10-Q 1 0001.txt 1 U. S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE [X] SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE [ ] SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-13801 QUALITY SYSTEMS, INC. (Exact name of registrant as specified in its charter) California 95-2888568 _______________________________ ___________________ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 17822 East 17th Street, Tustin, California 92780 (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (714) 731-7171 NOT APPLICABLE (Former name, former address and former fiscal year, if changed, since last year) Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes XX No ---- ---- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 6,186,841 shares of Common Stock, $.01 par value, as of October 31, 2000 2 PART I. CONSOLIDATED FINANCIAL INFORMATION. ------- ----------------------------------- Item 1. Financial Statements. ------- --------------------- QUALITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
ASSETS September 30, March 31, 2000 2000 ---------- ---------- (Unaudited) Current Assets: Cash and cash equivalents $ 16,605 $ 15,926 Short-term investments 248 243 Accounts receivable, net 15,107 13,710 Inventories 967 1,010 Other current assets 1,322 2,496 ---------- ---------- Total current assets 34,249 33,385 Equipment and Improvements, net 2,026 1,797 Capitalized Software Costs, net 1,894 1,984 Deferred Tax Asset 2,936 3,042 Excess of Cost Over Net Assets of Acquired Business, net 1,942 2,112 Other Assets 1,655 1,816 ---------- ---------- Total assets $ 44,702 $ 44,136 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 1,617 $ 1,246 Deferred service revenue 5,712 5,691 Other current liabilities 3,871 5,116 ---------- ---------- Total liabilities 11,200 12,053 ---------- ---------- Commitments and Contingencies Shareholders' Equity: Common stock, $0.01 par value, 20,000 shares authorized, 6,208 and 6,201 shares issued and outstanding, respectively 62 62 Additional paid-in capital 35,533 35,483 Accumulated deficit (2,093) (3,462) ---------- ---------- Total shareholders' equity 33,502 32,083 ---------- ---------- Total liabilities and shareholders' equity $ 44,702 $ 44,136 ========== ==========
See notes to consolidated financial statements. 3 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Unaudited) (in thousands, except per share amounts)
Three Months Ended Six Months Ended ------------------ ------------------ September 30, September 30, 2000 1999 2000 1999 -------- -------- -------- -------- Net Revenues: Sales of computer systems, upgrades and supplies $ 4,794 $5,633 $9,189 $ 10,749 Maintenance, EDI, and other 4,869 4,076 9,736 8,062 -------- -------- -------- -------- 9,663 9,709 18,925 18,811 Cost of Products and Services 4,363 4,466 8,395 8,524 -------- -------- -------- -------- Gross Profit 5,300 5,243 10,530 10,287 Selling, General and Administrative Expenses 3,264 3,138 6,609 6,178 Research and Development Costs 974 965 1,979 1,857 -------- -------- -------- -------- Income from Operations 1,082 1,140 1,942 2,252 Investment Income 251 182 497 348 -------- -------- -------- -------- Income before Provision for Income Taxes 1,333 1,322 2,439 2,600 Provision for Income Taxes 589 584 1,070 1,120 -------- -------- -------- -------- Net Income and Comprehensive Income $ 744 $ 738 $ 1,369 $ 1,480 ======== ======== ======== ======== Net Income per Share, basic & diluted $ 0.12 $ 0.12 $ 0.22 $ 0.24 ======== ======== ======== ========
See notes to consolidated financial statements. 4 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands)
Six Months Ended September 30, ----------------------------- 2000 1999 ------------ ------------ Cash Flows from Operating Activities: Net income $ 1,369 $ 1,480 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,342 1,308 Loss(Gain) on short-term investments (5) 10 Deferred income taxes 1,364 (26) Changes in: Accounts receivable (1,397) 259 Inventories 43 (435) Other current assets (84) (88) Other assets (6) (75) Accounts payable 371 463 Deferred service revenue 21 446 Income taxes payable and taxes related to equity accounts (1,287) (522) Other current liabilities 42 59 ------------ ------------ Net Cash Provided by Operating Activities 1,773 2,879 ------------ ------------ Cash Flows from Investing Activities: Net additions to equipment and improvements (572) (196) Additions to capitalized software costs (559) (593) Purchase of short-term investment - (50) Proceeds from sale of short-term investment - 29 Change in other assets (13) (45) ------------ ------------ Net Cash Used in Investing Activities (1,144) (855) ------------ ------------ Cash Flows from Financing Activities: Purchases of Common Stock (35) - Proceeds from exercise of stock options 85 6 ------------ ------------ Net Cash Provided by Financing Activities 50 6 ------------ ------------ Net Increase in Cash and Cash Equivalents 679 2,030 Cash and Cash Equivalents, beginning of period 15,926 14,196 ------------ ------------ Cash and Cash Equivalents, end of period $ 16,605 $ 16,226 ============ ============
See notes to consolidated financial statements. 5 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited) (in thousands) Supplemental Information - During the six months ended September 30, 2000 and 1999, the Company made income tax payments, net of refunds received, of $831 and $1,670, respectively. 6 QUALITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION ------ --------------------- The accompanying unaudited consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and, therefore, do not include all information and footnotes which would be presented were such financial statements prepared in accordance with accounting principles generally accepted in the United States of America, and should be read in conjunction with the audited financial statements presented in the Company's Annual Report for the fiscal year ended March 31, 2000. In the opinion of management, the accompanying financial statements reflect all adjustments which are necessary for a fair presentation of the results of operations for the interim periods presented. The results of operations for such interim periods are not necessarily indicative of results of operations to be expected for the full year. NOTE 2 - STOCK REPURCHASE ------ ---------------- In February 1997, the Company's Board of Directors authorized the repurchase on the open market of up to 10% of the shares of the Company's outstanding Common stock, subject to compliance with applicable laws and regulations. This stock authorization has been renewed annually and currently expires on June 7, 2001. The timing and amount of any repurchase is at the discretion of the Company's Board of Directors. The Company's Board of Directors could, in the exercise of its judgment, repurchase fewer shares than authorized. During the three months ended September 30, 2000, the Company repurchased 5,000 shares at a cost of approximately $35,000. Since the inception of the repurchase authorization through October 31, 2000, 137,800 shares have been repurchased at a cost of approximately $829,000. NOTE 3 - INCOME TAXES ------ ------------ The provision for income taxes for the three months ended September 30, 2000 and 1999 differ from the expected combined statutory rates primarily due to the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 acquisition of Clinitec International, Inc. and the effect of varying state income tax rates. 7 NOTE 4 - NET INCOME (LOSS) PER SHARE ------ --------------------------- The following table reconciles the weighted average shares outstanding for basic and diluted net income per share for the period indicated.
Three Months Ended Six Months Ended September 30, September 30, ------------------ ------------------ 2000 1999 2000 1999 -------- -------- -------- -------- (in thousands except per share amounts) Net income $ 744 $ 738 $ 1,369 $ 1,480 -------- -------- -------- -------- Basic net income per share: Weighted average number of common shares outstanding 6,209 6,215 6,209 6,215 -------- -------- -------- -------- Basic net income per share $ 0.12 $ 0.12 $ 0.22 $ 0.24 ======== ======== ======== ======== Diluted net income per share: Weighted average number of common shares outstanding 6,209 6,215 6,209 6,215 Weighted average number of common shares equivalents- Weighted average options outstanding 64 26 86 14 -------- -------- -------- -------- Weighted average number of common and common equivalent shares 6,273 6,241 6,286 6,229 -------- -------- -------- -------- Diluted net income per share $ 0.12 $ 0.12 $ 0.22 $ 0.24 ======== ======== ======== ========
NOTE 5 - NEW ACCOUNTING STANDARD ------ ----------------------- In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin #101, Revenue Recognition in Financial Statements (SAB 101). SAB 101 summarizes the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 101 is effective for the third quarter of fiscal year 2001. The Company is currently evaluating the impact SAB 101 will have on its financial statements, but does not believe the impact will be significant. In March 2000, the FASB issued Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving Stock Compensation." FIN 44 is an interpretation of Accounting Principal Board's Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). Among other matters, FIN 44 clarifies the application of APB 25 regarding the definition of employee for purposes of applying APB 25, the criteria for determining whether a plan qualifies as noncompensatory and the accounting consequences of modifications to the terms of a previously issued stock options or similiar awards. The Company adopted the provisions of FIN 44 in the third quarter of 2000. The adoption of FIN 44 did not have a material impact on the Company's financial condition or results of operations. 8 Item 2. Management's Discussion and Analysis of Financial Condition ------- ----------------------------------------------------------- and Results of Operations. -------------------------- Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q, including discussions of the Company's product development plans and business strategies and market factors influencing the Company's results, are forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by the Company as a result of various factors, both foreseen and unforeseen, including, but not limited to, the Company's ability to continue to develop new products and increase systems sales in a market characterized by rapid technological evolution, consolidation, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact the Company's ability to achieve its goals and interested persons are urged to review the risks described below, as well as in the Company's other public disclosures and filings with the Securities and Exchange Commission. COMPANY OVERVIEW. Quality Systems, Inc. ("QSI") and its wholly-owned subsidiaries, Clinitec International, Inc. ("Clinitec") and MicroMed Healthcare Information Systems, Inc. ("MicroMed"), (collectively, the "Company") develop and market healthcare information systems that automate medical and dental group practices, physician hospital organizations ("PHOs"), management service organizations ("MSOs"), community health centers and dental schools. In response to the growing need for more comprehensive, cost- effective information solutions for physician and dental practices, the Company's systems provide its clients with the ability to redesign patient care and other workflow processes, improve productivity, reduce information processing and administrative costs, and provide multi-site access to patient information. The Company's proprietary software systems include general patient information, electronic medical records, appointment scheduling, billing, insurance claims submission and processing, managed care plan implementation and referral management, treatment outcome studies, treatment planning, drug formularies, dental charting, and letter generation. Several of the Company's proprietary software systems may be operated remotely using thin client connectivity or a standard web browser. In addition to providing fully integrated software information solutions to its clients, the Company offers comprehensive hardware and software installation services, maintenance and support services, system training services, and electronic insurance claims submission services. The Company currently has an installed base of more than 600 healthcare information systems serving PHOs, MSOs, group practices, specialty practices, dental schools and other healthcare organizations, each of which consists of from one to 250 physicians or dentists. The Company believes that as healthcare providers are increasingly required to reduce costs while maintaining the quality of healthcare, the Company will be able to capitalize on its strategy of providing fully integrated information systems and superior client service. 9 QSI is a California Corporation formed in 1974 and was founded with an early focus on providing information systems and services primarily for dental group practices. QSI's initial "turnkey" systems were designed to improve productivity while reducing information processing costs and personnel requirements. In the mid-1980's, QSI capitalized on the opportunity presented by the increasing pressure of cost containment on physicians and healthcare organizations and further expanded its information processing systems into the broader medical market. Today, QSI primarily develops and provides integrated character-based healthcare information systems for both the medical and dental markets. These expandable systems operate on a stand-alone basis or in a networked environment. QSI's wholly owned subsidiaries, Clinitec and Micromed, develop and sell both proprietary electronic medical records software and practice management systems under the product name of NextGen*. Major product categories of the NextGen suite of applications include Electronic Medical Records (NextGenemr), Enterprise Practice Management (NextGenepm), Enterprise Appointment Scheduling (NextGeneas), Enterprise Master Patient Index (NextGenepi), Managed Care, Electronic Data Interchange, System Interfaces, Internet Operability (NextGen web), and a Patient-centric and Provider- centric Web Portal Solution (NextMD). NextGenemr allows healthcare providers to create and maintain medical records using a series of user-definable clinical "templates." Data is generally captured using a light pen or a mouse, and entries are then turned into sentences and/or paragraphs to create documentation. NextGenemr also supports the scanning and annotation of paper documents, photographs and X-rays, and contains many other advanced features. NextGenemr is marketed both in conjunction with the Company's practice management software offerings as well as on a stand-alone basis where NextGenemr may interface with other practice management systems. The Company believes that it currently provides a comprehensive information management solution for the medical marketplace. NextGenepm has been developed with a client/server architecture; a GUI design utilizing Windows 95, Windows 98, Windows 2000, or Windows NT operating system platforms; and, a platform independent relational database that is ANSI SQL-compliant. NextGenepm is designed to provide a flexible, enterprise-wide solution employing a master patient index. * NextGen is a registered trademark of Clinitec International, Inc. 10 Recognizing the need and benefits to be obtained by using its software in conjunction with the capabilities of the Internet, the Company enhanced its enterprise practice management and electronic medical software packages in fiscal 2000 to enable them to be run via Private Intranet or the Internet in an Application Services Provider (ASP) environment. Additionally, in April 2000, the Company announced the launch of an Internet-based consumer health portal, NextMD.com. NextMD.com will be a vertical portal for the healthcare industry, linking patients with their physicians, insurers, laboratories, and online pharmacies, while providing a centralized source of health-oriented information for both consumers and medical professionals. Patients whose physicians are linked to the portal will be able to request appointments, send appointment changes or cancellations, receive test results online, request prescription refills, view and/or pay their statements, and communicate with their physicians, all in a secure, online environment. The Company's NextGen suite of information systems will be linked to NextMD.com, integrating a number of these features with physicians' existing systems. RISK FACTORS. COMPETITION. The market for healthcare information systems is intensely competitive and the Company faces significant competition from a number of different sources. The electronic medical records market, in particular, is subject to rapid changes in technology and the Company expects that competition in this portion of the market will increase as new competitors enter the marketplace. In addition, several of the Company's competitors have significantly greater name recognition as well as substantially greater financial, technical, product development and marketing resources than the Company. The industry is highly fragmented and includes numerous competitors, none of which the Company believes dominates the overall market for either group practice management or clinical systems. Furthermore, the Company also competes indirectly and to varying degrees with other major healthcare related companies, information management companies generally, and other software developers which may more directly enter the markets in which the Company competes. There can be no assurance that future competition or new product introductions will not have a material adverse effect on the Company's business, results of operations and financial condition. Competitive pressures and other factors, such as new product introductions by the Company or its competitors, may result in price or market share erosion that could have a material adverse effect on the Company's business, results of operations and financial condition. 11 In addition, the Company believes that once a healthcare provider has chosen a particular healthcare information system vendor, the provider will, for a period of time, be more likely to rely on that vendor for its future information system requirements. Furthermore, if the healthcare industry continues to undergo further consolidation as it has recently experienced, each sale of the Company's systems will assume even greater importance to the Company's business, results of operations and financial condition. The Company's inability to make initial sales of its systems to either newly formed groups and/or healthcare providers that are replacing or substantially modifying their healthcare information systems could have a material adverse effect on the Company's business, results of operations and financial condition. If new systems sales do not materialize, maintenance service revenues can be expected to decrease over time due to the effect of failure to capture new maintenance revenues therefrom in combination with attrition of existing maintenance revenues associated with the Company's current clients whose systems become obsolete or are replaced by competitors' products. FLUCTUATION IN QUARTERLY OPERATING RESULTS. The Company's revenues and operating results have in the past fluctuated, and may in the future fluctuate, from quarter to quarter and period to period, as a result of a number of factors including, without limitation: the size and timing of orders from clients; the length of sales cycles and installation processes; the ability of the Company's clients to obtain financing for the purchase of the Company's products; changes in pricing policies or price reductions by the Company or its competitors; the timing of new product announcements and product introductions by the Company or its competitors; the availability and cost of system components; the financial stability of major clients; market acceptance of new products, applications and product enhancements; the Company's ability to develop, introduce and market new products, applications and product enhancements and to control costs; the Company's success in expanding its sales and marketing programs; deferrals of client orders in anticipation of new products, applications or product enhancements; changes in Company strategy; personnel changes; and general economic factors. The Company's products are generally shipped as orders are received and accordingly, the Company has historically operated with minimal backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. Furthermore, the Company's systems can be relatively large and expensive and individual systems sales can represent a significant portion of the Company's revenues for a quarter such that the loss of even one such sale can have a significant adverse impact on the Company's quarterly profitability. Clients often defer systems purchases until the Company's quarter end, so quarterly results generally cannot be predicted and frequently are not known until the quarter has concluded. The Company's initial contact with a potential customer depends in significant part on the customer's decision to replace, or substantially modify, its existing information system. How and when to implement, replace or substantially modify an information system are major decisions for healthcare providers. Accordingly, the sales cycle for the Company's systems can vary significantly and typically ranges from three to 12 months from initial contact to contract execution/shipment. 12 Because a significant percentage of the Company's expenses are relatively fixed, a variation in the timing of systems sales and installations can cause significant variations in operating results from quarter to quarter. As a result, the Company believes that interim period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Further, the Company's historical operating results are not necessarily indicative of future performance for any particular period. Through March 31, 1998, the Company recognized revenue in accordance with the provisions of the American Institute of Certified Public Accountants ("AICPA") Statement of Position No. 91-1, "Software Revenue Recognition" ("SOP 91-1"). The AICPA has adopted Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), that supersedes SOP 91-1 and became effective for the Company on April 1, 1998. There can be no assurance that application and subsequent interpretations of this pronouncement by the Company, its independent auditors or the Securities and Exchange Commission will not further modify the Company's revenue recognition policies, or that such modifications would not have a material adverse effect on the operating results reported in any particular quarter. There can be no assurance that the Company will not be required to adopt changes in its licensing or services practices to conform to SOP 97-2, or that such changes, if adopted, would not result in delays or cancellations of potential sales of the Company's products. Due to all of the foregoing factors, it is possible that in some future quarter the Company's operating results may be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. DEPENDENCE ON PRINCIPAL PRODUCT AND NEW PRODUCT DEVELOPMENT. The Company currently derives substantially all of its net revenues from sales of its healthcare information systems and related services. The Company believes that a primary factor in the market acceptance of its systems has been its ability to meet the needs of users of healthcare information systems. The Company's future financial performance will depend in large part on the Company's ability to continue to meet the increasingly sophisticated needs of its clients through the timely development, successful introduction and implementation of new and enhanced versions of its systems and other complementary products. The Company has historically expended a significant amount of its net revenues on product development and believes that significant continuing product development efforts will be required to sustain the Company's growth. There can be no assurance that the Company will be successful in its product development efforts, that the market will continue to accept the Company's existing or new products, or that products or product enhancements will be developed and implemented in a timely manner, meet the requirements of healthcare providers, or achieve market acceptance. If new products or product enhancements do not achieve market acceptance, the Company's business, results of operations and financial condition could be materially adversely affected. At certain times in the past, the Company has also experienced delays in purchases of its products by clients anticipating the launch of new products by the Company. There can be no assurance that material order deferrals in anticipation of new product introductions will not occur. 13 TECHNOLOGICAL CHANGE. The software market generally is characterized by rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards. The introduction of products incorporating new technologies and the emergence of new industry standards could render the Company's existing products obsolete and unmarketable. There can be no assurance that the Company will be successful in developing and marketing new products that respond to technological changes or evolving industry standards. New product development depends upon significant research and development expenditures which depend ultimately upon sales growth. Any material weakness in revenues or research funding could impair the Company's ability to respond to technological advances in the marketplace and to remain competitive. If the Company is unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, the Company's business, results of operations and financial condition will be materially adversely affected. In response to increasing market demand, the Company is currently developing new generations of certain of its software products designed for the client-server and Internet/intranet environments. There can be no assurance that the Company will successfully develop these new software products or that these products will operate successfully on the principal client-server operating systems, which include UNIX, Microsoft Windows, Windows NT, Windows 95, Windows 98 and Windows 2000, or that any such development, even if successful, will be completed concurrently with or prior to introduction by competitors of products designed for the client- server and Internet/intranet environments. Any such failure or delay could adversely affect the Company's competitive position or could make the Company's current products obsolete. LITIGATION. On April 22, 1997, a purported class action entitled JOHN P. CAVENY v. QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of California for the County of Orange, in which Mr. Caveny, on behalf of himself and all others who purchased the Company's Common Stock between June 26, 1995 and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck, Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers, Graeme H. Frehner, and Gordon L. Setran (all of the foregoing individuals were either officers, directors or both during the period from June 26, 1995 through July 3, 1996), as well as other defendants not affiliated with the Company, violated California Corporations Code Sections 25400 and 25500, California Civil Code Sections 1709 and 1710, and California Business and Professions Code Sections 17200 et. seq., by issuing positive statements about the Company that allegedly were knowingly false, in part, in order to assist the Company and the individual defendants in selling Common Stock at an inflated price in the Company's March 5, 1996 public offering and at other points during the class period. The complaint seeks compensatory and punitive damages in unspecified amounts, disgorgement, declaratory and injunctive relief, and attorneys' fees. The Company and the other named defendants successfully demurred to the plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that claim, which served as the only basis for plaintiffs' request for punitive damages, has been dismissed from both actions. 14 On January 25, 1999, the court denied plaintiffs' motion to certify the class representative and class legal counsel. Plaintiffs have appealed that decision. On February 25, 2000, the Fourth District Court of Appeals affirmed the order disqualifying the class legal counsel. On May 9, 2000, the Court of Appeals issued its Remittur certifying its decision as final. In June 2000, plaintiffs moved for approval of a second firm as class legal counsel. Defendants opposed the motion. On August 17, 2000, the court denied the motion for approval of plaintiffs' second proposed class legal counsel. The court has ordered plaintiffs to retain new proposed class counsel by December 1, 2000. However, the named defendants will again have the opportunity to oppose class certification. The Company and its named officers and directors deny all remaining allegations of wrongdoing made against them in these suits, consider the allegations groundless and without merit, and intend to vigorously defend against these actions. On May 14, 1997, a second purported class action entitled WENDY WOO v. QUALITY SYSTEMS, INC., ET AL. was filed in the same court. This complaint, which has been consolidated with the Caveny lawsuit, essentially repeats the allegations in the Caveny lawsuit and seeks identical relief. The Company and the other named defendants successfully demurred to the plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that claim, which served as the only basis for plaintiffs' request for punitive damages, has been dismissed from both actions. On July 1, 1997, a third purported class action entitled WADE CHENEY v. QUALITY SYSTEMS, INC., ET AL. was filed in the United States District Court of the Central District of California, Southern Division. The complaint makes essentially the same factual allegations as in the Caveny and Woo complaints, and purports to state claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and under Section 20(a) of said Act. By Court order dated August 13, 1997, this action was stayed temporarily and the Court reserved jurisdiction to lift the stay after all matters are final in the Caveny and Woo actions or if otherwise appropriate, and on August 15, 1997 the case was removed from the Court's active caseload. The Company denies all allegations of wrongdoing made in this suit, considers the allegations groundless and without merit, and if the stay is ever lifted, the Company intends to vigorously defend against this action. On March 23, 1999, a purported class action and derivative complaint entitled IRVING ROSENZWEIG v. SHELDON RAZIN, ET AL. was filed in the Superior Court of the State of California for the County of Orange, in which Mr. Rosenzweig, on behalf of himself and all non-director shareholders, and derivatively on behalf of the Company, alleges that Sheldon Razin, John Bowers, William Bowers, Patrick Cline, Janet Razin and Gordon Setran (all of the foregoing individuals are directors of the Company) breached their fiduciary duties by allegedly entrenching themselves in their positions of control, failing to ensure that third- party offers involving the Company were fully and fairly considered, and/or failing to conduct a reasonable inquiry to assure the maximization of shareholder value. The complaint seeks declaratory and injunctive relief, an accounting of monetary damages allegedly suffered by plaintiff and the purported class, and attorneys' fees. Defendants demurred to each of the causes of action alleged in the complaint and the court sustained those demurrers with leave to amend in December 1999. Rather than file an amended complaint, plaintiff filed a motion for attorney's fees. Defendants, in turn, filed a motion to dismiss the action for failure to 15 file an amended pleading within the time limit specified by the court. The parties agreed to a settlement of action and stipulated to a final judgement and order which was entered by the court on May 15, 2000 at which time the action was dismissed. The final judgement and order provided for a dismissal of the action with prejudice, releases given to each of the defendants, and payment of the nominal sum of $100,000 (paid by the Company's Directors and Officers Liability Insurance Company) in full settlement of plaintiff's motion for attorney's fees. The settlement further expressly provided that it did not constitute an admission of any liability of defendants, which defendants continue to vigorously deny. The Company is a party to various other legal proceedings incidental to its business, none of which are considered by the Company to be material. PROPRIETARY TECHNOLOGY. The Company is heavily dependent on the maintenance and protection of its intellectual property and relies largely on license agreements, confidentiality procedures, and employee nondisclosure agreements to protect its intellectual property. The Company's software is not patented and existing copyright laws offer only limited practical protection. There can be no assurance that the legal protections and precautions taken by the Company will be adequate to prevent misappropriation of the Company's technology or that competitors will not independently develop technologies equivalent or superior to the Company's. Further, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as do the laws of the United States and are often not enforced as vigorously as those in the United States. The Company does not believe that its operations or products infringe on the intellectual property rights of others. However, there can be no assurance that others will not assert infringement or trade secret claims against the Company with respect to its current or future products or that any such assertion will not require the Company to enter into a license agreement or royalty arrangement with the party asserting the claim. As competing healthcare information systems increase in complexity and overall capabilities and the functionality of these systems further overlaps, providers of such systems may become increasingly subject to infringement claims. Responding to and defending any such claims may distract the attention of Company management and have a material adverse effect on the Company's business, results of operations and financial condition. In addition, claims may be brought against third parties from which the Company purchases software, and such claims could adversely affect the Company's ability to access third party software for its systems. ABILITY TO MANAGE GROWTH. The Company has experienced periods of growth which has placed, and may continue to place, a significant strain on the Company's resources. The Company also anticipates expanding its overall software development, marketing, sales, client management and training capacity. In the event the Company is unable to identify, hire, train and retain qualified individuals in such capacities within a reasonable timeframe, such failure could have a material adverse effect on the Company. In addition, the Company's ability to manage future increases, if any, in the scope of its operations or personnel will depend on significant expansion of its research and 16 development, marketing and sales, management, and administrative and financial capabilities. The failure of the Company's management to effectively manage expansion in its business could have a material adverse effect on the Company's business, results of operations and financial condition. DEPENDENCE UPON KEY PERSONNEL. The Company's future performance also depends in significant part upon the continued service of its key technical and senior management personnel, many of whom have been with the Company for a significant period of time. The Company does not maintain key man life insurance on any of its employees. Because the Company has a relatively small number of employees when compared to other leading companies in the same industry, its dependence on maintaining its employees is particularly significant. The Company is also dependent on its ability to attract and retain high quality personnel, particularly highly skilled software engineers for applications development. The industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that the Company's current employees will continue to work for the Company. Loss of services of key employees could have a material adverse effect on the Company's business, results of operations and financial condition. Furthermore, the Company may need to grant additional stock options to key employees and provide other forms of incentive compensation to attract and retain such key personnel. PRODUCT LIABILITY. Certain of the Company's products provide applications that relate to patient clinical information. Any failure by the Company's products to provide accurate and timely information could result in claims against the Company. In addition, a court or government agency may take the position that our delivery of health information directly, including through licensed physicians, or delivery of information by a third party-site that a consumer accesses through the Company's web sites, exposes the Company to malpractice or other personal injury liability for wrongful delivery of healthcare services or erroneous health information. The Company maintains insurance to protect against claims associated with the use of its products, but there can be no assurance that its insurance coverage would adequately cover any claim asserted against the Company. A successful claim brought against the Company in excess of its insurance coverage could have a material adverse effect on the Company's business, results of operations and financial condition. Even unsuccessful claims could result in the Company's expenditure of funds in litigation and management time and resources. Certain physicians or other healthcare professionals who use the Company's Internet based products will directly enter health information about their patients including information that constitutes a record under applicable law, that the Company will store on the Company's computer systems. Numerous federal and state laws and regulations, the common law, and contractual obligations govern collection, dissemination, use and confidentiality of patient-identifiable health information, including: - State privacy and confidentiality laws; 17 - The Company's contracts with customers and partners; - State laws regulating healthcare professionals, such as physicians, pharmacists and nurse practitioners; - Medicaid laws; - The Heath Insurance Portability and Accountability Act of 1996 and related rules proposed by the Heath Care Financing Administration; and Health Care Financing Administration standards for Internet transmission of health data. The U.S. Congress has been considering proposed legislation that would establish a new federal standard for protection and use of health information. Any failure by us or by our personnel or partners to comply with any of these legal and other requirements would result in material liability. Although the company has systems in place for safeguarding patient health information from unauthorized disclosure, these systems may not preclude successful claims against the Company for violation of applicable law or other requirements. Other third-party sites or links that consumers access through the Company's web sites also may not maintain systems to safeguard this health information, or may circumvent systems the Company put in place to protect the information from disclosure. In addition, future laws or changes in current laws may necessitate costly adaptations to the Company's systems. There can be no assurance that the Company will not be subject to product liability claims, that such claims will not result in liability in excess of its insurance coverage, that the Company's insurance will cover such claims or that appropriate insurance will continue to be available to the Company in the future at commercially reasonable rates. Such claims could have a material adverse affect on the Company's business, results of operations and financial condition. UNCERTAINTY IN HEALTHCARE INDUSTRY; GOVERNMENT REGULATION. The healthcare industry is subject to changing political, economic and regulatory influences that may affect the procurement processes and operation of healthcare facilities. During the past several years, the healthcare industry has been subject to an increase in governmental regulation of, among other things, reimbursement rates and certain capital expenditures. In the past, various legislators have announced that they intend to examine proposals to reform certain aspects of the U.S. healthcare system including proposals which may increase governmental involvement in healthcare, lower reimbursement rates and otherwise change the operating environment for the Company's clients. Healthcare providers may react to these proposals and the uncertainty surrounding such proposals by curtailing or deferring investments, including those for the Company's systems and related services. Cost-containment measures instituted by healthcare providers as a result of regulatory reform or otherwise could result in greater selectivity in the allocation of capital funds. Such selectivity could have an adverse effect on the Company's ability to sell its systems and related services. The Company cannot predict what impact, if any, such proposals or healthcare reforms might have on its business, results of operations and financial condition. 18 In the year 2001, the Department of Health and Human Services expects to finalize proposed regulations at the federal level authorized under the Health Insurance Portability and Accountability Act of 1996. These proposed regulations will establish new federal standards for privacy of health information. The Company anticipates that these regulations will directly affect the Company's products and services, but the Company cannot accurately predict the impact at this time. Achieving compliance with these regulations could be costly and distract management's attention and other resources from the Company's historical business, and any noncompliance by the Company could result in civil and criminal penalties. In addition, development of related federal and state regulations and policies on confidentiality of health information could negatively affect the Company's business. The Company's software may be subject to regulation by the FDA as a medical device. Such regulation could require the registration of the applicable manufacturing facility and software/hardware products, application of detailed record-keeping and manufacturing standards, and FDA approval or clearance prior to marketing. An approval or clearance could create delays in marketing, and the FDA could require supplemental filings or object to certain of these applications, the result of which could have a material adverse effect on the Company's business, results of operations and financial condition. YEAR 2000 The Company is aware of issues associated with the programming code in existing computer systems related to the millennium. In particular, software applications that use only two digits to identify a year in the date field may fail or create errors in the year 2000 ("Year 2000 Issues"). Year 2000 Issues create risk for the Company from unforeseen problems in computer systems that the Company sells to customers on a nationwide basis which are used, among other things, to process their financial transactions and schedule patients ("Company Products"), as well as systems that the Company uses internally to provide certain services to its customers and to process its own financial transactions ("Internal Use Systems"). The potential costs and uncertainties associated with Year 2000 Issues will depend upon a number of factors, including the Company's proprietary and third party developed software, hardware (hardware and third party developed software will hereinafter be referred to collectively as "Third Party Products") and the nature of the industry in which the Company operates. The nature of the Company's business and its relationships with its customers make it difficult to assess the magnitude of the Company's potential exposure as a result of Year 2000 issues. Company Products and Third Party Products sold by the Company may fail to operate properly or as expected due to Year 2000 Issues. Such failures could result in system failures or miscalculations causing disruptions of customers' operations, including among other things, an inability to process transactions, send invoices, conduct communications, treat patients or engage in similar normal business activities. As a result of one or more of the above potential system failures, certain of the Company's customers may assert breach of warranty or other claims against the Company relating to Year 2000 functionality. 19 The assertion of such claims may have a material adverse impact upon the Company's business, results of operations and financial condition. Furthermore, the efforts and resources devoted to Year 2000 Issues of current and potential customers of the Company could result in the deferral, delay or cancellation by customers of current installations of and plans to purchase systems from the Company. Internal Use Systems, including both information systems and non- information systems, may not operate properly or as expected due to Year 2000 Issues. Year 2000 issues could result in system failures or miscalculations causing disruption of the Company's operations, including among other things, an inability to process its own and certain of its customers' financial transactions, send invoices, conduct communications, or engage in similar normal business activities. The failure of one or more Internal Use Systems as a result of Year 2000 Issues may have a material adverse impact upon the Company's business, results of operations and financial condition. The Company cannot be sure that Year 2000 Issues will not affect its business. Thus far, the Company has incurred no materially adverse problems related to Year 2000 Issues associated with the computer systems, software, other property and equipment it uses. However, the Company cannot guarantee that Year 2000 Issues will not adversely affect its business, operating results or financial condition at some point in the future. RESULTS OF OPERATIONS. The following table sets forth for the periods indicated, the percentage of net revenues represented by each item in the Company's consolidated statements of operations.
Three Months Six Months Ended Ended September 30, September 30, ---------------- ---------------- 2000 1999 2000 1999 ------ ------ ------ ------ Net Revenues: Sales of computer systems, upgrades and supplies 49.6% 58.0% 48.6% 57.1% Maintenance and other services 50.4 42.0 51.4 42.9 ------ ------ ------ ------ 100.0 100.0 100.0 100.0 Cost of Products and Services 45.2 46.0 44.4 45.3 ------ ------ ------ ------ Gross Profit 54.8 54.0 55.6 54.7 Selling, General and Administrative Expenses 33.6 32.3 34.9 32.8 Research and Development Costs 10.1 9.9 10.5 9.9 ------ ------ ------ ------ Income from Operations 11.1 11.8 10.2 12.0 Investment Income 2.6 1.8 2.6 1.8 ------ ------ ------ ------ Income before Provision for Income Taxes 13.7 13.6 12.8 13.8 Provision for Income Taxes 6.1 6.0 5.7 5.9 ------ ------ ------ ------ Net Income 7.6% 7.6% 7.1% 7.9% ====== ====== ====== ======
20 FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2000 AND 1999. The Company's net income for the three months ended September 30, 2000 was $744,000, or $0.12 per share on a basic and diluted basis, as compared to a net income of $738,000, or $0.12 per share on a basic and diluted basis, for the three months ended September 30, 1999. Net Revenues. Net revenues for the three months ended September 30, 2000 at $9.7 million were unchanged compared to the three months ended September 30, 1999. Sales of computer systems, upgrades and supplies declined 14.9% to $4.8 million from $5.6 million while net revenues from maintenance and other services grew 19.5% to $4.9 million from $4.1 million during the comparable periods. The decline in net revenues from sales of computer systems, upgrades and supplies was principally the result of a decrease in sales of the Legacy product and a modest decline in Nextgen systems sales. The increase in maintenance and other services net revenue resulted principally from an increase in revenues from the Company's increased client base from which to generate maintenance and other service revenue together with an increase in revenues generated from the Company's electronic data interchange services. Cost of Products and Services. Cost of products and services for the three months ended September 30, 2000 and 1999 declined 2.3% at $4.4 million and $4.5 million, respectively, while cost of products and services as a percentage of net revenues decreased to 45% from 46% during the comparable periods. The cost of products and services as a percentage of net revenues decreased while the dollar amount declined primarily as a result of a change in the relative mix of hardware content included in system sales in the respective periods. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended September 30, 2000 increased 4.0% to $3.3 million as compared to $3.1 million for the three months ended September 30, 1999. Selling, general and administrative expenses as a percentage of net revenues increased to 33.6% from 32.3%. The increase in the amount of such expenses resulted primarily from increased expenses related to marketing the Nextgen product line, sales personnel and administrative infrastructure, and costs associated with the Company's internet portal Nextmd.com. The increase of such expenses as a percentage of net revenues resulted from the increase in the aforementioned expenses combined with relatively unchanged revenue. Research and Development Costs. Research and development costs for the three months September 30, 2000 were relatively unchanged at $1.0 million compared to approximately $1.0 million in the three months ended September 30, 1999. Research and development costs as a percentage of net revenues were relatively unchanged at 10.1% as compared to 9.9% for the respective periods. Investment Income. Investment income for the three months ended September 30, 2000 was up 38% at approximately $251,000 compared to $182,000 in the three months ended September 30, 1999. The increase in investment income is largely due to a rise in interest income from the Company's money market accounts resulting from an increase in interest rates, and higher cash balances. Provision for Income Taxes. The provision for income taxes for the three months ended September 30, 2000 was approximately $589,000 as compared to approximately $584,000 for the three months ended September 30, 1999. 21 The provision for income taxes for the three months ended September 30, 2000 and 1999 differ from the combined statutory rates primarily due to the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 Clinitec acquisition and the effect of varying state income tax rates. FOR THE SIX-MONTH PERIODS ENDED SEPTEMBER 30, 2000 AND 1999. The Company's net income for the six months ended September 30, 2000 was $1.4 million, or $0.22 per share on a basic and diluted basis, as compared to $1.5 million, or $0.24 per share for the six months ended September 30, 1999. Net Revenues. Net revenues for the six months ended September 30, 2000 increased 0.6% to $18.9 million from $18.8 million for the six months ended September 30, 1999. Sales of computer systems, upgrades and supplies decreased 14.5% to $9.2 million from $10.7 million while net revenues from maintenance and other services grew 20.8% to $9.7 million from $8.1 million during the comparable periods. The decrease in net revenues from sales of computer systems, upgrades and supplies was principally the result of decreases in the sales of the Legacy, NextGen EPM and NextGen EMR systems. The increase in maintenance and other services net revenue resulted principally from an increase in revenues from the Company's increased client base from which to generate maintenance and other services revenue together with an increase in revenues generated from the Company's electronic data interchange services. Cost of Products and Services. Cost of products and services for the six months ended September 30, 2000 decreased 1.5% to $8.4 million from $8.5 million for the six months ended September 30, 1999 while cost of products and services as a percentage of net revenues decreased to 44.4% from 45.3% during the comparable periods. The decrease in the cost of products and services resulted from the impact of a change in the relative mix of hardware content systems sales revenue. The cost of products and services as a percentage of net revenues decreased as a result of the impact of a change in the relative mix of hardware content of systems sales also. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the six months ended September 30, 2000 increased 7.0% to $6.6 million as compared to $6.2 million for the six months ended September 30, 1999. Selling, general and administrative expenses as a percentage of net revenues increased to 34.9% from 32.8%. The increase in the amount of such expenses resulted primarily from increased marketing expenses of the NextGen EPM and EMR along with additions to sales personnel and administrative infrastructure, and added costs associated with maintenance of the Company's internet portal Nextmd.com. The increase of such expenses as a percentage of net revenues resulted from the increase in expenses combined with the relatively unchanged revenue. Research and Development Costs. Research and development costs for the six months ended September 30, 2000 and 1999 increased 6.6% at approximately $2.0 million and 1.9 million respectively. Research and development costs as a percentage of net revenues increased to 10.5% as compared to 9.9% for the respective periods primarily as a result of the effect of the increase in research and development costs for the September 2000 period. 22 Investment Income. Investment income for the six months ended September 30, 2000 and 1999 was up 43% at $497,000 and $348,000, respectively. The increase in investment income is largely due to a rise in interest income from the Company's money market accounts resulting from an increase in interest rates, and higher cash balances. Provision for Income Taxes. The provision for income taxes for the six months ended September 30, 2000 was $1.1 million as compared to $1.1 million for the six months ended September 30, 1999. The provision for and benefit from income taxes for the six months ended September 30, 1999 and 1998 differ from the combined statutory rates primarily due to the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 Clinitec acquisition and the effect of varying state income tax rates. LIQUIDITY AND CAPITAL RESOURCES. Cash and cash equivalents increased approximately $679,000 for the six months ended September 30, 2000 primarily as a result of income from operations, offset by increases in accounts receivable. Cash and cash equivalents increased $2.0 million for the six months ended September 30, 1999 principally as a result of cash provided by operating activities also. Net cash generated by operating activities for the six months ended September 30, 2000 was approximately $1,773,000 consisting primarily of the Company's $1,369,000 in net income adjusted for the principal non-cash operating expenses of depreciation and amortization, an increase in accounts payable less an increase in accounts receivable. Net cash provided by operating activities for the six months ended September 30, 1999 was $2.9 million consisting primarily of the Company's $1.5 million in net income adjusted for the principal non-cash operating expenses of depreciation and amortization. Net cash used in investing activities for the six months ended September 30, 2000 was $1.1 million consisting principally of additions to equipment and improvements and capitalized software. Net cash used in investing activities for the six months ended September 30, 1999 was $0.9 million consisting of additions to equipment and improvements and capitalized software. Net cash provided by financing activities for the six months ended September 30, 2000 and 1999 was $50,000 and $6,000, respectively, generated by the exercise of stock options. Cash provided by financing activities in the six months ended September 30, 2000 was offset by the repurchase of 5,000 shares of stock at a cost of approximately $35,000. In February 1997, the Company's Board of Directors authorized the repurchase on the open market of up to 10% of the shares of the Company's outstanding Common, subject to compliance with applicable laws and regulations. This stock authorization has been renewed annually and currently expires on June 7, 2001. The timing and amount of any repurchase is at the discretion of the Company's management. The Company's management could, in the exercise of its judgment, repurchase fewer shares than authorized. During the six months ended September 30, 2000, the Company purchased 5,000 shares at a cost of approximately $35,000. 23 At September 30, 2000, the Company had cash and cash equivalents of $16.6 million and short-term investments of $248,000. Except for the Company's intention to expend funds for the development of complementary products to its existing product line and alternative versions of certain of its products for the client-server environment to take advantage of more powerful technologies and to enable a more seamless integration of the Company's products, the Company has no other significant capital Commitments. The Company believes that its cash and cash equivalents and short-term investments on hand at September 30, 2000, together with cash flows from operations, if any, will be sufficient to meet its working capital and capital expenditure requirements for the next year. PART II. OTHER INFORMATION. Item 1. Litigation -------- ---------- On April 22, 1997, a purported class action entitled JOHN P. CAVENY v. QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of California for the County of Orange, in which Mr. Caveny, on behalf of himself and all others who purchased the Company's Common Stock between June 26, 1995 and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck, Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers, Graeme H. Frehner, and Gordon L. Setran (all of the foregoing individuals were either officers, directors or both during the period from June 26, 1995 through July 3, 1996), as well as other defendants not affiliated with the Company, violated California Corporations Code Sections 25400 and 25500, California Civil Code Sections 1709 and 1710, and California Business and Professions Code Sections 17200 et. seq., by issuing positive statements about the Company that allegedly were knowingly false, in part, in order to assist the Company and the individual defendants in selling Common Stock at an inflated price in the Company's March 5, 1996 public offering and at other points during the class period. The complaint seeks compensatory and punitive damages in unspecified amounts, disgorgement, declaratory and injunctive relief, and attorneys' fees. The Company and the other named defendants successfully demurred to the plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that claim, which served as the only basis for plaintiffs' request for punitive damages, has been dismissed from both actions. On January 25, 1999, the court denied plaintiffs' motion to certify the class representative and class legal counsel. Plaintiffs have appealed that decision. On February 25, 2000, the Fourth District Court of Appeals affirmed the order disqualifying the class legal counsel. On May 9, 2000, the Court of Appeals issued its Remittur certifying its decision as final. In June 2000, plaintiffs moved for approval of a second firm as class legal counsel. Defendants opposed the motion. On August 17, 2000, the court denied the motion for approval of plaintiffs' second proposed class legal counsel. The court has ordered plaintiffs to retain new proposed class counsel by December 1, 2000. However, the named defendants will again have the opportunity to oppose class certification. The Company and its named officers and directors deny all remaining allegations of wrongdoing made against them in these suits, consider the allegations groundless and without merit, and intend to vigorously defend against these actions. 24 On May 14, 1997, a second purported class action entitled WENDY WOO v. QUALITY SYSTEMS, INC., ET AL. was filed in the same court. This complaint, which has been consolidated with the Caveny lawsuit, essentially repeats the allegations in the Caveny lawsuit and seeks identical relief. On July 1, 1997, a third purported class action entitled WADE CHENEY v. QUALITY SYSTEMS, INC., ET AL. was filed in the United States District Court of the Central District of California, Southern Division. The complaint makes essentially the same factual allegations as in the Caveny and Woo complaints, and purports to state claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and under Section 20(a) of said Act. By Court order dated August 13, 1997, this action was stayed temporarily and the Court reserved jurisdiction to lift the stay after all matters are final in the Caveny and Woo actions or if otherwise appropriate, and on August 15, 1997 the case was removed from the Court's active caseload. The Company denies all allegations of wrongdoing made in this suit, considers the allegations groundless and without merit, and if the stay is ever lifted, the Company intends to vigorously defend against this action. On March 23, 1999, a purported class action and derivative complaint entitled IRVING ROSENZWEIG v. SHELDON RAZIN, ET AL. was filed in the Superior Court of the State of California for the County of Orange, in which Mr. Rosenzweig, on behalf of himself and all non-director shareholders, and derivatively on behalf of the Company, alleges that Sheldon Razin, John Bowers, William Bowers, Patrick Cline, Janet Razin and Gordon Setran (all of the foregoing individuals are directors of the Company) breached their fiduciary duties by allegedly entrenching themselves in their positions of control, failing to ensure that third- party offers involving the Company were fully and fairly considered, and/or failing to conduct a reasonable inquiry to assure the maximization of shareholder value. The complaint seeks declaratory and injunctive relief, an accounting of monetary damages allegedly suffered by plaintiff and the purported class, and attorneys' fees. Defendants demurred to each of the causes of action alleged in the complaint and the court sustained those demurrers with leave to amend in December 1999. Rather than file an amended complaint, plaintiff filed a motion for attorney's fees. Defendants, in turn, filed a motion to dismiss the action for failure to file an amended pleading within the time limit specified by the court. The parties agreed to a settlement of action and stipulated to a final judgement and order which was entered by the court on May 15, 2000 at which time the action was dismissed. The final judgement and order provided for a dismissal of the action with prejudice, releases given to each of the defendants, and payment of the nominal sum of $100,000 (paid by the Company's Directors and Officers Liability Insurance Company) in full settlement of plaintiff's motion for attorney's fees. The settlement further expressly provided that it did not constitute an admission of any liability of defendants, which defendants continue to vigorously deny. The Company is a party to various other legal proceedings incidental to its business, none of which are considered by the Company to be material. 25 Item 2. Changes in Securities and Use of Proceeds. ------- ------------------------------------------ None Item 3. Defaults Upon Senior Securities ------- ------------------------------- None Item 4. Submissions of Matters to a Vote of Securities Holders ------- ------------------------------------------------------- On September 14, 2000, the Company held its Annual Meeting of Shareholders. At the meeting, the shareholders elected as directors Sheldon Razin (with 4,482,670 affirmative votes and 6,150 votes withheld), Ahmed Hussein (with 4,410,431 affirmative votes and 78,389 votes withheld), Mohammed-Tawfick El-Bardai (with 4,411,431 affirmative votes and 77,389 votes withheld), Dale Hanson (with 4,484,570 affirmative votes and 4,250 votes withheld), Frank Meyer (with 4,484,670 affirmative votes and 4,150 votes withheld), William Small (with 4,484,670 affirmative votes and 4,150 votes withheld), and Emad Zikry (with 4,411,431 affirmative votes and 77,389 votes withheld) The shareholders also ratified the appointment of Deloitee & Touche LLP as the independent public accountants for the Company for the fiscal year ending March 31, 2001 (with 4,488,080 affirmative votes, 40 against, and 700 abstaining.) Item 5. Other Information ------- ----------------- None Item 6. Exhibits and Reports on Form 8-K. ------- --------------------------------- Exhibits: --------- None Reports on Form 8-K: -------------------- None. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. QUALITY SYSTEMS, INC. Date: November 02, 2000 By /s/ Lou Silverman ---------------------------------- Lou Silverman Chief Executive Officer Principal Executive Officer Date: November 02, 2000 By /s/ Paul Holt ---------------------------------- Paul Holt Chief Financial Officer; Principal Accounting Officer
27 INDEX TO EXHIBITS Sequential Page Exhibit No. ------- ---------- 10.18* Employment Agreement dated July 20, 2000 between 28 Quality Systems, Inc. and Lou Silverman 27.0 Financial Data Schedule, is filed herewith. 40 *This exhibit is a management contract or a compensatory plan or arrangement. 28 EXHIBIT 10.18 29 EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of July 20, 2000, ("Effective Date") is between Quality Systems Inc. ("Company"), and Lou Silverman ("Executive") (collectively, the "Parties"). RECITALS Company desires to obtain the services of Executive, and Executive desires to secure employment from Company upon the following terms and conditions. ACCORDINGLY, THE PARTIES AGREE AS FOLLOWS: 1. Period of Employment. The Company hereby employs Executive to render services to Company in the position and with the duties and responsibilities described in Section 2 for the period commencing on a date no later than August 24, 2000 and ending as hereinafter provided in Section 5, below (the "Period of Employment"). 2. Position, Duties, Place of Employment, Other Activities. (a) Position. Executive hereby accepts employment with Company as President and Chief Executive Officer. (b) Duties. Executive shall always, during the Period of Employment, be the Company's Chief Executive Officer. Executive's responsibilities and authority shall include those activities that are customarily associated with such position, but shall exclude those duties and decisions which are reserved to the Board. (c) Other Activities. Executive agrees to devote his full business time during regular business hours to working for the Company and performing the aforesaid duties and such other duties as shall from time to time be assigned to him by the Board of Directors of the Company consistent with his position as the Chief Executive Officer of the Company. During the Term of his employment hereunder, Executive shall have no interest in, or perform any services during regular business hours for any other company, whether or not such company is competitive with the Company, except that this prohibition shall not be deemed to apply to passive investments in businesses not competitive with the business of the Company or to investments of 5% or less of the outstanding stock of public companies whose stock is traded on a national securities exchange or in the over-the-counter market. For purposes of this paragraph, a "passive investment" shall be deemed to mean investment in a business that does not require or result in the participation of Executive in the management or operations of such business except during times other than regular business hours and 30 which does not interfere with his duties and responsibilities to the Company. Nothing contained herein shall limit the right of Executive to make speeches, write articles or participate in public debate and discussions in and by means of any medium of communication or serve as a director or trustee of any non-competing Company or organization, provided that such activities are not inconsistent with Executive's obligations hereunder. 3. Compensation, Benefits, Expenses. (a) Base Compensation. In consideration of the services to be rendered hereunder, Executive shall be paid the annual salary described in Schedule A to this Agreement in equal regular installments and pursuant to the procedures regularly established, and as they may be amended, by Company during the course of this Agreement. This rate shall be reviewed by the Board at the end of each calendar year, and may be increased by the Board in its sole discretion to reflect executive performance, company performance, increases in the cost of living and such other increases as may be awarded in accordance with Company's regular practice for giving salary increases to similarly situated executives. (b) Benefits. Executive shall be entitled to the benefits described in Schedule A to this Agreement. In addition, Company shall provide Executive with the right to participate in and to receive benefits from all present and future life, accident, disability, medical, dental, retirement, pension, savings, bonus and incentive plans and all benefits and perquisites made available to any executive of Company. (c) Expenses. The Company shall reimburse Executive for reasonable travel and other business expenses incurred by Executive in the performance of his duties hereunder in accordance with Company's general policies, as they may be amended from time to time during the course of this Agreement. 4. At-Will Employment. Executive's employment shall be "at-will," and may be terminated for any reason by either the Company or Executive upon 60 days' written notice to the other party, subject only to the provisions of Section 6 of this Agreement. 5. Termination of Employment. (a) By Death. The Period of Employment shall terminate automatically upon the death of Executive. (b) By Disability. If, in the sole opinion of the Board, Executive shall be prevented from properly performing his 31 duties hereunder by reason of any physical or mental incapacity for a period of more than twelve (12) consecutive weeks or for a cumulative period of ninety (90) business days in any eighteen -month period, then, to the extent permitted by law, Company shall have the right to terminate this Agreement. (c) By Company For Cause. If Company believes that an event constituting Cause has occurred, Company may give Executive written notice of its intention to terminate this Agreement for Cause (as defined below). The preceding sentence notwithstanding, Executive's employment shall not be deemed to have been terminated for Cause in the case of (b) below unless (i) Company has given or delivered to Executive reasonable notice setting forth the reasons for Company's intention to terminate Executive's employment for Cause and has afforded Executive a reasonable period of time not less than ten (10) business days following actual receipt of such notice in which to cure; (ii) Executive has been provided a reasonable opportunity at any time during the 30-day period after Executive's receipt of such notice, for Executive, together with Executive's counsel, to be heard before the Board; and (iii) if such a Board hearing occurs, Executive receives a second written notice from Company stating that, in the good faith opinion of not less than a majority of the entire membership of the Board, Executive was guilty of the conduct giving rise to termination for Cause and the Cause has not been cured. If this Agreement is terminated for Cause, the termination shall be effective as of the date Company's notice is given pursuant to clause (i) above, or such later date that may be specified in such notice as the termination date. "Cause" shall mean Executive (a) engaged in any criminal conduct constituting a felony (or that involved dishonesty, breach of trust or moral turpitude) and criminal charges are brought against Executive by a governmental authority or Executive enters a plea of nolo contender (or similar plea) to such charge or (b) knowingly and willfully engaged in activities that would constitute a material breach of any term of this Agreement resulting in a material injury to the business condition, financial or otherwise, results of operation or prospects of the Company, as determined in good faith by the Board of Directors of the Company. (d) By Executive For Good Reason. If Executive has not received written notice from Company that it intends to terminate Executive's employment for Cause, Executive may terminate the Period of Employment for Good Reason (as defined below) upon ten (10) days' advance written notice to Company. Any written notice pursuant to this section shall set forth the reasons for the termination. Good Reason shall exist if without Executive's prior written consent and in the absence of written notice of Cause, one or more of the following events occurs: (i) there is an assignment to Executive of any duties materially inconsistent with or which constitute a material change in Executive's position, duties, responsibilities, or status with Company, or a material change in Executive's reporting responsibilities, title, or offices; 32 or removal of Executive from or failure to re-elect Executive to any of such positions, except in connection with the termination of the Period of Employment pursuant to subparagraphs (a) through (c), above; (ii) there is a reduction by Company in Executive's annual salary then in effect or a material diminishment in the position, duties, authority or status of Executive; (iii) Company acts in any way that would adversely affect Executive's participation in or materially reduce Executive's benefit under any benefit plan of Company in which Executive is participating or deprive Executive of any material fringe benefit enjoyed by Executive, except in so far that such action or inaction by the Company (1) is also taken or not taken as the case may be, in respect of all employees generally, (2) is required by the terms of any benefit plan as in effect immediately before such action or inaction, or (3) is necessary to comply with applicable law or to preserve the qualification of any benefit plan under section 401 (a) of the Internal Revenue Code; (iv) Company fails to comply with any provisions of this Agreement, which failure is not remedied by Company promptly, and in no event later than ten (10) business days, after Company's receipt of written notice thereof from Executive; or (v) there is a material change in the nature or direction of the Business or Executive's place of employment. (e) Upon a Change in Control. Termination Upon a Change in Control shall be deemed to occur upon (1) the termination of Executive without Cause within 120 days prior to or 90 days after the event constituting the Change in Control or (2) the election of Executive, within 90 days of the event constituting the Change in Control, not to continue with the successor or surviving Corporation. A "Change in Control" occurs for purposes of this Agreement upon the earliest occurrence of any of the following events: (1) The direct or indirect sale, lease, exchange or other transfer of all, substantially all, or a material percentage (35% or more) of the assets of the Company to any person or entity or group of persons or entities acting in concert as a partnership or other group (a "Group of Persons").The terms "Persons" and "Group of Persons" are as defined in Rule 13d 3 of the Exchange Act; (2) The merger, consolidation or other business combination of the Company with or into another Company with the effect that the shareholders of the Company immediately prior to the merger, consolidation or other business combination, hold less than 51% of the combined voting power of the then outstanding securities of the surviving Company of such merger, consolidation or other business combination ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors; 33 (3) The replacement of a majority of the Company's Board in any given year as compared to the directors who constituted the Company's Board at the beginning of such year, and such replacement shall have not been approved by the Company's Board of Directors as constituted at the beginning of such year; and (4) A person or Group of Persons shall, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise (other than as a result of the purchase by Ahmed Hussein or his affiliates of the Company's securities beneficially owned by Sheldon Razin or his affiliates or vice versa), have become the beneficial owner (within the meaning of Rule 13D-3 under the Securities Exchange Act of 1934, as amended (the Exchange Act) of securities of the Company representing 25% or more of the combined voting power of the then outstanding securities of such Company ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors. 6. Compensation Upon Termination or Change in Control. (a) Upon termination due to death or Disability, Executive or Executive's legal representatives, as the case may be, shall be entitled to: (i) unpaid Base Compensation earned or accrued through Executive's date of termination, accrued and unused vacation pay, unreimbursed expenses and the disability benefit available under and only to the extent of the insurance maintained as provided in Schedule A; (ii) any performance or other bonus earned but not yet paid; (iii) any other compensation and benefits to which Executive or Executive's legal representatives may be entitled under applicable plans, programs and agreements of Company to the extent permitted under the terms thereof, including, without limitation, life insurance as provided in Schedule A to this Agreement; and (iv) any vested stock options in accordance with the terms of the stock option agreement governing such stock option. (b) Upon termination by Company for Cause, Executive shall be entitled to receive his Base Compensation earned to date of termination, any accrued but unused vacation pay, and any unreimbursed expenses, and all other rights shall terminate. (c) Upon Company's breach of the Agreement prior to the Period of Employment, Executive shall be entitled to (i) a lump sum payment equal to six (6) months' of Executive's then current Base Compensation; and (ii) immediate vesting of an additional 25% of all granted, but unvested stock options. 34 (d) Upon a Change in Control, regardless of whether Executive's employment terminates, Executive shall be entitled to immediate vesting of all granted, but unvested stock options. (e) Upon Termination Upon a Change in Control, Executive shall be entitled to (i) unpaid Base Compensation and vacation earned and accrued through Executive's date of termination plus a lump sum payment equal to six (6) months' of Executive's then current Base Compensation; (ii) any other performance bonus earned but not yet paid; (iii) reimbursement of expenses incurred but not yet reimbursed by Company; and (iv) immediate vesting of all granted, but unvested stock options. (f) Upon Termination by Company without Cause or by Executive With Good Reason, Executive shall be entitled to (i) unpaid Base Compensation and vacation earned and accrued through Executive's date of termination plus a lump sum payment equal to six (6) months' of Executive's then current Base Compensation; (ii) any other performance bonus earned but not yet paid; (iii) reimbursement of expenses incurred but not yet reimbursed by Company; and (iv) immediate vesting of an additional 25% of all granted, but unvested stock options. (g) Upon termination of the Period of Employment, Executive shall be deemed to have resigned from all offices and directorships then held with Company. 7. Damages and Set Off. Executive shall not be required to seek other employment or otherwise mitigate damages incurred as a result of termination of Executive's employment by Company. Company shall not be entitled to set off against the amounts payable to Executive any amounts earned by Executive in other employment or any amounts which might have been earned by Executive in other employment had Executive sought such other employment. The amounts payable to Executive in the event of termination shall not be treated as damages but as severance compensation to which Executive is entitled by reason of such termination. 35 8. Confidential Information. Executive acknowledges that, because of his duties and his position of trust under this Agreement, he will become familiar with trade secrets and other confidential information (including but not limited to operating methods and procedures, customers, employees, and plans for future developments) which are valuable assets and property rights of the Company and not publicly known and Executive acknowledges that public disclosure of such trade secrets and other confidential information will have an adverse effect on the Company and its business. Except in connection with the performance of his duties for the Company, Executive agrees that he will not, during or at any time after the Period of Employment, either directly or indirectly, disclose to any person, entity, firm or Company such trade secrets or other confidential information, including, but not limited to, any facts concerning the systems, methods, procedures or plans developed or used by the Company, and not to release, use or disclose the same except with the prior written consent of the Company. Executive agrees to retain all such trade secrets and other confidential information in a fiduciary capacity for the sole benefit of the Company, its successors and assigns. All records, files, memoranda, reports, price lists, customer lists, documents, equipment, systems, methods, procedures and plans, and the like, relating to the business of the Company, which Executive shall use or prepare or come in contact with shall remain the sole property of the Company. Upon termination of his employment by the Company or at any time the Company may so request, Executive will surrender to the Company all non- public papers, notes, reports, plans and other documents (and all copies thereof) relating to the business of the Company which he may then possess or have under his control. 9. Non Solicitation; Non Interference. Executive acknowledges that (i) the services to be performed by him under this Agreement are of a special, unique, extraordinary and intellectual character; (ii) Executive possesses substantial technical and managerial expertise and skill with respect to the Company's business; (iii) the Company's business is national in scope and its products and services are marketed throughout the nation; (iv) the Company competes with other businesses that are or could be located in any part of the nation; (v) the covenants and obligations of Executive under this Paragraph 9 are material inducement and condition to the Company's entering into this Agreement and performing its obligations hereunder, and (vi) the provisions of this Paragraph 9 are reasonable and necessary to protect the Company's business. In consideration of the acknowledgements by Executive, and in consideration of the compensation and benefits to be paid or provided to Executive by the Company, Executive covenants that he will not, for a period of two (2) years following the expiration or earlier termination of this Agreement, without 36 the prior written consent of the Company, directly or indirectly either for himself or any other person, (i) solicit or induce, or attempt to solicit or induce any employee of, or agent or independent contractor providing services to the Company to leave the employ of or to cease to provide services, in whole or in part to, the Company, or to terminate or fail or refuse to renew or renegotiate, any contract for services with the Company, whether such control is written or oral, (ii) in any way interfere with the relationship between the Company and employee of or agent or independent contractor of the Company, (iii) employ or otherwise engage as an employee, sales, or independent contractor, consultant or otherwise, and employee, agent or independent contractor of the Company (this subsection (iii) shall not apply to any person after two (2) years have elapsed subsequent to the date on which such person's employment by or association with the Company has terminated), and for a period of one (1) year following the expiration or earlier termination of this agreement induce or attempt to induce any customer, supplier, licensee, or business relation of the Company to cease doing business with the Company, or in any way interfere with the relationship between any customer, supplier, licensee, or business relation of the Company, 10. Assignment; Successors and Assigns. Executive agrees that he will not assign, sell, transfer, delegate or otherwise dispose of, whether voluntarily or involuntarily, or by operation of law, any rights or obligations under this Agreement, nor shall Executive's rights be subject to encumbrance or the claims of creditors. Any purported assignment, transfer, or delegation shall be null and void. Nothing in this Agreement shall prevent the consolidation of Company with, or its merger into, any other corporation, or the sale by Company of all or substantially all of its properties or assets, or the assignment by Company of this Agreement and the performance of its obligations hereunder to any successor in interest or any Affiliated Company. Subject to the foregoing, this Agreement shall be binding upon and shall inure to the benefit of the Parties and their respective heirs, legal representatives, successors, and permitted assigns, and shall not benefit any person or entity other than those enumerated above. 11. Notices. All notices or other communications required or permitted hereunder shall be made in writing and shall be deemed to have been duly given if delivered by hand or mailed, postage prepaid, by certified or registered mail, return receipt requested, and addressed to Company at: ___________________________ ___________________________ ___________________________ Attn: ______________________ 37 or to Executive at: ___________________________ ___________________________ ___________________________ Notice of change of address shall be effective only when done in accordance with this Section. 12. Entire Agreement. The terms of this Agreement are intended by the Parties to be the final expression of their agreement with respect to the employment of Executive by Company and may not be contradicted by evidence of any prior or contemporaneous agreement. The Parties further intend that this Agreement shall constitute the complete and exclusive statement of its terms and that no extrinsic evidence whatsoever may be introduced in any judicial, administrative, or other legal proceeding involving this Agreement. 13. Amendments; Waivers. This Agreement may not be modified, amended, or terminated except by an instrument in writing, signed by Executive and by a duly authorized representative of Company other than Executive. By an instrument in writing similarly executed, either party may waive compliance by the other party with any provision of this Agreement that such other party was or is obligated to comply with or perform, provided, however, that such waiver shall not operate as a waiver of, or estoppel with respect to, any other or subsequent failure. No failure to exercise and no delay in exercising any right, remedy, or power hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, remedy, or power hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, or power provided herein or by law or in equity. 14. Severability; Enforcement. If any provision of this Agreement, or the application thereof to any person, place, or circumstance, shall be held by a court of competent jurisdiction to be invalid, unenforceable, or void, the remainder of this Agreement and such provisions as applied to other persons, places, and circumstances shall remain in full force and effect. 15. Interpretation; Governing Law. This Agreement shall be deemed to be the result of arms-length negotiation between the Parties and shall not be deemed to have been drafted by either Party. Titles and headings are for convenience of reference only and are not interpretive of text. The validity, interpretation, enforceability, and performance of this Agreement shall be governed by and construed in accordance with the law of the State of California. 16. Executive Acknowledgment. Executive acknowledges (i) that he has consulted with or has had the opportunity to consult with 38 independent counsel of his own choice concerning this Agreement and has been advised to do so by Company, and (ii) that he has read and understands the Agreement, is fully aware of its legal effect, and has entered into it freely based on his own judgment. 17. Execution. This Agreement may be executed in counterparts, and if so executed and delivered, all of the counterparts together shall constitute one and the same Agreement. A facsimile signature may be treated as an original, and each party agrees to deliver to the other party an original executed Agreement within seven days of execution. The Parties have duly executed this Agreement as of the date first written above. Lou Silverman ____/s/ Lou Silverman____________________ Quality Systems Inc. By: _/s Ahmed Hussein_________________ Its: Co-Chairman Board of Directors___ 39 Schedule A Base Salary: Executive will be paid base salary at the annualized rate of $250,000.00 Cash Bonus: Executive will earn a cash bonus of up to 50% of annual Base Compensation, based upon performance on goals established jointly between Executive and the Board, which goals shall be established within a reasonable period of time, but no later than 90 days after the Period of Employment commences, and which shall be reviewed not less than annually. Any Cash Bonus will be paid no later than 90 days after the end of the period in which such bonus was earned. Stock Options: Effective upon execution of this Agreement, Executive shall be granted an option to purchase One Hundred Twenty-Four Thousand Two Hundred Sixty (124,260) shares of QSI common stock. The exercise price of such option shall equal the bid price at the close of trading on the Nasdaq National Market on the Effective Date. Additionally, Executive will be granted stock options in the amount of not less than 1% of the issued and outstanding shares of QSI stock at the one year anniversary of the Effective Date, if the Executive remains an Employee of the Company at that time. The exercise price of such option shall be the closing price of the stock on the Nasdaq National Market on the one year anniversary of the Effective Date, or if the anniversary date falls on a non-business day, the business day immediately following the anniversary date. Benefits: Executive will be eligible to earn and participate in all other benefit programs offered by the company with the same eligibility requirements as would apply to any other executive of the company. However, all waiting periods for health benefits and 401k benefits will be waived for Executive. 40 EXHIBIT 27.0