-----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, Tpej4oXhprX17DTITkdAQCQzYM4C09iH4Llo1U6shuiIMkWYErVQOevvEos9T21Y t+MUaGkc6DmAMCgpd1OWIQ== 0001169232-05-002145.txt : 20050418 0001169232-05-002145.hdr.sgml : 20050418 20050418071145 ACCESSION NUMBER: 0001169232-05-002145 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20050418 DATE AS OF CHANGE: 20050418 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/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-12537 FILM NUMBER: 05755339 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/A 1 d63390_10q-a.txt FORM 10-Q/A ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Amendment No. 2) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [ 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: 13,110,885 shares of Common Stock, $.01 par value, as of April 15, 2005. ================================================================================ PURPOSE OF AMENDMENT This Amendment No. 2 to Form 10-Q is being filed solely to amend Part I, Item 2. to modify NextGen maintenance billing site information to conform to what was presented in our December 31, 2004 quarterly filing, which counts resellers who are being billed for more than one end user as one billing site. PART I - FINANCIAL INFORMATION Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Except for the historical information contained herein, the matters discussed in this quarterly report 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 its 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 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 our 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. We currently recognize 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". We generate revenue from the sale of licensing rights to use our software products sold directly to end-users and value-added resellers (VARs). We also generate revenue from sales of hardware and third party software, and implementation, training, software customization, EDI, post-contract support ("maintenance") and other services performed for customers who license our products. A typical system contract contains multiple elements 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 vendor specific objective evidence ("VSOE"). We limit our assessment of VSOE for each element 1 to either the price charged when the same element is sold separately (using a rolling average of stand alone transactions) or the price established by management having the relevant authority to do so, for an element not yet sold separately. VSOE calculations are updated and reviewed at the end of each quarter. 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 relative 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 used. Under the residual method, the Company defers revenue related to the undelivered elements in a system sale based on VSOE of fair value of each of the undelivered elements, and allocates the remainder of the contract price net of all discounts to revenue recognized from the delivered elements. Undelivered elements of a system sale may include implementation and training services, hardware and third party software, maintenance, future purchase discounts, or other services. If VSOE of fair value of any undelivered element does not exist, all revenue is deferred until VSOE of fair value of the undelivered element is established or the element has been delivered. We bill 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 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 is generally recognized upon shipment and transfer of title. Revenue from implementation and training services is recognized as the corresponding services are performed. Maintenance revenue is recognized ratably over the contractual maintenance period. 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". Pursuant to SOP 81-1, the Company uses the percentage of completion method provided all of the following conditions exist: o contract includes provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement; o the customer can be expected to satisfy its obligations under the contract.; o the Company can be expected to perform it's contractual obligations; and o reliable estimates of progress towards completion can be made. We measure completion using labor input hours. Costs of providing services, including services accounted for in accordance with SOP 81-1, are expensed as incurred. If a situation occurs in which a contract is so short term that the financial statements would not vary materially from using the percentage-of-completion method or in which we are unable to make reliable estimates of progress of completion of the contract, the completed contract method is utilized. From time to time, we offer future purchase discounts on our products and services as part of our sales arrangements. Pursuant to AICPA TPA 5100.51, discounts which are incremental to the range of discounts reflected in the pricing of the other elements of the arrangement, which are incremental to the range of discounts typically given in comparable transactions, and which are significant, are treated as an additional element of the contract to be deferred. Amounts deferred related to future purchase options are not recognized until either the customer exercises the discount offer or the offer expires. 2 Valuation Allowances. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We perform 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 September 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 certain 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 our tax returns for the years ended March 31, 2004, 2003 and 2002. Management has recorded a cumulative tax benefit which accounts for approximately 50% of the aggregate federal tax credits accumulated through September 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 six month periods ending September 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 we have received all of federal refunds claimed on the amended returns for fiscal years ended March 31, 1998 through 2001, 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 November 9, 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 certain aspects of 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 3 the medical market. These two acquisitions formed the basis for what is today the NextGen Division. Today, we serve 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 our 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 for 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 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 (NextGen(epm)), - -------- (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. (3) NextGen is a registered trademark of NextGen Healthcare Information Systems, Inc. 4 Enterprise Appointment Scheduling (NextGen(eas)), Enterprise Master Patient Index (NextGen(epi)), NextGen Image Control System (NextGen(ics)), Managed Care Server (NextGen(mcs)), Electronic Data Interchange, System Interfaces, Internet Operability (NextGen(web)), a Patient-centric and Provider-centric Web Portal solution (NextMD(4).com), and a handheld product (NextGen(pda)). 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 to the NextGen Division product line and client base. Inclusive of divisional EDI revenue, the NextGen Division accounted for approximately 81% of our revenue for the second quarter of fiscal 2005 compared to 76% in the second quarter of fiscal 2004. The QSI Division accounted for 19% and 24% of revenue in the second quarter of fiscal 2005 and 2004, respectively. The NextGen Division's year over year revenue grew at 38% and 57% in second quarter of fiscal 2005 and 2004, respectively, while the QSI Division's year over year revenue declined by 6% and 5% in the second 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. 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 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; - ---------- (4) NextMD is a registered trademark of NextGen Healthcare Information Systems, Inc. 5 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 decisions 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 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. 6 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. 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 7 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 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 8 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 but are not limited to 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; 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. 9 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 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 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 10 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; 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 11 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 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, 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 12 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 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 per share price may be adversely effected if weaknesses in our internal controls are identified by ourselves or our independent auditors. Any weaknesses identified in our internal controls as part of the evaluation being undertaken by us and our independent public accountants pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 could have an adverse effect on our business and the price at which our stock trades. 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 13 forecast and plan future business activities, and they could cause constrained spending on our products and services, and/or delay and lengthen sales cycles. Results of Operations Overview of results o We have experienced significant growth in revenue as a result of revenue growth in our NextGen division. Revenue grew 22% on a consolidated basis in the six months ended September 30, 2004 versus 2003 and 34% in the six months ended September 30, 2003 versus 2002. o Consolidated Operating Income grew 54% in the six months ended September 30, 2004 versus 2003 and 42% in the six months ended September 30, 2003 versus 2002. This performance was driven in large part by the results in our NextGen Division. o We have benefited and hope to continue to benefit from the increased demands on healthcare providers for greater efficiency and lower costs, as well as increased adoption rates for electronic medical records and other technology. NextGen Division o Our NextGen Division has experienced significant growth in revenue and operating income. Divisional revenue grew 30% in the six months ended September 30, 2004 versus 2003 and 57% in the six months ended September 30, 2003 versus 2002 while divisional operating income grew 56% in the six months end September 30, 2004 and 72% in the six months ended September 30, 2003. o During the six months ended September 30, 2004, we added staffing resources to departments including sales, support, implementation, and software development areas and intend to continue to do so during the remainder of fiscal year 2005. o Our goals include continuing to further enhance our existing products, developing new products for targeted markets, continuing to add new customers, and expanding penetration of connectivity services to new and existing customers. QSI Division o Our QSI division experienced a revenue decline of 5% in the six months ended September 30, 2004 versus 2003 and 3% in the six months ended September 30, 2003 versus 2002. The division experienced a 2% increase in operating income in the six months ended September 30, 2004 and 2003. o Our goals for the QSI division include maximizing revenue and profit performance given the constraints present in this division's target market. 14 The following table sets forth for the periods indicated, the percentage of net revenues represented by each item in our Consolidated Statements of Income.
-------------------------------------------------------- Three Months Ended Six Months Ended (unaudited) September 30, September 30, - ---------------------------------------------------------------------------------------------------------- 2004 2003 2004 2003 -------------------------------------------------------- Net revenues: Software, hardware and supplies 43.9 46.7 43.8 47.3 Implementation and training services 10.8 10.1 11.0 10.1 -------------------------------------------------------- Systems sales 54.7% 56.8% 54.8% 57.4% Maintenance and other services 45.3 43.2 45.2 42.6 -------------------------------------------------------- 100.0 100.0 100.0 100.0 Cost of revenue: Software, hardware and supplies 8.0 14.8 9.8 13.5 Implementation and training services 7.4 7.3 7.2 7.5 -------------------------------------------------------- Total cost of System sales 15.4 22.1 17.0 21.0 Cost of Maintenance and other services 22.0 20.4 21.8 20.5 -------------------------------------------------------- Total cost of revenue 37.4 42.5 38.8 41.5 -------------------------------------------------------- Gross profit 62.6 57.5 61.2 58.5 Selling, General and Administrative Expenses 25.5 27.0 25.1 28.0 Research and Development Costs 8.6 8.5 8.3 8.4 -------------------------------------------------------- Income from Operations 28.5 22.0 27.8 22.0 Investment Income .8 .5 .7 .6 -------------------------------------------------------- Income before Provision for Income Taxes 29.3 22.5 28.5 22.6 Provision for Income Taxes 11.8 8.9 11.3 8.8 -------------------------------------------------------- Net Income 17.5% 13.6% 17.2% 13.8% - ----------------------------------------------------------------------------------------------------------
For the Three-Month Periods September 30, 2004 versus 2003 Net Income. The Company's net income for the three months ended September 30, 2004 was $3,715,000 or $ 0.58 per share on a basic and $ 0.56 per share on a fully diluted basis. In comparison, we earned $2,408,000 or $0.39 per share on a basic and $0.37 per share on a fully diluted basis for the three months ended September 30, 2003. The increase in net income for the three months ended September 30, 2004 was achieved through the following: o a 20% increase in consolidated revenue; and o selling, general and administrative expenses and cost of revenues which grew at 14% and 6% respectively; slower than the overall revenue growth rate. Net Revenue. Net revenue for the three months ended September 30, 2004 increased 20% to $21.2 million from $17.6 million for the three months ended September 30, 2003. NextGen Division net revenue increased 28% from approximately $13.5 million to approximately $17.3 million in the period, while QSI Division net revenue declined by 5% during the period from approximately $4.2 million to approximately $ 4.0 million. 15 We report revenue in two major categories, "Systems sales" and "Maintenance and other services". Revenue in the Systems sales category includes software license fees, hardware, third party software, supplies and implementation and training services related to purchase of the Company's software systems. The majority of the revenue in the System sales category is related to the sale of software. 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. Systems Sales. Company-wide sales of systems for the three months ended September 30, 2004 increased 16% to $11.6 million from $10.0 million in the prior year quarter. Our increase in revenue from sales of systems was principally the result of a 16% increase in category revenue at our NextGen Division whose sales in this category grew from $9.5 million during the quarter ended September 30, 2003 to $11.0 million during the quarter ended September 30, 2004. This increase was driven primarily by higher sales of NextGenemr and NextGenepm software to both new and existing clients, as well as delivery of related implementation services offset by declines in related hardware, third party software, and supplies. Systems sales revenue in the QSI Division was relatively unchanged at approximately $0.6 million in each period. The following table breaks down our reported Systems sales into software, hardware, third party software, supplies, and implementation and training services components by division:
------------------------------------------------------------- Hardware, Third Party Implementation Software & & Training (In thousands) Software Supplies Services Systems sales - ------------------------------------------------------------------------------------------------ Three Months Ended September 30, 2004 - ------------------------------------------------------------------------------------------------ NextGen $ 7,484 $ 1,306 $ 2,200 $ 10,990 - ------------------------------------------------------------------------------------------------ QSI Division 196 321 100 617 - -----------------------------------============================================================= Consolidated $ 7,680 $ 1,627 $ 2,300 $ 11,607 - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------ Three Months Ended September 30, 2003 - ------------------------------------------------------------------------------------------------ NextGen $ 5,756 $ 2,001 $ 1,699 $ 9,456 - ------------------------------------------------------------------------------------------------ QSI Division 117 370 83 570 - -----------------------------------============================================================= Consolidated $ 5,873 $ 2,371 $ 1,782 $ 10,026 - ------------------------------------------------------------------------------------------------
NextGen division software revenue increased 30% between the three months ended September 30, 2003 and the three months ended September 30, 2004. The Division's software revenue accounted for 68% of divisional category revenue during the three months ended September 30, 2004, an increase from 61% in the prior year period. The increase in software's share of systems sales was not the result of any new trend or change in emphasis on our part relative to software sales. Software license revenue growth continues to be an area of primary emphasis for the NextGen Division and management was pleased with the division's performance in this area. During the three months ended September 30, 2004, 12% of NextGen's systems sales revenue was represented by hardware and third party software compared to 21% in the same prior year period. This decrease was not the result of any identifiable trend or change in emphasis on our part. The number of customers who purchase hardware and third party software and the dollar amount of hardware and third party software revenue fluctuates each quarter depending on the needs of customers. The inclusion of hardware and third party software in the division's sales arrangements is typically at the request of the customer and is not a priority focus for us. 16 Implementation and training revenue at the NextGen Division increased 30% in the three months ended September 30, 2004 compared to the three months ended September 30, 2003. Implementation and training revenue at the NextGen division increased its share of category revenue slightly to 20% in the three months ended September 30, 2004 from 18% in the three months ended September 30, 2003. The growth in implementation and training revenue is the result of increases in the amount of implementation and training services rendered to our customers. The number of implementation and training staff increased during the three months ended September 30, 2004 versus 2003 in order to accommodate the increased amount of implementation services sold in conjunction with increased software sales. In order to achieve continued increased revenue in this area, additional staffing increases are anticipated, though actual future increases in revenue and staff will depend upon the availability of qualified staff, business conditions, and our ability to retain current staff members. The NextGen Division's growth has come in part from investments in sales and marketing activities including hiring additional sales representatives, trade show attendance, and advertising expenditures. We have also benefited from winning numerous industry awards for the NextGen Division's flagship NextGenemr and NextGenepm software products in fiscal years 2004 and 2003, as well as in prior years, and the apparent increasing acceptance of electronic medical records technology in the healthcare industry. For the QSI division, sales of software systems increased 8% in the three months ended September 30, 2004 compared to the three months ended September 30, 2003. We do not presently foresee any material changes in the business environment for the Division with respect to the constrained environment that has been in place for the past several years. The year over year increases in software sales and implementation services was partially offset by decreases in hardware/third party software. Maintenance and Other. For the three months ended September 30, 2004, company-wide revenue from maintenance and other services grew 26% to $9.6 million from $7.6 million in the same period in the prior year. The increase in this category resulted from an increase in maintenance and EDI revenue from the NextGen Division's client base. Total NextGen Division maintenance revenue for the three months ended September 30, 2004 grew 63% to $4,245,000 from $2,606,000 in the same year ago period, while EDI revenue grew 109% to $1,361,000 compared to $652,000 during the same period. QSI Division maintenance revenue declined 6% from $1,902,000 to $1,794,000 in the same period during the prior year while QSI Divisional EDI revenue declined by approximately 8% from $1,339,000 to $1,227,000 between the same periods. The following table details revenue included in the maintenance and other category for the three month periods ended September 30, 2004 and 2003:
----------------------------------------------------------------------------------- Three Months Ended September 30, Three Months Ended September 30, (in thousands) 2004 2003 ----------------------------------------------------------------------------------- QSI NextGen Consolidated QSI NextGen Consolidated =================================================================================================================== Maintenance $1,794 $4,245 $6,039 $1,902 $2,606 $4,508 - ------------------------------------------------------------------------------------------------------------------- EDI 1,227 1,361 2,588 1,339 652 1,991 - ------------------------------------------------------------------------------------------------------------------- Other 317 666 983 379 738 1,117 =================================================================================================================== Total Maintenance & Other $3,338 $6,272 $9,610 $3,620 $3,996 $7,616 - -------------------------------------------------------------------------------------------------------------------
The growth in maintenance revenue for the NextGen Division has come from new customers that have been added each quarter as well as our relative success in retaining existing maintenance customers. NextGen EDI revenue growth has come from new customers, further penetration of the Division's existing customer base, and an increase in the average EDI revenue per customer . NextGen's growth in 17 maintenance and EDI revenue was at or above our expectations for the period. We intend to continue to promote maintenance and EDI services to both new and existing customers. The following table provides the number of billing sites which were receiving maintenance services as of the last business day of the quarters ended September 30, 2004 and 2003 respectively, as well as the number of billing sites receiving EDI services during the last month of each respective period at each division of the Company. The table presents summary information only and includes billing entities added and removed for any reason. Note also that a single client may include one or multiple billing sites.
- --------------------------------------------------------------------------------------------------------------- NextGen QSI Division Consolidated Period Maintenance EDI Maintenance EDI Maintenance EDI - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- September 30, 2003 373 267 343 253 716 520 - --------------------------------------------------------------------------------------------------------------- Billing sites added 96 131 5 3 101 134 - --------------------------------------------------------------------------------------------------------------- Billing sites removed (4) (26) (44) (37) (48) (63) - --------------------------------------------------------------------------------------------------------------- September 30, 2004 465 372 304 219 769 591 - ---------------------------------------------------------------------------------------------------------------
Cost of Products and Services. Cost of products and services for the three months ended September 30, 2004 increased 6% to $7.9 million from $7.5 million in the quarter ended September 30, 2003 , while the cost of products and services as a percentage of net revenue decreased to 37.4% from 42.5%. The decrease in our consolidated cost of revenue as a percentage of revenue between the three months ended September 30, 2004 and the three months ended September 30, 2003 is attributable to three main factors: o a reduction in the level of hardware and third party software expense as a percentage of revenue in the NextGen Division; o an increase in the NextGen division's share of consolidated revenue from 76% in the quarter ended September 30, 2003 to 81% in the quarter ended September 30, 2004. The NextGen division's gross margins have been and continue to be higher than those of the QSI Division; and o a decrease in the cost of revenue as a percentage of revenue at each of our divisions causing a corresponding increase in gross profit margins of both of our divisions. 18 The following table details the individual components of cost of products and services and gross profits as a percentage of total revenue for our Company and our two divisions:
---------------------------------------------------------------------------------- Hardware & Outside Services, Third Party Payroll & Amortization of Software Total Cost Gross Software Benefits Development Costs & Other of Revenue Profit - ----------------------------------------------------------------------------------------------------------- Three months ended September 30, 2004 - ----------------------------------------------------------------------------------------------------------- NextGen 5.5% 12.9% 16.1% 34.5% 65.5% - ----------------------------------------------------------------------------------------------------------- QSI Division 9.3 16.9 24.1 50.3 49.7 - --------------------------================================================================================= Consolidated 6.2% 13.7% 17.5% 37.4% 62.6% - ----------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------- Three months ended September 30, 2003 - ----------------------------------------------------------------------------------------------------------- NextGen 14.8% 12.5% 12.3% 39.6% 60.4% - ----------------------------------------------------------------------------------------------------------- QSI Division 7.9 16.5 27.2 51.6 48.4 - --------------------------================================================================================= Consolidated 13.2% 13.4% 15.7% 42.5% 57.5% - -----------------------------------------------------------------------------------------------------------
During the three months ended September 30, 2004, hardware and third party software constituted a smaller portion of consolidated revenue compared to the same year ago period driven principally by the composition of NextGen Division revenue. This year over year reduction was not the result of any identifiable trend or change in emphasis on our part. The number of customers who purchase hardware and third party software and the dollar amount of hardware and third party software purchased fluctuates each quarter depending on the needs of the customers and is not a priority focus for us. Our payroll and benefits expense associated with delivering our products and services increased to 13.7% of consolidated revenue compared to 13.4% during the prior three months ended September 30, 2003. The absolute level of consolidated payroll and benefit expenses grew from $2.4 million in the three months ended September 30, 2003 to $2.9 million in the three months ended September 30, 2004, an increase of 21% or $0.5 million. This increase was due primarily to additions to related headcount, payroll and benefits expense associated with delivering products and services in the NextGen Division where such expenses increased to $2.2 million in three months ended September 30, 2004 from $1.7 million in the three months ended September 30, 2003. Payroll and benefits expense associated with delivering products and services in the QSI Division during the three months ended September 30, 2004 and 2003 remained relatively unchanged at approximately $0.7 million. We anticipate continued additions to headcount in the NextGen Division in areas related to delivering products and services in future periods but due to the uncertainties in the timing of our sales arrangements, our sales mix, the acquisition and training of qualified personnel, and other issues, we cannot accurately predict if related headcount expense as a percentage of revenue will increase or decrease in the future. We do not currently intend to make any significant additions to related headcount at the QSI Division. Should the NextGen division continue to represent an increasing share of our revenue and should the NextGen division continue to carry higher gross margins than the QSI division, our consolidated gross margin percentages should increase to more closely match those of the NextGen division. 19 As a result of the foregoing events and activities, our gross margins for the Company and our two operating divisions increased for the three month period ended September 30, 2004 versus the prior year period. The following table details revenue and cost of products and services on a consolidated and divisional basis for the three month periods ended September 30, 2004 and 2003: -------------------------------------------- (in thousands) Three Months Ended September 30, -------------------------------------------- 2004 % 2003 % ============================================================================ Consolidated ---------------------------------------------------------------------------- Net Revenue $21,217 100% $17,642 100% ---------------------------------------------------------------------------- Cost of Product & Services 7,937 37.4% 7,492 42.5% ---------------------------------------------------------------------------- Gross Margin 13,280 62.6% 10,150 57.5% ============================================================================ NextGen Division ---------------------------------------------------------------------------- Net Revenue $17,262 100% $13,452 100% ---------------------------------------------------------------------------- Cost of Product & Services 5,947 34.5% 5,332 39.6% ---------------------------------------------------------------------------- Gross Margin 11,315 65.5% 8,120 60.4% ============================================================================ QSI Division ---------------------------------------------------------------------------- Net Revenue $ 3,955 100% $ 4,190 100% ---------------------------------------------------------------------------- Cost of Product & Services 1,990 50.3% 2,160 51.6% ============================================================================ Gross Margin $ 1,965 49.7% $ 2,030 48.4% ---------------------------------------------------------------------------- Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended September 30, 2004 increased 13% to $5.4 million as compared to $4.8 million for the three months ended September 30, 2003. The increase in the amount of such expenses resulted primarily from a $0.4 million increase in selling related compensation expenses and a net $0.3 million increase in other selling, general and administrative expenses in the NextGen Division offset by a $0.1 million decline in corporate related expenses. Selling, general and administrative expenses as a percentage of revenue declined from 27.0% in the three months ended September 30, 2003 to 25.5% in the three months ended September 30, 2004 due to the fact that the rate of growth in selling, general and administrative expense was less than the aggregate revenue growth rate for the Company. We anticipate increased expenditures for trade shows, advertising and the employment of additional sales representatives primarily at the NextGen Division. We also anticipate future increases in corporate expenditures being made in the areas of staffing and professional services in areas including but not limited to the Sarbanes-Oxley Act and related compliance issues. While we expect selling, general and administrative expenses to increase on an absolute basis, we cannot accurately predict the impact these additional expenditures will have on selling, general, and administrative expenses as a percentage of revenue. Research and Development Costs. Research and development costs for the three months ended September 30, 2004 and 2003 were $1.8 million and $1.5 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 increased to 8.6% from 8.5% during the 20 months ended September 30, 2003. Research and development expenses are expected to continue at or above current levels. Investment Income. Investment income for the three months ended September 30, 2004 increased 93% to approximately $170,000 compared with $89,000 in the three months ended September 30, 2003. Investment income in the three months ended September 30, 2004 increased primarily due to the effect of an increase in short term interest rates versus the prior year quarter as well as comparatively higher amounts of funds available for investment during the three months ended September 30, 2004. Our investment policy is determined by our Board of Directors. We currently maintain our cash in very liquid short term assets including money market funds and short term U.S. Treasuries with maturities of less than 90 days. Our Board of Directors may consider alternate uses for our cash including, but not limited to payment of a special dividend, initiation of a regular dividend, initiation of a stock buy-back program, an expansion of our investment policy to include investments with maturities of greater than 90 days, or other items. Additionally, it is possible that we will utilize some or all of our cash to fund an acquisition or other similar business activity. Any or all of these programs could significantly impact our investment income in future periods. Provision for Income Taxes. The provision for income taxes for the three months ended September 30, 2004 was approximately $2.5 million as compared to approximately $1.6 million for the year ago period. The effective tax rates for the three months ended September 30, 2004 and 2003 were 40.3% and 39.3%, respectively. The provision for income taxes for the three months ended September 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 three months ended September 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. For the Six-Month Periods September 30, 2004 versus 2003 Net Income. The Company's net income for the six months ended September 30, 2004 was $7,097,000 or $ 1.12 per share on a basic and $ 1.08 per share on a fully diluted basis. In comparison, we earned $4,685,000 or $0.76 per share on a basic and $0.72 per share on a fully diluted basis in the six months ended September 30, 2003. The increase in net income for the six months ended September 30, 2004, was achieved through the following: o a 22% increase in consolidated revenue; and o selling, general and administrative and costs of revenues which grew at 9% and 14% respectively; slower than the overall revenue growth rate. Net Revenue. Net revenue for the six months ended September 30, 2004 increased 22% to $41.3 million from $33.9 million for the six months ended September 30, 2003. NextGen Division net revenue increased 30% from approximately $25.7 million during the quarter ended September 30, 2003 to approximately $33.4 million during the quarter ended September 30, 2004, while QSI Division net revenue declined by 4% during the same period from approximately $8.3 million to approximately $7.9 million. We report revenue in two major categories, "Systems sales" and "Maintenance and other services". Revenue in the systems sales category includes software license fees, hardware, third party software, supplies and implementation and training services related to purchase of the Company's software systems. The majority of the revenue in the System sales category is related to the sale of software. 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. Systems Sales. Company-wide sales of systems for the six months ended September 30, 2004 increased 16% to $22.7 million from $19.5 million in the prior year period Our increase in revenue from sales of systems for the Company was principally the result of a 17% increase in category revenue at our NextGen Division whose systems sales grew from $18.4 million to 21 $21.6 million. This increase was driven primarily by higher sales of NextGenemr and NextGenepm software to both new and existing clients, as well as delivery of related implementation and training services, partially offset by declines in the sale of hardware, third party software, and supplies. Category revenue in the QSI Division was unchanged at approximately $1.1 million in each period. The following table breaks down our reported systems sales into software, hardware and third party software and supplies, and implementation and training services components by division:
----------------------------------------------------------------------------------------------------- Hardware, third party software & Implementation & (in thousands) Software supplies training services Systems Sales ----------------------------------------------------------------------------------------------------- Six Months Ended September 2004 ----------------------------------------------------------------------------------------------------- NextGen $14,220 $2,925 $4,409 $21,554 ----------------------------------------------------------------------------------------------------- QSI Division 519 446 157 1,122 --------------------------------===================================================================== Consolidated $14,739 $3,371 $4,566 $22,676 ----------------------------------------------------------------------------------------------------- Six Months Ended September 2003 ----------------------------------------------------------------------------------------------------- NextGen $11,623 $3,560 $3,244 $18,427 ----------------------------------------------------------------------------------------------------- QSI Division 306 574 193 1,073 --------------------------------===================================================================== Consolidated $11,929 $4,134 $3,437 $19,500 -----------------------------------------------------------------------------------------------------
NextGen Division software revenue increased 22% between the six months ended September 30, 2004 and the six months ended September, 2003. The Division's software revenue accounted for 66% of divisional systems sales revenue during the six months ending 2004, an increase from 63% in the six months ended September 30, 2003. This increase was not the result of any new trend or change in emphasis on our part relative to software sales. Software license revenue continues to be an area of primary emphasis for the NextGen Division and management was pleased with the division's performance in this area. During the six months ended September 30, 2004, 14% of NextGen's systems sales revenue was represented by hardware and third party software compared to 19% in the same prior year period. This decrease was not the result of any new trend or change in emphasis on our part. The number of customers who purchase hardware and third party software and the dollar amount of hardware and third party software revenue fluctuates each quarter depending on the needs of customers. The inclusion of hardware and third party software in the division's sales arrangements is typically at the request of the customer and is not a priority focus for us. Implementation and training revenue at the NextGen Division increased 36% from the six months ended September 30, 2003 to the six months ended September, 2004. Implementtion and training revenue at the NextGen Division increased its share of category revenue from 18% in the six months ended September 30, 2003 to 20% in the six months ended September 30, 2004. The growth in implementation and training revenue is the result of increases in the amount of implementation and training services rendered to our customers. The number of implementation and training staff increased during the course of the six months ended September 30, 2004 versus 2003 in order to accommodate the increased amount of implementation services sold in conjunction with increased software sales. In order to achieve continued increased revenue in this area, additional staffing increases are anticipated, though actual future increases will depend upon the availability of qualified staff, business conditions, and our ability to retain current staff members. 22 The NextGen Division's growth has come in part from investments in sales and marketing activities including hiring additional sales representatives, trade show attendance, and advertising expenditures. We have also benefited from winning numerous industry awards for the NextGen Division's flagship NextGenemr and NextGenepm software products in fiscal years 2004 and 2003 as well as in prior years, and the apparent increasing acceptance of electronic medical records technology in the healthcare industry. For the QSI Division, sales of systems,increased 4% from the six months ended September 30, 2003 to the six months ended September 30, 2004. Increased software revenue in the division was offset by decreases in hardware, third party software, and implementation and training services. We do not presently foresee any material changes in the business environment for the division from that which we have experienced in recent quarters. Maintenance and Other. For the six months ended September 30, 2004, company-wide revenue from maintenance and other services grew 29% to $ 18.7 million from $14.4 million during the same period last year. 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 six months ended September 30, 2004 grew 67% to $8,000,000 from $4,789,000 in the year ago period, while EDI revenue grew 94% to $2,421,000 compared to $1,248,000 during the same period. QSI Division maintenance revenue declined 4% from $3,841,000 to $3,678,000 in the same period while QSI Divisional EDI revenue declined by approximately 8% from $2,682,000 to $2,455,000 during such period. The following table details revenue included in maintenance and other for the six month periods ended September 30, 2004 and 2003:
------------------------------------------------------------------------------- (in thousands) Six Months Ended September 30, 2004 Six Months Ended September 30, 2003 ------------------------------------------------------------------------------- QSI NextGen Consolidated QSI NextGen Consolidated =============================================================================================================== Maintenance $3,678 $ 8,000 $11,678 $3,841 $4,789 $ 8,630 - --------------------------------------------------------------------------------------------------------------- EDI 2,455 2,421 4,876 2,682 1,248 3,930 - --------------------------------------------------------------------------------------------------------------- Other 681 1,436 2,117 657 1,231 1,888 - --------------------------------------------------------------------------------------------------------------- Total Maintenance & Other $6,814 $11,857 $18,671 $7,180 $7,268 $14,448 - ---------------------------------------------------------------------------------------------------------------
The growth in overall maintenance revenue has come from new customers that have been added each quarter as well as our relative success in retaining existing maintenance customers. NextGen EDI revenue growth has come from new customers, further penetration of the Division's existing customer base, and an increase in the average EDI revenue per customer. NextGen's growth in maintenance and EDI revenue was at or above our expectations for the period. We intend to continue to promote maintenance and EDI services to both new and existing customers. 23 The following table provides the number of billing sites who were receiving maintenance services as of the last business day of the quarters ended September 30, 2004 and 2003 respectively, as well as the number of billing sites receiving EDI services during the last month of each respective period at each division of the Company. The table presents summary information only and includes billing entities added and removed for any reason. Note that a single client may include one or multiple billing sites.
---------------------------------------------------------------------------------------------------- NextGen QSI Division Consolidated Period Maintenance EDI Maintenance EDI Maintenance EDI ---------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------- September 30, 2003 373 267 343 253 716 520 ---------------------------------------------------------------------------------------------------- Billing sites added 96 131 5 3 101 134 ---------------------------------------------------------------------------------------------------- Billing sites removed (4) (26) (44) (37) (48) (63) ---------------------------------------------------------------------------------------------------- September 30, 2004 465 372 304 219 769 591 ----------------------------------------------------------------------------------------------------
Cost of Products and Services. The Cost of products and services for the six months ended September 30, 2004 increased 14% to $ 16.0 million from $14.1, while the cost of products and services as a percentage of net revenue decreased to 39% from 42% during the same period a year ago. The decrease in our consolidated cost of revenue as a percentage of revenue between the six months ended September 30, 2004 and the six months ended September 30, 2003 is attributable to three main factors: o a reduction in the level of third party hardware and software as a percentage of revenue in the NextGen Division; o an increase in the NextGen Division's share of consolidated revenue from 76% in the six months ended September 30, 2003 to 81% in September 30, 2004. The NextGen Division's gross margins have been and continue to be higher than those of the QSI Division; and o a decrease in the cost of revenue as a percentage of revenue at each of our divisions causing a corresponding increase in gross profit margins at both of our divisions. The following table details the individual components of cost of products and services and gross profits as a percentage of total revenue for our Company and our two divisions:
------------------------------------------------------------------------------- Outside Services, Hardware & Amortization of Software Third Party Payroll & Development Costs & Total Cost Gross Software Benefits Other of revenue Profit - -------------------------------------------------------------------------------------------------------- Six months ended September 30, 2004 - -------------------------------------------------------------------------------------------------------- NextGen 7.5% 13.6% 15.1% 36.2% 63.8% - -------------------------------------------------------------------------------------------------------- QSI Division 8.1 17.2 24.4 47.7 50.3 - ------------------------================================================================================ Consolidated 8.0% 14.3% 16.5% 38.8% 61.2% - -------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------- Six months ended September 30, 2003 - -------------------------------------------------------------------------------------------------------- NextGen 13.4% 12.6% 12.2% 38.2% 61.8% - -------------------------------------------------------------------------------------------------------- QSI Division 8.1 17.1 26.5 51.7 48.3 - ------------------------================================================================================ Consolidated 12.1% 13.7% 15.8% 41.6% 58.4% - --------------------------------------------------------------------------------------------------------
24 During the six months ended September 30, 2004, the cost of hardware and third party software constituted 8.0% of consolidated revenue compared to 12.1% in the same year ago period. This year over year reduction was not the result of any identifiable trend or change in emphasis on our part. The number of customers who purchase hardware and third party software and the dollar amount of hardware and third party software purchased fluctuates each quarter depending on the needs of the customers and is not a priority focus for us. Our payroll and benefits expense associated with delivering our products and services increased to 14.3% of consolidated revenue compared to 13.7% in the six months ended September 30, 2003. The absolute level of consolidated payroll and benefit expenses grew from $4.6 million in the six months ended September 30, 2003 to $5.9 million in 2004, an increase of 28% or $1.3 million. This increase was due primarily to additions to headcount, payroll and benefits expense associated with delivering products and services in the NextGen Division. These expenses increased to $4.5 million in the six months ended September 30, 2004 compared to $3.2 million in the six months ended September 30, 2003, an increase of 41%. The Division's payroll and benefits expense associated with delivering products and services as a percentage of divisional revenue in the six months ended September 30, 2004 increased to 13.6% compared to 12.6% in the prior year period. Headcount expense as a percentage of revenue for the six month period ended September 30, 2004 at the QSI Division remained relatively unchanged compared to the prior year at 17.2% versus 17.1%, in the prior year period. We anticipate continued additions to headcount in the NextGen Division in areas related to delivering products and services in future periods but due to the uncertainties in the timing of our sales arrangements, our sales mix, the acquisition and training of qualified personnel, and other issues we cannot accurately predict if related headcount expense as a percentage of revenue will increase or decrease in the future. We do not currently intend to make any significant additions to related headcount at the QSI Division. Should the NextGen division continue to represent an increasing share of our revenue and NextGen continue to show higher margins compared to the QSI division, our gross margin percentages should increase to more closely match those of the NextGen division. As a result of the foregoing events and activities, our gross margins for the Company and our two operating divisions increased for the six month period ended September 30, 2004 versus the prior year period. The following table details revenue and cost of products and services on a consolidated and divisional basis for the six month periods ended September 30, 2004 and 2003:
------------------------------------------------ (in thousands) Six Months Ended September 30, ------------------------------------------------ 2004 % 2003 % ================================================================================ Consolidated -------------------------------------------------------------------------------- Net Revenue $41,347 100% $33,948 100% -------------------------------------------------------------------------------- Cost of Product & Services 16,038 38.8% 14,102 41.6% -------------------------------------------------------------------------------- Gross Margin 25,309 61.2% 19,846 58.4% ================================================================================ NextGen Division -------------------------------------------------------------------------------- Net Revenue $33,411 100% $25,694 100% --------------------------------------------------------------------------------
25 -------------------------------------------------------------------------------- Cost of Product & Services 12,098 36.2% 9,839 38.2% -------------------------------------------------------------------------------- Gross Margin 21,313 63.8% 15,855 61.8% ================================================================================ QSI Division -------------------------------------------------------------------------------- Net Revenue $ 7,936 100% $ 8,254 100% -------------------------------------------------------------------------------- Cost of Product & Services 3,940 49.7% 4,263 51.7% ================================================================================ Gross Margin $ 3,996 50.3% $ 3,991 48.3% --------------------------------------------------------------------------------
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the six months ended September 30, 2004 increased 9% to $10.4 million as compared to $9.5 million for the six months ended September 30, 2003. The increase in the amount of such expenses resulted primarily from increases of $1.0 million in selling related compensation expenses in the NextGen Division. Selling, general and administrative expenses as a percentage of revenue declined from 28.0% in the six months ended September 30, 2003 to 25.1% in the six months ended September 30, 2004 due to minimal growth in consolidated non-corporate selling, general and administrative expenses compared to the prior year, as well as revenues growing at a faster rate then selling, general, administrative expenses at the NextGen Division. We anticipate increased expenditures for trade shows, advertising and the employment of additional sales representatives primarily at the NextGen Division We also anticipate continued increases in corporate expenditures being made in the areas of staffing and professional services in areas including but not limited to Sarbanes-Oxley Act and related compliance issues. While we expect selling, general and administrative expenses to increase, we cannot accurately predict the impact these additional expenditures will have on selling, general, and administrative expenses as a percentage of revenue. Research and Development Costs. Research and development costs for the six months ended September 30, 2004 and 2003 were $3.4 million and $2.9 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 8.3% 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. Investment Income. Investment income for the six months ended September 30, 2004 increased 53% to approximately $290,000 compared with $189,000 in the six months ended September 30, 2003. Investment income in the six months ended September 30, 2004 increased primarily due to the effect of an increase in short term interest rates versus the prior year period as well as comparatively higher amounts of funds available for investment during the six months ended September 30, 2004. Our investment policy is determined by our Board of Directors. We currently maintain our cash in very liquid short term assets including money market funds and short term U.S. Treasuries with maturities of less than 90 days. Our Board of Directors may consider alternate uses for our cash including, but not limited to payment of a special dividend, initiation of a regular dividend, initiation of a stock buy back program, an expansion of our investment policy to include investments with maturities of greater than 90 days, or other items. Additionally, it is possible that we will utilize some or all of our cash to fund an acquisition or other similar business activity. Any or all of these programs could significantly impact our investment income in future periods. Provision for Income Taxes. The provision for income taxes for the six months ended September 30, 2004 was approximately $4.7 million as compared to approximately $3.0 million for the year ago period. The effective tax rates for the six months ended September 30, 2004 and 2003 were 39.9% and 38.8%, respectively. The provision for income taxes for the six months ended September 30, 2004 and 2003 26 differ from the combined statutory rates primarily due to the impact of varying state income tax rates and the impact of research and development tax credits. The effective rate for the six months ended September 30, 2004 increased from the prior year primarily due to a relatively smaller impact of research and development tax credits as well as slightly higher effective federal income tax rates. Liquidity and Capital Resources The following table presents selected financial statistics and information for each of the six months ended September 30, 2004 and 2003:
-------------------------------- ($ in thousands) Six Months Ended September 30, ---------------------------------------------------------------------------------------------- (unaudited) 2004 2003 ---------------------------------------------------------------------------------------------- Cash and cash equivalents $59,522 $40,573 ---------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents during the six month period $ 8,127 $ 4,130 ---------------------------------------------------------------------------------------------- Net income during the period $ 7,097 $ 4,685 ---------------------------------------------------------------------------------------------- Net cash provided by operations during the period $ 9,121 $ 5,625 ---------------------------------------------------------------------------------------------- Number of days of sales outstanding at start of period 99 106 ---------------------------------------------------------------------------------------------- Number of days of sales outstanding at end of period 108 110 ----------------------------------------------------------------------------------------------
The Company's principal source of cash was cash provided by operations. The number of days sales outstanding at the end of the period decreased by two days compared to September 30, 2003. The number of days sales outstanding increased by nine days during the six months ended September 30, 2004 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 six months ended September 30, 2004, the Company anticipates being able to continue to generate cash from operations during fiscal 2005 primarily from the net income of the Company. Cash and cash equivalents increased $8.1 million between March 31, 2004 and September 30, 2004 primarily as a result of cash provided by operating activities. Cash and cash equivalents increased approximately $4.1 million during the six months ended September 30, 2003, also primarily as a result of cash generated by operating activities. Net cash used in investing activities for the six months ended September 30, 2004 and 2003 was $1.8 and $1.7 million respectively. Net cash used in investing activities for the three months ended September 30, 2004 and 2003 consisted of additions to equipment and improvements and capitalized software. At September 30, 2004, we had cash and cash equivalents of $59.5 million. We intend to expend some of these funds for the development of products complementary to our existing product line as well as new versions of certain of our 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. 27 Management believes that its cash and cash equivalents on hand at September 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 September 30, 2004, and the effect that such obligations are expected to have on our liquidity and cash in future periods:
- ---------------------------------------------------------------------------------------------------------------------- Less than a Beyond 5 Contractual Obligations Total year 1-3 years 3-5 years years - ---------------------------------------------------------------------------------------------------------------------- Non-cancelable lease obligations 2,941 1,157 1,391 393 0 - ----------------------------------------------------------------------------------------------------------------------
PART II - OTHER INFORMATION Item 6. Exhibits Exhibit Number Description - --------- ------------------------------------------------------------------ 10.1 Form of Incentive Stock Option Agreement (Employees) (#) (1) 10.2 Form of Nonqualified Stock Option Agreement (Directors) (#) (1) 10.3 Bonus Criteria for Named Executive Officers (#) (1) 10.4 Director Compensation Program (#) (1) 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 (#) Management contract or compensatory plan, contract or arrangement. (1) Filed as an exhibit to Amendment No. 1 to this Form 10-Q. 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: April 15 , 2005 By: /s/ Louis Silverman --------------------------------------- Louis Silverman Chief Executive Officer Date: April 15, 2005 By: /s/ Paul Holt --------------------------------------- Paul Holt Chief Financial Officer; Principal Accounting Officer 28 EX-31.1 2 d63390_ex31-1.txt SECTION 302 CERTIFICATION OF CEO 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; and 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. Date: April 15, 2005 /s/ LOUIS SILVERMAN - ----------------------------------------------------- Louis Silverman Chief Executive Officer (principal executive officer) 29 EX-31.2 3 d63390_ex31-2.txt SECTION 302 CERTIFICATION OF CFO 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; and 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. Date: April 15, 2005 /s PAUL HOLT - ------------------------------------------------------ Paul Holt Chief Financial Officer (principal accounting officer) 30 EX-32.1 4 d63390_ex32-1.txt SECTION 906 CERTIFICATION OF CEO AND CFO 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 September 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: April 15, 2005 By: /s/ LOUIS SILVERMAN --------------------------------------- Louis Silverman Chief Executive Officer (principal executive officer) Dated: April 15, 2005 By: /s/ PAUL HOLT --------------------------------------- Paul Holt Chief Financial Officer (principal accounting 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. 31 -----END PRIVACY-ENHANCED MESSAGE-----