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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 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 0-26816
IDX SYSTEMS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
VERMONT 03-0222230
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
40 IDX DRIVE
SOUTH BURLINGTON, VT 05403
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (802) 862-1022
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 Rule 12b-2 of the Exchange Act).
Yes X No ____
The number of shares outstanding of the registrant's common stock as of July 30,
2004 was 30,372,992.
The following trademarks used herein are owned by IDX: Flowcast, Groupcast,
Carecast, Imagecast, IDX, LastWord, IDXtend and Web Framework. All other
trademarks referenced in this Quarterly Report on Form 10-Q are the property of
their respective owners.
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IDX SYSTEMS CORPORATION
FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 2004
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements 3
Condensed Consolidated Balance Sheets (unaudited) 3
Condensed Consolidated Statements of Income (unaudited) 4
Condensed Consolidated Statements of Cash Flows (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 39
ITEM 4. Controls and Procedures 40
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 41
ITEM 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities 42
ITEM 3. Defaults Upon Senior Securities 42
ITEM 4. Submission of Matters to a Vote of Security Holders 42
ITEM 5. Other Information 42
ITEM 6. Exhibits and Reports on Form 8-K 43
SIGNATURES 44
EXHIBIT INDEX 45
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
IDX SYSTEMS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2004 2003
----------- -------------
ASSETS
Cash and cash equivalents $ 45,844 $ 25,536
Marketable securities 78,734 79,068
Accounts receivable, net 120,755 85,971
Unbilled receivables 4,894 7,738
Costs and estimated earnings in excess of
billings on uncompleted contracts 11,595 3,961
Refundable income taxes 9,006 8,564
Prepaid and other current assets 11,663 7,485
Deferred tax asset 4,594 5,899
------------ -------------
TOTAL CURRENT ASSETS 287,085 224,222
Property and equipment, net 86,202 86,216
Capitalized software costs, net 4,922 3,806
Goodwill, net 2,508 2,508
Costs and estimated earnings in excess of
billings on uncompleted contracts 12,004 -
Other assets 10,304 10,357
Deferred tax asset 10,878 11,404
------------ -------------
TOTAL ASSETS $ 413,903 $ 338,513
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable, accrued expenses and
other liabilities $ 61,862 $ 54,843
Deferred revenue 62,923 23,016
------------ -------------
TOTAL CURRENT LIABILITIES 124,785 77,859
Deferred revenue 4,264 -
------------ -------------
TOTAL LIABILITIES 129,049 77,859
Commitments and contingencies - -
Stockholders' equity 284,854 260,654
------------ -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 413,903 $ 338,513
============ =============
SEE NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3
IDX SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- --------- ---------
REVENUES
System sales $ 46,085 $ 36,786 $ 82,059 $ 69,327
Maintenance and service fees 84,300 61,493 150,876 121,393
--------- --------- --------- -----------
TOTAL REVENUES 130,385 98,279 232,935 190,720
Operating expenses
Cost of system sales 15,593 11,508 26,810 23,300
Cost of maintenance and services 60,992 43,690 107,583 85,351
Selling, general and administrative 26,464 21,058 54,891 41,512
Software development costs 15,259 14,228 29,146 27,578
Restructuring costs 387 - 387 -
--------- --------- --------- ---------
TOTAL OPERATING EXPENSES 118,695 90,484 218,817 177,741
--------- --------- --------- ---------
OPERATING INCOME 11,690 7,795 14,118 12,979
OTHER INCOME (EXPENSE) 1,344 (38) 1,460 86
--------- --------- --------- ---------
Income before income taxes 13,034 7,757 15,578 13,065
Income tax provision (4,953) (2,327) (5,920) (3,919)
--------- --------- --------- ---------
INCOME FROM CONTINUING OPERATIONS 8,081 5,430 9,658 9,146
DISCONTINUED OPERATIONS
Income from discontinued operations,
net of income taxes - 311 - 426
Gain on sale of discontinued
operations, net of income taxes - 26,400 - 26,400
--------- --------- --------- ---------
INCOME FROM DISCONTINUED OPERATIONS - 26,711 - 26,826
--------- --------- --------- ---------
NET INCOME $ 8,081 $ 32,141 $ 9,658 $ 35,972
========= ========= ========= =========
BASIC EARNINGS PER SHARE
Income from continuing operations $ 0.27 $ 0.19 $ 0.32 $ 0.31
Income from discontinued operations $ - $ 0.91 $ - $ 0.92
--------- --------- --------- ---------
BASIC EARNINGS PER SHARE $ 0.27 $ 1.10 $ 0.32 $ 1.23
========= ========= ========= =========
Basic weighted average shares
outstanding 30,181 29,195 30,031 29,184
========= ========= ========= =========
DILUTED EARNINGS PER SHARE
Income from continuing operations $ 0.26 $ 0.18 $ 0.31 $ 0.31
Income from discontinued operations $ - $ 0.91 $ - $ 0.91
--------- --------- --------- ---------
DILUTED EARNINGS PER SHARE $ 0.26 $ 1.09 $ 0.31 $ 1.22
========= ========= ========= =========
Diluted weighted average shares
outstanding 31,572 29,456 31,503 29,436
========= ========= ========= =========
SEE NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4
IDX SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
--------------------------------
2004 2003
---- ----
OPERATING ACTIVITIES:
Net income $ 9,658 $ 35,972
Less: Income from discontinued operations,
net of income taxes - (426)
Gain on disposal of discontinued
operations, net of income taxes - (26,400)
------------ ------------
Net income from continuing operations 9,658 9,146
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 8,174 6,093
Amortization 1,584 1,049
Deferred taxes 1,831 2,019
Increase in allowance for doubtful accounts 838 588
Tax benefit related to exercise of
non-qualified stock options 3,863 -
Foreign currency transaction (gains)
losses, net (18) -
Gain on sale of investments (1,009) -
Loss on disposition of equipment 29 -
Restructuring costs 387 -
Other 154 243
Changes in operating assets and liabilities:
Accounts receivable and costs and
estimated earnings in excess of
billings on uncompleted contracts (52,142) (7,530)
Prepaid expenses and other assets (4,335) (926)
Accounts payable and accrued expenses 7,341 (5,537)
Federal and state income taxes (958) 744
Deferred revenue 44,172 3,991
------------ ------------
Net cash provided by operating
activities from continuing
operations 19,569 9,880
INVESTING ACTIVITIES:
Purchase of property and equipment, net (8,249) (17,349)
Purchase of marketable securities (62,831) (182,374)
Proceeds from sale of marketable securities 64,180 121,439
Proceeds from the sale of EDiX Corporation, net - 53,645
Other assets (2,492) (813)
------------ ------------
Net cash used in investing activities
from continuing operations (9,392) (25,452)
FINANCING ACTIVITIES:
Proceeds from sale of common stock 10,560 1,914
Proceeds from debt issuance - 23,727
Repayment of debt issuance - (42,454)
------------ ------------
Net cash provided by (used in)
financing activities from
continuing operations 10,560 (16,813)
Effect of exchange rate fluctuations on cash
and cash equivalents (429) -
------------ ------------
Net cash provided by (used in) continuing
operations 20,308 (32,385)
Net cash provided by discontinued operations - 7,697
------------ ------------
Net increase (decrease) in cash and cash
equivalents 20,308 (24,688)
Cash and cash equivalents at beginning of period 25,536 40,135
------------ ------------
Cash and cash equivalents at end of period $ 45,844 $ 15,447
============ ============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION
IDX Systems Corporation ("IDX" or the "Company") provides healthcare information
systems and services to large integrated healthcare delivery enterprises located
in the United States, the United Kingdom and Canada. Revenues are derived from
the licensing of software, hardware sales, and providing maintenance and
services related to system sales.
On June 18, 2003, the Company completed the sale of its wholly owned subsidiary
EDiX Corporation ("EDiX") to Spheris, formerly Total eMed, Inc. ("TEM"), a
medical transcription company based in Franklin, Tennessee. EDiX was accounted
for as a discontinued operation, and therefore, EDiX's results of operations and
cash flows have been removed from the Company's results of continuing operations
and cash flows for all periods presented in this Quarterly Report on Form 10-Q.
See Note 3 for further information on the sale of EDiX.
The interim unaudited condensed consolidated financial statements have been
prepared by the Company pursuant to the rules and regulations of the United
States Securities and Exchange Commission (the "SEC") and in accordance with
accounting principles generally accepted in the United States. Accordingly,
certain information and footnote disclosures normally included in annual
financial statements have been omitted or condensed. In the opinion of
management, all necessary adjustments (consisting of normal recurring accruals)
have been made to provide a fair presentation. The operating results for the
three and six month periods ended June 30, 2004 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2004. For
further information, refer to the consolidated financial statements and
footnotes included in the Company's latest annual report on Form 10-K filed with
the SEC on March 15, 2004.
Certain reclassifications of prior period data have been made to conform to the
current reporting period.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
IDX enters into contracts to license software and sell hardware and related
ancillary products to customers through its direct sales force. The majority of
the Company's system sales attributable to software license revenue are earned
from software that does not require significant customization or modification.
The Company recognizes revenue for the licensing of software in accordance with
American Institute of Certified Public Accountants Statement of Position ("SOP")
97-2, as amended by SOP No. 98-4, SOP 98-9 and clarified by Staff Accounting
Bulletin's (SAB) 101 "Revenue Recognition in Financial Statements." and SAB No.
104 "Revenue Recognition" and Emerging Issues Task Force 00-21 "Accounting for
Revenue Arrangements with Multiple Deliverables" ("EITF 00-21") and,
accordingly, the Company recognizes revenue from software licenses, hardware,
and related ancillary products when:
o persuasive evidence of an arrangement exists, which is typically when
a customer has signed a non-cancelable sales and software license
agreement;
o delivery, which is typically FOB shipping point, is complete for the
software (either physically or electronically), hardware and related
ancillary products;
o the customer's fee is deemed to be fixed or determinable and free of
contingencies or significant uncertainties; and
o collectibility is probable.
Judgment is required in assessing the probability of collection and the current
creditworthiness of each customer. If the financial condition of our customers
were to deteriorate, it may affect the timing and the amount of revenue the
Company recognizes on a contract to the extent of cash collected. In addition,
in certain instances judgment is required in assessing if there are
uncertainties in determining the fee. If there are significant uncertainties,
the revenue is not recognized until the fee is determinable.
The Company uses the residual method to recognize revenue when a contract
includes one or more elements to be delivered at a future date and vendor
specific objective evidence ("VSOE") of the fair value of all undelivered
elements (typically maintenance and professional services) exists. Under the
residual method, the Company defers revenue recognition of the fair value of the
undelivered elements and we allocate the remaining portion of the arrangement
fee to the delivered elements and recognize it as revenue, assuming all other
conditions for revenue recognition have been satisfied. The Company recognizes
6
substantially all of its product revenue in this manner. If the Company cannot
determine the fair value of any undelivered element included in an arrangement,
the Company will defer revenue recognition until all elements are delivered,
services are performed or until fair value can be objectively determined.
As part of an arrangement, the Company typically sells maintenance contracts as
well as professional services to customers. Maintenance services include
telephone and web-based support as well as rights to unspecified upgrades and
enhancements, when and if the Company makes them generally available.
Professional services are deemed to be non-essential and typically are for
implementation planning, loading of software, installation of hardware,
training, building simple interfaces, running test data, assisting in the
development and documentation of process rules, and best practices consulting.
The Company recognizes revenues from maintenance services ratably over the term
of the maintenance contract period based on VSOE of fair value. VSOE of fair
value is based upon the amount charged for maintenance when purchased
separately, which is typically the contract's renewal rate. Maintenance services
are typically stated separately in an arrangement. The allocated fair value of
revenues pertaining to contractual maintenance obligations are classified as a
current liability, since they are typically for the twelve-month period
subsequent to the balance sheet date.
The Company recognizes revenues from professional services based on VSOE of fair
value when: (1) a non-cancelable agreement for the services has been signed or a
customer's purchase order has been received; and (2) the professional services
have been delivered. VSOE of fair value is based upon the price charged when
professional services are sold separately and is typically based on an hourly
rate for professional services.
The Company's arrangements with customers generally include acceptance
provisions. However, these acceptance provisions are typically based on our
standard acceptance provision, which provides the customer with a right to a
refund if the arrangement is terminated because the product did not meet our
published specifications. This right generally expires 30 days after
installation. The product is deemed accepted unless the customer notifies the
Company otherwise. Generally, the Company determines that these acceptance
provisions are not substantive and historically have not been exercised, and
therefore should be accounted for as a warranty in accordance with Statement of
Financial Accounting Standards No. 5. In addition, for IDX Carecast system, IDX
specifications include a 99.9% uptime guarantee and subsecond response time. The
length of the guarantee typically ranges from one to three years with an annual
renewal option. Historically, the Company has not incurred substantial costs
relating to this guarantee and the Company currently accrues for such costs as
they are incurred. The Company reviews these costs on a regular basis as actual
experience and other information becomes available; and should they become more
substantial, the Company would accrue an estimated exposure.
At the time the Company enters into an arrangement, the Company assesses the
probability of collection of the fee and the terms granted to the customer. The
Company's typical payment terms include a deposit and subsequent payments based
on specific milestone events and dates. If the Company considers the payment
terms for the arrangement to be extended or if the arrangement includes a
substantive acceptance provision, the Company defers revenue not meeting the
criterion for recognition under SOP 97-2 and classifies this revenue as deferred
revenue, including deferred product revenue. The Company's payment terms are
generally fewer than 90 days and payments from customers are typically due
within 30 days of invoice date. If payment terms for an arrangement are
considered extended or if the arrangement contains a substantive acceptance
provision, the Company defers the recognition of revenue not meeting the
criterion under SOP 97-2, including product revenue. The Company recognizes this
revenue, assuming all other conditions for revenue recognition have been
satisfied, when the payment of the arrangement fee becomes due and/or when the
uncertainty regarding acceptance is resolved as generally evidenced by written
acceptance or payment of the arrangement fee.
Additionally, the Company enters into certain arrangements for the sale of
software that require significant customization. In these instances, the Company
accounts for the contract in accordance with Accounting Research Bulletin No.
45, LONG-TERM CONSTRUCTION-TYPE CONTRACTS AND SOP 81-1, ACCOUNTING FOR
PERFORMANCE OF CONSTRUCTION-TYPE AND CERTAIN PRODUCTION-TYPE CONTRACTS. The
Company generally recognizes revenue on a percentage of completion basis using
labor input measures, which involves the use of estimates. Labor input measures
are used because they reasonably measure the stage of completion of the
contract. Revisions to cost estimates, which could be material, are recorded to
income in the period in which the facts that give rise to the revision become
known. The Company recognizes losses, if any, on fixed price contracts when the
loss is determined. The complexity of the estimation process and the assumptions
inherent in the application of the percentage of completion method of accounting
affects the amounts of revenue and related expenses reported in the Company's
consolidated financial statements. The Company records costs and estimated
earnings in excess of billings on uncompleted contracts as an asset and records
billings in excess of costs and estimated earnings on uncompleted contracts as
deferred income until revenue recognition criteria are met.
7
The Company also enters into arrangements that involve the delivery or
performance of multiple products and services, that include the development and
customization of software, implementation services, and licensed software and
support services. For these contracts, the Company applies the consensus of EITF
00-21 to determine whether the deliverables specified in a multiple element
arrangement should be treated as separate units of accounting for revenue
recognition purposes. Accordingly, if the elements qualify as separate units of
accounting, and fair value exists for the elements of the contract that are
unrelated to the customization services, these elements are accounted for
separately, and the related revenue is recognized as the products are delivered
or the services are rendered.
The application of SOP 97-2 and EITF 00-21, require judgment, including whether
a software arrangement includes multiple elements, and if so, whether
fair value exists for those elements. Typically the Company's contracts contain
multiple elements, and while the majority of the Company's contracts contain
standard terms and conditions, there are instances where our contracts contain
non-standard terms and conditions. As a result, contract interpretation is
sometimes required to determine the appropriate accounting, including whether
the deliverables specified in a multiple element arrangement should be treated
as separate units of accounting for revenue recognition purposes in accordance
with SOP 97-2 or EITF 00-21, and if so, the relative fair value that should be
allocated to each of the elements and when to recognize revenue for each
element. Interpretations would not affect the amount of revenue recognized but
could impact the timing of recognition.
ACCOUNTING FOR STOCK BASED COMPENSATION
The Company accounts for its stock-based compensation plan under Accounting
Principles Board ("APB") Opinion No. 25 ("APB No. 25"), ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES, and related interpretations in accounting for its
stock-based compensation plans. Accordingly, the Company records expense for
employee stock compensation plans equal to the excess of the market price of the
underlying IDX shares at the date of grant over the exercise price of the
stock-related award, if any (known as the intrinsic value). In general, all
employee stock options are issued with the exercise price equal to the market
price of the underlying shares at the grant date and therefore, no compensation
expense is recorded. In addition, no compensation expense is recorded for
purchases under the 1995 Employee Stock Purchase Plan (the "ESPP"), as the plan
is non-compensatory under the provisions of APB No. 25. The intrinsic value of
restricted stock units and certain other stock-based compensation issued to
employees as of the date of grant is amortized to compensation expense over the
vesting period.
Statement of Financial Accounting Standards ("SFAS") No. 123 establishes the
fair value based method of accounting for stock-based compensation plans. The
Company has adopted the disclosure-only alternative for stock options granted to
employees and directors and for employee stock purchases under the ESPP under
SFAS No. 123. The table below summarizes the pro forma operating results of the
Company had compensation cost been determined in accordance with the fair value
based method prescribed by SFAS No. 123.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA) 2004 2003 2004 2003
- ----------------------------------------- ---- ---- ---- ----
Net income as reported $ 8,081 $32,141 $ 9,658 $35,972
Add:
Stock-based compensation expense included
in reported net income, net of tax 64 118 96 170
Deduct:
Total stock-based compensation under fair
value based methods, net of tax (1,690) (2,235) (3,279) (3,476)
---------------- ------------------
Pro forma net income - SFAS 123 $ 6,455 $30,024 $ 6,475 $32,666
================ ==================
Basic net income per share:
As reported $ 0.27 $ 1.10 $ 0.32 $ 1.23
Pro forma - SFAS 123 $ 0.21 $ 1.03 $ 0.22 $ 1.12
Diluted net income per share:
As reported $ 0.26 $ 1.09 $ 0.31 $ 1.22
Pro forma - SFAS 123 $ 0.20 $ 1.02 $ 0.21 $ 1.11
8
NOTE 3 - BUSINESS COMBINATIONS AND DIVESTITURES
On June 18, 2003, the Company sold its wholly owned subsidiary, EDiX, to TEM
resulting in a net gain on the sale of discontinued operations of $26.4 million.
The Company received approximately $64.0 million in cash from TEM in exchange
for all the capital stock of EDiX. The Company transferred approximately $8.2
million of cash to TEM as part of the sale of EDiX, resulting in a net cash
inflow related to the EDiX sale of $53.5 million, net of transaction costs. EDiX
represented the Company's medical transcription services segment (See Note 7).
Summarized operating results for discontinued operations is as follows (in
thousands):
APRIL 1, 2003 JANUARY 1, 2003
THROUGH JUNE 18, THROUGH JUNE 18,
2003 2003
---------------- ----------------
Revenues $ 26,175 $ 54,810
================ ================
Pre-tax income from discontinued operations 956 1,121
Pre-tax gain on disposal of discontinued
operations 23,849 23,849
Provision for income taxes from loss from
discontinued operations (645) (695)
Benefit for income taxes from gain on
disposal of discontinued operations 2,551 2,551
---------------- ----------------
Income from discontinued operations,
net of tax $ 26,711 $ 26,826
================ ================
The provision for income taxes on loss from discontinued operations was
significantly higher than statutory provision primarily due to certain state tax
payments.
The gain on the disposal of EDiX resulted in an income tax benefit of $2.6
million. The Company's tax basis in the stock of EDiX exceeded the net proceeds
from the sale, resulting in a capital loss on the sale for tax purposes. A tax
benefit arises from this deductible temporary difference, which more likely than
not will reverse in the foreseeable future and be realized.
NOTE 4 - INVESTMENTS IN AFFILIATES, AT EQUITY
On January 8, 2001, the Company sold certain of the net assets and operations of
its majority owned subsidiary, ChannelHealth Incorporated ("ChannelHealth"), to
Allscripts Healthcare Solutions, Inc. ("Allscripts"), a public company providing
point-of-care e-prescribing and productivity solutions for physicians. In
exchange for the Company's 87% ownership of ChannelHealth, the Company received
approximately 7.5 million shares (with restrictions as to resale as discussed
below) of Allscripts common stock, which represented approximately a 20%
ownership interest in Allscripts. In addition to the sale, the Company entered
into a ten-year strategic alliance (the "Alliance Agreement") whereby Allscripts
is the exclusive provider of point-of-care clinical applications sold by IDX to
physician practices.
At June 30, 2004, the Company owned approximately 18.6% of the outstanding
shares of common stock of Allscripts and accounts for its investment in
Allscripts under the equity method of accounting. Under the equity method of
accounting, the Company recognized its pro-rata share of Allscripts losses
during the 2001 fiscal year resulting in the elimination of the carrying value
of this investment. In accordance with the equity method of accounting, the
Company has not recorded its share of losses since then, which share amounts to
$68.3 million through March 31, 2004. At June 30, 2004, the estimated market
value of the Company's investment in Allscripts is approximately $57.7 million,
based on the last reported sales price per share of Allscripts common stock on
the NASDAQ National Market on that date. The fair market value of this stock
would be affected by the Company's contractual restriction that it is allowed to
sell only 25% of its initial Allscripts shares in any one year.
Through June 30, 2004, the Company has sold approximately 139,000 shares of
Allscripts common stock.
NOTE 5 - DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING AGREEMENTS
The Company currently enters into forward foreign exchange contracts to hedge,
on a net basis, the foreign currency exposure of a portion of the Company's
assets and liabilities denominated in the British pound sterling, including
inter-company accounts. Inter-company transactions are denominated in the
functional currency of our foreign subsidiary in order to centralize foreign
exchange risk in the parent company in the United States. Increases or decreases
in our foreign currency exposures are partially offset by gains and losses on
the forward contracts, so as to mitigate foreign currency transaction gains and
9
losses. The terms of these forward contracts are generally for one month. The
Company does not use forward contracts for trading or speculative purposes. The
forward contracts are not designated as cash flow or fair value hedges under
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), as amended. All outstanding
forward contracts are marked to market at the end of the period and recorded on
the balance sheet at fair value in other current assets and other current
liabilities. The changes in fair value from these contracts and from the
underlying hedged exposures are generally offsetting and are recorded in other
income, net in the accompanying Consolidated Statement of Income.
During the three and six month periods ended June 30, 2004, the Company recorded
net foreign currency transaction gains of $207,000 and $18,000, respectively.
At June 30, 2004, the Company had approximately $3.6 million outstanding forward
foreign exchange contracts to exchange British pounds for US dollars. There were
no unrealized gains or losses on the foreign exchange contracts at June 30,
2004.
NOTE 6 - RESTRUCTURING COSTS AND OTHER CHARGES
RESTRUCTURING COSTS
On September 28, 2001, the Company announced its plan to restructure and realign
its large physician group practice businesses. The Company implemented a
workforce reduction and restructuring program affecting approximately four
percent of the Company's employees. The restructuring program resulted in a
charge to earnings of approximately $19.5 million during the fourth quarter of
2001, in connection with costs associated with employee severance arrangements
of approximately $5.5 million, lease payment costs of approximately $5.2
million, equipment and leasehold improvement write-offs related to the leased
facilities of $8.6 million and other restructuring costs, primarily related to
professional and consulting fees related to the restructuring. Workforce related
accruals, consisting principally of employee severance costs, were based on
specific identification of employees to be terminated, along with their job
classification and functions, and their location. Approximately 200 employees
were terminated primarily in the Flowcast operating unit and certain corporate
services functions. Substantially all workforce related actions were completed
during the fourth quarter of 2001, with the exception of a minimal number of
staff assigned to transition teams. As of December 31, 2003, the Company had an
accrual balance of $1.4 million related to lease payments through the end of the
lease term in 2006.
On June 1, 2004, the Company entered into an agreement to terminate its
contractual commitments under the remaining lease. Such termination was in part,
related to the restructuring. The Company paid $1.5 million to terminate the
lease, which was approximately $387,000 higher than the amount accrued at the
date of termination.
LEASE ABANDONMENT CHARGES
In 1999, the Company entered into a lease commitment for new office space in
Seattle, Washington under a lease that commenced in 2003. The Company continued
to utilize its existing space and an active search for a sublessee was initiated
and has been ongoing. In 2002, the Company made the decision to consolidate its
Seattle operations into the new office space. Due to the depressed Seattle real
estate market and the inability to obtain a sublessee, the Company recorded a
lease abandonment charge of $9.2 million in the fourth quarter of 2002. The
lease abandonment charge is related to lease payments of approximately $7.9
million through the end of the lease term in 2005 and non-cash write-offs of
certain leasehold improvements of approximately $1.3 million. As of December 31,
2003, the Company had an accrual balance of $5.1 million. During the first six
months of 2004, lease payments of $1.3 million were made. Of the $3.8 million
accrual remaining at June 30, 2004, approximately $1.2 million will be paid
during the remainder of 2004 and approximately $2.6 million thereafter. In the
event that the Company is able to secure a sub-tenant to assume its prior lease
in a future reporting period or is able to negotiate lease terminations with the
landlord, the present value of the savings generated from the future sub-lease
income or lease terminations would be recorded as a reduction in lease
abandonment expense in the period in which the sub-lease or termination
agreements are signed.
10
NOTE 7 - SEGMENT AND GEOGRAPHIC INFORMATION
Statement of Financial Accounting Standards No. 131, "DISCLOSURES ABOUT SEGMENTS
OF AN ENTERPRISE AND RELATED INFORMATION" ("SFAS 131"), establishes standards
for reporting information about operating segments. SFAS 131 also establishes
standards for related disclosures about major customers, products and services,
and geographic areas. Operating segments are identified as components of an
enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision maker, or decision-making group, in
making decisions how to allocate resources and assess performance. The Company
internally identifies operating segments by the type of products produced and
markets served, and in accordance with SFAS 131, the Company has aggregated
similar operating segments into one segment: Information Systems and Services.
Information Systems and Services consist of IDX's healthcare information
solutions that include software, hardware and related services. IDX solutions
are designed to enable healthcare organizations to redesign patient care and
other workflow processes in order to improve efficiency and quality. The
principal markets for this segment include physician groups, management service
organizations, hospitals and integrated delivery networks primarily located in
the United States, United Kingdom and Canada.
Through the first quarter of 2003, the Company reported results of an additional
segment, Medical Transcription Services (EDiX), which provided medical
transcription outsourcing services for hospitals and large physician group
practices primarily located in the United States. This segment was reported as
discontinued operations (see Note 3) effective the second quarter of 2003 due to
the sale of EDiX to TEM. Accordingly, because the Company currently operates
under one business segment, segment information is no longer being disclosed
separately. Operating results for the discontinued Medical Transcription
Services segment have been reclassified to exclude general corporate overhead
previously allocated to the segment and interest charged on certain
inter-company loans, net of income taxes.
NOTE 8 - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
Accounts payable, accrued expenses and other liabilities consist of the
following (in thousands):
JUNE 30, DECEMBER 31,
2004 2003
-------------- -----------------
Accounts payable $ 17,563 $ 13,688
Employee compensation and benefits 10,200 11,380
Accrued expenses 14,702 10,098
Reserve for lease abandonment charges 3,801 5,099
Restructuring costs 1,557 1,411
Income taxes 7,935 7,717
Other 6,104 5,450
-------------- -----------------
$ 61,862 $ 54,843
============== =================
NOTE 9 - DEFERRED REVENUES
Deferred revenues consists of the following (in thousands):
JUNE 30, DECEMBER 31,
2004 2003
------------------ -----------------
Maintenance and services $ 42,341 $ 18,835
Systems 10,182 4,181
Billings in excess of costs and estimated
earnings on uncompleted contracts 14,664 -
------------------ -----------------
$ 67,187 $ 23,016
================== =================
JUNE 30, DECEMBER 31,
2004 2003
------------------ -----------------
Short-term deferred revenues $ 62,923 $ 23,016
Long-term deferred revenues 4,264 -
------------------ -----------------
$ 67,187 $ 23,016
================== =================
11
NOTE 10 - INCOME TAXES
The Company's 2004 and 2003 effective tax rate for continuing operations was
38.0% and 30.0%, respectively, which is lower than the Company's statutory rate
of 40.0% due to the utilization of research and experimentation credits. The
Company currently expects to realize net recorded deferred tax assets as of June
30, 2004 of approximately $15.5 million. Management's conclusion that such
assets will be recovered is based upon its expectation that future earnings of
the Company combined with tax planning strategies available to the Company will
provide sufficient taxable income to realize recorded tax assets. Such tax
strategies include estimates and involve judgment relating to unrealized gains
on the Company's investment in publicly traded common stock of an equity
investee. While the realization of the Company's net recorded deferred tax
assets cannot be assured, to the extent that future taxable income against which
these tax assets may be applied is not sufficient, some or all of the Company's
net recorded deferred tax assets would not be realizable.
NOTE 11 - FINANCING ARRANGEMENTS
The Company has a revolving line of credit agreement (the "Line") allowing the
Company to borrow up to $40.0 million subject to certain restrictions. The Line
is secured by deposit accounts, accounts receivable and other assets and bears
interest at the bank's base rate plus .25%, resulting in a rate of 4.25% as of
June 30, 2004. The Line expires on June 27, 2005, but may be terminated earlier
at the option of the Company. As of December 31 2003 and June 30, 2004, no
amounts were outstanding under the Line.
On June 30, 2004, the Company provided notice to terminate the revolving line of
credit agreement. Such termination is effective 30 days after notice.
NOTE 12 - STOCKHOLDERS' EQUITY
EARNINGS PER SHARE:
The following sets forth the computation of basic and diluted earnings per
share:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ----------------------
2004 2003 2004 2003
---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator for basic and
diluted earnings per share
Continuing operations $ 8,081 $ 5,430 $ 9,658 $ 9,146
Discontinued operations - 26,711 - 26,826
-------- -------- --------- --------
Total $ 8,081 $ 32,141 $ 9,658 $ 35,972
======== ======== ======== ========
Denominator:
Basic weighted average
shares outstanding 30,181 29,195 30,031 29,184
Effect of employee stock
options 1,391 261 1,472 252
-------- -------- --------- --------
Denominator for diluted
earnings per share 31,572 29,456 31,503 29,436
======== ======== ======== ========
Basic earnings per share
Continuing operations $ 0.27 $ 0.19 $ 0.32 $ 0.31
Discontinued operations - 0.91 - 0.92
-------- -------- --------- --------
Total $ 0.27 $ 1.10 $ 0.32 $ 1.23
======== ======== ======== ========
Diluted earnings per share
Continuing operations $ 0.26 $ 0.18 $ 0.31 $ 0.31
Discontinued operations - 0.91 - 0.91
-------- -------- --------- --------
Total $ 0.26 $ 1.09 $ 0.31 $ 1.22
======== ======== ======== ========
Options to acquire 439,543 and 3,702,934 shares for the three months ended June
30, 2004 and 2003, respectively, were excluded from the calculation of diluted
earnings per share, as the effect would not have been dilutive. Options to
acquire 196,269 and 3,267,859 shares for the six months ended June 30, 2004 and
2003, respectively, were excluded from the calculation of diluted earnings per
share, as the effect would not have been dilutive.
COMPREHENSIVE INCOME:
12
Components of other comprehensive income consisted of unrealized gains (losses)
on marketable securities and foreign currency translation adjustments as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
(IN THOUSANDS)
Net income $ 8,081 $ 32,141 $ 9,658 $ 35,972
Other comprehensive income,
net of tax:
Unrealized gain (loss) on
marketable securities (1) (3) 4 (5)
Foreign currency translation
adjustments (71) - (39) -
--------- --------- -------- ---------
Comprehensive income $ 8,009 $ 32,138 $ 9,623 $ 35,967
========= ========= ======== =========
NOTE 13 - COMMITMENTS AND CONTINGENCIES
LEASES:
At June 30, 2004, minimum lease payments for certain facilities and equipment
under noncancelable leases commitments are as follows (in thousands):
2004
Remaining 2005 2006 2007 2008 Thereafter Total
--------- ---- ---- ---- ---- ---------- -----
Gross minimum
rental commitments $ 6,979 $14,414 $13,575 $13,875 $14,209 $79,545 $142,597
======= ======= ======= ======= ======= ======= ========
Of the $142.6 million in non-cancelable operating lease obligations,
approximately $3.8 million is included in accrued expenses at June 30, 2004
relating to a lease abandonment charge. See Notes 6 and 8.
Richard E. Tarrant, Chairman of the Company's Board of Directors, is the
President and a director of LBJ Real Estate Inc., a Vermont corporation ("LBJ
Real Estate"). Certain executive officers of LBJ Real Estate are also directors
or executive officers of the Company, including Robert H. Hoehl, a director of
the Company, and John A. Kane, the Company's Chief Financial Officer, who also
serves as a director of LBJ Real Estate. The stockholders of LBJ Real Estate
include Messrs. Tarrant and Hoehl and an independent individual. LBJ Real Estate
holds a 1% general partnership interest in LBJ Limited Partnership, a Vermont
limited partnership and an affiliate of the Company ("LBJ"), and Messrs. Hoehl,
Tarrant, and Kane and Mr. Robert F. Galin, President of IDX Global Business
Development and Executive Vice President of the Company, and two other employees
of the Company hold in the aggregate a 72.95% limited partnership interest.
Through September 30, 2003, the Company leased an office building from LBJ. On
September 30, 2003, LBJ sold the real estate leased by the Company to an
unrelated third party. The Company is continuing to lease the real estate from
the new owners under a new lease agreement, which has been approved by certain
independent members of the Board of Directors of the Company who have no
financial interest in the transaction.
Total rent expense from continuing operations amounted to $4.1 million and $3.2
million during the three months ended June 30, 2004 and 2003, respectively.
Total rent expense from continuing operations amounted to $7.9 million and $6.1
million during the six months ended June 30, 2004 and 2003, respectively. Total
rent paid to LBJ was approximately $138,000 and $276,000 during the three and
six month periods ended June 30, 2003, respectively.
The Company leases office space to Allscripts in Burlington, Vermont. Total rent
received from Allscripts was approximately $51,000 and $45,000 for the three
months ended June 30, 2004 and 2003, respectively and $101,000 and $122,000 for
the six months ended June 30, 2004 and 2003, respectively.
CONTINGENCIES:
Federal regulations issued in accordance with the Health Insurance Portability
and Accountability Act of 1996, ("HIPAA"), impose national health data standards
on health care providers that conduct electronic health transactions, health
care clearinghouses that convert health data between HIPAA-compliant and
non-compliant formats, and health plans. Collectively, these groups, including
most of IDX's customers and IDX's eCommerce Services clearinghouse business, are
known as covered entities. These HIPAA standards include:
13
o transaction and code set standards (the "TCS Standards") that
prescribe specific transaction formats and data code sets for certain
electronic health care transactions;
o privacy standards (the "Privacy Standards") that protect individual
privacy by limiting the uses and disclosures of individually
identifiable health information; and
o data security standards (the "Security Standards") that require
covered entities to implement administrative, physical and
technological safeguards to ensure the confidentiality, integrity,
availability and security of individually identifiable health
information in electronic form.
All covered entities were required to comply with the TCS Standards by October
16, 2003. The Privacy Standards imposed by HIPAA have been in effect for most
covered entities since April 14, 2003, while the compliance deadline for the
Security Standards is April 21, 2005.
Many covered entities, including some of IDX's customers, IDX's eCommerce
Services clearinghouse business, and trading partners of IDX's clearinghouse
business, were not fully compliant with the TCS Standards as of October 16,
2003. However, IDX has deployed contingency plans to accept non-standard
transactions. Because the entire healthcare system, including IDX's eCommerce
Services clearinghouse business and the business of IDX's customers who use our
information systems to generate claims data, has not operated at full capacity
using the newly-mandated standard transactions, it is possible that currently
undetected errors may cause rejection of claims, extended payment cycles, system
implementation delays and cash flow reduction, with the attendant risk of
liability and claims against IDX.
The Privacy Standards place on covered entities specific limitations on the use
and disclosure of individually identifiable health information. IDX has made
certain changes in products and services to comply with the Privacy Standards.
The effect of the Privacy Standards on IDX's business is difficult to predict
and there can be no assurances that IDX will adequately address the risks
created by the Privacy Standards and their implementation or that IDX will be
able to take advantage of any resulting opportunities.
Failure to comply with these standards under HIPAA may subject IDX to civil
monetary penalties and, in certain circumstances, criminal penalties. Under
HIPAA, covered entities may be subject to civil monetary penalties in the amount
of $100 per violation, capped at a maximum of $25,000 per year for violation of
any particular standard. Also, the U.S. Department of Justice, or DOJ, may seek
to impose criminal penalties for certain violations of HIPAA. Criminal penalties
under the statute vary depending upon the nature of the violation but could
include fines of not more than $250,000 and/or imprisonment.
The effect of HIPAA on IDX's business is difficult to predict and there can be
no assurances that IDX will adequately address the business risks created by
HIPAA and its implementation, or that IDX will be able to take advantage of any
resulting business opportunities. Furthermore, IDX is unable to predict what
changes to HIPAA, or the regulations issued pursuant to HIPAA, might be made in
the future or how those changes could affect IDX's business or the costs of
compliance with HIPAA.
INDEMNIFICATIONS:
IDX includes indemnification provisions in software license agreements with its
customers. These indemnification provisions include provisions indemnifying the
customer against losses, expenses, and liabilities from damages that could be
awarded against the customer in the event that IDX's software is found to
infringe upon a patent or copyright of a third party. The scope of remedies
available under these indemnification obligations is limited by the software
license agreements. IDX believes that its internal business practices and
policies and the ownership of information, works and rights agreements signed by
all employees, limits IDX's risk in paying out any claims under these
indemnification provisions. To date IDX has not been subject to any litigation
and has not had to reimburse any customers for any losses associated with these
indemnification provisions.
NOTE 14 - LEGAL PROCEEDINGS
In late 2001, the Company finalized a "Cooperative Agreement" with a
non-regulatory federal agency within the U.S. Commerce Department's Technology
Administration, NIST, whereby the Company agreed to lead a $9.2 million,
multi-year project awarded by NIST to a joint venture composed of the Company
and four other joint venture partners (the "SAGE Project"). The project entails
research and development to be conducted by the Company and its partners in the
grant. Subsequently, an employee of the Company made allegations that the
Company had illegally submitted claims for labor expenses and license fees to
NIST and that the Company never had a serious interest in researching the
technological solutions described in the proposal to NIST.
14
On March 31, 2004, IDX submitted certain information to NIST, which NIST
requested in conjunction with a proposed amendment to the Cooperative Agreement.
As a result of the Amendment, payment on the award is discontinued until IDX
demonstrates regulatory compliance relating to certain aspects of its grant
accounting and reporting procedures and relating to an in-kind contribution of
software IDX made to the project. In issuing the Amendment, NIST made no finding
of regulatory noncompliance by IDX in connection with the award. In connection
with NIST's Amendment, the U.S. Commerce Department, Office of Inspector General
("OIG"), is presently conducting an audit of the SAGE Project. IDX is
cooperating with OIG auditors, and continues to be in discussions to resolve the
issues raised by the Amendment. Pending the outcome of this audit, IDX is
working with its joint venture partners to review current procedures and develop
a plan for operations during the audit period.
The Company believes the employee has likely filed an action under the Federal
False Claims Act under seal in the Federal District Court for the Western
District of Washington with respect to his claims, sometimes referred to as a
"qui tam" complaint. The Company has no information regarding the specific
allegations in the qui tam complaint. Further, the Company has no information
concerning the actual amount of money at issue in the qui tam complaint. The
Company has not yet been served with legal process detailing the allegations.
Prompted by the employee's allegations, the Civil Division of the U.S.
Attorney's office in Seattle, Washington, in conjunction with the U.S. Commerce
Department, OIG, is investigating whether the Company made false statements in
connection with the application for the project award from NIST. The Company is
cooperating in the government's ongoing investigation.
In April 2003, the Company filed a complaint against the employee with the
United States District Court for the Western District of Washington, entitled
IDX SYSTEMS CORPORATION V. MAURICIO LEON (case no. C03-972R). The Company's
lawsuit asks the Court to grant a declaratory judgment stating that, should the
Company terminate the employee's employment, such action would not constitute
retaliation for alleged whistle-blowing activities in violation of the Federal
False Claims Act or the Sarbanes-Oxley Act and would not constitute a violation
of the employee's rights under other laws. On June 10, 2004, the Company
terminated the employee based upon, among other things, information obtained
during the litigation and, as a result, the Company intends to dismiss the
aforementioned declaratory relief action.
In May 2003, the employee filed a complaint against the Company with the Federal
District Court for the Western District of Washington, entitled MAURICIO A.
LEON, M.D. V. IDX SYSTEMS CORPORATION (case no. CV03-1158P) asserting that the
Company had knowledge that the employee engaged in "protected activity" and
retaliated against the employee in violation of the False Claims Act. In
addition, the employee alleges that the Company violated the Americans with
Disabilities Act and its Washington State counterpart in part through
retaliation against the employee for exercising the employee's rights under the
federal and state discrimination laws. The employee also asserts other causes of
action including (a) wrongful termination in violation of public policy, (b)
fraudulent inducement to enter into an employment contract with the Company
(which has since been dismissed), and (c) negligent and intentional infliction
of emotional distress. The employee requests relief including, but not limited
to, an injunction against the Company enjoining and restraining the Company from
the alleged harassment and discrimination, wages, damages, attorneys' fees,
interest and costs. In addition, the employee's complaint alleges that the
Company submitted false statements to the government to obtain the grant and to
obtain reimbursement from the government for project costs.
Following a hearing on October 21, 2003, the Court on October 22, 2003, issued a
series of orders regarding alignment of the IDX V. LEON and LEON V. IDX cases.
Pursuant to the orders, the claims asserted by the parties will proceed under
the case of LEON V. IDX, case number CV03-1158. IDX realigned its declaratory
judgment claims as affirmative defenses and/or counterclaims in that case. The
employee filed a motion for an injunction to reinstate his pay and benefits
pending conclusion of the action. The motion was denied on December 12, 2003.
Trial of the consolidated cases is presently scheduled for November 2004. The
Company intends to vigorously defend itself and to vigorously pursue relief
through prosecution of its own claims in the consolidated lawsuits. Although the
Company believes that these actions are without merit, the Company currently
cannot predict the outcome or the impact these matters may have on the Company's
operations.
In May 2003, the employee filed a complaint against the Company with the U.S.
Department of Labor, pursuant to Section 1514A of the Sarbanes-Oxley Act of
2002. The employee's complaint asserts that, notwithstanding alleged notice to
the Company of the employee's allegations, Company management conspired to
continue to defraud the government by allowing fraudulent activities to continue
uncorrected and by concealing and avoiding its obligations to report any and all
fraudulent activities to the proper authorities. In addition, the employee's
complaint alleges that the Company acted to retaliate, harass and intimidate the
employee in contravention of the Sarbanes-Oxley Act's whistleblower provisions.
The employee's complaint requests relief including, but not limited to,
reinstatement, back-pay, with interest, and compensation for any damages
sustained by the employee as a result of the alleged discrimination. The
Department of Occupational Health and Safety is investigating the employee's
complaint on behalf of the U.S. Department of Labor, and the Company intends to
15
cooperate in the investigation. The Company intends to vigorously defend against
the employee's claims, however, the outcome or the impact these claims may have
on the Company's operations cannot currently be predicted.
There are additional claims made by the employee against the Company, including
a charge with the U.S. Equal Employment Opportunity Commission, claiming that
the employee was discriminated against in violation of the Americans with
Disabilities Act, the processing of which the EEOC has subsequently terminated
through a Notice of Right to Sue. The Company intends to vigorously defend
against the employee's claims, however, the outcome or the impact these claims
may have on the Company's operations cannot currently be predicted.
From time to time, the Company is a party to or may be threatened with other
litigation in the ordinary course of its business. The Company regularly
analyzes current information, including, as applicable, the Company's defenses
and insurance coverage and, as necessary, provides accruals for probable and
estimable liabilities for the eventual disposition of these matters. The
ultimate outcome of these matters is not expected to materially affect the
Company's business, financial condition or results of operations.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION TOGETHER WITH THE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES APPEARING ELSEWHERE IN THIS
QUARTERLY REPORT ON FORM 10-Q. THIS ITEM CONTAINS FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E
OF THE SECURITIES AND EXCHANGE ACT OF 1934 THAT INVOLVE RISKS AND UNCERTAINTIES.
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INCLUDED IN SUCH FORWARD-LOOKING
STATEMENTS. FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
INCLUDE THOSE SET FORTH UNDER "FORWARD-LOOKING INFORMATION AND FACTORS AFFECTING
FUTURE PERFORMANCE" COMMENCING ON PAGE 30, AS WELL AS THOSE OTHERWISE DISCUSSED
IN THIS SECTION AND ELSEWHERE IN THIS QUARTERLY REPORT ON FORM 10-Q. UNLESS
OTHERWISE SPECIFIED OR THE CONTEXT REQUIRES OTHERWISE, THE TERMS "WE", "US",
"OUR" AND THE "COMPANY" REFER TO IDX SYSTEMS CORPORATION AND ITS SUBSIDIARIES.
THERE ARE A NUMBER OF IMPORTANT FACTORS THAT COULD CAUSE RESULTS TO DIFFER
MATERIALLY FROM THOSE INDICATED BY THESE FORWARD-LOOKING STATEMENTS, INCLUDING
AMONG OTHERS, STATEMENTS REGARDING THE HEALTH CARE INDUSTRY, STATEMENTS
REGARDING OUR PRODUCTS, PRODUCT DEVELOPMENT AND INFORMATION TECHNOLOGY,
STATEMENTS REGARDING FUTURE REVENUE OR OTHER FINANCIAL TRENDS, STATEMENTS
REGARDING FUTURE ACQUISITIONS, STRATEGIC ALLIANCES, OR OTHER AGREEMENT,
INCLUDING OUR AGREEMENTS IN THE UK AND STATEMENTS REGARDING OUR INTELLECTUAL
PROPERTY. IF ANY RISK OR UNCERTAINTY IDENTIFIED IN THE FOLLOWING FACTORS
ACTUALLY OCCURS, OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS WOULD
LIKELY SUFFER. IN THAT EVENT, THE MARKET PRICE OF OUR COMMON STOCK COULD
DECLINE.
WE UNDERTAKE NO OBLIGATION TO UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO
REFLECT CHANGED ASSUMPTIONS, THE OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES
IN FUTURE OPERATING RESULTS, FINANCIAL CONDITION OR BUSINESS OVER TIME.
BECAUSE OF THESE AND OTHER FACTORS, PAST FINANCIAL PERFORMANCE SHOULD NOT BE
CONSIDERED AN INDICATOR OF FUTURE PERFORMANCE. INVESTORS SHOULD NOT USE
HISTORICAL TRENDS TO ANTICIPATE FUTURE RESULTS.
INTRODUCTION
Founded in 1969, IDX Systems Corporation provides information technology
(software and services) solutions designed to maximize value in the delivery of
healthcare by improving the quality of patient service and reducing the costs of
care. We offer business performance and clinical software solutions. Healthcare
providers purchase IDX systems to improve their patients' experience through
simpler access, safer care delivery and more streamlined accounting.
We generate revenues from system sales and from maintenance and service fees for
the implementation and support of system sales. Our system sales are comprised
of a combination of IDX software licensed under the IDX(R) Flowcast(TM), IDX(R)
Groupcast(TM), IDX(R) Carecast(TM) System, and IDX(R) Imagecast(TM) brands to
primarily end-user customers, as well as bundled third party hardware and
software. IDX patient access, financial and business intelligence products for
hospitals, integrated delivery networks and group practices are packaged under
Flowcast and Groupcast. Clinical solutions are generally packaged as the
Carecast System, which require more configuration and have a longer install
period than our business performance solutions. Specialty care products, which
include IDX's radiology and imaging products, are marketed under Imagecast. Our
IDX eCommerce Services business offers web-based electronic data interchange
("EDI") claims, remittance and statement services and is designed to improve
data quality and streamline business processes by linking physician practices to
sophisticated mailing services and other businesses. Our maintenance and service
fees consist of software maintenance fees, installation fees, development fees,
professional and technical service fees, consulting fees and other miscellaneous
fees. Costs relating to system sales consist primarily of external costs for
bundled third party hardware and software purchases. Costs relating to
maintenance and service fees consist primarily of employee costs and related
infrastructure costs incurred in providing installation services,
post-installation support and training and consulting services.
Our revenue growth is driven by demand for new healthcare information technology
systems and services as well as installation, maintenance and service to our
existing customers. Our ability to increase earnings is driven primarily by IDX
software sales, which yield significantly higher gross profit margins than our
hardware and services revenue components. Our ability to maintain or increase
our services revenue in the future depends primarily on our ability to increase
our installed customer base, to resubscribe existing customers to maintenance
agreements and to maintain or increase current levels of our professional
services business.
MATTERS AFFECTING ANALYSIS
In June 2003, we completed the disposition of our wholly owned subsidiary, EDiX,
to TEM, a medical transcription company based in Franklin, Tennessee. With the
sale of EDiX, we no longer provide medical transcription outsourcing services.
Our condensed consolidated financial statements have been reclassified to
reflect EDiX as a discontinued operation for all periods presented in this
Quarterly Report on Form 10-Q. As a result, we no longer discuss EDiX as a
separate segment. For purposes of this Quarterly Report on Form 10-Q, the
discussion will relate to our only segment, Information Systems and Services,
17
which is discussed under the RESULTS FROM CONTINUING OPERATIONS section below.
The results of EDiX are discussed under the RESULTS OF DISCONTINUED OPERATIONS
section below.
OVERVIEW
During the first quarter of 2004, we finalized our subcontract agreement with
British Telecommunications PLC ("BT") to provide our clinical information
technology systems to BT. BT is the local service provider for the London region
contract awarded by the United Kingdom National Health Service ("NHS"). In
December 2003, we reached a binding agreement in principle with Fujitsu
Services, which is the local service provider for the Southern region contract
awarded by the NHS. We continue to work on finalizing our definitive subcontract
agreement to provide our clinical information technology systems to Fujitsu
Services.
On March 31, 2004, we released Flowcast 3.0. Flowcast 3.0 represents a
next-generation, revenue cycle management solution for hospitals, integrated
delivery networks and large physician organizations and was the culmination of a
two-year development effort.
This quarter, we launched Flowcast Business Services Outsourcing ("BSO").
Flowcast BSO provides a revenue cycle management outsourcing solution for large
physician organizations, hospitals and integrated delivery networks. The
Flowcast BSO solution provides the technology, services, human resources and
best practices for key processes in the revenue cycle.
Total revenues increased 32.7% to $130.4 million during the three months ended
June 30, 2004 from $98.3 million for the same period in 2003. System sales and
maintenance and service fees increased by 25.3% and 37.1%, respectively, driven
largely from revenues generated from our subcontract arrangement with BT. We did
not recognize any revenues during the three months ended June 30, 2004 under our
subcontract arrangement with Fujitsu Services. Total operating expenses
increased 31.2% resulting in operating income of $11.7 million or an operating
margin of 9.0% for the three months ended June 30, 2004 as compared to an
operating margin of 7.9% for the same period in 2003. For the three months ended
June 30, 2004, we reported income from continuing operations of $8.1 million, or
$0.26 diluted earnings per share, and at June 30, 2004, cash and marketable
securities totaled $124.6 million.
A more detailed discussion of our results is presented in the RESULTS FROM
CONTINUING OPERATIONS section below.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations
are based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amount of assets and
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities. We base our estimates and judgments on our experience, our
current knowledge, including terms of existing contracts, and our beliefs of
what could occur in the future, based on our observation of trends in the
industry, information provided by our customers and information available from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
The following critical accounting policies affect the more significant judgments
and estimates used in the preparation of our consolidated financial statements
and could potentially create materially different results under different
assumptions and conditions.
o revenue recognition,
o allowance for doubtful accounts and credits,
o capitalization of software development costs,
o income taxes, and
o accounting for contingencies.
This is not a comprehensive list of all of IDX's accounting policies. For a
detailed discussion on the application of these and other accounting policies,
see Note 1 of Notes to Consolidated Financial Statements in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003.
REVENUE RECOGNITION - We enter into contracts to license software and sell
hardware and related ancillary products to customers through our direct sales
force. The majority of our system sales attributable to software license revenue
are earned from software that does not require significant customization or
modification. We recognize revenue for the licensing of software in accordance
with American Institute of Certified Public Accountants Statement of Position
("SOP") 97-2, as amended by SOP No. 98-4, SOP 98-9 and clarified by Staff
Accounting Bulletin's (SAB) 101 "Revenue Recognition in Financial Statements."
18
and SAB No. 104 "Revenue Recognition" and Emerging Issues Task Force 00-21
"Accounting for Revenue Arrangements with Multiple Deliverables" ("EITF 00-21")
and, accordingly, we recognize revenue from software licenses, hardware, and
related ancillary products when:
o persuasive evidence of an arrangement exists, which is typically when
a customer has signed a non-cancelable sales and software license
agreement;
o delivery, which is typically FOB shipping point, is complete for the
software (either physically or electronically), hardware and related
ancillary products;
o the customer's fee is deemed to be fixed or determinable and free of
contingencies or significant uncertainties; and
o collectibility is probable.
We must exercise our judgment when we assess the probability of collection and
the current creditworthiness of each customer. If the financial condition of our
customers were to deteriorate, it may affect the timing and the amount of
revenue we recognize on a contract to the extent of cash collected. In addition,
in certain instances judgment is required in assessing if there are
uncertainties in determining the fee. If there are significant uncertainties,
the revenue is not recognized until the fee is determinable.
We use the residual method to recognize revenue when a contract includes one or
more elements to be delivered at a future date and vendor specific objective
evidence ("VSOE") of the fair value of all undelivered elements (typically
maintenance and professional services) exists. Under the residual method, we
defer revenue recognition of the fair value of the undelivered elements and we
allocate the remaining portion of the arrangement fee to the delivered elements
and recognize it as revenue, assuming all other conditions for revenue
recognition have been satisfied. We recognize substantially all of our product
revenue in this manner. If we cannot determine the fair value of any undelivered
element included in an arrangement, we will defer revenue recognition until all
elements are delivered, services are performed or until fair value can be
objectively determined.
As part of an arrangement, we typically sell maintenance contracts as well as
professional services to customers. Maintenance services include telephone and
web-based support as well as rights to unspecified upgrades and enhancements,
when and if we make them generally available. Professional services are deemed
to be non-essential and typically are for implementation planning, loading of
software, installation of hardware, training, building simple interfaces,
running test data, assisting in the development and documentation of process
rules, and best practices consulting.
We recognize revenues from maintenance services ratably over the term of the
maintenance contract period based on VSOE of fair value. VSOE of fair value is
based upon the amount charged for maintenance when purchased separately, which
is typically the contract's renewal rate. Maintenance services are typically
stated separately in an arrangement. We classify the allocated fair value of
revenues pertaining to contractual maintenance obligations as a current
liability, since they are typically for the twelve-month period subsequent to
the balance sheet date.
We recognize revenues from professional services based on VSOE of fair value
when: (1) a non-cancelable agreement for the services has been signed or a
customer's purchase order has been received; and (2) the professional services
have been delivered. VSOE of fair value is based upon the price charged when
professional services are sold separately and is typically based on an hourly
rate for professional services.
Our arrangements with customers generally include acceptance provisions.
However, these acceptance provisions are typically based on our standard
acceptance provision, which provides the customer with a right to a refund if
the arrangement is terminated because the product did not meet our published
specifications. This right generally expires 30 days after installation. The
product is deemed accepted unless the customer notifies the Company otherwise.
Generally, we determine that these acceptance provisions are not substantive and
historically have not been exercised, and therefore should be accounted for as a
warranty in accordance with Statement of Financial Accounting Standards No. 5.
In addition, for our Carecast system, our specifications include a 99.9% uptime
guarantee and subsecond response time. The length of the guarantee typically
ranges from one to three years with an annual renewal option. Historically, we
have not incurred substantial costs relating to this guarantee and we currently
accrue for such costs as they are incurred. We review these costs on a regular
basis as actual experience and other information becomes available; and should
they become more substantial, we would accrue an estimated exposure.
At the time we enter into an arrangement, we assess the probability of
collection of the fee and the terms granted to the customer. Our typical payment
terms include a deposit and subsequent payments based on specific milestone
19
events and dates. If we consider the payment terms for the arrangement to be
extended or if the arrangement includes a substantive acceptance provision, we
defer revenue not meeting the criterion for recognition under SOP 97-2 and
classify this revenue as deferred revenue, including deferred product revenue.
Our payment terms are generally fewer than 90 days and payments from customers
are typically due within 30 days of invoice date. If payment terms for an
arrangement are considered extended or if the arrangement contains a substantive
acceptance provision, we defer the recognition of revenue not meeting the
criterion under SOP 97-2, including product revenue. We recognize this revenue,
assuming all other conditions for revenue recognition have been satisfied, when
the payment of the arrangement fee becomes due and/or when the uncertainty
regarding acceptance is resolved as generally evidenced by written acceptance or
payment of the arrangement fee.
Additionally, we enter into certain arrangements for the sale of software that
require significant customization. In these instances, we account for the
contract in accordance with Accounting Research Bulletin No. 45, LONG-TERM
CONSTRUCTION-TYPE CONTRACTS and SOP 81-1, ACCOUNTING FOR PERFORMANCE OF
CONSTRUCTION-TYPE AND CERTAIN PRODUCTION-TYPE CONTRACTS. In those situations, we
generally recognize revenue on a percentage of completion basis using labor
input measures, which involves the use of estimates. Labor input measures are
used because they reasonably measure the stage of completion of the contract.
Revisions to cost estimates, which could be material, are recorded to income in
the period in which the facts that give rise to the revision become known. We
recognize losses, if any, on fixed price contracts when the loss is determined.
The complexity of the estimation process and the assumptions inherent in the
application of the percentage of completion method of accounting affects the
amounts of revenue and related expenses reported in our consolidated financial
statements. We record costs and estimated earnings in excess of billings on
uncompleted contracts as an asset. We record billings in excess of costs and
estimated earnings on uncompleted contracts as deferred income until revenue
recognition criteria are met.
We also enter into arrangements that involve the delivery or performance of
multiple products and services, that include the development and customization
of software, implementation services, and licensed software and support
services. For these contracts, we apply the consensus of EITF 00-21 to determine
whether the deliverables specified in a multiple element arrangement should be
treated as separate units of accounting for revenue recognition purposes.
Accordingly, if the elements qualify as separate units of accounting, and fair
value exists for the elements of the contract that are unrelated to the
customization services, these elements are accounted for separately, and the
related revenue is recognized as the products are delivered or the services are
rendered.
The application of SOP 97-2 and EITF 00-21, require judgment, including whether
a software arrangement includes multiple elements, and if so, whether
fair value exists for those elements. Typically our contracts contain multiple
elements, and while the majority of our contracts contain standard terms and
conditions, there are instances where our contracts contain non-standard terms
and conditions. As a result, contract interpretation is sometimes required to
determine the appropriate accounting, including whether the deliverables
specified in a multiple element arrangement should be treated as separate units
of accounting for revenue recognition purposes in accordance with SOP 97-2 or
EITF 00-21, and if so, the relative fair value that should be allocated to each
of the elements and when to recognize revenue for each element. Interpretations
would not affect the amount of revenue recognized but could impact the timing of
recognition.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND CREDITS - IDX maintains an allowance for
doubtful accounts to reflect estimated losses resulting from the inability of
customers to make required payments. We record an allowance for receivables
based on a percentage of revenues. Additionally, we review individual overdue
accounts and record an additional allowance when we determine it necessary to
state the specific receivable at realizable value. We base our allowance on
estimates after consideration of factors such as the composition of the accounts
receivable aging, bad debt experience and our evaluation of the financial
condition of the customers. If the financial condition of customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances and bad debt expense may be required. We typically do not
require collateral. Historically, our estimates have been adequate to cover
accounts receivable exposures.
We also record a provision for estimated credits on product and service related
sales in the same period the related revenues are recorded. These estimates are
based on an analysis of historical credits issued and other known factors. If
the historical data we use to calculate these estimates does not properly
reflect the future credits, then a change in the credit reserve would be made in
the period in which such a determination is made and revenues in that period
would be affected.
CAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS - We expense all costs incurred in
the research, design and development of software for sale to others until
technological feasibility is established. Technological feasibility is
established when planning, designing, coding and testing activities have been
completed so that the working model is consistent with the product design as
confirmed by testing. Thereafter, we capitalize and amortize software
development costs to software development expense on a straight-line basis over
the lesser of 18 months or the estimated lives of the respective products,
beginning when the products are offered for sale. We capitalize software
20
acquired if the related software under development has reached technological
feasibility or if there are alternative future uses for the software. We
evaluate the recoverability of capitalized software based on estimated future
gross revenues reduced by the estimated cost of completing the products and of
performing maintenance and customer support. If our gross revenues were to be
significantly less than our estimates, the net realizable value of our
capitalized software intended for sale would be impaired.
While we believe that our current estimates and the underlying assumptions
regarding capitalized software development costs are appropriate, future events
could necessitate adjustments to these estimates, resulting in additional
software development expense in the period of adjustment.
We expense costs incurred in the development of software for internal use until
we have completed the conceptual formulation, design, and testing of possible
project alternatives, including the process of vendor selection for purchased
software, if any. We capitalize and amortize certain costs; principally external
direct costs and payroll and payroll related costs directly associated with the
internal-use computer software project, incurred subsequent to the preliminary
project stage, to operating expense on a straight-line basis over the lesser of
seven years or the estimated economic life of the software.
INCOME TAXES - We account for income taxes under the liability method. We
determine deferred tax assets and liabilities based on differences between the
financial reporting and tax basis of assets and liabilities, measured using the
enacted tax rates that will be in effect when these differences are expected to
reverse. We have typically had net deferred tax assets at our reporting dates.
In assessing the realization of our net deferred tax assets, we evaluated
certain relevant criteria, including future taxable income, and tax planning
strategies designed to generate future taxable income. We currently believe that
future earnings and current tax planning strategies will be sufficient to
recover substantially all of our net recorded deferred tax assets. These
strategies include estimates and involve judgments relating to certain
unrealized gains in our investment in common stock of an equity investee. To the
extent that facts and circumstances change - for example, if there is a decline
in the fair value of the equity method investment - this tax-planning strategy
may no longer be sufficient to support certain deferred tax assets and we may be
required to increase the valuation allowance. Furthermore, to the extent that
future taxable income against which these tax assets may be applied is not
sufficient, some portion or all of our recorded deferred tax assets would not be
realizable.
ACCOUNTING FOR CONTINGENCIES - We are currently involved in certain legal
proceedings, which, if unfavorably determined, could have a material adverse
effect on our operating results and financial condition. In connection with our
assessment of these legal proceedings, we must determine if an unfavorable
outcome is probable and evaluate the costs for resolution of these matters, if
reasonably estimable. We have developed these determinations and related
estimates in consultation with outside counsel handling our defense in these
matters, and through an analysis of potential results assuming a combination of
litigation and defense strategies. See Part II, Item 1, "Legal Proceedings" and
Note 14 of Notes to Consolidated Financial Statements included in this Quarterly
Report on 10-Q.
The above listing is not intended to be a comprehensive list of all of our
accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by generally accepted accounting
principles, with no need for management's judgment in their application. There
are also areas in which management's judgment in selecting any available
alternative would not produce a materially different result. See our audited
consolidated financial statements and notes thereto contained in our Annual
Report on Form 10-K for the year ended December 31, 2003 which contain
accounting policies and other disclosures required by generally accepted
accounting principles.
21
RESULTS OF CONTINUING OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 AS COMPARED TO THE THREE MONTHS ENDED
JUNE 30, 2003
The following table indicates the percentage of total revenues and the dollar
and percentage of period over period change represented by line items in our
condensed consolidated statements of income from continuing operations:
CHANGE PERIOD OVER PERIOD
-------------------------
THREE MONTHS ENDED
JUNE 30, 2004 OVER
THREE MONTHS ENDED
JUNE 30, 2003
-------------------------
THREE THREE
MONTHS MONTHS
ENDED JUNE ENDED JUNE
30, 2004 % SALES 30, 2003 % SALES $ VARIANCE %VARIANCE
-------- ------- -------- ------- ---------- ---------
(IN THOUSANDS, EXCEPT PERCENTAGES AND PER SHARE AMOUNTS)
System sales $ 46,085 35.3% $ 36,786 37.4% $ 9,299 25.3%
Maintenance and
service fees 84,300 64.7% 61,493 62.6% 22,807 37.1%
------------------------------------ --------
TOTAL REVENUES 130,385 100.0% 98,279 100.0% 32,106 32.7%
Cost of system sales 15,593 12.0% 11,508 11.7% 4,085 35.5%
Cost of maintenance
and services 60,992 46.8% 43,690 44.5% 17,302 39.6%
Selling, general and
administrative 26,464 20.3% 21,058 21.4% 5,406 25.7%
Software development
costs 15,259 11.7% 14,228 14.5% 1,031 7.2%
Restructuring costs 387 0.3% - - 387 100.0%
------------------------------------ --------
TOTAL OPERATING
EXPENSES 118,695 91.0%+ 90,484 92.1% 28,211 31.2%
------------------------------------ --------
Operating income 11,690 9.0% 7,795 7.9% 3,895 50.0%
Other income (expense),
net 1,344 1.0% (38) 0.0% 1,382 *
Income tax provision (4,953) -3.8% (2,327) -2.4% (2,626) 112.8%
----------------------------------- ---------
INCOME FROM CONTINUING
OPERATIONS $ 8,081 6.2% $ 5,430 5.5% $ 2,651 48.8%
=================================== =========
DILUTED EARNINGS
PER SHARE FROM
CONTINUING
OPERATIONS $ 0.26 $ 0.18 $ 0.08 44.4%
======== ======== ========
_________________________________________
+ Does not total due to rounding.
* Not meaningful.
TOTAL REVENUES
Total revenues consist of system sales and maintenance and service fees. Our
system sales consist of our software licensed to primarily end-user customers,
along with bundled third party hardware and software. Maintenance and service
fees represent services to implement and support our system sales. More
specifically, our maintenance and service fees consist of software maintenance
fees, installation fees, professional and technical service fees, training fees,
outsourcing services, and other miscellaneous fees.
SYSTEM SALES
The increase in system sales during the three months ended June 30, 2004 as
compared to the same period in 2003 was attributable to increases of $5.9
million in software license and subscription revenues and $3.4 million in
hardware and third party software sales. The increase was primarily due to
several Imagecast radiology contracts. In addition, eCommerce revenues increased
$1.7 million during the three months ended June 30, 2004 as compared to the same
period in 2003 as we continue to grow this business.
22
MAINTENANCE AND SERVICE FEES
The following table indicates the percentage of total revenues and the dollar
and percentage of period over period change by line items comprising maintenance
and service fees as represented in our condensed consolidated statements of
income from continuing operations:
CHANGE PERIOD OVER PERIOD
-------------------------
THREE MONTHS ENDED
JUNE 30, 2004 OVER
THREE MONTHS ENDED
JUNE 30, 2003
-------------------------
THREE THREE
MONTHS MONTHS
ENDED JUNE ENDED JUNE
30, 2004 % SALES 30, 2003 % SALES $ VARIANCE %VARIANCE
-------- ------- -------- ------- ---------- ---------
(IN THOUSANDS, EXCEPT PERCENTAGES)
Maintenance fees $ 38,278 29.4% $ 32,974 33.6% $ 5,304 16.1%
Installation fees 14,950 11.5% 11,843 12.1% 3,107 26.2%
Development services 13,621 10.4% - - 13,621 100.0%
Consulting,
professional and
other fees 17,451 13.4% 16,676 17.0% 775 4.6%
------------------------------------- --------
Total maintenance
and service fees $ 84,300 64.7% $ 61,493 62.6%+ $ 22,807 37.1%
===================================== ========
__________________________________________
+ Does not total due to rounding.
The increase in maintenance and service fees was driven largely by the increase
in development services, which represent revenues for our development efforts
associated with the production and customization of certain product
functionalities specific to the UK. The increase in maintenance fees for
software and hardware support was primarily due to an increase in our installed
base of $4.1 million combined with annual maintenance price increases of
approximately $1.2 million. Installation fees increased across all areas of our
business as a result of increased installation of both our business workflow and
clinical solutions. We currently expect our installation fees to increase in
future periods for installation work related to our subcontract arrangements
with BT and Fujitsu Services to provide our clinical solutions in the UK.
COST OF SALES
The following table indicates total cost of system sales and maintenance and
service fees as a percentage of total revenues and the cost of system sales and
maintenance and service fees as a percentage of their respective revenues:
THREE MONTHS ENDED
JUNE 30,
---------------------------
2004 2003
---- ----
(IN THOUSANDS, EXCEPT
PERCENTAGES)
Total revenues $ 130,385 $ 98,279
Total cost of system sales and
maintenance and service fees 76,585 55,198
Total cost of system sales and
maintenance and service fees as a
percentage of total revenues 58.7% 56.2%
SYSTEM SALES:
System sales $ 46,085 $ 36,786
Cost of system sales 15,593 11,508
Cost of system sales as a percentage
of system sales 33.8% 31.3%
MAINTENANCE AND SERVICE FEES:
Maintenance and service fees $ 84,300 $ 61,493
Cost of maintenance and service fees 60,992 43,690
Cost of maintenance and service fees as
a percentage of maintenance and
service fees 72.4% 71.0%
The cost components of our total revenues vary based on the type of products and
services we provide, namely system sales and maintenance and service fees. Our
cost of system sales consists primarily of external costs relating to third
party hardware and software purchases, while cost of maintenance and service
fees are employee-driven and consist primarily of employee and related
infrastructure costs incurred in providing maintenance and installation
23
services, post-installation support and training and consulting services. These
costs as a percentage of total revenues typically have varied as the mix of
revenue (software, bundled third party software, hardware, maintenance and
service fees) components carry different margin rates from period to period. In
addition, fluctuations in our cost of system sales typically result from the
revenue mix of our software license revenue, which has a lower cost percentage
and higher margins, and third party hardware and software sales, which have a
higher cost percentage and lower margins.
COST OF SYSTEM SALES
The product mix between our software license revenue and third party hardware
and software sales remained relatively consistent during the three months ended
June 30, 2004 as compared to the same period in 2003. The cost of system sales
as a percentage of system sales increased principally from the hardware and
third party software product mix. Hardware and third party software sales are
dependent on the timing of contract sales. Hardware and third party software
components related to certain of our clinical software solutions typically yield
lower margins than on our business performance workflow solutions, due to the
fact that the clinical market is not as mature as the business performance
workflow market.
COST OF MAINTENANCE AND SERVICE FEES
The cost of maintenance and service fees increased $17.3 million to support the
growth in our installed base of software applications. The increase was
primarily attributable to increases of $9.8 million in subcontractor consulting
services, $4.4 million in employee compensation and benefit costs, and $1.8
million in third party maintenance contract costs. The subcontractor consulting
services and employee compensation and benefit costs increased primarily to
support the growth in our revenues from our operations in the UK. A portion of
our research and development costs, principally employee compensation and
benefit costs, were allocated to the cost of maintenance and services that
relate to the development work in the UK. Certain third party maintenance
contract costs increased as customers upgraded to new systems, which have a
higher support cost per user. Subcontractor consulting services typically have a
higher cost of revenue percentage as opposed to internal labor, which resulted
in the increase in the cost of maintenance and service fees as a percentage of
maintenance and service fees for the three months ended June 30, 2004 as
compared to the same period in 2003.
As the demand for services from new and existing customers for installation,
maintenance and consulting services increases in future periods, we anticipate
that our cost of services will also increase. In addition, we expect the cost of
maintenance and service fees to increase in future periods, primarily due to
classification of development costs related to services provided in the UK as
cost of maintenance and service fees. We expect that the use of specialized
professional outside services will increase as well, further increasing cost of
services, which may reduce our overall margin.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The increase of $5.4 million in selling, general and administrative expenses was
principally due to increases of $1.8 million in outside professional fees, $1.2
million in depreciation charges, $1.0 million in occupancy related expenses and
$800,000 in employee compensation and benefit costs.
Professional fees increased principally due to litigation matters as described
in Note 14 of Notes to Condensed Consolidated Financial Statements, audit and
accounting fees incurred in conjunction with the enhanced testing and the
general expansion of our UK operations, and consulting fees incurred in
conjunction with the Sarbanes-Oxley Act of 2002. The increase in depreciation
charges was primarily attributable to the enterprise resource planning ("ERP")
system, of which a significant portion went live in fourth quarter 2003.
Occupancy expenses increased primarily as a result of the expansion of our
facilities in our Seattle and UK locations. The increase in employee
compensation and benefit costs was due primarily to expansion in our operations
in the UK.
We expect our selling, general and administrative expenses to increase in future
periods as we increase our administrative and accounting staff to support our
growth. In addition, we anticipate that we will continue to incur higher
professional fees in 2004 in conjunction with current litigation matters and
increased use of outside professional accounting and consulting firms and
outside legal counsel to assist us in our continued compliance efforts with the
requirements of the Sarbanes-Oxley Act of 2002.
SOFTWARE DEVELOPMENT COSTS
Software development costs consist primarily of costs related to our software
developers, associated infrastructure costs required to fund product development
initiatives and amortization of such costs. As described in Note 1 to the Notes
to Consolidated Financial Statements and notes thereto contained in our Annual
Report on Form 10-K for the year ended December 31, 2003, which contain
24
accounting policies and other disclosures required by generally accepted
accounting principles, software development costs incurred subsequent to the
establishment of technological feasibility until general release of the related
products are capitalized. Technological feasibility is established upon the
completion of a working model. Historically, costs incurred after establishment
of technological feasibility have not been significant; however, as we develop
products that use more complex technologies as well as more comprehensive
clinical systems, the time and effort required to complete testing after
technological feasibility has been established may become significantly more
extensive. Consequently, we anticipate that as we continue to focus our
development efforts on enhancing functionality and developing new applications
for our current product suites, capitalized software development costs may
become more significant in future reporting periods. Approximately $857,000 and
$602,000 of software development costs were capitalized during the three months
ended June 30, 2004 and 2003, respectively. Amortization of software development
costs was approximately $969,000 and $470,000 during the three months ended June
30, 2004 and 2003, respectively.
The following table indicates software development costs as a percentage of
system sales:
THREE MONTHS ENDED
JUNE 30,
---------------------------
2004 2003
---- ----
(IN THOUSANDS, EXCEPT
PERCENTAGES)
SOFTWARE DEVELOPMENT COSTS:
System sales $ 46,085 $ 36,786
Software development costs 15,259 14,228
Software development costs as a
percentage of system sales 33.1% 38.7%
The $1.0 million increase in software development costs was due primarily to
increases of $600,000 in subcontractor consulting costs and $500,000 in
capitalized software development costs amortization attributable to costs
previously capitalized for Flowcast 3.0 released on March 31, 2004. The decrease
in software development costs as a percentage of system sales during the three
months ended June 30, 2004 as compared the same period in 2003 was a result of a
portion of our research and development costs, principally employee compensation
and benefit costs, allocated to the cost of maintenance and services that relate
to the development work under our subcontract arrangement with BT. We currently
expect this trend to continue as we perform development work in the UK.
RESTRUCTURING COSTS
During the fourth quarter of 2001, we implemented a workforce reduction and
restructuring program affecting approximately four percent of our employees. The
restructuring program resulted in a charge to earnings of approximately $19.5
million during the fourth quarter of 2001, in connection with costs associated
with employee severance arrangements of approximately $5.5 million, lease
payment costs of approximately $5.2 million, equipment and leasehold improvement
write-offs related to the leased facilities of $8.6 million and other
restructuring costs, primarily related to professional and consulting fees
related to the restructuring.
On June 1, 2004, we entered into an agreement to terminate our contractual
commitments under the remaining lease. Such termination was in part related to
the restructuring. We paid $1.5 million to terminate the lease, which was
approximately $387,000 higher than the amount accrued at the date of
termination.
TOTAL OTHER INCOME (EXPENSE), NET
The following table sets forth the components of total other income, net:
THREE MONTHS ENDED
JUNE 30,
---------------------------
2004 2003
---- ----
OTHER INCOME (EXPENSE) (IN THOUSANDS)
Interest income $ 473 $ 164
Interest expense (345) (202)
Gain on sale of equity investment 1,009 -
Foreign currency transaction gains
(losses), net 207 -
---------------------------
Total other income, net $ 1,344 $ (38)
===========================
25
INTEREST INCOME
The increase in interest income for the three months ended June 30, 2004 as
compared to the same period in 2003 was due to higher average invested balances
due to the proceeds received from the sale of EDiX.
INTEREST EXPENSE
The increase in interest expense for the three months ended June 30, 2004 as
compared to the same period in 2003 was due to the write-off of approximately
$200,000 of loan origination fees on the line of credit.
GAIN ON SALE OF EQUITY INVESTMENT
During the three months ended June 30, 2004, we realized a gain of approximately
$1.0 million on the sale of 125,000 shares of our equity investment in
Allscripts common stock.
FOREIGN CURRENCY TRANSACTION GAINS (LOSSES), NET
Revenues generated from our operations in the UK are primarily denominated in
pounds sterling, the local foreign currency. In addition, certain expenses to
service our UK contracts are incurred in pounds sterling. As such, we are
exposed to foreign exchange rate fluctuations from these transactions. For the
three months ended June 30, 2004, we incurred a net foreign currency transaction
gain of $207,000.
INCOME TAX PROVISION
Our effective income tax rate was 38.0% for the three months ended June 30, 2004
and 30.0% for the three months ended June 30, 2003 resulting in an income tax
provision of $5.0 million and $1.6 million for the three months ended June 30,
2004 and 2003, respectively. Our effective income tax rates for 2004 and 2003
are lower than our historical tax rate of 40.0% primarily due to our use of
research and development credits to offset income taxes.
SIX MONTHS ENDED JUNE 30, 2004 AS COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2003
The following table indicates the percentage of total revenues and the dollar
and percentage of period over period change represented by line items in our
condensed consolidated statements of income from continuing operations:
CHANGE PERIOD OVER PERIOD
-------------------------
SIX MONTHS ENDED JUNE 30,
2004 OVER SIX MONTHS
ENDED JUNE 30, 2003
--------------------------
SIX MONTHS SIX MONTHS
ENDED JUNE ENDED JUNE
30, 2004 % SALES 30, 2003 % SALES $ VARIANCE %VARIANCE
-------- ------- -------- ------- ---------- ---------
(IN THOUSANDS, EXCEPT PERCENTAGES AND PER SHARE AMOUNTS)
System sales $ 82,059 35.2% $ 69,327 36.4% $ 12,732 18.4%
Maintenance and
service fees 150,876 64.8% 121,393 63.6% 29,483 24.3%
----------------------------------- ---------
TOTAL REVENUES 232,935 100.0% 190,720 100.0% 42,215 22.1%
Cost of system sales 26,810 11.5% 23,300 12.2% 3,510 15.1%
Cost of maintenance
and services 107,583 46.2% 85,351 44.8% 22,232 26.0%
Selling, general and
administrative 54,891 23.6% 41,512 21.8% 13,379 32.2%
Software development
costs 29,146 12.5% 27,578 14.5% 1,568 5.7%
Restructuring costs 387 0.2% - - 387 100.0%
------------------------------------ ---------
TOTAL OPERATING
EXPENSES 218,817 93.9%+ 177,741 93.2%+ 41,076 23.1%
------------------------------------ ---------
Operating income 14,118 6.1% 12,979 6.8% 1,139 8.8%
Other income 1,460 0.6% 86 0.0% 1,374 1,597.7%
Income tax provision (5,920) -2.5% (3,919) -2.1% (2,001) 51.1%
------------------------------------ ----------
INCOME FROM CONTINUING
OPERATIONS $ 9,658 4.2% $ 9,146 4.8%+ $ 512 5.6%
==================================== ==========
DILUTED EARNINGS PER
SHARE FROM
CONTINUING
OPERATIONS $ 0.31 $ 0.31 $ - -%
======== ======== ========
________________________________________
+ Does not total due to rounding.
26
SYSTEM SALES
The increase in system sales during the six months ended June 30, 2004 as
compared to the same period in 2003 was attributable to increases of $11.3
million in software license and subscription revenues and $1.4 million in
hardware and third party software sales. The increase was primarily attributable
to system sales relating principally to Imagecast radiology contracts. In
addition, eCommerce revenues increased $3.6 million during the six months ended
June 30, 2004 as compared to the same period in 2003 as we continue to grow this
business.
MAINTENANCE AND SERVICE FEES
The following table indicates the percentage of total revenues and the dollar
and percentage of period over period change by line items comprising maintenance
and service fees as represented in our condensed consolidated statements of
income from continuing operations:
CHANGE PERIOD OVER PERIOD
-------------------------
SIX MONTHS ENDED JUNE 30,
2004 OVER SIX MONTHS
ENDED JUNE 30, 2003
-------------------------
SIX MONTHS SIX MONTHS
ENDED JUNE ENDED JUNE
30, 2004 % SALES 30, 2003 % SALES $ VARIANCE %VARIANCE
-------- ------- -------- ------- ---------- ---------
(IN THOUSANDS, EXCEPT PERCENTAGES)
Maintenance fees $ 74,470 32.0% $ 66,031 34.6% $ 8,439 12.8%
Installation fees 30,017 12.9% 23,583 12.4% 6,434 27.3%
Development services 13,621 5.8% - - 13,621 100.0%
Consulting,
professional and
other fees 32,768 14.1% 31,779 16.7% 989 3.1%
------------------------------------ -------
Total maintenance and
service fees $150,876 64.8% $ 121,393 63.6%+ $29,483 24.3%
==================================== =======
_________________________________________
+ Does not total due to rounding.
The increase in maintenance and service fees was driven largely by the increase
in development services, which represent revenues for our development efforts
associated with the production and customization of certain product
functionalities specific to the UK. The increase in maintenance fees for
software and hardware support was primarily due to an increase in our installed
base of $6.0 million combined with annual maintenance price increases of
approximately $2.4 million. The increase in installation fees was primarily
driven by installations of our clinical solutions.
COST OF SALES
The following table indicates total cost of system sales and maintenance and
service fees as a percentage of total revenues and the cost of system sales and
the cost of maintenance and service fees as a percentage of their respective
revenues:
27
SIX MONTHS ENDED
JUNE 30,
---------------------------
2004 2003
---- ----
(IN THOUSANDS, EXCEPT
PERCENTAGES)
Total revenues $ 232,935 $ 190,720
Total cost of system sales and maintenance and
service fees 134,393 108,651
Total cost of system sales and maintenance and
service fees as a percentage of total revenues 57.7% 57.0%
SYSTEM SALES:
System sales $ 82,059 $ 69,327
Cost of system sales 26,810 23,300
Cost of system sales as a percentage of system sales 32.7% 33.6%
MAINTENANCE AND SERVICE FEES:
Maintenance and service fees $ 150,876 $ 121,393
Cost of maintenance and service fees 107,583 85,351
Cost of maintenance and service fees as a percentage
of maintenance and service fees 71.3% 70.3%
COST OF SYSTEM SALES
For the six months ended June 30, 2004 as compared to the same period in 2003,
our cost of system sales as a percentage of system sales decreased principally
as a result of the change in the product mix between our software license
revenue and third party hardware and software sales. IDX software sales, which
carry a lower cost of revenue percentage, represented a larger portion of system
sales during the six months ended June 30, 2004 as compared to the same period
in 2003.
COST OF MAINTENANCE AND SERVICE FEES
The cost of maintenance and service fees increased $22.2 million to support the
growth in our installed base of software applications. The increase was
primarily attributable to increases of $14.3 million in subcontractor consulting
services, $4.8 million in employee compensation and benefit costs and $1.8
million in the cost of maintenance. The subcontractor consulting services and
employee compensation and benefit costs increased primarily to support the
growth in our revenues from our operations in the UK. A portion of our research
and development costs, principally employee compensation and benefit costs, were
allocated to the cost of maintenance and services that relate to the development
work in the UK. Certain third party maintenance contract costs increased as
customers upgraded to new systems, which have a higher support cost per user.
Subcontractor consulting services typically have a higher cost of revenue
percentage as opposed to internal labor, which resulted in the increase in the
cost of maintenance and service fees as a percentage of maintenance and service
fees for the three months ended June 30, 2004 as compared to the same period in
2003.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The increase of $13.4 million in selling, general and administrative expenses
was principally due to increases of $4.6 million in employee compensation and
benefit costs, $3.6 million in outside professional fees, $2.1 million in
depreciation charges, $1.7 million in occupancy expenses and $700,000 in travel
related expenses.
The increase in employee compensation and benefit costs was primarily due to the
start-up efforts of our UK operations. Professional fees increased principally
due to litigation matters as described in Note 14 of Notes to Condensed
Consolidated Financial Statements, audit and accounting fees incurred in
conjunction with the enhanced testing and analysis surrounding our 2003 year-end
audit and the expansion of our UK operations, and consulting fees incurred in
conjunction with the Sarbanes-Oxley Act of 2002. The increase in depreciation
charges was primarily attributable to the enterprise resource planning ("ERP")
system, of which a significant portion went live in fourth quarter 2003.
Occupancy expenses increased as a result of the expansion of our facilities in
the Seattle location and the expansion of our UK operations. The increase in
travel related expenses was a result of our expansion in the UK.
28
SOFTWARE DEVELOPMENT COSTS
The following table indicates software development costs as a percentage of
system sales:
SIX MONTHS ENDED
JUNE 30,
---------------------------
2004 2003
---- ----
(IN THOUSANDS, EXCEPT
PERCENTAGES)
SOFTWARE DEVELOPMENT COSTS:
System sales $ 82,059 $ 69,327
Software development costs 29,146 27,578
Software development costs as a percentage of
system sales 35.5% 39.8%
The $1.6 million increase in software development costs was primarily due to
increases in personnel costs and subcontractor consulting fees of approximately
$1.6 million, associated infrastructure costs of approximately $500,000 and
travel related expenses of $300,000, offset with an increase in capitalized
software development costs, net of amortization, of $1.4 million. Associated
infrastructure costs increased as a result of the expansion of our facilities in
the Seattle location in April 2003 and our UK operations in April 2004, which
support research and development efforts. Travel related expenses increased due
to our expansion in the UK. The increase in capitalized software development
costs, net of amortization, was primarily related to costs capitalized during
the three months ended March 31, 2004 relating to Flowcast 3.0.
The decrease in software development costs as a percentage of system sales
during the six months ended June 30, 2004 as compared to the same period in 2003
was a result of a portion of our research and development employee compensation
and benefit costs allocated to the cost of maintenance and services that relate
to the development work under our subcontract arrangement with BT.
Approximately $2.4 million and $716,000 of software development costs were
capitalized during the six months ended June 30, 2004 and 2003, respectively.
Amortization of software development costs was approximately $1.4 million and
$1.0 million during the six months ended June 30, 2004 and 2003, respectively.
RESTRUCTURING COSTS
Same as previously described for the three months ended June 30, 2004 as
compared to the three months ended June 30, 2003.
TOTAL OTHER INCOME, NET
The following table sets forth the components of total other income, net:
SIX MONTHS ENDED
JUNE 30,
---------------------------
2004 2003
---- ----
(in thousands)
Other income (expense)
Interest income $ 930 $ 410
Interest expense (497) (324)
Gain on sale of equity investment 1,009 -
Foreign currency transaction gains (losses), net 18 -
---------------------------
Total other income, net $ 1,460 $ 86
===========================
INTEREST INCOME
The increase in interest income for the six months ended June 30, 2004 as
compared to the same period in 2003 was due to higher average invested balances
due to the proceeds received from the sale of EDiX.
INTEREST EXPENSE
The increase in interest expense for the six months ended June 30, 2004 as
compared to the same period in 2003 was due to the write-off of approximately
$200,000 of loan origination fees on the line of credit.
29
GAIN ON SALE OF EQUITY INVESTMENT
Same as previously described for the three months ended June 30, 2004 as
compared to the three months ended June 30, 2003.
INCOME TAX PROVISION
Our effective income tax rate was 38.0% for the six months ended June 30, 2004
and 30.0% for the six months ended June 30, 2003 resulting in an income tax
provision of $5.9 million and $1.6 million for the six months ended June 30,
2004 and 2003, respectively. Our effective income tax rates for 2004 and 2003
are lower than our historical tax rate of 40.0% primarily due to our use of
research and development credits to offset income taxes.
RESULTS OF DISCONTINUED OPERATIONS
The following is a summary of the results of discontinued operations:
APRIL 1, 2003 JANUARY 1, 2003
THROUGH JUNE 18, THROUGH JUNE 18,
2003 2003
---------------- -----------------
(IN THOUSANDS)
Revenues $ 26,175 $ 54,810
================ =================
Pre-tax income from discontinued
operations 956 1,121
Pre-tax gain on disposal of
discontinued operations 23,849 23,849
Provision for income taxes from loss
from discontinued operations (645) (695)
Benefit for income taxes from gain on
disposal of discontinued operations 2,551 2,551
---------------- -----------------
Income from discontinued operations,
net of tax $ 26,711 $ 26,826
================ =================
The provision for income taxes on loss from discontinued operations was
significantly higher than statutory provision primarily due to certain state tax
payments.
The gain on the disposal of EDiX resulted in an income tax benefit of $2.6
million. The Company's tax basis in the stock of EDiX exceeded the net proceeds
from the sale, resulting in a capital loss on the sale for tax purposes. A tax
benefit arises from this deductible temporary difference, which more likely than
not will reverse in the foreseeable future and be realized.
LIQUIDITY AND CAPITAL RESOURCES
We primarily generate cash from the sale of our software, maintenance fees,
which are typically paid on a monthly basis, implementation services and
providing professional and consulting services. We primarily use cash to pay
employees' salaries, commissions and benefits, pay rent for office facilities,
procure insurance, pay taxes and pay vendors for services and supplies. We also
use cash to procure capital assets to support our business. We principally have
funded our operations, working capital needs and capital expenditures from
operations. At June 30, 2004, we had no debt, $45.8 million in cash and cash
equivalents and $78.7 million in short-term investments, consisting principally
of investments in interest-bearing demand deposit accounts, money market funds
and highly liquid debt securities of corporations and municipalities, and $162.3
million of working capital.
Net cash provided by or used in continuing operations is principally comprised
of net income or loss and is primarily affected by the net change in accounts
and unbilled receivables, prepaid cost of sales, accounts payable, accrued
expenses and non-cash items relating to depreciation and amortization, deferred
taxes, and certain components of lease abandonment and restructuring charges.
Due to the nature of our business, accounts and unbilled receivables, prepaid
cost of sales, deferred revenue, and accounts payable can fluctuate considerably
due to, among other things, the length of installation efforts, which is
dependent upon the size of the transaction, the changing business plans of the
customer, the effectiveness of customers' management and general economic
conditions. Accounts receivable and costs and estimated earnings in excess of
billings on uncompleted contracts increased $52.1 million and deferred revenue
increased $44.2 million during the six months ended June 30, 2004 due primarily
to billings relating to our UK contracts. Our Days Sales Outstanding ("DSO"),
which represents the average number of days sales in accounts receivable, was 88
days during the three months ended June 30, 2004 as compared to 87 days during
the same period in 2003 and 86 days for the year ended December 31, 2003. Our
DSO is higher than historical DSO due primarily to billings under certain of our
UK contracts in excess of revenue recognized. Management continues to focus
30
efforts on reducing the average time to collect payment on sales. The increase
in accounts payable and accrued expenses of $7.3 million was attributable
primarily to the expansion into the UK.
Cash flows related to investing activities have historically been related to the
purchase of computer and office equipment, leasehold improvements and the
purchase and sale of investment grade marketable securities. We invested
approximately $20.1 million through December 31, 2003 on the acquisition and
implementation of the ERP system and have invested an additional $2.1 million in
the ERP system during the six months ended June 30, 2004. We anticipate
investing an additional $6.2 million in 2004 and an additional $5.5 million in
2005 related to this system implementation. Of the $5.9 million we anticipate
investing in the ERP system in 2004, approximately $4.0 million relates to
systems implementation for our UK operations. In addition, we plan to invest
approximately $1.8 million in 2004 for leasehold improvements relating to our UK
facilities.
In addition, investing activities may also include purchases of, interests in,
loans to and acquisitions of businesses for access to complementary products and
technologies. We expect these activities to continue, but there can be no
assurance that we will be able to successfully complete any such purchases or
acquisitions in the future.
In April 2002, we acquired a minority interest in Stentor, Inc. ("Stentor"), one
of our strategic partners, by exercising a warrant to purchase 562,069 shares of
preferred stock of Stentor for $7.5 million. Each preferred share is
convertible, at any time at our option, into one share of common stock of
Stentor, subject to certain adjustments. In addition, the preferred shares are
not entitled to dividends but are entitled to a liquidation preference equal to
the amount we paid to purchase such shares.
Cash flows from financing activities historically relate to the issuance of
shares of our common stock through the exercise of employee stock options and in
connection with the employee stock purchase plan and proceeds from our line of
credit.
We own, through a wholly owned subsidiary, approximately 7.5 million shares of
common stock of Allscripts Healthcare Solutions, Inc., a public company listed
on the NASDAQ National Market under the symbol MDRX. This investment had a
quoted market value of approximately $57.7 million as of June 30, 2004, and is
subject to certain sale restrictions that may significantly impact the market
value. See Note 3 of Notes to Condensed Consolidated Financial Statements.
We expect that our requirements for office facilities and other office equipment
will grow as staffing requirements dictate. Our operating lease commitments
consist primarily of office leases for our operating facilities. We plan to
increase our professional staff during 2004 as needed to meet anticipated sales
volume and support research and development efforts for certain products. We
also plan to hire additional accounting personnel in our finance department. To
the extent necessary to support increases in staffing, we may obtain additional
office space. We do not have any present intention to pay cash dividends on our
capital stock.
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations at June 30, 2004, and
the effect such obligations are expected to have on our liquidity and cash in
the future periods:
(IN THOUSANDS) TOTAL REMAINDER 2005-2006 2007-2008 2009+
OF 2004
- --------------------------------------------------------------------------------
Non-cancelable
operating leases $ 142,597 $ 6,979 $ 27,989 $ 28,084 $ 79,545
----------------------------------------------------------
Total $ 142,597 $ 6,979 $ 27,989 $ 28,084 $ 79,545
==========================================================
Of the $142.6 million in non-cancelable operating lease obligations,
approximately $3.8 million is included in accrued expenses at June 30, 2004
relating to a lease abandonment charge. See Notes 6 and 8 of the Notes to the
Condensed Consolidated Financial Statements.
We believe that the level of our cash and investment balances and anticipated
cash flow from operations will be sufficient to satisfy our cash requirements
for at least the next twelve to eighteen months. To date, inflation has not had
a material impact on our revenues or income.
31
OFF-BALANCE SHEET ARRANGEMENTS
During the six months ended June 30, 2004 and 2003, we did not engage in:
o Material off-balance sheet activities, including the use of structured
finance or special purpose entities;
o Trading activities in non-exchange traded contracts; or
o Transactions with persons or entities that benefit from their
non-independent relationship with IDX, other than as described below.
Mr. Richard E. Tarrant, the Chairman of our Board of Directors, is the President
and a director of LBJ Real Estate Inc., a Vermont corporation ("LBJ Real
Estate"). Certain executive officers of LBJ Real Estate are also members of our
Board of Directors or executive officers of the Company, including Mr. Robert H.
Hoehl, a member of our Board of Directors, and John A. Kane, our Chief Financial
Officer, who also serves as a director of LBJ Real Estate. The stockholders of
LBJ Real Estate include Messrs. Tarrant and Hoehl. LBJ Real Estate holds a 1%
general partnership interest in 4901 LBJ Limited Partnership, a Vermont limited
partnership ("LBJ"), and Messrs. Hoehl, Tarrant, and Kane and Mr. Robert F.
Galin, President of IDX Global Business Development and Executive Vice President
of the Company, and two other employees hold in the aggregate a 72.95% limited
partnership interest.
Through September 30, 2003, we leased an office building from LBJ, a real estate
partnership owned by certain stockholders and key employees of the Company. On
September 30, 2003, LBJ sold the real estate leased by the Company to an
unrelated third party. We continue to lease the real estate from the new owners
under a new lease agreement. Lease agreements are based on fair market value
rents and are reviewed and approved by independent members of our Board of
Directors. Total rent paid to LBJ was approximately $138,000 and $276,000 for
the three and six month periods ended June 30, 2003.
FORWARD-LOOKING INFORMATION AND FACTORS AFFECTING FUTURE PERFORMANCE
The following important factors affect our business and operations:
QUARTERLY OPERATING RESULTS MAY VARY. Our quarterly operating results have
varied in the past and may vary in the future. We expect our quarterly results
of operations to continue to fluctuate. Because a significant percentage of our
expenses are relatively fixed, the following factors could cause these
fluctuations:
o delays in customers' purchasing decisions due to a variety of factors
such as consideration and management changes;
o long sales cycles;
o long installation and implementation cycles for the larger, more
complex and costlier systems;
o recognizing revenue at various points during the installation process,
typically based on milestones; and
o timing of new product and service introductions and product upgrade
releases.
In light of the above, we believe that our results of operations for any
particular quarter or fiscal year are not necessarily meaningful or reliable
indicators of future performance.
RISKS ASSOCIATED WITH OPERATIONS IN THE UNITED KINGDOM. We have been awarded
contracts to perform services in the UK, which require the expansion of our
operations in the UK. Significant management attention and financial resources
are needed to develop our UK operations. International operations are subject to
inherent risks, and our future results could be adversely affected by a variety
of changing factors. These include:
o significant start-up costs, resulting in initial lower operating
margins for our UK operations;
o unanticipated difficulties with respect to the conversion of our
products to UK standards, including UK regulatory standards;
o difficulties and costs of staffing and managing foreign operations;
o foreign currency exchange risk;
o unexpected changes in UK regulatory requirements;
32
o changes in the relationship between our prime contractors, BT and
Fujitsu Services, and the NHS, including any changes relating to the
timeliness or willingness of the NHS to pay BT and Fujitsu Services
for goods and services;
o changes in our relationships with our prime contractors or our
sub-contractors, including difficulties in finalizing the
documentation of these relationships, or pressure to re-negotiate the
terms of these relationships; and
o difficulties in the development of any new products contemplated by
our subcontract arrangements.
INTERNAL CONTROLS. Our management has reviewed our internal controls and
procedures and we continue to monitor controls for any weaknesses or
deficiencies. No evaluation can provide complete assurance that our internal
controls will detect or uncover all failures of persons within IDX to disclose
material information otherwise required to be reported. The effectiveness of our
controls and procedures could also be limited by simple errors or faulty
judgments in decision-making. In addition, if we continue to expand globally,
the challenges involved in implementing appropriate internal controls will
increase and will require that we continue to improve our internal controls.
VOLATILITY OF STOCK PRICE. We have experienced, and expect to continue to
experience, fluctuations in our stock price due to a variety of factors,
including:
o actual or anticipated quarterly variations in operating results;
o changes in expectations of future financial performance;
o changes in estimates of securities analysts;
o market conditions, particularly in the computer software, healthcare,
and Internet industries;
o announcements of technological innovations, including Internet
delivery of information, clinical information systems advances and use
of application service provider technology;
o new product introductions by us or our competitors;
o delay in customers' purchasing decisions due to a variety of factors;
o market prices of competitors; and
o healthcare reform measures and healthcare regulation.
These fluctuations have had a significant impact on the market price of our
common stock, and may have a significant impact on the future market price of
our common stock.
These fluctuations may affect our operating results by affecting:
o our ability to transact stock acquisitions; and
o our ability to retain and incent key employees.
GOVERNMENT REGULATION IN THE UNITED STATES. Virtually all of our customers and
the other entities with which we have a business relationship operate in the
healthcare industry and, as a result, are subject to governmental regulation.
Because our products and services are designed to function within the structure
of the healthcare financing and reimbursement systems currently in place in the
United States, and because we are pursuing a strategy of developing and
marketing products and services that support our customers' regulatory and
compliance efforts, we may become subject to the reach of, and liability under,
these regulations.
ANTI-KICKBACK LAW
The federal Anti-Kickback Law, among other things, prohibits the direct or
indirect payment or receipt of any remuneration for Medicare, Medicaid and
certain other federal or state healthcare program patient referrals, or
arranging for or recommending referrals or other business paid for in whole or
in part by these federal health care programs. If the activities of one of the
entities with which we have a business relationship were found to constitute a
violation of the federal Anti-Kickback Law and, as a result of the provision of
products or services to the customer or entity which engaged in these
33
activities, we were found to have knowingly participated in such activities, we
could be subject to sanction or liability, including exclusion from government
health programs. As a result of exclusion from government health programs, our
customers would not be permitted to make any payments to us.
HIPAA AND RELATED REGULATIONS
Federal regulations issued in accordance with the Health Insurance Portability
and Accountability Act of 1996 ("HIPAA") impose national health data standards
on health care providers that conduct electronic health transactions, health
care clearinghouses that convert health data between HIPAA-compliant and
non-compliant formats, and health plans. Collectively, these groups, including
most of our customers and our e-Commerce Services clearinghouse business, are
known as covered entities. These HIPAA standards include:
o transaction and code set standards, which we refer to as TCS
Standards, that prescribe specific transaction formats and data code
sets for certain electronic health care transactions;
o Privacy Standards that protect individual privacy by limiting the uses
and disclosures of individually identifiable health information; and
o data security standards, which we refer to as Security Standards, that
require covered entities to implement administrative, physical and
technological safeguards to ensure the confidentiality, integrity,
availability and security of individually identifiable health
information in electronic form.
Failure to comply with these standards under HIPAA, may subject us to civil
monetary penalties and, in certain circumstances, criminal penalties. Under
HIPAA, covered entities may be subject to civil monetary penalties in the amount
of $100 per violation, capped at a maximum of $25,000 per year for violation of
any particular standard. Also, the U.S. Department of Justice, or DOJ, may seek
to impose criminal penalties for certain violations of HIPAA. Criminal penalties
under the statute vary depending upon the nature of the violation but could
include fines of not more than $250,000 and/or imprisonment.
The effect of HIPAA on our business is difficult to predict, and there can be no
assurances that we will adequately address the business risks created by HIPAA
and its implementation, or that we will be able to take advantage of any
resulting business opportunities. Furthermore, we are unable to predict what
changes to HIPAA, or the regulations issued pursuant to HIPAA, might be made in
the future or how those changes could affect our business or the costs of
compliance with HIPAA.
HIPAA - TRANSACTION AND CODE SET STANDARDS
Many covered entities, including some of our customers, our eCommerce Services
clearinghouse business, and trading partners of our clearinghouse business, were
not fully compliant with the TCS Standards as of October 16, 2003. However, we
have deployed contingency plans to accept non-standard transactions, as
contemplated in the "Guidance on Compliance with HIPAA Transactions and Code
Sets after the October 16, 2003 Implementation Deadline" (which we refer to as
the CMS Guidance) issued by the Centers for Medicare & Medicaid Services, or
CMS, on July 24, 2003.
Although the CMS Guidance indicates that CMS will follow a complaint-driven
approach, we cannot provide any assurances regarding how CMS would apply the CMS
Guidance in general or to our e-Commerce Services clearinghouse business in
particular. In the event of enforcement action by CMS against us, there can be
no assurances that we will be able to establish good faith efforts sufficient to
protect us from liability for the civil monetary penalties described above.
There can be no assurances that CMS would be willing to extend the 30-day time
period for us to remedy our non-compliance, or that we would be able to remedy
our non-compliance within the 30-day time period or any extended period granted
by CMS. There can also be no assurances that the DOJ will not seek the criminal
penalties described above for our failure to comply with the TCS Standards.
Because the entire healthcare system, including customers who use our
information systems to generate claims data, has not operated at full capacity
using the newly-mandated standard transactions, it is possible that currently
undetected errors may cause rejection of claims, extended payment cycles, system
implementation delays and cash flow reduction, with the attendant risk of
liability and claims against us.
The CMS Guidance also indicates that in connection with its enforcement
activities, CMS might require non-compliant covered entities to submit and
implement corrective action plans to achieve compliance in a time and manner
acceptable to CMS. In the event that we were required to submit and implement a
corrective action plan, we could be required to take steps and incur costs to
34
achieve compliance in a different manner or shorter timeframe than we would
otherwise choose, which could have an adverse impact on our business operations.
HIPAA - PRIVACY STANDARDS
The Privacy Standards place on covered entities specific limitations on the use
and disclosure of individually identifiable health information. We made certain
changes in our products and services to comply with the Privacy Standards. The
effect of the Privacy Standards on our business is difficult to predict and
there can be no assurances that we will adequately address the risks created by
the Privacy Standards and their implementation or that we will be able to take
advantage of any resulting opportunities.
HIPAA - SECURITY STANDARDS
The Security Standards establish detailed requirements for safeguarding patient
information that is electronically transmitted or electronically stored. Most
participants in the healthcare industry must be in compliance with the Security
Standards by April 21, 2005.
Some of the Security Standards are technical in nature, while others may be
addressed through policies and procedures for using information systems. The
Security Standards may require us to incur significant costs in evaluating our
products and in ensuring that our systems meet all of the implementation
specifications. We are unable to predict what changes might be made to the
Security Standards prior to the 2005 implementation deadline or how those
changes might impact our business. The effect of the Security Standards on our
business is difficult to predict and there can be no assurances that we will
adequately address the risks created by the Security Standards and their
implementation or that we will be able to take advantage of any resulting
opportunities.
MEDICAL DEVICE REGULATIONS
We expect that the United States Food and Drug Administration, or FDA, is likely
to become increasingly active in regulating computer software intended for use
in healthcare settings. The FDA has increasingly focused on the regulation of
computer products and computer-assisted products as medical devices under the
Food, Drug, and Cosmetic Act, or the FDC Act. If computer software is considered
medical device under the FDC Act, as a manufacturer of such products, we could
be required, depending on the product, to:
o register and list our products with the FDA;
o notify the FDA and demonstrate substantial equivalence to other
products on the market before marketing our products; or
o obtain FDA approval by demonstrating safety and effectiveness before
marketing a product.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY. Our success and competitiveness
are dependent to a significant degree on the protection of our proprietary
technology. We rely primarily on a combination of copyrights, trade secret laws,
patent laws and restrictions on disclosure to protect our proprietary
technology. Despite these precautions, others may be able to copy or reverse
engineer aspects of our products, to obtain and use information that we regard
as proprietary or to independently develop similar technology. Litigation may
continue to be necessary to enforce or defend our proprietary technology or to
determine the validity and scope of the proprietary rights of others. This
litigation, whether successful or unsuccessful, could result in substantial
costs and diversion of management and technical resources.
FINANCIAL TRENDS. In the past, some of our customers delayed making purchasing
decisions with respect to some of our software systems, resulting in longer
sales cycles for such systems. We believe these delays were due to a number of
factors, including customer organization changes, government approvals, pressure
to reduce expenses, product complexity, competition and terrorist attacks on the
United States. While we believe these factors were temporary, reductions or
delays in spending for new systems and services could reoccur in the future. If
these delays reoccur, they may cause unanticipated revenue volatility, decreased
revenue visibility and affect our future financial performance.
NEW PRODUCT DEVELOPMENT AND RAPIDLY CHANGING TECHNOLOGY. To be successful, we
must continuously enhance our existing products, respond effectively to
technology changes, and help our customers adopt new technologies. In addition,
we must introduce new products and technologies to meet the evolving needs of
our customers in the healthcare information systems market. We may have
difficulty in accomplishing these tasks because of:
35
o the continuing evolution of industry standards, such as standards
pursuant to HIPAA; and
o the creation of new technological developments, such as Internet and
application service provider technologies.
We devote significant resources toward the development of enhancements to our
existing products. However, we may not successfully complete these product
developments or their adaptation in a timely fashion, and our current or future
products may not satisfy the needs of the healthcare information systems market.
Any of these developments may adversely affect our competitive position or
render our products or technologies noncompetitive or obsolete.
CHANGES AND CONSOLIDATION IN THE HEALTHCARE INDUSTRY. We currently derive
substantially all of our revenues from sales of financial, administrative and
clinical healthcare information systems, and other related services within the
healthcare industry. As a result, our success is dependent in part on the
political and economic conditions in the healthcare industry.
Virtually all of our customers and the other entities with which we have a
business relationship operate in the healthcare industry and, as a result, are
subject to governmental regulation, including Medicare and Medicaid regulation.
Accordingly, our customers and the other entities with which we have a business
relationship are affected by changes in such regulations and limitations in
governmental spending for Medicare and Medicaid programs. Recent actions by
Congress have limited governmental spending for the Medicare and Medicaid
programs, limited payments to hospitals and other providers under Medicare and
Medicaid programs, and increased emphasis on competition and other programs that
potentially could have an adverse effect on our customers and the other entities
with which we have a business relationship. In addition, federal and state
legislatures have considered proposals to reform the U.S. healthcare system at
both the federal and state level. If enacted, these proposals could increase
government involvement in healthcare, lower reimbursement rates and otherwise
change the business environment of our customers and the other entities with
which we have a business relationship. Our customers and the other entities with
which we have a business relationship could react to these proposals and the
uncertainty surrounding these proposals by curtailing or deferring investments,
including those for our products and services.
In addition, many healthcare providers are consolidating to create integrated
healthcare delivery systems with greater market power. These providers may try
to use their market power to negotiate price reductions for our products and
services. If we are forced to reduce our prices, our operating margins would
likely decrease. As the healthcare industry consolidates, competition for
customers will become more intense and the importance of acquiring each customer
will increase.
COMPETITION FOR HEALTHCARE INFORMATION SYSTEMS. The market for healthcare
information systems is intensely competitive, rapidly evolving and subject to
rapid technological change. We believe that the principal competitive factors in
this market include the breadth and quality of system and product offerings, the
features and capabilities of the systems, the price of the system and product
offerings, the ongoing support for the systems, the potential for enhancements
and future compatible products.
Some of our competitors have greater financial, technical, product development,
marketing and other resources than we do, and some of our competitors offer
products that we do not offer. Our principal existing competitors include
Eclipsys Corporation, McKesson Corporation, Siemens AG, Epic Systems
Corporation, GE Medical and Cerner Corporation. Each of these competitors offers
a suite of products that competes with many of our products. There are other
competitors that offer a more limited number of competing products. We may be
unable to compete successfully against these organizations. In addition, we
expect that major software information systems companies, large information
technology consulting service providers and system integrators, Internet-based
start-up companies and others specializing in the healthcare industry may offer
competitive products or services.
PRODUCT LIABILITY CLAIMS. Any failure by our products that provide applications
relating to patient treatment could expose us to product liability claims for
personal injury and wrongful death. These potential claims may exceed our
current insurance coverage. Unsuccessful claims could be costly to defend and
divert our management's time and resources. In addition, we cannot make
assurances that we will continue to have appropriate insurance available to us
in the future at commercially reasonable rates.
PRODUCT MALFUNCTION FINANCIAL CLAIMS. Any failure by our eCommerce electronic
claims submission service, or by elements of our systems that provide
administrative and financial management applications could expose us to
liability claims for incorrect billing and electronic claims. These potential
claims may exceed our current insurance coverage. Unsuccessful claims could be
costly to defend and divert management time and resources. In addition, we
cannot make assurances that we will continue to have appropriate insurance
available to us in the future at commercially reasonable rates.
36
KEY PERSONNEL. Our success is dependent to a significant degree on our key
management, sales, marketing, and technical personnel. To be successful we must
attract, motivate, and retain highly skilled managerial, sales, marketing,
consulting and technical personnel, including programmers, consultants and
systems architects skilled in the technical environments in which our products
operate. Competition for such personnel in the software and information services
industries is intense. We do not maintain "key man" life insurance policies on
any of our executives. Not all of our personnel have executed noncompetition
agreements. Noncompetition agreements, even if executed, are difficult and
expensive to enforce, and enforcement efforts could result in substantial costs
and diversion of our management and technical resources.
SYSTEM ERRORS, SECURITY BREACHES AND WARRANTIES. Our healthcare information
systems are very complex. As with all complex information systems, our
healthcare information systems may contain errors, especially when first
introduced. Our healthcare information systems are intended to provide
information to healthcare providers for use in the diagnosis and treatment of
patients. Therefore, users of our products may have a greater sensitivity to
system errors than the market for software products generally. Failure of a
customer's system to perform in accordance with its documentation could
constitute a breach of warranty and require us to incur additional expenses in
order to make the system comply with the documentation. If such failure is not
timely remedied, it could constitute a material breach under a contract allowing
our customer to cancel the contract and subject us to liability.
A security breach could damage our reputation or result in liability. We retain
and transmit confidential information, including patient health information, in
our processing centers and other facilities. It is critical that these
facilities and infrastructure remain secure and be perceived by the marketplace
as secure. We may be required to expend significant capital and other resources
to protect against security breaches and hackers or to alleviate problems caused
by breaches. Despite the implementation of security measures, this
infrastructure or other systems that we interface with, including the Internet
and related systems, may be vulnerable to physical break-ins, hackers, improper
employee or contractor access, computer viruses, programming errors, attacks by
third parties or similar disruptive problems. Any compromise of our security,
whether as a result of our own systems or systems with which they interface,
could reduce demand for our services and products.
Customer satisfaction and our business could be harmed if our business
experiences delays, failures or loss of data in its systems. The occurrence of a
major catastrophic event or other system failure at any of our facilities or at
any third-party facility, including telecommunications provider facilities,
could interrupt data processing or result in the loss of stored data, which
could harm our business.
POTENTIAL INFRINGEMENT OF PROPRIETARY RIGHTS OF OTHERS. If any of our products
violate third-party proprietary rights, we may be required to re-engineer our
products or seek to obtain licenses from third parties to continue offering our
products without substantial re-engineering. Any efforts to reengineer our
products or obtain licenses from third parties may not be successful, in which
case we may be forced to stop selling the infringing product or remove the
infringing functionality or feature. We may also become subject to damage awards
as a result of infringing the proprietary rights of others, which could cause us
to incur additional losses and have an adverse impact on our financial position.
We do not conduct comprehensive patent searches to determine whether the
technologies used in our products infringe patents held by others. In addition,
product development is inherently uncertain in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies.
RISKS ASSOCIATED WITH ACQUISITION STRATEGY. We may decide to meet business
objectives in part through either acquisitions of complementary products,
technologies and businesses or alliances with complementary businesses. We may
not be successful in these acquisitions or alliances, or in integrating any such
acquired or aligned products, technologies or businesses into our current
business and operations. Factors which may affect our ability to expand
successfully include:
o the generation of sufficient financing to fund potential acquisitions
and alliances;
o the successful identification and acquisition of products,
technologies or businesses;
o effective integration and operation of the acquired or aligned
products, technologies or businesses despite technical difficulties,
geographic limitations and personnel issues; and
o our ability to overcome significant competition for acquisition and
alliance opportunities from companies that have significantly greater
financial and management resources.
37
STRATEGIC ALLIANCE WITH ALLSCRIPTS HEALTHCARE SOLUTIONS. In 2001, we entered
into a ten-year strategic alliance with Allscripts to cooperatively develop,
market and sell integrated clinical and practice management products.
During the term of the alliance, we are prohibited from cooperating with direct
competitors of Allscripts to develop or provide any products similar to or in
competition with Allscripts products in the practice management systems market.
If the strategic alliance is not successful, or the restrictions placed on us
during the term of the strategic alliance prohibit us from successfully
marketing and selling certain products and services, our operating results may
suffer. Additionally, if either Allscripts or we breach the strategic alliance,
we may be left without critical clinical components for our information systems
offerings in the physician group practice markets.
ANTI-TAKEOVER DEFENSES. Our Second Amended and Restated Articles of
Incorporation and Second Amended and Restated Bylaws contain certain
anti-takeover provisions, which could deter an unsolicited offer to acquire our
company. For example, our board of directors is divided into three classes, only
one of which will be elected at each annual meeting. These provisions may delay
or prevent a change in control of our company.
LITIGATION. We are involved in litigation matters which are described in greater
detail in Part II, Item 1, Legal Proceedings. An unfavorable resolution of
pending litigation could have a material adverse effect on our financial
condition. Litigation may result in substantial costs and expenses and
significantly divert the attention of our management regardless of the outcome.
There can be no assurance that we will be able to achieve a favorable settlement
of pending litigation or obtain a favorable resolution of litigation if it is
not settled. In addition, current litigation could lead to increased costs or
interruptions of our normal business operations.
No charges of wrongdoing have been brought against us in connection with the
U.S. Attorney's investigation, described in greater detail in Part II, Item 1,
Legal Proceedings, and we do not believe that we have engaged in any wrongdoing
in connection with this matter. However, because this investigation is or may
still be underway and investigations of this type customarily are conducted in
whole or in part in secret, we lack sufficient information to determine with
certainty its ultimate scope and whether the government authorities will assert
claims resulting from this investigation that could implicate or reflect
adversely upon us. Because our reputation for integrity is an important factor
in our business dealings with NIST and other governmental agencies, if a
government authority were to make an allegation, or if there were to be a
finding, of improper conduct on the part of or attributable to us in any matter,
including in respect of the U.S. Attorney's investigation, such an allegation or
finding could have a material adverse effect on our business, including our
ability to retain existing contracts and to obtain new or renewal contracts. In
addition, continuing adverse publicity resulting from this investigation and
related matters could have such a material adverse effect.
38
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY EXCHANGE RISK
Internationally, we currently operate in Canada and the United Kingdom. Our
international business is subject to risks, including, but not limited to:
unique economic conditions, changes in political climate, differing tax
structures, other regulations and restrictions, and foreign exchange rate
volatility. Accordingly, our future results could be materially adversely
impacted by changes in these or other factors.
We invoice Canadian customers in United States dollars. Our United Kingdom
customers are invoiced in British pounds sterling, and to a lesser extent in US
dollars. Expenses to service our UK contracts are incurred both by our UK
subsidiary in the local currency and by the parent company in US dollars. As
such, our operating results and certain assets and liabilities that are
denominated in the British pound are affected by changes in the relative
strength of the United States dollar against the British pound. Our revenues are
adversely affected when the United States dollar strengthens against the British
pound and are positively affected when the United States dollar weakens.
Conversely our expenses are positively affected when the United States dollar
strengthens against the British pound and adversely affected when the United
States dollar weakens.
As described in Note 5 in Notes to Consolidated Financial Statements contained
in Part I; Item 1 of this Quarterly Report on Form 10-Q, we currently use
forward foreign exchange contracts to mitigate our foreign currency exchange
rate exposures related to our foreign currency denominated assets and
liabilities, and more specifically, to hedge, on a net basis, the foreign
currency exposure of a portion of our assets and liabilities denominated in the
British pound sterling. The terms of these forward contracts are for periods
matching the underlying exposures and generally are for one month. The
short-term nature of these contracts has resulted in these instruments having
book values that approximate fair values at June 30, 2004. We do not use forward
contracts for trading or speculative purposes.
The market risk associated with the forward foreign exchange contracts resulting
from currency exchange rate or interest rate movements is expected to mitigate
the market risk of the underlying assets and liabilities being hedged. Our
foreign currency denominated net assets were approximately $45.6 million at June
30, 2004. A hypothetical 10 percent movement in the foreign currency exchange
rate would increase or decrease net assets by approximately $4.6 million with a
corresponding charge to operations.
INTEREST RATE RISK
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted due to a rise in interest rates, while floating
rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, our future investment income may fall short of
expectations due to changes in interest rates or we may suffer losses in
principal if forced to sell securities that experience a decline in market value
due to changes in interest rates. A hypothetical 10% increase or decrease in
interest rates, however, would not have a material adverse effect on our
financial condition. Interest income on our investments is included in "Other
Income".
Interest rates on short-term borrowings with floating rates carry a degree of
interest rate risk. Our future interest expense may increase if interest rates
fluctuate. A hypothetical 10% increase or decrease in interest rates, however,
would not have a material adverse effect on our financial condition. Interest
expense was immaterial during the first three months of 2004 and 2003.
EQUITY PRICE RISK
We account for cash equivalents and marketable securities in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Cash equivalents are short-term
highly liquid investments with original maturity dates of three months or less.
Cash equivalents are carried at cost, which approximates fair market value. Our
marketable securities are classified as available-for-sale and are recorded at
fair value with any unrealized gain or loss recorded as an element of
stockholders' equity. We generally place our marketable securities in high
credit quality instruments: primarily U.S. Government and federal agency
obligations, tax-exempt municipal obligations and corporate obligations with
contractual maturities of a year or less. Although our investments in
available-for-sale securities are subject to price risk, we do not expect any
material loss from our marketable security investments.
39
ITEM 4. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's chief
executive officer and chief financial officer, evaluated the effectiveness of
the Company's disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as
of June 30, 2004. Based on this evaluation, the Company's chief executive
officer and chief financial officer concluded that, as of June 30, 2004, the
Company's disclosure controls and procedures were (1) designed to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to the Company's chief executive officer and chief
financial officer by others within those entities, 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 the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
CHANGES IN INTERNAL CONTROLS
During 2002, the Company began implementation of an enterprise resource planning
("ERP") system, designed to align and integrate the Company's employees,
processes and technology through software applications. The ERP system includes
enterprise financial reporting applications, of which the Company implemented
the core applications for general ledger, accounts receivable, billing, accounts
payable and fixed assets during the fourth quarter of 2002. During the fourth
quarter of 2003, the Company implemented additional applications principally
including payroll and benefits, contract management, order management, project
management, resource management, and time and expense reporting. The
applications implemented during the fourth quarter of 2003 represent a
culmination of over a year of preparation, including five months of testing and
three months of training. Management believes that the ongoing implementation of
the ERP system will ultimately enhance our internal controls over financial
reporting. However, the Company's financial controls in the fourth quarter of
2003 were adversely impacted by this conversion to the ERP system and the
assignment of Company personnel responsible for overseeing such controls to
additional special projects. At that time, the Company's independent auditors,
Ernst & Young, determined that the Company had significant deficiencies in the
design or operation of the Company's internal control which, if not addressed,
could adversely affect the assertions of management in the financial statements
as to particular accounts. The Company addressed these conditions with enhanced
testing and analysis, and it believes these procedures were adequate to permit
us to report appropriate results in our Annual Report on Form 10-K for 2003.
In 2004, the Company has taken steps to improve its internal controls and
believes that these steps have adequately addressed the significant deficiencies
identified during the fourth quarter of 2003. These steps included the
re-assignment of Company personnel responsible for overseeing such controls,
increased scrutiny of account reconciliations related to revenue recognition
issues and closer monitoring of financial results. We are also in the process of
further enhancing our internal finance staff. The Company believes the measures
it has taken and additional measures it continues to implement will enhance our
internal controls over financial reporting. In addition, we are currently in the
process, with the assistance of qualified outside consultants, of evaluating our
internal controls and we may make other modifications or take other corrective
actions if our reviews identify any deficiencies or weaknesses in our controls.
40
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In late 2001, the Company finalized a "Cooperative Agreement" with a
non-regulatory federal agency within the U.S. Commerce Department's Technology
Administration, NIST, whereby the Company agreed to lead a $9.2 million,
multi-year project awarded by NIST to a joint venture composed of the Company
and four other joint venture partners. The project entails research and
development to be conducted by the Company and its partners in the grant.
Subsequently, an employee of the Company made allegations that the Company had
illegally submitted claims for labor expenses and license fees to NIST and that
the Company never had a serious interest in researching the technological
solutions described in the proposal to NIST.
On March 31, 2004, IDX submitted certain information to NIST, which NIST
requested in conjunction with a proposed amendment to the Cooperative Agreement.
The Amendment discontinued payment on the award until IDX demonstrates
regulatory compliance relating to certain aspects of its grant accounting and
reporting procedures and relating to an in-kind contribution of software IDX
made to the project. In issuing the Amendment, NIST made no finding of
regulatory noncompliance by IDX in connection with the award. In connection with
NIST's Amendment, the U.S. Commerce Department, Office of Inspector General
("OIG"), is presently conducting an audit of the SAGE Project. IDX is
cooperating with OIG auditors, and continues to be in discussions to resolve the
issues raised by the Amendment. Pending the outcome of this audit, IDX is
working with its joint venture partners to review current procedures and develop
a plan for operations during the audit period.
The Company believes the employee has likely filed an action under the Federal
False Claims Act under seal in the Federal District Court for the Western
District of Washington with respect to his claims, sometimes referred to as a
"qui tam" complaint. The Company has no information regarding the specific
allegations in the qui tam complaint. Further, the Company has no information
concerning the actual amount of money at issue in the qui tam complaint. The
Company has not yet been served with legal process detailing the allegations.
Prompted by the employee's allegations, the Civil Division of the U.S.
Attorney's office in Seattle, Washington, in conjunction with the U.S. Commerce
Department, Office of the Inspector General, is investigating whether the
Company made false statements in connection with the application for the project
award from NIST. The Company is cooperating in the government's ongoing
investigation.
In April 2003, the Company filed a complaint against the employee with the
United States District Court for the Western District of Washington, entitled
IDX SYSTEMS CORPORATION V. MAURICIO LEON (case no. C03-972R). The Company's
lawsuit asks the Court to grant a declaratory judgment stating that, should the
Company terminate the employee's employment, such action would not constitute
retaliation for alleged whistle-blowing activities in violation of the Federal
False Claims Act or the Sarbanes-Oxley Act and would not constitute a violation
of the employee's rights under other laws. On June 10, 2004, the Company
terminated the employee based upon, among other things, information obtained
during the litigation and, as a result, the Company intends to dismiss the
aforementioned declaratory relief action.
In May 2003, the employee filed a complaint against the Company with the Federal
District Court for the Western District of Washington, entitled MAURICIO A.
LEON, M.D. V. IDX SYSTEMS CORPORATION (case no. CV03-1158P) asserting that the
Company had knowledge that the employee engaged in "protected activity" and
retaliated against the employee in violation of the False Claims Act. In
addition, the employee alleges that the Company violated the Americans with
Disabilities Act and its Washington State counterpart in part through
retaliation against the employee for exercising the employee's rights under the
federal and state discrimination laws. The employee also asserts other causes of
action including (a) wrongful termination in violation of public policy, (b)
fraudulent inducement to enter into an employment contract with the Company
(which has since been dismissed), and (c) negligent and intentional infliction
of emotional distress. The employee requests relief including, but not limited
to, an injunction against the Company enjoining and restraining the Company from
the alleged harassment and discrimination, wages, damages, attorneys' fees,
interest and costs. In addition, the employee's complaint alleges that the
Company submitted false statements to the Government to obtain the grant and to
obtain reimbursement from the government for project costs.
Following a hearing on October 21, 2003, the Court on October 22, 2003, issued a
series of orders regarding alignment of the IDX V. LEON and LEON V. IDX cases.
Pursuant to the orders, the claims asserted by the parties will proceed under
the case of LEON V. IDX, case number CV03-1158. IDX realigned its declaratory
judgment claims as affirmative defenses and/or counterclaims in that case. The
employee filed a motion for an injunction to reinstate his pay and benefits
pending conclusion of the action. The motion was denied on December 12, 2003.
Trial of the consolidated cases is presently scheduled for November 2004. The
Company intends to vigorously defend itself and to vigorously pursue relief
through prosecution of its own claims in the consolidated lawsuits. Although the
41
Company believes that these actions are without merit, the Company currently
cannot predict the outcome or the impact these matters may have on the Company's
operations.
In May 2003, the employee filed a complaint against the Company with the U.S.
Department of Labor, pursuant to Section 1514A of the Sarbanes-Oxley Act of
2002. The employee's complaint asserts that, notwithstanding alleged notice to
the Company of the employee's allegations, Company management conspired to
continue to defraud the government by allowing fraudulent activities to continue
uncorrected and by concealing and avoiding its obligations to report any and all
fraudulent activities to the proper authorities. In addition, the employee's
complaint alleges that the Company acted to retaliate, harass and intimidate the
employee in contravention of the Sarbanes-Oxley Act's whistleblower provisions.
The employee's complaint requests relief including, but not limited to,
reinstatement, back-pay, with interest, and compensation for any damages
sustained by the employee as a result of the alleged discrimination. The
Department of Occupational Health and Safety is investigating the employee's
complaint on behalf of the U.S. Department of Labor, and the Company intends to
cooperate in the investigation. The Company intends to vigorously defend against
the employee's claims, however, the outcome or the impact these claims may have
on the Company's operations cannot currently be predicted.
There are additional claims made by the employee against the Company, including
a charge with the U.S. Equal Employment Opportunity Commission, claiming that
the employee was discriminated against in violation of the Americans with
Disabilities Act, the processing of which the EEOC has subsequently terminated
through a Notice of Right to Sue. The Company intends to vigorously defend
against the employee's claims, however, the outcome or the impact these claims
may have on the Company's operations cannot currently be predicted.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its 2004 Annual Meeting of Stockholders on May 18, 2004. Of the
30,085,867 shares of common stock outstanding and entitled to vote at this
meeting, 25,336,147 were represented at this meeting, in person or by proxy. The
following matter was voted upon at the Annual Meeting; there were no broker
non-votes for this matter.
1. Robert H. Hoehl, Stuart H. Altman, Ph.D. and Mark F. Wheeler, M.D. were
elected to serve for a term of three years as Class III Directors. The
remaining terms of Richard E. Tarrant, Allen Martin, Esq., Henry M. Tufo,
M.D., David P. Hunter, William L. Asmundson, Connie R. Curran and James H.
Crook, Jr. continued after the meeting. The results of the vote with
respect to each nominee for director was as follows:
For Withheld
--- --------
Robert H. Hoehl 20,438,021 4,898,126
Stuart H. Altman, Ph.D. 22,557,178 2,778,969
Mark F. Wheeler, M.D. 20,768,814 4,567,333
ITEM 5. OTHER INFORMATION
Stockholder's Proposal for 2005 Annual Meeting
As set forth in the Company's Proxy Statement for its 2004 Annual Meeting of
Stockholders, proposals of stockholders intended to be included in the Company's
proxy statement for the 2005 Annual Meeting of Stockholders must be received by
the Company at its principal office in South Burlington, Vermont not later than
December 24, 2004.
Stockholders who wish to make a proposal at the 2005 Annual Meeting - other than
one that will be included in the Company's proxy materials - must notify the
Company no later than March 9, 2005. If a stockholder who wishes to present a
proposal fails to notify the Company by this date, the proxies that management
solicits for the meeting will have discretionary authority to vote on the
stockholder's proposal if it is properly brought before the meeting.
42
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits filed as part of this Form 10-Q are listed on the Exhibit
Index immediately preceding such exhibits, which Exhibit Index is
incorporated herein by reference.
(b) On April 29, 2004, the registrant furnished a report on Item 12 of Form
8-K, dated April 29, 2004, containing a copy of its earnings release for
the quarter ended March 31, 2004.
43
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.
IDX SYSTEMS CORPORATION
/S/ JOHN A. KANE
Date: August 3, 2004 By: _____________________________________
John A. Kane,
Sr. Vice President, Finance and
Administration, Chief Financial
Officer and Treasurer
(Principal Financial and
Accounting Officer)
44
EXHIBIT INDEX
-------------
The following exhibits are filed as part of this Quarterly Report on Form 10-Q:
Exhibit No. Description
- ---------- -----------
10.1 Letter Agreement, dated May 7, 2004, terminating Stock
Restriction and Voting Agreement, dated April 29, 1999, by and
between Richard E. Tarrant and Amy E. Tarrant
10.2 Termination of Redemption Agreement, dated April 21, 2004,
terminating Redemption Agreement, dated June 2, 1993, by and
among the Company, Richard E. Tarrant, Robert H. Hoehl, Amy
E. Tarrant and Cynthia K. Hoehl
31.1 Certification of the CEO of the Company pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended
31.2 Certification of the CFO of the Company pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended
32.1 Certification of CEO and CFO of the Company pursuant to
18 U.S.C. Section 1350
45