-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MGJ05XWTjq/h1fgZ1Gluwrh5vGYHter3p/PLrtN/VIDwd4th+X/HIqewmhUsf7GU CKAFpziyEgtAEmBRp7BEXA== 0000708818-98-000008.txt : 19980813 0000708818-98-000008.hdr.sgml : 19980813 ACCESSION NUMBER: 0000708818-98-000008 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980812 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUALITY SYSTEMS INC CENTRAL INDEX KEY: 0000708818 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 952888568 STATE OF INCORPORATION: CA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12537 FILM NUMBER: 98682818 BUSINESS ADDRESS: STREET 1: 17822 E 17TH ST STE 210 CITY: TUSTIN STATE: CA ZIP: 92680 BUSINESS PHONE: 7147317171 MAIL ADDRESS: STREET 1: 178222 E 17TH STREET SUITE 210 CITY: TUSTIN STATE: CA ZIP: 92680 10-Q 1 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 June 30, 1998 ______________________ 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. 6,233,266 shares of Common Stock, $.01 par value, as of August 5, 1998 PART I. CONSOLIDATED FINANCIAL INFORMATION. ------- ----------------------------------- Item 1. Financial Statements. - ------- --------------------- QUALITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
June 30, March 31, ASSETS 1998 1998 ----------- ----------- Current Assets: (unaudited) Cash and cash equivalents $12,032 $16,107 Short-term investments 942 973 Accounts receivable, less allowance for doubtful accounts of $551 and $521, respectively 9,631 9,946 Inventories 907 1,328 Other current assets 691 574 ------- ------- Total current assets 24,203 28,928 Equipment and Improvements, net 1,819 1,790 Capitalized Software Costs, net 2,229 2,183 Deferred Tax Asset 3,413 3,105 Excess of Cost Over Net Assets of Acquired Business, net 2,707 2,793 Other Assets, net 2,054 2,117 ------- ------- Total assets $36,425 $40,916 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 1,515 $ 1,327 Acquisition obligation - 5,676 Deferred service revenue 2,605 2,244 Estimated costs to complete system installations 582 592 Other current liabilities 3,034 3,636 ------- ------- Total current liabilities 7,736 13,475 ------- ------- Commitments and Contingencies Shareholders' Equity: Common stock, $0.01 par value, 20,000 shares authorized, 6,243 and 5,988 shares issued and outstanding, respectively 62 60 Additional paid-in capital 35,780 33,931 Accumulated deficit (7,153) (6,550) ------- ------- Total shareholders' equity 28,689 27,441 ------- ------- Total liabilities and shareholders' equity $36,425 $40,916 ======= =======
See notes to consolidated financial statements. QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (in thousands)
Three Months Ended June 30, ------------------------ 1998 1997 ----------- ----------- Net Revenues: Sales of computer systems, upgrades and supplies $ 3,930 $ 4,710 Maintenance and other services 3,295 2,463 ------- ------- 7,225 7,173 Cost of Products and Services 4,040 3,567 ------- ------- Gross Profit 3,185 3,606 Selling, General and Administrative Expenses 3,328 2,537 Research and Development Costs 905 828 Purchased In-Process Research and Development - 4,720 ------- ------- Loss from Operations (1,048) (4,479) Investment Income 176 276 ------- ------- Loss before Benefit from Income Taxes (872) (4,203) Benefit from Income Taxes (269) (1,468) ------- ------- Net Loss $ (603) $(2,735) ======= ======= Net Loss per Share, basic and diluted $(0.10) $(0.46) ======= =======
See notes to consolidated financial statements. QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands)
Three Months Ended June 30, --------------------------- 1998 1997 ------------ ------------ Cash Flows from Operating Activities: Net loss $ (603) $(2,735) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Purchased in-process research and development - 4,720 Depreciation and amortization 600 396 Loss (Gain) on short-term investments 31 (27) Deferred income taxes (217) (1,771) Changes, net of amounts acquired, in: Accounts receivable 315 (1,292) Inventories 421 9 Other current assets (78) (117) Other assets (34) (53) Accounts payable 188 101 Deferred service revenue 361 (42) Estimated costs to complete system installations (10) (43) Income taxes payable and taxes related to equity accounts (683) 119 Other current liabilities (49) 469 ------------ ------------- Net Cash Provided by (Used in) Operating Activities 242 (266) ------------ ------------- Cash Flows from Investing Activities: Net additions to equipment and improvements (167) (341) Additions to capitalized software costs (333) (300) Purchase of net assets of MicroMed Healthcare Information Systems, Inc. (3,840) (5,259) Change in other assets 8 200 ------------ ------------ Net Cash Used in Investing Activities (4,332) (5,700) ------------ ------------ See notes to consolidated financial statements. QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited) (in thousands) Three Months Ended June 30, --------------------------- 1998 1997 ------------ ------------ Cash Flows from Financing Activities: Purchase of Common Stock $ - $ (34) Proceeds from exercise of stock options 15 6 ------------ ------------ Net Cash Provided by (Used in) Financing Activities 15 (28) ------------ ------------ Net Decrease in Cash and Cash Equivalents (4,075) (5,994) Cash and Cash Equivalents, beginning of period 16,107 21,852 ------------ ------------ Cash and Cash Equivalents, end of period $12,032 $15,858 ============ ============
Supplemental Information - During the three months ended June 30, 1998 and 1997, the Company made income tax payments of $624 and $186, respectively.
Three Months Ended June 30, --------------------------- Detail of business acquired in 1998 1997 purchase transaction: ------------ ------------ Purchased In-Process Research and Development $ - $ 4,720 Fair Value of Assets Acquired (net of previous investment, if any) - 1,216 Liabilities Assumed - (677) Common Stock Issued in the Acquisition (1,836) - Retirement of Acquisition Obligation 5,676 - ------------ ------------ Cash Paid for the Acquisition, net of cash acquired $ 3,840 $ 5,259 ============ ============
See notes to consolidated financial statements. 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 generally accepted accounting principles, and should be read in conjunction with the audited financial statements presented in the Company's Annual Report for the fiscal year ended March 31, 1998. 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 - ACQUISITION OF MICROMED HEALTHCARE INFORMATION SYSTEMS, INC. - ------ ------------------------------------------------------------ On May 15, 1997, the Company acquired substantially all of the assets of MicroMed Healthcare Information Systems, Inc. ("MicroMed"), a developer and marketer of proprietary information systems utilizing a graphical user interface client-server platform for medical group practices. The purchase price consists of an initial cash payment of $4.8 million paid at the closing of the transaction and an additional payment, based upon certain operating results of MicroMed for the twelve-month period ended March 31, 1998, of $5.7 million due no later than June 29, 1998. The additional payment consisted of $3.8 million in cash and 245,454 shares of the Company's Common Stock valued at $1.8 million, or $7.48 per share. The shares of Common Stock may not be sold or otherwise transferred in any manner until June 1999. NOTE 3 - STOCK REPURCHASE - ------ ---------------- In February 1997, the Company's Board of Directors authorized the repurchase on the open market of up to 10% of the Company's outstanding Common Stock at various times through February 1998, subject to compliance with applicable laws and regulations. On February 9, 1998, the Company's Board of Directors extended this authorization through February 9, 1999. 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 three months ended June 30, 1998, the Company did not repurchase any shares. Since the inception of the repurchase authorization through August 5, 1998, 49,900 shares have been repurchased at a cost of $329,000. NOTE 4 - INCOME TAXES - ------ ------------ The benefit from income taxes for the three months ended June 30, 1998 and 1997 differ from the expected combined statutory rate 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. NOTE 5 - NET LOSS PER SHARE - ------ ------------------ The net loss per share, basic and diluted, for each of the three months ended June 30, 1998 and 1997 was computed using the weighted average number of shares actually outstanding during the periods of 6,002,000 and 5,998,000, respectively, and any common share equivalents were excluded because their impact would have been anti-dilutive. NOTE 6 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - ------ ----------------------------------------- In October 1997, the American Institute of Certified Public Accounts issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP 97-2"), which was later amended in part by SOP 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP 98-4"). As of April 1, 1998, the Company has adopted SOP 97-2, as amended by SOP 98-4. SOP 97-2 provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions and supersedes the guidance contained in SOP 91-1 which the Company has heretofore been following. The Company generates revenues from licensing rights to use its software products directly to end users. The Company also generates revenues from sales of hardware and third party software, and implementation, training, software customization and post- contract support ("maintenance") services performed for customers who license the Company's products. A typical system contract contains multiple elements of two or more of the above items. In accordance with SOP 97-2, revenue is allocated to each element of the contract based on evidence of each element's fair market value. Provided the fees are fixed and determinable and collection is considered probable, revenue from licensing rights and sales of hardware and third party software are recognized upon shipment. Revenue from implementation, training and software customization services is recognized as the corresponding services are performed. Maintenance revenue is recognized ratably over the contractural maintenance period. The adoption of SOP 97-2 has, in certain circumstances, resulted in the deferral of some portion of contract revenues that would have otherwise been recognized under SOP 91-1. During the quarter ended June 30, 1998, the impact of adopting SOP 97-2 as of April 1, 1998, was to reduce net revenues by $443,000, increase the loss from operations by $314,000, and increase the net loss by $187,000, or $0.03 per share on a basic and diluted basis. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). This statement establishes standards for the reporting of comprehensive income and its components. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. For the three months ended June 30, 1998 and 1997, there were no differences between the net loss, as reported, and comprehensive income/loss. In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131"). This statement establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosure about products and services, geographic areas and major customers. The Company has not yet determined the impact, if any, of adopting this new standard. The disclosures prescribed by SFAS No. 131 are effective for fiscal years beginning after December 15, 1997, but are not required for interim periods in the initial year of application. 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"), and community health centers. 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. 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 500 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. QSI 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 markets integrated character-based healthcare information systems utilizing a UNIX* operating system for both the medical and dental markets ("Legacy Product"). These expandable systems operate on a stand-alone basis or in a networked environment. Augmenting its medical practice management software system, QSI added Clinitec's electronic medical records software, NextGen**, to its product line in 1995 and completed its acquisition of Clinitec in May 1996. NextGen 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. NextGen also supports the scanning and annotation of paper documents, photographs and X-rays, and contains many other advanced features. NextGen is marketed both in conjunction with the Company's practice management software offerings as well as on a stand-alone basis where NextGen may interface with other practice management systems. With the addition of NextGen, the Company believes that it currently provides a comprehensive information management solution for the medical marketplace. In September 1996, QSI entered into a software licensing and development agreement to utilize and market a computerized oral health records system for dental practitioners ("Charting Product"). QSI continues to modify and expand the product's source code to meet the needs of large dental groups and has interfaced this charting system with the dental Legacy Product. The dental charting software incorporates specific clinical information associated with tooth and perio charting, video image management (including interfacing with digital X-ray equipment and intra-oral cameras), periodontal screening and recording ("PSR") examination results and patient education, and maintains chart notes in both text and audio form. The system is being developed with a client-server architecture; a GUI design utilizing either Windows 95*** or Windows NT*** operating system platforms; and, a platform independent relational database that is ANSI SQL-compliant. In addition, the dental charting software can be integrated with components from the NextGen electronic medical records system to form the base for a chartless, paperless dental office environment. Further augmenting its medical practice management system product line, the Company purchased MicroMed in May 1997. MicroMed develops and markets proprietary medical practice management systems. MicroMed's practice management system ("Windows Product") has been developed with a client- server architecture; a GUI design utilizing either Windows 95 or Windows NT operating system platforms; and, a platform independent relational database that is ANSI SQL-compliant. MicroMed's product is designed to provide a flexible, enterprise-wide solution employing a master patient index. * UNIX is a registered trademark of AT&T Corporation. ** NextGen is a registered trademark of Clinitec International, Inc. *** Microsoft Windows, Windows NT and Windows 95 are registered trademarks of Microsoft Corporation. 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, financial condition and results of operations. Competitive pressures and other factors, such as new product introductions by the Company or its competitors, may result in price erosion that could have a material adverse effect on the Company's business, financial condition and results of operations. 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, financial condition and results of operations. 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, financial condition and results of operations. 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 and the installation cycle is typically two to four months from contract execution/shipment to completion of installation. 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 recently 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 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. ACQUISITIONS. During the past two years, the Company has made two significant acquisitions of relatively new companies each of which has products utilizing newer technology than the Company's Legacy Product and each company having a limited sales history. Acquisitions involve a number of special risks, including possible adverse effects on the Company's operating results, diversion of management's attention, failure to retain key acquired personnel, amortization of acquired intangible assets, and risks associated with unanticipated events or liabilities, some or all of which could have a material adverse effect on the Company's business, results of operations and financial condition. Customer dissatisfaction or performance problems at a single acquired business can also have an adverse effect on the reputation of the Company. 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, operating results and financial condition could be adversely affected. At certain times in the past, the Company has also experienced delays in purchases of its products by clients anticipating the launch of new products by the Company. There can be no assurance that material order deferrals in anticipation of new product introductions will not occur. TECHNOLOGICAL CHANGE. The software market generally is characterized by rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards. The introduction of products incorporating new technologies and the emergence of new industry standards could render the Company's existing products obsolete and unmarketable. There can be no assurance that the Company will be successful in developing and marketing new products that respond to technological changes or evolving industry standards. New product development depends upon significant research and development expenditures which depend ultimately upon sales growth. Any material weakness in revenues or research funding could impair the Company's ability to respond to technological advances in the marketplace and 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 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 and Windows 95, 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. YEAR 2000 COMPLIANCE. The Company is aware of the issues associated with the programming code in existing computer systems as the millennium ("Year 2000") approaches. The Year 2000 issue is whether the computer systems will properly recognize date sensitive information when the year changes to 2000. This Year 2000 problem creates risk for the Company from unforeseen problems in its own computer systems and from third parties with whom the Company deals on financial transactions nationwide. The Company's Windows Product, NextGen and Charting Product are designed to be Year 2000 compliant. However, there can be no assurance that such products do not contain undetected errors or defects associated with Year 2000 date functions. The Company is currently evaluating the impact of Year 2000 issues upon its medical and dental Legacy Product software and, pending the conclusion of its evaluation, the impact of such Year 2000 issues upon the Company and its financial performance is uncertain. The Company has begun to review software used internally by the Company in all support systems to determine whether they are Year 2000 compliant. The Company plans to have formal Year 2000 initiatives developed to address any conversion update or upgrade necessary to become Year 2000 compliant on software currently used by the Company. Any new software or support systems implemented in the future will be Year 2000 compliant or will have updates or upgrades available before the Year 2000 to enable the system to be Year 2000 compliant. Management is currently assessing the Year 2000 compliance expense and related potential effect on the Company's earnings. LITIGATION. On April 22, 1997, a purported class action was filed in California Superior Court on behalf of all persons who purchased the Company's Common Stock between June 26, 1995 and July 3, 1996. The complaint alleges that the Company and certain of its officers and directors, as well as other defendants not affiliated with the Company, violated sections of the California Corporations Code by issuing positive statements about the Company that allegedly were knowingly false, in part, in order to assist the Company and certain of its officers and directors in selling Common Stock at an inflated price in the Company's March 5, 1996 public offering and at other points during the period specified. On May 14, 1997, a second purported class action was filed in the same court essentially repeating the allegations of the April 22, 1997 suit. On July 1, 1997, a third purported class action was filed in the United States District Court repeating essentially the same factual allegations as the April 22, 1997 suit and purports to state claims under the Federal securities laws. The Company and its named officers and directors deny all allegations of wrongdoing made against them in these suits, consider the allegations groundless and without merit, and intend to vigorously defend against these actions. The pending federal and state securities actions are in the early states of procedure. Consequently, at this time it is not reasonably possible to estimate the damage, or the range of damages, if any, that the Company might incur in connection with such actions. However, the uncertainty associated with substantial unresolved litigation may be expected to have an adverse impact on the Company's business. In particular, such litigation could impair the Company's relationships with existing customers and its ability to obtain new customers. Defending such litigation will likely result in a diversion of management's time and attention away from business operations, which could have a material adverse effect on the Company's business, results of operations and financial condition. Such litigation may also have the effect of discouraging potential acquirors from bidding for the Company or reducing the consideration such acquirors would otherwise be willing to pay in connection with an acquisition. 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. 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 arrangements 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, financial condition and results of operations. 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 recently experienced a period of growth and increased personnel which has placed, and will continue to place, a significant strain on the Company's resources. The Company anticipates expanding its overall software development, marketing, sales, client management and training capacity. In the event the Company is unable to identify, hire, train and retain qualified individuals in such capacities within a reasonable timeframe, such failure could have a material adverse effect on the Company. In addition, the Company's ability to manage future increases, if any, in the scope of its operations or personnel will depend on significant expansion of its research and development, marketing and sales, management and administrative, and financial capabilities. The failure of the Company's management to effectively manage expansion in its business could have a material adverse effect on the Company's business, results of operations and financial condition. DEPENDENCE UPON KEY PERSONNEL. The Company's future performance also depends in significant part upon the continued service of its key technical and senior management personnel, many of whom have been with the Company for a significant period of time. The Company does not maintain key man life insurance on any of its employees. Because the Company has a relatively small number of employees when compared to other leading companies in the same industry, its dependence on maintaining its employees is particularly significant. The Company is also dependent on its ability to attract and retain high quality personnel, particularly 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. 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, financial condition and results of operations. Even unsuccessful claims could result in the Company's expenditure of funds in litigation and management time and resources. There can be no assurance that the Company will not be subject to product liability claims, that such claims will not result in liability in excess of its insurance coverage, that the Company's insurance will cover such claims or that appropriate insurance will continue to be available to the Company in the future at commercially reasonable rates. Such claims could have a material adverse affect on the Company's business, financial condition and results of operations. 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, financial condition and results of operations. 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 recordkeeping 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, financial condition and results of operations. RESULTS OF OPERATIONS. The following table sets forth for the periods indicated, the percentage of net revenues represented by each item in the Company's consolidated statements of operations.
Three Months Ended June 30, ----------------- 1998 1997 ------- ------- Net Revenues: Sales of computer systems, upgrades and supplies 54.4 % 65.7 % Maintenance and other services 45.6 34.3 ------- ------- 100.0 100.0 Cost of Products and Services 55.9 49.7 ------- ------- Gross Profit 44.1 50.3 Selling, General and Administrative Expenses 46.1 35.4 Research and Development Costs 12.5 11.5 Purchased In-Process Research and Development - 65.8 ------- ------- Loss from Operations (14.5) (62.4) Investment Income 2.4 3.8 ------- ------- Loss before Benefit from Income Taxes (12.1) (58.6) Benefit from Income Taxes (3.7) (20.5) ------- ------- Net Loss (8.4)% (38.1)% ======= =======
For the Three-Month Periods Ended June 30, 1998 and 1997. - --------------------------------------------------------- The Company incurred a net loss of $(603,000), or $(0.10) per share on a basic and diluted basis, for the three months ended June 30, 1998. In comparison, after recognizing a $4.7 million charge for purchased in- process research and development in connection with the MicroMed acquisition, the Company incurred a net loss of $(2.7) million, or $(0.46) per share on a basic and diluted basis, for the three months ended June 30, 1997. Excluding the charge, net of the related income tax benefit, net income and basic and diluted income per share for the three months ended June 30, 1997 would have been $256,000, and $0.04, respectively. Net Revenues. Net revenues for the three months ended June 30, 1998 were relatively unchanged at $7.2 million as compared to the three months ended June 30, 1997. Sales of computer systems, upgrades and supplies decreased 16.6% to $3.9 million from $4.7 million while net revenues from maintenance and other services grew 33.8% to $3.3 million from $2.5 million during the comparable periods. The decrease in net revenues from sales of computer systems, upgrades and supplies was principally due to the impact of adopting SOP 97-2 as of April 1, 1998 resulting in the deferral of certain revenues from system contracts executed and shipped during the quarter combined with the effect of an overall decrease in new system sales during the quarter. The increase in maintenance and other services net revenue resulted principally from an increase in such revenues for QSI which has a larger client base from which to generate maintenance and other service revenue than the more recently formed Clinitec and MicroMed organizations, each of which also contributed, to a lesser degree, to the increase in such revenues. Cost of Products and Services. Cost of products and services for the three months ended June 30, 1998 increased 13.3% to $4.0 million from $3.6 million for the three months ended June 30, 1997 while cost of products and services as a percentage of net revenues increased to 55.9% from 49.7% during the comparable periods. The increase in cost of products and services in amount during the June 30, 1998 quarter as compared to the June 30, 1997 quarter results from the effect of increased product development, customer service, support, and training personnel at both Clinitec and MicroMed during the June 30, 1998 quarter as compared to the June 30, 1997 quarter together with a change in the mix of new system sales toward systems with higher hardware content in the fiscal 1999 quarter offset in part by the overall decrease in net revenues from sales of computer systems and upgrades. The increase in cost of products and services as a percentage of net revenues results from the growth of the Clinitec and MicroMed infrastructures together with the changing mix of sales both taken in conjunction with the negligible net revenue growth in the June 1998 quarter as compared to the June 1997 quarter. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended June 30, 1998 increased 31.2% to $3.3 million from $2.5 million for the three months ended June 30, 1997 primarily as a result of: the inclusion of such MicroMed expenses for the entire quarter ended June 30, 1998 as compared to only that portion of the corresponding period ended June 30, 1997 following the May 1997 MicroMed acquisition; and, an increase in Clinitec's and MicroMed's selling efforts, sales personnel and administrative infrastructure offset in part by a decrease in such costs for QSI. In addition, primarily as a result of the negligible net revenue growth in conjunction with the increased Clinitec and MicroMed infrastructures, selling, general and administrative expenses as a percentage of net revenues increased to 46.1% from 35.4% for the respective periods. Research and Development Costs. Research and development costs for the three months ended June 30, 1998 increased 9.3% to $905,000 from $828,000 for the three months ended June 30, 1997. The increase is the result of increased research and development efforts by Clinitec as well as consolidation of MicroMed's research and development costs for the entire quarter ended June 30, 1998 as compared to only that portion of such expenses for the June 30, 1997 quarter which were incurred following the May 1997 purchase of the MicroMed business. Research and development costs as a percentage of net revenues increased to 12.5% as compared to 11.5% for the respective periods as a result of the increased research and development efforts in conjunction with the negligible net revenue growth between the periods. Purchased In-Process Research and Development. In connection with the acquisition of MicroMed in May 1997, MicroMed's in-process research and development for which technological feasibility had not been established was valued in excess of $4.7 million. After allocating the purchase price paid to identifiable tangible and certain intangible assets, the remaining unallocated portion of $4.7 million was allocated to MicroMed's in-process research and development. In accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," software development costs must be expensed until technological feasibility has been established. Accordingly, the $4.7 million value allocated to MicroMed's purchased in- process research and development was expensed during the quarter ended June 30, 1997. There was no similar acquisition transaction in the June 30, 1998 quarter. Investment Income. Investment income for the three months ended June 30, 1998 decreased 36.2% to $176,000 from $276,000 for the three months ended June 30, 1997 primarily as a result of a decrease in average funds available for investment during the quarter ended June 30, 1998. The decrease in available funds is primarily the result of the payment made to acquire the MicroMed business in May 1997 together with funds used to fund the growth of Clinitec and MicroMed. Benefit from Income Taxes. The benefit from income taxes for the three months ended June 30, 1998 was $269,000 as compared to $1.5 million for the three months ended June 30, 1997. The benefit from income taxes for the three months ended June 30, 1998 and 1997 differ from the expected combined statutory rate because of the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 acquisition of Clinitec and the effect of varying state income tax rates. LIQUIDITY AND CAPITAL RESOURCES. - -------------------------------- Cash and cash equivalents decreased $4.1 million for the three months ended June 30, 1998 primarily as a result of the final cash payment in connection with the MicroMed acquisition. Correspondingly, cash and cash equivalents decreased $6.0 million for the three months ended June 30, 1997 principally as a result of the initial cash payment in connection with the MicroMed acquisition. Net cash provided by operating activities for the three months ended June 30, 1998 was $242,000 consisting primarily of the Company's net loss adjusted for the principal non-cash operating expenses of depreciation and amortization plus increases in accounts payable and deferred service revenue and decreases in accounts receivable and inventory offset by decreases in deferred income taxes and income taxes payable. Net cash used in operating activities for the three months ended June 30, 1997 was $266,000 consisting primarily of the Company's net loss adjusted for the principal non-cash operating expenses of depreciation, amortization and the $4.7 million charge for the MicroMed purchased in-process research and development, plus an increase in other current liabilities offset by the deferred tax benefit from the charge for purchased in-process research and development and an increase in accounts receivable. Net cash used in investing activities for the three months ended June 30, 1998 was $4.3 million consisting principally of $3.8 million used for the final cash payment for the MicroMed business, plus additions to equipment and improvements and capitalized software. Net cash used in investing activities for the three months ended June 30, 1997 was $5.7 million consisting principally of $5.3 million, including a $550,000 operating loan made by QSI to MicroMed prior to the acquisition, used for the initial payment in connection with the MicroMed acquisition plus additions to equipment and improvements and capitalized software. Net cash provided by (used in) financing activities for the three months ended June 30, 1998 and 1997 was negligible. In February 1997, the Company's Board of Directors authorized the repurchase on the open market of up to 10% of the Company's outstanding Common Stock at various times through February 1998, subject to compliance with applicable laws and regulations. On February 9, 1998, the Company's Board of Directors extended this authorization through February 9, 1999. 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 three months ended June 30, 1998, the Company did not repurchase any shares. Since the inception of the repurchase authorization through August 5, 1998, 49,900 shares have been repurchased at a cost of $329,000. At June 30, 1998, the Company had cash and cash equivalents of $12.0 million and short-term investments of $942,000. Short-term investments include a $732,000 investment in a fund which trades in special situation securities. There can be no assurance that the markets for these securities will not change, causing a loss of principal. In March 1996, QSI raised $20.2 million to be used for general corporate purposes, including the financing of product sales growth, development of new products, working capital requirements, an increase in its ownership interest in Clinitec, and the possible acquisitions of complementary businesses and technologies. The Company continues to evaluate potential investment opportunities and in May 1997 acquired substantially all of the assets of MicroMed for cash payments made in May 1997 and June 1998 totaling $8.6 million, 245,454 shares of the Company's Common Stock issued in June 1998 valued at $1.8 million, or $7.48 per share, and related net acquisition costs and loans made to MicroMed prior to the acquisition totaling $527,000. The shares of Common Stock issued in connection with the MicroMed acquisition may not be sold or otherwise transferred in any manner until June 1999. Except for Company's intention to expend funds for the development of complementary products to its existing product line, 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 and currently anticipates that additions to equipment and improvements for fiscal 1999 will be comparable to fiscal 1998. The Company believes that its cash and cash equivalents and short-term investments on hand at June 30, 1998, together with the cash flows from operations, if any, will be sufficient to meet its working capital and capital expenditure requirements for the next year. YEAR 2000 COMPLIANCE. The Company is aware of the issues associated with the programming code in existing computer systems as the millennium ("Year 2000") approaches. The Year 2000 issue is whether the computer systems will properly recognize date sensitive information when the year changes to 2000. This Year 2000 problem creates risk for the Company from unforeseen problems in its own computer systems and from third parties with whom the Company deals on financial transactions nationwide. The Company's Windows Product, NextGen and Charting Product are designed to be Year 2000 compliant. However, there can be no assurance that such products do not contain undetected errors or defects associated with Year 2000 date functions. The Company is currently evaluating the impact of Year 2000 issues upon its medical and dental Legacy Product software and, pending the conclusion of its evaluation, the impact of such Year 2000 issues upon the Company and its financial performance is uncertain. The Company has begun to review software used internally by the Company in all support systems to determine whether they are Year 2000 compliant. The Company plans to have formal Year 2000 initiatives developed to address any conversion update or upgrade necessary to become Year 2000 compliant on software currently used by the Company. Any new software or support systems implemented in the future will be Year 2000 compliant or will have updates or upgrades available before the Year 2000 to enable the system to be Year 2000 compliant. Management is currently assessing the Year 2000 compliance expense and related potential effect on the Company's earnings. PART II. OTHER INFORMATION. -------- ------------------ Item 2. Changes in Securities and Use of Proceeds. - ------- ------------------------------------------ In June 1998, the Company issued 245,454 shares of its Common Stock to a single accredited investor as defined in Rule 501(a) of the Securities Act of 1933, as amended (the "Act"), in connection with the acquisition of MicroMed Healthcare Information Systems, Inc. The issuance of such shares was made in reliance upon the exemptive provisions of Section 4(2) and Rule 506 of the Act. Item 6. Exhibits and Reports on Form 8-K. - ------- --------------------------------- (a) Exhibits: --------- The Exhibits listed on the accompanying Index to Exhibits on page 25 are filed as part of this report. (b) Reports on Form 8-K: -------------------- None. 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 August 11, 1998 By /s/ Sheldon Razin --------------- ---------------------------------- Sheldon Razin President and Chairman of the Board of Directors; Principal Executive Officer Date August 11, 1998 By /s/ Robert G. McGraw --------------- ---------------------------------- Robert G. McGraw Chief Financial Officer; Principal Accounting Officer
INDEX TO EXHIBITS Sequential Page Exhibit No. ------- ---------- 27.0 Financial Data Schedule, is filed herewith. 26 EX-27 2
5 3-MOS MAR-31-1999 JUN-30-1998 12,032,000 942,000 9,631,000 0 907,000 24,203,000 1,819,000 0 36,425,000 7,736,000 0 0 0 62,000 28,627,000 36,425,000 3,930,000 7,225,000 0 4,040,000 4,233,000 0 0 (872,000) (269,000) (603,000) 0 0 0 (603,000) (0.10) (0.10)
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