursement systems could require us to make
unplanned enhancements of applications or services, or result in delays or
cancellations of orders or in the revocation of endorsement of our services by
our strategic partners and others. Federal and state legislatures have
periodically considered programs to reform or amend the U.S. healthcare system
at both the federal and state level. These programs may contain proposals to
increase governmental involvement in healthcare, lower reimbursement rates or
otherwise change the environment in which healthcare industry participants
operate. Healthcare industry participants may respond by reducing their
investments or postponing investment decisions, including investments in our
applications and services.
LARGER COMPETITORS AND CONSOLIDATION OF COMPETITORS COULD CAUSE US TO LOWER OUR
PRICES OR TO LOSE CUSTOMERS.
Our principal competitors include both national and regional practice
management and clinical systems vendors. Currently, the practice management and
clinical systems industry in the United States is characterized by a large
number of relatively small, regionally-focused companies, comprising a highly
fragmented industry with only a few national vendors. Until recently, larger,
national vendors have targeted primarily large healthcare providers. We believe
that the larger, national vendors may broaden their markets to include both
small and large healthcare providers. In addition, we compete with national and
regional providers of computerized billing, insurance processing and record
management services to healthcare practices. As the market for our products and
services expands, additional competitors are likely to enter this market. We
believe that the primary competitive factors in our markets are:
o product features and functionality;
o customer service, support and satisfaction;
o price;
o ongoing product enhancements; and
o 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.
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VitalWorks Inc.
Current and potential competitors may make strategic acquisitions or
establish cooperative relationships among themselves or with third parties,
thereby increasing the ability of their products to address the needs of our
existing and prospective customers. Further competitive pressures, such as those
resulting from competitors' discounting of their products, may require us to
reduce the price of our software and complementary products, which would
materially adversely affect our business, operating results, cash flows and
financial condition. There can be no assurance that we will be able to compete
successfully against current and future competitors, and the failure to do so
would have a material adverse effect upon our business, operating results, cash
flows and financial condition.
WE DEPEND ON PARTNERS/SUPPLIERS FOR DELIVERY OF ELECTRONIC DATA INTERCHANGE
(INSURANCE CLAIMS PROCESSING AND INVOICE PRINTING SERVICES), COMMONLY REFERRED
TO AS EDI, HARDWARE MAINTENANCE SERVICES AND SALES LEAD GENERATION. ANY FAILURE,
INABILITY OR UNWILLINGNESS OF THESE SUPPLIERS TO PERFORM THESE SERVICES COULD
NEGATIVELY IMPACT CUSTOMER SATISFACTION AND REVENUES.
We use various third-party suppliers to provide our customers with EDI
transactions and on-site hardware maintenance. EDI revenues 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.
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VitalWorks Inc.
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 OR ITS SUCCESSORS 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 or its successors
will have sufficient resources to fulfill its indemnification obligations and
even if it had the resources, we cannot assure you that PracticeWorks or its
successors will not refute its indemnifications altogether. In either case, if
we are not indemnified, we may incur substantial liabilities, which could have a
material adverse effect on our business, financial condition, cash flows and
results of operations.
OUR GROWTH COULD BE LIMITED IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.
We believe that our success depends largely on our ability to attract
and retain highly skilled technical, managerial and sales personnel to develop,
sell and implement our products and services. Individuals with the information
technology, managerial and selling skills we need to further develop, sell and
implement our products and services are in short supply and competition for
qualified personnel is particularly intense. We may not be able to hire the
necessary personnel to implement our business strategy, or we may need to pay
higher compensation for employees than we currently expect. We cannot assure you
that we will succeed in attracting and retaining the personnel we need to
continue to grow and to implement our business strategy. In addition, we depend
on the performance of our executive officers and other key employees. The loss
of any member of our senior management team could negatively impact our ability
to execute our business strategy.
IF OUR INTERPRETATION OF THE ACCOUNTING PRONOUNCEMENTS REGARDING REVENUE
RECOGNITION IS NOT CORRECT OR IF THE REGULATORS OF ACCOUNTING STANDARDS 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.
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VitalWorks Inc.
OVERVIEW
VitalWorks Inc. is a leading provider of information management
technology and services targeted to healthcare practices and organizations
throughout the United States. We provide IT-based solutions for general medical
practices and have specialty-specific products and services for practices such
as radiology, anesthesiology, ophthalmology, emergency medicine, plastic
surgery, and dermatology. We also offer enterprise-level systems designed for
large physician groups and networks. Our range of software solutions, which
include workflow features related to patient encounters, automate the
administrative, financial, and clinical information management functions for
physicians and other healthcare providers. We provide our clients with ongoing
software support, implementation, training, electronic data interchange, or EDI,
services for patient billing and claims processing, and a variety of Web-based
services.
Software license fees and system revenues are derived from the sale of
software product licenses and computer hardware. Maintenance and services
revenues come from providing ongoing product support, implementation, training
and transaction processing services. Approximately 60% of our total revenues are
of a recurring nature.
We market our products and services primarily to three types of physician
practices:
o ambulatory imaging centers and radiology practices, as well as
anesthesiology practices;
o large general and emergency medicine practices, such as physician
networks, clinics and management service organizations that generally
include ten or more doctors; and
o small group practices of generally fewer than ten doctors that serve a
local community, including ophthalmology, dermatology and general
medicine practices.
In the first half of 2003 and 2002, approximately 40% of our revenues
were derived from the radiology/anesthesiology market and 30% from each of our
other markets.
RESULTS OF OPERATIONS
REVENUES
Second Quarter Ended Six Months Ended
June 30, 2003 CHANGE 2002 2003 CHANGE 2002
- -----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Maintenance and services $22,569 6.3% $21,229 $45,099 6.4% $42,394
Percentage of total revenues 80.1% 73.5% 79.5% 74.2%
- -----------------------------------------------------------------------------------------------------------------------------
Software licenses and system sales $ 5,619 (26.8)% $ 7,673 $11,662 (20.8)% $14,716
Percentage of total revenues 19.9% 26.5% 20.5% 25.8%
- -----------------------------------------------------------------------------------------------------------------------------
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
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VitalWorks Inc.
arrangement to each element based on the relative fair values of the respective
elements. The residual method is used to determine revenue recognition with
respect to a multiple-element arrangement when specific objective evidence of
fair value exists for all of the undelivered elements (e.g., implementation,
training and maintenance services), but does not exist for one or more of the
delivered elements of the contract (e.g., computer software or hardware). The
fair value of an element is determined by the average price charged when that
element is sold separately (e.g., the fair value of maintenance services is
determined based on the average renewal price charged to clients for continued
maintenance). If evidence of fair value cannot be established for the
undelivered element(s) of an arrangement, the total value of the customer
arrangement is deferred until the undelivered element(s) is delivered or until
objective evidence of fair value is established. In our contracts and
arrangements with our customers, we generally do not include acceptance
provisions, which would give the customer the right to accept or reject the
product after we ship it. However, if an acceptance provision is included,
revenue is recognized upon the customer's acceptance of the product, which
occurs upon the earlier of receipt of a written customer acceptance or
expiration of the acceptance period. We provide allowances for estimated future
returns and discounts (recorded as contra-revenue), as well as bad debts, upon
recognition of revenues.
Recognition of revenues in conformity with generally accepted
accounting principles requires management to make judgments that affect the
timing and amount of reported revenues.
If we were to adopt new, or change our current, business practices in
response to a preference from the market or otherwise, then our revenue
recognition practices may be subject to significant change to comply with the
requisite accounting principles. For example, subscription-type arrangements and
practices strictly for software services and support would result in the
recognition of revenues ratably over the term of the arrangement.
The increase in maintenance and services revenues for the second
quarter and the six-month periods is mainly attributable to an increase in
implementation and training services revenues of $1.8 million and $3.5 million,
respectively, which related primarily to HIPAA compliance. The increases were
partially offset by the loss of rental revenue of $.3 million and $.6 million,
respectively, due to the sale of our former headquarters building in August 2002
and, to a lesser extent, a 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 large
physician group 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, our
Intuition(TM) product line of practice management and electronic medical records
systems, 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.
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COST OF REVENUES
Second Quarter Ended Six Months Ended
June 30, 2003 CHANGE 2002 2003 CHANGE 2002
- -----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Maintenance and services $5,538 3.0% $5,376 $11,744 7.5% $10,920
Percentage of maintenance and services
revenue 24.5% 25.3% 26.0% 25.8%
- -----------------------------------------------------------------------------------------------------------------------------
Software licenses and system sales $2,034 (7.8)% $2,207 $4,753 25.0% $3,801
Percentage of software licenses and
system sales 36.2% 28.8% 40.8% 25.8%
- -----------------------------------------------------------------------------------------------------------------------------
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 in the second
quarter is primarily due to the additional use of third parties for
implementation and training services. The increase for the six-month period
principally reflects $.4 million of additional costs incurred with respect to
arrangements with our EDI suppliers and $.2 million of additional third-party
service provider costs.
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 decrease in the June quarter is
primarily due to a decline in computer hardware sales. The increase regarding
the six-month comparison is largely attributable to an increase in amortization
of product development costs of $.5 million and $.4 million of additional
software royalties.
OPERATING EXPENSES
Second Quarter Ended Six Months Ended
June 30, 2003 CHANGE 2002 2003 CHANGE 2002
- ----------------------------------------------------------------------------------- --------------------------------------
(DOLLARS IN THOUSANDS)
Selling, general and administrative $11,678 (2.1)% $11,928 $23,926 (2.5)% $24,542
Percentage of total revenues 41.4% 41.3% 42.2% 43.0%
- --------------------------------------------------------------------------------------------------------------------------
Research and development $ 3,850 8.0% $ 3,565 $ 7,697 14.2% $ 6,740
Percentage of total revenues 13.7% 12.3% 13.6% 11.8%
- --------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 573 (9.0)% $ 630 $ 1,128 (8.6)% $ 1,234
Percentage of total revenues 2.0% 2.2% 2.0% 2.2%
- --------------------------------------------------------------------------------------------------------------------------
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 primarily due to decreases in bad debt expense of $.4 million
and $.7 million and variable compensation expense of $.2 million and $.6
million, respectively, for the three and six-month periods ended June 30, 2003.
These decreases were partially offset by smaller increases in marketing and
fixed compensation expenses. Moreover,
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VitalWorks Inc.
the June 2003 quarter includes a credit of $.5 million that reflects the
resolution of an outstanding matter involving a federally subsidized research
and development project dating back to 1997. The June 2002 quarter also includes
a credit of $.5 million that reflects a savings in connection with the early
termination of an office lease for a facility closed in March 2001 as part of a
major restructuring plan. The credits were recognized through the reduction of
certain accrued liabilities.
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 quarter and six months ended June 30, 2003, we capitalized $.3 million
(or 7.0% of total research and development expenditures) and $.7 million (or
8.1% 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." For the same periods of 2002, we capitalized $1.6
million (or 31.4% of total research and development expenditures) and $2.4
million (or 26.1% of total research and development expenditures) of third-party
programmer fees. 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 the first seven months of 2002, we received final payments from
three former officers totaling $12.1 million satisfying their outstanding loans
from us, including interest. Consequently, we recorded a credit of $6.0 million
($3.0 million each in the March and June 2002 quarters) reflecting a complete
reversal of the allowance for loan losses established in March 2001.
INTEREST INCOME (EXPENSE)
Second Quarter Ended Six Months Ended
June 30, 2003 CHANGE 2002 2003 CHANGE 2002
- -----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Interest income $73 (88.8)% $649 $164 (86.5)% $1,219
Interest expense (302) (42.0)% (521) (623) (44.0)% (1,112)
- -----------------------------------------------------------------------------------------------------------------------------
The decrease in interest income reflects interest recognized in 2002 in
connection with the recovery of the notes receivable from former officers.
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 were 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 first half of 2003 and 2002, we recorded quarterly income tax
provisions of $50,000 and $25,000, respectively. Management has assessed the
realizable value of our deferred tax assets of $53.3 million and
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determined that a valuation allowance of $23.2 million was necessary as of June
30, 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 and
six-month periods ended June 30, 2003 decreased to $4.2 million and $7.0 million
from $8.3 million and $15.9 million, respectively, for the corresponding periods
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 six months ended June 30, 2003, and for fiscal years 2002,
2001 and 2000, we generated positive cash flows from operating activities of $.3
million, $20.8 million, $18.2 million and $12.8 million, respectively. 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 continue, for a fee, to provide printing services for our
physicians under the subcontracting arrangement with NDC. The amended
arrangement, which extends until April 2009, 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 2001 (in connection
with the August 2000 agreement, we had received $8.8 million), 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 were
reduced. In turn, we refunded $4.3 million of unearned discounts. The new
quarterly commitment approximates 60% of our current aggregate transaction
level. These discount amounts, received and refunded, have been classified as
cash provided by and used in operating activities.
Days sales outstanding (calculated as accounts receivable, net of
allowances, divided by quarterly revenues multiplied by 90 days) for the second
quarter of 2003 was 41 days, down from 49 days for the corresponding June 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 six months ended June 30, 2003 resulted in
a use of cash of $1.6 million. This total includes $1.0 million used for
software development costs, and $.5 million used primarily for purchases of
computer equipment and software.
Cash used in financing activities for the six months ended June 30,
2003 amounted to $1.4 million consisting of $2.0 million of principal payments
of long-term debt, partly offset by $.6 million of payments received in
connection with the exercise of stock options by employees.
As of June 30, 2003, we had cash and cash equivalents of $36.7 million
and $17.0 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
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2002, we entered into a new four-year credit agreement with Wells Fargo
Foothill, Inc. The new agreement included a term loan of $22.0 million at an
interest rate of prime plus 2%, and a mortgage loan of $5.5 million. We repaid
the mortgage loan in August 2002 in connection with the sale of our Atlanta
property. Subject to achieving certain specified earnings targets, the margin by
which our interest rate on the term loan exceeds prime may be reduced by as much
as 1.1% over the life of the loan. Interest is payable monthly in arrears.
Principal is payable over the life of the agreement, including a balloon payment
in March 2006. Should we decide to prepay the term loan in full prior to year
four, we would incur a prepayment fee equal to 2% in year two and 1% in year
three of the then outstanding principal balance of the term loan. The prepayment
fee may be reduced should the loan be prepaid in connection with a change of
control of VitalWorks. The outstanding term loan, which is collateralized by
substantially all of our assets and intellectual property rights, subjects 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 June 30, 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................... $16,600 $ 2,100 $ 2,500 $12,000
Operating leases................. 9,311 1,359 2,415 $ 1,858 1,850 $ 1,829
Capital leases................... 388 246 128 14
Other long-term liabilities...... 547 86 321 130 10
-------------------------------------------------------------------------------------------
$26,846 $ 3,705 $ 5,129 $ 2,193 $13,980 $ 1,839
===========================================================================================
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 incurred $.5 million for processing services. For the
twelve-month period ending May 2004, we are committed to pay $.6 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 $.4 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.
We anticipate capital expenditures of approximately $3 million for the
remainder of 2003, including software development costs of approximately $1
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 share repurchases are determined by management based on our evaluation of
market conditions and other factors. The repurchase program may be suspended or
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VitalWorks Inc.
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 half of 2003. As of August 11, 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.
In August 2003, we were served with a summons and complaint as part of
a bankruptcy proceeding relating to a former business associate of ours. The
complaint alleges that in 2001, we received a preference payment from the
business associate and seeks to avoid and recover the $.8 million payment made
to 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. The Court has appointed a lead
plaintiff and lead attorney, and our law firm was served with a consolidated
complaint on August 4, 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. The plaintiffs have retained new counsel and have served a second
amended complaint upon us.
While management believes that we have meritorious defenses in each of
the foregoing matters and we intend to pursue our positions vigorously,
litigation is inherently subject to many uncertainties. Thus, the outcome of
these matters is uncertain and could be adverse to us. However, even if the
outcome of these cases is adverse, we do not believe that the outcome of these
cases, individually or in the aggregate, will have a material adverse effect on
our financial position. However, depending on the amount and timing of an
unfavorable resolution(s) of the contingencies, it is possible that our future
results of operations or cash flows could be materially affected in a particular
reporting period(s).
We 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
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VitalWorks Inc.
potential repurchase of up to $9 million of our outstanding common stock in
accordance with our stock repurchase program described above.
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 and is often adjusted based on the findings. The allowance
is increased through a reduction of revenues, an
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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.
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VitalWorks Inc.
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 second quarter and six
months ended June 30, 2003 was $2.20 and $2.24, 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 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):
SECOND QUARTER SIX MONTHS
ENDED ENDED
JUNE 30, 2003 JUNE 30, 2003
--------------------------------------------
Net income, as reported $4,236 $6,954
Less: total stock-based employee compensation
expense determined under fair value-based
method for all awards, net of related tax effects (1,096) (2,181)
---------------------- ---------------------
Pro forma net income $3,140 $4,773
====================== =====================
Earnings per share:
Basic - as reported $0.10 $0.16
====================== =====================
Basic - pro forma $0.07 $0.11
====================== =====================
Diluted - as reported $0.09 $0.15
====================== =====================
Diluted - pro forma $0.07 $0.11
====================== =====================
The fair value of our employee stock options awarded in 2003 was
estimated at the date of grant using the Black-Scholes option valuation model
with the following weighted average assumptions:
Risk-free interest rate.................................... 2.2% TO 2.5%
Expected dividend yield.................................... 0.0%
Expected stock price volatility............................ 75.4% TO 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.
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EARNINGS PER SHARE. The following table sets forth the computation of
basic and diluted earnings per share ("EPS") (IN THOUSANDS, EXCEPT PER SHARE
DATA):
SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
-------------------------------- --------------------------------
Numerator:
Net income $4,236 $8,299 $6,954 $15,930
================================ ================================
Denominator:
Basic EPS - weighted-average shares 42,998 40,865 42,858 40,006
Effect of dilutive securities, stock option
and warrant rights 3,417 8,825 3,531 8,619
-------------------------------- --------------------------------
Diluted EPS - adjusted weighted-average
shares and assumed conversions 46,415 49,690 46,389 48,625
================================ ================================
Basic EPS $0.10 $0.20 $0.16 $0.40
Diluted EPS $0.09 $0.17 $0.15 $0.33
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.7 million common shares (with exercise prices ranging from
$3.74 to $17.84 per share) and 1.6 million common shares (with exercise prices
ranging from $3.85 to $17.84 per share) were excluded from the diluted EPS
calculation for the three and six-month periods ended June 30, 2003,
respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board, or FASB,
Emerging Issues Task Force reached consensus with respect to Issue 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." EITF 00-21
addresses the accounting for multiple-element revenue arrangements.
Specifically, EITF 00-21 addresses how to determine whether an arrangement
involving multiple deliverables contains more than one unit of accounting and
how arrangement consideration should be measured and allocated to the separate
units of accounting. EITF 00-21 is effective for revenue arrangements entered
into on or after July 1, 2003 and is not expected to have a material effect on
our financial statements.
In June 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." Statement 146 requires companies to recognize costs associated with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Examples of costs covered by Statement
146 include lease termination costs and certain employee severance costs that
are associated with a restructuring, discontinued operation, facility closing,
or other exit or disposal activity. Statement 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002.
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.
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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
$16.6 million of our outstanding debt at June 30, 2003 relates to long-term
indebtedness under our credit agreement with Wells Fargo Foothill, Inc. 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
June 30, 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
Our management, with the participation of our chief executive officer
and chief financial officer, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) as of June 30, 2003. Based on this evaluation, our chief executive
officer and chief financial officer concluded that, as of June 30, 2003, our
disclosure controls and procedures were (1) designed to ensure that material
information relating to us is made known to our chief executive officer and
chief financial officer by others within our company, particularly during the
period in which this report was being prepared and (2) effective, in that they
provide reasonable assurance 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
Securities and Exchange Commission's rules and forms.
No change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
fiscal quarter ended June 30, 2003 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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.
In August 2003, we were served with a summons and complaint as part of
a bankruptcy proceeding relating to a former business associate of ours. The
complaint alleges that in 2001, we received a preference payment from the
business associate and seeks to avoid and recover the $.8 million payment made
to 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
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VitalWorks Inc.
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.
The Court has appointed a lead plaintiff and lead attorney, and our law firm was
served with a consolidated complaint on August 4, 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. The plaintiffs have retained new counsel and have served a second
amended complaint upon us.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on June 11, 2003, our
stockholders adopted the following proposals by the margins indicated:
1. To elect members of the Board of Directors to serve for a one-year
term.
Number of Shares
For Against Abstain
-------------------------------------------------
Joseph M. Walsh 31,149,494 0 6,282,304
Stephen N. Kahane, M.D., M.S. 31,183,115 0 6,248,683
Michael A. Manto 31,151,304 0 6,280,494
Kenneth R. Adams 36,674,424 0 757,374
Stephen J. DeNelsky 36,673,925 0 757,873
David B. Shepherd 36,673,788 0 758,010
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2. To ratify our appointment of BDO Seidman, LLP as our independent
certified public accountants for the fiscal year ending December 31,
2003.
Number of Shares
For Against Abstain
-------------------------------------------------
36,697,855 712,328 21,615
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
specified trading periods that generally extended for up to one year, number of
shares to be sold, and prices at which shares may be sold. More specifically,
the Rule 10b5-1 plan of Joseph M. Walsh, our president and chief executive
officer, provided for the sale of not more than 90,000 shares on-average per
quarter over the twelve-month period ended May 30, 2003. The aggregate number of
shares sold under Mr. Walsh's plan represented 11.3% of the number of shares,
including option shares, then held by him. The plans of all the executive
officers have expired. Since March 6, 2001, approximately 11.7% of the aggregate
holdings, including option shares, 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.
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.
(B) REPORTS ON FORM 8-K
We filed the following report on Form 8-K during the quarter
ended June 30, 2003:
Current Report on Form 8-K filed with the Securities and
Exchange Commission on April 23, 2003 with respect to our
announcement of our financial results for the quarter ended
March 31, 2003.
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Form 10-Q for the Three-month Period Ended June 30, 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 8/13/03
----------------------------------------------------------
Michael A. Manto Date
Executive Vice President and Chief
Financial Officer
/s/ Joseph M. Walsh 8/13/03
----------------------------------------------------------
Joseph M. Walsh Date
Chairman and Chief Executive Officer
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