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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission file number 0-13801
QUALITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California 95-2888568
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
18191 Von Karman Avenue, Irvine California 92612
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 255-2600
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of the latest practicable date: 6,162,988 shares of Common
Stock, $.01 par value, as of August 5, 2003
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PART I - CONSOLIDATED FINANICAL INFORMATION
Item 1. Financial Statements
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
-------------------------------
(In thousands) June 30, March 31,
2003 2003
(unaudited)
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ASSETS
Current assets:
Cash and cash equivalents $38,976 $36,443
Accounts receivable, net 19,039 17,561
Inventories, net 1,152 667
Deferred tax assets 2,029 2,029
Other current assets 1,432 2,086
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Total current assets 62,628 58,786
Equipment and improvements, net 1,734 1,777
Capitalized software costs, net 2,760 2,511
Deferred tax assets 1,819 1,819
Goodwill 1,840 1,840
Other assets 861 869
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Total assets $71,642 $67,602
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,483 $ 2,477
Deferred revenue 13,979 11,699
Other current liabilities 6,298 5,893
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Total liabilities 21,760 20,069
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Commitments and contingencies -- --
Shareholders' equity:
Common stock, $0.01 par value, 20,000 shares authorized,
6,161 and 6,152 shares issued and outstanding, respectively 62 62
Additional paid-in capital 35,193 35,121
Retained Earnings 14,627 12,350
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Total shareholders' equity 49,882 47,533
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Total liabilities and shareholders' equity $71,642 $67,602
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See notes to consolidated financial statements.
1
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
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(In thousands except per share amounts) Three Months Ended June 30,
2003 2002
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Net revenues:
Sales of computer systems, upgrades and supplies $ 9,474 $ 6,425
Maintenance and other services 6,832 5,882
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16,306 12,307
Cost of products and services 6,610 4,920
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Gross profit 9,696 7,387
Selling, general and administrative expenses 4,740 3,673
Research and development costs 1,366 1,135
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Income from operations 3,590 2,579
Investment income 100 104
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Income before provision for income taxes 3,690 2,683
Provision for income taxes 1,413 1,057
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Net income $ 2,277 $ 1,626
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Net income per share, basic $ 0.37 $ 0.27
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Net income per share, diluted $ 0.35 $ 0.26
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Weighted average shares outstanding - basic 6,157 6,106
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Weighted average shares outstanding - diluted 6,466 6,332
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See notes to consolidated financial statements.
2
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
---------------------------
(In thousands) Three Months Ended June 30,
2003 2002
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Cash Flows from Operating Activities:
Net Income $ 2,277 $ 1,626
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 573 523
Loss on short-term investments and other -- 20
Changes in:
Accounts receivable (1,478) 450
Inventories (485) 99
Other current assets 654 58
Other assets 8 (85)
Accounts payable (994) (1,794)
Deferred revenue 2,280 1,727
Other current liabilities 405 1,057
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Net Cash Provided By Operating Activities 3,240 3,681
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Cash Flows From Investing Activities:
Proceeds from the sale of short term investments -- 235
Net additions to equipment and improvements (175) (209)
Additions to capitalized software costs (604) (325)
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Net Cash Used In Investing Activities (779) (299)
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Cash Flows from Financing Activities:
Proceeds from exercise of stock options 72 37
---------------------------
Net Cash Provided by Financing Activities 72 37
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Net Increase in Cash and Cash Equivalents 2,533 3,419
Cash and Cash Equivalents, beginning of period 36,443 25,443
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Cash and Cash Equivalents, end of period $ 38,976 $ 28,862
===========================
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Supplemental Information - During the three months ended June 30, 2003 and 2002,
the Company made income tax payments, net of refunds received, of $30 and $371
respectively.
See notes to consolidated financial statements.
3
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements as of June 30, 2003
and the three months ended June 30, 2003 and 2002, have been prepared in
accordance with the requirements of Form 10-Q and, therefore, do not include all
information and footnotes which would be presented were such financial
statements prepared in accordance with generally accepted accounting principles.
These financial statements should be read in conjunction with the audited
financial statements presented in the Company's Annual Report for the fiscal
year ended March 31, 2003. In the opinion of management, the accompanying
consolidated financial statements reflect all adjustments which are necessary
for a fair presentation of the results of operations for the periods presented.
The results of operations for such interim periods are not necessarily
indicative of results of operations to be expected for the full year.
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 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 certain
performance milestones or include services to provide significant customization
of the software. License and hardware revenues for
4
such contracts may be 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.
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.
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.
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 quarters ended June 30, 2003 and 2002 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
5
grants to 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 or
the first quarter of fiscal 2004.
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:
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Quarter Ended June 30,
2003 2002
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Net Income $2,277,000 $1,626,000
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Proforma Option Compensation Cost (Net of Taxes) 84,000 133,000
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Proforma Net Income $2,193,000 $1,493,000
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Reported Basic Net Income Per Share $ 0.37 $ 0.27
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Proforma Net Income Per Share $ 0.36 $ 0.24
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Value of Option Awards Granted $ 0 $ 0
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3. Recent Accounting Pronouncements
In November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 provides guidance
on how to account for arrangements that involve the delivery or performance of
multiple products, services and/or rights to use assets. The provisions of EITF
Issue No. 00-21 will apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. We are currently evaluating the effect
that the adoption of EITF Issue No. 00-21 but do not expect a material impact on
our consolidated financial position or results of operations.
In December, 2002, the FASB issued Statement of Financial Accounting Standards
("SFAS 148"), Accounting for Stock-Based Compensation-Transition and Disclosure.
SFAS 148 supercedes Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS 123") and provides alternative methods of
transition to the fair value method of accounting for stock based compensation.
SFAS 148 also requires (i) 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 and (ii) disclosure
of option status on a more prominent and frequent basis. The statement is
required for annual periods ending after December 15, 2002. The Company adopted
SFAS 148 effective March 31, 2003. Adoption of SFAS 148 did not have a material
impact on the Company's consolidated financial position or results of operations
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
6
and the adoption of FIN 46 on January 1, 2003, did not have a material impact on
the Company's consolidated financial statements.
In May 2003, the FASB issued Statement No. 150 ("SFAS 150"), "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity." This statement establishes standards for how an issuer classifies and
measures in its statement of financial position certain financial instruments
with characteristics of both liabilities and equity. In accordance with the
standard, financial instruments that embody obligations for the issuer are
required to be classified as liabilities. SFAS 150 is effective for all
financial instruments created or modified after May 31, 2003, and otherwise
shall be effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS 150 is not expected to have a material
effect on the Company's consolidated financial condition or results of
operations.
4. Intangible Assets
In accordance with FASB 142, the Company does not amortize goodwill. The balance
of goodwill is related to the Company's NextGen Healthcare Information Systems
Division (NextGen), which was acquired by virtue of two acquisitions in May of
1996 and 1997, respectively. In accordance with FASB 142, the Company has
compared the fair value of the NextGen Division with the carrying amount of
assets associated with the Division and determined that none of the goodwill
recorded as of June 30, 2003 was impaired. The fair value of the NextGen
Division was determined using a reasonable estimate of future cash flows of the
Division and a risk adjusted discount rate to compute a net present value of
future cash flows.
As of June 30, 2003, the Company had the following amounts related to
intangible assets:
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(in thousands) Gross Carrying Accumulated Net Intangible
Amount Amortization Assets
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Capitalized software development (3 yrs) $ 8,627 $5,867 $2,760
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Aggregate amortization expense three months ended June 30, 2003 $ 355
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The unamortized balance of capitalized software development costs as of
June 30, 2003 is estimated to be amortized as follows:
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Estimated Amortization Expense
For the year ended March 31, (in thousands)
---------------------------------------------------------------
2004 $ 1,065
2005 $ 1,076
2006 $ 619
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5. 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 June 30, 2003, no shares
have been repurchased
7
6. Income Taxes
The provision for income taxes for the three month period ended June 30, 2003
differs from the expected combined statutory rates primarily due to the
estimated impact of varying state income tax rates, as well as estimated
research and development tax credits for fiscal 2004. The provision for income
taxes for the three month period ended June 30, 2002 differs from the expected
combined statutory rates primarily due to the estimated impact of varying state
income tax rates.
7. Net Income Per Share
The following table reconciles the weighted average shares outstanding for basic
and diluted net income per share for the periods indicated. Basic net income per
share is based upon the weighted average number of common shares outstanding.
Diluted net income per share is based on the assumption that the Company's
outstanding options are included in the calculation of diluted earnings per
share, except when their effect would be anti-dilutive. Dilution is computed by
applying the treasury stock method. Under this method, options are assumed to be
exercised at the beginning of the period (or at the time of issuance, if later),
and as if funds obtained thereby were used to purchase common stock at the
average market price during the period.
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(in thousands except per share amounts) Three Months Ended June 30,
2003 2002
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Net income $ 2,277 $ 1,626
Basic net income per common share:
Weighted average of common shares outstanding 6,157 6,106
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Basic net income per common share $ 0.37 $ 0.27
===========================
Diluted net income per share:
Weighted average of common shares outstanding 6,157 6,106
Effect of potentially dilutive securities (options) 309 226
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Weighted average number of common and shares - Diluted 6,466 6,332
---------------------------
Diluted net income per common share $ 0.35 $ 0.26
===========================
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8. Operating Segment Information
The Company has prepared operating segment information in accordance with
Statement of Accounting Standards ("SFAS") No. 131 "Disclosures About Segments
of an Enterprise and Related Information" ("SFAS No. 131") to report components
that are evaluated regularly by the Company's chief operating decision maker, or
decision making group in deciding how to allocate resources and in assessing
performance.
The Company's reportable operating segments include its NextGen Healthcare
Information Systems Division and the QSI Division.
The disaggregated financial results of the segments reflect allocation of
certain functional expense categories consistent with the basis and manner in
which Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions. Certain corporate
overhead costs are not allocated to the individual segments by management. The
Company evaluates performance based on stand-alone segment revenue and operating
income performance. 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.
8
Operating segment data for the quarters ended June 30, 2002 and 2003 is as
follows:
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(In thousands) NextGen Healthcare
Information Systems Unallocated
QSI Division Division Corporate Expenses Consolidated
- ----------------------------------------------------------------------------------------------------------------
Quarter ended June 30, 2003
Revenue $4,064 $12,242 $ 16,306
Operating income (loss) $1,064 $ 3,359 $ (833) $ 3,590
Quarter ended June 30, 2002
Revenue $4,229 $ 8,078 $ 12,307
Operating income (loss) $1,166 $ 2,073 $ (660) $ 2,579
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9. Composition of Accounts Receivable
Included in accounts receivable are amounts related to maintenance and services
which were billed but not yet rendered as of the end of the period. Undelivered
maintenance and services are included on the consolidated balance sheet as part
of the deferred revenue balance.
---------------------------------
(in thousands) June 30, 2003 March 31, 2003
- -------------------------------------------------------------------------------------------------------
Accounts receivable:
Accounts receivable, excluding undelivered maintenance and services $ 12,372 $ 12,392
Undelivered maintenance and services billed in advance,
included in deferred revenue 7,656 6,159
---------------------------------
Gross Accounts receivable 20,028 18,551
---------------------------------
Reserve for bad debts (989) (990)
---------------------------------
Net accounts receivable $ 19,039 $ 17,561
=================================
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10. Concentration of Credit Risk
The Company had cash deposits at U.S. banks and financial institutions, which
exceeded federally insured limits at June 30, 2003. The Company is exposed to
credit loss for amounts in excess of insured limits in the event of
non-performance by the institution; however, the Company does not anticipate
non-performance by these institutions.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Except for the historical information contained herein, the matters discussed in
this Quarterly Report on Form 10-Q, including discussions of the Company's
product development plans, business strategies and market factors influencing
the Company's results, are forward-looking statements that involve certain risks
and uncertainties. Actual results may differ from those anticipated by the
Company as a result of various factors, both foreseen and unforeseen, including,
but not limited to, the Company's ability to continue to develop new products
and increase systems sales in markets characterized by rapid technological
evolution, consolidation within the Company's target marketplace and among the
Company's competitors, and competition from larger, better capitalized
competitors. Many other economic, competitive, governmental and technological
factors could impact the Company's ability to
9
achieve its goals. Interested persons are urged to review the risks described
below, as well as in the Company's other public disclosures and filings with the
Securities and Exchange Commission.
Company Overview
Quality Systems, Inc., through its NextGen Healthcare Information Systems,
Inc. (NextGen(1)) and QSI (QSI) Divisions (collectively, the "Company"), develop
and market healthcare information systems that automate medical and dental group
practices, physician hospital organizations ("PHOs"), management service
organizations ("MSOs"), ambulatory care centers, community health centers, and
medical and dental schools. In response to the growing need for more
comprehensive, cost-effective information solutions for physician and dental
practices, the Company's systems enable clients to redesign office workflow
processes, improve productivity, reduce information processing and
administrative costs, and utilize electronic medical records to store and access
patient information. The Company's proprietary software systems cover a number
of important practice elements including, but not limited to, general patient
information, electronic patient records, appointment scheduling, billing,
insurance claims submission and processing, eligibility verification, managed
care plan implementation, referral management, treatment outcome studies,
treatment planning, drug formularies, dental charting, and letter generation.
Several of the Company's software systems may be operated remotely using thin
client connectivity or a standard web browser. In addition to providing fully
integrated software solutions to its clients, the Company offers comprehensive
hardware and software installation services, maintenance and support services,
and system training services.
The Company currently has a base of approximately 700 clients, with each
client generally including between one and 500 physicians or dentists. The
Company believes that as healthcare providers are increasingly required to
reduce costs and maintain the quality of healthcare, the Company will be able to
capitalize on its strategy of providing fully integrated information systems and
superior client service.
The Company, a California corporation formed in 1974, was founded with an
early focus on providing information systems and services for dental group
practices. In the mid-1980's, the Company capitalized on the increasing focus on
medical cost containment and further expanded its information processing systems
to serve the medical market. Today, the Company has dedicated products serving
both the medical and dental markets.
The Company's QSI Division develops and markets dental practice management
and medical practice management software suites utilizing a UNIX(2) operating
system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(3) operating
system and can be fully integrated with the Company's dental practice management
applications. CPS incorporates a wide range of clinical tools including, but not
limited to, periodontal charting and digital imaging of X-ray and inter-oral
camera images as part of an electronic patient record. In addition, the QSI
Division develops and markets the Company's QUIC product suite which
incorporates a variety of products that enhance the connectivity between
provider and payor, and provider and patient. The QSINet Application Service
Provider ("ASP")/Internet product offering is also developed and marketed in
this Division. QSINet enables providers to extend patient appointment
scheduling, electronic bill payment, and other functions to patients via the
Internet.
The Company's NextGen Healthcare Information Systems, Inc. Division
develops and sells proprietary electronic medical records software and practice
management systems under the NextGen(R)(4) product name. Major product
categories of the NextGen suite include Electronic Medical Records
(NextGen(emr)), Enterprise Practice Management (NextGen(epm)), Enterprise
Appointment Scheduling (NextGen(eas)), Enterprise Master Patient Index
(NextGen(epi)), Managed Care, Electronic Data Interchange,
- ----------
(1) The Company's NextGen Division, formerly known as "MicroMed Healthcare
Information Systems" or the "MicroMed Division", changed its name in
fiscal 2002.
(2) UNIX is a registered trademark of AT&T Corporation.
(3) Microsoft Windows, Windows NT, Windows 95, Windows 98, and Windows 2000
are registered trademarks of Microsoft Corporation.
(4) NextGen is a registered trademark of NextGen Healthcare Information
Systems, Inc.
10
System Interfaces, Internet Operability (NextGen(web)), a Patient-centric and
Provider-centric Web Portal Solution (NextMD.com(5)), and a handheld product
(NextGen(pda)). The Company's enterprise practice management and electronic
medical records software packages can run via private intranet or via the
Internet in an ASP environment.
Enhancements to these products continued during the quarter.
Risk Factors
Competition. The markets for healthcare information systems are intensely
competitive, and the Company faces significant competition from a number of
different sources. Several of the Company's competitors have significantly
greater name recognition as well as substantially greater financial, technical,
product development and marketing resources than the Company.
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
- ----------
(5) NextMD.com is a trademark of NextGen Healthcare Information Systems, Inc.
11
Company's systems can vary significantly and typically ranges from three to
twelve months from initial contact to contract execution/shipment.
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can cause
significant variations in operating results from quarter to quarter. As a
result, the Company believes that interim period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, the Company's historical
operating results are not necessarily indicative of future performance for any
particular period.
The Company 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
12
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 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
13
on the Company's business. In particular, such litigation could impair the
Company's relationships with existing customers and its ability to obtain new
customers. Defending such litigation may result in a diversion of management's
time and attention away from business operations, which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Such litigation may also have the effect of discouraging potential
acquirers from bidding for the Company or reducing the consideration such
acquirers would otherwise be willing to pay in connection with an acquisition.
There can be no assurance that such litigation will not result in
liability in excess of its insurance coverage, that the Company's insurance will
cover such claims or that appropriate insurance will continue to be available to
the Company in the future at commercially reasonable rates.
Proprietary Technology. The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely on
license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect its intellectual property. The Company's software is not
patented and existing copyright laws offer only limited practical protection.
There can be no assurance that the legal protections and precautions taken
by the Company will be adequate to prevent misappropriation of the Company's
technology or that competitors will not independently develop technologies
equivalent or superior to the Company's. Further, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an extent
as do the laws of the United States and are often not enforced as vigorously as
those in the United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no assurance
that others will not assert infringement or trade secret claims against the
Company with respect to its current or future products or that any such
assertion will not require the Company to enter into a license agreement or
royalty arrangement 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
14
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.
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
15
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.
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
16
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
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
17
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.
Results of Operations
The following table sets forth for the periods indicated, the percentage
of net revenues represented by each item in the Company's Consolidated
Statements of Income.
---------------------------
(unaudited) Three Months Ended June 30,
2003 2002
- --------------------------------------------------------------------------------
Net Revenues:
Sales of computer systems, upgrades and supplies 58.1% 52.2%
Maintenance and other services 41.9 47.8
---------------------------
100.0 100.0
Cost of Products and Services 40.5 40.0
---------------------------
Gross Profit 59.5 60.0
Selling, General and Administrative Expenses 29.1 29.8
Research and Development Costs 8.4 9.2
---------------------------
Income from Operations 22.0 21.0
Investment Income 0.6 0.8
---------------------------
Income before Provision for Income Taxes 22.6 21.8
Provision for Income Taxes 8.6 8.6
---------------------------
Net Income 14.0% 13.2%
===========================
- --------------------------------------------------------------------------------
For the Three-Month Periods Ended June 30, 2003 and 2002
The Company's net income for the three months ended June 30, 2003 was
$2,277,000 or $0.37 per share on a basic and $.35 per share on a diluted basis,
as compared to a net income of $1,626,000, or $0.27 on a basic and $0.26 per
share on a diluted basis, for the three months ended June 30, 2002.
Net Revenues. Net revenues for the three months ended June 30, 2003
increased 33% to $16.3 million from $12.3 million for the three months ended
June 30, 2002. Sales of computer systems, upgrades and supplies increased 48% to
$9.5 million from $6.4 million in the year ago quarter while net revenues from
maintenance and other services grew 15% to $6.8 million from $5.9 million during
the comparable period last year. The increase in net revenues from sales of
computer systems, upgrades and supplies was principally the result of an
increase in sales of the Company's NextGenemr and NextGenepm software as well as
related hardware and third party software. The increase in maintenance and other
services revenue resulted principally from an increase in maintenance revenues
generated from the Company's expanded client base, and secondarily from an
increase in revenues generated from the Company's electronic data interchange
services.
Cost of Products and Services. Cost of products and services for the three
months ended June 30, 2003 rose 35% to $6.6 million from $4.9 million in the
prior year quarter. Cost of products and services as a percentage of net
revenues increased from 40.0% to 40.5% for the respective periods. The dollar
increase in the cost of products and services was a result of the impact of
higher labor costs associated with installation and customer support as well as
increased hardware and third party software costs. The cost of products and
services as a percentage of net revenues increased in the quarter ended June 30,
2003 compared to the same period last year, largely as a result of an increase
in hardware and third party software sales as a percentage of total revenue.
18
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended June 30, 2003 increased 27%
to approximately $4.7 million as compared to $3.7 million for the three months
ended June 30, 2002. Selling, general and administrative expenses as a
percentage of net revenues were slightly lower at 29.1% as compared to 29.8% in
the prior year quarter. The increase in the dollar amount of such expenses
resulted primarily from increased sales and marketing expenses at the Company's
NextGen Division and higher corporate expenses.
Research and Development Costs. Research and development costs for the
three months ended June 30, 2003 increased by 20% to $1,366,000 from $1,135,000
in the prior year's quarter. The increase in research and development costs is
attributed primarily to increased investments in the NextGen(emr) and
NextGen(epm) product suites. Research and development costs as a percentage of
net revenues declined to 8.4% as compared to 9.2% for the quarter ended June 30,
2002. This percentage decline was driven by the fact that revenues grew faster
than the increase in research and development expense. The Company has, over
time, changed the mix of its overall research and development expenditures to
facilitate increased research and development spending at the NextGen Division
while moderating the overall growth rate of research and development costs.
Investment Income. Investment income for the three months ended June 30,
2003 decreased by 4% from approximately $104,000 to $100,000. Investment income
in the quarter declined due to the lower interest rates earned on the Company's
balances during the quarter vis a vis the year earlier quarter. The decrease in
interest rates was partially offset by higher cash balances.
Provision for Income Taxes. The provision for income taxes for the three
months ended June 30, 2003 was approximately $1,413,000 as compared to
approximately $1,057,000 for the three months ended June 30, 2002. The provision
for income taxes for the three months ended June 30, 2003 differs from the
combined statutory rates primarily due to the impact of the effect of varying
state income tax rates as well as the impact of estimated research and
development tax credits. The provision for income taxes for the three months
ended June 30, 2002 differs from the combined statutory rates primarily due to
the impact of the effect of varying state income tax rates.
Liquidity and Capital Resources
The following table presents selected financial statistics and information for
each of the past two quarters ended June 30:
--------------------------
($ in thousands) Quarter Ended June 30,
(unaudited) 2003 2002
----------------------------------------------------------------------------------------------
Cash and cash equivalents $38,976 $28,862
----------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents during the quarter $ 2,533 $ 3,419
----------------------------------------------------------------------------------------------
Net income during the quarter $ 2,277 $ 1,626
----------------------------------------------------------------------------------------------
Net cash provided by operations during the quarter $ 3,240 $ 3,681
----------------------------------------------------------------------------------------------
Number of days of sales outstanding at start of quarter 106 104
----------------------------------------------------------------------------------------------
Number of days of sales outstanding at end of quarter 107 98
----------------------------------------------------------------------------------------------
The Company's principal source of cash was cash provided by operations.
The Company was able to generate operating cash flows in excess of net income in
the quarter ended June 30, 2003 primarily as a result of an increase in deferred
revenue which grew faster than accounts receivable during the period. Provided
turnover of accounts receivable and deferred revenue, and profitability remain
consistent with
19
the quarter ended June 30, 2003, the Company anticipates being able to continue
to generate cash from operations primarily from the net income of the Company.
Cash and cash equivalents increased $2,533,000 between March 31, 2003 and
June 30, 2003 primarily as a result of cash provided by operating activities.
Cash and cash equivalents increased approximately $3,419,000 during the three
months ended June 30, 2002, also primarily as a result of cash generated by
operating activities. Also, during the quarter ended June 30, 2002, the Company
liquidated approximately $235,000 in short-term equity investments, and moved
those funds into cash and cash equivalent accounts.
Net cash used in investing activities for the three months ended June 30,
2003 and 2002 was $779,000 and $299,000 respectively. Net cash used in investing
activities for the three months ended June 30, 2003 consisted of additions to
equipment and improvements and capitalized software. Net cash used in investing
activities for the three months ended June 30, 2002 consisted of additions to
equipment and improvements and capitalized software and was partially offset by
the proceeds from the sale of short term investments.
At June 30, 2003, the Company had cash and cash equivalents of $39.0
million. The Company intends to expend funds for the development of products
complementary to its existing product line as well as new versions of certain of
its products. These developments are intended to take advantage of more powerful
technologies and to increase the integration of the Company's products. The
Company has no additional significant current capital commitments.
Management believes that its cash and cash equivalents on hand at June 30,
2003, together with cash flows from operations, if any, will be sufficient to
meet its working capital and capital expenditure requirements for the balance of
fiscal 2004.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company has a significant amount of cash and short-term investments
with maturities less than three months. This cash portfolio exposes the Company
to interest rate risk as short-term investment rates can be volatile. Given the
short-term maturity structure of the Company's investment portfolio, the Company
believes that it is not subject to principal fluctuations and the effective
interest rate of the Company's portfolio tracks closely to various short-term
money market interest rate benchmarks.
Item 4. Controls and Procedures
The Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) conducted an
evaluation of the design and operation of the Company's "disclosure controls and
procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934, as amended ("Exchange Act")). Based on that evaluation, which was
conducted within 90 days of the date on which this quarterly report was filed
with the Securities and Exchange Commission, the Chief Executive Officer and
Chief Financial Officer concluded that the disclosure controls and procedures
are effective to ensure that information required to be disclosed by the Company
in the reports filed or submitted by the Company under the Exchange Act is
accumulated, recorded, processed, summarized and reported to management,
including the Company's Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding whether or not disclosure is
required.
During the quarter ended June 30, 2003, there were no changes in our
"internal controls over financial reporting" (as defined in Rule 13a-15(f) under
the Exchange Act) that have materially affected, or are reasonably likely to
materially affect, the Company's internal controls over financial reporting
except that subsequent to the end of the quarter, the Company's Audit Committee
engaged a third party consulting firm to examine certain matters described as
material weaknesses by the Company's accountants, Grant Thornton LLP. Upon
conclusion of its review, the consulting firm will issue its report
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to the Company's Audit Committee. Following review and analysis of the report by
the Audit Committee, the Company shall take any appropriate required corrective
action.
PART II - OTHER INFORMATION
Item 1. Litigation.
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v.
QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of
California for the County of Orange, in which Mr. Caveny, on behalf of himself
and all others who purchased the Company's Common Stock between June 26, 1995
and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck,
Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers,
Graeme H. Frehner, and Gordon L. Setran (all of the foregoing individuals were
either officers, directors or both during the period from June 26, 1995 through
July 3, 1996), as well as other defendants not affiliated with the Company,
violated California Corporations Code Sections 25400 and 25500, California Civil
Code Sections 1709 and 1710, and California Business and Professions Code
Sections 17200 et. seq., by issuing positive statements about the Company that
allegedly were knowingly false, in part, in order to assist the Company and the
individual defendants in selling Common Stock at an inflated price in the
Company's March 5, 1996 public offering and at other points during the class
period. The complaint seeks compensatory and punitive damages in unspecified
amounts, disgorgement, declaratory and injunctive relief, and attorneys' fees.
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 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.
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The Company is a party to various other legal proceedings incidental to
its business, none of which are considered by the Company to be material.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submissions of Matters to a Vote of Securities Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
Exhibits:
31.1 Certifications Required by Rule 13a-14(a) of the Securities Exchange
Act of 1934, as amended, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
Reports on Form 8-K:
On May 16, 2003, the Company filed a Report on Form 8-K with the SEC concerning
the settlement of certain legal actions involving the Company.
On May 28, 2003, the Company filed a Report on Form 8-K with the SEC concerning
the Company's financial performance for the period ended March 31, 2003 and a
transcript of the conference call with management regarding such period. A copy
of the (i) Company's press release announcing the results and certain other
information and (ii) the conference call transcript, were attached to the Report
on Form 8-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
QUALITY SYSTEMS, INC.
Date: August 14, 2003 By: /s/ LOUIS SILVERMAN
------------------------------------
Louis Silverman
Chief Executive Officer
Date: August 14, 2003 By: /s/ PAUL HOLT
------------------------------------
Paul Holt
Chief Financial Officer;
Principal Accounting Officer
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