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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended March 31, 2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 0-13801
Quality Systems, Inc.
(Exact name of Registrant as specified in its charter)
California 95-2888568
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
18191 Von Karman Avenue, Irvine, California 92603
(Address of principal executive offices, including zip code)
(949) 255-2600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None None
(Title of each class) (Name of each exchange on which registered)
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 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark 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. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of September 30, 2004: 200,543,000 (based on the closing sales
price of the Registrant's Common Stock as reported in the NASDAQ National Market
System on that date, $50.51 per share).*
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of June 3, 2005: $415,011,000 (based on the closing sales
price of the Registrant's Common Stock as reported in the NASDAQ National Market
System on that date, $51.30 per share).*
Indicate the number of shares outstanding of each of the Registrant's
classes of Common Stock, as of the latest practicable date.
Common Stock, $.01 par value 13,115,360
- -------------------------------------- ----------------------------------------
(Class) (Outstanding at June 8, 2005)
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III, Items 10, 11, 12, 13 and 14, of the
Form 10-K is incorporated by reference from Registrant's Definitive Proxy
Statement for its 2005 annual meeting which is to be filed with the Commission
within 120 days of its fiscal year ended on March 31, 2005.
* 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 for purposes of this Report.
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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 our representatives that are not historical
in nature, or that state our 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. We undertake 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
General
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 our
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.
3
Company Overview
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, we, our, or us) develops and markets
healthcare information systems that automate certain aspects of medical and
dental practices, networks of practices such as physician hospital organizations
(PHO's) and management service organizations (MSO's), ambulatory care centers,
community health centers, and medical and dental schools.
The Company, a California corporation formed in 1974, was founded with an early
focus on providing information systems to dental group practices. In the
mid-1980's, we capitalized on the increasing focus on medical cost containment
and further expanded our information processing systems to serve the medical
market. In the mid 1990's we made two acquisitions that accelerated our
penetration of the medical market. These two acquisitions formed the basis for
the NextGen Division. Today, we serve the medical and dental markets through our
two divisions.
The two Divisions operate largely as stand-alone operations, with each Division
maintaining its own distinct product lines, product platforms, development,
implementation and support teams, sales staffing, and branding. The two
Divisions share the resources of our "corporate office" which includes a variety
of accounting and other administrative functions. Additionally, there are a
small number of clients who are simultaneously utilizing software from each of
our two Divisions.
The QSI Division, co-located with our Corporate Headquarters in Irvine,
California, currently focuses on developing, marketing and supporting software
suites sold to dental and certain niche medical practices. In addition, the
Division supports a number of medical clients that utilize the Division's
UNIX(1) based medical practice management software product.
The NextGen Division, with headquarters in Horsham, Pennsylvania, and a second
significant location in Atlanta, Georgia, focuses principally on developing and
marketing products and services for medical practices.
Both Divisions develop and market practice management software which is designed
to automate and streamline a number of the administrative functions required for
operating a medical or dental practice. Examples of practice management software
functions include scheduling and billing capabilities. It is important to note
that in both the medical and dental environments, practice management software
systems have already been implemented by the vast majority of practices.
Therefore, we actively compete for the replacement market.
In addition, both Divisions develop and market software that automates the
patient record and enhances patient-provider interactions. Adoption of this
software, commonly referred to as clinical software, is in its relatively early
stages. Therefore, we are typically competing to replace paper-based patient
record alternatives as opposed to replacing previously purchased systems.
Electronic Data Interchange (EDI)/connectivity products are intended to automate
a number of manual, often paper-based or telephony intensive communications
between patients and/or providers and/or payors. Two of the more common EDI
services are forwarding insurance claims electronically from providers to payors
and assisting practices with issuing statements to patients. Most practices
utilize at least some of these services from us or one of our competitors. Other
EDI/connectivity services are used
______________________________
(1) UNIX is a registered trademark of the AT&T Corporation.
4
more sporadically by client practices. We typically compete to displace
incumbent vendors for claims and statements accounts, and attempt to increase
usage of other elements in our EDI/connectivity product line. In general, EDI
services are only sold to those accounts utilizing software from one of our
Divisions.
The QSI Division's practice management software suite utilizes a UNIX operating
system. Its Clinical Product Suite (CPS) utilizes a Windows NT(2) operating
system and can be fully integrated with the practice management software from
each Division. 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 the electronic patient record. The Division develops,
markets, and manages our EDI/connectivity applications. The QSInet Application
Service Provider (ASP/Internet) offering is also developed and marketed by the
Division.
Our NextGen Division develops and sells proprietary electronic medical records
software and practice management systems under the NextGen(R)(3) 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)), NextGen Image Control System (NextGen(ics)), Managed Care Server
(NextGen(mcs)), Electronic Data Interchange, System Interfaces, Internet
Operability (NextGen(web)), a Patient-centric and Provider-centric Web Portal
solution (NextMD(4).com), and a handheld product (NextGen(pda)). During the year
ended March 31, 2005, the NextGen Division introduced NextGen Express, a version
of NextGen(emr) designed for small practices. NextGen products utilize Microsoft
Windows technology and can operate in a client-server environment as well as via
private intranet, the Internet, or in an ASP environment.
We continue to pursue product enhancement initiatives within each Division. The
majority of such expenditures are currently targeted to the NextGen Division
product line and client base.
Inclusive of divisional EDI revenue, the NextGen Division accounted for
approximately 82.7% of our revenue for fiscal 2005 compared to 76.8% in fiscal
2004. Inclusive of divisional EDI revenue ,the QSI Division accounted for 17.3%
and 23.2% of revenue in fiscal 2005 and 2004, respectively. The NextGen
Division's year over year revenue grew at 35.2% and 45.8% in fiscal 2005 and
2004, respectively, while the QSI Division's year over year revenue declined by
6.8% and 5.3% in fiscal 2005 and 2004, respectively.
In addition to the aforementioned software solutions which we offer through our
two divisions, each division offers comprehensive hardware and software
installation services, maintenance and support services, and system training
services.
Industry Background
To compete in the continually changing healthcare environment, providers are
increasingly using technology to help maximize the 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
______________________________
(2) Microsoft Windows, Windows NT, Windows 95, Windows 98, Windows XP, and
Windows 2000 are registered trademarks of the Microsoft Corporation.
(3) NextGen is a registered trademark of NextGen Healthcare Information
Systems, Inc.
(4) NextMD is a registered trademark of NextGen Healthcare Information
Systems, Inc.
5
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.
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. We believe that practices that leverage technology to
more efficiently handle patient clinical data as well as 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, we believe such organizations will be migrating toward the
implementation of enterprise-wide, patient-centric computing systems embedded
with automated clinical patient records.
Company Strategy
The Company's strategy is, at present, to focus on it's core software business.
Among the key elements central to this strategy are:
o Continued development and enhancement of select software solutions
in target markets;
o Continued investments in our infrastructure including but not
limited to product development, sales, marketing, implementation,
and support;
o Continued efforts to make infrastructure investments within an
overall context of maintaining reasonable expense discipline; and
o Addition of new customers through maintaining and expanding sales,
marketing and product development activities.
While these are the key elements of our current strategy, there can be no
guarantees that our strategy will not change, or that we will succeed in
achieving these goals individually or collectively.
Products
In response to the growing need for more comprehensive, cost-effective
healthcare information solutions for physician and dental practices, our systems
provide our clients with the ability to redesign patient care and other workflow
processes while improving productivity through facilitation of managed access to
patient information. Utilizing our proprietary software in combination with
third party hardware and software solutions, our products enable the integration
of a variety of administrative and clinical information operations. Leveraging
more than 30 years of experience in the healthcare information services
industry, we believe that we continue to add value by providing our clients with
sophisticated, full-featured software systems along with comprehensive systems
implementation, maintenance and support services. Any single transaction may or
may not include software, hardware or services.
Practice Management Systems. Our 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
thousands of users, allowing us to address the needs of both small and large
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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(5) central
processing unit and IBM'S AIX(6) version of the UNIX operating system as a
platform for our 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. We configure and test the hardware components and incorporate our
software and other third party packages into completed systems tailored to
accommodate particular client requirements. We continually evaluate third party
hardware components with a view toward utilizing hardware that is functional,
reliable and cost-effective.
NextGen(epm) is the NextGen division's practice management offering.
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.
We also offer 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. Our 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 our 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 or Windows 2000 or Windows XP operating system and the
hardware is typically a Pentium(7)-based single or multi-processor platform.
Based on the
______________________________
(5) RS6000 is a registered trademark of International Business Machines
Corporation.
(6) AIX is a registered trademark of International Business Machines
Corporation.
(7) Pentium is a registered trademark of Intel Corporation.
7
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 us for resale to the customer.
NextGen provides clinical software applications that are complementary to, and
are integrated with, our medical practice management offerings and interface
with many of the other leading practice management software systems on the
market. The applications incorporated into our 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. We believe that we currently
provide 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 XP on each workstation
and either Windows 2000, Windows NT, Windows XP or UNIX on the database server.
NextGen(emr) maintains data using industry standard relational database engines
such as Microsoft SQL Server(8) or Oracle(9). 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.
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 our customers. The
EDI/connectivity capabilities encompass direct interfaces between our products
and external third party systems, as well as transaction-based services.
Services include:
o Electronic claims submission through our 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.
_______________________________
(8) Microsoft and SQL Server is a registered trademark of Microsoft
Corporation.
(9) Oracle is a registered trademark of Oracle Corporation.
8
Internet Applications. Our 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. Our
NextGen suite of information systems are or can be linked to NextMD.com,
integrating a number of these features with physicians' existing systems.
Our 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
We sell and market our 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 us. Software license sales to resellers
represented less than 10% of total revenue for the years ended March 31, 2005
and 2004.
Our direct sales force typically makes presentations to potential clients by
demonstrating the system and our capabilities on the prospective client's
premises. Sales efforts aimed at smaller practices are primarily performed
remotely via telephone or internet based presentations. Our 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.
Our sales cycle can vary significantly and typically ranges from three to twelve
months from initial contact to contract execution. Software licenses are
normally delivered to a customer almost immediately upon receipt of an order.
Implementation and training services are normally rendered based on a mutually
agreed upon timetable. As part of the fees paid by our clients, we receive
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 our 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 our software for a fee to one or more practitioners.
Although we typically do 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.
We continue to concentrate our direct sales and marketing efforts on medical and
dental practices, networks of such practices including MSO's and PHO's,
professional schools, community health centers and other ambulatory care
settings.
MSO's, PHO's and similar networks to which we have sold systems provide use of
our software to those group and single physician practices associated with the
organization or hospital on either a service basis or by directing us to
contract with those practices for the sale of stand-alone systems.
We have also entered into marketing assistance agreements with certain of our
clients pursuant to which the clients allow us to demonstrate to potential
clients the use of systems on the existing clients' premises.
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From time to time we assist prospective clients in identifying third party
sources for financing the purchase of our 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. We do not guarantee the financing nor retain any
continuing interest in the transaction.
We have numerous clients and do not believe that the loss of any single client
would have a material adverse effect on us. No client accounted for ten percent
or more of net revenue during the fiscal years ended March 31, 2005, 2004, or
2003.
Customer Service and Support
We believe our success is attributable in part to our customer service and
support departments. We offer support to our clients seven days a week, 24 hours
a day.
Our client support staff is comprised of specialists who are knowledgeable in
the areas of software and hardware 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.
We utilize automated online support systems which assist clients in resolving
minor problems and facilitate automated electronic retrieval of problems and
symptoms following a client's call to the automated support system.
Additionally, our online support systems maintain call records, available at
both the client's facility and our offices.
We offer our clients support services for most system components, including
hardware and software, 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. We also subcontract, in certain
instances, with third party vendors to perform specific hardware maintenance
tasks.
Implementation and Training
We offer full service implementation and training services. When a client signs
a contract for the purchase of a system that includes implementation and
training services, 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 our employees as well as certified third parties and certain
resellers.
Training may include a combination of computer assisted instruction (CAI) for
certain of our products, remote training techniques and training classes
conducted at the client's or our 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 our offices 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, our on-line "help" and other documentation features
facilitate client training as well as ongoing support.
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Competition
The markets for healthcare information systems are intensely competitive. The
industry is highly fragmented and includes numerous competitors, none of which
we believe dominates these markets. The electronic patient records and
connectivity markets, in particular, are subject to rapid changes in technology,
and we expect that competition in these market segments will increase as new
competitors enter the market. We believe our principal competitive advantages
are the features and capabilities of our products and services, our high level
of customer support, and our extensive experience in the industry.
Production Enhancement and Development
The healthcare information management and computer software and hardware
industries are characterized by rapid technological change requiring us to
engage in continuing investments to update, enhance, and improve our systems.
During fiscal years 2005, 2004, and 2003, we expended approximately $9.6
million, $8.7 million, and $6.7 million, respectively, on research and
development activities, including capitalized software amounts of $2.7 million,
$2.6 million, and $1.7 million, respectively. In addition, a portion of our
product enhancements have resulted from software development work performed
under contracts with our clients.
Employees
As of May 27, 2005, we employed 418 persons, of which 409 were full-time
employees. We believe that our future success depends in part upon recruiting
and retaining qualified sales, marketing and technical personnel as well as
other employees.
Risks Relating to our Business
The more prominent risks and uncertainties inherent in our business are
described below. However, additional risks and uncertainties may also impair our
business operations. If any of the following risks actually occur, our business,
financial condition or results of operations will likely suffer. Any of these or
other factors could harm our business and future results of operations and may
cause you to lose all or part of your investment.
We face significant competition. The markets for healthcare information systems
are intensely competitive and we face significant competition from a number of
different sources. Several of our competitors have significantly greater name
recognition as well as substantially greater financial, technical, product
development and marketing resources than we do.
We compete in all of our 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 ourselves or our competitors, may result in price or market
share erosion that could have a material adverse effect on our business, results
of operations and financial condition. Also, there can be no assurance that our
applications will achieve broad market acceptance or will successfully compete
with other available software products.
Our inability to make initial sales of our systems to newly formed groups and/or
healthcare providers that are replacing or substantially modifying their
healthcare information systems could have a material adverse effect on our
business, results of operations and financial condition. If new systems sales do
not materialize, our near term and longer term revenue will be negatively
affected.
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Our quarterly operating results have historically fluctuated and may do so in
the future. Our revenue has 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:
o the size and timing of orders from clients;
o the specific mix of software, hardware, and services in client orders;
o the length of sales cycles and installation processes;
o the ability of our clients to obtain financing for the purchase of our
products;
o changes in pricing policies or price reductions by us or our competitors;
o the timing of new product announcements and product introductions by us or
our competitors;
o changes in revenue recognition or other accounting guidelines employed by
us and/or established by the Financial Accounting Standards Board or other
rule-making bodies;
o the availability and cost of system components;
o the financial stability of clients;
o market acceptance of new products, applications and product enhancements;
o our ability to develop, introduce and market new products, applications
and product enhancements;
o our success in expanding our sales and marketing programs;
o deferrals of client orders in anticipation of new products, applications,
product enhancements, or public/private sector initiatives;
o execution of or changes to our strategy;
o personnel changes; and
o general market/economic factors.
Our software products are generally shipped as orders are received and
accordingly, we have historically operated with a minimal backlog of license
fees. As a result, revenue in any quarter is dependent on orders booked and
shipped in that quarter and is not predictable with any degree of certainty.
Furthermore, our systems can be relatively large and expensive and individual
systems sales can represent a significant portion of our revenue and profits for
a quarter such that the loss or deferral of even one such sale can have a
significant adverse impact on our quarterly revenue and profitability.
Clients often defer systems purchases until our quarter end, so quarterly
results generally cannot be predicted and frequently are not known until the
quarter has concluded.
Our sales are dependent upon clients' initial decisions to replace or
substantially modify their existing information systems, 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 our
systems can vary significantly and typically ranges from three to twelve months
from initial contact to contract execution/shipment.
Because a significant percentage of our expenses are relatively fixed, a
variation in the timing of systems sales, implementations, and installations can
cause significant variations in operating results from quarter to quarter. As a
result, we believe that interim period-to-period comparisons of our results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Further, our historical operating results are
not necessarily indicative of future performance for any particular period.
We currently recognize revenue pursuant to SOP 97-2, as modified by SOP 98-9 and
SAB 104. SAB 104 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements.
12
There can be no assurance that application and subsequent interpretations of
these pronouncements will not further modify our 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 our operating results
may be below the expectations of public market analysts and investors. In such
event, the price of our common stock would likely be materially adversely
affected.
The price of our shares and the trading volume of our shares have been volatile
historically and may continue to be volatile. Volatility may be caused by a
number of factors including but not limited to:
o actual or anticipated quarterly variations in operating results;
o rumors about our performance, software solutions, or merger and
acquisition activity;
o changes in expectations of future financial performance or changes in
estimates of securities analysts;
o governmental regulatory action;
o health care reform measures;
o client relationship developments;
o purchases or sales of company stock;
o changes occurring in the markets in general; and
o other factors, many of which are beyond our control.
Furthermore, the stock market in general, and the market for software,
healthcare 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 our common stock, regardless of actual operating
performance.
Two of our directors are significant shareholders, which makes it possible for
them to have significant influence over the outcome of all matters submitted to
our shareholders for approval and which influence may be alleged to conflict
with our interests and the interests of our other shareholders. Two of our
directors and principal shareholders beneficially owned an aggregate of
approximately 38% of the outstanding shares of our common stock at March 31,
2005. The Company's Bylaws permit its shareholders to cumulate their votes, the
effect of which is to provide shareholders with sufficiently large
concentrations of Company shares the opportunity to assure themselves one or
more seats on the Company's Board. The amounts required to assure a Board
position can vary based upon the number of shares outstanding, the number of
shares voting, the number of directors to be elected and the number of shares
held by the shareholder exercising cumulative voting rights. In the event that
cumulative voting is invoked, it is likely that the two of our directors holding
an aggregate of approximately 38% of the outstanding shares of our common stock
at March 31, 2005 will each have sufficient votes to assure themselves of one or
more seats on our Board. With or without cumulative voting, these shareholders
will have significant influence over the outcome of all matters submitted to our
shareholders for approval, including the election of our directors and other
corporate actions. In addition, such influence by one or both of these
affiliates could have the effect of discouraging others from attempting to
purchase us, take us over, and/or reducing the market price offered for our
common stock in such an event.
We are dependent on our principal products and our new product development. We
currently derive substantially all of our net revenue from sales of our
healthcare information systems and related services. We believe that a primary
factor in the market acceptance of our systems has been our ability to meet the
needs of users of healthcare information systems. Our future financial
performance will depend in large part on our ability to continue to meet the
increasingly sophisticated needs of our clients through the timely development
and successful introduction and implementation of new and enhanced versions of
our systems and other complementary products. We have historically expended a
significant percentage of
13
our net revenue on product development and believe that significant continuing
product development efforts will be required to sustain our growth. Continued
investment in our sales staff and our client implementation and support staffs
will also be required to support future growth.
There can be no assurance that we will be successful in our product development
efforts, that the market will continue to accept our 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, our business, results of operations and financial condition could be
materially adversely affected. At certain times in the past, we have also
experienced delays in purchases of our products by clients anticipating our
launch of new products. There can be no assurance that material order deferrals
in anticipation of new product introductions from ourselves or other entities
will not occur.
If the emerging technologies and platforms of Microsoft and others upon which we
build our products do not gain broad market acceptance, or if we fail to develop
and introduce in a timely manner new products and services compatible with such
emerging technologies, we may not be able to compete effectively and our ability
to generate revenue will suffer. Our software products are built and depend upon
several underlying and evolving relational database management system platforms
such as those developed by Microsoft. To date, the standards and technologies
upon which we have chosen to develop our products have proven to have gained
industry acceptance. However, the market for our software products is subject to
ongoing rapid technological developments, quickly evolving industry standards
and rapid changes in customer requirements, and there may be existing or future
technologies and platforms that achieve industry standard status, which are not
compatible with our products.
We face the possibility of subscription pricing. We currently derive
substantially all of our revenue 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 our products, in addition to a
periodic maintenance fee. If the marketplace demands subscription pricing, we
may be forced to adjust our sales, marketing and pricing strategies accordingly,
by offering a higher percentage of our products and services through these
means. Shifting to a significantly greater degree of subscription pricing could
materially adversely impact our financial condition, cash flows and quarterly
and annual revenue and results of operations, as our revenue would initially
decrease substantially. There can be no assurance that the marketplace will not
increasingly embrace subscription pricing.
The industry in which we operate is subject to significant 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 our existing products
obsolete and unmarketable. There can be no assurance that we 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 revenue or research funding could impair our ability to
respond to technological advances or opportunities in the marketplace and to
remain competitive. If we are 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, our business, results of operations
and financial condition may be materially adversely affected.
In response to increasing market demand, we are currently developing new
generations of certain of our software products. There can be no assurance that
we will successfully develop these new software products or that these products
will operate successfully, or that any such development, even if successful,
14
will be completed concurrently with or prior to introduction of competing
products. Any such failure or delay could adversely affect our competitive
position or could make our current products obsolete.
We face the possibility of claims based upon our web site. We could be subject
to third party claims based on the nature and content of information supplied on
our Web site by us or third parties, including content providers or users. We
could also be subject to liability for content that may be accessible through
our Web site or third party Web sites linked from our 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 our applications. Even if
these claims do not result in liability to us, investigating and defending
against these claims could be expensive and time consuming and could divert
management's attention away from our operations.
We face the possibility of claims from activities of strategic partners. We rely
on third parties to provide services that impact our business. For example, we
use national clearinghouses in the processing of some insurance claims and we
outsource some of our hardware maintenance services and the printing and
delivery of patient statements for our customers. We also have relationships
with certain third parties where these third parties serve as sales channels
through which we generate a portion of our revenue. Due to these third-party
relationships, we could be subject to claims as a result of the activities,
products, or services of these third-party service providers even though we were
not directly involved in the circumstances leading to those claims. Even if
these claims do not result in liability to us, defending and investigating these
claims could be expensive and time-consuming, divert personnel and other
resources from our business and result in adverse publicity that could harm our
business.
We may engage in future acquisitions, which may be expensive and time consuming
and from which we may not realize anticipated benefits. We may acquire
additional businesses, technologies and products if we determine that these
additional businesses, technologies and products are likely to serve our
strategic goals. We currently have no commitments or agreements with respect to
any acquisitions. The specific risks we may encounter in these types of
transactions include but are not limited to the following:
o potentially dilutive issuances of our securities, the incurrence of debt
and contingent liabilities and amortization expenses related to intangible
assets, which could adversely affect our results of operations and
financial conditions;
o use of cash as acquisition currency may adversely impact interest or
investment income , thereby potentially negatively affecting our earnings
and /or earnings per share
o difficulty in effectively integrating any acquired technologies or
software products into our current products and technologies;
o difficulty in predicting and responding to issues related to product
transition such as development, distribution and customer support;
o the possible adverse impact of such acquisitions on existing relationships
with third party partners and suppliers of technologies and services;
o the possibility that staff or customers of the acquired company might not
accept new ownership and may transition to different technologies or
attempt to renegotiate contract terms or relationships, including
maintenance or support agreements;
o the possibility that the due diligence process in any such acquisition may
not completely identify material issues associated with product quality,
product architecture, product development, intellectual property issues,
key personnel issues or legal and financial contingencies; and
o difficulty in integrating acquired operations due to geographical
distance, and language and cultural differences;
o The possibility that acquired assets become impaired, requiring the
Company to take a charge to earnings which could be significant.
15
A failure to successfully integrate acquired businesses or technology for any of
these reasons could have a material adverse effect on the Company's results of
operations.
We face the risks and uncertainties that are associated with litigation against
us. We face the risks associated with litigation concerning the operation of our
business. The uncertainty associated with substantial unresolved litigation may
have an adverse impact on our business. In particular, such litigation could
impair our relationships with existing customers and our 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 our business, results of operations and financial condition.
Such litigation may also have the effect of discouraging potential acquirers
from bidding for us 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 our insurance coverage, that our insurance will cover such claims or
that appropriate insurance will continue to be available to us in the future at
commercially reasonable rates.
We rely heavily on our proprietary technology. We are heavily dependent on the
maintenance and protection of our intellectual property and we rely largely on
license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect our intellectual property. Our software is not patented
and existing copyright laws offer only limited practical protection.
There can be no assurance that the legal protections and precautions we take
will be adequate to prevent misappropriation of our technology or that
competitors will not independently develop technologies equivalent or superior
to ours. Further, the laws of some foreign countries do not protect our
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.
We do not believe that our 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 us with respect to our
current or future products or that any such assertion will not require us 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 our business, results of operations and financial condition.
In addition, claims may be brought against third parties from which we purchase
software, and such claims could adversely affect our ability to access third
party software for our systems.
We are dependent on our license rights from third parties. We depend upon
licenses for some of the technology used in our products from third-party
vendors. Most of these licenses can be renewed only by mutual consent and may be
terminated if we breach the terms of the license and fail to cure the breach
within a specified period of time. We may not be able to continue using the
technology made available to us under these licenses on commercially reasonable
terms or at all. As a result, we may have to discontinue, delay or reduce
product shipments until we can obtain equivalent technology. Most of our
third-party licenses are non-exclusive. Our competitors may obtain the right to
use any of the technology covered by these licenses and use the technology to
compete directly with us. In addition, if our vendors choose to discontinue
support of the licensed technology in the future or are unsuccessful in their
continued research and development efforts, we may not be able to modify or
adapt our own products.
We face the possibility of damages resulting from internal and external security
breaches, and viruses. In the course of our business operations, we compile and
transmit confidential information, including
16
patient health information, in our processing centers and other facilities. A
breach of security in any of these facilities could damage our reputation and
result in damages being assessed against us. In addition, the other systems with
which we 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 disrupt our ability to perform certain key business functions and could
potentially reduce demand for our services. Accordingly, we have expended
significant resources toward establishing and enhancing the security of our
related infrastructures, although no assurance can be given that they will be
entirely free from potential breach. Maintaining and enhancing our
infrastructure security may require us to expend significant capital in the
future.
The success of our strategy to offer our EDI services and Internet solutions
depends on the confidence of our customers in our ability to securely transmit
confidential information. Our EDI services and Internet solutions rely on
encryption, authentication and other security technology licensed from third
parties to achieve secure transmission of confidential information. We may not
be able to stop unauthorized attempts to gain access to or disrupt the
transmission of communications by our customers. Anyone who is able to
circumvent our security measures could misappropriate confidential user
information or interrupt us, or our customers', operations. In addition, our EDI
and Internet solutions may be vulnerable to viruses, physical or electronic
break-ins, and similar disruptions.
Any failure to provide secure infrastructure and/or electronic communication
services could result in a lack of trust by our customers causing them to seek
out other vendors, and/or, damage our reputation in the market making it
difficult to obtain new customers.
We are subject to the development and maintenance of the Internet infrastructure
which is not within our control. We deliver Internet-based services and,
accordingly, we are dependent on the maintenance of the Internet by third
parties. The Internet infrastructure may be unable to support the demands placed
on it and our performance may decrease if the Internet continues to experience
it's historic trend of expanding usage. As a result of damage 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 us for
transmittal of our Internet-based services. In addition, difficulties, outages,
and delays by Internet service providers, online service providers and other web
site operators may obstruct or diminish access to our Web site by our customers
resulting in a loss of potential or existing users of our services.
Our failure to manage growth could harm us. We have in the past experienced
periods of growth which have placed, and may continue to place, a significant
strain on our non-cash resources. We also anticipate expanding our overall
software development, marketing, sales, client management and training capacity.
In the event we are 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 us. In addition, our ability to manage future
increases, if any, in the scope of our operations or personnel will depend on
significant expansion of our research and development, marketing and sales,
management, and administrative and financial capabilities. The failure of our
management to effectively manage expansion in our business could have a material
adverse effect on our business, results of operations and financial condition.
Our operations are dependent upon our key personnel. If such personnel were to
leave unexpectedly, we may not be able to execute our business plan. Our future
performance depends in significant part upon the continued service of our key
technical and senior management personnel, many of whom have been with us for a
significant period of time. These personnel have acquired specialized knowledge
and skills with respect to our business. We maintain key man life insurance on
only one of our employees. Because we have a relatively small number of
employees when compared to other leading companies in
17
our industry, our dependence on maintaining our relationships with key employees
is particularly significant. We are also dependent on our ability to attract
high quality personnel, particularly in the areas of sales and applications
development.
The industry in which we operate is characterized by a high level of employee
mobility and aggressive recruiting of skilled personnel. There can be no
assurance that our current employees will continue to work for us. Loss of
services of key employees could have a material adverse effect on our business,
results of operations and financial condition. Furthermore, we may need to grant
additional equity incentives 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 our recruitment
and retention capabilities.
Our products may be subject to product liability legal claims. Certain of our
products provide applications that relate to patient clinical information. Any
failure by our products to provide accurate and timely information could result
in claims against us. In addition, a court or government agency may take the
position that our delivery of health information directly, including through
licensed practitioners, or delivery of information by a third party site that a
consumer accesses through our web sites, exposes us to assertions of
malpractice, other personal injury liability, or other liability for wrongful
delivery/handling of healthcare services or erroneous health information. We
maintain insurance to protect against claims associated with the use of our
products as well as liability limitation language in our end-user license
agreements, but there can be no assurance that our insurance coverage or
contractual language would adequately cover any claim asserted against us. A
successful claim brought against us in excess of or outside of our insurance
coverage could have a material adverse effect on our business, results of
operations and financial condition. Even unsuccessful claims could result in our
expenditure of funds for litigation and management time and resources.
Certain healthcare professionals who use our Internet-based products will
directly enter health information about their patients including information
that constitutes a record under applicable law that we may store on our 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 our contracts with customers and partners;
o state laws regulating healthcare professionals;
o Medicaid laws;
o the Health Insurance Portability and Accountability Act of 1996 (HIPAA)
and related rules proposed by the Health Care Financing Administration;
and
o 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 elements including, but not limited
to, new federal privacy and security standards for the use and protection of
Protected Health Information. Any failure by us or by our personnel or partners
to comply with applicable requirements may result in a material liability to us.
Although we have systems and policies in place for safeguarding Protected Health
Information from unauthorized disclosure, these systems and policies may not
preclude claims against us for alleged violations of applicable requirements.
Also, third party sites and/or links that consumers may access through our web
sites may not maintain adequate systems to safeguard this information, or may
circumvent systems and policies we have put in place. In addition, future laws
or changes in current laws may necessitate costly adaptations to our policies,
procedures, or systems.
18
There can be no assurance that we will not be subject to product liability
claims, that such claims will not result in liability in excess of our insurance
coverage, that our insurance will cover such claims or that appropriate
insurance will continue to be available to us in the future at commercially
reasonable rates. Such product liability claims could have a material adverse
affect on our business, results of operations and financial condition.
We are subject to the effect of payor and provider conduct which we cannot
control. We offer certain electronic claims submission products and services as
part of our product line. While we have implemented certain product features
designed to maximize the accuracy and completeness of claims submissions, these
features may not be sufficient to prevent inaccurate claims data from being
submitted to payors. Should inaccurate claims data be submitted to payors, we
may be subject to liability claims.
Electronic data transmission services are offered by certain payors to
healthcare providers that establish a direct link between the provider and
payor. This process reduces revenue to third party EDI service providers such as
us. Accordingly, we are unable to insure that we will continue to generate
revenue at or in excess of prior levels for such services. A significant
increase in the utilization of direct links between healthcare providers and
payers could have a material adverse effect on our transaction volume and
financial results. In addition, we cannot provide assurance that we will be able
to maintain our exiting links to payors or develop new connections on terms that
are economically satisfactory to us, if at all.
There is significant uncertainty in the healthcare industry in which we operate
and we are subject to the possibility of changing 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 us and
our clients. Healthcare providers may react to these proposals, and the
uncertainty surrounding such proposals, by curtailing or deferring investments,
including those for our 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 our ability to sell our 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. We cannot predict what impact, if
any, such proposals or healthcare reforms might have on our business, financial
condition and results of operations.
The HIPAA regulations, as adopted by the Department of Health and Human
Services, established, among other things:
o a national standard for electronic transactions and code sets to be used
in those transactions involving certain common health care transactions;
o privacy regulations to protect the privacy of plan participants and
patients' medical records; and
o 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).
As these regulations mature and become better defined, we anticipate that these
regulations will continue to directly affect certain of our products and
services, but we cannot fully predict the impact at this time.
19
We have taken steps to modify our products, services and internal practices as
necessary to facilitate our and our client's compliance with the final
regulations, but there can be no assurance that we 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 us 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 may or may
not supercede HIPAA and have the potential to positively or negatively affect
our business.
In addition, our 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 our business,
financial condition and results of operations.
We may be subject to other e-commerce regulations. We 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 our products and services are subject to these laws and regulations, the
sale of our products and services could be harmed.
We are subject to changes in and interpretations of financial accounting matters
that govern the measurement of our performance. Based on our 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 our 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 our business practices could result in future changes in our revenue
recognition and/or other accounting policies and practices that could have a
material adverse effect on our business, financial condition, cash flows,
revenue and results of operations.
Our per share price may be adversely effected if weaknesses in our internal
controls are identified by ourselves or our independent auditors. Any weaknesses
identified in our internal controls as part of the evaluation being undertaken
by us and our independent public accountants pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002 could have an adverse effect on the price at which
our stock trades. In the process of evaluating and documenting our controls
pursuant to Section 404 of the Sarbanes-Oxley Act. we have identified various
deficiencies which we are in the course of remediating. Management does not
believe that any of these identified deficiencies constitute a material weakness
in our internal controls.
No evaluation process can provide complete assurance that our internal controls
will detect and correct all failures within the Company to disclose material
information otherwise required to be reported. The effectiveness of our controls
and procedures could also be limited by simple errors or faulty judgments. In
addition, if we continue to expand, the challenges involved in implementing
appropriate controls will increase and may require that we evolve some or all of
our internal control processes.
20
It is also possible that the overall scope of Section 404 of the Sarbanes Oxley
Act of 2002 may be revised in the future, thereby causing our auditors and
ourselves to review, revise or reevaluate our internal control processes which
may result in the expenditure of additional human and financial resources.
Our earnings will be affected beginning fiscal year 2007 when we begin
recognizing employee stock option expense, pursuant to recently issued
accounting standards. Stock options have from time to time been an important
component of the compensation packages for many of our mid- and senior-level
employees. We currently do not deduct the expense of employee stock option
grants from our income. However, beginning with the quarter ended June 30, 2006
and beyond, we will begin recognizing employee stock option expense for
remaining unvested stock options and any future stock option grants, resulting
in additional pre-tax compensation expense. Option expensing could have a
negative impact upon the price of our stock.
Continuing worldwide political and economic uncertainties may adversely impact
our revenue and profitability. In the last three years, worldwide economic
conditions have experienced a downturn due to numerous factors including but not
limited to concerns about inflation and deflation, decreased consumer
confidence, the lingering effects of international conflicts, and terrorist and
military activities. These conditions make it extremely difficult for our
customers, our vendors and ourselves to accurately forecast and plan future
business activities, and they could cause constrained spending on our products
and services, and/or delay and lengthen sales cycles.
Our future policy concerning the payment of dividends is uncertain. While we
paid a one-time cash dividend in March 2005, we have not historically paid
dividends, cash or otherwise, and there can be no assurance that we will pay
another dividend in the future. Unfulfilled expectation to the contrary could
have a material negative impact upon the price of our stock.
ITEM 2. PROPERTIES
Our principal administrative, accounting and QSI Division operations are located
in Irvine, California, under a lease that commenced May 15, 2002, and expired in
April 30, 2005. In April 2005, we renewed our lease through May 31, 2008. We
lease approximately 12,000 square feet of space at this location. In August
2002, we executed a new lease for the principal office of our NextGen Division.
This lease includes approximately 32,000 square feet of space in Horsham,
Pennsylvania, and expires on January 31, 2010. In the year ended March 31, 2005,
we added approximately 14,000 of additional space in Horsham, Pennsylvania under
new lease which expires on January 31, 2010. In addition, we lease approximately
6,000 square feet of space in Santa Ana, California, to house our assembly and
warehouse operations. We have approximately 12,000 square feet of space in
Atlanta, Georgia under a lease which expires in February, 2006. We also have an
aggregate of approximately 4,000 square feet of space in Massachusetts,
Minnesota, New Jersey, Texas, Utah, 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
2010. The Company's growth will require it to lease additional space. We believe
that suitable additional or substitute space is available, if needed, at
commercially reasonable rates.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are involved in various claims and legal
proceedings. While the ultimate resolution of these matters, has yet to be
determined, we do not believe that their outcome will have a material adverse
effect on our financial position, results of operations or liquidity.
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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 2005.
Executive Officers of the Company
Our executive officers as of May 31, 2005 were as follows:
Name Age Position
- ---- --- -----------------------------------------------------------
Louis E. Silverman............... 46 President, Chief Executive Officer
Patrick B. Cline................. 44 President, NextGen Healthcare Information Systems Division
Greg Flynn....................... 47 Executive Vice President and General Manger of QSI Division
Paul A. Holt..................... 39 Secretary, Chief Financial Officer
Our executive officers are elected by, and serve at the discretion of, the Board
of Directors. Additional information regarding our 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 our NextGen Healthcare
Information Systems Division. He served as our 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.
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 our
ongoing management and sales. Previously, Mr. Flynn served as our Vice
President, Corporate Communications. Mr. Flynn joined us in January 1982. He
holds a B.A. degree in English from the University of California, Santa Barbara.
Paul A. Holt was appointed Chief Financial Officer in November 2000. Mr. Holt
has served as our Controller from January 2000 to May 2000 and was appointed
interim Chief Financial Officer in May 2000. Prior to joining us, 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, Irvin
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our 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, 2003 ......................... $ 18.23 $ 11.25
September 30, 2003 .................... 23.43 12.58
December 31, 2003 ..................... 24.88 19.91
March 31, 2004 ........................ 30.80 19.50
June 30, 2004 ......................... 25.75 19.75
September 30, 2004 .................... 27.75 20.77
December 31, 2004 ..................... 32.49 24.05
March 31, 2005 ........................ $ 48.90 $ 27.90
At May 31, 2005, there were approximately 130 holders of record of our Common
Stock. We estimate the number of beneficial holders of our Common Stock to be in
excess of 6,000.
On February 2, 2005, the Company announced that its Board of Directors had
declared a 2-for-1 stock split with respect to our outstanding shares of common
stock for shareholders of record on March 4, 2005. The stock began trading post
split on March 28, 2005. All share prices in the foregoing table have been
retroactively adjusted to reflect such stock split.
On March 16, 2005, we paid a one time dividend on shares of our Common Stock
equal to $1.50 per share. ($3.00 pre-split) The record date for the dividend was
February 24, 2005. Payment of future dividends, if any, will be at the
discretion of our Board of Directors after taking into account various factors,
including our financial condition, operating results, current and anticipated
cash needs and plans for expansion.
We did not make any unregistered sales of our common stock during the fourth
quarter of 2005.
23
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to our Consolidated
Statements of Income data for each of the five years in the period ended March
31 and the Consolidated Balance Sheet data as of the end of each such fiscal
year are derived from our audited financial statements. The following
information should be read in conjunction with our Consolidated Financial
Statements and the related notes thereto and "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations." included
elsewhere herein.
Consolidated Financial Data
(In Thousands, Except Per Share Data) Year Ended March 31,
2005 2004 2003 2002 2001
-------- -------- -------- -------- --------
Statement of Income Data:
Revenue...................................... $ 88,961 $ 70,934 $ 54,769 $ 44,422 $ 39,936
Cost of revenue.............................. 32,669 28,673 23,755 19,253 17,283
-------- -------- -------- -------- --------
Gross profit................................. 56,292 42,261 31,014 25,169 22,653
Selling, general and administrative expenses. 24,776 19,482 15,293 13,068 13,585
Research and development costs............... 6,903 6,139 5,062 4,243 4,081
-------- -------- -------- -------- --------
Income from operations....................... 24,613 16,640 10,659 7,858 4,987
Investment income............................ 876 386 434 643 1,032
-------- -------- -------- -------- --------
Income before provision for income taxes..... 25,489 17,026 11,093 8,501 6,019
Provision for income taxes................... 9,380 6,626 4,058 3,233 2,510
-------- -------- -------- -------- --------
Net income................................... $ 16,109 $ 10,400 $ 7,035 $ 5,268 $ 3,509
======== ======== ======== ======== ========
Basic net income per share................... $ 1.25 $ 0.84 $ 0.57 $ 0.44 $ 0.29
Diluted net income per share................. $ 1.22 $ 0.80 $ 0.55 $ 0.42 $ 0.28
Basic weighted average shares outstanding.... 12,872 12,436 12,254 12,050 12,260
Diluted weighted average shares outstanding.. 13,203 12,966 12,778 12,480 12,406
Balance Sheet Data (at end of period):
Cash and cash equivalents and short-term
investments.................................. $ 51,157 $ 51,395 $ 36,443 $ 25,698 $ 18,729
Working capital.............................. 55,111 53,415 38,717 30,799 24,196
Total assets................................. 99,442 86,678 67,602 52,143 44,883
Total liabilities............................ 36,711 25,673 20,069 12,093 10,996
Total shareholders' equity................... $ 62,731 $ 61,005 $ 47,533 $ 40,050 $ 33,887
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Except for the historical information contained herein, the matters discussed in
this Annual Report on Form 10-K, including discussions of our product
development plans, business strategies and market factors influencing our
results, may include forward-looking statements that involve certain risks and
uncertainties. Actual results may differ from those anticipated by us as a
result of various factors, both foreseen and unforeseen, including, but not
limited to, our 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 our
ability to achieve our goals, and interested persons are urged to review the
risks described in "Item 1. Business. Risk Factors" as set forth above, as well
as in our other public disclosures and filings with the Securities and Exchange
Commission.
The following discussion should be read in conjunction with, and is qualified in
our entirety by, the Consolidated Financial Statements and related notes thereto
included elsewhere in this Report. 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 our financial condition and results of operations
is based upon our 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 us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenue and expenses, and related disclosures of contingent assets and
liabilities. On an on-going basis, we evaluate estimates, including those
related to revenue recognition, uncollectible accounts receivable, and
intangible assets, for reasonableness. We base our 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.
We believe revenue recognition, the allowance for doubtful accounts, goodwill
impairment, capitalized software costs and research and development tax credits
are among the most critical accounting policies that impact our consolidated
financial statements. We believe that significant accounting policies, as
described in Note 2 of our 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. Our revenue is primarily generated from the sale of
software licenses, services, hardware, maintenance fees, and EDI services. We
currently recognize revenue pursuant to Statement of Position No. 97-2,
"Software Revenue Recognition" (SOP 97-2), as modified by Statement of Position
No. 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect
of Certain Transactions" (SOP 98-9), Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" (SAB 101) and Staff Accounting Bulletin No.
104, "Revenue Recognition" (SAB 104). SAB 101 summarizes the staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. SAB 104 modifies certain guidance provided in SAB 101.
Inherent in the revenue recognition process are significant management estimates
and judgments, which influence the timing and amount of revenue recognition.
25
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 revenue is based on our
assessment that the above criteria have been met. In general, the first two
criteria are met with a signed contract and evidence that we have shipped our
software to the customer. We determine that our 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 may
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, generally requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair values of the elements. Our determination of the fair value of
each element in multi-element arrangements is based on vendor-specific objective
evidence (VSOE). We limit our assessment of VSOE for each element to either the
price charged when the same element is sold separately or the price established
by management having the relevant authority to do so, for an element not yet
sold separately. Management determines the price of individual elements sold
separately using a rolling average of stand alone transactions. VSOE
calculations are reviewed on a quarterly basis.
If evidence of fair value of all undelivered elements exists but evidence of
fair value does not exist for one or more delivered elements, then revenue is
recognized using the residual method. Under the residual method, the fair value
of the undelivered elements is deferred at VSOE and the remaining portion of the
arrangement fee is recognized as revenue, net of all discounts.
Contract accounting is applied where services include significant software
modification, development or customization. In such instances, the arrangement
fee is accounted for in accordance with Statement of Position No. 81-1
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1), whereby the revenue is recognized, generally using the
percentage-of-completion method measured on labor input hours. The complexity of
the estimation process and judgment related to the assumptions, risks and
uncertainties inherent with the application of the percentage-of-completion
method of accounting affect the amounts of revenue reported in its consolidated
financial statements.
Valuation Allowances. We maintain allowances for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments.
We perform ongoing credit evaluations of our customers and maintain 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 our historical experience of
bad debt expense and the aging of our accounts receivable balances net of
deferred revenue and specifically reserved accounts. If the financial condition
of our customers were to deteriorate resulting in an impairment of their ability
to make payments, additional allowances would be required.
Goodwill Impairment. Our long-lived assets include goodwill of $1.8 million as
of March 31, 2005 and 2004, respectively. We follow Statement of Financial
Accounting Standards No. 142 "Goodwill and Other Intangible Assets" (SFAS 142).
The statement applies to the amortization of goodwill and other
26
intangible assets. We no longer amortize amounts related to goodwill. The
balance of goodwill is related to our NextGen Division. Under SFAS 142, we are
required to perform an annual assessment of the implied fair value of goodwill
and intangible assets with indefinite lives for impairment. We have 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, 2004 (the date of our last annual impairment test) 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. There have been no changes that would
lead us to believe there is any impairment of the goodwill since the date of the
last annual impairment test through March 31, 2005.
The process of evaluating goodwill for impairment involves the determination of
the fair value of our 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 our
strategic plans with regard to operations. To the extent additional information
arises or our strategies change, it is possible that our conclusion regarding
goodwill impairment could change and result in a material effect on our
financial position or results of operations.
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 Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed" (SFAS 86). Such capitalized costs are
amortized on a straight line basis over the estimated economic life of the
related product, of three years. We perform 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.
Research and Development Tax Credits. 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 tax credits related to our
research and development activities. In addition, the Company claimed research
and development credit on its tax returns for the years ended March 31, 2004,
2003 and 2002. The provision for income taxes for the year ended March 31, 2004
and 2003 accounted for a portion of the aggregate tax credits accumulated
through the end of each period due to the uncertainly concerning the ultimate
amount of tax to be credited. As of March 31, 2004, the Company had a balance of
$0.5 million in credits which had not been recognized. In the quarter ended
March 31, 2005, the state of California completed an audit of the Company's tax
returns and did not materially change credits related to research and
development. Based on the results of that audit as well the expiration of the
statue of limitations on certain amended returns, the provision for income taxes
for the year ended March 31, 2005 was reduced by the $0.5 million in tax credits
which had not been recognized as of March 31 2004.
Management's treatment of research and development tax credits represented a
significant estimate which affected the effective income tax rates for the
Company in the years ending March 31, 2005 and 2004. Research and development
credits taken by the Company involve certain assumptions and judgments regarding
qualification of expenses under the relevant tax codes. While the Company has
received all of federal refunds claimed, none of the credits have been audited
by the Internal Revenue Service.
27
Overview of Company results
o We have experienced significant growth in our total revenue as a result of
revenue growth in our NextGen Healthcare Information Services Division.
Our total Company revenue grew 25.4% on a consolidated basis during the
twelve months ended March 31, 2005 versus 2004 and 29.5% in the twelve
months ended March 31, 2004 versus 2003.
o Consolidated income from operations grew 47.9% in the twelve months ended
March 31, 2005 versus 2004 and 56.1% in the twelve months ended March 31,
2004 versus 2003. This performance was driven in large part by the results
in our NextGen Division.
o We have benefited and hope to continue to benefit from the increased
demands on healthcare providers for greater efficiency and lower costs, as
well as increased adoption rates of technology in the healthcare arena.
NextGen Division
o Our NextGen Division has experienced significant growth in revenue and
operating income. Divisional revenue grew 35.2% in the twelve months ended
March 31, 2005 versus 2004 and 45.8% in the twelve months ended March 31,
2004 versus 2003 while divisional operating income (excluding unallocated
corporate expenses) grew 64.1% in the twelve months end March 31, 2005 and
77.4% in the twelve months ended March 31, 2004.
o During the twelve months ended March 31, 2005, we added staffing resources
to departments including sales, marketing, support, implementation,
software development, and administration and intend to continue to do so
in fiscal year 2006.
o Our goals include continuing to further enhance our existing products,
developing new products for targeted markets, continuing to add new
customers, selling additional software and services to existing customers
and expanding penetration of connectivity services to new and existing
customers.
QSI Division
o Our QSI Division experienced a revenue decline of 6.8% in the twelve
months ended March 31, 2005 versus 2004 and 5.3% in the twelve months
ended March 31, 2004 versus 2003. The Division experienced a 14.7%
decrease in operating income (excluding unallocated corporate expenses) in
the twelve months ended March 31, 2005 versus 2004.
o Our goals for the QSI Division include maximizing revenue and profit
performance given the constraints present in this Division's target
market.
28
The following table sets forth for the periods indicated the percentage of net
revenue represented by each item in our Consolidated Statements of Operations.
Year Ended March 31,
2005 2004 2003
--------- --------- ---------
Revenue:
System sales............................................ 54.5% 55.7% 53.3%
Maintenance, EDI, and other services.................... 45.5 44.3 46.7
--------- --------- ---------
Total revenue........................................... 100.0 100.0 100.0
Cost of revenue......................................... 36.7 40.4 43.4
--------- --------- ---------
Gross profit............................................ 63.3 59.6 56.6
Selling, general and administrative expenses............ 27.9 27.4 27.9
Research and development costs.......................... 7.8 8.7 9.2
--------- --------- ---------
Income from operations.................................. 27.7 23.5 19.5
Investment income....................................... 1.0 0.5 0.8
--------- --------- ---------
Income before provision for income taxes................ 28.7 24.0 20.3
Provision for income taxes.............................. 10.5 9.3 7.5
--------- --------- ---------
Net income.............................................. 18.1% 14.7% 12.8%
Comparison of the Years Ended March 31, 2005 and March 31, 2004
For the year ended March 31, 2005, our net income was $16.1 million or $1.25 per
share on a basic and $1.22 per share on a fully diluted basis. In comparison, we
earned $10.4 million or $0.84 per share on a basic and $0.80 on a fully diluted
basis in the year ended March 31, 2004. The increase in net income for the year
ended March 31, 2005, was achieved primarily through the following:
o a 25.4% increase in revenue;
o an increase in our gross profit margin from 59.6% to 63.3%.
Revenue. Revenue for the year ended March 31, 2005 increased 25.4% to $89.0
million from $70.9 million for the year ended March 31, 2004. NextGen Division
revenue increased 35.2% from $54.4 million to approximately $73.6 million in the
period, while QSI Division revenue declined by 6.8% during the period from
approximately $16.5 million to $15.4 million.
We divide revenue into two categories, "System sales" and "Maintenance, EDI, and
other services". Revenue in the system sales category includes software license
fees, third party hardware and software, and implementation and training
services related to purchase of the Company's software systems. Revenue in the
maintenance and other services category includes maintenance, EDI, and other
revenue. Maintenance and EDI revenue are the principle sources of revenue in
this category.
System Sales. Company-wide sales of systems for the twelve months ended March
31, 2005 increased 22.8% to $48.5 million from $39.5 million in the prior year.
Our increase in revenue from sales of systems was principally the result of a
24.8% increase in category revenue at our NextGen Division whose sales in this
category grew from $37.3 million during the year ended March 31, 2004 to $46.6
million during the year ended March 31, 2005. This increase was driven primarily
by higher sales of NextGen(emr) and NextGen(epm) software to both new and
existing clients, as well as an increase in the delivery of related
implementation services offset by a decline in the sale of related hardware,
third party software and supplies.
Systems sales revenue in the QSI Division declined 11.1% to approximately $1.9
million in the year ended March 31, 2005 from $2.2 million in the year ended
March 31, 2004.
29
The following table breaks down our reported system sales into software,
hardware, third party software, supplies, and implementation and training
services components by Division:
--------------------------------------------------------------------
Hardware,
Third Party Implementation
Software and and Training Total
Software Supplies Services System Sales
------------- ------------- -------------- -------------
Twelve months ended
March 31, 2005
QSI Division............ $ 889 $ 744 $ 306 $ 1,939
NextGen Division........ 33,230 4,811 8,548 46,589
------------- ------------- -------------- -------------
Consolidated............ $ 34,119 $ 5,555 $ 8,854 $ 48,528
============= ============= ============== =============
Twelve months ended
March 31, 2004
QSI Division............ $ 807 $ 1,029 $ 345 $ 2,181
NextGen Division........ 24,657 6,139 6,548 37,344
------------- ------------- -------------- -------------
Consolidated............ $ 25,464 $ 7,168 $ 6,893 $ 39,525
============= ============= ============== =============
NextGen Division software revenue increased 34.8% between the twelve months
ended March 31, 2004 and the twelve months ended March 31, 2005. The Division's
software revenue accounted for 71.3% of divisional system sales revenue during
the twelve months ended March 31, 2005, an increase from 66.0% in the prior year
period. The increase in software's share of systems sales was not the result of
any new trend or change in emphasis on our part relative to software sales.
Software license revenue growth continues to be an area of primary emphasis for
the NextGen Division and management was pleased with the Division's performance
in this area.
During the twelve months ended March 31, 2005, 10.3% of NextGen's system sales
revenue was represented by hardware and third party software compared to 16.4%
in the same prior year period. We have noted that the last several quarter's
results have included a relatively lower amount of hardware and third party
software compared to prior year periods. However, this decrease was not the
result of any change in emphasis on our part. The number of customers who
purchase hardware and third party software and the dollar amount of hardware and
third party software revenue fluctuates each year depending on the needs of
customers. The inclusion of hardware and third party software in the division's
sales arrangements is typically at the request of the customer and is not a
priority focus for us.
Implementation and training revenue at the NextGen Division increased 30.5% in
the twelve months ended March 31, 2005 compared to the twelve months ended March
31, 2004. Implementation and training revenue at the NextGen Division increased
its share of divisional system sales revenue to 18.3% in the twelve months ended
March 31, 2005 from 17.5% in the twelve months ended March 31, 2004. The growth
in implementation and training revenue is the result of increases in the amount
of implementation and training services rendered to our customers. The amount of
implementation and training services revenue and the corresponding rate of
growth compared to a prior period in any given year is dependant on several
factors including timing of customer implementations, the availability of
qualified staff, and the mix of services being rendered. The number of
implementation and training staff increased during the twelve months ended March
31, 2005 versus March 31, 2004 in order to accommodate the increased amount of
implementation services sold in conjunction with increased software sales. In
order to achieve continued increased revenue in this area, additional staffing
increases are anticipated, though actual future increases in revenue and staff
will depend upon the availability of qualified staff, business mix and
conditions, and our ability to retain current staff members.
30
The NextGen Division's growth has come in part from investments in sales and
marketing activities, including hiring additional sales representatives, trade
show attendance, and advertising expenditures. We have also benefited from
winning numerous industry awards for the NextGen Division's flagship NextGenemr
and NextGenepm software products in fiscal years 2005 and 2004, as well as in
prior years, and the apparent increasing acceptance of electronic medical
records technology in the healthcare industry.
For the QSI Division, total system sales decreased 11.1% in the twelve months
ended March 31, 2005 compared to the twelve months ended March 31, 2004. We do
not presently foresee any material changes in the business environment for the
Division with respect to the constrained environment that has been in place for
the past several years. QSI systems sales during the fiscal year ended March 31,
2005 were impacted by year over year declines in hardware and implementation and
training services.
Maintenance, EDI, and other. Company-wide revenue from maintenance, EDI, and
other services grew 28.7% to $40.4 million from $31.4 million. The increase in
this category resulted principally from an increase in maintenance and EDI
revenue generated from the NextGen Division's client base. Total NextGen
Division maintenance revenue for the year ended March 31, 2005 grew 55.7% to
$17.9 million from $11.5 million in the year ago period, while EDI revenue grew
86.0% to $5.6 million compared to $3.0 million in the year ago period. QSI
Division maintenance revenue declined 3.8% from $7.6 million to $7.3 million in
the same period while divisional EDI revenue declined by approximately 7.6% from
$5.3 million to $4.9 million.
The following table details revenue by category for the twelve month periods
ended March 31, 2005 and 2004:
--------------------------------------------------------------------
Maintenance EDI Other Total
------------- ------------- ------------- -------------
Twelve months ended
March 31, 2005
QSI Division............ $ 7,279 $ 4,877 $ 1,273 $ 13,429
NextGen Division........ 17,881 5,611 3,512 27,004
------------- ------------- ------------- -------------
Consolidated............ $ 25,160 $ 10,488 $ 4,785 $ 40,433
============= ============= ============= =============
Twelve months ended
March 31, 2004
QSI Division............ $ 7,570 $ 5,276 $ 1,464 $ 14,310
NextGen Division........ 11,481 3,016 2,602 17,099
------------- ------------- ------------- -------------
Consolidated............ $ 19,051 $ 8,292 $ 4,066 $ 31,409
============= ============= ============= =============
The following table provides the number of billing sites which were receiving
maintenance services as of the last business day of the period ended March 31,
2005 and 2004 respectively, as well as the number of billing sites receiving EDI
services during the last month of each respective period at each Division of the
Company. The table presents summary information only and includes billing
entities added and removed for any reason. Note also that a single client may
include one or multiple billing sites.
-------------------------------------------------------------------------------------------------------
NextGen QSI Consolidated
------------------------------- ------------------------------- -------------------------------
Maintenance EDI Maintenance EDI Maintenance EDI
------------- ------------- ------------- ------------- ------------- -------------
March 31, 2004. 421 293 321 234 742 527
Billing sites added 138 144 4 7 142 151
Billing sites removed (1) (43) (29) (23) (30) (66)
------------- ------------- ------------- ------------- ------------- -------------
March 31, 2005 558 394 296 218 854 612
============= ============= ============= ============= ============= =============
31
Cost of revenue. Cost of revenue for the year ended March 31, 2005 increased
13.9% to $32.7 million from $28.7 million for the year ended March 31, 2004,
while the cost of revenue as a percentage of net revenue declined to 36.7% from
40.4% during the same period. Our consolidated gross profit is impacted by the
level of hardware content included in system sales, the percentage of EDI
revenue in our overall sales mix, and certain headcount expenses directly
related to the cost of delivering our products and services. Consolidated gross
profit is also impacted by the higher margin revenues of the NextGen Division
which increased its share of total company revenue to 82.7% from 76.8% in the
prior year.
The following table details revenue and cost of revenue on a consolidated and
divisional basis for the twelve month periods ended March 31, 2005 and 2004:
Year Ended March 31,
-------------------------------------------------------------------
2005 % 2004 %
Consolidated
Revenue................. $ 88,961 100.0% $ 70,934 100.0%
Cost of revenue......... 32,669 36.7 28,673 40.4
------------- ------------- ------------ -------------
Gross profit............ 56,292 63.3 42,261 59.6
NextGen Division
Revenue................. 73,594 100.0 54,443 100.0
Cost of revenue......... 25,004 34.0 20,398 37.5
------------- ------------- ------------ -------------
Gross profit............ 48,590 66.0 34,045 62.5
QSI Division
Revenue................. 15,367 100.0 16,491 100.0
Cost of revenue......... 7,665 49.9 8,275 50.2
------------- ------------- ------------ -------------
Gross profit............ $ 7,702 50.1% $ 8,216 49.8%
Gross profit margins at the NextGen Division for the year ended March 31, 2005
increased to 66.0% from 62.5% primarily due to a decrease in the proportionate
level of hardware and third party software content included in revenue as well
as a slight decrease in the relative level of applicable headcount expense
associated with delivering our products and services. The QSI Division's gross
profit margin improved slightly to 50.1% in the year ended March 31, 2005 from
49.8% in the same period last year due to proportionately lower hardware and
third party software content included in revenue.
32
The following table details the individual components of cost of revenue and
gross profit as a percentage of total revenue for our Company and our two
divisions:
------------------------------------------------------------------- -------------
Outside
Services,
Amortization of
Hardware, Payroll and Software
Third Party related Development Total Cost of
Software Benefits Costs and Other Revenue Gross Profit
------------- ------------- --------------- ------------- -------------
Twelve months ended
March 31, 2005
QSI Division.......... 6.1% 17.8% 26.0% 49.9% 50.1%
NextGen Division...... 6.8 12.6 14.6 34.0 66.0
------------- ------------- --------------- ------------- -------------
Consolidated.......... 6.7 13.5 16.5 36.7 63.3
============= ============= =============== ============= =============
Twelve months ended
March 31, 2004
QSI Division.......... 7.6 16.8 25.8 50.2 49.8
NextGen Division...... 10.8 14.2 12.5 37.5 62.5
------------- ------------- --------------- ------------- -------------
Consolidated.......... 10.0% 14.8% 15.6% 40.4% 59.6%
============= ============= =============== ============= =============
During the twelve months ended March 31, 2005, hardware and third party software
constituted a smaller portion of consolidated revenue compared to the same prior
year period, driven principally by the composition of NextGen Division revenue.
This year over year reduction was not the result of any identifiable trend or
change in emphasis on our part. The number of customers who purchase hardware
and third party software and the dollar amount of hardware and third party
software purchased fluctuates each quarter depending on the needs of the
customers and is not a priority focus for us.
Our payroll and benefits expense associated with delivering our products and
services decreased to 13.5% of consolidated revenue compared to 14.8% during the
prior twelve months ended March 31, 2004. The absolute level of consolidated
payroll and benefit expenses grew primarily due to additions to related
headcount, payroll and benefits expense associated with delivering products and
services in the NextGen Division. Payroll and benefits expense associated with
delivering products and services in the QSI Division declined slightly on an
absolute basis, but increased slightly on a percentage of revenue basis. We
anticipate continued additions to headcount in the NextGen Division in areas
related to delivering products and services in future periods, but due to the
uncertainties in the timing of our sales arrangements, our sales mix, the
acquisition and training of qualified personnel, and other issues, we cannot
accurately predict if related headcount expense as a percentage of revenue will
increase or decrease in the future.
We do not currently intend to make any significant additions to related
headcount at the QSI Division.
Should the NextGen Division continue to represent an increasing share of our
revenue and should the NextGen Division continue to carry higher gross margins
than the QSI Division, our consolidated gross margin percentages should increase
to more closely match those of the NextGen Division.
As a result of the foregoing events and activities, our gross profit for the
Company and our two operating divisions increased for the twelve month period
ending March 31, 2005 versus the prior year period.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended March 31, 2005 increased 27.2% to
$24.8 million as compared to $19.5 million for the year ended
33
March 31, 2004. The increase resulted primarily from increases of $2.0 million
in selling and administrative salaries and related benefits expenses in the
NextGen Division, $0.9 million for corporate related professional services
principally in the area of Sarbanes-Oxley compliance, $0.6 million in commission
expense principally in the NextGen division, $0.4 million in corporate related
salaries and related benefit expenses, $0.4 million in NextGen travel expenses
and $1.0 million in other general and administrative expenses primarily in the
NextGen Division. Selling, general and administrative expenses as a percentage
of revenue slightly increased to 27.9% in the fiscal year ended March 31, 2005
from 27.4% in the fiscal period ended March 31, 2004 due to selling, general and
administrative expenses growing at a slightly faster rate than revenue.
We anticipate increased expenditures for trade shows, advertising and the
employment of additional sales representatives primarily at the NextGen
Division. We are hopeful that we will be able to achieve at least a moderate
reduction in expenses related to Sarbanes Oxley Act compliance. While we expect
selling, general and administrative expenses to increase on an absolute basis,
we cannot accurately predict the impact these additional expenditures will have
on selling, general, and administrative expenses as a percentage of revenue.
Research and Development Costs. Research and development costs for the year
ended March 31, 2005 and 2004 were $6.9 million and $6.1 million, respectively.
The increase in research and development costs was primarily due to increased
investment in the NextGen product line. Research and development costs as a
percentage of net revenue decreased to 7.8% from 8.7% primarily due to revenue
growing at a faster rate than the increase in research and development spending.
Research and development costs are expected to continue at or above current
levels.
Investment Income. Investment income for the year ended March 31, 2005 increased
127% to approximately $0.9 million compared with $0.4 million in the year ended
March 31, 2004. The increase was primarily due to the effect of an increase in
short term interest rates versus the prior year period as well as comparatively
higher amounts available for investment during the fiscal period ended March 31,
2005. During the fourth quarter of fiscal year 2005, the Company paid a one time
dividend of approximately $19.6 million, which reduced the amount of funds
available for investment during this period.
Provision for Income Taxes. The provision for income taxes for the year ended
March 31, 2005 was approximately $9.4 million as compared to approximately $6.6
million for the year ago period. The effective tax rates for fiscal 2005 and
2004 were 36.8% and 38.9%, respectively. The provision for income taxes for the
years ended March 31, 2005 and 2004 differ from the combined statutory rates
primarily due to the impact of varying state income tax rates and the impact of
research and development tax credits. During fiscal 2005, the Company recognized
approximately $0.5 million of research and development credits which had not
been recognized previously due to the uncertainly concerning the ultimate amount
of tax to be credited. In the quarter ended March 31, 2005, the State of
California completed an audit of the Company's tax returns and did not
materially change credits related to research and development. Based on the
results of that audit as well the expiration of the statue of limitations on
certain amended returns, the provision for income taxes for the year ended March
31, 2005 was reduced by the $0.5 million in tax credits which had not been
recognized as of March 31 2004.
34
Comparison of the Years Ended March 31, 2004 and March 31, 2003
For the year ended March 31, 2004, our net income was $10.4 million or $0.84 per
share on a basic and $0.80 per share on a fully diluted basis. In comparison,
the Company earned $7.0 million or $0.57 per share on a basic and $0.55 per
shares on a diluted basis in the year ended March 31, 2003. The increase in net
income for the year ended March 31, 2004, was achieved through the following:
o a 29.5% increase in revenue;
o an increase in our gross profit margin from 56.6% to 59.6%; and
o Selling, general and administrative and research and development
expenses which grew at 27.4% and 21.3% respectively; slower than the
overall revenue growth rate.
Revenue. Net revenue for the year ended March 31, 2004 increased 29.5% to $70.9
million from $54.8 million for the year ended March 31, 2003. Sales of computer
systems, upgrades and supplies increased 35.5% to $39.5 million from $29.2
million while net revenue from maintenance, EDI, and other service grew 22.7% to
$31.4 from $25.6 million during the comparable prior period. The increase in net
revenue 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.
We divide revenue into two categories, "System sales" and "Maintenance, EDI, and
other services". Revenue in the systems sales category includes software license
fees, third party hardware and software, and implementation and training
services related to purchase of the Company's software systems. Revenue in the
maintenance and other services category includes maintenance, EDI, and other
revenue. Maintenance and EDI revenue are the principle sources of revenue in
this category.
System Sales. Company-wide sales of systems for the twelve months ended March
31, 2004 increased 35.5% to $39.5 million from $29.2 million in the prior year.
Our increase in revenue from sales of systems was principally the result of a
42.5% increase in category revenue at our NextGen Division whose sales in this
category grew from $26.2 million during the year ended March 31, 2003 to $37.3
million during the year ended March 31, 2004. This increase was driven primarily
by higher sales of NextGenemr and NextGenepm software to both new and existing
clients, as well as delivery of related implementation services and sales of
related hardware, third party software, and supplies.
Systems sales revenue in the QSI Division declined 26.2% to approximately $2.2
million in the year ended March 31, 2004 from $3.0 million in the year ended
March 31, 2003.
35
The following table breaks down our reported system sales into software,
hardware, third party software, supplies, and implementation and training
services components by Division:
--------------------------------------------------------------------
Hardware,
Third Party Implementation
Software and and Training Total
Software Supplies Services System Sales
------------- ------------- -------------- -------------
Twelve months ended
March 31, 2004
QSI Division......... $ 807 $ 1,029 $ 345 $ 2,181
NextGen Division..... 24,657 6,139 6,548 37,344
------------- ------------- -------------- -------------
Consolidated......... $ 25,464 $ 7,168 $ 6,893 $ 39,525
============= ============= ============== =============
Twelve months ended
March 31, 2003
QSI Division......... $ 1,591 $ 1,160 $ 205 $ 2,956
NextGen Division..... 17,982 4,658 3,573 26,213
------------- ------------- -------------- -------------
Consolidated......... $ 19,573 $ 5,818 $ 3,778 $ 29,169
============= ============= ============== =============
Maintenance, EDI, and other. Company-wide revenue from maintenance, EDI, and
other services grew 22.7% to $31.4 million from $25.6 million. The increase in
this category resulted principally from an increase in maintenance and EDI
revenue from the NextGen Division's client base. Total NextGen Division
maintenance revenue for the year ended March 31, 2004 grew 58.0% to $11.5
million from $7.3 million in the year ago period, while EDI revenue grew 74.0%
to $3.0 million compared to $1.7 million in the same period. QSI Division
maintenance revenue declined 4.7% from $7.9 million to $7.6 million in the same
period while divisional EDI revenue declined by approximately 2.8% from $5.4
million to $5.3 million.
The following table details revenue by category for the twelve month periods
ended March 31, 2004 and 2003:
--------------------------------------------------------------------
Maintenance EDI Other Total
------------- ------------- ------------- -------------
Twelve months ended
March 31, 2004
QSI Division......... $ 7,570 $ 5,276 $ 1,464 $ 14,310
NextGen Division..... 11,481 3,016 2,602 17,099
------------- ------------- ------------- -------------
Consolidated......... $ 19,051 $ 8,292 $ 4,066 $ 31,409
============= ============= ============= =============
Twelve months ended
March 31, 2003
QSI Division......... $ 7,941 $ 5,426 $ 1,100 $ 14,467
NextGen Division..... 7,267 1,733 2,133 11,133
------------- ------------- ------------- -------------
Consolidated......... $ 15,208 $ 7,159 $ 3,233 $ 25,600
============= ============= ============= =============
The following table provides the number of billing sites which were receiving
maintenance services as of the last business day of the period ended March 31,
2004 and 2003 respectively, as well as the number of billing sites receiving EDI
services during the last month of each respective period at each Division of the
Company. The table presents summary information only and includes billing
entities added and removed for any reason. Note also that a single client may
include one or multiple billing sites.
36
-------------------------------------------------------------------------------------------------------
NextGen QSI Consolidated
------------------------------- ------------------------------- -------------------------------
Maintenance EDI Maintenance EDI Maintenance EDI
------------- ------------- ------------- ------------- ------------- -------------
March 31, 2003 315 219 348 254 663 473
Billing sites added 117 99 4 4 121 103
Billing sites removed (11) (25) (31) (24) (42) (49)
------------- ------------- ------------- ------------- ------------- -------------
March 31, 2004 421 293 321 234 742 527
============= ============= ============= ============= ============= =============
Cost of Revenue. Cost of revenue for the year ended March 31, 2004 increased
20.7% to $28.7 million from $23.8 million for the year ended March 31, 2003,
while the cost of revenue as a percentage of revenue at 40.4% for 2004 declined
compared to the prior year's 43.4% of revenue.
The following table details revenue and cost of revenue on a consolidated and
divisional basis for the twelve month periods ended March 31, 2004 and 2003:
Year Ended March 31,
-------------------------------------------------------------------
2004 % 2003 %
Consolidated
Revenue................. $ 70,934 100.0% $ 54,769 100.0%
Cost of revenue......... 28,673 40.4 23,755 43.4
------------- ------------- ------------- -------------
Gross profit............ 42,261 59.6 31,014 56.6
NextGen Division
Revenue................. 54,443 100.0 37,346 100.0
Cost of revenue......... 20,398 37.5 14,511 38.9
------------- ------------- ------------- -------------
Gross profit............ 34,045 62.5 22,835 61.1
QSI Division
Revenue................. 16,491 100.0 17,423 100.0
Cost of revenue......... 8,275 50.2 9,244 53.1
------------- ------------- ------------- -------------
Gross profit............ $ 8,216 49.8% $ 8,179 46.9%
Gross profit is impacted by the level of hardware content included in system
sales, the percentage of EDI revenue in our overall sales mix, and certain
headcount expenses. Gross profit at the NextGen Division for the year ended
March 31, 2004 improved to 62.5% from 61.1% primarily due to a decrease in the
relative level of applicable outside service, amortization of software
development costs and other expenses associated with delivering the Company's
products and services. The QSI Division's gross profit for the year ended March
31, 2004 improved to 49.8% from 46.9% in the same period during the prior year
primarily due to a proportionately lower hardware and third party software
content included in revenue. In addition, our gross profit percentage increased
as the higher margined NextGen Division increased its share of total Company
revenue to 76.8% from 68.2% in the prior year.
The following table details the individual components of cost of revenue and
gross profit as a percentage of total revenue for our Company and our two
divisions:
37
------------------------------------------------------------------------------------
Outside
Services,
Amortization of
Software
Hardware, Payroll and Development
Third Party related Costs and Total Cost
Software Benefits Other of Revenue Gross Profit
------------- ------------- --------------- ------------- -------------
Twelve months ended
March 31, 2004
QSI division....... 7.6% 16.8% 25.8% 50.2% 49.8%
NextGen division... 10.8 14.2 12.5 37.5 62.5
------------- ------------- --------------- ------------- -------------
Consolidated....... 10.0 14.8 15.6 40.4 59.6
============= ============= =============== ============= =============
Twelve months ended
March 31, 2003
QSI division....... 11.1 15.5 26.5 53.1 46.9
NextGen division... 11.9 11.8 15.2 38.9 61.1
------------- ------------- --------------- ------------- -------------
Consolidated....... 11.6% 13.0% 18.8% 43.4% 56.6%
============= ============= =============== ============= =============
During the twelve months ended March 31, 2004, hardware and third party software
constituted a slightly smaller portion of consolidated revenue compared to the
same year ago period driven principally by the composition of NextGen Division
revenue. This year over year reduction was not the result of any identifiable
trend or change in emphasis on our part. The number of customers who purchase
hardware and third party software and the dollar amount of hardware and third
party software purchased fluctuates each quarter depending on the needs of the
customers and is not a priority focus for us.
Our payroll and benefits expense associated with delivering our products and
services increased to 14.8% of consolidated revenue compared to 13.0% during the
prior twelve months ended March 31, 2003. The level of consolidated payroll and
benefit expenses grew due to additions to related headcount, payroll and
benefits expense associated with delivering products and services in the NextGen
Division. Payroll and benefits expense associated with delivering products and
services in the QSI Division increased slightly on both an absolute and a
percentage of revenue basis. We anticipate continued additions to headcount in
the NextGen Division in areas related to delivering products and services in
future periods but due to the uncertainties in the timing of our sales
arrangements, our sales mix, the acquisition and training of qualified
personnel, and other issues, we cannot accurately predict if related headcount
expense as a percentage of revenue will increase or decrease in the future. We
do not currently intend to make any significant additions to related headcount
at the QSI Division.
Our outside services, amortization of software development costs and other
expenses included in cost of revenue declined to 15.6% compared to 18.8% during
the twelve months ended March 31, 2003. This decline was due to a number of
factors including a slight decline in the proportion of EDI revenue included in
consolidated revenue during fiscal 2004, a slight improvement in gross profit
related to EDI revenue, and certain overhead and amortization of capitalized
software costs increasing at a slower rate compared to the rate of revenue
growth.
Should the NextGen Division continue to represent an increasing share of our
revenue and should the NextGen Division continue to carry higher gross margins
than the QSI Division, our consolidated gross profit percentages should increase
to more closely match those of the NextGen Division.
As a result of the foregoing events and activities, our gross profit for the
Company and our two operating divisions increased for the twelve month period
ending March 31, 2004 versus the prior year period.
38
Selling, General and Administrative. Selling, general and administrative
expenses for the year ended March 31, 2004 increased 27.4% to $19.5 million from
$15.3 million for the year ended March 31, 2003, and declined on a percentage of
revenue basis to 27.4% from 27.9% for the respective fiscal years. The increase
in the amount of such expenses resulted primarily from increases of $1.1 million
in corporate expenses, principally in the area of professional service fees, as
well as $1.0 million in selling and administrative payroll and benefits
expenses, $0.9 million in commissions expenses, and $0.6 million in travel and
trade show expenses primarily in the NextGen Division. Further increases in
selling, general and administrative expenses are expected.
Research and Development Costs. Research and development costs for the year
ended March 31, 2004 and 2003 were $6.1 million and $5.1 million, respectively.
The increase in research and development costs was primarily due to increased
investment in the NextGen product line. Research and development costs as a
percentage of net revenue decreased to 8.7% from 9.2% 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 our investments in capitalized software
increased to $2.6 million from $1.7 million in the prior year, reflecting
increased expenditures directed at enhancements of the NextGen products.
Research and development costs are expected to continue at or above current
levels.
Investment Income. Investment income for the year ended March 31, 2004 decreased
11.1% to approximately $0.4 million compared with $0.4 million in the year ended
March 31, 2003. Investment income in the year ended March 31, 2004 declined
primarily due to the effect of the drop in short term interest rates versus the
prior year. The decline in interest rates was partially offset by an increase in
average funds available for investment during the year ended March 31, 2004.
Provision for Income Taxes. The provision for income taxes for the year ended
March 31, 2004 was approximately $6.6 million as compared to approximately $4.1
million for the year ago period. The effective tax rates for fiscal 2004 and
20003 were 38.9% and 36.6%, respectively. The provision for income taxes for the
years ended March 31, 2004 and 2003 differ from the combined statutory rates
primarily due to the impact of varying state income tax rates and the impact of
research and development tax credits. The effective rate for the fiscal year
2004 increased from the prior year primarily due to a relatively smaller impact
of research and development tax credits as well as slightly higher effective
state income tax rates. The provision for income taxes for the year ended March
31, 2004 and 2003 accounted for a portion of the aggregate tax credits
accumulated through the end of each period due to the uncertainly concerning the
ultimate amount of tax to be credited.
Liquidity and Capital Resources. The following table presents selected financial
statistics and information for each of the past three fiscal years:
Year Ended March 31,
------------------------------------------
2005 2004 2003
---------- ---------- -----------
Cash and cash equivalents at year end.................... $ 51,157 $ 51,395 $ 36,443
Net (decrease) increase in cash and cash equivalents..... (238) 14,952 11,000
Net income............................................... 16,109 10,400 7,035
Net cash provided by operating activities................ $ 21,631 $ 17,303 $ 13,183
Days of sales outstanding................................ 119 98 104
Cash provided by operations is our principal source of cash. Cash from
operations for the year ended March 31, 2005 consisted principally of net income
before non-cash related expenses of depreciation,
39
amortization, and provision for bad debts and inventory obsolescence, and
increases in deferred revenue and other current liabilities, offset by an
increase in gross accounts receivable. We were able to generate operating cash
flows significantly in excess of net income in the year ended March 31, 2005
primarily as a result of increases in deferred revenue of $8.2 million. We were
able to generate operating cash flows significantly in excess of net income in
the year ended March 31, 2004 primarily as a result of increases in deferred
revenue of $5.6 million and improved turnover of accounts receivable. Provided
turnover of accounts receivable, increased revenue, and profitability remain
consistent with results experienced for the year ended March 31, 2005, we
anticipate continuing to generate cash from operations primarily from net
income.
Net cash used in investing activities for the year ended March 31, 2005 was $4.4
million and was primarily composed of investments in capitalized software and
equipment and improvements. We have no significant capital commitments, and
currently anticipate that additions to equipment and improvements for fiscal
2006 will be equal to or greater than historical levels.
Net cash used in financing activities for the year ended March 31, 2005 was
$17.5 million was primarily composed of a one-time dividend paid to shareholders
of $19.6 million partially offset by proceeds from the exercise of stock
options. Cash received from employee stock option exercises can fluctuate from
year to year.
At March 31, 2005, we had cash and cash equivalents of $51.2 million. We intend
to expend some of these funds for the development of products complementary to
our existing product line as well as new versions of certain of our products.
These developments are intended to take advantage of more powerful technologies
and to increase the integration of our products. We have no additional
significant current capital commitments. Management believes that our cash and
cash equivalents on hand at March 31, 2005, together with the cash flows from
operations, if any, will be sufficient to meet our working capital and capital
expenditure requirements for fiscal 2006.
The following table summarizes our significant contractual obligations at March
31, 2005, and the effect of such obligations is expected to have on our
liquidity and cash in future periods:
Contractual Obligations Total 2006 2007-2008 2009-2010 Beyond 2010
Non-cancelable operating leases $ 4,001 $ 1,257 $ 1,867 $ 877 --
ITEM 7A. QUANTITATIVE AND QUALITIVE DISCLOSURE ABOUT MARKET RISKS
We have a significant amount of cash and short-term investments with maturities
less than three months. This cash portfolio exposes us to interest rate risk as
short-term investment rates can be volatile. Given the short-term maturity
structure of our investment portfolio, we believe that it is not subject to
principal fluctuations and the effective interest rate of our portfolio tracks
closely to various short-term money market interest rate benchmarks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Financial Statements identified in the Index to Financial Statements
appearing under "Item 15. Exhibits and Financial Statement Schedules" of this
report are incorporated herein by reference to Item 15.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
40
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on their evaluation of our disclosure controls and procedures as of a date
within 90 days of the filing date of this report, our officers including our
Chief Executive Officer and Chief Financial Officer have concluded that our
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 we file under the Securities Exchange Act of 1934
and the rules there under.
Changes in Internal Control Over Financial Reporting
During the year ended March 31, 2005, the following changes have occurred 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, our financial reporting function.
During the year ended March 31, 2005, the Company implemented revenue
application software "Softrax" to automate certain processes surrounding the
recognition and the deferral of revenue related to our software sales
arrangements with multiple elements. The Company added numerous additional
policies and procedures in order to strengthen the Company's internal control
structure in conjunction with the Company's evaluation of internal controls. The
Company also added a controller with public accounting and SEC reporting
experience.
There were no other significant changes in our 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.
Management's Report on Internal Control Over Financial Reporting
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act. Under the supervision and with the
participation of the Company's management, including our principal executive
officer and principal financial officer, the Company conducted an evaluation of
the effectiveness of its internal control over financial reporting based on the
framework set forth in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
evaluation, the Company's management concluded that its internal control over
financial reporting was effective as of March 31, 2005.
The Company's internal control over financial reporting is supported by written
policies and procedures, that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the Company's assets; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the Company are being made only in accordance with
authorizations of the Company's management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risks that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
41
The Company's independent registered public accounting firm has audited
management's assessment of the effectiveness of the Company's internal control
over financial reporting as of March 31, 2005 as stated in their report which is
included herein.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Except for information concerning our 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 our definitive proxy statement for our 2005 annual shareholders' meeting to
be filed with the Securities and Exchange Commission within 120 days after the
end of the fiscal year ended March 31, 2005.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference from our
definitive proxy statement for our 2005 annual shareholders' meeting to be filed
with the Securities and Exchange Commission within 120 days after the end of the
fiscal year ended March 31, 2005.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated herein by reference from our
definitive proxy statement for our 2005 annual shareholders' meeting to be filed
with the Securities and Exchange Commission within 120 days after the end of the
fiscal year ended March 31, 2005.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference from our
definitive proxy statement for our 2005 annual shareholders' meeting to be filed
with the Securities and Exchange Commission within 120 days after the end of the
fiscal year ended March 31, 2005.
ITEM 14. PRINCIPAL ACCOUNTING AND FEES AND SERVICES
The information required by Item 14 is incorporated herein by reference from our
definitive proxy statement for our 2005 annual shareholders' meeting to be filed
with the Securities and Exchange Commission within 120 days after the end of the
fiscal year ended March 31, 2005.
42
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES AND REPORTS ON FORM
10-K
(a) (1) Index to Financial Statements:
Page
----
o Report of Independent Registered Public Accounting Firm... 49
o Report of Independent Registered Public Accounting Firm on
Internal Control Over Financial Reporting................. 50
o Consolidated Balance Sheets -- Years Ended
March 31, 2005 and March 31, 2004......................... 52
o Consolidated Statements of Income -- Years Ended
March 31, 2005, March 31, 2004 and 2003................... 53
o Consolidated Statements of Shareholders' Equity -- Years
Ended March 31, 2005, March 31, 2004 and 2003............. 54
o Consolidated Statements of Cash Flows -- Years Ended
March 31, 2005, March 31, 2004 and 2003................... 55
o Notes to Consolidated Financial Statements................ 56
(2) The following financial statement schedule for the years ended March
31, 2005, March 31, 2004 and 2003, read in conjunction with the
financial statements of Quality Systems, Inc., is filed as part of
this Annual Report on Form 10-K.
o Schedule II -- Valuation and Qualifying Accounts.......... 71
Schedules other than that listed above have been omitted since they
are either not required, not applicable, or because the information
required is included in the financial statements or the notes
thereto.
(3) The exhibits listed in the Index to Exhibits hereof are attached
hereto or incorporated herein by reference and filed as apart of
this Report.
43
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
3.1 Articles of Incorporation of the Company, as amended, are
hereby incorporated by reference to Exhibit 3.1 to our Annual
Report on Form 10-K for the year ended March 31, 1984, File
No. 2-80056.
3.1.1 Amendment to Articles of Incorporation, effective March 4,
2005. **
3.2 Bylaws of the Company, as amended and restated. **
3.3 Certificate of Amendment of Bylaws of the Company is hereby
incorporated by reference to Exhibit 3.2.1 to our 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 our 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, is hereby
incorporated by reference to Exhibit 3.2.3 to our 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 our 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 our 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 our 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 our Registration
Statement on Form S-1, File No. 2-80056.
10.4* 1993 Deferred Compensation Plan is hereby incorporated by
reference to Exhibit 10.5 to our 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 our 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 our Annual Report on Form 10-KSB for the year ended
March 31, 1996, File No. 0-13801.
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 our Annual Report on Form 10-KSB for the year
ended March 31, 1995, File No. 0-13801.
44
10.6 Form of Indemnification Agreement is hereby incorporated by
reference to Exhibit 10.10 to our Registration Statement on
Form S-1, File No. 333-00161.
10.6.1* Form of Indemnification Agreement for directors and executive
officers authorized January 27, 2005. **
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 are hereby
incorporated by reference to Exhibit 2 to our 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 our 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 our Registration Statement on Form S-8, File
No. 333-67115.
10.10.1* Amended and Restated 1998 Stock Option Plan. **
10.11* Memorandum of Understanding regarding the April 3, 2000
resignation of Sheldon Razin between Sheldon Razin and Quality
Systems, Inc., is hereby incorporated by reference to Exhibit
10.16 to our 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 our 1999 Shareholder's Meeting, File No.
001-12537.
10.13* Employment Agreement dated July 20, 2000 between Quality
Systems, Inc. and Lou Silverman is hereby incorporated by
reference to Exhibit 10.18 to our 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 is hereby
incorporated by reference to Exhibit 10.14 to our 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, is hereby
incorporated by reference to Exhibit 10.15 to our 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 is hereby incorporated by
reference to Exhibit 10.16 to our 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 is hereby incorporated by reference to
Exhibit 10.17 to our Annual Report on Form 10-K for the year
ended March 31, 2003, File No. 0-13801.
45
10.18 Lease Agreement between Company and HUB Properties LLC dated
May 8, 2002 is hereby incorporated by reference to Exhibit
10.18 to our Annual Report on Form 10-K for the year ended
March 31, 2003, File No. 0-13801.
10.19 Lease Agreement between the Company and LakeShore Towers
Limited Partnership Phase IV, a California limited
partnership, dated September 15, 2004. **
10.20* Board Service Agreement between the Company and Lou Silverman
is incorporated by reference to Exhibit 10.2.1 to our Current
Report of Form 8-K, dated May 31, 2005, File No. 001-12537.
10.21* Board Service Agreement between the Company and Patrick Cline
is incorporated by reference to Exhibit 10.2.1 to our Current
Report of Form 8-K, dated May 31, 2005, File No. 001-12537.
21 List of Subsidiaries.
23.1 Consent of Independent Certified Public Accountants - Grant
Thornton LLP.
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. **
* This exhibit is a management contract or a compensatory plan or
arrangement.
** Filed herewith.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, we have duly caused this Report to be signed on our behalf by the
undersigned, thereunto duly authorized.
By: /s/ LOUIS E. SILVERMAN
--------------------------
Louis E. Silverman,
President and Chief Executive Officer
Date: June 3, 2005
KNOW ALL PERSONS BY THESE PRESENTS, that each of the persons whose signature
appears below hereby constitutes and appoints Louis E. Silverman and Paul Holt,
each of them acting individually, as his attorney-in-fact, each with the full
power of substitution, for him in any and all capacities, to sign any and all
amendments to this Annual Report on Form 10-K, and to file the same, with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact, and
each of them, full power and authority to do and perform each and every act and
thing requisite and necessary to be done in and about the premises as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming our signatures as they may be signed by our said attorney-in-fact and
any and all amendments to this Annual Report on Form 10-K.
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report
has been signed by the following persons on our behalf in the capacities and on
the dates indicated.
Signature Title Date
- ----------------------- ----------------------------------------- ------------
/s/ SHELDON RAZIN Chairman of the Board June 9, 2005
- -----------------------
Sheldon Razin
/s/ LOUIS E. SILVERMAN. Director, President and Chief Executive June 9, 2005
- ----------------------- Officer (Principal Executive
Louis E. Silverman Officer)/Director
/s/ PATRICK CLINE Director, President, NextGen Healthcare June 9, 2005
- ----------------------- Information Systems Division
Patrick Cline
/s/ PAUL HOLT Secretary and Chief Financial Officer June 9, 2005
- ----------------------- (Principal Financial Officer)
Paul Holt
/s/ WILLIAM BOTTS Director June 9, 2005
- -----------------------
William Botts
/s/ MAURICE DEWALD Director June 9, 2005
- -----------------------
Maurice DeWald
47
Signature Title Date
- ----------------------- ----------------------------------------- ------------
/s/ AHMED HUSSEIN Director June 9, 2005
- -----------------------
Ahmed Hussein
/s/ JONATHAN JAVITT Director June 9, 2005
- -----------------------
Jonathan Javitt
/s/ VINCENT LOVE Director June 6, 2005
- -----------------------
Vincent Love
/s/ STEVEN PLOCHOCKI Director June 9, 2005
- -----------------------
Steven Plochocki
48
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited the accompanying consolidated balance sheets of Quality Systems,
Inc. as of March 31, 2005 and 2004, and the related consolidated statements of
income, shareholders' equity, and cash flow for each of the three years in the
period ended March 31, 2005. These 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2005 and 2004 and the consolidated results of
operations and its consolidated cash flows for each of the three years in the
period ended March 31, 2005 in conformity with accounting principles generally
accepted in the United States of America.
We have also audited Schedule II of Quality Systems, Inc. for each of the three
years in the period ended March 31, 2005. In our opinion, this schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Quality
Systems, Inc.'s internal control over financial reporting as of March 31, 2005,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated June 3, 2005, expressed an unqualified opinion thereon.
/s/ GRANT THORNTON LLP
Irvine, California
June 3, 2005
49
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Shareholders
Quality Systems, Inc.
We have audited management's assessment, included in the accompanying Quality
Systems, Inc. Management's Report on Internal Control Over Financial Reporting,
that Quality Systems, Inc. maintained effective internal control over financial
reporting as of March 31, 2005, based on criteria established in Internal
Control - Integrated Framework issues by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Quality Systems, Inc.'s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Quality Systems, Inc. maintained
effective internal control over financial reporting as of March 31, 2005, is
fairly stated, in all material respects, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, Quality Systems,
Inc. maintained, in all material respects, effective internal control over
financial reporting as of March 31, 2005, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Quality Systems, Inc. as of March 31, 2005 and 2004, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of
50
the three years in the period ended March 31, 2005, and our report dated June 3,
2005 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Irvine, California
June 3, 2005
51
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
--------------------
March 31, March 31,
2005 2004
-------- --------
ASSETS
Current Assets
Cash and cash equivalents .............................................. $ 51,157 $ 51,395
Accounts receivable, net ............................................... 33,362 20,280
Inventories, net ....................................................... 960 725
Income tax receivable .................................................. 15 --
Net current deferred tax assets ........................................ 1,796 2,979
Other current assets ................................................... 1,677 1,493
-------- --------
Total current assets ............................................. 88,967 76,872
Other assets
Equipment and improvements, net ........................................ 2,697 2,012
Capitalized software costs, net ........................................ 4,334 3,608
Net long-term deferred tax assets ...................................... -- 1,104
Goodwill, net .......................................................... 1,840 1,840
Other assets, net ...................................................... 1,604 1,242
-------- --------
Total assets ..................................................... $ 99,442 $ 86,678
======== ========
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable ....................................................... $ 2,284 $ 1,655
Deferred revenue ....................................................... 24,115 16,060
Accrued employee compensation and benefits ............................. 3,436 2,610
Income tax payable ..................................................... -- 273
Other current liabilities .............................................. 4,021 2,859
-------- --------
Total current liabilities ........................................ 33,856 23,457
Deferred revenue, net of current .............................................. 1,362 1,203
Net deferred tax liabilities .................................................. 291 --
Deferred compensation ......................................................... 1,202 1,013
-------- --------
Total liabilities 36,711 25,673
-------- --------
Commitments and contingencies ................................................. -- --
Shareholders' equity
Common Stock, $0.01 par value; 40,000 shares authorized, 13,111 and
12,650 shares issued and outstanding at March 31, 2005 and 2004,
respectively ......................................................... 131 127
Additional paid-in capital ............................................. 44,499 39,671
Retained earnings ...................................................... 19,213 22,750
Deferred compensation .................................................. (1,112) (1,543)
-------- --------
Total shareholders' equity ....................................... 62,731 61,005
-------- --------
Total liabilities and shareholders' equity ....................... $ 99,442 $ 86,678
======== ========
________________________________________________________________________________
The accompanying notes to these consolidated financial statements are an
integral part of these consolidated statements.
52
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except per share amounts)
Year Ended March 31,
---------------------------
2005 2004 2003
------- ------- -------
Revenue:
Software, hardware and supplies ..................... $39,672 $32,632 $25,391
Implementation and training services ................ 8,856 6,893 3,778
------- ------- -------
System sales .............................................. 48,528 39,525 29,169
------- ------- -------
Maintenance and other services ...................... 29,945 23,117 18,441
Electronic data interchange services ................ 10,488 8,292 7,159
------- ------- -------
Maintenance, EDI, and other services ...................... 40,433 31,409 25,600
------- ------- -------
Total revenue ....................................... 88,961 70,934 54,769
------- ------- -------
Cost of revenue:
Software, hardware and supplies ..................... 7,525 8,141 7,299
Implementation and training services ................ 6,300 5,197 2,929
------- ------- -------
Total cost of system sales 13,825 13,338 10,228
------- ------- -------
Maintenance and other ............................... 12,120 10,313 9,072
Electronic data interchange services ................ 6,724 5,022 4,455
------- ------- -------
Total cost of maintenance, EDI, and other services 18,844 15,335 13,527
------- ------- -------
Total cost of revenue ............................... 32,669 28,673 23,755
------- ------- -------
Gross profit ........................................ 56,292 42,261 31,014
------- ------- -------
Operating expenses:
Selling, general and administrative expenses .............. 24,776 19,482 15,293
Research and development costs ............................ 6,903 6,139 5,062
------- ------- -------
Total operating expenses ............................ 31,679 25,621 20,355
------- ------- -------
Income from operations .............................. 24,613 16,640 10,659
Investment income ......................................... 876 386 434
------- ------- -------
Income before provision for income taxes .................. 25,489 17,026 11,093
Provision for income taxes ................................ 9,380 6,626 4,058
------- ------- -------
Net income .......................................... $16,109 $10,400 $ 7,035
======= ======= =======
Net income per share, basic ............................... $ 1.25 $ 0.84 $ 0.57
Net income per share, diluted ............................. $ 1.22 $ 0.80 $ 0.55
Weighted average shares outstanding, basic ................ 12,872 12,436 12,254
Weighted average shares outstanding, diluted .............. 13,203 12,966 12,778
________________________________________________________________________________
The accompanying notes to these consolidated financial statements are an
integral part of these consolidated statements.
53
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS'
EQUITY
For the Three Years Ended March 31, 2005, 2004 and 2003
(In Thousands)
Common Stock Total
----------------- Retained Deferred Shareholders'
Shares Amount APIC Earnings Compensation Equity
- -----------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2002 12,210 $ 122 $ 34,613 $ 5,315 $ -- $ 40,050
Exercise of stock options ................... 94 1 351 -- -- 352
Tax benefit resulting from stock
options ..................................... -- -- 96 -- -- 96
Net income .................................. -- -- -- 7,035 -- 7,035
------ -------- -------- -------- ------------ -----------
Balance, March 31, 2003 12,304 123 35,060 12,350 -- 47,533
Exercise of stock options ................... 346 4 1,304 -- -- 1,308
Tax benefit resulting from stock
options ..................................... -- -- 1,454 -- -- 1,454
Stock based compensation .................... -- -- 1,853 -- (1,543) 310
Net income .................................. -- -- -- 10,400 -- 10,400
------ -------- -------- -------- ------------ -----------
Balance, March 31, 2004 12,650 127 39,671 22,750 (1,543) 61,005
Exercise of stock options ................... 461 4 2,148 -- -- 2,152
Tax benefit resulting from stock
options ..................................... -- -- 2,680 -- -- 2,680
Stock based compensation .................... -- -- -- -- 431 431
Dividends paid .............................. -- -- -- (19,646) -- (19,646)
Net income .................................. -- -- -- 16,109 -- 16,109
------ -------- -------- -------- ------------ -----------
Balance, March 31, 2005 13,111 $ 131 $ 44,499 $ 19,213 $ (1,112) $ 62,731
====== ======== ======== ======== ============ ===========
________________________________________________________________________________
The accompanying notes to these consolidated financial statements are an
integral part of these consolidated statements.
54
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Year Ended March 31,
--------------------------------
2005 2004 2003
-------- -------- --------
Cash flows from operating activities:
Net income $ 16,109 $ 10,400 $ 7,035
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation .............................................. 1,012 836 910
Amortization of capitalized software costs ................ 1,952 1,490 1,267
Provision for bad debts ................................... 797 647 623
Provision for inventory obsolescence ...................... 160 54 40
Non-cash compensation from stock option grants ............ 431 310 --
Loss on short-term investments and other .................. -- -- 21
Tax benefit from exercise of stock options ................ 2,680 1,454 96
Deferred income taxes, net ................................ 2,578 (235) 298
Change in assets and liabilities:
Accounts receivable ....................................... (13,879) (3,400) (4,455)
Inventories ............................................... (395) (112) 411
Income tax receivable ..................................... (15) -- --
Other current assets ...................................... (184) 627 (943)
Other assets .............................................. (362) (373) --
Accounts payable .......................................... 629 (822) (180)
Deferred revenue .......................................... 8,214 5,564 5,544
Accrued compensation and related benefits ................. 826 248 687
Income tax payable ........................................ (273) 273 --
Other current liabilities ................................. 1,162 8 1,871
Deferred compensation ..................................... 189 334 (42)
-------- -------- --------
Net cash provided by operating activities 21,631 17,303 13,183
-------- -------- --------
Cash flows from investing activities:
Additions to capitalized software costs ........................ (2,678) (2,587) (1,660)
Additions to equipment and improvements ........................ (1,697) (1,072) (1,109)
Proceeds from the sale of short-term investments ............... -- -- 234
-------- -------- --------
Net cash used in investing activities .................. (4,375) (3,659) (2,535)
-------- -------- --------
Cash flows from financing activities:
Dividends paid (19,646) -- --
Proceeds from the exercise of stock options ............... 2,152 1,308 352
-------- -------- --------
Net cash (used in) provided by financing activities .... (17,494) 1,308 352
-------- -------- --------
Net (decrease) increase in cash and cash equivalents ................ (238) 14,952 11,000
Cash and cash equivalents, beginning of year ........................ 51,395 36,443 25,443
-------- -------- --------
Cash and cash equivalents, end of year .............................. $ 51,157 $ 51,395 $ 36,443
======== ======== ========
________________________________________________________________________________
The accompanying notes to these consolidated financial statements are an
integral part of these consolidated statements.
Supplemental Information. During fiscal 2005, 2004 and 2003 the Company made
income tax payments of $4,541, $4,716, and $4,280, respectively.
55
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 and 2004
(dollars in thousands, except per share amounts)
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), develops and markets 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 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 offers its clients
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 NextGen Division is located in
Horsham, Pennsylvania.
On February 2, 2005, the Board of Directors declared a 2-for-1 stock split with
respect to the Company's outstanding shares of common stock. The stock split
record date was March 4, 2005 and the stock began trading post split on March
28, 2005. References to share and per share data contained in the consolidated
financial statements and notes to the consolidated financial statements has been
retroactively adjusted to reflect the stock split.
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
intercompany accounts 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.
References to dollar amounts in this financial statement sections are in
thousands, except share and per share data, unless otherwise specified. Certain
prior year amounts have been reclassified to conform with fiscal year 2005
presentation.
Revenue recognition. The Company currently recognizes revenue pursuant to
Statement of Position No. 97-2, "Software Revenue Recognition" (SOP 97-2), as
amended by Statement of Position No. 98-9 "Modification of SOP 97-2, Software
Revenue Recognition" (SOP 98-9). The Company generates revenue from the sale of
licensing rights to its software products directly to end-users and value-added
resellers (VARs). The Company also generates revenue from sales of hardware and
third party software, implementation, training, software customization,
Electronic Data Interchange (EDI), post-contract support (maintenance) and other
services performed for customers who license its products.
A typical system contract contains multiple elements of the above items. SOP
98-9, 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 vendor specific
objective evidence (VSOE). The Company limits its assessment of VSOE for each
element to either the price charged when the same element is sold separately
(using a rolling average of stand alone transactions) or the price established
by management having the relevant authority to do so, for an element not yet
sold separately. VSOE calculations are updated and reviewed at the end of each
quarter.
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
elements' fair value relative to the total contract fair value.
56
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 VSOE of fair value of each of the undelivered elements, and
allocates the remainder of the contract price net of all discounts to revenue
recognized from the delivered elements. Undelivered elements of a system sale
may include implementation and training services, hardware and third party
software, maintenance, future purchase discounts, or other services. If VSOE of
fair value of any undelivered element does not exist, all revenue is deferred
until VSOE of fair value of the undelivered element is established or the
element has been delivered.
The Company bills 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 is generally recognized upon shipment and transfer of title. In certain
transactions where collection risk is high, the cash basis method is used to
recognized revenue. Revenue from implementation and training services is
recognized as the corresponding services are performed. Maintenance revenue is
recognized ratably over the contractual maintenance period.
Contract accounting is applied where services include significant software
modification, development or customization. In such instances, the arrangement
fee is accounted for in accordance with Statement of Position No. 81-1
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1). Pursuant to SOP 81-1, the Company uses the percentage of
completion method provided all of the following conditions exist:
o contract includes provisions that clearly specify the enforceable rights
regarding goods or services to be provided and received by the parties,
the consideration to be exchanged, and the manner and terms of settlement;
o the customer can be expected to satisfy its obligations under the
contract;
o the Company can be expected to perform it's contractual obligations; and
o reliable estimates of progress towards completion can be made.
The Company measures completion using labor input hours. Costs of providing
services, including services accounted for in accordance with SOP 81-1, are
expensed as incurred.
If a situation occurs in which a contract is so short term that the financial
statements would not vary materially from using the percentage-of-completion
method or in which the Company is unable to make reliable estimates of progress
of completion of the contract, the completed contract method is utilized.
From time to time, the Company offers future purchase discounts on its products
and services as part of its sales arrangements. Pursuant to AICPA TPA 5100.51,
such discounts which are incremental to the range of discounts reflected in the
pricing of the other elements of the arrangement, which are incremental to the
range of discounts typically given in comparable transactions, and which are
significant, are treated as an additional element of the contract to be
deferred. Amounts deferred related to future purchase options are not recognized
until either the customer exercises the discount offer or the offer expires.
Cash and Cash Equivalents. Cash and cash equivalents consist of cash,
money market funds and short term U.S. Treasuries with maturities of less than
90 days. The money market fund in which the Company holds a portion of its cash
invests in only investment grade money market instruments from a variety of
industries, and therefore bears minimal risk. The average maturity of the
investments held by the money market fund is approximately two months.
Short-Term Investments. The Company classifies any short-term investments
into one of the following categories:
57
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 on 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. The
Company had no short term investments at March 31, 2005 or 2004.
Accounts Receivable. The Company provides credit terms 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 it's 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 our historical experience of bad debt expense
and the aging of our accounts receivable balances, net of deferred revenue and
specifically reserved accounts. Accounts are written off as uncollectible only
after the Company has expended extensive collection efforts.
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 consist of hardware for specific customer orders
and spare parts, and are valued at lower of cost (first-in, first-out) or
market. Management provides a reserve to reduce inventory to its net realizable
value.
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, generally by the straight-line
method. Useful lives range as follows:
Computers and electronic test equipment 3-5 years
Furniture and fixtures 5-7 years
Vehicles 7 years
Leasehold improvements lesser of lease term or estimated useful life of asset
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 Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed" (SFAS 86). Such capitalized costs are
amortized on a straight line basis over the estimated economic life of the
related product, of 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 follows Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142).
This statement applies to the
58
amortization of goodwill and other intangible assets. The Company ceased
amortizing amounts related to goodwill effective April 1, 2001. The balance of
goodwill is related to the NextGen Division. Under SFAS 142, management is
required to perform an annual assessment of the implied fair value of goodwill
and intangible assets with indefinite lives for impairment. The Company compared
the fair value of the NextGen Division with the carrying amount of its assets
and determined that none of the goodwill recorded was impaired as of June 30,
2004 (the date of the Company's last annual impairment test). The fair value of
the NextGen Division was determined using an estimate of future cash flows for
the NextGen Division over ten years and risk adjusted discount rates of between
15 and 25 percent to compute a net present value of future cash flows.
Long Lived Assets. The Company follows 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 Standard No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" (SFAS 121), and Accounting Principles Board 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" (APB 30). Management periodically reviews the carrying
value of long-lived assets to determine whether or not impairment to such value
has occurred and has determined that there was no impairment at March 31, 2005.
Income Taxes. Income taxes are provided for the tax effects of
transactions reported in the financial statements and consists of taxes
currently due plus deferred taxes related to differences between the basis of
assets and liabilities for financial and tax reporting. The deferred income 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 income 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 income tax assets when management
determines that it is more likely than not that the deferred assets will not be
realized.
Advertising Costs. Advertising costs are charged to operations as
incurred. The Company does not have any direct-response advertising. Advertising
costs, which includes trade shows and conventions, were approximately $1,251,
$1,262 and $874 for the years ended March 31, 2005, 2004 and 2003, respectively,
and were included primarily in selling, general and administrative expenses in
the consolidated statements of income
Marketing Assistance Agreements. The Company has entered into marketing
assistance agreements with existing users of the Company's products which
provide the opportunity for those users to earn commissions if and only if they
host specific site visits upon our request for prospective customers which
directly result in a purchase of our software by the visiting prospects. Amounts
earned by existing users under this program are treated as a selling expense in
the period in which commissionable software has been recognized as revenue.
Earnings per Share. Pursuant to Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (SFAS 128), 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.
59
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,
------------------------------
2005 2004 2003
-------- -------- --------
Basic net income per share:
Net income ................................................. $ 16,109 $ 10,400 $ 7,035
Weighted average of common shares outstanding .............. 12,872 12,436 12,254
-------- -------- --------
Net income share ........................................... $ 1.25 $ 0.84 $ 0.57
======== ======== ========
Diluted net income per share:
Weighted average of common shares outstanding 12,872 12,436 12,254
Weighted average of common shares equivalents:
Weighted average options outstanding ....................... 331 530 524
-------- -------- --------
Weighted average number of common and common equivalent
shares ..................................................... 13,203 12,966 12,778
======== ======== ========
Net income per share ....................................... $ 1.22 $ 0.80 $ 0.55
======== ======== ========
Stock-Based Compensation. The Company accounts for stock-based employee
compensation as prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB No. 25), and has adopted the
disclosure provisions from the Statement of Financial Accounting Standards No.
148, "Accounting for Stock-Based Compensation-Transition and Disclosure" (SFAS
148) that supersedes Statement of 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, 2005, 2004 and 2003 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 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 on February 11,
2005 were made using the Black-Scholes option pricing model with the following
assumptions: expected life - approximately 57 months from the date of the grant;
stock volatility - 47.7% , risk free interest rate of 3.7% and, no dividends
during the expected term. Although the Company announced a one-time $1.50 per
share dividend on January 31, 2005, no commitment to any future dividends was
made at the time the dividend was announced and no commitment to any future
dividends exists as of the filing of the Company's annual report. The Company
had not paid a dividend to its shareholders prior to the one-time dividend
announced on January 31, 2005. Therefore, management believes that using a zero
dividend rate in the valuation of the stock options granted on February 11, 2005
is appropriate.
The Company's fair value calculations for options granted in fiscal years
ended 2005 and 2004 with the exception of the above grant on February 11, 2005,
were made using the Black-Scholes option pricing model with the following
assumptions: expected life - approximately 48 months from the date of the grant;
stock volatility - 55 to 57% , risk free interest rate of 3.0% ; and, no
dividends during the expected term. No options were granted in fiscal 2003.
60
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:
(in thousands, except for per share amounts) Year Ended March 31,
------------------------------
2005 2004 2003
-------- -------- -------
Net income ..................................... $ 16,109 $ 10,400 $ 7,035
Option compensation expense (net of taxes) ..... 272 189 --
Proforma option compensation cost (net of taxes) (1,483) (414) (322)
-------- -------- -------
Proforma net income ............................ 14,898 10,175 6,713
======== ======== =======
Reported basic net income per share ........ $ 1.25 $ 0.84 $ 0.57
Proforma basic net income per share ........ 1.16 0.82 0.55
Reported diluted net income per share ...... 1.22 0.80 0.55
Proforma diluted net income per share ...... 1.13 0.78 0.53
Fair value of option awards granted ............ $ 12,707 $ 2,078 $ --
Had the Company used a different methodology such as the binomial model to
value options, a different valuation may have been determined which may have
changed the proforma expense.
Segment Disclosures. The Company presents reporting information regarding
operating segments in accordance with Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" (SFAS 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 accounting principles generally accepted in the United States of America
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
revenue 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 revenue. 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. In November 2004, the FASB issued Statement
of Financial Accounting Standards No. 151 "Inventory Costs - an amendment of ARB
No. 43, Chapter 4" (SFAS 151) to clarify the accounting for abnormal amount of
idle facility expense, freight, handling costs and wasted material. This
statement requires that those items be recognized as current period charges. In
addition, this statement requires that allocation of fixed production overhead
to the costs of conversion be based on the normal capacity of the production
facilities. SFAS 151 is effective for inventory costs incurred during fiscal
years beginning after June 15, 2005. The Company does not expect the adoption of
SFAS 151 to have material effect on its financial statements.
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment"
(SFAS 123R) which is a revision of SFAS 123. Statement 123R supersedes APB 25
and amends Statement of Financial Accounting Standards No. 95, "Statement of
Cash Flows" (SFAS 95). SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values and the pro forma disclosure alternative is
no longer allowable under Statement 123R. Subsequently, in April 2005, the
Securities and Exchange Commission (SEC) changed the effective date from the
first interim or annual reporting period beginning after June 15, 2005 to the
first annual reporting period beginning after June 15, 2005, which for the
Company will be fiscal year 2007. The Company has not completed the process of
evaluating the impact that will result from adopting SFAS 123R and is
61
therefore unable to disclose the impact that adoption will have on the Company's
financial position and results of operations.
3. Intangible Assets - Capitalized Software Costs
As of March 31, 2005 and 2004, the Company had the following amounts
related to intangible assets with definite lives:
(in thousands) As of March 31,
------------------
2005 2004
-------- --------
Capitalized software development (3 yrs):
Gross carry amount ....................................... $ 13,287 $ 10,610
Accumulated amortization ................................. (8,953) (7,002)
-------- --------
Net capitalization software development .................. $ 4,334 $ 3,608
======== ========
Aggregate amortization expense during year ended March 31. $ 1,952 $ 1,490
======== ========
Information related to net capitalized software costs is as follows:
(in thousands) As of March 31,
------------------
2005 2004
-------- --------
Beginning of year .......................................... $ 3,608 $ 2,511
Capitalization ............................................. 2,678 2,587
Amortization ............................................... (1,952) (1,490)
-------- --------
End of year ................................................ $ 4,334 $ 3,608
======== ========
The following table represents the remaining estimated amortization of
intangible assets with determinable lives as of March 31, 2005 (in thousands):
For the year ended March 31,
- ----------------------------
2006 ..................................................... $ 2,055
2007 ..................................................... 1,574
2008 ..................................................... 705
--------
Total $ 4,334
========
4. Cash and Cash Equivalents
At March 31, 2005 and 2004, the Company had cash and cash equivalents of
$51,157 and $51,395, respectively, invested in both a major national brokerage
firm's institutional fund that specializes in U.S. government securities and
commercial paper with high credit ratings, and short term U.S. treasury
securities.
Investment income for each of the three years ended March 31 consists of
the following:
(in thousands) Year Ended
---------------------------------------------------
March 31, 2005 March 31, 2004 March 31, 2003
-------------- -------------- --------------
Investment income .... $ 876 $ 386 $ 434
62
5. Composition of Certain Financial Statement Captions
(in thousands) March 31,
--------------------
2005 2004
-------- --------
Accounts Receivable
Accounts receivable, excluding undelivered maintenance and services ..... $ 22,162 $ 13,075
Undelivered maintenance and services billed in advance, included in
deferred revenue ........................................................ 13,037 8,498
Reserved for bad debt ................................................... (1,837) (1,293)
-------- --------
Accounts receivable, net .......................................... $ 33,362 $ 20,280
======== ========
Inventories
Computer systems and components, net of reserve for obsolescence of $146
and $207, respectively .................................................. $ 891 $ 478
Replacement parts for certain client systems, net of accumulated
amortization of $849 and $684, respectively ............................. -- 221
Miscellaneous parts and supplies ........................................ 69 26
-------- --------
Inventories, net .................................................. $ 960 $ 725
======== ========
Equipment and Improvements
Computer and electronic test equipment .................................. $ 5,788 $ 4,568
Furniture and fixtures .................................................. 1,950 1,509
Vehicles ................................................................ -- 8
Leasehold improvements .................................................. 187 151
-------- --------
7,925 6,236
Accumulated depreciation and amortization ............................... (5,228) (4,224)
-------- --------
Equipment and improvements, net ................................... $ 2,697 $ 2,012
======== ========
Deferred Revenue
Maintenance ............................................................. $ 4,639 $ 3,794
Implementation services ................................................. 17,471 10,756
Undelivered software and other .......................................... 3,367 2,713
-------- --------
Deferred revenue .................................................. $ 25,477 $ 17,263
======== ========
Accrued Compensation and Related Benefits
Bonus ................................................................... $ 1,998 $ 1,435
Vacation ................................................................ 1,438 1,175
-------- --------
$ 3,436 $ 2,610
======== ========
Other current liabilities
Sales tax payable ....................................................... $ 726 $ 442
Commissions payable ..................................................... 625 356
Customer deposits ....................................................... 527 397
Accrued EDI expenses .................................................... 419 467
Professional services ................................................... 417 96
Deferred rent ........................................................... 198 352
Other accrued expenses .................................................. 1,109 749
-------- --------
$ 4,021 $ 2,859
======== ========
6. Income Taxes
During the year ended March 31, 2003, the Company filed amended federal
returns for the fiscal years ended March 31, 1999 through 2001 and certain state
tax returns for the fiscal years ended March 31, 1998 through 2001, to take
advantage of available tax credits related to its research and development
activities. The tax credits reported on the aforementioned returns resulted in
refund claims of $418 for federal and $158 for state income tax purposes.
Additionally, the Company claimed research and
63
development credits of $781 for the years ended March 31, 2002, 2003, and 2004
and has estimated $400 in tax credits for the year ended March 31, 2005.
The provision for income taxes for the year ended March 31, 2004 and 2003
accounted for a portion of the aggregate tax credits accumulated through the end
of each period due to the uncertainly concerning the ultimate amount of tax to
be credited. As of March 31, 2004, the Company had a balance of $505 in credits
which had not been recognized. In the quarter ended March 31, 2005, the state of
California completed an audit of the Company's tax returns and did not
materially change credits related to research and development. Based on the
results of that audit, the provision for income taxes for the year ended March
31, 2005 was offset by the recognition of the $505 in tax credits which had not
been recognized as of March 31 2004.
The provision for income taxes consists of the following components:
(in thousands) Year Ended
-------------------------------
March 31, March 31, March 31,
2005 2004 2003
-------- -------- --------
Current:
Federal taxes ................... $ 5,365 $ 5,551 $ 3,211
State taxes .................... 1,438 1,310 549
-------- -------- --------
Total .................. 6,803 6,861 3,760
-------- -------- --------
Deferred:
Federal taxes ................... 2,040 (179) 268
State taxes ..................... 537 (56) 30
-------- -------- --------
2,577 (235) 298
-------- -------- --------
Total ...................... $ 9,380 $ 6,626 $ 4,058
======== ======== ========
The provision for income taxes differs from the amount computed at the
federal statutory rate as follows:
(in thousands) Year Ended
-------------------------------
March 31, March 31, March 31,
2005 2004 2003
-------- -------- --------
Federal income tax statutory ........... 35.0% 35.0% 34.0%
Increase (decreases) resulting from:
State income taxes .................. 4.6 4.9 5.1
Research & development tax credits .. (4.3) (1.0) (1.9)
Other ............................... 1.5 -- (0.6)
-------- -------- --------
Effective income tax rate .............. 36.8% 38.9% 36.6%
======== ======== ========
64
The net deferred tax assets in the accompanying consolidated balance
sheets consist of the following at March 31, 2005 and 2004:
(in thousands) As of March 31,
-------------------
2005 2004
-------- --------
Deferred tax assets:
Deferred revenue and bad debt allowance ............ $ 1,081 $ 2,477
Inventory valuation 195 164
Purchased in-process research and development ...... 2,038 2,348
Intangible assets .................................. 118 118
Accrued compensation ............................... 903 716
Deferred compensation .............................. 517 442
Other .............................................. 102 147
-------- --------
Total deferred tax assets .................... 4,954 6,412
-------- --------
Deferred tax liabilities:
Accelerated depreciation ........................... (1,791) (927)
Capitalized software ............................... (1,469) (1,133)
State income taxes/Other ........................... (189) (269)
-------- --------
Total deferred tax liabilities ............... (3,449) (2,329)
-------- --------
Total deferred tax assets, net ............... $ 1,505 $ 4,083
======== ========
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. No valuation
allowance has been made against the deferred tax assets as the Company expects
to receive the full benefit of the assets recorded.
7. Employee Benefit Plans and Employment Agreements
The Company has a 401 (k) for the benefit of substantially all of its
employees. Participating employees may defer up to the IRS limit based on the
IRS Code per year. The annual contribution is determined by a formula set by the
Company's Board of Directors and may include matching and/or discretionary
contributions. The Retirement Plans may be amended or discontinued at the
discretion of the Board of Directors. Contributions of $162, $161 and $143 were
made by the Company to the retirement plan for the fiscal years ended March 31,
2005, 2004 and 2003, respectively.
The Company has a deferred compensation plan (the Deferral Plan) for the
benefit of officers and key employees. Participating employees may defer between
five and 50% 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 employee's deferrals together with
earnings thereon are accrued as part of the long-term liabilities of the
Company. Investment decisions are made by each participating employee from a
family of mutual funds. To offset this liability, the Company has purchased life
insurance policies on most of the participants. The Company is the owner and
beneficiary of the policies and the cash values are intended to produce cash
needed to help make the benefit payments to employees when they retire or
otherwise leave the Company. The values of the life insurance policies and the
cumulative liability for deferrals are included on the balance sheet of the
Company. . The net cash surrender value of the life insurance policies and an
equal amount of related Company obligation for deferred compensation was $1,202
and $1,013 at March 31, 2005 and 2004, respectively. The values of the life
insurance policies and the related Company obligation are included on the
balance sheet in other assets and other liabilities, respectively. The Company
made contributions of $13, $12 and $12 to the Deferral Plan for each of the
fiscal years ended March 31, 2005, 2004 and 2003, respectively.
The Company has a voluntary employee stock contribution plan for the
benefit of all full time employees. The plan is designed to allow employees to
acquire shares of the Company's common stock through automatic payroll
deduction. Each eligible employee may authorize the withholding of up to
65
10% of his/her gross payroll each pay period to be used to purchase shares on
the open market by a broker designated by the Company. In addition, the Company
will match 5% of each employee's contribution and will pay all brokerage
commissions and fees in connection with each purchase. The amount of the Company
match is discretionary and subject to change. The plan is not intended to be an
employee benefit plan under the Employee Retirement Income Security Act of 1974,
and is therefore not required to comply with that act. Contributions of
approximately $6, $3 and $1 were made by the Company for fiscal years ended
March 31, 2005, 2004 and 2003, respectively.
The Company has an Employment Agreement ("Agreement") with Mr. Louis E.
Silverman dated July 20, 2000 which details the terms of his employment as its
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) 12 months
worth of accelerated vesting of stock options granted pursuant to the agreement.
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) 12 months worth of accelerated vesting of stock options granted
pursuant to the agreement. 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 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% or 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 Sheldon Razin or Ahmed Hussein 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.
8. Employee Stock Option Plans
During fiscal 1990, the Company's shareholders approved a stock option
plan (the "1989 Plan") under which 2,000,000 shares of Common Stock were
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 may be subject to accelerated vesting under
certain circumstances. The 1989 Plan terminated on June 30, 1999, and there are
no outstanding options under this plan at March 31, 2005.
In September 1998, the Company's shareholders approved a stock option plan
(the "1998 Plan") under which 2,000,000 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 Board of Directors at the date of grant. Upon an
acquisition of the Company by merger or asset sale, each outstanding option may
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, 2005, 138,150 shares were available for future grant under the 1998 Plan. As
of March 31, 2005, there were 1,084,722 outstanding options related to this
plan.
66
On February 11, 2005, the Board of Directors granted 522,450 options under
the 1998 plan to selected employees and to Directors (7,000 for each Director)
at an exercise price equal to the market price of the Company's Common Stock on
the date of grant ($38.68 per share). The options granted to employees vest in
four annual installments beginning February 11, 2006 and expire on February 11,
2012. The options granted to Directors fully vested on May 11, 2005 and expire
on February 11, 2012. No compensation expense has been recorded for these
options.
On September 21, 2004, the Board of Directors granted 35,000 options under
the 1998 plan to Directors (5,000 for each Director) at an exercise price equal
to the market price of the Company's Common Stock on the date of the grant
($25.50 per share). The options fully vested on March 21, 2005 and expire on
September 21, 2009. No compensation expense has been recorded for these options.
On September 3, 2004, the Board of Directors granted 30,000 options under
the 1998 plan to selected employees at an exercise price equal to the market
price of the Company's Common Stock on the date of the grant ($23.71 per share).
The options vest in four equal annual installments beginning September 3, 2005
and expire on September 3, 2009. No compensation expense has been recorded for
these options.
On June 10, 2004, the Board of Directors granted 300,000 options under the
1998 plan to selected employees at an exercise price equal to the market price
of the Company's Common Stock on the date of the grant ($23.34 per share). The
options vest in four equal annual installments beginning June 10, 2005 and
expire on June 10, 2009. No compensation expense has been recorded for these
options.
On October 29, 2003, the Board of Directors granted 7,000 options under
the 1998 plan to Emad Zikry, a then Director of the Company, at an exercise
price of $3.50 per share, as director fees solely for his service on the Board
of Directors. The options vested immediately and expire on October 20, 2008.
This option grant resulted in compensation expense of approximately $130
recorded in the quarter ended December 31, 2003 using the intrinsic value
method.
On October 29, 2003, the Board of Directors granted 120,000 options under
the 1998 plan to employees at an exercise price of $7.73 per share. The options
vest in four equal annual installments beginning October 29, 2004 and expire on
October 29, 2008. Based on the closing share price of the Company's stock on
October 29, 2003 ($22.08 per share), this option grant will result in
compensation expense of up to $1,722 (assuming all employees granted options
continue their employment at the Company throughout the entire four year vesting
period) to be amortized evenly over the next four years ending October, 2007.
During the years ended March 31, 2005 and 2004, the Company recognized
compensation expense of $431 and $180 related to these options. During the years
ended March 31, 2005, 2004 and 2003, the Company received tax benefit from the
exercise of stock options of $2,680, $1,454 and $96, respectively.
A summary of option transactions under the 1989 & 1998 Plans for the three
years ended March 31, 2005 is as follows:
----------------------------------------------------------------------------
2005 2004 2003
---------------------- ---------------------- ------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- --------- --------- --------- ---------- ----------
Outstanding,
beginning of year 661,174 $ 5.26 896,154 4.37 990,966 $ 4.31
Granted 887,450 32.46 127,000 7.50 -- --
Exercised (460,278) 4.58 (346,480) 3.78 (94,812) 3.72
Canceled (3,624) 4.05 (15,500) 4.49 -- --
--------- --------- ----------
Outstanding,
end of year 1,084,722 $ 27.77 661,174 $ 5.26 896,154 $ 4.37
--------- ========= --------- ========= ---------- ==========
Available
for future grants 138,150 1,025,600 1,152,600
========= ========= ==========
67
The majority of the outstanding stock options vest ratably over a
four-year period commencing from the respective option grant dates. Stock
options outstanding at March 31, 2005 are summarized as follows:
Options Outstanding Options Exercisable
--------------------------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Price Outstanding Contractual Life Price Exercisable Price
- --------------------- ----------- ---------------- -------- ----------- --------
$ 3.50 to $ 7.73 197,272 2.44 $ 6.68 46,550 $ 5.46
23.34 to 25.50 365,000 4.17 23.57 35,000 25.50
$ 38.68 to $ 38.68 522,450 6.22 $ 38.68 -- $ --
9. Commitments and Contingencies
Litigation. The Company is a party to various legal proceedings incidental
to its business, none of which are considered by management to be material.
Rental Commitments. The Company leases facilities and offices under
irrevocable operating lease agreements expiring at various dates through March
2010. Rent expense for the years ended March 31, 2005, 2004, and 2003 was
$1,285, $1,226 and $1,068, respectively. Rental commitments under these
agreements are as follows:
Year Ending March 31,
- ---------------------
2006 ........................................ $ 1,257
2007 ........................................ 925
2008 ........................................ 942
2009 ........................................ 671
2010 ........................................ 206
--------
$ 4,001
========
Commitments & Guarantees. Software license agreements in both our QSI and
NextGen Divisions include a performance guarantee that our software products
will substantially operate as described in the applicable program documentation
for a period of 365 days after delivery. To date, we have not incurred any
significant costs associated with these warranties and do not expect to incur
significant warranty costs in the future. Therefore, no accrual has been made
for potential costs associated with these warranties.
We have historically offered short-term rights of return of less than 20
days in certain of our sales arrangements. Based on our historical experience
with similar types of sales transactions bearing these short-term rights of
return, we have not recorded any accrual for returns in our financial
statements.
Our standard sales agreements in the NextGen Division contain an
indemnification provision pursuant to which we indemnify, hold harmless, and
agree to reimburse the indemnified party for losses suffered or incurred by the
indemnified party in connection with any United States patent, any copyright or
other intellectual property infringement claim by any third party with respect
to our software. The QSI division arrangements occasionally utilize this type of
language as well. As we have not incurred any significant costs to defend
lawsuits or settle claims related to these indemnification agreements, we
believe that our estimated exposure on these agreements is currently minimal.
Accordingly, we have no liabilities recorded for these indemnification
obligations.
68
10. Fair Value of Financial Instruments
The Company's financial instruments include cash, accounts receivable,
accounts payable, deferred revenue and accrued liabilities. Management believes
that the fair value of cash, accounts receivable, accounts payable, deferred
revenue, and accrued liabilities approximate their carrying values due to the
short-term nature of these instruments.
11. Operating Segment Information
The Company has prepared operating segment information in accordance with
SFAS 131 "Disclosures About Segments of an Enterprise and Related Information"
to report components that are evaluated regularly by its chief operating
decision maker, or decision making group in deciding how to allocate resources
and in assessing performance. Reportable operating segments include the 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, are not allocated to the individual segments by
management. Management 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)
Unallocated Corp.
Year Ended March 31, QSI Division NextGen Division Expenses Consolidated
2005
Revenue ........................ $ 15,367 $ 73,594 $ -- $ 88,961
Operating income (loss) ........ 4,162 25,904 (5,453) 24,613
2004
Revenue. ....................... 16,491 54,443 -- 70,934
Operating income (loss) ........ 4,877 15,789 (4,026) 16,640
2003
Revenue ........................ 17,423 37,346 -- 54,769
Operating income (loss) ........ $ 4,675 $ 8,902 $ (2,918) $ 10,659
69
12. Selected Quarterly Operating Results (unaudited)
The following table presents quarterly unaudited consolidated financial
information for the eight quarters in the period ended March 31, 2005. 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 *
---------------------------------------------------------------------------------
(in thousands) Quarter Ended (Unaudited)
- -----------------------------------------------------------------------------------------------------------------------
6/30/03 9/30/03 12/31/03 3/31/04 6/30/04 9/30/04 12/31/04 3/31/05
------- ------- -------- ------- -------- ------- -------- --------
Software, hardware and supplies $ 7,819 $ 8,244 $ 8,068 $ 8,501 $ 8,819 $ 9,307 $ 9,781 $ 11,765
Implementation and training 1,655 1,782 1,791 1,665 2,265 2,300 1,889 2,402
------- ------- -------- ------- -------- ------- -------- --------
Total system sales 9,474 10,026 9,859 10,166 11,084 11,607 11,670 14,167
------- ------- -------- ------- -------- ------- -------- --------
Maintenance, EDI and other 6,832 7,616 8,340 8,621 9,046 9,610 10,418 11,359
------- ------- -------- ------- -------- ------- -------- --------
Total revenue 16,306 17,642 18,199 18,787 20,130 21,217 22,088 25,526
Cost of revenue:
------- ------- -------- ------- -------- ------- -------- --------
Software, hardware and supplies 1,972 2,603 1,966 1,600 2,352 1,692 1,384 2,097
------- ------- -------- ------- -------- ------- -------- --------
Implementation and training 1,253 1,129 1,427 1,388 1,392 1,579 1,575 1,754
------- ------- -------- ------- -------- ------- -------- --------
Total cost of system sales 3,225 3,732 3,393 2,988 3,744 3,271 2,959 3,851
------- ------- -------- ------- -------- ------- -------- --------
Cost of maintenance, EDI and
other 3,385 3,760 4,130 4,060 4,357 4,666 4,556 5,265
------- ------- -------- ------- -------- ------- -------- --------
Total cost of revenue 6,610 7,492 7,523 7,048 8,101 7,937 7,515 9,116
------- ------- -------- ------- -------- ------- -------- --------
Gross profit 9,696 10,150 10,676 11,739 12,029 13,280 14,573 16,410
Selling, general, & administrative 4,740 4,768 4,902 5,072 4,953 5,414 6,420 7,989
Research and development 1,366 1,502 1,628 1,643 1,612 1,818 1,707 1,766
------- ------- -------- ------- -------- ------- -------- --------
Income from operations 3,590 3,880 4,146 5,024 5,464 6,048 6,446 6,655
Investment income 100 89 95 102 120 170 263 323
------- ------- -------- ------- -------- ------- -------- --------
Income before provision for
income taxes 3,690 3,969 4,241 5,126 5,584 6,218 6,709 6,978
Provision for income taxes 1,413 1,561 1,630 2,022 2,202 2,503 2,488 2,187
------- ------- -------- ------- -------- ------- -------- --------
Net income $ 2,277 $ 2,408 $ 2,611 $ 3,104 $ 3,382 $ 3,715 $ 4,221 $ 4,791
======= ======= ======== ======= ======== ======= ======== ========
Net income per share - basic* $ 0.18 $ 0.20 $ 0.21 $ 0.25 $ 0.27 $ 0.29 $ 0.33 $ 0.37
Net income per share - diluted* $ 0.18 $ 0.19 $ 0.20 $ 0.24 $ 0.26 $ 0.28 $ 0.32 $ 0.36
Weighted average shares
outstanding - basic 12,314 12,334 12,478 12,624 12,666 12,780 12,952 13,089
Weighted average shares
outstanding - diluted 12,932 12,982 13,098 13,164 13,154 13,196 13,282 13,370
* will not add to annual EPS due to rounding
70
Schedule II
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(in thousands)
Additions
Balance at Charged to
Beginning Costs and Balance at
For the Year Ended of Period Expenses Deductions End of Period
March 31, 2005 ............ $ 1,293 $ 797 $ (253) $ 1,837
March 31, 2004 ............ $ 990 $ 647 $ (344) $ 1,293
March 31, 2003 ............ $ 813 $ 623 $ (446) $ 990
ALLOWANCE FOR INVENTORY OBSOLESCENSE
(in thousands)
Additions
Balance at Charged to
Beginning Costs and Balance at
For the Year Ended of Period Expenses Deductions End of Period
March 31, 2005 ............ $ 207 $ 160 $ (221) $ 146
March 31, 2004 ............ $ 160 $ 54 $ (7) $ 207
March 31, 2003 ............ $ 127 $ 40 $ (7) $ 160
71
INDEX TO EXHIBITS
3.1.1 Amendment to Articles of Incorporation, effective March 4, 2005.
3.6 Bylaws of the Company, as amended and restated.
10.6.1 Form of Indemnification Agreement for directors and executive officers
authorized January 27, 2005.
10.10.1 Amended and Restated 1998 Stock Option Plan.
10.19 Lease Agreement between the Company and Lakeshore Towers Limited
Partnership Phase IV, a California limited partnership.
23.1 Consent of Independent Registered Public Accounting Firm - Grant
Thornton LLP.
31.1 Certification of Chief Executive Officer 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.
31.2 Certification of Chief Financial Officer 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.
72
QUALITY SYSTEMS, INC.
LIST OF SUBSIDIARIES
1. NextGen Healthcare Information Systems, Inc, Inc., a California
corporation, is a wholly-owned subsidiary of Quality Systems, Inc.
73