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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission file number 0-13801
QUALITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California 95-2888568
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
17822 East 17th Street, Tustin, California 92780
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (714) 731-7171
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange on which registered:
Common Stock, par value $.01 per share NA
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 twelve 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 ninety days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
State the aggregate market value of the voting stock held by non-affiliates of
the Registrant as of May 31, 2001: $35,746,654.*
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of May 31, 2001: 5,988,503.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of the Form 10-K is incorporated by
reference from Registrant's Definitive Proxy Statement for its 2001 annual
meeting which is to be filed with the Commission on or before July 29, 2001.
* For purposes of this report, in addition to those shareholders which fall
within the definition of "affiliates" under Rule 405 of the Securities Act of
1933, as amended, holders of ten percent or more of the Registrant's Common
Stock are deemed to be affiliates.
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PART I
Item 1. Business
Except for the historical information contained herein, the matters discussed in
this Annual Report on Form 10-K, including discussions of the Registrant's
product development plans, business strategies and market factors influencing
the Registrant's results, are forward-looking statements that involve certain
risks and uncertainties. Actual results may differ from those anticipated by the
Registrant as a result of various factors, both foreseen and unforeseen,
including, but not limited to, the Registrant's ability to continue to develop
new products and increase systems sales in markets characterized by rapid
technological evolution, consolidation within the Registrant's target
marketplace and among the Registrant's competitors, and competition from larger,
better capitalized competitors. Many other economic, competitive, governmental
and technological factors could impact the Registrant's ability to achieve its
goals. Interested persons are urged to review the risks described under "Item 1.
Business. Risk Factors" and in "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" as well as in the Registrant's
other public disclosures and filings with the Securities and Exchange
Commission.
Company Overview
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiary, Clinitec
International, Inc. ("Clinitec") d/b/a MicroMed Healthcare Information Systems,
Inc. ("MicroMed"), (collectively, the "Company") develop and market healthcare
information systems that automate medical and dental group practices, physician
hospital organizations ("PHOs"), management service organizations ("MSOs"),
ambulatory care centers, community health centers, and medical and dental
schools. In response to the growing need for more comprehensive, cost-effective
information solutions for physician and dental practices, the Company's systems
enable clients to redesign office workflow processes, improve productivity,
reduce information processing and administrative costs, and utilize electronic
medical records to store and access patient information. The Company's
proprietary software systems cover a number of important practice elements
including but not limited to general patient information, electronic medical
records, appointment scheduling, billing, insurance claims submission and
processing, eligibility verification, managed care plan implementation, referral
management, treatment outcome studies, treatment planning, drug formularies,
dental charting, and letter generation. Several of the Company's software
systems may be operated remotely using thin client connectivity or a standard
web browser. In addition to providing fully integrated software solutions to its
clients, the Company offers comprehensive hardware and software installation
services, maintenance and support services, and system training services.
The Company currently has a base of approximately 700 clients, with each
client including between one and 500 physicians or dentists. The Company
believes that as healthcare providers are increasingly required to reduce costs
and maintain the quality of healthcare, the Company will be able to capitalize
on its strategy of providing fully integrated information systems and superior
client service.
QSI, a California corporation formed in 1974, was founded with an early
focus on providing information systems and services for dental group practices.
In the mid-1980's, QSI capitalized on the increasing focus on medical cost
containment and further expanded its information processing systems to serve the
medical market. Today, the Company has dedicated products serving both the
medical and dental markets.
The Company's QSI Division develops and markets dental practice management
and medical practice management software suites utilizing a UNIX(1) operating
system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(2) operating
system and can be fully integrated with the Company's dental practice
- ----------
(1) UNIX is a registered trademark of AT&T Corporation.
(2) Microsoft Windows, Windows NT, Windows 95, Windows 98, and Windows 2000 are
registered trademarks of Microsoft Corporation.
2
management applications. CPS incorporates a wide range of clinical tools
including but not limited to periodontal charting and digital imaging of X-ray
and inter-oral camera images as part of a complete electronic patient record. In
addition, the QSI Division develops and markets the Company's QUIC product suite
which incorporates a variety of products that enhance the connectivity between
provider and payor, and provider and patient. The QSINet Application Services
Provider ("ASP")/Internet product offering is also developed and marketed in
this division. QSINet enables providers to extend patient appointment
scheduling, electronic bill payment, and other functions to patients via the
Internet.
QSI's MicroMed Division develops and sells proprietary electronic medical
records software and practice management systems under the NextGen(R)(3) product
name. Major product categories of the NextGen suite include Electronic Medical
Records (NextGen(emr)), Enterprise Practice Management (NextGen(epm)),
Enterprise Appointment Scheduling (NextGen(eas)), Enterprise Master Patient
Index (NextGen(epi)), Managed Care, Electronic Data Interchange, System
Interfaces, Internet Operability (NextGen(web)), and a Patient-centric and
Provider-centric Web Portal Solution (NextMD.com(4)). The Company's enterprise
practice management and electronic medical records software packages can run via
private intranet or via the Internet in an ASP environment.
Enhancements to these products continued during fiscal 2001.
For the purposes of Statement of Accounting Standards ("SFAS") No. 131
"Disclosures About Segments of an Enterprise and Related Information" we have
provided a breakdown of our business utilizing the management approach in the
Notes to Consolidated Financial Statements No. 11 "Operating Segment
Information."
Industry Background
To compete in the continually changing healthcare environment, providers
are increasingly using technology to help maximize the efficiency of their
business practices and to assist in enhancing patient care.
As the managed care environment continues to expand, more healthcare
providers enter into contracts, often with multiple entities, which define the
terms under which care is administered. The expansion in the number of managed
care and third party payor organizations, as well as additional government
regulation and changes in reimbursement models, has greatly increased the
complexity of pricing, billing, reimbursement, and records management for
medical and dental practices. To operate effectively, healthcare provider
organizations must efficiently manage patient care and other information and
workflow processes which increasingly extend across multiple locations and
business entities.
In response, healthcare provider organizations have placed increasing
demands on their information systems. Initially, these information systems
automated financial and administrative functions. As it became necessary to
manage patient flow processes, the need arose to integrate "back-office" data
with such clinical information as patient test results and office visits.
Particularly for larger organizations and group practices, the Company believes
information systems must facilitate enterprise-wide management of patient
information incorporating administrative, financial and clinical information
from multiple entities. In addition, large healthcare organizations increasingly
require information systems that can deliver high performance in environments
with multiple concurrent computer users.
Many existing healthcare information systems were designed for limited
administrative tasks such as billing and scheduling and can neither accommodate
multiple computing environments nor operate effectively across multiple
locations and entities. The Company believes as the healthcare industry
continues to evolve, healthcare organizations will increasingly require systems
that compile structured clinical information from multiple sources and enable
measurement of treatment outcomes and management of clinical processes. Further,
the Company believes that systems which integrate this patient clinical data
with administrative, financial and other practice management data to maintain
patient
- ----------
(3) NextGen is a registered trademark of MicroMed Healthcare Information
Systems, Inc.
(4) NextMD.com is a trademark of MicroMed Healthcare Information Systems, Inc.
3
flow while contributing to reduced costs and improved quality of care are best
positioned to succeed in the evolving managed care environment. As healthcare
organizations transition to new computer platforms and newer technologies, the
Company believes such organizations will be migrating toward the implementation
of enterprise-wide, patient-centric computing systems embedded with automated
clinical patient records.
Products
In response to the growing need for more comprehensive, cost-effective
healthcare information solutions for physician and dental practices, the
Company's systems provide its clients with the ability to redesign patient care
and other workflow processes while improving productivity through facilitation
of managed access to patient information. Utilizing the Company's proprietary
software combined with proven third party hardware solutions, the Company's
products enable the integration of a variety of administrative and clinical
information operations. Leveraging more than 20 years of experience in the
healthcare information services industry, the Company believes that it continues
to distinguish its solutions by providing its clients with sophisticated,
full-featured software systems along with comprehensive systems implementation,
maintenance and support.
Practice Management Systems. The Company's products consist primarily of
proprietary healthcare software applications together with third party hardware
and other non-industry specific software. The systems range in capacity from one
to hundreds of users, allowing the Company to address the needs of both small
and large organizations. The systems are modular in design and may be expanded
to grow with changing client requirements.
The Company's character-based practice management system is available in
both dental and medical versions and primarily uses the IBM RS6000(5) central
processing unit and IBM'S AIX(6) version of the UNIX operating system as a
platform for its application software enabling a wide range of flexible and
functional systems. The hardware components, as well as the requisite operating
system licenses, are purchased from manufacturers or distributors of those
components. QSI assembles and tests the hardware components and incorporates its
software and other third party packages into completed systems tailored to
accommodate particular client requirements. The Company continually evaluates
the hardware components of its systems with a view toward utilizing hardware
that is functional, reliable and cost-effective.
NextGen(epm) expands the Company's practice management system product
line. NextGen(epm) has been developed using a graphical user interface ("GUI")
client-server platform for compatibility with Windows 95, Windows 98, Windows
2000, and Windows NT operating systems and a relational database that is ANSI
SQL-compliant. NextGen(epm) is scalable and includes a master patient index,
enterprise-wide appointment scheduling with referral tracking, clinical support,
and centralized or decentralized patient financial management based on either a
managed care or fee-for-service model. The system's three-tiered architecture
allows work to be performed on the database server, the application server and
the client workstation.
To date, the Company generally has made hardware recommendations for
NextGen(epm) to its clients based upon information provided by each client.
Clients are responsible for the selection, installation, and integration of the
hardware purchased from third party suppliers other than the Company.
The Company also offers practice management solutions for both dental and
medical practices through the Internet. These products are marketed under the
QSINet and NextGen(web) trade names, respectively.
Clinical Systems. The Company's dental charting software system, the
Clinical Product Suite (CPS), is a comprehensive solution designed specifically
for the dental group practice environment. CPS integrates the dental practice
management product with a computer-based clinical information system that
incorporates a wide range of clinical tools, including:
- ----------
(5) RS6000 is a registered trademark of International Business Machines
Corporation.
(6) AIX is a registered trademark of International Business Machines
Corporation.
4
o Electronic charting of dental procedures, treatment plans and
existing conditions;
o Periodontal charting via light-pen, voice-activation, or keyboard
entry for full periodontal examinations and PSR scoring;
o Digital imaging of X-ray and intra-oral camera images;
o Computer-based patient education modules, viewable chair-side to
enhance case presentation;
o Full access to patient information, treatment plans, and insurance
plans via a fully integrated interface with the Company's dental
practice management product; and
o Document and image scanning for digital storage and linkage to the
electronic patient record.
The result is a comprehensive clinical information management system that
helps practices save time, reduce costs, improve case presentation, and enhance
the delivery of dental services and quality of care. Clinical information is
managed and maintained electronically thus forming an electronic patient record
that allows for the implementation of the "chartless" office.
CPS incorporates Windows-based client-server technology consisting of one
or more file servers together with any combination of one or more desktop,
laptop, or pen-based PC workstations. The file server(s) used in connection with
CPS utilize(s) a Windows NT operating system and the hardware is typically a
Pentium(7)-based single or multi-processor platform. Based on the server
configuration chosen, CPS is scalable from one to hundreds of workstations. A
typical configuration may also include redundant disk storage, magnetic tape
units, intra- and extra-oral cameras, digital X-ray components, digital
scanners, conventional and flat screen displays, and printers. The hardware
components, including the requisite operating system licenses, are purchased
from third party manufacturers or distributors either directly by the customer
or by the Company for resale to the customer.
MicroMed provides software applications that are complementary to, and
interface with, the Company's medical practice management offerings as well as
many of the other leading practice management software systems on the market.
The applications incorporated into the Company's practice management solutions
and others such as scheduling, eligibility, billing and claims processing are
augmented by clinical information captured by NextGen(emr), including services
rendered and diagnoses used for billing purposes. The Company believes that it
currently provides a comprehensive information management solution for the
medical marketplace.
NextGen(emr) was developed with client-server architecture and a GUI
utilizing Microsoft Windows 95, Windows 98, Windows 2000, or Windows NT on each
workstation and either Windows NT, UNIX or Novell(8) on the server. NextGen(emr)
maintains data using an industry standard relational database engine such as
Microsoft SQL Server(9), INFORMIX(10) or Oracle(11). The system is scalable from
one to hundreds of workstations.
NextGen(emr) stores and maintains clinical data including:
o Data captured using user-customized input "templates";
o Scanned or electronically acquired images, including X-rays and
photographs;
o Data electronically acquired through interfaces with clinical
instruments;
o Other records, documents or notes, including electronically captured
handwriting and annotations; and
o Digital voice recordings.
NextGen(emr) also offers a workflow module, prescription management,
automatic document and letter generation, patient education, referral tracking,
interfaces to billing and lab systems, physician alerts and reminders, and
powerful reporting and data analysis tools.
- ----------
(7) Pentium is a registered trademark of Intel Corporation.
(8) Novell is a registered trademark of Novell, Inc.
(9) Microsoft is a registered trademark and SQL Server is a registered trademark
of Microsoft Corporation.
(10) INFORMIX is a registered trademark of Informix Corporation.
(11) Oracle is a registered trademark of Oracle Corporation.
5
NextGen(emr) is sold either as a combination of software and services, or
as a turnkey system including computer hardware and requisite operating system
software. Computer hardware for turnkey systems is purchased for resale by the
Company from third party manufacturers or distributors.
The Company continued to enhance the NextGen(emr) application in fiscal
2001 to enable NextGen(emr) to be run via private intranet or the Internet in an
ASP environment.
Connectivity Services. The Company makes available electronic data
interchange ("EDI") capabilities and connectivity services to its customers.
These capabilities and services facilitate the sharing of information between
providers and payors as well as providers and patients to increase office
efficiency, reduce processing time, and enhance collection of accounts
receivable. The EDI/connectivity capabilities encompass direct interfaces
between the Company's products and external third party systems, as well as
transaction-based services. Services include:
o Electronic claims submission through the Company's relationships
with a number of national claims clearinghouses;
o Electronic patient statements, appointment reminder cards and calls,
recall cards, patient letters, and other correspondence;
o Electronic insurance eligibility verification; and
o Electronic posting of remittances from insurance carriers into the
accounts receivable application.
Internet Applications. The Company maintains an Internet-based consumer
health portal, NextMD.com. NextMD.com is a vertical portal for the healthcare
industry, linking patients with their physicians, insurers, laboratories, and
online pharmacies, while providing a centralized source of health-oriented
information for both consumers and medical professionals. Patients whose
physicians are linked to the portal are able to request appointments, send
appointment changes or cancellations, receive test results on-line, request
prescription refills, view and/or pay their statements, and communicate with
their physicians, all in a secure, on-line environment. The Company's NextGen
suite of information systems are or will be linked to NextMD.com, integrating a
number of these features with physicians' existing systems.
The Company also provides a web-based application called QSINet which
allows clients to securely access information from their practice management
system via the Internet. This application also enables providers to offer their
patients convenient services such as on-line appointment scheduling and
electronic bill payment through the client's website, and posts this data
directly to the client's existing practice management system.
Sales and Marketing
The Company sells and markets its products nationwide through a direct
sales force. Sales staff typically make presentations to potential clients by
demonstrating the system and its capabilities on the prospective client's
premises. The Company's sales and marketing employees identify prospective
clients through a variety of means, including referrals from existing clients,
contacts at professional society meetings and seminars, trade journal
advertising, direct mail advertising, and telemarketing.
The Company's sales cycle can vary significantly and typically ranges from
three to twelve months from initial contact to contract execution. Systems are
normally delivered to a customer within sixty days of receipt of a system order,
and therefore, the Company does not believe data pertaining to backlog is
meaningful. As part of the fees paid by its clients, the Company receives
up-front licensing fees and a monthly or quarterly service fee based on system
configuration.
Several clients have purchased the Company's practice management system
and, in turn, are providing either time-share or billing services to single and
group practice practitioners. Under the time-share or billing service
agreements, the client provides the use of its system for a fee to one or more
practitioners. Although the Company does not receive a fee directly from the
distributor's customers, implementation of such arrangements has resulted in the
purchase of additional system capacity by the distributor, as well as new system
purchases made by the distributor's customers should such customers decide to
perform the practice management functions in-house.
6
The Company continues to concentrate its sales and marketing efforts on
medical and dental practices, professional schools, physician clinics, MSOs,
PHOs, ambulatory care settings and community health centers.
MSOs and PHOs to which the Company has sold systems provide use of the
Company's software to those group and single physician practices associated with
the organization or hospital on either a service basis or by directing the
Company to contract with those practices for the sale of stand-alone systems.
The Company has also entered into marketing assistance agreements with
certain of its clients pursuant to which the clients allow the Company to
demonstrate to potential clients the use of systems on the existing clients'
premises. In addition, the Company has established a network of resellers for
its systems. Through these arrangements the reseller markets and sells the
Company's products and services to prospects in a defined market area or
segment. These prospects are generally smaller healthcare facilities than those
actively pursued by the Company. Resellers are compensated through a variety of
contractual arrangements.
The Company from time to time assists prospective clients in identifying
third party sources for financing the purchase of the Company's systems. The
financing is typically obtained by the client directly from institutional
lenders and typically takes the form of a loan from the institution secured by
the system to be purchased or a leasing arrangement.
The Company has numerous clients and does not believe that the loss of any
single client would have a material adverse effect on the Company. No client
accounted for ten percent or more of net revenues during fiscal years ended
March 31, 2001, 2000 or 1999.
Customer Service and Support
The Company believes its success is attributable in part to its customer
service and support departments. The Company offers support to its clients seven
days a week, 24 hours a day. Because most of the Company's installed systems
have a dedicated computer port for dial-up remote access facilitating rapid
response by technicians to system inquiries, most inquiries can be resolved
without the need to dispatch technicians to the client location. These support
services also provide the Company with the opportunity to monitor changes in
each client's information processing requirements and to recommend the purchase
of system hardware or software enhancements designed to satisfy these additional
requirements.
The Company's client support staff is comprised of specialists who are
knowledgeable in the areas of hardware and software technology as well as in the
day-to-day operations of a group practice. System support activities range from
correcting minor procedural problems in the client's system to performing
complex database reconstructions or software updates. The Company's QSI Division
also utilizes an automated online support system which assists clients in
resolving minor problems and facilitates automated electronic retrieval of
problems and symptoms following a client's call to the automated support system.
Additionally, this online support system maintains a complete call record at
both the client's facility and the Company.
The Company offers its clients support services for most system
components, including hardware and software maintenance, for a fixed monthly or
quarterly fee. The Company also subcontracts, in certain instances, with third
party vendors to perform specific hardware maintenance tasks under the Company's
direction.
Implementation and Training
The Company offers full service implementation and training services and
believes that its system delivery, implementation and support services are key
elements of successful client relationships. When a client signs a contract for
the purchase of a system, a client manager/implementation specialist trained in
medical and/or dental group practice procedures is assigned to oversee the
installation of the system and the training of appropriate practice staff.
7
Before activation of the client's system, Company personnel typically
convert, or assist in conversion of, the relevant client data onto the system.
Data is typically converted electronically from the preceding computer system
enabling a quick, cost-effective and accurate conversion. The system is then
subjected to extensive testing which includes processing representative data
using the client's system configuration.
Training may include a combination of computer assisted instruction
("CAI") for certain of the Company's products, remote training techniques and
training classes conducted by Company staff at the client's office(s). CAI
consists of workbooks, computer interaction and self-paced instruction. CAI is
also offered to clients, for an additional charge, after the initial training
program is completed for the purpose of training new and additional employees.
Remote training allows a trainer at the Company office to train one or more
people at a client site via telephone and computer connection, thus allowing an
interactive and client-specific mode of training without the expense and time
required for travel. In addition, the Company's on-line "help" documentation
feature facilitates client training as well as ongoing support.
Competition
The markets for healthcare information systems are intensely competitive.
The industry is highly fragmented and includes numerous competitors, none of
which the Company believes dominates these markets. The electronic medical
records and connectivity markets, in particular, are subject to rapid changes in
technology, and the Company expects that competition in these market segments
will increase as new competitors enter. The Company believes its principal
competitive advantages are the features and capabilities of its products and
services, its high level of customer support, and its extensive experience in
the industry.
Product Enhancement and Development
The healthcare information management and computer software and hardware
industries are characterized by rapid technological change requiring the Company
to engage in continuing investments to update, enhance, and improve its systems.
During fiscal years 2001, 2000, and 1999, the Company expended approximately
$5.1 million, $4.9 million and $4.8 million, respectively, on research and
development activities including capitalized software amounts of $1.1 million,
$1.1 million and $1.2 million, respectively. In addition, many of the Company's
product enhancements have resulted from software development work performed
under contracts with its clients.
Employees
As of May 31, 2001, the Company employed 227 persons of which 223 were
full-time employees. The Company believes that its future success depends in
part upon recruiting and retaining qualified sales, marketing and technical
personnel as well as other employees.
Risk Factors
Competition. The markets for healthcare information systems are intensely
competitive, and the Company faces significant competition from a number of
different sources. Several of the Company's competitors have significantly
greater name recognition as well as substantially greater financial, technical,
product development and marketing resources than the Company.
The Company competes in all of its markets with other major healthcare
related companies, information management companies, systems integrators, and
other software developers. Competitive pressures and other factors, such as new
product introductions by the Company or its competitors, may result in price or
market share erosion that could have a material adverse effect on the Company's
business, results of operations and financial condition. Also, there can be no
assurance that the Company's applications will achieve broad market acceptance
or will successfully compete with other competing software products.
8
The Company's inability to make initial sales of its systems to either
newly formed groups and/or healthcare providers that are replacing or
substantially modifying their healthcare information systems could have a
material adverse effect on the Company's business, results of operations and
financial condition. If new systems sales do not materialize, the Company's
maintenance revenues can be expected to decrease over time due to the combined
effects of potential attrition of existing clients and a shortfall in new client
additions.
Fluctuation in Quarterly Operating Results. The Company's revenues and
operating results have fluctuated in the past, and may fluctuate in the future
from quarter to quarter and period to period, as a result of a number of factors
including, without limitation: the size and timing of orders from clients; the
length of sales cycles and installation processes; the ability of the Company's
clients to obtain financing for the purchase of the Company's products; changes
in pricing policies or price reductions by the Company or its competitors; the
timing of new product announcements and product introductions by the Company or
its competitors; the availability and cost of system components; the financial
stability of major clients; market acceptance of new products, applications and
product enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements and to control costs; the
Company's success in expanding its sales and marketing programs; deferrals of
client orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with minimal backlog. As a
result, sales in any quarter are dependent on orders booked and shipped in that
quarter and are not predictable with any degree of certainty. Furthermore, the
Company's systems can be relatively large and expensive and individual systems
sales can represent a significant portion of the Company's revenues for a
quarter such that the loss or deferral of even one such sale can have a
significant adverse impact on the Company's quarterly profitability.
Clients often defer systems purchases until the Company's quarter end, so
quarterly results generally cannot be predicted and frequently are not known
until the quarter has concluded.
The Company's sales are dependent upon client's initial decision to
replace, or substantially modify its existing information system, and
subsequently a decision as to which products and services to purchase. These are
major decisions for healthcare providers, and accordingly, the sales cycle for
the Company's systems can vary significantly and typically ranges from three to
twelve months from initial contact to contract execution/shipment.
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can cause
significant variations in operating results from quarter to quarter. As a
result, the Company believes that interim period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, the Company's historical
operating results are not necessarily indicative of future performance for any
particular period.
The Company recognizes revenue pursuant to Statement of Position ("SOP")
No. 97-2, "Software Revenue Recognition" ("SOP 97-2"). Additionally, in December
1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101
became effective for the Company in the third quarter of fiscal 2001.
There can be no assurance that application and subsequent interpretations
of these pronouncements will not further modify the Company's revenue
recognition policies, or that such modifications would not have a material
adverse effect on the operating results reported in any particular quarter.
There can be no assurance that the Company will not be required to adopt
changes in its licensing or services practices to conform to SOP 97-2 or SAB
101, or that such changes, if adopted, would not result in delays or
cancellations of potential sales of the Company's products.
9
Due to all of the foregoing factors, it is possible that in some future
quarter(s) the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially adversely affected.
Dependence on Principal Product and New Product Development. The Company
currently derives substantially all of its net revenues from sales of its
healthcare information systems and related services. The Company believes that a
primary factor in the market acceptance of its systems has been its ability to
meet the needs of users of healthcare information systems. The Company's future
financial performance will depend in large part on the Company's ability to
continue to meet the increasingly sophisticated needs of its clients through the
timely development, successful introduction and implementation of new and
enhanced versions of its systems and other complementary products. The Company
has historically expended a significant percentage of its net revenues on
product development and believes that significant continuing product development
efforts will be required to sustain the Company's growth.
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing products, or that new products or product enhancements will
be developed and implemented in a timely manner, meet the requirements of
healthcare providers, or achieve market acceptance. If new products or product
enhancements do not achieve market acceptance, the Company's business, results
of operations and financial condition could be materially adversely affected. At
certain times in the past, the Company has also experienced delays in purchases
of its products by clients anticipating the launch of new products by the
Company. There can be no assurance that material order deferrals in anticipation
of new product introductions will not occur.
Technological Change. The software market generally is characterized by
rapid technological change, changing customer needs, frequent new product
introductions, and evolving industry standards. The introduction of products
incorporating new technologies and the emergence of new industry standards could
render the Company's existing products obsolete and unmarketable. There can be
no assurance that the Company will be successful in developing and marketing new
products that respond to technological changes or evolving industry standards.
New product development depends upon significant research and development
expenditures which depend ultimately upon sales growth. Any material weakness in
revenues or research funding could impair the Company's ability to respond to
technological advances in the marketplace and to remain competitive. If the
Company is unable, for technological or other reasons, to develop and introduce
new products in a timely manner in response to changing market conditions or
customer requirements, the Company's business, results of operations and
financial condition may be materially adversely affected.
In response to increasing market demand, the Company is currently
developing new generations of certain of its software products. There can be no
assurance that the Company will successfully develop these new software products
or that these products will operate successfully, or that any such development,
even if successful, will be completed concurrently with or prior to introduction
of competing products. Any such failure or delay could adversely affect the
Company's competitive position or could make the Company's current products
obsolete.
Litigation. The Company faces one Federal securities action (see "Item 3.
Legal Proceedings."). At this time it is not reasonably possible to estimate the
damage, or the range of damages, if any, that the Company might incur in
connection with this action. However, the uncertainty associated with
substantial unresolved litigation may have an adverse impact on the Company's
business. In particular, such litigation could impair the Company's
relationships with existing customers and its ability to obtain new customers.
Defending such litigation may result in a diversion of management's time and
attention away from business operations, which could have a material adverse
effect on the Company's business, results of operations and financial condition.
Such litigation may also have the effect of discouraging potential acquirers
from bidding for the Company or reducing the consideration such acquirers would
otherwise be willing to pay in connection with an acquisition.
There can be no assurance that such litigation will not result in
liability in excess of its insurance coverage, that the Company's insurance will
cover such claims or that appropriate insurance will continue to be available to
the Company in the future at commercially reasonable rates.
10
Proprietary Technology. The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely on
license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect its intellectual property. The Company's software is not
patented and existing copyright laws offer only limited practical protection.
There can be no assurance that the legal protections and precautions taken
by the Company will be adequate to prevent misappropriation of the Company's
technology or that competitors will not independently develop technologies
equivalent or superior to the Company's. Further, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an extent
as do the laws of the United States and are often not enforced as vigorously as
those in the United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no assurance
that others will not assert infringement or trade secret claims against the
Company with respect to its current or future products or that any such
assertion will not require the Company to enter into a license agreement or
royalty arrangement with the party asserting the claim. As competing healthcare
information systems increase in complexity and overall capabilities and the
functionality of these systems further overlaps, providers of such systems may
become increasingly subject to infringement claims. Responding to and defending
any such claims may distract the attention of Company management and have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, claims may be brought against third parties
from which the Company purchases software, and such claims could adversely
affect the Company's ability to access third party software for its systems.
Ability to Manage Growth. The Company has in the past experienced periods
of growth which have placed, and may continue to place, a significant strain on
the Company's resources. The Company also anticipates expanding its overall
software development, marketing, sales, client management and training capacity.
In the event the Company is unable to identify, hire, train and retain qualified
individuals in such capacities within a reasonable timeframe, such failure could
have a material adverse effect on the Company. In addition, the Company's
ability to manage future increases, if any, in the scope of its operations or
personnel will depend on significant expansion of its research and development,
marketing and sales, management, and administrative and financial capabilities.
The failure of the Company's management to effectively manage expansion in its
business could have a material adverse effect on the Company's business, results
of operations and financial condition.
Dependence Upon Key Personnel. The Company's future performance also
depends in significant part upon the continued service of its key technical and
senior management personnel, many of whom have been with the Company for a
significant period of time. The Company does not maintain key man life insurance
on any of its employees. Because the Company has a relatively small number of
employees when compared to other leading companies in the same industry, its
dependence on maintaining its employees is particularly significant. The Company
is also dependent on its ability to attract and retain high quality personnel,
particularly in the areas of sales and applications development.
The industry is characterized by a high level of employee mobility and
aggressive recruiting of skilled personnel. There can be no assurance that the
Company's current employees will continue to work for the Company.
Loss of services of key employees could have a material adverse effect on
the Company's business, results of operations and financial condition.
Furthermore, the Company may need to grant additional stock options to key
employees and provide other forms of incentive compensation to attract and
retain such key personnel.
Product Liability. Certain of the Company's products provide applications
that relate to patient clinical information. Any failure by the Company's
products to provide accurate and timely information could result in claims
against the Company. In addition, a court or government agency may take the
position that the Company's delivery of health information directly, including
through licensed practitioners, or delivery of information by a third party site
that a consumer accesses through the Company's web sites, exposes the Company to
malpractice or other personal injury liability for wrongful
11
delivery of healthcare services or erroneous health information. The Company
maintains insurance to protect against claims associated with the use of its
products, but there can be no assurance that its insurance coverage would
adequately cover any claim asserted against the Company. A successful claim
brought against the Company in excess of its insurance coverage could have a
material adverse effect on the Company's business, results of operations and
financial condition. Even unsuccessful claims could result in the Company's
expenditure of funds in litigation and management time and resources.
Certain healthcare professionals who use the Company's Internet-based
products will directly enter health information about their patients including
information that constitutes a record under applicable law that the Company will
store on the Company's computer systems. Numerous federal and state laws and
regulations, the common law, and contractual obligations govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:
o State privacy and confidentiality laws;
o The Company's contracts with customers and partners;
o State laws regulating healthcare professionals;
o Medicaid laws; and
o The Heath Insurance Portability and Accountability Act of 1996
("HIPAA") and related rules proposed by the Heath Care Financing
Administration; and Health Care Financing Administration standards
for Internet transmission of health data.
The U.S. Congress has been working to finalize proposed legislation that
would establish a new federal standard for protection and use of health
information. Any failure by the Company or by its personnel or partners to
comply with any of these legal or other requirements may result in a material
liability.
Although the Company has systems in place for safeguarding patient health
information from unauthorized disclosure, these systems may not preclude claims
against the Company for violation of applicable law or other requirements. Other
third party sites or links that consumers access through the Company's web sites
also may not maintain systems to safeguard this health information, or may
circumvent systems the Company put in place to protect the information from
disclosure. In addition, future laws or changes in current laws may necessitate
costly adaptations to the Company's systems.
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess of its
insurance coverage, that the Company's insurance will cover such claims or that
appropriate insurance will continue to be available to the Company in the future
at commercially reasonable rates. Such claims could have a material adverse
affect on the Company's business, results of operations and financial condition.
Uncertainty in Healthcare Industry; Government Regulation. The healthcare
industry is subject to changing political, economic and regulatory influences
that may affect the procurement processes and operation of healthcare
facilities. During the past several years, the healthcare industry has been
subject to an increase in governmental regulation of, among other things,
reimbursement rates and certain capital expenditures.
In the past, various legislators have announced that they intend to
examine proposals to reform certain aspects of the U.S. healthcare system
including proposals which may increase governmental involvement in healthcare,
lower reimbursement rates and otherwise change the operating environment for the
Company's clients. Healthcare providers may react to these proposals, and the
uncertainty surrounding such proposals, by curtailing or deferring investments,
including those for the Company's systems and related services. Cost-containment
measures instituted by healthcare providers as a result of regulatory reform or
otherwise could result in a reduction in the allocation of capital funds. Such a
reduction could have an adverse effect on the Company's ability to sell its
systems and related services. On the other hand, changes in the regulatory
environment have increased and may continue to increase the needs of healthcare
organizations for cost-effective data management and thereby enhance the overall
market for healthcare management information systems. The Company cannot predict
what impact, if any, such
12
proposals or healthcare reforms might have on the Company's business, financial
condition and results of operations.
HIPAA mandates the use of national standards for transmissions of certain
patient healthcare information, and prescribes security measures to protect the
confidentiality of such information as well as other patient record privacy and
security provisions within two years after the adoption of final regulations by
the Department of Health and Human Services ("HHS"). These proposed regulations
will establish new federal standards for privacy of health information. The
Company anticipates that these regulations will directly affect the Company's
products and services, but the Company cannot fully predict the impact at this
time. The Company's intention is to modify its products and services as
necessary to facilitate client compliance with the final regulations, but there
can be no assurance that the Company will be able to do so in a timely manner.
Achieving compliance with these regulations could be costly and distract
management's attention and other resources from the Company's historical
business, and any noncompliance by the Company could result in civil and
criminal penalties. In addition, development of related federal and state
regulations and policies on confidentiality of health information could
negatively affect the Company's business.
In addition, the Company's software may be subject to regulation by the
U.S. Food and Drug Administration (the "FDA") as a medical device. Such
regulation could require the registration of the applicable manufacturing
facility and software and hardware products; application of detailed
recordkeeping and manufacturing standards; and FDA approval or clearance prior
to marketing. An approval or clearance requirement could create delays in
marketing, and the FDA could require supplemental filings or object to certain
of these applications, the result of which could have a material adverse effect
on the Company's business, financial condition and results of operations.
Item 2. Properties
The Company's principal administrative, data processing, marketing and
development operations are located in approximately 15,000 square feet of leased
space in Tustin, California, under a lease which expires in March 2002. In
addition, the Company leases approximately 13,000 square feet of space in Santa
Ana, California, to house its assembly and warehouse operations, approximately
15,000 square feet of space in Horsham, Pennsylvania, the principal office for
the Company's MicroMed Division, approximately 8,000 square feet of space in
Atlanta, Georgia, and an aggregate of 4,000 square feet of space in Florida,
Kansas, Minnesota, Texas, Wisconsin, and Washington to house additional sales,
training, development and service operations. These leases, including options,
have expiration dates ranging from month-to-month to February 2006. The Company
believes that its facilities are adequate for its current needs and that
suitable additional or substitute space is available, if needed, at commercially
reasonable rates.
Item 3. Legal Proceedings
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v. QUALITY
SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of California
for the County of Orange, in which Mr. Caveny, on behalf of himself and all
others who purchased the Company's Common Stock between June 26, 1995 and July
3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck, Gregory S.
Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers, Graeme H.
Frehner, and Gordon L. Setran (all of the foregoing individuals were either
officers, directors or both during the period from June 26, 1995 through July 3,
1996), as well as other defendants not affiliated with the Company, violated
California Corporations Code Sections 25400 and 25500, California Civil Code
Sections 1709 and 1710, and California Business and Professions Code Sections
17200 et. seq., by issuing positive statements about the Company that allegedly
were knowingly false, in part, in order to assist the Company and the individual
defendants in selling Common Stock at an inflated price in the Company's March
5, 1996 public offering and at other points during the class period. The
complaint seeks compensatory and punitive damages in unspecified amounts,
disgorgement, declaratory and injunctive relief, and attorneys' fees.
13
The Company and the other named defendants successfully demurred to the
plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that
claim, which served as the only basis for plaintiffs' request for punitive
damages, has been dismissed from both actions.
On January 25, 1999, the court denied plaintiffs' motion to certify the
class representative and class legal counsel. Plaintiffs appealed that decision
as to class legal counsel. On February 25, 2000, the Fourth District Court of
Appeals affirmed the order disqualifying the class legal counsel. On May 9,
2000, the Court of Appeals issued its Remittur certifying its decision as final.
In May 2000, plaintiffs associated in additional class legal counsel, and
moved for approval by the court. Upon defendants' objection, the court on August
17, 2000, denied plaintiffs' motion, and ordered plaintiffs to retain new class
counsel.
At the end of November 2000, the plaintiffs retained new class counsel who
substituted in for plaintiffs' previous class counsel. The Company and the other
named defendants did not oppose plaintiffs' motion for approval of the new class
counsel. On January 24, 2001, the court granted the motion to certify class
legal counsel.
On March 27, 2001, the court approved a notice of class certification to
be mailed to shareholders who are potential class members. Between April 9, 2001
and May 9, 2001, class notice was mailed to potential class members.
Merits-related discovery in the action had been stayed pending the
appointment of class counsel. In March 2001, the plaintiffs requested that
documents be produced informally. The defendants have produced documents
informally for plaintiffs' review. The court has entered a stipulated protective
order governing discovery in the action. Counsel for plaintiffs and defendants
intend to meet to discuss the plaintiffs' review of the informal document
production at or around the time that the parties appear in court for the next
status conference on July 30, 2001.
In Management's opinion the outcome of this case is uncertain, and
therefore no accrual has been made to the financial statements.
On May 14, 1997, a second purported class action entitled WENDY WOO v.
QUALITY SYSTEMS, INC., ET AL. was filed in the same court, essentially repeating
the allegations in the Caveny lawsuit and seeking identical relief. This action
has for all purposes been consolidated with the Caveny action.
On March 23, 1999, a purported class action and derivative complaint
entitled IRVING ROSENZWEIG v. SHELDON RAZIN, ET AL. was filed in the Superior
Court of the State of California for the County of Orange, in which Mr.
Rosenzweig, on behalf of himself and all non-director shareholders, and
derivatively on behalf of the Company, alleges that Sheldon Razin, John Bowers,
William Bowers, Patrick Cline, Janet Razin and Gordon Setran (all of the
foregoing individuals were directors of the Company) breached their fiduciary
duties by allegedly entrenching themselves in their positions of control,
failing to ensure that third party offers involving the Company were fully and
fairly considered, and/or failing to conduct a reasonable inquiry to assure the
maximization of shareholder value. The complaint sought declaratory and
injunctive relief, an accounting of monetary damages allegedly suffered by
plaintiff and the purported class, and attorneys' fees. Defendants demurred to
each of the causes of action alleged in the complaint and the court sustained
those demurrers with leave to amend in December 1999. Rather than file an
amended complaint, plaintiff filed a motion for attorney's fees. Defendants, in
turn, filed a motion to dismiss the action for failure to file an amended
pleading within the time limit specified by the court.
The parties agreed to a settlement of action and stipulated to a final
judgment and order which was entered by the court on May 15, 2000, at which time
the action was dismissed. The final judgment and order provided for a dismissal
of the action with prejudice, releases given to each of the defendants, and
payment of the nominal sum of $100,000 (paid by the Company's directors and
officers liability insurance company) in full settlement of plaintiff's motion
for attorney's fees.
The settlement further expressly provided that it did not constitute an
admission of any liability of defendants, which defendants continue to
vigorously deny.
14
The Company is a party to various other legal proceedings incidental to its
business, none of which are considered by the Company to be material.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth quarter
of fiscal year 2001.
Executive Officers of the Company
The executive officers of the Company as of May 31, 2001 were as follows:
--------------------------------------------------------------------------------------
Name Age Position
--------------------------------------------------------------------------------------
Louis E. Silverman 42 President, Chief Executive Officer
--------------------------------------------------------------------------------------
Patrick B. Cline 40 President, MicroMed Healthcare Information Systems Division
--------------------------------------------------------------------------------------
Greg Flynn 43 Executive Vice President and General Manager of QSI Division
--------------------------------------------------------------------------------------
Paul Holt 35 Chief Financial Officer, Secretary
--------------------------------------------------------------------------------------
Executive officers of the Company are elected by, and serve at the
discretion of, the Board of Directors. Additional information regarding the
Company's executive officers is set forth below.
Louis E. Silverman was appointed President and Chief Executive Officer of
the company on July 31, 2000. Mr. Silverman was previously Chief Operations
Officer of CorVel Corp., a $200 million publicly traded national managed care
services and technology firm with headquarters in Irvine, California. Mr.
Silverman holds a Master of Business Administration degree from Harvard Graduate
School of Business Administration and a Bachelor of Arts degree from Amherst
College.
Patrick B. Cline currently serves as president of the Company's MicroMed
Healthcare Information Systems Division. He served as the Company's Interim
Chief Executive Officer for the April - July 2000 period. Mr. Cline was a
co-founder of Clinitec and has served as its President since its inception in
January 1994. Prior to co-founding Clinitec, Mr. Cline served, from July 1987 to
January 1994, as Vice President of Sales and Marketing with Script Systems, a
subsidiary of InfoMed, a healthcare information systems company. From January
1994 to May 1994, after the founding of Clinitec, Mr. Cline continued to serve,
on a part time basis, as Script Systems' Vice President of Sales and Marketing.
Mr. Cline has held senior positions in the healthcare information systems
industry since 1981.
Greg Flynn has served as the Company's General Manager since April 2000
and as Executive Vice President since August 1998 after serving as Vice
President of Sales and Marketing from January 1996 to August 1998. Prior to
January 1996, Mr. Flynn served as Vice President Administration since June 1992.
In these capacities, Mr. Flynn has been responsible for numerous functions
related to the ongoing management of the Company and sales. Previously, Mr.
Flynn served as the Company's Vice President Corporate Communications. Since
joining the Company in January 1982, Mr. Flynn has held a variety of
increasingly responsible management positions within the organization. He holds
a B.A. degree in English from the University of California, Santa Barbara.
Paul Holt was appointed Chief Financial Officer in November 2000. Mr. Holt
has served as the Company's Controller from January 2000 to May 2000 and was
appointed interim Chief Financial Officer in May 2000. Prior to joining the
Company, Mr. Holt was the Controller of Sierra Alloys Co., Inc., a titanium
metal manufacturing company from August 1999 to December 1999. From May 1997 to
July 1999, he was Controller of Refrigeration Supplies Distributor, a wholesale
distributor and manufacturer of refrigeration supplies and heating controls.
From March 1995 to April 1997 he was Assistant Controller of Refrigeration
Supplies Distributor. Mr. Holt is a Certified Public Accountant and holds an
M.B.A. from the University of Southern California and a B.A. in Economics from
the University of California, Irvine.
15
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the NASDAQ National Market under the
symbol "QSII". The following table sets forth for the quarters indicated the
high and low sales prices as reported by NASDAQ. The quotations reflect
inter-dealer prices, without retail markup, markdown, or commissions, and may
not necessarily represent actual transactions.
----------------------------------------------------------------------------------------------
Quarter Ended High Low
----------------------------------------------------------------------------------------------
June 30, 1999 $ 6.56 $ 3.75
----------------------------------------------------------------------------------------------
September 30, 1999 $ 8.38 $ 5.63
----------------------------------------------------------------------------------------------
December 31, 1999 $ 7.75 $ 5.88
----------------------------------------------------------------------------------------------
March 31, 2000 $ 18.75 $ 6.75
----------------------------------------------------------------------------------------------
June 30, 2000 $ 15.25 $ 6.50
----------------------------------------------------------------------------------------------
September 30, 2000 $ 9.75 $ 6.75
----------------------------------------------------------------------------------------------
December 31, 2000 $ 8.27 $ 6.69
----------------------------------------------------------------------------------------------
March 31, 2001 $ 11.13 $ 7.76
----------------------------------------------------------------------------------------------
At May 31, 2001, there were approximately 130 holders of record of the
Company's Common Stock. The Company estimates the number of beneficial holders
of its Common Stock to be in excess of 1,300.
Through May 31, 2001, the Company has not paid cash dividends on shares of
its Common Stock. The Company anticipates that for the foreseeable future, all
earnings, if any, will be retained for use in the Company's business and it does
not anticipate paying any cash dividends in the future. Payment of future
dividends, if any, will be at the discretion of the Company's Board of Directors
after taking into account various factors, including the Company's financial
condition, operating results, current and anticipated cash needs and plans for
expansion.
Item 6. Selected Financial Data
The following selected financial data with respect to the Company's Consolidated
Statements of Income Data for each of the five years in the period ended March
31, 2001 and the Consolidated Balance Sheet Data as of the end of each such
fiscal year are derived from the audited financial statements of the Company.
The following information should be read in conjunction with the Consolidated
Financial Statements of the Company and the related notes thereto and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Income." included elsewhere herein.
16
Consolidated Statements of operations Data
(In thousands, except for per share data)
-----------------------------------------------------------------------------
Year Ended March 31,
2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Net Revenues $ 39,936 $ 36,373 $ 33,816 $ 31,216 $ 20,127
Cost of Products and Services 17,283 16,395 15,834 13,509 10,089
-----------------------------------------------------------------------------
Gross Profit 22,653 19,978 17,982 17,707 10,038
Selling, General and Administrative Expenses 13,585 12,645 13,495 12,485 7,736
Research and Development Costs 4,081 3,726 3,603 3,072 1,978
Purchased In-Process Research and Development(1) -- -- -- 10,200 8,300
-----------------------------------------------------------------------------
Income (Loss) from Operations(2) 4,987 3,607 884 (8,050) (7,976)
Investment Income 1,032 759 413 971 1,285
-----------------------------------------------------------------------------
Income (Loss) before Provision for (Benefit from)
Income Taxes(2) 6,019 4,366 1,297 (7,079) (6,691)
Provision for (Benefit from) Income Taxes(3) 2,510 1,862 713 (2,463) 784
-----------------------------------------------------------------------------
Net Income (Loss)(2) $ 3,509 $ 2,504 $ 584 $ (4,616) $ (7,475)
-----------------------------------------------------------------------------
Net Income (Loss) per Share, Basic and Diluted(2) $ 0.57 $ 0.40 $ 0.09 $ (0.77) $ (1.26)
-----------------------------------------------------------------------------
Weighted Average Shares Outstanding, Basic 6,130 6,208 6,176 5,981 5,937
-----------------------------------------------------------------------------
Weighted Average Shares Outstanding, Diluted 6,203 6,261 6,185 5,981 5,937
=============================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
(1) In May 1996, the Company acquired Clinitec which was treated as a purchase
transaction for accounting purposes. In connection with this treatment,
the Company incurred an $8.3 million charge for purchased in-process
research and development during the year ended March 31, 1997.
In May 1997, the Company acquired MicroMed which was treated as a purchase
transaction for accounting purposes. In connection with this treatment,
the Company incurred a $10.2 million charge for purchased in-process
research and development during the year ended March 31, 1998.
(2) Includes a charge of $10.2 million and $8.3 million for purchased
in-process research and development for the years ended March 31, 1998 and
1997, respectively. Excluding the charge, on a pro forma basis, income
from operations and income before provision for (benefit from) income
taxes would have been $2.2 million and $3.1 million, respectively, for
fiscal 1998 and $324,000 and $1.6 million, respectively for fiscal 1997.
The income tax benefit related to the charge for purchased in-process
research and development for the years ended March 31, 1998 and 1997 was
$3.9 million and $0, respectively. Excluding the charge and related income
tax benefit, on a pro forma basis, net income and basic and diluted income
per share would have been $1.7 million, $0.29 and $0.28, respectively, for
fiscal 1998 and $825,000, $0.14 and $0.14, respectively, for fiscal 1997.
(3) The provision for income taxes for the year ended March 31, 1997 differs
from the Company's combined Federal and State statutory rates primarily
due to the non-deductible charge for purchased in-process research and
development incurred in connection with the acquisition of Clinitec in May
1996.
Consolidated Balance Sheet Data
(in thousands)
----------------------------------------------------------------------
March 31,
2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents and Short-Term Investments $ 18,729 $ 16,169 $ 14,441 $ 17,080 $ 22,735
----------------------------------------------------------------------
Working Capital 24,196 21,332 18,166 15,453 25,613
----------------------------------------------------------------------
Total Assets 44,883 44,136 40,218 40,916 37,866
----------------------------------------------------------------------
Total Liabilities 10,996 12,053 10,554 13,475 5,596
----------------------------------------------------------------------
Shareholders' Equity $ 33,887 $ 32,083 $ 29,664 $ 27,441 $ 32,270
- ------------------------------------------------------------------------------------------------------------------------------------
17
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Except for the historical information contained herein, the matters discussed in
this Annual Report on Form 10-K, including discussions of the Company's product
development plans, business strategies and market factors influencing the
Company's results, are forward-looking statements that involve certain risks and
uncertainties. Actual results may differ from those anticipated by the Company
as a result of various factors, both foreseen and unforeseen, including, but not
limited to, the Company's ability to continue to develop new products and
increase systems sales in markets characterized by rapid technological
evolution, consolidation, and competition from larger, better capitalized
competitors. Many other economic, competitive, governmental and technological
factors could impact the Company's ability to achieve its goals, and interested
persons are urged to review the risks described in "Item 1. Business. Risk
Factors" and in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" set forth below, as well as in the Company's other public
disclosures and filings with the Securities and Exchange Commission.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Consolidated Financial Statements and related
notes thereto included elsewhere herein. Historical results of operations,
percentage margin fluctuations and any trends that may be inferred from the
discussion below are not necessarily indicative of the operating results for any
future period.
Results of Operations
The following table sets forth for the periods indicated the percentage of
net revenues represented by each item in the Company's Consolidated Statements
of Operations.
---------------------------------------------------
Year Ended March 31,
2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Net Revenues:
Sales of computer systems, upgrades and supplies 49.9% 52.9% 55.8%
Maintenance and other services 50.1 47.1 44.2
---------------------------------------------------
100.0 100.0 100.0
Cost of Products and Services 43.3 45.1 46.8
---------------------------------------------------
Gross Profit 56.7 54.9 53.2
Selling, General and Administrative Expenses 34.0 34.8 39.9
Research and Development Costs 10.2 10.2 10.7
---------------------------------------------------
Income from Operations 12.5 9.9 2.6
Investment Income 2.6 2.1 1.2
---------------------------------------------------
Income before Provision for Income Taxes 15.1 12.0 3.8
Provision for Income Taxes 6.3 5.1 2.1
---------------------------------------------------
Net Income 8.8% 6.9% 1.7%
===================================================
- -----------------------------------------------------------------------------------------------------------------------------------
For the Years Ended March 31, 2001 and 2000
For the year ended March 31, 2001, the Company's net income was $3,509,000
or $0.57 per share on a basic and diluted basis. In comparison, the Company
earned $2,504,000 or $0.40 per share on a basic and diluted basis in the year
ended March 31, 2000. The increase in net income was achieved through a
combination of an increase in revenue from software systems sales, maintenance,
and other services along with an increase in the gross profit margin associated
with software systems, maintenance and other services. Also, operating expenses
grew at a lesser rate than revenues and gross margin.
Net Revenues. Net revenues for the year ended March 31, 2001 increased
9.8% to $39.9 million from $36.4 million for the year ended March 31, 2000.
Sales of computer systems, upgrades and supplies increased 3.6% to $19.9 million
from $19.2 million while net revenues from maintenance and other service grew
16.8% to $20.0 from $17.1 million during the comparable prior period. The
increase in net revenues from sales of computer systems, upgrades and supplies
was principally due to increased sales of the Company's NextGen(epm) and
NextGen(emr) products, offset by a decrease in sales of new systems in the
18
Company's QSI Division. The increase in maintenance and other services net
revenue resulted primarily from the Company's increased client base together
with an increase in revenues generated from the Company's EDI services. Revenue
from the Company's EDI services increased 37.2% to $5.2 million for the year
ended March 31, 2001, compared to $3.8 million in the year ended March 31, 2000.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 2001 increased 5.4% to $17.3 million from $16.4 million for the
year ended March 31, 2000, while the cost of products and services as a
percentage of net revenues decreased to 43.3% compared to 45.1% during the
comparable periods. The decrease in cost of products and services as a
percentage of net revenues resulted from the effects of the increase in
maintenance and other services revenues, and a decrease in the hardware content
of new system sales. Margins on new system sales are inversely proportional to
the relative level of hardware content. The relative level of hardware content
in new systems sales fluctuates from period to period. The effect of the
above-mentioned items was slightly offset by an increase in revenue from EDI
services which yields a lower gross margin than other products and services.
Selling, General and Administrative. Selling, general and administrative
expenses for the year ended March 31, 2001 increased 7.4% to $13.6 million from
$12.6 million, while decreasing on a percentage of revenues basis from 34.8% to
34.0% for the respective fiscal years. These numbers were driven primarily by an
increase in the Company's reserve for bad debts and limited increases in most
other SG&A expense categories.
Research and Development Costs. Research and development costs for the
year ended March 31, 2001 increased 9.5% to $4.1 million from $3.7 million for
the year ended March 31, 2000. The increase is primarily the result of increased
research and development efforts at MicroMed. Research and development costs as
a percentage of net revenues remained constant at 10.2% for the respective
fiscal years.
Investment Income. Investment income for the year ended March 31, 2001
increased 36.0% to $1,032,000 from $759,000 for the year ended March 31, 2000.
Contributing to the increase in investment income was an increase in average
funds available for investment during the year ended March 31, 2001 combined
with an increase in average interest rates compared to the year ended March 31,
2000.
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 2001 was $2,510,000 as compared to $1,862,000 for the year ended
March 31, 2000. The provision for income taxes for the years ended March 31,
2001 and 2000 respectively, differ from the combined statutory rates primarily
due to the effect of varying state tax rates together with the impact of
non-deductible amortization of certain intangible assets acquired in the May
1996 acquisition of Clinitec.
For the Years Ended March 31, 2000 and 1999
For the year ended March 31, 2000, the Company's net income was $2,504,000
or $0.40 per share on a basic and diluted basis. In comparison, the Company
earned $584,000 or $0.09 per share on a basic and diluted basis in the year
ended March 31, 1999. The increase in net income was achieved through a
combination of an increase in revenue from software systems sales, maintenance,
and other services along with a reduction in selling, general and administrative
expenses. Selling, general and administrative expenses declined due to the
integration of the Company's two subsidiaries, Clinitec and MicroMed. For the
year ended March 31, 2000, revenue increased 7.6% to $36.4 million compared to
$33.8 million in the year ended March 31, 1999. Selling, general and
administrative expenses declined 6.3% to $12.6 million in the year ended March
31, 2000 compared to $13.5 million in the year ended March 31, 1999.
Net Revenues. Net revenues for the year ended March 31, 2000 increased
7.6% to $36.4 million from $33.8 million for the year ended March 31, 1999.
Sales of computer systems, upgrades and supplies increased 2.0% to $19.2 million
from $18.9 million while net revenues from maintenance and other service grew
14.6% to $17.1 from $14.9 million during comparable periods. The increase in net
revenues from sales of computer systems, upgrades and supplies was principally
due to increased sales of the Company's Clinical Product Suite, NextGen(epm) and
NextGen(emr) products, offset by a decrease in sales of the Company's dental
practice management product. The increase in maintenance and other services net
19
revenue resulted primarily from the Company's increased client base together
with an increase in revenues generated from the Company's EDI services. Revenue
from the Company's EDI services increased 37.6% to $3.8 million for the year
ended March 31, 2000 compared to $2.8 million in the year ended March 31, 1999.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 2000 increased 3.5% to $16.4 million from $15.8 million for the
year ended March 31, 1999 while the cost of products and services as a
percentage of net revenues decreased to 45.1% compared to 46.8% during the
comparable periods. The decrease in cost of products and services as a
percentage of net revenues resulted from a combination of: the effects of the
increase of maintenance and other services revenues, a change in the mix of new
systems sales toward systems with lower hardware content, a leveling out of
product development, customer service, support and training costs, and an
increase in the cost of EDI services. In the year ended March 31, 2000, the
Company was able to leverage its existing infrastructure on to a higher level of
computer systems, upgrades and supplies sales. This contributed to the reduction
in cost of products and services as a percentage of revenue during the year
ended March 31, 2000. Also, new computer systems sales in the year ended March
31, 2000 had a lower relative level of hardware content compared to the year
ended March 31, 1999. Margins on system sales are inversely proportional to the
relative level of hardware content which fluctuates from period to period. The
effect of the above-mentioned items was slightly offset by an increase in
revenue from EDI services which yields a lower gross margin than other products
and services.
Selling, General and Administrative. Selling, general and administrative
expenses for the year ended March 31, 2000 decreased 6.3% to $12.6 million from
$13.5 million. The decrease in selling, general and administrative expenses was
primarily the result of the integration of the Company's Clinitec and MicroMed
subsidiaries along with a reduction in bad debt expense for the year ended March
31, 2000 compared to the year ended March 31, 1999.
Selling, general and administrative expenses as a percentage of net
revenue declined to 34.8% for the year ended March 31, 2000 compared to 39.9% in
the year ended March 31, 1999.
Research and Development Costs. Research and development costs for the
year ended March 31, 2000 increased 3.4% to $3.7 million from $3.6 million for
the year ended March 31, 1999. The increase is the result of increased research
and development efforts by Clinitec and MicroMed. Research and development costs
as a percentage of net revenues decreased to 10.2% as compared to 10.7% for the
respective fiscal years as a result of the effect of costs associated with the
increased research and development efforts growing at a proportionately lower
rate than net revenues during the comparable years.
Investment Income. Investment income for the year ended March 31, 2000
increased 83.8% to $759,000 from $413,000 for the year ended March 31, 1999.
During the year ended March 31, 1999, the Company liquidated certain investments
and incurred a loss of $241,000. Also contributing to the comparative increase
in investment income was an increase in average funds available for investment
during the year ended March 31, 2000.
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 2000 was $1,862,000 as compared to $713,000 for the year March
31, 1999. The provision for income taxes for the years ended March 31, 2000 and
1999, differ from the combined statutory rates primarily due to the effect of
varying state tax rates together with the impact of non-deductible amortization
of certain intangible assets acquired in the May 1996 acquisition of Clinitec.
Liquidity and Capital Resources
Cash and cash equivalents increased $2.5 million in the year ended March
31, 2001 after increasing by $1.7 million in the year ended March 31, 2000 and
declining by $1.9 million in the year ended March 31, 1999. The decreases in
cash and cash equivalents in fiscal 1999 was primarily a result of payments made
in connection with the MicroMed acquisition.
20
Net cash provided by operating activities was $6.1 million, $3.6 million
and $3.3 million for the years ended March 31, 2001, 2000 and 1999,
respectively. Net cash provided by operations for the year ended March 31, 2001
consisted principally of net income before depreciation, amortization and
provision for bad debts, and an increase in accounts payable offset by a
decrease in income taxes payable and an increase in gross accounts receivable.
Net cash provided by operations for the year ended March 31, 2000 consisted
primarily of net income before depreciation and amortization and increases in
deferred service revenue, offset by an increase in gross accounts receivable and
a decrease in accounts payable.
Net cash used in investing activities for the years ended March 31, 2001,
2000, and 1999 was $1.9 million, $1.8 million, and $5.1 million, respectively.
Net cash used in investing activities for the years ended March 31, 2001 and
2000 was principally composed of investments in capitalized software and
equipment and improvements. Net cash used in investing activities for the year
ended March 31, 1999 was principally impacted by the $3.8 million paid in
connection with the MicroMed acquisition. Net cash used for additions to
equipment, improvements and capitalized software for the years ended March 31,
2001, 2000 and 1999 were $1.8 million, $1.7 million and $1.7 million
respectively. There were no material short-term investment sales or purchases
during the years ended March 31, 2001 and 2000. Net cash used in investing
activities for the year ended March 31, 1999 were offset in part by cash
provided from net sales of short-term investments of $467,000.
Net cash used in financing activities for the years ended March 31, 2001
and 2000 was $1,703,000 and $86,000, respectively, which includes $1,864,000 and
$111,000 used in each fiscal year to repurchase 235,900 shares and 17,400
shares, respectively, of the Company's Common Stock. Net cash used in financing
activities for the years ended March 31, 2001, 2000 and 1999 also includes the
proceeds from the exercise of employee stock options.
The Company has no significant capital commitments and currently
anticipates that additions to equipment and improvements for fiscal 2002 will be
comparable to fiscal 2001.
At March 31, 2001, the Company had cash and cash equivalents of $18.5
million and short-term investments of $258,000. The Company believes that its
cash and cash equivalents and short-term investments on hand at March 31, 2001,
together with the cash flows from operations, if any, will be sufficient to meet
its working capital and capital expenditure requirements for the next year.
Item 7A. Qualitative and Quantitative Disclosures About Market Risk
The Company has a significant amount of cash and short-term investments with
maturities less than three months. This cash portfolio exposes the Company to
interest rate risk as short-term investment rates can be volatile. Given the
short-term maturity structure of the Company's investment portfolio, the Company
believes that it is not subject to principal fluctuations and the effective
interest rate of the Company's portfolio tracks closely to various short-term
money market interest rate benchmarks.
Item 8. Financial Statements and Supplementary Data
The Financial Statements of the Company identified in the Index to Financial
Statements appearing under "Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K." of this report are incorporated herein by reference to
Item 14.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
21
PART III
Item 10. Directors and Executive Officers of the Company
Except for information concerning the Company's executive officers which is
included under the caption "Executive Officers of the Company" following Part I,
Item 4 of this report, the information required by Item 10 is incorporated
herein by reference from the Company's definitive proxy statement scheduled to
be filed with the Securities and Exchange Commission on or before July 29, 2001
for the Company's 2001 annual shareholders' meeting.
Item 11. Executive Compensation
The information required by Item 11 is incorporated herein by reference from the
Company's definitive proxy statement scheduled to be filed with the Securities
and Exchange Commission on or before July 29, 2001 for the Company's 2001 annual
shareholders' meeting.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is incorporated herein by reference from the
Company's definitive proxy statement scheduled to be filed with the Securities
and Exchange Commission on or before July 29, 2001 for the Company's 2001 annual
shareholders' meeting.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is incorporated herein by reference from the
Company's definitive proxy statement scheduled to be filed with the Securities
and Exchange Commission on or before July 29, 2001 for the Company's 2001 annual
shareholders' meeting.
22
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Page
----
(a) 1. Index to Financial Statements
Independent Auditors' Report F-1
Consolidated Balance Sheets at March 31, 2001 and 2000 F-2
Consolidated Statements of Income and Comprehensive
Income for the Years Ended March 31, 2001, 2000 and 1999 F-3
Consolidated Statements of Shareholders' Equity for the Years
Ended March 31, 2001, 2000 and 1999 F-3
Consolidated Statements of Cash Flows for the Years Ended March
31, 2001, 2000 and 1999 F-4
Notes to Financial Statements F-5
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts F-15
3. Exhibits
Exhibit Sequential
Number Description Page Number
------ ----------- -----------
3.1 Articles of Incorporation of the Company, as
amended, are hereby incorporated by reference to
Exhibit 3.1 to the Company's Annual Report on Form
10-K for the year ended March 31, 1984, File No.
2-80056.
3.2 Bylaws of the Company, as amended, are hereby
incorporated by reference to Exhibit 3.3 to the
Company's Registration Statement on Form S-1, File
No. 2-80056.
3.3 Certificate of Amendment of Bylaws of the Company
is hereby incorporated by reference to Exhibit
3.2.1 to the Company's Registration Statement on
Form S-1, File No. 333-00161.
3.4 Text of Sections 2 and 3 of Article II of the
Bylaws of the Company is hereby incorporated By
reference to Exhibit 3.2.2 to the Company's
Quarterly report on Form 10-QSB for the period
Ended December 31, 1996, File No. 0-13801.
3.5 Certificate of Amendment of Bylaws of the Company,
incorporated by reference to Exhibit 3.2.3 to the
Company's Annual Report on Form 10-K for the year
ended March 31, 2000, File No. 0-13801.
10.2* 1989 Incentive Stock Option Plan is hereby
incorporated by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-8, File
No. 33-31949.
10.2.1* Form of Incentive Stock Option Agreement is hereby
incorporated by reference to Exhibit 10.2 to the
Company's Registration Statement on Form S-1, File
No. 333-00161.
10.2.2* Form of Non-Qualified Stock Option Agreement is
hereby incorporated by reference to Exhibit 10.3
to the Company's Registration Statement on Form
S-1, File No. 333-00161.
10.3* Form of Incentive Stock Option Agreement is hereby
incorporated by reference to Exhibit 10.2 to the
Company's Registration Statement on Form S-1, File
No. 2-80056.
10.4* 1993 Deferred Compensation Plan, is hereby
incorporated by reference to Exhibit 10.5 to the
Company's Annual Report on Form 10-KSB for the
year ended March 31, 1994, File No. 0-13801.
23
Exhibit Sequential
Number Description Page Number
------ ----------- -----------
10.4.2* Profit Sharing and Retirement Plan, as amended, is
hereby incorporated by reference to Exhibit 10.4.2
to the Company's Annual Report on Form 10-KSB for
the year ended March 31, 1994, File No. 0-13801.
10.4.3* Profit Sharing and Retirement Plan, as amended,
amendments No. 2 and 3, are hereby incorporated by
reference to Exhibit 10.4.3 to the Company's
Annual Report on Form 10-KSB for the year ended
March 31, 1996, File No. 0-13801.
10.5 Series "A" Convertible Preferred Stock Purchase
Agreement, as amended, dated April 21, 1995
between the Company and Clinitec International,
Inc., is hereby incorporated by reference to
Exhibit 10.11 to the Company's Annual Report on
Form 10-KSB for the year ended March 31, 1995,
File No. 0-13801.
10.6 Form of Indemnification Agreement is hereby
incorporated by reference to Exhibit 10.10 to the
Company's Registration Statement on Form S-1, File
No. 333-00161.
10.7 Agreement and Plan of Merger, dated May 16, 1996,
by and among Quality Systems, Inc., CII
Acquisition Corporation, Clinitec International,
Inc. and certain shareholders of Clinitec
International, Inc. and certain exhibits is hereby
incorporated by reference to Exhibit 2 to the
Company's Current Report on Form 8-K, dated May
17, 1996 and filed May 30, 1996.
10.8 Asset Purchase Agreement, dated May 15, 1997, by
and among MicroMed Healthcare Information Systems,
Inc., MHIS Acquisition Corp., Quality Systems,
Inc., and certain shareholders of MicroMed
Healthcare Information Systems, Inc. is hereby
incorporated by reference to Exhibit 2 of
Company's Current Report on Form 8-K, dated May
15, 1997 and filed May 29, 1997, File No. 0-13801.
10.9* 1998 Employee Stock Contribution Plan is hereby
incorporated by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-8, File
No. 333-63131.
10.10* 1998 Stock Option Plan is hereby incorporated by
reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-8, File No.
333-67115.
10.11* Memorandum of Understanding regarding the April 3,
2000 resignation of Sheldon Razin between Sheldon
Razin and Quality Systems, Inc., incorporated by
reference to Exhibit 10.16 to the Company's Annual
Report on Form 10-K for the year ended March 31,
2000, File No. 0-13801.
10.12* Memorandum of Understanding Relating to Director
Nominees is hereby incorporated by reference to
Company's Definitive Proxy Statement for the
Company's 1999 Shareholder's Meeting, File No.
001-12537.
10.13* Employment Agreement dated July 20, 2000 between
Quality Systems, Inc. and Lou Silverman,
incorporated by reference to Exhibit 10.18 to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000, File No.
0-13801.
10.14 Lease Agreement between Company and Tower Place,
L.P. dated November 15, 2000, commencing February
5, 2001.
10.15 Lease Agreement between Company and Orangewood
Business Center Inc. dated April 3, 2000, amended
February 22, 2001.
10.16 Lease Agreement between Company and Craig
Development Corporation dated February 22, 2001.
21 List of Subsidiaries. 44
23.1 Independent Auditor's Consent - Deloitte & Touche
LLP. 45
* This exhibit is a management contract or a compensatory plan or arrangement.
(b) Reports on Form 8-K: None
24
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Company caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
QUALITY SYSTEMS, INC.
By: /s/ LOUIS SILVERMAN
----------------------------
Louis Silverman
Chief Executive Officer
Date: June 26, 2001
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Company and in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ SHELDON RAZIN Chairman of the Board of Directors June 27, 2001
- ------------------------------
SHELDON RAZIN
/s/ AHMED HUSSEIN Co-Chairman of the Board of Directors June 26, 2001
- ------------------------------
AHMED HUSSEIN
/s/ LOUIS SILVERMAN Chief Executive Officer June 27, 2001
- ------------------------------
LOUIS SILVERMAN
/s/ PAUL HOLT Chief Financial Officer, Secretary June 27, 2001
- ------------------------------
PAUL HOLT
/s/ MOHAMMED TAWFICK EL-BARDAI Director June 25, 2001
- ------------------------------
MOHAMMED TAWFICK EL-BARDAI
/s/ DALE HANSON Director June 25, 2001
- ------------------------------
DALE HANSON
/s/ FRANK MEYER Director June 26, 2001
- ------------------------------
FRANK MEYER
/s/ WILLIAM SMALL Director June 27, 2001
- ------------------------------
WILLIAM SMALL
/s/ EMAD ZIKRY Director June 26, 2001
- ------------------------------
EMAD ZIKRY
25
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated balance sheets of Quality Systems,
Inc. and subsidiary as of March 31, 2001 and 2000, and the related consolidated
statements of income and comprehensive income, shareholders' equity and cash
flows for each of the three years in the period ended March 31, 2001. Our audits
also included the financial statement schedule listed in the Index of Item 14.
(a) (2). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Quality Systems, Inc. and
subsidiary as of March 31, 2001 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended March 31,
2001 in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
/s/ Deloitte & Touche LLP
Costa Mesa, California
May 22, 2001
F-1
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except for per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
March 31,
ASSETS 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 18,471 $ 15,926
Short-term investments 258 243
Accounts receivable, less allowance for doubtful accounts
of $1,335 and $1,121, respectively 13,335 13,710
Inventories, net 1,030 1,010
Deferred tax assets 1,566 2,066
Other current assets 532 430
---------------------------------------------
Total current assets 35,192 33,385
Equipment and Improvements, net 1,819 1,797
Capitalized Software Costs, net 1,769 1,984
Deferred Tax Assets 2,960 3,042
Goodwill, net of accumulated amortization of
$1,634 and $1,294, respectively 1,772 2,112
Other Assets, net 1,371 1,816
---------------------------------------------
Total assets $ 44,883 $ 44,136
=============================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,829 $ 1,246
Deferred revenue 5,595 5,691
Other current liabilities 3,572 5,116
---------------------------------------------
Total liabilities 10,996 12,053
---------------------------------------------
Commitments and Contingencies (Note 9)
Shareholders' Equity:
Common Stock, $0.01 par value, 20,000 shares authorized,
5,987 and 6,201 shares issued and outstanding, respectively 60 62
Additional paid-in capital 33,780 35,483
Retained earnings (accumulated deficit) 47 (3,462)
---------------------------------------------
Total shareholders' equity 33,887 32,083
---------------------------------------------
Total liabilities and shareholders' equity $ 44,883 $ 44,136
=============================================
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
F-2
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except per share amounts)
-------------------------------------------------------
Year Ended March 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Net Revenues:
Sales of computer systems, upgrades and supplies $ 19,935 $ 19,247 $ 18,875
Maintenance and other services 20,001 17,126 14,941
-------------------------------------------------------
39,936 36,373 33,816
Cost of Products and Services 17,283 16,395 15,834
-------------------------------------------------------
Gross Profit 22,653 19,978 17,982
Selling, General and Administrative Expenses 13,585 12,645 13,495
Research and Development Costs 4,081 3,726 3,603
-------------------------------------------------------
Income from Operations 4,987 3,607 884
Investment Income 1,032 759 413
-------------------------------------------------------
Income before Provision for Income Taxes 6,019 4,366 1,297
Provision for Income Taxes 2,510 1,862 713
-------------------------------------------------------
Net Income and Comprehensive Income $ 3,509 $ 2,504 $ 584
=======================================================
Net Income per Share, basic and diluted $ 0.57 $ 0.40 $ 0.09
=======================================================
Weighted Average Shares Outstanding - Basic 6,130 6,208 6,176
-------------------------------------------------------
Weighted Average Shares Outstanding - Diluted 6,203 6,261 6,185
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
-----------------------------------------------------------------------------
Retained
Common Shares Issued Earnings Total
Additional (Accumulated Shareholders'
Number Amount Paid-in Capital Deficit) Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at April 1, 1998 5,988 $60 $ 33,931 $ (6,550) $ 27,441
Shares Issued for contingent purchase obligation 245 3 1,833 -- 1,836
Exercise of Stock Options 33 -- 50 -- 50
Purchases of Common Stock (52) (1) (246) -- (247)
Net Income -- -- -- 584 584
-----------------------------------------------------------------------------
Balance at March 31, 1999 6,214 62 35,568 (5,966) 29,664
Exercise of Stock Options 4 -- 25 -- 25
Tax Benefit Resulting From Stock Options -- -- 1 -- 1
Purchases of Common Stock (17) -- (111) -- (111)
Net Income -- -- -- 2,504 2,504
-----------------------------------------------------------------------------
Balance at March 31, 2000 6,201 62 35,483 (3,462) 32,083
Exercise of Stock Options 22 -- 152 -- 152
Tax Benefit Resulting From Stock Options -- -- 7 -- 7
Purchases of Common Stock (236) (2) (1,862) -- (1,864)
Net Income -- -- -- 3,509 3,509
-----------------------------------------------------------------------------
Balance at March 31, 2001 5,987 $60 $ 33,780 $ 47 $ 33,887
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
F-3
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
---------------------------------------------------
Year Ended March 31,
2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Income $ 3,509 $ 2,504 $ 584
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,697 2,204 2,465
Provision for bad debts 1,272 529 954
Loss on short-term investments and other 19 132 261
Deferred income taxes 582 (1,088) (592)
Changes in:
Accounts receivable (897) (1,751) (3,496)
Inventories (20) (238) 556
Other current assets (102) (176) (2)
Accounts payable 583 (567) 486
Deferred service revenue (96) 1,207 2,240
Income taxes payable (1,233) 723 344
Other current liabilities (203) 136 (453)
---------------------------------------------------
Net Cash Provided By Operating Activities 6,111 3,615 3,347
---------------------------------------------------
Cash Flows from Investing Activities:
Proceeds from sales of short-term investments -- 29 542
Purchases of short-term investments -- (50) (75)
Additions to equipment and improvements (778) (588) (521)
Additions to capitalized software costs (1,063) (1,130) (1,204)
Payment of contingent purchase obligation -- -- (3,840)
Change in other assets (13) (60) 37
---------------------------------------------------
Net Cash Used In Investing Activities (1,854) (1,799) (5,061)
---------------------------------------------------
Cash Flows from Financing Activities:
Purchases of Common Stock $ (1,864) $ (111) $ (247)
Proceeds from exercise of stock options 152 25 50
---------------------------------------------------
Net Cash Used In Financing Activities (1,712) (86) (197)
---------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 2,545 1,730 (1,911)
Cash and Cash Equivalents, beginning of year 15,926 14,196 16,107
---------------------------------------------------
Cash and Cash Equivalents, end of year $ 18,471 $ 15,926 $ 14,196
===================================================
- -----------------------------------------------------------------------------------------------------------------------------------
Supplemental Information - During fiscal 2001, 2000 and 1999 the Company made
income tax payments of $2,779, $2,421 and $951, respectively.
See notes to consolidated financial statements.
F-4
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiary, Clinitec
International, Inc. ("Clinitec"), d/b/a MicroMed Healthcare Information Systems,
Inc. ("MicroMed"), (collectively the "Company") develop and market proprietary
healthcare information systems that automate medical and dental group practices,
community health centers, physician hospital organizations, management service
organizations, and dental schools. The Company's proprietary software systems
include general patient information, appointment scheduling, billing, insurance
claims submission and processing, managed care plan implementation and referral
management, treatment outcome studies, treatment planning, drug formularies,
electronic medical records, dental charting and letter generation. In addition
to providing fully integrated solutions, the Company provides its clients with
comprehensive hardware and software maintenance and support services, system
training services and electronic claims submission services.
2. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiary. All inter-company
amounts have been eliminated.
Basis of Presentation. The accompanying consolidated financial statements
have been prepared in accordance with accounting principals generally accepted
in the United States of America.
Revenue Recognition. The Company recognizes revenue pursuant to Statement
of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP 97-2"). The
Company generates revenues from licensing rights to use its software products
directly to end-users. The Company also generates revenues from sales of
hardware and third party software, and implementation, training, software
customization and post-contract support ("maintenance") services performed for
customers who license the Company's products. A typical system contract contains
multiple elements of two or more of the above items. In accordance with SOP
97-2, revenue is allocated to each element of the contract based on vendor
specific evidence of each element's fair market value. Provided the fees are
fixed and determinable and collection is considered probable, revenue from
licensing rights and sales of hardware and third party software are recognized
upon shipment and transfer of title. Revenue from implementation, training and
software customization services is recognized as the corresponding services are
performed. Maintenance revenue is recognized ratably over the contractual
maintenance period.
In December 1999, the SEC issued SAB No. 101, "Revenue Recognition in
Financial Statements" ("SAB No. 101"). SAB No. 101 summarizes the staff's views
in applying generally accepted accounting principles to revenue recognition in
financial statements. SAB No. 101 became effective for the Company in the third
quarter of fiscal year 2001 and did not have a significant effect on the
Company's financial statements.
Cash and Cash Equivalents. Cash and cash equivalents generally consist of
cash and money market funds. The Company invests its excess cash in a money
market fund which invests in only investment grade money market instruments from
a variety of industries, and therefore bears minimal risk. The average maturity
of the investments owned by the money market fund is approximately two months.
Short-Term Investments. The Company classifies its short-term investments
into one of the following categories:
o Held to maturity - Debt securities for which the Company has the
intent and the ability to hold to maturity.
o Trading - Debt securities that do not meet the "intent-to-hold"
criteria and equity securities, both of which are bought and held
principally for the purpose of being sold in the near term.
F-5
o Available-for-sale - Debt securities that do not meet the
"intent-to-hold" criteria and which are not classified as trading
securities, as well as all equity securities not otherwise
classified as trading securities.
Held to maturity securities are carried in the balance sheet at cost
(unless there are declines in the values of individual securities that are not
due to temporary declines), and realized gains and losses are recorded in the
statement of operations in the period that they are earned or incurred. Trading
securities are carried in the balance sheet at fair market value and unrealized
gains and losses are recorded in the statement of operations. Available-for-sale
securities are carried in the balance sheet at fair market value; realized gains
and losses are recorded in the statement of operations when they are earned or
incurred, and unrealized gains and losses, net of tax effect, are recognized as
a component of shareholders' equity. Realized gains and losses from investment
transactions are determined on a first-in, first-out basis.
Accounts Receivable. The Company provides credit terms typically ranging
from thirty days to twelve months for most system and maintenance contract sales
and generally does not require collateral. The Company performs ongoing credit
evaluations of its customers and maintains reserves for potential credit losses.
Inventories. Inventories are valued at lower of cost (first-in, first-out)
or market. Certain inventories are maintained for customer support pursuant to
service agreements and are amortized over a five-year period using the
straight-line method.
Equipment and Improvements. Equipment and improvements are stated at cost
less accumulated depreciation and amortization. Depreciation and amortization of
equipment and improvements are provided over the estimated useful lives of the
assets, or the related lease terms if shorter, by the straight-line method.
Useful lives range from three to seven years.
Software Development Costs. Development costs incurred in the research and
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established, any additional
development costs are capitalized in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed." Such costs are amortized on
a straight line basis over the estimated economic life of the related product,
generally three years. The Company performs a periodic review of the
recoverability of such capitalized software costs. At the time a determination
is made that capitalized amounts are not recoverable based on the estimated cash
flows to be generated from the applicable software, any remaining capitalized
amounts are written off.
Goodwill and Intangible Assets. Goodwill and intangible assets are being
amortized using the straight-line method over ten years and five years,
respectively. The Company performs a periodic review of the recoverability of
such unamortized amounts. At the time a determination is made that any portion
of such unamortized amounts are not recoverable based on the estimated cash
flows to be generated, the excess amount is written off pursuant to APB Opinion
No. 17, "Intangible Assets". The recoverability of intangible assets is measured
based upon SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" ("SFAS No. 121").
Long Lived Assets. The Company accounts for the impairment and disposition
of long-lived assets in accordance with SFAS No. 121. In accordance with SFAS
No. 121, long-lived assets to be held are reviewed for events or changes in
circumstances which indicate that their carrying value may not be recoverable.
The Company periodically reviews the carrying value of long-lived assets to
determine whether or not an impairment to such value has occurred and has
determined that there was no impairment at March 31, 2001.
Income Taxes. Income taxes are provided for the tax effects of
transactions reported in the financial statements and consist of taxes currently
due plus deferred taxes related primarily to differences between the basis of
assets and liabilities for financial and tax reporting. The deferred tax assets
and liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the assets and
liabilities are recovered or settled. Deferred taxes also are recognized for
F-6
operating losses that are available to offset future taxable income and tax
credits that are available to offset future income taxes. Valuation allowances
are established as a reduction of net deferred tax assets when management cannot
determine that it is now more likely than not that the deferred assets will be
realized.
Earnings per Share. Pursuant to SFAS No. 128, "Earnings Per Share," the
Company provides dual presentation of "basic" and "diluted" earnings per share
("EPS").
Basic EPS excludes dilution from Common Stock equivalents and is computed
by dividing income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution from Common Stock equivalents.
The following table reconciles the weighted average shares outstanding for
basic and diluted net income per share for the periods presented.
-------------------------------------------------------
(in thousands except per share amounts) Year Ended March 31,
2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------------------
Net income $ 3,509 $ 2,504 $ 584
-------------------------------------------------------
Basic net income per common share:
Weighted average of common shares outstanding 6,130 6,208 6,176
-------------------------------------------------------
Basic net income per common share $ 0.57 $ 0.40 $ 0.09
=======================================================
Diluted net income per share:
Weighted average of common shares outstanding 6,130 6,208 6,176
Weighted average of common shares equivalents-
Weighted average options outstanding 73 53 9
-------------------------------------------------------
Weighted average number of common and 6,203 6,261 6,185
common equivalent shares
-------------------------------------------------------
Diluted net income per common share $ 0.57 $ 0.40 $ 0.09
=======================================================
- --------------------------------------------------------------------------------------------------------------------------------
Stock-Based Compensation. The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB Opinion No. 25"), as
amended.
Comprehensive Income. In fiscal 1999, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income" ("SFAS No. 130"). This statement establishes
standards for the reporting of comprehensive income and its components.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period, from non-owner sources. For the years ended, March 31, 2001,
2000, and 1999, there were no significant differences between net income and
comprehensive income.
Segment Disclosures. In fiscal 1999, the Company adopted SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("SFAS No.
131"). The Company adopted SFAS No. 131 effective with the fiscal year ended
March 31, 1999. SFAS No. 131 establishes standards for reporting information
regarding operating segments in annual financial statements and requires
selected information for those segments to be presented in interim financial
reports issued to shareholders. SFAS No. 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 on
how to allocate resources and assess performance.
The Company has prepared operating segment information in accordance with
SFAS No. 131 in Note 11.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
F-7
New Accounting Pronouncements. In June 1998 the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133").
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. In July 1999 the FASB issued SFAS No.
137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of
the Effective Date of FASB Statement No. 133," which delays the effective date
of SFAS No. 133 to fiscal years beginning after June 15, 2000. The Company
adopted SFAS No. 133 effective April 1, 2001. The adoption of SFAS No. 133 did
not have a material effect on the Company's consolidated results of operations
or financial condition.
3. Cash Equivalents and Short-Term Investments
At March 31, 2001 and 2000, the Company had cash equivalents of $18.5
million and $15.9 million, respectively, invested in a major national brokerage
firm's institutional fund that specializes in U.S. government securities and
commercial paper with high credit ratings.
At March 31, 2001 and 2000, all short-term investments consist of trading
securities. The Company bears no off-balance sheet risk on its investments.
Investment income for each of the three years ended March 31, 2001
consists of the following:
------------------------------------------------------
(in thousands) Year Ended March 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income $ 1,012 $ 783 $ 674
Net Gains (Losses) on Short-Term Investments -
Realized 0 0 (220)
Unrealized 15 (24) (38)
Other 5 0 (3)
------------------------------------------------------
$ 1,032 $ 759 $ 413
======================================================
- ------------------------------------------------------------------------------------------------------------------------------------
4. Capitalized Software Costs
Capitalized software costs at March 31, 2001 and 2000 were net of
accumulated amortization of $4.3 million and $3.3 million, respectively.
Information related to net capitalized software costs is as follows:
------------------------------------------------------
(in thousands) Year Ended March 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning of year $ 1,984 $ 2,144 $ 2,183
Capitalized 1,063 1,130 1,204
Amortization (1,278) (1,290) (1,243)
------------------------------------------------------
End of year $ 1,769 $ 1,984 $ 2,144
======================================================
- ------------------------------------------------------------------------------------------------------------------------------------
F-8
5. Composition of Certain Financial Statement Captions
-------------------------------------------
(in thousands) Year Ended March 31,
2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Inventories:
Computer systems and components $ 679 $ 785
Replacement parts for certain client systems, net of accumulated
amortization of $633 and $594, respectively 309 188
Miscellaneous parts and supplies 42 37
-------------------------------------------
$ 1,030 $ 1,010
===========================================
EQUIPMENT AND IMPROVEMENTS:
Computers and electronic test equipment $ 3,764 $ 3,175
Furniture and fixtures 1,092 964
Vehicles 8 72
Leasehold improvements 139 133
-------------------------------------------
5,003 4,344
Accumulated depreciation and amortization (3,184) (2,547)
-------------------------------------------
$ 1,819 $ 1,797
===========================================
OTHER ASSETS:
Intangible assets, net of accumulated amortization of $1,550
and $1,196, respectively $ 220 $ 574
Other 1,151 1,242
-------------------------------------------
$ 1,371 $ 1,816
===========================================
OTHER CURRENT LIABILITIES:
Accrued payroll and related expenses $ 1,373 $ 1,322
Deferred compensation 967 1,021
Income taxes payable 380 1,445
Other accrued expenses 852 1,328
-------------------------------------------
$ 3,572 $ 5,116
===========================================
- ------------------------------------------------------------------------------------------------------------------------------------
6. Income Taxes
The income tax provision consists of the following components:
------------------------------------------------------
(in thousands) Year Ended March 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Federal:
Current taxes $ 1,823 $ 2,308 $ 1,095
Deferred taxes 500 (808) (473)
------------------------------------------------------
$ 2,323 $ 1,500 $ 622
------------------------------------------------------
State:
Current taxes 105 642 210
Deferred taxes 82 (280) (119)
------------------------------------------------------
187 362 91
------------------------------------------------------
$ 2,510 $ 1,862 $ 713
======================================================
- ------------------------------------------------------------------------------------------------------------------------------------
F-9
The income tax provision differs from an amount computed at the Federal
statutory rate as follows:
------------------------------------------------------
(in thousands) Year Ended March 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Federal income tax provision at statutory rate (34%) $ 2,046 $ 1,485 $ 441
Increases (decreases) resulting from:
Non-deductible amortization of Goodwill 167 160 161
State income taxes 262 222 96
Other 35 (5) 15
------------------------------------------------------
$ 2,510 $ 1,862 $ 713
======================================================
- ------------------------------------------------------------------------------------------------------------------------------------
The net deferred tax assets in the accompanying consolidated balance
sheets include the following components:
-------------------------------------------
(in thousands) Year Ended March 31,
2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Short-term investments $ 6 $ 14
Accounts receivable 1,062 1,459
Inventories 80 70
Purchased in-process research and development 2,872 3,130
Intangible assets 173 128
Accrued compensation 275 291
Accrued liability for deferred compensation 348 348
Other accrued liabilities 4 12
Deferred revenue 79 109
State income taxes 77 139
-------------------------------------------
$ 4,976 $ 5,700
===========================================
Deferred tax liabilities:
Inventories $ (17) $ (18)
Equipment and improvements (12) (12)
Accumulated depreciation (52) (57)
Capitalized software (369) (495)
Deferred revenue -- (10)
-------------------------------------------
(450) (592)
-------------------------------------------
$ 4,526 $ 5,108
- ------------------------------------------------------------------------------------------------------------------------------------
The deferred tax assets and liabilities have been shown net in the
accompanying balance sheets based on the long-term or short-term nature of the
items which give rise to the deferred amount.
7. Employee Benefit Plans
QSI and MicroMed each have a profit sharing and retirement plan
(collectively, the "Retirement Plans") for the benefit of substantially all of
their employees. Participating employees may defer up to 15% of their
compensation per year. The Company's annual contribution is determined by the
Company's Board of Directors and the Retirement Plans may be amended or
discontinued at the discretion of the Board of Directors. Contributions of
$77,000, $73,000 and $53,000 were made to the Retirement Plans for the fiscal
years ended March 31, 2001, 2000 and 1999, respectively.
During the fiscal year ended March 31, 1994, QSI initiated a deferred
compensation plan (the "Deferral Plan") for the benefit of officers and key
employees. Participating employees may defer all or a portion of their
compensation for a Deferral Plan year. In addition, the Company may, but is not
required to, make contributions into the Deferral Plan on behalf of
participating employees. Each participating employee's deferred compensation and
share of Company contributions has been invested in a life insurance policy
which has death benefit and mutual fund features. Investment decisions are made
by each participating employee from a family of mutual funds. The Company is the
owner and beneficiary of
F-10
the life insurance policies and has an obligation to pay the greater of the
death benefit or the net cash surrender value upon each employee's death or
termination. The net cash surrender value of the life insurance policies and the
related Company obligation for deferred compensation was $967,000 and $1,021,000
at March 31, 2001 and 2000, respectively. The Company made contributions of
$11,000, $10,000 and $8,000 to the Deferral Plan for the fiscal years ended
March 31, 2001, 2000 and 1999, respectively.
8. Employee Stock Option Plans
During fiscal 1990, the Company's shareholders approved a stock option
plan (the "1989 Plan") under which 1,000,000 shares of Common Stock have been
reserved for the issuance of options. The 1989 Plan provides that salaried
officers, key employees and non-employee directors of the Company may, at the
discretion of the Board of Directors, be granted options to purchase shares of
Common Stock at an exercise price not less than 85% of their fair market value
on the option grant date. Upon an acquisition of the Company by merger or asset
sale, each outstanding option will be subject to accelerated vesting under
certain circumstances. The 1989 Plan terminated on June 30, 1999, however there
remain 212,238 outstanding options under the 1989 plan which remain eligible for
exercise until the expiration of their respective terms.
In September 1998, the Company's shareholders approved a stock option plan
(the "1998 Plan") under which 1,000,000 shares of Common Stock have been
reserved for the issuance of options. The 1998 Plan provides that employees,
directors and consultants of the Company, at the discretion of the Board of
Directors, be granted options to purchase shares of Common Stock. The exercise
price of each option granted shall be determined by the Company's Board of
Directors at the date of grant. Upon an acquisition of the Company by merger or
asset sale, each outstanding option will be subject to accelerated vesting under
certain circumstances. The 1998 Plan terminates on December 31, 2007, unless
sooner terminated by the Board. At March 31, 2001, 716,240 shares were available
for future grant under the 1998 Plan.
A summary of option transactions under the 1989 & 1998 Plans for the three
years ended March 31, 2001 is as follows:
---------------------------------------------------------
(in thousands) Weighted Average
Number of Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding, March 31, 1998 (50,500 exercisable at a
weighted average price of $3.45) 219,532 6.31
Granted (weighted average fair value of $2.05) 60,000 7.26
Exercised (33,000) 1.50
Cancelled (66,250) 7.56
------------------------------
Outstanding, March 31, 1999 (53,821 exercisable at a
weighted average price of $7.09) 180,282 7.04
Granted (weighted average fair value of $3.51) 220,250 6.58
Exercised (4,625) 5.52
Cancelled (23,048) 6.86
------------------------------
Outstanding, March 31, 2000 (107,867 exercisable at a
weighted average price of $7.11) 372,859 $ 6.80
Granted (weighted average fair value of $2.57) 179,010 7.97
Exercised (22,512) 6.73
Cancelled (50,859) 7.73
------------------------------
Outstanding, March 31, 2001 (143,429 exercisable at a
weighted average price of $6.76) 478,498 $ 7.16
=========================================================
- ------------------------------------------------------------------------------------------------------------------------------------
F-11
The outstanding stock options vest ratably over a four-year period
commencing from the respective option grant dates. Stock options outstanding at
March 31, 2001 are summarized as follows:
--------------------------------------------------------------------------------------------------------
Number
Outstanding at Weighted Avg. Remaining Weighted Average
(in thousands) Range of Exercise Prices March 31, 2001 Contractual Life (Yrs.) Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Options Outstanding $ 3.69 - $ 6.25 89,750 3.1 $ 6.04
$ 6.38 - $ 8.13 358,248 3.1 $ 7.26
$ 9.13 - $ 10.06 30,500 4.3 $ 9.37
-------
478,498 3.2 $ 7.16
=======
- ------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------
Number
Exercisable at Weighted Average
(in thousands) Range of Exercise Prices March 31, 2000 Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Options Exercisable $ 3.69 - $ 6.25 24,750 $ 5.86
$ 6.38 - $ 8.13 116,429 $ 6.90
$ 9.13 - $ 10.06 2,250 $ 12.82
-------
143,429 $ 6.76
=======
- ------------------------------------------------------------------------------------------------------------------------------------
The Company continues to account for its stock-based awards using the
intrinsic value method in accordance with APB Opinion No. 25. Accordingly, no
compensation expense has been recognized in the financial statements for
employee stock option grants all of which had market value exercise prices at
the date of grant. SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123") requires the disclosure of pro forma net income and pro forma
net income per share had the Company adopted the fair value method. Under SFAS
No. 123, the fair value of stock-based awards to employees is calculated through
the use of option pricing models, even though such models were developed to
estimate the fair value of freely tradable, fully transferable options without
vesting restrictions, which significantly differ from the Company's stock option
awards. These models also require subjective assumptions, including future stock
price volatility and expected time to exercise, which greatly affect the
calculated values.
The Company's calculations were made using the Black-Scholes option
pricing model with the following assumptions: expected life - twelve months
following full vesting or approximately 60 months from the date of the grant;
stock volatility - ranging from 50% to 60% in fiscal 2001 and 2000, and ranging
from 44% to 81% in fiscal 1999, risk free interest rates - 5.0% in fiscal 2001,
6.0% in fiscal 2000, and 5.5% in fiscal 1999; and, no dividends during the
expected term. The Company's calculations are based on a single option valuation
approach and forfeitures are recognized as they occur. If the computed fair
values of awards had been amortized to expense over the vesting period of the
awards, pro forma net income would have been $3,169,000 or $0.52 per share in
fiscal 2001, $2,111,000 or $0.34 per share in fiscal 2000, and $410,000 or $.06
per share in fiscal 1999. These amounts are based on calculated values for
option awards in fiscal 2001, 2000 and 1999 of $461,000, $775,000 and $123,000,
respectively.
9. Commitments and Contingencies
Litigation. On April 22, 1997, a purported class action entitled JOHN P.
CAVENY v. QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the
State of California for the County of Orange, in which Mr. Caveny, on behalf of
himself and all others who purchased the Company's Common Stock between June 26,
1995 and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J.
Beck, Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A.
Bowers, Graeme H. Frehner, and Gordon L. Setran (all of the foregoing
individuals were either officers, directors or both during the period from June
26, 1995 through July 3, 1996), as well as other defendants not affiliated with
the Company, violated California Corporations Code Sections 25400 and 25500,
California Civil Code Sections 1709 and 1710, and California Business and
Professions Code Sections 17200 et. seq., by issuing positive statements about
the Company that allegedly were knowingly false, in part, in
F-12
order to assist the Company and the individual defendants in selling Common
Stock at an inflated price in the Company's March 5, 1996 public offering and at
other points during the class period. The complaint seeks compensatory and
punitive damages in unspecified amounts, disgorgement, declaratory and
injunctive relief, and attorneys' fees.
The Company and the other named defendants successfully demurred to the
plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that
claim, which served as the only basis for plaintiffs' request for punitive
damages, has been dismissed from both actions.
On January 25, 1999, the court denied plaintiffs' motion to certify the
class representative and class legal counsel. Plaintiffs appealed that decision
as to class legal counsel. On February 25, 2000, the Fourth District Court of
Appeals affirmed the order disqualifying the class legal counsel. On May 9,
2000, the Court of Appeals issued its Remittur certifying its decision as final.
In May 2000, plaintiffs associated in additional class legal counsel, and
moved for approval by the court. Upon defendants' objection, the court on August
17, 2000, denied plaintiffs' motion, and ordered plaintiffs to retain new class
counsel.
At the end of November 2000, the plaintiffs retained new class counsel who
substituted in for plaintiffs' previous class counsel. The Company and the other
named defendants did not oppose plaintiffs' motion for approval of the new class
counsel. On January 24, 2001, the court granted the motion to certify class
legal counsel.
On March 27, 2001, the court approved a notice of class certification to
be mailed to shareholders who are potential class members. Between April 9, 2001
and May 9, 2001, class notice was mailed to potential class members.
Merits-related discovery in the action had been stayed pending the
appointment of class counsel. In March 2001, the plaintiffs requested that
documents be produced informally. The defendants have produced documents
informally for plaintiffs' review. The court has entered a stipulated protective
order governing discovery in the action. Counsel for plaintiffs and defendants
intend to meet to discuss the plaintiffs' review of the informal document
production at or around the time that the parties appear in court for the next
status conference on July 30, 2001.
In Management's opinion the outcome of this case is uncertain, and
therefore no accrual has been made to the financial statements.
On May 14, 1997, a second purported class action entitled WENDY WOO v.
QUALITY SYSTEMS, INC., ET AL. was filed in the same court, essentially repeating
the allegations in the Caveny lawsuit and seeking identical relief. This action
has for all purposes been consolidated with the Caveny action.
On March 23, 1999, a purported class action and derivative complaint
entitled IRVING ROSENZWEIG v. SHELDON RAZIN, ET AL. was filed in the Superior
Court of the State of California for the County of Orange, in which Mr.
Rosenzweig, on behalf of himself and all non-director shareholders, and
derivatively on behalf of the Company, alleges that Sheldon Razin, John Bowers,
William Bowers, Patrick Cline, Janet Razin and Gordon Setran (all of the
foregoing individuals were directors of the Company) breached their fiduciary
duties by allegedly entrenching themselves in their positions of control,
failing to ensure that third party offers involving the Company were fully and
fairly considered, and/or failing to conduct a reasonable inquiry to assure the
maximization of shareholder value. The complaint sought declaratory and
injunctive relief, an accounting of monetary damages allegedly suffered by
plaintiff and the purported class, and attorneys' fees. Defendants demurred to
each of the causes of action alleged in the complaint and the court sustained
those demurrers with leave to amend in December 1999. Rather than file an
amended complaint, plaintiff filed a motion for attorney's fees. Defendants, in
turn, filed a motion to dismiss the action for failure to file an amended
pleading within the time limit specified by the court.
The parties agreed to a settlement of action and stipulated to a final
judgment and order which was entered by the court on May 15, 2000, at which time
the action was dismissed. The final judgment and order provided for a dismissal
of the action with prejudice, releases given to each of the defendants, and
F-13
payment of the nominal sum of $100,000 (paid by the Company's directors and
officers liability insurance company) in full settlement of plaintiff's motion
for attorney's fees.
The settlement further expressly provided that it did not constitute an
admission of any liability of defendants, which defendants continue to
vigorously deny.
The Company is a party to various other legal proceedings incidental to
its business, none of which are considered by the Company to be material.
Rental Commitments. The Company leases its facilities and offices under
non-cancelable operating lease agreements expiring at various dates through
February 2006. The Company has rental commitments under these agreements in
fiscal 2002, 2003, 2004, 2005 and 2006 of $674,000, $203,000, $203,000, $189,000
and $173,000, respectively. Total rental expense for all operating leases was
$914,000, $901,000 and $807,000 for the years ended March 31, 2001, 2000 and
1999, respectively.
10. Stock Repurchase Plan
In February 1997, the Company's Board of Directors authorized the
repurchase on the open market of up to 10% of the shares of the Company's
outstanding Common Stock, subject to compliance with applicable laws and
regulations. This authorization has been renewed annually and currently expires
on June 7, 2001. As of March 31, 2001, the Company has repurchased 345,800
shares at a cash cost of $2,494,000. The Company's management could, in the
exercise of its judgment, decide not to effect any additional repurchases, or to
repurchase fewer shares than authorized.
11. Operating Segment Information
The Company has prepared operating segment information in accordance with
SFAS No. 131 "Disclosures About Segments of an Enterprise and Related
Information" to report components that are evaluated regularly by the Company's
chief operating decision maker, or decision making group in deciding how to
allocate resources and in assessing performance.
The Company's reportable operating segments include its MicroMed Division
and the QSI Division.
The accounting policies of the Company's operating segments are the same
as those described in Note 2 - Summary of Significant Accounting Policies -
except that the disaggregated financial results of the segments reflect
allocation of certain functional expense categories consistent with the basis
and manner in which Company management internally disaggregates financial
information for the purpose of assisting in making internal operating decisions.
Certain corporate overhead costs are not allocated to the individual segments by
Management. The Company evaluates performance based on stand-alone segment
operating income. Because the Company does not evaluate performance based on
return on assets at the operating segment level, assets are not tracked
internally by segment. Therefore, segment asset information is not presented.
Operating segment data for the three years ended March 31, was as follows:
---------------------------------------------------------------------------------------------------
(in thousands) Unallocated
QSI Division MicroMed Division Corporate Expenses Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended March 31, 2001
Revenue $ 17,225 $ 22,711 -- $ 39,936
Operating Income (Loss) $ 3,231 $ 3,662 $ (1,906) $ 4,987
Assets -- -- -- $ 44,883
Year Ended March 31, 2000
Revenue $ 18,955 $ 17,418 -- $ 36,373
Operating Income (Loss) $ 3,230 $ 2,346 $ (1,969) $ 3,607
Assets -- -- -- $ 44,136
Year Ended March 31, 1999
Revenue $ 19,396 $ 14,420 -- $ 33,816
Operating Income (Loss) $ 3,814 $ (1,339) $ (1,591) $ 884
Assets -- -- -- $ 40,218
- ------------------------------------------------------------------------------------------------------------------------------------
F-14
In fiscal 2001 management adopted certain internal allocation conventions
for use in the evaluating the performance of individual operating divisions on a
go-forward basis. Although these conventions were not applied during the fiscal
years 2000 and 1999, management has estimated the segment disclosures and
related corporate costs for the respective periods.
12. Selected Quarterly Operating Results
The following table presents quarterly unaudited consolidated financial
information for the eight quarters in the period ended March 31, 2001. Such
information is presented on the same basis as the annual information presented
in other sections of this report. In management's opinion, this information
reflects all adjustments, all of which are of a normal recurring nature, that
are necessary for a fair presentation of the results for these periods.
COMPARISON BY QUARTER
--------------------------------------------------------------------------------------------
(in thousands) Quarter Ended (Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
6/30/99 9/30/99 12/31/99 3/31/00 6/30/00 9/30/00 12/31/00 3/31/01
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Systems, upgrades and supplies sales $ 5,116 $ 5,633 $ 4,435 $ 4,063 $ 4,395 $ 4,794 $ 5,230 $ 5,516
Maintenance and other $ 3,986 $ 4,076 $ 4,373 $ 4,691 $ 4,867 $ 4,869 $ 5,103 $ 5,162
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$ 9,102 $ 9,709 $ 8,808 $ 8,754 $ 9,262 $ 9,663 $ 10,333 $ 10,678
Costs of products and services $ 4,058 $ 4,466 $ 4,023 $ 3,848 $ 4,032 $ 4,363 $ 4,459 $ 4,429
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$ 5,044 $ 5,243 $ 4,785 $ 4,906 $ 5,230 $ 5,300 $ 5,874 $ 6,249
Selling, General, & Administrative $ 3,040 $ 3,138 $ 3,166 $ 3,301 $ 3,365 $ 3,244 $ 3,451 $ 3,525
Research & Development $ 892 $ 965 $ 962 $ 907 $ 1,005 $ 974 $ 1,010 $ 1,092
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$ 1,112 $ 1,140 $ 657 $ 698 $ 860 $ 1,082 $ 1,413 $ 1,632
Investment Income $ 166 $ 182 $ 183 $ 228 $ 246 $ 251 $ 261 $ 274
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$ 1,278 $ 1,322 $ 840 $ 926 $ 1,106 $ 1,333 $ 1,674 $ 1,906
Provision for Income Taxes $ 536 $ 584 $ 365 $ 377 $ 481 $ 589 $ 708 $ 732
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Net Income $ 742 $ 738 $ 475 $ 549 $ 625 $ 744 $ 966 $ 1,174
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Net Income per share - Basic $ .12 $ .12 $ .08 $ .09 $ .10 $ .12 $ .16 $ .20
Net Income per share - Diluted $ .12 $ .12 $ .08 $ .09 $ .10 $ .12 $ .16 $ .19
Weighted Average Shares
Outstanding - Basic 6,215 6,215 6,208 6,199 6,209 6,209 6,119 5,983
Weighted Average Shares
Outstanding - Diluted 6,218 6,241 6,218 6,355 6,297 6,273 6,162 6,099
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Schedule II
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(in thousands)
Additions
Balance at ---------------------------------------------
beginning of Charged to costs and Charged to other Balance at
Description period expenses accounts Deductions End of Period
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For the year ended:
March 31, 2001 $ 1,121 $ 1,272 $ -- $ (1,058) $ 1,335
March 31, 2000 $ 754 $ 529 $ -- $ (162) $ 1,121
March 31, 1999 $ 521 $ 954 $ -- $ (721) $ 754
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F-15