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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 SEPTEMBER 30, 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 X No __
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 October 31, 2003, there were 27,645,610 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 SEPTEMBER 30, 2003
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Interim Condensed Consolidated Balance Sheets as of September 30,
2003 and December 31, 2002...................................... 3
Interim Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2003 and 2002......... 4
Interim Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2003 and 2002................... 5
Notes to Interim Condensed Consolidated Financial Statements...... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 26
Item 4. Controls and Procedures........................................... 27
PART II. OTHER INFORMATION
Item 4. Submission of Matter to a Vote of Security Holders................ 29
Item 6. Exhibits and Reports on Form 8-K.................................. 30
Signatures........................................................ 31
2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
September 30, December 31,
ASSETS 2003 2002
----------- ------------
Current assets (unaudited)
Cash and cash equivalents $ 33,200 $ 23,663
Short-term investments 2,380 2,528
Accounts receivable, net of allowance for doubtful
accounts of $3,016 and $4,346, respectively 32,749 31,612
Unbilled receivables 4,920 3,475
Notes and other receivables 650 4,416
Prepaid expenses and other current assets 10,431 8,972
--------- ---------
Total current assets 84,330 74,666
Restricted cash 5,534 5,849
Property and equipment, net of accumulated depreciation
and amortization of $18,820 and $16,170, respectively 5,861 6,019
Capitalized software development costs, net of
accumulated amortization of $9,655 and $7,776,
respectively 3,791 5,670
Goodwill 18,445 18,445
Other intangible assets, net of accumulated
amortization of $15,040 and $13,316, respectively 7,551 9,275
Other long-term assets 7,840 7,003
--------- ---------
Total assets $ 133,352 $ 126,927
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accounts payable and accrued expenses $ 4,561 $ 3,586
Accrued payroll and related 8,150 6,942
Other accrued liabilities 11,387 6,509
Deferred revenue 49,141 39,492
--------- ---------
Total current liabilities 73,239 56,529
5.25% Convertible subordinated debt due 2005 11,931 73,719
10% Senior secured debt due 2008, net of unamortized
discount of $11,705 and none, respectively 59,295 --
Other long-term liabilities 4,394 3,914
--------- ---------
Total liabilities 148,859 134,162
--------- ---------
Commitments and contingencies
Stockholders' deficit
Preferred stock -- --
Common stock 278 205
Additional paid-in-capital 289,271 275,631
Deferred compensation (470) (588)
Accumulated other comprehensive loss (220) (310)
Accumulated deficit (304,366) (282,173)
--------- ---------
Total stockholders' deficit (15,507) (7,235)
--------- ---------
Total liabilities and stockholders' deficit $ 133,352 $ 126,927
========= =========
The accompanying notes are an integral part of these interim
condensed consolidated financial statements.
3
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
Revenue
Services and other $ 19,340 $ 18,564 $ 58,294 $ 57,419
Licenses 10,363 7,027 30,079 21,653
-------- -------- -------- --------
Total revenue 29,703 25,591 88,373 79,072
-------- -------- -------- --------
Cost of revenue
Cost of services and other 9,418 10,250 31,190 26,508
Cost of licenses 1,754 2,121 5,363 6,193
-------- -------- -------- --------
Total cost of revenue 11,172 12,371 36,553 32,701
-------- -------- -------- --------
Gross margin 18,531 13,220 51,820 46,371
-------- -------- -------- --------
Operating expenses
Sales and marketing 5,548 5,743 16,858 16,030
Research and development 6,375 4,778 17,080 12,535
General and administrative 8,766 12,030 32,747 26,572
Amortization and other operating
charges 615 774 1,756 2,401
-------- -------- -------- --------
Total operating expenses 21,304 23,325 68,441 57,538
-------- -------- -------- --------
Loss from operations (2,773) (10,105) (16,621) (11,167)
-------- -------- -------- --------
Other income (expense)
Interest expense (2,661) (866) (6,766) (2,596)
Interest income 151 129 438 453
Other income (expense), net 42 (374) 756 (945)
-------- -------- -------- --------
Other income (expense) (2,468) (1,111) (5,572) (3,088)
-------- -------- -------- --------
Loss from continuing operations (5,241) (11,216) (22,193) (14,255)
Loss from discontinued operations -- (240) -- (1,528)
-------- -------- -------- --------
Net loss $ (5,241) $(11,456) $(22,193) $(15,783)
======== ======== ======== ========
Loss per share
Basic and diluted
Continuing operations $ (0.19) $ (0.42) $ (0.81) $ (0.53)
Discontinued operations -- (0.01) -- (0.06)
-------- -------- -------- --------
Net $ (0.19) $ (0.43) $ (0.81) $ (0.59)
======== ======== ======== ========
Weighted average shares outstanding
Basic and diluted 27,520 26,950 27,263 26,900
======== ======== ======== ========
The accompanying notes are an integral part of these interim
condensed consolidated financial statements.
4
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine months ended
September 30,
------------------------
2003 2002
---- ----
Cash flows from operating activities
Net loss from continuing operations $ (22,193) $ (14,255)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization 8,701 6,496
Provision for bad debts 487 915
Write-off of marketable investments -- 444
In-process research and development -- 400
Other 151 219
Changes in assets and liabilities:
Accounts receivable (1,624) 5,136
Prepaid expenses and other (4,041) (89)
Accounts payable and accrued liabilities 7,559 630
Deferred revenue 9,649 7,497
--------- ---------
Cash (used in) provided by continuing operations (1,311) 7,393
Cash used in discontinued operations -- (1,563)
--------- ---------
Cash (used in) provided by operating activities (1,311) 5,830
--------- ---------
Cash flows from investing activities
Decrease (increase) in restricted cash 314 (92)
Purchases of available-for-sale securities (620) (367)
Proceeds from sale of available-for-sale securities 656 316
Acquisitions of businesses -- (11,930)
Purchases of property and equipment (2,491) (1,508)
Proceeds from sale of assets 4,190 --
Capitalized software development costs -- (1,700)
--------- ---------
Cash provided by (used in) investing activities 2,049 (15,281)
--------- ---------
Cash flows from financing activities
Issuances (repayments) of debt 8,561 (438)
Proceeds from issuance of common stock 238 1,885
--------- ---------
Cash provided by financing activities 8,799 1,447
--------- ---------
Net increase (decrease) in cash and cash equivalents 9,537 (8,004)
Cash and cash equivalents, beginning of period 23,663 29,799
--------- ---------
Cash and cash equivalents, end of period $ 33,200 $ 21,795
========= =========
Supplemental disclosure of cash flow information
Cash paid for interest $ 1,854 $ 1,935
========= =========
Net cash (refunded) paid for taxes $ (1) $ 418
========= =========
Supplemental disclosure of non-cash investing and
financing transactions
Issuances of restricted common stock $ 268 $ 348
========= =========
Issuance of warrants in connection with debt offering $ 13,209 $ --
========= =========
The accompanying notes are an integral part of these interim
condensed consolidated financial statements.
5
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
1. NATURE OF OPERATIONS
QuadraMed Corporation, along with all significant business divisions and
subsidiaries (collectively, 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: Enterprise Division, Health
Information Management Software Division, and Financial Services Division. In
December 2002, QuadraMed sold its Health Information Management Services
Division. Results of operations for this division are reflected as
discontinued operations in the Statement of Operations.
2. BASIS OF PRESENTATION
Unaudited Interim Results
-------------------------
The condensed consolidated financial statements at September 30, 2003 and
December 31, 2002 and for the three and nine months ended September 30, 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 and nine months ended September
30, 2003 are not necessarily indicative of the results for the fiscal year
ending December 31, 2003 or any other future periods.
3. LONG-TERM DEBT
--------------
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 Agreement 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, 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, were $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.
The 2008 Debt bears interest at an initial rate of 10%, of which 6% is due
in semi-annual cash coupon payments in the first year with the remainder added
to the outstanding principal balance of the notes. The interest rate on the
2008 Debt will be reduced to 9% upon relisting of QuadraMed's common stock on
the Nasdaq, including Nasdaq SmallCap or any U.S. National Market, and is
secured by substantially all of QuadraMed's 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 warrants to purchase 11.6 million shares of common stock, of which
warrants for 11.3 million shares were issued to purchasers of the 2008 Debt and
283,000 shares were issued as compensation for services provided
6
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 2003
with the offering. The warrants have a term of five years, 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. QuadraMed valued the warrants using the Black-Scholes valuation
model using a volatility of 142%, expected life of 5 years, 2.74% risk-free
interest rate and no dividend yield. The result was a fair value of $12.9
million for the warrants issued to debt holders. This amount was recorded as a
discount to the debt and will be amortized to interest expense ratably over the
5-year term of the debt. In addition, costs associated with the debt offering,
including the warrants for 283,000 shares, totaled $1.0 million, which will be
amortized to interest expense ratably over the same term. In June 2003, 283,000
warrants were exercised.
At September 30, 2003, long-term debt consisted of a principal balance of
$11.9 million for the 2005 debt, $71.0 million for the 2008 debt and
unamortized warrants of $11.7 million.
4. STOCK-BASED COMPENSATION
SFAS No. 123, Accounting for Stock Based Compensation, encourages, but
---------------------------------------
does 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
--------------
Stock Issued to Employees, and Related Interpretations. Accordingly,
- ------------------------------------------------------
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 QuadraMed 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. Had compensation cost for QuadraMed's stock option plan
and employee stock purchase plan been determined consistent with SFAS No. 123,
QuadraMed'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):
Three months ended
September 30,
--------------------
2003 2002
---- ----
Net loss as reported $ (5,241) $(11,456)
Add: Stock-based employee compensation expense included
in reported net loss, net of related tax effects 117 139
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (920) (1,671)
-------- --------
Pro forma net loss $ (6,044) $(12,988)
======== ========
Earnings per share:
Basic and diluted - as reported $ (0.19) $ (0.43)
======== ========
Basic and diluted - pro forma $ (0.22) $ (0.48)
======== ========
7
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 2003
Nine months ended
September 30,
--------------------
2003 2002
---- ----
Net loss as reported $(22,193) $(15,783)
Add: Stock-based employee compensation expense included
in reported net loss, net of related tax effects 385 417
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (3,402) (4,842)
-------- --------
Pro forma net loss $(25,210) $(20,208)
======== ========
Earnings per share:
Basic and diluted - as reported $ (0.81) $ (0.59)
======== ========
Basic and diluted - pro forma $ (0.92) $ (0.75)
======== ========
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 138.91% 135.55%
Risk-free interest rate 2.74% 2.26%
Expected life of options 5 years 5 years
5. NET LOSS PER SHARE AND COMPREHENSIVE INCOME (LOSS)
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 the three and nine months ended
September 30, 2003 and 2002, no common equivalent shares were included in the
net loss per share calculation because they were anti-dilutive.
The components of QuadraMed's comprehensive income (loss) include the
unrealized gain (loss) on available-for-sale securities which is not
significant for any period presented.
6. 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
- -----------
those described in the summary of significant accounting policies described in
notes to the financial statements in its 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.
8
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 2003
Summary financial data by business segment as reported to the CODM is
presented below for the three and nine months ended September 30, 2003 and 2002
(in thousands):
Three months ended September 30, 2003
----------------------------------------------------
HIM Financial Consolidated
Description Enterprise Software Services Other (1) Total
- -------------------------- ---------- -------- -------- --------- -----
Total revenues $ 17,762 $ 9,689 $ 2,252 $ -- $ 29,703
Gross margin $ 11,255 $ 6,619 $ 657 $ -- $ 18,531
Interest income (expense),
net $ (1,490) $ (562) $ (463) $ 5 $ (2,510)
Segment assets $ 40,747 $ 41,274 $ 4,137 $ 47,194 $ 133,352
Total depreciation and
amortization (2) $ 1,257 $ 941 $ 255 $ 225 $ 2,678
- ------------------------------------
(1) Other includes non-allocable assets such as cash and cash equivalents and
restricted cash, investments and certain enterprise-wide intangible 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 reflected in interest
expense, amortization of deferred compensation and amortization of other
intangibles.
Three months ended September 30, 2002
----------------------------------------------------
HIM Financial Consolidated
Description Enterprise Software Services Other (1) Total
- -------------------------- ---------- -------- -------- --------- -----
Total revenues $ 16,246 $ 6,786 $ 2,559 $ -- $ 25,591
Gross margin $ 9,605 $ 2,988 $ 627 $ -- $ 13,220
Interest income (expense),
net $ (454) $ (184) $ (145) $ 46 $ (737)
Segment assets $ 40,374 $ 44,512 $ 4,959 $ 31,256 $ 121,101
Total depreciation and
amortization (2) $ 713 $ 1,155 $ 148 $ 18 $ 2,034
- ------------------------------------
(1) Other includes non-allocable assets such as cash and cash equivalents and
restricted cash, investments and certain enterprise-wide intangible 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 reflected in interest
expense, amortization of deferred compensation and amortization of other
intangibles.
Nine months ended September 30, 2003
----------------------------------------------------
HIM Financial Consolidated
Description Enterprise Software Services Other (1) Total
- -------------------------- ---------- -------- -------- --------- -----
Total revenues $ 54,629 $ 26,327 $ 7,417 $ -- $ 88,373
Gross margin $ 32,502 $ 17,773 $ 1,545 $ -- $ 51,820
Interest income (expense),
net $ (3,826) $ (1,446) $ (1,191) $ 135 $ (6,328)
Segment assets $ 40,747 $ 41,274 $ 4,137 $ 47,194 $ 133,352
Total depreciation and
amortization (2) $ 3,870 $ 3,115 $ 760 $ 956 $ 8,701
- ------------------------------------
(1) Other includes non-allocable assets such as cash and cash equivalents and
restricted cash, investments and certain enterprise-wide intangible 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 reflected in interest
expense, amortization of deferred compensation and amortization of other
intangibles.
9
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 2003
Nine months ended September 30, 2002
----------------------------------------------------
HIM Financial Consolidated
Description Enterprise Software Services Other (1) Total
- -------------------------- ---------- -------- -------- --------- -----
Total revenues $ 49,400 $ 19,859 $ 9,813 $ -- $ 79,072
Gross margin $ 30,610 $ 11,508 $ 4,253 $ -- $ 46,371
Interest income (expense),
net $ (1,316) $ (529) $ (418) $ 120 $ (2,143)
Segment assets $ 40,374 $ 44,512 $ 4,959 $ 31,256 $ 121,101
Total depreciation and
amortization (2) $ 1,647 $ 2,814 $ 426 $ 1,609 $ 6,496
- ------------------------------------
(1) Other includes non-allocable assets such as cash and cash equivalents and
restricted cash, investments and certain enterprise-wide intangible 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 reflected in interest
expense, amortization of deferred compensation and amortization of other
intangibles.
7. MAJOR CUSTOMERS
For the three and nine month periods ended September 30, 2003 and 2002, no
single customer accounted for more than 10% of total revenues. However, for
the three and nine months ended September 30, 2003 and 2002, U.S. government
revenue accounted for 21.8% and 22.0%, and 27.1% and 23.9%, respectively, of
HIM Software Division revenues.
8. 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 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. On October 10,
2003, QuadraMed announced that the Staff of the San Francisco District Office
of the Securities and Exchange Commission ("the Staff") has informed QuadraMed
that the Staff intends to recommend to the SEC that it institute an enforcement
action against QuadraMed for violations of the antifraud, periodic filing and
books and records provisions of the federal securities laws. The proposed
recommendation concerns QuadraMed's accounting for transactions that it entered
into with Health+Cast LLP in 1998 and 1999. The 1999 transactions were restated
as part of QuadraMed's recent restatement of its 1999 financial statements. The
Staff invited QuadraMed to make a Wells submission with respect to the proposed
recommendation. QuadraMed plans to continue to discuss this matter with the
Staff; however, QuadraMed cannot predict when the SEC will conclude its
inquiry, or the outcome and impact thereof. The staff also indicated that it
does not presently intend to recommend any action against QuadraMed's current
officers, directors or employees.
10
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 2003
9. SUBSEQUENT EVENTS
On October 23, 2003, QuadraMed received a written Demand Request from a
Holder of Registrable Securities, pursuant to Section 2 of the Registration
Rights Agreement (the "Agreement"), dated as of April 17, 2003. QuadraMed
mailed a Request Notice to all Holders under the Agreement on November 3, 2003.
QuadraMed is required to file for registration of the warrants within 90 days
of receiving the Demand Request and is preparing such filing.
On November 5, 2003 QuadraMed consolidated the organization of the HIM
Software Division and Enterprise Division into a single functional software
organization. This reorganization is designed to use existing resources more
efficiently and to facilitate the integration of products and technologies. The
change does not affect the Financial Services Division.
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.
Critical Accounting Policies and Estimates
- ------------------------------------------
Our critical accounting policies have a considerable impact on
Management's Discussion and Analysis.
Principles of Consolidation
---------------------------
Our 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
accounts, capitalized software, income taxes, pensions and other benefits,
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 which management believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from other sources. 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 and other.
Our license revenue consists of fees for licenses of proprietary and
third-party software. Cost of license revenue primarily includes third-party
software and royalties and amortization of capitalized software. 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, seminars and
12
hardware. Cost of services consists primarily of salaries, benefits, and
allocated costs related to providing such services, labor costs for engineers
performing implementation services, technical support, training personnel and
hardware.
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 our consolidated financial
statements. A number of internal and external factors can affect our
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.
13
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.
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 SFAS No. 142, Goodwill and Other
-------- ------------------
Intangible Assets, effective for fiscal years beginning after December 15,
- -----------------
2001. Under SFAS No. 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 No. 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 No. 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 No. 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 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 No. 142 on an annual basis or more often, as
deemed 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.
14
Results of Operations
- ---------------------
The following table sets forth selected data for the indicated periods.
Percentages are expressed as a percentage of total revenues, except for cost of
revenue, which is expressed as a percentage of the related revenue
classification.
Three months ended September 30, Nine months ended September 30,
----------------------------------- -----------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenue
Services and other $ 19,340 65.1% $ 18,564 72.5% $ 58,294 66.0% $ 57,419 72.6%
Licenses 10,363 34.9 7,027 27.5 30,079 34.0 21,653 27.4
-------- ----- -------- ----- -------- ----- -------- -----
Total revenue 29,703 100.0 25,591 100.0 88,373 100.0 79,072 100.0
-------- ----- -------- ----- -------- ----- -------- -----
Cost of revenue
Cost of services and
other 9,418 48.7 10,250 55.2 31,190 53.5 26,508 46.2
Cost of licenses 1,754 16.9 2,121 30.2 5,363 17.8 6,193 28.6
-------- ----- -------- ----- -------- ----- -------- -----
Total cost of revenue 11,172 37.6 12,371 48.3 36,553 41.4 32,701 41.4
-------- ----- -------- ----- -------- ----- -------- -----
Gross margin 18,531 62.4 13,220 51.7 51,820 58.6 46,371 58.6
-------- ----- -------- ----- -------- ----- -------- -----
Operating expenses
Sales and marketing 5,548 18.7 5,743 22.4 16,858 19.1 16,030 20.3
Research and development 6,375 21.4 4,778 18.7 17,080 19.3 12,535 15.9
General and
administrative 8,766 29.5 12,030 47.0 32,747 37.1 26,572 33.6
Amortization and other
operating charges 615 2.1 774 3.0 1,756 2.0 2,401 3.0
-------- ----- -------- ----- -------- ----- -------- -----
Total operating
expenses 21,304 71.7 23,325 91.1 68,441 77.5 57,538 72.8
======== ===== ======== ===== ======== ===== ======== =====
Revenue
-------
Total Revenue. Total revenue for the three months ended September 30,
-------------
2003, was $29.7 million, an increase of $4.1 million or 16.1% from $25.6
million for the three months ended September 30, 2002. Total revenue for the
nine months ended September 30, 2003, was $88.4 million, an increase of $9.3
million or 11.8% from $79.1 million for the nine months ended September 30,
2002. Total revenue for the three months ended September 30, 2003, was $29.7
million, an increase of $267,000 or 0.9% from $29.4 million for the three
months ended June 30, 2003.
As of September 30, 2003, deferred revenue was $49.1 million, an increase
of $9.6 million or 24.4% from $39.5 million as of December 31, 2002. Deferred
revenue increased by $9.6 million during the same period primarily due to $5.4
million related to HIM government sales, $2.7 million in other HIM software
division and $1.5 million in Enterprise division sales. Deferred revenue
increased by $2.1 million or 4.4% during the three months ended September 30,
2003 compared to June 30, 2003.
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 Health Information
Management (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 our software license revenues.
Financial Services' revenue is recognized as services are performed. Our
maintenance revenues depend on both licenses of our software products and
renewals of maintenance agreements by our existing customer base. Services and
other revenue was $19.3 million for the three months ended September 30, 2003,
an increase of $776,000 or 4.2% from $18.6 million for the three months ended
September 30, 2002. For the nine months ended September 30, 2003, services and
other revenue was $58.3 million, an increase of $875,000 or 1.5% from $57.4
million from the first nine months of 2002. Services and other revenue for the
three months ended September 30, 2003 increased $66,000 or 0.3% from the three
months ended June 30, 2003.
15
For the three months ended September 30, 2003, the Enterprise division's
services and other revenue increased due to increased installations of our
software products offset by a decrease in hardware revenue. For the nine
months ended September 30, 2003, the Enterprise division's service and other
revenue increased primarily due to a significant hardware sale and overall
increased installations.
Service and other revenue for the HIM Software division improved slightly
for the three and nine months ended September 30, 2003 primarily due to the
increase in coding software and record management product's revenue resulting
from increased customer installations and maintenance renewals.
Revenue for the Financial Services division has decreased by approximately $2.4
million for the nine months in 2003 compared to 2002 due to a decrease in the
quality of assignments and average lower contract fees.
Licenses. License revenue consists of fees for licenses of proprietary
--------
and third-party software. We market our products through our direct sales
force. License revenue in the three months ended September 30, 2003 was $10.4
million, an increase of $3.3 million or 47.5% from $7.0 million in the
corresponding period of 2002. For the nine months ended September 30, 2003,
license revenue was $30.1 million, an increase of $8.4 million or 38.9%
compared to $21.7 million in the first nine months of 2002. License revenue
for the three months ended September 30, 2003 was $10.4 million, an increase of
$202,000 or 2.0% from $10.2 million for the three months ended June 30, 2003.
The increase in absolute dollar amount of license revenue for the three
and nine months of 2003 was due to increases in the HIM software division. The
HIM division increase was due primarily to migration sales and recognition of
deferred revenue from coding software products and, to a lesser extent,
government sales. The increase in absolute dollar amount of license revenue
for the nine months ended September 30, 2003, was primarily due to recognition
of software license revenue from the coding software products and an increase
in government revenue due to growth in sales.
The Enterprise Division grew close to 22% quarter over quarter and 26% for
the nine month period of 2003 compared to 2002. The increase was directly
related to increased revenue for the Affinity suite of products, Performance
Measurement products and the acquisition of Pharmacy Data Systems, Inc. (PDS)
in June 2002.
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 and consulting services as well as third-party hardware costs. Cost of
services and other for the three months ended September 30, 2003 was $9.4
million, a decrease of $832,000 or 8.1% less than the $10.3 million recorded in
the corresponding period of 2002. As a percentage of services and other
revenue, cost of services and other was 48.7% and 55.2% for the three months
ended September 30, 2003 and 2002, respectively. Cost of services and other
for the nine months ended September 30, 2003 was $31.2 million, an increase of
$4.7 million or 17.7% compared to the $26.5 million recorded in the
corresponding period of 2002. As a percentage of services and other revenue,
cost of services and other was 53.5% and 46.2% for the nine months ended
September 30, 2003 and 2002, respectively. Cost of services and other for the
three months ended September 30, 2003 was $9.4 million, a decrease of $.6
million or 5.6% from $10.0 million for the three months ended June 30, 2003.
The Enterprise division cost of services and other was relatively flat
quarter over quarter but increased substantially for the nine months in 2003
compared to 2002 due to increased salary and bonus expense and hardware cost
due to the related hardware revenue.
The HIM software division cost of services and other decreased slightly in
operating expenses quarter over quarter and increased slightly for the nine
months in 2003 compared to 2002, due to salary and related expenses.
The Financial Services division cost of services and other decreased
slightly quarter over quarter and increased slightly for the nine months 2003
compared to 2002, due to salary and related expenses. The gross margin
decreased for the nine months ended September 30, 2003 compared to 2002 due to
the decline in service revenue while no change to cost of services.
16
Cost of Licenses. Cost of license consists primarily of third party
----------------
software and royalties and amortization of capitalized software. Cost of
license for the three months ended September 30, 2003 was $1.8 million, a
decrease of $367,000 or 17.3% compared to $2.1 million for the same period of
2002. As a percentage of license revenues, cost of license was 16.9% and 30.2%
for the three months ended September 30, 2003 and 2002, respectively. For the
nine months ended September 30, 2003, cost of license was $5.4 million, a
decrease of $830,000 or 13.4% from $6.2 million from the same period of 2002.
As a percentage of license revenues, cost of license was 17.8% and 28.6% for
the nine months ended September 30, 2003 and 2002, respectively. Cost of
licenses for the three months ended September 30, 2003 decreased $67,000 from
the three months ended June 30, 2003.
In absolute dollars, cost of license for the three months ended September
30, 2003 was down as compared to the prior period due to a decrease in the
amortization of capitalized software. The decrease for the nine months ended
September 30, 2003 was primarily due to a decrease in the cost of third party
software licenses in the Enterprise division as a result of lower third party
software license revenue. The gross margin in license revenue for the HIM
software division improved in 2003 due to the mix of license revenue in
comparison to the cost of licenses.
Operating Expenses
------------------
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 and promotional and advertising expenses. Sales and marketing expense
for the three months ended September 30, 2003 was $5.5 million, a decrease of
$195,000 or 3.4% compared to $5.7 million for the corresponding period of 2002.
As a percentage of revenue, sales and marketing expense was 18.7% for the three
months ended September 30, 2003 as compared to 22.4% for the same quarter of
2002. For the nine months ended September 30, 2003, sales and marketing
expense was $16.9 million, an increase of $828,000 or 5.2% compared to $16.0
million for the first nine months of 2002. As a percentage of total revenue,
sales and marketing expense was 19.1% for the nine months ended September 30,
2003 as compared to 20.3% for the same quarter of 2002. Sales and marketing
expense for the three months ended September 30, 2003 decreased $1,000 from the
three months ended June 30, 2003.
In absolute dollars, marketing and sales expenses have been relatively
comparable from quarter to quarter. The slight decrease for the three months
ended September 30, 2003 was due to a decrease in marketing expenses. In
absolute dollars, the increase in sales and marketing expense for the nine
months ended September 30, 2003 was primarily due to an increase in salaries
and bonus expense reduced by marketing expenses.
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 relates to compensation and benefits costs.
Research and development costs for the three months ended September 30, 2003
was $6.4 million, an increase of $1.6 million or 33.4% compared to $4.8 million
in the same period of 2002. As a percentage of revenue, research and
development costs were 21.4% for the three months ended September 30, 2003
compared to 18.7% in the same quarter of 2002. For the nine months ended
September 30, 2003, research and development costs were $17.1 million, an
increase of $4.5 million or 36.3% from $12.5 million in the first nine months
of 2002. The increase in research and development expense was primarily due to
product development efforts for the continued development of both the Affinity
and HIM software suite of products. The level of research and development
investments increased in the first nine months of 2003 with the primary funding
of Affinity development.
Research and development expense for the three months ended September 30,
2003 increased by $1.1 million or 22% over the three months ended June 30,
2003. The increase of approximately $580,000 was due to management's decision
to reverse previously capitalized software reported in the first half of the
year. This decision was based on management's judgment of facts that emerged
during the quarter. During the nine months ended September 30, 2003, there were
no capitalized costs from software development compared to approximately $1.7
million in the first nine months of 2002.
General and Administrative. General and administrative expense consists
--------------------------
of compensation and benefit costs for executive, finance, legal, information
technology, and administrative personnel. General and administrative expense
for the three months ended September 30, 2003 was $8.8 million, a decrease of
$3.3 million or 27.1% compared to $12.0 million in the same period of 2002. As
a percentage of revenue, general and administrative expense was 29.5% for the
three months ended September 30, 2003 as compared to 47.0% in the same quarter
of 2002. For the nine months ended September 30, 2003, general and
17
administrative expense was $32.7 million, an increase of $6.2 million or 23.2%
from $26.6 million in the comparable period in 2002. As a percentage of total
revenue, general and administrative expense increased to 37.1% for the nine
months ended September 30, 2003 from 33.6% in the nine months ended September
30, 2002. General and administrative expense for the three months ended
September 30, 2003 was $8.8 million, a decrease of $1.7 million or 16.1% from
$10.5 million for the three months ended June 30, 2003.
The decrease in general and administrative expense for the three months
ended September 30, 2003 was primarily due to a decrease of approximately $3.0
million in restatement fees incurred in the prior period of 2002. The increase
in general and administrative expense for the nine months ended September 30,
2003, was due to an increase in accountants, consultants and attorneys' fees
and retention bonuses as part of the restatement process of $3.5 million, and
in increase in employee benefits and contractual services. General and
administrative expenses decreased sequentially from the third quarter of 2003
compared to the second quarter of 2003 as a result of no restatement costs in
the third quarter of 2003.
Amortization and Other Operating Charges. Amortization and other
----------------------------------------
operating charges represented amortization of identifiable intangible assets
and in-process research and development. Amortization and other operating
charges for the three months ended September 30, 2003 was $615,000, a decrease
of $159,000 compared to $774,000 in the same period of 2002. The expense for
the third quarter of 2003 was for the amortization of identifiable intangible
assets. For the same period in 2002, the charges consisted of amortization of
identifiable intangible assets and acquired software, which became fully
amortized in the fourth quarter of 2002. Expense for the nine months in 2002
also includes a $400,000 write-off of in-process research and development
expense associated with the acquisition of PDS. Amortization and other
operating charges decreased slightly in the three months ended September 30,
2003, as compared to the three months ended June 30, 2003.
Other Income (Expense)
---------------------
Other Income (Expense), Net. Net other expense was $2.5 million and $1.1
---------------------------
million for the three months ended September 30, 2003 and 2002, respectively.
For the nine months ended September 30, 2003 and 2002, net other income
(expense) was $5.6 million and $3.1 million, respectively. The increase for
the three and nine months ended was due to the additional interest expense on
the new debentures entered into April 2003, which have a current interest rate
of 10%, and $1.2 million of year-to-date amortization of the associated
warrants, offset by $565,000 income from a short swing profit from an investor.
Net other expense for the three months ended September 30, 2003 was $2.5
million, an increase of $340,000 or 16.0% from $2.1 million for the three
months ended June 30, 2003.
Income Taxes
------------
Provision for Income Taxes. There was no provision for income taxes for
--------------------------
the three and nine months ended September 30, 2003 and 2002. For financial
reporting purposes, a 100% valuation allowance has been recorded against our
deferred tax assets under SFAS No. 109, Accounting for Income Taxes.
Liquidity and Capital Resources
- -------------------------------
Balance Sheet and Cash Flows
----------------------------
Prepaid expenses and other accrued liabilities increased by $1.5 million
and $2.2 million, respectively from December 31, 2002 to September 30, 2003 due
to third-party royalties owed on HIM government sales. An additional $2.9
million of other accrued liabilities resulted from accrued interest on the 2008
debt. Deferred revenue increased by $9.6 million during the same period
primarily due to $5.4 million related to HIM government sales, $2.7 million in
other HIM software division and $1.5 million in Enterprise division sales.
On March 4, 2003, our common stock was delisted from the Nasdaq National
Market. The delisting constituted a "Repurchase Event" under the provisions of
our 5.25% Convertible Subordinated Debentures Agreements due 2005 (the "2005
Debt"). Upon such an event, the 2005 Debt Agreement grants to each debenture
holder the right, at the holder's option, to require us to repurchase all or
any of the holder's debentures. On April 17, 2003, we issued $71.0 million of
its Senior Secured Notes due 2008 (the "2008 Debt"). The proceeds from the
18
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, were $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.
The 2008 Debt bears interest at an initial rate of 10%, of which 6% is due
in semi-annual cash coupon payments in the first year with the remainder added
to the outstanding principal balance of the notes. The interest rate on the
2008 Debt will be reduced to 9% upon relisting of our common stock on the
Nasdaq, including Nasdaq Small Cap or any U.S. National Market, and is secured
by substantially all of our 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, we also issued warrants
to purchase 11.6 million shares of common stock, of which warrants for 11.3
million shares were issued to purchasers of the 2008 Debt and 283,000 shares
were issued as compensation for services provided with the offering. The
warrants have a term of five years, 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. We valued the
warrants using the Black-Scholes valuation model using a volatility of 142%,
expected life of 5 years, 2.74% risk-free interest rate and no dividend yield.
The result was a fair value of $12.9 million for the warrants issued to debt
holders. This amount was recorded as a discount to the debt and will be
amortized to interest expense ratably over the 5-year term of the debt. In
addition, costs associated with the debt offering, including the warrants for
283,000 shares, totaled $1.0 million, which will be amortized to interest
expense ratably over the same term. In June 2003, 283,000 warrants were
exercised.
At September 30, 2003, long-term debt consisted of a principal balance of
$11.9 million for the 2005 debt, $71.0 million for the 2008 debt and
unamortized warrants of $11.7 million at September 30, 2003.
Cash, and cash equivalents and short-term investments were $35.6 million
as of September 30, 2003 and $26.2 million as of December 31, 2002, an increase
of $9.4 million or 35.8% during the period. Cash flows used by operating
activities were $1.3 million for the nine months ended September 30, 2003.
These amounts primarily resulted from a net loss of $22.2 million for the nine
months ended September 30, 2003, offset by depreciation and amortization of
$8.7 million and a decrease of working capital of $7.1 million. Cash flows from
investing activities of $2.0 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 $2.5 million in fixed asset purchases. In
addition, $8.6 million was provided from the restructuring of the long term
debt.
Cash flows provided from operations for the three months ended September
30, 2003 were $4.1 million, including $6.4 million spent on research and
development. Cash flows provided for operations improved in the third quarter
of 2003 versus the second quarter, primarily as a result of a decrease in
working capital of $3.3 million.
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. For the nine months ended
September 30, 2003 we paid $6.5 million related to the restatement and other
non-recurring events. These expenses will be significantly reduced in future
quarters. For the nine months ended September 30, 2003 we invested $17.1
million in research and development of our software products. We expect to
continue to invest in research and development in the future.
19
Commitments
-----------
The following table summarizes financial data for our contractual
obligations and other commercial commitments, including interest obligations,
as of September 30, 2003 (in thousands):
Payments Due by Period
-----------------------------------------------
Less
than 1 1-3 3-5 After 5
Contractual Obligations Total year years years years
- ----------------------- ----- ---- ----- ----- -----
Principal on long-term debt $ 85,671 $ -- $11,931 $73,740 $ --
Interest on long term debt 34,858 4,736 15,374 14,748 --
Operating leases 26,739 4,660 7,663 7,077 7,339
Other long-term obligations 966 483 483 -- --
-------- ------- ------- ------- -------
Total contractual cash obligations $148,234 $ 9,879 $35,451 $95,565 $ 7,339
======== ======= ======= ======= =======
Other Commercial Commitments
- ----------------------------
Standby letters of credit (1) $ 4,076 $ 1,100 $ -- $ 2,620 $ 356
-------- ------- ------- ------- -------
Total commercial commitments $ 4,076 $ 1,100 $ -- $ 2,620 $ 356
======== ======= ======= ======= =======
- ----------------------------
(1) The 3-5 years amount of $2.6 million is for an existing surety bond
requirement on September 30, 2003. Actual requirements may be less as
work is completed towards the underlying contract.
In addition, as of September 30, 2003, we had approximately $26.7 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.
Business Risks
- --------------
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:
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.
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. On October 10, 2003, we
20
announced that the Staff of the San Francisco District Office of the Securities
and Exchange Commission has informed us that the Staff intends to recommend to
the SEC that it institute an enforcement action against us for violations of
the antifraud, periodic filing and books and records provisions of the federal
securities laws. The proposed recommendation concerns our accounting for
transactions that we entered into with Health+Cast LLP in 1998 and 1999. The
1999 transactions were restated as part of our recent restatement of our 1999
financial statements. The Staff invited us to make a Wells submission with
respect to the proposed recommendation. We plan to continue to discuss this
matter with the Staff; however, we cannot predict when the SEC will conclude
its inquiry, or the outcome and impact thereof. The staff also indicated that
it does not presently intend to recommend any action against our current
officers, directors or employees.
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.
Delisting from the Nasdaq National Market subjects us to numerous consequences
that may adversely affect our business, including the loss of investors. We
may no longer qualify for exemptions from state securities registration
requirements. Without an exemption from registration, we may need to file
time-consuming and costly registration statements for future securities
transactions and issuances and to amend our stock option and stock option
purchase plans. Furthermore, delisting may result in decreased coverage by
securities analysts.
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 other National Market as soon as practicable, we can offer no
assurances that we will be relisted on either market.
Our Debentures Have Been Partially Refinanced with Notes that Are Subject
-------------------------------------------------------------------------
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.
21
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.
The 2008 Notes bear an initial interest rate of 10%, which interest rate
is required to be reduced to 9% upon relisting of our common stock on the
Nasdaq, including Nasdaq SmallCap or any U.S. National 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 substantially all of our intellectual
property.
On October 23, 2003, we received a written Demand Request from a Holder of
Registrable Securities, pursuant to Section 2 of the Registration Rights
Agreement (the "Agreement"), dated as of April 17, 2003. We mailed a Request
Notice to all Holders under the Agreement on November 3, 2003. We are required
to file for registration of the warrants within 90 days of receiving the Demand
Request and are preparing such filing.
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.
The Trading Price of Our Common Stock Has Been, and Is Expected to
------------------------------------------------------------------
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 and SEC investigation;
o Developments or disputes with respect to proprietary rights; and
o General trends in our industry and overall market conditions.
Movements in prices of equity securities in general may also affect the
market price of our common stock.
Future Sales of Our Common Stock in the Public Market or Warrant or Option
--------------------------------------------------------------------------
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.
22
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
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.
Provisions in Our Certificate of Incorporation and Bylaws and Delaware Law
--------------------------------------------------------------------------
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.
23
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 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.
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.
We Face Product Development Risks Associated with Rapid Technological
---------------------------------------------------------------------
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.
24
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
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
-------------------------------------------------------------------------
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.
25
If We Are Unable to Compete Effectively, We Could Experience Price
------------------------------------------------------------------
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, and HSS,
Inc.;
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.
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.
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 re-investment risk. We invest in high-quality issuances, including
money market funds and corporate and United States government debt securities.
We have a policy of investing in securities with maturities of two years or
less. We do not invest in derivatives or foreign investments.
26
The table below presents fair values of principal amounts and weighted
average interest rates for our investment portfolio as of September 30, 2003
(in thousands, except average interest rates):
Aggregate Weighted Average
Fair Value Interest Rate
---------- -------------
Cash and cash equivalents:
Cash..................................... $ 10,689
Money Market funds....................... 22,511 0.83%
----------
Total cash and cash equivalents........ $ 33,200
==========
Short-term investments:
Corporate debt securities................ $ 2,380 1.70%
----------
Total short-term investments........... $ 2,380
==========
Long-term investments:
Corporate debt securities................ $ 472 5.17%
U.S. government debt securities.......... 876 5.02%
----------
Total long-term investments............ $ 1,348
==========
On September 30, 2003, our long-term debt consisted of our 2005 debt
balance of $11.9 million at a fixed interest rate of 5.25%, and our 2008 senior
secured notes of $71.0 million with an initial fixed interest rate of 10% which
may be reduced to 9%.
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, accordingly, there is no
foreign currency fluctuation risk associated with such 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 Rules 13a-
15(e), and 15d to 15(e) under the Securities Exchange Act of 1934) as of
September 30, 2003. Based on this evaluation, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were designed to provide reasonable assurance that
information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms.
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.
In addition, our Chief Executive Officer and Chief Financial Officer and
Audit Committee were made aware of conditions that were 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 Annual Report on Form 10-K and March 31, 2002
Quarterly Report on Form 10-Q. The 2001 Amended and Restated Annual Report on
27
Form 10-K/A was filed in June 2003 and the March 31, 2002 Amended and Restated
Quarterly Report on Form 10Q/A was filed in August 2003 to correct these errors
in our previously issued consolidated financial statements.
The aforementioned weaknesses in our internal controls pertained 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 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, and he built 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.
28
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
At 9:00 AM on October 29, 2003, the Company held its Annual Meeting of
Stockholders at the Company's offices at 12110 Sunset Hills Road, Reston,
Virginia 20190. The stockholders of the Company voted on five items at the
Annual Meeting:
a. A proposal to amend the Company's Certificate of Incorporation and
Bylaws of QuadraMed Corporation eliminating the Company's classified
Board of Directors;
b. The election of three Class I directors, each for a term of three years
or, in the event the amendments to QuadraMed's Certificate of
Incorporation and Bylaws described in the first proposal were approved,
the election of eight directors, each for a one-year term expiring in
2004;
c. A proposal to amend the Certificate of Incorporation of QuadraMed
Corporation to increase the number of authorized common shares of
QuadraMed Corporation from 50,000,000 to 150,000,000 and the total
number of shares the Company is authorized to issue from 55,000,000
shares to 155,000,000 shares;
d. A proposal to approve the amendment of the Company's 1996 Stock
Incentive Plan to increase the number of shares authorized for issuance
thereunder from 7,430,160 to 9,930,160, an increase of 2,500,000
shares, and to increase the maximum number of shares for which any one
person may receive options, separately exercisable stock appreciation
rights and direct stock issuance by an additional 500,000 shares to
1,500,000 in the aggregate per calendar year; and
e. A proposal to appoint BDO Seidman LLP as independent public accountants
for the fiscal year ending December 31, 2003.
The amendment of the Company's Certificate of Incorporation and Bylaws of
QuadraMed Corporation to eliminate the Company's classified Board of Directors
was approved as follows:
For Against Abstentions
--- ------- -----------
26,247,482 73,512 23,698
As the stockholders approved the proposal to eliminate the classified
Board of Directors, the eight nominees for directors were approved as follows:
Nominee For Against
------- --- -------
F. Scott Gross 25,709,839 634,853
William K. Jurika 25,718,289 626,403
Robert L. Pevenstein 25,734,289 610,403
Michael J. King 25,695,653 649,039
Cornelius T. Ryan 25,688,386 656,306
Lawrence P. English 25,722,149 622,543
Joseph L. Feshbach 25,725,839 618,853
Robert W. Miller 25,725,309 619,383
The amendment of the Certificate of Incorporation of QuadraMed Corporation
to increase the number of authorized common shares of QuadraMed Corporation
from 50,000,000 to 150,000,000 and the total number of shares the Company is
authorized to issue from 55,000,000 shares to 155,000,000 shares was approved
as follows:
For Against Abstentions
--- ------- -----------
24,986,713 1,341,599 16,380
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The amendment of the Company's 1996 Stock Incentive Plan to increase the
number of shares authorized for issuance to 9,930,160 shares, and to increase
the maximum number of shares for which any one person may receive options,
separately exercisable stock appreciation rights and direct stock issuance to
1,500,000 in the aggregate per calendar year was approved as follows:
For Against Abstentions
--- ------- -----------
10,101,665 2,975,809 34,214
The appointment of BDO Seidman LLP as independent public accountants for
the fiscal year ending December 31, 2003 was approved as follows:
For Against Abstentions
--- ------- -----------
26,281,227 51,069 12,396
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 18 U.S.C. Section 1350, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer under 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chairman of the Board and Chief Executive
Officer and Chief Financial Officer under 18 U.S.C. Section
1350.
(b) Reports filed on Form 8-K during the period of this Quarterly Report on
Form 10-Q:
There were no reports filed on Form 8-K during the period of this
Quarterly Report on Form 10-Q.
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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: November 14, 2003 By: /s/ Lawrence P. English
--------------------------------
Lawrence P. English
Chairman of the Board
Chief Executive Officer
Date: November 14, 2003 By: /s/ Charles J. Stahl
--------------------------------
Charles J. Stahl
Chief Financial Officer
31