-----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, Rzh741yXT8MsBCUdjzD0WZTHkRs8JxQdAaL8to/IcvslFMS46ho4PQWaXaD66ruL rPk5qMThcRdu5F8lZZ5Ytg== 0001169232-04-003949.txt : 20040806 0001169232-04-003949.hdr.sgml : 20040806 20040806163758 ACCESSION NUMBER: 0001169232-04-003949 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040806 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: 04958509 BUSINESS ADDRESS: STREET 1: 18191 VON KARMAN AVENUE CITY: IRVINE STATE: CA ZIP: 92612 BUSINESS PHONE: 7147317171 MAIL ADDRESS: STREET 1: 18191 VON KARMAN AVENUE STREET 2: SUITE 450 CITY: IRVINE STATE: CA ZIP: 92612 10-Q 1 d60288_10q.txt QUARTERLY REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] Commission file number 0-13801 QUALITY SYSTEMS, INC. (Exact name of Registrant as specified in its charter) California 95-2888568 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 18191 Von Karman Avenue, Irvine California 92612 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (949) 255-2600 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes |X| No |_| Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| Indicate the number of shares outstanding of each of the Registrant's classes of Common Stock as of the latest practicable date: 6,364,354 shares of Common Stock, $.01 par value, as of July 28, 2004 ================================================================================ PART I - CONSOLIDATED FINANICAL INFORMATION Item 1. Financial Statements QUALITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS
-------------------------- (In thousands, except per share amounts) June 30, March 31, 2004 2004 (unaudited) - -------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 54,941 $ 51,395 Accounts receivable, net 23,013 20,336 Inventories, net 784 725 Deferred tax assets 2,979 2,979 Other current assets 1,439 1,437 ----------------------- Total current assets 83,156 76,872 Equipment and improvements, net 2,213 2,012 Capitalized software costs, net 3,732 3,608 Deferred tax assets 1,104 1,104 Goodwill 1,840 1,840 Other assets 1,226 1,242 ----------------------- Total assets $ 93,271 $ 86,678 ======================= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,222 $ 1,655 Deferred revenue 19,442 17,263 Accrued compensation & benefits 2,092 2,985 Other current liabilities 3,753 3,770 ----------------------- Total liabilities 28,509 25,673 ----------------------- Commitments and contingencies Shareholders' equity: Common stock, $0.01 par value, 20,000 shares authorized, 6,361 and 6,325 shares issued and outstanding, respectively 64 63 Additional paid-in capital 40,002 39,735 Retained Earnings 26,132 22,750 Deferred compensation (1,436) (1,543) ----------------------- Total shareholders' equity 64,762 61,005 ----------------------- Total liabilities and shareholders' equity $ 93,271 $ 86,678 ======================= - --------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 1 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
--------------------------- (In thousands except per share amounts) Three Months Ended June 30, 2004 2003 - ----------------------------------------------------------------------------------------------- Net revenues: Sales of computer systems, upgrades and supplies $11,084 $ 9,474 Maintenance and other services 9,046 6,832 -------------------- 20,130 16,306 Cost of products and services 8,101 6,610 -------------------- Gross profit 12,029 9,696 Selling, general and administrative expenses 4,953 4,740 Research and development costs 1,612 1,366 -------------------- Income from operations 5,464 3,590 Investment income 120 100 -------------------- Income before provision for income taxes 5,584 3,690 Provision for income taxes 2,202 1,413 -------------------- Net income $ 3,382 $ 2,277 ==================== Net income per share, basic $ 0.53 $ 0.37 -------------------- Net income per share, diluted $ 0.51 $ 0.35 -------------------- Weighted average shares outstanding - basic 6,333 6,157 -------------------- Weighted average shares outstanding - diluted 6,577 6,466 - -----------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 2 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
--------------------------- (In thousands) Three Months Ended June 30, 2004 2003 - --------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net Income $ 3,382 $ 2,277 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 225 219 Amortization of capitalized software costs 418 354 Provision for bad debts 137 52 Non-Cash Compensation from stock option grants 107 -- Changes in: Accounts receivable (2,814) (1,530) Inventories (59) (485) Other assets 14 662 Accounts payable 1,567 (994) Deferred revenue 2,179 2,280 Accrued compensation & benefits (893) (304) Other current liabilities (16) 709 ----------------------- Net Cash Provided By Operating Activities 4,247 3,240 ----------------------- Cash Flows From Investing Activities: Additions to equipment and improvements (426) (175) Additions to capitalized software costs (542) (604) ----------------------- Net Cash Used In Investing Activities (968) (779) ----------------------- Cash Flows from Financing Activities: Proceeds from exercise of stock options 267 72 ----------------------- Net Cash Provided by Financing Activities 267 72 ----------------------- Net Increase in Cash and Cash Equivalents 3,546 2,533 Cash and Cash Equivalents, beginning of period 51,395 36,443 ----------------------- Cash and Cash Equivalents, end of period $ 54,941 $ 38,976 ----------------------- - ---------------------------------------------------------------------------------------
Supplemental Information - During the three months ended June 30, 2004 and 2003, the Company made income tax payments, net of refunds received, of $1,884,000 and $30,000 respectively. See notes to consolidated financial statements. 3 QUALITY SYSTEMS, INC. CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The accompanying unaudited consolidated financial statements as of June 30, 2004 and for the three months ended June 30, 2004 and 2003, have been prepared in accordance with the requirements of Form 10-Q and, therefore, do not include all information and footnotes which would be presented were such financial statements prepared in accordance with generally accepted accounting principles. These financial statements should be read in conjunction with the audited financial statements presented in the Company's Annual Report for the fiscal year ended March 31, 2004. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments which are necessary for a fair presentation of the results of operations for the periods presented. The results of operations for such interim periods are not necessarily indicative of results of operations to be expected for the full year. 2. Summary of Significant Accounting Policies Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant inter-company amounts and transactions have been eliminated. Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principals generally accepted in the United States of America. Revenue Recognition. The Company currently recognizes revenue pursuant to Statement of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-9 "Modification of SOP 97-2, "Software Revenue Recognition". The Company generates revenue from licensing rights to use its software products directly to end-users and value-added resellers (VARs). The Company also generates revenue from sales of hardware and third party software, and implementation, training, software customization and post-contract support ("maintenance") services performed for customers who license its products. A typical system contract contains multiple elements of two or more of the above items. SOP 97-2, as amended, requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. The fair value of an element must be based on objective evidence that is specific to the vendor. When evidence of fair value exists for the delivered and undelivered elements of a transaction, then discounts for individual elements are aggregated and the total discount is allocated to the individual elements in proportion to the elements' fair value to the total contract fair value. When evidence of fair value exists for the undelivered elements only, the residual method, provided for under SOP 98-9, is required to be used. Under the residual method, the Company defers revenue related to the undelivered elements in a system sale based on vendor specific objective evidence ("VSOE") of each element's fair value, which is based on the average sales price of those elements when sold separately, and allocates the remainder of the contract price net of all discounts to revenue recognized from the delivered elements. The Company limits its assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. VSOE is reviewed on a quarterly basis. Undelivered elements of a system sale generally may include implementation and training services, hardware and third party software, maintenance or other services. The Company bills for the entire contract amount upon contract execution. Amounts billed in excess of the amounts contractually due are recorded in accounts receivable as advance billings. Amounts are 4 contractually due when services are performed or in accordance with contractually specified payment dates. Provided the fees are fixed and determinable and collection is considered probable, revenue from licensing rights and sales of hardware and third party software are generally recognized upon shipment and transfer of title. Revenue from implementation, training and software customization services is recognized as the corresponding services are performed. Maintenance revenue is recognized ratably over the contractual maintenance period. Certain system sales contracts contain payment terms based on the performance of certain milestones or include services to provide significant production or customization of the software. License and hardware revenue for such contracts are recognized using the percentage of completion or completed contract method, as appropriate. License arrangements with Value-added resellers (VAR's) do not provide for returns, and thus license revenue from VARs are generally recognized upon shipment. Cash and Cash Equivalents. Cash and cash equivalents generally consist of cash, money market funds and short term U.S. Treasuries. The Company invests a portion of its cash in a money market fund which invests in only investment grade money market instruments from a variety of industries, and therefore bears minimal risk. The average maturity of the investments owned by the money market fund is approximately two months. Accounts Receivable. The Company provides credit terms typically ranging from thirty days to less than twelve months for most system and maintenance contract sales and generally does not require collateral. The Company performs ongoing credit evaluations of its customers and maintains reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management's estimate of the probability of collection for certain troubled accounts. General reserves are established based on the Company's historical experience of bad debt expense and the aging of the Company's accounts receivable balances net of deferred revenues and specifically reserved accounts. Accounts are written off as uncollectible only after the Company has expended extensive collection efforts. Included in accounts receivable are amounts related to maintenance and services which were billed, but which had not yet been rendered as of the end of the fiscal year. Undelivered maintenance and services are included on the balance sheet in deferred revenue. Inventories. Inventories are valued at lower of cost (first-in, first-out) or market. Certain inventories are maintained for customer support pursuant to service agreements and are amortized over a five-year period using the straight-line method. Equipment and Improvements. Equipment and improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of equipment and improvements are provided over the estimated useful lives of the assets, or the related lease terms if shorter, by the straight-line method. Useful lives range from three to seven years. Software Development Costs. Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional development costs are capitalized in accordance with the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Such costs are amortized on a straight line basis over the estimated economic life of the related product, generally three years. The Company performs an annual review of the recoverability of such capitalized software costs. At the time a determination is made that capitalized amounts are not recoverable based on the estimated cash flows to be generated from the applicable software, any remaining capitalized amounts are written off. 5 Stock-Based Compensation. The Company accounts for stock-based employee compensation using the intrinsic value method as prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and has adopted SFAS 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" that supercedes Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. SFAS 148 requires pro forma disclosures of net income and net income per share as if the fair value based method of accounting for stock-based awards had been applied to employee grants. It also requires disclosure of option status on a more prominent and frequent basis. Such disclosure for the quarters ended June 30, 2004 and 2003 is presented immediately below. The Company accounts for stock options and warrants issued to non-employees based on the fair value method, but has not elected this treatment for grants to employees and board members. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period. The Company's fair value calculations for options granted in the quarter ended June 30, 2004 were made using the Black-Scholes option pricing model with the following assumptions: expected life - time required to reach full vesting or approximately 48 months from the date of the grant; stock volatility - 50%, risk free interest rate of 3.0% ; and, no dividends during the expected term. No options were granted in quarter ended June 30, 2003. The Company's calculations are based on a single option valuation approach and forfeitures are recognized as they occur. If the computed fair values of awards had been amortized to expense over the vesting period of the awards, pro forma net income and net income per share would have been as follows:
------------------------- (in thousands, except for per share amounts) Quarter Ended June 30, 2004 2003 - ------------------------------------------------------------------------------- Net Income $ 3,382 $ 2,277 ------------------------- Proforma Option Compensation Cost (Net of Taxes) (79) (51) ------------------------- Proforma Net Income 3,303 2,226 ========================= Reported Basic Net Income Per Share $ 0.53 $ 0.37 ------------------------- Proforma Basic Net Income Per Share 0.52 0.36 ------------------------- Reported Diluted Net Income Per Share 0.51 0.35 ------------------------- Proforma Diluted Net Income Per Share 0.50 0.34 - ------------------------------------------------------------------------------- Fair Value of Option Awards Granted $ 2,942 $ 0 - -------------------------------------------------------------------------------
On October 29, 2003, the Board of Directors granted 60,000 options to selected employees at an exercise price of $15.46 per share. The options vest in four equal annual installments beginning October 29, 2004 and expire on October 29, 2008. Based on the closing share price of the Company's stock on October 29, 2003 ($44.16 per share), this option grant will result in compensation expense of up to $1,722,000 (assuming all employees granted options continue their employment at the Company throughout the entire four year vesting period) to be amortized evenly over the next four years. During the quarter ended June 30, 2004, the Company recognized compensation expense of $107,000 related to these options. On June 10, 2004, the Board of Directors granted 150,000 options to selected employees at an exercise price equal to the market price of the Company's common stock on the date of the grant ($46.67 per share). The options vest in four equal annual installments beginning June 10, 2005 and expire on June 10, 2009. No compensation expense has been recorded for these options. 6 3. Recent Accounting Pronouncements In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition" , which supercedes portions of SAB 101. The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superceded as a result of the issuance of EITF 00-21. While the wording of SAB 104 changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB No. 104 did not have a material effect on the Company's consolidated results of operations, financial position or cash flows. In December 2003, the FASB revised SFAS No. 132 --"Employers' Disclosures about Pensions and Other Postretirement Benefits" . The revisions to SFAS 132 retain the disclosure requirements contained in the original SFAS No. 132 but require additional disclosures describing the types of plan assets, investment strategy, measurement dates, plan obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The adoption of SFAS No. 132 had no effect on the Company's Consolidated Financial statement disclosures, as the Company does not provide any defined benefit plans to its employees. 4. Intangible Assets - Capitalized Software Development Costs In accordance with FASB 142, the Company does not amortize goodwill. The balance of goodwill is related to the Company's NextGen Healthcare Information Systems Division (NextGen), which was acquired by virtue of two acquisitions in May of 1996 and 1997, respectively. In accordance with FASB 142, the Company has compared the fair value of the NextGen Division with the carrying amount of assets associated with the Division and determined that none of the goodwill recorded as of June 30, 2004 was impaired. The fair value of the NextGen Division was determined using a reasonable estimate of future cash flows of the Division and a risk adjusted discount rate to compute a net present value of future cash flows. The Company had the following amounts related to intangible assets:
------------------------------ (in thousands) June 30, 2004 March 31, 2004 (unaudited) - --------------------------------------------------------------------------------- Capitalized software development (3 yrs) ----------------------- Gross Carrying Amount $ 11,152 $ 10,610 ----------------------- Accumulated Amortization (7,420) (7,002) ----------------------- Net Capitalized Software development $ 3,732 $ 3,608 ======================= Aggregate amortization expense during the quarter ended: $ 418 $ 399 ----------------------- - ---------------------------------------------------------------------------------
7 Information related to net capitalized software costs for the three month period ended June 30, 2004 is as follows: -------------- (in thousands) June 30, 2004 (unaudited) - ---------------------------------------------------------------------- Beginning of period $ 3,608 Capitalized 542 Amortization (418) ------- End of period $ 3,732 - ---------------------------------------------------------------------- The following table represents the remaining estimated amortization of intangible assets with determinable lives as of June 30, 2004 (in thousands):
For the year ended March 31, - ----------------------------------------------------------------- 2005 $1,384 2006 1,349 2007 857 2008 142 - ----------------------------------------------------------------- Total $3,732 - -----------------------------------------------------------------
5. Income Taxes The provision for income taxes for the three month periods ended June 30, 2004 and 2003 differ from the expected combined statutory rates primarily due to the estimated impact of varying state income tax rates, as well as estimated research and development tax credits for each of the corresponding periods. The Company has available a balance of approximately $525,000 of research and development credits which may be recognized as a whole or in part, once the amount of the credit has been cleared by the tax authorities, or once the statute of limitations related to the corresponding tax return has passed. The available balance of research and development credits account for approximately 50% of the aggregate federal tax credits accumulated through June 30, 2004. 6. Net Income Per Share The following table reconciles the weighted average shares outstanding for basic and diluted net income per share for the periods indicated. Basic net income per share is based upon the weighted average number of common shares outstanding. Diluted net income per share is based on the assumption that the Company's outstanding options are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 8
--------------------- (in thousands, except per share amounts) Three Months Ended June 30, --------------------- 2004 2003 - -------------------------------------------------------------------------------- Net income $3,382 $2,277 Basic net income per common share: Weighted average of common shares outstanding 6,333 6,157 ------------------ Basic net income per common share $ 0.53 $ 0.37 ------------------ Diluted net income per share: Weighted average of common shares outstanding 6,333 6,157 Effect of potentially dilutive securities (options) 244 309 ------------------ Weighted average common shares outstanding- diluted 6,577 6,466 ------------------ Diluted net income per common share $ 0.51 $ 0.35 ------------------ - --------------------------------------------------------------------------------
8. Operating Segment Information The Company has prepared operating segment information in accordance with Statement of Accounting Standards SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information" to report components that are evaluated regularly by the Company's chief operating decision maker, or decision making group in deciding how to allocate resources and in assessing performance. The Company's reportable operating segments include its NextGen Healthcare Information Systems Division and the QSI Division. The disaggregated financial results of the segments reflect allocation of certain functional expense categories consistent with the basis and manner in which Company management internally disaggregates financial information for the purpose of assisting in making internal operating decisions. Certain corporate overhead costs are not allocated to the individual segments by management. The Company evaluates performance based on stand-alone segment revenue and operating income performance. Because the Company does not evaluate performance based on return on assets at the operating segment level, assets are not tracked internally by segment. Therefore, segment asset information is not presented. Operating segment data for the three month periods ended June 30, 2004 and 2003 is as follows:
------------------------------------------------------------------------- (In thousands) NextGen Healthcare Information Systems Unallocated QSI Division Division Corporate Expenses Consolidated - ------------------------------------------------------------------------------------------------------------ Quarter ended June 30,2004 Revenue $3,982 $16,148 $ -- $20,130 Operating income (loss) $1,264 $ 5,194 $(994) $ 5,464 Quarter ended June 30,2003 Revenue $4,064 $12,242 $ -- $16,306 Operating income (loss) $1,064 $ 3,359 $(833) $ 3,590 - ------------------------------------------------------------------------------------------------------------
9 9. Composition of Accounts Receivable Included in accounts receivable are amounts related to maintenance and services which were billed but not yet rendered as of the end of the period. Undelivered maintenance and services are included on the consolidated balance sheet as part of the deferred revenue balance.
------------------------------- (in thousands) June 30, March 31, 2004 2004 - ----------------------------------------------------------------------------------------------------------------------- Accounts receivable: Accounts receivable, excluding undelivered maintenance and services $ 12,439 $ 13,131 Undelivered maintenance and services billed in advance, included in deferred revenue 11,889 8,498 ----------------------------- Gross accounts receivable 24,328 21,629 ----------------------------- Reserve for bad debts (1,315) (1,293) ----------------------------- Net accounts receivable $ 23,013 $ 20,336 ----------------------------- - -----------------------------------------------------------------------------------------------------------------------
10. Concentration of Credit Risk The Company had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at June 30, 2004. The Company is exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the institutions; however, the Company does not anticipate non-performance by these institutions. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Except for the historical information contained herein, the matter discussed in this quarterly report may include forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact our ability to achieve our goals, and interested persons are urged to review the risks described in Risk Factors" as set forth herein, as well as in our other public disclosures and filings with the Securities and Exchange Commission. The following discussion should be read in conjunction with, and is qualified in our entirety by, the Consolidated Financial Statements and related notes thereto included elsewhere in this Report. Historical results of operations, percentage margin fluctuations and any trends that may be inferred from the discussion below are not necessarily indicative of the operating results for any future period. Critical Accounting Policies. The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an 10 on-going basis, we evaluate estimates, including those related to revenue recognition, uncollectible accounts receivable, and intangible assets, for reasonableness. We base our estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe revenue recognition, the allowance for doubtful accounts, and goodwill impairment are among the most critical accounting policies that impact our consolidated financial statements. We believe that significant accounting policies, as described in Note 2 of our Consolidated Financial Statements, "Summary of Significant Accounting Policies", should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations. Revenue Recognition. Our revenue is primarily generated from the sale of software licenses, services, hardware, maintenance fees, and EDI services. We currently recognize revenue pursuant to Statement of Position No. 97-2, "Software Revenue Recognition", as modified by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect of Certain Transactions", Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements", and SAB 104, "Revenue Recognition". SAB 101 summarizes the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 104 modifies certain guidance provided in SAB 101. Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and amount of revenue recognition. In accordance with the governing revenue recognition guidelines, if the arrangement between vendor and purchaser does not require significant production, modification, or customization of software, revenue should be recognized when all of the following criteria are met: o persuasive evidence of an arrangement exists; o delivery has occurred; o the vendor's fee is fixed or determinable; and o collectibility is probable. In accordance with generally accepted accounting principles in the United States of America, the recognition of software license revenue is based on our assessment that the above criteria have been met. In general, the first two criteria are met with a signed contract and evidence that we have shipped our software to the customer. We determine that our fee is fixed and determinable based on the contract terms, which specify payment terms tied to specific dates and not to any future deliverables. Probability of collection is based on a credit review of customers. The timing or amount of revenue recognition may differ if different assessments of the above listed criteria had been made at the time transactions were recorded in revenue. SOP 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. Our determination of the fair value of each element in multi-element arrangements is based on vendor-specific objective evidence ("VSOE"). We limit our assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. Management determines the price of individual elements sold separately using a rolling average of stand alone transactions. VSOE calculations are reviewed on a quarterly basis. If evidence of fair value of all undelivered elements exists but evidence of fair value does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred at VSOE and the remaining portion of the arrangement fee is recognized as revenue, net of all discounts. 11 Contract accounting is applied where services include significant software modification, development or customization. In such instances, the arrangement fee is accounted for in accordance with SOP 81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts", whereby the revenue is recognized, generally using the percentage-of-completion method measured on labor input hours. The complexity of the estimation process and judgment related to the assumptions, risks and uncertainties inherent with the application of the percentage-of-completion method of accounting affect the amounts of revenue reported in its consolidated financial statements. Valuation Allowances. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We perform ongoing credit evaluations of our customers and maintain reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management's estimate of the probability of collection for certain troubled accounts. General reserves are established based on our historical experience of bad debt expense and the aging of our accounts receivable balances net of deferred revenue and specifically reserved accounts. If the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments, additional allowances would be required. Goodwill Impairment. Our long-lived assets include goodwill of $1.8 million as of June 30, 2004 and 2003, respectively. We adopted SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") effective April 1, 2001. The statement applies to the amortization of goodwill and other intangible assets. We ceased amortizing amounts related to goodwill beginning April 1, 2001. The balance of goodwill is related to our NextGen Division. Under SFAS 142, we are required to perform an annual assessment of the implied fair value of goodwill and intangible assets with indefinite lives for impairment. We have compared the fair value of the NextGen Division with the carrying amount of assets associated with the Division and determined that none of the goodwill recorded as of June 30, 2004 (the date of our last annual impairment test) was impaired. The fair value of the NextGen Division was determined using a reasonable estimate of future cash flows of the Division and a risk adjusted discount rate to compute a net present value of future cash flows. The process of evaluating goodwill for impairment involves the determination of the fair value of our business segments. Inherent in such fair value determinations are certain judgments and estimates, including the interpretation of current economic indicators and market valuations, and assumptions about our strategic plans with regard to operations. To the extent additional information arises or our strategies change, it is possible that our conclusion regarding goodwill impairment could change and result in a material effect on our financial position or results of operations. Research and Development Tax Credits. During the year ended March 31, 2003, we filed amended federal and state tax returns for the fiscal years ended March 31, 1998 through 2001, to take advantage of tax credits related to our research and development activities. In addition, we claimed research and development credit on its tax returns for the years ended March 31, 2004, 2003 and 2002. Management has recorded a cumulative tax benefit through the quarter ended June 30, 2004 which accounts for approximately 50% of the aggregate federal tax credits accumulated through June 30, 2004 due to the uncertainly concerning the ultimate amount to be credited. Management's election to not recognize all of the tax credits claimed represents a significant estimate which affects the effective income tax rate for the Company in the three month periods ending June 30, 2004 and 2003.. Research and development credits taken by the Company involve certain assumptions and judgments regarding qualification of expenses under the relevant tax codes. While the Company we have received all of federal refunds claimed, none of the credits have been audited by the Internal Revenue Service. Credits claimed for state income tax purposes are in the process of being audited. However, no final conclusions have been received by us as of August 1, 2004. Company Overview Quality Systems Inc., comprised of the QSI Division ("QSI Division") and a wholly owned subsidiary, NextGen Healthcare Information Systems, Inc. ("NextGen Division") (collectively, the "Company", "we", "our", or "us") develops and markets healthcare information systems that automate 12 medical and dental practices, networks of practices such as physician hospital organizations (PHO's) and management service organizations ("MSO's"), ambulatory care centers, community health centers, and medical and dental schools. The Company, a California corporation formed in 1974, was founded with an early focus on providing information systems to dental group practices. In the mid-1980's, we capitalized on the increasing focus on medical cost containment and further expanded our information processing systems to serve the medical market. In the mid 1990's we made two acquisitions that accelerated our penetration of the medical market. These two acquisitions formed the basis for what is today the NextGen Division. Today, we serve both the medical and dental markets through our two divisions. The two divisions operate largely as stand-alone operations with each division maintaining it's own distinct product lines, product platforms, development, implementation and support teams, sales staffing, and branding. The two divisions share the resources of the "corporate office" which includes a variety of accounting and other administrative functions. Additionally, there are a small number of clients who are simultaneously utilizing software from each of our two divisions. The QSI Division, co-located with out Corporate Headquarters in Irvine, California, currently focuses on developing, marketing and supporting software suites sold to dental and certain niche medical practices. In addition, the Division supports a number of medical clients that utilize the division's UNIX(1) based medical practice management software product. The NextGen Division, with headquarters in Horsham, Pennsylvania and a second significant location in Atlanta, Georgia, focuses principally on developing and marketing products and services to medical practices. Both divisions develop and market practice management software which is designed to automate and streamline a number of the administrative functions required for operating a medical or dental practice. Examples of practice management software functions include scheduling and billing capabilities. It is important to note that in both the medical and dental environments, practice management software systems have been implemented by the vast majority of practices. Therefore, we actively compete for the replacement market. In addition, both divisions develop and market software that automates the patient record and enhances patient-provider interactions. Adoption of this software, commonly referred to as clinical software, is in its relatively early stages. Therefore, we are typically competing to replace paper-based patient record alternatives as opposed to replacing previously purchased systems. Electronic Data Interchange ("EDI")/connectivity products are intended to automate a number of manual, often paper-based or telephony intensive communications between patients and/or providers and/or payors. Two of the more common EDI services are forwarding insurance claims electronically from providers to payors and assisting practices with issuing statements to patients. Most practices utilize at least some of these services from us or one of our competitors. Other EDI/connectivity services are used more sporadically by client practices. We typically compete to displace incumbent vendors for claims and statements accounts, and attempt to increase usage of other elements in our EDI/connectivity product line. In general, EDI services are only sold to those accounts utilizing software from one of our divisions. The QSI Division's practice management software suite utilizes a UNIX operating system. Its Clinical Product Suite (CPS) utilizes a Windows NT(2) operating system and can be fully integrated with the practice management software from each division. CPS incorporates a wide range of clinical tools including, but not limited to, periodontal charting and digital imaging of X-ray and inter-oral camera - -------- (1) UNIX is a registered trademark of the AT&T Corporation. (2) Microsoft Windows, Windows NT, Windows 95, Windows 98, Windows XP, and Windows 2000 are registered trademarks of the Microsoft Corporation. 13 images as part of the electronic patient record. The Division develops, markets, and manages our EDI/connectivity applications. The QSInet Application Service Provider (ASP/Internet) offering is also developed and marketed by the Division. Our NextGen Division develops and sells proprietary electronic medical records software and practice management systems under the NextGen(R)(3) product name. Major product categories of the NextGen suite include Electronic Medical Records (NextGenemr), Enterprise Practice Management (NextGenepm), Enterprise Appointment Scheduling (NextGeneas), Enterprise Master Patient Index (NextGenepi), NextGen Image Control System (NextGenics), Managed Care Server (NextGenmcs), Electronic Data Interchange, System Interfaces, Internet Operability (NextGenweb), a Patient-centric and Provider-centric Web Portal Solution (NextMD(4).com), and a handheld product (NextGenpda). NextGen products utilize Microsoft Windows technology and can operate in a client-server environment as well as via private intranet, the Internet, or in an ASP environment. We continue to pursue product enhancement initiatives within each division. The majority of such expenditures are currently targeted for the NextGen Division product line and client base. Inclusive of divisional EDI revenue, the NextGen Division accounted for approximately 80% of our revenue for the first quarter of fiscal 2005 compared to 75% in the first quarter of fiscal 2004. The QSI Division accounted for 20% and 25% of revenue in the first quarter of fiscal 2005 and 2004, respectively. The NextGen Division's year over year revenue grew at 32% and 52% in first quarter of fiscal 2005 and 2004, respectively, while the QSI Division's year over year revenue declined by 2% and 4% in the first quarter of fiscal 2005 and 2004 respectively. In addition to the aforementioned software solutions which we offer through our two divisions, each division offers comprehensive hardware and software installation services, maintenance and support services, and system training services. We currently have a base of approximately 900 clients, with each client generally including between one and 500 physicians or dentists. Risk Factors The more prominent risks and uncertainties inherent in our business are described below. However, additional risks and uncertainties may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations will likely suffer. Any of these or other factors could harm our business and future results of operations and may cause you to lose all or part of your investment. We face significant competition. The markets for healthcare information systems are intensely competitive and we face significant competition from a number of different sources. Several of our competitors have significantly greater name recognition as well as substantially greater financial, technical, product development and marketing resources than we do. We compete in all of our markets with other major healthcare related companies, information management companies, systems integrators, and other software developers. Competitive pressures and other factors, such as new product introductions by ourselves or our competitors, may result in price or market share erosion that could have a material adverse effect on our business, results of operations and financial condition. Also, there can be no assurance that our applications will achieve broad market acceptance or will successfully compete with other available software products. Our inability to make initial sales of our systems to newly formed groups and/or healthcare providers that are replacing or substantially modifying their healthcare information systems - -------- (3) NextGen is a registered trademark of NextGen Healtcare Information Systems, Inc (4) NextMD is a registered trademark of NextGen Healtcare Information Systems, Inc 14 could have a material adverse effect on our business, results of operations and financial condition. If new systems sales do not materialize, our near term and longer term revenue will be negatively affected. Our quarterly operating results have historically fluctuated and may do so in the future. Our revenue has fluctuated in the past, and may fluctuate in the future from quarter to quarter and period to period, as a result of a number of factors including, without limitation: o the size and timing of orders from clients; o the length of sales cycles and installation processes; o the ability of our clients to obtain financing for the purchase of our products; o changes in pricing policies or price reductions by us or our competitors; o the timing of new product announcements and product introductions by us or our competitors; o changes in revenue recognition or other accounting guidelines employed by us and/or established by the Financial Accounting Standards Board or other rule-making bodies; o the availability and cost of system components; o the financial stability of clients; o market acceptance of new products, applications and product enhancements; o our ability to develop, introduce and market new products, applications and product enhancements; o our success in expanding our sales and marketing programs; o deferrals of client orders in anticipation of new products, applications or product enhancements; o execution of or changes to Company strategy; o personnel changes; and o general market/economic factors. Our software products are generally shipped as orders are received and accordingly, we have historically operated with a minimal backlog of license fees. As a result, revenue in any quarter is dependent on orders booked and shipped in that quarter and is not predictable with any degree of certainty. Furthermore, our systems can be relatively large and expensive and individual systems sales can represent a significant portion of our revenue and profits for a quarter such that the loss or deferral of even one such sale can have a significant adverse impact on our quarterly revenue and profitability. Clients often defer systems purchases until our quarter end, so quarterly results generally cannot be predicted and frequently are not known until the quarter has concluded. Our sales are dependent upon clients' initial decision to replace or substantially modify their existing information systems, and subsequently a decision as to which products and services to purchase. These are major decisions for healthcare providers, and accordingly, the sales cycle for our systems can vary significantly and typically ranges from three to twelve months from initial contact to contract execution/shipment. Because a significant percentage of our expenses are relatively fixed, a variation in the timing of systems sales and installations can cause significant variations in operating results from 15 quarter to quarter. As a result, we believe that interim period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Further, our historical operating results are not necessarily indicative of future performance for any particular period. We currently recognize revenue pursuant to Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), as modified by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect of Certain Transactions", Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"), and SAB 104, "Revenue Recognition" ("SAB 104"). SAB 101 summarizes the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 104 modifies certain guidance provided in SAB 101. There can be no assurance that application and subsequent interpretations of these pronouncements will not further modify our revenue recognition policies, or that such modifications would not have a material adverse effect on the operating results reported in any particular quarter or year. Due to all of the foregoing factors, it is possible that our operating results may be below the expectations of public market analysts and investors. In such event, the price of our Common Stock would likely be materially adversely affected. The price of our shares and the trading volume of our shares have been volatile historically and may continue to be volatile. Volatility may be caused by a number of factors including but not limited to: o actual or anticipated quarterly variations in operating results; o rumors about our performance, software solutions, or merger and acquisition activity; o changes in expectations of future financial performance or changes in estimates of securities analysts; o governmental regulatory action; o health care reform measures; o client relationship developments; o purchases or sales of company stock; o changes occurring in the markets in general; and o other factors, many of which are beyond our control. Furthermore, the stock market in general, and the market for software, healthcare and high technology companies in particular, has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of actual operating performance. Two of our directors are significant shareholders which makes it possible for them to have significant influence over the outcome of all matters submitted to our shareholders for approval, which influence may be alleged to conflict with our interests and the interests of our other shareholders. Two of our directors and principal shareholders beneficially owned approximately 40% of the outstanding shares of our common stock at March 31, 2004. As such, these shareholders will have significant influence over the outcome of all matters submitted to our shareholders for approval, including the election of our directors and other corporate actions. 16 In addition, such influence by one or both of these affiliates could have the effect of discouraging others from attempting to take us over, and/or reducing the market price offered for our common stock in such an event. We are dependent on our principal products and our new product development. We currently derive substantially all of our net revenue from sales of our healthcare information systems and related services. We believe that a primary factor in the market acceptance of our systems has been our ability to meet the needs of users of healthcare information systems. Our future financial performance will depend in large part on our ability to continue to meet the increasingly sophisticated needs of our clients through the timely development and successful introduction and implementation of new and enhanced versions of our systems and other complementary products. We have historically expended a significant percentage of our net revenue on product development and believe that significant continuing product development efforts will be required to sustain our growth. Continued investment in our sales staff and our client implementation and support staffs will also be required to support future growth. There can be no assurance that we will be successful in our product development efforts, that the market will continue to accept our existing products, or that new products or product enhancements will be developed and implemented in a timely manner, meet the requirements of healthcare providers, or achieve market acceptance. If new products or product enhancements do not achieve market acceptance, our business, results of operations and financial condition could be materially adversely affected. At certain times in the past, we have also experienced delays in purchases of our products by clients anticipating our launch of new products. There can be no assurance that material order deferrals in anticipation of new product introductions from ourselves or other entities will not occur. If the emerging technologies and platforms of Microsoft and others upon which we build our products do not gain broad market acceptance, or if we fail to develop and introduce in a timely manner new products and services compatible with such emerging technologies, we may not be able to compete effectively and our ability to generate revenue will suffer. Our software products are built and depend upon several underlying and evolving relational database management system platforms such as those developed by Microsoft. To date, the standards and technologies upon which we have chosen to develop our products have proven to have gained industry acceptance. However, the market for our software products is subject to ongoing rapid technological developments, quickly evolving industry standards and rapid changes in customer requirements, and there may be existing or future technologies and platforms that achieve industry standard status, which are not compatible with our products. We face the possibility of subscription pricing and/or application service provider, ("ASP") delivered offerings. We currently derive substantially all of our revenue from traditional software license, maintenance and service fees, as well as the resale of computer hardware. Today, customers pay an initial license fee for the use of our products, in addition to a periodic maintenance fee. If the marketplace demands subscription pricing and/or ASP-delivered offerings, we may be forced to adjust our sales, marketing and pricing strategies accordingly, by offering a higher percentage of our products and services through these means. Shifting to subscription pricing and/or ASP-delivered offerings could materially adversely impact our financial condition, cash flows and quarterly and annual revenue and results of operations, as our revenue would initially decrease substantially. There can be no assurance that the marketplace will not embrace subscription pricing and/or ASP-delivered offerings. The industry in which we operate is subject to significant technological change. The software market generally is characterized by rapid technological change, changing customer 17 needs, frequent new product introductions, and evolving industry standards. The introduction of products incorporating new technologies and the emergence of new industry standards could render our existing products obsolete and unmarketable. There can be no assurance that we will be successful in developing and marketing new products that respond to technological changes or evolving industry standards. New product development depends upon significant research and development expenditures which depend ultimately upon sales growth. Any material weakness in revenue or research funding could impair our ability to respond to technological advances or opportunities in the marketplace and to remain competitive. If we are unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, our business, results of operations and financial condition may be materially adversely affected. In response to increasing market demand, we are currently developing new generations of certain of our software products. There can be no assurance that we will successfully develop these new software products or that these products will operate successfully, or that any such development, even if successful, will be completed concurrently with or prior to introduction of competing products. Any such failure or delay could adversely affect our competitive position or could make our current products obsolete. We face the possibility of claims based upon our web site. We could be subject to third party claims based on the nature and content of information supplied on our Web site by us or third parties, including content providers or users. We could also be subject to liability for content that may be accessible through our Web site or third party Web sites linked from our Web site or through content and information that may be posted by users in chat rooms, bulletin boards or on Web sites created by professionals using our applications. Even if these claims do not result in liability to us, investigating and defending against these claims could be expensive and time consuming and could divert management's attention away from our operations. We face the possibility of claims from activities of strategic partners. We rely on third parties to provide services that impact our business. For example, we use national clearinghouses in the processing of some insurance claims and we outsource some of our hardware maintenance services and the printing and delivery of patient statements for our customers. We also have relationships with certain third parties where these third parties serve as sales channels through which we generate a portion of our revenue. Due to these third-party relationships, we could be subject to claims as a result of the activities, products, or services of these third-party service providers even though we were not directly involved in the circumstances leading to those claims. Even if these claims do not result in liability to us, defending and investigating these claims could be expensive and time-consuming, divert personnel and other resources from our business and result in adverse publicity that could harm our business. We may engage in future acquisitions, which may be expensive and time consuming and from which we may not realize anticipated benefits. We may acquire additional businesses, technologies and products if we determine that these additional businesses, technologies and products are likely to serve our strategic goals. We currently have no commitments or agreements with respect to any acquisitions. The specific risks we may encounter in these types of transactions include the following: o Potentially dilutive issuances of our securities, the incurrence of debt and contingent liabilities and amortization expenses related to intangible assets, which could adversely affect our results of operations and financial conditions; o Difficulty in effectively integrating any acquired technologies or software products into our current products and technologies; 18 o Difficulty in predicting and responding to issues related to product transition such as development, distribution and customer support; o The possible adverse impact of such acquisitions on existing relationships with third party partners and suppliers of technologies and services; o The possibility that staff or customers of the acquired company might not accept new ownership and may transition to different technologies or attempt to renegotiate contract terms or relationships, including maintenance or support agreements; o The possibility that the due diligence process in any such acquisition may not completely identify material issues associated with product quality, product architecture, product development, intellectual property issues, key personnel issues or legal and financial contingencies; and o Difficulty in integrating acquired operations due to geographical distance, and language and cultural differences. A failure to successfully integrate acquired businesses or technology for any of these reasons could have a material adverse effect on the Company's results of operations. We face the risks and uncertainties that are associated with litigation against us. We face the risks associated with litigation concerning the operation of our business. The uncertainty associated with substantial unresolved litigation may have an adverse impact on our business. In particular, such litigation could impair our relationships with existing customers and our ability to obtain new customers. Defending such litigation may result in a diversion of management's time and attention away from business operations, which could have a material adverse effect on our business, results of operations and financial condition. Such litigation may also have the effect of discouraging potential acquirers from bidding for us or reducing the consideration such acquirers would otherwise be willing to pay in connection with an acquisition. There can be no assurance that such litigation will not result in liability in excess of our insurance coverage, that our insurance will cover such claims or that appropriate insurance will continue to be available to us in the future at commercially reasonable rates. We rely heavily on our proprietary technology. We are heavily dependent on the maintenance and protection of our intellectual property and we rely largely on license agreements, confidentiality procedures, and employee nondisclosure agreements to protect our intellectual property. Our software is not patented and existing copyright laws offer only limited practical protection. There can be no assurance that the legal protections and precautions we take will be adequate to prevent misappropriation of our technology or that competitors will not independently develop technologies equivalent or superior to ours. Further, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States and are often not enforced as vigorously as those in the United States. We do not believe that our operations or products infringe on the intellectual property rights of others. However, there can be no assurance that others will not assert infringement or trade secret claims against us with respect to our current or future products or that any such assertion will not require us to enter into a license agreement or royalty arrangement or other financial arrangement with the party asserting the claim. Responding to and defending any such claims may distract the attention of Company management and have a material adverse effect on our business, results of operations and financial condition. In addition, claims may be brought 19 against third parties from which we purchase software, and such claims could adversely affect our ability to access third party software for our systems. We are dependent on our license rights from third parties. We depend upon licenses for some of the technology used in our products from third-party vendors. Most of these licenses can be renewed only by mutual consent and may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. We may not be able to continue using the technology made available to us under these licenses on commercially reasonable terms or at all. As a result, we may have to discontinue, delay or reduce product shipments until we can obtain equivalent technology. Most of our third-party licenses are non-exclusive. Our competitors may obtain the right to use any of the technology covered by these licenses and use the technology to compete directly with us. In addition, if our vendors choose to discontinue support of the licensed technology in the future or are unsuccessful in their continued research and development efforts, we may not be able to modify or adapt our own products. We face the possibility of damages resulting from internal and external security breaches, and viruses. In the course of our business operations, we compile and transmit confidential information, including patient health information, in our processing centers and other facilities. A breach of security in any of these facilities could damage our reputation and result in damages being assessed against us. In addition, the other systems with which we may interface, such as the Internet and related systems, may be vulnerable to security breaches, viruses, programming errors, or similar disruptive problems. The effect of these security breaches and related issues could reduce demand for our services. Accordingly, we believe that it is critical that these facilities and related infrastructures not only be secure, but also be viewed by our customers as free from potential breach. Maintaining such standards, protecting against breaches and curing security flaws, may require us to expend significant capital. The success of our strategy to offer our EDI services and Internet solutions depends on the confidence of our customers in our ability to securely transmit confidential information. Our EDI services and Internet solutions rely on encryption, authentication and other security technology licensed from third parties to achieve secure transmission of confidential information. We may not be able to stop unauthorized attempts to gain access to or disrupt the transmission of communications by our customers. Anyone who is able to circumvent our security measures could misappropriate confidential user information or interrupt us, or our customers', operations. In addition, our EDI and Internet solutions may be vulnerable to viruses, physical or electronic break-ins, and similar disruptions. Any failure to provide secure electronic communication services could result in a lack of trust by our customers causing them to seek out other vendors, and/or, damage our reputation in the market making it difficult to obtain new customers. We are subject to the development and maintenance of the Internet infrastructure which is not within our control. We deliver Internet-based services and, accordingly, we are dependent on the maintenance of the Internet by third parties. The Internet infrastructure may be unable to support the demands placed on it and our performance may decrease if the Internet continues to experience it's historic trend of expanding usage. As a result of damage to portions of its infrastructure, the Internet has experienced a variety of performance problems which may continue into the foreseeable future. Such Internet related problems may diminish Internet usage and availability of the Internet to us for transmittal of our Internet-based services. In addition, difficulties, outages, and delays by Internet service providers, online service providers and other web site operators may obstruct or diminish access to our Web site by our customers resulting in a loss of potential or existing users of our services. Our failure to manage growth could harm us. We have in the past experienced periods of growth which have placed, and may continue to place, a significant strain on our non-cash 20 resources. We also anticipate expanding our overall software development, marketing, sales, client management and training capacity. In the event we are unable to identify, hire, train and retain qualified individuals in such capacities within a reasonable timeframe, such failure could have a material adverse effect on us. In addition, our ability to manage future increases, if any, in the scope of our operations or personnel will depend on significant expansion of our research and development, marketing and sales, management, and administrative and financial capabilities. The failure of our management to effectively manage expansion in our business could have a material adverse effect on our business, results of operations and financial condition. Our operations are dependent upon our key personnel. If such personnel were to leave unexpectedly, we may not be able to execute our business plan. Our future performance depends in significant part upon the continued service of our key technical and senior management personnel, many of whom have been with us for a significant period of time. These personnel have acquired specialized knowledge and skills with respect to our business. We do not maintain key man life insurance on any of our employees. Because we have a relatively small number of employees when compared to other leading companies in the same industry, our dependence on maintaining our relationship with key employees is particularly significant. We are also dependent on our ability to attract and retain high quality personnel, particularly in the areas of sales and applications development. The industry in which we operate is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that our current employees will continue to work for us. Loss of services of key employees could have a material adverse effect on our business, results of operations and financial condition. Furthermore, we may need to grant additional equity incentives to key employees and provide other forms of incentive compensation to attract and retain such key personnel. Failure to provide such types of incentive compensation could jeopardize our recruitment and retention capabilities. Our products may be subject to product liability legal claims. Certain of our products provide applications that relate to patient clinical information. Any failure by our products to provide accurate and timely information could result in claims against us. In addition, a court or government agency may take the position that our delivery of health information directly, including through licensed practitioners, or delivery of information by a third party site that a consumer accesses through our web sites, exposes us to assertions of malpractice, other personal injury liability, or other liability for wrongful delivery/handling of healthcare services or erroneous health information. We maintain insurance to protect against claims associated with the use of our products as well as liability limitation language in our end-user license agreements, but there can be no assurance that our insurance coverage or contractual language would adequately cover any claim asserted against us. A successful claim brought against us in excess of or outside of our insurance coverage could have a material adverse effect on our business, results of operations and financial condition. Even unsuccessful claims could result in our expenditure of funds for litigation and management time and resources. Certain healthcare professionals who use our Internet-based products will directly enter health information about their patients including information that constitutes a record under applicable law that we may store on our computer systems. Numerous federal and state laws and regulations, the common law, and contractual obligations, govern collection, dissemination, use and confidentiality of patient-identifiable health information, including: o state and federal privacy and confidentiality laws; o our contracts with customers and partners; 21 o state laws regulating healthcare professionals; o Medicaid laws; o the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") and related rules proposed by the Health Care Financing Administration; and o Health Care Financing Administration standards for Internet transmission of health data. The U.S. Congress has finalized the Health Insurance Portability and Accountability Act of 1996 that established elements including, but not limited to, new federal privacy and security standards for the use and protection of Protected Health Information. Any failure by us or by our personnel or partners to comply with applicable requirements may result in a material liability to us. Although we have systems and policies in place for safeguarding Protected Health Information from unauthorized disclosure, these systems and policies may not preclude claims against us for alleged violations of applicable requirements. Also, third party sites and/or links that consumers may access through our web sites may not maintain adequate systems to safeguard this information, or may circumvent systems and policies we have put in place. In addition, future laws or changes in current laws may necessitate costly adaptations to our policies, procedures, or systems. There can be no assurance that we will not be subject to product liability claims, that such claims will not result in liability in excess of our insurance coverage, that our insurance will cover such claims or that appropriate insurance will continue to be available to us in the future at commercially reasonable rates. Such product liability claims could have a material adverse affect on our business, results of operations and financial condition. We are subject to the effect of payor and provider conduct which we cannot control. Electronic data transmission services are offered by certain payors to healthcare providers that establish a direct link between the provider and payor. This process reduces revenue to third party EDI service providers such as us. Accordingly, we are unable to insure that we will continue to generate revenue at or in excess of prior levels for such services. A significant increase in the utilization of direct links between healthcare providers and payers could have a material adverse effect on our transaction volume and financial results. In addition, we cannot provide assurance that we will be able to maintain our exiting links to payors or develop new connections on terms that are economically satisfactory to us, if at all. There is significant uncertainty in the healthcare industry in which we operate and we are subject to the possibility of changing government regulation. The healthcare industry is subject to changing political, economic and regulatory influences that may affect the procurement processes and operation of healthcare facilities. During the past several years, the healthcare industry has been subject to an increase in governmental regulation of, among other things, reimbursement rates and certain capital expenditures. In the past, various legislators have announced that they intend to examine proposals to reform certain aspects of the U.S. healthcare system including proposals which may change governmental involvement in healthcare and reimbursement rates, and otherwise alter the operating environment for us and our clients. Healthcare providers may react to these proposals, and the uncertainty surrounding such proposals, by curtailing or deferring investments, including those for our systems and related services. Cost-containment measures instituted by healthcare providers as a result of regulatory reform or otherwise could result in a reduction in the allocation of capital funds. Such a reduction could have an adverse effect on our ability to sell 22 our systems and related services. On the other hand, changes in the regulatory environment have increased and may continue to increase the needs of healthcare organizations for cost-effective data management and thereby enhance the overall market for healthcare management information systems. We cannot predict what impact, if any, such proposals or healthcare reforms might have on our business, financial condition and results of operations. The HIPAA regulations, as adopted by the Department of Health and Human Services ("HHS"), established, among other things: o a national standard for electronic transactions and code sets to be used in those transactions involving certain common health care transactions; o privacy regulations to protect the privacy of plan participants and patients' medical records; and o security regulations designed to establish security controls and measures to protect the privacy and confidentiality of personal identifiable health information when it is electronically stored, maintained or transmitted (even if only internally transmitted within a medical practice). While the privacy and transaction and code set standards are currently in effect, the security regulation will become effective by 2005. As these regulations mature and become better defined, we anticipate that these regulations will continue to directly affect certain of our products and services, but we cannot fully predict the impact at this time. We have taken steps to modify our products, services and internal practices as necessary to facilitate our and our client's compliance with the final regulations, but there can be no assurance that we will be able to do so in a timely or complete manner. Achieving compliance with these regulations could be costly and distract management's attention and other resources, and any noncompliance by us could result in civil and criminal penalties. In addition, development of related federal and state regulations and policies regarding the confidentiality of health information or other matters could positively or negatively affect our business. In addition, our software may potentially be subject to regulation by the U.S. Food and Drug Administration (the "FDA") as a medical device. Such regulation could require the registration of the applicable manufacturing facility and software and hardware products, application of detailed record-keeping and manufacturing standards, and FDA approval or clearance prior to marketing. An approval or clearance requirement could create delays in marketing, and the FDA could require supplemental filings or object to certain of these applications, the result of which could have a material adverse effect on our business, financial condition and results of operations. We may be subject to other e-commerce regulations. We may be subject to additional federal and state statutes and regulations in connection with offering services and products via the Internet. On an increasingly frequent basis, federal and state legislators are proposing laws and regulations that apply to Internet commerce and communications. Areas being affected by these regulations include user privacy, pricing, content, taxation, copyright protection, distribution, and quality of products and services. To the extent that our products and services are subject to these laws and regulations, the sale of our products and services could be harmed. We are subject to changes in and interpretations of financial accounting matters that govern the measurement of our performance. Based on our reading and interpretations of relevant guidance, principles or concepts issued by, among other authorities, the American 23 Institute of Certified Public Accountants, the Financial Accounting Standards Board, and the United States Securities and Exchange Commission, Management believes our current sales and licensing contract terms and business arrangements have been properly reported. However, there continue to be issued interpretations and guidance for applying the relevant standards to a wide range of sales and licensing contract terms and business arrangements that are prevalent in the software industry. Future interpretations or changes by the regulators of existing accounting standards or changes in our business practices could result in future changes in our revenue recognition and/or other accounting policies and practices that could have a material adverse effect on our business, financial condition, cash flows, revenue and results of operations. Our earnings may be adversely affected if we change our accounting policy with respect to employee stock options. Stock options have from time to time been an important component of the compensation packages for many of our mid- and senior-level employees. We currently do not deduct the expense of employee stock option grants from our income. Many companies, however, are considering a change to their accounting policies to record the value of stock options issued to employees as an expense and changes in the accounting treatment of stock options are currently under consideration by the Financial Accounting Standards Board or other accounting standards-setting bodies. If we were to voluntarily or involuntarily change our accounting policy with respect to the treatment of employee stock option grants, our earnings could be materially adversely affected. Continuing worldwide political and economic uncertainties may adversely impact our revenue and profitability. In the last three years, worldwide economic conditions have experienced a downturn due to numerous factors including but not limited to concerns about inflation and deflation, decreased consumer confidence, the lingering effects of international conflicts, and terrorist and military activities. These conditions make it extremely difficult for our customers, our vendors and ourselves to accurately forecast and plan future business activities, and they could cause constrained spending on our products and services, and/or delay and lengthen sales cycles. 24 Results of Operations The following table sets forth for the periods indicated, the percentage of net revenues represented by each item in our Consolidated Statements of Income.
--------------------------- (unaudited) Three Months Ended June 30, 2004 2003 - ---------------------------------------------------------------------------- Net Revenues: Sales of computer systems, upgrades and supplies 55.1% 58.1% Maintenance and other services 44.9 41.9 ------------------ 100.0 100.0 Cost of Products and Services 40.2 40.5 ------------------ Gross Profit 59.8 59.5 Selling, General and Administrative Expenses 24.6 29.1 Research and Development Costs 8.0 8.4 ------------------ Income from Operations 27.2 22.0 Investment Income 0.6 0.6 ------------------ Income before Provision for Income Taxes 27.8 22.6 Provision for Income Taxes 11.0 8.6 ------------------ Net Income 16.8% 14.0% ------------------ - ----------------------------------------------------------------------------
For the Quarter Ended June 30, 2004 versus 2003 For the quarter ended June 30, 2004, our net income was $3,382,000 or $ 0.53 per share on a basic and $ 0.51 per share on a fully diluted basis. In comparison, we earned $2,277,000 or $.37 per share on a basic and $0.35 on a fully diluted basis in the quarter ended June 30, 2003. The increase in net income for the quarter ended June 30, 2004, was achieved through the following: o a 23% increase in revenue; and o Selling, general and administrative and research and development expenses which grew at 4% and 18% respectively; slower than the overall revenue growth rate. Net Revenue. Net revenue for the quarter ended June 30, 2004 increased 23% to $20.1 million from $16.3 million for the year ended June 30, 2003. NextGen Division net revenue increased 32% from approximately $12.2 million to approximately $16.1 million in the period, while QSI Division net revenue declined by 2% during the period from approximately $4.1 million to approximately $ 4.0 million. We report revenue in two categories, "Computer systems, upgrades, and supplies" and "Maintenance and other". Revenue in the computer systems, upgrades, and supplies category includes software license fees, third party hardware and software, and implementation and training services related to purchase of the Company's software systems. The majority of the revenue in the Computer systems, upgrades, and supplies category is related to the sale of software systems. Revenue in the maintenance and other category includes maintenance, EDI, and other revenue. Maintenance and EDI revenue are the principal sources of revenue in this category. 25 Computer systems, upgrades and supplies. Company-wide sales of computer systems, upgrades and supplies increased 17% to $11.1 million from $9.5 million. Our increase in revenue from sales of computer systems, upgrades and supplies for the Company was principally the result of a 18% increase in such revenue at out NextGen Division whose sales in this category grew from $9.0 million to $10.6 million. This increase was driven primarily by higher sales of NextGenemr and NextGenepm software to both new and existing clients, as well as related implementation services and hardware and third party software. Category revenue in the QSI Division was unchanged at approximately $0.5 million. Maintenance and Other. Company-wide revenue from maintenance and other services grew 32% to $ 9.0 million from $6.8 million. The increase in this category resulted principally from an increase in maintenance and EDI revenue from the NextGen Division's client base. Total NextGen Division maintenance revenue for the quarter ended June 30, 2004 grew 72% to $3,755,000 from $2,183,000 in the year ago period, while EDI revenue grew 78% to $1,060,000 compared to $596,000 during the same period. QSI Division maintenance revenue declined 3% from $1,938,000 to $1,884,000 in the same period while QSI Divisional EDI revenue declined by approximately 9% from $1,342,000 to $1,228,000. The following table details revenue by category for the three month periods ended June 30, 2004 and 2003:
------------------------------------------------------------------------------- Quarter Ended June 30, 2004 Quarter Ended June 30, 2003 (in thousands) ------------------------------------------------------------------------------- QSI NextGen Consolidated QSI NextGen Consolidated - -------------------------------------------------------------------------------------------------------------------- Computer Systems, upgrades & supplies $ 520 $10,564 $11,084 $ 504 $ 8,970 $ 9,474 =========================================================================== Maintenance 1,884 3,755 5,639 1,938 2,183 4,121 --------------------------------------------------------------------------- EDI 1,228 1,060 2,288 1,342 596 1,938 --------------------------------------------------------------------------- Other 349 770 1,119 280 493 773 =========================================================================== Total Maintenance & Other 3,461 5,585 9,046 3,560 3,272 6,832 Total Revenue $3,981 $16,149 $20,130 $4,064 $12,242 $16,306 - --------------------------------------------------------------------------------------------------------------------
Cost of Products and Services. Cost of products and services for the quarter ended June 30, 2004 increased 23% to $ 8.1 million from $6.6 million for the quarter ended June 30, 2004, while the cost of products and services as a percentage of net revenue decreased to 40.2% from 40.5% during the same period a year ago. Our consolidated gross margins are impacted by the level of hardware content included in system sales, the percentage of EDI revenue in our overall sales mix, and certain headcount expenses directly related to the cost of delivering our products and services. Consolidated gross margin percentages were also impacted by the higher margin revenues of the NextGen Division which increased it's share of our total revenue to 80% from 75% in the prior year quarter. Gross margins at the NextGen Division for the quarter ended June 30, 2004 declined to 61.9% from 63.2% in the prior year quarter primarily due to an increase in the relative level of applicable headcount expense associated with delivering our products and services. The QSI 26 Division's gross margin improved to 51.0% in the quarter ended June 30, 2004 from 48.3% in the same period last year due to a proportionately lower hardware and third party software content included in revenue. The following table details revenue and cost of products and services on a consolidated and divisional basis for the three month periods ended June 30, 2004 and 2003:
---------------------------------------------- (in thousands) Quarter Ended June 30, ---------------------------------------------- 2004 % 2003 % ==================================================================================================== Consolidated --------------------------------------------- Net Revenue $20,130 100.0% $16,306 100.0% --------------------------------------------- Cost of Product & Services 8,101 40.2% 6,610 40.5% --------------------------------------------- Gross Margin 12,029 59.8% 9,696 59.5% ============================================= NextGen Division --------------------------------------------- Net Revenue $16,148 100.0% $12,242 100.0% --------------------------------------------- Cost of Product & Services 6,151 38.1% 4,507 36.8% --------------------------------------------- Gross Margin 9,997 61.9% 7,735 63.2% ============================================= QSI Division --------------------------------------------- Net Revenue $ 3,982 100.0% $ 4,064 100.0% --------------------------------------------- Cost of Product & Services 1,950 49.0% 2,103 51.7% ============================================= Gross Margin $ 2,032 51.0% $ 1,961 48.3% - ---------------------------------------------------------------------------------------------------
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the quarter ended June 30, 2004 increased 4% to $4.9 million as compared to $4.7 million for the quarter ended June 30, 2003. The increase in the amount of such expenses resulted primarily from increases of $0.2 million in general, unallocated corporate expenses. Selling, general and administrative expenses as a percentage of revenue declined from 29.1% in the quarter ended June 30, 2003 to 24.6% in the quarter ended June 30, 2004 due to minimal growth in consolidated non-corporate selling, general and administrative expenses compared to the prior year. Total selling, general and administrative expenses in the NextGen Division increased by approximately $0.2 million dollars compared to the prior year, this was mostly offset by $0.2 million dollar decrease in the same type of expenses at the QSI Division. Research and Development Costs. Research and development costs for the quarter ended June 30, 2004 and 2003 were $1.6 million and $1.4 million, respectively. The increase in research and development expenses were primarily due to increased investment in the NextGen product line. Research and development costs as a percentage of net revenue decreased to 8.0% from 8.4% due in part, to the fact that revenue growth exceeded the increase in research and development spending. Research and development expenses are expected to continue at or above current levels. 27 Investment Income. Investment income for the quarter ended June 30, 2004 increased 20% to approximately $120,000 compared with $100,000 in the quarter ended June 30, 2003. Investment income in the quarter ended June 30, 2004 increased primarily due to the effect of an increase in average funds available for investment during the quarter ended June 30, 2004, offset by a drop in short term interest rates versus the prior year quarter. Provision for Income Taxes. The provision for income taxes for the quarter ended June 30, 2004 was approximately $2.2 million as compared to approximately $1.4 million for the year ago period. The effective tax rates for the quarter ended June 30, 2004 and 2003 were 39.4% and 38.3%, respectively. The provision for income taxes for the quarters ended June 30, 2004 and 2003 differ from the combined statutory rates primarily due to the impact of varying state income tax rates and the impact of research and development tax credits. The effective rate for the quarter ended June 30, 2004 increased from the prior year primarily due to a relatively smaller impact of research and development tax credits as well as slightly higher effective federal income tax rates. Liquidity and Capital Resources The following table presents selected financial statistics and information for each of the three months ended June 30, 2004 and 2003:
---------------------- ($ in thousands) Quarter Ended June 30, (unaudited) 2004 2003 - ------------------------------------------------------------------------------------------ Cash and cash equivalents $54,941 $38,976 -------------------- Net increase in cash and cash equivalents during the quarter $ 3,546 $ 2,533 -------------------- Net income during the quarter $ 3,382 $ 2,277 -------------------- Net cash provided by operations during the quarter $ 4,247 $ 3,240 -------------------- Number of days of sales outstanding at start of quarter 99 106 -------------------- Number of days of sales outstanding at end of quarter 104 107 - ------------------------------------------------------------------------------------------
The Company's principal source of cash was cash provided by operations. The number of days sales outstanding at the end of the quarter increased by five days compared to the beginning of the quarter primarily due to an increase in the volume of services sold by the NextGen Division which had not yet been rendered resulting in an increase in both accounts receivable and deferred revenue. Provided turnover of accounts receivable, deferred revenue, and profitability remain consistent with the quarter ended June 30, 2004, the Company anticipates being able to continue to generate cash from operations primarily from the net income of the Company. Cash and cash equivalents increased $3,546,000 between March 31, 2004 and June 30, 2004 primarily as a result of cash provided by operating activities. Cash and cash equivalents increased approximately $2.5 million during the three months ended June 30, 2003, also primarily as a result of cash generated by operating activities. Net cash used in investing activities for the three months ended June 30, 2004 and 2003 was $1.0 and $0.8 million respectively. Net cash used in investing activities for the three months ended June 30, 2004 and 2003 consisted of additions to equipment and improvements and capitalized software. 28 At June 30, 2004, we had cash and cash equivalents of $54.9 million. We intend to expend funds for the development of products complementary to its existing product line as well as new versions of certain of its products. These developments are intended to take advantage of more powerful technologies and to increase the integration of our products. We have no additional significant current capital commitments. Management believes that its cash and cash equivalents on hand at June 30, 2004, together with cash flows from operations, if any, will be sufficient to meet its working capital and capital expenditure requirements for the balance of fiscal 2005. The following table summarizes our significant contractual obligations at June 30, 2004, and the effect that such obligations are expected to have on our liquidity and cash in future periods:
- ---------------------------------------------------------------------------------------------------------------------- Contractual Obligations Total Less than a 1-3 years 3-5 years Beyond 5 year years - ---------------------------------------------------------------------------------------------------------------------- Non-concealable lease obligations 3,594 1,092 1,331 1,120 51 - ----------------------------------------------------------------------------------------------------------------------
Item 3. Qualitative and Quantitative Disclosures About Market Risk We have a significant amount of cash and short-term investments with maturities less than three months. This cash portfolio exposes us to interest rate risk as short-term investment rates can be volatile. Given the short-term maturity structure of our investment portfolio, we believe that it is not subject to principal fluctuations and the effective interest rate of our portfolio tracks closely to various short-term money market interest rate benchmarks. Item 4. Disclosure Controls and Procedures The Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively) conducted an evaluation of the design and operation of our "disclosure controls and procedures" (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act")). Based on that evaluation, which was conducted within 90 days of the date on which this quarterly report was filed with the Securities and Exchange Commission, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to ensure that information required to be disclosed by use in the reports filed or submitted by us under the Exchange Act is accumulated, recorded, processed, summarized and reported to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding whether or not disclosure is required. During the quarter ended June 30, 2004, the following changes have occurred in our "internal controls over financial reporting" (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting occurred. We began a process of implementing new software which will automate certain processes surrounding the recognition and the deferral of revenue related to our software sales arrangements with multiple elements. These processes include computing the amount of deferred revenue related to undelivered elements at the time a new sales arrangement is recorded and then subsequently recognizing the applicable portion of revenue as the elements are delivered to customers or are earned. These processes have historically been, and are currently being performed manually. During the quarter ended June 30, 2004 we used both the existing manual process as well as the new software to perform in a parallel manner the processes described above which related to revenue recognition of our software sales arrangements with multiple elements. As of June 30, 2004 (i) we had not developed sufficient controls 29 over our new software in order to rely on the new automated processes and instead, relied on our existing manual process for the June 30, 2004 quarter financial statements and (ii) we had also not completed our evaluation over our internal controls related to this new software. We have hired a third party accounting firm to assist in the process of evaluating and documenting our internal controls structure. Our goal is for this process to be completed by the end of the September 30, 2004 quarter. PART II - OTHER INFORMATION Item 1. Legal Proceedings. None Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submissions of Matters to a Vote of Securities Holders. None Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. Exhibits: 31.1 Certifications Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Reports on Form 8-K: On May 27, 2004, we filed a Report on Form 8-K with the SEC concerning the Company's financial performance for the period ended March 31, 2004. A copy of our press release announcing the results and certain other information was attached to the Report on Form 8-K. On June 3, 2004, we filed a Report on Form 8-K with the SEC concerning a transcript of the conference call with management covering the financial performance for the period ended March 31, 2004. A copy of a transcript of the conference call was attached to the report on Form 8-K. 30 On June 17, 2004, we filed a Report on Form 8-K with the SEC concerning a letter dated June 11,2004 from Dale Hanson, a member of our Board of Directors, informing us that Mr. Hanson has chosen not to stand for re-election at our 2004 Annual Shareholders' Meeting Pursuant to the requirements of the Securities Exchange Act of 1934, we have duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. QUALITY SYSTEMS, INC. Date: August 5, 2004 By: /s/ Louis Silverman --------------------------------- Louis Silverman Chief Executive Officer Date: August 5, 2004 By: /s/ Paul Holt ------------------------ Paul Holt Chief Financial Officer; Principal Accounting Officer 31 EX-31.1 2 d60288_ex31-1.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATIONS I, Louis Silverman, certify that: 1. I have reviewed this Form 10-Q of Quality Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) [language omitted pursuant to SEC Release 34-47986] for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [Omitted pursuant to SEC Release 34-47986]; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 5, 2004 /s/ LOUIS SILVERMAN - ------------------------------------ Louis Silverman Chief Executive Officer (principal executive officer) 32 I, Paul Holt, certify that: 1. I have reviewed this Form 10-Q of Quality Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) [language omitted pursuant to SEC Release 34-47986] for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [Omitted pursuant to SEC Release 34-47986]; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 5, 2004 /s PAUL HOLT - ------------------------------------ Paul Holt Chief Financial Officer (principal financial officer) 33 EX-32.1 3 d60288_ex32-1.txt CERTIFICATION EXHIBIT 32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the quarterly report on Form 10-Q of Quality Systems, Inc. (the "Company") for the quarterly period ended June 30, 2003 (the "Report"), the undersigned hereby certify in their capacities as Chief Executive Officer and Chief Financial Officer of the Company, respectively, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 5, 2004 By: /s/ LOUIS SILVERMAN --------------------------------- Louis Silverman Chief Executive Officer (principal executive officer) Dated: August 5, 2004 By: /s/ PAUL HOLT --------------------------------- Paul Holt Chief Financial Officer (principal financial officer) A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signatures that appear in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 34 -----END PRIVACY-ENHANCED MESSAGE-----