Back to GetFilings.com
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2003
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, Suite 450, Irvine, California 92612
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (949) 255-2600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|
State the aggregate market value of the voting stock held by non-affiliates of
the Registrant as of June 20, 2003: $103,825,924 (based on the closing sales
price of the Registrant's Common Stock as reported in the NASDAQ National Market
System on that date).*
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of June 20, 2003: 6,160,613.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of the Form 10-K is incorporated by
reference from Registrant's Definitive Proxy Statement for its 2003 annual
meeting which is to be filed with the Commission on or before July 29, 2003.
1
* For purposes of this report, in addition to those shareholders which fall
within the definition of "affiliates" under Rule 405 of the Securities Act of
1933, as amended, holders of ten percent or more of the Registrant's Common
Stock are deemed to be affiliates.
================================================================================
2
CAUTIONARY STATEMENT
Statements made in this report, the Annual Report to Shareholders in which
this report is made a part, other reports and proxy statements filed with the
Securities and Exchange Commission, communications to shareholders, press
releases and oral statements made by representatives of the Company that are not
historical in nature, or that state the Company's or management's intentions,
hopes, beliefs, expectations or predictions of the future, may constitute
"forward-looking statements" within the meaning of Section 21E of the Securities
and Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking
statements can often be identified by the use of forward-looking terminology,
such as "could," "should," "will," "will be," "will lead," "will assist,"
"intended," "continue," "believe," "may," "expect," "hope," "anticipate,"
"goal," "forecast," "plan," or "estimate" or variations thereof or similar
expressions. Forward-looking statements are not guarantees of future performance
or results. They involve risks, uncertainties and assumptions. It is important
to note that any such performance and actual results, financial condition or
business, could differ materially from those expressed in such forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed below as well as those discussed
elsewhere in reports filed with the Securities and Exchange Commission. Other
unforeseen factors not identified herein could also have such an effect. The
Company undertakes no obligation to update or revise forward-looking statements
to reflect changed assumptions, the occurrence of unanticipated events or
changes in future operating results, financial condition or business over time.
PART I
Item 1. Business
Except for the historical information contained herein, the matters discussed in
this Annual Report on Form 10-K, including discussions of the Registrant's
product development plans, business strategies and market factors influencing
the Registrant's results, are forward-looking statements that involve certain
risks and uncertainties. Actual results may differ from those anticipated by the
Registrant as a result of various factors, both foreseen and unforeseen,
including, but not limited to, the Registrant's ability to continue to develop
new products and increase systems sales in markets characterized by rapid
technological evolution, consolidation within the Registrant's target
marketplace and among the Registrant's competitors, and competition from larger,
better capitalized competitors. Many other economic, competitive, governmental
and technological factors could impact the Registrant's ability to achieve its
goals. Interested persons are urged to review the risks described under "Item 1.
Business. Risk Factors" and in "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" as well as in the Registrant's
other public disclosures and filings with the Securities and Exchange
Commission.
COMPANY OVERVIEW
Quality Systems, Inc., comprised of the QSI Division ("QSI Division") and
a wholly-owned subsidiary, NextGen Healthcare Information Systems, Inc.
("NextGen(1)") (collectively, the "Company"), develops and markets healthcare
information systems that automate medical and dental practices, networks of
practices such as physician hospital organizations ("PHOs") and 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 medical 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 health records to store and access
patient information. The Company's proprietary software systems cover a number
of important practice elements including, but not limited to, general patient
information, electronic patient records, appointment scheduling, billing,
insurance claims submission and processing, eligibility verification, managed
care plan implementation, referral management, treatment planning, drug
formularies, 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.
- ----------
(1) The Company's NextGen Division, formerly known as "MicroMed Healthcare
Information Systems" or the "MicroMed Division", changed its name in fiscal
2002.
3
The Company currently has a base of approximately 800 clients, with each
client including between one and 1,000 physicians or dentists. The Company
believes that as healthcare providers are increasingly required to reduce costs
and maintain the quality of healthcare, the Company will be able to capitalize
on its strategy of providing fully integrated information systems and superior
client service.
The Company, a California corporation formed in 1974, was founded with an
early focus on providing information systems and services for dental group
practices. In the mid-1980's, the Company capitalized on the increasing focus on
medical cost containment and further expanded its information processing systems
to serve the medical market. Today, the Company has dedicated products serving
both the medical and dental markets.
The Company's QSI Division develops and markets dental practice management
and medical practice management software suites utilizing a UNIX(2) operating
system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(3) operating
system and can be fully integrated with the Company's dental practice management
applications. CPS incorporates a wide range of clinical tools including but not
limited to periodontal charting and digital imaging of X-ray and inter-oral
camera images as part of a complete electronic patient record. The QSI Division
develops and markets the Company's EDI/Connectivity product suite both within
the QSI Division as well as within the NextGen Division. This product suite
incorporates a variety of products that enhance the connectivity between
provider and payor, and provider and patient. The QSINet Application Services
Provider ("ASP")/Internet product offering is also developed and marketed in the
QSI Division. QSINet enables QSI Division providers to extend patient
appointment scheduling, electronic bill payment, and other functions to patients
via the Internet.
The Company's NextGen Division develops and sells proprietary electronic
medical records software and practice management systems under the NextGen(R)(4)
product name. Major product categories of the NextGen suite include Electronic
Medical Records (NextGen(emr)), Enterprise Practice Management (NextGen(epm)),
Enterprise Appointment Scheduling (NextGen(eas)), Enterprise Master Patient
Index (NextGen(epi)), Managed Care Server (NextGen(mcs)), EDI/Connectivity
services (NextGenedi), System Interfaces, Internet Operability (NextGen(web)), a
hand-held product (NextGen(pda)) and a Patient-centric and Provider-centric Web
Portal Solution (NextMD.com(5)). The Company's enterprise practice management
and electronic medical records software packages can run via private intranet or
via the Internet, and can also be operated in an ASP environment Enhancements to
these products continued during fiscal 2003.
For the purposes of Statement of Accounting Standards ("SFAS") No. 131
"Disclosures About Segments of an Enterprise and Related Information" the
Company has provided a breakdown utilizing the management approach outlined in
Notes to Consolidated Financial Statements No. 13 "Operating Segment
Information."
The Company's principal executive offices are located at 18191 Von Karman
Avenue, Suite 450, Irvine, California 92612 and its phone number is
949-255-2600. The Company's Internet address is www.qsii.com. The company's
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, amendments to those reports and other Securities and Exchange
Commission, or SEC, filings are available free of charge through our website as
soon as reasonably practicable after such reports are electronically filed with,
or furnished to, the SEC.
Industry Background
To compete in the continually changing healthcare environment, providers
are increasingly using technology to help maximize efficiency of their business
practices, to assist in enhancing patient care, and to maintain the privacy of
patient information.
As the reimbursement environment continues to evolve, more healthcare
providers enter into contracts, often with multiple entities, which define the
terms under which care is administered and paid for. The diversity of payor
organizations, as well as additional government regulation and changes in
reimbursement models, have greatly increased the complexity of pricing, billing,
reimbursement, and records management for medical and dental practices. To
operate effectively, healthcare provider organizations must efficiently manage
patient care and other information and workflow processes which increasingly
extend across multiple locations and business entities.
- ----------
(2) UNIX is a registered trademark of AT&T Corporation.
(3) Microsoft Windows, Windows NT, Windows 95, Windows 98, Windows 2000 and
Windows XP are registered trademarks of Microsoft Corporation.
(4) NextGen is a registered trademark of NextGen Healthcare Information Systems,
Inc.
(5) NextMD is a registered trademark of NextGen Healthcare Information Systems,
Inc.
4
In response, healthcare provider organizations have placed increasing
demands on their information systems. Initially, these information systems
automated financial and administrative functions. As it became necessary to
manage patient flow processes, the need arose to integrate "back-office" data
with such clinical information as patient test results and office visits. The
Company believes information systems must facilitate management of patient
information incorporating administrative, financial and clinical information
from multiple entities. In addition, large healthcare organizations increasingly
require information systems that can deliver high performance in environments
with multiple concurrent computer users.
Many existing healthcare information systems were designed for limited
administrative tasks such as billing and scheduling and can neither accommodate
multiple computing environments nor operate effectively across multiple
locations and entities. The Company believes that practices that leverage
technology to more efficiently handle patient clinical data, administrative,
financial and other practice management data, will be best able to enhance
patient flow, pursue cost efficiencies, and improve quality of care. As
healthcare organizations transition to new computer platforms and newer
technologies, the Company believes such organizations will be migrating toward
the implementation of enterprise-wide, patient-centric computing systems
embedded with automated clinical patient records.
Products
In response to the growing need for more comprehensive, cost-effective
healthcare information solutions for physician and dental practices, the
Company's systems provide its clients the ability to redesign patient care and
other workflow processes while improving productivity through facilitation of
managed access to patient information. Utilizing the Company's proprietary
software in combination with third party hardware solutions, the Company's
products enable the integration of a variety of administrative and clinical
information operations. Leveraging nearly 30 years of experience in the
healthcare information services industry, the Company believes that it continues
to distinguish its solutions by providing its clients with sophisticated,
full-featured software systems along with comprehensive systems implementation,
maintenance and support services.
Practice Management Systems. The Company's products consist primarily of
proprietary healthcare software applications together with third party hardware
and other non-industry specific software. The systems range in capacity from one
to hundreds of users, allowing the Company to address the needs of both small
and large organizations. The systems are modular in design and may be expanded
to accommodate changing client requirements.
The QSI Division's character-based practice management system is available
in both dental and medical versions and primarily uses the IBM RS6000(6) central
processing unit and IBM'S AIX(7) version of the UNIX operating system as a
platform for its application software enabling a wide range of flexible and
functional systems. The hardware components, as well as the requisite operating
system licenses, are purchased from manufacturers or distributors of those
components. The Company configures and tests the hardware components and
incorporates its software and other third party packages into completed systems
tailored to accommodate particular client requirements. The Company continually
evaluates third party hardware components with a view toward utilizing hardware
that is functional, reliable and cost-effective.
NextGen(epm) expands the Company's practice management system product
line. NextGen(epm) has been developed using a graphical user interface ("GUI")
client-server platform for compatibility with Windows 2000, Windows NT and
Windows XP operating systems and relational databases that are ANSI
SQL-compliant. NextGen(epm) is scalable and includes a master patient index,
enterprise-wide appointment scheduling with referral tracking, clinical support,
and centralized or decentralized patient financial management based on either a
managed care or fee-for-service model. The system's three-tiered architecture
allows work to be performed on the database server, the application server and
the client workstation.
To date, the Company generally has made hardware recommendations for
NextGen(epm) to its clients based upon information provided by each client.
Clients may elect to purchase hardware from the Company, or alternatively, may
choose to utilize third party suppliers other than the Company for the
selection, installation, and integration of their related hardware purchases.
- ----------
(6) RS6000 is a registered trademark of International Business Machines
Corporation.
(7) AIX is a registered trademark of International Business Machines
Corporation.
5
The Company also offers practice management solutions for both dental and
medical practices through the Internet. These products are marketed under the
QSINet and NextGen(web) trade names, respectively.
Clinical Systems. The Company's dental charting software system, the
Clinical Product Suite (CPS), is a comprehensive solution designed specifically
for the dental group practice environment. CPS integrates the dental practice
management product with a computer-based clinical information system that
incorporates a wide range of clinical tools, including:
o Electronic charting of dental procedures, treatment plans and
existing conditions;
o Periodontal charting via light-pen, voice-activation, or keyboard
entry for full periodontal examinations and PSR scoring;
o Digital imaging of X-ray and intra-oral camera images;
o Computer-based patient education modules, viewable chair-side to
enhance case presentation;
o Full access to patient information, treatment plans, and insurance
plans via a fully integrated interface with the Company's dental
practice management product; and
o Document and image scanning for digital storage and linkage to the
electronic patient record.
The result is a comprehensive clinical information management system that
helps practices save time, reduce costs, improve case presentation, and enhance
the delivery of dental services and quality of care. Clinical information is
managed and maintained electronically thus forming an electronic patient record
that allows for the implementation of the "chartless" office.
CPS incorporates Windows-based client-server technology consisting of one
or more file servers together with any combination of one or more desktop,
laptop, or pen-based PC workstations. The file server(s) used in connection with
CPS utilize(s) a Windows NT/2000 operating system and the hardware is typically
a Pentium(8)-based single or multi-processor platform. Based on the server
configuration chosen, CPS is scalable from one to hundreds of workstations. A
typical configuration may also include redundant disk storage, magnetic tape
units, intra- and extra-oral cameras, digital X-ray components, digital
scanners, conventional and flat screen displays, and printers. The hardware
components, including the requisite operating system licenses, are purchased
from third party manufacturers or distributors either directly by the customer
or by the Company for resale to the customer.
NextGen provides clinical software applications that are complementary to,
and interface with, the Company's medical practice management offerings as well
as many of the other leading practice management software systems on the market.
The applications incorporated into the Company's practice management solutions
and others such as scheduling, eligibility, billing and claims processing are
augmented by clinical information captured by NextGen(emr), including services
rendered and diagnoses used for billing purposes. The Company believes that it
currently provides a comprehensive information management solution for the
medical marketplace.
NextGen(emr) was developed with client-server architecture and a GUI and
utilizes Microsoft Windows 2000, Windows NT or Windows on each workstation and
either Windows 2000, Windows NT or UNIX on the database server. NextGen(emr)
maintains data using industry standard relational database engines such as
Microsoft SQL Server(9) or Oracle(10). The system is scalable from one to
hundreds of workstations.
NextGen(emr) stores and maintains clinical data including:
o Data captured using user-customized input "templates";
o Scanned or electronically acquired images, including X-rays and
photographs;
o Data electronically acquired through interfaces with clinical
instruments or external systems;
o Other records, documents or notes, including electronically captured
handwriting and annotations; and
o Digital voice recordings.
NextGen(emr) also offers a workflow module, prescription management,
automatic document and letter generation, patient education, referral tracking,
interfaces to billing and lab systems, physician alerts and reminders, and
powerful reporting and data analysis tools.
- ----------
(8) Pentium is a registered trademark of Intel Corporation.
(9) Microsoft is a registered trademark and SQL Server is a registered trademark
of Microsoft Corporation.
(10) Oracle is a registered trademark of Oracle Corporation.
6
NextGen(emr) is sold either as a combination of software and services, or
as a turnkey system including computer hardware and requisite operating system
software. Upon client request, computer hardware for turnkey systems is
purchased for resale by the Company from third party manufacturers or
distributors.
NextGen(pda), the Pocket-PC-based suite of solutions allows mobile health
professionals to utilize many of NextGen's functions using a palm-sized device.
Connectivity Services. The Company makes available electronic data
interchange ("EDI") capabilities and connectivity services to its customers. The
EDI/connectivity capabilities encompass direct interfaces between the Company's
products and external third party systems, as well as transaction-based
services. Services include:
o Electronic claims submission through the Company's relationships
with a number of payors and national claims clearinghouses;
o Electronic patient statement processing, appointment reminder cards
and calls, recall cards, patient letters, and other correspondence;
o Electronic insurance eligibility verification; and
o Electronic posting of remittances from insurance carriers into the
accounts receivable application.
Internet Applications. The Company's NextGen Division maintains an
Internet-based consumer health portal, NextMD.com. NextMD.com is a vertical
portal for the healthcare industry, linking patients with their physicians,
insurers, laboratories, and online pharmacies, while providing a centralized
source of health-oriented information for both consumers and medical
professionals. Patients whose physicians are linked to the portal are able to
request appointments, send appointment changes or cancellations, receive test
results on-line, request prescription refills, view and/or pay their statements,
and communicate with their physicians, all in a secure, on-line environment. The
Company's NextGen suite of information systems are or can be linked to
NextMD.com, integrating a number of these features with physicians' existing
systems.
The Company's QSI Division also provides a web-based application called
QSINet which allows clients to access information from their practice management
system via the Internet. This application also enables providers to offer their
patients convenient services such as on-line appointment scheduling and
electronic bill payment through the client's website, and posts this data
directly to the client's existing practice management system.
Sales and Marketing
The Company sells and markets its products nationwide primarily through a
direct sales force. The efforts of the direct sales force are augmented by a
small number of reseller relationships established by the Company. The Company's
direct sales force typically makes presentations to potential clients by
demonstrating the system and its capabilities on the prospective client's
premises. The Company's sales and marketing employees identify prospective
clients through a variety of means, including referrals from existing clients,
industry consultants, contacts at professional society meetings, trade shows and
seminars, trade journal advertising, direct mail advertising, and telemarketing.
The Company's sales cycle can vary significantly and typically ranges from
three to twelve months from initial contact to contract execution. Systems are
normally delivered to a customer within sixty days of receipt of a system order.
As part of the fees paid by its clients, the Company receives up-front licensing
fees. Clients have the option to purchase maintenance services which, if
purchased, are invoiced on a monthly or quarterly basis.
Several clients have purchased the Company's practice management software
and, in turn, are providing either time-share or billing services to single and
group practice practitioners. Under the time-share or billing service
agreements, the client provides the use of its software for a fee to one or more
practitioners. Although the Company typically does not receive a fee directly
from the distributor's customers, implementation of such arrangements has, from
time to time, resulted in the purchase of additional software capacity by the
distributor, as well as new software purchases made by the distributor's
customers should such customers decide to perform the practice management
functions in-house.
The Company continues to concentrate its direct sales and marketing
efforts on medical and dental practices, networks of such practices including
MSOs and PHOs, professional schools, community health centers and other
ambulatory care settings.
7
MSOs, PHOs and similar networks to which the Company has sold systems
provide use of the Company's software to those group and single physician
practices associated with the organization or hospital on either a service basis
or by directing the Company to contract with those practices for the sale of
stand-alone systems.
The Company has also entered into marketing assistance agreements with
certain of its clients pursuant to which the clients allow the Company to
demonstrate to potential clients the use of systems on the existing clients'
premises.
The Company from time to time assists prospective clients in identifying
third party sources for financing the purchase of the Company's systems. The
financing is typically obtained by the client directly from institutional
lenders and typically takes the form of a loan from the institution secured by
the system to be purchased or a leasing arrangement.
The Company has numerous clients and does not believe that the loss of any
single client would have a material adverse effect on the Company. No client
accounted for ten percent or more of net revenues during the fiscal years ended
March 31, 2003, 2002, or 2001.
Customer Service and Support
The Company believes its success is attributable in part to its customer
service and support departments. The Company offers support to its clients seven
days a week, 24 hours a day. The Company's client support staff is comprised of
specialists who are knowledgeable in the areas of hardware and software
technology as well as in the day-to-day operations of a practice. System support
activities range from correcting minor procedural problems in the client's
system to performing complex database reconstructions or software updates. The
Company utilizes automated online support systems which assist clients in
resolving minor problems and facilitates automated electronic retrieval of
problems and symptoms following a client's call to the automated support system.
Additionally, this online support system maintains a complete call record,
available at both the client's facility and the Company.
The Company offers its clients support services for most system
components, including hardware and software maintenance, for a fixed monthly or
quarterly fee. Customers also receive access to future unspecified versions of
the software, on a when-and-if available basis, as part of support services. The
Company also subcontracts, in certain instances with third party vendors to
perform specific hardware maintenance tasks.
Implementation and Training
The Company offers full service implementation and training services. When
a client signs a contract for the purchase of a system, a client
manager/implementation specialist trained in medical and/or dental group
practice procedures is assigned to assist the client in the installation of the
system and the training of appropriate practice staff. Implementation services
include loading the software, training customer personnel, data conversion,
running test data, and assisting in the development and documentation of
procedures. Implementation and training services are provided by Company
employees as well as certified third parties and certain resellers.
Training may include a combination of computer assisted instruction
("CAI") for certain of the Company's products, remote training techniques and
training classes conducted at the client's or Company's office(s). CAI consists
of workbooks, computer interaction and self-paced instruction. CAI is also
offered to clients, for an additional charge, after the initial training program
is completed for the purpose of training new and additional employees. Remote
training allows a trainer at the Company office to train one or more people at a
client site via telephone and computer connection, thus allowing an interactive
and client-specific mode of training without the expense and time required for
travel. In addition, the Company's on-line "help" and other documentation
features facilitate client training as well as ongoing support.
Competition
The markets for healthcare information systems are intensely competitive.
The industry is highly fragmented and includes numerous competitors, none of
which the Company believes dominates these markets. The electronic patient
records and connectivity markets, in particular, are subject to rapid changes in
technology, and the Company expects that competition in these market segments
will increase as new competitors enter. The Company believes its principal
competitive advantages are the features and capabilities of its products and
services, its high level of customer support, and its extensive experience in
the industry.
8
Product Enhancement and Development
The healthcare information management and computer software and hardware
industries are characterized by rapid technological change requiring the Company
to engage in continuing investments to update, enhance, and improve its systems.
During fiscal years 2003, 2002, and 2001, the Company expended approximately
$6.8 million, $5.7 million, and $5.1 million, respectively, on research and
development activities including capitalized software amounts of $1.7 million,
$1.5 million, and $1.1 million, respectively. In addition, many of the Company's
product enhancements have resulted from software development work performed
under contracts with its clients.
Employees
As of May 31, 2003, the Company employed 263 persons of which 262 were
full-time employees. The Company believes that its future success depends in
part upon recruiting and retaining qualified sales, marketing and technical
personnel as well as other employees.
Risk Factors
Competition. The markets for healthcare information systems are intensely
competitive, and the Company faces significant competition from a number of
different sources. Several of the Company's competitors have significantly
greater name recognition as well as substantially greater financial, technical,
product development and marketing resources than the Company.
The Company competes in all of its markets with other major healthcare
related companies, information management companies, systems integrators, and
other software developers. Competitive pressures and other factors, such as new
product introductions by the Company or its competitors, may result in price or
market share erosion that could have a material adverse effect on the Company's
business, results of operations and financial condition. Also, there can be no
assurance that the Company's applications will achieve broad market acceptance
or will successfully compete with other competing software products.
The Company's inability to make initial sales of its systems to either
newly formed groups and/or healthcare providers that are replacing or
substantially modifying their healthcare information systems could have a
material adverse effect on the Company's business, results of operations and
financial condition. If new systems sales do not materialize, the Company's near
term and longer term revenues will be negatively affected.
Fluctuation in Quarterly Operating Results. The Company's revenues have
fluctuated in the past, and may fluctuate in the future from quarter to quarter
and period to period, as a result of a number of factors including, without
limitation: the size and timing of orders from clients; the length of sales
cycles and installation processes; the ability of the Company's clients to
obtain financing for the purchase of the Company's products; changes in pricing
policies or price reductions by the Company or its competitors; the timing of
new product announcements and product introductions by the Company or its
competitors; changes in revenue recognition guidelines employed by the Company
and/or established by the Financial Accounting Standards Board or other
rule-making bodies; the availability and cost of system components; the
financial stability of major clients; market acceptance of new products,
applications and product enhancements; the Company's ability to develop,
introduce and market new products, applications and product enhancements; the
Company's success in expanding its sales and marketing programs; deferrals of
client orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
market/economic factors.
The Company's software products are generally shipped as orders are
received and accordingly, the Company has historically operated with a minimal
backlog of license fees. As a result, revenues in any quarter are dependent on
orders booked and shipped in that quarter and are not predictable with any
degree of certainty. Furthermore, the Company's systems can be relatively large
and expensive and individual systems sales can represent a significant portion
of the Company's revenues and profits for a quarter such that the loss or
deferral of even one such sale can have a significant adverse impact on the
Company's quarterly revenue and profitability.
Clients often defer systems purchases until the Company's quarter end, so
quarterly results generally cannot be predicted and frequently are not known
until the quarter has concluded.
The Company's sales are dependent upon clients' initial decision to
replace or substantially modify their existing information system, and
subsequently a decision as to which products and services to purchase. These are
major decisions for healthcare providers, and accordingly, the sales cycle for
the Company's systems can vary significantly and typically ranges from three to
twelve months from initial contact to contract execution/shipment.
9
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 currently recognizes revenue pursuant to Statement of Position
No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), as modified by SOP 98-9
"Modification of SOP 97-2, Software Revenue Recognition, With Respect of Certain
Transactions". 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.
There can be no assurance that application and subsequent interpretations
of these pronouncements will not further modify the Company's revenue
recognition policies, or that such modifications would not have a material
adverse effect on the operating results reported in any particular quarter or
year.
Due to all of the foregoing factors, it is possible that 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.
Stock Price Volatility. The trading price of the Company's common stock
may be volatile. The market for the Company's common stock may experience
significant price and volume fluctuations in response to a number of factors
including actual or anticipated quarterly variations in operating results,
rumors about the Company's performance or software solutions, changes in
expectations of future financial performance or changes in estimates of
securities analysts, governmental regulatory action, health care reform
measures, client relationship developments, changes occurring in the markets in
general and other factors, many of which are beyond the Company's control. As a
matter of policy, the Company does not generally comment on rumors.
Furthermore, the stock market in general, and the market for software,
health care and high technology companies in particular, has experienced extreme
volatility that often has been unrelated to the operating performance of
particular companies. These broad market and industry fluctuations may adversely
affect the trading price of the Company's common stock, regardless of actual
operating performance.
Dependence on Principal Product and New Product Development. The Company
currently derives substantially all of its net revenues from sales of its
healthcare information systems and related services. The Company believes that a
primary factor in the market acceptance of its systems has been its ability to
meet the needs of users of healthcare information systems. The Company's future
financial performance will depend in large part on the Company's ability to
continue to meet the increasingly sophisticated needs of its clients through the
timely development and successful introduction and implementation of new and
enhanced versions of its systems and other complementary products. The Company
has historically expended a significant percentage of its net revenues on
product development and believes that significant continuing product development
efforts will be required to sustain the Company's growth. Continued investment
in the Company's sales staff and its client implementation and support staffs
will also be required to support future growth.
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing products, or that new products or product enhancements will
be developed and implemented in a timely manner, meet the requirements of
healthcare providers, or achieve market acceptance. If new products or product
enhancements do not achieve market acceptance, the Company's business, results
of operations and financial condition could be materially adversely affected. At
certain times in the past, the Company has also experienced 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.
Subscription Pricing And/Or Application Service Provider, Or ASP,
Delivered Offerings. The Company currently derives substantially all of it's
revenues from traditional software license, maintenance and service fees, as
well as the resale of computer hardware. Today, customers pay an initial license
fee for the use of the Company's products, in addition to a periodic maintenance
fee. If the marketplace demands subscription pricing and/or ASP-delivered
offerings, the Company may be forced to adjust its strategy accordingly, by
offering a higher percentage of the Company's products and services through
these means. Shifting to subscription pricing and/or ASP-delivered
10
offerings could materially adversely impact the Company's financial condition,
cash flows and quarterly and annual revenues and results of operations, as the
Company's revenues would initially decrease substantially. There can be no
assurance that the marketplace will not embrace subscription pricing and/or
ASP-delivered offerings.
Technological Change. The software market generally is characterized by
rapid technological change, changing customer needs, frequent new product
introductions, and evolving industry standards. The introduction of products
incorporating new technologies and the emergence of new industry standards could
render the Company's existing products obsolete and unmarketable. There can be
no assurance that the Company will be successful in developing and marketing new
products that respond to technological changes or evolving industry standards.
New product development depends upon significant research and development
expenditures which depend ultimately upon sales growth. Any material weakness in
revenues or research funding could impair the Company's ability to respond to
technological advances in the marketplace and to remain competitive. If the
Company is unable, for technological or other reasons, to develop and introduce
new products in a timely manner in response to changing market conditions or
customer requirements, the Company's business, results of operations and
financial condition may be materially adversely affected.
In response to increasing market demand, the Company is currently
developing new generations of certain of its software products. There can be no
assurance that the Company will successfully develop these new software products
or that these products will operate successfully, or that any such development,
even if successful, will be completed concurrently with or prior to introduction
of competing products. Any such failure or delay could adversely affect the
Company's competitive position or could make the Company's current products
obsolete.
Web Site Claims. The Company could be subject to third party claims based
on the nature and content of information supplied on the Company's Web site by
the Company or third parties, including content providers or users. The Company
could also be subject to liability for content that may be accessible through
the Company's Web site or third party Web sites linked from the Company's Web
site or through content and information that may be posted by users in chat
rooms, bulletin boards or on Web sites created by professionals using the
Company's applications. Even if these claims do not result in liability to the
Company, investigating and defending against these claims could be expensive and
time consuming and could divert management's attention away from the Company's
operations.
Claims From Activities of Strategic Partners. The Company relies on third
parties to provide services that impact the Company's business. For example, the
Company uses national clearinghouses in the processing of insurance claims and
the Company outsources some of its hardware maintenance services and the
printing and delivery of patient statements for the Company's customers. The
Company also has relationships with certain third parties where these third
parties serve as sales channels through which the Company generates a portion of
its revenues. Due to these third-party relationships, the Company could be
subject to claims as a result of the activities, products, or services of these
third-party service providers even though the Company was not directly involved
in the circumstances leading to those claims. Even if these claims do not result
in liability to the Company, defending and investigating these claims could be
expensive and time-consuming, divert personnel and other resources from its
business and result in adverse publicity that could harm the Company's business.
Litigation. The Company faces the risks associated with litigation
concerning the operation of its business. The uncertainty associated with
substantial unresolved litigation may have an adverse impact on the Company's
business. In particular, such litigation could impair the Company's
relationships with existing customers and its ability to obtain new customers.
Defending such litigation may result in a diversion of management's time and
attention away from business operations, which could have a material adverse
effect on the Company's business, results of operations and financial condition.
Such litigation may also have the effect of discouraging potential acquirers
from bidding for the Company or reducing the consideration such acquirers would
otherwise be willing to pay in connection with an acquisition.
There can be no assurance that such litigation will not result in
liability in excess of its insurance coverage, that the Company's insurance will
cover such claims or that appropriate insurance will continue to be available to
the Company in the future at commercially reasonable rates.
Proprietary Technology. The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely on
license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect its intellectual property. The Company's software is not
patented and existing copyright laws offer only limited practical protection.
11
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 or other financial arrangement with the party asserting the
claim. 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.
Dependence on License Rights. The Company depends upon licenses for some
of the technology used in its products from third-party vendors. Most of these
licenses can be renewed only by mutual consent and may be terminated if the
Company breaches the terms of the license and fails to cure the breach within a
specified period of time. The Company may not be able to continue using the
technology made available to it under these licenses on commercially reasonable
terms or at all. As a result, the Company may have to discontinue, delay or
reduce product shipments until it can obtain equivalent technology. Most of the
Company's third-party licenses are non-exclusive. The Company's competitors may
obtain the right to use any of the technology covered by these licenses and use
the technology to compete directly with the Company. In addition, if the
Company's vendors choose to discontinue support of the licensed technology in
the future or are unsuccessful in their continued research and development
efforts, the Company may not be able to modify or adapt the Company's own
products.
Possible Security Breaches. In the course of its business operations, the
Company compiles and transmits confidential information, including patient
health information, in the Company's processing centers and other facilities. A
breach of security in any of these facilities could damage the Company's
reputation and result in damages being assessed against the Company. In
addition, the other systems with which the Company may interface, such as the
Internet and related systems, may be vulnerable to security breaches, viruses,
programming errors, or similar disruptive problems. The effect of these security
breaches and related issues could reduce demand for the Company's services.
Accordingly, the Company believes that it is critical that these facilities and
infrastructure not only be secure, but also be viewed by the Company's customers
as free from potential breach. Maintaining such standards, protecting against
breaches and curing security flaws, may require the Company to expend
significant capital.
Development and Maintenance of Internet Infrastructure. The Company delivers
Internet-based services and, accordingly, is dependent on the maintenance of the
Internet by third parties. The Internet infrastructure may be unable to support
the demands placed on it and its performance may decrease if the Internet
continues to experience its historic trend of expanding usage. As a result of
damages to portions of its infrastructure, the Internet has experienced a
variety of performance problems which may continue into the foreseeable future.
Such Internet related problems may diminish Internet usage and availability of
the Internet to the Company for transmittal of Internet-based services by the
Company. In addition, difficulties, outages, and delays by Internet service
providers, online service providers and other web site operators may obstruct or
diminish access to the Company's web site by its customers resulting in a loss
of potential or existing users of the Company's services.
Security Breaches and Viruses. The success of the Company's strategy to
offer our EDI services and Internet solutions depends on the confidence of the
Company's customers in its ability to securely transmit confidential
information. The Company's EDI services and Internet solutions rely on
encryption, authentication and other security technology licensed from third
parties to achieve secure transmission of confidential information. The Company
may not be able to stop unauthorized attempts to gain access to or disrupt the
transmission of communications by the Company's customers. Anyone who is able to
circumvent our security measures could misappropriate confidential user
information or interrupt the Company, or the Company's customers', operations.
In addition, the Company's EDI and Internet solutions may be vulnerable to
viruses, physical or electronic break-ins, and similar disruptions. Any failure
to provide secure electronic communication services could result in a lack of
trust by the Company's customers causing them to seek out other vendors, and/or,
damage the Company's reputation in the market making it difficult to obtain new
customers.
12
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 maintaining its relationship with key employees is particularly
significant. The Company is also dependent on its ability to attract and retain
high quality personnel, particularly in the areas of sales and applications
development.
The industry is characterized by a high level of employee mobility and
aggressive recruiting of skilled personnel. There can be no assurance that the
Company's current employees will continue to work for the Company.
Loss of services of key employees could have a material adverse effect on
the Company's business, results of operations and financial condition.
Furthermore, the Company may need to grant additional stock options to key
employees and provide other forms of incentive compensation to attract and
retain such key personnel. Failure to provide such types of incentive
compensation could jeopardize the Company's recruitment and retention
capabilities.
Product Liability. Certain of the Company's products provide applications
that relate to patient clinical information. Any failure by the Company's
products to provide accurate and timely information could result in claims
against the Company. In addition, a court or government agency may take the
position that the Company's delivery of health information directly, including
through licensed practitioners, or delivery of information by a third party site
that a consumer accesses through the Company's web sites, exposes the Company to
assertions of malpractice, other personal injury liability, or other liability
for wrongful delivery/handling of healthcare services or erroneous health
information. The Company maintains insurance to protect against claims
associated with the use of its products, but there can be no assurance that its
insurance coverage would adequately cover any claim asserted against the
Company. A successful claim brought against the Company in excess of or outside
of its insurance coverage could have a material adverse effect on the Company's
business, results of operations and financial condition. Even unsuccessful
claims could result in the Company's expenditure of funds in litigation and
management time and resources.
Certain healthcare professionals who use the Company's Internet-based
products will directly enter health information about their patients including
information that constitutes a record under applicable law that the Company may
store on the Company's computer systems. Numerous federal and state laws and
regulations, the common law, and contractual obligations, govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:
o state and federal privacy and confidentiality laws;
o the Company's contracts with customers and partners;
o state laws regulating healthcare professionals;
o medicaid laws; and
o the Health Insurance Portability and Accountability Act of 1996
("HIPAA") and related rules proposed by the Health Care Financing
Administration; and Health Care Financing Administration standards
for Internet transmission of health data.
The U.S. Congress has finalized the Health Insurance Portability and
Accountability Act of 1996 that established, beginning April, 2003, elements
including, but not limited to, new federal privacy and security standards for
the use and protection of Protected Health Information. Under contractual
arrangement with its customers, any failure by the Company or by its personnel
or partners to comply with applicable requirements may result in a material
liability to the Company.
13
Although the Company has systems and policies in place for safeguarding
Protected Health Information from unauthorized disclosure, these systems and
policies may not preclude claims against the Company for alleged violations of
applicable requirements. Also, third party sites and/or links that consumers may
access through the Company's web sites may not maintain adequate systems to
safeguard this information, or may circumvent systems and policies the Company
has put in place. In addition, future laws or changes in current laws may
necessitate costly adaptations to the Company's policies, procedures, or
systems.
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess of its
insurance coverage, that the Company's insurance will cover such claims or that
appropriate insurance will continue to be available to the Company in the future
at commercially reasonable rates. Such product liability claims could have a
material adverse affect on the Company's business, results of operations and
financial condition.
Effect of Payer and Provider Conduct. Electronic data transmission
services are offered by certain payers to healthcare providers that establish a
direct link between the provider and payer. This process bypasses third party
EDI service providers such as the Company. Accordingly, the Company is unable to
insure that the Company and other independent companies will continue to be used
by healthcare payers and providers to transmit healthcare transactions. A
significant increase in the utilization of direct links between healthcare
providers and payers could have a material adverse effect on the Company's
transaction volume and financial results. In addition, the company cannot
provide assurance that the Company will be able to maintain the Company's
exiting links to payers or develop new connections on terms that are
economically satisfactory to the Company, if at all.
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 change governmental involvement in healthcare and
reimbursement rates, and otherwise alter the operating environment for the
Company and its clients. Healthcare providers may react to these proposals, and
the uncertainty surrounding such proposals, by curtailing or deferring
investments, including those for the Company's systems and related services.
Cost-containment measures instituted by healthcare providers as a result of
regulatory reform or otherwise could result in a reduction in the allocation of
capital funds. Such a reduction could have an adverse effect on the Company's
ability to sell its systems and related services. On the other hand, changes in
the regulatory environment have increased and may continue to increase the needs
of healthcare organizations for cost-effective data management and thereby
enhance the overall market for healthcare management information systems. The
Company cannot predict what impact, if any, such proposals or healthcare reforms
might have on the Company's business, financial condition and results of
operations.
The HIPAA regulation, as adopted by the Department of Health and Human
Services ("HHS"), established, among other things: (i) a national standard for
electronic transactions and code sets to be used in those transactions involving
certain common health care transactions, (ii) privacy regulations to protect the
privacy of plan participants and patients' medical records and (iii) security
regulations designed to establish security controls and measures to protect the
privacy and confidentiality of personal identifiable health information when it
is electronically stored, maintained or transmitted (even if only internally
transmitted within a medical practice.) While the privacy and transaction and
code set standards are currently in effect, the security regulation will become
effective by 2005. As these regulations mature and become better defined, the
Company anticipates that these regulations will continue to directly affect
certain of the Company's products and services, but the Company cannot fully
predict this impact at this time. The Company has taken steps to modify its
products, services and internal practices as necessary to facilitate its and its
client's compliance with the final regulations, but there can be no assurance
that the Company will be able to do so in a timely or complete manner. Achieving
compliance with these regulations could be costly and distract management's
attention and other resources, and any noncompliance by the Company could result
in civil and criminal penalties.
In addition, development of related federal and state regulations and
policies regarding the confidentiality of health information or other matters
could positively or negatively affect the Company's business.
In addition, the Company's software may potentially be subject to
regulation by the U.S. Food and Drug Administration (the "FDA") as a medical
device. Such regulation could require the registration of the applicable
14
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.
Other E-commerce Regulations. The Company may be subject to additional
federal and state statutes and regulations in connection with offering services
and products via the Internet. On an increasingly frequent basis, federal and
state legislators are proposing laws and regulations that apply to Internet
commerce and communications. Areas being affected by these regulations include
user privacy, pricing, content, taxation, copyright protection, distribution,
and quality of products and services. To the extent that the Company's products
and services are subject to these laws and regulations, the sale of the
Company's products and services could be harmed.
Financial Accounting Matters. Based on the Company's reading and
interpretations of relevant guidance, principles or concepts, issued by, among
other authorities, the American Institute of Certified Public Accountants, the
Financial Accounting Standards Board, and the United States Securities and
Exchange Commission, Management believes its current sales and licensing
contract terms and business arrangements have been properly reported. However,
there continue to be issued interpretations and guidance for applying the
relevant standards to a wide range of sales and licensing contract terms and
business arrangements that are prevalent in the software industry. Future
interpretations or changes by the regulators of existing accounting standards or
changes in the Company's business practices could result in future changes in
the Company's revenue recognition accounting policies and practices that could
have a material adverse effect on the Company's business, financial condition,
cash flows, revenues and results of operations.
Item 2. Properties
The Company's principal administrative, accounting and QSI Division
operations are located in Irvine, California, under a lease that commenced May
15, 2002, and expires April 30, 2005. The Company leases approximately 12,000
square feet of space at this location. In April 2002, the Company executed a new
lease for the principle office of the Company's NextGen Division. This lease
includes approximately 32,000 square feet of space in Horsham, Pennsylvania, and
expires March 31, 2009. In addition, the Company leases approximately 6,000
square feet of space in Santa Ana, California, to house its assembly and
warehouse operations, approximately 8,000 square feet of space in Atlanta,
Georgia, and an aggregate of approximately 4,000 square feet of space in Kansas,
Minnesota, Texas, Wisconsin, and Washington to house additional sales, training,
development and service operations. These leases, excluding options, have
expiration dates ranging from month-to-month to March 2009. The Company believes
that its facilities are adequate for its current needs and that suitable
additional or substitute space is available, if needed, at commercially
reasonable rates.
Item 3. Legal Proceedings
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of
California for the County of Orange, in which Mr. Caveny, on behalf of himself
and all others who purchased the Company's Common Stock between June 26, 1995
and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck,
Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers,
Graeme H. Frehner, and Gordon L. Setran (all of the foregoing individuals were
either officers, directors or both during the period from June 26, 1995 through
July 3, 1996), as well as other defendants not affiliated with the Company,
violated California Corporations Code Sections 25400 and 25500, California Civil
Code Sections 1709 and 1710, and California Business and Professions Code
Sections 17200 et. seq., by issuing positive statements about the Company that
allegedly were knowingly false, in part, in order to assist the Company and the
individual defendants in selling Common Stock at an inflated price in the
Company's March 5, 1996 public offering and at other points during the class
period. The complaint seeks compensatory and punitive damages in unspecified
amounts, disgorgement, declaratory and injunctive relief, and attorneys' fees.
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
was for all purposes consolidated with the Caveny action.
On July 1, 1997, a third purported class action entitled WADE CHENEY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the United States District Court,
repeating essentially the same factual allegations as the April 22,
15
1997 suit and purporting to state claims under the Federal securities laws. By
court order dated August 13, 1997, this action was stayed temporarily and the
Court reserved jurisdiction to lift the stay after all matters are final in the
class action filed on April 22, 1997. On August 15, 1997 the case was removed
from the Court's active caseload.
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. Six class
members opted out of the class, and their requests were filed with the Court.
On November 18, 2002, the parties reached an agreement to settle the
consolidated action. On January 6, 2003, the parties entered into a Stipulation
of Settlement whereby in consideration of a cash payment to the class fully
funded by the Company's directors and officers liability insurance, all members
of the class released all defendants from any and all claims that the class
members had or may have had relating to the purchase of the Company's securities
during the class period or based on any facts or events that were or could have
been asserted against the defendants in this action or in the companion Cheney
action referenced above. The settlement agreement expressly provides that the
Company and the named defendants do not admit, and continue to deny, any and all
allegations of wrongdoing.
On January 14, 2003, the court granted preliminary approval of the
settlement, and approved a notice of the settlement that was mailed to
shareholders who were potential class members. Two additional class members
opted out of the settlement, and their requests were filed with the Court. On
April 14, 2003, the class action settlement was approved by the Court and an
Order and Final Judgment was entered dismissing the entire action with
prejudice.
The releases given by the settling class in the Caveny action expressly
released all defendants from any and all claims that were or could have been
alleged in the Cheney action.
The Company is a party to various other legal proceedings incidental to
its business, none of which are considered by the Company to be material.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of fiscal year 2003.
Executive Officers of the Company
The executive officers of the Company as of May 31, 2003 were as follows:
Name Age Position
---- --- --------
Louis E. Silverman 44 President, Chief Executive Officer
Patrick B. Cline 42 President, NextGen Healthcare Information Systems Division
Greg Flynn 45 Executive Vice President and General Manager of QSI Division
Paul Holt 37 Secretary, Chief Financial Officer
Executive officers of the Company are elected by, and serve at the
discretion of, the Board of Directors. Additional information regarding the
Company's executive officers is set forth below.
Louis E. Silverman was appointed President and Chief Executive Officer of
the company on July 31, 2000. Mr. Silverman was previously Chief Operations
Officer of CorVel Corp., a publicly traded national managed care services and
technology firm with headquarters in Irvine, California. Mr. Silverman holds a
Master of Business Administration degree from Harvard Graduate School of
Business Administration and a Bachelor of Arts degree from Amherst College.
Patrick B. Cline currently serves as President of the Company's NextGen
Healthcare Information Systems Division. He served as the Company's interim
Chief Executive Officer for the April - July 2000 period. Mr. Cline was a
co-founder of Clinitec and has served as its President since its inception in
January 1994 and throughout its transition to NextGen Healthcare Information
Systems. Prior to co-founding Clinitec, Mr. Cline served, from July 1987 to
January 1994, as Vice President of Sales and Marketing with Script Systems, a
subsidiary of InfoMed, a healthcare information systems company. From January
1994 to May 1994, after the founding of Clinitec, Mr. Cline continued to serve,
on a part time basis, as Script Systems' Vice President of Sales and Marketing.
Mr. Cline has held senior positions in the healthcare information systems
industry since 1981.
16
Greg Flynn has served as the QSI Division's General Manager since April
2000 and as Executive Vice President since August 1998 after serving as Vice
President of Sales and Marketing from January 1996 to August 1998. Between June
1992 and January 1996, Mr. Flynn served as Vice President Administration. In
these capacities, Mr. Flynn has been responsible for numerous functions related
to the ongoing management of the Company and sales. Previously, Mr. Flynn served
as the Company's Vice President, Corporate Communications. Mr. Flynn joined the
Company in January 1982. He holds a B.A. degree in English from the University
of California, Santa Barbara.
Paul Holt was appointed Chief Financial Officer in November 2000. Mr. Holt
has served as the Company's Controller from January 2000 to May 2000 and was
appointed interim Chief Financial Officer in May 2000. Prior to joining the
Company, Mr. Holt was the Controller of Sierra Alloys Co., Inc., a titanium
metal manufacturing company from August 1999 to December 1999. From May 1997 to
July 1999, he was Controller of Refrigeration Supplies Distributor, a wholesale
distributor and manufacturer of refrigeration supplies and heating controls.
From March 1995 to April 1997 he was Assistant Controller of Refrigeration
Supplies Distributor. Mr. Holt is a Certified Public Accountant and holds an
M.B.A. from the University of Southern California and a B.A. in Economics from
the University of California, Irvine.
17
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the NASDAQ National Market under
the symbol "QSII". The following table sets forth for the quarters indicated the
high and low sales prices as reported by NASDAQ. The quotations reflect
inter-dealer prices, without retail markup, markdown, or commissions, and may
not necessarily represent actual transactions.
Quarter Ended High Low
- ------------- ---- ---
June 30, 2001 $15.04 $ 9.90
September 30, 2001 $14.44 $10.10
December 31, 2001 $18.00 $10.25
March 31, 2002 $17.52 $13.59
June 30, 2002 $17.84 $14.45
September 30, 2002 $18.05 $14.92
December 31, 2002 $24.35 $16.10
March 31, 2003 $26.60 $20.05
At May 31, 2003, there were approximately 130 holders of record of the
Company's Common Stock. The Company estimates the number of beneficial holders
of its Common Stock to be in excess of 1,300.
Through May 31, 2003, the Company has not paid cash dividends on shares of
its Common Stock. Payment of future dividends, if any, will be at the discretion
of the Company's Board of Directors after taking into account various factors,
including the Company's financial condition, operating results, current and
anticipated cash needs and plans for expansion.
Item 6. Selected Financial Data
The following selected financial data with respect to the Company's
Consolidated Statements of Income Data for each of the five years including the
period ended March 31, 2003 and the Consolidated Balance Sheet Data as of the
end of each such fiscal year are derived from the audited financial statements
of the Company. The following information should be read in conjunction with the
Consolidated Financial Statements of the Company and the related notes thereto
and "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Income." included elsewhere herein.
18
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
(In thousands, except for per share data)
Year Ended March 31,
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Net revenues $54,769 $44,422 $39,936 $36,373 $33,816
Cost of products and services 23,755 19,253 17,283 16,395 15,834
------- ------- ------- ------- -------
Gross profit 31,014 25,169 22,653 19,978 17,982
Selling, general and administrative
expenses 15,293 13,068 13,585 12,645 13,495
Research and development costs 5,062 4,243 4,081 3,726 3,603
------- ------- ------- ------- -------
Income from operations 10,659 7,858 4,987 3,607 884
Investment income 434 643 1,032 759 413
------- ------- ------- ------- -------
Income before provision for (benefit from)
income taxes 11,093 8,501 6,019 4,366 1,297
Provision for (benefit from) income taxes 4,058 3,233 2,510 1,862 713
------- ------- ------- ------- -------
Net income $ 7,035 $ 5,268 $ 3,509 $ 2,504 $ 584
======= ======= ======= ======= =======
Net income per share, basic $ 1.15 $ 0.87 $ 0.57 $ 0.40 $ 0.09
======= ======= ======= ======= =======
Net Income per share, diluted $ 1.10 $ 0.84 $ 0.57 $ 0.40 $ 0.09
======= ======= ======= ======= =======
Weighted average shares outstanding, basic 6,127 6,025 6,130 6,208 6,176
======= ======= ======= ======= =======
Weighted average shares outstanding, diluted 6,389 6,240 6,203 6,261 6,185
======= ======= ======= ======= =======
CONSOLIDATED BALANCE SHEET DATA
(in thousands)
March 31,
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Cash and cash equivalents and short-term
investments $36,443 $25,698 $18,729 $16,169 $14,441
------- ------- ------- ------- -------
Working capital 38,717 30,700 24,196 21,332 18,166
------- ------- ------- ------- -------
Total assets 67,602 52,143 44,883 44,136 40,218
------- ------- ------- ------- -------
Total liabilities 20,069 12,192 10,996 12,053 10,554
------- ------- ------- ------- -------
Shareholders' equity 47,533 40,050 33,887 32,083 29,664
------- ------- ------- ------- -------
19
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K, including discussions of the
Company's product development plans, business strategies and market factors
influencing the Company's results, may include forward-looking statements that
involve certain risks and uncertainties. Actual results may differ from those
anticipated by the Company as a result of various factors, both foreseen and
unforeseen, including, but not limited to, the Company's ability to continue to
develop new products and increase systems sales in markets characterized by
rapid technological evolution, consolidation, and competition from larger,
better capitalized competitors. Many other economic, competitive, governmental
and technological factors could impact the Company's ability to achieve its
goals, and interested persons are urged to review the risks described in "Item
1. Business. Risk Factors" as set forth below, as well as in the Company's other
public disclosures and filings with the Securities and Exchange Commission.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Consolidated Financial Statements and related
notes thereto included elsewhere herein. Historical results of operations,
percentage margin fluctuations and any trends that may be inferred from the
discussion below are not necessarily indicative of the operating results for any
future period.
Critical Accounting 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 the Company to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosures of contingent assets and liabilities. On an on-going basis,
the Company evaluates estimates, including those related to revenue recognition,
uncollectible accounts receivable, and intangible assets, for reasonableness.
The Company bases its estimates on historical experience and on various other
assumptions that management believes to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
The Company believes revenue recognition, the allowance for doubtful
accounts, and goodwill impairment are among the most critical accounting
policies that impact its consolidated financial statements. The Company believes
that significant accounting policies, as described in Note 2 of its consolidated
financial statements, Summary of Significant Accounting Policies, should be read
in conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Revenue Recognition. The Company's revenues are primarily generated from
the sale of software licenses, maintenance fees, and EDI services. Revenue
recognition is governed by Statement of Position (SOP) 97-2 as amended by SOP
98-9. Inherent in the revenue recognition process are significant management
estimates and judgments, which influence the timing and amount of revenue
recognition.
In accordance with the governing revenue recognition guidelines, if the
arrangement between vendor and purchaser does not require significant
production, modification, or customization of software, revenue should be
recognized when all of the following criteria are met:
o persuasive evidence of an arrangement exists;
o delivery has occurred;
o the vendor's fee is fixed or determinable; and
o collectibility is probable.
In accordance with generally accepted accounting principles in the United
States of America, the recognition of software license revenues is based on the
Company's assessment that the above criteria 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. The Company determines that its fee is
fixed and determinable based on the contract terms, which specify payment terms
tied to specific dates and not to any future deliverables. Probability of
collection is based on a credit review of customers. The timing or amount of
revenue recognition can differ if different assessments of the above listed
criteria had been made at the time transactions were recorded in revenue.
SOP 97-2, as amended, requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair values of each of those elements. The fair value of each element
20
must be based on objective evidence that is specific to the vendor. When
evidence of fair value exists for the delivered and undelivered elements of a
transaction, then discounts for individual elements are aggregated and the total
discount is allocated to the individual elements in proportion to the element's
fair value relative to the total contract fair value. When evidence of fair
value exists for the undelivered elements only, the residual method, provided
for under SOP 98-9, is used. Under the residual method, the Company defers
revenue related to the undelivered elements in a system sale based on vendor
specific objective evidence of each element's fair value and allocates the
remainder of the contract price, net of all discounts, to revenue recognized
from the delivered elements. Vendor specific objective evidence of fair value is
determined by the average sales price of the element when sold separately.
Management estimates used in the calculation of vendor specific objective
evidence include the average renewal rates for support services and the average
price of implementation and training services and interfaces sold on a stand
alone basis.
Valuation Allowances. The Company maintains allowances for doubtful
accounts for estimated losses resulting from the inability of its customers to
make required payments. The valuation allowance is based on interpretation of
client-specific credit information and payment history as well as an aggregated
review of the Company's accounts receivable. If the financial condition of its
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required.
Goodwill Impairment. The Company's long-lived assets include goodwill of
$1.8 million as of March 31, 2003 and 2002, respectively. The Company adopted
SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") effective April
1, 2001. The new statement applies to the amortization of goodwill and other
intangible assets. The Company has ceased amortizing amounts related to goodwill
starting April 1, 2001. The balance of goodwill is related to the Company's
NextGen Division. The Company has compared the fair value of the NextGen
Division with the carrying amount of assets associated with the Division and
determined that none of the goodwill recorded as of June 30, 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 Company's business segments. Inherent in
such fair value determinations are certain judgments and estimates, including
the interpretation of current economic indicators and market valuations, and
assumptions about the Company's strategic plans with regard to operations. To
the extent additional information arises or the strategies of the Company
change, it is possible that the Company's conclusion regarding goodwill
impairment could change and result in a material effect on its financial
position or results of operations.
Results of Operations
The following table sets forth for the periods indicated the percentage of
net revenues represented by each item in the Company's Consolidated Statements
of Operations.
Year Ended March 31,
2003 2002 2001
----- ----- -----
Net revenues:
Sales of computer systems, upgrades and supplies 53.3% 50.7% 49.9%
Maintenance and other services 46.7 49.3 50.1
----- ----- -----
100.0 100.0 100.0
Cost of products and services 43.4 43.3 43.3
----- ----- -----
Gross profit 56.6 56.7 56.7
Selling, general and administrative expenses 27.9 29.4 34.0
Research and development costs 9.2 9.6 10.2
----- ----- -----
Income from operations 19.5 17.7 12.5
Investment income 0.8 1.4 2.6
----- ----- -----
Income before provision for income taxes 20.3 19.1 15.1
Provision for income taxes 7.5 7.3 6.3
----- ----- -----
Net income 12.8% 11.8% 8.8%
===== ===== =====
21
For the Year Ended March 31, 2003 versus 2002
For the year ended March 31, 2003, the Company's net income was $7,035,000
or $1.15 per share on a basic and $1.10 per share on a fully diluted basis. In
comparison, the Company earned $5,268,000 or $0.87 per share on a basic and
$0.84 on a diluted basis in the year ended March 31, 2002. The increase in net
income was achieved through a combination of an increase in revenue from
software systems sales, maintenance, and EDI services along with a decrease in
selling, general, and administrative expenses as a percentage of revenue.
Net Revenues. Net revenues for the year ended March 31, 2003 increased 23%
to $54.8 million from $44.4 million for the year ended March 31, 2002. Sales of
computer systems, upgrades and supplies increased 30% to $29.2 million from
$22.5 million while net revenues from maintenance and other service grew 17% to
$25.6 from $21.9 million during the comparable prior period. The increase in net
revenues from sales of computer systems, upgrades and supplies was principally
due to increased sales of the Company's NextGen(epm) and NextGen(emr) software
licenses to new customers. The increase in maintenance and other services net
revenue resulted primarily from the Company's increased client base together
with an increase in revenues generated from the Company's EDI services. These
EDI service revenue increases were principally in the Company's NextGen
Division. Revenue from the Company's EDI services increased 15% to $7.1 million
for the year ended March 31, 2003, compared to $6.2 million in the year ended
March 31, 2002.
Software license sales to resellers represented less than 10% of total
revenue for the years ended March 31, 2003 and 2002.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 2003 increased 23% to $23.4 million from $19.3 million for the
year ended March 31, 2002, while the cost of products and services as a
percentage of net revenues at 43.4% of revenue was roughly unchanged compared to
the prior year's 43.3% of revenue.
Gross margins for the Company are impacted by the level of hardware
content included in system sales, based upon the percentage of EDI revenues in
the Company's overall sales mix, and certain headcount expenses. Gross margins
at the NextGen division for the year ended March 31, 2003 improved to 61.1% from
58.6% primarily due to a decrease in the relative level of applicable headcount
expense associated with delivering the Company's products and services. The
increase in gross margins at the NextGen Division was offset by a higher level
of hardware content at the QSI Division, which drove a decrease in gross margin
to 46.9% in the year ended March 31, 2003 from 53.6% in the year ended March 31,
2002. In addition, the Company's gross margin percentage increased as the higher
margined NextGen Division increased its share of total Company revenues to 68%
from 61% in the prior year.
Selling, General and Administrative. Selling, general and administrative
expenses for the year ended March 31, 2003 increased 17% to $15.3 million from
$13.1 million for the year ended March 31, 2002, and decreased on a percentage
of revenues basis to 27.9% from 29.4% for the respective fiscal years. The
increase in selling, general and administrative expenses were driven primarily
by an increase in selling and compensation related expenses in the NextGen
Division and higher corporate related expenses. Should the Company be able to
continue to increase revenues, further increases in selling-related expenses is
expected. The Company's goal is to increase selling, general and administrative
expenses at a rate less than its rate of revenue growth, though it may not
always succeed in achieving this goal.
Research and Development Costs. Research and development costs for the
year ended March 31, 2003 increased 19% to $5.1 million from $4.2 million for
the year ended March 31, 2002. The increase in research and development costs is
primarily the result of increased research and development efforts at the
NextGen Division. Research and development costs as a percentage of net revenues
declined to 9.2% compared to 9.6% in the prior year. Research and development
costs as a percentage of net revenues declined due, in part, to the fact that
revenue growth exceeded the increase in research and development spending, and
in part due to the fact that the Company's investments in capitalized software
increased to $1.7 million from $1.5 million in the prior year, reflecting
increased expenditures directed at future enhancements of the NextGen EMR, EPM,
and PDA products. Research and development expenses are expected to continue at
or above current levels.
Investment Income. Investment income for the year ended March 31, 2003
declined 33% to $434,000 from $643,000 for the year ended March 31, 2002.
Investment income was impacted by a decline in average short term interest rates
during the year ended March 31, 2003 which decline was partially offset by an
increase in average funds available for investment during the year ended March
31, 2003.
22
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 2003 was $4,058,000 as compared to $3,233,000 for the year ended
March 31, 2002. The effective tax rates for fiscal 2003 and 2002 were 36.6% and
38.0% respectively. The provision for income taxes for the year ended March 31,
2003, differed from the combined statutory rates primarily due to the effect of
varying state tax rates together with the impact of research and development tax
credits. The provision for income taxes for the year ended March 31, 2002,
differed from the combined statutory rates primarily due to the effect of
varying state tax rates.
For the Year Ended March 31, 2002 versus 2001
For the year ended March 31, 2002, the Company's net income was $5,268,000
or $0.87 per share on a basic and $0.84 on a diluted basis. In comparison, the
Company earned $3,509,000 or $0.57 per share on a basic and diluted basis in the
year ended March 31, 2001. The increase in net income was achieved through a
combination of an increase in revenue from software systems sales, maintenance,
and EDI services along with a decrease in selling, general, and administrative
expenses.
Net Revenues. Net revenues for the year ended March 31, 2002 increased
11.2% to $44.4 million from $39.9 million for the year ended March 31, 2001.
Sales of computer systems, upgrades and supplies increased 13% to $22.5 million
from $19.9 million while net revenues from maintenance and other service grew
9.5% to $21.9 from $20.0 million during the comparable prior period. The
increase in net revenues from sales of computer systems, upgrades and supplies
was principally due to increased sales of the Company's NextGen(epm) and
NextGen(emr) software licenses to new customers. The increase in maintenance and
other services net revenue resulted primarily from the Company's increased
client base together with an increase in revenues generated from the Company's
EDI services and such increases were principally in the Company's NextGen
Division. Revenue from the Company's EDI services increased 19.2% to $6.2
million for the year ended March 31, 2002, compared to $5.2 million in the year
ended March 31, 2001.
Software license sales to resellers represented less than 10% of total
revenue for the years ended March 31, 2002 and 2001.
Cost of Products and Services. Cost of products and services for the year
ended March 31, 2002 increased 11.6% to $19.3 million from $17.3 million for the
year ended March 31, 2001, while the cost of products and services as a
percentage of net revenues at 43.3% of revenue was unchanged compared to the
prior year.
Gross margins for the Company are impacted by the level of hardware
content included in system sales which fluctuates from period to period, the
percentage of EDI revenues in the Company's overall sales mix, changes in
certain headcount expenses, and the revenue split between the Company's two
operating divisions.
A higher level of hardware content in new systems sales at the NextGen
Division was primarily responsible for reducing gross margins in that Division
from 64.7% in the year ended March 31, 2001 to 58.6% in the year ended March 31,
2002.
The decline in gross margins at the NextGen Division was offset by certain
reductions in headcount and other expenses at the QSI Division, where gross
margins increased from 46.2% in the year ended March 31, 2001 to 53.6% in the
year ended March 31, 2002.
In addition, the Company's gross margin percentage was positively impacted
as the NextGen Division, which has a higher gross margin than the QSI Division,
increased its share of total company revenues to 61% from 57% in the prior year.
Selling, General and Administrative. Selling, general and administrative
expenses decreased 3.8% from $13.6 million to $13.1 million, and decreased on a
percentage of revenues basis from 34.0% to 29.4% for the respective fiscal years
ended March 31, 2002 and 2001. The decline in selling, general and
administrative expenses were driven primarily by a decline in bad debt expenses
of approximately $775,000 as a result of improved credit and collections
procedures put in place by the Company. The decline in bad debt expense
experienced by the Company in fiscal 2002 is not expected to continue into
fiscal 2003. Should the Company be able to continue to increase revenues, an
increase in selling-related expenses is expected. The Company's goal is to
increase selling, general and administrative expenses at a rate less than its
rate of revenue growth.
Research and Development Costs. Research and development costs for the
year ended March 31, 2002 increased 2.4% to $4.2 million from $4.1 million for
the year ended March 31, 2001. The increase in research and development costs is
primarily the result of increased research and development efforts at the
NextGen Division. Research and
23
development costs as a percentage of net revenues declined to 9.6% compared to
10.2% in the prior year. Research and development costs as a percentage of net
revenues declined as a percentage of revenues due to the fact that an increasing
percentage of the Company's incremental expenditures were directed at
enhancements of the NextGen EMR, EPM, and PDA products and were capitalized on
the balance sheet. Capitalization of the Company's incremental development costs
in fiscal 2002 resulted in research and development expenditures growing more
slowly than revenue. Research and development expenses are expected to continue
at or above current levels.
Investment Income. Investment income for the year ended March 31, 2002
declined 38% to $643,000 from $1,032,000 for the year ended March 31, 2001.
Investment income was impacted by a decline in average interest rates during the
year ended March 31, 2002 which decline was partially offset by an increase in
average funds available for investment during the year ended March 31, 2002.
Provision for Income Taxes. The provision for income taxes for the year
ended March 31, 2002 was $3,233,000 as compared to $2,510,000 for the year ended
March 31, 2001. The effective tax rates for fiscal 2002 and 2001 were 38.1% and
41.7% respectively. The provision for income taxes for the year ended March 31,
2002 differed from the combined statutory rates primarily due to the effect of
varying state tax rates. The provision for income taxes for the year ended March
31, 2001 differed from the combined statutory rates and was slightly higher
primarily due to the effect of varying state tax rates together with the impact
of non-deductible amortization of certain intangible assets acquired in the May
1996 acquisition of Clinitec.
Liquidity and Capital Resources
The following table presents selected financial statistics and information
for each of the past three fiscal years:
(in thousands) Year Ended March 31,
2003 2002 2001
------- ------- -------
Cash and cash equivalents at year end $36,443 $25,443 $18,471
------- ------- -------
Net increase in cash and cash equivalents $11,000 $ 6,972 $ 2,545
------- ------- -------
Net income $ 7,035 $ 5,268 $ 3,509
------- ------- -------
Net cash provided by operations $13,183 $ 8,218 $ 6,111
------- ------- -------
Days of sales outstanding 104 111 124
------- ------- -------
Cash provided by operations is the Company's principal source of cash.
Cash from operations for the year ended March 31, 2003, consisted principally of
net income before non-cash related expenses of depreciation, amortization, and
provision for bad debts, increases in deferred revenue and other current
liabilities, offset by an increase in gross accounts receivable. The Company was
able to generate operating cash flows significantly in excess of net income in
the year ended March 31, 2003 primarily as a result of increases in other
current liabilities of $2.6 million and improved turnover of accounts
receivable. The Company was able to generate operating cash flows significantly
in excess of net income in the year ended March 31, 2002, primarily as a result
of improved turnover of accounts receivable. Provided turnover of accounts
receivable, increased revenues, and profitability remain consistent with results
experienced for the year ended March 31, 2003, the Company anticipates it will
continue to generate cash from operations primarily from net income. Net cash
used in investing activities for the year ended March 31, 2003 was $2.5 million
and was primarily composed of investments in capitalized software and equipment
and improvements. The Company has no significant capital commitments, and
currently anticipates that additions to equipment and improvements for fiscal
2004 will be equal to or greater than historical levels.
Net cash provided by financing activities for the year ended March 31,
2003 was $352,000, and was solely composed of proceeds from the exercise of
stock options. Cash received from employee stock option exercises can fluctuate
from year to year. In October 2001, the 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 repurchase authorization expires on the date of the fiscal 2003
Annual Shareholders Meeting. Since the October 2001 authorization through March
31, 2003, no shares have been repurchased. The Company believes that cash on
hand plus cash flow from operations will be sufficient to accommodate any
repurchases of shares under this plan.
24
At March 31, 2003, the Company had cash and cash equivalents of $36.4
million. Management believes that its cash and cash equivalents on hand at March
31, 2003, together with the cash flows from operations, if any, will be
sufficient to meet its working capital and capital expenditure requirements for
fiscal 2004.
Item 7A. Qualitative and Quantitative Disclosures About Market Risk
The Company has a significant amount of cash and short-term investments with
maturities less than three months. This cash portfolio exposes the Company to
interest rate risk as short-term investment rates can be volatile. Given the
short-term maturity structure of the Company's investment portfolio, the Company
believes that it is not subject to principal fluctuations and the effective
interest rate of the Company's portfolio tracks closely to various short-term
money market interest rate benchmarks.
Item 8. Financial Statements and Supplementary Data
The Financial Statements of the Company identified in the Index to Financial
Statements appearing under "Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K" of this report are incorporated herein by reference to
Item 14.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Company
Except for information concerning the Company's executive officers which
is included under the caption "Executive Officers of the Company" following Part
I, Item 4 of this report, the information required by Item 10 is incorporated
herein by reference from the Company's definitive proxy statement scheduled to
be filed with the Securities and Exchange Commission on or before July 29, 2003
for the Company's 2003 annual shareholders' meeting.
Item 11. Executive Compensation
The information required by Item 11 is incorporated herein by reference
from the Company's definitive proxy statement scheduled to be filed with the
Securities and Exchange Commission on or before July 29, 2003 for the Company's
2003 annual shareholders' meeting.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is incorporated herein by reference
from the Company's definitive proxy statement scheduled to be filed with the
Securities and Exchange Commission on or before July 29, 2003 for the Company's
2003 annual shareholders' meeting.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is incorporated herein by reference
from the Company's definitive proxy statement scheduled to be filed with the
Securities and Exchange Commission on or before July 29, 2003 for the Company's
2003 annual shareholders' meeting.
Item 14. Evaluation of Controls and Procedures
Based on their evaluation of the Company's disclosure controls and
procedures as of a date within 90 days of the filing date of this report, the
Company's officers including the Chief Executive Officer and Chief Financial
Officer have concluded that the Company's disclosure controls and procedures
result in the effective recordation, processing, summarization and reporting of
information that is required to be disclosed in the reports that the Company
files under the Securities Exchange Act of 1934 and the rules thereunder.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect internal controls subsequent to
the date the Chief Executive Officer and Chief Financial Officer completed their
evaluation. However, the Company recently received a letter from Grant Thornton
LLP expressing its opinion as to material weaknesses involving (i) the adequacy
of the Company's current staffing levels and technical expertise concerning
interpretation of its software arrangements as it relates to revenue
recognition, (ii) the independence of mental attitude of certain members of the
board of directors relating to the Company's auditors and certain of their
conclusions reached and (iii) an over reliance by the board and management upon
such auditors to formulate judgments
25
and interpretations of the accounting literature applicable to the Company's
revenue recognition practices. The Audit Committee has carefully reviewed the
issues and discussed them with both Grant Thornton LLP and management. Without
accepting Grant Thorton LLP's conclusions, the Audit Committee has nevertheless
begun the process of gathering information which addresses the issues raised and
engaging a third party expert to study what corrective action, if any, is
warranted.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Page
----
(a) 1. Index to Financial Statements
Report of Independent Certified Public Accountants F-1
Independent Auditors' Report F-2
Consolidated Balance Sheets at March 31, 2003 and 2002 F-3
Consolidated Statements of Income for the Years Ended March 31,
2003, 2002 and 2001 F-4
Consolidated Statement of Shareholders' Equity for the Years
Ended March 31, 2003, 2002 and 2001 F-4
Consolidated Statements of Cash Flows for the Years Ended
March 31, 2003, 2002 and 2001 F-5
Notes to Consolidated Financial Statements F-6
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts F-19
3. Exhibits
Index to Exhibits E-1
Exhibit Sequential
Number Description Page Number
------ ----------- -----------
3.1 Articles of Incorporation of the Company, as
amended, are hereby incorporated by
reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the year
ended March 31, 1984, File No. 2-80056.
3.2 Bylaws of the Company, as amended, are
hereby incorporated by reference to Exhibit
3.3 to the Company's Registration Statement
on Form S-1, File No. 2-80056.
3.3 Certificate of Amendment of Bylaws of the
Company is hereby incorporated by reference
to Exhibit 3.2.1 to the Company's
Registration Statement on Form S-1, File No.
333-00161.
3.4 Text of Sections 2 and 3 of Article II of
the Bylaws of the Company is hereby
incorporated By reference to Exhibit 3.2.2
to the Company's Quarterly report on Form
10-QSB for the period Ended December 31,
1996, File No. 0-13801.
3.5 Certificate of Amendment of Bylaws of the
Company, incorporated by reference to
Exhibit 3.2.3 to the Company's Annual Report
on Form 10-K for the year ended March 31,
2000, File No. 0-13801.
10.2* 1989 Incentive Stock Option Plan is hereby
incorporated by reference to Exhibit 4.1 to
the Company's Registration Statement on Form
S-8, File No. 33-31949.
10.2.1* Form of Incentive Stock Option Agreement is
hereby incorporated by reference to Exhibit
10.2 to the Company's Registration Statement
on Form S-1, File No. 333-00161.
10.2.2* Form of Non-Qualified Stock Option Agreement
is hereby incorporated by reference to
Exhibit 10.3 to the Company's Registration
Statement on Form S-1, File No. 333-00161.
10.3* Form of Incentive Stock Option Agreement is
hereby incorporated by reference to Exhibit
10.2 to the Company's Registration Statement
on Form S-1, File No. 2-80056.
26
10.4* 1993 Deferred Compensation Plan, is hereby
incorporated by reference to Exhibit 10.5 to
the Company's Annual Report on Form 10-KSB
for the year ended March 31, 1994, File No.
0-13801.
10.4.2* Profit Sharing and Retirement Plan, as
amended, is hereby incorporated by reference
to Exhibit 10.4.2 to the Company's Annual
Report on Form 10-KSB for the year ended
March 31, 1994, File No. 0-13801.
10.4.3* Profit Sharing and Retirement Plan, as
amended, amendments No. 2 and 3, are hereby
incorporated by reference to Exhibit 10.4.3
to the Company's Annual Report on Form
10-KSB for the year ended March 31, 1996,
File No. 0-13801.
27
Exhibit Sequential
Number Description Page Number
------ ----------- -----------
10.5 Series "A" Convertible Preferred Stock
Purchase Agreement, as amended, dated April
21, 1995 between the Company and Clinitec
International, Inc., is hereby incorporated
by reference to Exhibit 10.11 to the
Company's Annual Report on Form 10-KSB for
the year ended March 31, 1995, File No.
0-13801.
10.6 Form of Indemnification Agreement is hereby
incorporated by reference to Exhibit 10.10
to the Company's Registration Statement on
Form S-1, File No. 333-00161.
10.7 Agreement and Plan of Merger, dated May 16,
1996, by and among Quality Systems, Inc.,
CII Acquisition Corporation, Clinitec
International, Inc. and certain shareholders
of Clinitec International, Inc. and certain
exhibits is hereby incorporated by reference
to Exhibit 2 to the Company's Current Report
on Form 8-K, dated May 17, 1996 and filed
May 30, 1996.
10.8 Asset Purchase Agreement, dated May 15,
1997, by and among NextGen Healthcare
Information Systems, Inc., MHIS Acquisition
Corp., Quality Systems, Inc., and certain
shareholders of NextGen Healthcare
Information Systems, Inc. is hereby
incorporated by reference to Exhibit 2 of
Company's Current Report on Form 8-K, dated
May 15, 1997 and filed May 29, 1997, File
No. 0-13801.
10.9* 1998 Employee Stock Contribution Plan is
hereby incorporated by reference to Exhibit
4.1 to the Company's Registration Statement
on Form S-8, File No. 333-63131.
10.10* 1998 Stock Option Plan is hereby
incorporated by reference to Exhibit 4.1 to
the Company's Registration Statement on Form
S-8, File No. 333-67115.
10.11* Memorandum of Understanding regarding the
April 3, 2000 resignation of Sheldon Razin
between Sheldon Razin and Quality Systems,
Inc., incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form
10-K for the year ended March 31, 2000, File
No. 0-13801.
10.12* Memorandum of Understanding Relating to
Director Nominees is hereby incorporated by
reference to Company's Definitive Proxy
Statement for the Company's 1999
Shareholder's Meeting, File No. 001-12537.
10.13* Employment Agreement dated July 20, 2000
between Quality Systems, Inc. and Lou
Silverman, incorporated by reference to
Exhibit 10.18 to the Company's Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2000, File No. 0-13801.
10.14 Lease Agreement between Company and Tower
Place, L.P. dated November 15, 2000,
commencing February 5, 2001, incorporated by
reference to Exhibit 10.14 to the Company's
Annual Report on Form 10-K for the year
ended March 31, 2001, File No. 0-13801.
10.15 Lease Agreement between Company and
Orangewood Business Center Inc. dated April
3, 2000, amended February 22, 2001,
incorporated by reference to Exhibit 10.15
to the Company's Annual Report on Form 10-K
for the year ended March 31, 2001, File No.
0-13801.
10.16 Lease Agreement between Company and Craig
Development Corporation dated February 20,
2001, incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form
10-K for the year ended March 31, 2001, File
No. 0-13801.
10.17 Sublease Agreement between Company and
Infinium Software dated February 22, 2002.**
10.18 Lease Agreement between Company and HUB
Properties LLC dated May 8, 2002.**
21 List of Subsidiaries. 33
23.1 Independent Auditors' Consent - Deloitte &
Touche LLP. 34
23.2 Consent of Independent Certified Public
Accountants - Grant Thornton LLP. 35
99.1 Section 906 Certification, as furnished by
the Chief Executive Officer and Chief
Financial Officer pursuant to SEC Releases
No. 33-8212, 34-47551. ** 36
* This exhibit is a management contract or a compensatory plan or
arrangement.
** Filed herewith.
28
(b) Reports on Form 8-K:
None.
29
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QUALITY SYSTEMS, INC.
By: /s/ LOUIS SILVERMAN
--------------------------------
Louis Silverman
President and Chief Executive Officer
Date: June 26, 2003
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Company and in the
capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Sheldon Razin Chairman of the Board of Directors June 20, 2003
- --------------------------
SHELDON RAZIN
/s/ Louis Silverman Chief Executive Officer June 26, 2003
- --------------------------
LOUIS SILVERMAN
/s/ Paul Holt Secretary, Chief Financial Officer June 26, 2003
- --------------------------
PAUL HOLT
/s/ Mohammed Tawfick El-Bardai Director June 26, 2003
- -----------------------------
MOHAMMED TAWFICK EL-BARDAI
/s/ Dale Hanson Director June 23, 2003
- --------------------------
DALE HANSON
/s/ Frank Meyer Director June 26, 2003
- --------------------------
FRANK MEYER
/s/ William Small Director June 25, 2003
- --------------------------
WILLIAM SMALL
30
CERTIFICATION OF CEO PURSUANT TO
SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Louis E. Silverman, President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Quality Systems,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ LOUIS E. SILVERMAN
-------------------------------------
Louis E. Silverman
President and Chief Executive Officer
(Principal Executive Officer)
June 23, 2003
31
CERTIFICATION OF CFO PURSUANT TO
SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Paul Holt, Secretary and Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Quality Systems,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ PAUL HOLT
-------------------------------------
Paul Holt
Secretary and Chief Financial Officer
(Principal Financial Officer)
June 23, 2003
32
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated balance sheets of Quality
Systems, Inc. as of March 31, 2003 and 2002, and the related consolidated
statements of income, shareholders' equity, and cash flows for the years then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Quality Systems, Inc. as of March 31, 2003 and 2002, and the consolidated
results of its operations and its consolidated cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America.
We have also audited Schedule II of Quality Systems, Inc. for the years
ended March 31, 2003 and 2002. In our opinion, this schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ Grant Thornton LLP
Irvine, California
May 21, 2003
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated statements of income,
shareholders' equity and cash flows of Quality Systems, Inc. and subsidiary for
the year ended March 31, 2001. Our audit also included the financial statement
schedule for the year ended March 31, 2001, listed in the Index of Item 15. (a)
(2). These financial statements and this schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and this schedule based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the results of operations and cash flows of Quality
Systems, Inc. and subsidiary for the year ended March 31, 2001, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, the related financial statement schedule for the year
ended March 31, 2001, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/s/ Deloitte & Touche LLP
Costa Mesa, California
May 22, 2001
F-2
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31,
2003 2002
------- -------
ASSETS
Current assets:
Cash and cash equivalents $36,443 $25,443
Short-term investments -- 255
Accounts receivable, less allowance for doubtful accounts
of $990 and $813, respectively 17,561 13,695
Inventories, net 667 1,118
Net deferred tax assets 2,029 1,368
Other current assets 2,086 1,013
------- -------
Total current assets 58,786 42,892
Equipment and improvements, net 1,777 1,578
Capitalized software costs, net 2,511 2,103
Net deferred tax assets 1,819 2,778
Goodwill 1,840 1,840
Other assets, net 869 952
------- -------
Total assets $67,602 $52,143
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,477 $ 2,657
Deferred revenue 11,699 6,155
Other current liabilities 5,893 3,281
------- -------
Total liabilities 20,069 12,093
------- -------
Commitments and contingencies (Note 9)
Shareholders' equity:
Common stock, $0.01 par value, 20,000 shares authorized,
6,152 and 6,105 shares issued and outstanding, respectively 62 61
Additional paid-in capital 35,121 34,674
Retained earnings 12,350 5,315
------- -------
Total shareholders' equity 47,533 40,050
------- -------
Total liabilities and shareholders' equity $67,602 $52,143
======= =======
See notes to consolidated financial statements.
F-3
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
Year Ended March 31,
2003 2002 2001
------- ------- -------
Net revenues:
Sales of computer systems, upgrades and supplies $29,169 $22,520 $19,935
Maintenance and other services 25,600 21,902 20,001
------- ------- -------
54,769 44,422 39,936
Cost of products and services 23,755 19,253 17,283
------- ------- -------
Gross profit 31,014 25,169 22,653
Selling, general and administrative
expenses 15,293 13,068 13,585
Research and development costs 5,062 4,243 4,081
------- ------- -------
Income from operations 10,659 7,858 4,987
Investment income 434 643 1,032
------- ------- -------
Income before provision for income taxes 11,093 8,501 6,019
Provision for income taxes 4,058 3,233 2,510
------- ------- -------
Net income $ 7,035 $ 5,268 $ 3,509
======= ======= =======
Net income per share, basic $ 1.15 $ 0.87 $ 0.57
------- ------- -------
Net income per share, diluted $ 1.10 $ 0.84 $ 0.57
------- ------- -------
Weighted average shares outstanding - basic 6,127 6,025 6,130
------- ------- -------
Weighted average shares outstanding - diluted 6,389 6,240 6,203
------- ------- -------
See notes to consolidated financial statements.
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
Retained
Common Shares Additional Earnings Total
------------- Paid-in (Accumulated Shareholders'
Number Amount Capital Deficit) Equity
-------- -------- -------- -------- --------
Balance at March 31, 2000 6,201 $ 62 $ 35,483 $ (3,462) $ 32,083
Exercise of stock options 22 -- 152 -- 152
Tax benefit resulting from stock options -- -- 7 -- 7
Purchases of common stock (236) (2) (1,862) -- (1,864)
Net income -- -- -- 3,509 3,509
-------- -------- -------- -------- --------
Balance at March 31, 2001 5,987 60 33,780 47 33,887
Exercise of stock options 118 1 795 -- 796
Tax benefit resulting from stock options -- -- 99 -- 99
Net income -- -- -- 5,268 5,268
-------- -------- -------- -------- --------
Balance at March 31, 2002 6,105 61 34,674 5,315 40,050
Exercise of stock options 47 1 351 -- 352
Tax benefit resulting from stock options -- -- 96 -- 96
Net income -- -- -- 7,035 7,035
-------- -------- -------- -------- --------
Balance at March 31, 2003 6,152 $ 62 $ 35,121 $ 12,350 $ 47,533
======== ======== ======== ======== ========
See notes to consolidated financial statements.
F-4
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended March 31,
2003 2002 2001
-------- -------- --------
Cash flows from operating activities:
Net income $ 7,035 $ 5,268 $ 3,509
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 910 807 723
Amortization 1,267 1,279 1,974
Provision for bad debts 623 497 1,272
Loss on short-term investments and other 21 3 19
Deferred income taxes 298 380 582
Changes in:
Accounts receivable (4,489) (857) (897)
Inventories 451 (88) (20)
Other assets (909) (481) (102)
Accounts payable (180) 828 583
Deferred revenue 5,544 560 (96)
Other current liabilities 2,612 22 (1,436)
-------- -------- --------
Net cash provided by operating activities 13,183 8,218 6,111
-------- -------- --------
Cash flows from investing activities:
Proceeds from the sale of short-term investments 234 -- --
Additions to capitalized software costs (1,660) (1,477) (1,063)
Additions to equipment and improvements (1,109) (565) (778)
Change in other assets -- -- (13)
-------- -------- --------
Net cash used in investing activities (2,535) (2,042) (1,854)
-------- -------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options 352 796 152
Purchases of common stock -- -- (1,864)
-------- -------- --------
Net cash provided by (used in) financing activities 352 796 (1,712)
-------- -------- --------
Net increase in cash and cash equivalents 11,000 6,972 2,545
Cash and cash equivalents, beginning of year 25,443 18,471 15,926
-------- -------- --------
Cash and cash equivalents, end of year $ 36,443 $ 25,443 $ 18,471
======== ======== ========
Supplemental Information. During fiscal 2003, 2002 and 2001 the Company made
income tax payments of $4,280, $3,386 and $2,779, respectively.
See notes to consolidated financial statements.
F-5
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003 AND 2002
1. Description of Business
Quality Systems, Inc., comprised of the QSI Division ("QSI Division") and
a wholly-owned subsidiary, NextGen Healthcare Information Systems, Inc.
("NextGen Division") (collectively, the "Company"), develop and market
proprietary healthcare information systems that automate medical and dental
group practices, community health centers, physician hospital organizations,
management service organizations, and dental schools. The Company's proprietary
software systems include general patient information, appointment scheduling,
billing, insurance claims submission and processing, managed care plan
implementation and referral management, treatment outcome studies, treatment
planning, drug formularies, electronic patient records, dental charting and
letter generation. In addition to providing fully integrated solutions, the
Company provides its clients with comprehensive hardware and software
maintenance and support services, system training services and electronic claims
submission services. The Company's principal administrative, accounting and QSI
Division operations are located in Irvine, California. The principal office of
the Company's NextGen Division is located in Horsham, Pennsylvania.
2. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiary. All significant
inter-company amounts and transactions have been eliminated.
Basis of Presentation. The accompanying consolidated financial statements
have been prepared in accordance with accounting principals generally accepted
in the United States of America.
Revenue Recognition. The Company currently recognizes revenue pursuant to
Statement of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP 97-2")
as amended by SOP 98-9 "Modification of SOP 97-2, "Software Revenue
Recognition". The Company generates revenues from licensing rights to use its
software products directly to end-users and value-added resellers (VARs). The
Company also generates revenues from sales of hardware and third party software,
and implementation, training, software customization and post-contract support
("maintenance") services performed for customers who license the Company's
products. A typical system contract contains multiple elements of two or more of
the above items. SOP 97-2, as amended, requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of those elements. The fair value of an element must
be based on objective evidence that is specific to the vendor. When evidence of
fair value exists for the delivered and undelivered elements of a transaction,
then discounts for individual elements are aggregated and the total discount is
allocated back to the individual elements in proportion to the elements' fair
value to the total contract fair value.
When evidence of fair value exists for the undelivered elements only, the
residual method, provided for under SOP 98-9, is required to be used. Under the
residual method, the Company defers revenue related to the undelivered elements
in a system sale based on vendor specific objective evidence of each element's
fair value, which is based on the average sales price of those elements when
sold separately, and allocates the remainder of the contract price to revenue
recognized from the delivered elements. Typically, the Company will bill for the
entire contract amount upon contract execution. Amounts billed in excess of the
amounts contractually due are recorded in accounts receivable as advance
billings. Amounts are contractually due when services are performed or in
accordance with contractually specified payment dates.
Provided the fees are fixed and determinable and collection is considered
probable, revenue from licensing rights and sales of hardware and third party
software are generally recognized upon shipment and transfer of title. Revenue
from implementation, training and software customization services is recognized
as the corresponding services are performed. Maintenance revenue is recognized
ratably over the contractual maintenance period.
Certain system sales contracts contain payment terms based on the
performance of certain milestones or include services to provide significant
production, or customization of the software. License and hardware revenues for
such contracts are recognized using the percentage of completion or completed
contract method, as appropriate.
License arrangements with VARs do not provide for returns, and thus
license revenues from VARs are generally recognized upon shipment.
F-6
Cash and Cash Equivalents. Cash and cash equivalents generally consist of
cash, money market funds and short term U.S. Treasuries. The Company invests its
excess cash in a money market fund which invests in only investment grade money
market instruments from a variety of industries, and therefore bears minimal
risk. The average maturity of the investments owned by the money market fund is
approximately two months.
Short-Term Investments. The Company classifies its short-term investments
into one of the following categories:
o Trading - Debt securities that do not meet the "intent-to-hold"
criteria and equity securities, both of which are bought and held
principally for the purpose of being sold in the near term.
o Available-for-sale - Debt securities that do not meet the
"intent-to-hold" criteria and which are not classified as trading
securities, as well as all equity securities not otherwise
classified as trading securities.
o Held to maturity - Debt securities for which the Company has the
intent and the ability to hold to maturity.
Trading securities are carried in the balance sheet at fair market value
and unrealized gains and losses are recorded in the statement of operations.
Available-for-sale securities are carried in the balance sheet at fair market
value; realized gains and losses are recorded in the statement of operations
when they are earned or incurred, and unrealized gains and losses, net of tax
effect, are recognized as a component of shareholders' equity. Held to maturity
securities are carried in the balance sheet at cost (unless there are declines
in the values of individual securities that are not due to temporary declines),
and realized gains and losses are recorded in the statement of operations in the
period that they are earned or incurred. Realized gains and losses from
investment transactions are determined on a specific identification basis.
Accounts Receivable. The Company provides credit terms typically ranging
from thirty days to less than twelve months for most system and maintenance
contract sales and generally does not require collateral. The Company performs
ongoing credit evaluations of its customers and maintains reserves for estimated
credit losses. Reserves for potential credit losses are determined by
establishing both specific and general reserves. Specific reserves are based on
management's estimate of the probability of collection for certain troubled
accounts. General reserves are established based on the Company's historical
experience of bad debt expense and the aging of the Company's accounts
receivable balances net of deferred revenues and specifically reserved accounts.
Accounts are written off as uncollectible only after the Company has exhausted
all possible means of collection.
Included in accounts receivable are amounts related to maintenance and
services which were billed, but which had not yet been rendered as of the end of
the fiscal year. Undelivered maintenance and services are included on the
balance sheet in deferred revenue.
Inventories. Inventories are valued at lower of cost (first-in, first-out)
or market. Certain inventories are maintained for customer support pursuant to
service agreements and are amortized over a five-year period using the
straight-line method.
Equipment and Improvements. Equipment and improvements are stated at cost
less accumulated depreciation and amortization. Depreciation and amortization of
equipment and improvements are provided over the estimated useful lives of the
assets, or the related lease terms if shorter, by the straight-line method.
Useful lives range from three to seven years.
Software Development Costs. Development costs incurred in the research and
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established, any additional
development costs are capitalized in accordance with the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed." Such costs are amortized on a straight line basis
over the estimated economic life of the related product, generally three years.
The Company performs an annual review of the recoverability of such capitalized
software costs. At the time a determination is made that capitalized amounts are
not recoverable based on the estimated cash flows to be generated from the
applicable software, any remaining capitalized amounts are written off.
Goodwill and Intangible Assets. The Company adopted SFAS No. 142 "Goodwill
and Other Intangible Assets" ("SFAS 142") effective April 1, 2001. The new
statement applies to the amortization of goodwill and other intangible assets.
The Company has ceased amortizing amounts related to goodwill starting April 1,
2001. The balance of goodwill is related to the Company's NextGen Division. The
Company has compared the fair value of the NextGen Division with the carrying
amount of assets associated with the Division and determined that none of the
goodwill recorded as of June 30, 2002 was impaired. The fair value of the
NextGen Division was determined using a
F-7
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.
Long Lived Assets. The Company has adopted Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" (SFAS 144). SFAS 144 establishes a single accounting model
for the Impairment or disposal of long-lived assets, including discontinued
operations. SFAS 144 superseded Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" (SFAS 121), and APB Opinion No. 30, Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. The adoption of this statement did not have a material effect on
the Company's consolidated financial statements. Management periodically reviews
the carrying value of long-lived assets to determine whether or not an
impairment to such value has occurred and has determined that there was no
impairment at March 31, 2003.
Income Taxes. Income taxes are provided for the tax effects of
transactions reported in the financial statements and consist of taxes currently
due plus deferred taxes related primarily to differences between the basis of
assets and liabilities for financial and tax reporting. The deferred tax assets
and liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the assets and
liabilities are recovered or settled. Deferred taxes also are recognized for
operating losses that are available to offset future taxable income and tax
credits that are available to offset future income taxes. Valuation allowances
are established as a reduction of net deferred tax assets when management cannot
determine that it is now more likely than not that the deferred assets will be
realized.
Earnings per Share. Pursuant to SFAS No. 128, "Earnings Per Share," the
Company provides dual presentation of "basic" and "diluted" earnings per share
("EPS").
Basic EPS excludes dilution from common stock equivalents and is computed
by dividing income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution from common stock equivalents.
The following table reconciles the weighted average shares outstanding for
basic and diluted net income per share for the periods presented.
(in thousands except per share amounts) Year Ended March 31,
2003 2002 2001
------ ------ ------
Net income $7,035 $5,268 $3,509
------ ------ ------
Basic net income per common share:
Weighted average of common shares outstanding 6,127 6,025 6,130
------ ------ ------
Basic net income per common share $ 1.15 $ 0.87 $ 0.57
====== ====== ======
Diluted net income per share:
Weighted average of common shares outstanding 6,127 6,025 6,130
Weighted average of common shares equivalents:
Weighted average options outstanding 262 215 73
------ ------ ------
Weighted average number of common and
common equivalent shares 6,389 6,240 6,203
------ ------ ------
Diluted net income per common share $ 1.10 $ 0.84 $ 0.57
====== ====== ======
Stock-Based Compensation.
The Company accounts for stock-based employee compensation as prescribed
by APB Opinion No. 25, Accounting for Stock Issued to Employees, and, effective
March 31, 2003, has adopted Statement of Financial Accounting Standards ("SFAS")
148, Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS
148") that supercedes Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS 123"). SFAS 148 requires pro forma disclosures
of net income and net income per share as if the fair value based method of
accounting for stock-based awards had been applied for both employee and
non-employee grants. It also requires disclosure of option status on a more
prominent and frequent basis. Such disclosure for the years ended March 31,
2003, 2002 and 2001 is presented immediately below. The Company accounts for
stock options and warrants issued to non-employees based on the fair value
method, but has not elected this treatment for grants to
F-8
employees and board members. Under the fair value based method, compensation
cost is recorded based on the value of the award at the grant date and is
recognized over the service period.
The Company's fair value calculations for options granted in fiscal 2002
and 2001 were made using the Black-Scholes option pricing model with the
following assumptions: expected life - twelve months following full vesting or
approximately 60 months from the date of the grant; stock volatility - ranging
from 55% to 57% in fiscal 2002, and 50% to 60% in fiscal 2001, risk free
interest rates of 3.5% to 4.5% in fiscal 2002 and 5.0% in fiscal 2001; and, no
dividends during the expected term. No options were granted in fiscal 2003.
The Company's calculations are based on a single option valuation approach
and forfeitures are recognized as they occur. If the computed fair values of
awards had been amortized to expense over the vesting period of the awards, pro
forma net income and net income per share would have been as follows:
Year Ended March 31, 2003 2002 2001
---------- ---------- ----------
Net Income $7,035,000 $5,268,000 $3,509,000
Proforma Option Compensation Cost (Net of Taxes) 530,000 561,000 340,000
---------- ---------- ----------
Proforma Net Income $6,505,000 $4,707,000 $3,169,000
========== ========== ==========
Reported Net Income Per Share $ 1.10 $ 0.84 $ 0.57
---------- ---------- ----------
Proforma Net Income Per Share $ 1.06 $ 0.78 $ 0.52
---------- ---------- ----------
Value of Option Awards Granted $ 0 $ 884,000 $ 461,000
---------- ---------- ----------
Segment Disclosures. The Company presents reporting information regarding
operating segments in accordance with SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" ("SFAS No. 131"). Operating segments
are identified as components of an enterprise about which separate discrete
financial information is available for evaluation by the chief operating
decision maker, or decision making group, in making decisions on how to allocate
resources and assess performance.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, the Company evaluates its
estimates, including those related to uncollectible receivables, vendor specific
objective evidence, and the percentage of completion related to certain service
revenues. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
New Accounting Pronouncements. The Company has adopted Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 establishes a single
accounting model for the Impairment or disposal of long-lived assets, including
discontinued operations. SFAS 144 superseded Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" (SFAS 121), and APB Opinion No. 30,
Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions. The adoption of this statement did not have a material
effect on the Company's consolidated financial statements.
In April 2002, the FASB issued FAS No. 145, "Rescission of FAS Statements
No. 4, 44 and 64, Amendment of FAS Statement No. 13, and Technical Corrections,"
to update, clarify and simplify existing accounting pronouncements. FAS
Statement No. 4, which required all gains and losses from debt extinguishment to
be
F-9
aggregated and, if material, classified as an extraordinary item, net of related
tax effect, was rescinded. Consequently, FAS Statement No. 64, which amended FAS
Statement No. 4, was rescinded because it was no longer necessary. The adoption
of this statement did not have a material effect on the Company's consolidated
financial statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS
146), which provides financial accounting and reporting guidance for costs
associated with exit or disposal activities, including one-time termination
benefits, contract termination costs other than for a capital lease, and costs
to consolidate facilities or relocate employees. SFAS 146 nullifies EITF Issue
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).
Under SFAS 146, a liability for a cost associated with an exit or disposal
activity should be recognized and measured initially at its fair value in the
period in which the liability is incurred, except for a liability for one-time
termination benefits that is incurred over time. Accounting for one-time
benefits depends on whether the employee will be providing future services. In
addition, a liability for costs to terminate a contract before the end of its
term should be recognized and measured at its fair value at the time the entity
terminates the contract in accordance with its terms. A liability for costs that
will continue to be incurred under the contract for its remaining term without
economic benefit to the entity should be recognized and measured at its fair
value when the entity ceases to use the right conveyed by the contract. SFAS 146
is effective for exit or disposal activities initiated after December 31, 2002.
The adoption of this statement did not have a material effect on the Company's
consolidated financial statements.
In December 2002, the FASB issued Statement of Financial Standards No. 148
"Accounting for Stock-Based Compensation- Transition and Disclosure" (SFAS 148).
SFAS 148 amends SFAS 123 and provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. SFAS 148 also amends the disclosure requirements of SFAS
123 to require more prominent and frequent disclosures in financial statements
about the effects of stock-based employee compensation. The transition guidance
and annual disclosure provisions of SFAS 148 are effective for financial
statements issued for fiscal years ending after December 15, 2002. The interim
disclosure provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. Since the
Company has not adopted the fair value based method of accounting for
stock-based employee compensation that is permitted, but not mandated, by SFAS
148, the adoption of SFAS 148 did not have a material impact on the Company's
financial position and results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure requirements for Guarantee, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 is an interpretation of
FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34.
This interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under certain
guarantees that it has issued. FIN 45 also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. This interpretation
also incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others", which is being
superseded. The adoption of FIN 45 effective January 1, 2003, did not have a
material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), an interpretation of Accounting Research
Bulletin No. 51. FIN 46 requires that a company consolidate variable interest
entities if that company is subject to a majority of the risk of loss from the
entities' activities or the company receives a majority of the entities'
residual returns. FIN 46 also requires certain disclosure about variable
interest entities in which the company has a significant interest, regardless of
whether consolidation is required. The Company has no interests in variable
interest entities and the adoption of FIN 46 on January 1, 2003, did not have a
material impact on the Company's consolidated financial statements.
3. Intangible Assets
As of March 31, 2003 and 2002, the Company had the following amounts
related to intangible assets with determinable lives. Under SFAS No. 142, these
intangible assets will continue to be amortized over their estimated lives as
seen below:
F-10
(in thousands) 2003 2002
------ ------
Developed technology (5 yrs)
Gross Carrying Amount $ 1,300 $ 1,300
Accumulated Amortization (1,300) (1,285)
------- -------
Net Developed technology $ 0 $ 15
======= =======
Capitalized software development (3 yrs)
Gross Carrying Amount $ 8,023 $ 6,663
Accumulated Amortization (5,512) (4,560)
------- -------
Net Capitalized Software development $ 2,511 $ 2,103
======= =======
Aggregate amortization expense twelve months
ended March 31 $ 1,267 $ 1,280
======= =======
The following table represents the total estimated amortization of
intangible assets with determinable lives as of March 31, 2003 (in thousands):
For the year ended March 31,
- ----------------------------
2004 $1,269
2005 $ 875
2006 $ 367
The following is reconciliation of reported net income adjusted for
adoption of SFAS No. 142 for the years ended March 31, 2003, 2002 and 2001.
2003 2002 2001
--------- --------- ---------
Reported Net income $ 7,035 $ 5,268 $ 3,509
--------- --------- ---------
Addback:
Goodwill amortization -- -- 400
--------- --------- ---------
Adjusted Net Income $ 7,035 $ 5,268 $ 3,909
========= ========= =========
Earnings per share:
Reported Net Income $ 1.10 $ 0.87 $ 0.57
Goodwill amortization -- -- 0.07
--------- --------- ---------
Adjusted net income $ 1.10 $ 0.87 $ 0.64
========= ========= =========
Diluted earnings per share:
Reported net income $ 1.10 $ 0.87 $ 0.57
Goodwill amortization -- -- .06
--------- --------- ---------
Adjusted net income $ 1.10 $ 0.87 $ 0.63
========= ========= =========
4. Cash Equivalents and Short-Term Investments
At March 31, 2003 and 2002, the Company had cash equivalents of $36.4
million and $25.4 million, respectively, invested in a major national brokerage
firm's institutional fund that specializes in U.S. government securities and
commercial paper with high credit ratings. The Company also invests a portion of
its cash in short term U.S. treasury securities. At March 31, 2002, all
short-term investments consist of trading securities with a market value of
$255,000.
Investment income for each of the three years in the period ended March
31, 2003 consists of the following:
F-11
(in thousands) Year Ended March 31,
2003 2002 2001
------- ------- -------
Interest income $ 434 $ 665 $ 1,012
Net unrealized gains (losses) -- (22) 15
Other -- -- 5
------- ------- -------
$ 434 $ 643 $ 1,032
======= ======= =======
5. Capitalized Software Costs
Information related to net capitalized software costs is as follows:
(in thousands) Year Ended March 31,
2003 2002
------- -------
Beginning of year $ 2,103 $ 1,769
Capitalized 1,660 1,477
Capitalized costs retired (300)
Amortization (1,252) (1,143)
Amortization related to retirements 300
------- -------
End of year $ 2,511 $ 2,103
======= =======
(in thousands) Year Ended March 31,
2003 2002
------- -------
Total capitalized development costs $ 8,023 $ 6,663
Accumulated amortization (5,512) (4,560)
------- -------
Net capitalized software $ 2,511 $ 2,103
======= =======
6. Composition of Certain Financial Statement Captions
(in thousands) Year Ended March 31,
2003 2002
-------- --------
ACCOUNTS RECEIVABLE:
Accounts receivable, excluding undelivered maintenance and services $ 12,392 $ 11,258
Undelivered maintenance and services billed in advance, included in deferred
revenue 6,159 3,250
Reserve for bad debts (990) (813)
-------- --------
Net accounts receivable $ 17,561 $ 13,695
======== ========
INVENTORIES:
Computer systems and components, net of reserve for obsolescence of $160 and
$127, respectively $ 348 $ 802
Replacement parts for certain client systems, net of accumulated amortization of
$676 and $674, respectively 268 266
Miscellaneous parts and supplies 51 50
-------- --------
$ 667 $ 1,118
======== ========
EQUIPMENT AND IMPROVEMENTS:
Computers and electronic test equipment $ 3,869 $ 4,007
Furniture and fixtures 1,321 1,253
Vehicles 8 8
Leasehold improvements 143 139
-------- --------
5,341 5,407
Accumulated depreciation and amortization (3,564) (3,829)
-------- --------
$ 1,777 $ 1,578
======== ========
F-12
DEFERRED REVENUES
Maintenance $ 2,709 $ 2,462
Implementation services 6,984 2,629
Undelivered software and other 2,006 1,064
-------- --------
$ 11,699 $ 6,155
======== ========
OTHER CURRENT LIABILITIES:
Accrued payroll and related expenses $ 2,259 $ 1,675
Deferred compensation 679 721
Income taxes payable -- 229
Other accrued expenses 2,955 755
-------- --------
$ 5,893 $ 3,380
======== ========
7. Income Taxes
During the year ended March 31, 2003, the Company filed amended federal
and state tax returns for the fiscal years ended March 31, 1998 through 2001, to
take advantage of available tax credits related to the Company's research and
development activities. The tax credits reported on the aforementioned returns
resulted in refund claims of $390,000 for federal and $158,000 for state income
tax purposes. Additionally, the Company claimed research and development credits
of $207,000 and $222,000 for the years ended March 31, 2003 and 2002,
respectively. The provision for income taxes for the years ended March 31, 2003
and 2002 account for approximately 50% of the aggregate tax credits accumulated
through March 31, 2003 due to the uncertainly concerning the ultimate amount to
be refunded.
The provision for income taxes consists of the following components:
(in thousands) Year Ended March 31,
2003 2002 2001
------- ------- -------
Federal:
Current taxes $ 3,211 $ 1,849 $ 1,823
Deferred taxes 268 1,043 500
------- ------- -------
3,479 2,892 2,323
------- ------- -------
State:
Current taxes 549 1,004 105
Deferred taxes 30 (663) 82
------- ------- -------
579 341 187
------- ------- -------
$ 4,058 $ 3,233 $ 2,510
======= ======= =======
The provision for income taxes differs from an amount computed at the
federal statutory rate as follows:
Year Ended March 31,
2003 2002 2001
---- ---- ----
Federal income tax statutory rate 34.0% 34.0% 34.0%
Increases (decreases) resulting from:
Non-deductible amortization of goodwill -- -- 2.8%
State income taxes 5.1% 4.6% 4.4%
Research & development tax credits (1.9%) -- --
Other (0.5%) (0.6%) 0.5%
---- ---- ----
Effective income tax rate 36.7% 38.0% 41.7%
==== ==== ====
The net deferred tax assets in the accompanying consolidated balance
sheets consist of the following at March 31, 2003 and 2002:
F-13
(in thousands) 2003 2002
------- -------
Deferred tax assets:
Timing differences in revenue recognition & bad debt allowance $ 1,644 $ 1,025
Book versus tax inventory valuation 178 131
Purchased in-process research and development 2,544 2,823
Intangible assets 114 147
Accrued compensation 382 400
Accrued liability for deferred compensation 290 409
Other 68 32
------- -------
5,220 4,967
------- -------
Deferred tax liabilities:
Accelerated depreciation $ (386) $ (113)
Capitalized software (663) (513)
State income taxes (323) (195)
------- -------
(1,372) (821)
------- -------
$ 3,848 $ 4,146
======= =======
The deferred tax assets and liabilities have been shown net in the
accompanying consolidated balance sheets based on the long-term or short-term
nature of the items which give rise to the deferred amount. The Company has
available approximately $548,000 of research and development credits to
recognize for financial reporting purposes, once the amount of the credit has
been cleared by the tax authorities.
8. Employee Benefit Plans and Employment Agreements
The Company has a profit sharing and retirement plan (collectively, the
"Retirement Plans") for the benefit of substantially all of their employees.
Participating employees may defer up to 15% of their compensation per year. The
Company's annual contribution is determined by a formula set by the Company's
Board of Directors. The Retirement Plans may be amended or discontinued at the
discretion of the Board of Directors. Contributions of $143,000, $116,000 and
$77,000 were made by the Company to the Retirement Plans for the fiscal years
ended March 31, 2003, 2002 and 2001, respectively.
During the fiscal year ended March 31, 1994, the Company initiated a
deferred compensation plan (the "Deferral Plan") for the benefit of officers and
key employees. Participating employees may defer all or a portion of their
compensation for a Deferral Plan year. In addition, the Company may, but is not
required to, make contributions into the Deferral Plan on behalf of
participating employees. Each participating employee's deferred compensation and
share of Company contributions has been invested in a life insurance policy
which has death benefit and mutual fund features. Investment decisions are made
by each participating employee from a family of mutual funds. The Company is the
owner and beneficiary of the life insurance policies and has an obligation to
pay the greater of the death benefit or the net cash surrender value upon each
employee's death or termination of employment. The net cash surrender value of
the life insurance policies and the related Company obligation for deferred
compensation was $679,000 and $721,000 at March 31, 2003 and 2002, respectively.
The Company made contributions of $12,000, $12,000 and $11,000 to the Deferral
Plan for the fiscal years ended March 31, 2003, 2002 and 2001, respectively.
The Company has an Employment Agreement ("Agreement") with Mr. Louis
Silverman dated July 20, 2000 which details the terms of his employment as the
Company's Chief Executive Officer. Mr. Silverman is eligible for a cash bonus of
up to 50% of his annual base compensation based on performance goals established
jointly between himself and the Board of Directors.
Mr. Silverman's employment may be terminated for any reason by himself or
the Company upon 60 days written notice. Should Mr. Silverman terminate his
employment due to the Company's breach of the Agreement he will be entitled to
(i) a lump sum payment equal to six months base compensation; and (ii) immediate
vesting of 25% of all unvested stock options. Should Mr. Silverman's employment
be terminated without cause or by himself for good reason, he will be entitled
to (i) unpaid base compensation and vacation earned and accrued through his date
of termination plus a lump sum equal to six months base compensation, (ii) any
other performance bonus earned and not paid, and (iii) immediate vesting of an
additional 25% of all granted but unvested stock options. Should Mr. Silverman's
employment be terminated due to a "change of control" he will be entitled to (i)
unpaid base compensation and vacation earned plus a lump sum payment equal to
six months base compensation; (ii) any
F-14
performance bonus earned but not paid; and (iii) immediate vesting of all
unvested options. A "change of control" is defined as the earliest occurrence of
any of the following events: the direct or indirect sale, lease, exchange or
other transfer of 35% of more of the total assets of the Company, the merger or
consolidation of the Company with another company with the effect that the
shareholders of the Company immediately prior to the merger hold less than 51%
of the combined voting power of the then outstanding securities of the surviving
company; the replacement of a majority of the Company's Directors without the
approval of the Board of Directors; the purchase of 25% or more of the combined
voting power of the outstanding securities of the Company with the exception of
the purchase of securities by Ahmed Hussein or Sheldon Razin of shares owned by
either Sheldon Razin or Ahmed Hussein. The Agreement also grants immediate
vesting of all unvested options should a change of control occur whether or not
Mr. Silverman's employment is terminated.
9. Employee Stock Option Plans
During fiscal 1990, the Company's shareholders approved a stock option
plan (the "1989 Plan") under which 1,000,000 shares of Common Stock have been
reserved for the issuance of options. The 1989 Plan provides that salaried
officers, key employees and non-employee directors of the Company may, at the
discretion of the Board of Directors, be granted options to purchase shares of
Common Stock at an exercise price not less than 85% of their fair market value
on the option grant date. Upon an acquisition of the Company by merger or asset
sale, each outstanding option will be subject to accelerated vesting under
certain circumstances. The 1989 Plan terminated on June 30, 1999, however there
remain granted 77,750 outstanding options at March 31, 2003 under the 1989 Plan
which remain eligible for exercise until the expiration of their respective
terms.
In September 1998, the Company's shareholders approved a stock option plan
(the "1998 Plan") under which 1,000,000 shares of Common Stock have been
reserved for the issuance of options. The 1998 Plan provides that employees,
directors and consultants of the Company, at the discretion of the Board of
Directors or a duly designated compensation committee, be granted options to
purchase shares of Common Stock. The exercise price of each option granted shall
be determined by the Company's Board of Directors at the date of grant. Upon an
acquisition of the Company by merger or asset sale, each outstanding option will
be subject to accelerated vesting under certain circumstances. The 1998 Plan
terminates on December 31, 2007, unless sooner terminated by the Board. At March
31, 2003, 576,300 shares were available for future grant under the 1998 Plan. As
of March 31, 2002, there were 370,327 outstanding options related to this plan.
A summary of option transactions under the 1989 & 1998 Plans for the three
years ended March 31, 2003 is as follows:
Weighted Average
Number of Shares Exercise Price
---------------- --------------
Outstanding, March 31, 2000 (107,867 exercisable at a
weighted average price of $7.11) 372,859 $ 6.80
Granted (weighted average fair value of $2.57) 179,010 7.97
Exercised (22,512) 6.73
Cancelled (50,859) 7.73
--------
Outstanding, March 31, 2001 (143,429 exercisable at a
weighted average price of $6.76) 478,498 $ 7.16
Granted (weighted average fair value of $5.97) 139,940 11.99
Exercised (117,205) 6.83
Cancelled (5,750) 6.74
--------
Outstanding, March 31, 2002 (156,551 exercisable at a weighted
average price of $7.04) 495,483 $ 8.61
Granted 0 --
Exercised (47,406) 7.43
Cancelled 0 --
--------
Outstanding, March 31, 2003 (230,147 exercisable at a weighted
average price of $7.94) 448,077 $ 8.74
======== ======
F-15
The outstanding stock options vest ratably over a four-year period
commencing from the respective option grant dates. Stock options outstanding at
March 31, 2003 are summarized as follows:
Range of Exercise Number Weighted Avg. Weighted
Prices Outstanding at Remaining Contractual Average
March 31, 2003 Life (Yrs.) Exercise Price
----------------- -------------- --------------------- --------------
Options Outstanding $ 6.25 - $ 7.00 117,376 1.3 $ 6.54
$ 7.01 - $ 10.00 195,261 2.2 $ 7.82
$10.01 - $ 12.99 135,440 3.4 $ 11.98
-------
448,077 2.3 $ 8.74
=======
Range of Number Weighted
Exercise Prices Exercisable at Average
March 31, 2003 Exercise Price
--------------- -------------- --------------
Options Exercisable $ 6.25 - $ 7.00 88,032 $ 6.54
$ 7.01 - $ 10.00 105,631 $ 7.77
$10.01 - $ 12.99 36,485 $ 11.85
-------
230,148 $ 7.94
=======
10. Commitments and Contingencies
Litigation.
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of
California for the County of Orange, in which Mr. Caveny, on behalf of himself
and all others who purchased the Company's Common Stock between June 26, 1995
and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck,
Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers,
Graeme H. Frehner, and Gordon L. Setran (all of the foregoing individuals were
either officers, directors or both during the period from June 26, 1995 through
July 3, 1996), as well as other defendants not affiliated with the Company,
violated California Corporations Code Sections 25400 and 25500, California Civil
Code Sections 1709 and 1710, and California Business and Professions Code
Sections 17200 et. seq., by issuing positive statements about the Company that
allegedly were knowingly false, in part, in order to assist the Company and the
individual defendants in selling Common Stock at an inflated price in the
Company's March 5, 1996 public offering and at other points during the class
period. The complaint seeks compensatory and punitive damages in unspecified
amounts, disgorgement, declaratory and injunctive relief, and attorneys' fees.
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
was for all purposes consolidated with the Caveny action.
On July 1, 1997, a third purported class action entitled WADE CHENEY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the United States District Court,
repeating essentially the same factual allegations as the April 22, 1997 suit
and purporting to state claims under the Federal securities laws. By court order
dated August 13, 1997, this action was stayed temporarily and the Court reserved
jurisdiction to lift the stay after all matters are final in the class action
filed on April 22, 1997. On August 15, 1997 the case was removed from the
Court's active caseload.
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. Six class
members opted out of the class, and their requests were filed with the Court.
On November 18, 2002, the parties reached an agreement to settle the
consolidated action. On January 6, 2003, the parties entered into a Stipulation
of Settlement whereby in consideration of a cash payment to the class fully
funded by the Company's directors and officers liability insurance, all members
of the class released all defendants from any and all claims that the class
members had or may have had relating to the purchase of the Company's securities
during the class period or based on any facts or events that were or could have
been asserted against the defendants in this action or in the companion Cheney
action. The settlement agreement expressly provides that Quality Systems and the
named defendants do not admit, and continue to deny, any and all allegations of
wrongdoing.
F-16
On January 14, 2003, the court granted preliminary approval of the
settlement, and approved a notice of the settlement that was mailed to
shareholders who were potential class members. Two additional class members
opted out of the settlement, and their requests were filed with the Court. On
April 14, 2003, the class action settlement was approved by the Court and an
Order and Final Judgment was entered dismissing the entire action with
prejudice.
The releases given by the settling class in the Caveny action expressly
released all defendants from any and all claims that were or could have been
alleged in the Cheney action.
The Company is a party to various other legal proceedings incidental to
its business, none of which are considered by management to be material.
Rental Commitments.
The Company leases its facilities and offices under irrevocable operating
lease agreements expiring at various dates through March 2010. Rent expense for
the years ended March 31, 2003, 2002, and 2001 was $1,068,000, $897,000, and
$914,000, respectively. The Company has rental commitments under these
agreements as follows:
Year Ending March 31 Amount
- -------------------- ------
2004 $1,077
2005 1,087
2006 765
2007 571
2008 586
Thereafter 1,008
------
Total $5,094
------
11. 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 repurchase authorization expires on the date of the fiscal 2003
Annual Shareholders Meeting. Since the October 2001 authorization through March
31, 2003, no shares have been repurchased.
12. Fair Value of Financial Instruments
The Company's financial instruments include cash, accounts receivable,
accounts payable, and accrued liabilities. Management believes that the fair
value of cash, accounts receivable, accounts payable, deferred revenue, and
accrued liabilities approximate the carrying values due to the short-term nature
of these instruments.
13. Operating Segment Information
The Company has prepared operating segment information in accordance with
SFAS No. 131 "Disclosures About Segments of an Enterprise and Related
Information" to report components that are evaluated regularly by the Company's
chief operating decision maker, or decision making group in deciding how to
allocate resources and in assessing performance. The Company's reportable
operating segments include its NextGen Division and the QSI Division.
The accounting policies of the Company's operating segments are the same
as those described in Note 2 - Summary of Significant Accounting Policies -
except that the disaggregated financial results of the segments reflect
allocation of certain functional expense categories consistent with the basis
and manner in which Company management internally disaggregates financial
information for the purpose of assisting in making internal operating decisions.
Certain corporate overhead costs, such as executive and accounting department
personnel related expenses,
F-17
are not allocated to the individual segments by management. The Company
evaluates performance based on stand-alone segment operating income. Because the
Company does not evaluate performance based on return on assets at the operating
segment level, assets are not tracked internally by segment. Therefore, segment
asset information is not presented.
Operating segment data for the three years ended March 31, was as follows:
(in thousands) QSI Division NextGen Division Unallocated Consolidated
Corporate Expenses
------------ ---------------- ------------------ ------------
Year Ended March 31, 2003
Revenue $ 17,423 $ 37,346 $ 54,769
Operating Income (Loss) $ 4,675 $ 8,902 $ (2,918) $ 10,659
Year Ended March 31, 2002
Revenue $ 17,224 $ 27,198 -- $ 44,422
Operating Income (Loss) $ 5,196 $ 4,656 $ (1,994) $ 7,858
Year Ended March 31, 2001
Revenue $ 17,225 $ 22,711 -- $ 39,936
Operating Income (Loss) $ 3,231 $ 3,662 $ (1,906) $ 4,987
14. Selected Quarterly Operating Results (unaudited)
The following table presents quarterly unaudited consolidated financial
information for the eight quarters in the period ended March 31, 2003. Such
information is presented on the same basis as the annual information presented
in other sections of this report. In management's opinion, this information
reflects all adjustments that are necessary for a fair presentation of the
results for these periods.
COMPARISON BY QUARTER(1)
(in thousands) Quarter Ended (Unaudited)
-----------------------------------------------------------------------------
6/30/01 9/30/01 12/31/01 3/31/02 6/30/02 9/30/02 12/31/02 3/31/03
------- ------- -------- ------- ------- ------- -------- -------
Systems, upgrades and supplies sales $ 5,594 $ 5,110 $ 5,458 $ 6,358 $ 6,425 $ 6,814 $ 7,666 $ 8,264
Maintenance and other 5,315 5,387 5,585 5,615 5,882 6,180 6,734 6,804
------- ------- ------- ------- ------- ------- ------- -------
10,909 10,497 11,043 11,973 12,307 12,994 14,400 15,068
Costs of products and services 4,734 4,547 4,900 5,072 4,920 5,660 6,353 6,822
------- ------- ------- ------- ------- ------- ------- -------
Gross Profit 6,175 5,950 6,143 6,901 7,387 7,334 8,047 8,246
Selling, General, & Administrative 3,245 3,294 3,019 3,510 3,673 3,442 3,918 4,260
Research & Development 1,107 1,000 1,057 1,079 1,135 1,213 1,347 1,367
------- ------- ------- ------- ------- ------- ------- -------
1,823 1,656 2,067 2,312 2,579 2,679 2,782 2,619
Investment Income 206 190 147 100 104 123 109 98
------- ------- ------- ------- ------- ------- ------- -------
2,029 1,846 2,214 2,412 2,683 2,802 2,891 2,717
Provision for Income Taxes 771 714 832 918 1,057 1,092 956 953
------- ------- ------- ------- ------- ------- ------- -------
Net Income $ 1,258 $ 1,132 $ 1,382 $ 1,494 1,626 1,710 1,935 1,764
======= ======= ======= ======= ===== ===== ===== =====
Net Income per share - Basic $ .21 $ .19 $ .23 $ .25 $ .27 $ .28 $ .32 $ .29
Net Income per share - Diluted $ .20 $ .18 $ .22 $ .24 $ .26 $ .27 $ .30 $ .27
Weighted Average Shares
Outstanding - Basic 5,989 6,005 6,025 6,078 6,106 6,122 6,134 6,144
Weighted Average Shares
Outstanding - Diluted 6,173 6,204 6,224 6,320 6,333 6,351 6,403 6,431
(1) In the quarter ended December 31, 2002 the Company recorded a $165,000
reduction in its provision for income taxes to reflect the cumulative year to
date benefit of the availability of certain state and federal research and
development tax credits. In the quarter ended March 31, 2003, the application of
the residual method for revenue recognition resulted in a $475,000 reduction in
revenue for the fourth quarter.
F-18
Schedule II
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(in thousands)
Description Balance at Additions
beginning of Charged to costs Balance at
period and expenses Deductions End of Period
---------- ---------------- ---------- ----------
For the year ended:
March 31, 2003 $ 813 $ 623 $ (446) $ 990
-------
March 31, 2002 $ 1,335 $ 497 $(1,019) $ 813
-------
March 31, 2001 $ 1,121 $ 1,272 $(1,058) $ 1,335
-------
F-19
INDEX TO EXHIBITS
10.17 Sublease Agreement between Company and Infinium Software dated
February 22, 2002.
10.18 Lease Agreement between Company and HUB Properties LLC dated May 8,
2002.
99.1 Section 906 Officer Certifications.
E-1