Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ------------ to -------------.
--------------------------------
COMMISSION FILE NUMBER 000-25311
VITALWORKS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-2248411
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
239 ETHAN ALLEN HIGHWAY, RIDGEFIELD, CT 06877
(Address of principal executive offices, including zip code)
(203) 894-1300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [X] NO [ ]
As of May 5, 2004 there were 43,421,352 shares of the registrant's common stock,
$.001 par value, outstanding.
================================================================================
VITALWORKS INC.
FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Report of Independent Certified Public Accountants....................................................... 2
Condensed Consolidated Balance Sheets --
March 31, 2004 and December 31, 2003................................................................... 3
Condensed Consolidated Statements of Operations --
Three Months Ended March 31, 2004 and 2003............................................................. 4
Condensed Consolidated Statements of Cash Flows --
Three Months Ended March 31, 2004 and 2003............................................................. 5
Notes to Condensed Consolidated Financial Statements --
March 31, 2004........................................................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......................................... 31
Item 4. Controls and Procedures ............................................................................ 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................................... 31
Item 6. Exhibits and Reports on Form 8-K.................................................................... 32
SIGNATURES.................................................................................................. 34
For further information, refer to the VitalWorks Inc. Annual Report on Form 10-K
filed on March 12, 2004.
VitalWorks, AMICAS and RadConnect are registered trademarks of VitalWorks Inc.
All other trademarks and company names mentioned are the property of their
respective owners.
Report of Independent Certified Public Accountants
Board of Directors and Stockholders
VitalWorks Inc.
We have reviewed the condensed consolidated balance sheet of VitalWorks
Inc. and subsidiary as of March 31, 2004 and the related condensed consolidated
statements of operations and cash flows for the three-month periods ended March
31, 2004 and 2003, included in the accompanying Securities and Exchange
Commission Form 10-Q for the period ended March 31, 2004. 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 consolidated 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, 2003, and the related statements of operations, stockholders'
equity and cash flows for the year then ended (not presented herein); and in our
report dated January 26, 2004, we expressed an unqualified opinion on those
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2003 is
fairly stated in all material respects in relation to the balance sheet from
which it has been derived.
/s/ BDO Seidman, LLP
New York, New York
April 26, 2004
2
VitalWorks Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
(unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 18,552 $ 20,128
Accounts receivable, net of allowances of $3,100 and $2,800 18,079 16,409
Computer hardware held for resale 596 832
Deferred income taxes, net 2,203 2,203
Prepaid expenses and other current assets 2,993 2,934
------------ ------------
TOTAL CURRENT ASSETS 42,423 42,506
Property and equipment, at cost, less accumulated
depreciation and amortization of $12,428 and $11,642 4,904 4,681
Goodwill 34,140 34,472
Acquired/developed software, less accumulated amortization
of $2,599 and $1,804 21,235 21,469
Other intangible assets, less accumulated amortization of $142 and $36 3,258 3,364
Deferred income taxes, net 24,547 24,547
Other assets 1,645 1,537
------------ ------------
Total assets $ 132,152 $ 132,576
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 13,196 $ 11,049
Accrued employee compensation and benefits 2,200 2,486
Accrued restructuring costs 541 923
Deferred revenue, including unearned discounts of $1,200 14,370 11,762
Current portion of long-term debt 5,399 6,738
------------ ------------
TOTAL CURRENT LIABILITIES 35,706 32,958
Long-term debt 22,035 23,019
Other liabilities, primarily unearned discounts re: outsourced printing services 5,564 5,937
COMMITMENTS AND CONTINGENCIES - NOTES B AND F
Stockholders' equity:
Preferred stock $.001 par value; 2,000,000 shares authorized;
none issued
Common stock $.001 par value; 200,000,000 shares authorized;
45,391,879 and 45,278,816 shares issued 45 45
Additional paid-in capital 205,808 205,439
Accumulated deficit (130,534) (128,350)
Treasury stock, at cost, 1,985,502 shares (6,472) (6,472)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 68,847 70,662
------------ ------------
Total liabilities and stockholders' equity $ 132,152 $ 132,576
============ ============
Note: The balance sheet at December 31, 2003 has been derived from the audited
financial statements at that date.
See accompanying notes.
3
VitalWorks Inc.
Condensed Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------ ------------
REVENUES
Maintenance and services $ 21,308 $ 22,530
Software licenses and system sales 5,470 6,043
------------ ------------
Total revenues 26,778 28,573
------------ ------------
COSTS AND EXPENSES
Cost of revenues:
Maintenance and services 5,299 6,206
Software licenses and system sales, includes
amortization of software costs
of $794 and $428 2,220 2,719
Selling, general and administrative 15,301 12,248
Research and development 4,553 3,847
Depreciation and amortization 841 555
Settlement of litigation 325
------------ ------------
28,539 25,575
------------ ------------
OPERATING INCOME (LOSS) (1,761) 2,998
Interest income 26 91
Interest expense (374) (321)
------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (2,109) 2,768
Provision for income taxes 75 50
------------ ------------
NET INCOME (LOSS) $ (2,184) $ 2,718
============ ============
EARNINGS (LOSS) PER SHARE
Basic $ (0.05) $ 0.06
Diluted $ (0.05) $ 0.06
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 43,371 42,716
Diluted 43,371 46,391
See accompanying notes.
4
VitalWorks Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
(in thousands)
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------ ------------
OPERATING ACTIVITIES
Net income (loss) $ (2,184) $ 2,718
Adjustments to reconcile net income (loss) to cash provided by
operating activities:
Settlement of litigation 325
Depreciation and amortization 841 555
Provisions for bad debts, returns and discounts 492 507
Amortization of deferred finance costs, charged to interest expense 54 45
Amortization of software costs 794 428
Changes in operating assets and liabilities:
Accounts receivable (2,162) 726
Computer hardware held for resale, prepaid expenses and other 151 (514)
Accounts payable, accrued costs and expenses 928 (723)
Deferred revenue 2,971 (977)
Unearned discounts re: outsourced printing services (300) (342)
------------ ------------
CASH PROVIDED BY OPERATING ACTIVITIES 1,910 2,423
------------ ------------
INVESTING ACTIVITIES
Software product development costs (487) (715)
Proceeds from sale of office building 90
Purchases of property and equipment (703) (343)
Security deposit (308)
------------ ------------
CASH USED IN INVESTING ACTIVITIES (1,190) (1,276)
------------ ------------
FINANCING ACTIVITIES
Long-term debt payments (2,366) (1,413)
Exercise of stock options and warrants 237 344
Deferred finance costs (167)
------------ ------------
CASH USED IN FINANCING ACTIVITIES (2,296) (1,069)
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,576) 78
Cash and cash equivalents at beginning of period 20,128 39,474
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 18,552 $ 39,552
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid, net of refunds $ 5 $ 127
Interest paid 329 196
See accompanying notes.
5
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
March 31, 2004
A. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments, consisting only of normal recurring accruals, considered necessary
for a fair presentation have been included in the accompanying unaudited
financial statements. Operating results for the three-month period ended March
31, 2004 are not necessarily indicative of the results that may be expected for
the full year ending December 31, 2004. These interim financial statements
should be read in conjunction with the VitalWorks Inc. (the "Company" or
"VitalWorks") Annual Report on Form 10-K for the year ended December 31, 2003.
B. BUSINESS COMBINATION
On November 25, 2003, VitalWorks acquired 100% of the outstanding capital
stock of AMICAS, Inc., a developer of Web-based diagnostic image management
software solutions, for $31 million in cash, including direct transaction costs.
Commonly referred to in the marketplace as PACS (picture archiving and
communication systems), these software solutions allow radiologists and other
physicians to examine, store, and distribute digitized medical images. The
merger agreement provides for an additional purchase payment of up to $25
million, payable in cash and/or shares of VitalWorks common stock, based on
attainment of specified earnings targets through 2004 which, if paid, would be
recognized as additional goodwill. In addition, VitalWorks assumed incentive
plans for certain management employees of AMICAS that provide for up to $5
million of compensation, tied to the attainment of the earnings targets for the
contingent earn-out period.
Accordingly, the accompanying statement of operations for the first
quarter of 2004 includes the operating results of AMICAS. The unaudited
financial information below summarizes the combined results of operations of
VitalWorks and AMICAS, on a pro forma basis, as though the companies had been
combined as of January 1, 2003. This pro forma data for the three-month period
ended March 31, 2003 is presented for informational purposes only and is not
intended to represent or be indicative of the results of operations that would
have been reported had the acquisition taken place on January 1, 2003, and
should not be taken as representative of the future results of operations of the
Company (in thousands, except per share data):
Combined:
Revenues.............................................. $ 29,476
Net loss.............................................. $ (232)
Loss per share - basic and diluted.................... $ (0.01)
The acquisition was accounted for as a purchase transaction and,
accordingly, the purchase price has been allocated to the assets and liabilities
of AMICAS based on their estimated fair values. Independent valuation
specialists conducted an appraisal of a significant portion of the assets,
including purchased software, in-process technology, trademarks and noncompete
agreements. Management has made an estimate of the fair value of the remaining
assets and liabilities. The estimated fair values included in the accompanying
balance sheets reflect management's estimates, which are subject to change, and
the valuation specialists' appraisal. At March 31, 2004, the Company reduced its
goodwill by $.3 million to reflect an adjustment of the estimated fair value of
the acquired deferred revenues of AMICAS.
C. STOCK-BASED COMPENSATION
The Company accounts for stock option grants and stock awards, based on
their intrinsic value, in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" and
6
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
March 31, 2004
related interpretations. Under the intrinsic value method, compensation expense
is 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 or if the number
of shares is not fixed. The weighted-average estimated grant date fair value, as
defined by Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 123, of options granted in the three-month periods
ended March 31, 2004 and 2003, was $1.95 and $2.30, respectively, as calculated
using the Black-Scholes option valuation model. The Company prices its stock
options at fair market value on the date of grant, and, therefore, under Opinion
25, no compensation expense is recognized for stock options granted. The
following table illustrates the effect on net income (loss) 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):
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------ ------------
Net income (loss), as reported $ (2,184) $ 2,718
Less: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (135) (1,085)
------------ ------------
Pro forma net income (loss) $ (2,319) $ 1,633
============ ============
Earnings (loss) per share:
Basic - as reported $ (0.05) $ 0.06
============ ============
Basic - pro forma $ (0.05) $ 0.04
============ ============
Diluted - as reported $ (0.05) $ 0.06
============ ============
Diluted - pro forma $ (0.05) $ 0.04
============ ============
The fair value of the Company's employee stock options was estimated at
the date of grant using the Black-Scholes option valuation model with the
following weighted average assumptions:
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------ ------------
Risk-free interest rate ............................. 2.7% 2.5%
Expected dividend yield ............................. 0.0% 0.0%
Expected stock price volatility ..................... 73.6% 77.3%
Expected life (in years) ............................ 4 4
The Black-Scholes option valuation model was not developed for use in
valuing employee stock options. Instead, this model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable, which differ significantly from the Company's stock
option awards. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility.
7
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
March 31, 2004
D. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings (loss) per share ("EPS") (in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------ ------------
Numerator:
Net income (loss) $ (2,184) $ 2,718
============ ============
Denominator:
Basic EPS - weighted-average shares 43,371 42,716
Effect of dilutive securities, stock option
and warrant rights 3,675
------------ ------------
Diluted EPS - adjusted weighted-average
shares and assumed conversions 43,371 46,391
============ ============
Basic EPS $ (0.05) $ 0.06
Diluted EPS $ (0.05) $ 0.06
Because their effect would be antidilutive, stock option and warrant
rights for up to 1.5 million common shares (with exercise prices ranging from
$4.37 to $17.84 per share) were excluded from the diluted EPS calculation for
the three-month period ended March 31, 2004.
E. COMPREHENSIVE INCOME
Comprehensive income is a measure of all changes in equity of an
enterprise that results from recognized transactions and other economic events
of a period other than transactions with owners in their capacity as owners. For
the Company, comprehensive income (loss) is equivalent to its consolidated net
income (loss).
F. COMMITMENTS AND CONTINGENT MATTERS
From time to time, in the normal course of business, various claims are
made against the Company. Except for the proceedings described below, there are
no material proceedings to which the Company is a party, and management is
unaware of any material contemplated actions against the Company.
On or about July 31, 2003, a Consolidated Class Action Complaint was filed
in the United States District Court for the District of Connecticut on behalf of
purchasers of the common stock of VitalWorks Inc. during the class period of
January 24, 2002 to October 23, 2002. The defendants are VitalWorks and three of
its individual officers and directors. Plaintiffs have asserted claims against
the defendants under Section 10(b) of the Securities Exchange Act of 1934 and
against the individual defendants under Section 20(a) of the Exchange Act.
According to the Consolidated Complaint, the defendants made materially false
and misleading statements during the Class Period concerning the Company's
products and financial forecasts. In addition, the Consolidated Complaint
alleges that the individual defendants acted as controlling persons in
connection with the Company's alleged securities law violations. Compensatory
damages in an unspecified amount, pre-judgment and post-judgment interest, costs
and expenses, including reasonable attorneys' fees and experts' fees and other
costs, as well as other relief the Court may deem just and proper are sought. On
November 14, 2003, the defendants filed with the Court a motion to dismiss the
Consolidated Complaint pursuant to Federal Rules of Civil Procedure 12(b)(6) and
8
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
March 31, 2004
(9)(b). The motion has been fully briefed and is awaiting disposition by the
Court. At this time, discovery is automatically stayed under the Private
Securities Litigation Reform Act and no class has been certified.
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 and the case was subsequently transferred to the
Northern District Court of Georgia. The complaint alleged state securities law
violations, breach of contract, and fraud claims against the defendants. The
complaint did not specify the amount of damages sought by plaintiffs, but sought
rescission of a transaction that the plaintiffs valued at $5 million, as well as
punitive damages and reimbursement for the plaintiffs' attorneys' fees and
associated costs and expenses of the lawsuit. In October 2001, the plaintiffs'
request for a preliminary injunction to preserve their remedy of rescission was
denied and part of their complaint was dismissed. The plaintiffs' subsequent
appeal of this decision was denied. Thereafter, plaintiffs retained new counsel
and served an amended complaint that added additional former officers and
directors as defendants, dropped the claim for rescission, and asserted new
state securities law violations. After disqualification of plaintiffs' second
counsel in May 2003, plaintiffs retained new counsel and, in July 2003, served a
second amended complaint upon the Company which added, among other things, a
claim for Georgia RICO violations. In August 2003, the Company filed with the
Court a partial motion to dismiss the second amended complaint which motion was
granted in part and denied in part on January 9, 2004. On February 6, 2004, the
Company served an answer to the second amended complaint. The discovery process
is now ongoing.
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.
Depending on the amount and timing of an unfavorable resolution(s) of the
contingencies, it is possible that the Company's financial position, future
results of operations or cash flows could be materially affected in a particular
reporting period(s).
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 alleged that in 2001, the Company received a preference
payment from the business associate and sought to avoid and recover the $.8
million payment made to the Company. The Company agreed to settle this matter in
March 2004 and in April 2004 paid $.3 million to the former business associate
through its committee of unsecured creditors.
As permitted under Delaware law, the Company has agreements whereby it
indemnifies its officers and directors for certain events or occurrences while
the officer or director is or was serving at the Company's request in such
capacity. The term of the indemnification period is for the officer's or
director's lifetime. The maximum potential amount of future payments the Company
could be required to make under these indemnification agreements is unlimited;
however, with respect to certain events or occurrences after March 6, 2001, the
Company has a director and officer insurance policy that limits its exposure and
enables it to recover a portion of any future amounts paid. Given the insurance
coverage in effect, the Company believes the estimated fair value of these
indemnification agreements is minimal. The Company has no liabilities recorded
for these agreements as of March 31, 2004.
The Company includes standard intellectual property indemnification
provisions in its software license agreements. Pursuant to these provisions, the
Company holds harmless and agrees to defend the indemnified party, generally its
business partners and customers, in connection with certain patent, copyright,
trademark and trade secret infringement claims by third parties with respect to
the Company's products. The term of the indemnification provisions varies and
may be perpetual. In the event an infringement claim against the Company or an
indemnified party is made, generally the Company, in its sole discretion, agrees
to do one of the following: (i) procure for the indemnified party the right to
continue use of the software, (ii) provide a modification to the software so
that its use becomes noninfringing; (iii) replace the software with software
which is substantially similar in functionality and performance; or (iv) refund
the residual value of the software license fees paid by the
9
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
March 31, 2004
indemnified party for the infringing software. The Company believes the
estimated fair value of these intellectual property indemnification agreements
is minimal. The Company has no liabilities recorded for these agreements as of
March 31, 2004.
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.
G. ACCRUED RESTRUCTURING COSTS
In the fourth quarter of 2003, the Company committed to restructuring its
medical businesses through a plan of employee reductions. The Company's work
force was reduced by approximately 45 employees. In 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.
In the quarter ended March 31, 2004, the restructuring accrual was reduced
by $.4 million consisting primarily of severance payments relating to the 2003
restructuring. The nature of the accrual as of March 31, 2004 was primarily the
total cost of future payments that remained outstanding under lease commitments
regarding certain of the offices that were closed in connection with the 2000
restructuring.
H. STOCKHOLDERS' EQUITY AND NONCASH ACTIVITIES
In the quarter ended March 31, 2004, the Company issued 113,063 shares of
its common stock, consisting of 90,019 shares in connection with the exercise of
stock options by certain employees, and 23,044 shares with respect to the
Company-sponsored employee savings plan. As a result, the Company recognized $.4
million as a credit to additional paid-in capital.
I. 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 operations disclose the financial information of
the Company's reportable segments for the three-month periods ended March 31,
2004 and 2003. The Company does not account for or report its assets or capital
expenditures by segments.
The Company markets its products and services primarily to two types of
physician practices: radiology practices, including hospital radiology
departments and ambulatory imaging centers, and medical practices such as
anesthesiology, ophthalmology, emergency medicine, plastic surgery, dermatology
and internal medicine.
10
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. 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 CONSISTENT PROFITABILITY.
Our operating results will vary significantly from quarter to quarter and
from year to year. Although we had net income of $8.0 million and $24.2 million
for the years 2003 and 2002, we incurred net losses of $(2.2) million and $(2.0)
million for the March 2004 and December 2003 quarters, respectively. Prior to
2002, we had consistently experienced net losses. Our net loss was $(27.8)
million for the year ended December 31, 2001 and $(78.1) million for the year
ended December 31, 2000.
Our operating results have been and/or may be influenced significantly by
factors such as:
- release of new products, product upgrades and services, and the rate
of adoption of these products and services by new and existing
customers;
- timing, cost and success or failure of our new product and service
introductions and upgrade releases;
- length of sales and delivery cycles;
- size and timing of orders for our products and services;
- changes in the mix of products and/or services sold;
- availability of specified computer hardware for resale;
11
VitalWorks Inc.
- deferral and/or realization of deferred software license and system
revenues according to contract terms;
- interpretations of accounting regulations, principles or concepts
that are or may be considered relevant to our business arrangements
and practices;
- changes in customer purchasing patterns;
- changing economic, political and regulatory conditions, particularly
with respect to the IT-spending environment;
- competition, including alternative product and service offerings,
and price pressure;
- customer attrition;
- timing of and charges or costs associated with mergers, acquisitions
or other strategic events or transactions, completed or not
completed;
- timing, cost and level of advertising and promotional programs;
- changes of accounting estimates and assumptions used to prepare the
prior periods' financial statements and accompanying notes, and
management's discussion and analysis of financial condition and
results of operations (e.g., our valuation of assets and estimation
of liabilities); and
- uncertainties concerning threatened, 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 image management systems, AMICAS(R) Vision
Series(TM) PACS, our new radiology information system, RadConnect(R) RIS, and
our Intuition(TM) product line of practice management and electronic medical
records systems, 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.
WE MAY FAIL TO REALIZE THE LONG-TERM FINANCIAL BENEFITS THAT WE ANTICIPATE WILL
RESULT FROM OUR ACQUISITION OF AMICAS.
Although we expect the 2004 operating results of AMICAS to dilute our
consolidated results of operations for 2004, we anticipate that in 2005 AMICAS
will contribute positive results of operations. Our expectations are subject to
significant risks and uncertainties including:
- our ability to retain AMICAS' key personnel or integrate them into
our operations. In particular, the loss of these employees would
compromise the value of the AMICAS client base and/or its software
products and technologies;
- our ability to integrate the RIS and PACS products as may be, and/or
to the extent, required by the marketplace, including our ability to
deliver the related professional services;
- our ability to sell AMICAS products and services into the imaging
center market, including to our existing radiology customers;
12
VitalWorks Inc.
- our ability to execute on our strategy and realize our revenue goals
and control costs and expenses relating to the acquisition;
- our ability to coordinate the business cultures of the two
organizations;
- the integrity of the intellectual property of AMICAS;
- continued compliance with all government laws, rules and regulations
for all applicable products;
- dilution to existing stockholders if we issue equity securities in
order to satisfy the payment of earn-out related consideration, if
any; and
- our ability to satisfy earn-out obligations or a portion thereof, if
any, through the use of cash on hand and/or, subject to
availability, borrowed funds.
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 large part on the market
acceptance of:
- new products and services, such as our medical image management
systems, our radiology information system, or RIS, and our
Intuition(TM) product line, existing products and services; and
- enhancements to our existing products and services.
There can be no assurance that our clients will accept any of these
products, product upgrades, or services. In addition, there can be no assurance
that any pricing strategy that we implement for any of our new products, product
upgrades, or services will be economically viable or acceptable to our target
markets. Failure to achieve significant penetration in our target markets with
respect to any of our new products, product upgrades, or services could have a
material adverse effect on our business.
Achieving market acceptance for our new products, product upgrades and
services is likely to require substantial marketing and service efforts and the
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.
If we are unable to sell our new and next-generation software products to
healthcare providers that are in the market for healthcare information and/or
image management systems, such inability will likely 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
electronic data interchange, or EDI, services revenues can be expected to
decrease over time due to the combined effects of attrition of existing clients
and a shortfall in new client additions.
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, current 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 with respect to 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, diagnostic, or patient data or the loss of the ability to
process data for any length of time may be a significant problem for some
13
VitalWorks Inc.
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.
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. Most of our software
technology is not patented and existing copyright laws offer only limited
practical protection. In addition, prior to 2002 we did not generally enter 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 to enforce our intellectual property rights.
Generally, lawsuits and proceedings of this type, even if successful, are
costly, time consuming and could divert our personnel and other resources away
from our business, which could harm our business.
Moreover, these protections do not prevent independent third-party
development of competitive technology or services. Unauthorized parties may
attempt to copy or otherwise obtain and use our technology. Monitoring use of
our technology is difficult, and we cannot assure you that the steps we have
taken will prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US COULD BE COSTLY TO DEFEND
AND COULD DIVERT OUR MANAGEMENT'S ATTENTION AWAY FROM OUR BUSINESS.
As the number of software products and services in our target markets
increases and as the functionality of these products and services overlaps, we
may become increasingly subject to the threat of intellectual property
infringement claims. Any infringement claims alleged against us, regardless of
their merit, can be time consuming and expensive to defend. Infringement claims
may also divert our management's attention and resources and could also cause
delays in the delivery of our applications to our customers. Settlement of any
infringement claims could require us to enter into royalty or licensing
agreements on terms that are costly or cost-prohibitive. If a claim of
infringement against us were to be 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.
14
VitalWorks Inc.
WE MAY UNDERTAKE ADDITIONAL ACQUISITIONS, WHICH MAY INVOLVE SIGNIFICANT
UNCERTAINTIES AND MAY INCREASE COSTS, DIVERT MANAGEMENT RESOURCES FROM OUR CORE
BUSINESS ACTIVITIES, OR WE MAY FAIL TO REALIZE ANTICIPATED BENEFITS OF SUCH
ACQUISITIONS.
We may undertake additional 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 are unable to retain acquired companies' personnel or
integrate them into our operations, the value of the acquired products,
technology, and/or client base could be compromised. The amount and timing of
the expected benefits of any acquisition are also subject to other significant
risks and uncertainties. These risks and uncertainties include:
- our ability to cross-sell products and services to customers with
which we have established relationships and those with which the
acquired business had established relationships;
- diversion of our management's attention from our existing business;
- potential conflicts in customer and supplier relationships;
- our ability to coordinate organizations that are geographically
diverse and may have different business cultures;
- dilution to existing stockholders if we issue equity securities in
connection with acquisitions;
- assumption of liabilities or other obligations in connection with
the acquisition; and
- compliance with regulatory requirements.
Further, our profitability may also suffer because of acquisition-related
costs and/or amortization or impairment of intangible assets.
TECHNOLOGY SOLUTIONS MAY CHANGE FASTER THAN WE ARE ABLE TO UPDATE OUR
TECHNOLOGIES, WHICH COULD CAUSE A LOSS OF CUSTOMERS AND HAVE A NEGATIVE IMPACT
ON OUR REVENUES.
The information management technology market in which we compete is
characterized by rapidly changing technology, evolving industry standards,
emerging competition and the frequent introduction of new services, software and
other products. Our success depends partly on our ability to:
- develop new or enhance existing products and services to meet our
customers' changing needs in a timely and cost-effective way; and
- respond effectively to technological changes, new product offerings,
product enhancements and new services of our competitors.
We cannot be sure that we will be able to accomplish these goals. Our
development of new and enhanced products and services may take longer than
originally expected, require more testing than originally anticipated and
require the acquisition of additional personnel and other resources. In
addition, there can be no assurance that the products and/or services we develop
or license will be able to compete with the alternatives available to our
customers. Our competitors may develop products or technologies that are better
or more attractive than our products or technologies, or that may render our
products or technologies obsolete. If we do not succeed in adapting our
products, technology and services or developing new products, technologies and
services, our business could be harmed.
15
VitalWorks Inc.
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.
Errors or malfunctions with respect to our products or services could result in
product liability claims. In addition, certain agreements require us to
indemnify and hold others harmless against certain matters. 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, agreements which we enter into contain 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 such 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.
WE MAY BE SUBJECT TO CLAIMS RESULTING FROM THE ACTIVITIES OF OUR STRATEGIC
PARTNERS.
We rely on third parties to provide services and products 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 against
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 impact the manner in which we conduct our business. We
have been, and may continue to 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 some of these regulations are new and some
are not yet effective, there is uncertainty as to how they will be interpreted
and enforced.
Although we have made, and will continue to 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 penalties and damages, as well as civil
liability and criminal sanctions to the extent we are a business associate of a
covered entity or regulated directly as a covered entity. In addition, any 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
16
VitalWorks Inc.
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.
FDA
The Food and Drug Administration, or FDA, is responsible for ensuring the
safety and effectiveness of medical devices under the 1976 Medical Device
Amendments to the Food, Drug and Cosmetic Act. Computer applications and
software are generally subject to regulation as medical devices, requiring
registration with the FDA, application of detailed record-keeping and
manufacturing standards, and FDA approval or clearance prior to marketing when
such products are intended to be used in the diagnosis, cure, mitigation,
treatment, or prevention of disease. Our PACS product is subject to FDA
regulation. If the FDA were to decide that any of our other products and
services should be subject to FDA regulation or, if in the future we were to
expand our application and service offerings into areas that may subject us to
further FDA regulation, the costs of complying with FDA requirements could be
substantial. Application of the approval or clearance requirements could create
delays in marketing, and the FDA could require supplemental filings or object to
certain of these products. FDA compliance efforts with regard to our PACS
product are time consuming, burdensome, and expensive, and any failure to comply
could have a material adverse effect on our business, revenues, operating
results, cash flows and financial condition.
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 governmental
regulation. Although compliance with these laws and regulations is principally
the responsibility of the healthcare provider, under these current laws and
regulations patient confidentiality rights are evolving rapidly. In addition to
the obligations being imposed at the state level, there is also legislation
governing the dissemination of medical information at the federal level. The
federal regulations may require holders of this information to implement
security measures, which could entail substantial expenditures on our part.
Adoption of these types of legislation or other changes to state or federal laws
could materially affect or restrict the ability of healthcare providers to
submit information from patient records using our products and services. These
kinds of restrictions would likely decrease the value of our applications to our
customers, which could materially harm our business.
CHANGES IN THE REGULATORY AND ECONOMIC ENVIRONMENT IN THE HEALTHCARE INDUSTRY
COULD CAUSE US TO LOSE REVENUE AND INCUR SUBSTANTIAL COSTS TO COMPLY WITH NEW
REGULATIONS.
The healthcare industry is highly regulated and is subject to changing
political, economic and regulatory influences. These factors affect the
purchasing practices and operations of healthcare organizations. Changes in
current healthcare financing and reimbursement systems could require us to make
unplanned enhancements of applications or services, or result in delays or
cancellations of orders or in the revocation of endorsement of our
17
VitalWorks Inc.
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. Until recently, larger, national
vendors have targeted primarily large healthcare providers. We believe that the
larger, national vendors may broaden their markets to include both small and
large healthcare providers. In addition, we compete with national and regional
providers of computerized billing, insurance processing and record management
services to healthcare practices. As the market for our products and services
expands, additional competitors are likely to enter this market. We believe that
the primary competitive factors in our markets are:
- product features and functionality;
- customer service, support and satisfaction;
- price;
- ongoing product enhancements; and
- vendor reputation and stability.
We have experienced, and we expect to continue to experience, increased
competition from current and potential competitors, many of which have
significantly greater financial, technical, marketing and other resources than
us. Such competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of their products than us. Also, certain
current and potential competitors have greater name recognition or more
extensive customer bases that could be leveraged, thereby gaining market share
to our detriment. We expect additional competition as other established and
emerging companies enter into the practice management and clinical software
markets and as new products and technologies are introduced. Increased
competition could result in price reductions, fewer customer orders, reduced
gross margins and loss of market share, any of which would materially adversely
affect our business, operating results, cash flows and financial condition.
Current and potential competitors may make strategic acquisitions or
establish cooperative relationships among themselves or with third parties,
thereby increasing their abilities 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 our failure to do so
would have a material adverse effect upon our business, operating results, cash
flows and financial condition.
18
VitalWorks Inc.
WE DEPEND ON PARTNERS/SUPPLIERS FOR DELIVERY OF ELECTRONIC DATA INTERCHANGE
(E.G., 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 if 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 from the resale of
computer hardware. Today, customers pay an initial license fee for the use of
our products, in addition to a periodic maintenance fee. If the marketplace
demands subscription pricing and/or ASP-delivered offerings, we may be forced to
adjust our strategy accordingly, by offering a higher percentage of our products
and services through these means. Shifting to subscription pricing and/or
ASP-delivered offerings could materially adversely impact our financial
condition, cash flows and quarterly and annual revenues and results of
operations, as our revenues would initially decrease substantially. We cannot
assure you that the marketplace will not embrace subscription pricing and/or
ASP-delivered offerings.
WE STRUCTURED THE SPIN-OFF OF PRACTICEWORKS AS A TAX-FREE TRANSACTION AND
PRACTICEWORKS AGREED TO INDEMNIFY US FOR ANY TAX LIABILITIES ARISING OUT OF THE
TRANSACTION THAT ARE ATTRIBUTABLE TO ITS ACTIONS. IF THE SPIN-OFF DOES NOT
QUALIFY AS A TAX-FREE TRANSACTION, WE MAY BE SUBJECT TO LIABILITIES AND WE
CANNOT ASSURE YOU THAT PRACTICEWORKS 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 contains certain requirements that must be complied
with in order for the spin-off to qualify for tax-free treatment. Failure to
comply with those restrictions could cause us to incur significant liabilities.
PracticeWorks or its successors 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
19
VitalWorks Inc.
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 Nos. 101 and
104), 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.
20
VitalWorks Inc.
OVERVIEW
VitalWorks Inc. is a leading provider of information and image management
technology and services targeted to healthcare practices and organizations
throughout the United States. We provide IT-based, specialty-specific solutions
for imaging centers and hospital radiology departments, and medical practices
specializing in anesthesiology, ophthalmology, emergency medicine, plastic
surgery, dermatology, and internal medicine. We also offer enterprise-level
systems designed for large physician groups and networks. Our range of software
solutions provide image management, workflow management, and information
management related to administrative, financial, and clinical functions for
physicians, radiologists and other healthcare providers. We provide our clients
with ongoing software support, implementation, training, and electronic data
interchange, or EDI, services for patient billing and claims processing.
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 two-thirds of our total
revenues are of a recurring nature.
For the three months ended March 31, 2004 and 2003, approximately
two-thirds of our total revenues were derived from the medical practices market
and one-third from the radiology market.
RESULTS OF OPERATIONS
On November 25, 2003, we acquired 100% of the outstanding capital stock of
AMICAS, Inc., a developer of Web-based diagnostic image management software
solutions, for $31 million in cash, including direct transaction costs. Commonly
referred to in the marketplace as PACS (picture archiving and communication
systems), these software solutions allow radiologists and other physicians to
examine, store, and distribute digitized medical images. The merger agreement
provides for an additional purchase payment of up to $25 million based on
attainment of specified earnings targets through 2004 which, if paid, would be
recognized as additional goodwill. In addition, we assumed incentive plans for
certain management employees of AMICAS that provide for up to $5 million of
compensation, tied to the attainment of the earnings targets for the contingent
earn-out period. The addition of AMICAS provides us with the ability to offer
radiology/imaging center clients a comprehensive, integrated information and
image management solution, incorporating the key components of a complete
radiology data management system. In conformity with purchase accounting
principles, only our statement of operations for the March 2004 quarter includes
the operating results of AMICAS.
REVENUES
First Quarter Ended
March 31, 2004 CHANGE 2003
----------- ------ ---------
(dollars in thousands)
Maintenance and services $ 21,308 (5.4)% $ 22,530
Percentage of total revenues 79.6% 78.9%
----------- ------ ---------
Software licenses and system sales $ 5,470 (9.5)% $ 6,043
Percentage of total revenues 20.4% 21.1%
----------- ------ ---------
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
21
VitalWorks Inc.
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/or 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 decrease in maintenance and services revenues is mainly attributable
to a decline in implementation and training services revenues of $1.9 million,
including $1.1 million relating to HIPAA-compliance services, and a decrease in
maintenance revenues of approximately $.8 million relating to net customer
attrition including the cessation of support for certain of our legacy systems.
These decreases were partially offset by an increase in EDI services revenues of
approximately $.8 million and the addition of maintenance and services revenues
from AMICAS of $.8 million. The HIPAA service revenues relate to the
government's October 2003 compliance deadline regarding its electronic
processing standards for most healthcare transactions among physicians, payors,
patients and other healthcare industry participants. Accordingly, for the most
part, these HIPAA related services are no longer required.
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). The decline was partially offset by the addition of
software license revenues from AMICAS of $1.2 million.
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 image management systems, AMICAS(R) Vision
Series(TM) PACS, our new radiology information system, RadConnect(R) RIS, and
our Intuition(TM) product line of practice management and electronic medical
records systems, which may not be realized. Due to these and other factors, our
revenues and
22
VitalWorks Inc.
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. Moreover, 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 attrition of
existing clients and a shortfall in new client additions.
COST OF REVENUES
First Quarter Ended
March 31, 2004 CHANGE 2003
----------- ------ ---------
(dollars in thousands)
Maintenance and services $ 5,299 (14.6)% $ 6,206
Percentage of maintenance and services
revenue 24.9% 27.5%
----------- ------ ---------
Software licenses and system sales $ 2,220 (18.4)% $ 2,719
Percentage of software licenses and
system sales 40.6% 45.0%
----------- ------ ---------
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 decrease principally
reflects additional costs incurred in 2003 with respect to an arrangement with
an EDI supplier of $.5 million and, to a lesser extent, a decline in 2004 in the
number of EDI billing and statement printing transactions.
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
software product costs. The decrease is largely attributable to a decline in
computer hardware costs of $.9 million due to a decrease in computer hardware
sales. This decrease was partially offset by an increase in amortization of
software costs of $.4 million relating to software product assets from the
acquisition of AMICAS.
OPERATING EXPENSES
First Quarter Ended
March 31, 2004 CHANGE 2003
----------- ------ ---------
(dollars in thousands)
Selling, general and administrative $ 15,301 24.9% $ 12,248
Percentage of total revenues 57.1% 42.9%
----------- ------ ---------
Research and development $ 4,553 18.4% $ 3,847
Percentage of total revenues 17.0% 13.5%
----------- ------ ---------
Depreciation and amortization $ 841 51.5% $ 555
Percentage of total revenues 3.1% 1.9%
----------- ------ ---------
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,
23
VitalWorks Inc.
marketing, insurance and other administrative expenses. The increase is
primarily due to the inclusion of AMICAS' expenses in 2004 of $2.1 million and,
to a lesser extent, an increase in costs relating to our sales and marketing
initiatives.
Likewise, the increase in research and development expenses is mainly
attributable to additional personnel costs relating to the inclusion of AMICAS
as part of our operations in 2004. In addition, for the three months ended March
31, 2004 and 2003, we capitalized $.6 million and $.4 million (or 11.0% and 9.2%
of total research and development expenditures) of third-party programmer fees,
respectively, in conformity with Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed." The amounts capitalized relate to our development of
Web-based applications, including an enterprise-wide electronic medical records
system. 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 increase in depreciation and amortization expense primarily reflects
the depreciation and amortization of certain intangible assets and property and
equipment from the acquisition of AMICAS.
SETTLEMENT OF LITIGATION
In August 2003, we were served with a summons and complaint as part of a
bankruptcy proceeding related to a former business associate (an e-prescribing
vendor) of ours. The complaint alleged that in 2001, we received a preference
payment from the business associate and sought to avoid and recover the $.8
million payment made to us. We agreed to settle this matter in March 2004 and in
April 2004 paid $.3 million to the former business associate through its
committee of unsecured creditors.
INTEREST INCOME (EXPENSE)
First Quarter Ended
March 31, 2004 CHANGE 2003
----------- ------ ---------
(dollars in thousands)
Interest income $ 26 (71.4)% $ 91
Interest expense (374) 16.5% (321)
----------- ------ ---------
Interest expense consists primarily of interest costs incurred in
connection with our outstanding term loans. The increase is related to the $15.0
million we borrowed in November 2003 in connection with the acquisition of
AMICAS.
INCOME TAXES
For the three-month periods ended March 31, 2004 and 2003, we recorded
income tax provisions of $75,000 and $50,000, respectively. Management has
assessed the realizable value of our deferred tax assets of $63.7 million and
determined that a valuation allowance of $26.9 million was necessary as of March
31, 2004 to, along with deferred tax liabilities of $10.0 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 five years.
We expect an income tax provision of approximately $.3 million for 2004.
24
VitalWorks Inc.
NET INCOME (LOSS)
As a result of the above factors, our operating results for the
three-month period ended March 31, 2004 declined to a net loss of $(2.2) million
from net income of $2.7 million for the corresponding period of 2003.
To date, the overall impact of inflation on us has not been material.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have financed our business through positive cash flows from
operations and proceeds from the issuance of common stock and long-term
borrowings. For the three months ended March 31, 2004, and for fiscal years
2003, 2002 and 2001, we generated positive cash flows from operations of $1.9
million, $2.2 million, $20.8 million and $18.2 million, respectively.
Days sales outstanding (calculated as accounts receivable, net of
allowances, divided by quarterly revenues multiplied by 90 days) for the first
quarter of 2004 was 61 days, up from 55 days for the December 2003 quarter and
41 days for the corresponding March 2003 quarter. As we sell more of our
products and services to hospitals and large medical imaging centers, we would
expect this trend to continue.
Investing activities for the three months ended March 31, 2004 resulted in
a use of cash of $1.2 million. This total includes $.7 million used primarily
for purchases of computer equipment and software including an enterprise
resource planning, or ERP, system, and $.5 million used for software development
costs. Once fully implemented, the ERP system will serve all businesses and
departments of our company as an integrated information system.
Cash used in financing activities for the three months ended March 31,
2004 amounted to $2.3 million consisting of $2.4 million of principal payments
of long-term debt and $.2 million of finance costs, partly offset by $.2 million
of payments received in connection with the exercise of stock options by certain
employees.
As of March 31, 2004, we had cash and cash equivalents of $18.6 million
and $27.4 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 August 2003, we entered into an amended and restated four-year
credit agreement with Wells Fargo Foothill, Inc. The amended agreement included
our outstanding term loan of $15.8 million at an interest rate of prime plus .5%
(4.5% at March 31, 2004). Interest is payable monthly in arrears. Principal was
payable quarterly through April 1, 2004, with a balloon payment in August 2007.
Should we decide to prepay the term loan in full prior to year three, we would
incur a prepayment fee equal to 2% in year one and 1% in year two 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, (iii) the required maintenance of a minimum of
$6 million in cash, and (iv) the prohibition of dividend payments to
stockholders. The amended agreement also provides for an acquisition credit line
of up to $50 million, less any amounts outstanding under term loans.
Availability of the acquisition credit line is at the discretion of Wells Fargo.
On November 25, 2003 in connection with the AMICAS acquisition, we borrowed
$15.0 million under the credit line in the form of a term loan at an interest
rate of prime plus .75% (4.75% at March 31, 2004). Principal is payable in 15
equal quarterly installments, which began on January 1, 2004, and interest is
payable monthly in arrears.
25
VitalWorks Inc.
The following table summarizes, as of March 31, 2004, the general timing
of future payments under our outstanding loan agreements, lease agreements that
include noncancellable terms, and other long-term contractual obligations.
PAYMENTS DUE BY PERIOD
------------------------------------------------------------------------------------------
TOTALS 2004 2005 2006 2007 THEREAFTER
---------- ---------- ---------- ---------- ---------- ----------
(in thousands)
Long-term debt ............... $ 27,250 $ 4,250 $ 4,000 $ 4,000 $ 15,000
Operating leases ............. 8,949 2,339 2,256 2,113 1,454 $ 787
Other commitments (a) ........ 5,628 3,495 1,000 800 333
Other long-term liabilities .. 412 17 252 132 11
Capital leases ............... 184 165 19
---------- ---------- ---------- ---------- ---------- ----------
$ 42,423 $ 10,266 $ 7,527 $ 7,045 $ 16,798 $ 787
========== ========== ========== ========== ========== ==========
- ------------------
(a) Included in other commitments are the following:
- 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 2005. Also,
during a royalty term ending January 2006, we are obligated to pay
royalty fees of up to $5 million based on related software license
sales, if any.
- 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.
- We have committed, for the 2004 plan year, to contribute to our
employee savings plan. Our matching contribution for 2004 is
expected to be approximately $1 million and will be made 75% in cash
and 25% in shares of our common stock.
Should there be any additional consideration due under the earn-out
provisions of the AMICAS merger agreement, the amount shall be satisfied by us
in cash and/or shares of VitalWorks common stock.
We anticipate capital expenditures of approximately $3.5 million for the
remainder of 2004, including software development costs of approximately $1.5
million.
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.
26
VitalWorks Inc.
From time to time, in the normal course of business, various claims are
made against us. Except for the proceedings described below, there are no
material proceedings to which we are a party, and management is unaware of any
material contemplated actions against us.
On or about July 31, 2003, a Consolidated Class Action Complaint was filed
in the United States District Court for the District of Connecticut on behalf of
purchasers of the common stock of VitalWorks Inc. during the class period of
January 24, 2002 to October 23, 2002. The defendants are VitalWorks and three of
our individual officers and directors. Plaintiffs have asserted claims against
the defendants under Section 10(b) of the Securities Exchange Act of 1934 and
against the individual defendants under Section 20(a) of the Exchange Act.
According to the Consolidated Complaint, the defendants made materially false
and misleading statements during the Class Period concerning our products and
financial forecasts. In addition, the Consolidated Complaint alleges that the
individual defendants acted as controlling persons in connection with our
alleged securities law violations. Compensatory damages in an unspecified
amount, pre-judgment and post-judgment interest, costs and expenses, including
reasonable attorneys' fees and experts' fees and other costs, as well as other
relief the Court may deem just and proper are sought. On November 14, 2003, the
defendants filed with the Court a motion to dismiss the Consolidated Complaint
pursuant to Federal Rules of Civil Procedure 12(b)(6) and (9)(b). The motion has
been fully briefed and is awaiting disposition by the Court. At this time,
discovery is automatically stayed under the Private Securities Litigation Reform
Act and no class has been certified.
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 and the case was subsequently transferred to the
Northern District Court of Georgia. The complaint alleged state securities law
violations, breach of contract, and fraud claims against the defendants. The
complaint did not specify the amount of damages sought by plaintiffs, but sought
rescission of a transaction that the plaintiffs valued at $5 million, as well as
punitive damages and reimbursement for the plaintiffs' attorneys' fees and
associated costs and expenses of the lawsuit. In October 2001, the plaintiffs'
request for a preliminary injunction to preserve their remedy of rescission was
denied and part of their complaint was dismissed. The plaintiffs' subsequent
appeal of this decision was denied. Thereafter, plaintiffs retained new counsel
and served an amended complaint that added additional former officers and
directors as defendants, dropped the claim for rescission, and asserted new
state securities law violations. After disqualification of plaintiffs' second
counsel in May 2003, plaintiffs retained new counsel and, in July 2003, served a
second amended complaint upon us which added, among other things, a claim for
Georgia RICO violations. In August 2003, we filed with the Court a partial
motion to dismiss the second amended complaint which motion was granted in part
and denied in part on January 9, 2004. On February 6, 2004, we served an answer
to the second amended complaint. The discovery process is now ongoing.
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. Depending on the amount and timing of
an unfavorable resolution(s) of the contingencies, it is possible that our
financial position, future results of operations or cash flows could be
materially affected in a particular reporting period(s).
As permitted under Delaware law, we have agreements whereby we indemnify
our officers and directors for certain events or occurrences while the officer
or director is or was serving at our request in such capacity. The term of the
indemnification period is for the officer's or director's lifetime. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is unlimited; however, with respect to certain events
or occurrences after March 6, 2001, we have a director and officer insurance
policy that limits our exposure and enables us to recover a portion of any
future amounts paid. Given the insurance coverage in effect, we believe the
estimated fair value of these indemnification agreements is minimal. We have no
liabilities recorded for these agreements as of March 31, 2004.
27
VitalWorks Inc.
We include standard intellectual property indemnification provisions in
our software license agreements. Pursuant to these provisions, we hold harmless
and agree to defend the indemnified party, generally our business partners and
customers, in connection with certain patent, copyright, trademark and trade
secret infringement claims by third parties with respect to our products. The
term of the indemnification provisions varies, and may be perpetual. In the
event an infringement claim against us or an indemnified party is made,
generally we, in our sole discretion, agree to do one of the following: (i)
procure for the indemnified party the right to continue use of the software,
(ii) provide a modification to the software so that its use becomes
noninfringing; (iii) replace the software with software which is substantially
similar in functionality and performance; or (iv) refund the residual value of
the software license fees paid by the indemnified party for the infringing
software. We believe the estimated fair value of these intellectual property
indemnification agreements is minimal. We have no liabilities recorded for these
agreements as of March 31, 2004.
For 2004, 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. This assumes that, among other things, we
attain our projected results of operations and related cash flows, and that
earnings targets under the earn-out provisions of the AMICAS merger agreement
are not achieved. Otherwise, we may require additional debt or equity funding
which may or may not be available.
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/or 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
28
VitalWorks Inc.
customer the right to accept or reject the product after we ship it. However, if
an acceptance provision is included, revenue is recognized upon the customer's
acceptance of the product, which occurs upon the earlier of receipt of a written
customer acceptance or expiration of the acceptance period. We provide
allowances for estimated future returns and discounts (recorded as
contra-revenue), as well as bad debts, upon recognition of revenues.
Recognition of revenues in conformity with generally accepted accounting
principles requires management to make judgments that affect the timing and
amount of reported revenues.
Accounts Receivable. Our accounts receivable are customer obligations due
under normal trade terms carried at their face value, less allowances for
estimated future returns and discounts, as well as bad debts. We evaluate the
carrying amount of our accounts receivable on an ongoing basis and establish a
valuation allowance based on a number of factors, including specific customer
circumstances, historical rate of write-offs and the past due status of the
accounts. At the end of each fiscal quarter, the allowance is reviewed and
analyzed for adequacy and is often adjusted based on the findings. The allowance
is increased through a reduction of revenues, an increase in bad debt expense
and/or recovery of amounts previously written-off. The allowance is reduced by
write-offs of amounts deemed uncollectible and adjustments to revenue and/or bad
debt expense, if any, based on management's determination as to the adequacy of
the recorded allowance.
Long-lived Assets. We review our long-lived assets, such as property and
equipment, and purchased intangible assets that are subject to amortization, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability is measured
by a comparison of the carrying amount of an asset to the estimated undiscounted
future cash flows it is expected to generate. If the carrying amount of an asset
exceeds its estimated future cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. Assets to be disposed of would be separately presented in the balance
sheet and reported at the lower of the carrying amount or fair value less cost
to sell, and would no longer be amortized or depreciated. The assets and
liabilities of a disposed group classified as held for sale would also be
presented separately in the appropriate asset and liability sections of the
balance sheet.
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. To date, the results of our tests have not revealed an impairment of
value. Pursuant to Statement 142, we discontinued amortizing goodwill on January
1, 2002.
Our acquisition of AMICAS in 2003 was accounted for as a purchase
transaction and, accordingly, the excess purchase price over the estimated fair
value of the net assets acquired was recognized as goodwill. Acquired software
and other intangible assets are being amortized through operations over their
estimated economic lives.
Software Product Development Costs. We begin capitalizing software product
development costs, exclusively third-party programmer fees, only after
establishing commercial and technical viability. Annual amortization of these
costs represents the greater of the amount computed using (i) the ratio that
current gross revenues for the product(s) bear to the total current and
anticipated future gross revenues of the product(s), or (ii) the straight-line
method over the remaining estimated economic life of the product(s); generally,
depending on the nature and success of the product, such deferred costs are
amortized over a three- to five-year period. Amortization commences when the
product is made commercially available. Two products under development
29
VitalWorks Inc.
were made commercially available in 2002. No additional products were made
commercially available in 2003 or in the first quarter of 2004.
We evaluate the recoverability of capitalized software based on estimated
future gross revenues less the estimated cost of completing the products and of
performing maintenance and product support. If our gross revenues turn out to be
significantly less than our estimates, the net realizable value of our
capitalized software intended for sale would be impaired.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2003, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 104, "Revenue Recognition", which amends
SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary
purpose is to rescind accounting guidance contained in SAB 101 related to
multiple-element revenue arrangements, superseded as a result of the issuance of
EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial
Statements Frequently Asked Questions and Answers, or FAQ, issued with SAB 101
that had been codified in SEC Topic 13, "Revenue Recognition." Selected portions
of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has
changed to reflect the issuance of EITF 00-21, the revenue recognition
principles of SAB 101 remain largely unchanged by the issuance of SAB 104.
Adoption of this standard had no material impact on our financial statements.
In December 2003, the Financial Accounting Standards Board, or FASB,
issued Interpretation No. 46, or FIN 46R, "Consolidation of Variable Interest
Entities, an Interpretation of Accounting Research Bulletin No. 51", which
addresses how a business enterprise should evaluate whether it has a controlling
interest in an entity through means other than voting rights and, accordingly,
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, or
FIN 46, which was issued in January 2003. Before concluding that it is
appropriate to apply ARB 51 voting interest consolidation model to an entity, an
enterprise must first determine that the entity is not a variable interest
entity. As of the effective date of FIN 46R, an enterprise must evaluate its
involvement with all entities or legal structures created before February 1,
2003, to determine whether consolidation requirements of FIN 46R apply to those
entities. There is no grandfathering of existing entities. Public companies must
apply either FIN 46 or FIN 46R immediately to entities created after December
15, 2003 and no later than the end of the first reporting period that ends after
March 15, 2004 to entities considered to be special purpose entities. The
adoption of FIN 46R had no effect on our financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, "Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity" that establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. Statement 150 was effective for financial
instruments entered into or modified after May 31, 2003, and otherwise was
effective at the beginning of the first interim period beginning after June 15,
2003. On November 7, 2003, FASB Staff Position 150-3 was issued, which
indefinitely deferred the effective date of Statement 150 for certain mandatory
redeemable noncontrolling interests. The adoption of Statement 150 had no effect
on our financial statements.
In November 2002, the FASB Emerging Issues Task Force reached consensus
with respect to Issue 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." EITF 00-21, as amended in May 2003, addresses the accounting for
multiple-element revenue arrangements. Specifically, EITF 00-21 addresses how to
30
VitalWorks Inc.
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 did not have a
material effect on our financial statements.
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
$27.3 million of our outstanding debt at March 31, 2004 related 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 $.3
million in pre-tax operating results assuming no further changes in the amount
of our borrowings subject to variable rate interest from amounts outstanding at
March 31, 2004. 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 March 31, 2004. Based on this evaluation, our chief executive officer
and chief financial officer concluded that, as of March 31, 2004, 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 March 31, 2004 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 proceedings described below, there are no material
proceedings to which we are a party, and management is unaware of any material
contemplated actions against us.
On or about July 31, 2003, a Consolidated Class Action Complaint was filed
in the United States District Court for the District of Connecticut on behalf of
purchasers of the common stock of VitalWorks Inc. during the class period of
January 24, 2002 to October 23, 2002. The defendants are VitalWorks and three of
our individual
31
VitalWorks Inc.
officers and directors. Plaintiffs have asserted claims against the defendants
under Section 10(b) of the Securities Exchange Act of 1934 and against the
individual defendants under Section 20(a) of the Exchange Act. According to the
Consolidated Complaint, the defendants made materially false and misleading
statements during the Class Period concerning our products and financial
forecasts. In addition, the Consolidated Complaint alleges that the individual
defendants acted as controlling persons in connection with our alleged
securities law violations. Compensatory damages in an unspecified amount,
pre-judgment and post-judgment interest, costs and expenses, including
reasonable attorneys' fees and experts' fees and other costs, as well as other
relief the Court may deem just and proper are sought. On November 14, 2003, the
defendants filed with the Court a motion to dismiss the Consolidated Complaint
pursuant to Federal Rules of Civil Procedure 12(b)(6) and (9)(b). The motion has
been fully briefed and is awaiting disposition by the Court. At this time,
discovery is automatically stayed under the Private Securities Litigation Reform
Act and no class has been certified.
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 and the case was subsequently transferred to the
Northern District Court of Georgia. The complaint alleged state securities law
violations, breach of contract, and fraud claims against the defendants. The
complaint did not specify the amount of damages sought by plaintiffs, but sought
rescission of a transaction that the plaintiffs valued at $5 million, as well as
punitive damages and reimbursement for the plaintiffs' attorneys' fees and
associated costs and expenses of the lawsuit. In October 2001, the plaintiffs'
request for a preliminary injunction to preserve their remedy of rescission was
denied and part of their complaint was dismissed. The plaintiffs' subsequent
appeal of this decision was denied. Thereafter, plaintiffs retained new counsel
and served an amended complaint that added additional former officers and
directors as defendants, dropped the claim for rescission, and asserted new
state securities law violations. After disqualification of plaintiffs' second
counsel in May 2003, plaintiffs retained new counsel and, in July 2003, served a
second amended complaint upon us which added, among other things, a claim for
Georgia RICO violations. In August 2003, we filed with the Court a partial
motion to dismiss the second amended complaint which motion was granted in part
and denied in part on January 9, 2004. On February 6, 2004, we served an answer
to the second amended complaint. The discovery process is now ongoing.
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. Depending on the amount and timing of
an unfavorable resolution(s) of the contingencies, it is possible that our
financial position, future results of operations or cash flows could be
materially affected in a particular reporting period(s).
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 alleged that in 2001, we received a preference payment from the
business associate and sought to avoid and recover the $.8 million payment made
to us. We agreed to settle this matter in March 2004 and in April 2004 paid $.3
million to the former business associate through its committee of unsecured
creditors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Description
10 Form of Employment Agreement, dated April 26, 2004, by and
between VitalWorks Inc. and our Named Executive Officers.
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
VitalWorks Inc.
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 or furnished the following reports on Form 8-K during
the quarter ended March 31, 2004:
Current Report on Form 8-K furnished to the Securities and
Exchange Commission on February 4, 2004 with respect to our
announcement of our financial results for the quarter ended
December 31, 2003.
Current Report on Form 8-K/A filed with the Securities and
Exchange Commission on February 9, 2004 with respect to the
historical financial statements of AMICAS, Inc. and certain
pro forma financial information.
33
VitalWorks Inc.
Form 10-Q for the Three-Month Period Ended March 31, 2004
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 May 10, 2004
-------------------------------------------------------------------------
Michael A. Manto Date
Executive Vice President and Chief Financial Officer
/s/ Joseph M. Walsh May 10, 2004
-------------------------------------------------------------------------
Joseph M. Walsh Date
Chairman and Chief Executive Officer
34