================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission file number 0-13801
QUALITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California 95-2888568
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
18191 Von Karman Avenue, Irvine California 92612
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 255-2600
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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: 6,364,354 shares of Common
Stock, $.01 par value, as of July 28, 2004
================================================================================
PART I - CONSOLIDATED FINANICAL INFORMATION
Item 1. Financial Statements
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
--------------------------
(In thousands, except per share amounts) June 30, March 31,
2004 2004
(unaudited)
- --------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 54,941 $ 51,395
Accounts receivable, net 23,013 20,336
Inventories, net 784 725
Deferred tax assets 2,979 2,979
Other current assets 1,439 1,437
-----------------------
Total current assets 83,156 76,872
Equipment and improvements, net 2,213 2,012
Capitalized software costs, net 3,732 3,608
Deferred tax assets 1,104 1,104
Goodwill 1,840 1,840
Other assets 1,226 1,242
-----------------------
Total assets $ 93,271 $ 86,678
=======================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,222 $ 1,655
Deferred revenue 19,442 17,263
Accrued compensation & benefits 2,092 2,985
Other current liabilities 3,753 3,770
-----------------------
Total liabilities 28,509 25,673
-----------------------
Commitments and contingencies
Shareholders' equity:
Common stock, $0.01 par value, 20,000 shares authorized,
6,361 and 6,325 shares issued and outstanding, respectively 64 63
Additional paid-in capital 40,002 39,735
Retained Earnings 26,132 22,750
Deferred compensation (1,436) (1,543)
-----------------------
Total shareholders' equity 64,762 61,005
-----------------------
Total liabilities and shareholders' equity $ 93,271 $ 86,678
=======================
- --------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
1
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
---------------------------
(In thousands except per share amounts) Three Months Ended June 30,
2004 2003
- -----------------------------------------------------------------------------------------------
Net revenues:
Sales of computer systems, upgrades and supplies $11,084 $ 9,474
Maintenance and other services 9,046 6,832
--------------------
20,130 16,306
Cost of products and services 8,101 6,610
--------------------
Gross profit 12,029 9,696
Selling, general and administrative
expenses 4,953 4,740
Research and development costs 1,612 1,366
--------------------
Income from operations 5,464 3,590
Investment income 120 100
--------------------
Income before provision for income taxes 5,584 3,690
Provision for income taxes 2,202 1,413
--------------------
Net income $ 3,382 $ 2,277
====================
Net income per share, basic $ 0.53 $ 0.37
--------------------
Net income per share, diluted $ 0.51 $ 0.35
--------------------
Weighted average shares outstanding - basic 6,333 6,157
--------------------
Weighted average shares outstanding - diluted 6,577 6,466
- -----------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
2
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
---------------------------
(In thousands) Three Months Ended June 30,
2004 2003
- ---------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Income $ 3,382 $ 2,277
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 225 219
Amortization of capitalized software costs 418 354
Provision for bad debts 137 52
Non-Cash Compensation from stock option grants 107 --
Changes in:
Accounts receivable (2,814) (1,530)
Inventories (59) (485)
Other assets 14 662
Accounts payable 1,567 (994)
Deferred revenue 2,179 2,280
Accrued compensation & benefits (893) (304)
Other current liabilities (16) 709
-----------------------
Net Cash Provided By Operating Activities 4,247 3,240
-----------------------
Cash Flows From Investing
Activities:
Additions to equipment and improvements (426) (175)
Additions to capitalized software costs (542) (604)
-----------------------
Net Cash Used In Investing Activities (968) (779)
-----------------------
Cash Flows from Financing Activities:
Proceeds from exercise of stock options 267 72
-----------------------
Net Cash Provided by Financing Activities 267 72
-----------------------
Net Increase in Cash and Cash Equivalents 3,546 2,533
Cash and Cash Equivalents, beginning of period 51,395 36,443
-----------------------
Cash and Cash Equivalents, end of period $ 54,941 $ 38,976
-----------------------
- ---------------------------------------------------------------------------------------
Supplemental Information - During the three months ended June 30, 2004 and 2003,
the Company made income tax payments, net of refunds received, of $1,884,000 and
$30,000 respectively.
See notes to consolidated financial statements.
3
QUALITY SYSTEMS, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements as of June 30, 2004
and for the three months ended June 30, 2004 and 2003, have been prepared in
accordance with the requirements of Form 10-Q and, therefore, do not include all
information and footnotes which would be presented were such financial
statements prepared in accordance with generally accepted accounting principles.
These financial statements should be read in conjunction with the audited
financial statements presented in the Company's Annual Report for the fiscal
year ended March 31, 2004. In the opinion of management, the accompanying
consolidated financial statements reflect all adjustments which are necessary
for a fair presentation of the results of operations for the periods presented.
The results of operations for such interim periods are not necessarily
indicative of results of operations to be expected for the full year.
2. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiary. All significant
inter-company amounts and transactions have been eliminated.
Basis of Presentation. The accompanying consolidated financial statements have
been prepared in accordance with accounting principals generally accepted in the
United States of America.
Revenue Recognition. The Company currently recognizes revenue pursuant to
Statement of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP 97-2"),
as amended by SOP 98-9 "Modification of SOP 97-2, "Software Revenue
Recognition". The Company generates revenue from licensing rights to use its
software products directly to end-users and value-added resellers (VARs). The
Company also generates revenue from sales of hardware and third party software,
and implementation, training, software customization and post-contract support
("maintenance") services performed for customers who license its products. A
typical system contract contains multiple elements of two or more of the above
items. SOP 97-2, as amended, requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair values of those elements. The fair value of an element must be
based on objective evidence that is specific to the vendor. When evidence of
fair value exists for the delivered and undelivered elements of a transaction,
then discounts for individual elements are aggregated and the total discount is
allocated to the individual elements in proportion to the elements' fair value
to the total contract fair value.
When evidence of fair value exists for the undelivered elements only, the
residual method, provided for under SOP 98-9, is required to be used. Under the
residual method, the Company defers revenue related to the undelivered elements
in a system sale based on vendor specific objective evidence ("VSOE") of each
element's fair value, which is based on the average sales price of those
elements when sold separately, and allocates the remainder of the contract price
net of all discounts to revenue recognized from the delivered elements. The
Company limits its assessment of VSOE for each element to either the price
charged when the same element is sold separately or the price established by
management having the relevant authority to do so, for an element not yet sold
separately. VSOE is reviewed on a quarterly basis. Undelivered elements of a
system sale generally may include implementation and training services, hardware
and third party software, maintenance or other services.
The Company bills for the entire contract amount upon contract execution.
Amounts billed in excess of the amounts contractually due are recorded in
accounts receivable as advance billings. Amounts are
4
contractually due when services are performed or in accordance with
contractually specified payment dates.
Provided the fees are fixed and determinable and collection is considered
probable, revenue from licensing rights and sales of hardware and third party
software are generally recognized upon shipment and transfer of title. Revenue
from implementation, training and software customization services is recognized
as the corresponding services are performed. Maintenance revenue is recognized
ratably over the contractual maintenance period.
Certain system sales contracts contain payment terms based on the
performance of certain milestones or include services to provide significant
production or customization of the software. License and hardware revenue for
such contracts are recognized using the percentage of completion or completed
contract method, as appropriate.
License arrangements with Value-added resellers (VAR's) do not provide for
returns, and thus license revenue from VARs are generally recognized upon
shipment.
Cash and Cash Equivalents. Cash and cash equivalents generally consist of cash,
money market funds and short term U.S. Treasuries. The Company invests a portion
of its cash in a money market fund which invests in only investment grade money
market instruments from a variety of industries, and therefore bears minimal
risk. The average maturity of the investments owned by the money market fund is
approximately two months.
Accounts Receivable. The Company provides credit terms typically ranging from
thirty days to less than twelve months for most system and maintenance contract
sales and generally does not require collateral. The Company performs ongoing
credit evaluations of its customers and maintains reserves for estimated credit
losses. Reserves for potential credit losses are determined by establishing both
specific and general reserves. Specific reserves are based on management's
estimate of the probability of collection for certain troubled accounts. General
reserves are established based on the Company's historical experience of bad
debt expense and the aging of the Company's accounts receivable balances net of
deferred revenues and specifically reserved accounts. Accounts are written off
as uncollectible only after the Company has expended extensive collection
efforts.
Included in accounts receivable are amounts related to maintenance and services
which were billed, but which had not yet been rendered as of the end of the
fiscal year. Undelivered maintenance and services are included on the balance
sheet in deferred revenue.
Inventories. Inventories are valued at lower of cost (first-in, first-out) or
market. Certain inventories are maintained for customer support pursuant to
service agreements and are amortized over a five-year period using the
straight-line method.
Equipment and Improvements. Equipment and improvements are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization of
equipment and improvements are provided over the estimated useful lives of the
assets, or the related lease terms if shorter, by the straight-line method.
Useful lives range from three to seven years.
Software Development Costs. Development costs incurred in the research and
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established, any additional
development costs are capitalized in accordance with the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed." Such costs are amortized on a straight line basis
over the estimated economic life of the related product, generally three years.
The Company performs an annual review of the recoverability of such capitalized
software costs. At the time a determination is made that capitalized amounts are
not recoverable based on the estimated cash flows to be generated from the
applicable software, any remaining capitalized amounts are written off.
5
Stock-Based Compensation. The Company accounts for stock-based employee
compensation using the intrinsic value method as prescribed by APB Opinion No.
25, Accounting for Stock Issued to Employees, and has adopted SFAS 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure" that
supercedes Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation. SFAS 148 requires pro forma disclosures of net income and net
income per share as if the fair value based method of accounting for stock-based
awards had been applied to employee grants. It also requires disclosure of
option status on a more prominent and frequent basis. Such disclosure for the
quarters ended June 30, 2004 and 2003 is presented immediately below. The
Company accounts for stock options and warrants issued to non-employees based on
the fair value method, but has not elected this treatment for grants to
employees and board members. Under the fair value based method, compensation
cost is recorded based on the value of the award at the grant date and is
recognized over the service period.
The Company's fair value calculations for options granted in the quarter ended
June 30, 2004 were made using the Black-Scholes option pricing model with the
following assumptions: expected life - time required to reach full vesting or
approximately 48 months from the date of the grant; stock volatility - 50%, risk
free interest rate of 3.0% ; and, no dividends during the expected term. No
options were granted in quarter ended June 30, 2003.
The Company's calculations are based on a single option valuation approach and
forfeitures are recognized as they occur. If the computed fair values of awards
had been amortized to expense over the vesting period of the awards, pro forma
net income and net income per share would have been as follows:
-------------------------
(in thousands, except for per share amounts) Quarter Ended June 30,
2004 2003
- -------------------------------------------------------------------------------
Net Income $ 3,382 $ 2,277
-------------------------
Proforma Option Compensation Cost (Net of Taxes) (79) (51)
-------------------------
Proforma Net Income 3,303 2,226
=========================
Reported Basic Net Income Per Share $ 0.53 $ 0.37
-------------------------
Proforma Basic Net Income Per Share 0.52 0.36
-------------------------
Reported Diluted Net Income Per Share 0.51 0.35
-------------------------
Proforma Diluted Net Income Per Share 0.50 0.34
- -------------------------------------------------------------------------------
Fair Value of Option Awards Granted $ 2,942 $ 0
- -------------------------------------------------------------------------------
On October 29, 2003, the Board of Directors granted 60,000 options to
selected employees at an exercise price of $15.46 per share. The options vest in
four equal annual installments beginning October 29, 2004 and expire on October
29, 2008. Based on the closing share price of the Company's stock on October 29,
2003 ($44.16 per share), this option grant will result in compensation expense
of up to $1,722,000 (assuming all employees granted options continue their
employment at the Company throughout the entire four year vesting period) to be
amortized evenly over the next four years. During the quarter ended June 30,
2004, the Company recognized compensation expense of $107,000 related to these
options.
On June 10, 2004, the Board of Directors granted 150,000 options to
selected employees at an exercise price equal to the market price of the
Company's common stock on the date of the grant ($46.67 per share). The options
vest in four equal annual installments beginning June 10, 2005 and expire on
June 10, 2009. No compensation expense has been recorded for these options.
6
3. Recent Accounting Pronouncements
In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104,
"Revenue Recognition" , which supercedes portions of SAB 101. The primary
purpose of SAB 104 is to rescind accounting guidance contained in SAB 101
related to multiple element revenue arrangements, which was superceded as a
result of the issuance of EITF 00-21. While the wording of SAB 104 changed to
reflect the issuance of EITF 00-21, the revenue recognition principles of SAB
101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB No.
104 did not have a material effect on the Company's consolidated results of
operations, financial position or cash flows.
In December 2003, the FASB revised SFAS No. 132 --"Employers' Disclosures about
Pensions and Other Postretirement Benefits" . The revisions to SFAS 132 retain
the disclosure requirements contained in the original SFAS No. 132 but require
additional disclosures describing the types of plan assets, investment strategy,
measurement dates, plan obligations, cash flows, and net periodic benefit cost
of defined benefit pension plans and other defined benefit postretirement plans.
The adoption of SFAS No. 132 had no effect on the Company's Consolidated
Financial statement disclosures, as the Company does not provide any defined
benefit plans to its employees.
4. Intangible Assets - Capitalized Software Development Costs
In accordance with FASB 142, the Company does not amortize goodwill. The balance
of goodwill is related to the Company's NextGen Healthcare Information Systems
Division (NextGen), which was acquired by virtue of two acquisitions in May of
1996 and 1997, respectively. In accordance with FASB 142, the Company has
compared the fair value of the NextGen Division with the carrying amount of
assets associated with the Division and determined that none of the goodwill
recorded as of June 30, 2004 was impaired. The fair value of the NextGen
Division was determined using a reasonable estimate of future cash flows of the
Division and a risk adjusted discount rate to compute a net present value of
future cash flows.
The Company had the following amounts related to intangible assets:
------------------------------
(in thousands) June 30, 2004 March 31, 2004
(unaudited)
- ---------------------------------------------------------------------------------
Capitalized software development (3 yrs)
-----------------------
Gross Carrying Amount $ 11,152 $ 10,610
-----------------------
Accumulated Amortization (7,420) (7,002)
-----------------------
Net Capitalized Software development $ 3,732 $ 3,608
=======================
Aggregate amortization expense during the quarter
ended: $ 418 $ 399
-----------------------
- ---------------------------------------------------------------------------------
7
Information related to net capitalized software costs for the three month
period ended June 30, 2004 is as follows:
--------------
(in thousands) June 30, 2004
(unaudited)
- ----------------------------------------------------------------------
Beginning of period $ 3,608
Capitalized 542
Amortization (418)
-------
End of period $ 3,732
- ----------------------------------------------------------------------
The following table represents the remaining estimated amortization of
intangible assets with determinable lives as of June 30, 2004 (in thousands):
For the year ended March 31,
- -----------------------------------------------------------------
2005 $1,384
2006 1,349
2007 857
2008 142
- -----------------------------------------------------------------
Total $3,732
- -----------------------------------------------------------------
5. Income Taxes
The provision for income taxes for the three month periods ended June 30, 2004
and 2003 differ from the expected combined statutory rates primarily due to the
estimated impact of varying state income tax rates, as well as estimated
research and development tax credits for each of the corresponding periods. The
Company has available a balance of approximately $525,000 of research and
development credits which may be recognized as a whole or in part, once the
amount of the credit has been cleared by the tax authorities, or once the
statute of limitations related to the corresponding tax return has passed. The
available balance of research and development credits account for approximately
50% of the aggregate federal tax credits accumulated through June 30, 2004.
6. Net Income Per Share
The following table reconciles the weighted average shares outstanding for basic
and diluted net income per share for the periods indicated. Basic net income per
share is based upon the weighted average number of common shares outstanding.
Diluted net income per share is based on the assumption that the Company's
outstanding options are included in the calculation of diluted earnings per
share, except when their effect would be anti-dilutive. Dilution is computed by
applying the treasury stock method. Under this method, options are assumed to be
exercised at the beginning of the period (or at the time of issuance, if later),
and as if funds obtained thereby were used to purchase common stock at the
average market price during the period.
8
---------------------
(in thousands, except per share amounts) Three Months Ended
June 30,
---------------------
2004 2003
- --------------------------------------------------------------------------------
Net income $3,382 $2,277
Basic net income per common share:
Weighted average of common shares outstanding 6,333 6,157
------------------
Basic net income per common share $ 0.53 $ 0.37
------------------
Diluted net income per share:
Weighted average of common shares outstanding 6,333 6,157
Effect of potentially dilutive securities
(options) 244 309
------------------
Weighted average common shares outstanding- diluted 6,577 6,466
------------------
Diluted net income per common share $ 0.51 $ 0.35
------------------
- --------------------------------------------------------------------------------
8. Operating Segment Information
The Company has prepared operating segment information in accordance with
Statement of Accounting Standards SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information" to report components that are evaluated
regularly by the Company's chief operating decision maker, or decision making
group in deciding how to allocate resources and in assessing performance.
The Company's reportable operating segments include its NextGen Healthcare
Information Systems Division and the QSI Division.
The disaggregated financial results of the segments reflect allocation of
certain functional expense categories consistent with the basis and manner in
which Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions. Certain corporate
overhead costs are not allocated to the individual segments by management. The
Company evaluates performance based on stand-alone segment revenue and operating
income performance. Because the Company does not evaluate performance based on
return on assets at the operating segment level, assets are not tracked
internally by segment. Therefore, segment asset information is not presented.
Operating segment data for the three month periods ended June 30, 2004 and
2003 is as follows:
-------------------------------------------------------------------------
(In thousands) NextGen Healthcare
Information Systems Unallocated
QSI Division Division Corporate Expenses Consolidated
- ------------------------------------------------------------------------------------------------------------
Quarter ended June 30,2004
Revenue $3,982 $16,148 $ -- $20,130
Operating income (loss) $1,264 $ 5,194 $(994) $ 5,464
Quarter ended June 30,2003
Revenue $4,064 $12,242 $ -- $16,306
Operating income (loss) $1,064 $ 3,359 $(833) $ 3,590
- ------------------------------------------------------------------------------------------------------------
9
9. Composition of Accounts Receivable
Included in accounts receivable are amounts related to maintenance and
services which were billed but not yet rendered as of the end of the period.
Undelivered maintenance and services are included on the consolidated balance
sheet as part of the deferred revenue balance.
-------------------------------
(in thousands) June 30, March 31, 2004
2004
- -----------------------------------------------------------------------------------------------------------------------
Accounts receivable:
Accounts receivable, excluding undelivered maintenance and services $ 12,439 $ 13,131
Undelivered maintenance and services billed in advance, included in deferred
revenue 11,889 8,498
-----------------------------
Gross accounts receivable 24,328 21,629
-----------------------------
Reserve for bad debts (1,315) (1,293)
-----------------------------
Net accounts receivable $ 23,013 $ 20,336
-----------------------------
- -----------------------------------------------------------------------------------------------------------------------
10. Concentration of Credit Risk
The Company had cash deposits at U.S. banks and financial institutions
which exceeded federally insured limits at June 30, 2004. The Company is exposed
to credit loss for amounts in excess of insured limits in the event of
non-performance by the institutions; however, the Company does not anticipate
non-performance by these institutions.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Except for the historical information contained herein, the matter
discussed in this quarterly report may include forward-looking statements that
involve certain risks and uncertainties. Actual results may differ from those
anticipated by us as a result of various factors, both foreseen and unforeseen,
including, but not limited to, our ability to continue to develop new products
and increase systems sales in markets characterized by rapid technological
evolution, consolidation, and competition from larger, better capitalized
competitors. Many other economic, competitive, governmental and technological
factors could impact our ability to achieve our goals, and interested persons
are urged to review the risks described in Risk Factors" as set forth herein, as
well as in our other public disclosures and filings with the Securities and
Exchange Commission.
The following discussion should be read in conjunction with, and is
qualified in our entirety by, the Consolidated Financial Statements and related
notes thereto included elsewhere in this Report. Historical results of
operations, percentage margin fluctuations and any trends that may be inferred
from the discussion below are not necessarily indicative of the operating
results for any future period.
Critical Accounting Policies. The discussion and analysis of our financial
condition and results of operations is based upon our consolidated financial
statements which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenue and expenses, and related
disclosures of contingent assets and liabilities. On an
10
on-going basis, we evaluate estimates, including those related to revenue
recognition, uncollectible accounts receivable, and intangible assets, for
reasonableness. We base our estimates on historical experience and on various
other assumptions that management believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe revenue recognition, the allowance for doubtful accounts, and
goodwill impairment are among the most critical accounting policies that impact
our consolidated financial statements. We believe that significant accounting
policies, as described in Note 2 of our Consolidated Financial Statements,
"Summary of Significant Accounting Policies", should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Revenue Recognition. Our revenue is primarily generated from the sale of
software licenses, services, hardware, maintenance fees, and EDI services. We
currently recognize revenue pursuant to Statement of Position No. 97-2,
"Software Revenue Recognition", as modified by SOP 98-9, "Modification of SOP
97-2, Software Revenue Recognition, With Respect of Certain Transactions", Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements", and SAB 104, "Revenue Recognition". SAB 101 summarizes the staff's
views in applying generally accepted accounting principles to revenue
recognition in financial statements. SAB 104 modifies certain guidance provided
in SAB 101.
Inherent in the revenue recognition process are significant management
estimates and judgments, which influence the timing and amount of revenue
recognition.
In accordance with the governing revenue recognition guidelines, if the
arrangement between vendor and purchaser does not require significant
production, modification, or customization of software, revenue should be
recognized when all of the following criteria are met:
o persuasive evidence of an arrangement exists;
o delivery has occurred;
o the vendor's fee is fixed or determinable; and
o collectibility is probable.
In accordance with generally accepted accounting principles in the United
States of America, the recognition of software license revenue is based on our
assessment that the above criteria have been met. In general, the first two
criteria are met with a signed contract and evidence that we have shipped our
software to the customer. We determine that our fee is fixed and determinable
based on the contract terms, which specify payment terms tied to specific dates
and not to any future deliverables. Probability of collection is based on a
credit review of customers. The timing or amount of revenue recognition may
differ if different assessments of the above listed criteria had been made at
the time transactions were recorded in revenue.
SOP 97-2, as amended, generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. Our determination of the fair value
of each element in multi-element arrangements is based on vendor-specific
objective evidence ("VSOE"). We limit our assessment of VSOE for each element to
either the price charged when the same element is sold separately or the price
established by management having the relevant authority to do so, for an element
not yet sold separately. Management determines the price of individual elements
sold separately using a rolling average of stand alone transactions. VSOE
calculations are reviewed on a quarterly basis.
If evidence of fair value of all undelivered elements exists but evidence
of fair value does not exist for one or more delivered elements, then revenue is
recognized using the residual method. Under the residual method, the fair value
of the undelivered elements is deferred at VSOE and the remaining portion of the
arrangement fee is recognized as revenue, net of all discounts.
11
Contract accounting is applied where services include significant software
modification, development or customization. In such instances, the arrangement
fee is accounted for in accordance with SOP 81-1 "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts", whereby the revenue is
recognized, generally using the percentage-of-completion method measured on
labor input hours. The complexity of the estimation process and judgment related
to the assumptions, risks and uncertainties inherent with the application of the
percentage-of-completion method of accounting affect the amounts of revenue
reported in its consolidated financial statements.
Valuation Allowances. We maintain allowances for doubtful accounts for
estimated losses resulting from the inability of our customers to make required
payments. We perform ongoing credit evaluations of our customers and maintain
reserves for estimated credit losses. Reserves for potential credit losses are
determined by establishing both specific and general reserves. Specific reserves
are based on management's estimate of the probability of collection for certain
troubled accounts. General reserves are established based on our historical
experience of bad debt expense and the aging of our accounts receivable balances
net of deferred revenue and specifically reserved accounts. If the financial
condition of our customers were to deteriorate resulting in an impairment of
their ability to make payments, additional allowances would be required.
Goodwill Impairment. Our long-lived assets include goodwill of $1.8
million as of June 30, 2004 and 2003, respectively. We adopted SFAS No. 142
"Goodwill and Other Intangible Assets" ("SFAS 142") effective April 1, 2001. The
statement applies to the amortization of goodwill and other intangible assets.
We ceased amortizing amounts related to goodwill beginning April 1, 2001. The
balance of goodwill is related to our NextGen Division. Under SFAS 142, we are
required to perform an annual assessment of the implied fair value of goodwill
and intangible assets with indefinite lives for impairment. We have compared the
fair value of the NextGen Division with the carrying amount of assets associated
with the Division and determined that none of the goodwill recorded as of June
30, 2004 (the date of our last annual impairment test) was impaired. The fair
value of the NextGen Division was determined using a reasonable estimate of
future cash flows of the Division and a risk adjusted discount rate to compute a
net present value of future cash flows.
The process of evaluating goodwill for impairment involves the
determination of the fair value of our business segments. Inherent in such fair
value determinations are certain judgments and estimates, including the
interpretation of current economic indicators and market valuations, and
assumptions about our strategic plans with regard to operations. To the extent
additional information arises or our strategies change, it is possible that our
conclusion regarding goodwill impairment could change and result in a material
effect on our financial position or results of operations.
Research and Development Tax Credits. During the year ended March 31,
2003, we filed amended federal and state tax returns for the fiscal years ended
March 31, 1998 through 2001, to take advantage of tax credits related to our
research and development activities. In addition, we claimed research and
development credit on its tax returns for the years ended March 31, 2004, 2003
and 2002. Management has recorded a cumulative tax benefit through the quarter
ended June 30, 2004 which accounts for approximately 50% of the aggregate
federal tax credits accumulated through June 30, 2004 due to the uncertainly
concerning the ultimate amount to be credited. Management's election to not
recognize all of the tax credits claimed represents a significant estimate which
affects the effective income tax rate for the Company in the three month periods
ending June 30, 2004 and 2003.. Research and development credits taken by the
Company involve certain assumptions and judgments regarding qualification of
expenses under the relevant tax codes. While the Company we have received all of
federal refunds claimed, none of the credits have been audited by the Internal
Revenue Service. Credits claimed for state income tax purposes are in the
process of being audited. However, no final conclusions have been received by us
as of August 1, 2004.
Company Overview
Quality Systems Inc., comprised of the QSI Division ("QSI Division") and a
wholly owned subsidiary, NextGen Healthcare Information Systems, Inc. ("NextGen
Division") (collectively, the "Company", "we", "our", or "us") develops and
markets healthcare information systems that automate
12
medical and dental practices, networks of practices such as physician hospital
organizations (PHO's) and management service organizations ("MSO's"), ambulatory
care centers, community health centers, and medical and dental schools.
The Company, a California corporation formed in 1974, was founded with an
early focus on providing information systems to dental group practices. In the
mid-1980's, we capitalized on the increasing focus on medical cost containment
and further expanded our information processing systems to serve the medical
market. In the mid 1990's we made two acquisitions that accelerated our
penetration of the medical market. These two acquisitions formed the basis for
what is today the NextGen Division. Today, we serve both the medical and dental
markets through our two divisions.
The two divisions operate largely as stand-alone operations with each
division maintaining it's own distinct product lines, product platforms,
development, implementation and support teams, sales staffing, and branding. The
two divisions share the resources of the "corporate office" which includes a
variety of accounting and other administrative functions. Additionally, there
are a small number of clients who are simultaneously utilizing software from
each of our two divisions.
The QSI Division, co-located with out Corporate Headquarters in Irvine,
California, currently focuses on developing, marketing and supporting software
suites sold to dental and certain niche medical practices. In addition, the
Division supports a number of medical clients that utilize the division's
UNIX(1) based medical practice management software product.
The NextGen Division, with headquarters in Horsham, Pennsylvania and a
second significant location in Atlanta, Georgia, focuses principally on
developing and marketing products and services to medical practices.
Both divisions develop and market practice management software which is
designed to automate and streamline a number of the administrative functions
required for operating a medical or dental practice. Examples of practice
management software functions include scheduling and billing capabilities. It is
important to note that in both the medical and dental environments, practice
management software systems have been implemented by the vast majority of
practices. Therefore, we actively compete for the replacement market.
In addition, both divisions develop and market software that automates the
patient record and enhances patient-provider interactions. Adoption of this
software, commonly referred to as clinical software, is in its relatively early
stages. Therefore, we are typically competing to replace paper-based patient
record alternatives as opposed to replacing previously purchased systems.
Electronic Data Interchange ("EDI")/connectivity products are intended to
automate a number of manual, often paper-based or telephony intensive
communications between patients and/or providers and/or payors. Two of the more
common EDI services are forwarding insurance claims electronically from
providers to payors and assisting practices with issuing statements to patients.
Most practices utilize at least some of these services from us or one of our
competitors. Other EDI/connectivity services are used more sporadically by
client practices. We typically compete to displace incumbent vendors for claims
and statements accounts, and attempt to increase usage of other elements in our
EDI/connectivity product line. In general, EDI services are only sold to those
accounts utilizing software from one of our divisions.
The QSI Division's practice management software suite utilizes a UNIX
operating system. Its Clinical Product Suite (CPS) utilizes a Windows NT(2)
operating system and can be fully integrated with the practice management
software from each division. CPS incorporates a wide range of clinical tools
including, but not limited to, periodontal charting and digital imaging of X-ray
and inter-oral camera
- --------
(1) UNIX is a registered trademark of the AT&T Corporation.
(2) Microsoft Windows, Windows NT, Windows 95, Windows 98, Windows XP, and
Windows 2000 are registered trademarks of the Microsoft Corporation.
13
images as part of the electronic patient record. The Division develops, markets,
and manages our EDI/connectivity applications. The QSInet Application Service
Provider (ASP/Internet) offering is also developed and marketed by the Division.
Our NextGen Division develops and sells proprietary electronic medical
records software and practice management systems under the NextGen(R)(3) product
name. Major product categories of the NextGen suite include Electronic Medical
Records (NextGenemr), Enterprise Practice Management (NextGenepm), Enterprise
Appointment Scheduling (NextGeneas), Enterprise Master Patient Index
(NextGenepi), NextGen Image Control System (NextGenics), Managed Care Server
(NextGenmcs), Electronic Data Interchange, System Interfaces, Internet
Operability (NextGenweb), a Patient-centric and Provider-centric Web Portal
Solution (NextMD(4).com), and a handheld product (NextGenpda). NextGen products
utilize Microsoft Windows technology and can operate in a client-server
environment as well as via private intranet, the Internet, or in an ASP
environment.
We continue to pursue product enhancement initiatives within each
division. The majority of such expenditures are currently targeted for the
NextGen Division product line and client base.
Inclusive of divisional EDI revenue, the NextGen Division accounted for
approximately 80% of our revenue for the first quarter of fiscal 2005 compared
to 75% in the first quarter of fiscal 2004. The QSI Division accounted for 20%
and 25% of revenue in the first quarter of fiscal 2005 and 2004, respectively.
The NextGen Division's year over year revenue grew at 32% and 52% in first
quarter of fiscal 2005 and 2004, respectively, while the QSI Division's year
over year revenue declined by 2% and 4% in the first quarter of fiscal 2005 and
2004 respectively.
In addition to the aforementioned software solutions which we offer
through our two divisions, each division offers comprehensive hardware and
software installation services, maintenance and support services, and system
training services.
We currently have a base of approximately 900 clients, with each client
generally including between one and 500 physicians or dentists.
Risk Factors
The more prominent risks and uncertainties inherent in our business are
described below. However, additional risks and uncertainties may also impair our
business operations. If any of the following risks actually occur, our business,
financial condition or results of operations will likely suffer. Any of these or
other factors could harm our business and future results of operations and may
cause you to lose all or part of your investment.
We face significant competition. The markets for healthcare information
systems are intensely competitive and we face significant competition from a
number of different sources. Several of our competitors have significantly
greater name recognition as well as substantially greater financial, technical,
product development and marketing resources than we do.
We compete in all of our markets with other major healthcare related
companies, information management companies, systems integrators, and other
software developers. Competitive pressures and other factors, such as new
product introductions by ourselves or our competitors, may result in price or
market share erosion that could have a material adverse effect on our business,
results of operations and financial condition. Also, there can be no assurance
that our applications will achieve broad market acceptance or will successfully
compete with other available software products.
Our inability to make initial sales of our systems to newly formed groups
and/or healthcare providers that are replacing or substantially modifying their
healthcare information systems
- --------
(3) NextGen is a registered trademark of NextGen Healtcare Information
Systems, Inc
(4) NextMD is a registered trademark of NextGen Healtcare Information Systems,
Inc
14
could have a material adverse effect on our business, results of operations and
financial condition. If new systems sales do not materialize, our near term and
longer term revenue will be negatively affected.
Our quarterly operating results have historically fluctuated and may do so
in the future. Our revenue has fluctuated in the past, and may fluctuate in the
future from quarter to quarter and period to period, as a result of a number of
factors including, without limitation:
o the size and timing of orders from clients;
o the length of sales cycles and installation processes;
o the ability of our clients to obtain financing for the purchase of
our products;
o changes in pricing policies or price reductions by us or our
competitors;
o the timing of new product announcements and product introductions by
us or our competitors;
o changes in revenue recognition or other accounting guidelines
employed by us and/or established by the Financial Accounting
Standards Board or other rule-making bodies;
o the availability and cost of system components;
o the financial stability of clients;
o market acceptance of new products, applications and product
enhancements;
o our ability to develop, introduce and market new products,
applications and product enhancements;
o our success in expanding our sales and marketing programs;
o deferrals of client orders in anticipation of new products,
applications or product enhancements;
o execution of or changes to Company strategy;
o personnel changes; and
o general market/economic factors.
Our software products are generally shipped as orders are received and
accordingly, we have historically operated with a minimal backlog of license
fees. As a result, revenue in any quarter is dependent on orders booked and
shipped in that quarter and is not predictable with any degree of certainty.
Furthermore, our systems can be relatively large and expensive and individual
systems sales can represent a significant portion of our revenue and profits for
a quarter such that the loss or deferral of even one such sale can have a
significant adverse impact on our quarterly revenue and profitability.
Clients often defer systems purchases until our quarter end, so quarterly
results generally cannot be predicted and frequently are not known until the
quarter has concluded.
Our sales are dependent upon clients' initial decision to replace or
substantially modify their existing information systems, and subsequently a
decision as to which products and services to purchase. These are major
decisions for healthcare providers, and accordingly, the sales cycle for our
systems can vary significantly and typically ranges from three to twelve months
from initial contact to contract execution/shipment.
Because a significant percentage of our expenses are relatively fixed, a
variation in the timing of systems sales and installations can cause significant
variations in operating results from
15
quarter to quarter. As a result, we believe that interim period-to-period
comparisons of our results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Further, our
historical operating results are not necessarily indicative of future
performance for any particular period.
We currently recognize revenue pursuant to Statement of Position No. 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as modified by SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect of Certain
Transactions", Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition
in Financial Statements" ("SAB 101"), and SAB 104, "Revenue Recognition" ("SAB
104"). SAB 101 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 104
modifies certain guidance provided in SAB 101.
There can be no assurance that application and subsequent interpretations
of these pronouncements will not further modify our revenue recognition
policies, or that such modifications would not have a material adverse effect on
the operating results reported in any particular quarter or year.
Due to all of the foregoing factors, it is possible that our operating
results may be below the expectations of public market analysts and investors.
In such event, the price of our Common Stock would likely be materially
adversely affected.
The price of our shares and the trading volume of our shares have been
volatile historically and may continue to be volatile. Volatility may be caused
by a number of factors including but not limited to:
o actual or anticipated quarterly variations in operating results;
o rumors about our performance, software solutions, or merger and
acquisition activity;
o changes in expectations of future financial performance or changes
in estimates of securities analysts;
o governmental regulatory action;
o health care reform measures;
o client relationship developments;
o purchases or sales of company stock;
o changes occurring in the markets in general; and
o other factors, many of which are beyond our control.
Furthermore, the stock market in general, and the market for software,
healthcare and high technology companies in particular, has experienced extreme
volatility that often has been unrelated to the operating performance of
particular companies. These broad market and industry fluctuations may adversely
affect the trading price of our common stock, regardless of actual operating
performance.
Two of our directors are significant shareholders which makes it possible
for them to have significant influence over the outcome of all matters submitted
to our shareholders for approval, which influence may be alleged to conflict
with our interests and the interests of our other shareholders. Two of our
directors and principal shareholders beneficially owned approximately 40% of the
outstanding shares of our common stock at March 31, 2004. As such, these
shareholders will have significant influence over the outcome of all matters
submitted to our shareholders for approval, including the election of our
directors and other corporate actions.
16
In addition, such influence by one or both of these affiliates could have the
effect of discouraging others from attempting to take us over, and/or reducing
the market price offered for our common stock in such an event.
We are dependent on our principal products and our new product
development. We currently derive substantially all of our net revenue from sales
of our healthcare information systems and related services. We believe that a
primary factor in the market acceptance of our systems has been our ability to
meet the needs of users of healthcare information systems. Our future financial
performance will depend in large part on our ability to continue to meet the
increasingly sophisticated needs of our clients through the timely development
and successful introduction and implementation of new and enhanced versions of
our systems and other complementary products. We have historically expended a
significant percentage of our net revenue on product development and believe
that significant continuing product development efforts will be required to
sustain our growth. Continued investment in our sales staff and our client
implementation and support staffs will also be required to support future
growth.
There can be no assurance that we will be successful in our product
development efforts, that the market will continue to accept our existing
products, or that new products or product enhancements will be developed and
implemented in a timely manner, meet the requirements of healthcare providers,
or achieve market acceptance. If new products or product enhancements do not
achieve market acceptance, our business, results of operations and financial
condition could be materially adversely affected. At certain times in the past,
we have also experienced delays in purchases of our products by clients
anticipating our launch of new products. There can be no assurance that material
order deferrals in anticipation of new product introductions from ourselves or
other entities will not occur.
If the emerging technologies and platforms of Microsoft and others upon
which we build our products do not gain broad market acceptance, or if we fail
to develop and introduce in a timely manner new products and services compatible
with such emerging technologies, we may not be able to compete effectively and
our ability to generate revenue will suffer. Our software products are built and
depend upon several underlying and evolving relational database management
system platforms such as those developed by Microsoft. To date, the standards
and technologies upon which we have chosen to develop our products have proven
to have gained industry acceptance. However, the market for our software
products is subject to ongoing rapid technological developments, quickly
evolving industry standards and rapid changes in customer requirements, and
there may be existing or future technologies and platforms that achieve industry
standard status, which are not compatible with our products.
We face the possibility of subscription pricing and/or application service
provider, ("ASP") delivered offerings. We currently derive substantially all of
our revenue from traditional software license, maintenance and service fees, as
well as the resale of computer hardware. Today, customers pay an initial license
fee for the use of our products, in addition to a periodic maintenance fee. If
the marketplace demands subscription pricing and/or ASP-delivered offerings, we
may be forced to adjust our sales, marketing and pricing strategies accordingly,
by offering a higher percentage of our products and services through these
means. Shifting to subscription pricing and/or ASP-delivered offerings could
materially adversely impact our financial condition, cash flows and quarterly
and annual revenue and results of operations, as our revenue would initially
decrease substantially. There can be no assurance that the marketplace will not
embrace subscription pricing and/or ASP-delivered offerings.
The industry in which we operate is subject to significant technological
change. The software market generally is characterized by rapid technological
change, changing customer
17
needs, frequent new product introductions, and evolving industry standards. The
introduction of products incorporating new technologies and the emergence of new
industry standards could render our existing products obsolete and unmarketable.
There can be no assurance that we will be successful in developing and marketing
new products that respond to technological changes or evolving industry
standards. New product development depends upon significant research and
development expenditures which depend ultimately upon sales growth. Any material
weakness in revenue or research funding could impair our ability to respond to
technological advances or opportunities in the marketplace and to remain
competitive. If we are unable, for technological or other reasons, to develop
and introduce new products in a timely manner in response to changing market
conditions or customer requirements, our business, results of operations and
financial condition may be materially adversely affected.
In response to increasing market demand, we are currently developing new
generations of certain of our software products. There can be no assurance that
we will successfully develop these new software products or that these products
will operate successfully, or that any such development, even if successful,
will be completed concurrently with or prior to introduction of competing
products. Any such failure or delay could adversely affect our competitive
position or could make our current products obsolete.
We face the possibility of claims based upon our web site. We could be
subject to third party claims based on the nature and content of information
supplied on our Web site by us or third parties, including content providers or
users. We could also be subject to liability for content that may be accessible
through our Web site or third party Web sites linked from our Web site or
through content and information that may be posted by users in chat rooms,
bulletin boards or on Web sites created by professionals using our applications.
Even if these claims do not result in liability to us, investigating and
defending against these claims could be expensive and time consuming and could
divert management's attention away from our operations.
We face the possibility of claims from activities of strategic partners.
We rely on third parties to provide services that impact our business. For
example, we use national clearinghouses in the processing of some insurance
claims and we outsource some of our hardware maintenance services and the
printing and delivery of patient statements for our customers. We also have
relationships with certain third parties where these third parties serve as
sales channels through which we generate a portion of our revenue. Due to these
third-party relationships, we could be subject to claims as a result of the
activities, products, or services of these third-party service providers even
though we were not directly involved in the circumstances leading to those
claims. Even if these claims do not result in liability to us, defending and
investigating these claims could be expensive and time-consuming, divert
personnel and other resources from our business and result in adverse publicity
that could harm our business.
We may engage in future acquisitions, which may be expensive and time
consuming and from which we may not realize anticipated benefits. We may acquire
additional businesses, technologies and products if we determine that these
additional businesses, technologies and products are likely to serve our
strategic goals. We currently have no commitments or agreements with respect to
any acquisitions. The specific risks we may encounter in these types of
transactions include the following:
o Potentially dilutive issuances of our securities, the incurrence of
debt and contingent liabilities and amortization expenses related to
intangible assets, which could adversely affect our results of
operations and financial conditions;
o Difficulty in effectively integrating any acquired technologies or
software products into our current products and technologies;
18
o Difficulty in predicting and responding to issues related to product
transition such as development, distribution and customer support;
o The possible adverse impact of such acquisitions on existing
relationships with third party partners and suppliers of
technologies and services;
o The possibility that staff or customers of the acquired company
might not accept new ownership and may transition to different
technologies or attempt to renegotiate contract terms or
relationships, including maintenance or support agreements;
o The possibility that the due diligence process in any such
acquisition may not completely identify material issues associated
with product quality, product architecture, product development,
intellectual property issues, key personnel issues or legal and
financial contingencies; and
o Difficulty in integrating acquired operations due to geographical
distance, and language and cultural differences.
A failure to successfully integrate acquired businesses or technology for
any of these reasons could have a material adverse effect on the Company's
results of operations.
We face the risks and uncertainties that are associated with litigation
against us. We face the risks associated with litigation concerning the
operation of our business. The uncertainty associated with substantial
unresolved litigation may have an adverse impact on our business. In particular,
such litigation could impair our relationships with existing customers and our
ability to obtain new customers. Defending such litigation may result in a
diversion of management's time and attention away from business operations,
which could have a material adverse effect on our business, results of
operations and financial condition. Such litigation may also have the effect of
discouraging potential acquirers from bidding for us or reducing the
consideration such acquirers would otherwise be willing to pay in connection
with an acquisition.
There can be no assurance that such litigation will not result in
liability in excess of our insurance coverage, that our insurance will cover
such claims or that appropriate insurance will continue to be available to us in
the future at commercially reasonable rates.
We rely heavily on our proprietary technology. We are heavily dependent on
the maintenance and protection of our intellectual property and we rely largely
on license agreements, confidentiality procedures, and employee nondisclosure
agreements to protect our intellectual property. Our software is not patented
and existing copyright laws offer only limited practical protection.
There can be no assurance that the legal protections and precautions we
take will be adequate to prevent misappropriation of our technology or that
competitors will not independently develop technologies equivalent or superior
to ours. Further, the laws of some foreign countries do not protect our
proprietary rights to as great an extent as do the laws of the United States and
are often not enforced as vigorously as those in the United States.
We do not believe that our operations or products infringe on the
intellectual property rights of others. However, there can be no assurance that
others will not assert infringement or trade secret claims against us with
respect to our current or future products or that any such assertion will not
require us to enter into a license agreement or royalty arrangement or other
financial arrangement with the party asserting the claim. Responding to and
defending any such claims may distract the attention of Company management and
have a material adverse effect on our business, results of operations and
financial condition. In addition, claims may be brought
19
against third parties from which we purchase software, and such claims could
adversely affect our ability to access third party software for our systems.
We are dependent on our license rights from third parties. We depend upon
licenses for some of the technology used in our products from third-party
vendors. Most of these licenses can be renewed only by mutual consent and may be
terminated if we breach the terms of the license and fail to cure the breach
within a specified period of time. We may not be able to continue using the
technology made available to us under these licenses on commercially reasonable
terms or at all. As a result, we may have to discontinue, delay or reduce
product shipments until we can obtain equivalent technology. Most of our
third-party licenses are non-exclusive. Our competitors may obtain the right to
use any of the technology covered by these licenses and use the technology to
compete directly with us. In addition, if our vendors choose to discontinue
support of the licensed technology in the future or are unsuccessful in their
continued research and development efforts, we may not be able to modify or
adapt our own products.
We face the possibility of damages resulting from internal and external
security breaches, and viruses. In the course of our business operations, we
compile and transmit confidential information, including patient health
information, in our processing centers and other facilities. A breach of
security in any of these facilities could damage our reputation and result in
damages being assessed against us. In addition, the other systems with which we
may interface, such as the Internet and related systems, may be vulnerable to
security breaches, viruses, programming errors, or similar disruptive problems.
The effect of these security breaches and related issues could reduce demand for
our services. Accordingly, we believe that it is critical that these facilities
and related infrastructures not only be secure, but also be viewed by our
customers as free from potential breach. Maintaining such standards, protecting
against breaches and curing security flaws, may require us to expend significant
capital. The success of our strategy to offer our EDI services and Internet
solutions depends on the confidence of our customers in our ability to securely
transmit confidential information. Our EDI services and Internet solutions rely
on encryption, authentication and other security technology licensed from third
parties to achieve secure transmission of confidential information. We may not
be able to stop unauthorized attempts to gain access to or disrupt the
transmission of communications by our customers. Anyone who is able to
circumvent our security measures could misappropriate confidential user
information or interrupt us, or our customers', operations. In addition, our EDI
and Internet solutions may be vulnerable to viruses, physical or electronic
break-ins, and similar disruptions. Any failure to provide secure electronic
communication services could result in a lack of trust by our customers causing
them to seek out other vendors, and/or, damage our reputation in the market
making it difficult to obtain new customers.
We are subject to the development and maintenance of the Internet
infrastructure which is not within our control. We deliver Internet-based
services and, accordingly, we are dependent on the maintenance of the Internet
by third parties. The Internet infrastructure may be unable to support the
demands placed on it and our performance may decrease if the Internet continues
to experience it's historic trend of expanding usage. As a result of damage to
portions of its infrastructure, the Internet has experienced a variety of
performance problems which may continue into the foreseeable future. Such
Internet related problems may diminish Internet usage and availability of the
Internet to us for transmittal of our Internet-based services. In addition,
difficulties, outages, and delays by Internet service providers, online service
providers and other web site operators may obstruct or diminish access to our
Web site by our customers resulting in a loss of potential or existing users of
our services.
Our failure to manage growth could harm us. We have in the past
experienced periods of growth which have placed, and may continue to place, a
significant strain on our non-cash
20
resources. We also anticipate expanding our overall software development,
marketing, sales, client management and training capacity. In the event we are
unable to identify, hire, train and retain qualified individuals in such
capacities within a reasonable timeframe, such failure could have a material
adverse effect on us. In addition, our ability to manage future increases, if
any, in the scope of our operations or personnel will depend on significant
expansion of our research and development, marketing and sales, management, and
administrative and financial capabilities. The failure of our management to
effectively manage expansion in our business could have a material adverse
effect on our business, results of operations and financial condition.
Our operations are dependent upon our key personnel. If such personnel
were to leave unexpectedly, we may not be able to execute our business plan. Our
future performance depends in significant part upon the continued service of our
key technical and senior management personnel, many of whom have been with us
for a significant period of time. These personnel have acquired specialized
knowledge and skills with respect to our business. We do not maintain key man
life insurance on any of our employees. Because we have a relatively small
number of employees when compared to other leading companies in the same
industry, our dependence on maintaining our relationship with key employees is
particularly significant. We are also dependent on our ability to attract and
retain high quality personnel, particularly in the areas of sales and
applications development.
The industry in which we operate is characterized by a high level of
employee mobility and aggressive recruiting of skilled personnel. There can be
no assurance that our current employees will continue to work for us. Loss of
services of key employees could have a material adverse effect on our business,
results of operations and financial condition. Furthermore, we may need to grant
additional equity incentives to key employees and provide other forms of
incentive compensation to attract and retain such key personnel. Failure to
provide such types of incentive compensation could jeopardize our recruitment
and retention capabilities.
Our products may be subject to product liability legal claims. Certain of
our products provide applications that relate to patient clinical information.
Any failure by our products to provide accurate and timely information could
result in claims against us. In addition, a court or government agency may take
the position that our delivery of health information directly, including through
licensed practitioners, or delivery of information by a third party site that a
consumer accesses through our web sites, exposes us to assertions of
malpractice, other personal injury liability, or other liability for wrongful
delivery/handling of healthcare services or erroneous health information. We
maintain insurance to protect against claims associated with the use of our
products as well as liability limitation language in our end-user license
agreements, but there can be no assurance that our insurance coverage or
contractual language would adequately cover any claim asserted against us. A
successful claim brought against us in excess of or outside of our insurance
coverage could have a material adverse effect on our business, results of
operations and financial condition. Even unsuccessful claims could result in our
expenditure of funds for litigation and management time and resources.
Certain healthcare professionals who use our Internet-based products will
directly enter health information about their patients including information
that constitutes a record under applicable law that we may store on our computer
systems. Numerous federal and state laws and regulations, the common law, and
contractual obligations, govern collection, dissemination, use and
confidentiality of patient-identifiable health information, including:
o state and federal privacy and confidentiality laws;
o our contracts with customers and partners;
21
o state laws regulating healthcare professionals;
o Medicaid laws;
o the Health Insurance Portability and Accountability Act of 1996
("HIPAA") and related rules proposed by the Health Care Financing
Administration; and
o Health Care Financing Administration standards for Internet
transmission of health data.
The U.S. Congress has finalized the Health Insurance Portability and
Accountability Act of 1996 that established elements including, but not limited
to, new federal privacy and security standards for the use and protection of
Protected Health Information. Any failure by us or by our personnel or partners
to comply with applicable requirements may result in a material liability to us.
Although we have systems and policies in place for safeguarding Protected
Health Information from unauthorized disclosure, these systems and policies may
not preclude claims against us for alleged violations of applicable
requirements. Also, third party sites and/or links that consumers may access
through our web sites may not maintain adequate systems to safeguard this
information, or may circumvent systems and policies we have put in place. In
addition, future laws or changes in current laws may necessitate costly
adaptations to our policies, procedures, or systems.
There can be no assurance that we will not be subject to product liability
claims, that such claims will not result in liability in excess of our insurance
coverage, that our insurance will cover such claims or that appropriate
insurance will continue to be available to us in the future at commercially
reasonable rates. Such product liability claims could have a material adverse
affect on our business, results of operations and financial condition.
We are subject to the effect of payor and provider conduct which we cannot
control. Electronic data transmission services are offered by certain payors to
healthcare providers that establish a direct link between the provider and
payor. This process reduces revenue to third party EDI service providers such as
us. Accordingly, we are unable to insure that we will continue to generate
revenue at or in excess of prior levels for such services. A significant
increase in the utilization of direct links between healthcare providers and
payers could have a material adverse effect on our transaction volume and
financial results. In addition, we cannot provide assurance that we will be able
to maintain our exiting links to payors or develop new connections on terms that
are economically satisfactory to us, if at all.
There is significant uncertainty in the healthcare industry in which we
operate and we are subject to the possibility of changing government regulation.
The healthcare industry is subject to changing political, economic and
regulatory influences that may affect the procurement processes and operation of
healthcare facilities. During the past several years, the healthcare industry
has been subject to an increase in governmental regulation of, among other
things, reimbursement rates and certain capital expenditures.
In the past, various legislators have announced that they intend to
examine proposals to reform certain aspects of the U.S. healthcare system
including proposals which may change governmental involvement in healthcare and
reimbursement rates, and otherwise alter the operating environment for us and
our clients. Healthcare providers may react to these proposals, and the
uncertainty surrounding such proposals, by curtailing or deferring investments,
including those for our systems and related services. Cost-containment measures
instituted by healthcare providers as a result of regulatory reform or otherwise
could result in a reduction in the allocation of capital funds. Such a reduction
could have an adverse effect on our ability to sell
22
our systems and related services. On the other hand, changes in the regulatory
environment have increased and may continue to increase the needs of healthcare
organizations for cost-effective data management and thereby enhance the overall
market for healthcare management information systems. We cannot predict what
impact, if any, such proposals or healthcare reforms might have on our business,
financial condition and results of operations.
The HIPAA regulations, as adopted by the Department of Health and Human
Services ("HHS"), established, among other things:
o a national standard for electronic transactions and code sets to be
used in those transactions involving certain common health care
transactions;
o privacy regulations to protect the privacy of plan participants and
patients' medical records; and
o security regulations designed to establish security controls and
measures to protect the privacy and confidentiality of personal
identifiable health information when it is electronically stored,
maintained or transmitted (even if only internally transmitted
within a medical practice).
While the privacy and transaction and code set standards are currently in
effect, the security regulation will become effective by 2005. As these
regulations mature and become better defined, we anticipate that these
regulations will continue to directly affect certain of our products and
services, but we cannot fully predict the impact at this time. We have taken
steps to modify our products, services and internal practices as necessary to
facilitate our and our client's compliance with the final regulations, but there
can be no assurance that we will be able to do so in a timely or complete
manner. Achieving compliance with these regulations could be costly and distract
management's attention and other resources, and any noncompliance by us could
result in civil and criminal penalties.
In addition, development of related federal and state regulations and
policies regarding the confidentiality of health information or other matters
could positively or negatively affect our business.
In addition, our software may potentially be subject to regulation by the
U.S. Food and Drug Administration (the "FDA") as a medical device. Such
regulation could require the registration of the applicable manufacturing
facility and software and hardware products, application of detailed
record-keeping and manufacturing standards, and FDA approval or clearance prior
to marketing. An approval or clearance requirement could create delays in
marketing, and the FDA could require supplemental filings or object to certain
of these applications, the result of which could have a material adverse effect
on our business, financial condition and results of operations.
We may be subject to other e-commerce regulations. We may be subject to
additional federal and state statutes and regulations in connection with
offering services and products via the Internet. On an increasingly frequent
basis, federal and state legislators are proposing laws and regulations that
apply to Internet commerce and communications. Areas being affected by these
regulations include user privacy, pricing, content, taxation, copyright
protection, distribution, and quality of products and services. To the extent
that our products and services are subject to these laws and regulations, the
sale of our products and services could be harmed.
We are subject to changes in and interpretations of financial accounting
matters that govern the measurement of our performance. Based on our reading and
interpretations of relevant guidance, principles or concepts issued by, among
other authorities, the American
23
Institute of Certified Public Accountants, the Financial Accounting Standards
Board, and the United States Securities and Exchange Commission, Management
believes our current sales and licensing contract terms and business
arrangements have been properly reported. However, there continue to be issued
interpretations and guidance for applying the relevant standards to a wide range
of sales and licensing contract terms and business arrangements that are
prevalent in the software industry. Future interpretations or changes by the
regulators of existing accounting standards or changes in our business practices
could result in future changes in our revenue recognition and/or other
accounting policies and practices that could have a material adverse effect on
our business, financial condition, cash flows, revenue and results of
operations.
Our earnings may be adversely affected if we change our accounting policy
with respect to employee stock options. Stock options have from time to time
been an important component of the compensation packages for many of our mid-
and senior-level employees. We currently do not deduct the expense of employee
stock option grants from our income. Many companies, however, are considering a
change to their accounting policies to record the value of stock options issued
to employees as an expense and changes in the accounting treatment of stock
options are currently under consideration by the Financial Accounting Standards
Board or other accounting standards-setting bodies. If we were to voluntarily or
involuntarily change our accounting policy with respect to the treatment of
employee stock option grants, our earnings could be materially adversely
affected.
Continuing worldwide political and economic uncertainties may adversely
impact our revenue and profitability. In the last three years, worldwide
economic conditions have experienced a downturn due to numerous factors
including but not limited to concerns about inflation and deflation, decreased
consumer confidence, the lingering effects of international conflicts, and
terrorist and military activities. These conditions make it extremely difficult
for our customers, our vendors and ourselves to accurately forecast and plan
future business activities, and they could cause constrained spending on our
products and services, and/or delay and lengthen sales cycles.
24
Results of Operations
The following table sets forth for the periods indicated, the percentage
of net revenues represented by each item in our Consolidated Statements of
Income.
---------------------------
(unaudited) Three Months Ended June 30,
2004 2003
- ----------------------------------------------------------------------------
Net Revenues:
Sales of computer systems, upgrades and supplies 55.1% 58.1%
Maintenance and other services 44.9 41.9
------------------
100.0 100.0
Cost of Products and Services 40.2 40.5
------------------
Gross Profit 59.8 59.5
Selling, General and Administrative Expenses 24.6 29.1
Research and Development Costs 8.0 8.4
------------------
Income from Operations 27.2 22.0
Investment Income 0.6 0.6
------------------
Income before Provision for Income Taxes 27.8 22.6
Provision for Income Taxes 11.0 8.6
------------------
Net Income 16.8% 14.0%
------------------
- ----------------------------------------------------------------------------
For the Quarter Ended June 30, 2004 versus 2003
For the quarter ended June 30, 2004, our net income was $3,382,000 or $
0.53 per share on a basic and $ 0.51 per share on a fully diluted basis. In
comparison, we earned $2,277,000 or $.37 per share on a basic and $0.35 on a
fully diluted basis in the quarter ended June 30, 2003. The increase in net
income for the quarter ended June 30, 2004, was achieved through the following:
o a 23% increase in revenue; and
o Selling, general and administrative and research and development
expenses which grew at 4% and 18% respectively; slower than the
overall revenue growth rate.
Net Revenue. Net revenue for the quarter ended June 30, 2004 increased 23%
to $20.1 million from $16.3 million for the year ended June 30, 2003. NextGen
Division net revenue increased 32% from approximately $12.2 million to
approximately $16.1 million in the period, while QSI Division net revenue
declined by 2% during the period from approximately $4.1 million to
approximately $ 4.0 million.
We report revenue in two categories, "Computer systems, upgrades, and
supplies" and "Maintenance and other". Revenue in the computer systems,
upgrades, and supplies category includes software license fees, third party
hardware and software, and implementation and training services related to
purchase of the Company's software systems. The majority of the revenue in the
Computer systems, upgrades, and supplies category is related to the sale of
software systems. Revenue in the maintenance and other category includes
maintenance, EDI, and other revenue. Maintenance and EDI revenue are the
principal sources of revenue in this category.
25
Computer systems, upgrades and supplies. Company-wide sales of computer
systems, upgrades and supplies increased 17% to $11.1 million from $9.5 million.
Our increase in revenue from sales of computer systems, upgrades and
supplies for the Company was principally the result of a 18% increase in such
revenue at out NextGen Division whose sales in this category grew from $9.0
million to $10.6 million. This increase was driven primarily by higher sales of
NextGenemr and NextGenepm software to both new and existing clients, as well as
related implementation services and hardware and third party software.
Category revenue in the QSI Division was unchanged at approximately $0.5
million.
Maintenance and Other. Company-wide revenue from maintenance and other
services grew 32% to $ 9.0 million from $6.8 million. The increase in this
category resulted principally from an increase in maintenance and EDI revenue
from the NextGen Division's client base. Total NextGen Division maintenance
revenue for the quarter ended June 30, 2004 grew 72% to $3,755,000 from
$2,183,000 in the year ago period, while EDI revenue grew 78% to $1,060,000
compared to $596,000 during the same period. QSI Division maintenance revenue
declined 3% from $1,938,000 to $1,884,000 in the same period while QSI
Divisional EDI revenue declined by approximately 9% from $1,342,000 to
$1,228,000.
The following table details revenue by category for the three month
periods ended June 30, 2004 and 2003:
-------------------------------------------------------------------------------
Quarter Ended June 30, 2004 Quarter Ended June 30, 2003
(in thousands) -------------------------------------------------------------------------------
QSI NextGen Consolidated QSI NextGen Consolidated
- --------------------------------------------------------------------------------------------------------------------
Computer Systems, upgrades &
supplies $ 520 $10,564 $11,084 $ 504 $ 8,970 $ 9,474
===========================================================================
Maintenance 1,884 3,755 5,639 1,938 2,183 4,121
---------------------------------------------------------------------------
EDI 1,228 1,060 2,288 1,342 596 1,938
---------------------------------------------------------------------------
Other 349 770 1,119 280 493 773
===========================================================================
Total Maintenance & Other
3,461 5,585 9,046 3,560 3,272 6,832
Total Revenue $3,981 $16,149 $20,130 $4,064 $12,242 $16,306
- --------------------------------------------------------------------------------------------------------------------
Cost of Products and Services. Cost of products and services for the
quarter ended June 30, 2004 increased 23% to $ 8.1 million from $6.6 million for
the quarter ended June 30, 2004, while the cost of products and services as a
percentage of net revenue decreased to 40.2% from 40.5% during the same period a
year ago. Our consolidated gross margins are impacted by the level of hardware
content included in system sales, the percentage of EDI revenue in our overall
sales mix, and certain headcount expenses directly related to the cost of
delivering our products and services. Consolidated gross margin percentages were
also impacted by the higher margin revenues of the NextGen Division which
increased it's share of our total revenue to 80% from 75% in the prior year
quarter.
Gross margins at the NextGen Division for the quarter ended June 30, 2004
declined to 61.9% from 63.2% in the prior year quarter primarily due to an
increase in the relative level of applicable headcount expense associated with
delivering our products and services. The QSI
26
Division's gross margin improved to 51.0% in the quarter ended June 30, 2004
from 48.3% in the same period last year due to a proportionately lower hardware
and third party software content included in revenue.
The following table details revenue and cost of products and services on a
consolidated and divisional basis for the three month periods ended June 30,
2004 and 2003:
----------------------------------------------
(in thousands) Quarter Ended June 30,
----------------------------------------------
2004 % 2003 %
====================================================================================================
Consolidated
---------------------------------------------
Net Revenue $20,130 100.0% $16,306 100.0%
---------------------------------------------
Cost of Product & Services 8,101 40.2% 6,610 40.5%
---------------------------------------------
Gross Margin 12,029 59.8% 9,696 59.5%
=============================================
NextGen Division
---------------------------------------------
Net Revenue $16,148 100.0% $12,242 100.0%
---------------------------------------------
Cost of Product & Services 6,151 38.1% 4,507 36.8%
---------------------------------------------
Gross Margin 9,997 61.9% 7,735 63.2%
=============================================
QSI Division
---------------------------------------------
Net Revenue $ 3,982 100.0% $ 4,064 100.0%
---------------------------------------------
Cost of Product & Services 1,950 49.0% 2,103 51.7%
=============================================
Gross Margin $ 2,032 51.0% $ 1,961 48.3%
- ---------------------------------------------------------------------------------------------------
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the quarter ended June 30, 2004 increased 4% to $4.9
million as compared to $4.7 million for the quarter ended June 30, 2003. The
increase in the amount of such expenses resulted primarily from increases of
$0.2 million in general, unallocated corporate expenses. Selling, general and
administrative expenses as a percentage of revenue declined from 29.1% in the
quarter ended June 30, 2003 to 24.6% in the quarter ended June 30, 2004 due to
minimal growth in consolidated non-corporate selling, general and administrative
expenses compared to the prior year. Total selling, general and administrative
expenses in the NextGen Division increased by approximately $0.2 million dollars
compared to the prior year, this was mostly offset by $0.2 million dollar
decrease in the same type of expenses at the QSI Division.
Research and Development Costs. Research and development costs for the
quarter ended June 30, 2004 and 2003 were $1.6 million and $1.4 million,
respectively. The increase in research and development expenses were primarily
due to increased investment in the NextGen product line. Research and
development costs as a percentage of net revenue decreased to 8.0% from 8.4% due
in part, to the fact that revenue growth exceeded the increase in research and
development spending. Research and development expenses are expected to continue
at or above current levels.
27
Investment Income. Investment income for the quarter ended June 30, 2004
increased 20% to approximately $120,000 compared with $100,000 in the quarter
ended June 30, 2003. Investment income in the quarter ended June 30, 2004
increased primarily due to the effect of an increase in average funds available
for investment during the quarter ended June 30, 2004, offset by a drop in short
term interest rates versus the prior year quarter.
Provision for Income Taxes. The provision for income taxes for the quarter
ended June 30, 2004 was approximately $2.2 million as compared to approximately
$1.4 million for the year ago period. The effective tax rates for the quarter
ended June 30, 2004 and 2003 were 39.4% and 38.3%, respectively. The provision
for income taxes for the quarters ended June 30, 2004 and 2003 differ from the
combined statutory rates primarily due to the impact of varying state income tax
rates and the impact of research and development tax credits. The effective rate
for the quarter ended June 30, 2004 increased from the prior year primarily due
to a relatively smaller impact of research and development tax credits as well
as slightly higher effective federal income tax rates.
Liquidity and Capital Resources
The following table presents selected financial statistics and information for
each of the three months ended June 30, 2004 and 2003:
----------------------
($ in thousands) Quarter Ended June 30,
(unaudited) 2004 2003
- ------------------------------------------------------------------------------------------
Cash and cash equivalents $54,941 $38,976
--------------------
Net increase in cash and cash equivalents during the
quarter $ 3,546 $ 2,533
--------------------
Net income during the quarter $ 3,382 $ 2,277
--------------------
Net cash provided by operations during the quarter $ 4,247 $ 3,240
--------------------
Number of days of sales outstanding at start of quarter 99 106
--------------------
Number of days of sales outstanding at end of quarter 104 107
- ------------------------------------------------------------------------------------------
The Company's principal source of cash was cash provided by operations.
The number of days sales outstanding at the end of the quarter increased by five
days compared to the beginning of the quarter primarily due to an increase in
the volume of services sold by the NextGen Division which had not yet been
rendered resulting in an increase in both accounts receivable and deferred
revenue. Provided turnover of accounts receivable, deferred revenue, and
profitability remain consistent with the quarter ended June 30, 2004, the
Company anticipates being able to continue to generate cash from operations
primarily from the net income of the Company.
Cash and cash equivalents increased $3,546,000 between March 31, 2004 and
June 30, 2004 primarily as a result of cash provided by operating activities.
Cash and cash equivalents increased approximately $2.5 million during the three
months ended June 30, 2003, also primarily as a result of cash generated by
operating activities.
Net cash used in investing activities for the three months ended June 30,
2004 and 2003 was $1.0 and $0.8 million respectively. Net cash used in investing
activities for the three months ended June 30, 2004 and 2003 consisted of
additions to equipment and improvements and capitalized software.
28
At June 30, 2004, we had cash and cash equivalents of $54.9 million. We
intend to expend funds for the development of products complementary to its
existing product line as well as new versions of certain of its products. These
developments are intended to take advantage of more powerful technologies and to
increase the integration of our products. We have no additional significant
current capital commitments.
Management believes that its cash and cash equivalents on hand at June 30,
2004, together with cash flows from operations, if any, will be sufficient to
meet its working capital and capital expenditure requirements for the balance of
fiscal 2005. The following table summarizes our significant contractual
obligations at June 30, 2004, and the effect that such obligations are expected
to have on our liquidity and cash in future periods:
- ----------------------------------------------------------------------------------------------------------------------
Contractual Obligations Total Less than a 1-3 years 3-5 years Beyond 5
year years
- ----------------------------------------------------------------------------------------------------------------------
Non-concealable lease obligations 3,594 1,092 1,331 1,120 51
- ----------------------------------------------------------------------------------------------------------------------
Item 3. Qualitative and Quantitative Disclosures About Market Risk
We have a significant amount of cash and short-term investments with
maturities less than three months. This cash portfolio exposes us to interest
rate risk as short-term investment rates can be volatile. Given the short-term
maturity structure of our investment portfolio, we believe that it is not
subject to principal fluctuations and the effective interest rate of our
portfolio tracks closely to various short-term money market interest rate
benchmarks.
Item 4. Disclosure Controls and Procedures
The Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) conducted an
evaluation of the design and operation of our "disclosure controls and
procedures" (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended ("Exchange Act")). Based on that evaluation,
which was conducted within 90 days of the date on which this quarterly report
was filed with the Securities and Exchange Commission, the Chief Executive
Officer and Chief Financial Officer concluded that the disclosure controls and
procedures are effective to ensure that information required to be disclosed by
use in the reports filed or submitted by us under the Exchange Act is
accumulated, recorded, processed, summarized and reported to management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding whether or not disclosure is
required.
During the quarter ended June 30, 2004, the following changes have
occurred in our "internal controls over financial reporting" (as defined in Rule
13a-15(f) under the Exchange Act) that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting occurred. We began a process of implementing new software which will
automate certain processes surrounding the recognition and the deferral of
revenue related to our software sales arrangements with multiple elements. These
processes include computing the amount of deferred revenue related to
undelivered elements at the time a new sales arrangement is recorded and then
subsequently recognizing the applicable portion of revenue as the elements are
delivered to customers or are earned. These processes have historically been,
and are currently being performed manually. During the quarter ended June 30,
2004 we used both the existing manual process as well as the new software to
perform in a parallel manner the processes described above which related to
revenue recognition of our software sales arrangements with multiple elements.
As of June 30, 2004 (i) we had not developed sufficient controls
29
over our new software in order to rely on the new automated processes and
instead, relied on our existing manual process for the June 30, 2004 quarter
financial statements and (ii) we had also not completed our evaluation over our
internal controls related to this new software. We have hired a third party
accounting firm to assist in the process of evaluating and documenting our
internal controls structure. Our goal is for this process to be completed by the
end of the September 30, 2004 quarter.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity
Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submissions of Matters to a Vote of Securities Holders.
None
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
Exhibits:
31.1 Certifications Required by Rule 13a-14(a) of the Securities Exchange
Act of 1934, as amended, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
Reports on Form 8-K:
On May 27, 2004, we filed a Report on Form 8-K with the SEC concerning the
Company's financial performance for the period ended March 31, 2004. A copy of
our press release announcing the results and certain other information was
attached to the Report on Form 8-K.
On June 3, 2004, we filed a Report on Form 8-K with the SEC concerning a
transcript of the conference call with management covering the financial
performance for the period ended March 31, 2004. A copy of a transcript of the
conference call was attached to the report on Form 8-K.
30
On June 17, 2004, we filed a Report on Form 8-K with the SEC concerning a letter
dated June 11,2004 from Dale Hanson, a member of our Board of Directors,
informing us that Mr. Hanson has chosen not to stand for re-election at our 2004
Annual Shareholders' Meeting
Pursuant to the requirements of the Securities Exchange Act of 1934, we have
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
QUALITY SYSTEMS, INC.
Date: August 5, 2004 By: /s/ Louis Silverman
---------------------------------
Louis Silverman
Chief Executive Officer
Date: August 5, 2004 By: /s/ Paul Holt
------------------------
Paul Holt
Chief Financial Officer;
Principal Accounting Officer
31