UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q/A10-Q


 

(Mark One)

xQUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 20032004

 

or

 

¨TRANSITION REPORT PURSUANT OF SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                    

 

Commission File Number: 000-50082

 


 

IMPAC MEDICAL SYSTEMS, INC.


 

Delaware 94-3109238

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

100 West Evelyn Avenue, Mountain View, California 94041

(Address of principle executive offices)

 

(650) 623-8800

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 


 

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.    x  Yes    ¨  Yes    x  No

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    x  Yes    ¨  Yes    x  No

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  ¨

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock outstanding as of April 22, 2003May 10, 2004

 9,401,4449,904,824

 



Explanatory Note

The purpose of this Amendment No. 1 on Form 10-Q/A to the Quarterly Report on Form 10-Q of IMPAC Medical Systems, Inc. (the “Company”) for the quarter ended March 31, 2003 is to restate our consolidated financial statements at and for the three and six months ended March 31, 2003 and 2002, and related disclosures, including the selected financial data included herein as of and for the three and six months ended March 31, 2003 and 2002.

Generally, no attempt has been made in this Amendment No. 1 to modify or update other disclosures presented in the original report on Form 10-Q except as required to reflect the effects of the restatement. This Form 10-Q/A generally does not reflect events occurring after the filing of the original Form 10-Q or modify or update those disclosures affected by subsequent events. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the original filing of the Form 10-Q on April 25, 2003. Accordingly, this Form 10-Q/A should be read in conjunction with our filings made subsequent to the filing of the original Form 10-Q, including any amendments to those filings. The following items have been amended as a result of the restatement:

Part I – Item 1 – Condensed Consolidated Financial Statements;

Part I – Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations;

Part I – Item 4 – Controls and Procedures; and

Part II – Item 6 – Exhibits Reports on Form 8-K.

Our Chief Executive Officer and Chief Financial Officer have also reissued their certifications required by Sections 302 and 906 of the Sarbanes-Oxley Act.

We have restated our financial results for the three and six months ended March 31, 2003 and 2002 to conform certain of our revenue recognition policies to Statement of Position (SOP) 97-2 “Software Revenue Recognition.” As a result of the restatement, some previously recognized revenues have been shifted to later quarters and others have been reclassified to deferred revenue and will be recognized in periods subsequent to March 31, 2003 in accordance with SOP 97-2. The restatement does not impact previously reported total cash flows from operations. As a result of the impact of changes in the timing of revenue recognition, net sales decreased by $2.6 million and $2.3 million in the three months ended March 31, 2003 and 2002, respectively, and by $3.7 million and $2.1 million in the six months ended March 31, 2003 and 2002, respectively, with corresponding increases in deferred revenue. We also deferred the recognition of the related direct incremental commission expense and certain direct incremental travel expenses associated with installations at customer sites as well as the federal income tax provision (benefit) and allowance for doubtful accounts. Net income decreased by $1.4 million and $1.3 million in the three months ended March 31, 2003 and 2002, respectively, and by $2.0 million and $1.2 million in the six months ended March 31, 2003 and 2002, respectively.

Additional detail regarding the restatement is included in Note 7 of the Notes to the Condensed Consolidated Financial Statements included in Part I – Item 1 of this Amendment No. 1 on Form 10-Q/A.

i


TABLE OF CONTENTS

 

      Page

PART I. FINANCIAL INFORMATION   

Item 1.

  Condensed Consolidated Financial Statements (unaudited)  1
   Condensed Consolidated Balance Sheets as of March 31, 20032004 and September 30, 20022003  1
   Condensed Consolidated Statements of Operations for the Three and Six Months Ended March 31, 20032004 and 20022003  2
   Condensed Consolidated Statements of Cash Flows for the Six Months Ended March 31, 20032004 and 20022003  3
   Notes to Condensed Consolidated Financial Statements  4

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations  119

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk  2125

Item 4.

  Controls and Procedures  2225
PART II. OTHER INFORMATION   

Item 1.

  Legal Proceedings  2426

Item 2.

  Changes in Securities, and Use of Proceeds and Issuer Purchases of Equity Securities  2426

Item 3.

  Defaults Upon Senior Securities  2426

Item 4.

  Submission of Matter to a Vote of Securities Holders  2426

Item 5.

  Other Information  2426

Item 6.

  Exhibits and Reports on Form 8-K  2426

Signatures

  2528

 

ii


Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

 

The statements contained in this Form 10-Q/A10-Q that are not purely historical are forward looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Company’s expectations, beliefs, hopes, intentions or strategies regarding the future. Forward looking statements include statements regarding the Company’s business strategy, timing of, and plans for, the introduction of new products and enhancements, future sales, market growth and direction, competition, market share, revenue growth, operating margins and profitability. All forward looking statements included in this document are based upon information available to the Company as of the date hereof, and the Company assumes no obligation to update any such forward looking statement. Actual results could differ materially from the Company’s current expectations. Factors that could cause or contribute to such differences include the Company’s ability to expand outside the radiation oncology market or expand into international markets, our inability to recognize revenue from multiple element software contracts where certain elements have been delivered, installed and accepted but other elements remain undelivered, lost sales or lower sales prices due to competitive pressures, the ability to integrate its products successfully with related products and systems in the medical services industry, reliance on distributors and manufacturers of oncology equipment to market its products, changes in Medicare reimbursement policies, the integration and performance of acquired businesses, and other factors and risks discussed in the Company’s10-K/A and other reports filed by the Company from time to time with the Securities and Exchange Commission.

 

iiii


PART I. FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

Item 1.Condensed Consolidated Financial Statements (unaudited)

 

IMPAC MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

  

March 31,

2003


 

September 30,

2002


   March 31,
2004


  September 30,
2003


 
(In thousands)  (Restated)     
  (See Note 7) 

Assets

         

Current assets:

         

Cash and cash equivalents

  $48,227  $23,432   $37,560  $57,979 

Available-for-sale securities

   458   385    3,905   7,052 

Accounts receivable, net

   12,555   8,086    19,612   12,100 

Unbilled accounts receivable

   905   —   

Inventories

   64   86    68   66 

Deferred income taxes, net

   5,354   4,098    6,966   6,334 

Income tax refund receivable

   685   686    —     339 

Prepaid expenses and other current assets

   4,296   4,316    5,809   4,667 
  


 


  

  


Total current assets

   71,639   41,089    74,825   88,537 
  


 


Available-for-sale securities

   3,265   3,156    3,762   2,719 

Property and equipment, net

   3,565   3,379    4,423   3,573 

Deferred income taxes

   864   864    1,116   1,137 

Goodwill and other intangible assets, net

   1,704   1,892 

Goodwill

   14,759   654 

Other intangible assets, net

   8,855   918 

Other assets

   529   341    477   459 
  


 


  

  


Total assets

  $81,566  $50,721   $108,217  $97,997 
  


 


  

  


Liabilities, Redeemable Convertible Preferred Stock, Common Stock Subject to Rescission Rights and Stockholders’ Equity   
Liabilities, Common Stock Subject to Rescission Rights and Stockholders’ Equity      

Current liabilities:

         

Customer deposits

  $9,585  $9,829   $11,243  $10,900 

Accounts payable

   976   872    756   864 

Accrued liabilities

   3,197   3,252    3,355   4,758 

Income taxes payable

   998   1,950    2,485   2,353 

Deferred revenue

   23,384   18,043    36,343   27,079 

Capital lease obligations

   69   65    1   74 
  


 


  

  


Total current liabilities

   38,209   34,011    54,183   46,028 
  


 


Customer deposits

   92   92    266   232 

Capital lease obligations, non-current

   79   114    —     41 
  


 


  

  


Total liabilities

   38,380   34,217    54,449   46,301 
  


 


Redeemable convertible preferred stock

   —     14,489 
  


 


  

  


Common stock subject to rescission rights

   98   —      —     98 
  


 


  

  


Stockholders’ equity:

         

Preferred stock

   —     —      —     —   

Common stock

   9   6    10   10 

Additional paid-in capital

   42,748   1,144    49,083   47,792 

Accumulated other comprehensive loss

   (20)  (1)

Accumulated other comprehensive income (loss)

   7   (16)

Retained earnings

   351   866    4,668   3,812 
  


 


  

  


Total stockholders’ equity

   43,088   2,015    53,768   51,598 
  


 


  

  


Total liabilities, redeemable convertible preferred stock, common stock subject to rescission rights and stockholders’ equity

  $81,566  $50,721 

Total liabilities, common stock subject to rescission rights and stockholders’ equity

  $108,217  $97,997 
  


 


  

  


 

The accompanying notes are an integral part of these condensed consolidated financial statements.

IMPAC MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

  Three Months Ended
March 31,


 Six Months Ended
March 31,


 
  Three Months Ended
March 31,


 Six Months Ended
March 31,


   2004

 2003

 2004

 2003

 
(In thousands, except per share data)  2003

 2002

 2003

 2002

           
  

(Restated)

(See Note 7)

 

(Restated)

(See Note 7)

 

Sales:

      

Software license and other, net

  $7,818  $6,176  $14,525  $11,536   $8,559  $7,818  $16,897  $14,525 

Maintenance and services

   4,872   3,376   9,325   6,825    6,873   4,872   12,926   9,325 
  


 


 


 


  


 


 


 


Total net sales

   12,690   9,552   23,850   18,361    15,432   12,690   29,823   23,850 

Cost of sales:

      

Software license and other, net

   2,363   1,907   4,357   3,645    3,449   2,363   6,379   4,357 

Maintenance and services

   1,674   950   3,375   1,798    2,512   1,674   4,715   3,375 
  


 


 


 


  


 


 


 


Total cost of sales

   4,037   2,857   7,732   5,443    5,961   4,037   11,094   7,732 
  


 


 


 


  


 


 


 


Gross profit

   8,653   6,695   16,118   12,918    9,471   8,653   18,729   16,118 
  


 


 


 


  


 


 


 


Operating expenses:

      

Research and development

   2,358   2,019   4,470   3,735    3,009   2,358   5,440   4,470 

Sales and marketing

   3,324   2,961   6,485   5,810    3,861   3,324   7,869   6,485 

General and administrative

   1,428   1,178   2,539   1,977    1,859   1,428   3,094   2,539 

Amortization of intangible assets

   103   130   205   221    581   103   701   205 

Write-off of purchased in-process research and development

   —     —     557   —   
  


 


 


 


  


 


 


 


Total operating expenses

   7,213   6,288   13,699   11,743    9,310   7,213   17,661   13,699 
  


 


 


 


  


 


 


 


Operating income

   1,440   407   2,419   1,175    161   1,440   1,068   2,419 

Interest expense

   (5)  (7)  (11)  (14)   (1)  (5)  (4)  (11)

Interest and other income

   143   89   226   204    102   143   250   226 
  


 


 


 


  


 


 


 


Income before provision for income taxes

   1,578   489   2,634   1,365    262   1,578   1,314   2,634 

Provision for income taxes

   (551)  (169)  (920)  (472)   (92)  (551)  (460)  (920)
  


 


 


 


  


 


 


 


Net income

   1,027   320   1,714   893    170   1,027   854   1,714 

Accretion of redeemable convertible preferred stock

   —     (3,178)  (2,229)  (4,982)   —     —     —     (2,229)
  


 


 


 


  


 


 


 


Net income (loss) available for common stockholders

  $1,027  $(2,858) $(515) $(4,089)  $170  $1,027  $854  $(515)
  


 


 


 


  


 


 


 


Net income (loss) per common share:

      

Basic

  $0.11  $(0.47) $(0.06) $(0.68)  $0.02  $0.11  $0.09  $(0.06)
  


 


 


 


  


 


 


 


Diluted

  $0.10  $(0.47) $(0.06) $(0.68)  $0.02  $0.10  $0.08  $(0.06)
  


 


 


 


  


 


 


 


Weighted-average shares used in computing net income (loss) per common share:

      

Basic

   9,340   6,027   8,394   6,026    9,863   9,340   9,810   8,394 
  


 


 


 


  


 


 


 


Diluted

   9,913   6,027   8,394   6,026    10,315   9,913   10,277   8,394 
  


 


 


 


  


 


 


 


 

The accompanying notes are an integral part of these condensed consolidated financial statements.

IMPAC MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

  Six Months Ended
March 31,


   Six Months Ended
March 31,


 
  2003

 2002

   2004

 2003

 
(In thousands)  

(Restated)

(see Note 7)

     

Cash flows from operating activities:

      

Net income

  $1,714  $893   $854  $1,714 

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization of property and equipment

   811   698    939   811 

Amortization of goodwill and other intangible assets

   205   220 

Amortization of intangible assets

   701   205 

Write-off of purchased in-process research and development

   557   —   

Provision for doubtful accounts

   64   46    66   64 

Deferred income taxes

   —     51    (631)  —   

Loss on disposal of property and equipment

   101   —      —     101 

Gain from sale of investment

   —     (8)

Changes in assets and liabilities, net of effects of acquisitions:

      

Accounts receivable

   (4,550)  (1,080)   (5,921)  (4,550)

Unbilled accounts receivable

   58   —   

Inventories

   21   —      (2)  21 

Prepaid expenses and other current assets

   24   (516)   (1,127)  24 

Other assets

   (190)  (2)   19   (190)

Customer deposits

   (244)  639    377   (244)

Accounts payable

   106   24    (471)  106 

Accrued liabilities

   (55)  (513)   (1,406)  (55)

Income tax payable/refund receivable

   (2,217)  (438)   471   (2,217)

Deferred revenue

   5,357   3,344    5,578   5,357 
  


 


  


 


Net cash provided by operating activities

   1,147   3,358    62   1,147 
  


 


  


 


Cash flows from investing activities:

      

Acquisition of property and equipment

   (1,149)  (560)   (1,112)  (1,149)

Proceeds from disposal of property and equipment

   51   —      —     51 

Payments for MC2 acquisition, net

   —     (500)

Proceeds from sale of investment

   —     44 

Payments for the acquisition of Tamtron and MRS product lines

   (22,494)  —   

Purchases of available-for-sale securities

   (16,634)  (4,271)   (23,587)  (16,634)

Proceeds from sales of available-for-sale securities

   16,387   3,790    14,044   16,387 

Proceeds from maturities of available-for-sale securities

   66   480    11,635   66 
  


 


  


 


Net cash used in investing activities

   (1,279)  (1,017)   (21,514)  (1,279)
  


 


  


 


Cash flows from financing activities:

      

Principal payments on capital leases

   (31)  (28)   (194)  (31)

Proceeds from the issuance of common stock, net

   24,986   38    1,194   24,986 

Repurchase of common stock

   —     (21)
  


 


  


 


Net cash provided by (used in) financing activities

   24,955   (11)

Net cash provided by financing activities

   1,000   24,955 
  


 


  


 


Net increase in cash and cash equivalents

   24,823   2,330 

Effect of exchange rates on cash

   (28)  —      33   (28)

Net increase (decrease) in cash and cash equivalents

   (20,419)  24,795 

Cash and cash equivalents at beginning of period

   23,432   12,456    57,979   23,432 
  


 


  


 


Cash and cash equivalents at end of period

  $48,227  $14,786   $37,560  $48,227 
  


 


  


 


 

The accompanying notes are an integral part of these condensed consolidated financial statements.

IMPAC MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 1 – 1—Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of IMPAC Medical Systems, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended March 31, 20032004 are not necessarily indicative of the results that may be expected for the year ending September 30, 2003,2004, or for any future period. The balance sheet at September 30, 20022003 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These financial statements and notes should be read with the financial statements and notes thereto for the year ended September 30, 20022003 included in the Company’s Form 10-K/A for the fiscal year ended September 30, 2003.

 

NOTE 2 – 2—Public Offerings

Initial Public Offering

 

On November 20, 2002, the Company completed an initial public offering in which it sold 1,875,000 shares of common stock at $15.00 per share for net cash proceeds of approximately $24,400,000,$24,300,000, net of underwriting discounts, commissions and other offering costs. Upon the closing of the offering, all of the Company’s outstanding shares of redeemable convertible preferred stock automatically converted into 1,238,390 shares of common stock. In addition to the shares sold by the Company, an additional 312,500 shares were sold by selling stockholders on the date of the offering and 328,125 shares were sold by selling stockholders in the exercise of the underwriters’ over-allotment option during December 2002. The Company did not receive any proceeds from the sale of shares by the selling stockholders or the exercise of the over-allotment.

Secondary Public Offering

On May 12, 2003, the Company completed a secondary offering in which it sold 200,000 shares of common stock at $19.00 per share for net cash proceeds of approximately $3,200,000, net of underwriting discounts, commissions and other offering costs. In addition to the shares sold by the Company, 2,178,223 shares were sold by selling stockholders on the date of the offering and 356,733 shares were sold by selling stockholders in the exercise of the underwriters’ over-allotment option during May 2003. The Company did not receive any proceeds from the sale of shares by the selling stockholders or from the exercise of the over-allotment option.

 

NOTE 3 – 3—Significant Accounting Policies

The Company’s significant accounting policies are disclosed in the Company’s Form 10-K/A for the fiscal year ended September 30, 2003. With the exception of the new significant accounting policies set forth below, the Company’s significant accounting policies have not materially changed as of March 31, 2003.

 

Inventories

 

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. As of March 31, 20032004 and September 30, 2002,2003, inventories are comprised entirely of finished goods.

Goodwill and other intangible assets

Goodwill and other intangible assets, including customer lists and acquired workforce, are stated at cost and were amortized on a straight-line basis over their estimated useful lives of generally two to five years. Effective October 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” which establishes financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board Opinion No. 17 (“APB No. 17”), “Intangible Assets.” In accordance with SFAS No. 142, the Company has ceased amortizing goodwill and instead performs an assessment for impairment at least annually by applying a fair-value based test. The Company has also reclassified the unamortized balance of acquired workforce to goodwill. Accordingly, no goodwill or acquired or acquired workforce amortization was recognized during the three and six months ended March 31, 2003. The provisions of SFAS No. 142 also required the completion of a transitional impairment test within 12 months of adoption, with any impairment treated as a cumulative effect of change in accounting principle. During the first quarter of fiscal 2003, the Company completed the transitional impairment test, which did not result in impairment of recorded goodwill.

For comparative purposes, the following table illustrates the Company’s net income (loss) available for common stockholders adjusted to exclude goodwill and acquired workforce amortization expense as if amortization had ceased October 1, 2001 (in thousands, except per share data):

   

Three Months Ended

March 31,


  

Six Months Ended

March 31,


 
   2003

  2002

  2003

  2002

 
   

(Restated)

(See Note 7)

  

(Restated)

(See Note 7)

 

Net income (loss) available for common stockholders as reported

  $1,027  $(2,858) $(515) $(4,089)

Amortization of goodwill

   —     54   —     69 
   

  


 


 


Adjusted net income (loss) available for common stockholders

  $1,027  $(2,804) $(515) $(4,020)
   

  


 


 


Net income (loss) per common share, basic

                 

As reported

  $0.11  $(0.47) $(0.06) $(0.68)
   

  


 


 


As adjusted

  $0.11  $(0.47) $(0.06) $(0.67)
   

  


 


 


Net income (loss) per common share, diluted

                 

As reported

  $0.10  $(0.47) $(0.06) $(0.68)
   

  


 


 


As adjusted

  $0.10  $(0.47) $(0.06) $(0.67)
   

  


 


 


 

Redeemable convertible preferred stock

 

Upon the closing of the Company’s initial public offering, in November 2002, all outstanding shares of redeemable convertible preferred stock automatically converted into shares of common stock. Prior to the initial public offering,conversion, the carrying value of the redeemable convertible preferred stock was increased by periodic accretions using the effective interest method, so that the carrying amount would equal the redemption value at the redemption date. These increases were effected through charges against retained earnings.

Accounting for stock-based compensation

In December 2002,earnings and were carried out through the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123” (“SFAS No. 148”) which amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods ending after December 15, 2002.

The Company uses the intrinsic value method of APB Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” in accounting for its employee stock options, and presents disclosure of pro forma information required under SFAS No. 123, as amended by SFAS No. 148. No compensation expense is included in the net income (loss) available for common stockholders as reported during the three and six months ended March 31, 2003 and 2002.

Had compensation costs been determined based upon the fair value at the grant date, consistent with the methodology prescribed under SFAS No. 123, the Company’s total stock-based compensation cost, pro forma net loss attributable to common stockholders and pro forma net loss per common share, basic and diluted, would have been as follows (in thousands, except per share data):

   

Three Months Ended

March 31,


  

Six Months Ended

March 31,


 
   2003

  2002

  2003

  2002

 
   

(Restated)

(See Note 7)

  

(Restated)

(See Note 7)

 

Net income (loss) available for common stockholders as reported

  $1,027  $(2,858) $(515) $(4,089)

Less stock-based compensation cost under a fair value method

   (165)  (42)  (330)  (86)
   


 


 


 


Pro forma net income (loss) available for common stockholders

  $(862) $(2,900) $(845) $(4,175)
   


 


 


 


Net income (loss) per common share, basic

                 

As reported

  $0.11  $(0.47) $(0.06) $(0.68)
   


 


 


 


Pro forma

  $0.09  $(0.48) $(0.10) $(0.69)
   


 


 


 


Net income (loss) per common share, diluted

                 

As reported

  $0.10  $(0.47) $(0.06) $(0.68)
   


 


 


 


Pro forma

  $0.09  $(0.48) $(0.10) $(0.69)
   


 


 


 


The determination of fair value of all options granted after the Company’s initial public offering include an expected volatility factorclosing date. Because the redeemable convertible preferred stock automatically converted into common stock upon the closing of the initial public offering, the non-cash accretion charges are no longer required and will not be applied in addition to the risk free interest rate, expected term and expected dividends.future quarters.

 

Revenue recognition

 

The Company’s revenue is derived primarily from two sources: (i) software license revenue from sales to distributors and end users and (ii) maintenance and services revenue from providing software support, education and consulting services to end users. The Company typically requires deposits upon the receipt of a signed purchase and license agreement, which are classified as customer deposit liabilities on the Company’s consolidated balance sheet.

 

The Company accounts for sales of software and maintenance revenue under the provisions of Statement of Position 97-2, (“SOP 97-2”), “Software Revenue Recognition,” as amended. SOP 97-2 requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on vendor-specific objective evidence (“VSOE”) of the fair value of the delivered and/or undelivered elements. For hardware transactions where no software is involved, the Company applies the provisions of Staff Accounting Bulletin 101 “Revenue Recognition.”

 

The fee for multiple-element arrangements is allocated to each element of the arrangement, such as maintenance and support services, based on the relative fair values of the elements. The Company determines the fair value of each element in multi-element arrangements based on vendor-specific objective evidence for each element which is based on the price charged when the same element is sold separately. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue.

The Company recognizes revenue from the sale of software licenses when persuasive evidence of an arrangement exists, the product has been accepted, the fee is fixed or determinable, and collection of the resulting receivable is probable. Acceptance generally occurs after the product has been installed, training has occurred and the product is in clinical use at the customer site. For distributor related transactions, acceptance occurs with delivery of software registration keys to the distributor’s order fulfillment department.

The fee for multiple-element arrangements is allocated to each element of the arrangement, such as maintenance and support services, based on the relative fair values of the elements. The Company determines the fair value of each element in multi-element arrangements based on vendor-specific objective evidence for each element which is based on the price charged when the same element is sold separately. If evidence of fair value of all undelivered elements

exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue.

The first year of maintenance and support, which includes updates and support, for the Company’s software products is included in the purchase price. Upon revenue recognition, the Company defers 12% of the list price, which is the renewal rate, and recognizerecognizes that portion over the remaining term of the included maintenance and support period. Fair value of services, such as training or consulting, are based upon separate sales by the Company of these services to other customers. Payments received for maintenance and services are deferred and recognized as revenue ratably over the contract term. Training and consulting services are billed based on hourly rates, and are generally recognized as revenue as these services are performed. Amounts deferred for installed and accepted software products under multiple element arrangements where VSOE of the fair value for all undelivered elements does not exist, maintenance services and term software license agreements comprise the main components of deferred revenue.

 

For direct software sales licensed on a term basis, the initial term lasts from three to five years with annual renewals after the initial term. The customer pays a deposit typically equal to the initial annual fee upon signing the license agreement, and the Company invoices the customer for subsequent annual fees 60 days before the anniversary date of the signed agreement. The Company recognizes revenue for the annual fees under these term license agreements ratably over the applicable twelve-month period. The annual fee includes maintenance and support.

 

The Company recognizes revenue from third-party products and related configuration and installation services sold with its licensed software upon acceptance by the customer. The Company recognizes revenue from third-party products sold separately from its licensed software upon delivery.

 

In December 2003, the Company added a pathology information management system to its suite of product offerings with the acquisition of certain assets of Tamtron Corporation from IMPATH Inc. (see Note 6). Pathology information management systems involve significant implementation and customization efforts essential to the functionality of the related products. Accordingly, the Company recognizes the license and professional consulting services generated through the sale of pathology management information systems using the percentage-of-completion method using labor hours incurred as prescribed by SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts.” The progress toward completion is measured based on labor hours incurred as compared to total estimated hours to complete. The Company accounts for a change in estimate in the period the change was identified. Provisions for estimated contract losses are recognized in the period in which the loss becomes probable and can be reasonably estimated.

The Company has also entered into an application service provider agreement whereby the Company provides all software, equipment and support during the term of the agreement. Revenues are recognized ratably over the term of the agreement, generally 60 months. Under the terms of these agreements,this agreement, the customers must pay for the final two months of the term up front. These deposits are classified as long termlong-term customer deposit liabilities on the Company’s consolidated balance sheet.

 

Accounting for stock-based compensation

The Company uses the intrinsic value method of APB Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” in accounting for its employee stock options, and presents disclosure of pro forma information required under SFAS No. 123, as amended by SFAS No. 148. No compensation expense is included in the net loss attributable to common stockholders as reported during the three and six months ended March 31, 2004 and 2003.

Had compensation costs been determined based upon the fair value at the grant date, consistent with the methodology prescribed under SFAS No. 123, the Company’s total stock-based compensation cost, pro forma net income (loss) available for common stockholders and pro forma net income (loss) per common share, basic and diluted, would have been as follows (in thousands, except per share data):

   

Three Months
Ended

March 31,


  

Six Months
Ended

March 31,


 
   2004

  2003

  2004

  2003

 

Net income (loss) available for common stockholders as reported

  $170  $1,027  $854  $(515)

Less stock-based compensation cost under a fair value method

   (534)  (165)  (807)  (330)
   


 


 


 


Pro forma net income (loss) available for common stockholders

  $(364) $862  $47  $(845)
   


 


 


 


Net income (loss) per common share, basic

                 

As reported

  $0.02  $0.11  $0.09  $(0.06)
   


 


 


 


Pro forma

  $(0.04) $0.09  $0.00  $(0.10)
   


 


 


 


Net income (loss) per common share, diluted

                 

As reported

  $0.02  $0.11  $0.08  $(0.06)
   


 


 


 


Pro forma

  $(0.04) $0.09  $0.00  $(0.10)
   


 


 


 


The determination of fair value of all options granted after the Company’s initial public offering include an expected volatility factor in addition to the risk free interest rate, expected term and expected dividends.

Other comprehensive lossincome (loss)

 

Comprehensive lossincome (loss) generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s unrealized gains and losses on available-for-sale securities and cumulative translation adjustments represent the components of comprehensive lossincome (loss) that were excluded from the net income (loss) available for common stockholders.

During the three and six months ended March 31, 2002, the only component of accumulated other Total comprehensive loss was the change in unrealized gains (losses) on available-for-sale securities, which was not significant. The following table lists the beginning balance, the change duringincome (loss) for the six months ended March 31, 2004 and 2003 and ending balance of each component of accumulated other comprehensive lossis presented in the following table (in thousands):

 

   

Unrealized
gains (losses)

on securities


  Foreign
currency
translation
adjustments


  Accumulated
other
comprehensive
loss


 

Balances, October 1, 2002

  $(1) $—    $(1)

Change during the three months ended December 31, 2002

   5   (6)  (1)

Change during the three months ended March 31, 2003

   (5)  (13)  (18)
   


 


 


Balances, March 31, 2003

  $(1) $(19) $(20)
   


 


 


   

Three Months
Ended

March 31,


  

Six Months
Ended

March 31,


 
   2004

  2003

  2004

  2003

 

Net income (loss) available for common stockholders

  $170  $1,027  $854  $(515)

Other comprehensive income:

                 

Change in unrealized gain (loss) on securities

   12   (5)  (12)  (1)

Foreign currency translation adjustment

   29   (13)  35   (19)
   

  


 


 


Comprehensive income (loss)

  $211  $1,009  $877  $(535)
   

  


 


 


 

During the three and six months ended March 31, 2003, the total comprehensive net income (loss), comprised of net income (loss) available for common stockholders and accumulated other comprehensive loss, was $1,009,000 and $(534,000) respectively.

Net income (loss) per common share

 

Basic net income (loss) per common share is computed by dividing net income (loss) available for common stockholders by the weighted-average number of vested common shares outstanding for the period. Diluted net income (loss) per common share is computed giving effect to all potential dilutive common stock, including options and redeemable convertible preferred stock.

 

A reconciliation of the numerator and denominator used in the basic and diluted net loss per share follows (in thousands).

 

  

Three Months Ended

March 31,


 

Six Months Ended

March 31,


 
  2003

  2002

 2003

 2002

   

Three Months
Ended

March 31,


  

Six Months

Ended

March 31,


 
  

(Restated)

(See Note 7)

 

(Restated)

(See Note 7)

   2004

  2003

  2004

  2003

 

Numerator:

                  

Net income

  $1,027  $320  $1,714  $893   $170  $1,027  $854  $1,714 

Accretion of redeemable convertible preferred stock

   —     (3,178)  (2,229)  (4,982)   —     —     —     (2,229)
  

  


 


 


  

  

  

  


Net income (loss) available for common stockholders

  $1,027  $(2,858) $(515) $(4,089)  $170  $1,027  $854  $(515)
  

  


 


 


  

  

  

  


Denominator:

                  

Weighted average shares used in computing basic net income (loss) per common share

   9,340   6,027   8,394   6,026    9,863   9,340   9,810   8,394 

Dilutive effect of options to purchase shares

   573   —     —     —      452   573   467   —   
  

  


 


 


  

  

  

  


Weighted average shares used in computing diluted net income (loss) per common share

   9,913   6,027   8,394   6,026    10,315   9,913   10,277   8,394 
  

  


 


 


  

  

  

  


 

The following outstanding options and redeemable convertible preferred stock were excluded from the computation of diluted net income (loss) per share as their effect is antidilutive (in thousands):antidilutive:

 

   March 31,

   2003

  2002

Options to purchase common stock

  5,357  345,242

Redeemable convertible preferred stock

  —    1,238,390
   

Three Months
Ended

March 31,


  

Six Months

Ended

March 31,


   2004

  2003

  2004

  2003

Options to purchase common stock

  9,670  10,833  8,497  5,357

 

Recent accounting pronouncements

 

In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. These consolidated financial statements comply with the disclosure requirements of this interpretation.

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. As the Company accounts for multiple element arrangements under the higher-level authoritative literature of Statement of Position No. 97-2, “Software Revenue Recognition,” as amended, the Company expects that the adoption of EITF Issue No. 00-21 will have no material impact on its financial position or on its results of operations.

In January 2003, the FASBFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.FIN 46, (“FIN 46”), “Consolidation of Variable Interest Entities,Entities”, an Interpretation of ARB No. 51.”51, which subsequently has been revised by FIN 46 requires certain variable46-R. The primary objectives of FIN 46-R are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (variable interest entities or VIEs) and how to be consolidated bydetermine when and which business enterprise should consolidate the VIE (the primary beneficiary of thebeneficiary). This new model for consolidation applies to an entity ifin which either (1) the equity investors in the entity(if any) do not have the characteristics of a controlling financial interest or do not have sufficient(2) the equity investment at risk for the entityis insufficient to finance itsthat entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 4646-R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46-R is effective immediately for all new variable interest entitiesVIEs created or acquired after January 31, 2003. For variable interest entities2003 and is effective for all VIEs created or acquired prior tobefore February 1, 2003 the provisions of FIN 46 must be applied forthat are Special Purpose Entities (SPEs) in the first interim or annualreporting period beginningending after JuneDecember 15, 2003.2003 and for all other VIEs created before February 1, 2003 in the first reporting period ending after March 15, 2004. The Company expects thatbelieves there are no entities qualifying as VIEs and the adoption of FIN 46 will46-R to date has not had any effect on the Company’s financial position, cash flows or results of operations.

In May 2003, the EITF reached a consensus on EITF Issue No. 03-05, “Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to Non-Software Deliverables in Arrangements Containing More-Than-Incidental Software”. EITF No. 03-05 addresses the applicability of Statement of

Position No. 97-2 regarding software and non-software deliverables in a multiple element arrangement, giving consideration to whether the deliverables are essential to the functionality of one another and whether the whole arrangement falls within SOP 97-2 as a result. EITF Issue No. 03-05 is effective for interim periods beginning after August 13, 2003. The adoption of EITF Issue No. 03-05 did not have noa material impact on itsthe Company’s financial position or on its results of operations.

 

NOTE 4 – 4—Commitments

 

Facilities

 

In addition to facility leases listed in our Form 10-K/A filed on April 16, 2004, the Company acquired certain assets and assumed certain liabilities of Tamtron Corporation and Medical Registry Services, Inc. on December 2002,23, 2003 (see Note 6). In connection with this acquisition, the Company assumed lease agreements for facilities in San Jose, California and Hackensack, New Jersey from that date forward. The lease for the San Jose, California location expired in March 2004 and was not renewed. The facility lease for the Hackensack, New Jersey location expires in July 2005. As of March 31, 2004, total minimum future payments under the Hackensack, New Jersey lease, payable in monthly installments, amounted to approximately $119,000.

In March 2004, the Company entered into a sublease agreement to lease additional office space in Cambridge, Massachusetts. The term of the sublease is three years from the commencement date of April 4, 2003. At the time of signing, total obligations under the sublease amounted to $1,077,180 or $359,060 per year, payable in equal monthly installments.

In February 2003, the Company executed an addendum to the existingnew facility lease to expand the corporate headquarters facility. The addendum terminates concurrently with the original leaseagreement in San Jose, California which expires in March 2007. At the timeAs of signing,March 31, 2004, total obligationsminimum future payments under the addendumthis lease, payable in monthly installments, amounted to $1,717,307, or $431,424 per year, payable in equal monthly installments.approximately $504,000.

 

NOTE 5 – 5—Common Stock Subject to Rescission Rights

 

Prior to the effectiveness of the Company’s registration statement for its initial public offering, an officer of the Company sent an email to 15 friends whom he had designated as potential purchasers of common stock in a directed share program in connection with the initial public offering. The email requested that the recipients send an indication of interest to the officer. The email was not accompanied by a preliminary prospectus and may have constituted a prospectus that does not meet the requirements of the Securities Act of 1933. The email was promptly followed by telephone conversations advising recipients that they could indicate an interest in purchasing shares only after they had received a preliminary prospectus. If the email did constitute a violation of the Securities Act of 1933, the recipients of the letter who purchased common stock in the Company’s initial public offering could have the right, for a period of one year from the date of their purchase of common stock, to obtain recovery of the consideration paid in connection with their purchase of common stock or, if they had already soldstock. For one year following the stock, sueoffering, the Company for damages resulting from their purchase of common stock. As of March 31, 2003, the Company has classified a total of 6,500 shares of common stock which have theseissued with rescission rights outside of stockholders’ equity, as the redemption features arewere not within the control of the Company. Any possible rescission rights would have lapsed in November 2003, and the 6,500 shares were reclassified to stockholders’ equity.

 

NOTE 6 – Stockholders’ Equity6—Acquisitions

 

Reincorporation

On October 29, 2002,December 23, 2003, the Company’s BoardCompany completed the acquisition of Directorscertain assets and stockholders approvedcertain liabilities of Tamtron Corporation (“Tamtron”) and Medical Registry Services, Inc. (“MRS”), the reincorporationPowerPath® pathology information management and cancer registry information system businesses of IMPATH Inc. for total cash consideration of $22.0 million and approximately $494,000 of acquisition costs. The acquisitions were made pursuant to an asset purchase agreement, dated November 24, 2003, by and among Tamtron, MRS and the Company. The Company intends to continue to operate each of the Company in the state of Delaware, which became effective on November 13, 2002. Under the terms of its Certificate of Incorporation, the Company is authorized to issue 60,000,000 shares of $0.001 par value common stock and 5,000,000 shares of $0.001 par value preferred stock. The Board of Directors has the authority to issue the undesignated preferred stock in one or more series and to fix the rights preferences, privileges and restrictions thereof. The accompanying condensed consolidated financial statements have been retroactively restated to give effect to the reincorporation.

NOTE 7 – Restatement of Financial Statementsacquired businesses.

 

The Company adopted Statementacquisition of Position (SOP) 97-2 “Software Revenue Recognition” which became effectiveassets and liabilities of Tamtron and MRS was accounted for in accordance with SFAS No. 141 “Business Combinations” using the Companypurchase method of accounting and, accordingly, the results of operations of Tamtron and MRS were included in October 1999 for the purposes of revenue recognition. Subsequent to filing the Form 10-Q for the quarter ended March 31, 2003, management determined that the Company had recognized revenue for certain transactions prematurely. Accordingly, the Company has restated itsCompany’s consolidated financial statements for the three and six months ended March 31, 2003 and 2002 to shift some previously recognized revenues to later quarters and to defer other previously recorded revenues to periods subsequent to March 31,December 23, 2003.

The accounting issues that gave risepurchase price was allocated to the restatement fell into three categories. First,net tangible and identifiable intangible assets acquired and the Company recognized revenue from certain multiple element software contracts once individual elements had been installed, accepted and were in clinical useliabilities assumed based on their estimated fair values at the customer site.date of acquisition as determined by management. The Company has now determined thatexcess of the Company did not have vendor specific objective evidence (“VSOE”) ofpurchase price over the fair value of the undelivered elements. Accordingly,net identifiable assets was allocated to goodwill. The purchase price was allocated as follows (in thousands):

Tangible assets

  $2,986 

Deferred revenue

   (3,692)

Other assumed liabilities

   (101)

Developed/core technology

   5,138 

Customer base

   3,032 

Tradename

   469 

In-process research and development

   557 

Goodwill

   14,105 
   


   $22,494 
   


The Company is amortizing developed/core technology, the customer base and tradename on a straight line basis over two to five years, five to seven years and two to six years, respectively. In accordance with SFAS No. 142, no amortization has been recorded on the goodwill. As a result of these acquisitions, the Company should have deferredexpects to recognize amortization expense of $1.0 million during the recognitionremainder of revenue on those contracts until thefiscal year 2004. The Company had VSOEexpects to recognize amortization expense of $2.0 million, $1.6 million, $1.4 million, $1.4 million and $638,000 during fiscal years 2005, 2006, 2007, 2008 and thereafter, respectively.

The fair value of the fair value for allidentifiable assets, including the undelivered elements, the elements for which VSOE of the fair value did not exist had subsequently been delivered or the elements for which VSOE did not exist had been canceled.

Second, the Company recognized revenue as of the date of first clinical use, unless a customer objected in writing within five business days after first clinical use. The Company has now determined that formal acceptance could not have occurred without the passage of five days, and, hence, the Company must adjust the date of revenue recognition of delivered and accepted products forward five business days from the date of first clinical use.

Third, the Company recognized revenue for maintenance and support of perpetually licensed software products during the first year by deferring 12%portion of the purchase price attributed to the developed/core technology, acquired in-process research and recognizing this amountdevelopment, the customer base and the tradename was determined by management. The income approach was used to value developed/core technology, acquired in-process research and development, the customer base and the tradename, which includes an analysis of the completion costs, cash flows, other required assets and risk associated with achieving such cash flows. Gross margins were estimated to be stable and operating expense ratios were estimated to slightly improve over the 12 months followingyears. The present value of the customer’s acceptance.cash flows for MRS was calculated with a discount rate of 15% for the developed/core technology, customer base and tradename, and 20% for the in-process research and development. The present value of the cash flows for Tamtron was calculated with a discount rate of 15% for the developed/core technology and customer base, 17.5% for the tradename and 20% for the in-process research and development.

The in-process research and development projects relate primarily to the development of additional modules to the pathology information system and additional features for the registry system and are expected to be completed over the next twelve months. The purchased in-process technology was not considered to have reached technological feasibility and it has no alternative future use. Accordingly, it was recorded as a component of operating expense. The revenues, expenses, cash flows and other assumptions underlying the estimated fair value of the acquired in-process research and development involve significant risks and uncertainties. The risks and uncertainties associated with completing the acquired in-process projects include retaining key personnel

and being able to successfully and profitably produce, market and sell related products. The Company has now determined that the Company should have deferred 12%does not know of any developments which would lead it to significantly change its original estimate of the current list price rather than purchase price.expected timing and commercial viability of these projects.

 

As a resultGoodwill of approximately $14.1 million represented the excess of the impactpurchase price over the fair value of changesthe net tangible and identifiable intangible assets acquired. The Company believes that its existing registry product offering along with the assets of MRS positions it as a leader in the timingmarket for data aggregation of revenue recognition, net sales decreased by $2.6 million and $2.3 million in the three months ended March 31, 2003 and 2002, respectively, and by $3.7 million and $2.1 million in the six months ended March 31, 2003 and 2002, respectively, with a corresponding increase in deferred revenue.cancer care information. The Company also deferredbelieves that the recognitionaddition of assets from Tamtron in the area of pathology information systems creates a more relevant and comprehensive product offering to its customers. The combination of both acquisitions allows the Company to better achieve its goal to provide a total solution that manages the complexity of cancer care throughout the spectrum of detection, diagnosis, treatment and follow-up.

Pro Forma Financial Information

The following pro forma financial information is based on the respective historical financial statements of the related direct incremental commission expenseCompany, Tamtron and certain direct incremental travel expenses associated with revenue now being deferred untilMRS. The pro forma financial information reflects the related revenue is recognizedconsolidated results of operations as if the acquisitions of Tamtron and consideredMRS occurred at the deferred revenuebeginning of each of the periods presented and includes the amortization of the identifiable intangible assets. The pro form data excludes non-recurring charges, such as in-process research and development of approximately $557,000 in the determinationquarter ended December 31, 2003. The pro forma financial data presented is not necessarily indicative of its allowancethe Company’s results of operations that might have occurred had the transaction been completed at the beginning of the periods presented, and do not purport to represent what the Company’s consolidated results of operations might be for doubtful accounts. The Company also revised its provision for income taxes for the effect of these matters.any future period (in thousands, except per share data).

 

As a result, the accompanying condensed consolidated financial statements have been restated from the amounts previously reported. A summary of the significant effects of the restatement is as follows:
   

Three Months Ended

March 31


  Six Months Ended
March 31,


 
   2003

  2004

  2003

 

Net sales

  $16,240  $32,639  $29,846 

Net income available for common stockholders

  $1,378  $1,490  $(444)

Net income per common share,

             

Basic

  $0.15  $0.15  $(0.05)

Diluted

  $0.14  $0.14  $(0.05)

Weighted-average shares used in computing net income per common share:

             

Basic

   9,340   9,810   8,394 

Diluted

   9,913   10,277   8,394 

   Three Months Ended March 31,

  Six Months Ended March 31,

 
   2003

  2002

  2003

  2002

 
   As Reported

  Restated

  As Reported

  Restated

  As Reported

  Restated

  As Reported

  Restated

 
   (in thousands except per share data) 

Consolidated Statement of

Operations Data:

                                 

Net sales

  $15,338  $12,690  $11,820  $9,552  $27,546  $23,850  $20,436  $18,361 

Gross profit

   11,126   8,653   8,834   6,695   19,593   16,118   14,903   12,918 

Operating income

   3,716   1,440   2,436   407   5,665   2,419   3,084   1,175 

Net income

   2,428   1,027   1,586   320   3,704   1,714   2,063   893 

Net income (loss) available to common stockholders

   2,428   1,027   (1,592)  (2,858)  1,475   (515)  (2,919)  (4,089)

Net income (loss) per common share:

                                 

Basic

  $0.26  $0.11  $(0.26) $(0.47) $0.18  $(0.06) $(0.48) $(0.68)
   

  

  


 


 

  


 


 


Diluted

  $0.24  $0.10  $(0.26) $(0.47) $0.16  $(0.06) $(0.48) $(0.68)
   

  

  


 


 

  


 


 


   

As of

March 31, 2003


  

As of

September 30, 2002


   As Reported

  Restated

  As Reported

  Restated

   (in thousands)

Consolidated Balance Sheet Data:

                

Allowance for doubtful accounts

  $706  $288  $520  $224

Prepaid expenses and other current assets

   2,934   4,296   3,281   4,316

Deferred income taxes, net

   1,576   6,218   1,576   4,962

Deferred revenue

   9,839   23,384   8,194   18,043

Retained earnings

   7,474   351   5,999   866

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our consolidated financial statements and the related notes appearing in our Form 10K/A for the fiscal year ended September 30, 2003. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth elsewhere in this Form 10-Q/A.10-Q.

 

The Management’s Discussion and Analysis of Financial Condition and Results of Operations presented below reflects the effects of the restatement of our condensed consolidated financial statementsbalance sheet as of March 31, 2003 and the condensed consolidated statement of operations for the three and six months ended March 31, 20022003 and 2003, as discussed in Note 7 tostatement of cash flows for the condensed consolidated financial statements.six months ended March 31, 2003.

 

Overview

 

We provide information technology systems for cancer care. Our systems provide electronic medical record, imaging, decision support, scheduling and billing applications in an integrated platform to manage the complexities of cancer care, from detection and diagnosis through treatment and follow-up. We were founded in 1990, and our growth has been primarily organic, supplemented by several product and small company acquisitions.

 

Recent Market Factors Affecting Business

Although our revenues in the first and second quarter of fiscal 2004 have increased over the comparable fiscal 2003 periods, the bookings in our core oncology point-of-care business, which constitutes the majority of our non-recurring revenue, have unexpectedly flattened over the last several months. We initially noted a softening of backlog in the first quarter of fiscal 2004, which, at the time, was within historical norms. However, bookings have remained soft in calendar 2004. We believe several factors are contributing to this softness.

First, on the radiation oncology front, all three linear accelerator manufacturers have introduced “next generation” devices which have new operator front-ends and require new integration strategies. This has created uncertainty in the marketplace as customers are not fully aware of the connectivity options and the device manufacturers have used it as a means to confuse the marketplace and bundle their proprietary solutions. Second, we are also facing increasing pressure from competitors who have bundled deals where the software component is being offered at significant discounts as we have seen price shifting from the software to the hardware components putting us at a pricing disadvantage. Third, the second quarter of fiscal 2004 also witnessed a consolidation of oncology software players with the two independent medical oncology IT players being acquired by radiation oncology companies. Fourth, Medicare reimbursement policies also continue to put a damper on oncology IT spending. Decreased reimbursements in the radiation oncology segment and anticipated reductions in the medical oncology segment have led to delays in purchasing as facilities re-examine their budgets and return on investment expectations. Fifth, over the last several months our accounting restatement had a minor effect on bookings as some of our competitors used the event to sell against us. Finally, if our new installation backlog continues to contract, we will have less installation scheduling flexibility, which will expose our revenue stream to quarterly fluctuations if customers are not willing to take installation due to, for example, construction or equipment delays.

Net Sales and Revenue Recognition

 

We sell our products directly throughout the world and primarily in North America, Europe and the Pacific Rim countries. In addition, we use non-exclusive distributors to augment our direct sales efforts. Sales through distributorsour primary distributor, Siemens Medical Systems, Inc., represented 7.5%12.2% and 8.7%9.9% of our total net sales in the three and six months ended March 31, 2003,2004, respectively, and 12.5%7.3% and 13.9%8.7% for the same periods in fiscal 2002, respectively, all of which were sold through Siemens Medical Systems, Inc.2003, respectively. The declineincrease in distributor sales as a percentage of net sales is primarily attributable to a higher growth rate in our directdistributor sales relative to non-distributor sales. We have signed agreements with other distributors, which have not yet generated sales. Revenues from the sale of our products and services outside the United States accounted for 5.6%7.4% and 5.9%4.9% of our net sales in the three and six months ended March 31, 2003,2004, respectively, and 7.8%5.5% and 9.3%5.8% of our net sales for the same periods in fiscal 2002,2003, respectively. The fiscal year to date decline in international sales as a percentage of net sales is primarily attributable to a higher growth rate in our domestic sales.

 

We license point-of-care and registry software products. Our point-of-care products are comprised of modules that process administrative, clinical, imaging and therapy delivery information. Our registry products aggregate data on patient outcomes for regulatory and corporate reporting purposes. Currently, a majority of our point-of-care software is licensed on a perpetual basis, and a majority of our registry sales is licensed on a term basis.

 

Our focus with regard to software licensing and maintenance and support service is to provide flexibility in the structure and pricing of our product offerings to meet the unique functional and financial needs of our customers. For those customers who license on a perpetual basis, we promote annual maintenance and support service agreements as an incremental investment designed to preserve the value of the customer’s initial investment. For those customers who license on a term basis, annual maintenance and support contributes greatly to the value of the annual license, and the two cannot be segregated from each other. For those customers using our application service provider option, independent of the licensing method, these annual fees allow the customer to outsource, in a cost effective manner, support and connectivity functions that are normally handled by internal resources.

 

The decision to implement, replace, expand or substantially modify an information system is a significant commitment for healthcare organizations. In addition, our systems typically require significant capital expenditures by the customer. Consequently, we experience long sales and implementation cycles. The sales cycle for our systems ranges from six to twenty-four months or more from initial contact to contract execution. Our implementation cycle generally ranges from three to nine months from contract execution to completion of implementation. In addition to the core system, approximately one-third of our customers purchase additional product modules along with the core system that they intend to implement over a period of time greater than beyond the typical implementation cycle of three to nine months.

We have experienced significant variations in revenues and operating results from quarter to quarter. Our quarterly operating results may continue to fluctuate due to a number of factors, including: the timing, size and complexity of our product sales and implementations; our inability to recognize revenue from multiple element software contracts where certain elements have been delivered, installed and accepted but other elements remain undelivered; construction delays at client centers which impact our ability to install products; the timing of installation of third party medical devices, including accelerators, simulation machines and imaging devices, at client sites, which must be installed before we can implement our systems; overall demand for healthcare information technology; and other factors discussed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors” section of our Annual Report on Form 10-K/A for the year ended September 30, 2003.

 

We record orders for products licensed on a perpetual basis upon the receipt of a signed purchase and license agreement, purchase order, and a substantial deposit. We record orders for products licensed on a term basis upon

receipt of a signed purchase and license agreement, purchase order and a deposit typically equal to the first year’s fees. All contract deposits are held as a liability as outlined in the terms and conditions set forth in the purchase and license agreement. Maintenance and support is recorded as deferred revenue upon the invoice date and held as a current liability on the balance sheet. Under the terms of the original purchase and license agreement, maintenance and support automatically renews on an annual basis unless the customer provides a written cancellation. We recognize revenue from these sales ratably over the underlying maintenance period.

 

For direct software sales licensed on a perpetual basis, we include one year of maintenance and support as part of the purchase price. Standard annual fees for maintenance and support after the first year equal 12% of the then current list price unless the customer negotiates other terms or service levels.

 

We recognize revenue once software products outlined in the related purchase and license agreement have been installed, accepted and are in clinical use at the customer site. When a customer accepts only a subset of the products outlined in a multiple-elementmultiple element purchase and license agreement and we have not established vendor specific objective evidence, or VSOE, of the fair value of the undelivered elements, we invoice the customer for the accepted products and record the transaction as deferred software license revenue. We recognize the deferred revenue when all elements in a multiple-elementmultiple element arrangement have beenare accepted, VSOE of the fair value is established on the remaining undelivered elements, or the undelivered elements for which VSOE of the fair value does not exist have been canceled, whichever occurs first.

 

The first year of maintenance and support for our software products is included in the purchase price. Upon revenue recognition, we defer 12% of the list price, which is the renewal rate, and recognize that portion over the remaining term of the included maintenance and support period. For example, if revenue recognition occurs four months subsequent to product acceptance, we would recognize one-thirdone third of the 12% maintenance and support deferral as revenue and recognize the remaining two-thirdstwo thirds of the deferral over the following eight months. In situations where the first phase of software products are installed more

greater than one year beforeprior to our ability to recognize the related revenue, it is not be necessary to defer 12% of the list price and recognize that portion over the included maintenance and support period as the first year maintenance and support obligation is no longer applicable. In these cases, however, 12% of the listlicense purchase price is classified as maintenance and services revenue at the time of revenue recognition.

 

For direct software sales licensed on a term basis, the initial term lasts from three to five years with annual renewals after the initial term. The customer pays a deposit typically equal to the initial annual fee upon signing the license agreement, and we invoice the customer for subsequent annual fees 60 days before the anniversary date of the signed agreement. We recognize revenue for the annual fees under these term license agreements ratably over the applicable twelve-month period. The purchase price includes annual maintenance and support.

 

We recognize revenue from third-party products and related configuration and installation services sold with our licensed software upon acceptance by the customer. We recognize revenue from third-party products sold separately from our licensed software upon delivery. Third-party products represented 5.4%2.1% and 4.9%3.3% of our total net sales in the three and six months ended March 31, 2003,2004, respectively, and 6.0%5.4% and 4.5%4.9% for the same period in fiscal 2002,2003, respectively. The increasedecrease in third-party sales as a percentage of net sales is attributable to a higherlower growth rate in our third-party product sales.

 

We recognize distributor related revenues upon the receipt of a completed purchase order and the related customer information needed to generate software registration keys, which allow us to distribute the software to the end user and satisfy our regulatory information tracking requirements. We provide maintenance and support to our primary distributor. The distributor’s cost of the first year’s support is included in the transfer fee. Renewal support is purchased for 5% of the transfer price. Forprice for software licenses sold to their customers, wecustomers. We defer the distributor’s first year post-contract support, based on the renewal rate, and recognize that portion of the revenue ratably over the support period. We invoice renewal maintenance and support annually to our distributor at the beginning of each fiscal year and recognize the revenue ratably over the applicable twelve-month period.

In December 2003, we added a pathology information management system to our suite of product offerings with the acquisition of certain assets of Tamtron Corporation from IMPATH Inc. (see Note 6 to the condensed consolidated financial statements). Pathology information management systems involve significant implementation and customization efforts essential to the functionality of the related products. Accordingly, we recognize the license and professional consulting services generated through the sale of pathology management information systems using the percentage-of-completion method using labor hours incurred as prescribed by SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts.” The progress toward completion is measured based on labor hours incurred as compared to total estimated hours to complete. We account for a change in estimate in the period the change was identified. Provisions for estimated contract losses are recognized in the period in which the loss becomes probable and can be reasonably estimated.

 

Costs and Expenses

 

A large part of our company cost structure is driven by the number of employees and all related benefit and facility costs. As a result, a significant amount of strategic and fiscal planning is focused on this area, so we can develop internal resources at a controlled and sustainable rate. Since revenue recognition happens subsequent to all implementation and training activities, we incur the costs of labor, travel and some third-party product expenses in advance.

Cost of sales consists primarily of:

 

labor costs relating to the implementation, installation, training and application support of our point-of-care and registry software;

 

travel expenses incurred in the installation and training of our point-of-care software;

 

direct expenses related to the purchase, shipment, installation and configuration of third-party hardware and software sold with our point-of-care software;

 

continuing engineering expenses related to the maintenance of existing released software; and

 

overhead attributed to our client services personnel.

 

System installations require several phases of implementation in the process of accepting product delivery and have led to our development of a highly specialized client service organization. All new orders require multiple site visits from our personnel to properly install, configure and train customer personnel. In transactions where we are required to defer the recognition of software license revenue, the associated incremental direct travel expenses are recorded as a prepaid expense until the associated revenue is recognized. Several point-of-care products are used with various third-party hardware and software products that are also sold and configured during the implementation process. After the initial implementation process, our application support staff provides phone support and any applicable system updates. A substantial percentage of engineering costs are allocated to client services due to continuing engineering efforts related to the support and enhancement of our products. Historically, cost of sales has increased at approximately the same rate as net sales. However, as newly developed products and acquired product lines are released to the customers, additional investments in client service staff could cause gross margins to fluctuate.

 

Research and development expenses include costs associated with the design, development and testing of our products. These costs consist primarily of:

 

salaries and related development personnel expenses;

 

software license and support fees associated with development tools;

 

travel expenses incurred to test products in the customer environment; and

 

overhead attributed to our development and test engineering personnel.

 

We currently expense all research and development costs as incurred. Our research and development efforts are periodically subject to significant non-recurring costs that can cause fluctuations in our quarterly research and development expense trends. We expect that research and development expenses will increase in absolute dollars for the foreseeable future as we continue to invest in product development.

 

Sales and marketing expenses primarily consist of:

 

salaries, commissions and related travel expenses for personnel engaged in sales and the contracts administration process;

 

salaries and related product marketing, marketing communications, media services and business development personnel expenses;

 

expenses related to marketing programs, public relations, trade shows, advertising and related communications; and

overhead attributed to our sales and marketing personnel.

 

We have recently expanded our sales force, made significant investments in marketing communications and increased trade show activities to enhance market awareness of our products. We expect that sales and marketing expenses will increase in absolute dollars for the foreseeable future as we continue to expand our sales and marketing capabilities. In transactions where we are required to defer the recognition of software license revenue, the associated incremental direct commission expense is recorded as a prepaid expense until the associated revenue is recognized.

General and administrative expenses primarily consist of:

 

salaries and related administrative, finance, human resources, regulatory, information services and executive personnel expenses;

other significant expenses relate to facilities, recruiting, external accounting and legal and regulatory fees;

general corporate expenses; and

overhead attributed to our general and administrative personnel.

 

A significant portion of facility, infrastructure and maintenance costs are allocated as overhead to other functions based on distribution of headcount. OurWe expect that our general and administrative expenses increased after our initialwill increase as a public offering, and we expect these expenses will remain higher in absolute dollars in the future.company.

 

Depreciation and Amortization

 

Our property and equipment is recorded at our cost minus accumulated depreciation and amortization. We depreciate the costs of our tangible capital assets on a straight-line basis over the estimated economic life of the asset, which is generally three to seven years. Acquisition related intangible assets have historically been amortized based upon the estimated economic life, which is generally two to fivesix years. Leasehold improvements and equipment purchased through a capital lease are amortized over the life of the related asset or the lease term, if shorter. If we sell or retire an asset, the cost and accumulated depreciation is removed from the balance sheet and the appropriate gain or loss is recorded. We expense repair and maintenance costs as incurred.

 

Accretion of Redeemable Convertible Preferred Stock

 

From September 27, 2002 until our initial public offering, the holders of a majority of our then outstanding redeemable convertible preferred stock could have required us to redeem the preferred shares by paying in cash an amount equal to the greater of $3.23 per share or the fair market value plus all declared or accumulated but unpaid dividends within thirty days. These shares automatically converted to common stock upon the closing of our initial public offering in November 2002. We accreted charges that reflected the increase in market value of the redeemable convertible preferred stock as an adjustment to retained earnings and, as a result, increased the amount of net loss attributable to common stockholders. After the initial public offering, no further accretion has beenis required. The redemption value of the redeemable convertible preferred stock was $16.7$16.8 million at the time of the initial public offering. This amount was reclassifiedreallocated on our balance sheet from redeemable convertible preferred stock to common stock and additional paid-in capital, uponless the closing of the initial public offering.

Restatement of Financial Statements

We adopted Statement of Position (SOP) 97-2 “Software Revenue Recognition” which became effective for us in October 1999 for the purposes of revenue recognition. Subsequent to filing the Form 10-Q for the quarter ended March 31, 2003, management determined that we recognized revenue for certain transactions prematurely. Accordingly we have restated our financial statements for the three and six months ended March 31, 2002 and 2003 to shift some previously recognized revenues to later quarters and to defer other previously recorded revenues to periods subsequent to March 31, 2003.

The accounting issues that gave rise to the restatement fell into three categories. First, we recognized revenue from certain multiple element software contracts once individual elements had been installed, accepted and were in clinical use at the customer site. We have now determined that we did not have vendor specific objective evidence (“VSOE”) of the fair value of the undelivered elements. Accordingly, we should have deferred the recognition of revenue on those contracts until we had VSOE of the fair value for all the undelivered elements, the elements for which VSOE of the fair value did not exist had subsequently been delivered or the elements for which VSOE did not exist had been canceled.

Second, we recognized revenue as of the date of first clinical use, unless a customer objected in writing within five business days after first clinical use. We have now determined that formal acceptance could not have occurred without the passage of five days, and, hence, we must adjust the date of revenue recognition of delivered and accepted products forward five business days from the date of first clinical use.

Third, we recognized revenue for maintenance and support of perpetually licensed software products during the first year by deferring 12% of the purchase price and recognizing this amount over the 12 months following the customer’s acceptance. We have now determined that we should have deferred 12% of the current list price rather than purchase price.

Details regarding the restatement are discussed further in Note 7 to the condensed consolidated financial statements.stated par value.

 

Results of Operations

 

The following table sets forth certain operating data as a percentage of net sales for the periods indicated:

 

  Three Months Ended
March 31,


 Six Months Ended
March 31,


 
  2003

 2002

 2003

 2002

   Three Months Ended
March 31,


 Six Months Ended
March 31,


 
  

(Restated)

(See Note 7)

 

(Restated)

(See Note 7)

   2004

 2003

 2004

 2003

 

Sales:

      

Software license and other, net

  61.6% 64.7% 60.9% 62.8%  55.5 % 61.6% 56.7 % 60.9 %

Maintenance and services

  38.4  35.3  39.1  37.2   44.5  38.4  43.3  39.1 
  

 

 

 

  

 

 

 

Total net sales

  100.0  100.0  100.0  100.0   100.0  100.0  100.0  100.0 

Cost of sales:

      

Software license and other, net

  18.6  20.0  18.3  19.8   22.3  18.6  21.4  18.3 

Maintenance and services

  13.2  9.9  14.2  9.8   16.3  13.2  15.8  14.2 
  

 

 

 

  

 

 

 

Total cost of sales

  31.8  29.9  32.5  29.6   38.6  31.8  37.2  32.5 
  

 

 

 

  

 

 

 

Gross profit

  68.2  70.1  67.5  70.4   61.4  68.2  62.8  67.5 
  

 

 

 

  

 

 

 

Operating expenses:

      

Research and development

  18.6  21.1  18.7  20.4   19.5  18.6  18.2  18.7 

Sales and marketing

  26.1  31.0  27.2  31.6   25.1  26.1  26.3  27.2 

General and administrative

  11.3  12.3  10.6  10.8   12.0  11.3  10.4  10.6 

Amortization of intangible assets

  0.8  1.4  0.9  1.2   3.8  0.8  2.4  0.9 

In-process research and development write-off

  —    —    1.9  —   
  

 

 

 

  

 

 

 

Total operating expenses

  56.8  65.8  57.4  64.0   60.4  56.8  59.2  57.4 
  

 

 

 

  

 

 

 

Operating income

  11.4  4.3  10.1  6.4   1.0  11.4  3.6  10.1 

Interest and other income, net

  1.0  0.8  0.9  1.0   0.7  1.0  0.8  0.9 
  

 

 

 

  

 

 

 

Income before provision for income taxes

  12.4  5.1  11.0  7.4   1.7  12.4  4.4  11.0 

Provision for income taxes

  (4.3) (1.7) (3.9) (2.5)  (0.6) (4.3) (1.5) (3.8)
  

 

 

 

  

 

 

 

Net income

  8.1% 3.4% 7.2% 4.9%  1.1% 8.1% 2.9% 7.2%
  

 

 

 

  

 

 

 

Comparison of Three Months Ended March 31, 20032004 and 20022003

 

Net Sales. Net sales increased 32.9%21.6% to $12.7$15.4 million in the three months ended March 31, 20032004 from $9.6$12.7 million for the same period in fiscal 2002. 2003 including $2.0 million related to the acquisition of certain assets and certain liabilities of Tamtron Corporation (“Tamtron”) and Medical Registry Services, Inc. (“MRS”), the PowerPath® pathology information management and cancer registry information system businesses of IMPATH Inc.

Net software related sales increased 26.6%9.5% to $7.8$8.6 million in the three months ended March 31, 20032004 from $6.2$7.8 million for the same period in fiscal 2002. Sales of additional new products2003. New systems sales in oncology accounted for $931,000$238,000 of the $1.6 million$741,000 increase, sales of registry systems from the acquired product line accounted for $814,000, sales of pathology lab systems from the acquired product line accounted for $501,000, sales of imaging systems accounted for $799,000,$379,000, offset by a net decrease in sales of new products to existing customers of $1.2 million. We deferred a net amount of $1.8 million in software license revenue in the three months ended March 31, 2004, installations of new systems in oncology accounted for $1.5 million, installations of new products to existing customers accounted for $148,000 and installations of imaging systems accounted for the remaining increase is attributed to new salesamount of the deferral. We deferred $2.6 million of software license revenue for the same period in registry and laboratory software. fiscal 2003.

Maintenance and services sales also increased 44.3%41.1% to $4.9$6.9 million for the three months ended March 31, 20032004 from $3.4$4.9 million for the same period in fiscal 2002.2003. Maintenance and support contracts contributed $1.3$2.1 million of the $1.5$2.0 million increase and additionaloffset by a decrease in training and installation of $80,000. The acquired pathology line of business contributed $114,000.$624,000 of the total increase in maintenance and services. Our continued high customer retention on maintenance and support contracts, the general price increase, deferral of installed and accepted software license revenue, and expansion of our service offerings all contributed to the growth of maintenance and services as a percentage of net sales. For a discussion of Deferred Revenue, see Backlog below.

Cost of Sales. Total cost of sales increased 41.3%47.7% to $4.0$6.0 million for the three months ended March 31, 20032004 from $2.8$4.0 million for the same period in fiscal 2002.2003. Our gross margin decreased to 68.2%61.4% for the three months ended March 31, 20032004 from 70.1%68.2% for the same period in fiscal 2002. 2003.

Cost of sales relating to net software sales increased 23.9%46.0% to $2.4$3.4 million for the three months ended March 31, 20032004 from $1.9$2.4 million for the same period in fiscal 2002.2003. Our gross margin associated with net software sales increased slightly at 69.8%decreased to 59.7% for the three months ended March 31, 20032004 compared to 69.1%69.8% for the same period in fiscal 2002.2003. The increase in expenses was related to $278,000$1.1 million in employee costs, $256,000 in travel costs, $109,000 in implementation costs and $153,000$24,000 in telephone costs offset by a reduction of $355,000 in supplies and materials. Cost of sales relating to maintenance and services increased 76.2% to $1.7 million for the three months ended March 31, 2003 from $950,000 for the same period in fiscal 2002. Our gross margin associated with maintenance and services decreased to 65.6% for the three months ended March 31, 2003 from 71.9% for the same period in fiscal 2002. The increase in expenses of $724,000 was related to $296,000 in employee related expenses, $201,000 in telecommunication costs associated with our data center operations, $149,000 in continuing engineering costs, and $57,000 in travel expenses. Planned investment in our support organization to accommodate the application service provider agreement signed with US Oncology and continued development of our direct international support presence for the three months ended March 31, 2003 contributed to the decline in our gross margin associated with maintenance and services. During the three months ended March 31, 2003,2004, we deferred $174,000$93,000 in direct incremental travel expenses associated with software installation and training trips compared to $128,000$174,000 during the same period in fiscal 2002.2003. We expect to recognize the deferred travel expenses once the associated product revenues are recognized. The decline in gross margins associated with net software sales relates to delayed implementation of new oncology systems and increased employee expenses associated with the two product line acquisitions in December 2003. We believe the margins related to the acquired businesses should improve once we have depleted the acquired deferred revenue backlog.

Cost of sales relating to maintenance and services increased 50.1% to $2.5 million for the three months ended March 31, 2004 from $1.7 million for the same period in fiscal 2003. Our gross margin associated with maintenance and services decreased to 63.5% for the three months ended March 31, 2004 from 65.6% for the same period in fiscal 2003. The increase in expenses of $838,000 was related to $432,000 in continuing engineering costs, $427,000 in employee related expenses, $11,000 in travel expenses offset by reductions of $17,000 in supplies and materials and $16,000 in telephone expense. Expenses associated with the support personnel from the acquired product lines for the three months ended March 31, 2004 contributed to the decline in our gross margin associated with maintenance and services.

 

Research and Development. Research and development expenses increased 16.8%27.6% to $2.4$3.0 million for the three months ended March 31, 20032004 from $2.0$2.4 million for the same period in fiscal 2002.2003. As a percentage of total net sales, research and development expenses decreasedincreased to 18.6%19.5% for the three months ended March 31, 20032004 from 21.1%18.6% for the same period in fiscal 2002.2003. Additional engineering headcount and the associated personnel expenses were the primary factorsaccounted for the$667,000, travel expenses accounted for $15,000 offset by reductions of $26,000 of supplies and materials and $5,000 in telephone expense. The increase in absolute dollars. The decrease as a percentage of total net sales in the three months ended March 31, 20032004 was primarily due to increased net sales relative to research and development expenses.engineering headcount associated with the acquired product lines in December 2003.

 

Sales and Marketing.Sales and marketing expenses increased 12.3%16.2% to $3.3$3.9 million for the three months ended March 31, 20032004 from $3.0$3.3 million for the same period in fiscal 2002.2003. As a percentage of total net sales, sales and marketing expenses decreased to 26.2%25.1% for the three months ended March 31, 20032004 from 31.0%26.2% for the same period in fiscal 2002.2003. The increase in expenses in absolute dollars related to $166,000$577,000 in employee related expenses, $56,000 in advertising expenses, $48,000 in travel expenses, $137,00039,000 in employee related costs, $85,000outside services, $28,000 in commission expense, $16,000supplies and materials and $13,000 in advertising expense, and $7,000 in telephone costs partiallysponsorships offset by a $24,000 reduction in outside services for marketing communications and a $19,000 reduction in sponsorships.commissions of $233,000. The decrease as a percentage of total net sales in the three months ended March 31, 2003 was due to increased net sales relative to sales and marketing expenses. During the three months ended March 31, 2003,2004, we deferred $93,000$171,000 in direct incremental commission expenses compared to $136,000$93,000 during the same period in fiscal 2002.2003. We expect to recognize the deferred commission expenses once the associated product revenues are recognized.

 

General and Administrative. General and administrative expenses increased 21.2%30.2% to $1.4$1.9 million for the three months ended March 31, 20032004 from $1.2$1.4 million for the same period in fiscal 2002.2003. As a percentage of total net sales, general and administrative expenses decreasedincreased to 11.3%12.0% for the three months ended March 31, 20032004 from 12.3%11.3% for the same period in fiscal 2002.2003. The increase in absolute dollars was primarily due to increases in accounting and legal fees of $314,000 primarily related to our restatement, maintenance expense of $44,000, regulatory fees of $30,000, business insurance premiums of $161,000, an increase in our allowance for doubtful accounts$27,000, travel expense of $136,000, an increase in outside professional service fees$22,000 and contributions of $64,000 and regulatory fees$20,000. The percentage of $17,000 offset by a decrease in travel expenses of $20,000, a decrease in telephone expenses of $6,000 and a decrease in maintenance expenses of $3,000. The increasetotal net sales in the allowance for doubtful accountsthree months ended March 31, 2004 was influenced by additional expenses related to the overall increase inrestatement of our accounts receivable balance at March 31, 2003.financial statements.

 

Amortization of Intangible Assets. Amortization expenses decreased 20.8%increased 464.1% to $103,000$581,000 for the three months ended March 31, 20032004 from $130,000$103,000 for the same period in fiscal 2002.2003. Our acquisition of Intellidata, Inc.substantially all of the assets of Tamtron and MRS in April 2002December 2003 increased amortization expense as it relates to developed/core technology, customer base and a covenant-not-to-compete. No goodwill is included in the amortization related to this transaction. In compliance with Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and other Intangible Assets,” we have ceased amortization of goodwill and acquired workforce effective October 1, 2002 and this has resulted in an overall decline in total amortization expense for the three month period.trade name.

 

Operating Income. Operating income increased 253.8%decreased 88.8% to $1.4 million$161,000 for the three months ended March 31, 20032004 from $407,000$1.4 million for the same period in fiscal 2002.2003. Operating income increaseddecreased significantly due to thedelayed implementations of new oncology systems, higher rateamortization of increase in net sales relativeintangible assets related to the rateDecember 2003 asset purchases and additional fees associated with the restatement of increase in operating expenses.our financial statements.

Interest and Other Income, Net. Interest and other income, net increased 68.3%decreased 26.8% to $138,000$101,000 for the three months ended March 31, 20032004 from $82,000$138,000 for the same period in fiscal 2002.2003. The increase isdecrease was primarily related to additionalour lower cash balances being invested from our public offering proceeds.balance subsequent to the asset purchases in December 2003.

Income Taxes. Our effective tax rate was increased slightly to 34.9%35.0% during the three months ended March 31, 20032004 from 34.6%34.9% during the same period in fiscal 2002. The increase in absolute dollars was due primarily to higher operating income.

Accretion of Redeemable Convertible Preferred Stock. Historically, each reporting period, the carrying value of the redeemable convertible preferred stock has been increased by periodic accretions, using the effective interest method, so that the carrying amount would equal the redemption value at the redemption date. These increases were effected through charges against retained earnings. Several factors have influenced our determination of the value of the redeemable convertible preferred stock. These factors included plans for the initial public offering, the performance of our business, changes in our business model and significant product introductions, current market conditions and the performance of the stock price of our comparable companies. During the three months ended March 31, 2002, we recorded accretion charges of $3.2 million, representing the increase in the redemption value of the Series A redeemable convertible preferred stock. Upon the closing of our initial public offering in November 2002, all shares of our redeemable convertible preferred stock automatically converted into an equal number of shares of common stock. Therefore, we did not incur accretion charges related to the Series A redeemable convertible preferred stock during the three months ended March 31, 2003.

 

Comparison of Six Months Ended March 31, 20032004 and 20022003

 

Net Sales. Net sales increased 29.9%25.0% to $23.8$29.8 million in the six months ended March 31, 20032004 from $18.4$23.9 million for the same period in fiscal 2002. 2003 including $2.2 million related to the acquisition of certain assets and certain liabilities of Tamtron and MRS.

Net software related sales increased 25.9%16.3% to $14.5$16.9 million in the six months ended March 31, 20032004 from $11.5$14.5 million for the same period in fiscal 2002. New2003. Registry sales from the acquired product line accounted for $918,000 of the $2.4 million increase, new system sales in oncology accounted for $1.1 million$738,000, sales of pathology from the $3.0 million increase,acquired product line and lab systems accounted for $508,000, sales of imaging systems accounted for $844,000$445,000 offset by a decrease in imaging and urology sales of additional new products in oncology accounted for $906,000, and the remaining increase was attributed to new sales in registry, urology and laboratory software. $238,000.

Maintenance and services also increased 36.6%38.6% to $9.3$12.9 million for the six months ended March 31, 20032004 from $6.8$9.3 million for the same period in fiscal 2002.2003. Maintenance and support contracts contributed $2.2$3.7 million of the $2.5$3.6 million increase offset by a decrease in installation and additional training and installation contributed $193,000.of $93,000. Our continued high customer retention on maintenance and support contracts, the general price increase, deferral of installed and accepted software license revenue, and expansion of our service offerings all contributed to the growth of maintenance and services as a percentage of net sales. For a discussion of Deferred Revenue, see Backlog below.

 

Cost of Sales. Total cost of sales increased 42.1%43.5% to $7.7$11.1 million for the six months ended March 31, 20032004 from $5.4$7.7 million for the same period in fiscal 2002.2003. Our gross margin decreased to 67.5%62.8% for the six months ended March 31, 20032004 from 70.3%67.5% for the same period in fiscal 2002. 2003.

Cost of sales relating to net software sales increased 19.5%46.4% to $4.4$6.4 million for the six months ended March 31, 20032004 from $3.6$4.4 million for the same period in fiscal 2003. Our gross margin associated with net software sales increaseddecreased to 70.0%62.2% for the six months ended March 31, 20032004 from 68.4%70.0% for the same period in fiscal 2002.2003. The increase in expenses related to $431,000$1.7 million in employee costs, and $264,000$296,000 in travel expenses, $165,000 in implementation costs, $15,000 in telephone expenses offset by a reduction of $129,000 in supplies and materials. The improvement in gross margins associated with net software sales relates to stronger demand for implementation of new systems during the six months ended March 31, 2003, a slight delay in recruiting qualified personnel, as well as efficiencies gained by organizational improvements during fiscal 2002. Cost of sales relating to maintenance and services increased 87.7% to $3.4 million for the six months ended March 31, 2003 from $1.8 million for the same period in fiscal 2002. Our gross margin associated with maintenance and services decreased to 63.8% for the six months ended March 31, 2003 from 73.7% for the same period in fiscal 2002. The increase in expenses was associated with $674,000 in employee related expenses, $350,000 in continuing engineering costs, $400,000 in telecommunication costs associated with our data center operations, $109,000 in travel expenses, and $43,000 in supplies. Planned investment in our support organization to accommodate the application service provider agreement signed with US Oncology and continued development of our direct international support presence for the six months ended March 31, 2003 contributed to the decline in our gross margin associated with maintenance and services. During the six months ended March 31, 2003,2004, we deferred $221,000$209,000 in direct incremental travel expenses associated with software installation and training trips compared to $89,000$221,000 during the same period in fiscal 2002.2003. We expect to recognize the deferred travel expenses once the associated product revenues are recognized. The decline in gross margins associated with net software sales relates to delays implementations of new oncology systems and increased employee expenses associated with the two product line acquisitions in December 2003. We believe the margins related to the acquired businesses should improve once we have recognized the acquired deferred revenue balance.

Cost of sales relating to maintenance and services increased 39.7% to $4.7 million for the six months ended March 31, 2004 from $3.4 million for the same period in fiscal 2003. Our gross margin associated with maintenance and services decreased slightly to 63.6% for the six months ended March 31, 2004 from 63.9% for the same period in fiscal 2003. The increase in expenses was associated with $744,000 in continuing engineering costs, $661,000 in employee related expenses offset by reductions of $26,000 in supplies and materials, $25,000 in telephone expense and $15,000 in travel expenses. Expenses associated with the support personnel from the acquired product lines for the six months ended March 31, 2004 contributed to the slight decline in our gross margin associated with maintenance and services.

 

Research and Development. Research and development expenses increased 19.7%21.7% to $4.5$5.4 million for the six months ended March 31, 20032004 from $3.7$4.5 million for the same period in fiscal 2002.2003. As a percentage of total net sales, research and development expenses decreased to 18.7%18.2% for the six months ended March 31, 20032004 from 20.4%

18.7% for the same period in fiscal 2002.2003. Additional engineering headcount and the associated personnel expenses were the primary factorsaccounted for the increase$1.0 million and travel expenses accounted for $22,000 offset by a reduction of $38,000 in absolute dollars.supplies and materials, $23,000 in telephone expense and $5,000 in outside services. The decrease as a percentage of total net sales in the six months ended March 31, 20032004 was due to increased net sales relative to research and development expenses.

 

Sales and Marketing.Sales and marketing expenses increased 11.7%21.3% to $6.5$7.9 million for the six months ended March 31, 20032004 from $5.8$6.5 million for the same period in fiscal 2002.2003. As a percentage of total net sales, sales and marketing expenses decreased to 27.2%26.3% for the six months ended March 31, 20032004 from 31.6%27.2% for the same period in fiscal 2002.2003. The increase in expenses related to $299,000 in commissions due to higher sales, $272,000$1.2 million in employee related costs, $244,000expenses, $162,000 in travel expenses, $27,000$110,000 in telephone costsadvertising expenses, $101,000 in outside services, $66,000 in sponsorships, $45,000 in supplies and $14,000materials and $28,000 in trade show expenses offset by a $129,000 reduction in outside services for marketing communications and $41,000 in sponsorships.commission expense of $332,000. The decrease as a percentage of total net sales in the six months ended March 31, 20032004 was due to increased net sales relative to sales and marketing expenses and the cyclical nature of trade show spending and a slight delay in recruiting qualified sales staff.spending. During the six months ended March 31, 2003,2004, we deferred $105,000$222,000 in direct incremental commission expenses compared to $123,000$105,000 during the same period in fiscal 2002.2003. We expect to recognize the deferred commission expenses oncewhen the associated product revenues are recognized.

 

General and Administrative. General and administrative expenses increased 28.3%21.9% to $2.5$3.1 million for the six months ended March 31, 20032004 from $2.0$2.5 million for the same period in fiscal 2002.2003. As a percentage of total net sales, general and administrative expenses decreased slightly to 10.6%10.4% for the six months ended March 31, 20032004 from 10.8%10.6% for the same period in fiscal 2002.2003. The increase in absolute dollars was primarily due to increases in business insurance premiums of $223,000, an increase in our allowance for doubtful accounts of $186,000, employee related expenses of $114,000, professional serviceaccounting and legal fees of $75,000,$432,000, maintenance fees of $92,000, regulatory fees of $34,000, contributions of $20,000 and travel expenses of $58,000, rent expense$10,000 offset by reductions in various operational expenses of $50,000, depreciation expense of $36,000, outside services of $27,000, and regulatory fees of $27,000.$36,000. The increase as a percentage of total net sales in the allowance for doubtful accountssix months ended March 31, 2004 was influenced by additional expenses related to the overall increaserestatement of our financial statements.

In-process Research and Development. We recorded a write-off of in-process research and development in our accounts receivable balancethe amount of $557,000 in the six months ended March 31, 2004 due to an analysis allocating the purchase price paid for certain intellectual property in that period. Both product lines that were acquired were in the process of bringing certain new products and functionality to their existing product offerings at March 31,the time of acquisition. In conjunction with the management of those businesses, we estimated that the products were incomplete and believed there were sufficient technological risks associated with these products to qualify the in-process research and development $557,000 write-off. We did not have an in-process research and development write-off for the same period in 2003.

 

Amortization of Intangible Assets. Amortization expenses decreased 7.2%increased 242.0% to $205,000$701,000 for the six months ended March 31, 20032004 from $221,000$205,000 for the same period in fiscal 2002.2003. Our acquisition of Intellidatasubstantially all of the assets of Tamtron, Inc. and Medical Registry Services, Inc. in April 2002December 2003 increased amortization expense as it relates to developed/core technology, customer base and a covenant-not-to-compete. No goodwill is included in the amortization related to this transaction. In compliance with SFAS No. 142, we have ceased amortization of goodwill and acquired workforce effective October 1, 2002 and this has resulted in an overall decline in total amortization expense for the six month period.trade name.

 

Operating Income. Operating income increased 105.9%decreased 55.8% to $2.4$1.1 million for the six months ended March 31, 20032004 from $1.2$2.4 million for the same period in fiscal 2002.2003. Operating income increaseddecreased significantly due to thedelays in implementations of new oncology systems, an in-process research and development write-off, higher rateamortization of increase in net sales relativeintangible assets related to the rateDecember 2003 asset purchases and additional fees associated with the restatement of increase in operating expenses.our financial statements.

Interest and Other Income, Net. Interest and other income, net increased 13.2%14.4% to $215,000$246,000 for the six months ended March 31, 20032004 from $190,000$215,000 for the same period in fiscal 2002.2003. The increase iswas primarily related to additional cash balances being invested from our public offering proceeds offset by lower interest income from investmentscash balances subsequent to our product line acquisitions in short and long-term marketable securities resulting from lower interest rates in the 2003 period.December 2003.

 

Income Taxes. Our effective tax rate was increased slightly to 34.9%35.0% during the six months ended March 31, 20032004 from 34.6%34.9% during the same period in fiscal 2002. The increase in absolute dollars was due primarily to higher operating income.2003.

 

Accretion of Redeemable Convertible Preferred Stock. Historically, each reporting period, the carrying value of the redeemable convertible preferred stock has been increased by periodic accretions, using the effective interest method, so that the carrying amount would equal the redemption value at the redemption date. These increases were effected through charges against retained earnings. Several factors have influenced our determination of the value of the redeemable convertible preferred stock. These factors included plans for the initial public offering, the performance of our business, changes in our business model and significant product introductions, current market conditions and the performance of the stock price of our comparable companies. During the six months ended March 31, 2003, we recorded accretion charges of $2.2 million, all of which was incurred during the first quarter in the time period leading up to the initial public offering. This represents a 55.3% decrease from theThere were no accretion charges incurred inrecorded for the six months endedending March 31, 2002 of $5.0 million.2004. Upon the closing of our initial public offering in November 2002, all shares of our redeemable convertible preferred stock automatically converted into an equal number of shares of common stock. Therefore, we have not incurred, nor will we incur, accretion charges related to the Series A redeemable convertible preferred stock after our initial public offering.

Backlog

 

Our backlog is comprised of customer deposits, deferred software license revenue, other deferred revenue and unearned revenue. Customer deposits represent required deposits paid by our customers when they place orders. These deposits are held as a liability until revenue recognition. Deferred software license revenue represents the revenues on installed, accepted and invoiced products that we cannot yet recognize because the products installed were only a subset of the products outlined in a multiple element arrangement for which we do not have VSOE of the fair value on all of the undelivered elements. The amounts classified as deferred software license revenue will be recognized as revenue once we establish VSOE of the fair value on the remaining undelivered elements, the remaining elements for which VSOE of the fair value does not exist have been installed and accepted or the remaining elements for which VSOE of the fair value does not exist have been canceled, whichever occurs first. Other deferred revenue represents maintenance and support services and term licenses which are generally recognized ratably over the support period and license term, respectively. Unearned revenue represents the value of products ordered but not installed or accepted in excess of the contract deposit. Orders are recognized only once we have received a signed purchase and license agreement, an authorized purchase order and a deposit check. Therefore, amounts in our sales pipeline that have not met all three order recognition criteria are not included in our backlog.

 

The components of backlog as of March 31, 2004 and 2003 and 2002December 31, 2003 are as follows (amounts in thousands):

 

  March 31,

  2003

  2002

  March 31,

  December 31,

  

(Restated)

(See Note 7)

  2004

  2003

  2003

Customer deposits

  $9,677  $7,656  $11,509  $9,677  $10,911

Deferred software license revenue

   11,535   6,314   16,257   11,535   14,482

Other deferred revenue

   11,849   8,548   20,086   11,849   18,212

Unearned revenue

   20,288   12,750   32,859   20,288   26,027
  

  

  

  

  

Total backlog

  $53,349  $35,268  $80,711  $53,349  $69,632
  

  

  

  

  

 

Total backlog increased 50.3% to $80.7 million at March 31, 2004 from $53.3 million at March 31, 2003. In addition, total backlog increased 15.9%, or $11.1 million, from $69.6 million at December 31, 2003. During the three months ended March 31, 2004, bookings in our core oncology point-of-care business, have unexpectedly flattened. We initially noted a softening of backlog in the three months ended December 31, 2003; however, at that time the amount was within historical norms and we expected our typical second quarter upswing. Bookings have remained soft however in the three months ended March 31, 2004. Of the total $53.3$80.7 million of backlog at March 31, 2003,2004, we expect to recognize approximately $50.0$75.2 million of our backlog during the twelve months following March 31, 20032004 with the remaining portion to be completed in subsequent periods. We cannot assure you that contracts included in backlog will generate the specified revenues or that these revenues will be fully recognized within the specified time periods.

 

Deferred revenue increased $8.5$13.0 million to $23.4$36.4 million for the twelve months ended March 31, 20032004 from $14.9$23.4 million at March 31, 2002.2003. Of the $8.5$13.0 million increase, deferred software license revenue and the related deferred maintenance and support contributed $6.1$4.9 million. This increase was comprised of $3.5$3.3 million of new installations in oncology $1.5and $2.4 million in imaging systems and $529,000offset by a decrease of $743,000 in new products to existing customers. The remaining $2.5$8.0 million was associated withincrease relates to other deferred revenue related to term licenses andof $3.9 million in post contract maintenance and support.support for oncology products, $1.9 million in registry term licenses, $1.2 million in post contract maintenance and support for pathology products and $1.0 million of pathology license revenue.

 

Seasonality

 

After giving effect to the restatement, we continue toWe experience a seasonal pattern in our revenues, with our first quarter typically having the lowest revenues followed by increasing revenue growth in the subsequent quarters of our fiscal year. Although our seasonality is less pronounced after the restatement, weWe believe the seasonality of our revenue continues to beis influenced by the year end of many of our customers’ budgetary cycles. As much of the labor and indirect expense associated with software systems for which revenue has been deferred are not matched with the subsequent revenue recognition, net income does not display a clear and predictable seasonal pattern.

 

In addition, the implementation of a significant contract previously included in backlog, or a contract intended to be installed in a phased manner over a longer than average time period, could generate a large increase in revenue and net income for any given quarter or fiscal year, which may prove unusual when compared to changes in revenue and net income in other periods. Furthermore, we typically experience long sales cycles for new customers, which may extend over several quarters before a sale is consummated and a customer implementation occurs. As a result, we believe that quarterly results of operations will continue to fluctuate and that quarterly results may not be indicative of future periods. The timing of revenues is influenced by a number of factors, including the timing of individual orders, customer implementations and seasonal customer buying patterns.

Liquidity and Capital Resources

 

We have financed our operations since inception primarily through cash from operating activities, a $4.0 million private placement of equity in 1996, and in November 2002, we received net proceeds of $24.4 million from our initial public offering of common stock.stock in November 2002 and net proceeds of $3.2 million from our secondary public offering of common stock in May 2003. Cash, cash equivalents and available-for-sale securities were $52.0$45.2 million at March 31, 2003.2004.

 

During the six months ended March 31, 2003,2004, net cash provided by operating activities was $1.1 million$62,000 compared to $3.4$1.1 million for the same period in fiscal 2002.2003. In the six months ended March 31, 2003,2004, cash provided by operations was primarily attributable to increases in sales leading to a higher net income after adjustment for the non-cash charges relating to depreciation and amortization, a decreasean increase in deferred revenue, offset by increases in accounts receivable, prepaid expenses and other current assets and an increase in deferred revenue, offset by an increase in accounts receivable due to higher sales and a decrease in income taxesaccrued liabilities and accounts payable. In the six months ended March 31, 2002,2003, cash provided by operations was primarily attributable to increases in sales leading to a higher net income after adjustment for the non-cash charges relating to depreciation and amortization, an increase in customer deposits and increases in income taxes payable and deferred revenue, offset by an increase in accounts receivable due to higher sales and a decrease in accrued liabilities. As referenced previously in the backlog section, bookings in our core oncology point-of-care business, have unexpectedly flattened. The subsequent impact of orders may effect the historical trend of operating cash in subsequent quarters.

 

In determining average days’ sales outstanding and accounts receivable turnover, we use our gross annual invoicing and gross accounts receivable balances in each calculation as we believe this provides a more conservative and relevant measurement basis due to the significance of our deferred revenue. Our accounts receivable turnover decreased to 4.53.5 for the six months ended March 31, 20032004 from 5.34.5 for the same period in fiscal 2002.2003. Our days’ sales outstanding at March 31, 20032004 increased to 79103 from 6879 at March 31, 2002.2003. We believe that the overall increase in sales for the six months ended March 31, 2003 as compared to the same period in fiscal 2002acquired accounts receivable balances from Tamtron and MRS have impacted the calculation of accounts receivable turnover and days sales outstanding ratios. In addition, during the three months ended March 31, 2004, the collections personnel devoted the majority of their time to assisting with the restatement and were unable to complete as many collection calls. We are currently recruiting additional dedicated collections resources, and we continue our efforts to improve collections by maintaining appropriate staffing levels, formalizing escalation procedures and improving internal communications. Revenue is only recognized when all of the criteria for revenue recognition have been met which is upon acceptance and invoicing of the final balance of the fee unless the invoice has payment terms extending longer than 60 days. Any invoice that has payment terms longer than 60 days is considered to have extended payment terms and is not be recognized as a receivable or revenue until it is due and payable.

 

Net cash used in investing activities was $1.3$21.5 million for the six months ended March 31, 20032004 and $1.0$1.3 million for the same period in fiscal 2002.2003. During the six months ended March 31, 2004, cash used in investing activities primarily related to the acquisition of certain assets of Tamtron and MRS for $22.0 million and approximately $494,000 in acquisition costs and the purchase of $1.1 million of capital equipment to support two office moves during the period, offset by $2.1 million in net proceeds from sales and maturities of available-for-sale securities.. During the six months ended March 31, 2003, cash used in investing activities primarily related to the purchase of $1.1 million of capital equipment to support ongoing operations. During the six months ended March 31, 2002, cash used in investing activities primarily related to the purchase of $560,000 in capital assets and $500,000$181,000 in payments relating to the acquisitionnet purchases of MC2.available-for-sale securities.

 

Net cash provided by financing activities was $25.0$1.0 million for the six months ended March 31, 2003,2004, compared to net cash used in financing activities of $11,000$25.0 million for the same period in fiscal 2002.2003. Cash provided by financing activities during the six months ended March 31, 2004 can be attributed to $1.2 million received from the issuance of common stock, offset by capital lease principal payments of $194,000. Cash provided by financing activities during the six months ended March 31, 2003 can be attributed primarily to net proceeds of $24.4 million received in our initial public offering during November 2002. During the six months ended March 31, 2002, cash used in financing activities can be attributed to principal payments on our capital lease of $28,000 and repurchases of common stock in the amount of $21,000, offset from proceeds received from stock option exercises of $38,000.

 

In fiscal 2000, we entered a capital lease for the purchase of furniture for our corporate headquarters. This capital lease is scheduled to be fully repaid in February 2005. The interest rate for this financing is 13.54% per year and equates to an aggregate monthly payment of $7,000. As of March 31, 2003, the principal balance outstanding on the capital lease totaled $148,000. We have granted a security interest to the lenders in all furniture covered by this lease.

The following table describes our commitments to settle contractual obligations in cash not recorded on the balance sheet as of March 31, 20032004 (in thousands). The telecommunications contracts with AT&T include wireless, frame-relay, voice/data and internet transport services.

 

Fiscal Year


  Property Leases

  Operating Leases

  Telecommunications
Contracts


  Total Future Obligations

2003

  $1,411  $31  $545  $1,987

2004

   2,673   52   1,353   4,078

2005

   2,713   27   1,232   3,972

2006

   2,514   6   1,200   3,720

2007

   1,011   —     930   1,941
   Operating
Leases


  Telecommunications
Contracts


  Total Future
Obligations


Remainder of Fiscal 2004

  $1,587  $760  $2,347

Fiscal 2005

   3,034   1,299   4,333

Fiscal 2006

   2,701   1,200   3,901

Fiscal 2007

   1,102   930   2,032
   

  

  

Total

  $8,424  $4,189  $12,613

 

We expect to increase capital expenditures consistent with our anticipated growth in infrastructure and personnel. We also may increase our capital expenditures as we expand our product lines or invest in new markets. We believe that the net proceeds from the common stock sold in the initial public offering, together with available funds and cash generated from operations will be sufficient to meet our operating requirements, assuming no change in the operations of our business, for at least the next 18 months.

 

Recent Accounting Pronouncements

 

In November 2002,January 2003, the Financial Accounting Standards Board (“FASB”) issued FASBFIN 46, “Consolidation of Variable Interest Entities”, an Interpretation No. 45 (“of ARB 51, which subsequently has been revised by FIN 45”), “Guarantor’s Accounting46-R. The primary objectives of FIN 46-R are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (variable interest entities or VIEs) and Disclosure Requirementshow to determine when and which business enterprise should consolidate the VIE (the primary beneficiary). This new model for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”consolidation applies to an entity in which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 4546-R requires that upon issuance ofboth the primary beneficiary and all other enterprises with a guarantee,significant variable interest in a guarantor must recognize a liabilityVIE make additional disclosures. FIN 46-R is effective for VIEs created after January 31, 2003 and is effective for all VIEs created before February 1, 2003 that are Special Purpose Entities (SPEs) in the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantorfirst reporting period ending after December 15, 2003 and for all other VIEs created before February 1, 2003 in its interimthe first reporting period ending after March 15, 2004. We believe there are no entities qualifying as VIES and annual financial statements about the obligations associated with guarantees issued. The recognition provisionsadoption of FIN 45 are effective for46-R to date has not had any guarantees issuedeffect on our financial position, cash flows or modified after December 31, 2002. These consolidated financial statements comply with the disclosure requirementsresults of this interpretation.operations.

 

In November 2002,May 2003, the Emerging Issues Task Force (“EITF”)EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how03-05, “Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to account for arrangements that involveNon-Software Deliverables in Arrangements Containing More-Than-Incidental Software”. EITF No. 03-05 addresses the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. As we account for multiple element arrangements under the higher-level authoritative literatureapplicability of Statement of Position No. 97-2 “Software Revenue Recognition,” as amended, we expect thatregarding software and non-software deliverables in a multiple element arrangement, giving consideration to whether the deliverables are essential to the functionality of one another. EITF Issue No. 03-05 is effective for interim periods beginning after August 13, 2003. The adoption of EITF Issue No. 00-21 will03-05 did not have noa material impact on our financial position or results of operations.

Risk Factors Affecting Financial Performance

This Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of factors both in and out of our control, including the risks faced by us described below and elsewhere in this Form 10-Q and in our Form 10-K/A for the fiscal year ended September 30, 2003.

You should carefully consider the risks described below. In addition, the risks described below are not the only ones facing us. We have only described the risks we consider to be the most material. However, there may be additional risks that are viewed by us as not material or are not presently known to us.

If any of the events described below were to occur, our business, prospects, financial condition and/or results of operations could be materially adversely affected. When we say below that something could or will have a material adverse effect on us, we mean that it could or will have one or more of these effects. In any such case, the price of our common stock could decline, and you could lose all or part of your investment in our company.

Risks Relating to Our Business

Our operating results may fluctuate significantly and may cause our stock price to decline.

We have experienced significant variations in revenues and operating results from quarter to quarter. Our quarterly operating results may continue to fluctuate due to a number of factors, including:

the timing, size and complexity of our product sales and implementations, in each case exacerbated by the lengthy sales and implementation cycles and unpredictable buying patterns of our customers;

our inability to recognize revenue from multiple element software contracts where certain elements have been delivered, installed and accepted but other elements remain undelivered;

overall demand for healthcare information technology, particularly in the oncology market;

seasonality of our quarterly operating results, which may be impacted by the degree to which our customers have allocated and spent their yearly budgets and slower systems implementation during the holiday seasons;

market acceptance of services, products and product enhancements by us and our competitors;

product and price competition;

changes in our operating expenses;

the timing and size of future acquisitions;

personnel changes; and

the financial condition of our current and potential customers.

Because a significant percentage of our expenses will be relatively fixed, changes in the timing of sales and implementations could cause significant variations in operating results from quarter to quarter. We believe that period to period comparisons of our historical results of operations are not necessarily meaningful. You should not rely on these comparisons as indicators of our future performance.

Due to the length of our sales cycle, we are required to spend substantial time and expense before we are able to recognize revenue.

The sales cycle for our systems ranges from six to twenty four months or more from initial contact to contract execution, and we may require an additional three to nine months to complete implementation. During this period, we will expend substantial time, effort and financial resources preparing contract proposals, negotiating the contract and implementing our systems. As a result, we may not realize any revenues from some customers after expending considerable resources. Even if we do realize revenues from a project, delays in implementation may keep us from recognizing these revenues during the same period in which sales and implementation expenses were incurred. This could cause our operating results to fluctuate from quarter to quarter.

The majority of our sales has been into the radiation oncology market. If we are unable to expand outside the radiation oncology market or expand into international markets, our ability to grow will be limited.

Sales of our products into the radiation oncology market in the United States, including maintenance and services, represented approximately 73.4% of our net sales in the fiscal year ended September 30, 2003. Many of the largest radiation oncology facilities and practices in the United States have previously purchased our systems. In addition, in 2004, we have experienced softness in bookings in our core oncology point-of-care business. To sustain our growth, we must expand our radiation oncology sales outside the United States and increase our sales outside of the radiation oncology market. We have expanded our product offerings domestically to address medical oncology, hospital and central registry data aggregation and reporting, and recently, laboratory information systems, urology and pathology. However, we may not be successful selling our products in international radiation oncology markets, or marketing our products in new markets.

If we are unable to integrate our products successfully with existing information systems and oncology treatment devices, or we are restricted from access to new device interfaces, customers may choose not to use our products and services.

For healthcare facilities to fully benefit from our products, our systems must integrate with the customer’s existing information systems and medical devices. This may require substantial cooperation, investment and coordination on the part of our customers. There is little uniformity in the systems and devices currently used by our customers, which complicates the integration process. If these systems are not successfully integrated, our customers could choose not to use, or to reduce their use of, our systems, which would harm our business.

Our ability to design systems that integrate applications, devices and information systems has been a key to our success in the radiation oncology market. Our competitors include manufacturers of radiation oncology equipment. The three major linear accelerator manufacturers are expected to introduce “next generation” devices in 2004, which will have new operator front-ends and require new integration strategies. We have been in the process of developing our next generation of connectivity options and expect them to be ready when these new devices begin to ship. If these manufacturers were to deny us access to new device interfaces, we would lose one of our key competitive advantages and our sales would be adversely impacted. In addition, we don’t know whether our new products will be accepted in the marketplace or whether they will generate revenues and margins comparable to our current products.

We operate in an intensely competitive market that includes companies that have greater financial, technical and marketing resources than we do, and companies who bundle their software with hardware sales at little or no additional cost, which makes it harder for us to sell our systems.

We operate in a market that is intensely competitive. Our principal oncology competitor is Varian Medical Systems, Inc. We also face competition from providers of enterprise level healthcare information systems, practice management systems, general decision support and database systems and other segment-specific software applications. In addition, although we have cooperative strategic arrangements with Siemens Medical Systems, Inc. and other companies for the sale of some of our products, these companies also compete with us on the sale of some of our products. A number of existing and potential competitors are more established than we are and have greater name recognition and financial, technical and marketing resources than we do.

Our most significant competitors also manufacture radiation oncology devices and other equipment used by healthcare providers who may be our potential customers. These particular competitors pose a competitive risk for us because they market their software with their hardware products as a bundled solution at little or no additional cost, which could enhance their ability to meet a potential customer’s needs. In recent quarters, this bundling practice has been intensified, placing us at a pricing disadvantage. As a result, to make a sale, we must convince

potential customers that our products are sufficiently superior to the software offered by the medical device manufacturer to justify the additional costs of purchasing our products. In addition, one of our most significant competitors recently acquired an oncology software company, which may make it a more effective competitor. We also expect that competition will continue to increase, particularly if enterprise level healthcare software providers, such as Cerner Corporation and Eclipsys Corporation, choose to focus on the oncology market. As a result of increased competition, we may need to reduce the price of our products and services, and we may experience reduced gross margins or loss of market share, any one of which could significantly reduce our future revenues and operating results.

A decline in spending for healthcare information technology and services may result in less demand for our products and services, which could adversely affect our financial results.

The purchase of our products and services involves a significant financial commitment by our customers. The cost of our systems typically ranges from $75,000 to more than $500,000. At the same time, the healthcare industry faces significant financial pressures that could adversely affect overall spending on healthcare information technology and services. For example, the Balanced Budget Act of 1997 significantly reduced Medicare reimbursements to hospitals, leaving them less money to invest in infrastructure. To date in 2004. we estimate that reimbursements in the radiation oncology segment have decreased by approximately 10%, and reimbursement in the medical oncology segment is expected to decrease in 2005. Moreover, a general economic decline or further reductions in Medicare reimbursements to hospitals could cause hospitals to reduce or eliminate information technology-related spending. If spending for healthcare information technology and services declines or increases slower than we anticipate, demand for our products and services could decline, adversely affecting the prices we may charge.

Changing customer requirements could decrease the demand for our products, which could harm our business and adversely affect our revenues.

The market for our products and services is characterized by rapidly changing technologies, evolving industry standards and new product introductions and enhancements that may render existing products obsolete or less competitive. For example, the three major linear accelerator manufacturers are expected to introduce “next generation” devices in 2004, which will have new operator front-ends and require new integration strategies. As a result, our position in the healthcare information technology market could erode rapidly due to unforeseen changes in the features, functions or pricing of competing products. Our future success will depend in part on our ability to enhance our existing products and services and to develop and introduce new products and services to meet changing customer requirements. We have been in the process of developing our next generation of connectivity options and expect them to be ready when these new devices begin to ship this summer. We don’t know; however, whether our new products will be accepted in the marketplace or whether they will generate revenues and margins comparable to our current products.

The process of developing products and services such as those we offer is complex and in the future is expected to become increasingly more complex and expensive as new technologies and new methods of treating cancer are introduced. If we are unable to enhance our existing products or develop new products to meet changing customer requirements, including the introduction of new cancer treatment methods with which our products are not currently compatible, demand for our products could suffer.

Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace.

Technology companies like ours have a history of using broad based employee stock option programs to hire, incentivize and retain our workforce in a competitive marketplace. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) allows companies the choice of either using a fair value method of accounting for options, which would result in expense recognition for all options granted, or using an intrinsic value method, as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), with a pro forma disclosure of the impact on net income (loss) of using the fair value option expense recognition method. We have elected to apply APB 25, and, accordingly, we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.

In March 2004, the FASB issued a proposed Statement, “Share-Based Payment, an amendment of FASB Statements No. 123 and 95”, which generally would require share-based payments to employees be accounted for using a fair-value-based method and recognized as expenses in our statements of operations. The effective date the proposed standard is recommending is for fiscal years beginning after December 15, 2004. Should this proposed statement be finalized, it will have a significant impact on our consolidated statement of operations as we will be required to expense the fair value of our stock options rather than disclosing the impact on our consolidated result of operations within our footnotes. This will result in lower reported earnings per share which could negatively impact our future stock price. In addition, should the proposal be finalized, this could impact our ability to utilize broad based employee stock plans to reward employees and could result in a competitive disadvantage to us in the employee marketplace.

We depend on our relationships with distributors and oncology equipment manufacturers to market our products, and if these relationships are discontinued, or we are unable to develop new relationships, our revenues could decline.

To successfully market and sell our products both in the United States and in foreign markets, we have developed relationships with distributors and leading oncology equipment manufacturers, including Siemens Medical Systems, Inc. Sales to Siemens represented 8.2% of our net sales in fiscal 2003, 13.0% in fiscal 2002 and 13.3% in fiscal 2001. We rely on these collaborative relationships to augment our direct sales efforts and maintain market access to potential customers, particularly in Europe and Asia, and our business strategy includes entering into additional third-party relationships in the future. Some of these manufacturers and distributors also produce or distribute products that directly compete with our core products.

We may not be able to maintain or develop these relationships with distributors and oncology equipment manufacturers, and these relationships may not continue to be successful. If any of these relationships is terminated, not renewed or otherwise unsuccessful, or if we are unable to develop additional relationships, our sales could decline, and our ability to continue to grow our business could be adversely affected. This is particularly the case for our international sales, where we rely on our distributors’ expertise regarding foreign regulatory matters and their access to actual and potential customers. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. In addition, if these relationships fail, we will have to devote additional resources to market our products than we would otherwise, and our efforts may not be as effective as those of the distributors and manufacturers with whom we have relationships. We are currently investing, and plan to continue to invest, significant resources to develop these relationships. Our operating results could be adversely affected if these efforts with distributors and manufacturers do not generate revenues necessary to offset these investments.

Recent changes to Medicare reimbursement policies could negatively affect oncologists, which could adversely affect their IT spending decisions and our growth prospects.

Sales of our IT systems to medical oncologists, who treat cancer through the infusion of chemotherapy agents, represent a small but growing portion of our current revenue and an opportunity for future growth. The Centers for Medicare and Medicaid Services (CMS), which regulates payment rates for drugs and services reimbursed under Medicare Part B, including chemotherapy drugs and services, has indicated that it may eliminate the drug administration charge for chemotherapy in 2005. While there is not necessarily a direct correlation between provider revenue and IT spending, a significant decease in the Part B reimbursement could negatively influence an oncologist’s willingness to invest in new systems. If these Medicare reforms result in reduced IT spending by oncologists, our growth opportunities could be adversely impacted.

We are subject to extensive federal, state and international regulations, which could cause us to incur significant costs.

Four of our medical device products, including two device connectivity products and two imaging products, are subject to extensive regulation by the U.S. Food and Drug Administration, or FDA, under the Federal

Food, Drug and Cosmetic Act, or FDC Act, and by the Food and Drug Branch of the California Department of Health Services, or FDB, which is the California state agency that oversees compliance with FDA regulations. The FDA’s regulations govern product design and development, product testing, product labeling, product storage, premarket clearance or approval, advertising and promotion, and sales and distribution. Unanticipated changes in existing regulatory requirements or adoption of new requirements could hurt our business, financial condition and results of operations.

 

Numerous regulatory requirements apply to our medical device products, including the FDA’s Quality System Regulations, which require that our manufacturing operations follow design, testing, process control, documentation and other quality assurance procedures during the manufacturing process. We are also subject to FDA regulations regarding labeling, adverse event reporting, and the FDA’s prohibition against promoting products for unapproved or “off-label” uses.

We face the risk that a future inspection by the FDA or FDB could find that we are not in full regulatory compliance. Our failure to comply with any applicable FDA regulation could lead to warning letters, non-approvals, suspensions of existing approvals, civil penalties and criminal fines, product seizures and recalls, operating restrictions, injunctions and criminal prosecution. If we fail to take adequate corrective action in response to any FDA observation of noncompliance, we could face enforcement actions, including a shutdown of our manufacturing operations and a recall of our products, which would cause our product sales, operating results and business reputation to suffer.

To market and sell our products in countries outside the United States, we must obtain and maintain regulatory approvals and comply with the regulations of those countries. These regulations and the time required for regulatory review vary from country to country. Obtaining and maintaining foreign regulatory approvals is expensive and time consuming. We plan to apply for regulatory approvals in particular countries, but we may not receive the approvals in a timely way or at all in any foreign country in which we plan to market our products, and if we fail to receive such approvals, our ability to generate revenue will be harmed.

Our products could be subject to recalls even after receiving FDA approval or clearance. A recall would harm our reputation and adversely affect our operating results.

The FDA, FDB and similar governmental authorities in other countries in which we market and sell our products have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government mandated recall, or a voluntary recall by us, could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. A recall could divert management’s attention, cause us to incur significant expenses, harm our reputation with customers and negatively affect our future sales.

Regulation of additional products of ours not currently subject to regulation as medical devices by the FDA could increase our costs, delay the introduction of new products and adversely affect our revenue growth.

The FDA has increasingly regulated computer products and computer-assisted products as medical devices under the FDC Act. If the FDA chooses to regulate any more of our products as medical devices, we would likely be required to take the following actions:

seek FDA clearance by demonstrating that our product is substantially equivalent to a device already legally marketed, or obtain FDA approval by establishing the safety and effectiveness of our product;

comply with rigorous regulations governing pre-clinical and clinical testing, manufacture, distribution, labeling and promotion of medical devices; and

comply with the FDC Act’s general controls, including establishment registration, device listing, compliance with good manufacturing practices and reporting of specified device malfunctions and other adverse device events.

We may not be able to convince the FDA to grant approval to a request for market clearance. If any of our products fails to comply with FDA requirements, we could face FDA refusal to grant pre-market clearance or approval of products, withdrawal of existing FDA clearances and approvals, fines, injunctions or civil penalties, recalls or product corrections, production suspensions and criminal prosecution. FDA regulation of additional products could increase our operating costs, delay or prevent the marketing of new or existing products and adversely affect our revenue growth.

New and potential federal regulations relating to patient confidentiality could require us to redesign our products.

State, federal and foreign laws regulate the privacy and security of individually identifiable health information. Although compliance with these laws and regulations is presently the principal responsibility of the hospital, physician or other healthcare provider, we must ensure that our products and business operations support these requirements by providing adequate privacy and security protection to associated patient health information. Regulations governing electronic health data transmission, privacy and security are evolving rapidly and are often unclear and difficult to apply.

Of particular importance is the Health Insurance Portability and Accountability Act of 1996, or HIPAA. Under HIPAA, the Secretary of Health and Human Services, or HHS, has adopted national data interchange standards for some types of electronic transactions and the data elements used in those transactions; adopted security standards to protect the confidentiality, integrity and availability of patient health information; and adopted privacy standards to prevent inappropriate access, use and disclosure of patient health information. In JanuaryDecember 2000, HHS published the final privacy regulations, which took effect in April 2003. These regulations restrict the use and disclosure of individually identifiable health information without the prior informed consent of the patient. In February 2003, HHS published the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidationfinal security regulations, which will take effect in April 2005. These regulations mandate that healthcare facilities implement operational, physical and technical security measures to reasonably prevent accidental, negligent or intentional inappropriate access or disclosure of Variable Interest Entities, an Interpretationpatient health information. We have made changes to our products and business operations to support these regulatory requirements. We feel that our currently available products and operations fully support our customers’ requirements to comply with the above regulations. However, HHS enforcement efforts may find that our operations and product offerings are insufficient to support our customers’ regulatory requirements. A customer’s failure to meet any applicable HIPAA regulation could lead to fines, injunctions or criminal prosecution of ARB No. 51.” FIN 46 requires certain variable interest entitiesthe customer, which would cause our product sales and business reputation to suffer. Initial enforcement efforts and regulatory changes could also force us to redesign our products or further change our operations. We may incur significant product development costs to modify or redesign our products to address evolving data security and privacy requirements.

We cannot predict the potential impact of any rules that have not yet been proposed or any forthcoming changes to the newly enacted rules. In addition, other foreign, federal and/or state privacy and security legislation may be enacted at any time.

If our products fail to provide accurate and timely information to our customers in their treatment of patients, our customers may be able to assert claims against us that could result in substantial costs to us, harm our reputation in the industry and cause demand for our products to decline.

We provide products that assist clinical decision-making and relate to patient medical histories and treatment plans. If these products fail to provide accurate and timely information, customers may be able to assert liability claims against us. Any potential liability claims, regardless of their outcome, could result in substantial costs to us, divert management’s attention from operations and decrease market acceptance of our products. We attempt to limit by contract our liability for damages arising from negligence, errors or mistakes. Despite this precaution, the limitations of liability set forth in our contracts may not be enforceable or may not otherwise protect us from liability for damages. We maintain general liability insurance coverage, including coverage for errors or omissions. However, this coverage may not continue to be consolidatedavailable on acceptable terms or may not be available in sufficient amounts to cover one or more large claims against us. In addition, the insurer might refuse coverage as to any future claim.

Highly complex software products such as ours often contain undetected errors or failures when first introduced or as updates and new versions are released. It is particularly challenging for us to test our products

because it is difficult to simulate the wide variety of computing environments in which our customers may deploy them. Despite extensive testing, from time to time we have discovered defects or errors in our products. Defects, errors or difficulties could cause delays in product introductions and shipments, result in increased costs and diversion of development resources, require design modifications or decrease market acceptance or customer satisfaction with our products. In addition, despite testing by us and by current and potential customers, errors may be found after commencement of commercial shipments, which may result in loss of or delay in market acceptance of our products.

We recently completed a major acquisition in December 2003. If we undertake additional acquisitions, they may be disruptive to our business and could have an adverse effect on our future operations and cause the primary beneficiarymarket price of our common stock to decline.

An element of our business strategy has been expansion through acquisitions. Since 1997, we have completed seven acquisitions of businesses or product lines, including the acquisition of certain assets and certain liabilities of Tamtron Corporation and Medical Registry Services, Inc., the pathology information management and cancer registry information system businesses of IMPATH Inc., for total cash consideration, including acquisition costs, of $22.5 million. As a result of these acquisitions, we face the following risks:

integrating the existing management, sales force, engineers and other personnel into one existing culture and business;

developing and implementing an integrated business strategy from what had been previously independent companies; and

developing compatible or complementary products and technologies from previously independent operations.

If we pursue any future acquisitions, we will also face additional risks, including the following:

the diversion of our management’s attention and the expense of identifying and pursuing suitable acquisition candidates, whether or not consummated;

the anticipated benefits from any acquisition may not be achieved;

the integration of acquired businesses requires substantial attention from management;

the diversion of the entity if the equity investorsattention of management and any difficulties encountered in the entitytransition process could hurt our business;

in future acquisitions, we could issue additional shares of our capital stock, incur additional indebtedness or pay consideration in excess of book value, which could have a dilutive effect on future net income, if any, per share; and

the potential negative effect on our financial statements from the increase in goodwill and other intangibles, the write-off of research and development costs and the high cost and expenses of completing acquisitions.

Interruptions in our power supply or telecommunications capabilities or the occurrence of an earthquake or other natural disaster could disrupt our operations and cause us to lose revenues or incur additional expenses.

Our primary facilities are located in California near known earthquake fault zones and are vulnerable to significant damage from earthquakes. We are also vulnerable to damage from other types of disasters, including tornadoes, fires, floods, power loss, communications failures and similar events. If any disaster were to occur, our ability to operate our business at our facilities could be seriously impaired or destroyed. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions.

We currently do not have backup generators to be used as alternative sources of power in the characteristicsevent of a controlling financial interestloss of power to our facilities. During any power outage, we would be temporarily unable to continue operations at our facilities. This would have adverse consequences for our customers who depend on us for system support and outsourcing services. Any such interruption in operations at our facilities could damage our reputation and harm our ability to obtain and retain customers, which could result in lost revenue and increased operating costs.

We have customers for whom we store and maintain critical patient and administrative data on computer servers in our application service provider, or do not have sufficient equity at riskASP, data center. Those customers access this data remotely through telecommunications lines. If our back-up power generators fail during any power outage or if our telecommunications lines are severed or impaired for any reason, those customers would be unable to access their critical data causing an interruption in their operations. In such event our remote access customers and their patients could seek to hold us responsible for any losses. We may also potentially lose those customers and our reputation could be harmed.

If we fail to attract, motivate and retain highly qualified technical, marketing, sales and management personnel, our ability to operate our business could be impaired.

Our success depends, in significant part, upon the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisionscontinued services of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We believe that the adoption of this FIN 46 will have no material impactour key technical, marketing, sales and management personnel and on our financial position orability to continue to attract, motivate and retain highly qualified employees. Competition for these employees is intense. In addition, the process of recruiting personnel with the combination of skills and attributes required to operate our business can be difficult, time-consuming and expensive. The success of our business depends to a considerable degree on our resultssenior management team. The loss of operations.any member of that team, particularly Joseph Jachinowski, James Hoey or David Auerbach, our founders, could hurt our business.

We depend on licenses from third parties for rights to the technology used in several of our products. If we are unable to continue these relationships and maintain our rights to this technology, our business could suffer.

We depend upon licenses for some of the technology used in our products from a number of third-party vendors, including Pervasive Software Inc., Medicomp Systems, Inc., First DataBank, Inc., Crystal Decisions, Inc. and SoftVelocity, Inc. If we were unable to continue using the technology made available to us under these licenses on commercially reasonable terms or at all, we may have to discontinue, delay or reduce product shipments until we obtain equivalent replacement technology, which could hurt our business. In addition, if our vendors choose to discontinue support of the licensed technology in the future, we may not be able to modify or adapt our own products.

If we fail to protect our intellectual property, our business could be harmed.

We are dependent upon our proprietary information and technology. Our means of protecting our proprietary rights may not be adequate to prevent misappropriation. The laws of some foreign countries may not protect our proprietary rights as fully as do the laws of the United States. Also, despite the steps we have taken to protect our proprietary rights, it may be possible for unauthorized third parties to copy aspects of our products, reverse engineer our products or otherwise obtain and use information that we regard as proprietary. In some limited instances, customers can access source-code versions of our software, subject to contractual limitations on the permitted use of the source code. Although our license agreements with these customers attempt to prevent misuse of the source code, the possession of our source code by third parties increases the ease and likelihood of potential misappropriation of such software. Furthermore, others could independently develop technologies similar or superior to our technology or design around our proprietary rights. In addition, infringement or invalidity claims or claims for indemnification resulting from infringement claims could be asserted or prosecuted against us. Regardless of the validity of any claims, defending against these claims could result in significant costs and diversion of our resources. The assertion of infringement claims could also result in injunctions preventing us from distributing products. If any claims or actions are asserted against us, we might be required to obtain a license to the disputed intellectual property rights, which might not be available on reasonable terms or at all.

Our international sales, marketing and service activities expose us to uncertainties that could limit our growth and adversely affect our operating results.

In addition to our domestic operations, we currently conduct sales, marketing and service activities in other countries in North America, Europe and the Pacific Rim. Our international operations pose risks that include:

potential adverse tax consequences;

foreign currency fluctuations;

potentially higher operating expenses, resulting from the establishment of international offices, the hiring of additional personnel and the localization and marketing of products for particular countries;

the impact of smaller healthcare budgets in some international markets, which could result in greater pricing pressure and reduced gross margins;

uncertainties relating to product feature requirements in foreign markets;

order deposits at lower levels than historically achieved with U.S. orders;

unproven performance of new distributors;

greater difficulty in collecting accounts receivable;

the difficulty of building and managing an organization with geographically dispersed operations;

burdens and uncertainties related to foreign laws; and

lengthy sales cycles typical in overseas markets.

If we are unable to meet and overcome these challenges, our international operations may not be successful, which would limit the growth of our business.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 3.Quantitative and Qualitative Disclosures About Market Risk

 

The following discusses our exposure to market risk related to changes in interest rates and foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.

 

We have been exposed to interest rate risk as it applies to our limited use of debt instruments and interest earned on holdings of long and short-term marketable securities. Interest rates that may affect these items in the future will depend on market conditions and may differ from the rates we have experienced in the past. A 10% change in interest rates would not be material to our results of operations. We reduce the sensitivity of our results of operations to these risks by maintaining an investment portfolio, which is primarily comprised of highly rated, short-term investments. We do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes.

We have operated mainly in the United States and greater than 99% of our sales were made in U.S. dollars in each of the six months ended March 31, 20032004 and 2002.2003. Accordingly, we have not had any material exposure to foreign currency rate fluctuations. Currently, all of our international distributors denominate all transactions in U.S. dollars. However, as we sell to customers in the United Kingdom and Europe through our recently formed UK subsidiary a majority of those sales may be denominated in euros or pounds sterling. The functional currency of our new UK subsidiary is pounds sterling. Thus, exchange rate fluctuations between the euro and pounds sterling will be recognized in the statements of operations as these foreign denominated sales are remeasured by our UK subsidiary. As exchange rate fluctuations occur between pounds sterling and the U.S. dollar, these fluctuations will be recorded as cumulative translation adjustments within stockholders’ equity as a component of accumulated other comprehensive income (loss) as our UK subsidiary is translated into U.S. dollars for consolidation purposes.

Item 4. Controls and Procedures

Item 4.Controls and Procedures

 

a. Evaluation Of Disclosure Controls And Procedures.

In April 2004, our management determined to restate our consolidated financial statements as of and for the years ended September 30, 2003, 2002 and 2001, to shift some previously recognized revenues to later quarters or to defer recorded revenues and recognize them in periods subsequent to September 30, 2003. During the restatement, our independent auditors, PricewaterhouseCoopers LLP, advised management and the Audit Committee that it noted certain matters regarding software revenue recognition practices during the periods under review that it considered to be material weaknesses.

 

Joseph Jachinowski, our Chief Executive Officer, and Kendra Borrego, our Chief Financial Officer, conducted an evaluation of the effectiveness of IMPAC’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2003. Based upon their evaluation, they each found the Company’s disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports that IMPAC files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required, and that information required to be disclosed is accumulated and communicated to them as appropriate to allow timely decisions regarding required disclosure.

As described in Note 7 of the notes to the condensed consolidated financial statements included in Part I – Item 1 of this Form 10-Q/A, subsequent to the issuance of IMPAC’s condensed consolidated financial statements for the quarter ended March 31, 2002, our management determined to restate our consolidated financial statements as of and for the quarters ended March 31, 2003 and 2002, to shift some previously recognized revenues to later quarters or to defer recorded revenues and recognize them in periods subsequent to March 31, 2003.

In connection with restating our financial statements as provided in this report, our Chief Executive Officer and Chief Financial Officer, with the participation of other management, re-evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report and as of the date of this report. During the restatement, our independent auditors, PricewaterhouseCoopers LLP, advised management and the Audit Committee that it noted certain matters regarding software revenue recognition practices during the periods under review that it considered to be material weaknesses. As part of the re-evaluation, we have conducted an extensive internal review of our revenue recognition practices for all periods for which financial statements are included in this report. Among other things, this involved the review of each of the over 1,500 customer contracts entered into since October 1, 1999.

2004. Based on the re-evaluation by our Chief Executive Officer and Chief Financial Officer,this evaluation, they concluded that, as of the end of the period covered by this report, there were still certain deficiencies in our disclosure controls and procedures.

 

As part of our disclosure controls and procedures over the selection and application of accounting principles, in particular software revenue recognition under SOP 97-2, our accounting officers independently reviewed SOP 97-2 together with other accounting literature, consulted with our independent auditing firm regarding revenue recognition and accounting developments, attended continuing education courses for the accounting profession and reviewed various accounting journals and other literature with respect to the existence of new accounting pronouncements and their application to IMPAC.

 

These controls and procedures were found to be deficient in identifying the accounting issues which arewere the subject of the restatement. Specifically, the controls and procedures did not result in (i) our proper understanding of the application of SOP 97-2 for multiple element contracts, (ii) the identification of an improper usage of a retroactive acceptance clause resulting in revenue being recognized in the incorrect period and (iii) the deferral of 12% of the current list price of the software rather than 12% of the net purchase price.

In response to the matters identified, we have taken steps to strengthen control processes and procedures to identify, rectify and prevent the recurrence of the circumstances that resulted in our determination to restate prior period financial statements. We intend to correct the identified weaknesses in our disclosure controls and procedures that led to the restatement by taking the following steps, among others:

 

InitiatingContinuing a search for an in-house finance person with extensive software revenue recognition experience, including the application of SOP 97-2.

 

Establishing a procedure for conducting internal training sessions for affected employees on applicable policies and procedures and providing opportunities for accounting personnel to attend external training and continuing education programs.

 

Supplementing our revenue recognition policy to include a clearly understandable summary of key elements of the policy to better ensure broader understanding of the policy among our personnel.

 

Documenting the review of revenue transactions prior to recognizing revenue, including how each of the four criteria for revenue recognition (i.e. persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable) has been met, and requiring that this documentation be reviewed and approved by a responsible person prior to recording revenue.

 

Establishing procedures to perform an on-going analysis of the VSOE of maintenance to support the fair value of maintenance to be used in deferring the fair value from multiple element arrangements.

 

Corresponding with accounting professionals, including but not limited to our independent auditing firm, to ascertain any changes in application of Generally Accepted Accounting Principles (GAAP).

 

Reviewing the Financial Accounting Standards Board’s (FASB) and American Institute of Certified Public Accountants’ websites and any available information to acknowledge, review and interpret any applicable accounting changes, including changes relating to software revenue recognition.

 

We believe changes to our system of internal controls and our disclosure controls and procedures will be adequate to provide reasonable assurance that the objectives of these control systems will be met. However, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.

 

b. Changes in Internal Controls.

 

There were none.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 1.Legal Proceedings

 

We are not currently a party to any material legal proceedings.

 

Item 2. Changes in Securities and Use of Proceeds

Item 2.Changes in Securities, Use of Proceeds and Issuer Purchase of Equity Securities

 

Our registration statement (Registration No. 333-89724) under the Securities Act of 1933, as amended, for our initial public offering became effective on November 19, 2002. A total of 2,515,625 shares of common stock were registered, and we sold 1,875,000 shares of our common stock to an underwriting syndicate. Thomas Weisel Partners LLC, SG Cowen Securities Corporation and U.S. Bancorp Piper Jaffray Inc. were the managing underwriters of the offering. An additional 640,625 shares of common stock were sold on behalf of selling stockholders as part of the same offering. All shares were sold to the public at a price of $15.00 per share. In connection with the offering, we paid approximately $2.0 million in underwriting discounts and commissions to the underwriters. Offering proceeds, net of aggregate costs to us of approximately $1.8 million, were approximately $24.4 million. As discussed in Note 6 to the condensed consolidated financial statements, we acquired certain assets and assumed certain liabilities of Tamtron Corporation and Medical Registry Services, Inc. from IMPATH Inc. We used approximately $22.5 million of the funds received in our public offerings to finance this acquisition.

We intend to use the remaining net proceeds of the offering for working capital and to expand our business generally, including possible acquisitions.generally.

Item 3. Defaults Upon Senior Securities

Item 3.Defaults Upon Senior Securities

 

Not Applicable.

Item 4.Submission of Matter to a Vote of Securities Holders

The Company held its annual meeting of stockholders on February 17, 2004. At the annual meeting, the following matters were voted upon:

 

Item 4. Submission1. Election of MatterDirectors: Election of the following directors to serve for a Voteterm ending upon the 2007 annual meeting of Securities Holdersstockholders or when their successors are elected and qualified:

 

Nominee


  

Total Votes

For


  

Total Votes

Withheld


James P. Hoey

  8,048,869  944,927

Dr. Christopher M. Rose

  8,620,487  373,309

Not applicable.

Joseph K. Jachinowski and Gregory M. Avis continue to serve the Company for a term ending upon the 2005 annual meeting of stockholders or when their successors are elected and qualified, and David A. Auerbach, Dr. Robert J. Becker and Gregory T. Schiffman continue to serve the Company for a term ending upon the 2006 annual meeting of stockholders or when their successors are elected and qualified.

2. Amendment to 2002 Stock Plan: Approval of an amendment and restatement of the IMPAC Medical Systems, Inc. 2002 Stock Plan to allow for grants of stock appreciation rights and stock units.

For


 

Against


 

Abstain


 

No Vote


6,184,299

 2,278,492 725 530,280

Item 5.Other Information

 

Item 5. Other InformationNot applicable.

 

The audit committee has reviewed the range of services provided by PricewaterhouseCoopers LLP to the Company for both historic and proposed projects. In addition to audit services for the Company and all wholly owned subsidiaries, PricewaterhouseCoopers LLP is authorized to provide services related to federal and state tax compliance and any transaction services that may be needed in connection with due diligence projects.

Item 6. Exhibits and Reports on Form 8-K

Item 6.Exhibits and Reports on Form 8-K

 

(a)Exhibits

 

10.3.2Third Addendum dated February 5, 2003 to Lease Agreement dated September 1, 1999 between the Revocable Living Trust dated March 23, 1987, Hillview Management, Inc. and IMPAC for the premises in Mountain View, California (incorporated by reference from Exhibit 10.3.2 to IMPAC’s Registration Statement on Form S-1 (File No. 333-104739)).
10.72002 Stock Plan, as amended and restated on November 18, 2003.
31.1  Certification of Principal Executive Officer Pursuant to Section 302.
31.2  Certification of Principal Financial Officer Pursuant to Section 302.
32.1  Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350.
32.2  Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350.

(b)Reports on Form 8-K

 

There were noThe following reports on formForm 8-K were filed during the three month period ended March 31, 2003.2004:

Form 8-K filed January 6, 2004 relating to the completed acquisition of substantially all of the assets and certain liabilities of Tamtron Corporation and Medical Registry Services, Inc..

Form 8-K filed March 2, 2004 relating to our press release announcing our intent to restate our financial statements and receipt of a Nasdaq delisting notification.

The following report on Form 8-K was furnished during the three month period ended March 31, 2004:

Form 8-K filed February 9, 2004 relating to our press release announcing the postponement of our previously scheduled first quarter 2004 earnings release and conference call due to an ongoing review of our financial statements relating to the timing of our recognition of revenues during prior periods.

SIGNATURES

 

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized.

 

IMPAC MEDICAL SYSTEMS, INC.


Registrant

Dated: April 16,May 14, 2004

/s/    JOSEPH K. JACHINOWSKI


Joseph K. Jachinowski

Chairman of the Board, President and

Chief Executive Officer

/s/    KENDRA A. BORREGO


Kendra A. Borrego

Chief Financial Officer

 

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