-----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, NfMwkvC8NGIF6AlMRpKp77nymhoWZl+ET2vXhQmKgR8ENwZixggZqmofZ63QetNL PA4o+LZ9ULLZjz0mXWXhtA== 0001005477-01-501853.txt : 20020410 0001005477-01-501853.hdr.sgml : 20020410 ACCESSION NUMBER: 0001005477-01-501853 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011113 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: 1934 Act SEC FILE NUMBER: 001-12537 FILM NUMBER: 1781463 BUSINESS ADDRESS: STREET 1: 17822 E 17TH ST STE 210 CITY: TUSTIN STATE: CA ZIP: 92780 BUSINESS PHONE: 7147317171 MAIL ADDRESS: STREET 1: 178222 E 17TH STREET STREET 2: SUITE 210 CITY: TUSTIN STATE: CA ZIP: 92780 10-Q 1 d01-35066.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] Commission file number 0-13801 QUALITY SYSTEMS, INC. (Exact name of Registrant as specified in its charter) California 95-2888568 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 17822 East 17th Street, Tustin, California 92780 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (714) 731-7171 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes |X| No |_| Indicate the number of shares outstanding of each of the Registrant's classes of Common Stock as of the latest practicable date: 6,019,648 shares of Common Stock, $.01 par value, as of November 8, 2001 ================================================================================ QUALITY SYSTEMS, INC. QUARTERLY REPORT ON FORM 10-Q SIX MONTHS ENDED SEPTEMBER 30, 2001 TABLE OF CONTENTS PAGE PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited) and March 30, 2001 2 Unaudited Condensed Consolidated Statements of Income for the Three and Six Months Ended September 30, 2001 and 2000 3 Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2001 and 2000 4 Notes to Condensed Consolidated Financial Statements 5 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 7 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 16 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 16 ITEM 2. CHANGES IN SECURITIES 17 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17 ITEM 5. OTHER INFORMATION 17 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18 SIGNATURE 18 1 PART I - CONSOLIDATED FINANICAL INFORMATION Item 1. Financial Statements QUALITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
September 30, March 31, 2001 2001 ASSETS (Unaudited) ------------- --------- Current Assets: Cash and cash equivalents $21,177 $18,471 Short-term investments 258 258 Accounts receivable, net 13,951 13,335 Inventories, net 926 1,030 Deferred tax assets 1,566 1,566 Other current assets 740 532 ------- ------- Total current assets 38,618 35,192 Equipment and Improvements, net 1,570 1,819 Capitalized Software Costs, net 1,892 1,769 Deferred Tax Assets 2,960 2,960 Goodwill, net 1,840 1,840 Other Intangible Assets, net 75 152 Other Assets 1,269 1,151 ------- ------- Total assets $48,224 $44,883 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 1,698 $ 1,829 Deferred service revenue 6,127 5,595 Other current liabilities 3,917 3,572 ------- ------- Total liabilities 11,742 10,996 ------- ------- Commitments and Contingencies Shareholders' Equity: Common Stock, $0.01 par value, 20,000 shares authorized, 6,017 and 5,987 shares issued and outstanding, respectively 60 60 Additional paid-in capital 33,984 33,780 Retained earnings 2,438 47 ------- ------- Total shareholders' equity 36,482 33,887 ------- ------- Total liabilities and shareholders' equity $48,224 $44,883 ======= =======
See notes to consolidated financial statements. 2 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (in thousands, except per share amounts)
Three Months Ended Six Months Ended September 30, September 30, ------------------ ------------------ 2001 2000 2001 2000 ------- ------- ------- ------- Net Revenues: Sales of computer systems, upgrades and supplies $ 5,110 $ 4,794 $10,704 $ 9,189 Maintenance and other services 5,387 4,869 10,702 9,736 ------- ------- ------- ------- 10,497 9,663 21,406 18,925 Cost of Products and Services 4,547 4,363 9,281 8,395 ------- ------- ------- ------- Gross Profit 5,950 5,300 12,125 10,530 Selling, General and Administrative Expenses 3,294 3,244 6,539 6,609 Research and Development Costs 1,000 974 2,107 1,979 ------- ------- ------- ------- Income from Operations 1,656 1,082 3,479 1,942 Investment Income 190 251 396 497 ------- ------- ------- ------- Income before Provision for Income Taxes 1,846 1,333 3,875 2,439 Provision for Income Taxes 714 589 1,485 1,070 ------- ------- ------- ------- Net Income $ 1,132 $ 744 $ 2,390 $ 1,369 ======= ======= ======= ======= Net Income per Share, basic $ 0.19 $ 0.12 $ 0.40 $ 0.22 ======= ======= ======= ======= Net Income per Share, diluted $ 0.18 $ 0.12 $ 0.39 $ 0.22 ======= ======= ======= =======
See notes to consolidated financial statements. 3 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands)
Six Months Ended September 30, ------------------------------ 2001 2000 -------- -------- Cash Flows from Operating Activities: Net Income $ 2,390 $ 1,369 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,039 1,342 Gain on short-term investments and other -- (5) Deferred income taxes -- 1,364 Changes in: Accounts receivable (616) (1,397) Inventories 104 43 Other current assets (208) (84) Other assets (118) (6) Accounts payable (131) 371 Deferred service revenue 532 21 Income taxes payable and taxes related to equity accounts (71) (1,287) Other current liabilities 417 42 -------- -------- Net Cash Provided By Operating Activities 3,338 1,773 -------- -------- Cash Flows used in Investing Activities: Net additions to equipment and improvements (147) (572) Additions to capitalized software costs (689) (559) Change in Other Assets -- (13) -------- -------- Net Cash Used In Investing Activities (836) (1,144) -------- -------- Cash Flows from Financing Activities: Purchases of Common Stock -- (35) Proceeds from exercise of stock options 204 85 -------- -------- Net Cash Provided by Financing Activities 204 50 -------- -------- Net Increase in Cash and Cash Equivalents 2,706 679 Cash and Cash Equivalents, beginning of period 18,471 15,926 -------- -------- Cash and Cash Equivalents, end of period $ 21,177 $ 16,605 ======== ========
Supplemental Information - During the six months ended September 30, 2001 and 2000, the Company made income tax payments, net of refunds received, of $1,444,000 and $831,000 respectively. See notes to consolidated financial statements. 4 QUALITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and, therefore, do not include all information and footnotes which would be presented were such financial statements prepared in accordance with generally accepted accounting principles, and should be read in conjunction with the audited financial statements presented in the Company's Annual Report for the fiscal year ended March 31, 2001. In the opinion of management, the accompanying financial statements reflect all adjustments which are necessary for a fair presentation of the results of operations for the interim periods presented. The results of operations for such interim periods are not necessarily indicative of results of operations to be expected for the full year. Certain amounts in the accompanying financial statements have been reclassified to conform with the September 30, 2001 presentation. 2. New Accounting Pronouncement The Company adopted Financial Accounting Standards Board No. 142 "Goodwill and Other Intangible Assets" ("FASB 142") effective April 1, 2001. The new statement applies to the amortization of goodwill and other intangible assets. In accordance with FASB 142, the Company has ceased amortizing amounts related to goodwill starting April 1, 2001. The balance of goodwill is related to the Company's MicroMed Division. In accordance with FASB 142, the Company has compared the fair value of the MicroMed Division with the carrying amount of assets associated with the Division and determined that none of the goodwill recorded as of June 30, 2001 was impaired. The fair value of the MicroMed Division was determined using a reasonable estimate of future cash flows of the Division and a risk adjusted discount rate to compute a net present value of future cash flows. As of September 30, 2001, the Company had the following amounts related to intangible assets with determinable lives. Under FASB 142, these intangible assets will continue to be amortized over their assumed lives as seen below:
(amounts in thousands) Gross Carrying Accumulated Amount Amortization -------------- ----------- Amortized intangible assets (Life) Developed Technology (5 yrs) $1,300 $(1,225) Capitalized Software Development (3 yrs) $4,050 $(2,158) Aggregate Amortization Expense Six Months Ended September 30, 2001 $ 641
The following table represents the total estimated amortization of intangible assets beginning with fiscal year ending March 31, 2002: Estimated Amortization Expense For the year ending March 31, (in thousands) - ----------------------------- ------------------------------ 2002 $1,264 2003 $ 811 2004 $ 444 2005 $ 89 5 Reconciliation of reported net income adjusted for adoption of FASB 142:
(in thousands except per share amounts) Three Months Ended Six Months Ended September 30, September 30, ---------------------- ---------------------- 2001 2000 2001 2000 --------- --------- --------- --------- Reported Net Income $ 1,132 $ 744 $ 2,390 $ 1,369 Addback: Goodwill amortization $ 100 $ 200 --------- --------- --------- --------- Adjusted Net Income $ 1,132 $ 844 $ 2,390 $ 1,569 --------- --------- --------- --------- Basic earnings per share: Reported Net Income $ 0.19 $ 0.12 $ 0.40 $ .22 Goodwill amortization .02 .03 --------- --------- --------- --------- Adjusted Net Income $ 0.19 $ 0.14 $ 0.40 $ 0.25 --------- --------- --------- --------- Diluted earnings per share: Reported Net Income $ 0.18 $ 0.12 $ 0.39 $ 0.22 Goodwill amortization .01 .03 --------- --------- --------- --------- Adjusted Net Income $ 0.18 $ 0.13 $ 0.39 $ 0.25 --------- --------- --------- ---------
3. Stock Repurchase Plan In October 2001, the Company's Board of Directors authorized the repurchase on the open market of up to 5% of the shares of the Company's outstanding Common stock, subject to compliance with applicable laws and regulations. Purchases are entirely at the discretion of the company's management. This authorization expires on the date of the Fiscal 2003 annual shareholders meeting . 4. Income Taxes The provision for income taxes for the three and six month periods ended September 30, 2001 and 2000 differ from the expected combined statutory rates primarily due to the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 acquisition of Clinitec International, Inc. and the effect of varying state income tax rates. 5. Net Income Per Share The following table reconciles the weighted average shares outstanding for basic and diluted net income per share for the periods indicated.
(in thousands except per share amounts) Three Months Ended Six Months Ended September 30, September 30, ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ Net income $1,132 $ 744 $2,390 $1,369 Basic net income per common share: Weighted average of common shares outstanding 5,997 6,209 5,997 6,209 ------ ------ ------ ------ Basic net income per common share $ 0.19 $ 0.12 $ 0.40 $ 0.22 ====== ====== ====== ====== Diluted net income per share: Weighted average of common shares outstanding 5,997 6,209 5,997 6,209 Effect of potentially dilutive securities (options) 207 64 192 77 ------ ------ ------ ------ Weighted average number of common and shares - Diluted 6,204 6,273 6,189 6,286 ------ ------ ------ ------ Diluted net income per common share $ 0.18 $ 0.12 $ 0.39 $ 0.22 ====== ====== ====== ======
6 6. Operating Segment Information The Company has prepared operating segment information in accordance with Statement of Accounting Standards ("SFAS") No. 131 "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131") to report components that are evaluated regularly by the Company's chief operating decision maker, or decision making group in deciding how to allocate resources and in assessing performance. The Company's reportable operating segments include its MicroMed Division and the QSI Division. The disaggregated financial results of the segments reflect allocation of certain functional expense categories consistent with the basis and manner in which Company management internally disaggregates financial information for the purpose of assisting in making internal operating decisions. Certain corporate overhead costs are not allocated to the individual segments by management. The Company evaluates performance based on stand-alone segment operating income. Because the Company does not evaluate performance based on return on assets at the operating segment level, assets are not tracked internally by segment. Therefore, segment asset information is not presented. Operating segment data for the six months ended September 30, was as follows:
(in thousands) MicroMed Unallocated QSI Division Division Corporate Expenses Consolidated ------------ -------- ------------------ ------------ Six Months Ended September 30, 2001 Revenue $8,545 $12,861 -- $21,406 Operating Income (Loss) $2,489 $ 1,926 $ (936) $ 3,479 Assets -- -- -- $48,224 Six Months Ended September 30, 2000 Revenue $8,728 $10,197 -- $18,925 Operating Income (Loss) $1,474 $ 1,476 $(1,008) $ 1,942 Assets -- -- -- $44,702
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q, including discussions of the Company's product development plans, business strategies and market factors influencing the Company's results, are forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by the Company as a result of various factors, both foreseen and unforeseen, including, but not limited to, the Company's ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation within the Company's target marketplace and among the Company's competitors, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact the Company's ability to achieve its goals. Interested persons are urged to review the risks described below, as well as in the Company's other public disclosures and filings with the Securities and Exchange Commission. Company Overview Quality Systems, Inc. ("QSI") and its wholly-owned subsidiary, Clinitec International, Inc. ("Clinitec") d/b/a MicroMed Healthcare Information Systems, Inc. ("MicroMed") (collectively, the "Company"), develop and market healthcare information systems that automate medical and dental group practices, physician hospital organizations ("PHOs"), management service organizations ("MSOs"), ambulatory care centers, community health centers, and medical and dental schools. In response to the growing need for more comprehensive, cost-effective information solutions for physician and dental practices, the Company's systems enable clients to redesign office workflow processes, improve productivity, reduce information processing and administrative costs, and utilize electronic medical records to store and access patient information. The Company's proprietary software systems cover a 7 number of important practice elements including but not limited to general patient information, electronic medical records, appointment scheduling, billing, insurance claims submission and processing, eligibility verification, managed care plan implementation, referral management, treatment outcome studies, treatment planning, drug formularies, dental charting, and letter generation. Several of the Company's software systems may be operated remotely using thin client connectivity or a standard web browser. In addition to providing fully integrated software solutions to its clients, the Company offers comprehensive hardware and software installation services, maintenance and support services, and system training services. The Company currently has a base of approximately 700 clients, with each client including between one and 500 physicians or dentists. The Company believes that as healthcare providers are increasingly required to reduce costs and maintain the quality of healthcare, the Company will be able to capitalize on its strategy of providing fully integrated information systems and superior client service. QSI, a California corporation formed in 1974, was founded with an early focus on providing information systems and services for dental group practices. In the mid-1980's, QSI capitalized on the increasing focus on medical cost containment and further expanded its information processing systems to serve the medical market. Today, the Company has dedicated products serving both the medical and dental markets. The Company's QSI Division develops and markets dental practice management and medical practice management software suites utilizing a UNIX(1) operating system. Its Clinical Product Suite ("CPS") utilizes a Windows NT(2) operating system and can be fully integrated with the Company's dental practice management applications. CPS incorporates a wide range of clinical tools including but not limited to periodontal charting and digital imaging of X-ray and inter-oral camera images as part of a complete electronic patient record. In addition, the QSI Division develops and markets the Company's QUIC product suite which incorporates a variety of products that enhance the connectivity between provider and payor, and provider and patient. The QSINet Application Services Provider ("ASP")/Internet product offering is also developed and marketed in this Division. QSINet enables providers to extend patient appointment scheduling, electronic bill payment, and other functions to patients via the Internet. QSI's MicroMed Division develops and sells proprietary electronic medical records software and practice management systems under the NextGen(R)(3) product name. Major product categories of the NextGen suite include Electronic Medical Records (NextGen(emr)), Enterprise Practice Management (NextGen(epm)), Enterprise Appointment Scheduling (NextGen(eas)), Enterprise Master Patient Index (NextGen(epi)), Managed Care, Electronic Data Interchange, System Interfaces, Internet Operability (NextGen(web)), and a Patient-centric and Provider-centric Web Portal Solution (NextMD.com(4)). The Company's enterprise practice management and electronic medical records software packages can run via private intranet or via the Internet in an ASP environment. Enhancements to these products has continued into fiscal 2002. Risk Factors Competition. The markets for healthcare information systems are intensely competitive, and the Company faces significant competition from a number of different sources. Several of the Company's competitors have significantly greater name recognition as well as substantially greater financial, technical, product development and marketing resources than the Company. The Company competes in all of its markets with other major healthcare related companies, information management companies, systems integrators, and other software developers. Competitive pressures and other factors, such as new product introductions by the Company or its competitors, may - ---------- 1 UNIX is a registered trademark of AT&T Corporation. 2 Microsoft Windows, Windows NT, Windows 95, Windows 98, and Windows 2000 are registered trademarks of Microsoft Corporation. 3 NextGen is a registered trademark of Clinitec International, Inc. 4 NextMD.com is a trademark of Clinitec International, Inc. 8 result in price or market share erosion that could have a material adverse effect on the Company's business, results of operations and financial condition. Also, there can be no assurance that the Company's applications will achieve broad market acceptance or will successfully compete with other competing software products. The Company's inability to make initial sales of its systems to either newly formed groups and/or healthcare providers that are replacing or substantially modifying their healthcare information systems could have a material adverse effect on the Company's business, results of operations and financial condition. If new systems sales do not materialize, the Company's maintenance revenues can be expected to decrease over time due to the combined effects of potential attrition of existing clients and a shortfall in new client additions. Fluctuation in Quarterly Operating Results. The Company's revenues and operating results have fluctuated in the past, and may fluctuate in the future from quarter to quarter and period to period, as a result of a number of factors including, without limitation: the size and timing of orders from clients; the length of sales cycles and installation processes; the ability of the Company's clients to obtain financing for the purchase of the Company's products; changes in pricing policies or price reductions by the Company or its competitors; the timing of new product announcements and product introductions by the Company or its competitors; the availability and cost of system components; the financial stability of major clients; market acceptance of new products, applications and product enhancements; the Company's ability to develop, introduce and market new products, applications and product enhancements and to control costs; the Company's success in expanding its sales and marketing programs; deferrals of client orders in anticipation of new products, applications or product enhancements; changes in Company strategy; personnel changes; and general economic factors. The Company's products are generally shipped as orders are received and accordingly, the Company has historically operated with minimal backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. Further, the Company's systems can be relatively large and expensive and individual systems sales can represent a significant portion of the Company's revenues for a quarter such that the loss or deferral of even one such sale can have a significant adverse impact on the Company's quarterly profitability. Clients often defer systems purchases until the Company's quarter end, so quarterly results generally cannot be predicted and frequently are not known until the quarter has concluded. The Company's sales are dependent upon a client's initial decision to replace, or substantially modify its existing information system, and subsequently a decision as to which products and services to purchase. These are major decisions for healthcare providers, and accordingly, the sales cycle for the Company's systems can vary significantly and typically ranges from three to twelve months from initial contact to contract execution/shipment. Because a significant percentage of the Company's expenses are relatively fixed, a variation in the timing of systems sales and installations can cause significant variations in operating results from quarter to quarter. As a result, the Company believes that interim period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Further, the Company's historical operating results are not necessarily indicative of future performance for any particular period. The Company recognizes revenue pursuant to Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition" ("SOP 97-2"). Additionally, in December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 summarizes the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 101 became effective for the Company in the third quarter of fiscal 2001. There can be no assurance that application and subsequent interpretations of these pronouncements will not further modify the Company's revenue recognition policies, or that such modifications would not have a material adverse effect on the operating results reported in any particular quarter. 9 There can be no assurance that the Company will not be required to adopt changes in its licensing or services practices to conform to SOP 97-2 or SAB 101, or that such changes, if adopted, would not result in delays or cancellations of potential sales of the Company's products. Due to all of the foregoing factors, it is possible that in some future quarter(s) the Company's operating results may be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. Dependence on Principal Product and New Product Development. The Company currently derives substantially all of its net revenues from sales of its healthcare information systems and related services. The Company believes that a primary factor in the market acceptance of its systems has been its ability to meet the needs of users of healthcare information systems. The Company's future financial performance will depend in large part on the Company's ability to continue to meet the increasingly sophisticated needs of its clients through the timely development, successful introduction and implementation of new and enhanced versions of its systems and other complementary products. The Company has historically expended a significant percentage of its net revenues on product development and believes that significant continuing product development efforts will be required to sustain the Company's growth. There can be no assurance that the Company will be successful in its product development efforts, that the market will continue to accept the Company's existing products, or that new products or product enhancements will be developed and implemented in a timely manner, meet the requirements of healthcare providers, or achieve market acceptance. If new products or product enhancements do not achieve market acceptance, the Company's business, results of operations and financial condition could be materially adversely affected. At certain times in the past, the Company has also experienced delays in purchases of its products by clients anticipating the launch of new products by the Company. There can be no assurance that material order deferrals in anticipation of new product introductions will not occur. Technological Change. The software market generally is characterized by rapid technological change, changing customer needs, frequent new product introductions, and evolving industry standards. The introduction of products incorporating new technologies and the emergence of new industry standards could render the Company's existing products obsolete and unmarketable. There can be no assurance that the Company will be successful in developing and marketing new products that respond to technological changes or evolving industry standards. New product development depends upon significant research and development expenditures which depend ultimately upon sales growth. Any material weakness in revenues or research funding could impair the Company's ability to respond to technological advances in the marketplace and to remain competitive. If the Company is unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, the Company's business, results of operations and financial condition may be materially adversely affected. In response to increasing market demand, the Company is currently developing new generations of certain of its software products. There can be no assurance that the Company will successfully develop these new software products or that these products will operate successfully, or that any such development, even if successful, will be completed concurrently with or prior to introduction of competing products. Any such failure or delay could adversely affect the Company's competitive position or could make the Company's current products obsolete. Litigation. The Company faces one Federal securities action (see "Part II - - Other Information, Item 1. Litigation."). At this time it is not reasonably possible to estimate the damage, or the range of damages, if any, that the Company might incur in connection with this action. However, the uncertainty associated with substantial unresolved litigation may have an adverse impact on the Company's business. In particular, such litigation could impair the Company's relationships with existing customers and its ability to obtain new customers. Defending such litigation may result in a diversion of management's time and attention away from business operations, which could have a material adverse effect on the Company's business, results of operations and financial condition. Such litigation may also have the effect of discouraging potential acquirers from bidding for the Company or reducing the consideration such acquirers would otherwise be willing to pay in connection with an acquisition. 10 There can be no assurance that such litigation will not result in liability in excess of the Company's insurance coverage, that the Company's insurance will cover such claims or that appropriate insurance will continue to be available to the Company in the future at commercially reasonable rates. Proprietary Technology. The Company is heavily dependent on the maintenance and protection of its intellectual property and relies largely on license agreements, confidentiality procedures, and employee nondisclosure agreements to protect its intellectual property. The Company's software is not patented and the Company believes that existing copyright laws offer only limited practical protection. There can be no assurance that the legal protections and precautions taken by the Company will be adequate to prevent misappropriation of the Company's technology or that competitors will not independently develop technologies equivalent or superior to the Company's. Further, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as do the laws of the United States and are often not enforced as vigorously as those in the United States. The Company does not believe that its operations or products infringe on the intellectual property rights of others. However, there can be no assurance that others will not assert infringement or trade secret claims against the Company with respect to its current or future products or that any such assertion will not require the Company to enter into a license agreement or royalty arrangement with the party asserting the claim. As competing healthcare information systems increase in complexity and overall capabilities and the functionality of these systems further overlaps, providers of such systems may become increasingly subject to infringement claims. Responding to and defending any such claims may distract the attention of Company management and have a material adverse effect on the Company's business, results of operations and financial condition. In addition, claims may be brought against third parties from which the Company purchases software, and such claims could adversely affect the Company's ability to access third party software for its systems. Ability to Manage Growth. The Company has in the past experienced periods of growth which have placed, and may continue to place, a significant strain on the Company's resources. The Company also anticipates expanding its overall software development, marketing, sales, client management and training capacity. In the event the Company is unable to identify, hire, train and retain qualified individuals in such capacities within a reasonable timeframe, such failure could have a material adverse effect on the Company. In addition, the Company's ability to manage future increases, if any, in the scope of its operations or personnel will depend on significant expansion of its research and development, marketing and sales, management, and administrative and financial capabilities. The failure of the Company's management to effectively manage expansion in its business could have a material adverse effect on the Company's business, results of operations and financial condition. Dependence Upon Key Personnel. The Company's future performance also depends in significant part upon the continued service of its key technical and senior management personnel, many of whom have been with the Company for a significant period of time. The Company does not maintain key man life insurance on any of its employees. Because the Company has a relatively small number of employees when compared to other leading companies in the same industry, its dependence on maintaining its employees is particularly significant. The Company is also dependent on its ability to attract and retain high quality personnel, particularly in the areas of sales and applications development. The industry in which the Company operates is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that the Company's current employees will continue to work for the Company. Loss of services of key employees could have a material adverse effect on the Company's business, results of operations and financial condition. Furthermore, the Company may need to grant additional stock options to key employees and provide other forms of incentive compensation to attract and retain such key personnel. Product Liability. Certain of the Company's products provide applications that relate to patient clinical information. Any failure by the Company's products to provide accurate and timely information could result in claims against the Company. In addition, a court or government agency may take the 11 position that the Company's delivery of health information directly, including through licensed practitioners, or delivery of information by a third party site that a consumer accesses through the Company's web sites, exposes the Company to malpractice or other personal injury liability for wrongful delivery of healthcare services or erroneous health information. The Company maintains insurance to protect against claims associated with the use of its products, but there can be no assurance that its insurance coverage would adequately cover any claim asserted against the Company. A successful claim brought against the Company in excess of its insurance coverage could have a material adverse effect on the Company's business, results of operations and financial condition. Even unsuccessful claims could result in the Company's expenditure of funds in litigation and management time and resources. There can be no assurance that the Company will not be subject to product liability claims, that such claims will not result in liability in excess of its insurance coverage, that the Company's insurance will cover such claims or that appropriate insurance will continue to be available to the Company in the future at commercially reasonable rates. Such claims could have a material adverse affect on the Company's business, results of operations and financial condition. Uncertainty in Healthcare Industry; Government Regulation. The healthcare industry is subject to changing political, economic and regulatory influences that may affect the procurement processes and operation of healthcare facilities. During the past several years, the healthcare industry has been subject to an increase in governmental regulation of, among other things, reimbursement rates and certain capital expenditures. In the past, various legislators have announced that they intend to examine proposals to reform certain aspects of the U.S. healthcare system including proposals which may increase governmental involvement in healthcare, lower reimbursement rates and otherwise change the operating environment for the Company's clients. Healthcare providers may react to these proposals, and the uncertainty surrounding such proposals, by curtailing or deferring investments, including those for the Company's systems and related services. Cost-containment measures instituted by healthcare providers as a result of regulatory reform or otherwise could result in a reduction in the allocation of capital funds. Such a reduction could have an adverse effect on the Company's ability to sell its systems and related services. On the other hand, changes in the regulatory environment have increased and may continue to increase the needs of healthcare organizations for cost-effective data management and thereby enhance the overall market for healthcare management information systems. The Company cannot predict what impact, if any, such proposals or healthcare reforms might have on the Company's business, financial condition and results of operations. Certain healthcare professionals who use the Company's Internet-based products will directly enter health information about their patients including information that constitutes a record under applicable law that the Company will store on the Company's computer systems. Numerous federal and state laws and regulations, the common law, and contractual obligations govern collection, dissemination, use and confidentiality of patient-identifiable health information, including: o State privacy and confidentiality laws; o The Company's contracts with customers and partners; o State laws regulating healthcare professionals; o Medicaid laws; and o The Heath Insurance Portability and Accountability Act of 1996 ("HIPAA") and related rules proposed by the Heath Care Financing Administration; and Health Care Financing Administration standards for Internet transmission of health data. The U.S. Congress has been working to finalize proposed legislation that would establish a new Federal standard for protection and use of health information. Any failure by the Company or by its personnel or partners to comply with any of these legal or other requirements may result in a material liability to the Company. Although the Company has systems in place for safeguarding patient health information from unauthorized disclosure, these systems may not preclude claims against the Company for violation of 12 applicable law or other requirements. Other third party sites or links that consumers access through the Company's web sites also may not maintain systems to safeguard this health information, or may circumvent systems the Company put in place to protect the information from disclosure. In addition, future laws or changes in current laws may necessitate costly adaptations to the Company's systems. HIPAA mandates the use of national standards for transmissions of certain patient healthcare information, and prescribes security measures to protect the confidentiality of such information as well as other patient record privacy and security provisions within two years after the adoption of final regulations by the Department of Health and Human Services ("HHS"). These proposed regulations will establish new federal standards for privacy of health information. The Company anticipates that these regulations will directly affect the Company's products and services, but the Company cannot fully predict the impact at this time. The Company's intention is to modify its products and services as necessary to facilitate client compliance with the final regulations, but there can be no assurance that the Company will be able to do so in a timely manner. Achieving compliance with these regulations could be costly and distract management's attention and other resources from the Company's historical business, and any noncompliance by the Company could result in civil and criminal penalties. In addition, development of related Federal and state regulations and policies on confidentiality of health information could negatively affect the Company's business. In addition, the Company's software may be subject to regulation by the U.S. Food and Drug Administration (the "FDA") as a medical device. Such regulation could require the registration of the applicable manufacturing facility and software and hardware products, application of detailed record-keeping and manufacturing standards, and FDA approval or clearance prior to marketing. An approval or clearance requirement could create delays in marketing, and the FDA could require supplemental filings or object to certain of these applications, the result of which could have a material adverse effect on the Company's business, financial condition and results of operations. Results of Operations The following table sets forth for the periods indicated, the percentage of net revenues represented by each item in the Company's Consolidated Statements of Income.
Three Months Ended Six Months Ended September 30, September 30, ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ Net Revenues: Sales of computer systems, upgrades and supplies 48.7% 49.6% 50.0% 48.6% Maintenance and other services 51.3 50.4 50.0 51.4 ------ ------ ------ ------ 100.0 100.0 100.0 100.0 Cost of Products and Services 43.3 45.2 43.4 44.4 ------ ------ ------ ------ Gross Profit 56.7 54.8 56.6 55.6 Selling, General and Administrative Expenses 31.4 33.6 30.5 34.9 Research and Development Costs 9.5 10.1 9.8 10.5 ------ ------ ------ ------ Income from Operations 15.8 11.1 16.3 10.2 Investment Income 1.8 2.6 1.8 2.6 ------ ------ ------ ------ Income before Provision for Income Taxes 17.6 13.7 18.1 12.8 Provision for Income Taxes 6.8 6.1 6.9 5.7 ------ ------ ------ ------ Net Income 10.8% 7.6% 11.2% 7.1% ====== ====== ====== ======
For the Three-Month Periods Ended September 30, 2001 and 2000 The Company's net income for the three months ended September 30, 2001 was $1,132,000 or $0.19 per share on a basic and $.18 per share on a diluted basis, as compared to a net income of $744,000, or $0.12 per share on a basic and diluted basis, for the three months ended September 30, 2000. 13 Net Revenues. Net revenues for the three months ended September 30, 2001 increased 9% to $10.5 million from $9.7 million for the three months ended September 30, 2000. Sales of computer systems, upgrades and supplies increased 7% to $5.1 million from $4.8 million while net revenues from maintenance and other services grew 11% to $5.4 million from $4.9 million during the comparable periods. The increase in net revenues from sales of computer systems, upgrades and supplies was principally the result of an increase in sales of the Company's NextGen EMR and EPM software licenses. The increase in maintenance and other services net revenue resulted principally from an increase in revenues from the Company's increased client base from which to generate maintenance and other service revenue together with an increase in revenues generated from the Company's electronic data interchange services. Cost of Products and Services. Cost of products and services for the three months ended June 30, 2001 rose 4% to $4.7 million from $4.4 million in the prior year quarter, while cost of products and services as a percentage of net revenues to 43.3% compared to 45.2% in the prior year quarter. The dollar increase in the cost of products and services was a result of the impact of higher sales volumes. The cost of products and services as a percentage of net revenues decreased as a result of the impact of increased sales in the September 30, 2001 period together with a change in the relative mix of hardware content in such sales. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended 30, 2001 increased slightly by 1.5% to approximately $3.3 million as compared to $3.2 million for the three months ended September 30, 2000. Selling, general and administrative expenses as a percentage of net revenues decreased to 31.6% from 33.6%. The increase in the dollar amount of such expenses resulted primarily from a combination of a higher level of commissions from the higher sales volumes as well as expenses related to the expansion of the MicroMed sales and marketing staff during the quarter offset by the adoption of FASB 142, which reduced amortization expenses in the September 320, 2001 quarter, and reductions in staffing levels in the QSI division. Research and Development Costs. Research and development costs for the three months ended September 30, 2001 increased 2.7% to $1.0 million compared to $974,000 in the three months ended September 30, 2000. The increase in research and development costs can be attributed primarily to increased investments in NextGen EMR and EPM enhancements. Research and development costs as a percentage of net revenues declined to 9.5% as compared to 10.1% for the respective periods as revenues grew faster than the increase in research and development expense. Investment Income. Investment income for the three months ended September 30, 2001 was down 24% at approximately $190,000 compared to $251,000 in the three months ended September 30, 2000. Investment income in the quarter ended September 30, 2001 declined primarily due to the effect of a drop in short term interest rates which occurred during the quarter. This was partially offset by higher cash balances. Provision for Income Taxes. The provision for income taxes for the three months ended September 30, 2001 was approximately $714,000 as compared to approximately $589,000 for the three months ended September 30, 2000. The provision for income taxes for the three months ended September 30, 2001 and 2000 differ from the combined statutory rates primarily due to the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 Clinitec acquisition and the effect of varying state income tax rates. The adoption of FASB 142 eliminated certain non-deductible amortization expenses during the September quarter resulting in a decline in the Company's effective tax rate to 38.8% in the September 30, 2001 quarter compared to 44.2% in the September 30, 2000 quarter. For the Six-Month Periods Ended September 30, 2001 and 2000 The Company's net income for the six months ended September 30, 2001 was $2.4 million, or $0.40 per share on a basic and $.39 per share on a diluted basis, as compared to $1.4 million, or $0.22 per share on a basic and diluted basis for the six months ended September 30, 2000. 14 Net Revenues Net revenues for the six months ended September 30, 2001 increased 13.1% to $21.4 million from $18.9 million for the six months ended September 30, 2000. Sales of computer systems, upgrades and supplies increased 16.5% to $10.7 million from $9.2 million while net revenues from maintenance and other services grew 9.9% to $10.7 million from $9.7 million during the comparable periods. The increase in net revenues from sales of computer systems, upgrades and supplies was principally the result of increases in the sales of the NextGen EPM and NextGen EMR systems. The increase in maintenance and other services net revenue resulted principally from an increase in revenues from the Company's growing client base from which to generate maintenance and other services revenue together with an increase in revenues generated by the Company's electronic data interchange services. Cost of Products and Services. Cost of products and services for the six months ended September 30, 2001 increased 10.6% to $9.3 million from $8.4 million for the six months ended September 30, 2000 while cost of products and services as a percentage of net revenues decreased to 43.4% from 44.4% during the comparable periods. The cost of products and services as a percentage of net revenues decreased primarily as a result of the impact of a change in the relative mix of hardware content of systems sales. Selling, General and Administrative Expenses Selling, general and administrative expenses for the six months ended September 30, 2001 decreased 1.1% to $6.5 million as compared to $6.6 million for the six months ended September 30, 2000. Selling, general and administrative expenses as a percentage of net revenues decreased to 30.5% from 34.9%. The decrease in the amount of such expenses resulted primarily from the adoption of FASB 142, which reduced amortization expenses, and a reduction in comparative bad debt expense offset by additions to sales personnel and higher commission expenses. Research and Development Costs Research and development costs for the six months ended September 30, 2001 and 2000 were $2.1 million and 2.0 million respectively. Research and development costs as a percentage of net revenues decreased to 9.8% from 10.5% due to the fact that revenues increased more quickly than R&D expense in the respective periods. Investment Income. Investment income for the six months ended September 30, 2001 was down 20% at approximately $396,000 compared to $497,000 in the six months ended September 30, 2000. Investment income in the six months ended September 30, 2001 declined primarily due to the effect of a drop in short term interest rates which occurred during the period. This was partially offset by higher cash balances. Provision for Income Taxes. The provision for income taxes for the six months ended September 30, 2001 was approximately $1,485,000 as compared to approximately $1,070,000 for the six months ended September 30, 2000. The provision for income taxes for the three months ended September 30, 2001 and 2000 differ from the combined statutory rates primarily due to the impact of non-deductible amortization of certain intangible assets acquired in the May 1996 Clinitec acquisition and the effect of varying state income tax rates. The adoption of FASB 142 eliminated certain non-deductible amortization expenses during the six months ended September 2001 resulting in a decline in the Company's effective tax rate to 38.3% in the September 30, 2001 period compared to 43.9% in the September 30, 2000 period. Liquidity and Capital Resources Cash and cash equivalents increased $2,706,000 during the six months ending September 30, 2001 primarily as a result of cash provided by operating activities. Cash and cash equivalents increased approximately $679,000 during the months ended September 30, 2000 primarily as a result of operations, offset by increases in accounts receivable. Net cash provided by operating activities for the six months ended September 30, 2001 was $3.3 million consisting primarily of the Company's $2.4 million in net income adjusted for the principal non-cash operating expenses of depreciation and amortization plus an increase in deferred revenue and other current liabilities offset in part by an increase in other current assets and an increase in accounts receivable. Net cash provided by operating activities for the six months ended September 30, 2000 was approximately $1.8 million consisting primarily of the Company's $1.4 in net income adjusted for the 15 principal non-cash operating expenses of depreciation and amortization plus a large decrease in deferred income taxes less, an increase in accounts receivable and a large decrease in income taxes payable. Net cash used in investing activities for the six months ended September 30, 2001 was $836,000 consisting of additions to equipment and improvements and capitalized software. Net cash used in investing activities for the six months ended September 30, 2000 was $1,144,000 consisting principally of additions to equipment and improvements and capitalized software. Net cash provided by financing activities for the six months ended September 30, 2001 and 2000 was $204,000 and $50,000, respectively, generated primarily by the exercise of stock options. At September 30, 2001, the Company had cash and cash equivalents of $21.2 million and short-term investments of $258,000. Except for the Company's intention to expend funds for the development of complementary products to its existing product line and alternative versions of certain of its products, the Company has no other significant capital commitments and currently anticipates that additions to equipment and improvements for fiscal 2002 will be comparable to fiscal 2001. The Company believes that its cash and cash equivalents and short-term investments on hand at September 30, 2001, together with cash flows from operations, if any, will be sufficient to meet its working capital and capital expenditure requirements for the next year. Item 3. Qualitative and Quantitative Disclosures About Market Risk The Company has a significant amount of cash and short-term investments with maturities less than three months. This cash portfolio exposes the Company to interest rate risk as short-term investment rates can be volatile. Given the short-term maturity structure of the Company's investment portfolio, the Company believes that it is not subject to principal fluctuations and the effective interest rate of the Company's portfolio tracks closely to various short-term money market interest rate benchmarks. PART II - OTHER INFORMATION Item 1. Litigation. On April 22, 1997, a purported class action entitled JOHN P. CAVENY v. QUALITY SYSTEMS, INC., ET AL. was filed in the Superior Court of the State of California for the County of Orange, in which Mr. Caveny, on behalf of himself and all others who purchased the Company's Common Stock between June 26, 1995 and July 3, 1996, alleges that the Company, and Sheldon Razin, Robert J. Beck, Gregory S. Flynn, Abe C. LaLande, Donn Neufeld, Irma G. Carmona, John A. Bowers, Graeme H. Frehner, and Gordon L. Setran (all of the foregoing individuals were either officers, directors or both during the period from June 26, 1995 through July 3, 1996), as well as other defendants not affiliated with the Company, violated California Corporations Code Sections 25400 and 25500, California Civil Code Sections 1709 and 1710, and California Business and Professions Code Sections 17200 et. seq., by issuing positive statements about the Company that allegedly were knowingly false, in part, in order to assist the Company and the individual defendants in selling Common Stock at an inflated price in the Company's March 5, 1996 public offering and at other points during the class period. The complaint seeks compensatory and punitive damages in unspecified amounts, disgorgement, declaratory and injunctive relief, and attorneys' fees. The Company and the other named defendants successfully demurred to the plaintiffs' claim under California Civil Code Sections 1709 and 1710, and that claim, which served as the only basis for plaintiffs' request for punitive damages, has been dismissed from both actions. On January 25, 1999, the court denied plaintiffs' motion to certify the class representative and class legal counsel. Plaintiffs appealed that decision as to class legal counsel. On February 25, 2000, the Fourth District Court of Appeals affirmed the order disqualifying the class legal counsel. On May 9, 2000, the Court of Appeals issued its Remittur certifying its decision as final. 16 In May 2000, plaintiffs associated in additional class legal counsel, and moved for approval by the court. Upon defendants' objection, the court on August 17, 2000, denied plaintiffs' motion, and ordered plaintiffs to retain new class counsel. At the end of November 2000, the plaintiffs retained new class counsel who substituted in for plaintiffs' previous class counsel. The Company and the other named defendants did not oppose plaintiffs' motion for approval of the new class counsel. On January 24, 2001, the court granted the motion to certify class legal counsel. On March 27, 2001, the court approved a notice of class certification to be mailed to shareholders who are potential class members. Between April 9, 2001 and May 9, 2001, class notice was mailed to potential class members. Merits-related discovery in the action had been stayed pending the appointment of class counsel. In March 2001, the plaintiffs requested that documents be produced informally. Following the appointment of class counsel, plaintiffs have propounded two rounds of informal requests for the production of documents. Defendants have produced two rounds of documents informally for plaintiffs' review. The parties are scheduled to appear in court for the next status conference on December 17, 2001. In Management's opinion the outcome of this case is uncertain, and therefore no accrual has been made to the financial statements. On May 14, 1997, a second purported class action entitled WENDY WOO v. QUALITY SYSTEMS, INC., ET AL. was filed in the same court, essentially repeating the allegations in the Caveny lawsuit and seeking identical relief. This action has for all purposes been consolidated with the Caveny action. The Company is a party to various other legal proceedings incidental to its business, none of which are considered by the Company to be material. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submissions of Matters to a Vote of Securities Holders. On August 30, 2001, the Company held its Annual Meeting of Shareholders. At the meeting, the shareholders elected as directors Sheldon Razin (with 5,189,171 affirmative votes and 679,468 votes withheld), Ahmed Hussein (with 5,199,921 affirmative votes and 668,718 votes withheld), Mohammed-Tawfick El-Bardai (with 5,699,901 affirmative votes and 168,738 votes withheld), Dale Hanson (with 5,862,191 affirmative votes and 6,448 votes withheld), Frank Meyer (with 5,862,191 affirmative votes and 6,448 votes withheld), William Small (with 5,862,191 affirmative votes and 6,448 votes withheld), and Emad Zikry (with 5,853,291 affirmative votes and 15,348 votes withheld) The shareholders also ratified the appointment of Grant Thornton LLP as the independent public accountants for the Company for the fiscal year ending March 31, 2002 (with 4,331,932 affirmative votes, 1,535,947 against, and 760 abstaining.) Item 5. Other Information. None. 17 Item 6. Exhibits and Reports on Form 8-K. Exhibits: - --------- None. Reports on Form 8-K: - -------------------- None. Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. QUALITY SYSTEMS, INC. Date: November 9, 2001 By: /s/ LOUIS SILVERMAN ------------------------------------- Louis Silverman Chief Executive Officer Date: November 9, 2001 By: /s/ PAUL HOLT ------------------------------------- Paul Holt Chief Financial Officer; Principal Accounting Officer 18 -----END PRIVACY-ENHANCED MESSAGE-----