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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange
Act Of 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2003
Or
[ ] Transition Report Pursuant To Section 13 Or 15(d) Of The Securities
Exchange Act Of 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission File Number: 0-21031
QUADRAMED CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1992861
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
12110 SUNSET HILLS ROAD, SUITE 600,
RESTON, VIRGINIA 20190
(Address of Principal Executive Offices) (Zip Code)
(703) 709-2300
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common
Stock, $0.01 Par Value Per Share
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes __ No X
Indicate by check mark whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Act. Yes X No _
As of August 31, 2003, there were 27,606,069 shares of the Registrant's
common stock outstanding, par value $0.01.
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QUADRAMED CORPORATION
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Interim Condensed Consolidated Balance Sheets as of
March 31, 2003 and December 31, 2002.......................... 2
Interim Condensed Consolidated Statements of Operations for
the three months ended March 31, 2003 and 2002................. 3
Interim Condensed Consolidated Statements of Cash Flows for
the three months ended March 31, 2003 and 2002................. 4
Notes to Interim Condensed Consolidated Financial Statements..... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 31
Item 4. Controls and Procedures.......................................... 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 33
Item 6. Exhibits and Reports on Form 8-K................................. 33
Signatures............................................................... 34
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(unaudited)
March 31, December 31,
ASSETS 2003 2002
----------- ------------
Current assets
Cash and cash equivalents $ 20,937 $ 23,663
Short-term investments 2,528 2,528
Accounts receivable, net of allowance for doubtful
accounts of $4,585 and $4,346, respectively 39,071 31,612
Unbilled receivables 3,581 3,475
Notes and other receivables 110 4,416
Prepaid expenses and other current assets 9,474 8,972
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Total current assets 75,701 74,666
Restricted cash 5,849 5,849
Property and equipment, net of accumulated depreciation
and amortization of $17,115 and $16,170 respectively 5,553 6,019
Capitalized software development costs, net of
accumulated amortization of $8,454 and $7,776,
respectively 5,125 5,670
Goodwill 18,445 18,445
Other intangible assets, net of accumulated amortization
of $13,901 and $13,316, respectively 8,690 9,275
Other long-term assets 6,887 7,003
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Total assets $ 126,250 $ 126,927
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses $ 2,776 $ 3,586
Accrued payroll and related 5,649 6,942
Other accrued liabilities 8,895 6,509
Deferred revenue 48,704 39,492
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Total current liabilities 66,024 56,529
Convertible subordinated debentures 73,719 73,719
Other long-term liabilities 4,100 3,914
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Total liabilities 143,843 134,162
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Stockholders' equity (deficit)
Preferred stock, $0.01 par, 5,000 shares authorized,
zero shares issued and outstanding -- --
Common stock, $0.01 par, 50,000 shares authorized,
27,044 and 26,965 shares issued and outstanding,
respectively 272 205
Additional paid-in-capital 275,668 275,631
Deferred compensation (422) (588)
Accumulated other comprehensive loss (260) (310)
Accumulated deficit (292,851) (282,173)
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Total stockholders' equity (deficit) (17,593) (7,235)
--------- ---------
Total liabilities and stockholders' equity (deficit) $ 126,250 $ 126,927
========= =========
The accompanying notes are an integral part of these interim
condensed consolidated financial statements.
2
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended March 31,
----------------------------
2003 2002
---- ----
Revenue
Services and other $ 19,679 $ 19,000
Licenses 9,555 8,180
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Total revenue 29,234 27,180
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Cost of revenue
Cost of services and other 11,700 7,727
Cost of licenses 1,882 2,133
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Total cost of revenue 13,582 9,860
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Gross margin 15,652 17,320
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Operating expenses
General and administration 13,531 7,823
Sales and marketing 5,761 5,175
Research and development 5,477 3,653
Amortization and other operating charges 585 512
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Total operating expenses 25,354 17,163
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Income (loss) from operations (9,702) 157
Other income (expense)
Interest expense (1,063) (865)
Interest income 157 174
Other income (expense), net (70) (90)
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Other income (expense) (976) (781)
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Loss from continuing operations (10,678) (624)
Loss from discontinued operations -- (704)
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Net loss $ (10,678) $ (1,328)
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Loss per share
Basic and Diluted
Continuing operations $ (0.40) $ (0.02)
Discontinued operations -- (0.03)
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Net $ (0.40) $ (0.05)
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Weighted average shares outstanding
Basic and diluted 27,005 26,809
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The accompanying notes are an integral part of these interim
condensed consolidated financial statements.
3
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three months ended March 31,
----------------------------
2003 2002
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Cash flows from operating activities
Net loss from continuing operations $ (10,678) $ (624)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization 2,468 2,115
Provision for bad debts 239 (16)
Write-off of assets -- 102
Other 51 52
Changes in assets and liabilities:
Accounts receivable (7,698) (3,382)
Prepaid expenses and other (485) (1,221)
Accounts payable and accrued liabilities 486 (2,105)
Deferred revenue 9,212 6,256
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Cash (used in) provided by continuing
operations (6,405) 1,177
Cash (used in) provided by discontinued
operations -- (709)
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Cash (used in) provided by operating
activities (6,405) 468
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Cash flows from investing activities
Increase in restricted cash -- (103)
Proceeds from sale of assets 4,190 --
Purchases of available-for-sale securities (255) --
Proceeds from sale of available-for-sale securities 270 --
Capitalized software development costs (133) (784)
Purchases of property and equipment (479) (707)
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Cash provided by (used in) investing
activities 3,593 (1,594)
--------- ---------
Cash flows from financing activities
Proceeds from issuance of common stock 104 1,810
Repayments of debt (18) (20)
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Cash provided by financing activities 86 1,790
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Net (decrease) increase in cash and cash
equivalents (2,726) 664
Cash and cash equivalents, beginning of period 23,663 29,799
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Cash and cash equivalents, end of period $ 20,937 $ 30,463
========= =========
Supplemental disclosure of cash flow information
Cash paid for interest $ -- $ --
========= =========
Net cash (refunded) paid for taxes $ (13) $ 336
========= =========
The accompanying notes are an integral part of these interim
condensed consolidated financial statements.
4
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003
1. NATURE OF OPERATIONS
QuadraMed Corporation along with all significant business divisions and
subsidiaries, (the "Company" or "QuadraMed") is dedicated to improving
healthcare delivery by providing innovative healthcare information technology
and services. From clinical to patient information management and revenue cycle
to health information management, QuadraMed delivers real-world solutions that
help healthcare professionals deliver outstanding patient care with optimum
efficiency. QuadraMed was reincorporated in Delaware in 1996, having been
originally incorporated in California in 1993. QuadraMed is managed in three
distinct business segments which are as follows: Enterprise Division, Health
Information Management Software Division, and Financial Services Division. In
December 2002, QuadraMed sold its Health Information Management Systems
Division. Results of operations for this division are reflected as
discontinued operations in the Statement of Operations.
2. BASIS OF PRESENTATION
Unaudited Interim Results
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The condensed consolidated financial statements at March 31, 2003 and
December 31, 2002 and for the three months ended March 31, 2003 and 2002 have
been prepared in accordance with accounting principles generally accepted in
the United States of America ("GAAP"). The interim financial information is
unaudited, but reflects all adjustments that are, in the opinion of management,
necessary for a fair presentation of QuadraMed's condensed consolidated
financial position, operating results, and cash flows for the interim periods.
The preparation of condensed consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the condensed
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting periods.
These condensed consolidated financial statements have been prepared in
accordance with the instructions for a report on Form 10-Q as required by the
SEC, and therefore, do not include all information and notes normally provided
in annual financial statements. As a result, these condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, together with management's discussion
and analysis of financial condition and results of operations, contained in
QuadraMed's annual report on Form 10-K for the fiscal year ended December 31,
2002. The results of operations for the three months ended March 31, 2003 are
not necessarily indicative of the results for the fiscal year ending December
31, 2003 or any other further periods.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, Rescission of
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FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and
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Technical Corrections. This statement updates and clarifies existing
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pronouncements relating to the classification and reporting of gains and losses
from the extinguishment of debt, the treatment of sale-leaseback transactions
and also makes technical corrections to existing pronouncements. QuadraMed
adopted the provisions of SFAS 145 effective January 1, 2003. The
implementation of this new standard did not have a significant impact on
QuadraMed's financial condition, results of operations and cash flows.
In November 2002, the FASB reached a consensus on EITF No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables. The guidance
- --------------------------------------------------------------
in EITF 00-21 is effective for revenue arrangements entered into in fiscal
years beginning after June 15, 2003. This issue addresses certain aspects of
the accounting by a vendor for arrangements under which it will perform
multiple revenue-generating activities. Specifically, EITF 00-21 addresses how
to determine whether an arrangement involving multiple deliverables contains
more than one earnings process and, if it does, how to divide the arrangement
into separate units of accounting consistent with the identified earning
processes for revenue recognition purposes. EITF 00-21 also addresses how
arrangement consideration should be measured and allocated to the separate
units of accounting in the arrangement. QuadraMed is evaluating the effect of
this issue on its financial statements.
5
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
March 31, 2003
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
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Interest Entities. FIN 46 expands upon and strengthens existing accounting
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guidance that addresses when a company should include in its financial
statements the assets, liabilities and activities of another entity. A variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. FIN
46 requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or is entitled to receive a majority of the entity's
residual returns or both. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year or
interim period beginning after June 15, 2003. Disclosure requirements apply to
any financial statements issued after January 31, 2003. QuadraMed has
considered the provisions of FIN 46 and believe it will not be necessary to
include in its financial statements any assets, liabilities, or activities of
the third-party entities holding its corporate headquarters leases. QuadraMed
will continue to evaluate the impact of FIN 46 on other areas of its financial
statements and disclosures, as appropriate.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
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Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies
- ---------------------------------------------
the accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 149
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is generally effective for contracts entered into or modified after June 30,
2003 and for hedging relationships designated after June 30, 2003. QuadraMed is
currently evaluating the impact of SFAS 149 on its consolidated financial
position and results of operations. QuadraMed does not expect the adoption of
SFAS 149 to have a material impact on its consolidated financial position,
results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
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Financial Instruments with Characteristics of both Liabilities and Equity.
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SFAS 150 requires that certain financial instruments, which under previous
guidance were accounted for as equity, must now be accounted for as
liabilities. The financial instruments affected include mandatory redeemable
stock, certain financial instruments that require or may require the issuer to
buy back some of its shares in exchange for cash or other assets and certain
obligations that can be settled with shares of stock. SFAS 150 is effective for
all financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. QuadraMed does not expect the adoption of SFAS 150 to have
a material impact on its consolidated financial position, results of operations
or cash flows.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
-----------------------------
Assets, effective for fiscal years beginning after December 15, 2001. Under
- ------
SFAS 142, goodwill and intangible assets deemed to have indefinite lives are to
be separately disclosed on the balance sheet, and no longer amortized but
subject to annual impairment tests. With the adoption of SFAS 142, QuadraMed
ceased amortization of goodwill as of January 1, 2002. Prior to this point,
goodwill was amortized using the straight-line method over its estimated useful
life.
SFAS 142 requires that goodwill be tested for impairment at the reporting
unit level (i.e., business segments) upon adoption and at least annually
thereafter using a two-step impairment analysis. In accordance with SFAS 142,
QuadraMed performed the first of the required two-step impairment tests of
goodwill and indefinite-lived assets as of January 1, 2002 utilizing an
independent appraiser. The test results showed no indicators of impairment as
of January 1, 2002.
As of January 1, 2003, QuadraMed re-engaged the same independent appraiser
to review the goodwill as of this date for impairment. Once again, the test
showed no indicators of impairment. QuadraMed will continue to perform the
tests of impairment for goodwill required by SFAS 142 on an annual basis or
more often, as necessary.
Except for capitalized software development costs, other intangible assets
are amortized on a straight-line basis over a period of five to ten years.
Capitalized software development costs are amortized on a straight-line basis
6
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
March 31, 2003
generally over a period of five years. These assets are reviewed annually for
impairment and written down to net realizable value, if necessary, in
accordance with SFAS No. 144, Impairment of Long-Lived Assets.
Amortization of intangible assets for the three months ended March 31,
2003 and 2002 was $585,000 and $512,000, respectively. There were no
impairment charges recorded during the three months ended March 31, 2003 and
2002.
5. RESTRICTED STOCK GRANTS
During the three months ended March 31, 2003 and 2002, QuadraMed issued an
aggregate of no and 39,000 shares, respectively of its common stock as
restricted stock under QuadraMed's 1996 Stock Plan. QuadraMed grants
restricted shares to certain senior executives for no consideration. All of
the outstanding restricted shares fully vest at the conclusion of a three-year
period. QuadraMed has recorded the difference between fair market value of the
restricted shares on the date the restricted stock purchase rights were
granted, and the exercise price of such shares on that date as deferred
compensation within the Stockholders' Equity (Deficit) section of the
Consolidated Balance Sheet. In accordance with the provisions of SFAS 123,
QuadraMed amortizes this amount, pro rata over the related service period as it
expects the shares to fully vest. Any changes in the expected or actual
outcome of the grants are considered to be changes in estimate and are
accordingly, recognized in the period the change becomes known. In March 2003,
a senior executive of QuadraMed was terminated. In accordance with the
provisions of his employment agreement, 75,000 unvested shares immediately
vested upon his termination. Accordingly, QuadraMed recognized the remaining
$75,000 associated with the accelerated vesting as the vesting was a known
event. Compensation expense associated with the grants of restricted stock
totaling $91,000 and $131,000 was recognized during the three months ended
March 31, 2003 and 2002, respectively. As of March 31, 2003, 332,000
restricted shares remained subject to vesting.
6. STOCK-BASED COMPENSATION
SFAS 123, Accounting for Stock Based Compensation, encourages, but does
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not require, companies to record compensation cost for stock based employee
compensation plans at fair value. QuadraMed has chosen to continue to account
for stock based employee compensation using the intrinsic value method
prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for
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Stock Issued to Employees, and Related Interpretations. Accordingly,
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compensation cost for stock options granted to employees is measured as the
excess, if any, of the quoted market price of QuadraMed's stock at the date of
the grant over the amount an employee must pay to acquire the stock.
QuadraMed has determined pro-forma information regarding net income and
earnings per share as if we had accounted for employee stock options under the
fair value method as required by SFAS No. 123. The fair value of these stock-
based awards to employees was estimated using the Black-Scholes option pricing
model. Please see below for assumptions used in the Black-Scholes option
pricing model. Had compensation cost for the Company's stock option plan and
employee stock purchase plan been determined consistent with SFAS No. 123, the
Company's reported net income (loss) and net earnings (loss) per share would
have been changed to the amounts indicated below (in thousands except per share
data):
7
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
March 31, 2003
Three months ended March 31,
----------------------------
2003 2002
---- ----
Net loss as reported $ (10,678) $ (1,328)
Add: Stock-based employee compensation expense
included in reported net loss, net of related
tax effects 166 139
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1,124) (1,266)
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Pro forma net loss $ (11,636) $ (2,455)
========= =========
Earnings per share:
Basic and diluted- as reported $ (0.40) $ (0.05)
========= =========
Basic and diluted- pro forma $ (0.43) $ (0.09)
========= =========
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following assumptions:
2003 2002
---- ----
Expected dividend yield -- --
Expected stock price volatility 142.66% 135.20%
Risk-free interest rate 2.74% 4.12%
Expected life of options 5 years 5 years
NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding during the period less restricted
shares of common stock. Diluted net loss per share is computed by dividing
income by the sum of the weighted average number of common shares, as adjusted
for restricted shares, and common equivalent shares outstanding during the
period. Common equivalent shares consist of shares issuable upon the exercise
of stock options and warrants (using the treasury stock method) and convertible
subordinated debentures (using the as-converted method). Common equivalent
shares are excluded from the diluted computation only if their effect is anti-
dilutive. As QuadraMed recorded net losses for each of the three-month periods
ended March 31, 2003 and 2002, no common equivalent shares were included in the
net loss per share calculation because they were anti-dilutive.
7. COMPREHENSIVE LOSS
The components of comprehensive loss for the three months ended March 31,
2003 and 2002 are as follows (in thousands):
Three months ended March 31,
----------------------------
2003 2002
---- ----
Net loss $ (10,678) $ (1,328)
Unrealized gain (loss) on available-for-sale
securities, net of taxes (1) (48)
Amortization of unrecognized pension costs,
net of taxes 51 51
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Comprehensive loss $ (10,628) $ (1,325)
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8
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
March 31, 2003
8. SEGMENT REPORTING
QuadraMed aligns its operations into three business segments for
management reporting purposes. These segments are based on product
functionality and shared target markets. This alignment allows management to
more accurately measure financial performance by product/division and to
establish greater management accountability. QuadraMed's business segments are
(i) the Enterprise Division, (ii) the Health Information Management Software
Division, and (iii) the Financial Services Division. The operations and assets
of these segments are primarily located in the United States. QuadraMed reports
the Enterprise Division, the Health Information Management Software Division,
and the Financial Services Division as reportable segments in accordance with
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
-------------------------------------------------------
Information. The accounting policies of the operating segments are the same as
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those described in the summary of significant accounting policies described in
notes to the financial statements in our Annual Report on Form 10-K for the
year ended December 31, 2002. The financial results for these operating
segments for prior periods have been reclassified to conform to the current
period presentation.
Selected results of operations for these business segments are provided to
QuadraMed's Chief Operating Decision Maker (CODM), who is the Chairman of the
Board and Chief Executive Officer.
Summary financial data by business segment as reported to the CODM in
presented below for the three months ended March 31, 2003 and 2002 (in
thousands):
Three months ended March 31, 2003
---------------------------------------------------
HIM Financial Consolidated
Description Enterprise Software Services Other (1) Total
- -------------------------- ---------- -------- -------- --------- -----
Total revenues $ 18,512 $ 7,816 $ 2,906 $ -- $ 29,234
Gross margin $ 9,966 $ 5,072 $ 614 $ -- $ 15,652
Interest income (expense),
net $ (577) $ (220) $ (181) $ 72 $ (906)
Segment assets $ 48,440 $ 35,936 $ 6,129 $ 35,745 $ 126,250
Total depreciation and
amortization (2) $ 944 $ 921 $ 217 $ 386 $ 2,468
- ----------------------------------
(1) Other includes non-allocated expenses for bad debt, legal costs,
restructuring charges and divested product lines for operating results and
non-allocable assets such as cash and cash equivalents and restricted cash,
investments, certain enterprise-wide intangible assets, etc. and assets of
divested product lines for segment assets.
(2) Total depreciation and amortization is comprised of capitalized and
acquired software amortization reflected in gross margin, equipment
depreciation, amortization of debt-offering costs as reflected in interest
expense, amortization of deferred compensation and amortization of other
intangibles.
9
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
March 31, 2003
Three months ended March 31, 2002
---------------------------------------------------
HIM Financial Consolidated
Description Enterprise Software Services Other (1) Total
- -------------------------- ---------- -------- -------- --------- -----
Total revenues $ 16,627 $ 6,829 $ 3,724 $ -- $ 27,180
Gross margin $ 10,535 $ 4,748 $ 2,037 $ -- $ 17,320
Interest income (expense),
net $ (421) $ (169) $ (134) $ 33 $ (691)
Segment assets $ 34,017 $ 45,236 $ 5,715 $ 44,914 $ 129,882
Total depreciation and
amortization (2) $ 442 $ 811 $ 131 $ 731 $ 2,115
- --------------------------------
(1) Other includes non-allocated expenses for bad debt, legal costs,
restructuring charges and divested product lines for operating results and
non-allocable assets such as cash and cash equivalents and restricted cash,
investments, certain enterprise-wide intangible assets, etc. and assets of
divested product lines for segment assets.
(2) Total depreciation and amortization is comprised of capitalized and
acquired software amortization reflected in gross margin, equipment
depreciation, amortization of debt-offering costs as reflected in interest
expense, amortization of deferred compensation and amortization of other
intangibles.
9. MAJOR CUSTOMERS
In the three months ended March 31, 2003 and 2002, no single customer
accounted for more than 10% of total revenues however, in the three months
ended March 31, 2003 and 2002, sales to the U. S. government accounted for
24.4% and 21.1%, respectively, of HIM Software Division revenues.
10. LITIGATION AND OTHER MATTERS
In October 2002, a series of securities law class action complaints were
filed in the United States District Court, California Northern District,
against QuadraMed and certain of its officers and directors. The plaintiffs in
these actions allege, among other things, violations of the Securities Exchange
Act of 1934 due to issuing a series of allegedly false and misleading
statements concerning its business and financial condition between May 11, 2000
and August 11, 2002. The complaints seek unspecified monetary damages and
other relief. These matters are at an early stage. No responses to the
complaints have yet been filed, and no discovery has taken place. QuadraMed
intends to defend itself vigorously against these allegations. However, the
ultimate outcome of these matters cannot presently be determined.
On February 28, 2003, QuadraMed reported that the SEC issued a formal non-
public order of investigation concerning QuadraMed's accounting and financial
reporting practices for the period beginning January 1, 1998. QuadraMed
intends to continue to cooperate with the SEC and has complied with the SEC's
requests for information. QuadraMed cannot predict when the SEC will conclude
its inquiry, or the outcome and impact thereof.
On March 4, 2003, QuadraMed's common stock was delisted from the Nasdaq
National Market. The delisting constituted a "Repurchase Event" under the
provisions of QuadraMed's 5.25% Convertible Subordinated Debentures Agreements
due 2005 (the "2005 Debt"). Upon such an event, the 2005 Debt grants to each
debenture holder the right, at the holder's option, to require QuadraMed to
repurchase all or any of the holder's debentures. On April 17, 2003, under the
terms of a refinance agreement with certain of the 2005 debt holders and new
investors, QuadraMed issued $71.0 million of its Senior Secured Notes due 2008
(the "2008 Debt"). The proceeds from the issuance of the 2008 Debt were used
to repurchase $61.8 million (plus $1.5 million in accrued interest) of the 2005
Debt required to be repurchased. Accordingly, the net proceeds as a result of
the issuance of the 2008 Debt less the costs (including fees) associated with
the repurchase of the 2005 Debt was $8.5 million, with $11.9 million of the
2005 Debt remaining outstanding. Additionally, the repurchase right on the
2005 Debt remaining outstanding expired on April 17, 2003.
10
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
March 31, 2003
The 2008 Debt bears interest at an initial rate of 10% which will be
reduced to 9% upon any relisting of QuadraMed's common stock on the Nasdaq,
including Nasdaq SmallCap or U.S. National Market and is secured by certain
intellectual property. The 2008 Debt contains certain events of default. These
events include: failure to timely repay principal or interest owed on the
debentures, default under any other borrowing, and bankruptcy. As part of the
transaction, QuadraMed also issued 11.6 million warrants to purchase common
stock. The warrants have a term of five years, have an exercise price of $.01
per share and are subject to certain anti-dilution provisions including
dilution from the issuance of shares in settlement of any existing litigation.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Cautionary Statement on Risks Associated With Forward-Looking Statements
------------------------------------------------------------------------
You should read the following discussion in conjunction with our Interim
Condensed Consolidated Financial Statements and related Notes. This Report
contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 that are subject to risks and
uncertainties. The words "believe", "expect", "target", "goal", "project",
"anticipate", "predict", "intend", "plan", "estimate", "may", "will", "should",
"could", and similar expressions and their negatives are intended to identify
such statements. Forward-looking statements are not guarantees of future
performance, anticipated trends and growth in businesses, or other
characterizations of future events or circumstances and are to be interpreted
only as of the date on which they are made. We undertake no obligation to
update or revise any forward-looking statement. You should not place undue
reliance on these forward-looking statements. Our actual results could differ
materially from those anticipated in these forward-looking statements for many
reasons, including the risks faced by us described below and elsewhere in this
Report, and in other documents we file with the SEC from time to time.
Significant Accounting Policies and Estimates
- ---------------------------------------------
Our significant accounting policies have a considerable impact on
Management's Discussion and Analysis.
Principles of Consolidation
---------------------------
These consolidated financial statements, which include our accounts and
all our significant business divisions and subsidiaries, have been prepared in
conformity with (i) GAAP; and (ii) the rules and regulations of the SEC. All
significant intercompany accounts and transactions between us and our
subsidiaries have been eliminated in the consolidated financial statements.
Use of Estimates
----------------
Management's discussion and analysis of our financial condition and
results of operations are based upon our condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. In preparing these
financial statements, we make estimates, assumptions, and judgments that affect
the reported amounts of assets and liabilities, contingent assets and
liabilities, revenues, and expenses. Significant estimates and assumptions
have been made regarding revenue recognition, the allowance for doubtful
account, investments, capitalized software, income taxes, restructuring,
pensions and other benefits, and contingencies and litigation and intangibles,
primarily goodwill and customer lists, resulting from our purchase business
combinations. We base our estimates, assumptions, and judgments on historical
experience and on various other assumptions 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. Uncertainties inherent in these estimates include
projections of future operating results and the discount rates used to
determine the net present values of these future results and useful lives of
the acquired assets as well as technological advances. In addition, for our
fixed-price contracts, we make significant estimates within percentage-of-
completion accounting, including estimating total costs to be incurred as
calculated on a labor hour basis. We annually review and test our estimates,
specifically those related to the valuations of intangibles including acquired
software, goodwill, customer lists, trademarks and other intangibles, and
capitalized software. Actual results may differ materially from these
estimates.
Revenue Recognition
-------------------
Our revenue in the ordinary course of business is principally generated
from two sources: (i) licensing arrangements and (ii) services.
Our license revenue consists of fees for licenses of our software and
hosted services. Cost of license revenue primarily includes product, delivery
and royalty costs and facilities costs. Our service revenue consists of
maintenance, customer training and consulting services and fees for providing
management services such as accounts receivable and payment collection
outsourcing, specialized staffing, analytical services and seminars. Cost of
services consists primarily of salaries, benefits, and allocated costs related
to providing such services, labor costs for engineers performing implementation
services and technical support and training personnel.
12
We license our products through our direct sales force. Our license
agreements for such products do not provide for a right of return, and
historically product returns have not been significant.
We recognize revenue on our software products in accordance with Statement
of Position ("SOP") 97-2, Software Revenue Recognition, as amended by SOP 98-9,
----------------------------------------------------
Modification of SOP 97-2, Software Revenue Recognition, With Respect to
- -----------------------------------------------------------------------
Certain Transactions; SOP 81-1, Accounting for Performance of Construction-Type
- -------------------- -----------------------------------------------
and Certain Production-Type Contracts; and Staff Accounting Bulletin ("SAB")
- -------------------------------------
101, Revenue Recognition in Financial Statements.
-------------------------------------------
We recognize revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery of the product has
occurred; no significant obligations by us with regard to implementation
remain; the fee is fixed and determinable; and, collectibility is probable.
Delivery is considered to have occurred when title and risk of loss have been
transferred to the customer, which generally occurs when media containing the
licensed programs is provided to a common carrier. We consider all
arrangements with payment terms extending beyond 180 days to be not fixed and
determinable, and revenue is recognized as payments become due from the
customer. If collectibility is not considered probable, revenue is recognized
when the fee is collected.
SOP 97-2, as amended, generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. Revenue recognized from multiple-
element arrangements is allocated to undelivered elements of the arrangement,
such as maintenance, support and professional services, based on the relative
fair values of the elements specific to us. Our determination of fair value of
each element in multi-element arrangements is based on vendor-specific
objective evidence ("VSOE"). We limit our assessment of VSOE for each element
to either the price charged when the same element is sold separately or the
price established by management, having the relevant authority to do so, for an
element not yet sold separately.
If evidence of fair value of all undelivered elements exists but evidence
does not exist for one or more delivered elements, then revenue is recognized
using the residual method. Under the residual method, the fair value of the
undelivered elements is deferred and the remaining portion of the arrangement
fee is recognized as revenue. Revenue from hosted applications is recognized
ratably over the term of the arrangement. The proportion of revenue recognized
upon delivery may vary from quarter to quarter depending upon the relative mix
of licensing arrangements and the availability of VSOE of fair value for
undelivered elements.
Certain of our perpetual and time-based licenses include unspecified
additional products and/or payment terms that extend beyond 12 months. We
recognize revenue from perpetual and time-based licenses that include
unspecified additional software products ratably over the term of the
arrangement.
Contract accounting is utilized for service revenue from fixed-price
contracts and those requiring significant software modification, development or
customization. In such instances, the arrangement fee is accounted for in
accordance with SOP 81-1, whereby the arrangement fee is recognized, generally
using the percentage-of-completion method measured on labor input costs. If
increases in projected costs-to-complete are sufficient to create a loss
contract, the entire estimated loss is charged to operations in the period the
loss first becomes known. The complexity of the estimation process and
judgment related to the assumptions, risks and uncertainties inherent with the
application of the percentage-of-completion method of accounting affect the
amounts of revenue and related expenses reported in its consolidated financial
statements. A number of internal and external factors can affect its
estimates, including labor rates, utilization, changes to specification and
testing requirements and collectibility of unbilled receivables.
Service revenues from software maintenance and support are recognized
ratably over the maintenance term, which in most cases is one year. Service
revenues from training, consulting and other service elements are recognized as
the services are performed.
Service revenues from providing management services such as accounts
receivable and payment collection outsourcing are recognized in accordance with
SAB 101. When all criteria for revenue recognition, as noted above, have been
met, revenue is recognized upon invoicing. If collectibility is not considered
probable, revenue is recognized when the fee is collected.
13
Accounts Receivable and Allowance for Doubtful Accounts
-------------------------------------------------------
Accounts receivable consist primarily of amounts due us from our normal
business activities. We maintain an allowance for doubtful accounts to reflect
the expected non-collection of accounts receivable based on past collection
history and specific risks identified within our portfolio. If the financial
condition of our customers were to deteriorate resulting in an impairment of
their ability to make payments, or if payments from customers are significantly
delayed, additional allowances might be required.
Intangible Assets
-----------------
Goodwill. In June 2001, the FASB issued Accounting SFAS No. 142, Goodwill
-------- --------
and Other Intangible Assets, effective for fiscal years beginning after
- ---------------------------
December 15, 2001. Under SFAS 142, goodwill and intangible assets deemed to
have indefinite lives are to be separately disclosed on the balance sheet, and
no longer amortized but subject to annual impairment tests. With the adoption
of SFAS 142, we ceased amortization of goodwill as of January 1, 2002. Prior to
this point, goodwill was amortized using the straight-line method over its
estimated useful life.
SFAS 142 requires that goodwill be tested for impairment at the reporting
unit level (i.e., business segments) upon adoption and at least annually
thereafter using a two-step impairment analysis. In accordance with SFAS 142,
we performed the first of the required two-step impairment tests of goodwill
and indefinite-lived assets as of January 1, 2002 utilizing an independent
appraiser. The test results showed no indicators of impairment as of January
1, 2002.
As of January 1, 2003, we re-engaged the same independent appraiser to
review the goodwill as of this date for impairment. Once again, the test
showed no indicators of impairment. We will continue to perform the tests of
impairment for goodwill required by SFAS 142 on an annual basis or more often,
as necessary.
Capitalized Software. Software development costs are capitalized upon the
--------------------
establishment of technological feasibility. In accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
- ------------------------------------------------------------------------------
Marketed, we establish technological feasibility upon completion of a detailed
- --------
program design determined on a project-by-project basis, which substantiates
that the computer software product can be produced in accordance with its
design specifications. Software development costs are capitalized based upon
an assessment of their recoverability. This assessment requires considerable
judgment by management with respect to various factors, including, but not
limited to, anticipated future gross margins, estimated economic lives, and
changes in software and hardware technology. Amortization is based on the
greater of the ratio that current revenues bear to total and anticipated future
revenues for the applicable product, or the straight-line method over the
remaining estimated economic life of the product, generally five years, and is
charged to cost of licenses.
Other Intangible Assets. Other intangible assets primarily relate to
-----------------------
acquired software, trademarks and customer lists acquired in our purchase
business combinations. On January 1, 2002, we adopted the provisions of SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which
--------------------------------------------------------------
generally requires impairment losses to be recorded on long-lived assets
(excluding goodwill) used in operations, such as property, equipment and
improvements, and intangible assets, when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amount of the assets. The provisions of this statement
did not have a significant impact on our financial condition or operating
results.
Recent Accounting Pronouncements
- --------------------------------
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement updates and clarifies existing pronouncements
relating to the classification and reporting of gains and losses from the
extinguishment of debt, the treatment of sale-leaseback transactions and also
makes technical corrections to existing pronouncements. We adopted the
provisions of SFAS 145 effective January 1, 2003. The implementation of this
new standard did not have a significant impact on our financial condition,
results of operations and cash flows.
14
In November 2002, the FASB reached a consensus on EITF No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables. The guidance
- --------------------------------------------------------------
in EITF 00-21 is effective for revenue arrangements entered into in fiscal
years beginning after June 15, 2003. This issue addresses certain aspects of
the accounting by a vendor for arrangements under which it will perform
multiple revenue-generating activities. Specifically, EITF 00-21 addresses how
to determine whether an arrangement involving multiple deliverables contains
more than one earnings process and, if it does, how to divide the arrangement
into separate units of accounting consistent with the identified earning
processes for revenue recognition purposes. EITF 00-21 also addresses how
arrangement consideration should be measured and allocated to the separate
units of accounting in the arrangement. We are evaluating the effect of this
issue on our financial statements.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
-------------------------
Interest Entities. FIN 46 expands upon and strengthens existing accounting
- -----------------
guidance that addresses when a company should include in its financial
statements the assets, liabilities and activities of another entity. A variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. FIN
46 requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or is entitled to receive a majority of the entity's
residual returns or both. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year or
interim period beginning after June 15, 2003. Disclosure requirements apply to
any financial statements issued after January 31, 2003. We have considered the
provisions of FIN 46 and believe it will not be necessary to include in our
financial statements any assets, liabilities, or activities of the third-party
entities holding our corporate headquarters leases. We will continue to
evaluate the impact of FIN 46 on other areas of our financial statements and
disclosures, as appropriate.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
-----------------------------
Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies
- ---------------------------------------------
the accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 149
is generally effective for contracts entered into or modified after June 30,
2003 and for hedging relationships designated after June 30, 2003. We are
currently evaluating the impact of SFAS 149 on our consolidated financial
position and results of operations. We do not expect the adoption of SFAS 149
to have a material impact on our consolidated financial position, results of
operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
----------------------
Financial Instruments with Characteristics of both Liabilities and Equity.
- -------------------------------------------------------------------------
SFAS 150 requires that certain financial instruments, which under previous
guidance were accounted for as equity, must now be accounted for as
liabilities. The financial instruments affected include mandatory redeemable
stock, certain financial instruments that require or may require the issuer to
buy back some of its shares in exchange for cash or other assets and certain
obligations that can be settled with shares of stock. SFAS 150 is effective for
all financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. We do not expect the adoption of SFAS 150 to have a
material impact on our consolidated financial position, results of operations
or cash flows.
15
Results of Operations
- ---------------------
The following table sets forth selected data for the indicated periods.
Percentages are expressed as a percentage of total revenues.
Three months ended March 31,
---------------------------------------------
2003 2002
-------------------- --------------------
Revenue
Services and other $ 19,679 67.3% $ 19,000 69.9%
Licenses 9,555 32.7 8,180 30.1
--------- ------ --------- ------
Total revenue 29,234 100.0 27,180 100.0
--------- ------ --------- ------
Cost of revenue
Cost of services and other 11,700 40.0 7,727 28.4
Cost of licenses 1,882 6.4 2,133 7.9
--------- ------ --------- ------
Total cost of revenue 13,582 46.4 9,860 36.3
--------- ------ --------- ------
Gross margin 15,652 53.6 17,320 63.7
--------- ------ --------- ------
Operating expenses
General and administration 13,531 46.3 7,823 28.8
Sales and marketing 5,761 19.7 5,175 19.0
Research and development 5,477 18.7 3,653 13.4
Amortization and other
operating charges 585 2.0 512 1.9
--------- ------ --------- ------
Total operating expenses 25,354 86.7 17,163 63.1
========= ====== ========= ======
Revenue
-------
Services and Other. Services and other revenue consists of professional
------------------
services, such as implementation services and training, maintenance, which
consists of technical support and product upgrades, hardware, reimbursable
expenses and other service revenue. Professional services are typically
provided over a period of three months to six months for the HIM software
division and up to two years for the Enterprise division. These services are
provided subsequent to the signing of a software license arrangement and depend
in large part on the Company's software license revenues. The Company's
maintenance revenues depend on both the Company's software license revenues and
renewals of maintenance agreements by the Company's existing customer base.
Services and other revenue was $19.7 million in the three months ended March
31, 2003, an increase of $679,000, or 3.6% from $19.0 million for the
corresponding period of 2002.
The increase in absolute dollar amount of services and other revenue was
primarily due to a hardware sale, required for the use of the Enterprise
products, which was purchased for an existing customer. The cost of the
hardware is included in cost of services and other. There was also a decrease
in professional services and slight increase in maintenance revenue. The
Enterprise division represented a majority of the increase in services and
other revenue offset by a decrease in the Financial Services division, which
continues to decline due to the decrease in the quality of assignments and
average lower contracted fees.
Licenses. License revenue consists of software license and third-party
--------
software sales. The Company markets its products through its direct sales
force. License revenue in the three months ended March 31, 2003 was $9.6
million, an increase of $1.4 million or 16.8% from $8.2 million in the
corresponding period of 2002.
The increase in absolute dollar amount of license revenue was due to an
increase in both the Enterprise and HIM software divisions. The Enterprise
division grew in the first quarter of 2003, due to the purchase of Pharmacy
Data Systems, Inc. (PDS) in June 2002. The HIM software division grew due to
increased sales in the government sector.
16
Cost of Revenue
---------------
Cost of Services and Other. Cost of services and other consists of
--------------------------
salaries and related expenses associated with services performed for customer
support, consulting services as well as third-party hardware costs. Cost of
services and other for the quarter ended March 31, 2003 of $11.7 million was
$4.0 million more than the $7.7 million in the corresponding period of 2002. As
a percentage of services and other revenue, cost of services and other was
59.4% and 40.7% for the three months ended March 31, 2003 and 2002,
respectively. In absolute dollars, the increase was primarily due to an
increase in hardware costs and salary and overhead expenses. The hardware
costs were directly affected by the increase in hardware purchase for the first
quarter of 2003. The increase was primarily attributable to the Enterprise
division. There was a slight increase in Financial Services division offset by
the same decrease in HIM Software division.
Cost of Licenses. Cost of licenses consists of third party royalties,
----------------
amortization of capitalized software, production costs and third party
software. Cost of licenses in the three months ended March 31, 2003 was $1.9
million, a decrease of $251,000, compared to $2.1 million for the same period
of 2002. As a percentage of license revenues, cost of licenses was 19.7% and
26.1% for the three months ended March 31, 2003 and 2002, respectively. The
percentages vary due primarily to the variables in royalty expense. The
decrease in absolute dollars was due to slight decreases in royalties and
software costs offset by an increase in amortization of capitalized software.
Operating Expenses
- ------------------
General and Administration. General and administration expense consists
--------------------------
of compensation and benefit costs for executive, finance, legal, information
technology, and administrative personnel. General and administration expense
was $13.5 million in the first quarter of 2003, an increase of $5.7 million
compared to $7.8 million in the corresponding period of 2002. As a percentage
of revenue, general and administration expense increased 17.5 percentage points
to 46.3% in the first quarter of 2003, compared to 28.8% in the first quarter
of 2002. The increase in general and administration expense was the result of
an increase in accountants', consultants' and attorneys' fees, retention
bonuses, and employee benefits as part of the restatement process, for the
restated 2001 Annual Report on Form 10-K/A. For the three months ended March
31, 2003, these expenses were approximately $4.3 million. We expect these
expenses to decrease in the following quarter.
Sales and Marketing. Sales and marketing expense includes costs
-------------------
associated with our sales and marketing personnel and product marketing
personnel and consists primarily of compensation and benefits, commissions and
bonuses, promotional and advertising expenses. Sales and marketing expense
increased $586,000 in the first quarter of 2003 to $5.8 million, compared to
the same period of 2002. As a percentage of revenue, sales and marketing
expenses increased to 19.7% in the first quarter of 2003 from 19.0% in the same
period of 2002. The increase was due primarily to an increase in personnel
costs, due to increased salaries and employee benefits expense.
Research and Development. Research and development expense includes costs
------------------------
associated with the development of new products, enhancements of existing
products for which technological feasibility has not been achieved, and quality
assurance activities, and primarily includes compensation and benefits expense.
Research and development costs in the three months ended March 31, 2003 were
$5.5 million, compared to $3.7 million in the same period in 2002. As a
percentage of revenue, research and development costs were 18.7% in the first
quarter of 2003 compared to 13.4% in the corresponding period of 2002.
Research and development costs increased due to increased investments in
Enterprise Division's Affinity products applications and to a lesser extent in
HIM software products. During the first three months of 2003, we capitalized
approximately $130,000 in software development costs compared to approximately
$700,000 in the same period of 2002.
Amortization and other operating charges. Amortization and other
----------------------------------------
operating charges represented amortization of identifiable intangible assets
and amortization of acquired software. The increase to $585,000 in the first
quarter of 2003 from $512,000 in the same period of 2002 reflects the net
increase in amortization of identifiable intangible assets offset by the
amortization of acquired software in the prior period.
Other Income (Expense)
---------------------
Other Income (Expense), Net. Net other expense was $976,000 and $781,000
---------------------------
in the three-month periods ended March 31, 2003 and 2002, respectively. The
slight increase was due to interest expense on the debentures.
17
Income Taxes
------------
Provision for Income Taxes. There was no provision for income taxes for
--------------------------
the three-month periods ended March 31, 2003 and 2002. For financial reporting
purposes, a 100% valuation allowance has been recorded against our deferred tax
assets under SFAS No. 109.
Liquidity and Capital Resources
- -------------------------------
Balance Sheet and Cash Flows
----------------------------
Cash and cash equivalents were $20.9 million as of March 31, 2003 and
$23.7 million as of December 31, 2002, a decrease of $2.8 million or 12% during
the period. Cash flows used in operating activities were $6.4 million for the
three months ended March 31, 2003. These amounts primarily resulted from a net
loss of $10.7 million for the three months ended March 31, 2003, offset by $2.5
million of depreciation and amortization and an increase of $9.2 million in
deferred revenue and a decrease of $7.7 million in accounts receivable. Cash
flows from investing activities of $3.6 million resulted from a $2.7 million
payment received for the HIM Services sale and $1.5 million earn-out payment
associated with the EZ-CAP sale offset by $479,000 in fixed asset purchases.
We expect that cash provided by operating activities may fluctuate in
future periods as a result of a number of factors, including fluctuations in
our operating results, specifically the timing of our accounts receivable
collections, and the timing of other payments. In the three months ended March
31, 2003, the Company paid $4.3 million related to the restatement. These
expenses will not continue at this rate in future quarters. In the three
months ended March 31, 2003, the Company invested $5.5 million in research and
development. The Company expects to continue to invest in research and
development in the future.
Commitments
-----------
The following table summarizes financial data for our contractual
obligations and other commercial commitments, including interest obligations,
as of March 31, 2003 (in thousands):
Payments Due by Period
---------------------------------------
Less
than 1 1-3 3-5 After 5
Contractual Obligations Total year years years years
- --------------------------- -------- --------- --------- --------- ---------
Long-term debt $ 81,782 $ 3,870 $ 77,912 $ -- $ --
Operating leases 29,266 5,087 7,954 10,410 5,815
Other long-term obligations 1,449 483 966 -- --
-------- -------- -------- -------- --------
Total contractual cash
obligations $112,497 $ 9,440 $ 86,832 $ 10,410 $ 5,815
======== ======== ======== ======== ========
Other Commercial Commitments
- ----------------------------
Standby letters of credit(1) $ 4,220 $ 1,100 $ -- $ 2,620 $ 500
-------- -------- -------- -------- --------
Total commercial commitments $ 4,220 $ 1,100 $ -- $ 2,620 $ 500
======== ======== ======== ======== ========
(1) The 3-5 years amount of $2.6 million is for an existing surety bond
requirement on December 31, 2002. Actual requirements may be less as work
is completed towards the underlying contract.
As of March 31, 2003, we had $73.7 million in outstanding 5.25%
Convertible Subordinated Debentures due 2005 (the "2005 Debt"), which bear
interest at 5.25% per annum. On April 16, 2003, we announced that we had
executed an agreement with certain of our bondholders and additional investors
to refinance our 2005 Debt. On April 17, 2003, under the terms of the
refinance agreement, we issued $71.0 million of our Senior Secured Notes due
2008 (the "2008 Debt"). The proceeds from the issuance of the 2008 Debt were
used to repurchase $61.8 million (plus $1.5 million in accrued interest) of the
2005 Debt which became subject to repurchase by us as a result of our delisting
from the Nasdaq National Market on March 4, 2003. Accordingly, the net
proceeds to us as a result of the issuance of the 2008 Debt less the costs
(including fees) associated with the repurchase of the 2005 Debt was $8.5
million, with $11.9 million of the 2005 Debt remaining outstanding.
18
Additionally, the repurchase right on the 2005 Debt remaining outstanding
expired on April 17, 2003. The 2008 Debt bears interest at an initial rate of
10% which will be reduced to 9% upon the relisting of QuadraMed's common stock
on the Nasdaq Smallcap or National Market and is secured by certain
intellectual property of QuadraMed. However, we may be obligated to redeem the
2005 and 2008 debentures earlier than the maturity dates based upon certain
events of default occurring as defined within the debenture agreements. These
events include, failure to timely repay principal or interest owed on the
debentures, default under any other borrowing, and bankruptcy.
In addition, as of March 31, 2003, we had approximately $29.2 million in
minimum operating lease commitments that will be repaid through 2011. Finally,
we have a Supplemental Executive Retirement Plan ("SERP") that will require
total payments from 2008 through 2027 estimated at $7.8 million. We owe annual
premiums of $483,000 on the SERP through 2005 to fund our obligations.
We believe that we will have sufficient liquidity and capital resources to
fund our scheduled debt and other obligations through the next twelve months.
Risk Factors That May Impact Future Operating Results
-----------------------------------------------------
Factors that have affected our results of operations in the past and are
likely to affect our results of operations in the future, include the
following:
Our Vendors, Suppliers and Customers May React Adversely to the Lack of
-----------------------------------------------------------------------
Timely SEC Filings of Our Historical Financial Statements.
- ---------------------------------------------------------
Our future success depends in large part on the support of our vendors and
suppliers, who may react adversely to the lack of timely SEC filings of our
historical financial statements. The restatement of our historical financial
statements has resulted in negative publicity about us, which may cause some of
our potential customers to defer purchases of our products. Our vendors and
suppliers may re-examine their willingness to do business with us, to develop
critical interfaces for us or to supply software and services if they lose
confidence in our ability to fulfill our commitments.
We Are Currently the Target of Securities Litigation and May Be the Target
--------------------------------------------------------------------------
of Further Actions, Which May Be Costly and Time Consuming to Defend.
- --------------------------------------------------------------------
In October 2002, a series of securities law class action complaints were
filed in the United States District Court, California Northern District,
against us and certain of our officers and directors. The plaintiffs in these
actions allege, among other things, violations of the Securities Exchange Act
of 1934 due to issuing a series of allegedly false and misleading statements
concerning our business and financial condition between May 11, 2000 and August
11, 2002. The complaints seek unspecified monetary damages and other relief.
The ultimate outcome of these matters cannot presently be determined and
may require significant commitment of our financial and management resources
and time, which may seriously harm our business, financial condition and
results of operations. We cannot assure you that any of the allegations
discussed above can be resolved without costly and protracted litigation, and
the outcome may have a materially adverse impact upon our financial position,
results of operations and cash flows.
In addition, securities class action litigation has often been brought
against a company following a decline in the market price of its securities.
The uncertainty of the currently pending investigation and litigation could
lead to more volatility in our stock price. We may in the future be the target
of securities class action claims similar to those described above.
We Are Subject to a Formal SEC Inquiry as a Result of the Restatement of
------------------------------------------------------------------------
Our Financial Statements.
- ------------------------
Following our August 12, 2002 announcement that we intended to restate
prior period financial statements, the staff of the San Francisco District
Office of the SEC requested certain information concerning the anticipated
restatement as part of an informal, preliminary inquiry.
19
On February 28, 2003, we reported that the SEC had issued a formal non-
public order of investigation concerning our accounting and financial reporting
practices for the period beginning January 1, 1998. We have cooperated fully
with the SEC and have complied fully with all requests for information by the
SEC. We intend to continue such cooperation and compliance. We cannot predict
when the SEC will conclude its inquiry, or the outcome and impact thereof.
Our Common Stock Has Been Delisted from the Nasdaq Stock Market.
---------------------------------------------------------------
We received a notice from the Nasdaq Stock Market that required us to file
Forms 10-Q for the quarters ended June 30, and September 30, 2002 as well as
restated financial statements for the years ended December 31, 2001, 2000 and
1999 and the quarter ended March 31, 2002. Our trading symbol as of August 22,
2002 was amended from "QMDC" to "QMDCE", as a result of the delinquent filings.
We requested an appeals hearing before a Nasdaq Listing Qualifications Panel
(the "Panel"). The Panel notified us on February 6, 2003, that Nasdaq would
continue to list our common shares on the Nasdaq National Market until February
28, 2003, by which date we must file our Quarterly Report on Form 10-Q for the
interim periods ended June 30, 2002 and September 30, 2002 and our amended SEC
filings for the years ended December 31, 2001, 2000 and 1999 and the interim
period ended March 31, 2002. Further, we were required to file timely all
other annual and periodic reports with the SEC and evidence our continued
compliance with all requirements for continued listing on the Nasdaq National
Market upon the filing of these documents as well as an ability to sustain
compliance with those requirements over the long term. We were unable to meet
these requirements in a timely manner, and on March 4, 2003, our common stock
was delisted from the Nasdaq National Market. As of the date of this report,
we have filed with the SEC all annual and periodic reports required under the
Exchange Act. Although we intend to comply with all other listing requirements
and to apply for relisting on the Nasdaq Small Cap or National Market as soon
as practicable, we can offer no assurances that we will be relisted on either
market.
The delisting constituted a "Repurchase Event" under the provisions of our
Convertible Subordinated Debentures. Upon such an event, our Debentures
provide the holders with the individual option to redeem the Debentures (see
below). In addition, the delisting of our common stock may have an adverse
reaction on our operating results and ultimately, our financial condition.
Our Debentures Have Been Partially Refinanced with Notes that Are Subject
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to New Terms.
- ------------
We issued Debentures through a public offering on May 1, 1998 that mature
on May 1, 2005 in the principal amount of $115 million (the "2005 Notes"). Our
net proceeds from the offering were $110.8 million. The 2005 Notes bear
interest at 5.25% per annum and are convertible into common stock at any time
prior to the redemption or final maturity, initially at the conversion price of
$33.25 per share (resulting in an initial conversion ratio of 30.075 shares per
$1,000 principal amount).
We are obligated to provide holders of the 2005 Notes with notice of and
the holders have the individual option to redeem the 2005 Notes should we, (i)
cease to be traded on a U.S. national securities exchange or cease to be
approved for trading on a U.S. automated over-the-counter securities market; or
(ii) experience defined Changes of Control, including a merger in which we are
not the surviving entity or our shareholders do not control 50% of the new
entity, the sale of substantially all of our assets, a liquidation, or if there
is a substantial change in the board of directors over a two-year period.
Additionally, we are obligated to redeem the 2005 Notes upon defined Events of
Default, including failure to timely repay principal or interest under the 2005
Notes, default under any other borrowing, and bankruptcy. On March 4, 2003,
our common stock was delisted from the Nasdaq Stock Market, and a repurchase
event was triggered.
On April 17, 2003, we closed the partial refinancing of our 2005 Notes. In
conjunction with our repurchase of $61.8 million of our outstanding 2005 Notes
pursuant to our offer to repurchase such Notes previously announced on March
19, 2003, we issued $71 million of our Senior Secured Notes due 2008 (the "2008
Notes"), together with warrants to purchase 11,303,842 shares of our common
stock. Investors in the 2008 Notes included certain holders of 2005 Notes as
well as new investors. Additional warrants to purchase 2,047,978 shares of our
common stock will be issued to holders of the 2008 Notes if we do not file a
registration statement within 90 days after receiving a request from the
holders on or after the date that is 270 days after April 17, 2003, the date of
issuance of the 2008 Notes. We also issued warrants to purchase 282,596 shares
of our common stock to Philadelphia Brokerage Corporation as consideration in
connection with the transaction. The warrants have a term of five years, have
an exercise price of $0.01 per share and are subject to certain anti-dilution
provisions including dilution from any issuance of shares in settlement of
existing litigation.
20
The 2008 Notes bear an initial interest rate of 10%, which interest rate
is required to be reduced to 9% upon the listing of the Company's common stock
for trading on a U.S. national securities exchange or upon the common stock's
relisting on the Nasdaq National Market or the Nasdaq SmallCap Market. The
terms of the 2008 Notes provide that interest is initially payable 6% in cash
and 4% in additional notes for the first year and payable entirely in cash
thereafter. The 2008 Notes are also secured by certain intellectual property
of the Company.
The terms of the new debt could result in increased dilution to existing
shareholders as a result of the warrants issued and potential future issuances.
In addition, the higher rate of interest on the new debt will result in
increased interest costs.
Provisions in Our Certificate of Incorporation and Bylaws and Delaware Law
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Could Delay or Discourage a Takeover which Could Adversely Affect the Price of
- ------------------------------------------------------------------------------
Our Common Stock.
- ----------------
Our board of directors has the authority to issue up to 5 million shares
of preferred stock and to determine the price, rights, preferences, privileges,
and restrictions, including voting rights, of those shares without any further
vote or action by holders of our common stock. If preferred stock is issued,
the voting and other rights of the holders of our common stock may be subject
to, and may be adversely affected by, the rights of the holders of our
preferred stock. The issuance of preferred stock may have the effect of
delaying or preventing a change of control of the Company that could have been
at a premium price to our stockholders.
Certain provisions of our certificate of incorporation and bylaws could
discourage potential takeover attempts and make attempts to change management
by stockholders difficult. Our board of directors, which is classified into
three classes of directors serving staggered, three-year terms, has the
authority to impose various procedural and other requirements that could make
it more difficult for our stockholders to effect certain corporate actions. In
addition, our certificate of incorporation provides that directors may be
removed only by the affirmative vote of the holders of two-thirds of the shares
of our capital stock entitled to vote. Any vacancy on our board of directors
may be filled only by a vote of the majority of directors then in office.
Further, our certificate of incorporation provides that the affirmative vote of
two-thirds of the shares entitled to vote, voting together as a single class,
subject to certain exceptions, is required for certain business combination
transactions. These provisions, and certain other provisions of our
certificate of incorporation, could have the effect of delaying or preventing
(i) a tender offer for our common stock or other changes of control of the
Company that could be at a premium price, or (ii) changes in our management.
In addition, certain provisions of Delaware law could have the effect of
delaying or preventing a change in control of the Company. Section 203 of the
Delaware General Corporation Law, for example, prohibits a Delaware corporation
from engaging in any business combination with any interested stockholder for a
period of three years from the date the person became an interested stockholder
unless certain conditions are met.
The Trading Price of Our Common Stock Has Been, and Is Expected to
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Continue to Be, Volatile.
- ------------------------
The Nasdaq SmallCap Market on which our common stock was listed, the "Pink
Sheets" over-the-counter market, where our stock currently trades, and stock
markets in general, have historically experienced extreme price and volume
fluctuations that have affected companies unrelated to their individual
operating performance. The trading price of our common stock has been and is
likely to continue to be volatile due to such factors as:
o Variations in quarterly results of operations;
o Announcements of new products or acquisitions by our competitors;
o Governmental regulatory action;
o Resolution of pending or unasserted litigation, including the existing
shareholder lawsuits;
o Developments or disputes with respect to proprietary rights; and
o General trends in our industry and overall market conditions.
21
Movements in prices of equity securities in general may also affect the
market price of our common stock.
Future Sales of a Substantial Number of Shares of Our Common Stock Could
------------------------------------------------------------------------
Cause the Price of the Stock to Decrease or Fluctuate Substantially.
- -------------------------------------------------------------------
Our existing stockholders hold a significant number of shares of common
stock that may be sold in the future under Rule 144 of the Securities Act or
through the exercise of registration rights. Sales of a substantial number of
the aforementioned shares in the public markets or the prospect of such sales
could adversely affect or cause substantial fluctuations in the market price of
our common stock and debt securities and impair our ability to raise additional
capital through the sale of our securities.
Future Sales of Our Common Stock in the Public Market or Warrant or Option
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Exercises and Sales Could Lower Our Stock Price.
- -----------------------------------------------
A substantial number of the unissued shares of our common stock are
subject to outstanding stock options and warrants. In addition, our
outstanding 2005 Notes may be converted into shares of common stock. We cannot
predict the effect, if any, that future sales of shares of common stock, or the
availability of shares of common stock for future sale, will have on the market
price of our common stock. Sales of substantial amounts of common stock,
including shares issued upon the exercise of stock options or warrants or the
conversion of our outstanding 2005 Notes, or the perception that such sales
could occur, may adversely affect prevailing market prices for our common
stock.
We Face Product Development Risks Associated with Rapid Technological
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Changes.
- -------
The healthcare software market is highly fragmented and characterized by
ongoing technological developments, evolving industry standards, and rapid
changes in customer requirements. Our success depends on our ability to timely
and effectively:
o Offer a broad range of software products;
o Enhance existing products and expand product offerings;
o Respond promptly to new customer requirements and industry standards;
o Remain compatible with popular operating systems and develop products that
are compatible with the new or otherwise emerging operating systems; and
o Develop new interfaces with competing HIS vendors to fully integrate our
Quantim product suite in order to maximize features and functionality of
the new products.
Our performance depends in large part upon our ability to provide the
increasing functionality required by our customers through the timely
development and successful introduction of new products and enhancements to our
existing suite of products. We may not successfully, or in a timely manner,
develop, acquire, integrate, introduce, or market new products or product
enhancements. Product enhancements or new products developed by us also may
not meet the requirements of hospitals or other healthcare providers and payers
or achieve or sustain market acceptance. Our failure to either estimate
accurately the resources and related expenses required for a project, or to
complete our contractual obligations in a manner consistent with the project
plan upon which a contract was based, could have a material adverse effect on
our business, financial condition, and results of operations. In addition, our
failure to meet a customer's expectations in the performance of our services
could damage our reputation and adversely affect our ability to attract new
business.
Our Inability to Protect Our Intellectual Property Could Lead to
----------------------------------------------------------------
Unauthorized Use of Our Products, which Could Have an Adverse Effect on Our
- ---------------------------------------------------------------------------
Business.
- --------
We rely on a combination of trade secret, copyright and trademark laws,
nondisclosure, non-compete, and other contractual provisions to protect our
proprietary rights. In 2001, we filed our first patent application covering
our developed technology, the Affinity CPOE software application. Measures
taken by us to protect our intellectual property may not be adequate, and our
22
competitors could independently develop products and services that are
substantially equivalent or superior to our products and services. Any
infringement or misappropriation of our proprietary software and databases
could put us at a competitive disadvantage in a highly competitive market and
could cause us to lose revenues, incur substantial litigation expense, and
divert management's attention from other operations.
We depend on licenses from a number of third-party vendors for certain
technology used to develop and operate our products. Most of these licenses
expire within three to five years. Such licenses can be renewed only by mutual
consent and may be terminated if we breach the license terms and fail to cure
the breach within a specified time period. If such licenses are terminated, we
may not be able to continue using the technology on commercially reasonable
terms or at all. As a result, we may have to discontinue, delay or reduce
product shipments until equivalent technology is obtained, which could have a
material adverse effect on our business, financial condition, and results of
operations. Most of our third-party licenses are non-exclusive and competitors
may obtain the same or similar technology. In addition, if vendors choose to
discontinue support of the licensed technology, we may not be able to modify or
adapt our products.
Intellectual property litigation is increasingly common in the software
industry. The risk of an infringement claim against us may increase over time
as the number of competitors in our industry segment grows and the
functionality of products overlaps. Third parties could assert infringement
claims against us in the future. Regardless of the merits, we could incur
substantial litigation expenses in defending any such asserted claim. In the
event of an unfavorable ruling on any such claim, a license or similar
agreement may not be available to us on reasonable terms, if at all.
Infringement may also result in significant monetary liabilities that could
have a material adverse effect on our business, financial condition, and
results of operations. We may not be successful in the defense of these or
similar claims.
The Nature of Our Products Makes Us Particularly Vulnerable to Undetected
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Errors or Bugs that Could Reduce Revenues, Market Share or Demand for Our
- -------------------------------------------------------------------------
Products and Services.
- ---------------------
Products such as those we offer may contain errors or failures, especially
when initially introduced or when new versions are released. Although we
conduct extensive testing on our products, software errors have been discovered
in certain enhancements and products after their introduction. Despite such
testing by us and by our current and potential customers, products under
development, enhancements, or shipped products may contain errors or
performance failures, resulting in, among other things:
o Loss of customers and revenue;
o Delay in market acceptance;
o Diversion of resources;
o Damage to our reputation; or
o Increased service and warranty costs.
Any of these consequences could have a material adverse effect on our
business, financial condition, and results of operations.
If Our Products Fail to Accurately Assess, Process, or Collect Healthcare
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Claims or Administer Managed Care Contracts, We Could Be Subject to Costly
- --------------------------------------------------------------------------
Litigation and Be Forced to Make Costly Changes to Our Products.
- ---------------------------------------------------------------
Some of our products and services are used in the payment, collection,
coding, and billing of healthcare claims and the administration of managed care
contracts. If our employees or products fail to accurately assess, process, or
collect these claims, customers could file claims against us. Our insurance
coverage may not be adequate to cover such claims. A successful claim that is
in excess of, or is not covered by, insurance coverage could adversely affect
our business, financial condition, and results of operations. Even a claim
without merit could result in significant legal defense costs and could consume
23
management time and resources. In addition, claims could increase our premiums
such that appropriate insurance could not be found at commercially reasonable
rates. Furthermore, if we were found liable, we may have to significantly
alter one or more of our products, possibly resulting in additional
unanticipated research and development expenses.
We May Be Required to Make Substantial Changes to Our Products if They
----------------------------------------------------------------------
Become Subject to FDA Regulation, which Could Require a Significant Capital
- ---------------------------------------------------------------------------
Investment.
- ----------
Computer products used or intended for use in the diagnosis, cure,
mitigation, treatment, or prevention of disease or other conditions or that
affect the structure or function of the body are subject to regulation by the
FDA under the Federal Food, Drug and Cosmetic Act. At present, none of our
software products are so regulated. In the future, the FDA could determine
that some of our products, because of their predictive aspects, are clinical
decision tools and subject them to regulation. Compliance with FDA regulations
could be burdensome, time consuming, and expensive. Other new laws and
regulations affecting healthcare software development and marketing also could
be enacted in the future. If so, it is possible that our costs and the length
of time for product development and marketing could increase and that other
unforeseeable consequences could arise.
Governmental Regulation of the Confidentiality of Patient Health
----------------------------------------------------------------
Information Could Result in Our Customers Being Unable to Use Our Products
- --------------------------------------------------------------------------
Without Significant Modification, which Could Require Us to Expend Substantial
- ------------------------------------------------------------------------------
Amounts.
- -------
There is substantial state and federal regulation of the confidentiality
of patient health information and the circumstances under which such
information may be used by, disclosed to or processed by us as a consequence of
our contacts with various health care providers. Although compliance with
these laws and regulations is presently the principal responsibility of the
hospital, physician, or other healthcare provider, regulations governing
patient confidentiality rights are dynamic and rapidly evolving. Changes may
be made which require us to change our systems and our methods which could
require significant expenditure of capital and decrease future business
prospects. Additional federal and state legislation governing the
dissemination of individually identifiable information have been proposed and
may be adopted, which may also significantly affect our business.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
is a federal law that affects the use, disclosure, transmission and storage of
individually identifiable health information. As directed by HIPAA, the United
States Department of Health and Human Services ("HHS") must promulgate
standards and implementation guidelines for certain electronic health
transactions, code sets, data security, unique identification numbers, and
privacy of individually identifiable health information. HHS has made several
regulatory proposals, which are in various stages of development.
First, HHS has published a final regulation governing transaction and
code-set standards that had a compliance date of October 16, 2002. If a
covered entity (health care providers that transmit certain covered
transactions in electronic form, health plans and health care clearinghouses)
or its agent file an extension by October 16, 2003, the covered entity would
receive an additional year to comply with the HIPAA transaction and code sets
requirements.
Second, HHS has published a final HIPAA privacy rule which had a
compliance date of April 14, 2003. The HIPAA privacy rule is complex and far
reaching. Similar to the HIPAA transaction and code sets rule, the HIPAA
privacy rule applies to covered entities. Covered entities are required to
execute a contract with any business associate that performs certain services
on the covered entity's behalf. We may be implicated by the HIPAA privacy rule
as a business associate of a covered entity. The HIPAA privacy rule and state
healthcare privacy regulations could materially restrict the ability of
healthcare providers to disclose individually identifiable health information
from patient records using our products and services or could require us to
make substantial capital expenditures to be in compliance. Accordingly, the
HIPAA Privacy Rule and state privacy laws may significantly impact our
product's use in the health care delivery system and therefore decrease our
revenue, increase working capital requirements and decrease future business
prospects.
Third, HHS published the final HIPAA security rule with a compliance date
of April 20, 2005. The HIPAA security rule applies to the use, disclosure,
transmission, storage and destruction of electronic protected health
information by covered entities. Covered entities must implement stringent
security measures to ensure the confidentiality of the electronic protected
24
health information, and to protect against the unauthorized use of the
electronic protected health information. Implementing such measures will
require us to expend substantial capital due to required product, service, and
procedure changes.
Government Regulation to Adopt and Implement ICD-10-CM and ICD-10-PCS
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Medical Code Set Standards.
- --------------------------
Prominent HIM organizations are calling on the Department of Health and
Human Services (HHS) and the healthcare industry to take action to adopt and
implement ICD-10-CM and ICD-10-PCS code sets, rules, and guidelines as a
replacement for current ICD-9-CM guidelines used in our software products.
Adoption of these new code sets would require us to change our systems and our
methods which could require a significant expenditure of R & D capital and
decrease future business prospects for our current product line.
Government Regulation of the Health Care Delivery System May Affect Health
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Care Providers' Discretionary Spending.
- --------------------------------------
During the past several years, the healthcare industry has been subject
to, among other things, increasing levels of governmental regulation of
reimbursement rates and certain capital expenditures. Certain proposals to
reform the healthcare system have been and are being considered by Congress.
These proposals, if enacted, could change the operating environment for our
clients in ways that could have a negative impact on our business, financial
condition, and results of operations. We are unable to predict what, if any,
changes will occur.
Changes in Procurement Practices of Hospitals Have and May Continue to
----------------------------------------------------------------------
Have a Negative Impact on Our Revenues.
- --------------------------------------
A substantial portion of our revenues has been and is expected to continue
to be derived from sales of software products and services to hospitals.
Consolidation in the healthcare industry, particularly in the hospital and
managed care markets, could decrease the number of existing or potential
purchasers of products and services and could adversely affect our business.
In addition, the decision to purchase our products often involves a committee
approval. Consequently, it is difficult for us to predict the timing or
outcome of the buying decisions of our customers or potential customers. In
addition, many healthcare providers are consolidating to create IDNs with
greater regional market power. These emerging systems could have greater
bargaining power, which may lead to decreases in prices for our products, which
could adversely affect our business, financial condition, and results of
operations.
Changes in the Healthcare Financing and Reimbursement System Could
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Adversely Affect the Amount of and Manner in which Our Customers Purchase Our
- -----------------------------------------------------------------------------
Products And Services.
- ---------------------
Changes in current healthcare financing and reimbursement systems could
result in unplanned product enhancements, delays, or cancellations of product
orders or shipments, or reduce the need for certain systems. We could also
have the endorsement of products by hospital associations or other customers
revoked. Any of these occurrences could have a material adverse effect on our
business. Alternatively, the federal government recently mandated the use of
electronic transmissions for large Medicare providers which may positively
affect our systems and product.
The healthcare industry in the United States is subject to changing
political, economic, and regulatory influences that may affect the procurement
practices and operations of healthcare organizations. The traditional hospital
delivery system is evolving as more hospital services are being provided by
niche, free standing practices and outpatient providers. The commercial value
and appeal of our products may be adversely affected if the current healthcare
financing and reimbursement system were to revert to a fee-for-service model.
In addition, many of our customers provide services under capitated service
agreements, and a reduction in the use of capitation arrangements as a result
of regulatory or market changes could have a material adverse effect on our
business. During the past several years, the healthcare industry has been
subject to increasing levels of governmental regulation of, among other things,
reimbursement rates and capital expenditures. Proposals to reform the
healthcare system have been and are being considered by the United States
Congress. These proposals, if enacted, could change the operating environment
of our customers in ways that cannot be predicted. Healthcare organizations
may react to these proposals by curtailing or deferring investments, including
those for our products and services. In addition, the regulations promulgated
under HIPAA could lead healthcare organizations to curtail or defer investments
in non-HIPAA related features in the next several years.
25
Our Quarterly Operating Results Are Subject to Fluctuations, which Could
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Adversely Affect Our Financial Results and the Market Price of Our Common
- -------------------------------------------------------------------------
Stock.
- -----
Our quarterly operating results have varied significantly in the past and
may fluctuate in the future as a result of a variety of factors, many of which
are outside our control. Accordingly, quarter-to-quarter comparisons of our
operating results may not be indicative of our future performance. Some of the
factors causing these fluctuations include:
o Variability in demand for products and services;
o Introduction of product enhancements and new products by us and our
competitors;
o Timing and significance of announcements concerning present or prospective
strategic alliances;
o Discontinuation of, or reduction in, the products and services we offer;
o Loss of customers due to consolidation in the healthcare industry;
o Delays in product delivery requested by our customers;
o Customer budget cycle fluctuation;
o Investment in marketing, sales, research and development, and
administrative personnel necessary to support anticipated operations;
o Costs incurred for marketing and sales promotional activities;
o Software defects and other product quality factors;
o General economic conditions and their impact on the healthcare industry;
o Cooperation from competitors on interfaces and implementation when a
customer chooses a QuadraMed software application to use with various
vendors;
o Delays in implementation due to product readiness, customer induced delays
in training or installation, and third party interface development delays;
o Final negotiated sales prices of systems;
o Federal regulations (i.e., OIG, HIPAA, ICD-10) that can increase demand
for new, updated systems;
o Federal regulations that directly affect reimbursements received, and
therefore the amount of money available for purchasing information
systems;
o The fines and penalties a healthcare provider or system may incur due to
fraudulent billing practices; and
o Increases in third party royalty fees associated with embedded products in
QuadraMed software applications.
Our operating expense levels, which increase with the addition of acquired
businesses, are relatively fixed. Accordingly, if future revenues were below
expectations, we would experience a disproportionate adverse affect on our net
income and financial results. In the event of a revenue shortfall, we will
likely be unable to, or may elect not to, reduce spending quickly enough to
offset any such shortfall. As a result, it is possible that our future
revenues or operating results may fall below the expectations of securities
analysts and investors. In such a case, the price of our publicly traded
securities may be adversely affected.
26
The Variability and Length of Our Sales Cycle for Our Products May
------------------------------------------------------------------
Exacerbate the Unpredictability and Volatility of Our Operating Results.
- -----------------------------------------------------------------------
We cannot accurately forecast the timing of customer purchases due to the
complex procurement decision processes of most healthcare providers and payers.
How and when to implement, replace, expand or substantially modify an
information system are major decisions for customers, and such decisions
require significant capital expenditures by them. As a result, we typically
experience sales cycles that extend over several quarters. In addition,
certain products we acquired with Compucare have higher average selling prices
and longer sales cycles than many of our other products. As a result, we have
only a limited ability to forecast the timing and size of specific sales,
making the prediction of quarterly financial performance more difficult.
If We Are Unable to Compete Effectively, We Could Experience Price
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Reduction, Reduced Gross Margins and Loss of Market Share.
- ---------------------------------------------------------
Competition for our products and services is intense and is expected to
increase. Increased competition could result in reductions in our prices,
gross margins, and market share and have a material adverse effect on our
business, financial condition, and results of operations. We compete with
other providers of healthcare information software and services, as well as
healthcare consulting firms. Some competitors have formed business alliances
with other competitors that may affect our ability to work with some potential
customers. In addition, if some of our competitors merge, a stronger
competitor may emerge. Some principal competitors include:
o In the market for enterprise healthcare information systems in the
Enterprise Division: McKesson Corporation, Inc., Shared Medical Systems,
Inc., a division of Siemens, MediTech Corporation, Eclipsys Corporation,
Cerner, and, IDX Corporation;
o In the market for electronic document management products in the
Enterprise Division: McKesson Corporation, SoftMed Corporation Inc.,
FileNet, Lanvision, MedPlus, and, Eclipsys Corporation;
o In the market for MPI products and services in the Enterprise Division:
Madison Technologies, Inc., McKesson Corporation, Shared Medical Systems,
Inc., a division of Siemens, and, Medibase;
o In the market for decision support products in the Enterprise Division:
Eclipsys Corporation, Healthcare Microsystems, Inc., a division of Health
Management Systems Inc., McKesson Corporation, Shared Medical Systems,
Inc., a division of Siemens, and, MediQual Systems, Inc., a division of
Cardinal Health, Inc.;
o In the market for coding, compliance, data, and record management products
in the Health Information Management Software Division: 3M Corporation,
SoftMed Corporation, Inc., MetaHealth, Eclipsys Corporation,
PricewaterhouseCoopers LLP and, HSS, Inc.;
o In the Health Information Management Services Division:
PricewaterhouseCoopers LLP, Bearing Point and Cap Gemini for compliance
products and services and health information management consulting
services; and
o In the Financial Services Division: Advanced Receivables Strategy, Inc.,
a division of Perot Systems Corporation, NCO Group, Inc., Outsourcing
Solutions, Inc., Health Management Systems, Inc., and Triage Consulting
Group.
Current and prospective customers also evaluate our products' capabilities
against the merits of their existing information systems and expertise. Major
software information systems companies, including those specializing in the
healthcare industry, that do not presently offer competing products may enter
our markets. Many of our competitors and potential competitors have
significantly greater financial, technical, product development, marketing and
other resources, and market recognition than we have. Many of these
competitors also have, or may develop or acquire, substantial installed
customer bases in the healthcare industry. As a result of these factors, our
competitors may be able to respond more quickly to new or emerging
technologies, changes in customer requirements, and changes in the political,
economic or regulatory environment in the healthcare industry.
27
These competitors may be in a position to devote greater resources to the
development, promotion, and sale of their products than we can. We may not be
able to compete successfully against current and future competitors, and such
competitive pressures could materially adversely affect our business, financial
condition, and operating results.
Our Services Face Review and Scrutiny from the Department of Health and
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Human Services, the Department of Justice and Other Law Enforcement Agencies.
- ----------------------------------------------------------------------------
As a result of rising health care costs, federal and state governments
have placed an increased emphasis on detecting and eliminating fraud and abuse
in Medicare, Medicaid, and other health care programs. Numerous laws and
regulations now exist to prevent fraudulent or abusive billing, to protect
patients' privacy rights, and to ensure patients' access to health care.
Violation of the laws or regulations governing our operations could result in
the imposition of civil or criminal penalties, including temporary or permanent
exclusion from participation in government health care programs such as
Medicare and Medicaid, the cancellation of our contracts to provide managed
care services, and the suspension or revocation of our licenses. We routinely
conduct internal audits in our effort to ensure compliance with all applicable
laws and regulations. If errors, discrepancies or violations of laws are
discovered in the course of these audits or otherwise, we may be required by
law to disclose the relevant facts, once known, to the appropriate authorities.
We Face Risks Associated with U.S. Government Contracting.
---------------------------------------------------------
We have been awarded a U.S. General Services Administration ("GSA")
Schedule Contract for Federal Supply Service of commercial information
technology. The willingness of government agencies to enter into future
contracts depends upon (i) our ability to continue supporting existing
products; (ii) maintaining ongoing relationships with third party suppliers of
certain elements of our products; and (iii) developing new products with third
party suppliers to address new regulatory requirements of government agencies
and having these products added to our GSA commercial price list. These
contracts are subject to cancellation at the convenience of the contracting
government agency.
As a commercial vendor, we must file a quarterly sales report with the GSA
and remit a 1% "Industrial Funding Fee" based on the sales value of the
contract. Reductions or delays in federal funds available for projects we are
performing could also have an adverse impact on our government business.
Contracts involving time and material fees are also subject to the risks of
disallowance of costs upon audit, changes in government procurement policies,
required competitive bidding for products not identified on the GSA commercial
product price list, and, with respect to contracts involving prime contractors
or government-designated subcontractors, the inability of those parties to
perform under their contracts.
We Have Encountered Significant Challenges Integrating Acquired
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Businesses, and Future Transactions May Adversely Affect Our Business,
- ---------------------------------------------------------------------
Operations, and Financial Condition.
- -----------------------------------
From 1993 to 1999, we completed 28 acquisitions encountering significant
challenges integrating the acquired businesses into our operations and, in
years 2000 and 2002 focused in particular on their integration. Some of the
challenges we have encountered, and may encounter with acquisitions in the
future, in integrating acquired businesses have included:
o Interruption, disruption or delay of our ongoing business;
o Distraction of management's attention from other matters;
o Additional operational and administrative expenses;
o Difficulty managing geographically dispersed operations;
o Failure of acquired businesses to achieve expected results, resulting in
our failure to realize anticipated benefits;
o Write-down or reclassification of acquired assets;
28
o Failure to retain key acquired personnel and difficulty and expense of
training those retained;
o Increases in stock compensation expense and increased compensation expense
resulting from newly hired employees;
o Assumption of liabilities and potential for disputes with the sellers of
acquired businesses;
o Customer dissatisfaction or performance problems related to acquired
businesses;
o Exposure to the risks of entering markets in which we have no direct prior
experience and to risks associated with market acceptance of acquired
products and technologies; and
o Platform and technical issues related to integrating systems from various
acquired companies.
All of these factors have had an adverse effect on our business, financial
condition, and results of operations in the past, and could have an adverse
effect in the future.
New Accounting Standards May Make Acquisitions Necessary for Our Growth
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Less Accretive and Less Attractive.
- ----------------------------------
In June 2001, the FASB issued SFAS No. 141, Business Combinations. The
---------------------
statement addresses financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, Business Combinations, and SFAS
No. 38, Accounting for Pre-acquisition Contingencies of Purchased Enterprises.
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From 1993-1999, we completed 28 acquisitions, certain of which were accounted
for using the pooling-of-interests methodology, which is no longer acceptable
under SFAS 141. Effective June 2001, prospective business combinations are
required to be accounted for using purchase accounting. As a result, any
amounts paid in excess of fair value of the assets acquired are capitalized and
recorded as intangible assets or goodwill whose amortization or impairment
which may reduce future earnings. Accordingly, future business combinations
may be less attractive as our reported GAAP operating results are likely to be
negatively impacted.
We May Suffer Losses Due to the Investment Performance of Variable Life
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Insurance Policies That Are Tied to the Performance of Equity Markets That May
- ------------------------------------------------------------------------------
Lead to Delays in Repayments of Premiums Pursuant to Certain Split-Dollar Life
- ------------------------------------------------------------------------------
Insurance Agreements or Result in Increased Supplemental Executive Retirement
- -----------------------------------------------------------------------------
Plan (SERP) Expenses in Future Periods.
- --------------------------------------
We have an investment interest in three variable life insurance policies.
Each of the variable life insurance policies provides for the investment of the
cash value portion of policies into various sub-accounts that are similar in
nature to mutual funds. Two policies are issued pursuant to split-dollar
agreements with the former executives, and trusts established for their benefit
make the investment decisions on these policies. The third policy is a
corporate-owned policy that we contributed to a grantor or "rabbi" trust
established to make contributions to satisfy our obligations under the SERP and
two other subsequently terminated benefit plans. We make the investment
decisions only on this policy. The performance of the variable life insurance
policies for cash value and premium amounts will vary depending on the
performance of the selected underlying sub-accounts. Pursuant to FTB 85-4 and
FTB 97-14, we report the amounts that could be realized under these variable
life insurance contracts as an asset valued as of the balance sheet date and
treat the change in cash surrender value during the reported period as an
adjustment of premiums paid in determining the expense or income to be
recognized. The reduced value of the variable life insurance policies and
future adverse changes in the condition of equity markets or poor operating
results of underlying policy sub-accounts could result in (i) the delayed
repayment of advanced premiums in the case of the split-dollar policies, and/or
(ii) increased SERP expenses in future periods.
A Significant Amount of Our Assets Are Comprised of Goodwill, Capitalized
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Software, Customer Lists and Other Intangible Items Subject to Impairment and
- -----------------------------------------------------------------------------
Adjustment That Could Possibly Negatively Impact Our Results of Operations and
- ------------------------------------------------------------------------------
Stockholders' Equity.
- --------------------
A significant amount of our assets are comprised of capitalized software
and intangible assets, such as the value of the installed customer base, core
technology, capitalized software, goodwill, and other identifiable intangible
assets acquired through our acquisitions, such as trademarks.
29
Pursuant to SFAS No. 142, we must test goodwill, capitalized software and
other intangible assets beyond their economic life for impairment at least
annually, and adjust them when impaired to the appropriate net realizable
value. We engaged a valuation firm to perform an impairment test on the
carrying value of our goodwill and intangibles as of December 31, 2002 and
2001. The valuation firm determined that there was no impairment as of these
dates. In addition, our internally-developed software has been capitalized
assuming our earnings from these product developments exceeds the costs
incurred to develop them. If it is determined that these assets have been
impaired and our future operating results will not support the existing
carrying value of the capitalized software, we will be required to adjust the
carrying value of the capitalized software to net realizable value.
We, however, cannot predict that all of our intangible assets will
continue to remain unimpaired. Our future operating results and stockholders'
equity could possibly decrease with any future impairment and write-down of
goodwill, customer lists, or other such intangibles.
No Mirror Processing Site for Our Customer Data Processing Facilities
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Exists; Our Business, Financial Condition, and Results of Operations Could Be
- -----------------------------------------------------------------------------
Adversely Affected if These Facilities Were Subject to a Closure from a
- -----------------------------------------------------------------------
Catastrophic Event or Otherwise.
- -------------------------------
We currently process substantially all of our customer data at our
facilities in Neptune, New Jersey; Irving, Texas; Kansas City, Missouri; and
San Rafael, California. Although we back up our data nightly and have
safeguards for emergencies, such as power interruption or breakdown in
temperature controls, we have no mirror processing site to which processing
could be transferred in the case of a catastrophic event at any of these
facilities. If a major catastrophic event occurs at these facilities possibly
leading to an interruption of data processing, or any other interruption or
closure, our business, financial condition, and results of operations could be
adversely affected.
30
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
------------------
Our exposure to market risk for changes in interest rates primarily
relates to our investment portfolio. It is our intent to ensure the safety and
preservation of our invested principal funds by limiting default risk, market
risk, and reinvestment risk. We invest in high-quality issuers, including
money market funds, corporate debt securities, and debt securities issued by
the United States government. We have a policy of investing in securities with
maturities of two years or less. We do not invest in derivative financial or
foreign investments.
The table below presents fair values of principal amounts and weighted
average interest rates for our investment portfolio as of March 31, 2003, (in
thousands, except average interest rates):
Aggregate Fair Weighted Average
Value Interest Rate
----- -------------
Cash and cash equivalents:
Cash $ 4,377
Money Market funds 16,560 1.07%
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Total cash and cash equivalents $ 20,937
==========
Short-term investments:
Corporate debt securities $ 2,528 1.68%
----------
Total short-term investments $ 2,528
==========
Long-term investments:
Corporate debt securities $ 494 5.15%
Debt issued by the U.S. government 790 5.21%
----------
Total long-term investments $ 1,284
==========
On March 31, 2003 our long-term debt consists solely of our Debentures
totaling $73.7 million, at a fixed interest rate of 5.25% maturing in 2005. On
April 17, 2003, we refinanced our Debentures due 2005 and issued %71.0 million
of Senior Secured Notes due 2008 with an initial interest rate of 10%.
Performance of Equity Markets
-----------------------------
The performance of equity markets can have an effect on our operations,
and recent declines in equity markets, if sustained, will have an adverse
effect on us related to certain variable life insurance policies in which we
have an investment interest.
Foreign Currency Risk
---------------------
Although we sell our products internationally from time to time, all such
transactions are denominated in U.S. Dollars and, as such, there is no foreign
currency fluctuation risk associated with these sales.
Item 4. Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer, with the
participation or our management evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in the
Securities Exchange Act of 1934 Rules 13(a)-14(c), and 15(d), which became
effective August 29, 2002) as of a date (the "Evaluation Date") within 90 days
prior to the filing date of this report. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the controls and
other procedures they designed to ensure that information required to be
disclosed in the reports we file or submit under the Act are accumulated and
communicated to them as appropriate to allow timely decisions regarding
required disclosures, were effective.
Our Chief Executive Officer and Chief Financial Officer evaluated the
effectiveness of our Internal Controls as of the Evaluation Date and concluded
that our current practices and procedures, albeit not as mature or as formal as
management intends them to be in the future, are appropriate under the
circumstances. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Because of the inherent limitations in all control
systems no evaluation of controls can provide absolute assurance that all
control issues within a company have been detected. No significant changes
were made to our internal controls or other factors that could significantly
affect these controls subsequent to the date of their evaluation.
31
In addition, our Chief Executive Officer and Chief Financial Officer and
Audit Committee are aware of conditions that are considered to be reportable
conditions in internal controls under standards established by the American
Institute of Certified Public Accountants. These reportable conditions allowed
errors to go undetected in some of our 2002 internal financial statements and
in our previously issued consolidated financial statements reported in our 2001
10-K and March 31, 2002 10-Q. The 2001 10-K/A was filed in June 2003 and the
March 31, 2002 10Q/A was filed in August 2003 to correct these errors in our
previously issued consolidated financial statements.
The aforementioned weaknesses our internal controls pertain to the
following areas:
o Revenue recognition, billings, collections and allowances;
o Formal policies and procedures for significant transactions;
o Timely analysis and reconciliation of general ledger accounts; and
o Depth of technical accounting knowledge and training.
We have implemented certain new procedures and corrective actions that
address the cited weaknesses. These corrective actions included:
o We engaged Deloitte & Touche LLP (D&T) to perform forensic analysis of the
Company's accounting records and reported results for the years 2000
through 2002. D&T's forensic analysis also covered years 1999 and prior
to the extent any items originating in earlier years impact 2000, 2001 or
2002;
o We engaged a team of accounting consultants, most of whom are CPAs with
technology industry experience, to lead the restatement effort of the
financial statements for 1999, 2000 and 2001 and the first quarter of
2002. D&T transitioned detailed work and reconciliations to this group of
professionals. These professionals filled in gaps in the financial
organization where temporary vacancy occurred. They reviewed all material
business transactions including revenue contracts, acquisitions &
dispositions of businesses, impairment of assets, accrued and actual
expenses, stockholders' equity transactions and accounting and financial
reporting thereof for 1999, 2000 and 2001 and the first quarter of 2002;
o We retained Charles Stahl, formerly an audit partner with Deloitte &
Touche, LLP, as a full-time consultant to lead the final phase of the
restatement effort. We then hired him as Executive Vice President and
Chief Financial Officer to build a complete permanent finance department
to replace the one that was based, in part, on consultants to strengthen
our internal controls; and
o Our Audit Committee has strengthened its role in corporate governance.
32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In October 2002, a series of securities law class action complaints were
filed in the United States District Court, California Northern District,
against us and certain of our officers and directors. The plaintiffs in these
actions allege, among other things, violations of the Securities Exchange Act
of 1934 due to issuing a series of allegedly false and misleading statements
concerning our business and financial condition between May 11, 2000 and August
11, 2002. The complaints seek unspecified monetary damages and other relief.
These matters are at an early stage. No responses to the complaints have yet
been filed, and no discovery has taken place. We intend to defend ourselves
vigorously against these allegations. On December 31, 2002, the Court entered
an order consolidating all related securities class actions against the
Company.
Following our August 12, 2002 announcement that we intended to restate
prior period financial statements, the staff of the San Francisco District
Office of the SEC requested certain information and documents relating to this
matter as part of an informal, preliminary inquiry. We provided that
information, and expect to provide further information now that the restatement
is completed. On February 28, 2003, we reported that the SEC had issued a
formal non-public order of investigation concerning our accounting and
financial reporting practices for the period beginning January 1, 1998. We
intend to continue to cooperate with the SEC in the event it requests other
information. We cannot predict whether such information will be requested,
when the SEC will conclude its inquiry, or the impact or outcome thereof.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of the Chairman of the Board and Chief Executive
Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer under Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chairman of the Board and Chief Executive
Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer under Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K. There were no reports on Form 8-K during the quarter
for which this report is filed.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
QUADRAMED CORPORATION
Date: September 19, 2003 By: /s/ Lawrence P. English
--------------------------------------
Lawrence P. English
Chairman of the Board
Chief Executive Officer
Date: September 19, 2003 By: /s/ Charles J. Stahl
--------------------------------------
Charles J. Stahl
Chief Financial Officer
34