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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2002
Commission file number 0-13801
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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.)
18191 Von Karman Avenue, Suite 450 , Irvine, California 92612
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (949) 255-2600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
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, 2002: $43,682,649.*
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of May 31, 2002: 6,105,083.
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 2002 annual
meeting which is to be filed with the Commission on or before July 29, 2002.
* 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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1
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., comprised of the QSI Division ("QSI Division") and
a wholly-owned subsidiary, NextGen Healthcare Information Systems, Inc.
("NextGen Division(1)") (collectively, the "Company"), develops and markets
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 clinical 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
patient 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 1,000 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.
The Company, 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, the Company 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(2) operating
system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(3) operating
system and can be fully integrated with the Company's dental practice 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 EDI/Connectivity 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.
- ----------
(1) The Company's NextGen Division, formerly known as "MicroMed Healthcare
Information System" or "MicroMed Division", changed names in fiscal 2002.
(2) UNIX is a registered trademark of AT&T Corporation.
(3) Microsoft Windows, Windows NT, Windows 95, Windows 98, and Windows 2000
are registered trademarks of Microsoft Corporation.
2
The Company's NextGen Division develops and sells proprietary electronic
medical records software and practice management systems under the NextGen(R)(4)
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 Server (NextGen(mcs), EDI/Connectivity services
(NextGen(edi), System Interfaces, Internet Operability (NextGen(web), and a
Patient-centric and Provider-centric Web Portal Solution (NextMD.com(5)). 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.
The Company's PDA product (NextGen(pda) was involved in beta testing throughout
much of fiscal 2002 with initial sales of the product occurring during the
fourth quarter of the fiscal year.
Enhancements to these products continued during fiscal 2002.
For the purposes of Statement of Accounting Standards ("SFAS") No. 131
"Disclosures About Segments of an Enterprise and Related Information" the
Company has provided a breakdown utilizing the management approach outlined in
Notes to Consolidated Financial Statements No. 13 "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 that 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 practices that leverage technology to more efficiently
handle patient clinical data, administrative, financial and other practice
management data, will be best able to enhance patient flow, pursue cost
efficiencies, and improve quality of care. 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 in combination with 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 services.
- ----------
(4) NextGen is a registered trademark of NextGen Healthcare Information
Systems, Inc.
(5) NextMD.com is a trademark of NextGen Healthcare Information Systems, Inc.
3
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 accommodate changing client requirements.
The QSI Division's character-based practice management system is available
in both dental and medical versions and primarily uses the IBM RS6000(6) central
processing unit and IBM'S AIX(7) 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. The Company 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.
NextGene(pm) expands the Company's practice management system product
line. NextGene(pm) 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 relational databases that are ANSI
SQL-compliant. NextGene(pm) 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
NextGene(pm) to its clients based upon information provided by each client.
Clients may elect to purchase hardware from the Company, or alternatively, may
choose to utilize third party suppliers other than the Company for the
selection, installation, and integration of their related hardware purchases.
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:
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(8)-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.
- ----------
(6) RS6000 is a registered trademark of International Business Machines
Corporation.
(7) AIX is a registered trademark of International Business Machines
Corporation.
(8) Pentium is a registered trademark of Intel Corporation.
4
NextGen provides clinical 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 NextGene(mr), 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 and
utilizes Microsoft Windows 95, Windows 98, Windows 2000, or Windows NT on each
workstation and either Windows NT, UNIX or Novell(9) on the server. NextGene(mr)
maintains data using industry standard relational database engines such as
Microsoft SQL Server(10), INFORMIX(11) or Oracle(12). 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.
NextGene(mr) 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.
NextGene(mr) is sold either as a combination of software and services, or
as a turnkey system including computer hardware and requisite operating system
software. Upon client request, computer hardware for turnkey systems is
purchased for resale by the Company from third party manufacturers or
distributors.
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 payors and national claims clearinghouses;
o Electronic patient statement processing, 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's NextGen Division 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 can be linked to
NextMD.com, integrating a number of these features with physicians' existing
systems.
The Company's QSI Division 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.
- ----------
(9) Novell is a registered trademark of Novell, Inc.
(10) Microsoft is a registered trademark and SQL Server is a registered
trademark of Microsoft Corporation.
(11) INFORMIX is a registered trademark of Informix Corporation.
(12) Oracle is a registered trademark of Oracle Corporation.
5
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,
industry consultants, contacts at professional society meetings, trade shows 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.
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 typically does not receive a fee directly
from the distributor's customers, implementation of such arrangements has, from
time to time, 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.
The Company continues to concentrate its direct 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, 2002, 2001, or 2000.
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.
6
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.
Before activation of the client's system, Company personnel typically
convert, or assist in conversion of selected elements of the relevant client
data onto the system.
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 or Company'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 patient
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 2002, 2001, and 2000, the Company expended approximately
$5.7 million, $5.1 million, and $4.9 million respectively, on research and
development activities including capitalized software amounts of $1.5 million,
$1.1 million, and $1.1 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, 2002, the Company employed 237 persons of which 235 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.
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.
7
Fluctuation in Quarterly Operating Results. The Company's revenues 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; changes in revenue recognition guidelines established by the
Financial Accounting Standards Board or other rule-making bodies; 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; 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 market/economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with a minimal backlog of
license fees. 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 and profits 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 revenue and 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 clients' initial decision to
replace or substantially modify their 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 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.
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 and 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. Continued investment
in the Company's sales staff and its client implementation and support staffs
will also be required to support future 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
8
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. 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.
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 non-cash 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
9
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 relationship with key 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
assertions of malpractice, other personal injury liability, or other liability
for wrongful delivery/handling 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 may
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 and federal 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 Health Insurance Portability and Accountability Act of 1996
("HIPAA") and related rules proposed by the Health 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 applicable 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
10
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 change governmental involvement in healthcare and
reimbursement rates, and otherwise alter the operating environment for the
Company and its 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 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, 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 positively or negatively affect the Company's business.
In addition, the Company's software may potentially 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 record-keeping 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, accounting and QSI Division operations
have relocated to Irvine, California, under a lease that commenced May 15, 2002,
and expires April 30, 2005. The Company leases approximately 12,000 square feet
of space under this lease. In April 2002, the Company executed a new lease for
the principle office of the Company's NextGen Division. This lease includes
approximately 32,000 square feet of space in Horsham, Pennsylvania, and expires
March 31, 2009. In addition, the Company leases approximately 6,000 square feet
of space in Santa Ana, California, to house its assembly and warehouse
operations, 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, excluding options, have expiration dates
ranging from month-to-month to August 2008. 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
11
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, which had been stayed pending the
appointment of class counsel, is now ongoing. In March 2002, defendant Graeme H.
Frehner and certain other defendants not affiliated with the Company were
dismissed from the action with prejudice by stipulated order.
The parties are scheduled to appear in court for the next status
conference on October 22, 2002. Trial in the action has been set for March 24,
2003.
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.
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, 2002 were as follows:
------------------------------------------------------------------------------------------------
Name Age Position
------------------------------------------------------------------------------------------------
Louis E. Silverman 43 President, Chief Executive Officer
------------------------------------------------------------------------------------------------
Patrick B. Cline 41 President, NextGen Healthcare Information Systems Division
------------------------------------------------------------------------------------------------
Greg Flynn 44 Executive Vice President and General Manager of QSI Division
------------------------------------------------------------------------------------------------
Paul Holt 36 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 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.
12
Patrick B. Cline currently serves as president of the Company's NextGen
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 and throughout its transition to NextGen Healthcare Information
Systems. 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 QSI Division'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. Between June
1992 and January 1996, Mr. Flynn served as Vice President Administration. 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. Mr. Flynn joined the
Company in January 1982. 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.
13
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, 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
--------------------------------------------------------
June 30, 2001 $ 15.04 $ 9.90
--------------------------------------------------------
September 30, 2001 $ 14.44 $ 10.10
--------------------------------------------------------
December 31, 2001 $ 18.00 $ 10.25
--------------------------------------------------------
March 31, 2002 $ 17.52 $ 13.59
--------------------------------------------------------
At May 31, 2002, 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, 2002, 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 including the period ended
March 31, 2002 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.
14
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
(In thousands, except for per share data)
--------------------------------------------------------
Year Ended March 31,
2002 2001 2000 1999 1998
--------------------------------------------------------------------------------------------------------------
Net revenues $44,422 $39,936 $36,373 $33,816 $ 31,216
Cost of products and services 19,253 17,283 16,395 15,834 13,509
--------------------------------------------------------
Gross profit 25,169 22,653 19,978 17,982 17,707
Selling, general and administrative
expenses 13,068 13,585 12,645 13,495 12,485
Research and development costs 4,243 4,081 3,726 3,603 3,072
Purchased in-process research and development(1) -- -- -- -- 10,200
--------------------------------------------------------
Income (loss) from operations(2) 7,858 4,987 3,607 884 (8,050)
Investment income 643 1,032 759 413 971
--------------------------------------------------------
Income (loss) before provision for (benefit from)
income taxes(2) 8,501 6,019 4,366 1,297 (7,079)
Provision for (benefit from) income taxes 3,233 2,510 1,862 713 (2,463)
--------------------------------------------------------
Net income (loss)(2) $ 5,268 $ 3,509 $ 2,504 $ 584 $ (4,616)
--------------------------------------------------------
Net income (loss) per share, basic(2) $ 0.87 $ 0.57 $ 0.40 $ 0.09 $ (0.77)
--------------------------------------------------------
Net Income (loss) per share, diluted(2) $ 0.84 $ 0.57 $ 0.40 $ 0.09 $ (0.77)
--------------------------------------------------------
Weighted average shares outstanding, basic 6,025 6,130 6,208 6,176 5,981
--------------------------------------------------------
Weighted average shares outstanding, diluted 6,240 6,203 6,261 6,185 5,981
------------------------------------------------------========================================================
(1) In May 1997, the Company acquired NextGen 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 for purchased in-process research and
development for the year ended March 31, 1998. 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. The income tax benefit related to the
charge for purchased in-process research and development for the year
ended March 31, 1998 was $3.9 million. 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 , respectively, for
fiscal 1998.
CONSOLIDATED BALANCE SHEET DATA
(in thousands)
-------------------------------------------------------
March 31,
2002 2001 2000 1999 1998
----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents and short-term investments $25,698 $18,729 $16,169 $14,441 $17,080
-------------------------------------------------------
Working capital 30,700 24,196 21,332 18,166 15,453
-------------------------------------------------------
Total assets 52,143 44,883 44,136 40,218 40,916
-------------------------------------------------------
Total liabilities 12,192 10,996 12,053 10,554 13,475
-------------------------------------------------------
Shareholders' equity $39,951 $33,887 $32,083 $29,664 $27,441
----------------------------------------------------------------------------------------------------------------
15
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, may include 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.
Critical Accounting Procedures
The discussion and analysis of the Company's financial condition and
results of operations is based upon the Company's consolidated financial
statements which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires the Company to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosures of contingent assets and liabilities. On an on-going basis,
the Company evaluates estimates, including those related to revenue recognition,
uncollectible accounts receivables, and intangible assets for reasonableness.
The Company bases its estimates on historical experience and on various other
assumptions that management believes to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
The Company believes revenue recognition, the allowance for doubtful
accounts, and goodwill impairment are among the most critical accounting
policies that impact its consolidated financial statements. The Company suggests
that significant accounting policies, as described in its consolidated financial
statements in Note 2, Summary of Significant Accounting Policies, be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Revenue Recognition. The Company's revenues are primarily generated from
the sale of software licenses, maintenance fees, and EDI services. Revenue
recognition is governed by Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). Per SOP 97-2, if the arrangement does not require
significant production, modification, or customization of software, revenue
should be recognized when all of the following criteria are met:
o persuasive evidence of an arrangement exists;
o delivery has occurred;
o the vendor's fee is fixed or determinable; and
o collectibility is probable.
In accordance with generally accepted accounting principles in the United
States of America, the recognition of software license revenues is based on the
Company's assessment that the above criteria has been met. In general, the first
two criteria are met with a signed contract and evidence that the Company has
shipped its software to the customer. In those cases where undelivered elements
of a system sales exist, the Company defers revenue related to the undelivered
element based on vendor specific objective evidence of each element's fair
value. The Company bases each element's fair value on its price list which is
used in pricing all contracts. Discounts for individual elements are aggregated,
and the total discount is allocated back to the individual elements in its
proportion of fair value to the total contract fair value. The Company
determines that its fee is fixed and determinable based on the contract terms,
which specify payment terms tied to dates and not to any future deliverables.
Probability of collection is based on a credit review of new customers. The
timing or amount of revenue recognition may have been different if different
assessments of the above criteria had been made at the time transactions were
recorded in revenue.
Valuation Allowances. The Company maintains allowances for doubtful
accounts for estimated losses resulting from the inability of its customers to
make required payments. If the financial condition of its customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
16
Goodwill Impairment. The Company's long-lived assets include goodwill of
$1.8 million as of March 31, 2002 and 2001, respectively. The Company adopted
SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") effective April
1, 2001. The new statement applies to the amortization of goodwill and other
intangible assets. The Company has ceased amortizing amounts related to goodwill
starting April 1, 2001. The balance of goodwill is related to the Company's
NextGen Division. The Company has compared the fair value of the NextGen
Division with the carrying amount of assets associated with the Division and
determined that none of the goodwill recorded as of June 30, 2001 was impaired.
The fair value of the NextGen Division was determined using a reasonable
estimate of future cash flows of the Division and a risk adjusted discount rate
to compute a net present value of future cash flows.
The process of evaluating goodwill for impairment involves the
determination of the fair value of the Company's business segments. Inherent in
such fair value determinations are certain judgments and estimates, including
the interpretation of current economic indicators and market valuations, and
assumptions about the Company's strategic plans with regard to operations. To
the extent additional information arises or the strategies of the Company
change, it is possible that the Company's conclusion regarding goodwill
impairment could change and result in a material effect on its financial
position or results of operations.
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,
2002 2001 2000
-------------------------------------------------------------------------------------
Net revenues:
Sales of computer systems, upgrades and supplies 50.7% 49.9% 52.9%
Maintenance and other services 49.3 50.1 47.1
-------------------------------
100.0 100.0 100.0
Cost of products and services 43.3 43.3 45.1
-------------------------------
Gross profit 56.7 56.7 54.9
Selling, general and administrative expenses 29.4 34.0 34.8
Research and development costs 9.6 10.2 10.2
-------------------------------
Income from operations 17.7 12.5 9.9
Investment income 1.4 2.6 2.1
-------------------------------
Income before provision for income taxes 19.1 15.1 12.0
Provision for income taxes 7.3 6.3 5.1
-------------------------------
Net income 11.8% 8.8% 6.9%
------------------------------------------------------===============================
For the Year Ended March 31, 2002 versus 2001
For the year ended March 31, 2002, the Company's net income was $5,268,000
or $0.87 per share on a basic and $0.84 on a diluted basis. In comparison, the
Company earned $3,509,000 or $0.57 per share on a basic and diluted basis in the
year ended March 31, 2001. The increase in net income was achieved through a
combination of an increase in revenue from software systems sales, maintenance,
and EDI services along with a decrease in selling, general, and administrative
expenses.
Net Revenues. Net revenues for the year ended March 31, 2002 increased
11.2% to $44.4 million from $39.9 million for the year ended March 31, 2001.
Sales of computer systems, upgrades and supplies increased 13% to $22.5 million
from $19.9 million while net revenues from maintenance and other service grew
9.5% to $21.9 from $20.0 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 NextGenepm and
NextGenemr software licenses to new customers. 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 and such increases were principally in the Company's NextGen
Division. Revenue from the Company's EDI services increased 19.2% to $6.2
million for the year ended March 31, 2002, compared to $5.2 million in the year
ended March 31, 2001.
Software license sales to resellers represented less than 10% of total
revenue for the years ended March 31, 2002 and 2001.
17
Cost of Products and Services. Cost of products and services for the year
ended March 31, 2002 increased 11.6% to $19.3 million from $17.3 million for the
year ended March 31, 2001, while the cost of products and services as a
percentage of net revenues at 43.3% of revenue was unchanged compared to the
prior year.
Gross margins for the Company are impacted by the level of hardware
content included in system sales which fluctuates from period to period, the
percentage of EDI revenues in the Company's overall sales mix, changes in
certain headcount expenses, and the revenue split between the Company's two
operating divisions.
A higher level of hardware content in new systems sales at the NextGen
Division was primarily responsible for reducing gross margins in that division
from 64.7% in the year ended March 31, 2001 to 58.6% in the year ended March 31,
2002.
The decline in gross margins at the NextGen Division was offset by certain
reductions in headcount and other expenses at the QSI Division, where gross
margins increased from 46.2% in the year ended March 31, 2001 to 53.6% in the
year ended March 31, 2002.
In addition, the Company's gross margin percentage was impacted as the
NextGen Division, which has a higher gross margin than the QSI Division,
increased its share of total company revenues to 61% from 57% in the prior year.
Selling, General and Administrative. Selling, general and administrative
expenses for the year ended March 31, 2002 decreased 3.8% to $13.1 million from
$13.6 million, and decreased on a percentage of revenues basis from 34.0% to
29.4% for the respective fiscal years. The decline in selling, general and
administrative expenses were driven primarily by a decline in bad debt expenses
of approximately $775,000 as a result of improved credit and collections
procedures put in place by the Company.. The decline in bad debt expense
experienced by the Company in fiscal 2002 is not expected to continue into
fiscal 2003. Should the Company be able to continue to increase revenues, an
increase in selling-related expenses is expected. The Company's goal is to
increase selling, general and administrative expenses at a rate less than its
rate of revenue growth.
Research and Development Costs. Research and development costs for the
year ended March 31, 2002 increased 2.4% to $4.2 million from $4.1 million for
the year ended March 31, 2001. The increase in research and development costs is
primarily the result of increased research and development efforts at the
NextGen Division. Research and development costs as a percentage of net revenues
declined to 9.6% compared to 10.2% in the prior year. Research and development
costs as a percentage of net revenues declined as a percentage of revenues due
to the fact that an increasing percentage of the company's incremental research
and development expenditures were directed at future enhancements to the NextGen
EMR, EPM, and PDA products and were capitalized on the balance sheet.
Capitalization of the Company's incremental development costs in fiscal 2002
resulted in research and development expenditures growing more slowly than
revenue. Research and development expenses are expected to continue at or above
current levels.
Investment Income. Investment income for the year ended March 31, 2002
declined 38% to $643,000 from $1,032,000 for the year ended March 31, 2001.
Investment income was impacted by a decline in average interest rates during the
year ended March 31, 2002 which was partially offset by an increase in average
funds available for investment during the year ended March 31, 2002.
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 2002 was $3,233,000 as compared to $2,510,000 for the year ended
March 31, 2001. The effective tax rates for fiscal 2002 and 2001 were 38.1% and
41.7% respectively. The provision for income taxes for the year ended March 31,
2001, differed 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 Year Ended March 31, 2001 versus 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 generated by the Company's NextGen Division 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, principally as a result of expense reductions in
the Company's QSI Division.
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
18
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 NextGenepm and NextGenemr products, offset by a decrease in
sales of new systems in the Company's QSI Division. The increase in maintenance
and other services net revenue resulted primarily from the Company's increased
NextGen 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 NextGen. 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.
Liquidity and Capital Resources
The following table presents selected financial statistics and information
for each of the past three fiscal years:
(in thousands) ---------------------------------
Year Ended March 31,
2002 2001 2000
-----------------------------------------------------------------------------
Cash and cash equivalents at year end $25,443 $18,471 $15,926
-----------------------------------------------------------------------------
Net increase in cash and cash equivalents $ 6,972 $ 2,545 $ 1,730
-----------------------------------------------------------------------------
Net income $ 5,268 $ 3,509 $ 2,504
-----------------------------------------------------------------------------
Net cash provided by operations $ 8,218 $ 6,111 $ 3,144
-----------------------------------------------------------------------------
Days of sales outstanding 111 124 131
-----------------------------------------------------------------------------
Cash provided by operations is the Company's principal source of cash.
Cash from operations for the year ended March 31, 2002, consisted principally of
net income before non-cash related expenses of depreciation, amortization, and
provision for bad debts offset by an increase in gross accounts receivable. The
Company was able to generate operating cash flows significantly in excess of net
income in the years ended March 31, 2002 and 2001, primarily as a result of
improved turnover of accounts receivable. Provided turnover of accounts
receivable, revenues, and profitability remains consistent with the year ended
March 31, 2002, the Company anticipates it will continue to generate cash from
operations primarily from the net income. Net cash used in investing activities
for the year ended March 31, 2002 was $2.0 million and was principally composed
of investments in capitalized software and equipment and improvements. The
Company has no
19
significant capital commitments, and currently anticipates that additions to
equipment and improvements for fiscal 2003 will be equal to or greater than
historical levels.
Net cash provided by financing activities for the year ended March 31,
2002 was $796,000, and was solely composed of proceeds from the exercise of
stock options. Cash received from employee stock option exercises can fluctuate
from year to year. In October 2001, the Board of Directors approved a stock
repurchase plan to replace a prior plan which had expired in June 2001. This
repurchase plan authorizes the repurchase of up to 5% of the Company's
outstanding shares. The Company believes that cash on hand plus cash flow from
operations will be sufficient to accommodate any repurchases of shares under
this plan.
At March 31, 2002, the Company had cash and cash equivalents of $25.4
million and short-term investments of $255,000. The Company believes that its
cash and cash equivalents and short-term investments on hand at March 31, 2002,
together with the cash flows from operations, if any, will be sufficient to meet
its working capital and capital expenditure requirements for fiscal 2003.
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
On July 12, 2001 the Company filed a current report on Form 8-K dated July 5,
2001 reporting a change in the Company's certifying accountant.
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, 2002
for the Company's 2002 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, 2002 for the Company's 2002 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, 2002 for the Company's 2002 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, 2002 for the Company's 2002 annual
shareholders' meeting.
20
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Page
----
(a) 1. Index to Financial Statements
Report of Independent Certified Public Accountants F-1
Independent Auditors' Report F-2
Consolidated Balance Sheets at March 31, 2002 and 2001 F-3
Consolidated Statements of Income and Comprehensive Income for
the Years Ended March 31, 2002, 2001 and 2000 F-4
Consolidated Statement of Shareholders' Equity for the Years Ended March 31, 2002, 2001 and 2000 F-4
Consolidated Statements of Cash Flows for the Years Ended March 31, 2002, 2001 and 2000 F-5
Notes to Consolidated Financial Statements F-6
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts F-17
3. Exhibits
Index to Exhibits E-1
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.
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.
21
Exhibit Sequential
Number Description Page Number
------ ----------- -----------
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
NextGen Healthcare Information Systems, Inc., MHIS
Acquisition Corp., Quality Systems, Inc., and certain
shareholders of NextGen 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, incorporated
by reference to Exhibit 10.14 to the Company's Annual Report
on Form 10-K for the year ended March 31, 2001, File No.
0-13801.
10.15 Lease Agreement between Company and Orangewood Business
Center Inc. dated April 3, 2000, amended February 22, 2001,
incorporated by reference to Exhibit 10.15 to the Company's
Annual Report on Form 10-K for the year ended March 31,
2001, File No. 0-13801.
10.16 Lease Agreement between Company and Craig Development
Corporation dated February 20, 2001, incorporated by
reference to Exhibit 10.16 to the Company's Annual Report on
Form 10-K for the year ended March 31, 2001, File No.
0-13801.
10.17 Sublease Agreement between Company and Infinium Software
dated February 22, 2002.**
10.18 Lease Agreement between Company and HUB Properties LLC dated
May 8, 2002.**
21 List of Subsidiaries.** 110
23.1 Independent Auditor's Consent - Deloitte & Touche LLP.** 111
23.2 Consent of Independent Certified Public Accountants - Grant
Thornton LLP.** 112
* This exhibit is a management contract or a compensatory plan
or arrangement.
** Filed herewith.
(b) Reports on Form 8-K: On July 12, 2001 the Company filed a current report
on Form 8-K dated July 5, 2001 reporting a change in the Company's
certifying accountant.
22
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, 2002
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 26, 2002
- -------------------------------
SHELDON RAZIN
/s/ AHMED HUSSEIN Co-Chairman of the Board of Directors June 26, 2002
- -------------------------------
AHMED HUSSEIN
/s/ LOUIS SILVERMAN Chief Executive Officer June 26, 2002
- -------------------------------
LOUIS SILVERMAN
/s/ PAUL HOLT Chief Financial Officer, Secretary June 26, 2002
- -------------------------------
PAUL HOLT
/s/ MOHAMMED TAWFICK EL-BARDAI Director June 26, 2002
- -------------------------------
MOHAMMED TAWFICK EL-BARDAI
/s/ DALE HANSON Director June 26, 2002
- -------------------------------
DALE HANSON
/s/ FRANK MEYER Director June 24, 2002
- -------------------------------
FRANK MEYER
/s/ WILLIAM SMALL Director June 26, 2002
- -------------------------------
WILLIAM SMALL
/s/ EMAD ZIKRY Director June 24, 2002
- -------------------------------
EMAD ZIKRY
23
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated balance sheet of Quality Systems,
Inc. as of March 31, 2002, and the related consolidated statements of income and
comprehensive income, shareholders' equity, and cash flows for the year then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Quality
Systems, Inc. as of March 31, 2002, and the results of its operations and its
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America.
We have also audited Schedule II of Quality Systems, Inc. for the year ended
March 31, 2002. In our opinion, this schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
/s/ Grant Thornton LLP
Irvine, California
May 22, 2002
F-1
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 the related consolidated
statements of income and comprehensive income, shareholders' equity and cash
flows for the years ended March 31, 2001 and 2000. Our audits also included the
financial statement schedule for the years ended March 31, 2001 and 2000, 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 the results of their operations and their
cash flows for the years ended March 31, 2001 and 2000, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement schedule for the years ended
March 31, 2001 and 2000, 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-2
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except for per share data)
-------------------
March 31,
2002 2001
- ----------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $25,443 $18,471
Short-term investments 255 258
Accounts receivable, less allowance for doubtful accounts
of $813 and $1,335, respectively 13,695 13,335
Inventories, net 1,118 1,030
Deferred tax assets 1,368 1,566
Other current assets 1,013 532
-------------------
Total current assets 42,892 35,192
Equipment and improvements, net 1,578 1,819
Capitalized software costs, net 2,103 1,769
Deferred tax assets 2,778 2,960
Goodwill 1,840 1,840
Other assets, net 952 1,303
-------------------
Total assets $52,143 $44,883
===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,657 $ 1,829
Deferred revenue 6,155 5,595
Other current liabilities 3,281 3,572
-------------------
Total liabilities 12,093 10,996
-------------------
Commitments and contingencies (Note 9)
Shareholders' equity:
Common stock, $0.01 par value, 20,000 shares authorized,
6,105 and 5,987 shares issued and outstanding, respectively 61 60
Additional paid-in capital 34,674 33,780
Retained earnings 5,315 47
-------------------
Total shareholders' equity 40,050 33,887
-------------------
Total liabilities and shareholders' equity $52,143 $44,883
- ---------------------------------------------------------------------===================
See notes to consolidated financial statements.
F-3
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except per share amounts)
-------------------------------
Year Ended March 31,
2002 2001 2000
- -----------------------------------------------------------------------------------------------------
Net revenues:
Sales of computer systems, upgrades and supplies $22,520 $19,935 $19,247
Maintenance and other services 21,902 20,001 17,126
-------------------------------
44,422 39,936 36,373
Cost of products and services 19,253 17,283 16,395
-------------------------------
Gross profit 25,169 22,653 19,978
Selling, general and administrative expenses 13,068 13,585 12,645
Research and development costs 4,243 4,081 3,726
-------------------------------
Income from operations 7,858 4,987 3,607
Investment income 643 1,032 759
-------------------------------
Income before provision for income taxes 8,501 6,019 4,366
Provision for income taxes 3,233 2,510 1,862
-------------------------------
Net income and comprehensive income $ 5,268 $ 3,509 $ 2,504
===============================
Net income per share, basic $ 0.87 $ 0.57 $ 0.40
-------------------------------
Net income per share, diluted $ 0.84 $ 0.57 $ 0.40
-------------------------------
Weighted average shares outstanding - basic 6,025 6,130 6,208
-------------------------------
Weighted average shares outstanding - diluted 6,240 6,203 6,261
- -----------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
Retained
Common Shares Additional Earnings Total
---------------- Paid-in (Accumulated Shareholders'
Number Amount Capital Deficit) Equity
- -----------------------------------------------------------------------------------------------------------------
Balance at April 1, 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
Exercise of stock options 118 1 795 -- 796
Tax benefit resulting from stock options -- -- 99 -- 99
Net income -- -- -- 5,268 5,268
--------------------------------------------------------------
Balance at March 31, 2002 6,105 $ 61 $ 34,674 $ 5,315 $ 40,050
- -----------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
F-4
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
------------------------------------
Year Ended March 31,
2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 5,268 $ 3,509 $ 2,504
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 807 723 574
Amortization 1,279 1,974 1,630
Provision for bad debts 497 1,272 529
Loss on short-term investments and other 3 19 111
Deferred income taxes 380 582 (1,088)
Changes in:
Accounts receivable (857) (897) (1,751)
Inventories (88) (20) (238)
Other current assets (481) (102) (176)
Accounts payable 828 583 (567)
Deferred revenue 560 (96) 1,207
Other current liabilities 22 (1,436) 859
------------------------------------
Net cash provided by operating activities 8,218 6,111 3,594
------------------------------------
Cash flows from investing activities:
Additions to capitalized software costs (1,477) (1,063) (1,130)
Additions to equipment and improvements (565) (778) (588)
Change in other assets -- (13) (60)
------------------------------------
Net cash used in investing activities (2,042) (1,854) (1,778)
------------------------------------
Cash flows from financing activities:
Proceeds from exercise of stock options 796 152 25
Purchases of common stock -- (1,864) (111)
------------------------------------
Net cash provided by (used in) financing activities 796 (1,712) (86)
------------------------------------
Net increase in cash and cash equivalents 6,972 2,545 1,730
Cash and cash equivalents, beginning of year 18,471 15,926 14,196
------------------------------------
Cash and cash equivalents, end of year $ 25,443 $ 18,471 $ 15,926
- -------------------------------------------------------------------------====================================
Supplemental Information - During fiscal 2002, 2001 and 2000 the Company made
income tax payments of $3,386, $2,779 and $2,421, respectively.
See notes to consolidated financial statements.
F-5
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
1. Description of Business
Quality Systems, Inc., comprised of the QSI Division ("QSI Division") and
a wholly-owned subsidiary, NextGen Healthcare Information Systems, Inc.
("NextGen Division") (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. The Company's principal administrative, accounting and QSI
Division operations are located in Irvine, California. The principal office of
the Company's NextGen Division is located in Horsham, Pennsylvania.
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 and transactions 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 and value-added resellers (VARs). 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 objective 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 generally 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 some situations, certain system sales contracts contain payment terms
based on the performance of certain milestones. License and hardware revenues
for such contracts are recognized using the percentage of completion or
completed contract method, as appropriate.
License arrangements with VARs generally do not provide for returns, and
therefore, license revenues to VARs are generally recognized upon shipment.
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 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.
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.
o Held to maturity - Debt securities for which the Company has the
intent and the ability to hold to maturity.
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,
F-6
net of tax effect, are recognized as a component of shareholders' equity. 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. Realized gains and
losses from investment transactions are determined on a specific identification
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 estimated credit losses.
Reserves for potential credit losses are determined by establishing both
specific and general reserves. Specific reserves are based on management's
estimate of the probability of collection for certain troubled accounts. General
reserves are established based on the Company's historical experience of bad
debt expense and the aging of the Company's accounts receivable balances net of
specifically reserved accounts. Accounts are written off as uncollectible only
after the Company has exhausted all possible means of collection.
Included in accounts receivable are amounts related to maintenance and
services which were billed but not yet rendered as of the end of the fiscal
year. Undelivered maintenance and services are included on the balance sheet in
deferred revenue.
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 the Financial Accounting
Standards Board ("FASB") issued 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 an annual 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. The Company adopted SFAS No. 142 "Goodwill
and Other Intangible Assets" ("SFAS 142") effective April 1, 2001. The new
statement applies to the amortization of goodwill and other intangible assets.
The Company has ceased amortizing amounts related to goodwill starting April 1,
2001. The balance of goodwill is related to the Company's NextGen Division. The
Company has compared the fair value of the NextGen Division with the carrying
amount of assets associated with the Division and determined that none of the
goodwill recorded as of April 1, 2001 was impaired. The fair value of the
NextGen Division was determined using a reasonable estimate of future cash flows
of the Division and a risk adjusted discount rate to compute a net present value
of future cash flows. On an ongoing basis, the Company intends to evaluate the
carrying amount of goodwill as of June 30 of each year.
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, 2002.
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
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").
F-7
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,
2002 2001 2000
---------------------------------------------------------------------------------
Net income $5,268 $3,509 $2,504
----------------------------
Basic net income per common share:
Weighted average of common shares outstanding 6,025 6,130 6,208
----------------------------
Basic net income per common share $ 0.87 $ 0.57 $ 0.40
============================
Diluted net income per share:
Weighted average of common shares outstanding 6,025 6,130 6,208
Weighted average of common shares equivalents:
Weighted average options outstanding 215 73 53
----------------------------
Weighted average number of common and
common equivalent shares 6,240 6,203 6,261
----------------------------
Diluted net income per common share $ 0.84 $ 0.57 $ 0.40
-----------------------------------------------------=============================
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.
Segment Disclosures. The Company presents reporting information regarding
operating segments in accordance with SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" ("SFAS No. 131"). 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.
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. On an on-going basis, the Company evaluates its
estimates, including those related to uncollectible receivables, and the
percentage of completion related to certain service revenues. The Company bases
its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
New Accounting Pronouncements. In June 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. It applies
to legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development and/or the normal
operation of a long-lived asset, except for certain obligations of lessees. SFAS
No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset. Statement
143 is effective for financial statements issued for fiscal years beginning
after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to
have a material impact on its financial condition, results of operations or cash
flows.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which supersedes both SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" for the disposal of a segment of a business
(as previously defined in that Opinion). SFAS No. 144 retains the fundamental
provisions in SFAS No. 121 for recognizing and measuring impairment losses on
long-lived assets held for use and long-lived assets to be disposed of by sale,
while also resolving significant implementation
F-8
issues associated with SFAS No. 121. For example, SFAS No. 144 provides guidance
on how a long-lived asset that is used as part of a group should be evaluated
for impairment, establishes criteria for when a long-lived asset is held for
sale, and prescribes the accounting for a long-lived asset that will be disposed
of other than by sale. SFAS No. 144 retains the basic provisions of APB Opinion
No. 30 on how to present discontinued operations in the income statement but
broadens that presentation to include a component of an entity (rather than a
segment of a business). Unlike SFAS No. 121, an impairment assessment under SFAS
No. 144 will never result in a write-down of goodwill. Rather, goodwill is
evaluated for impairment under SFAS No. 142, "Goodwill and Other Intangible
Assets."
SFAS 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001 and interim periods within those fiscal years.
Management does not expect the adoption of SFAS No. 144 to have a material
impact on the Company's financial statements.
Reclassifications. Certain reclassifications have been made to prior
years' balances to conform with the 2002 presentation.
3. Intangible Assets
As of March 31, 2002, the Company had the following amounts related to
intangible assets with determinable lives. Under SFAS No. 142, these intangible
assets will continue to be amortized over their estimated lives as seen below:
(in thousands) ----------------------------------------------------
Gross Carrying Accumulated Net Intangible
Amount Amortization Assets
------------------------------------------------------------------------------------------------------------------------
Developed technology (5 yrs) $1,300 $(1,285) $ 15
Capitalized software development (3 yrs) $6,663 $(4,560) $2,103
----------------------------------------------------
Total amortized intangible assets $7,963 $(5,845) $2,118
------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------
Aggregate amortization expense twelve months ended March 31, 2002 $1,280
------------------------------------------------------------------------------------------------------------------------
The following table represents the total estimated amortization of intang ible
assets with determinable lives:
------------------------------------------------------------------
Estimated Amortization Expense
For the year ended March 31, (in thousands)
------------------------------------------------------------------
2003 $ 1,085
2004 $ 712
2005 $ 321
------------------------------------------------------------------
The following is reconciliation of reported net income adjusted for adoption of
SFAS No. 142 for the years ended March 31, 2002 and 2001:
---------------------------------
2002 2001
------------------------------------------------------------------
Reported net income $ 5,268 $ 3,509
Addback:
Goodwill amortization -- 400
---------------------------------
Adjusted net income $ 5,268 $ 3,909
=================================
Basic earnings per share:
Reported net income $ 0.87 $ .57
Goodwill amortization -- .07
---------------------------------
Adjusted net income $ 0.87 $ 0.64
=================================
Diluted earnings per share:
Reported net income $ 0.87 $ 0.57
Goodwill amortization -- .06
---------------------------------
Adjusted net income $ 0.87 $ 0.63
---------------------------------=================================
F-9
4. Cash Equivalents and Short-Term Investments
At March 31, 2002 and 2001, the Company had cash equivalents of $25.4
million and $18.5 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, 2002 and 2001, all
short-term investments consist of trading securities with a market value of
$255,000 and $258,000, respectively. The Company bears no off-balance sheet risk
on its investments.
Investment income for each of the three years ended March 31, 2002
consists of the following:
(in thousands) ------------------------------------
Year Ended March 31,
2002 2001 2000
---------------------------------------------------------------------------
Interest income $ 665 $ 1,012 $ 783
Net unrealized gains (losses) (22) 15 (24)
Other 0 5 0
------------------------------------
$ 643 $ 1,032 $ 759
---------------------------------------====================================
5. Capitalized Software Costs
Information related to net capitalized software costs is as follows:
(in thousands) -----------------------
Year Ended March 31,
2002 2001
-------------------------------------------------------------------
Beginning of year $ 1,769 $ 1,984
Capitalized 1,477 1,063
Amortization (1,143) (1,278)
-----------------------
End of year $ 2,103 $ 1,769
--------------------------------------------=======================
(in thousands) -----------------------
Year Ended March 31,
2002 2001
-------------------------------------------------------------------
Total capitalized development costs $ 6,663 $ 6,055
Accumulated amortization (4,560) (4,286)
(in thousands) -----------------------
Net capitalized software $ 2,103 $ 1,769
--------------------------------------------=======================
F-10
6. Composition of Certain Financial Statement Captions
(in thousands) -----------------------
Year Ended March 31,
2002 2001
- -------------------------------------------------------------------------------------------------------------------
Accounts receivable:
Accounts receivable, excluding undelivered maintenance and services $ 11,258 $ 12,270
Undelivered maintenance and services billed in advance, included in deferred revenue 3,250 2,400
Reserve for bad debts (813) (1,335)
-----------------------
Net accounts receivable $ 13,695 $ 13,335
-----------------------
Inventories:
Computer systems and components, net of reserve for obsolescence of $127 and
$56, respectively $ 802 $ 679
Replacement parts for certain client systems, net of accumulated amortization of
$674 and $633, respectively 266 309
Miscellaneous parts and supplies 50 42
-----------------------
$ 1,118 $ 1,030
=======================
EQUIPMENT AND IMPROVEMENTS:
Computers and electronic test equipment $ 4,007 $ 3,764
Furniture and fixtures 1,253 1,092
Vehicles 8 8
Leasehold improvements 139 139
5,407 5,003
Accumulated depreciation and amortization (3,829) (3,184)
-----------------------
$ 1,578 $ 1,819
=======================
OTHER ASSETS:
Intangible assets, net $ 15 $ 152
Deferred compensation plan assets 721 967
Other assets 216 184
-----------------------
$ 952 $ 1,303
=======================
OTHER CURRENT LIABILITIES:
Accrued payroll and related expenses $ 1,675 $ 1,373
Deferred compensation 721 967
Income taxes payable 229 380
Other accrued expenses 755 852
-----------------------
$ 3,380 $ 3,572
- --------------------------------------------------------------------------------------------=======================
7. Income Taxes
The provision for income taxes consists of the following components:
(in thousands) --------------------------------
Year Ended March 31,
2002 2001 2000
-----------------------------------------------------------------
Federal:
Current taxes $ 1,849 $1,823 $ 2,308
Deferred taxes 1,043 500 (808)
--------------------------------
2,892 2,323 1,500
--------------------------------
State:
Current taxes 1,004 105 642
Deferred taxes (663) 82 (280)
--------------------------------
341 187 362
--------------------------------
$ 3,233 $2,510 $ 1,862
---------------------------------================================
F-11
The provision for income taxes differs from an amount computed at the Federal
statutory rate as follows:
--------------------------
Year Ended March 31,
2002 2001 2000
------------------------------------------------------------------------
Federal income tax statutory rate 34% 34% 34%
Increases (decreases) resulting from:
Non-deductible amortization of Goodwill -- 2.8% 3.6%
State income taxes 4.6% 4.4% 5.0%
Other (.6%) .5% --
--------------------------
Effective income tax rate 38% 41.7% 42.6%
----------------------------------------------==========================
The net deferred tax assets in the accompanying consolidated balance
sheets consist of the following at March 31, 2002 and 2001:
(in thousands)
--------------------
2002 2001
---------------------------------------------------------------------------
Deferred tax assets:
Accounts receivable $ 1,025 $ 1,062
Inventories 131 80
Purchased in-process research and development 2,823 2,872
Intangible assets 147 173
Accrued compensation 400 275
Accrued liability for deferred compensation 409 348
Other 32 166
--------------------
$ 4,967 $ 4,976
--------------------
Deferred tax liabilities:
Accelerated depreciation $ (113) $ (52)
Capitalized software (513) (369)
Deferred revenue (195) --
Inventories -- (17)
Equipment and improvements -- (12)
--------------------
(821) (450)
--------------------
$ 4,146 $ 4,526
-------------------------------------------------------====================
The deferred tax assets and liabilities have been shown net in the
accompanying consolidated balance sheets based on the long-term or short-term
nature of the items which give rise to the deferred amount.
8. Employee Benefit Plans
The Company has 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 $116,000, $77,000 and $73,000 were made by
the Company to the Retirement Plan for the fiscal years ended March 31, 2002,
2001 and 2000, respectively.
During the fiscal year ended March 31, 1994, the Company 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 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 $721,000 and $967,000 at March 31, 2002 and 2001, respectively. The Company
made contributions of $12,000, $11,000 and $10,000 to the Deferral Plan for the
fiscal years ended March 31, 2002, 2001 and 2000, respectively.
F-12
9. 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 granted 103,595 outstanding options at March 31, 2002 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 or a duly designated compensation committee, 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, 2002, 576,300 shares were available for future grant under the 1998 Plan. As
of March 31, 2002, there were 391,888 outstanding options related to this plan.
A summary of option transactions under the 1989 & 1998 Plans for the three
years ended March 31, 2002 is as follows:
----------------------------------------
Weighted Average
Number of Shares Exercise Price
------------------------------------------------------------------------------------------------------
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
Granted (weighted average fair value of $5.97) 139,940 11.99
Exercised (117,205) 6.83
Cancelled (5,750) 6.74
----------------------
Outstanding, March 31, 2002 (156,551 exercisable at a
weighted average price of $7.04) 495,483 $ 8.61
--------------------------------------------------------------========================================
The outstanding stock options vest ratably over a four-year period
commencing from the respective option grant dates. Stock options outstanding at
March 31, 2002 are summarized as follows:
-----------------------------------------------------------------------------------
Number Weighted Avg. Weighted
Range of Exercise Outstanding at Remaining Contractual Average Exercise
Prices March 31, 2002 Life (Yrs.) Price
----------------------------------------------------------------------------------------------------------------
Options Outstanding $ 3.69 - $ 6.25 72,500 2.0 $ 6.06
$ 6.38 - $ 7.75 253,668 2.1 $ 7.39
$ 9.13 - $ 12.99 169,315 4.0 $ 11.54
-------
495,483 2.7 $ 8.61
=======
----------------------------------------------------------------------------------------------------------------
F-13
---------------------------------------------------------
Number Weighted
Range of Exercisable at Average
Exercise Prices March 31, 2002 Exercise Price
--------------------------------------------------------------------------------------
Options Exercisable $ 3.69 - $ 6.25 38,000 $ 5.97
$ 6.38 - $ 7.75 108,957 $ 7.20
$ 9.13 - $ 12.99 9,594 $ 9.51
-------
156,551 $ 7.04
=======
--------------------------------------------------------------------------------------
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 fair value 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 55% to 57% in fiscal 2002, and 50% to 60%
in both fiscal 2001 and 2000; risk free interest rates of 3.5% to 4.5% in fiscal
2002, 5.0% in 2001, and 6.0% in fiscal 2000; 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 $4,707,000 or $0.78 per share in
fiscal 2002, $3,169,000 or $0.52 per share in fiscal 2001, and $2,111,000 or
$0.34 per share in fiscal 2000. These amounts are based on calculated values for
option awards in fiscal 2002, 2001 and 2000 of $884,000, $461,000 and $775,000,
respectively.
10. 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 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.
F-14
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, which had been stayed pending the
appointment of class counsel, is now ongoing. In March 2002, defendant Graeme H.
Frehner and certain other defendants not affiliated with the Company were
dismissed from the action with prejudice by stipulated order.
The parties are scheduled to appear in court for the next status
conference on October 22, 2002. Trial in the action has been set for March 24,
2003.
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.
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
irrevocable operating lease agreements expiring at various dates through March
2009. The Company has rental commitments under these agreements in fiscal 2003,
2004, 2005, 2006, 2007 and thereafter of $825,000, $1,010,000, $1,085,000,
$768,000, $576,000, and $896,000, respectively. The total rental commitments is
$5,160,000. Total rental expense for all operating leases was $897,000, $914,000
and $901,000 for the years ended March 31, 2002, 2001 and 2000, respectively.
11. Stock Repurchase Plan
The Company had a stock repurchase plan in place that expired on June 7,
2001 in which the Company repurchased 345,800 shares at a cash cost of
$2,494,000. In October 2001, the Company's Board of Directors authorized the
repurchase on the open market of up to 5% of the shares of the Company's
outstanding Common Stock, subject to compliance with applicable laws and
regulations. This authorization expires on the date of the Fiscal 2003 Annual
Shareholders meeting. As of March 31, 2002, the Company has not repurchased any
shares. The Company's management could, in the exercise of its judgment, decide
not to effect any repurchases, or to repurchase fewer shares than authorized.
12. Fair Value of Financial Instruments
The Company's financial instruments include cash, accounts receivable,
accounts payable, deferred revenue, and accrued liabilities. Management believes
that the fair value of cash, accounts receivable, accounts payable, deferred
revenue, and accrued liabilities approximate the carrying values due to the
short-term nature of these instruments.
13. 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 NextGen 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.
F-15
Operating segment data for the three years ended March 31, was as follows:
(in thousands) ----------------------------------------------------------------------------------
NextGen (formerly Unallocated
QSI Division MicroMed) Division Corporate Expenses Consolidated
----------------------------------------------------------------------------------------------------------------------
Year Ended March 31, 2002
Revenue $ 17,224 $ 27,198 -- $ 44,422
Operating Income (Loss) $ 5,196 $ 4,656 $ (1,994) $ 7,858
Year Ended March 31, 2001
Revenue $ 17,225 $ 22,711 -- $ 39,936
Operating Income (Loss) $ 3,231 $ 3,662 $ (1,906) $ 4,987
Year Ended March 31, 2000
Revenue $ 18,955 $ 17,418 -- $ 36,373
Operating Income (Loss) $ 3,230 $ 2,346 $ (1,969) $ 3,607
----------------------------------------------------------------------------------------------------------------------
In fiscal 2001, management adopted certain internal allocation conventions
for use in the reporting the performance of individual operating divisions on a
go-forward basis. Although these conventions were not applied during the fiscal
year 2000, management has estimated the segment disclosures and related
corporate costs for the respective periods.
14. Selected Quarterly Operating Results (unaudited)
The following table presents quarterly unaudited consolidated financial
information for the eight quarters in the period ended March 31, 2002. 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)
-------------------------------------------------------------------------------------------------------------------
6/30/00 9/30/00 12/31/00 3/31/01 6/30/01 9/30/01 12/31/01 3/31/02
----------------------------------------------------------------------------
Systems, upgrades and supplies sales $4,395 $ 4,794 $ 5,230 $ 5,516 $ 5,594 $ 5,110 $ 5,458 $ 6,358
Maintenance and other 4,867 4,869 5,103 5,162 5,315 5,387 5,585 5,615
----------------------------------------------------------------------------
9,262 9,663 10,333 10,678 10,909 10,497 11,043 11,973
Costs of products and services 4,032 4,363 4,459 4,429 4,734 4,547 4,900 5,072
----------------------------------------------------------------------------
5,230 5,300 5,874 6,249 6,175 5,950 6,143 6,901
Selling, General, & Administrative 3,365 3,244 3,451 3,525 3,245 3,294 3,019 3,510
Research & Development 1,005 974 1,010 1,092 1,107 1,000 1,057 1,079
----------------------------------------------------------------------------
860 1,082 1,413 1,632 1,823 1,656 2,067 2,312
Investment Income 246 251 261 274 206 190 147 100
----------------------------------------------------------------------------
1,106 1,333 1,674 1,906 2,029 1,846 2,214 2,412
Provision for Income Taxes 481 589 708 732 771 714 832 918
Net Income $ 625 $ 744 $ 966 $ 1,174 $ 1,258 $ 1,132 $ 1,382 $ 1,494
============================================================================
Net Income per share - Basic $ .10 $ .12 $ .16 $ .20 $ .21 $ .19 $ .23 $ .25
Net Income per share -
Diluted $ .10 $ .12 $ .16 $ .19 $ .20 $ .18 $ .22 $ .24
Weighted Average Shares
Outstanding - Basic 6,209 6,209 6,119 5,983 5,989 6,005 6,025 6,078
Weighted Average Shares
Outstanding - Diluted 6,297 6,273 6,162 6,099 6,173 6,204 6,224 6,320
-------------------------------------------------------------------------------------------------------------------
F-16
Schedule II
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(in thousands)
- --------------------------------------------------------------------------------------------------------------------
Additions
Balance at -----------------------------------
beginning of Charged to costs Charged to other Balance at
Description period and expenses accounts Deductions End of Period
- --------------------------------------------------------------------------------------------------------------------
For the year ended:
March 31, 2002 $ 1,335 $ 497 $ -- $ (1,019) $ 813
March 31, 2001 $ 1,121 $ 1,272 $ -- $ (1,058) $ 1,335
March 31, 2000 $ 754 $ 529 $ -- $ (162) $ 1,121
- --------------------------------------------------------------------------------------------------------------------
F-17
INDEX TO EXHIBITS
10.17 Sublease Agreement between Company and Infinium Software dated February
22, 2002.
10.18 Lease Agreement between Company and HUB Properties LLC dated May 8,
2002.
E-1