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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission file number 0-13801
QUALITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California 95-2888568
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
18191 Von Karman Avenue, Irvine California 92612
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 255-2600
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of the latest practicable date: 6,122,953 shares of Common
Stock, $.01 par value, as of Aug. 8, 2002.
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PART I - CONSOLIDATED FINANICAL INFORMATION
Item 1. Financial Statements
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
----------------------------
(In thousands) June 30, March 31,
2002 2002
(unaudited)
- -----------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 28,862 $ 25,443
Short-term investments -- 255
Accounts receivable, net 13,245 13,695
Inventories, net 1,019 1,118
Deferred tax assets 1,368 1,368
Other current assets 955 1,013
----------------------------
Total current assets 45,449 42,892
Equipment and improvements, net 1,582 1,578
Capitalized software costs, net 2,125 2,103
Deferred tax assets 2,778 2,778
Goodwill, net 1,840 1,840
Other assets 1,022 952
----------------------------
Total assets $ 54,796 $ 52,143
----------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 863 $ 2,657
Deferred service revenue 7,882 6,155
Other current liabilities 4,338 3,281
----------------------------
Total liabilities 13,083 12,093
----------------------------
Commitments and contingencies
Shareholders' equity:
Common stock, $0.01 par value, 20,000 shares authorized,
6,111 and 6,105 shares issued and outstanding, respectively 61 61
Additional paid-in capital 34,711 34,674
Retained Earnings 6,941 5,315
----------------------------
Total shareholders' equity 41,713 40,050
----------------------------
Total liabilities and shareholders' equity $ 54,796 $ 52,143
- -------------------------------------------------------------------------------============================
See notes to consolidated financial statements.
1
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
----------------------------
(In thousands except per share amounts) Three Months Ended June 30,
2002 2001
- ----------------------------------------------------------------------------------------------------
Net revenues:
Sales of computer systems, upgrades and supplies $ 6,425 $ 5,594
Maintenance and other services 5,882 5,315
----------------------------
12,307 10,909
Cost of products and services 4,920 4,734
----------------------------
Gross profit 7,387 6,175
Selling, general and administrative expenses 3,673 3,245
Research and development costs 1,135 1,107
----------------------------
Income from operations 2,579 1,823
Investment income 104 206
----------------------------
Income before provision for income taxes 2,683 2,029
Provision for income taxes 1,057 771
----------------------------
Net income $ 1,626 $ 1,258
============================
Net income per share, basic $ 0.27 $ 0.21
----------------------------
Net income per share, diluted $ 0.26 $ 0.20
----------------------------
Weighted average shares outstanding - basic 6,106 5,989
----------------------------
Weighted average shares outstanding - diluted 6,332 6,173
- ----------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
2
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
----------------------------
(In thousands) Three Months Ended June 30,
2002 2001
- -----------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Income $ 1,626 $ 1,258
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 523 532
Loss (Gain) on short-term investments and other 20 (5)
Changes in:
Accounts receivable 450 (247)
Inventories 99 175
Other current assets 58 (170)
Other assets (85) --
Accounts payable (1,794) (277)
Deferred service revenue 1,727 592
Other current liabilities 1,057 (14)
----------------------------
Net Cash Provided By Operating Activities 3,681 1,844
----------------------------
Cash Flows From Investing Activities:
Proceeds from the sale of short term investments 235 --
Net additions to equipment and improvements (209) (87)
Additions to capitalized software costs (325) (305)
----------------------------
Net Cash Used In Investing Activities (299) (392)
----------------------------
Cash Flows from Financing Activities:
Proceeds from exercise of stock options 37 31
----------------------------
Net Cash Provided by Financing Activities 37 31
----------------------------
Net Increase in Cash and Cash Equivalents 3,419 1,483
Cash and Cash Equivalents, beginning of period 25,443 18,471
----------------------------
Cash and Cash Equivalents, end of period $ 28,862 $ 19,954
- -------------------------------------------------------------============================
Supplemental Information - During the three months ended June 30, 2002 and 2001,
the Company made income tax payments, net of refunds received, of $371,000 and
$669,000, respectively.
See notes to consolidated financial statements.
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QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements as of June 30, 2002
and the three months ended June 30, 2002 and 2001, have been prepared in
accordance with the requirements of Form 10-Q and, therefore, do not include all
information and footnotes which would be presented were such financial
statements prepared in accordance with generally accepted accounting principles.
These financial statements should be read in conjunction with the audited
financial statements presented in the Company's Annual Report for the fiscal
year ended March 31, 2002. In the opinion of management, the accompanying
consolidated financial statements reflect all adjustments which are necessary
for a fair presentation of the results of operations for the periods presented.
The results of operations for such interim periods are not necessarily
indicative of results of operations to be expected for the full year. Certain
amounts in the accompanying consolidated financial statements have been
reclassified to conform with the June 30, 2002 presentation.
2. Intangible Assets
The Company adopted Financial Accounting Standards Board No. 142 "Goodwill and
Other Intangible Assets" ("FASB 142") effective April 1, 2001. In accordance
with FASB 142, the Company does not amortize goodwill. The balance of goodwill
is related to the Company's NextGen Healthcare Information Systems (NextGen)
Division. In accordance with FASB 142, the Company has compared the fair value
of the NextGen Division with the carrying amount of assets associated with the
Division and determined that none of the goodwill recorded as of June 30, 2002
was impaired. The fair value of the NextGen Division was determined using a
reasonable estimate of future cash flows of the Division and a risk adjusted
discount rate to compute a net present value of future cash flows.
As of June 30, 2002, the Company had the following amounts related to
intangible assets:
-----------------------------------------------------
(In thousands) Gross Carrying Accumulated Net Intangible
Amount Amortization Assets
-------------------------------------------------------------------------------------------------------
Developed technology (5 yrs) $ 1,300 $(1,300) $ 0
Capitalized software development (3 yrs) $ 6,988 $(4,863) $ 2,125
-----------------------------------------------
Total amortized intangible assets $ 8,288 $(6,163) $ 2,125
-------------------------------------------------------------------------------------------------------
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Aggregate amortization expense three months ended June 30, 2002 $ 318
-------------------------------------------------------------------------------------------------------
The unamortized balance of capitalized software development costs is
estimated to be amortized as follows:
---------------------------------------------------------------------
Estimated Amortization Expense
For the year ended March 31, (in thousands)
---------------------------------------------------------------------
2003 $ 851
2004 $ 817
2005 $ 457
---------------------------------------------------------------------
3. Stock Repurchase Plan
In October 2001, the Company's Board of Directors authorized the repurchase on
the open market of up to 5% of the shares of the Company's outstanding Common
stock, subject to compliance with applicable laws and regulations. There is no
requirement that the Company repurchase such shares. This stock
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repurchase authorization expires on the date of the fiscal 2003 Annual
Shareholders Meeting, currently scheduled for August 29, 2002. During the three
months ended June 30, 2002, the Company did not repurchase any of its shares.
Since the October 2001 authorization through June 30, 2002, no shares were
repurchased.
4. Income Taxes
The provision for income taxes for the three months ended June 30, 2002 and 2001
differs from the expected combined statutory rates primarily due to the impact
of the effect of varying state income tax rates.
5. Net Income Per Share
The following table reconciles the weighted average shares outstanding for basic
and diluted net income per share for the periods indicated.
(in thousands except per share amounts) ----------------------------
Three Months Ended June 30,
2002 2001
------------------------------------------------------------------------------------------
Net income $ 1,626 $ 1,258
Basic net income per common share:
Weighted average of common shares outstanding 6,106 5,989
----------------------------
Basic net income per common share $ 0.27 $ 0.21
============================
Diluted net income per share:
Weighted average of common shares outstanding 6,106 5,989
Effect of potentially dilutive securities (options) 226 184
----------------------------
Weighted average number of common and shares - Diluted 6,332 6,173
----------------------------
Diluted net income per common share $ 0.26 $ 0.20
--------------------------------------------------------------============================
6. Operating Segment Information
The Company has prepared operating segment information in accordance with
Statement of Accounting Standards ("SFAS") No. 131 "Disclosures About Segments
of an Enterprise and Related Information" ("SFAS No. 131") to report components
that are evaluated regularly by the Company's chief operating decision maker, or
decision making group in deciding how to allocate resources and in assessing
performance.
The Company's reportable operating segments include its NextGen Healthcare
Information Systems Division and the QSI Division.
The disaggregated financial results of the segments reflect allocation of
certain functional expense categories consistent with the basis and manner in
which Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions. Certain corporate
overhead costs are not allocated to the individual segments by Management. The
Company evaluates performance based on stand-alone segment operating income.
Because the Company does not evaluate performance based on return on assets at
the operating segment level, assets are not tracked internally by segment.
Therefore, segment asset information is not presented.
Operating segment data for the quarters ended June 30, 2001 and 2002 is as
follows:
5
-------------------------------------------------------------------------------
(In thousands) NextGen Healthcare
Information Systems Unallocated
QSI Division Division Corporate Expenses Consolidated
- ----------------------------------------------------------------------------------------------------------------
Quarter ended June 30, 2002
Revenue $ 4,229 $ 8,078 -- $ 12,307
Operating income (loss) $ 1,166 $ 2,073 $ (660) $ 2,579
Quarter ended June 30, 2001
Revenue $ 4,325 $ 6,584 -- $ 10,909
Operating income (loss) $ 1,177 $ 1,050 $ (404) $ 1,823
- ----------------------------------------------------------------------------------------------------------------
7. Composition of Accounts Receivable
Included in accounts receivable are amounts related to maintenance and services
which were billed but not yet rendered as of the end of the period. Undelivered
maintenance and services are included on the consolidated balance sheet as part
of the deferred revenue balance.
--------------------
(in thousands) June 30,
2002 2001
- -------------------------------------------------------------------------------------------------------
ACCOUNTS RECEIVABLE:
Accounts receivable, net of reserve for bad debts, excluding undelivered
maintenance and services $ 9,538 $ 10,403
Undelivered maintenance and services billed in advance, included in deferred
revenue 3,707 3,292
--------------------
Net accounts receivable $ 13,245 $ 13,695
- -----------------------------------------------------------------------------------====================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Except for the historical information contained herein, the matters discussed in
this Quarterly Report on Form 10-Q, including discussions of the Company's
product development plans, business strategies and market factors influencing
the Company's results, are forward-looking statements that involve certain risks
and uncertainties. Actual results may differ from those anticipated by the
Company as a result of various factors, both foreseen and unforeseen, including,
but not limited to, the Company's ability to continue to develop new products
and increase systems sales in markets characterized by rapid technological
evolution, consolidation within the Company's target marketplace and among the
Company's competitors, and competition from larger, better capitalized
competitors. Many other economic, competitive, governmental and technological
factors could impact the Company's ability to achieve its goals. Interested
persons are urged to review the risks described below, as well as in the
Company's other public disclosures and filings with the Securities and Exchange
Commission.
Company Overview
Quality Systems, Inc., through its NextGen Healthcare Information Systems,
Inc. (NextGen(1)) and QSI (QSI) divisions (collectively, the "Company"), develop
and market healthcare information systems that automate medical and dental group
practices, physician hospital organizations ("PHOs"), management service
organizations ("MSOs"), ambulatory care centers, community health centers, and
medical and dental schools. In response to the growing need for more
comprehensive, cost-effective information solutions for physician and dental
practices, the Company's systems enable clients to redesign office workflow
processes, improve productivity, reduce information processing and
administrative costs, and utilize electronic medical records to store and access
patient information. The Company's proprietary
- ----------
(1) The Company's NextGen Division, formerly known as "MicroMed Healthcare
Information Systems" or "MicroMed Division", changed its name in fiscal 2002.
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software systems cover a number of important practice elements including, but
not limited to, general patient information, electronic patient records,
appointment scheduling, billing, insurance claims submission and processing,
eligibility verification, managed care plan implementation, referral management,
treatment outcome studies, treatment planning, drug formularies, dental
charting, and letter generation. Several of the Company's software systems may
be operated remotely using thin client connectivity or a standard web browser.
In addition to providing fully integrated software solutions to its clients, the
Company offers comprehensive hardware and software installation services,
maintenance and support services, and system training services.
The Company currently has a base of approximately 700 clients, with each
client generally including between one and 500 physicians or dentists. The
Company believes that as healthcare providers are increasingly required to
reduce costs and maintain the quality of healthcare, the Company will be able to
capitalize on its strategy of providing fully integrated information systems and
superior client service.
The Company, a California corporation formed in 1974, was founded with an
early focus on providing information systems and services for dental group
practices. In the mid-1980's, the Company capitalized on the increasing focus on
medical cost containment and further expanded its information processing systems
to serve the medical market. Today, the Company has dedicated products serving
both the medical and dental markets.
The Company's QSI Division develops and markets dental practice management
and medical practice management software suites utilizing a UNIX(2) operating
system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(3) operating
system and can be fully integrated with the Company's dental practice management
applications. CPS incorporates a wide range of clinical tools including, but not
limited to, periodontal charting and digital imaging of X-ray and inter-oral
camera images as part of an electronic patient record. In addition, the QSI
Division develops and markets the Company's QUIC product suite which
incorporates a variety of products that enhance the connectivity between
provider and payor, and provider and patient. The QSINet Application Service
Provider ("ASP")/Internet product offering is also developed and marketed in
this Division. QSINet enables providers to extend patient appointment
scheduling, electronic bill payment, and other functions to patients via the
Internet.
The Company's NextGen Healthcare Information Systems, Inc. Division
develops and sells proprietary electronic medical records software and practice
management systems under the NextGen(R)(4) product name. Major product
categories of the NextGen suite include Electronic Medical Records
(NextGen(emr)), Enterprise Practice Management (NextGen(epm)), Enterprise
Appointment Scheduling (NextGen(eas)), Enterprise Master Patient Index
(NextGen(epi)), Managed Care, Electronic Data Interchange, System Interfaces,
Internet Operability (NextGen(web)), a Patient-centric and Provider-centric Web
Portal Solution (NextMD.com(5)), and a handheld product (NextGen(pda)). The
Company's enterprise practice management and electronic medical records software
packages can run via private intranet or via the Internet in an ASP environment.
Enhancements to these products continued during the quarter.
Risk Factors
Competition. The markets for healthcare information systems are intensely
competitive, and the Company faces significant competition from a number of
different sources. Several of the Company's competitors have significantly
greater name recognition as well as substantially greater financial, technical,
product development and marketing resources than the Company.
- ----------
(2) UNIX is a registered trademark of AT&T Corporation.
(3) Microsoft Windows, Windows NT, Windows 95, Windows 98, and Windows 2000 are
registered trademarks of Microsoft Corporation.
(4) NextGen is a registered trademark of NextGen Healthcare Information Systems,
Inc.
(5) NextMD.com is a trademark of NextGen Healthcare Information Systems, Inc.
7
The Company competes in all of its markets with other major healthcare
related companies, information management companies, systems integrators, and
other software developers. Competitive pressures and other factors, such as new
product introductions by the Company or its competitors, may result in price or
market share erosion that could have a material adverse effect on the Company's
business, results of operations and financial condition. Also, there can be no
assurance that the Company's applications will achieve broad market acceptance
or will successfully compete with other competing software products.
The Company's inability to make initial sales of its systems to either
newly formed groups and/or healthcare providers that are replacing or
substantially modifying their healthcare information systems could have a
material adverse effect on the Company's business, results of operations and
financial condition. If new systems sales do not materialize, the Company's
maintenance revenues can be expected to decrease over time due to the combined
effects of potential attrition of existing clients and a shortfall in new client
additions.
Fluctuation in Quarterly Operating Results. The Company's revenues and
operating results have fluctuated in the past, and may fluctuate in the future
from quarter to quarter and period to period, as a result of a number of factors
including, without limitation: the size and timing of orders from clients; the
length of sales cycles and installation processes; the ability of the Company's
clients to obtain financing for the purchase of the Company's products; changes
in pricing policies or price reductions by the Company or its competitors; the
timing of new product announcements and product introductions by the Company or
its competitors; the availability and cost of system components; the financial
stability of major clients; market acceptance of new products, applications and
product enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements and to control costs; the
Company's success in expanding its sales and marketing programs; deferrals of
client orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
governmental and economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with minimal backlog. As a
result, sales in any quarter are dependent on orders booked and shipped in that
quarter and are not predictable with any degree of certainty. Further, the
Company's systems can be relatively large and expensive and individual systems
sales can represent a significant portion of the Company's revenues for a
quarter such that the loss or deferral of even one such sale can have a
significant adverse impact on the Company's quarterly profitability.
Clients often defer systems purchases until the Company's quarter end, so
quarterly results generally cannot be predicted and frequently are not known
until the quarter has concluded.
The Company's sales are dependent upon a client's initial decision to
replace, or substantially modify its existing information system, and
subsequently a decision as to which products and services to purchase. These are
major decisions for healthcare providers, and accordingly, the sales cycle for
the Company's systems can vary significantly and typically ranges from three to
twelve months from initial contact to contract execution/shipment.
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can cause
significant variations in operating results from quarter to quarter. As a
result, the Company believes that interim period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, the Company's historical
operating results are not necessarily indicative of future performance for any
particular period.
The Company recognizes revenue pursuant to Statement of Position ("SOP")
No. 97-2, "Software Revenue Recognition" ("SOP 97-2"). Additionally, in December
1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101
became effective for the Company in the third quarter of fiscal 2001.
8
There can be no assurance that the application and subsequent
interpretation of these pronouncements will not further modify the Company's
revenue recognition policies, or that such modifications would not have a
material adverse effect on the operating results reported in any particular
quarter.
There can be no assurance that the Company will not be required to adopt
changes in its licensing or services practices to conform to SOP 97-2 or SAB
101, or that such changes, if adopted, would not result in delays or
cancellations of potential sales of the Company's products.
Due to all of the foregoing factors, it is possible that in some future
quarter(s) the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially adversely affected.
Dependence on Principal Product and New Product Development. The Company
currently derives substantially all of its net revenues from sales of its
healthcare information systems and related services. The Company believes that a
primary factor in the market acceptance of its systems has been its ability to
meet the needs of users of healthcare information systems. The Company's future
financial performance will depend in large part on the Company's ability to
continue to meet the increasingly sophisticated needs of its clients through the
timely development, successful introduction and implementation of new and
enhanced versions of its systems and other complementary products. The Company
has historically expended a significant percentage of its net revenues on
product development and believes that significant continuing product development
efforts will be required to sustain the Company's growth.
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing products, or that new products or product enhancements will
be developed and implemented in a timely manner, meet the requirements of
healthcare providers, or achieve market acceptance. If new products or product
enhancements do not achieve market acceptance, the Company's business, results
of operations and financial condition could be materially adversely affected. At
certain times in the past, the Company has also experienced delays in purchases
of its products by clients anticipating the launch of new products by the
Company. There can be no assurance that material order deferrals in anticipation
of new product introductions will not occur.
Technological Change. The software market generally is characterized by
rapid technological change, changing customer needs, frequent new product
introductions, and evolving industry standards. The introduction of products
incorporating new technologies and the emergence of new industry standards could
render the Company's existing products obsolete and unmarketable. There can be
no assurance that the Company will be successful in developing and marketing new
products that respond to technological changes or evolving industry standards.
New product development depends upon significant research and development
expenditures which depend ultimately upon sales growth. Any material weakness in
revenues or research funding could impair the Company's ability to respond to
technological advances in the marketplace and to remain competitive. If the
Company is unable, for technological or other reasons, to develop and introduce
new products in a timely manner in response to changing market conditions or
customer requirements, the Company's business, results of operations and
financial condition may be materially adversely affected.
In response to increasing market demand, the Company is currently
developing new generations of certain of its software products. There can be no
assurance that the Company will successfully develop these new software products
or that these products will operate successfully, or that any such development,
even if successful, will be completed concurrently with or prior to introduction
of competing products. Any such failure or delay could adversely affect the
Company's competitive position and/or could make the Company's current products
obsolete.
Litigation. The Company faces one private Federal securities litigation
action (see "Part II - Other Information, Item 1. Litigation."). At this time it
is not reasonably possible to estimate the damage, or the range of damages, if
any, that the Company might incur in connection with this action. However, the
uncertainty associated with substantial unresolved litigation may have an
adverse impact on the Company's business. In particular, such litigation could
impair the Company's relationships with existing customers and its ability to
obtain new customers. Defending such litigation may result in a diversion of
9
management's time and attention away from business operations, which could have
a material adverse effect on the Company's business, results of operations and
financial condition. Such litigation may also have the effect of discouraging
potential acquirers from bidding for the Company or reducing the consideration
such acquirers would otherwise be willing to pay in connection with an
acquisition.
There can be no assurance that such litigation will not result in
liability in excess of the Company's insurance coverage, that the Company's
insurance will cover such claims or that appropriate insurance will continue to
be available to the Company in the future at commercially reasonable rates.
Proprietary Technology. The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely on
license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect its intellectual property. The Company's software is not
patented and the Company believes that existing copyright laws offer only
limited practical protection.
There can be no assurance that the legal protections and precautions taken
by the Company will be adequate to prevent misappropriation of the Company's
technology or that competitors will not independently develop technologies
equivalent or superior to the Company's. Further, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an extent
as do the laws of the United States and are often not enforced as vigorously as
those in the United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no assurance
that others will not assert infringement or trade secret claims against the
Company with respect to its current or future products or that any such
assertion will not require the Company to enter into a license agreement or
royalty arrangement with the party asserting the claim. As competing healthcare
information systems increase in complexity and overall capabilities and the
functionality of these systems further overlaps, providers of such systems may
become increasingly subject to infringement claims. Responding to and defending
any such claims may distract the attention of Company management and have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, claims may be brought against third parties
from which the Company purchases software, and such claims could adversely
affect the Company's ability to access third party software for its systems.
Ability to Manage Growth. The Company has in the past experienced periods
of growth which have placed, and may continue to place, a significant strain on
the Company's non-cash resources. The Company also anticipates expanding its
overall software development, marketing, sales, client management and training
capacity. In the event the Company is unable to identify, hire, train and retain
qualified individuals in such capacities within a reasonable timeframe, such
failure could have a material adverse effect on the Company. In addition, the
Company's ability to manage future increases, if any, in the scope of its
operations or personnel will depend on significant expansion of its research and
development, marketing and sales, management, and administrative and financial
capabilities. The failure of the Company's management to effectively manage
expansion in its business could have a material adverse effect on the Company's
business, results of operations and financial condition.
Dependence Upon Key Personnel. The Company's future performance also
depends in significant part upon the continued service of its key technical and
senior management personnel, many of whom have been with the Company for a
significant period of time. The Company does not maintain key man life insurance
on any of its employees. Because the Company has a relatively small number of
employees when compared to other leading companies in the same industry, its
dependence on retaining its employees is particularly significant. The Company
is also dependent on its ability to attract high quality personnel, particularly
in the areas of sales and applications development.
The industry in which the Company operates is characterized by a high
level of employee mobility and aggressive recruiting of skilled personnel. There
can be no assurance that the Company's current employees will continue to work
for the Company.
The loss of the services of key employees could have a material adverse
effect on the Company's business, results of operations and financial condition.
Furthermore, the Company may need to grant
10
additional stock options to key employees and provide other forms of incentive
compensation to attract and retain such key personnel.
Product Liability. Certain of the Company's products provide applications
that relate to patient clinical information. Any failure by the Company's
products to provide accurate and timely information could result in claims
against the Company. In addition, a court or government agency may take the
position that the Company's delivery of health information directly, including
through licensed practitioners, or delivery of information by a third party site
that a consumer accesses through the Company's web sites, exposes the Company to
malpractice or other personal injury liability for wrongful delivery of
healthcare services or erroneous health information. The Company maintains
insurance to protect against claims associated with the use of its products, but
there can be no assurance that its insurance coverage would adequately cover any
claim asserted against the Company. A successful claim brought against the
Company in excess of its insurance coverage could have a material adverse effect
on the Company's business, results of operations and financial condition. Even
unsuccessful claims could result in the Company's expenditure of funds in
litigation and management time and resources.
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess of its
insurance coverage, that the Company's insurance will cover such claims or that
appropriate insurance will continue to be available to the Company in the future
at commercially reasonable rates. Such claims could have a material adverse
affect on the Company's business, results of operations and financial condition.
Uncertainty in Healthcare Industry; Government Regulation. The healthcare
industry is subject to changing political, economic and regulatory influences
that may affect the procurement processes and operation of healthcare
facilities. During the past several years, the healthcare industry has been
subject to an increase in governmental regulation of, among other things,
reimbursement rates and certain capital expenditures.
In the past, various legislators have announced that they intend to
examine proposals to reform certain aspects of the U.S. healthcare system
including proposals which may increase governmental involvement in healthcare,
lower reimbursement rates and otherwise change the operating environment for the
Company's clients. Healthcare providers may react to these proposals, and the
uncertainty surrounding such proposals, by curtailing or deferring investments,
including those for the Company's systems and related services. Cost-containment
measures instituted by healthcare providers as a result of regulatory reform or
otherwise could result in a reduction in the allocation of capital funds. Such a
reduction could have an adverse effect on the Company's ability to sell its
systems and related services. On the other hand, changes in the regulatory
environment have increased and may continue to increase the needs of healthcare
organizations for cost-effective data management and thereby enhance the overall
market for healthcare management information systems. The Company cannot predict
what impact, if any, such proposals or healthcare reforms might have on the
Company's business, financial condition and results of operations.
Certain healthcare professionals who use the Company's Internet-based
products will directly enter health information about their patients including
information that constitutes a record under applicable law that the Company will
store on the Company's computer systems. Numerous federal and state laws and
regulations, the common law, and contractual obligations govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:
o State privacy and confidentiality laws;
o The Company's contracts with customers and partners;
o State laws regulating healthcare professionals;
o Medicaid laws; and
o The Heath Insurance Portability and Accountability Act of 1996
("HIPAA") and related rules proposed by the Heath Care Financing
Administration; and Health Care Financing Administration standards
for Internet transmission of health data.
11
The U.S. Congress has been working to finalize proposed legislation that
would establish a new Federal standard for protection and use of health
information. Any failure by the Company or by its personnel or partners to
comply with any of these legal or other requirements may result in a material
liability to the Company.
Although the Company has systems in place for safeguarding patient health
information from unauthorized disclosure, these systems may not preclude claims
against the Company for violation of applicable law or other requirements. Other
third party sites or links that consumers access through the Company's web sites
also may not maintain systems to safeguard this health information, or may
circumvent systems the Company put in place to protect the information from
disclosure. In addition, future laws or changes in current laws may necessitate
costly adaptations to the Company's systems.
HIPAA mandates the use of national standards for transmissions of certain
patient healthcare information, and prescribes security measures to protect the
confidentiality of such information as well as other patient record privacy and
security provisions within two years after the adoption of final regulations by
the Department of Health and Human Services ("HHS"). These proposed regulations
will establish new federal standards for privacy of health information. The
Company anticipates that these regulations will directly affect the Company's
products and services, but the Company cannot fully predict the impact at this
time. The Company's intention is to modify its products and services as
necessary to facilitate client compliance with the final regulations, but there
can be no assurance that the Company will be able to do so in a timely manner.
Achieving compliance with these regulations could be costly and distract
management's attention and other resources from the Company's historical
business, and any noncompliance by the Company could result in civil and
criminal penalties. In addition, development of related Federal and state
regulations and policies on confidentiality of health information could
negatively affect the Company's business.
In addition, the Company's software may be subject to regulation by the
U.S. Food and Drug Administration (the "FDA") as a medical device. Such
regulation could require the registration of the applicable manufacturing
facility and software and hardware products, application of detailed
record-keeping and manufacturing standards, and FDA approval or clearance prior
to marketing. An approval or clearance requirement could create delays in
marketing, and the FDA could require supplemental filings or object to certain
of these applications, the result of which could have a material adverse effect
on the Company's business, financial condition and results of operations.
Critical Accounting Policies
The discussion and analysis of the Company's financial condition and
results of operations is based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires Management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosures of contingent assets and liabilities. On an on-going basis,
Management evaluates estimates, including those related to revenue recognition,
uncollectible accounts receivables, and intangible assets for, reasonableness.
Management bases its estimates on historical experience and on various other
assumptions that management believes to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
The Company believes revenue recognition, the allowance for doubtful
accounts, and goodwill impairment are among the most critical accounting
policies that impact its consolidated financial statements.
Revenue Recognition. The Company's revenues are primarily generated from
the sale of software licenses, maintenance fees, and EDI services. Revenue
recognition is governed by Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). Per SOP 97-2, if the arrangement does not require
significant production, modification, or customization of software, revenue
should be recognized when all of the following criteria are met:
12
o persuasive evidence of an arrangement exists;
o delivery has occurred;
o the vendor's fee is fixed or determinable; and
o collectibility is probable.
In accordance with generally accepted accounting principles in the United
States of America, the recognition of software license revenues is based on
Management's assessment that the above criteria have been met. In general, the
first two criteria are met with a signed contract and evidence that the Company
has shipped its software to the customer. In those cases where undelivered
elements of a system sale exists, the Company defers revenue related to the
undelivered element based on vendor specific objective evidence of each
element's fair value. The Company bases each element's fair value on its price
list which is used in pricing all contracts. Discounts for individual elements
are aggregated, and the total discount is allocated back to the individual
elements in its proportion of fair value to the total contract fair value. The
Company determines that the fee is fixed or determinable based on the contract
terms, which specify payment terms tied to dates and not to any future
deliverables. Probability of collection is based on a credit review of new
customers. The timing or amount of revenue recognition may have been different
if different assessments of the above criteria had been made at the time
transactions were recorded in revenue.
Valuation Allowances. The Company maintains allowances for doubtful
accounts for estimated losses resulting from the inability of customers to make
required payments. If the financial condition of customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.
Goodwill Impairment. The Company's long-lived assets include goodwill of
$1.8 million as of June 30, 2002 and 2001, respectively. The Company adopted
SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") effective April
1, 2001. The statement applies to the amortization of goodwill and other
intangible assets. The Company has ceased amortizing amounts related to goodwill
effective April 1, 2001. The balance of goodwill is related to the Company's
NextGen Division. The Company has compared the fair value of the NextGen
Division with the carrying amount of assets associated with the Division and
determined that none of the goodwill recorded as of June 30, 2002 was impaired.
The fair value of the NextGen Division was determined using a reasonable
estimate of future cash flows of the Division and a risk adjusted discount rate
to compute a net present value of future cash flows.
The process of evaluating goodwill for impairment involves the
determination of the fair value of the relevant Company business segments.
Inherent in such fair value determinations are certain judgments and estimates,
including the interpretation of current economic indicators and market
valuations, and assumptions about the Company's strategic plans with regard to
operations. To the extent additional information arises or the strategies of the
Company change, it is possible that the Company's conclusion regarding goodwill
impairment could change and result in a material effect on its financial
position or results of operations.
Results of Operations
The following table sets forth for the periods indicated, the percentage
of net revenues represented by each item in the Company's Consolidated
Statements of Income.
----------------------------
Three Months Ended June 30,
2002 2001
- ------------------------------------------------------------------------------------
Net Revenues:
Sales of computer systems, upgrades and supplies 52.2% 51.3%
Maintenance and other services 47.8 48.7
----------------------------
100.0 100.0
Cost of Products and Services 40.0 43.4
----------------------------
Gross Profit 60.0 56.6
Selling, General and Administrative Expenses 29.8 29.7
Research and Development Costs 9.2 10.1
----------------------------
Income from Operations 21.0 16.7
Investment Income 0.8 1.9
----------------------------
Income before Provision for Income Taxes 21.8 18.6
Provision for Income Taxes 8.6 7.1
----------------------------
Net Income 13.2% 11.5%
- --------------------------------------------------------============================
13
For the Three-Month Periods Ended June 30, 2002 and 2001
The Company's net income for the three months ended June 30, 2002 was
$1,626,000 or $0.27 per share on a basic and $.26 per share on a diluted basis,
as compared to a net income of $1,258,000, or $0.21 per share on a basic and
$0.20 on a diluted basis, for the three months ended June 30, 2001.
Net Revenues. Net revenues for the three months ended June 30, 2002
increased 13% to $12.3 million from $10.9 million for the three months ended
June 30, 2001. Sales of computer systems, upgrades and supplies increased 15% to
$6.4 million from $5.6 million while net revenues from maintenance and other
services grew 11% to $5.9 million from $5.3 million during the comparable
period. The increase in net revenues from sales of computer systems, upgrades
and supplies was principally the result of an increase in sales of the Company's
NextGen(emr) and NextGen(epm) software. The increase in maintenance and other
services revenue resulted principally from an increase in maintenance revenues
generated from the Company's expanded client base, and secondarily from an
increase in revenues generated from the Company's electronic data interchange
services.
Cost of Products and Services. Cost of products and services for the three
months ended June 30, 2002 rose 4% to $4.9 million from $4.7 million in the
prior year quarter. Cost of products and services as a percentage of net
revenues decreased from 43.4% to 40.0%. The dollar increase in the cost of
products and services was a result of the impact of higher labor costs
associated with installation as well as increased amortization of software
development expenses partially offset by a slight reduction in hardware costs.
The cost of products and services as a percentage of net revenues decreased in
the quarter ended June 30, 2002, largely as a result of a reduction in hardware
cost of products and services as a percentage of total revenue.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended June 30, 2002 increased 13.2%
to approximately $3.7 million as compared to $3.2 million for the three months
ended June 30, 2001. Selling, general and administrative expenses as a
percentage of net revenues were virtually unchanged at 29.8% as compared to
29.7% in the year earlier quarter. The increase in the dollar amount of such
expenses resulted primarily from increased staffing and compensation expenses,
as well as increased sales and marketing expenses at the Company's NextGen
Division, and higher corporate expenses.
Research and Development Costs. Research and development costs for the
three months ended June 30, 2002 increased by 2.5% to $1,135,000 from $1,107,000
in the prior year's quarter. The modest increase in research and development
costs is attributed primarily to increased investments in the NextGen(emr) and
NextGen(epm) product suites. Research and development costs as a percentage of
net revenues declined to 9.2% as compared to 10.1% for the quarter ended June
30, 2001. This decline was driven by the fact that revenues grew faster than the
increase in research and development expense. The Company has, over time,
changed the mix of its overall research and development expenditures to increase
funds available for the NextGen Division while correspondingly decreasing the
level of expenditure at its QSI Division. This has facilitated increased
research and development spending at the NextGen Division while moderating the
overall growth rate of research and development costs.
Investment Income. Investment income for the three months ended June 30,
2002 decreased by 49.5% from approximately $206,000 to $104,000. Investment
income in the quarter declined due to the lower interest rates earned on the
Company's balances during the quarter vis a vis the year earlier quarter. The
decrease in interest income was partially offset by higher cash balances.
Provision for Income Taxes. The provision for income taxes for the three
months ended June 30, 2002 was approximately $1,057,000 as compared to
approximately $771,000 for the three months ended
14
June 30, 2001. The provision for income taxes for the three months ended June
30, 2002 and 2001 differs from the combined statutory rates primarily due to the
impact of the effect of varying state income tax rates. The increase in the tax
rates on a year over year basis is due, in part, to a change in the mix of
Company sales generated in states with higher state tax rates.
Liquidity and Capital Resources
The following table presents selected financial statistics and information for
each of the past two quarters ended June 30, (in thousands):
------------------------
(in thousands) Quarter Ended June 30,
2002 2001
-----------------------------------------------------------------------------------------
Cash and cash equivalents $28,862 $19,954
-----------------------------------------------------------------------------------------
Net increase in cash and cash equivalents during the
quarter $ 3,419 $ 1,483
-----------------------------------------------------------------------------------------
Net income during the quarter $ 1,626 $ 1,258
-----------------------------------------------------------------------------------------
Net cash provided by operations during the quarter $ 3,681 $ 1,844
-----------------------------------------------------------------------------------------
Number of days of sales outstanding at start of quarter 104 114
-----------------------------------------------------------------------------------------
Number of days of sales outstanding at end of quarter 98 114
-----------------------------------------------------------------------------------------
The Company's principal source of cash was cash provided by operations.
The Company was able to generate operating cash flows significantly in excess of
net income in the quarter ended June 30, 2002 primarily as a result of improved
turnover of accounts receivable. Provided turnover of accounts receivable and
revenues and profitability remain consistent with the quarter ended June 30,
2002, the Company anticipates being able to continue to generate cash from
operations primarily from the net income of the company.
Cash and cash equivalents increased $3,419,000 between March 31, 2002 and
June 30, 2002 primarily as a result of cash provided by operating activities.
Cash and cash equivalents increased approximately $1,483,000 during the three
months ended June 30, 2001, also primarily as a result of cash generated by
operating activities. Also, during the quarter ended June 30, 2002, the Company
liquidated approximately $235,000 in short-term equity investments, and moved
those funds into accounts in cash and cash equivalent accounts.
Net cash used in investing activities for the three months ended June 30,
2002 and 2001 was $299,000 and $392,000 respectively. Net cash used in investing
activities for the three months ended June 30, 2002 consisted of additions to
equipment and improvements and capitalized software and was partially offset by
the proceeds from the sale of short term investments. Net cash used in investing
activities for the three months ended June 30, 2001 consisted of additions to
equipment and improvements and capitalized software. Management currently
anticipates that additions to equipment and improvements for fiscal 2003 will be
in excess of expenditures made during fiscal 2002 due to the relocation of the
Company's principal administrative offices in California and the principal
office of the Company's NextGen division.
At June 30, 2002, the Company had cash and cash equivalents of $28.9
million. Except for the Company's intention to expend funds for the development
of complementary products to its existing product line, new versions of certain
of its products for the client-server environment to take advantage of more
powerful technologies and to enable a more seamless integration of the Company's
products, and certain investments in furniture, fixtures, and equipment related
to its relocation to new facilities in California and Pennsylvania, the Company
has no other significant capital commitments.
The Company believes that its cash and cash equivalents on hand at June
30, 2002, together with cash flows from operations, if any, will be sufficient
to meet its working capital and capital expenditure requirements for the balance
of fiscal 2003.
15
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company has a significant amount of cash and short-term investments with
maturities less than three months. This cash portfolio exposes the Company to
interest rate risk as short-term investment rates can be volatile. Given the
short-term maturity structure of the Company's investment portfolio, the Company
believes that it is not subject to principal fluctuations and the effective
interest rate of the Company's portfolio tracks closely to various short-term
money market interest rate benchmarks.
PART II - OTHER INFORMATION
Item 1. Litigation.
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v. QUALITY
SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of California
for the County of Orange, in which Mr. Caveny, on behalf of himself and all
others who purchased the Company's Common Stock between June 26, 1995 and July
3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck, Gregory S.
Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers, Graeme H.
Frehner, and Gordon L. Setran (all of the foregoing individuals were either
officers, directors or both during the period from June 26, 1995 through July 3,
1996), as well as other defendants not affiliated with the Company, violated
California Corporations Code Sections 25400 and 25500, California Civil Code
Sections 1709 and 1710, and California Business and Professions Code Sections
17200 et. seq., by issuing positive statements about the Company that allegedly
were knowingly false, in part, in order to assist the Company and the individual
defendants in selling Common Stock at an inflated price in the Company's March
5, 1996 public offering and at other points during the class period. The
complaint seeks compensatory and punitive damages in unspecified amounts,
disgorgement, declaratory and injunctive relief, and attorneys' fees.
The Company and the other named defendants successfully demurred to the
plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that
claim, which served as the only basis for plaintiffs' request for punitive
damages, has been dismissed from both actions.
On January 25, 1999, the court denied plaintiffs' motion to certify the class
representative and class legal counsel. Plaintiffs appealed that decision as to
class legal counsel. On February 25, 2000, the Fourth District Court of Appeals
affirmed the order disqualifying the class legal counsel. On May 9, 2000, the
Court of Appeals issued its Remittur certifying its decision as final.
In May 2000, plaintiffs associated in additional class legal counsel, and moved
for approval by the court. Upon defendants' objection, the court on August 17,
2000, denied plaintiffs' motion, and ordered plaintiffs to retain new class
counsel.
At the end of November 2000, the plaintiffs retained new class counsel who
substituted in for plaintiffs' previous class counsel. The Company and the other
named defendants did not oppose plaintiffs' motion for approval of the new class
counsel. On January 24, 2001, the court granted the motion to certify class
legal counsel.
On March 27, 2001, the court approved a notice of class certification to be
mailed to shareholders who are potential class members. Between April 9, 2001
and May 9, 2001, class notice was mailed to potential class members.
Merits-related discovery in the action, which had been stayed pending the
appointment of class counsel, is now ongoing. In March 2002, defendant Graeme H.
Frehner and certain other defendants not affiliated with the Company were
dismissed from the action with prejudice by stipulated order. The parties are
scheduled to appear in court for the next status conference on October 22, 2002.
Trial in the action has been set for March 24, 2003.
16
In Management's opinion the outcome of this case is uncertain, and therefore no
accrual has been made to the financial statements.
On May 14, 1997, a second purported class action entitled WENDY WOO v. QUALITY
SYSTEMS, INC., ET AL. was filed in the same court, essentially repeating the
allegations in the Caveny lawsuit and seeking identical relief. This action has
for all purposes been consolidated with the Caveny action.
The Company is a party to various other legal proceedings incidental to its
business, none of which are considered by the Company to be material.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submissions of Matters to a Vote of Securities Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
Exhibits:
99.1 Officers' Certification
Reports on Form 8-K:
None.
17
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
QUALITY SYSTEMS, INC.
Date: August 12, 2002 By: /s/ LOUIS SILVERMAN
--------------------------------
Louis Silverman
Chief Executive Officer
Date: August 12, 2002 By: /s/ PAUL HOLT
--------------------------------
Paul Holt
Chief Financial Officer; Principal
Accounting Officer
18