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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission file number 0-13801
QUALITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California 95-2888568
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
17822 East 17th Street, Tustin, California 92780
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (714) 731-7171
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of the latest practicable date: 6,019,648 shares of Common
Stock, $.01 par value, as of November 8, 2001
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QUALITY SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
SIX MONTHS ENDED SEPTEMBER 30, 2001
TABLE OF CONTENTS PAGE
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 2001
(unaudited) and March 30, 2001 2
Unaudited Condensed Consolidated Statements of Income for the Three
and Six Months Ended September 30, 2001 and 2000 3
Unaudited Condensed Consolidated Statements of Cash Flows for the
Six Months Ended September 30, 2001 and 2000 4
Notes to Condensed Consolidated Financial Statements 5
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 16
ITEM 2. CHANGES IN SECURITIES 17
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS 17
ITEM 5. OTHER INFORMATION 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18
SIGNATURE 18
1
PART I - CONSOLIDATED FINANICAL INFORMATION
Item 1. Financial Statements
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
September 30, March 31,
2001 2001
ASSETS (Unaudited)
------------- ---------
Current Assets:
Cash and cash equivalents $21,177 $18,471
Short-term investments 258 258
Accounts receivable, net 13,951 13,335
Inventories, net 926 1,030
Deferred tax assets 1,566 1,566
Other current assets 740 532
------- -------
Total current assets 38,618 35,192
Equipment and Improvements, net 1,570 1,819
Capitalized Software Costs, net 1,892 1,769
Deferred Tax Assets 2,960 2,960
Goodwill, net 1,840 1,840
Other Intangible Assets, net 75 152
Other Assets 1,269 1,151
------- -------
Total assets $48,224 $44,883
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,698 $ 1,829
Deferred service revenue 6,127 5,595
Other current liabilities 3,917 3,572
------- -------
Total liabilities 11,742 10,996
------- -------
Commitments and Contingencies
Shareholders' Equity:
Common Stock, $0.01 par value, 20,000 shares authorized,
6,017 and 5,987 shares issued and outstanding, respectively 60 60
Additional paid-in capital 33,984 33,780
Retained earnings 2,438 47
------- -------
Total shareholders' equity 36,482 33,887
------- -------
Total liabilities and shareholders' equity $48,224 $44,883
======= =======
See notes to consolidated financial statements.
2
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands, except per share amounts)
Three Months Ended Six Months Ended
September 30, September 30,
------------------ ------------------
2001 2000 2001 2000
------- ------- ------- -------
Net Revenues:
Sales of computer systems, upgrades and
supplies $ 5,110 $ 4,794 $10,704 $ 9,189
Maintenance and other services 5,387 4,869 10,702 9,736
------- ------- ------- -------
10,497 9,663 21,406 18,925
Cost of Products and Services 4,547 4,363 9,281 8,395
------- ------- ------- -------
Gross Profit 5,950 5,300 12,125 10,530
Selling, General and Administrative
Expenses 3,294 3,244 6,539 6,609
Research and Development Costs 1,000 974 2,107 1,979
------- ------- ------- -------
Income from Operations 1,656 1,082 3,479 1,942
Investment Income 190 251 396 497
------- ------- ------- -------
Income before Provision for Income Taxes 1,846 1,333 3,875 2,439
Provision for Income Taxes 714 589 1,485 1,070
------- ------- ------- -------
Net Income $ 1,132 $ 744 $ 2,390 $ 1,369
======= ======= ======= =======
Net Income per Share, basic $ 0.19 $ 0.12 $ 0.40 $ 0.22
======= ======= ======= =======
Net Income per Share, diluted $ 0.18 $ 0.12 $ 0.39 $ 0.22
======= ======= ======= =======
See notes to consolidated financial statements.
3
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Six Months Ended September 30,
------------------------------
2001 2000
-------- --------
Cash Flows from Operating Activities:
Net Income $ 2,390 $ 1,369
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,039 1,342
Gain on short-term investments and other -- (5)
Deferred income taxes -- 1,364
Changes in:
Accounts receivable (616) (1,397)
Inventories 104 43
Other current assets (208) (84)
Other assets (118) (6)
Accounts payable (131) 371
Deferred service revenue 532 21
Income taxes payable and taxes related to equity accounts (71) (1,287)
Other current liabilities 417 42
-------- --------
Net Cash Provided By Operating Activities 3,338 1,773
-------- --------
Cash Flows used in Investing Activities:
Net additions to equipment and improvements (147) (572)
Additions to capitalized software costs (689) (559)
Change in Other Assets -- (13)
-------- --------
Net Cash Used In Investing Activities (836) (1,144)
-------- --------
Cash Flows from Financing Activities:
Purchases of Common Stock -- (35)
Proceeds from exercise of stock options 204 85
-------- --------
Net Cash Provided by Financing Activities 204 50
-------- --------
Net Increase in Cash and Cash Equivalents 2,706 679
Cash and Cash Equivalents, beginning of period 18,471 15,926
-------- --------
Cash and Cash Equivalents, end of period $ 21,177 $ 16,605
======== ========
Supplemental Information - During the six months ended September 30, 2001 and
2000, the Company made income tax payments, net of refunds received, of
$1,444,000 and $831,000 respectively.
See notes to consolidated financial statements.
4
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the requirements of Form 10-Q and, therefore, do not include
all information and footnotes which would be presented were such financial
statements prepared in accordance with generally accepted accounting principles,
and should be read in conjunction with the audited financial statements
presented in the Company's Annual Report for the fiscal year ended March 31,
2001. In the opinion of management, the accompanying financial statements
reflect all adjustments which are necessary for a fair presentation of the
results of operations for the interim periods presented. The results of
operations for such interim periods are not necessarily indicative of results of
operations to be expected for the full year. Certain amounts in the accompanying
financial statements have been reclassified to conform with the September 30,
2001 presentation.
2. New Accounting Pronouncement
The Company adopted Financial Accounting Standards Board No. 142 "Goodwill and
Other Intangible Assets" ("FASB 142") effective April 1, 2001. The new statement
applies to the amortization of goodwill and other intangible assets. In
accordance with FASB 142, the Company has ceased amortizing amounts related to
goodwill starting April 1, 2001. The balance of goodwill is related to the
Company's MicroMed Division. In accordance with FASB 142, the Company has
compared the fair value of the MicroMed Division with the carrying amount of
assets associated with the Division and determined that none of the goodwill
recorded as of June 30, 2001 was impaired. The fair value of the MicroMed
Division was determined using a reasonable estimate of future cash flows of the
Division and a risk adjusted discount rate to compute a net present value of
future cash flows.
As of September 30, 2001, the Company had the following amounts related to
intangible assets with determinable lives. Under FASB 142, these intangible
assets will continue to be amortized over their assumed lives as seen below:
(amounts in thousands) Gross Carrying Accumulated
Amount Amortization
-------------- -----------
Amortized intangible assets (Life)
Developed Technology (5 yrs) $1,300 $(1,225)
Capitalized Software Development (3 yrs) $4,050 $(2,158)
Aggregate Amortization Expense Six Months Ended September 30, 2001 $ 641
The following table represents the total estimated amortization of intangible
assets beginning with fiscal year ending March 31, 2002:
Estimated Amortization Expense
For the year ending March 31, (in thousands)
- ----------------------------- ------------------------------
2002 $1,264
2003 $ 811
2004 $ 444
2005 $ 89
5
Reconciliation of reported net income adjusted for adoption of FASB 142:
(in thousands except per share amounts)
Three Months Ended Six Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Reported Net Income $ 1,132 $ 744 $ 2,390 $ 1,369
Addback:
Goodwill amortization $ 100 $ 200
--------- --------- --------- ---------
Adjusted Net Income $ 1,132 $ 844 $ 2,390 $ 1,569
--------- --------- --------- ---------
Basic earnings per share:
Reported Net Income $ 0.19 $ 0.12 $ 0.40 $ .22
Goodwill amortization .02 .03
--------- --------- --------- ---------
Adjusted Net Income $ 0.19 $ 0.14 $ 0.40 $ 0.25
--------- --------- --------- ---------
Diluted earnings per share:
Reported Net Income $ 0.18 $ 0.12 $ 0.39 $ 0.22
Goodwill amortization .01 .03
--------- --------- --------- ---------
Adjusted Net Income $ 0.18 $ 0.13 $ 0.39 $ 0.25
--------- --------- --------- ---------
3. Stock Repurchase Plan
In October 2001, the Company's Board of Directors authorized the repurchase on
the open market of up to 5% of the shares of the Company's outstanding Common
stock, subject to compliance with applicable laws and regulations. Purchases are
entirely at the discretion of the company's management. This authorization
expires on the date of the Fiscal 2003 annual shareholders meeting .
4. Income Taxes
The provision for income taxes for the three and six month periods ended
September 30, 2001 and 2000 differ from the expected combined statutory rates
primarily due to the impact of non-deductible amortization of certain intangible
assets acquired in the May 1996 acquisition of Clinitec International, Inc. and
the effect of varying state income tax rates.
5. Net Income Per Share
The following table reconciles the weighted average shares outstanding for basic
and diluted net income per share for the periods indicated.
(in thousands except per share amounts)
Three Months Ended Six Months Ended
September 30, September 30,
------------------ ----------------
2001 2000 2001 2000
------ ------ ------ ------
Net income $1,132 $ 744 $2,390 $1,369
Basic net income per common share:
Weighted average of common shares outstanding 5,997 6,209 5,997 6,209
------ ------ ------ ------
Basic net income per common share $ 0.19 $ 0.12 $ 0.40 $ 0.22
====== ====== ====== ======
Diluted net income per share:
Weighted average of common shares outstanding 5,997 6,209 5,997 6,209
Effect of potentially dilutive securities
(options) 207 64 192 77
------ ------ ------ ------
Weighted average number of common and
shares - Diluted 6,204 6,273 6,189 6,286
------ ------ ------ ------
Diluted net income per common share $ 0.18 $ 0.12 $ 0.39 $ 0.22
====== ====== ====== ======
6
6. Operating Segment Information
The Company has prepared operating segment information in accordance with
Statement of Accounting Standards ("SFAS") No. 131 "Disclosures About Segments
of an Enterprise and Related Information" ("SFAS No. 131") to report components
that are evaluated regularly by the Company's chief operating decision maker, or
decision making group in deciding how to allocate resources and in assessing
performance.
The Company's reportable operating segments include its MicroMed Division and
the QSI Division.
The disaggregated financial results of the segments reflect allocation of
certain functional expense categories consistent with the basis and manner in
which Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions. Certain corporate
overhead costs are not allocated to the individual segments by management. The
Company evaluates performance based on stand-alone segment operating income.
Because the Company does not evaluate performance based on return on assets at
the operating segment level, assets are not tracked internally by segment.
Therefore, segment asset information is not presented.
Operating segment data for the six months ended September 30, was as
follows:
(in thousands)
MicroMed Unallocated
QSI Division Division Corporate Expenses Consolidated
------------ -------- ------------------ ------------
Six Months Ended September 30, 2001
Revenue $8,545 $12,861 -- $21,406
Operating Income (Loss) $2,489 $ 1,926 $ (936) $ 3,479
Assets -- -- -- $48,224
Six Months Ended September 30, 2000
Revenue $8,728 $10,197 -- $18,925
Operating Income (Loss) $1,474 $ 1,476 $(1,008) $ 1,942
Assets -- -- -- $44,702
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Except for the historical information contained herein, the matters discussed in
this Quarterly Report on Form 10-Q, including discussions of the Company's
product development plans, business strategies and market factors influencing
the Company's results, are forward-looking statements that involve certain risks
and uncertainties. Actual results may differ from those anticipated by the
Company as a result of various factors, both foreseen and unforeseen, including,
but not limited to, the Company's ability to continue to develop new products
and increase systems sales in markets characterized by rapid technological
evolution, consolidation within the Company's target marketplace and among the
Company's competitors, and competition from larger, better capitalized
competitors. Many other economic, competitive, governmental and technological
factors could impact the Company's ability to achieve its goals. Interested
persons are urged to review the risks described below, as well as in the
Company's other public disclosures and filings with the Securities and Exchange
Commission.
Company Overview
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiary, Clinitec
International, Inc. ("Clinitec") d/b/a MicroMed Healthcare Information Systems,
Inc. ("MicroMed") (collectively, the "Company"), develop and market healthcare
information systems that automate medical and dental group practices, physician
hospital organizations ("PHOs"), management service organizations ("MSOs"),
ambulatory care centers, community health centers, and medical and dental
schools. In response to the growing need for more comprehensive, cost-effective
information solutions for physician and dental practices, the Company's systems
enable clients to redesign office workflow processes, improve productivity,
reduce information processing and administrative costs, and utilize electronic
medical records to store and access patient information. The Company's
proprietary software systems cover a
7
number of important practice elements including but not limited to general
patient information, electronic medical records, appointment scheduling,
billing, insurance claims submission and processing, eligibility verification,
managed care plan implementation, referral management, treatment outcome
studies, treatment planning, drug formularies, dental charting, and letter
generation. Several of the Company's software systems may be operated remotely
using thin client connectivity or a standard web browser. In addition to
providing fully integrated software solutions to its clients, the Company offers
comprehensive hardware and software installation services, maintenance and
support services, and system training services.
The Company currently has a base of approximately 700 clients, with each
client including between one and 500 physicians or dentists. The Company
believes that as healthcare providers are increasingly required to reduce costs
and maintain the quality of healthcare, the Company will be able to capitalize
on its strategy of providing fully integrated information systems and superior
client service.
QSI, a California corporation formed in 1974, was founded with an early
focus on providing information systems and services for dental group practices.
In the mid-1980's, QSI capitalized on the increasing focus on medical cost
containment and further expanded its information processing systems to serve the
medical market. Today, the Company has dedicated products serving both the
medical and dental markets.
The Company's QSI Division develops and markets dental practice management
and medical practice management software suites utilizing a UNIX(1) operating
system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(2) operating
system and can be fully integrated with the Company's dental practice management
applications. CPS incorporates a wide range of clinical tools including but not
limited to periodontal charting and digital imaging of X-ray and inter-oral
camera images as part of a complete electronic patient record. In addition, the
QSI Division develops and markets the Company's QUIC product suite which
incorporates a variety of products that enhance the connectivity between
provider and payor, and provider and patient. The QSINet Application Services
Provider ("ASP")/Internet product offering is also developed and marketed in
this Division. QSINet enables providers to extend patient appointment
scheduling, electronic bill payment, and other functions to patients via the
Internet.
QSI's MicroMed Division develops and sells proprietary electronic medical
records software and practice management systems under the NextGen(R)(3) product
name. Major product categories of the NextGen suite include Electronic Medical
Records (NextGen(emr)), Enterprise Practice Management (NextGen(epm)),
Enterprise Appointment Scheduling (NextGen(eas)), Enterprise Master Patient
Index (NextGen(epi)), Managed Care, Electronic Data Interchange, System
Interfaces, Internet Operability (NextGen(web)), and a Patient-centric and
Provider-centric Web Portal Solution (NextMD.com(4)). The Company's enterprise
practice management and electronic medical records software packages can run via
private intranet or via the Internet in an ASP environment.
Enhancements to these products has continued into fiscal 2002.
Risk Factors
Competition. The markets for healthcare information systems are intensely
competitive, and the Company faces significant competition from a number of
different sources. Several of the Company's competitors have significantly
greater name recognition as well as substantially greater financial, technical,
product development and marketing resources than the Company.
The Company competes in all of its markets with other major healthcare
related companies, information management companies, systems integrators, and
other software developers. Competitive pressures and other factors, such as new
product introductions by the Company or its competitors, may
- ----------
1 UNIX is a registered trademark of AT&T Corporation.
2 Microsoft Windows, Windows NT, Windows 95, Windows 98, and Windows 2000 are
registered trademarks of Microsoft Corporation.
3 NextGen is a registered trademark of Clinitec International, Inc.
4 NextMD.com is a trademark of Clinitec International, Inc.
8
result in price or market share erosion that could have a material adverse
effect on the Company's business, results of operations and financial condition.
Also, there can be no assurance that the Company's applications will achieve
broad market acceptance or will successfully compete with other competing
software products.
The Company's inability to make initial sales of its systems to either
newly formed groups and/or healthcare providers that are replacing or
substantially modifying their healthcare information systems could have a
material adverse effect on the Company's business, results of operations and
financial condition. If new systems sales do not materialize, the Company's
maintenance revenues can be expected to decrease over time due to the combined
effects of potential attrition of existing clients and a shortfall in new client
additions.
Fluctuation in Quarterly Operating Results. The Company's revenues and
operating results have fluctuated in the past, and may fluctuate in the future
from quarter to quarter and period to period, as a result of a number of factors
including, without limitation: the size and timing of orders from clients; the
length of sales cycles and installation processes; the ability of the Company's
clients to obtain financing for the purchase of the Company's products; changes
in pricing policies or price reductions by the Company or its competitors; the
timing of new product announcements and product introductions by the Company or
its competitors; the availability and cost of system components; the financial
stability of major clients; market acceptance of new products, applications and
product enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements and to control costs; the
Company's success in expanding its sales and marketing programs; deferrals of
client orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with minimal backlog. As a
result, sales in any quarter are dependent on orders booked and shipped in that
quarter and are not predictable with any degree of certainty. Further, the
Company's systems can be relatively large and expensive and individual systems
sales can represent a significant portion of the Company's revenues for a
quarter such that the loss or deferral of even one such sale can have a
significant adverse impact on the Company's quarterly profitability.
Clients often defer systems purchases until the Company's quarter end, so
quarterly results generally cannot be predicted and frequently are not known
until the quarter has concluded.
The Company's sales are dependent upon a client's initial decision to
replace, or substantially modify its existing information system, and
subsequently a decision as to which products and services to purchase. These are
major decisions for healthcare providers, and accordingly, the sales cycle for
the Company's systems can vary significantly and typically ranges from three to
twelve months from initial contact to contract execution/shipment.
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can cause
significant variations in operating results from quarter to quarter. As a
result, the Company believes that interim period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, the Company's historical
operating results are not necessarily indicative of future performance for any
particular period.
The Company recognizes revenue pursuant to Statement of Position ("SOP")
No. 97-2, "Software Revenue Recognition" ("SOP 97-2"). Additionally, in December
1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101
became effective for the Company in the third quarter of fiscal 2001.
There can be no assurance that application and subsequent interpretations
of these pronouncements will not further modify the Company's revenue
recognition policies, or that such modifications would not have a material
adverse effect on the operating results reported in any particular quarter.
9
There can be no assurance that the Company will not be required to adopt
changes in its licensing or services practices to conform to SOP 97-2 or SAB
101, or that such changes, if adopted, would not result in delays or
cancellations of potential sales of the Company's products.
Due to all of the foregoing factors, it is possible that in some future
quarter(s) the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially adversely affected.
Dependence on Principal Product and New Product Development. The Company
currently derives substantially all of its net revenues from sales of its
healthcare information systems and related services. The Company believes that a
primary factor in the market acceptance of its systems has been its ability to
meet the needs of users of healthcare information systems. The Company's future
financial performance will depend in large part on the Company's ability to
continue to meet the increasingly sophisticated needs of its clients through the
timely development, successful introduction and implementation of new and
enhanced versions of its systems and other complementary products. The Company
has historically expended a significant percentage of its net revenues on
product development and believes that significant continuing product development
efforts will be required to sustain the Company's growth.
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing products, or that new products or product enhancements will
be developed and implemented in a timely manner, meet the requirements of
healthcare providers, or achieve market acceptance. If new products or product
enhancements do not achieve market acceptance, the Company's business, results
of operations and financial condition could be materially adversely affected. At
certain times in the past, the Company has also experienced delays in purchases
of its products by clients anticipating the launch of new products by the
Company. There can be no assurance that material order deferrals in anticipation
of new product introductions will not occur.
Technological Change. The software market generally is characterized by
rapid technological change, changing customer needs, frequent new product
introductions, and evolving industry standards. The introduction of products
incorporating new technologies and the emergence of new industry standards could
render the Company's existing products obsolete and unmarketable. There can be
no assurance that the Company will be successful in developing and marketing new
products that respond to technological changes or evolving industry standards.
New product development depends upon significant research and development
expenditures which depend ultimately upon sales growth. Any material weakness in
revenues or research funding could impair the Company's ability to respond to
technological advances in the marketplace and to remain competitive. If the
Company is unable, for technological or other reasons, to develop and introduce
new products in a timely manner in response to changing market conditions or
customer requirements, the Company's business, results of operations and
financial condition may be materially adversely affected.
In response to increasing market demand, the Company is currently
developing new generations of certain of its software products. There can be no
assurance that the Company will successfully develop these new software products
or that these products will operate successfully, or that any such development,
even if successful, will be completed concurrently with or prior to introduction
of competing products. Any such failure or delay could adversely affect the
Company's competitive position or could make the Company's current products
obsolete.
Litigation. The Company faces one Federal securities action (see "Part II
- - Other Information, Item 1. Litigation."). At this time it is not reasonably
possible to estimate the damage, or the range of damages, if any, that the
Company might incur in connection with this action. However, the uncertainty
associated with substantial unresolved litigation may have an adverse impact on
the Company's business. In particular, such litigation could impair the
Company's relationships with existing customers and its ability to obtain new
customers. Defending such litigation may result in a diversion of management's
time and attention away from business operations, which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Such litigation may also have the effect of discouraging potential
acquirers from bidding for the Company or reducing the consideration such
acquirers would otherwise be willing to pay in connection with an acquisition.
10
There can be no assurance that such litigation will not result in
liability in excess of the Company's insurance coverage, that the Company's
insurance will cover such claims or that appropriate insurance will continue to
be available to the Company in the future at commercially reasonable rates.
Proprietary Technology. The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely on
license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect its intellectual property. The Company's software is not
patented and the Company believes that existing copyright laws offer only
limited practical protection.
There can be no assurance that the legal protections and precautions taken
by the Company will be adequate to prevent misappropriation of the Company's
technology or that competitors will not independently develop technologies
equivalent or superior to the Company's. Further, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an extent
as do the laws of the United States and are often not enforced as vigorously as
those in the United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no assurance
that others will not assert infringement or trade secret claims against the
Company with respect to its current or future products or that any such
assertion will not require the Company to enter into a license agreement or
royalty arrangement with the party asserting the claim. As competing healthcare
information systems increase in complexity and overall capabilities and the
functionality of these systems further overlaps, providers of such systems may
become increasingly subject to infringement claims. Responding to and defending
any such claims may distract the attention of Company management and have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, claims may be brought against third parties
from which the Company purchases software, and such claims could adversely
affect the Company's ability to access third party software for its systems.
Ability to Manage Growth. The Company has in the past experienced periods
of growth which have placed, and may continue to place, a significant strain on
the Company's resources. The Company also anticipates expanding its overall
software development, marketing, sales, client management and training capacity.
In the event the Company is unable to identify, hire, train and retain qualified
individuals in such capacities within a reasonable timeframe, such failure could
have a material adverse effect on the Company. In addition, the Company's
ability to manage future increases, if any, in the scope of its operations or
personnel will depend on significant expansion of its research and development,
marketing and sales, management, and administrative and financial capabilities.
The failure of the Company's management to effectively manage expansion in its
business could have a material adverse effect on the Company's business, results
of operations and financial condition.
Dependence Upon Key Personnel. The Company's future performance also
depends in significant part upon the continued service of its key technical and
senior management personnel, many of whom have been with the Company for a
significant period of time. The Company does not maintain key man life insurance
on any of its employees. Because the Company has a relatively small number of
employees when compared to other leading companies in the same industry, its
dependence on maintaining its employees is particularly significant. The Company
is also dependent on its ability to attract and retain high quality personnel,
particularly in the areas of sales and applications development.
The industry in which the Company operates is characterized by a high
level of employee mobility and aggressive recruiting of skilled personnel. There
can be no assurance that the Company's current employees will continue to work
for the Company.
Loss of services of key employees could have a material adverse effect on
the Company's business, results of operations and financial condition.
Furthermore, the Company may need to grant additional stock options to key
employees and provide other forms of incentive compensation to attract and
retain such key personnel.
Product Liability. Certain of the Company's products provide applications
that relate to patient clinical information. Any failure by the Company's
products to provide accurate and timely information could result in claims
against the Company. In addition, a court or government agency may take the
11
position that the Company's delivery of health information directly, including
through licensed practitioners, or delivery of information by a third party site
that a consumer accesses through the Company's web sites, exposes the Company to
malpractice or other personal injury liability for wrongful delivery of
healthcare services or erroneous health information. The Company maintains
insurance to protect against claims associated with the use of its products, but
there can be no assurance that its insurance coverage would adequately cover any
claim asserted against the Company. A successful claim brought against the
Company in excess of its insurance coverage could have a material adverse effect
on the Company's business, results of operations and financial condition. Even
unsuccessful claims could result in the Company's expenditure of funds in
litigation and management time and resources.
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess of its
insurance coverage, that the Company's insurance will cover such claims or that
appropriate insurance will continue to be available to the Company in the future
at commercially reasonable rates. Such claims could have a material adverse
affect on the Company's business, results of operations and financial condition.
Uncertainty in Healthcare Industry; Government Regulation. The healthcare
industry is subject to changing political, economic and regulatory influences
that may affect the procurement processes and operation of healthcare
facilities. During the past several years, the healthcare industry has been
subject to an increase in governmental regulation of, among other things,
reimbursement rates and certain capital expenditures.
In the past, various legislators have announced that they intend to
examine proposals to reform certain aspects of the U.S. healthcare system
including proposals which may increase governmental involvement in healthcare,
lower reimbursement rates and otherwise change the operating environment for the
Company's clients. Healthcare providers may react to these proposals, and the
uncertainty surrounding such proposals, by curtailing or deferring investments,
including those for the Company's systems and related services. Cost-containment
measures instituted by healthcare providers as a result of regulatory reform or
otherwise could result in a reduction in the allocation of capital funds. Such a
reduction could have an adverse effect on the Company's ability to sell its
systems and related services. On the other hand, changes in the regulatory
environment have increased and may continue to increase the needs of healthcare
organizations for cost-effective data management and thereby enhance the overall
market for healthcare management information systems. The Company cannot predict
what impact, if any, such proposals or healthcare reforms might have on the
Company's business, financial condition and results of operations.
Certain healthcare professionals who use the Company's Internet-based
products will directly enter health information about their patients including
information that constitutes a record under applicable law that the Company will
store on the Company's computer systems. Numerous federal and state laws and
regulations, the common law, and contractual obligations govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:
o State privacy and confidentiality laws;
o The Company's contracts with customers and partners;
o State laws regulating healthcare professionals;
o Medicaid laws; and
o The Heath Insurance Portability and Accountability Act of 1996
("HIPAA") and related rules proposed by the Heath Care Financing
Administration; and Health Care Financing Administration standards
for Internet transmission of health data.
The U.S. Congress has been working to finalize proposed legislation that
would establish a new Federal standard for protection and use of health
information. Any failure by the Company or by its personnel or partners to
comply with any of these legal or other requirements may result in a material
liability to the Company.
Although the Company has systems in place for safeguarding patient health
information from unauthorized disclosure, these systems may not preclude claims
against the Company for violation of
12
applicable law or other requirements. Other third party sites or links that
consumers access through the Company's web sites also may not maintain systems
to safeguard this health information, or may circumvent systems the Company put
in place to protect the information from disclosure. In addition, future laws or
changes in current laws may necessitate costly adaptations to the Company's
systems.
HIPAA mandates the use of national standards for transmissions of certain
patient healthcare information, and prescribes security measures to protect the
confidentiality of such information as well as other patient record privacy and
security provisions within two years after the adoption of final regulations by
the Department of Health and Human Services ("HHS"). These proposed regulations
will establish new federal standards for privacy of health information. The
Company anticipates that these regulations will directly affect the Company's
products and services, but the Company cannot fully predict the impact at this
time. The Company's intention is to modify its products and services as
necessary to facilitate client compliance with the final regulations, but there
can be no assurance that the Company will be able to do so in a timely manner.
Achieving compliance with these regulations could be costly and distract
management's attention and other resources from the Company's historical
business, and any noncompliance by the Company could result in civil and
criminal penalties. In addition, development of related Federal and state
regulations and policies on confidentiality of health information could
negatively affect the Company's business.
In addition, the Company's software may be subject to regulation by the
U.S. Food and Drug Administration (the "FDA") as a medical device. Such
regulation could require the registration of the applicable manufacturing
facility and software and hardware products, application of detailed
record-keeping and manufacturing standards, and FDA approval or clearance prior
to marketing. An approval or clearance requirement could create delays in
marketing, and the FDA could require supplemental filings or object to certain
of these applications, the result of which could have a material adverse effect
on the Company's business, financial condition and results of operations.
Results of Operations
The following table sets forth for the periods indicated, the percentage
of net revenues represented by each item in the Company's Consolidated
Statements of Income.
Three Months Ended Six Months Ended
September 30, September 30,
------------------ ----------------
2001 2000 2001 2000
------ ------ ------ ------
Net Revenues:
Sales of computer systems, upgrades and
supplies 48.7% 49.6% 50.0% 48.6%
Maintenance and other services 51.3 50.4 50.0 51.4
------ ------ ------ ------
100.0 100.0 100.0 100.0
Cost of Products and Services 43.3 45.2 43.4 44.4
------ ------ ------ ------
Gross Profit 56.7 54.8 56.6 55.6
Selling, General and Administrative Expenses 31.4 33.6 30.5 34.9
Research and Development Costs 9.5 10.1 9.8 10.5
------ ------ ------ ------
Income from Operations 15.8 11.1 16.3 10.2
Investment Income 1.8 2.6 1.8 2.6
------ ------ ------ ------
Income before Provision for Income
Taxes 17.6 13.7 18.1 12.8
Provision for Income Taxes 6.8 6.1 6.9 5.7
------ ------ ------ ------
Net Income 10.8% 7.6% 11.2% 7.1%
====== ====== ====== ======
For the Three-Month Periods Ended September 30, 2001 and 2000
The Company's net income for the three months ended September 30, 2001 was
$1,132,000 or $0.19 per share on a basic and $.18 per share on a diluted basis,
as compared to a net income of $744,000, or $0.12 per share on a basic and
diluted basis, for the three months ended September 30, 2000.
13
Net Revenues. Net revenues for the three months ended September 30, 2001
increased 9% to $10.5 million from $9.7 million for the three months ended
September 30, 2000. Sales of computer systems, upgrades and supplies increased
7% to $5.1 million from $4.8 million while net revenues from maintenance and
other services grew 11% to $5.4 million from $4.9 million during the comparable
periods. The increase in net revenues from sales of computer systems, upgrades
and supplies was principally the result of an increase in sales of the Company's
NextGen EMR and EPM software licenses. The increase in maintenance and other
services net revenue resulted principally from an increase in revenues from the
Company's increased client base from which to generate maintenance and other
service revenue together with an increase in revenues generated from the
Company's electronic data interchange services.
Cost of Products and Services. Cost of products and services for the three
months ended June 30, 2001 rose 4% to $4.7 million from $4.4 million in the
prior year quarter, while cost of products and services as a percentage of net
revenues to 43.3% compared to 45.2% in the prior year quarter. The dollar
increase in the cost of products and services was a result of the impact of
higher sales volumes. The cost of products and services as a percentage of net
revenues decreased as a result of the impact of increased sales in the September
30, 2001 period together with a change in the relative mix of hardware content
in such sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended 30, 2001 increased slightly
by 1.5% to approximately $3.3 million as compared to $3.2 million for the three
months ended September 30, 2000. Selling, general and administrative expenses as
a percentage of net revenues decreased to 31.6% from 33.6%. The increase in the
dollar amount of such expenses resulted primarily from a combination of a higher
level of commissions from the higher sales volumes as well as expenses related
to the expansion of the MicroMed sales and marketing staff during the quarter
offset by the adoption of FASB 142, which reduced amortization expenses in the
September 320, 2001 quarter, and reductions in staffing levels in the QSI
division.
Research and Development Costs. Research and development costs for the
three months ended September 30, 2001 increased 2.7% to $1.0 million compared to
$974,000 in the three months ended September 30, 2000. The increase in research
and development costs can be attributed primarily to increased investments in
NextGen EMR and EPM enhancements. Research and development costs as a percentage
of net revenues declined to 9.5% as compared to 10.1% for the respective periods
as revenues grew faster than the increase in research and development expense.
Investment Income. Investment income for the three months ended September
30, 2001 was down 24% at approximately $190,000 compared to $251,000 in the
three months ended September 30, 2000. Investment income in the quarter ended
September 30, 2001 declined primarily due to the effect of a drop in short term
interest rates which occurred during the quarter. This was partially offset by
higher cash balances.
Provision for Income Taxes. The provision for income taxes for the three
months ended September 30, 2001 was approximately $714,000 as compared to
approximately $589,000 for the three months ended September 30, 2000. The
provision for income taxes for the three months ended September 30, 2001 and
2000 differ from the combined statutory rates primarily due to the impact of
non-deductible amortization of certain intangible assets acquired in the May
1996 Clinitec acquisition and the effect of varying state income tax rates. The
adoption of FASB 142 eliminated certain non-deductible amortization expenses
during the September quarter resulting in a decline in the Company's effective
tax rate to 38.8% in the September 30, 2001 quarter compared to 44.2% in the
September 30, 2000 quarter.
For the Six-Month Periods Ended September 30, 2001 and 2000
The Company's net income for the six months ended September 30, 2001 was
$2.4 million, or $0.40 per share on a basic and $.39 per share on a diluted
basis, as compared to $1.4 million, or $0.22 per share on a basic and diluted
basis for the six months ended September 30, 2000.
14
Net Revenues Net revenues for the six months ended September 30, 2001
increased 13.1% to $21.4 million from $18.9 million for the six months ended
September 30, 2000. Sales of computer systems, upgrades and supplies increased
16.5% to $10.7 million from $9.2 million while net revenues from maintenance and
other services grew 9.9% to $10.7 million from $9.7 million during the
comparable periods. The increase in net revenues from sales of computer systems,
upgrades and supplies was principally the result of increases in the sales of
the NextGen EPM and NextGen EMR systems. The increase in maintenance and other
services net revenue resulted principally from an increase in revenues from the
Company's growing client base from which to generate maintenance and other
services revenue together with an increase in revenues generated by the
Company's electronic data interchange services.
Cost of Products and Services. Cost of products and services for the six
months ended September 30, 2001 increased 10.6% to $9.3 million from $8.4
million for the six months ended September 30, 2000 while cost of products and
services as a percentage of net revenues decreased to 43.4% from 44.4% during
the comparable periods. The cost of products and services as a percentage of net
revenues decreased primarily as a result of the impact of a change in the
relative mix of hardware content of systems sales.
Selling, General and Administrative Expenses Selling, general and
administrative expenses for the six months ended September 30, 2001 decreased
1.1% to $6.5 million as compared to $6.6 million for the six months ended
September 30, 2000. Selling, general and administrative expenses as a percentage
of net revenues decreased to 30.5% from 34.9%. The decrease in the amount of
such expenses resulted primarily from the adoption of FASB 142, which reduced
amortization expenses, and a reduction in comparative bad debt expense offset by
additions to sales personnel and higher commission expenses.
Research and Development Costs Research and development costs for the six
months ended September 30, 2001 and 2000 were $2.1 million and 2.0 million
respectively. Research and development costs as a percentage of net revenues
decreased to 9.8% from 10.5% due to the fact that revenues increased more
quickly than R&D expense in the respective periods.
Investment Income. Investment income for the six months ended September
30, 2001 was down 20% at approximately $396,000 compared to $497,000 in the six
months ended September 30, 2000. Investment income in the six months ended
September 30, 2001 declined primarily due to the effect of a drop in short term
interest rates which occurred during the period. This was partially offset by
higher cash balances.
Provision for Income Taxes. The provision for income taxes for the six
months ended September 30, 2001 was approximately $1,485,000 as compared to
approximately $1,070,000 for the six months ended September 30, 2000. The
provision for income taxes for the three months ended September 30, 2001 and
2000 differ from the combined statutory rates primarily due to the impact of
non-deductible amortization of certain intangible assets acquired in the May
1996 Clinitec acquisition and the effect of varying state income tax rates. The
adoption of FASB 142 eliminated certain non-deductible amortization expenses
during the six months ended September 2001 resulting in a decline in the
Company's effective tax rate to 38.3% in the September 30, 2001 period compared
to 43.9% in the September 30, 2000 period.
Liquidity and Capital Resources
Cash and cash equivalents increased $2,706,000 during the six months
ending September 30, 2001 primarily as a result of cash provided by operating
activities. Cash and cash equivalents increased approximately $679,000 during
the months ended September 30, 2000 primarily as a result of operations, offset
by increases in accounts receivable.
Net cash provided by operating activities for the six months ended
September 30, 2001 was $3.3 million consisting primarily of the Company's $2.4
million in net income adjusted for the principal non-cash operating expenses of
depreciation and amortization plus an increase in deferred revenue and other
current liabilities offset in part by an increase in other current assets and an
increase in accounts receivable. Net cash provided by operating activities for
the six months ended September 30, 2000 was approximately $1.8 million
consisting primarily of the Company's $1.4 in net income adjusted for the
15
principal non-cash operating expenses of depreciation and amortization plus a
large decrease in deferred income taxes less, an increase in accounts receivable
and a large decrease in income taxes payable.
Net cash used in investing activities for the six months ended September
30, 2001 was $836,000 consisting of additions to equipment and improvements and
capitalized software. Net cash used in investing activities for the six months
ended September 30, 2000 was $1,144,000 consisting principally of additions to
equipment and improvements and capitalized software.
Net cash provided by financing activities for the six months ended
September 30, 2001 and 2000 was $204,000 and $50,000, respectively, generated
primarily by the exercise of stock options.
At September 30, 2001, the Company had cash and cash equivalents of $21.2
million and short-term investments of $258,000. Except for the Company's
intention to expend funds for the development of complementary products to its
existing product line and alternative versions of certain of its products, the
Company has no other significant capital commitments and currently anticipates
that additions to equipment and improvements for fiscal 2002 will be comparable
to fiscal 2001.
The Company believes that its cash and cash equivalents and short-term
investments on hand at September 30, 2001, together with cash flows from
operations, if any, will be sufficient to meet its working capital and capital
expenditure requirements for the next year.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company has a significant amount of cash and short-term investments with
maturities less than three months. This cash portfolio exposes the Company to
interest rate risk as short-term investment rates can be volatile. Given the
short-term maturity structure of the Company's investment portfolio, the Company
believes that it is not subject to principal fluctuations and the effective
interest rate of the Company's portfolio tracks closely to various short-term
money market interest rate benchmarks.
PART II - OTHER INFORMATION
Item 1. Litigation.
On April 22, 1997, a purported class action entitled JOHN P. CAVENY v. QUALITY
SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of California
for the County of Orange, in which Mr. Caveny, on behalf of himself and all
others who purchased the Company's Common Stock between June 26, 1995 and July
3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck, Gregory S.
Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers, Graeme H.
Frehner, and Gordon L. Setran (all of the foregoing individuals were either
officers, directors or both during the period from June 26, 1995 through July 3,
1996), as well as other defendants not affiliated with the Company, violated
California Corporations Code Sections 25400 and 25500, California Civil Code
Sections 1709 and 1710, and California Business and Professions Code Sections
17200 et. seq., by issuing positive statements about the Company that allegedly
were knowingly false, in part, in order to assist the Company and the individual
defendants in selling Common Stock at an inflated price in the Company's March
5, 1996 public offering and at other points during the class period. The
complaint seeks compensatory and punitive damages in unspecified amounts,
disgorgement, declaratory and injunctive relief, and attorneys' fees.
The Company and the other named defendants successfully demurred to the
plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that
claim, which served as the only basis for plaintiffs' request for punitive
damages, has been dismissed from both actions.
On January 25, 1999, the court denied plaintiffs' motion to certify the
class representative and class legal counsel. Plaintiffs appealed that decision
as to class legal counsel. On February 25, 2000, the Fourth District Court of
Appeals affirmed the order disqualifying the class legal counsel. On May 9,
2000, the Court of Appeals issued its Remittur certifying its decision as final.
16
In May 2000, plaintiffs associated in additional class legal counsel, and
moved for approval by the court. Upon defendants' objection, the court on August
17, 2000, denied plaintiffs' motion, and ordered plaintiffs to retain new class
counsel.
At the end of November 2000, the plaintiffs retained new class counsel who
substituted in for plaintiffs' previous class counsel. The Company and the other
named defendants did not oppose plaintiffs' motion for approval of the new class
counsel. On January 24, 2001, the court granted the motion to certify class
legal counsel.
On March 27, 2001, the court approved a notice of class certification to
be mailed to shareholders who are potential class members. Between April 9, 2001
and May 9, 2001, class notice was mailed to potential class members.
Merits-related discovery in the action had been stayed pending the
appointment of class counsel. In March 2001, the plaintiffs requested that
documents be produced informally. Following the appointment of class counsel,
plaintiffs have propounded two rounds of informal requests for the production of
documents. Defendants have produced two rounds of documents informally for
plaintiffs' review. The parties are scheduled to appear in court for the next
status conference on December 17, 2001.
In Management's opinion the outcome of this case is uncertain, and
therefore no accrual has been made to the financial statements.
On May 14, 1997, a second purported class action entitled WENDY WOO v.
QUALITY SYSTEMS, INC., ET AL. was filed in the same court, essentially repeating
the allegations in the Caveny lawsuit and seeking identical relief. This action
has for all purposes been consolidated with the Caveny action.
The Company is a party to various other legal proceedings incidental to
its business, none of which are considered by the Company to be material.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submissions of Matters to a Vote of Securities Holders.
On August 30, 2001, the Company held its Annual Meeting of Shareholders. At the
meeting, the shareholders elected as directors Sheldon Razin (with 5,189,171
affirmative votes and 679,468 votes withheld), Ahmed Hussein (with 5,199,921
affirmative votes and 668,718 votes withheld), Mohammed-Tawfick El-Bardai (with
5,699,901 affirmative votes and 168,738 votes withheld), Dale Hanson (with
5,862,191 affirmative votes and 6,448 votes withheld), Frank Meyer (with
5,862,191 affirmative votes and 6,448 votes withheld), William Small (with
5,862,191 affirmative votes and 6,448 votes withheld), and Emad Zikry (with
5,853,291 affirmative votes and 15,348 votes withheld)
The shareholders also ratified the appointment of Grant Thornton LLP as the
independent public accountants for the Company for the fiscal year ending March
31, 2002 (with 4,331,932 affirmative votes, 1,535,947 against, and 760
abstaining.)
Item 5. Other Information.
None.
17
Item 6. Exhibits and Reports on Form 8-K.
Exhibits:
- ---------
None.
Reports on Form 8-K:
- --------------------
None.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
QUALITY SYSTEMS, INC.
Date: November 9, 2001 By: /s/ LOUIS SILVERMAN
-------------------------------------
Louis Silverman
Chief Executive Officer
Date: November 9, 2001 By: /s/ PAUL HOLT
-------------------------------------
Paul Holt
Chief Financial Officer; Principal
Accounting Officer
18