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 SEPTEMBER 30, 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 November 4, 2004 there were 43,628,431 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 Registered Public Accounting Firm.................. 2
Condensed Consolidated Balance Sheets --
September 30, 2004 and December 31, 2003............................... 3
Condensed Consolidated Statements of Operations --
Three and Nine Months Ended September 30, 2004 and 2003................ 4
Condensed Consolidated Statements of Cash Flows --
Nine Months Ended September 30, 2004 and 2003.......................... 5
Notes to Condensed Consolidated Financial Statements --
September 30, 2004.................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......... 33
Item 4. Controls and Procedures ............................................ 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 34
Item 6. Exhibits............................................................ 35
SIGNATURES.................................................................. 36
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 Registered Public Accounting Firm
Board of Directors and Stockholders
VitalWorks Inc.
We have reviewed the condensed consolidated balance sheet of VitalWorks
Inc. and subsidiary as of September 30, 2004 and the related condensed
consolidated statements of operations for the three and nine-month periods ended
September 30, 2004 and 2003, and cash flows for the nine-month periods ended
September 30, 2004 and 2003, included in the accompanying Securities and
Exchange Commission Form 10-Q for the period ended September 30, 2004. These
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 U.S. generally accepted accounting
principles.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), 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
October 26, 2004
2
VitalWorks Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ -----------
(unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 15,727 $ 20,128
Accounts receivable, net of allowances of $3,300 and $2,800 17,828 16,409
Computer hardware held for resale 633 832
Deferred income taxes, net 2,203 2,203
Prepaid expenses and other current assets 4,002 2,934
--------- ---------
TOTAL CURRENT ASSETS 40,393 42,506
Property and equipment, at cost, less accumulated
depreciation and amortization of $13,797 and $11,642 4,732 4,681
Goodwill 33,963 34,472
Acquired/developed software, less accumulated amortization
of $4,187 and $1,804 20,469 21,469
Other intangible assets, less accumulated amortization of $356 and $36 3,044 3,364
Deferred income taxes, net 24,547 24,547
Other assets 1,483 1,537
--------- ---------
Total assets $ 128,631 $ 132,576
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 12,733 $ 11,049
Accrued employee compensation and benefits 3,088 2,486
Accrued restructuring costs 152 923
Deferred revenue, including unearned discounts of $1,200 14,725 11,762
Current portion of long-term debt 4,081 6,738
--------- ---------
TOTAL CURRENT LIABILITIES 34,779 32,958
Long-term debt 20,017 23,019
Other liabilities, primarily unearned discounts re: outsourced printing services 4,728 5,937
COMMITMENTS AND CONTINGENCIES - NOTES B, F and J
Stockholders' equity:
Preferred stock $.001 par value; 2,000,000 shares authorized;
none issued
Common stock $.001 par value; 200,000,000 shares authorized;
45,576,783 and 45,278,816 shares issued 46 45
Additional paid-in capital 206,429 205,439
Accumulated deficit (130,896) (128,350)
Treasury stock, at cost, 1,985,502 shares (6,472) (6,472)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 69,107 70,662
--------- ---------
Total liabilities and stockholders' equity $ 128,631 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
-------- -------- -------- --------
REVENUES
Maintenance and services $ 22,249 $ 22,240 $ 65,847 $ 67,339
Software licenses and system sales 6,169 5,849 17,241 17,511
-------- -------- -------- --------
Total revenues 28,418 28,089 83,088 84,850
-------- -------- -------- --------
COSTS AND EXPENSES
Cost of revenues:
Maintenance and services 4,946 5,330 15,307 17,074
Software licenses and system sales, includes
amortization of software costs
of $794, $428, $2,383 and $1,283 2,895 2,119 7,502 6,872
Selling, general and administrative 15,386 12,758 45,654 36,684
Research and development 4,407 4,002 13,243 11,699
Depreciation and amortization 753 613 2,379 1,741
Settlement of litigation 325
-------- -------- -------- --------
28,387 24,822 84,410 74,070
-------- -------- -------- --------
OPERATING INCOME (LOSS) 31 3,267 (1,322) 10,780
Interest income 41 61 95 225
Interest expense (368) (247) (1,094) (870)
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (296) 3,081 (2,321) 10,135
Provision for income taxes 75 50 225 150
-------- -------- -------- --------
NET INCOME (LOSS) $ (371) $ 3,031 $ (2,546) $ 9,985
======== ======== ======== ========
EARNINGS (LOSS) PER SHARE
Basic $ (0.01) $ 0.07 $ (0.06) $ 0.23
Diluted $ (0.01) $ 0.06 $ (0.06) $ 0.21
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 43,552 43,203 43,454 42,974
Diluted 43,552 47,460 43,454 46,791
See accompanying notes.
4
VitalWorks Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
(in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
2004 2003
-------- --------
OPERATING ACTIVITIES
Net income (loss) $ (2,546) $ 9,985
Adjustments to reconcile net income (loss) to cash provided by
operating activities:
Depreciation and amortization 2,379 1,741
Provisions for bad debts, returns and discounts 1,704 1,512
Amortization of deferred finance costs, charged to interest expense 169 129
Amortization of software costs 2,383 1,283
Changes in operating assets and liabilities:
Accounts receivable (3,123) (2,008)
Computer hardware held for resale, prepaid expenses and other (727) (2,584)
Accounts payable, accrued costs and expenses 1,069 (1,740)
Deferred revenue 3,502 (1,360)
Unearned discounts re: outsourced printing services (900) (5,301)
-------- --------
CASH PROVIDED BY OPERATING ACTIVITIES 3,910 1,657
-------- --------
INVESTING ACTIVITIES
Software product development costs (1,233) (1,429)
Proceeds from sale of office building 270
Purchases of property and equipment (1,806) (854)
Security deposit (308)
-------- --------
CASH USED IN INVESTING ACTIVITIES (3,039) (2,321)
-------- --------
FINANCING ACTIVITIES
Long-term debt payments (5,767) (2,903)
Exercise of stock options and warrants 662 992
Deferred finance costs (167) (98)
-------- --------
CASH USED IN FINANCING ACTIVITIES (5,272) (2,009)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (4,401) (2,673)
Cash and cash equivalents at beginning of period 20,128 39,474
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15,727 $ 36,801
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid, net of refunds $ 33 $ 282
Interest paid 939 681
See accompanying notes.
5
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
September 30, 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 and nine-month periods
ended September 30, 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 statements of operations for 2004 include
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 and nine-month periods ended September 30,
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):
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2003
------------------ ------------------
Combined:
Revenues $29,198 $87,899
Net income $ 164 $ 1,371
Income per share - diluted $ 0.00 $ 0.03
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. In 2004, the Company reduced its goodwill
by $.5 million primarily to reflect an adjustment of the estimated fair value of
the acquired deferred revenues of AMICAS.
6
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
September 30, 2004
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 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 and nine-month periods ended September 30, 2004
and 2003, was $1.77, $2.44, $1.82 and $2.32, 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Net income (loss), as reported $ (371) $ 3,031 $ (2,546) $ 9,985
Less: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (450) (1,098) (775) (3,279)
--------- --------- --------- ---------
Pro forma net income (loss) $ (821) $ 1,933 $ (3,321) $ 6,706
========= ========= ========= =========
Earnings (loss) per share:
Basic - as reported $ (0.01) $ 0.07 $ (0.06) $ 0.23
========= ========= ========= =========
Basic - pro forma $ (0.02) $ 0.04 $ (0.08) $ 0.16
========= ========= ========= =========
Diluted - as reported $ (0.01) $ 0.06 $ (0.06) $ 0.21
========= ========= ========= =========
Diluted - pro forma $ (0.02) $ 0.04 $ (0.08) $ 0.15
========= ========= ========= =========
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)
September 30, 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
-------- ------- -------- -------
Numerator:
Net income (loss) $ (371) $ 3,031 $ (2,546) $ 9,985
======== ======= ======== =======
Denominator:
Basic EPS - weighted-average shares 43,552 43,203 43,454 42,974
Effect of dilutive securities, stock option
and warrant rights 4,257 3,817
-------- ------- -------- -------
Diluted EPS - adjusted weighted-average
shares and assumed conversions 43,552 47,460 43,454 46,791
======== ======= ======== =======
Basic EPS $ (0.01) $ 0.07 $ (0.06) $ 0.23
Diluted EPS $ (0.01) $ 0.06 $ (0.06) $ 0.21
Because their effect would be antidilutive, stock option and warrant
rights for up to 3.4 million common shares (with exercise prices ranging from
$3.46 to $17.84 per share) and 1.8 million common shares (with exercise prices
ranging from $3.82 to $17.84 per share) were excluded from the diluted EPS
calculation for the three and nine-month periods ended September 30, 2004,
respectively.
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.
In September 2004, a lawsuit styled DR Systems, Inc. v. VitalWorks Inc.
and AMICAS, Inc. was filed in the United States District Court for the Southern
District of California. The complaint alleges that VitalWorks and AMICAS
infringed the plaintiff's patent through the manufacture, use, importation, sale
and/or offer for sale of automated medical imaging and archival systems. The
plaintiff seeks monetary damages, treble damages and a permanent injunction. On
November 3, 2004, the Company served its answer.
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 are alleged to have made
materially false and misleading
8
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
September 30, 2004
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 (9)(b). In a
decision entered on October 1, 2004, United States District Judge Janet Bond
Arterton dismissed with prejudice the Consolidated Complaint as to all
defendants.
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 pending 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 under which 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 September 30, 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
9
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
September 30, 2004
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 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 September 30, 2004.
In April 2003, the Company 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, or a total of $3
million, for development services was incurred during the twelve-month period
ended March 2004. Also, during a royalty term ending January 2006, the Company
was obligated to pay royalty fees of up to $5 million based on related software
license sales, if any. In May 2004, the Company amended the agreement with
respect to the development services. The Company was obligated to pay the
development firm $.6 million during the four-month period ending August 15, 2004
for such services; however, such payment was contingent upon certain development
milestones being achieved. The milestones were achieved and the Company paid the
amounts due under the May amendment. In August 2004 and in October 2004, the
Company amended the agreement further with respect to the development services.
The Company is now obligated to pay the development firm $1.4 million during the
period from August 16, 2004 to May 1, 2005. At the end of such period, the
Company has the option to terminate the agreement or continue the development
services arrangement by paying a minimum monthly fee of $.2 million for an
additional twelve months. The terms of the royalty arrangement were amended and
now extend to March 2007. The Company is now obligated to pay reduced royalty
fees of up to $3 million based on related software license sales, if any. If the
Company terminates the development services portion of the agreement for reasons
other than nonperformance, it will still be liable for amounts due under the
royalty terms of the agreement, if any.
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. In connection with this arrangement, the Company is committed
to pay a minimum quarterly fee of $1.9 million to NDC until April 2009.
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 connection with the 2003
plan. 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 in connection with the 2000 plan. The offices that were closed are
subject to operating leases that expire at various dates through 2005.
10
VitalWorks Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
September 30, 2004
In the nine months ended September 30, 2004, the restructuring accrual was
reduced by $.6 million consisting of severance payments relating to the 2003
restructuring and lease payments relating to the 2000 restructuring. The accrual
was reduced by another $.2 million reflecting savings credited to selling,
general and administrative expenses in connection with the early termination of
one office lease and the sublease of a second office lease for facilities closed
in connection with the 2000 restructuring. The nature of the accrual as of
September 30, 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 first nine months of 2004, the Company issued 297,967 shares of its
common stock, consisting of 247,948 shares in connection with the exercise of
stock options by certain employees, and 50,019 shares with respect to the
Company-sponsored employee savings plan. As a result, the Company recognized
$1.0 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 and nine-month periods ended
September 30, 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.
J. SUBSEQUENT EVENT
On October 1, 2004, the Company announced that it plans to relocate its
executive offices from Ridgefield, Connecticut to Boston, Massachusetts in 2005.
The Company already has a significant presence in Boston, following its
acquisition of AMICAS in November 2003. On October 15, 2004, the Company
notified 57 of its employees that, in connection with the relocation of the
Company's executive offices, their employment would be terminated under a plan
of termination. The Company anticipates that a majority of the positions
terminated in Ridgefield will be filled by new employees in Boston. Accordingly,
the Company has offered to relocate many of its Ridgefield employees to Boston.
The Company expects to complete the executive office transition by June 30,
2005. The Company's preliminary estimate is that the total costs to be incurred
in connection with its relocation plan, including executive severance-related
costs of $.4 million discussed below, will be in the range of approximately $1.2
million to $1.7 million. These costs consist primarily of severance-related
costs, all of which are expected to result in future cash expenditures. The
Company recorded $.4 million of these severance-related costs in the third
quarter of 2004 for separation benefits to be paid to a certain former executive
officer pursuant to the terms of a pre-existing employment agreement. Subsequent
to November 2, 2004, the Company received from this former executive officer a
signed mutual separation agreement with the Company thereby resolving any
uncertainty regarding the separation benefits owed to the former executive
officer. Absent this separation agreement, the former executive would not have
been entitled to the separation benefits under his employment agreement. The
Company expects to record an additional $.4 million for the relocation costs
described above in the fourth quarter of 2004 and the remaining amount of the
charge in the first quarter of 2005.
11
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 risk
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 $9,000, $8.0 million and $24.2
million for the June 2004 quarter and for the years 2003 and 2002, we incurred
net losses of $(.4) million, $(2.2) million and $(2.0) million for the September
2004, 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;
12
VitalWorks Inc.
- availability of specified computer hardware for resale;
- deferral and/or realization of deferred software license and system
revenues according to contract terms;
- interpretations of accounting regulations, principles or concepts that are
or may be considered relevant to our business arrangements and practices;
- changes in customer purchasing patterns;
- 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.
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 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.
Our expectations with regard to the long-term financial benefits that we
anticipate will result from our acquisition of AMICAS 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;
- our ability to execute on our strategy and realize our revenue goals and
control costs and expenses relating to the acquisition;
13
VitalWorks Inc.
- 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 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
14
VitalWorks Inc.
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.
15
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.
16
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,
17
VitalWorks Inc.
our business, and the sale of our products and services, could be materially
harmed by failures with respect to our implementation of HIPAA regulations.
Other E-Commerce Regulations
We may be subject to additional federal and state statutes and regulations
in connection with offering services and products via the Internet. On an
increasingly frequent basis, federal and state legislators are proposing laws
and regulations that apply to Internet commerce and communications. Areas being
affected by these regulations include user privacy, pricing, content, taxation,
copyright protection, distribution, and quality of products and services. To the
extent that our products and services are subject to these laws and regulations,
the sale of our products and services could be harmed.
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
18
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.
19
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, THIRD-PARTY SOFTWARE OR
SOFTWARE OR HARDWARE COMPONENTS OF OUR OFFERINGS, AND SALES LEAD GENERATION. ANY
FAILURE, INABILITY OR UNWILLINGNESS OF THESE SUPPLIERS TO PERFORM THESE SERVICES
OR PROVIDE THEIR PRODUCTS 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. We rely on numerous third-party products that are made part of
our software offerings and/or that we resell. Although other vendors are
available in the marketplace to provide these products and services, it would
take time to switch suppliers. If these suppliers were unable or unwilling to
perform such services, provide their products or if the quality of these
services or products declined, it could have a negative impact on customer
satisfaction and result in a decrease in our revenues, cash flows and operating
results.
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. Some of our customers have had
their use of our software significantly impacted by computer viruses. 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.
20
VitalWorks Inc.
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.
WE ARE EXPOSED TO POTENTIAL RISKS FROM RECENT LEGISLATION REQUIRING COMPANIES TO
EVALUATE CONTROLS UNDER SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002.
We are evaluating our internal controls to allow management to report on, and
our independent registered public accounting firm to attest to, our internal
controls, as required by Section 404 of the Sarbanes-Oxley Act. We are
performing the system and process evaluation and testing required in an effort
to comply with the management certification and auditor attestation requirements
of Section 404. Our testing to date has not resulted in our having to make any
material changes in our internal controls. However, we are still in the process
of completing our testing of our internal controls and subsequent to the
completion of our testing, our independent registered public accounting firm
must perform its tests of our internal controls. Our continued testing and the
subsequent testing by our independent registered public accounting firm may
reveal deficiencies in our internal controls. We may not be able to remediate
any such deficiencies in a timely manner so as to be able to comply with the
requirements of Section 404 for the year ending December 31, 2004. If we are not
able to implement the requirements of Section 404 in a timely manner or with
adequate compliance, we might be subject to sanctions or investigations by
regulatory authorities, such as the Securities and Exchange Commission or the
Nasdaq National Market. Any such action could adversely affect our financial
results and the market price of our common stock.
21
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.
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 statements of operations for the three and nine-month
periods ended September 30, 2004, include the operating results of AMICAS.
REVENUES
Third Quarter Ended Nine Months Ended
September 30, 2004 CHANGE 2003 2004 CHANGE 2003
------- ------ ------- ------- ------ -------
(dollars in thousands)
Maintenance and services $22,249 0.0% $22,240 $65,847 (2.2)% $67,339
Percentage of total revenues 78.3% 79.2% 79.2% 79.4%
------- --- ------- ------- ---- -------
Software licenses and system sales $ 6,169 5.5% $ 5,849 $17,241 (1.5)% $17,511
Percentage of total revenues 21.7% 20.8% 20.8% 20.6%
------- --- ------- ------- ---- -------
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,
22
VitalWorks Inc.
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.
Maintenance and services revenues for the third quarter were flat compared
to the prior year due to the addition of maintenance and services revenues from
AMICAS of $1.7 million and an increase in EDI services revenues of approximately
$.4 million. These increases were offset by a decline in implementation and
training services revenues of $1.6 million relating to HIPAA-compliance
services. Moreover, there was a decrease in maintenance revenues of
approximately $.5 million relating to net customer attrition. 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. The decrease for the nine-month period is mainly attributable to a
decline in implementation and training services revenues of $5.7 million,
including $4.8 million relating to HIPAA-compliance services. In addition, there
was a decrease in maintenance revenues of approximately $1.9 million relating to
net customer attrition including the cessation of support for certain of our
legacy systems. These declines were partially offset by the addition of
maintenance and services revenues from AMICAS of $4.1 million and an increase in
EDI services revenues of approximately $2.3 million.
Software license and system revenues increased for the third quarter due
to the addition of software license revenues from AMICAS of $1.0 million, mostly
offset by a decrease in the number of licenses and systems sold (unit volume
versus, for example, price decreases). The decline for the nine-month period was
primarily due to a decrease in the number of licenses and systems sold, but was
largely offset by the addition of software license revenues from AMICAS of $3.2
million.
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
23
VitalWorks Inc.
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 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. 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
Third Quarter Ended Nine Months Ended
September 30, 2004 CHANGE 2003 2004 CHANGE 2003
------ ------ ------ ------- ------ -------
(dollars in thousands)
Maintenance and services $4,946 (7.2)% $5,330 $15,307 (10.3)% $17,074
Percentage of maintenance and services
revenue 22.2% 24.0% 23.2% 25.4%
------ ---- ------ ------- ----- -------
Software licenses and system sales $2,895 36.6% $2,119 $ 7,502 9.2% $ 6,872
Percentage of software licenses and
system sales 46.9% 36.2% 43.5% 39.2%
------ ---- ------ ------- ----- -------
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 in the third
quarter and the nine-month period is primarily due to a decline in billing and
statement printing costs of approximately $.3 million and $.6 million,
respectively, resulting from a decrease in 2004 in the number of EDI billing and
statement printing transactions. The decrease for the nine-month period also
reflects additional costs incurred in 2003 with respect to an arrangement with
an EDI supplier of $.5 million, and declines in EDI insurance claims processing
costs and hardware maintenance costs of $.3 million each.
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 increase in the third quarter and the nine-month
period is due to an increase in amortization of software costs of $.4 million
and $1.1 million, respectively, relating to software product assets from the
acquisition of AMICAS, and $.3 million and $.6 million, respectively, of
additional software royalties. These increases for the nine-month period were
partially offset by a decline in computer hardware costs of $1.1 million due to
a decrease in computer hardware sales.
24
VitalWorks Inc.
OPERATING EXPENSES
Third Quarter Ended Nine Months Ended
September 30, 2004 CHANGE 2003 2004 CHANGE 2003
------- ------ ------- ------- ------ -------
(dollars in thousands)
Selling, general and administrative $15,386 20.6% $12,758 $45,654 24.5% $36,684
Percentage of total revenues 54.1% 45.4% 54.9% 43.2%
------- ---- ------- ------- ---- -------
Research and development $ 4,407 10.1% $ 4,002 $13,243 13.2% $11,699
Percentage of total revenues 15.5% 14.2% 15.9% 13.8%
------- ---- ------- ------- ---- -------
Depreciation and amortization $ 753 22.8% $ 613 $ 2,379 36.6% $ 1,741
Percentage of total revenues 2.6% 2.2% 2.9% 2.1%
------- ---- ------- ------- ---- -------
Selling, general and administrative expenses include fixed and variable
compensation and benefits of all personnel (other than research and development
personnel), facilities, travel, communications, bad debt, legal, marketing,
insurance and other administrative expenses. The increases for the three and
nine-month periods are primarily due to the inclusion of AMICAS' expenses in
2004 of $1.9 million and $5.9 million, as well as increases in travel costs of
$.4 million and $1.0 million, respectively. Subsequent to November 2, 2004, we
received from a former executive officer a signed mutual separation agreement
with us thereby resolving any uncertainty regarding the separation benefits owed
to the former executive officer. Absent this separation agreement the former
executive would not have been entitled to the separation benefits under his
employment agreement. As a result, the amounts for 2004 also include $.4 million
of severance-related costs for separation benefits to be paid to the former
executive officer pursuant to the terms of a pre-existing employment agreement.
In addition, in the nine-month period, fixed compensation expense increased by
$.8 million and the amount for 2003 includes a credit of $.5 million that
reflects the favorable resolution of an outstanding matter involving a federally
subsidized research and development project dating back to 1997.
The increase in research and development expenses for the three and
nine-month periods is mainly attributable to additional personnel costs relating
to the inclusion of AMICAS as part of our operations in 2004 of $.7 million and
$2.0 million, respectively. This increase was partially offset by declines in
third-party software developer fees of $.4 million and $.7 million,
respectively. In addition, for the quarter and nine months ended September 30,
2004, we capitalized $.4 million and $1.4 million (or 8.4% and 9.5% of total
research and development expenditures) of third-party programmer fees,
respectively, in conformity with Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed." For the same periods of 2003, we capitalized $.4 million
and $1.1 million (or 9.0% and 8.4% of total research and development
expenditures) of third-party programmer fees. 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.
25
VitalWorks Inc.
INTEREST INCOME (EXPENSE)
Third Quarter Ended Nine Months Ended
September 30, 2004 CHANGE 2003 2004 CHANGE 2003
----- ------ ----- ------- ------ -----
(dollars in thousands)
Interest income $ 41 (32.8)% $ 61 $ 95 (57.8)% $ 225
Interest expense (368) 49.0% (247) (1,094) 25.7% (870)
----- ----- ----- ------- ----- -----
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 first nine months of 2004 and 2003, we recorded quarterly income
tax provisions of $75,000 and $50,000, respectively. Management has assessed the
realizable value of our deferred tax assets of $62.4 million and determined that
a valuation allowance of $26.0 million was necessary as of September 30, 2004
to, along with deferred tax liabilities of $9.6 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.
NET INCOME (LOSS)
As a result of the above factors, our operating results for the three and
nine-month periods ended September 30, 2004 declined to net losses of $(.4)
million and $(2.5) million from net income of $3.0 million and $10.0 million,
respectively, for the corresponding periods 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 nine months ended September 30, 2004, and for fiscal years
2003, 2002 and 2001, we generated positive cash flows from operations of $3.9
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 third
quarter of 2004 was 56 days, up from 55 days for the June 2004 quarter and up
from 47 days for the corresponding September 2003 quarter. As we sell more of
our products and services to hospitals and large medical imaging centers, we
would expect the increase over 2003 to continue.
26
VitalWorks Inc.
Investing activities for the nine months ended September 30, 2004 resulted
in a use of cash of $3.0 million. This total includes $1.8 million used
primarily for purchases of computer equipment and software including an
enterprise resource planning, or ERP, system, and $1.2 million used for software
development costs.
Cash used in financing activities for the nine months ended September 30,
2004 amounted to $5.3 million consisting of $5.8 million of principal payments
of long-term debt and $.2 million of finance costs, partly offset by $.7 million
of payments received in connection with the exercise of stock options by certain
employees.
As of September 30, 2004, we had cash and cash equivalents of $15.7
million and $24.1 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% (5.25% at September 30, 2004). Interest is payable monthly in arrears.
Principal was payable quarterly through April 1, 2004, with a balloon payment
due in August 2007. Should we decide to prepay the term loan in full prior to
September 2005, we would incur a prepayment fee equal to 1% 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 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% (5.5% at September 30, 2004). Principal is payable in 15
equal quarterly installments, which began on January 1, 2004, and interest is
payable monthly in arrears. The outstanding term loans, which are 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 following table summarizes, as of September 30, 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 .............. $24,000 $ 1,000 $ 4,000 $ 4,000 $15,000
Operating leases ............ 7,574 695 2,525 2,113 1,454 $ 787
Other commitments (a) ....... 38,590 2,688 9,502 8,400 7,867 10,133
Other long-term liabilities.. 176 33 132 11
Capital leases .............. 98 53 45
------- ------- ------- ------- ------- -------
$70,438 $ 4,436 $16,105 $14,645 $24,332 $10,920
======= ======= ======= ======= ======= =======
- ----------
(a) Included in other commitments are the following:
- 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
27
VitalWorks Inc.
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. In connection with this arrangement, we are committed to pay a
minimum quarterly fee of $1.9 million to NDC until April 2009.
- 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,
or a total of $3 million, for development services was incurred during
the twelve-month period ended March 2004. Also, during a royalty term
ending January 2006, we were obligated to pay royalty fees of up to $5
million based on related software license sales, if any. In May 2004,
we amended the agreement with respect to the development services. We
were obligated to pay the development firm $.6 million during the
four-month period ending August 15, 2004 for such services; however,
such payment was contingent upon certain development milestones being
achieved. The milestones were achieved and we paid the amounts due
under the May amendment. In August 2004 and in October 2004, we
amended the agreement further with respect to the development
services. We are now obligated to pay the development firm $1.4
million during the period from August 16, 2004 to May 1, 2005. At the
end of such period, we have the option to terminate the agreement or
continue the development services arrangement by paying a minimum
monthly fee of $.2 million for an additional twelve months. The terms
of the royalty arrangement were amended and now extend to March 2007.
We are now obligated to pay reduced royalty fees of up to $3 million
based on related software license sales, if any. If we terminate the
development services portion of the agreement for reasons other than
nonperformance, we will still be liable for amounts due under the
royalty terms of the agreement, 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
and second years of the agreement, we incurred $.5 million and $.6
million, respectively, for processing services. For the twelve-month
period ending May 2005, we are committed to pay $.5 million for
processing services. Thereafter, the annual services fee will range
from $.5 million to $.8 million based on our volume usage in the last
month of the preceding year.
- 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 $.8 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. The above contractual
obligations table does not include any contingent payments relating to the
earn-out provisions.
We anticipate capital expenditures of approximately $1.0 million for the
remainder of 2004, including software development costs of approximately $.5
million.
On October 1, 2004, we announced that we plan to relocate our executive
offices from Ridgefield, Connecticut to Boston, Massachusetts in 2005. We
already have a significant presence in Boston, following our acquisition of
AMICAS in November 2003. On October 15, 2004, we notified 57 of our employees
that, in connection with the relocation of our executive offices, their
employment would be terminated under a plan of
28
VitalWorks Inc.
termination. We anticipate that a majority of the positions terminated in
Ridgefield will be filled by new employees in Boston. Accordingly, we have
offered to relocate many of our Ridgefield employees to Boston. We expect to
complete the executive office transition by June 30, 2005. Our preliminary
estimate is that the total costs to be incurred in connection with our
relocation plan will be in the range of approximately $1.2 million to $1.7
million. These costs consist primarily of severance-related costs, all of which
are expected to result in future cash expenditures. As discussed above in the
operating expenses section, we recorded $.4 million of these costs in the third
quarter of 2004. We expect to record an additional $.4 million for these
costs in the fourth quarter of 2004 and the remaining amount of the charge in
the first quarter of 2005.
From time to time, in the normal course of business, various claims are
made against us. Except for the proceedings described below, there are no
material proceedings to which we are a party, and management is unaware of any
material contemplated actions against us.
In September 2004, a lawsuit styled DR Systems, Inc. v. VitalWorks Inc.
and AMICAS, Inc. was filed in the United States District Court for the Southern
District of California. The complaint alleges that VitalWorks and AMICAS
infringed the plaintiff's patent through the manufacture, use, importation, sale
and/or offer for sale of automated medical imaging and archival systems. The
plaintiff seeks monetary damages, treble damages and a permanent injunction. On
November 3, 2004, we served our answer.
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 are alleged to have 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). In a decision entered on October 1, 2004, United States District Judge
Janet Bond Arterton dismissed with prejudice the Consolidated Complaint as to
all defendants.
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 pending matters and we
29
VitalWorks Inc.
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 under which 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 September 30, 2004.
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 September 30, 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
30
VitalWorks Inc.
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 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
31
VitalWorks Inc.
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 were made
commercially available in 2002. No additional products were made commercially
available in 2003 or in the first nine months 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
32
VitalWorks Inc.
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
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
$24.0 million of our outstanding debt at September 30, 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 $.2
million in pre-tax operating results assuming no further changes in the amount
of our borrowings subject to variable rate interest from amounts outstanding at
September 30, 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 September 30, 2004. Based on this evaluation, our chief executive
officer and chief financial officer concluded that, as of September 30, 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 September 30, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
33
VitalWorks Inc.
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.
In September 2004, a lawsuit styled DR Systems, Inc. v. VitalWorks Inc.
and AMICAS, Inc. was filed in the United States District Court for the Southern
District of California. The complaint alleges that VitalWorks and AMICAS
infringed the plaintiff's patent through the manufacture, use, importation, sale
and/or offer for sale of automated medical imaging and archival systems. The
plaintiff seeks monetary damages, treble damages and a permanent injunction. On
November 3, 2004, we served our answer.
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 are alleged to have 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). In a decision entered on October 1, 2004, Untied States District Judge
Janet Bond Arterton dismissed with prejudice the Consolidated Complaint as to
all defendants.
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 pending 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).
34
VitalWorks Inc.
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
Exhibit No. Description
- ----------- -----------
10.1 Amended Employment Agreement, dated July 26, 2004, by and between
VitalWorks Inc. and Stephen N. Kahane.
10.2 Form of Amended Employment Agreement, dated July 26, 2004, by and
between VitalWorks Inc. and Joseph M. Walsh, Michael A. Manto and
Stephen Hicks.
10.3 Employment Agreement, dated October 1, 2004, by and between
VitalWorks Inc. and Joseph D. Hill.
15 Letter regarding unaudited interim financial information from BDO
Seidman, LLP, independent registered public accounting firm.
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350.
35
VitalWorks Inc.
Form 10-Q for the Three-Month Period Ended September 30, 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/ Joseph D. Hill November 9, 2004
------------------------------------------------
Joseph D. Hill Date
Vice President and Chief Financial Officer
/s/ Stephen N. Kahane November 9, 2004
------------------------------------------------
Stephen N. Kahane Date
President and Chief Executive Officer
36