-----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, AHbvAQPnYTmUP5IAid1QpVGtDCTFGCXuBKhROzqKLdgS5ldibZczCwv6Qe5Z6lOU Nv0tAKHWnglZNzDg2PuPmg== 0001169232-05-003136.txt : 20050614 0001169232-05-003136.hdr.sgml : 20050613 20050613213011 ACCESSION NUMBER: 0001169232-05-003136 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050614 DATE AS OF CHANGE: 20050613 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-12537 FILM NUMBER: 05893569 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-K 1 d64225_10k.txt ANNUAL REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 ---------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2005 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number: 0-13801 Quality Systems, Inc. (Exact name of Registrant as specified in its charter) California 95-2888568 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 18191 Von Karman Avenue, Irvine, California 92603 (Address of principal executive offices, including zip code) (949) 255-2600 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None None (Title of each class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per Share (Title of class) 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 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant as of September 30, 2004: 200,543,000 (based on the closing sales price of the Registrant's Common Stock as reported in the NASDAQ National Market System on that date, $50.51 per share).* The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 3, 2005: $415,011,000 (based on the closing sales price of the Registrant's Common Stock as reported in the NASDAQ National Market System on that date, $51.30 per share).* Indicate the number of shares outstanding of each of the Registrant's classes of Common Stock, as of the latest practicable date. Common Stock, $.01 par value 13,115,360 - -------------------------------------- ---------------------------------------- (Class) (Outstanding at June 8, 2005) DOCUMENTS INCORPORATED BY REFERENCE The information required by Part III, Items 10, 11, 12, 13 and 14, of the Form 10-K is incorporated by reference from Registrant's Definitive Proxy Statement for its 2005 annual meeting which is to be filed with the Commission within 120 days of its fiscal year ended on March 31, 2005. * For purposes of this report, in addition to those shareholders which fall within the definition of "affiliates" under Rule 405 of the Securities Act of 1933, as amended, holders of ten percent or more of the Registrant's Common Stock are deemed to be affiliates for purposes of this Report. ================================================================================ CAUTIONARY STATEMENT Statements made in this report, the Annual Report to Shareholders in which this report is made a part, other reports and proxy statements filed with the Securities and Exchange Commission, communications to shareholders, press releases and oral statements made by our representatives that are not historical in nature, or that state our or management's intentions, hopes, beliefs, expectations or predictions of the future, may constitute "forward-looking statements" within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," "will," "will be," "will lead," "will assist," "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," "plan," or "estimate" or variations thereof or similar expressions. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. It is important to note that any such performance and actual results, financial condition or business, could differ materially from those expressed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below as well as those discussed elsewhere in reports filed with the Securities and Exchange Commission. Other unforeseen factors not identified herein could also have such an effect. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time. PART I ITEM 1. BUSINESS General Except for the historical information contained herein, the matters discussed in this Annual Report on Form 10-K, including discussions of the Registrant's product development plans, business strategies and market factors influencing the Registrant's results, are forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by the Registrant as a result of various factors, both foreseen and unforeseen, including, but not limited to, the Registrant's ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation within the Registrant's target marketplace and among the Registrant's competitors, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact the Registrant's ability to achieve our goals. Interested persons are urged to review the risks described under "Item 1. Business. Risk Factors" and in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as in the Registrant's other public disclosures and filings with the Securities and Exchange Commission. 3 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 the medical market. These two acquisitions formed the basis for 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 its own distinct product lines, product platforms, development, implementation and support teams, sales staffing, and branding. The two Divisions share the resources of our "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 already 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 ______________________________ (1) UNIX is a registered trademark of the AT&T Corporation. 4 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 (NextGen(emr)), Enterprise Practice Management (NextGen(epm)), 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)). During the year ended March 31, 2005, the NextGen Division introduced NextGen Express, a version of NextGen(emr) designed for small practices. 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 82.7% of our revenue for fiscal 2005 compared to 76.8% in fiscal 2004. Inclusive of divisional EDI revenue ,the QSI Division accounted for 17.3% and 23.2% of revenue in fiscal 2005 and 2004, respectively. The NextGen Division's year over year revenue grew at 35.2% and 45.8% in fiscal 2005 and 2004, respectively, while the QSI Division's year over year revenue declined by 6.8% and 5.3% in 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. Industry Background To compete in the continually changing healthcare environment, providers are increasingly using technology to help maximize the efficiency of their business practices, to assist in enhancing patient care, and to maintain the privacy of patient information. As the reimbursement environment continues to evolve, more healthcare providers enter into contracts, often with multiple entities, which define the terms under which care is administered and paid for. The diversity of payor organizations, as well as additional government regulation and changes in ______________________________ (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) NextMD is a registered trademark of NextGen Healthcare Information Systems, Inc. 5 reimbursement models, have greatly increased the complexity of pricing, billing, reimbursement, and records management for medical and dental practices. To operate effectively, healthcare provider organizations must efficiently manage patient care and other information and workflow processes which increasingly extend across multiple locations and business entities. In response, healthcare provider organizations have placed increasing demands on their information systems. Initially, these information systems automated financial and administrative functions. As it became necessary to manage patient flow processes, the need arose to integrate "back-office" data with such clinical information as patient test results and office visits. The Company believes information systems must facilitate management of patient information incorporating administrative, financial and clinical information from multiple entities. In addition, large healthcare organizations increasingly require information systems that can deliver high performance in environments with multiple concurrent computer users. Many existing healthcare information systems were designed for limited administrative tasks such as billing and scheduling and can neither accommodate multiple computing environments nor operate effectively across multiple locations and entities. We believe that practices that leverage technology to more efficiently handle patient clinical data as well as administrative, financial and other practice management data, will be best able to enhance patient flow, pursue cost efficiencies, and improve quality of care. As healthcare organizations transition to new computer platforms and newer technologies, we believe such organizations will be migrating toward the implementation of enterprise-wide, patient-centric computing systems embedded with automated clinical patient records. Company Strategy The Company's strategy is, at present, to focus on it's core software business. Among the key elements central to this strategy are: o Continued development and enhancement of select software solutions in target markets; o Continued investments in our infrastructure including but not limited to product development, sales, marketing, implementation, and support; o Continued efforts to make infrastructure investments within an overall context of maintaining reasonable expense discipline; and o Addition of new customers through maintaining and expanding sales, marketing and product development activities. While these are the key elements of our current strategy, there can be no guarantees that our strategy will not change, or that we will succeed in achieving these goals individually or collectively. Products In response to the growing need for more comprehensive, cost-effective healthcare information solutions for physician and dental practices, our systems provide our clients with the ability to redesign patient care and other workflow processes while improving productivity through facilitation of managed access to patient information. Utilizing our proprietary software in combination with third party hardware and software solutions, our products enable the integration of a variety of administrative and clinical information operations. Leveraging more than 30 years of experience in the healthcare information services industry, we believe that we continue to add value by providing our clients with sophisticated, full-featured software systems along with comprehensive systems implementation, maintenance and support services. Any single transaction may or may not include software, hardware or services. Practice Management Systems. Our products consist primarily of proprietary healthcare software applications together with third party hardware and other non-industry specific software. The systems range in capacity from one to thousands of users, allowing us to address the needs of both small and large 6 organizations. The systems are modular in design and may be expanded to accommodate changing client requirements. The QSI Division's character-based practice management system is available in both dental and medical versions and primarily uses the IBM RS6000(5) central processing unit and IBM'S AIX(6) version of the UNIX operating system as a platform for our application software enabling a wide range of flexible and functional systems. The hardware components, as well as the requisite operating system licenses, are purchased from manufacturers or distributors of those components. We configure and test the hardware components and incorporate our software and other third party packages into completed systems tailored to accommodate particular client requirements. We continually evaluate third party hardware components with a view toward utilizing hardware that is functional, reliable and cost-effective. NextGen(epm) is the NextGen division's practice management offering. NextGen(epm) has been developed using a graphical user interface (GUI) client-server platform for compatibility with Windows 2000, Windows NT and Windows XP operating systems and relational databases that are ANSI SQL-compliant. NextGen(epm) is scalable and includes a master patient index, enterprise-wide appointment scheduling with referral tracking, clinical support, and centralized or decentralized patient financial management based on either a managed care or fee-for-service model. The system's three-tiered architecture allows work to be performed on the database server, the application server and the client workstation. We also offer practice management solutions for both dental and medical practices through the Internet. These products are marketed under the QSINet and NextGen(web) trade names, respectively. Clinical Systems. Our dental charting software system, the Clinical Product Suite (CPS), is a comprehensive solution designed specifically for the dental group practice environment. CPS integrates the dental practice management product with a computer-based clinical information system that incorporates a wide range of clinical tools, including: o Electronic charting of dental procedures, treatment plans and existing conditions; o Periodontal charting via light-pen, voice-activation, or keyboard entry for full periodontal examinations and PSR scoring; o Digital imaging of X-ray and intra-oral camera images; o Computer-based patient education modules, viewable chair-side to enhance case presentation; o Full access to patient information, treatment plans, and insurance plans via a fully integrated interface with our dental practice management product; and o Document and image scanning for digital storage and linkage to the electronic patient record. The result is a comprehensive clinical information management system that helps practices save time, reduce costs, improve case presentation, and enhance the delivery of dental services and quality of care. Clinical information is managed and maintained electronically thus forming an electronic patient record that allows for the implementation of the "chartless" office. CPS incorporates Windows-based client-server technology consisting of one or more file servers together with any combination of one or more desktop, laptop, or pen-based PC workstations. The file server(s) used in connection with CPS utilize(s) a Windows NT or Windows 2000 or Windows XP operating system and the hardware is typically a Pentium(7)-based single or multi-processor platform. Based on the ______________________________ (5) RS6000 is a registered trademark of International Business Machines Corporation. (6) AIX is a registered trademark of International Business Machines Corporation. (7) Pentium is a registered trademark of Intel Corporation. 7 server configuration chosen, CPS is scalable from one to hundreds of workstations. A typical configuration may also include redundant disk storage, magnetic tape units, intra- and extra-oral cameras, digital X-ray components, digital scanners, conventional and flat screen displays, and printers. The hardware components, including the requisite operating system licenses, are purchased from third party manufacturers or distributors either directly by the customer or by us for resale to the customer. NextGen provides clinical software applications that are complementary to, and are integrated with, our medical practice management offerings and interface with many of the other leading practice management software systems on the market. The applications incorporated into our practice management solutions and others such as scheduling, eligibility, billing and claims processing are augmented by clinical information captured by NextGen(emr), including services rendered and diagnoses used for billing purposes. We believe that we currently provide a comprehensive information management solution for the medical marketplace. NextGen(emr) was developed with client-server architecture and a GUI and utilizes Microsoft Windows 2000, Windows NT or Windows XP on each workstation and either Windows 2000, Windows NT, Windows XP or UNIX on the database server. NextGen(emr) maintains data using industry standard relational database engines such as Microsoft SQL Server(8) or Oracle(9). The system is scalable from one to hundreds of workstations. NextGen(emr) stores and maintains clinical data including: o Data captured using user-customized input "templates"; o Scanned or electronically acquired images, including X-rays and photographs; o Data electronically acquired through interfaces with clinical instruments or external systems; o Other records, documents or notes, including electronically captured handwriting and annotations; and o Digital voice recordings. NextGen(emr) also offers a workflow module, prescription management, automatic document and letter generation, patient education, referral tracking, interfaces to billing and lab systems, physician alerts and reminders, and powerful reporting and data analysis tools. NextGen(pda), the Pocket-PC-based suite of solutions, allows mobile health professionals to utilize many of NextGen's functions using a palm-sized device. Connectivity Services. The Company makes available electronic data interchange ("EDI") capabilities and connectivity services to our customers. The EDI/connectivity capabilities encompass direct interfaces between our products and external third party systems, as well as transaction-based services. Services include: o Electronic claims submission through our relationships with a number of payors and national claims clearinghouses; o Electronic patient statement processing, appointment reminder cards and calls, recall cards, patient letters, and other correspondence; o Electronic insurance eligibility verification; and o Electronic posting of remittances from insurance carriers into the accounts receivable application. _______________________________ (8) Microsoft and SQL Server is a registered trademark of Microsoft Corporation. (9) Oracle is a registered trademark of Oracle Corporation. 8 Internet Applications. Our NextGen Division maintains an Internet-based consumer health portal, NextMD.com. NextMD.com is a vertical portal for the healthcare industry, linking patients with their physicians, insurers, laboratories, and online pharmacies, while providing a centralized source of health-oriented information for both consumers and medical professionals. Patients whose physicians are linked to the portal are able to request appointments, send appointment changes or cancellations, receive test results on-line, request prescription refills, view and/or pay their statements, and communicate with their physicians, all in a secure, on-line environment. Our NextGen suite of information systems are or can be linked to NextMD.com, integrating a number of these features with physicians' existing systems. Our QSI Division also provides a web-based application called QSINet which allows clients to access information from their practice management system via the Internet. This application also enables providers to offer their patients convenient services such as on-line appointment scheduling and electronic bill payment through the client's website, and posts this data directly to the client's existing practice management system. Sales and Marketing We sell and market our products nationwide primarily through a direct sales force. The efforts of the direct sales force are augmented by a small number of reseller relationships established by us. Software license sales to resellers represented less than 10% of total revenue for the years ended March 31, 2005 and 2004. Our direct sales force typically makes presentations to potential clients by demonstrating the system and our capabilities on the prospective client's premises. Sales efforts aimed at smaller practices are primarily performed remotely via telephone or internet based presentations. Our sales and marketing employees identify prospective clients through a variety of means, including referrals from existing clients, industry consultants, contacts at professional society meetings, trade shows and seminars, trade journal advertising, direct mail advertising, and telemarketing. Our sales cycle can vary significantly and typically ranges from three to twelve months from initial contact to contract execution. Software licenses are normally delivered to a customer almost immediately upon receipt of an order. Implementation and training services are normally rendered based on a mutually agreed upon timetable. As part of the fees paid by our clients, we receive up-front licensing fees. Clients have the option to purchase maintenance services which, if purchased, are invoiced on a monthly or quarterly basis. Several clients have purchased our practice management software and, in turn, are providing either time-share or billing services to single and group practice practitioners. Under the time-share or billing service agreements, the client provides the use of our software for a fee to one or more practitioners. Although we typically do not receive a fee directly from the distributor's customers, implementation of such arrangements has, from time to time, resulted in the purchase of additional software capacity by the distributor, as well as new software purchases made by the distributor's customers should such customers decide to perform the practice management functions in-house. We continue to concentrate our direct sales and marketing efforts on medical and dental practices, networks of such practices including MSO's and PHO's, professional schools, community health centers and other ambulatory care settings. MSO's, PHO's and similar networks to which we have sold systems provide use of our software to those group and single physician practices associated with the organization or hospital on either a service basis or by directing us to contract with those practices for the sale of stand-alone systems. We have also entered into marketing assistance agreements with certain of our clients pursuant to which the clients allow us to demonstrate to potential clients the use of systems on the existing clients' premises. 9 From time to time we assist prospective clients in identifying third party sources for financing the purchase of our systems. The financing is typically obtained by the client directly from institutional lenders and typically takes the form of a loan from the institution secured by the system to be purchased or a leasing arrangement. We do not guarantee the financing nor retain any continuing interest in the transaction. We have numerous clients and do not believe that the loss of any single client would have a material adverse effect on us. No client accounted for ten percent or more of net revenue during the fiscal years ended March 31, 2005, 2004, or 2003. Customer Service and Support We believe our success is attributable in part to our customer service and support departments. We offer support to our clients seven days a week, 24 hours a day. Our client support staff is comprised of specialists who are knowledgeable in the areas of software and hardware as well as in the day-to-day operations of a practice. System support activities range from correcting minor procedural problems in the client's system to performing complex database reconstructions or software updates. We utilize automated online support systems which assist clients in resolving minor problems and facilitate automated electronic retrieval of problems and symptoms following a client's call to the automated support system. Additionally, our online support systems maintain call records, available at both the client's facility and our offices. We offer our clients support services for most system components, including hardware and software, for a fixed monthly or quarterly fee. Customers also receive access to future unspecified versions of the software, on a when-and-if available basis, as part of support services. We also subcontract, in certain instances, with third party vendors to perform specific hardware maintenance tasks. Implementation and Training We offer full service implementation and training services. When a client signs a contract for the purchase of a system that includes implementation and training services, a client manager/implementation specialist trained in medical and/or dental group practice procedures is assigned to assist the client in the installation of the system and the training of appropriate practice staff. Implementation services include loading the software, training customer personnel, data conversion, running test data, and assisting in the development and documentation of procedures. Implementation and training services are provided by our employees as well as certified third parties and certain resellers. Training may include a combination of computer assisted instruction (CAI) for certain of our products, remote training techniques and training classes conducted at the client's or our office(s). CAI consists of workbooks, computer interaction and self-paced instruction. CAI is also offered to clients, for an additional charge, after the initial training program is completed for the purpose of training new and additional employees. Remote training allows a trainer at our offices to train one or more people at a client site via telephone and computer connection, thus allowing an interactive and client-specific mode of training without the expense and time required for travel. In addition, our on-line "help" and other documentation features facilitate client training as well as ongoing support. 10 Competition The markets for healthcare information systems are intensely competitive. The industry is highly fragmented and includes numerous competitors, none of which we believe dominates these markets. The electronic patient records and connectivity markets, in particular, are subject to rapid changes in technology, and we expect that competition in these market segments will increase as new competitors enter the market. We believe our principal competitive advantages are the features and capabilities of our products and services, our high level of customer support, and our extensive experience in the industry. Production Enhancement and Development The healthcare information management and computer software and hardware industries are characterized by rapid technological change requiring us to engage in continuing investments to update, enhance, and improve our systems. During fiscal years 2005, 2004, and 2003, we expended approximately $9.6 million, $8.7 million, and $6.7 million, respectively, on research and development activities, including capitalized software amounts of $2.7 million, $2.6 million, and $1.7 million, respectively. In addition, a portion of our product enhancements have resulted from software development work performed under contracts with our clients. Employees As of May 27, 2005, we employed 418 persons, of which 409 were full-time employees. We believe that our future success depends in part upon recruiting and retaining qualified sales, marketing and technical personnel as well as other employees. Risks Relating to our Business 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. 11 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 specific mix of software, hardware, and services in client orders; o the length of sales cycles and installation processes; o the ability of our clients to obtain financing for the purchase of our products; o changes in pricing policies or price reductions by us or our competitors; o the timing of new product announcements and product introductions by us or our competitors; o changes in revenue recognition or other accounting guidelines employed by us and/or established by the Financial Accounting Standards Board or other rule-making bodies; o the availability and cost of system components; o the financial stability of clients; o market acceptance of new products, applications and product enhancements; o our ability to develop, introduce and market new products, applications and product enhancements; o our success in expanding our sales and marketing programs; o deferrals of client orders in anticipation of new products, applications, product enhancements, or public/private sector initiatives; o execution of or changes to our 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, implementations, 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 SOP 97-2, as modified by SOP 98-9 and SAB 104. SAB 104 summarizes the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. 12 There can be no assurance that application and subsequent interpretations of these pronouncements will not further modify our revenue recognition policies, or that such modifications would not have a material adverse effect on the operating results reported in any particular quarter or year. Due to all of the foregoing factors, it is possible that our operating results may be below the expectations of public market analysts and investors. In such event, the price of our common stock would likely be materially adversely affected. The price of our shares and the trading volume of our shares have been volatile historically and may continue to be volatile. Volatility may be caused by a number of factors including but not limited to: o actual or anticipated quarterly variations in operating results; o rumors about our performance, software solutions, or merger and acquisition activity; o changes in expectations of future financial performance or changes in estimates of securities analysts; o governmental regulatory action; o health care reform measures; o client relationship developments; o purchases or sales of company stock; o changes occurring in the markets in general; and o other factors, many of which are beyond our control. Furthermore, the stock market in general, and the market for software, healthcare and high technology companies in particular, has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of actual operating performance. Two of our directors are significant shareholders, which makes it possible for them to have significant influence over the outcome of all matters submitted to our shareholders for approval and 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 an aggregate of approximately 38% of the outstanding shares of our common stock at March 31, 2005. The Company's Bylaws permit its shareholders to cumulate their votes, the effect of which is to provide shareholders with sufficiently large concentrations of Company shares the opportunity to assure themselves one or more seats on the Company's Board. The amounts required to assure a Board position can vary based upon the number of shares outstanding, the number of shares voting, the number of directors to be elected and the number of shares held by the shareholder exercising cumulative voting rights. In the event that cumulative voting is invoked, it is likely that the two of our directors holding an aggregate of approximately 38% of the outstanding shares of our common stock at March 31, 2005 will each have sufficient votes to assure themselves of one or more seats on our Board. With or without cumulative voting, 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 purchase us, 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 13 our net revenue on product development and believe that significant continuing product development efforts will be required to sustain our growth. Continued investment in our sales staff and our client implementation and support staffs will also be required to support future growth. There can be no assurance that we will be successful in our product development efforts, that the market will continue to accept our existing products, or that new products or product enhancements will be developed and implemented in a timely manner, meet the requirements of healthcare providers, or achieve market acceptance. If new products or product enhancements do not achieve market acceptance, our business, results of operations and financial condition could be materially adversely affected. At certain times in the past, we have also experienced delays in purchases of our products by clients anticipating our launch of new products. There can be no assurance that material order deferrals in anticipation of new product introductions from ourselves or other entities will not occur. If the emerging technologies and platforms of Microsoft and others upon which we build our products do not gain broad market acceptance, or if we fail to develop and introduce in a timely manner new products and services compatible with such emerging technologies, we may not be able to compete effectively and our ability to generate revenue will suffer. Our software products are built and depend upon several underlying and evolving relational database management system platforms such as those developed by Microsoft. To date, the standards and technologies upon which we have chosen to develop our products have proven to have gained industry acceptance. However, the market for our software products is subject to ongoing rapid technological developments, quickly evolving industry standards and rapid changes in customer requirements, and there may be existing or future technologies and platforms that achieve industry standard status, which are not compatible with our products. We face the possibility of subscription pricing. 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, 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 a significantly greater degree of subscription pricing 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 increasingly embrace subscription pricing. 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, 14 will be completed concurrently with or prior to introduction of competing products. Any such failure or delay could adversely affect our competitive position or could make our current products obsolete. We face the possibility of claims based upon our web site. We could be subject to third party claims based on the nature and content of information supplied on our Web site by us or third parties, including content providers or users. We could also be subject to liability for content that may be accessible through our Web site or third party Web sites linked from our Web site or through content and information that may be posted by users in chat rooms, bulletin boards or on Web sites created by professionals using our applications. Even if these claims do not result in liability to us, investigating and defending against these claims could be expensive and time consuming and could divert management's attention away from our operations. We face the possibility of claims from activities of strategic partners. We rely on third parties to provide services that impact our business. For example, we use national clearinghouses in the processing of some insurance claims and we outsource some of our hardware maintenance services and the printing and delivery of patient statements for our customers. We also have relationships with certain third parties where these third parties serve as sales channels through which we generate a portion of our revenue. Due to these third-party relationships, we could be subject to claims as a result of the activities, products, or services of these third-party service providers even though we were not directly involved in the circumstances leading to those claims. Even if these claims do not result in liability to us, defending and investigating these claims could be expensive and time-consuming, divert personnel and other resources from our business and result in adverse publicity that could harm our business. We may engage in future acquisitions, which may be expensive and time consuming and from which we may not realize anticipated benefits. We may acquire additional businesses, technologies and products if we determine that these additional businesses, technologies and products are likely to serve our strategic goals. We currently have no commitments or agreements with respect to any acquisitions. The specific risks we may encounter in these types of transactions include 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 use of cash as acquisition currency may adversely impact interest or investment income , thereby potentially negatively affecting our earnings and /or earnings per share 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; o The possibility that acquired assets become impaired, requiring the Company to take a charge to earnings which could be significant. 15 A failure to successfully integrate acquired businesses or technology for any of these reasons could have a material adverse effect on the Company's results of operations. We face the risks and uncertainties that are associated with litigation against us. We face the risks associated with litigation concerning the operation of our business. The uncertainty associated with substantial unresolved litigation may have an adverse impact on our business. In particular, such litigation could impair our relationships with existing customers and our ability to obtain new customers. Defending such litigation may result in a diversion of management's time and attention away from business operations, which could have a material adverse effect on our business, results of operations and financial condition. Such litigation may also have the effect of discouraging potential acquirers from bidding for us or reducing the consideration such acquirers would otherwise be willing to pay in connection with an acquisition. There can be no assurance that such litigation will not result in liability in excess of our insurance coverage, that our insurance will cover such claims or that appropriate insurance will continue to be available to us in the future at commercially reasonable rates. We rely heavily on our proprietary technology. We are heavily dependent on the maintenance and protection of our intellectual property and we rely largely on license agreements, confidentiality procedures, and employee nondisclosure agreements to protect our intellectual property. Our software is not patented and existing copyright laws offer only limited practical protection. There can be no assurance that the legal protections and precautions we take will be adequate to prevent misappropriation of our technology or that competitors will not independently develop technologies equivalent or superior to ours. Further, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States and are often not enforced as vigorously as those in the United States. We do not believe that our operations or products infringe on the intellectual property rights of others. However, there can be no assurance that others will not assert infringement or trade secret claims against us with respect to our current or future products or that any such assertion will not require us to enter into a license agreement or royalty arrangement or other financial arrangement with the party asserting the claim. Responding to and defending any such claims may distract the attention of Company management and have a material adverse effect on our business, results of operations and financial condition. In addition, claims may be brought 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 16 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 disrupt our ability to perform certain key business functions and could potentially reduce demand for our services. Accordingly, we have expended significant resources toward establishing and enhancing the security of our related infrastructures, although no assurance can be given that they will be entirely free from potential breach. Maintaining and enhancing our infrastructure security may require us to expend significant capital in the future. 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 infrastructure and/or 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 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 maintain key man life insurance on only one of our employees. Because we have a relatively small number of employees when compared to other leading companies in 17 our industry, our dependence on maintaining our relationships with key employees is particularly significant. We are also dependent on our ability to attract 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 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. 18 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. We offer certain electronic claims submission products and services as part of our product line. While we have implemented certain product features designed to maximize the accuracy and completeness of claims submissions, these features may not be sufficient to prevent inaccurate claims data from being submitted to payors. Should inaccurate claims data be submitted to payors, we may be subject to liability claims. 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). As these regulations mature and become better defined, we anticipate that these regulations will continue to directly affect certain of our products and services, but we cannot fully predict the impact at this time. 19 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 may or may not supercede HIPAA and have the potential to 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 the price at which our stock trades. In the process of evaluating and documenting our controls pursuant to Section 404 of the Sarbanes-Oxley Act. we have identified various deficiencies which we are in the course of remediating. Management does not believe that any of these identified deficiencies constitute a material weakness in our internal controls. No evaluation process can provide complete assurance that our internal controls will detect and correct all failures within the Company to disclose material information otherwise required to be reported. The effectiveness of our controls and procedures could also be limited by simple errors or faulty judgments. In addition, if we continue to expand, the challenges involved in implementing appropriate controls will increase and may require that we evolve some or all of our internal control processes. 20 It is also possible that the overall scope of Section 404 of the Sarbanes Oxley Act of 2002 may be revised in the future, thereby causing our auditors and ourselves to review, revise or reevaluate our internal control processes which may result in the expenditure of additional human and financial resources. Our earnings will be affected beginning fiscal year 2007 when we begin recognizing employee stock option expense, pursuant to recently issued accounting standards. 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. However, beginning with the quarter ended June 30, 2006 and beyond, we will begin recognizing employee stock option expense for remaining unvested stock options and any future stock option grants, resulting in additional pre-tax compensation expense. Option expensing could have a negative impact upon the price of our stock. Continuing worldwide political and economic uncertainties may adversely impact our revenue and profitability. In the last three years, worldwide economic conditions have experienced a downturn due to numerous factors including but not limited to concerns about inflation and deflation, decreased consumer confidence, the lingering effects of international conflicts, and terrorist and military activities. These conditions make it extremely difficult for our customers, our vendors and ourselves to accurately forecast and plan future business activities, and they could cause constrained spending on our products and services, and/or delay and lengthen sales cycles. Our future policy concerning the payment of dividends is uncertain. While we paid a one-time cash dividend in March 2005, we have not historically paid dividends, cash or otherwise, and there can be no assurance that we will pay another dividend in the future. Unfulfilled expectation to the contrary could have a material negative impact upon the price of our stock. ITEM 2. PROPERTIES Our principal administrative, accounting and QSI Division operations are located in Irvine, California, under a lease that commenced May 15, 2002, and expired in April 30, 2005. In April 2005, we renewed our lease through May 31, 2008. We lease approximately 12,000 square feet of space at this location. In August 2002, we executed a new lease for the principal office of our NextGen Division. This lease includes approximately 32,000 square feet of space in Horsham, Pennsylvania, and expires on January 31, 2010. In the year ended March 31, 2005, we added approximately 14,000 of additional space in Horsham, Pennsylvania under new lease which expires on January 31, 2010. In addition, we lease approximately 6,000 square feet of space in Santa Ana, California, to house our assembly and warehouse operations. We have approximately 12,000 square feet of space in Atlanta, Georgia under a lease which expires in February, 2006. We also have an aggregate of approximately 4,000 square feet of space in Massachusetts, Minnesota, New Jersey, Texas, Utah, Wisconsin, and Washington to house additional sales, training, development and service operations. These leases, excluding options, have expiration dates ranging from month-to-month to March 2010. The Company's growth will require it to lease additional space. We believe that suitable additional or substitute space is available, if needed, at commercially reasonable rates. ITEM 3. LEGAL PROCEEDINGS In the normal course of business, we are involved in various claims and legal proceedings. While the ultimate resolution of these matters, has yet to be determined, we do not believe that their outcome will have a material adverse effect on our financial position, results of operations or liquidity. 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of fiscal year 2005. Executive Officers of the Company Our executive officers as of May 31, 2005 were as follows:
Name Age Position - ---- --- ----------------------------------------------------------- Louis E. Silverman............... 46 President, Chief Executive Officer Patrick B. Cline................. 44 President, NextGen Healthcare Information Systems Division Greg Flynn....................... 47 Executive Vice President and General Manger of QSI Division Paul A. Holt..................... 39 Secretary, Chief Financial Officer
Our executive officers are elected by, and serve at the discretion of, the Board of Directors. Additional information regarding our executive officers is set forth below. Louis E. Silverman was appointed President and Chief Executive Officer of the company on July 31, 2000. Mr. Silverman was previously Chief Operations Officer of CorVel Corp., a publicly traded national managed care services and technology firm with headquarters in Irvine, California. Mr. Silverman holds a Master of Business Administration degree from Harvard Graduate School of Business Administration and a Bachelor of Arts degree from Amherst College. Patrick B. Cline currently serves as President of our NextGen Healthcare Information Systems Division. He served as our interim Chief Executive Officer for the April - July 2000 period. Mr. Cline was a co-founder of Clinitec and has served as its President since its inception in January 1994 and throughout its transition to NextGen Healthcare Information Systems. Prior to co-founding Clinitec, Mr. Cline served, from July 1987 to January 1994, as Vice President of Sales and Marketing with Script Systems, a subsidiary of InfoMed, a healthcare information systems company. From January 1994 to May 1994, after the founding of Clinitec, Mr. Cline continued to serve, on a part time basis, as Script Systems' Vice President of Sales and Marketing. Mr. Cline has held senior positions in the healthcare information systems industry since 1981. Greg Flynn has served as the QSI Division's General Manager since April 2000 and as Executive Vice President since August 1998 after serving as Vice President of Sales and Marketing from January 1996 to August 1998. Between June 1992 and January 1996, Mr. Flynn served as Vice President Administration. In these capacities, Mr. Flynn has been responsible for numerous functions related to our ongoing management and sales. Previously, Mr. Flynn served as our Vice President, Corporate Communications. Mr. Flynn joined us in January 1982. He holds a B.A. degree in English from the University of California, Santa Barbara. Paul A. Holt was appointed Chief Financial Officer in November 2000. Mr. Holt has served as our Controller from January 2000 to May 2000 and was appointed interim Chief Financial Officer in May 2000. Prior to joining us, Mr. Holt was the Controller of Sierra Alloys Co., Inc., a titanium metal manufacturing company from August 1999 to December 1999. From May 1997 to July 1999, he was Controller of Refrigeration Supplies Distributor, a wholesale distributor and manufacturer of refrigeration supplies and heating controls. From March 1995 to April 1997 he was Assistant Controller of Refrigeration Supplies Distributor. Mr. Holt is a Certified Public Accountant and holds an M.B.A. from the University of Southern California and a B.A. in Economics from the University of California, Irvin 22 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our Common Stock is traded on the NASDAQ National Market under the symbol "QSII". The following table sets forth for the quarters indicated the high and low sales prices as reported by NASDAQ. The quotations reflect inter-dealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions. Quarter Ended High Low ------------- ------- ------- June 30, 2003 ......................... $ 18.23 $ 11.25 September 30, 2003 .................... 23.43 12.58 December 31, 2003 ..................... 24.88 19.91 March 31, 2004 ........................ 30.80 19.50 June 30, 2004 ......................... 25.75 19.75 September 30, 2004 .................... 27.75 20.77 December 31, 2004 ..................... 32.49 24.05 March 31, 2005 ........................ $ 48.90 $ 27.90 At May 31, 2005, there were approximately 130 holders of record of our Common Stock. We estimate the number of beneficial holders of our Common Stock to be in excess of 6,000. On February 2, 2005, the Company announced that its Board of Directors had declared a 2-for-1 stock split with respect to our outstanding shares of common stock for shareholders of record on March 4, 2005. The stock began trading post split on March 28, 2005. All share prices in the foregoing table have been retroactively adjusted to reflect such stock split. On March 16, 2005, we paid a one time dividend on shares of our Common Stock equal to $1.50 per share. ($3.00 pre-split) The record date for the dividend was February 24, 2005. Payment of future dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. We did not make any unregistered sales of our common stock during the fourth quarter of 2005. 23 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data with respect to our Consolidated Statements of Income data for each of the five years in the period ended March 31 and the Consolidated Balance Sheet data as of the end of each such fiscal year are derived from our audited financial statements. The following information should be read in conjunction with our Consolidated Financial Statements and the related notes thereto and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." included elsewhere herein. Consolidated Financial Data
(In Thousands, Except Per Share Data) Year Ended March 31, 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- Statement of Income Data: Revenue...................................... $ 88,961 $ 70,934 $ 54,769 $ 44,422 $ 39,936 Cost of revenue.............................. 32,669 28,673 23,755 19,253 17,283 -------- -------- -------- -------- -------- Gross profit................................. 56,292 42,261 31,014 25,169 22,653 Selling, general and administrative expenses. 24,776 19,482 15,293 13,068 13,585 Research and development costs............... 6,903 6,139 5,062 4,243 4,081 -------- -------- -------- -------- -------- Income from operations....................... 24,613 16,640 10,659 7,858 4,987 Investment income............................ 876 386 434 643 1,032 -------- -------- -------- -------- -------- Income before provision for income taxes..... 25,489 17,026 11,093 8,501 6,019 Provision for income taxes................... 9,380 6,626 4,058 3,233 2,510 -------- -------- -------- -------- -------- Net income................................... $ 16,109 $ 10,400 $ 7,035 $ 5,268 $ 3,509 ======== ======== ======== ======== ======== Basic net income per share................... $ 1.25 $ 0.84 $ 0.57 $ 0.44 $ 0.29 Diluted net income per share................. $ 1.22 $ 0.80 $ 0.55 $ 0.42 $ 0.28 Basic weighted average shares outstanding.... 12,872 12,436 12,254 12,050 12,260 Diluted weighted average shares outstanding.. 13,203 12,966 12,778 12,480 12,406 Balance Sheet Data (at end of period): Cash and cash equivalents and short-term investments.................................. $ 51,157 $ 51,395 $ 36,443 $ 25,698 $ 18,729 Working capital.............................. 55,111 53,415 38,717 30,799 24,196 Total assets................................. 99,442 86,678 67,602 52,143 44,883 Total liabilities............................ 36,711 25,673 20,069 12,093 10,996 Total shareholders' equity................... $ 62,731 $ 61,005 $ 47,533 $ 40,050 $ 33,887
24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Except for the historical information contained herein, the matters discussed in this Annual Report on Form 10-K, including discussions of our product development plans, business strategies and market factors influencing our results, 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 "Item 1. Business. Risk Factors" as set forth above, as well as in our other public disclosures and filings with the Securities and Exchange Commission. The following discussion should be read in conjunction with, and is qualified in our entirety by, the Consolidated Financial Statements and related notes thereto included elsewhere in this Report. Historical results of operations, percentage margin fluctuations and any trends that may be inferred from the discussion below are not necessarily indicative of the operating results for any future period. Critical Accounting Policies The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an 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, goodwill impairment, capitalized software costs and research and development tax credits are among the most critical accounting policies that impact our consolidated financial statements. We believe that significant accounting policies, as described in Note 2 of our Consolidated Financial Statements, "Summary of Significant Accounting Policies", should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations. Revenue Recognition. Our revenue is primarily generated from the sale of software licenses, services, hardware, maintenance fees, and EDI services. We currently recognize revenue pursuant to Statement of Position No. 97-2, "Software Revenue Recognition" (SOP 97-2), as modified by Statement of Position No. 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect of Certain Transactions" (SOP 98-9), Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101) and Staff Accounting Bulletin No. 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. Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and amount of revenue recognition. 25 In accordance with the governing revenue recognition guidelines, if the arrangement between vendor and purchaser does not require significant production, modification, or customization of software, revenue should be recognized when all of the following criteria are met: o persuasive evidence of an arrangement exists; o delivery has occurred; o the vendor's fee is fixed or determinable; and o collectibility is probable. In accordance with generally accepted accounting principles in the United States of America, the recognition of software license revenue is based on our assessment that the above criteria have been met. In general, the first two criteria are met with a signed contract and evidence that we have shipped our software to the customer. We determine that our fee is fixed and determinable based on the contract terms, which specify payment terms tied to specific dates and not to any future deliverables. Probability of collection is based on a credit review of customers. The timing or amount of revenue recognition may differ if different assessments of the above listed criteria had been made at the time transactions were recorded in revenue. SOP 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. Our determination of the fair value of each element in multi-element arrangements is based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. Management determines the price of individual elements sold separately using a rolling average of stand alone transactions. VSOE calculations are reviewed on a quarterly basis. If evidence of fair value of all undelivered elements exists but evidence of fair value does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred at VSOE and the remaining portion of the arrangement fee is recognized as revenue, net of all discounts. 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 Statement of Position No. 81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts" (SOP 81-1), whereby the revenue is recognized, generally using the percentage-of-completion method measured on labor input hours. The complexity of the estimation process and judgment related to the assumptions, risks and uncertainties inherent with the application of the percentage-of-completion method of accounting affect the amounts of revenue reported in its consolidated financial statements. Valuation Allowances. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We perform ongoing credit evaluations of our customers and maintain reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management's estimate of the probability of collection for certain troubled accounts. General reserves are established based on our historical experience of bad debt expense and the aging of our accounts receivable balances net of deferred revenue and specifically reserved accounts. If the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments, additional allowances would be required. Goodwill Impairment. Our long-lived assets include goodwill of $1.8 million as of March 31, 2005 and 2004, respectively. We follow Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" (SFAS 142). The statement applies to the amortization of goodwill and other 26 intangible assets. We no longer amortize amounts related to goodwill. 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. There have been no changes that would lead us to believe there is any impairment of the goodwill since the date of the last annual impairment test through March 31, 2005. 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. Software Development Costs. Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional development costs are capitalized in accordance with the Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" (SFAS 86). Such capitalized costs are amortized on a straight line basis over the estimated economic life of the related product, of three years. We perform an annual review of the recoverability of such capitalized software costs. At the time a determination is made that capitalized amounts are not recoverable based on the estimated cash flows to be generated from the applicable software, any remaining capitalized amounts are written off. Research and Development Tax Credits. During the year ended March 31, 2003, the Company filed amended federal and state tax returns for the fiscal years ended March 31, 1998 through 2001, to take advantage of tax credits related to our research and development activities. In addition, the Company claimed research and development credit on its tax returns for the years ended March 31, 2004, 2003 and 2002. The provision for income taxes for the year ended March 31, 2004 and 2003 accounted for a portion of the aggregate tax credits accumulated through the end of each period due to the uncertainly concerning the ultimate amount of tax to be credited. As of March 31, 2004, the Company had a balance of $0.5 million in credits which had not been recognized. In the quarter ended March 31, 2005, the state of California completed an audit of the Company's tax returns and did not materially change credits related to research and development. Based on the results of that audit as well the expiration of the statue of limitations on certain amended returns, the provision for income taxes for the year ended March 31, 2005 was reduced by the $0.5 million in tax credits which had not been recognized as of March 31 2004. Management's treatment of research and development tax credits represented a significant estimate which affected the effective income tax rates for the Company in the years ending March 31, 2005 and 2004. Research and development credits taken by the Company involve certain assumptions and judgments regarding qualification of expenses under the relevant tax codes. While the Company has received all of federal refunds claimed, none of the credits have been audited by the Internal Revenue Service. 27 Overview of Company results o We have experienced significant growth in our total revenue as a result of revenue growth in our NextGen Healthcare Information Services Division. Our total Company revenue grew 25.4% on a consolidated basis during the twelve months ended March 31, 2005 versus 2004 and 29.5% in the twelve months ended March 31, 2004 versus 2003. o Consolidated income from operations grew 47.9% in the twelve months ended March 31, 2005 versus 2004 and 56.1% in the twelve months ended March 31, 2004 versus 2003. 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 of technology in the healthcare arena. NextGen Division o Our NextGen Division has experienced significant growth in revenue and operating income. Divisional revenue grew 35.2% in the twelve months ended March 31, 2005 versus 2004 and 45.8% in the twelve months ended March 31, 2004 versus 2003 while divisional operating income (excluding unallocated corporate expenses) grew 64.1% in the twelve months end March 31, 2005 and 77.4% in the twelve months ended March 31, 2004. o During the twelve months ended March 31, 2005, we added staffing resources to departments including sales, marketing, support, implementation, software development, and administration and intend to continue to do so in fiscal year 2006. o Our goals include continuing to further enhance our existing products, developing new products for targeted markets, continuing to add new customers, selling additional software and services to existing customers and expanding penetration of connectivity services to new and existing customers. QSI Division o Our QSI Division experienced a revenue decline of 6.8% in the twelve months ended March 31, 2005 versus 2004 and 5.3% in the twelve months ended March 31, 2004 versus 2003. The Division experienced a 14.7% decrease in operating income (excluding unallocated corporate expenses) in the twelve months ended March 31, 2005 versus 2004. o Our goals for the QSI Division include maximizing revenue and profit performance given the constraints present in this Division's target market. 28 The following table sets forth for the periods indicated the percentage of net revenue represented by each item in our Consolidated Statements of Operations.
Year Ended March 31, 2005 2004 2003 --------- --------- --------- Revenue: System sales............................................ 54.5% 55.7% 53.3% Maintenance, EDI, and other services.................... 45.5 44.3 46.7 --------- --------- --------- Total revenue........................................... 100.0 100.0 100.0 Cost of revenue......................................... 36.7 40.4 43.4 --------- --------- --------- Gross profit............................................ 63.3 59.6 56.6 Selling, general and administrative expenses............ 27.9 27.4 27.9 Research and development costs.......................... 7.8 8.7 9.2 --------- --------- --------- Income from operations.................................. 27.7 23.5 19.5 Investment income....................................... 1.0 0.5 0.8 --------- --------- --------- Income before provision for income taxes................ 28.7 24.0 20.3 Provision for income taxes.............................. 10.5 9.3 7.5 --------- --------- --------- Net income.............................................. 18.1% 14.7% 12.8%
Comparison of the Years Ended March 31, 2005 and March 31, 2004 For the year ended March 31, 2005, our net income was $16.1 million or $1.25 per share on a basic and $1.22 per share on a fully diluted basis. In comparison, we earned $10.4 million or $0.84 per share on a basic and $0.80 on a fully diluted basis in the year ended March 31, 2004. The increase in net income for the year ended March 31, 2005, was achieved primarily through the following: o a 25.4% increase in revenue; o an increase in our gross profit margin from 59.6% to 63.3%. Revenue. Revenue for the year ended March 31, 2005 increased 25.4% to $89.0 million from $70.9 million for the year ended March 31, 2004. NextGen Division revenue increased 35.2% from $54.4 million to approximately $73.6 million in the period, while QSI Division revenue declined by 6.8% during the period from approximately $16.5 million to $15.4 million. We divide revenue into two categories, "System sales" and "Maintenance, EDI, and other services". Revenue in the system sales category includes software license fees, third party hardware and software, and implementation and training services related to purchase of the Company's software systems. Revenue in the maintenance and other services category includes maintenance, EDI, and other revenue. Maintenance and EDI revenue are the principle sources of revenue in this category. System Sales. Company-wide sales of systems for the twelve months ended March 31, 2005 increased 22.8% to $48.5 million from $39.5 million in the prior year. Our increase in revenue from sales of systems was principally the result of a 24.8% increase in category revenue at our NextGen Division whose sales in this category grew from $37.3 million during the year ended March 31, 2004 to $46.6 million during the year ended March 31, 2005. This increase was driven primarily by higher sales of NextGen(emr) and NextGen(epm) software to both new and existing clients, as well as an increase in the delivery of related implementation services offset by a decline in the sale of related hardware, third party software and supplies. Systems sales revenue in the QSI Division declined 11.1% to approximately $1.9 million in the year ended March 31, 2005 from $2.2 million in the year ended March 31, 2004. 29 The following table breaks down our reported system sales into software, hardware, third party software, supplies, and implementation and training services components by Division:
-------------------------------------------------------------------- Hardware, Third Party Implementation Software and and Training Total Software Supplies Services System Sales ------------- ------------- -------------- ------------- Twelve months ended March 31, 2005 QSI Division............ $ 889 $ 744 $ 306 $ 1,939 NextGen Division........ 33,230 4,811 8,548 46,589 ------------- ------------- -------------- ------------- Consolidated............ $ 34,119 $ 5,555 $ 8,854 $ 48,528 ============= ============= ============== ============= Twelve months ended March 31, 2004 QSI Division............ $ 807 $ 1,029 $ 345 $ 2,181 NextGen Division........ 24,657 6,139 6,548 37,344 ------------- ------------- -------------- ------------- Consolidated............ $ 25,464 $ 7,168 $ 6,893 $ 39,525 ============= ============= ============== =============
NextGen Division software revenue increased 34.8% between the twelve months ended March 31, 2004 and the twelve months ended March 31, 2005. The Division's software revenue accounted for 71.3% of divisional system sales revenue during the twelve months ended March 31, 2005, an increase from 66.0% 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 twelve months ended March 31, 2005, 10.3% of NextGen's system sales revenue was represented by hardware and third party software compared to 16.4% in the same prior year period. We have noted that the last several quarter's results have included a relatively lower amount of hardware and third party software compared to prior year periods. However, this decrease was not the result of any 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 year 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 30.5% in the twelve months ended March 31, 2005 compared to the twelve months ended March 31, 2004. Implementation and training revenue at the NextGen Division increased its share of divisional system sales revenue to 18.3% in the twelve months ended March 31, 2005 from 17.5% in the twelve months ended March 31, 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 amount of implementation and training services revenue and the corresponding rate of growth compared to a prior period in any given year is dependant on several factors including timing of customer implementations, the availability of qualified staff, and the mix of services being rendered. The number of implementation and training staff increased during the twelve months ended March 31, 2005 versus March 31, 2004 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 mix and conditions, and our ability to retain current staff members. 30 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 2005 and 2004, as well as in prior years, and the apparent increasing acceptance of electronic medical records technology in the healthcare industry. For the QSI Division, total system sales decreased 11.1% in the twelve months ended March 31, 2005 compared to the twelve months ended March 31, 2004. 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. QSI systems sales during the fiscal year ended March 31, 2005 were impacted by year over year declines in hardware and implementation and training services. Maintenance, EDI, and other. Company-wide revenue from maintenance, EDI, and other services grew 28.7% to $40.4 million from $31.4 million. The increase in this category resulted principally from an increase in maintenance and EDI revenue generated from the NextGen Division's client base. Total NextGen Division maintenance revenue for the year ended March 31, 2005 grew 55.7% to $17.9 million from $11.5 million in the year ago period, while EDI revenue grew 86.0% to $5.6 million compared to $3.0 million in the year ago period. QSI Division maintenance revenue declined 3.8% from $7.6 million to $7.3 million in the same period while divisional EDI revenue declined by approximately 7.6% from $5.3 million to $4.9 million. The following table details revenue by category for the twelve month periods ended March 31, 2005 and 2004:
-------------------------------------------------------------------- Maintenance EDI Other Total ------------- ------------- ------------- ------------- Twelve months ended March 31, 2005 QSI Division............ $ 7,279 $ 4,877 $ 1,273 $ 13,429 NextGen Division........ 17,881 5,611 3,512 27,004 ------------- ------------- ------------- ------------- Consolidated............ $ 25,160 $ 10,488 $ 4,785 $ 40,433 ============= ============= ============= ============= Twelve months ended March 31, 2004 QSI Division............ $ 7,570 $ 5,276 $ 1,464 $ 14,310 NextGen Division........ 11,481 3,016 2,602 17,099 ------------- ------------- ------------- ------------- Consolidated............ $ 19,051 $ 8,292 $ 4,066 $ 31,409 ============= ============= ============= =============
The following table provides the number of billing sites which were receiving maintenance services as of the last business day of the period ended March 31, 2005 and 2004 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 Consolidated ------------------------------- ------------------------------- ------------------------------- Maintenance EDI Maintenance EDI Maintenance EDI ------------- ------------- ------------- ------------- ------------- ------------- March 31, 2004. 421 293 321 234 742 527 Billing sites added 138 144 4 7 142 151 Billing sites removed (1) (43) (29) (23) (30) (66) ------------- ------------- ------------- ------------- ------------- ------------- March 31, 2005 558 394 296 218 854 612 ============= ============= ============= ============= ============= =============
31 Cost of revenue. Cost of revenue for the year ended March 31, 2005 increased 13.9% to $32.7 million from $28.7 million for the year ended March 31, 2004, while the cost of revenue as a percentage of net revenue declined to 36.7% from 40.4% during the same period. Our consolidated gross profit is impacted by the level of hardware content included in system sales, the percentage of EDI revenue in our overall sales mix, and certain headcount expenses directly related to the cost of delivering our products and services. Consolidated gross profit is also impacted by the higher margin revenues of the NextGen Division which increased its share of total company revenue to 82.7% from 76.8% in the prior year. The following table details revenue and cost of revenue on a consolidated and divisional basis for the twelve month periods ended March 31, 2005 and 2004:
Year Ended March 31, ------------------------------------------------------------------- 2005 % 2004 % Consolidated Revenue................. $ 88,961 100.0% $ 70,934 100.0% Cost of revenue......... 32,669 36.7 28,673 40.4 ------------- ------------- ------------ ------------- Gross profit............ 56,292 63.3 42,261 59.6 NextGen Division Revenue................. 73,594 100.0 54,443 100.0 Cost of revenue......... 25,004 34.0 20,398 37.5 ------------- ------------- ------------ ------------- Gross profit............ 48,590 66.0 34,045 62.5 QSI Division Revenue................. 15,367 100.0 16,491 100.0 Cost of revenue......... 7,665 49.9 8,275 50.2 ------------- ------------- ------------ ------------- Gross profit............ $ 7,702 50.1% $ 8,216 49.8%
Gross profit margins at the NextGen Division for the year ended March 31, 2005 increased to 66.0% from 62.5% primarily due to a decrease in the proportionate level of hardware and third party software content included in revenue as well as a slight decrease in the relative level of applicable headcount expense associated with delivering our products and services. The QSI Division's gross profit margin improved slightly to 50.1% in the year ended March 31, 2005 from 49.8% in the same period last year due to proportionately lower hardware and third party software content included in revenue. 32 The following table details the individual components of cost of revenue and gross profit as a percentage of total revenue for our Company and our two divisions:
------------------------------------------------------------------- ------------- Outside Services, Amortization of Hardware, Payroll and Software Third Party related Development Total Cost of Software Benefits Costs and Other Revenue Gross Profit ------------- ------------- --------------- ------------- ------------- Twelve months ended March 31, 2005 QSI Division.......... 6.1% 17.8% 26.0% 49.9% 50.1% NextGen Division...... 6.8 12.6 14.6 34.0 66.0 ------------- ------------- --------------- ------------- ------------- Consolidated.......... 6.7 13.5 16.5 36.7 63.3 ============= ============= =============== ============= ============= Twelve months ended March 31, 2004 QSI Division.......... 7.6 16.8 25.8 50.2 49.8 NextGen Division...... 10.8 14.2 12.5 37.5 62.5 ------------- ------------- --------------- ------------- ------------- Consolidated.......... 10.0% 14.8% 15.6% 40.4% 59.6% ============= ============= =============== ============= =============
During the twelve months ended March 31, 2005, hardware and third party software constituted a smaller portion of consolidated revenue compared to the same prior year 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 decreased to 13.5% of consolidated revenue compared to 14.8% during the prior twelve months ended March 31, 2004. The absolute level of consolidated payroll and benefit expenses grew primarily due to additions to related headcount, payroll and benefits expense associated with delivering products and services in the NextGen Division. Payroll and benefits expense associated with delivering products and services in the QSI Division declined slightly on an absolute basis, but increased slightly on a percentage of revenue basis. 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. As a result of the foregoing events and activities, our gross profit for the Company and our two operating divisions increased for the twelve month period ending March 31, 2005 versus the prior year period. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended March 31, 2005 increased 27.2% to $24.8 million as compared to $19.5 million for the year ended 33 March 31, 2004. The increase resulted primarily from increases of $2.0 million in selling and administrative salaries and related benefits expenses in the NextGen Division, $0.9 million for corporate related professional services principally in the area of Sarbanes-Oxley compliance, $0.6 million in commission expense principally in the NextGen division, $0.4 million in corporate related salaries and related benefit expenses, $0.4 million in NextGen travel expenses and $1.0 million in other general and administrative expenses primarily in the NextGen Division. Selling, general and administrative expenses as a percentage of revenue slightly increased to 27.9% in the fiscal year ended March 31, 2005 from 27.4% in the fiscal period ended March 31, 2004 due to selling, general and administrative expenses growing at a slightly faster rate than revenue. We anticipate increased expenditures for trade shows, advertising and the employment of additional sales representatives primarily at the NextGen Division. We are hopeful that we will be able to achieve at least a moderate reduction in expenses related to Sarbanes Oxley Act compliance. 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 year ended March 31, 2005 and 2004 were $6.9 million and $6.1 million, respectively. The increase in research and development costs was primarily due to increased investment in the NextGen product line. Research and development costs as a percentage of net revenue decreased to 7.8% from 8.7% primarily due to revenue growing at a faster rate than the increase in research and development spending. Research and development costs are expected to continue at or above current levels. Investment Income. Investment income for the year ended March 31, 2005 increased 127% to approximately $0.9 million compared with $0.4 million in the year ended March 31, 2004. The increase was primarily due to the effect of an increase in short term interest rates versus the prior year period as well as comparatively higher amounts available for investment during the fiscal period ended March 31, 2005. During the fourth quarter of fiscal year 2005, the Company paid a one time dividend of approximately $19.6 million, which reduced the amount of funds available for investment during this period. Provision for Income Taxes. The provision for income taxes for the year ended March 31, 2005 was approximately $9.4 million as compared to approximately $6.6 million for the year ago period. The effective tax rates for fiscal 2005 and 2004 were 36.8% and 38.9%, respectively. The provision for income taxes for the years ended March 31, 2005 and 2004 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. During fiscal 2005, the Company recognized approximately $0.5 million of research and development credits which had not been recognized previously due to the uncertainly concerning the ultimate amount of tax to be credited. In the quarter ended March 31, 2005, the State of California completed an audit of the Company's tax returns and did not materially change credits related to research and development. Based on the results of that audit as well the expiration of the statue of limitations on certain amended returns, the provision for income taxes for the year ended March 31, 2005 was reduced by the $0.5 million in tax credits which had not been recognized as of March 31 2004. 34 Comparison of the Years Ended March 31, 2004 and March 31, 2003 For the year ended March 31, 2004, our net income was $10.4 million or $0.84 per share on a basic and $0.80 per share on a fully diluted basis. In comparison, the Company earned $7.0 million or $0.57 per share on a basic and $0.55 per shares on a diluted basis in the year ended March 31, 2003. The increase in net income for the year ended March 31, 2004, was achieved through the following: o a 29.5% increase in revenue; o an increase in our gross profit margin from 56.6% to 59.6%; and o Selling, general and administrative and research and development expenses which grew at 27.4% and 21.3% respectively; slower than the overall revenue growth rate. Revenue. Net revenue for the year ended March 31, 2004 increased 29.5% to $70.9 million from $54.8 million for the year ended March 31, 2003. Sales of computer systems, upgrades and supplies increased 35.5% to $39.5 million from $29.2 million while net revenue from maintenance, EDI, and other service grew 22.7% to $31.4 from $25.6 million during the comparable prior period. The increase in net revenue from sales of computer systems, upgrades and supplies was principally due to increased sales of the Company's NextGen(epm) and NextGen(emr) software licenses to new customers. We divide revenue into two categories, "System sales" and "Maintenance, EDI, and other services". Revenue in the systems sales category includes software license fees, third party hardware and software, and implementation and training services related to purchase of the Company's software systems. Revenue in the maintenance and other services category includes maintenance, EDI, and other revenue. Maintenance and EDI revenue are the principle sources of revenue in this category. System Sales. Company-wide sales of systems for the twelve months ended March 31, 2004 increased 35.5% to $39.5 million from $29.2 million in the prior year. Our increase in revenue from sales of systems was principally the result of a 42.5% increase in category revenue at our NextGen Division whose sales in this category grew from $26.2 million during the year ended March 31, 2003 to $37.3 million during the year ended March 31, 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 and sales of related hardware, third party software, and supplies. Systems sales revenue in the QSI Division declined 26.2% to approximately $2.2 million in the year ended March 31, 2004 from $3.0 million in the year ended March 31, 2003. 35 The following table breaks down our reported system sales into software, hardware, third party software, supplies, and implementation and training services components by Division:
-------------------------------------------------------------------- Hardware, Third Party Implementation Software and and Training Total Software Supplies Services System Sales ------------- ------------- -------------- ------------- Twelve months ended March 31, 2004 QSI Division......... $ 807 $ 1,029 $ 345 $ 2,181 NextGen Division..... 24,657 6,139 6,548 37,344 ------------- ------------- -------------- ------------- Consolidated......... $ 25,464 $ 7,168 $ 6,893 $ 39,525 ============= ============= ============== ============= Twelve months ended March 31, 2003 QSI Division......... $ 1,591 $ 1,160 $ 205 $ 2,956 NextGen Division..... 17,982 4,658 3,573 26,213 ------------- ------------- -------------- ------------- Consolidated......... $ 19,573 $ 5,818 $ 3,778 $ 29,169 ============= ============= ============== =============
Maintenance, EDI, and other. Company-wide revenue from maintenance, EDI, and other services grew 22.7% to $31.4 million from $25.6 million. The increase in this category resulted principally from an increase in maintenance and EDI revenue from the NextGen Division's client base. Total NextGen Division maintenance revenue for the year ended March 31, 2004 grew 58.0% to $11.5 million from $7.3 million in the year ago period, while EDI revenue grew 74.0% to $3.0 million compared to $1.7 million in the same period. QSI Division maintenance revenue declined 4.7% from $7.9 million to $7.6 million in the same period while divisional EDI revenue declined by approximately 2.8% from $5.4 million to $5.3 million. The following table details revenue by category for the twelve month periods ended March 31, 2004 and 2003:
-------------------------------------------------------------------- Maintenance EDI Other Total ------------- ------------- ------------- ------------- Twelve months ended March 31, 2004 QSI Division......... $ 7,570 $ 5,276 $ 1,464 $ 14,310 NextGen Division..... 11,481 3,016 2,602 17,099 ------------- ------------- ------------- ------------- Consolidated......... $ 19,051 $ 8,292 $ 4,066 $ 31,409 ============= ============= ============= ============= Twelve months ended March 31, 2003 QSI Division......... $ 7,941 $ 5,426 $ 1,100 $ 14,467 NextGen Division..... 7,267 1,733 2,133 11,133 ------------- ------------- ------------- ------------- Consolidated......... $ 15,208 $ 7,159 $ 3,233 $ 25,600 ============= ============= ============= =============
The following table provides the number of billing sites which were receiving maintenance services as of the last business day of the period ended March 31, 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. 36
------------------------------------------------------------------------------------------------------- NextGen QSI Consolidated ------------------------------- ------------------------------- ------------------------------- Maintenance EDI Maintenance EDI Maintenance EDI ------------- ------------- ------------- ------------- ------------- ------------- March 31, 2003 315 219 348 254 663 473 Billing sites added 117 99 4 4 121 103 Billing sites removed (11) (25) (31) (24) (42) (49) ------------- ------------- ------------- ------------- ------------- ------------- March 31, 2004 421 293 321 234 742 527 ============= ============= ============= ============= ============= =============
Cost of Revenue. Cost of revenue for the year ended March 31, 2004 increased 20.7% to $28.7 million from $23.8 million for the year ended March 31, 2003, while the cost of revenue as a percentage of revenue at 40.4% for 2004 declined compared to the prior year's 43.4% of revenue. The following table details revenue and cost of revenue on a consolidated and divisional basis for the twelve month periods ended March 31, 2004 and 2003:
Year Ended March 31, ------------------------------------------------------------------- 2004 % 2003 % Consolidated Revenue................. $ 70,934 100.0% $ 54,769 100.0% Cost of revenue......... 28,673 40.4 23,755 43.4 ------------- ------------- ------------- ------------- Gross profit............ 42,261 59.6 31,014 56.6 NextGen Division Revenue................. 54,443 100.0 37,346 100.0 Cost of revenue......... 20,398 37.5 14,511 38.9 ------------- ------------- ------------- ------------- Gross profit............ 34,045 62.5 22,835 61.1 QSI Division Revenue................. 16,491 100.0 17,423 100.0 Cost of revenue......... 8,275 50.2 9,244 53.1 ------------- ------------- ------------- ------------- Gross profit............ $ 8,216 49.8% $ 8,179 46.9%
Gross profit is impacted by the level of hardware content included in system sales, the percentage of EDI revenue in our overall sales mix, and certain headcount expenses. Gross profit at the NextGen Division for the year ended March 31, 2004 improved to 62.5% from 61.1% primarily due to a decrease in the relative level of applicable outside service, amortization of software development costs and other expenses associated with delivering the Company's products and services. The QSI Division's gross profit for the year ended March 31, 2004 improved to 49.8% from 46.9% in the same period during the prior year primarily due to a proportionately lower hardware and third party software content included in revenue. In addition, our gross profit percentage increased as the higher margined NextGen Division increased its share of total Company revenue to 76.8% from 68.2% in the prior year. The following table details the individual components of cost of revenue and gross profit as a percentage of total revenue for our Company and our two divisions: 37
------------------------------------------------------------------------------------ Outside Services, Amortization of Software Hardware, Payroll and Development Third Party related Costs and Total Cost Software Benefits Other of Revenue Gross Profit ------------- ------------- --------------- ------------- ------------- Twelve months ended March 31, 2004 QSI division....... 7.6% 16.8% 25.8% 50.2% 49.8% NextGen division... 10.8 14.2 12.5 37.5 62.5 ------------- ------------- --------------- ------------- ------------- Consolidated....... 10.0 14.8 15.6 40.4 59.6 ============= ============= =============== ============= ============= Twelve months ended March 31, 2003 QSI division....... 11.1 15.5 26.5 53.1 46.9 NextGen division... 11.9 11.8 15.2 38.9 61.1 ------------- ------------- --------------- ------------- ------------- Consolidated....... 11.6% 13.0% 18.8% 43.4% 56.6% ============= ============= =============== ============= =============
During the twelve months ended March 31, 2004, hardware and third party software constituted a slightly 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 14.8% of consolidated revenue compared to 13.0% during the prior twelve months ended March 31, 2003. The level of consolidated payroll and benefit expenses grew due to additions to related headcount, payroll and benefits expense associated with delivering products and services in the NextGen Division. Payroll and benefits expense associated with delivering products and services in the QSI Division increased slightly on both an absolute and a percentage of revenue basis. 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. Our outside services, amortization of software development costs and other expenses included in cost of revenue declined to 15.6% compared to 18.8% during the twelve months ended March 31, 2003. This decline was due to a number of factors including a slight decline in the proportion of EDI revenue included in consolidated revenue during fiscal 2004, a slight improvement in gross profit related to EDI revenue, and certain overhead and amortization of capitalized software costs increasing at a slower rate compared to the rate of revenue growth. 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 profit percentages should increase to more closely match those of the NextGen Division. As a result of the foregoing events and activities, our gross profit for the Company and our two operating divisions increased for the twelve month period ending March 31, 2004 versus the prior year period. 38 Selling, General and Administrative. Selling, general and administrative expenses for the year ended March 31, 2004 increased 27.4% to $19.5 million from $15.3 million for the year ended March 31, 2003, and declined on a percentage of revenue basis to 27.4% from 27.9% for the respective fiscal years. The increase in the amount of such expenses resulted primarily from increases of $1.1 million in corporate expenses, principally in the area of professional service fees, as well as $1.0 million in selling and administrative payroll and benefits expenses, $0.9 million in commissions expenses, and $0.6 million in travel and trade show expenses primarily in the NextGen Division. Further increases in selling, general and administrative expenses are expected. Research and Development Costs. Research and development costs for the year ended March 31, 2004 and 2003 were $6.1 million and $5.1 million, respectively. The increase in research and development costs was primarily due to increased investment in the NextGen product line. Research and development costs as a percentage of net revenue decreased to 8.7% from 9.2% due in part, to the fact that revenue growth exceeded the increase in research and development spending, and in part due to the fact that our investments in capitalized software increased to $2.6 million from $1.7 million in the prior year, reflecting increased expenditures directed at enhancements of the NextGen products. Research and development costs are expected to continue at or above current levels. Investment Income. Investment income for the year ended March 31, 2004 decreased 11.1% to approximately $0.4 million compared with $0.4 million in the year ended March 31, 2003. Investment income in the year ended March 31, 2004 declined primarily due to the effect of the drop in short term interest rates versus the prior year. The decline in interest rates was partially offset by an increase in average funds available for investment during the year ended March 31, 2004. Provision for Income Taxes. The provision for income taxes for the year ended March 31, 2004 was approximately $6.6 million as compared to approximately $4.1 million for the year ago period. The effective tax rates for fiscal 2004 and 20003 were 38.9% and 36.6%, respectively. The provision for income taxes for the years ended March 31, 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 fiscal year 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 state income tax rates. The provision for income taxes for the year ended March 31, 2004 and 2003 accounted for a portion of the aggregate tax credits accumulated through the end of each period due to the uncertainly concerning the ultimate amount of tax to be credited. Liquidity and Capital Resources. The following table presents selected financial statistics and information for each of the past three fiscal years:
Year Ended March 31, ------------------------------------------ 2005 2004 2003 ---------- ---------- ----------- Cash and cash equivalents at year end.................... $ 51,157 $ 51,395 $ 36,443 Net (decrease) increase in cash and cash equivalents..... (238) 14,952 11,000 Net income............................................... 16,109 10,400 7,035 Net cash provided by operating activities................ $ 21,631 $ 17,303 $ 13,183 Days of sales outstanding................................ 119 98 104
Cash provided by operations is our principal source of cash. Cash from operations for the year ended March 31, 2005 consisted principally of net income before non-cash related expenses of depreciation, 39 amortization, and provision for bad debts and inventory obsolescence, and increases in deferred revenue and other current liabilities, offset by an increase in gross accounts receivable. We were able to generate operating cash flows significantly in excess of net income in the year ended March 31, 2005 primarily as a result of increases in deferred revenue of $8.2 million. We were able to generate operating cash flows significantly in excess of net income in the year ended March 31, 2004 primarily as a result of increases in deferred revenue of $5.6 million and improved turnover of accounts receivable. Provided turnover of accounts receivable, increased revenue, and profitability remain consistent with results experienced for the year ended March 31, 2005, we anticipate continuing to generate cash from operations primarily from net income. Net cash used in investing activities for the year ended March 31, 2005 was $4.4 million and was primarily composed of investments in capitalized software and equipment and improvements. We have no significant capital commitments, and currently anticipate that additions to equipment and improvements for fiscal 2006 will be equal to or greater than historical levels. Net cash used in financing activities for the year ended March 31, 2005 was $17.5 million was primarily composed of a one-time dividend paid to shareholders of $19.6 million partially offset by proceeds from the exercise of stock options. Cash received from employee stock option exercises can fluctuate from year to year. At March 31, 2005, we had cash and cash equivalents of $51.2 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. Management believes that our cash and cash equivalents on hand at March 31, 2005, together with the cash flows from operations, if any, will be sufficient to meet our working capital and capital expenditure requirements for fiscal 2006. The following table summarizes our significant contractual obligations at March 31, 2005, and the effect of such obligations is expected to have on our liquidity and cash in future periods:
Contractual Obligations Total 2006 2007-2008 2009-2010 Beyond 2010 Non-cancelable operating leases $ 4,001 $ 1,257 $ 1,867 $ 877 --
ITEM 7A. QUANTITATIVE AND QUALITIVE DISCLOSURE ABOUT MARKET RISKS We have a significant amount of cash and short-term investments with maturities less than three months. This cash portfolio exposes us to interest rate risk as short-term investment rates can be volatile. Given the short-term maturity structure of our investment portfolio, we believe that it is not subject to principal fluctuations and the effective interest rate of our portfolio tracks closely to various short-term money market interest rate benchmarks. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our Financial Statements identified in the Index to Financial Statements appearing under "Item 15. Exhibits and Financial Statement Schedules" of this report are incorporated herein by reference to Item 15. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 40 ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Based on their evaluation of our disclosure controls and procedures as of a date within 90 days of the filing date of this report, our officers including our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures result in the effective recordation, processing, summarization and reporting of information that is required to be disclosed in the reports that we file under the Securities Exchange Act of 1934 and the rules there under. Changes in Internal Control Over Financial Reporting During the year ended March 31, 2005, the following changes have occurred in our "internal controls over financial reporting" (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our financial reporting function. During the year ended March 31, 2005, the Company implemented revenue application software "Softrax" to automate certain processes surrounding the recognition and the deferral of revenue related to our software sales arrangements with multiple elements. The Company added numerous additional policies and procedures in order to strengthen the Company's internal control structure in conjunction with the Company's evaluation of internal controls. The Company also added a controller with public accounting and SEC reporting experience. There were no other significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. Management's Report on Internal Control Over Financial Reporting The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of the Company's management, including our principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework set forth in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, the Company's management concluded that its internal control over financial reporting was effective as of March 31, 2005. The Company's internal control over financial reporting is supported by written policies and procedures, that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company's assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company's management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 41 The Company's independent registered public accounting firm has audited management's assessment of the effectiveness of the Company's internal control over financial reporting as of March 31, 2005 as stated in their report which is included herein. ITEM 9B. OTHER INFORMATION None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT Except for information concerning our executive officers which is included under the caption "Executive Officers of the Company" following Part I, Item 4 of this Report, the information required by Item 10 is incorporated herein by reference from our definitive proxy statement for our 2005 annual shareholders' meeting to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended March 31, 2005. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference from our definitive proxy statement for our 2005 annual shareholders' meeting to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended March 31, 2005. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by Item 12 is incorporated herein by reference from our definitive proxy statement for our 2005 annual shareholders' meeting to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended March 31, 2005. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference from our definitive proxy statement for our 2005 annual shareholders' meeting to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended March 31, 2005. ITEM 14. PRINCIPAL ACCOUNTING AND FEES AND SERVICES The information required by Item 14 is incorporated herein by reference from our definitive proxy statement for our 2005 annual shareholders' meeting to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended March 31, 2005. 42 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES AND REPORTS ON FORM 10-K (a) (1) Index to Financial Statements: Page ---- o Report of Independent Registered Public Accounting Firm... 49 o Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting................. 50 o Consolidated Balance Sheets -- Years Ended March 31, 2005 and March 31, 2004......................... 52 o Consolidated Statements of Income -- Years Ended March 31, 2005, March 31, 2004 and 2003................... 53 o Consolidated Statements of Shareholders' Equity -- Years Ended March 31, 2005, March 31, 2004 and 2003............. 54 o Consolidated Statements of Cash Flows -- Years Ended March 31, 2005, March 31, 2004 and 2003................... 55 o Notes to Consolidated Financial Statements................ 56 (2) The following financial statement schedule for the years ended March 31, 2005, March 31, 2004 and 2003, read in conjunction with the financial statements of Quality Systems, Inc., is filed as part of this Annual Report on Form 10-K. o Schedule II -- Valuation and Qualifying Accounts.......... 71 Schedules other than that listed above have been omitted since they are either not required, not applicable, or because the information required is included in the financial statements or the notes thereto. (3) The exhibits listed in the Index to Exhibits hereof are attached hereto or incorporated herein by reference and filed as apart of this Report. 43 INDEX TO EXHIBITS EXHIBIT NUMBER EXHIBIT 3.1 Articles of Incorporation of the Company, as amended, are hereby incorporated by reference to Exhibit 3.1 to our Annual Report on Form 10-K for the year ended March 31, 1984, File No. 2-80056. 3.1.1 Amendment to Articles of Incorporation, effective March 4, 2005. ** 3.2 Bylaws of the Company, as amended and restated. ** 3.3 Certificate of Amendment of Bylaws of the Company is hereby incorporated by reference to Exhibit 3.2.1 to our Registration Statement on Form S-1, File No. 333-00161. 3.4 Text of Sections 2 and 3 of Article II of the Bylaws of the Company is hereby incorporated By reference to Exhibit 3.2.2 to our Quarterly report on Form 10-QSB for the period Ended December 31, 1996, File No. 0-13801. 3.5 Certificate of Amendment of Bylaws of the Company, is hereby incorporated by reference to Exhibit 3.2.3 to our Annual Report on Form 10-K for the year ended March 31, 2000, File No. 0-13801. 10.2* 1989 Incentive Stock Option Plan is hereby incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-8, File No. 33-31949. 10.2.1* Form of Incentive Stock Option Agreement is hereby incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-1, File No. 333-00161. 10.2.2* Form of Non-Qualified Stock Option Agreement is hereby incorporated by reference to Exhibit 10.3 to our Registration Statement on Form S-1, File No. 333-00161. 10.3* Form of Incentive Stock Option Agreement is hereby incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-1, File No. 2-80056. 10.4* 1993 Deferred Compensation Plan is hereby incorporated by reference to Exhibit 10.5 to our Annual Report on Form 10-KSB for the year ended March 31, 1994, File No. 0-13801. 10.4.2* Profit Sharing and Retirement Plan, as amended, is hereby incorporated by reference to Exhibit 10.4.2 to our Annual Report on Form 10-KSB for the year ended March 31, 1994, File No. 0-13801. 10.4.3* Profit Sharing and Retirement Plan, as amended, amendments No. 2 and 3, are hereby incorporated by reference to Exhibit 10.4.3 to our Annual Report on Form 10-KSB for the year ended March 31, 1996, File No. 0-13801. 10.5 Series "A" Convertible Preferred Stock Purchase Agreement, as amended, dated April 21, 1995 between the Company and Clinitec International, Inc., is hereby incorporated by reference to Exhibit 10.11 to our Annual Report on Form 10-KSB for the year ended March 31, 1995, File No. 0-13801. 44 10.6 Form of Indemnification Agreement is hereby incorporated by reference to Exhibit 10.10 to our Registration Statement on Form S-1, File No. 333-00161. 10.6.1* Form of Indemnification Agreement for directors and executive officers authorized January 27, 2005. ** 10.7 Agreement and Plan of Merger, dated May 16, 1996, by and among Quality Systems, Inc., CII Acquisition Corporation, Clinitec International, Inc. and certain shareholders of Clinitec International, Inc. and certain exhibits are hereby incorporated by reference to Exhibit 2 to our Current Report on Form 8-K, dated May 17, 1996 and filed May 30, 1996. 10.8 Asset Purchase Agreement, dated May 15, 1997, by and among NextGen Healthcare Information Systems, Inc., MHIS Acquisition Corp., Quality Systems, Inc., and certain shareholders of NextGen Healthcare Information Systems, Inc. is hereby incorporated by reference to Exhibit 2 of Company's Current Report on Form 8-K, dated May 15, 1997 and filed May 29, 1997, File No. 0-13801. 10.9* 1998 Employee Stock Contribution Plan is hereby incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-8, File No. 333-63131. 10.10* 1998 Stock Option Plan is hereby incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-8, File No. 333-67115. 10.10.1* Amended and Restated 1998 Stock Option Plan. ** 10.11* Memorandum of Understanding regarding the April 3, 2000 resignation of Sheldon Razin between Sheldon Razin and Quality Systems, Inc., is hereby incorporated by reference to Exhibit 10.16 to our Annual Report on Form 10-K for the year ended March 31, 2000, File No. 0-13801. 10.12* Memorandum of Understanding Relating to Director Nominees is hereby incorporated by reference to Company's Definitive Proxy Statement for our 1999 Shareholder's Meeting, File No. 001-12537. 10.13* Employment Agreement dated July 20, 2000 between Quality Systems, Inc. and Lou Silverman is hereby incorporated by reference to Exhibit 10.18 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, File No. 0-13801. 10.14 Lease Agreement between Company and Tower Place, L.P. dated November 15, 2000, commencing February 5, 2001 is hereby incorporated by reference to Exhibit 10.14 to our Annual Report on Form 10-K for the year ended March 31, 2001, File No. 0-13801. 10.15 Lease Agreement between Company and Orangewood Business Center Inc. dated April 3, 2000, amended February 22, 2001, is hereby incorporated by reference to Exhibit 10.15 to our Annual Report on Form 10-K for the year ended March 31, 2001, File No. 0-13801. 10.16 Lease Agreement between Company and Craig Development Corporation dated February 20, 2001 is hereby incorporated by reference to Exhibit 10.16 to our Annual Report on Form 10-K for the year ended March 31, 2001, File No. 0-13801. 10.17 Sublease Agreement between Company and Infinium Software dated February 22, 2002 is hereby incorporated by reference to Exhibit 10.17 to our Annual Report on Form 10-K for the year ended March 31, 2003, File No. 0-13801. 45 10.18 Lease Agreement between Company and HUB Properties LLC dated May 8, 2002 is hereby incorporated by reference to Exhibit 10.18 to our Annual Report on Form 10-K for the year ended March 31, 2003, File No. 0-13801. 10.19 Lease Agreement between the Company and LakeShore Towers Limited Partnership Phase IV, a California limited partnership, dated September 15, 2004. ** 10.20* Board Service Agreement between the Company and Lou Silverman is incorporated by reference to Exhibit 10.2.1 to our Current Report of Form 8-K, dated May 31, 2005, File No. 001-12537. 10.21* Board Service Agreement between the Company and Patrick Cline is incorporated by reference to Exhibit 10.2.1 to our Current Report of Form 8-K, dated May 31, 2005, File No. 001-12537. 21 List of Subsidiaries. 23.1 Consent of Independent Certified Public Accountants - Grant Thornton LLP. 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. ** * This exhibit is a management contract or a compensatory plan or arrangement. ** Filed herewith. 46 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, we have duly caused this Report to be signed on our behalf by the undersigned, thereunto duly authorized. By: /s/ LOUIS E. SILVERMAN -------------------------- Louis E. Silverman, President and Chief Executive Officer Date: June 3, 2005 KNOW ALL PERSONS BY THESE PRESENTS, that each of the persons whose signature appears below hereby constitutes and appoints Louis E. Silverman and Paul Holt, each of them acting individually, as his attorney-in-fact, each with the full power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming our signatures as they may be signed by our said attorney-in-fact and any and all amendments to this Annual Report on Form 10-K. Pursuant to the requirement of the Securities Exchange Act of 1934, this Report has been signed by the following persons on our behalf in the capacities and on the dates indicated. Signature Title Date - ----------------------- ----------------------------------------- ------------ /s/ SHELDON RAZIN Chairman of the Board June 9, 2005 - ----------------------- Sheldon Razin /s/ LOUIS E. SILVERMAN. Director, President and Chief Executive June 9, 2005 - ----------------------- Officer (Principal Executive Louis E. Silverman Officer)/Director /s/ PATRICK CLINE Director, President, NextGen Healthcare June 9, 2005 - ----------------------- Information Systems Division Patrick Cline /s/ PAUL HOLT Secretary and Chief Financial Officer June 9, 2005 - ----------------------- (Principal Financial Officer) Paul Holt /s/ WILLIAM BOTTS Director June 9, 2005 - ----------------------- William Botts /s/ MAURICE DEWALD Director June 9, 2005 - ----------------------- Maurice DeWald 47 Signature Title Date - ----------------------- ----------------------------------------- ------------ /s/ AHMED HUSSEIN Director June 9, 2005 - ----------------------- Ahmed Hussein /s/ JONATHAN JAVITT Director June 9, 2005 - ----------------------- Jonathan Javitt /s/ VINCENT LOVE Director June 6, 2005 - ----------------------- Vincent Love /s/ STEVEN PLOCHOCKI Director June 9, 2005 - ----------------------- Steven Plochocki 48 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders Quality Systems, Inc. We have audited the accompanying consolidated balance sheets of Quality Systems, Inc. as of March 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flow for each of the three years in the period ended March 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Quality Systems, Inc. as of March 31, 2005 and 2004 and the consolidated results of operations and its consolidated cash flows for each of the three years in the period ended March 31, 2005 in conformity with accounting principles generally accepted in the United States of America. We have also audited Schedule II of Quality Systems, Inc. for each of the three years in the period ended March 31, 2005. In our opinion, this schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Quality Systems, Inc.'s internal control over financial reporting as of March 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 3, 2005, expressed an unqualified opinion thereon. /s/ GRANT THORNTON LLP Irvine, California June 3, 2005 49 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING Board of Directors and Shareholders Quality Systems, Inc. We have audited management's assessment, included in the accompanying Quality Systems, Inc. Management's Report on Internal Control Over Financial Reporting, that Quality Systems, Inc. maintained effective internal control over financial reporting as of March 31, 2005, based on criteria established in Internal Control - Integrated Framework issues by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Quality Systems, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Quality Systems, Inc. maintained effective internal control over financial reporting as of March 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, Quality Systems, Inc. maintained, in all material respects, effective internal control over financial reporting as of March 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Quality Systems, Inc. as of March 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of 50 the three years in the period ended March 31, 2005, and our report dated June 3, 2005 expressed an unqualified opinion. /s/ GRANT THORNTON LLP Irvine, California June 3, 2005 51 QUALITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Data)
-------------------- March 31, March 31, 2005 2004 -------- -------- ASSETS Current Assets Cash and cash equivalents .............................................. $ 51,157 $ 51,395 Accounts receivable, net ............................................... 33,362 20,280 Inventories, net ....................................................... 960 725 Income tax receivable .................................................. 15 -- Net current deferred tax assets ........................................ 1,796 2,979 Other current assets ................................................... 1,677 1,493 -------- -------- Total current assets ............................................. 88,967 76,872 Other assets Equipment and improvements, net ........................................ 2,697 2,012 Capitalized software costs, net ........................................ 4,334 3,608 Net long-term deferred tax assets ...................................... -- 1,104 Goodwill, net .......................................................... 1,840 1,840 Other assets, net ...................................................... 1,604 1,242 -------- -------- Total assets ..................................................... $ 99,442 $ 86,678 ======== ======== LIABILITIES and STOCKHOLDERS' EQUITY Current liabilities Accounts payable ....................................................... $ 2,284 $ 1,655 Deferred revenue ....................................................... 24,115 16,060 Accrued employee compensation and benefits ............................. 3,436 2,610 Income tax payable ..................................................... -- 273 Other current liabilities .............................................. 4,021 2,859 -------- -------- Total current liabilities ........................................ 33,856 23,457 Deferred revenue, net of current .............................................. 1,362 1,203 Net deferred tax liabilities .................................................. 291 -- Deferred compensation ......................................................... 1,202 1,013 -------- -------- Total liabilities 36,711 25,673 -------- -------- Commitments and contingencies ................................................. -- -- Shareholders' equity Common Stock, $0.01 par value; 40,000 shares authorized, 13,111 and 12,650 shares issued and outstanding at March 31, 2005 and 2004, respectively ......................................................... 131 127 Additional paid-in capital ............................................. 44,499 39,671 Retained earnings ...................................................... 19,213 22,750 Deferred compensation .................................................. (1,112) (1,543) -------- -------- Total shareholders' equity ....................................... 62,731 61,005 -------- -------- Total liabilities and shareholders' equity ....................... $ 99,442 $ 86,678 ======== ========
________________________________________________________________________________ The accompanying notes to these consolidated financial statements are an integral part of these consolidated statements. 52 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME (In Thousands, except per share amounts)
Year Ended March 31, --------------------------- 2005 2004 2003 ------- ------- ------- Revenue: Software, hardware and supplies ..................... $39,672 $32,632 $25,391 Implementation and training services ................ 8,856 6,893 3,778 ------- ------- ------- System sales .............................................. 48,528 39,525 29,169 ------- ------- ------- Maintenance and other services ...................... 29,945 23,117 18,441 Electronic data interchange services ................ 10,488 8,292 7,159 ------- ------- ------- Maintenance, EDI, and other services ...................... 40,433 31,409 25,600 ------- ------- ------- Total revenue ....................................... 88,961 70,934 54,769 ------- ------- ------- Cost of revenue: Software, hardware and supplies ..................... 7,525 8,141 7,299 Implementation and training services ................ 6,300 5,197 2,929 ------- ------- ------- Total cost of system sales 13,825 13,338 10,228 ------- ------- ------- Maintenance and other ............................... 12,120 10,313 9,072 Electronic data interchange services ................ 6,724 5,022 4,455 ------- ------- ------- Total cost of maintenance, EDI, and other services 18,844 15,335 13,527 ------- ------- ------- Total cost of revenue ............................... 32,669 28,673 23,755 ------- ------- ------- Gross profit ........................................ 56,292 42,261 31,014 ------- ------- ------- Operating expenses: Selling, general and administrative expenses .............. 24,776 19,482 15,293 Research and development costs ............................ 6,903 6,139 5,062 ------- ------- ------- Total operating expenses ............................ 31,679 25,621 20,355 ------- ------- ------- Income from operations .............................. 24,613 16,640 10,659 Investment income ......................................... 876 386 434 ------- ------- ------- Income before provision for income taxes .................. 25,489 17,026 11,093 Provision for income taxes ................................ 9,380 6,626 4,058 ------- ------- ------- Net income .......................................... $16,109 $10,400 $ 7,035 ======= ======= ======= Net income per share, basic ............................... $ 1.25 $ 0.84 $ 0.57 Net income per share, diluted ............................. $ 1.22 $ 0.80 $ 0.55 Weighted average shares outstanding, basic ................ 12,872 12,436 12,254 Weighted average shares outstanding, diluted .............. 13,203 12,966 12,778
________________________________________________________________________________ The accompanying notes to these consolidated financial statements are an integral part of these consolidated statements. 53 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the Three Years Ended March 31, 2005, 2004 and 2003 (In Thousands)
Common Stock Total ----------------- Retained Deferred Shareholders' Shares Amount APIC Earnings Compensation Equity - ----------------------------------------------------------------------------------------------------------------------- Balance, March 31, 2002 12,210 $ 122 $ 34,613 $ 5,315 $ -- $ 40,050 Exercise of stock options ................... 94 1 351 -- -- 352 Tax benefit resulting from stock options ..................................... -- -- 96 -- -- 96 Net income .................................. -- -- -- 7,035 -- 7,035 ------ -------- -------- -------- ------------ ----------- Balance, March 31, 2003 12,304 123 35,060 12,350 -- 47,533 Exercise of stock options ................... 346 4 1,304 -- -- 1,308 Tax benefit resulting from stock options ..................................... -- -- 1,454 -- -- 1,454 Stock based compensation .................... -- -- 1,853 -- (1,543) 310 Net income .................................. -- -- -- 10,400 -- 10,400 ------ -------- -------- -------- ------------ ----------- Balance, March 31, 2004 12,650 127 39,671 22,750 (1,543) 61,005 Exercise of stock options ................... 461 4 2,148 -- -- 2,152 Tax benefit resulting from stock options ..................................... -- -- 2,680 -- -- 2,680 Stock based compensation .................... -- -- -- -- 431 431 Dividends paid .............................. -- -- -- (19,646) -- (19,646) Net income .................................. -- -- -- 16,109 -- 16,109 ------ -------- -------- -------- ------------ ----------- Balance, March 31, 2005 13,111 $ 131 $ 44,499 $ 19,213 $ (1,112) $ 62,731 ====== ======== ======== ======== ============ ===========
________________________________________________________________________________ The accompanying notes to these consolidated financial statements are an integral part of these consolidated statements. 54 QUALITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
Year Ended March 31, -------------------------------- 2005 2004 2003 -------- -------- -------- Cash flows from operating activities: Net income $ 16,109 $ 10,400 $ 7,035 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation .............................................. 1,012 836 910 Amortization of capitalized software costs ................ 1,952 1,490 1,267 Provision for bad debts ................................... 797 647 623 Provision for inventory obsolescence ...................... 160 54 40 Non-cash compensation from stock option grants ............ 431 310 -- Loss on short-term investments and other .................. -- -- 21 Tax benefit from exercise of stock options ................ 2,680 1,454 96 Deferred income taxes, net ................................ 2,578 (235) 298 Change in assets and liabilities: Accounts receivable ....................................... (13,879) (3,400) (4,455) Inventories ............................................... (395) (112) 411 Income tax receivable ..................................... (15) -- -- Other current assets ...................................... (184) 627 (943) Other assets .............................................. (362) (373) -- Accounts payable .......................................... 629 (822) (180) Deferred revenue .......................................... 8,214 5,564 5,544 Accrued compensation and related benefits ................. 826 248 687 Income tax payable ........................................ (273) 273 -- Other current liabilities ................................. 1,162 8 1,871 Deferred compensation ..................................... 189 334 (42) -------- -------- -------- Net cash provided by operating activities 21,631 17,303 13,183 -------- -------- -------- Cash flows from investing activities: Additions to capitalized software costs ........................ (2,678) (2,587) (1,660) Additions to equipment and improvements ........................ (1,697) (1,072) (1,109) Proceeds from the sale of short-term investments ............... -- -- 234 -------- -------- -------- Net cash used in investing activities .................. (4,375) (3,659) (2,535) -------- -------- -------- Cash flows from financing activities: Dividends paid (19,646) -- -- Proceeds from the exercise of stock options ............... 2,152 1,308 352 -------- -------- -------- Net cash (used in) provided by financing activities .... (17,494) 1,308 352 -------- -------- -------- Net (decrease) increase in cash and cash equivalents ................ (238) 14,952 11,000 Cash and cash equivalents, beginning of year ........................ 51,395 36,443 25,443 -------- -------- -------- Cash and cash equivalents, end of year .............................. $ 51,157 $ 51,395 $ 36,443 ======== ======== ========
________________________________________________________________________________ The accompanying notes to these consolidated financial statements are an integral part of these consolidated statements. Supplemental Information. During fiscal 2005, 2004 and 2003 the Company made income tax payments of $4,541, $4,716, and $4,280, respectively. 55 QUALITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2005 and 2004 (dollars in thousands, except per share amounts) 1. Description of Business 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), develops and markets proprietary healthcare information systems that automate medical and dental group practices, community health centers, physician hospital organizations, management service organizations, and dental schools. The Company's software systems include general patient information, appointment scheduling, billing, insurance claims submission and processing, managed care plan implementation and referral management, treatment outcome studies, treatment planning, drug formularies, electronic patient records, dental charting and letter generation. In addition to providing fully integrated solutions, the Company offers its clients comprehensive hardware and software maintenance and support services, system training services and electronic claims submission services. The Company's principal administrative, accounting and QSI Division operations are located in Irvine, California. The principal office of the NextGen Division is located in Horsham, Pennsylvania. On February 2, 2005, the Board of Directors declared a 2-for-1 stock split with respect to the Company's outstanding shares of common stock. The stock split record date was March 4, 2005 and the stock began trading post split on March 28, 2005. References to share and per share data contained in the consolidated financial statements and notes to the consolidated financial statements has been retroactively adjusted to reflect the stock split. 2. Summary of Significant Accounting Policies Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated. Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principals generally accepted in the United States of America. References to dollar amounts in this financial statement sections are in thousands, except share and per share data, unless otherwise specified. Certain prior year amounts have been reclassified to conform with fiscal year 2005 presentation. Revenue recognition. The Company currently recognizes revenue pursuant to Statement of Position No. 97-2, "Software Revenue Recognition" (SOP 97-2), as amended by Statement of Position No. 98-9 "Modification of SOP 97-2, Software Revenue Recognition" (SOP 98-9). The Company generates revenue from the sale of licensing rights to its software products directly to end-users and value-added resellers (VARs). The Company also generates revenue from sales of hardware and third party software, implementation, training, software customization, Electronic Data Interchange (EDI), post-contract support (maintenance) and other services performed for customers who license its products. A typical system contract contains multiple elements of the above items. SOP 98-9, 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). The Company limits its assessment of VSOE for each element 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. 56 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. The Company bills for the entire contract amount upon contract execution. Amounts billed in excess of the amounts contractually due are recorded in accounts receivable as advance billings. Amounts are 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. In certain transactions where collection risk is high, the cash basis method is used to recognized revenue. 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 Statement of Position No. 81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts" (SOP 81-1). 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. The Company measures 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 the Company is unable to make reliable estimates of progress of completion of the contract, the completed contract method is utilized. From time to time, the Company offers future purchase discounts on its products and services as part of its sales arrangements. Pursuant to AICPA TPA 5100.51, such 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. Cash and Cash Equivalents. Cash and cash equivalents consist of cash, money market funds and short term U.S. Treasuries with maturities of less than 90 days. The money market fund in which the Company holds a portion of its cash invests in only investment grade money market instruments from a variety of industries, and therefore bears minimal risk. The average maturity of the investments held by the money market fund is approximately two months. Short-Term Investments. The Company classifies any short-term investments into one of the following categories: 57 o Trading - Debt securities that do not meet the "intent-to-hold" criteria and equity securities, both of which are bought and held principally for the purpose of being sold in the near term. o Available-for-sale - Debt securities that do not meet the "intent-to-hold" criteria and which are not classified as trading securities, as well as all equity securities not otherwise classified as trading securities. o Held to maturity - Debt securities for which the Company has the intent and the ability to hold to maturity. Trading securities are carried on the balance sheet at fair market value and unrealized gains and losses are recorded in the statement of operations. Available-for-sale securities are carried in the balance sheet at fair market value; realized gains and losses are recorded in the statement of operations when they are earned or incurred, and unrealized gains and losses, net of tax effect, are recognized as a component of shareholders' equity. Held to maturity securities are carried in the balance sheet at cost (unless there are declines in the values of individual securities that are not due to temporary declines), and realized gains and losses are recorded in the statement of operations in the period that they are earned or incurred. Realized gains and losses from investment transactions are determined on a specific identification basis. The Company had no short term investments at March 31, 2005 or 2004. Accounts Receivable. The Company provides credit terms ranging from thirty days to less than twelve months for most system and maintenance contract sales and generally does not require collateral. The Company performs ongoing credit evaluations of it's customers and maintains reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management's estimate of the probability of collection for certain troubled accounts. General reserves are established based on our historical experience of bad debt expense and the aging of our accounts receivable balances, net of deferred revenue and specifically reserved accounts. Accounts are written off as uncollectible only after the Company has expended extensive collection efforts. Included in accounts receivable are amounts related to maintenance and services which were billed, but which had not yet been rendered as of the end of the fiscal year. Undelivered maintenance and services are included on the balance sheet in deferred revenue. Inventories. Inventories consist of hardware for specific customer orders and spare parts, and are valued at lower of cost (first-in, first-out) or market. Management provides a reserve to reduce inventory to its net realizable value. Equipment and Improvements. Equipment and improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of equipment and improvements are provided over the estimated useful lives of the assets, or the related lease terms if shorter, generally by the straight-line method. Useful lives range as follows: Computers and electronic test equipment 3-5 years Furniture and fixtures 5-7 years Vehicles 7 years Leasehold improvements lesser of lease term or estimated useful life of asset
Software Development Costs. Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional development costs are capitalized in accordance with the Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" (SFAS 86). Such capitalized costs are amortized on a straight line basis over the estimated economic life of the related product, of three years. The Company performs an annual review of the recoverability of such capitalized software costs. At the time a determination is made that capitalized amounts are not recoverable based on the estimated cash flows to be generated from the applicable software, any remaining capitalized amounts are written off. Goodwill and Intangible Assets. The Company follows Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). This statement applies to the 58 amortization of goodwill and other intangible assets. The Company ceased amortizing amounts related to goodwill effective April 1, 2001. The balance of goodwill is related to the NextGen Division. Under SFAS 142, management is required to perform an annual assessment of the implied fair value of goodwill and intangible assets with indefinite lives for impairment. The Company compared the fair value of the NextGen Division with the carrying amount of its assets and determined that none of the goodwill recorded was impaired as of June 30, 2004 (the date of the Company's last annual impairment test). The fair value of the NextGen Division was determined using an estimate of future cash flows for the NextGen Division over ten years and risk adjusted discount rates of between 15 and 25 percent to compute a net present value of future cash flows. Long Lived Assets. The Company follows Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 establishes a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. SFAS 144 superseded Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121), and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" (APB 30). Management periodically reviews the carrying value of long-lived assets to determine whether or not impairment to such value has occurred and has determined that there was no impairment at March 31, 2005. Income Taxes. Income taxes are provided for the tax effects of transactions reported in the financial statements and consists of taxes currently due plus deferred taxes related to differences between the basis of assets and liabilities for financial and tax reporting. The deferred income tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred income taxes also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future income taxes. Valuation allowances are established as a reduction of net deferred income tax assets when management determines that it is more likely than not that the deferred assets will not be realized. Advertising Costs. Advertising costs are charged to operations as incurred. The Company does not have any direct-response advertising. Advertising costs, which includes trade shows and conventions, were approximately $1,251, $1,262 and $874 for the years ended March 31, 2005, 2004 and 2003, respectively, and were included primarily in selling, general and administrative expenses in the consolidated statements of income Marketing Assistance Agreements. The Company has entered into marketing assistance agreements with existing users of the Company's products which provide the opportunity for those users to earn commissions if and only if they host specific site visits upon our request for prospective customers which directly result in a purchase of our software by the visiting prospects. Amounts earned by existing users under this program are treated as a selling expense in the period in which commissionable software has been recognized as revenue. Earnings per Share. Pursuant to Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128), the Company provides dual presentation of "basic" and "diluted" earnings per share (EPS). Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents. 59 The following table reconciles the weighted average shares outstanding for basic and diluted net income per share for the periods presented.
(In thousands except per share amounts) Year Ended March 31, ------------------------------ 2005 2004 2003 -------- -------- -------- Basic net income per share: Net income ................................................. $ 16,109 $ 10,400 $ 7,035 Weighted average of common shares outstanding .............. 12,872 12,436 12,254 -------- -------- -------- Net income share ........................................... $ 1.25 $ 0.84 $ 0.57 ======== ======== ======== Diluted net income per share: Weighted average of common shares outstanding 12,872 12,436 12,254 Weighted average of common shares equivalents: Weighted average options outstanding ....................... 331 530 524 -------- -------- -------- Weighted average number of common and common equivalent shares ..................................................... 13,203 12,966 12,778 ======== ======== ======== Net income per share ....................................... $ 1.22 $ 0.80 $ 0.55 ======== ======== ========
Stock-Based Compensation. The Company accounts for stock-based employee compensation as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), and has adopted the disclosure provisions from the Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" (SFAS 148) that supersedes Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). SFAS 148 requires pro forma disclosures of net income and net income per share as if the fair value based method of accounting for stock-based awards had been applied for both employee and non-employee grants. It also requires disclosure of option status on a more prominent and frequent basis. Such disclosure for the years ended March 31, 2005, 2004 and 2003 is presented immediately below. The Company accounts for stock options and warrants issued to non-employees based on the fair value method, but has not elected this treatment for grants to employees and board members. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period. The Company's fair value calculations for options granted on February 11, 2005 were made using the Black-Scholes option pricing model with the following assumptions: expected life - approximately 57 months from the date of the grant; stock volatility - 47.7% , risk free interest rate of 3.7% and, no dividends during the expected term. Although the Company announced a one-time $1.50 per share dividend on January 31, 2005, no commitment to any future dividends was made at the time the dividend was announced and no commitment to any future dividends exists as of the filing of the Company's annual report. The Company had not paid a dividend to its shareholders prior to the one-time dividend announced on January 31, 2005. Therefore, management believes that using a zero dividend rate in the valuation of the stock options granted on February 11, 2005 is appropriate. The Company's fair value calculations for options granted in fiscal years ended 2005 and 2004 with the exception of the above grant on February 11, 2005, were made using the Black-Scholes option pricing model with the following assumptions: expected life - approximately 48 months from the date of the grant; stock volatility - 55 to 57% , risk free interest rate of 3.0% ; and, no dividends during the expected term. No options were granted in fiscal 2003. 60 The Company's calculations are based on a single option valuation approach and forfeitures are recognized as they occur. If the computed fair values of awards had been amortized to expense over the vesting period of the awards, pro forma net income and net income per share would have been as follows: (in thousands, except for per share amounts) Year Ended March 31, ------------------------------ 2005 2004 2003 -------- -------- ------- Net income ..................................... $ 16,109 $ 10,400 $ 7,035 Option compensation expense (net of taxes) ..... 272 189 -- Proforma option compensation cost (net of taxes) (1,483) (414) (322) -------- -------- ------- Proforma net income ............................ 14,898 10,175 6,713 ======== ======== ======= Reported basic net income per share ........ $ 1.25 $ 0.84 $ 0.57 Proforma basic net income per share ........ 1.16 0.82 0.55 Reported diluted net income per share ...... 1.22 0.80 0.55 Proforma diluted net income per share ...... 1.13 0.78 0.53 Fair value of option awards granted ............ $ 12,707 $ 2,078 $ -- Had the Company used a different methodology such as the binomial model to value options, a different valuation may have been determined which may have changed the proforma expense. Segment Disclosures. The Company presents reporting information regarding operating segments in accordance with Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" (SFAS 131). Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to uncollectible receivables, vendor specific objective evidence, and the percentage of completion related to certain service revenue. The Company bases its estimates on historical experience and on various other assumptions that are believed 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. New Accounting Pronouncements. In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4" (SFAS 151) to clarify the accounting for abnormal amount of idle facility expense, freight, handling costs and wasted material. This statement requires that those items be recognized as current period charges. In addition, this statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect the adoption of SFAS 151 to have material effect on its financial statements. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" (SFAS 123R) which is a revision of SFAS 123. Statement 123R supersedes APB 25 and amends Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows" (SFAS 95). SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values and the pro forma disclosure alternative is no longer allowable under Statement 123R. Subsequently, in April 2005, the Securities and Exchange Commission (SEC) changed the effective date from the first interim or annual reporting period beginning after June 15, 2005 to the first annual reporting period beginning after June 15, 2005, which for the Company will be fiscal year 2007. The Company has not completed the process of evaluating the impact that will result from adopting SFAS 123R and is 61 therefore unable to disclose the impact that adoption will have on the Company's financial position and results of operations. 3. Intangible Assets - Capitalized Software Costs As of March 31, 2005 and 2004, the Company had the following amounts related to intangible assets with definite lives: (in thousands) As of March 31, ------------------ 2005 2004 -------- -------- Capitalized software development (3 yrs): Gross carry amount ....................................... $ 13,287 $ 10,610 Accumulated amortization ................................. (8,953) (7,002) -------- -------- Net capitalization software development .................. $ 4,334 $ 3,608 ======== ======== Aggregate amortization expense during year ended March 31. $ 1,952 $ 1,490 ======== ======== Information related to net capitalized software costs is as follows: (in thousands) As of March 31, ------------------ 2005 2004 -------- -------- Beginning of year .......................................... $ 3,608 $ 2,511 Capitalization ............................................. 2,678 2,587 Amortization ............................................... (1,952) (1,490) -------- -------- End of year ................................................ $ 4,334 $ 3,608 ======== ======== The following table represents the remaining estimated amortization of intangible assets with determinable lives as of March 31, 2005 (in thousands): For the year ended March 31, - ---------------------------- 2006 ..................................................... $ 2,055 2007 ..................................................... 1,574 2008 ..................................................... 705 -------- Total $ 4,334 ======== 4. Cash and Cash Equivalents At March 31, 2005 and 2004, the Company had cash and cash equivalents of $51,157 and $51,395, respectively, invested in both a major national brokerage firm's institutional fund that specializes in U.S. government securities and commercial paper with high credit ratings, and short term U.S. treasury securities. Investment income for each of the three years ended March 31 consists of the following: (in thousands) Year Ended --------------------------------------------------- March 31, 2005 March 31, 2004 March 31, 2003 -------------- -------------- -------------- Investment income .... $ 876 $ 386 $ 434 62 5. Composition of Certain Financial Statement Captions
(in thousands) March 31, -------------------- 2005 2004 -------- -------- Accounts Receivable Accounts receivable, excluding undelivered maintenance and services ..... $ 22,162 $ 13,075 Undelivered maintenance and services billed in advance, included in deferred revenue ........................................................ 13,037 8,498 Reserved for bad debt ................................................... (1,837) (1,293) -------- -------- Accounts receivable, net .......................................... $ 33,362 $ 20,280 ======== ======== Inventories Computer systems and components, net of reserve for obsolescence of $146 and $207, respectively .................................................. $ 891 $ 478 Replacement parts for certain client systems, net of accumulated amortization of $849 and $684, respectively ............................. -- 221 Miscellaneous parts and supplies ........................................ 69 26 -------- -------- Inventories, net .................................................. $ 960 $ 725 ======== ======== Equipment and Improvements Computer and electronic test equipment .................................. $ 5,788 $ 4,568 Furniture and fixtures .................................................. 1,950 1,509 Vehicles ................................................................ -- 8 Leasehold improvements .................................................. 187 151 -------- -------- 7,925 6,236 Accumulated depreciation and amortization ............................... (5,228) (4,224) -------- -------- Equipment and improvements, net ................................... $ 2,697 $ 2,012 ======== ======== Deferred Revenue Maintenance ............................................................. $ 4,639 $ 3,794 Implementation services ................................................. 17,471 10,756 Undelivered software and other .......................................... 3,367 2,713 -------- -------- Deferred revenue .................................................. $ 25,477 $ 17,263 ======== ======== Accrued Compensation and Related Benefits Bonus ................................................................... $ 1,998 $ 1,435 Vacation ................................................................ 1,438 1,175 -------- -------- $ 3,436 $ 2,610 ======== ======== Other current liabilities Sales tax payable ....................................................... $ 726 $ 442 Commissions payable ..................................................... 625 356 Customer deposits ....................................................... 527 397 Accrued EDI expenses .................................................... 419 467 Professional services ................................................... 417 96 Deferred rent ........................................................... 198 352 Other accrued expenses .................................................. 1,109 749 -------- -------- $ 4,021 $ 2,859 ======== ========
6. Income Taxes During the year ended March 31, 2003, the Company filed amended federal returns for the fiscal years ended March 31, 1999 through 2001 and certain state tax returns for the fiscal years ended March 31, 1998 through 2001, to take advantage of available tax credits related to its research and development activities. The tax credits reported on the aforementioned returns resulted in refund claims of $418 for federal and $158 for state income tax purposes. Additionally, the Company claimed research and 63 development credits of $781 for the years ended March 31, 2002, 2003, and 2004 and has estimated $400 in tax credits for the year ended March 31, 2005. The provision for income taxes for the year ended March 31, 2004 and 2003 accounted for a portion of the aggregate tax credits accumulated through the end of each period due to the uncertainly concerning the ultimate amount of tax to be credited. As of March 31, 2004, the Company had a balance of $505 in credits which had not been recognized. In the quarter ended March 31, 2005, the state of California completed an audit of the Company's tax returns and did not materially change credits related to research and development. Based on the results of that audit, the provision for income taxes for the year ended March 31, 2005 was offset by the recognition of the $505 in tax credits which had not been recognized as of March 31 2004. The provision for income taxes consists of the following components: (in thousands) Year Ended ------------------------------- March 31, March 31, March 31, 2005 2004 2003 -------- -------- -------- Current: Federal taxes ................... $ 5,365 $ 5,551 $ 3,211 State taxes .................... 1,438 1,310 549 -------- -------- -------- Total .................. 6,803 6,861 3,760 -------- -------- -------- Deferred: Federal taxes ................... 2,040 (179) 268 State taxes ..................... 537 (56) 30 -------- -------- -------- 2,577 (235) 298 -------- -------- -------- Total ...................... $ 9,380 $ 6,626 $ 4,058 ======== ======== ======== The provision for income taxes differs from the amount computed at the federal statutory rate as follows: (in thousands) Year Ended ------------------------------- March 31, March 31, March 31, 2005 2004 2003 -------- -------- -------- Federal income tax statutory ........... 35.0% 35.0% 34.0% Increase (decreases) resulting from: State income taxes .................. 4.6 4.9 5.1 Research & development tax credits .. (4.3) (1.0) (1.9) Other ............................... 1.5 -- (0.6) -------- -------- -------- Effective income tax rate .............. 36.8% 38.9% 36.6% ======== ======== ======== 64 The net deferred tax assets in the accompanying consolidated balance sheets consist of the following at March 31, 2005 and 2004: (in thousands) As of March 31, ------------------- 2005 2004 -------- -------- Deferred tax assets: Deferred revenue and bad debt allowance ............ $ 1,081 $ 2,477 Inventory valuation 195 164 Purchased in-process research and development ...... 2,038 2,348 Intangible assets .................................. 118 118 Accrued compensation ............................... 903 716 Deferred compensation .............................. 517 442 Other .............................................. 102 147 -------- -------- Total deferred tax assets .................... 4,954 6,412 -------- -------- Deferred tax liabilities: Accelerated depreciation ........................... (1,791) (927) Capitalized software ............................... (1,469) (1,133) State income taxes/Other ........................... (189) (269) -------- -------- Total deferred tax liabilities ............... (3,449) (2,329) -------- -------- Total deferred tax assets, net ............... $ 1,505 $ 4,083 ======== ======== The deferred tax assets and liabilities have been shown net in the accompanying consolidated balance sheets based on the long-term or short-term nature of the items which give rise to the deferred amount. No valuation allowance has been made against the deferred tax assets as the Company expects to receive the full benefit of the assets recorded. 7. Employee Benefit Plans and Employment Agreements The Company has a 401 (k) for the benefit of substantially all of its employees. Participating employees may defer up to the IRS limit based on the IRS Code per year. The annual contribution is determined by a formula set by the Company's Board of Directors and may include matching and/or discretionary contributions. The Retirement Plans may be amended or discontinued at the discretion of the Board of Directors. Contributions of $162, $161 and $143 were made by the Company to the retirement plan for the fiscal years ended March 31, 2005, 2004 and 2003, respectively. The Company has a deferred compensation plan (the Deferral Plan) for the benefit of officers and key employees. Participating employees may defer between five and 50% of their compensation for a Deferral Plan year. In addition, the Company may, but is not required to, make contributions into the Deferral Plan on behalf of participating employees. Each employee's deferrals together with earnings thereon are accrued as part of the long-term liabilities of the Company. Investment decisions are made by each participating employee from a family of mutual funds. To offset this liability, the Company has purchased life insurance policies on most of the participants. The Company is the owner and beneficiary of the policies and the cash values are intended to produce cash needed to help make the benefit payments to employees when they retire or otherwise leave the Company. The values of the life insurance policies and the cumulative liability for deferrals are included on the balance sheet of the Company. . The net cash surrender value of the life insurance policies and an equal amount of related Company obligation for deferred compensation was $1,202 and $1,013 at March 31, 2005 and 2004, respectively. The values of the life insurance policies and the related Company obligation are included on the balance sheet in other assets and other liabilities, respectively. The Company made contributions of $13, $12 and $12 to the Deferral Plan for each of the fiscal years ended March 31, 2005, 2004 and 2003, respectively. The Company has a voluntary employee stock contribution plan for the benefit of all full time employees. The plan is designed to allow employees to acquire shares of the Company's common stock through automatic payroll deduction. Each eligible employee may authorize the withholding of up to 65 10% of his/her gross payroll each pay period to be used to purchase shares on the open market by a broker designated by the Company. In addition, the Company will match 5% of each employee's contribution and will pay all brokerage commissions and fees in connection with each purchase. The amount of the Company match is discretionary and subject to change. The plan is not intended to be an employee benefit plan under the Employee Retirement Income Security Act of 1974, and is therefore not required to comply with that act. Contributions of approximately $6, $3 and $1 were made by the Company for fiscal years ended March 31, 2005, 2004 and 2003, respectively. The Company has an Employment Agreement ("Agreement") with Mr. Louis E. Silverman dated July 20, 2000 which details the terms of his employment as its Chief Executive Officer. Mr. Silverman is eligible for a cash bonus of up to 50% of his annual base compensation based on performance goals established jointly between himself and the Board of Directors. Mr. Silverman's employment may be terminated for any reason by himself or the Company upon 60 days written notice. Should Mr. Silverman terminate his employment due to the Company's breach of the Agreement he will be entitled to (i) a lump sum payment equal to six months base compensation; and (ii) 12 months worth of accelerated vesting of stock options granted pursuant to the agreement. Should Mr. Silverman's employment be terminated without cause or by himself for good reason, he will be entitled to (i) unpaid base compensation and vacation earned and accrued through his date of termination plus a lump sum equal to six months base compensation, (ii) any other performance bonus earned and not paid, and (iii) 12 months worth of accelerated vesting of stock options granted pursuant to the agreement. Should Mr. Silverman's employment be terminated due to a "change of control" he will be entitled to (i) unpaid base compensation and vacation earned plus a lump sum payment equal to six months base compensation; (ii) any performance bonus earned but not paid; and (iii) immediate vesting of all unvested options. A "change of control" is defined as the earliest occurrence of any of the following events: the direct or indirect sale, lease, exchange or other transfer of 35% or more of the total assets of the Company, the merger or consolidation of the Company with another company with the effect that the shareholders of the Company immediately prior to the merger hold less than 51% of the combined voting power of the then outstanding securities of the surviving company; the replacement of a majority of the Company's Directors without the approval of the Board of Directors; the purchase of 25% or more of the combined voting power of the outstanding securities of the Company with the exception of the purchase of securities by Sheldon Razin or Ahmed Hussein of shares owned by either Sheldon Razin or Ahmed Hussein. The Agreement also grants immediate vesting of all unvested options should a change of control occur whether or not Mr. Silverman's employment is terminated. 8. Employee Stock Option Plans During fiscal 1990, the Company's shareholders approved a stock option plan (the "1989 Plan") under which 2,000,000 shares of Common Stock were reserved for the issuance of options. The 1989 Plan provides that salaried officers, key employees and non-employee Directors of the Company may, at the discretion of the Board of Directors, be granted options to purchase shares of Common Stock at an exercise price not less than 85% of their fair market value on the option grant date. Upon an acquisition of the Company by merger or asset sale, each outstanding option may be subject to accelerated vesting under certain circumstances. The 1989 Plan terminated on June 30, 1999, and there are no outstanding options under this plan at March 31, 2005. In September 1998, the Company's shareholders approved a stock option plan (the "1998 Plan") under which 2,000,000 shares of Common Stock have been reserved for the issuance of options. The 1998 Plan provides that employees, directors and consultants of the Company, at the discretion of the Board of Directors or a duly designated compensation committee, be granted options to purchase shares of Common Stock. The exercise price of each option granted shall be determined by the Board of Directors at the date of grant. Upon an acquisition of the Company by merger or asset sale, each outstanding option may be subject to accelerated vesting under certain circumstances. The 1998 Plan terminates on December 31, 2007, unless sooner terminated by the Board. At March 31, 2005, 138,150 shares were available for future grant under the 1998 Plan. As of March 31, 2005, there were 1,084,722 outstanding options related to this plan. 66 On February 11, 2005, the Board of Directors granted 522,450 options under the 1998 plan to selected employees and to Directors (7,000 for each Director) at an exercise price equal to the market price of the Company's Common Stock on the date of grant ($38.68 per share). The options granted to employees vest in four annual installments beginning February 11, 2006 and expire on February 11, 2012. The options granted to Directors fully vested on May 11, 2005 and expire on February 11, 2012. No compensation expense has been recorded for these options. On September 21, 2004, the Board of Directors granted 35,000 options under the 1998 plan to Directors (5,000 for each Director) at an exercise price equal to the market price of the Company's Common Stock on the date of the grant ($25.50 per share). The options fully vested on March 21, 2005 and expire on September 21, 2009. No compensation expense has been recorded for these options. On September 3, 2004, the Board of Directors granted 30,000 options under the 1998 plan to selected employees at an exercise price equal to the market price of the Company's Common Stock on the date of the grant ($23.71 per share). The options vest in four equal annual installments beginning September 3, 2005 and expire on September 3, 2009. No compensation expense has been recorded for these options. On June 10, 2004, the Board of Directors granted 300,000 options under the 1998 plan to selected employees at an exercise price equal to the market price of the Company's Common Stock on the date of the grant ($23.34 per share). The options vest in four equal annual installments beginning June 10, 2005 and expire on June 10, 2009. No compensation expense has been recorded for these options. On October 29, 2003, the Board of Directors granted 7,000 options under the 1998 plan to Emad Zikry, a then Director of the Company, at an exercise price of $3.50 per share, as director fees solely for his service on the Board of Directors. The options vested immediately and expire on October 20, 2008. This option grant resulted in compensation expense of approximately $130 recorded in the quarter ended December 31, 2003 using the intrinsic value method. On October 29, 2003, the Board of Directors granted 120,000 options under the 1998 plan to employees at an exercise price of $7.73 per share. The options vest in four equal annual installments beginning October 29, 2004 and expire on October 29, 2008. Based on the closing share price of the Company's stock on October 29, 2003 ($22.08 per share), this option grant will result in compensation expense of up to $1,722 (assuming all employees granted options continue their employment at the Company throughout the entire four year vesting period) to be amortized evenly over the next four years ending October, 2007. During the years ended March 31, 2005 and 2004, the Company recognized compensation expense of $431 and $180 related to these options. During the years ended March 31, 2005, 2004 and 2003, the Company received tax benefit from the exercise of stock options of $2,680, $1,454 and $96, respectively. A summary of option transactions under the 1989 & 1998 Plans for the three years ended March 31, 2005 is as follows:
---------------------------------------------------------------------------- 2005 2004 2003 ---------------------- ---------------------- ------------------------ Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price --------- --------- --------- --------- ---------- ---------- Outstanding, beginning of year 661,174 $ 5.26 896,154 4.37 990,966 $ 4.31 Granted 887,450 32.46 127,000 7.50 -- -- Exercised (460,278) 4.58 (346,480) 3.78 (94,812) 3.72 Canceled (3,624) 4.05 (15,500) 4.49 -- -- --------- --------- ---------- Outstanding, end of year 1,084,722 $ 27.77 661,174 $ 5.26 896,154 $ 4.37 --------- ========= --------- ========= ---------- ========== Available for future grants 138,150 1,025,600 1,152,600 ========= ========= ==========
67 The majority of the outstanding stock options vest ratably over a four-year period commencing from the respective option grant dates. Stock options outstanding at March 31, 2005 are summarized as follows:
Options Outstanding Options Exercisable --------------------------------------- --------------------- Weighted Weighted Weighted Average Average Average Range of Number Remaining Exercise Number Exercise Exercise Price Outstanding Contractual Life Price Exercisable Price - --------------------- ----------- ---------------- -------- ----------- -------- $ 3.50 to $ 7.73 197,272 2.44 $ 6.68 46,550 $ 5.46 23.34 to 25.50 365,000 4.17 23.57 35,000 25.50 $ 38.68 to $ 38.68 522,450 6.22 $ 38.68 -- $ --
9. Commitments and Contingencies Litigation. The Company is a party to various legal proceedings incidental to its business, none of which are considered by management to be material. Rental Commitments. The Company leases facilities and offices under irrevocable operating lease agreements expiring at various dates through March 2010. Rent expense for the years ended March 31, 2005, 2004, and 2003 was $1,285, $1,226 and $1,068, respectively. Rental commitments under these agreements are as follows: Year Ending March 31, - --------------------- 2006 ........................................ $ 1,257 2007 ........................................ 925 2008 ........................................ 942 2009 ........................................ 671 2010 ........................................ 206 -------- $ 4,001 ======== Commitments & Guarantees. Software license agreements in both our QSI and NextGen Divisions include a performance guarantee that our software products will substantially operate as described in the applicable program documentation for a period of 365 days after delivery. To date, we have not incurred any significant costs associated with these warranties and do not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties. We have historically offered short-term rights of return of less than 20 days in certain of our sales arrangements. Based on our historical experience with similar types of sales transactions bearing these short-term rights of return, we have not recorded any accrual for returns in our financial statements. Our standard sales agreements in the NextGen Division contain an indemnification provision pursuant to which we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with any United States patent, any copyright or other intellectual property infringement claim by any third party with respect to our software. The QSI division arrangements occasionally utilize this type of language as well. As we have not incurred any significant costs to defend lawsuits or settle claims related to these indemnification agreements, we believe that our estimated exposure on these agreements is currently minimal. Accordingly, we have no liabilities recorded for these indemnification obligations. 68 10. Fair Value of Financial Instruments The Company's financial instruments include cash, accounts receivable, accounts payable, deferred revenue and accrued liabilities. Management believes that the fair value of cash, accounts receivable, accounts payable, deferred revenue, and accrued liabilities approximate their carrying values due to the short-term nature of these instruments. 11. Operating Segment Information The Company has prepared operating segment information in accordance with SFAS 131 "Disclosures About Segments of an Enterprise and Related Information" to report components that are evaluated regularly by its chief operating decision maker, or decision making group in deciding how to allocate resources and in assessing performance. Reportable operating segments include the NextGen Division and the QSI Division. The accounting policies of the Company's operating segments are the same as those described in Note 2 - Summary of Significant Accounting Policies, except that the disaggregated financial results of the segments reflect allocation of certain functional expense categories consistent with the basis and manner in which Company management internally disaggregates financial information for the purpose of assisting in making internal operating decisions. Certain corporate overhead costs, such as executive and accounting department personnel related expenses, are not allocated to the individual segments by management. Management evaluates performance based on stand-alone segment operating income. Because the Company does not evaluate performance based on return on assets at the operating segment level, assets are not tracked internally by segment. Therefore, segment asset information is not presented. Operating segment data for the three years ended March 31, was as follows:
(in thousands) Unallocated Corp. Year Ended March 31, QSI Division NextGen Division Expenses Consolidated 2005 Revenue ........................ $ 15,367 $ 73,594 $ -- $ 88,961 Operating income (loss) ........ 4,162 25,904 (5,453) 24,613 2004 Revenue. ....................... 16,491 54,443 -- 70,934 Operating income (loss) ........ 4,877 15,789 (4,026) 16,640 2003 Revenue ........................ 17,423 37,346 -- 54,769 Operating income (loss) ........ $ 4,675 $ 8,902 $ (2,918) $ 10,659
69 12. Selected Quarterly Operating Results (unaudited) The following table presents quarterly unaudited consolidated financial information for the eight quarters in the period ended March 31, 2005. Such information is presented on the same basis as the annual information presented in other sections of this report. In management's opinion, this information reflects all adjustments that are necessary for a fair presentation of the results for these periods. COMPARISON BY QUARTER *
--------------------------------------------------------------------------------- (in thousands) Quarter Ended (Unaudited) - ----------------------------------------------------------------------------------------------------------------------- 6/30/03 9/30/03 12/31/03 3/31/04 6/30/04 9/30/04 12/31/04 3/31/05 ------- ------- -------- ------- -------- ------- -------- -------- Software, hardware and supplies $ 7,819 $ 8,244 $ 8,068 $ 8,501 $ 8,819 $ 9,307 $ 9,781 $ 11,765 Implementation and training 1,655 1,782 1,791 1,665 2,265 2,300 1,889 2,402 ------- ------- -------- ------- -------- ------- -------- -------- Total system sales 9,474 10,026 9,859 10,166 11,084 11,607 11,670 14,167 ------- ------- -------- ------- -------- ------- -------- -------- Maintenance, EDI and other 6,832 7,616 8,340 8,621 9,046 9,610 10,418 11,359 ------- ------- -------- ------- -------- ------- -------- -------- Total revenue 16,306 17,642 18,199 18,787 20,130 21,217 22,088 25,526 Cost of revenue: ------- ------- -------- ------- -------- ------- -------- -------- Software, hardware and supplies 1,972 2,603 1,966 1,600 2,352 1,692 1,384 2,097 ------- ------- -------- ------- -------- ------- -------- -------- Implementation and training 1,253 1,129 1,427 1,388 1,392 1,579 1,575 1,754 ------- ------- -------- ------- -------- ------- -------- -------- Total cost of system sales 3,225 3,732 3,393 2,988 3,744 3,271 2,959 3,851 ------- ------- -------- ------- -------- ------- -------- -------- Cost of maintenance, EDI and other 3,385 3,760 4,130 4,060 4,357 4,666 4,556 5,265 ------- ------- -------- ------- -------- ------- -------- -------- Total cost of revenue 6,610 7,492 7,523 7,048 8,101 7,937 7,515 9,116 ------- ------- -------- ------- -------- ------- -------- -------- Gross profit 9,696 10,150 10,676 11,739 12,029 13,280 14,573 16,410 Selling, general, & administrative 4,740 4,768 4,902 5,072 4,953 5,414 6,420 7,989 Research and development 1,366 1,502 1,628 1,643 1,612 1,818 1,707 1,766 ------- ------- -------- ------- -------- ------- -------- -------- Income from operations 3,590 3,880 4,146 5,024 5,464 6,048 6,446 6,655 Investment income 100 89 95 102 120 170 263 323 ------- ------- -------- ------- -------- ------- -------- -------- Income before provision for income taxes 3,690 3,969 4,241 5,126 5,584 6,218 6,709 6,978 Provision for income taxes 1,413 1,561 1,630 2,022 2,202 2,503 2,488 2,187 ------- ------- -------- ------- -------- ------- -------- -------- Net income $ 2,277 $ 2,408 $ 2,611 $ 3,104 $ 3,382 $ 3,715 $ 4,221 $ 4,791 ======= ======= ======== ======= ======== ======= ======== ======== Net income per share - basic* $ 0.18 $ 0.20 $ 0.21 $ 0.25 $ 0.27 $ 0.29 $ 0.33 $ 0.37 Net income per share - diluted* $ 0.18 $ 0.19 $ 0.20 $ 0.24 $ 0.26 $ 0.28 $ 0.32 $ 0.36 Weighted average shares outstanding - basic 12,314 12,334 12,478 12,624 12,666 12,780 12,952 13,089 Weighted average shares outstanding - diluted 12,932 12,982 13,098 13,164 13,154 13,196 13,282 13,370
* will not add to annual EPS due to rounding 70 Schedule II ALLOWANCE FOR DOUBTFUL ACCOUNTS (in thousands) Additions Balance at Charged to Beginning Costs and Balance at For the Year Ended of Period Expenses Deductions End of Period March 31, 2005 ............ $ 1,293 $ 797 $ (253) $ 1,837 March 31, 2004 ............ $ 990 $ 647 $ (344) $ 1,293 March 31, 2003 ............ $ 813 $ 623 $ (446) $ 990 ALLOWANCE FOR INVENTORY OBSOLESCENSE (in thousands) Additions Balance at Charged to Beginning Costs and Balance at For the Year Ended of Period Expenses Deductions End of Period March 31, 2005 ............ $ 207 $ 160 $ (221) $ 146 March 31, 2004 ............ $ 160 $ 54 $ (7) $ 207 March 31, 2003 ............ $ 127 $ 40 $ (7) $ 160 71 INDEX TO EXHIBITS 3.1.1 Amendment to Articles of Incorporation, effective March 4, 2005. 3.6 Bylaws of the Company, as amended and restated. 10.6.1 Form of Indemnification Agreement for directors and executive officers authorized January 27, 2005. 10.10.1 Amended and Restated 1998 Stock Option Plan. 10.19 Lease Agreement between the Company and Lakeshore Towers Limited Partnership Phase IV, a California limited partnership. 23.1 Consent of Independent Registered Public Accounting Firm - Grant Thornton LLP. 31.1 Certification of Chief Executive Officer 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. 31.2 Certification of Chief Financial Officer 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. 72 QUALITY SYSTEMS, INC. LIST OF SUBSIDIARIES 1. NextGen Healthcare Information Systems, Inc, Inc., a California corporation, is a wholly-owned subsidiary of Quality Systems, Inc. 73 EX-3.1.1 2 d64225_ex3-1.txt AMEDMENT TO ARTICLES OF INCORPORATION Exhibit 3.1.1 CERTIFICATE OF AMENDMENT OF ARTICLES OF INCORPORATION OF QUALITY SYSTEMS, INC. The undersigned certify that: 1. They are the president and the secretary, respectively, of Quality Systems, Inc., a California corporation. 2. Article Third of the Articles of Incorporation of this corporation is hereby amended to read in its entirety as follows: THIRD: This corporation is authorized to issue only one class of shares, to be called "Common Stock." The total number of such shares that this corporation shall have authority to issue is Twenty Million (20,000,000), and each such share shall have a par value of one cent ($.01). On the amendment of this article to read as set forth herein, each outstanding share of Common Stock is split up and converted into two shares of Common Stock, and each such share shall have a par value of one cent $.01). 3. The foregoing amendment of Articles of Incorporation has been duly approved by the board of directors of the corporation. 4. The foregoing amendment of Articles of Incorporation is one that may be adopted with approval by the board of directors alone pursuant to Section 902(c) of the California General Corporation Law, because the corporation has only one class of shares outstanding and the amendment effects only a stock split. 5. The amendment shall become effective at the close of business on March 4, 2005. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of my/our own knowledge. Dated: February 18, 2005 /s/LOU SILVERMAN ----------------------------- Lou Silverman, President /s/PAUL HOLT ----------------------------- Paul Holt, Secretary EX-3.6 3 d64225_ex3-6.txt BYLAWS OF THE COMPANY, AS AMENDED AND RESTATED Exhibit 3.6 AMENDED AND RESTATED BYLAWS for the regulation, except as otherwise provided by statute or the Articles of Incorporation, of QUALITY SYSTEMS, INC. (a California corporation) ARTICLE I OFFICES Section 1. PRINCIPAL EXECUTIVE OFFICE. The corporation's principal executive office is fixed and located at 18191 Von Karman Avenue, Suite 450, Irvine, California 92612. The Board of Directors (herein called the "Board") is granted full power and authority to change said principal executive office from one location to another. Any such change shall be noted on the Bylaws opposite this Section, or this Section may be amended to state the new location. Section 2. OTHER OFFICES. Branch or subordinate offices may be established at any time by the Board at any place or places. ARTICLE II SHAREHOLDERS Section 1. PLACE OF MEETINGS. Meetings of shareholders shall be held either at the principal executive office of the corporation or at any other place within or without the State of California which may be designated either by the Board or by the written consent of all persons entitled to vote thereat, given either before or after the meeting and filed with the Secretary. Section 2. ANNUAL MEETING. (a) The annual meeting of shareholders shall be held each year on a date and at a time designated by the Board. At each annual meeting, directors shall be elected and any other proper business may be transacted. (b) At an annual meeting of shareholders, only such business shall be conducted, and only such proposals shall be acted upon, as shall have been brought before the annual meeting by or at the direction of a majority of the directors or by any shareholder of the corporation who complies with the notice procedures set forth -1- in this Section 2(b). For a proposal to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the secretary of the corporation. To be timely, a shareholder's notice must be delivered to, or mailed and received at, the principal executive offices of the corporation not less than sixty (60) days nor more than one hundred twenty (120) days prior to the scheduled annual meeting, regardless of any postponements, deferrals or adjournments of that meeting to a later date; provided, however, that if less than seventy (70) days notice or prior public disclosure of the date of the scheduled annual meeting is given or made, notice by the shareholder, to be timely, must be so delivered or received not later than the close of business on the tenth day following the earlier of the day on which such notice of the date of the scheduled annual meeting was mailed or the day on which such public disclosure was made. A shareholder's notice to the secretary shall set forth as to each matter the shareholder proposes to bring before the annual meeting (i) a brief description of the proposal desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the corporation's books, of the shareholder proposing such business and any other shareholders known by such shareholder to be supporting such proposal, (iii) the class and number of shares of the corporation's stock which are beneficially owned by the shareholder on the date of such shareholder notice and by any other shareholders known by such shareholder to be supporting such proposal on the date of such shareholder notice, and (iv) any financial interest of the shareholder in such proposal. The presiding officer of the annual meeting shall determine and declare at the annual meeting whether the shareholder proposal was made in accordance with the terms of this Section 2(b). If the presiding officer determines that a shareholder proposal was not made in accordance with the terms of this Section 2(b), he or she shall so declare at the annual meeting and any such proposal shall not be acted upon at the annual meeting. This provision shall not prevent the consideration and approval or disapproval at the annual meeting of reports of officers, directors and committees of the Board, but, in connection with such reports, no new business shall be acted upon at such annual meeting unless stated, filed and received as herein provided. (c) Only persons who are nominated in accordance with the following procedures shall be eligible for election as directors. Nominations of persons for election to the Board may be made at a meeting of shareholders by or at the direction of the Board, by any nominating committee or person appointed by the Board or by any shareholder of the corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 2(c). Such nominations, other than those made by or at the direction of the Board, shall be made pursuant to timely notice in writing to the secretary of the corporation. To be timely, a shareholder's notice must be delivered to, or mailed and received at, the principal executive offices of the corporation not less than sixty (60) days nor more than one hundred twenty (120) days prior to the scheduled annual meeting, regardless of any postponements, deferrals or adjournments of that -2- meeting to a later date, provided, however, that if less than seventy (70) days notice or prior public disclosure of the date of the scheduled annual meeting is given or made, notice by the shareholder, to be timely, must be so delivered or received not later than the close of business on the tenth day following the earlier of the day on which such notice of the date of the scheduled annual meeting was mailed or the day on which such public disclosure was made. A shareholder's notice to the secretary shall set forth (i) as to each person whom the shareholder proposes to nominate for election or re-election as a director, (A) the name, age, business address and residence address of the person, (B) the principal occupation or employment of the person (C) the class and number of shares of capital stock of the corporation which are beneficially owned by the person and (D) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of directors pursuant to applicable rules and regulations of the Securities and Exchange Commission promulgated under the Securities Exchange Act of 1934, as amended, and (ii) as to the shareholder giving the notice (A) the name and address, as they appear on the corporation's books, of the shareholder and (B) the class and number of shares of the corporation's stock which are beneficially owned by the shareholder on the date of such shareholder notice. The corporation may require any proposed nominee to furnish such other information as may reasonably be required by the corporation to determine the eligibility of such proposed nominee to serve as director of the corporation. The presiding officer of the annual meeting shall determine and declare at the annual meeting whether the nomination was made in accordance with the terms of the Section 2(c). If the presiding officer determines that a nomination was not made in accordance with the terms of this Section 2(c), he or she shall so declare at the annual meeting and any such defective nomination shall be disregarded. Section 3. SPECIAL MEETING. (a) A special meeting of the shareholders may be called at any time by the Board, or by the chairman of the board, or by the president, or by one or more shareholders holding shares in the aggregate entitled to cast not less than ten percent (10%) of the votes at that meeting. (b) For a special meeting of shareholders to be properly called by any person or persons other than the Board, the request must be in writing, specifying the date and time of such meeting and the information set forth in Section 3(c) hereof, and must be delivered to, or mailed and received by, the chairman of the board, the president or the secretary of the corporation not less than thirty-five (35) nor more than sixty (60) days prior to the date requested for such meeting. The officer receiving the request shall cause notice to be promptly given to the shareholders entitled to vote, in accordance with the provisions of Sections 4 and 5 of this Article II, that a meeting will be held at the time requested by the person or persons calling the meeting. If the notice is not given within twenty (20) days after receipt of the request, the person or persons requesting the meeting may give the notice. Nothing contained in this paragraph of this Section 3 shall be -3- construed as limiting, fixing or affecting the time when a meeting of shareholders called by action of the Board may be held. (c) Any request for a special meeting submitted by a shareholder pursuant to Section 3(b) hereof shall set forth as to each matter the shareholder proposes to bring before the special meeting (i) a brief description of the proposal desired to be brought before the special meeting and the reasons for conducting such business at the special meeting, (ii) the name and address, as they appear on the corporation's books, of the shareholder proposing such business and any other shareholders known by such shareholder to be supporting such proposal, (iii) the class and number of shares of the corporation's stock which are beneficially owned by the shareholder on the date of such shareholder request and by any other shareholders known by such shareholder to be supporting such proposal on the date of such shareholder request, and (iv) any financial interest of the shareholder in such proposal. In addition to whatever other limitations are imposed by applicable law, no person may be nominated for election to the Board by any of the person or persons making a request for a special meeting pursuant to Section 3(b) hereof unless the request sets forth as to each person whom the requesting person or persons propose to nominate for election as a director, (A) the name, age, business address and residence address of the person, (B) the principal occupation or employment of the person, (C) the class and number of shares of capital stock of the corporation which are beneficially owned by the person and (D) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of directors pursuant to applicable rules and regulations of the Securities and Exchange Commission promulgated under the Securities Exchange Act of 1934, as amended. Section 4. NOTICE OF ANNUAL OR SPECIAL MEETINGS. Written notice of each annual or special meeting of shareholders shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each shareholder entitled to vote thereat. Such notice shall state the place, date and hour of the meeting and (a) in the case of a special meeting, the general nature of the business to be transacted, and no other business may be transacted, or (b) in the case of the annual meeting, those matters which the Board, at the time of the mailing of the notice, intends to present for action by the shareholders, but, subject to the provisions of applicable law, any proper matter may be presented at the meeting for such action. The notice of any meeting at which directors are to be elected shall include the names of nominees intended at the time of the notice to be presented by the Board for election. Notice of a shareholders' meeting shall be given either personally or by mail or by other means of written communication, addressed to the shareholder at the address of such shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice, or, if no such address appears or is given, at the place where the principal executive office of the corporation is located or by publication at least once in a newspaper of general circulation in the county in which the principal executive office is located. Notice by -4- mail shall be deemed to have been given at the time a written notice is deposited in the United States mails, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or is delivered to a common carrier for transmission, or actually transmitted by the person giving the notice by electronic means, to the recipient. Section 5. QUORUM. A majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum at any meeting of shareholders. If a quorum is present, the affirmative vote of a majority of the shares represented and voting at the meeting (which shares voting affirmatively also constitute at least a majority of the required quorum) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by law or by the Articles of Incorporation, except as provided in the following sentence. The shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. Section 6. ADJOURNED MEETINGS AND NOTICE THEREOF. Any shareholders' meeting, whether or not a quorum is present, may be adjourned from time to time by the vote of a majority of the shares represented either in person or by proxy, but in the absence of a quorum (except as provided in Section 5 of this Article) no other business may be transacted at such meeting. It shall not be necessary to give any notice of the time and place of the adjourned meeting or of the business to be transacted thereat, other than by announcement at the meeting at which such adjournment is taken; provided, however, when any shareholders' meeting is adjourned for more than 45 days or, if after adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given as in the case of an original meeting. Section 7. VOTING. The shareholders entitled to notice of any meeting or to vote at any such meeting shall be only persons in whose name shares stand on the stock records of the corporation on the record date determined in accordance with Section 8 of this Article. Subject to the following sentence and to the provisions of Section 708 of the California General Corporation Law, every shareholder entitled to vote at any election of directors may cumulate such shareholder's votes and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which the shareholder's shares are entitled, or distribute the shareholder's votes on the same principle among as many candidates as the shareholder thinks fit. No shareholder shall be entitled to cumulate votes for any candidate or candidates pursuant to the preceding sentence unless such candidate or candidates' names have been placed in nomination prior to the voting and the shareholder has given notice at the meeting prior to the voting of the shareholder's intention to cumulate the shareholder's votes. If -5- any one shareholder has given such notice, all shareholders may cumulate their votes for candidates in nomination. Elections need not be by ballot; provided, however, that all elections for directors must be by ballot upon demand made by a shareholder at the meeting and before the voting begins. In any election of directors, the candidates receiving the highest number of votes of the shares entitled to be voted for them up to the number of directors to be elected by such shares are elected. Voting shall in all cases be subject to the provisions of Chapter 7 of the California General Corporation Law, and to the following provisions: (a) Subject to clause (g), shares held by an administrator, executor, guardian, conservator or custodian may be voted by such holder either in person or by proxy, without a transfer of such shares into the holder's name; and shares standing in the name of a trustee may be voted by the trustee, either in person or by proxy, but no trustee shall be entitled to vote shares held by such trustee without a transfer of such shares into the trustee's name. (b) Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such a receiver without the transfer thereof into the receiver's name if authority to do so is contained in the order of the court by which such receiver was appointed. (c) Subject to the provisions of Section 705 of the California General Corporation Law and except where otherwise agreed in writing between the parties, a shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. (d) Shares standing in the name of a minor may be voted and the corporation may treat all rights incident thereto as exercisable by the minor, in person or by proxy, whether or not the corporation has notice, actual or constructive, of the nonage, unless a guardian of the minor's property has been appointed and written notice of such appointment given to the corporation. (e) Shares standing in the name of another corporation, domestic or foreign, may be voted by such officer, agent or proxyholder as the bylaws of such other corporation may prescribe or, in the absence of such provision, as the Board of Directors of such other corporation may determine or, in the absence of such determination, by the chairman of the board, president or any vice president of such other corporation, or by any other person authorized to do so by the chairman of the board, president or any vice president of such other corporation. Shares which are purported to be voted or any proxy purported to be executed in the name of a corporation (whether or not any title of the person signing is -6- indicated) shall be presumed to be voted or the proxy executed in accordance with the provisions of this clause, unless the contrary is shown. (f) Shares of the corporation owned by any subsidiary shall not be entitled to vote on any matter. (g) Shares held by the corporation in a fiduciary capacity, and shares of the issuing corporation held in a fiduciary capacity by any subsidiary, shall not be entitled to vote on any matter, except to the extent that the settlor or beneficial owner possesses and exercises a right to vote or to give the corporation binding instructions as to how to vote such shares. (h) If shares stand of record in the names of two or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, husband and wife as community property, tenants by the entirety, voting trustees, persons entitled to vote under a shareholder voting agreement or otherwise, or if two or more persons (including proxyholders) have the same fiduciary relationship respecting the same shares, unless the secretary of the corporation is given written notice to the contrary and is furnished with a copy of the instrument or order appointing them or creating the relationship wherein it is so provided, their acts with respect to voting shall have the following effect: (i) If only one votes, such act binds all; (ii) If more than one vote, the act of the majority so voting binds all; (iii) If more than one vote, but the vote is evenly split on any particular matter, each faction may vote the securities in question proportionately. If the instrument so filed or the registration of the shares shows that any such tenancy is held in unequal interests, a majority or even split for the purpose of this section shall be a majority or even split in interest. Section 8. RECORD DATE. The Board may fix, in advance, a record date for the determination of the shareholders entitled to notice of any meeting or to vote or entitled to receive payment of any dividend or other distribution, or any allotment or rights, or to exercise rights in respect of any other lawful action. The record date so fixed shall be not more than 60 days nor less than 10 days prior to the date of the meeting nor more than 60 days prior to any other action. When a record date is so fixed, only shareholders of record on that date are entitled to notice of and to vote at the meeting or to receive the dividend, distribution, or allotment of rights, or to exercise of the rights, as the case may be, notwithstanding any transfer of shares on the books of the corporation after the record date. A determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders shall apply to any adjournment of the meeting unless the Board fixes a new record date for the adjourned meeting. The Board shall fix a new record date if the meeting is adjourned for more than 45 days. -7- If no record date is fixed by the Board, the record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. The record date for determining shareholders for any purpose other than set forth in this Section 8 or Section 10 of this Article shall be at the close of business on the day on which the Board adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later. Section 9. CONSENT OF ABSENTEES. The transactions of any meeting of shareholders, however called and noticed, and wherever held, are as valid as though had at a meeting duly held after regular call and notice, if a quorum is present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, signs a written waiver of notice, or a consent to the holding of the meeting or an approval of the minutes thereof. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance of a person at a meeting shall constitute a waiver of notice of and presence at such meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters required by the California General Corporation Law to be included in the notice but not so included, if such objection is expressly made at the meeting. Neither the business to be transacted at nor the purpose of any regular or special meeting of shareholders need be specified in any written waiver of notice, consent to the holding of the meeting or approval of the minutes thereof, except as provided in Section 601(f) of the California General Corporation Law. Section 10. ACTION WITHOUT MEETING. Subject to Section 603 of the California General Corporation Law, any action which, under any provision of the California General Corporation Law, may be taken at any annual or special meeting of shareholders, may be taken without a meeting and without prior notice if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Unless a record date for voting purposes be fixed as provided in Section 8 of this Article, the record date for determining shareholders entitled to give consent pursuant to this Section 10, when no prior action by the Board has been taken, shall be the day on which the first written consent is given. Section 11. PROXIES. Every person entitled to vote shares has the right to do so either in person or by one or more persons authorized by a written proxy executed by such shareholder and filed with the Secretary. Any proxy duly executed is not revoked and continues in full force and effect until revoked by the person executing it prior to the vote pursuant thereto. Such revocation may be -8- effected either (i) by a writing delivered to the Secretary of the Corporation stating that the proxy is revoked, (ii) by a subsequent proxy executed by the person executing the prior proxy and presented to the meeting, or (iii) by attendance at the meeting and voting in person by the person executing the proxy; provided, however, that no proxy shall be valid after the expiration of eleven months from the date of its execution unless otherwise provided in the proxy. Section 12. INSPECTORS OF ELECTION. In advance of any meeting of shareholders, the Board may appoint inspectors of election to act at such meeting and any adjournment thereof. If inspectors of election be not so appointed, or if any persons so appointed fail to appear or refuse to act, the chairman of any such meeting may, and on the request of any shareholder or shareholder's proxy shall, make such appointment at the meeting. The number of inspectors shall be either one or three. If appointed at a meeting on the request of one or more shareholders or proxies, the majority of shares present shall determine whether one or three inspectors are to be appointed. The duties of such inspectors shall be as prescribed by Section 707(b) of the California General Corporation Law and shall include: determining the number of shares outstanding and the voting power of each; determining the shares represented at the meeting; determining the existence of a quorum; determining the authenticity, validity, and effect of proxies; receiving votes, ballots or consents; hearing and determining all challenges and questions in any way arising in connection with the right to vote; counting and tabulating all votes or consents; determining when the polls shall close; determining the result; and doing such acts as may be proper to conduct the election or vote with fairness to all shareholders. If there are three inspectors of election, the decision, act or certificate of a majority is effective in all respects as the decision, act or certificate of all. Section 13. CONDUCT OF MEETING. The President shall preside as chairman at all meetings of the shareholders. The chairman shall conduct each such meeting in a businesslike and fair manner, but shall not be obligated to follow any technical, formal or parliamentary rules or principles of procedure. The chairman's rulings on procedural matters shall be conclusive and binding on all shareholders, unless at the time of a ruling a request for a vote is made to the shareholders holding shares entitled to vote and which are represented in person or by proxy at the meeting, in which case the decision of a majority of such shares shall be conclusive and binding on all shareholders. Without limiting the generality of the foregoing, the chairman shall have all of the powers usually vested in the chairman of a meeting of shareholders. ARTICLE III DIRECTORS Section 1. POWERS. Subject to limitations of the Articles of Incorporation, of these Bylaws and of the California General Corporation Law relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the Board. The -9- Board may delegate the management of the day-to-day operation of the business of the corporation to a management company or other person provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the Board. Without prejudice to such general powers, but subject to the same limitations, it is hereby expressly declared that the Board shall have the following powers in addition to the other powers enumerated in these Bylaws: (a) To select and remove all the other officers, agents and employees of the corporation, prescribe the powers and duties for them as may not be inconsistent with law, the Articles of Incorporation or these Bylaws, fix their compensation and require from them security for faithful service. (b) To conduct, manage and control the affairs and business of the corporation and to make such rules and regulations therefor not inconsistent with law, the Articles of Incorporation or these Bylaws, as the Board may deem best. (c) To adopt, make and use a corporate seal, and to prescribe the forms of certificates of stock, and to alter the form of such seal and of such certificates from time to time as they may deem best. (d) To authorize the issuance of shares of stock of the corporation from time to time, upon such terms and for such consideration as may be lawful. (e) To borrow money and incur indebtedness for the purposes of the corporation, and to cause to be executed and delivered therefor, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations or other evidences of debt and securities therefor. Section 2. NUMBER OF DIRECTORS. The authorized number of directors shall be not less than five (5) nor more than nine (9) until changed by amendment of the Articles of Incorporation or by a Bylaw duly adopted by approval of the outstanding shares. The exact number of directors shall be fixed, within the limits specified, by amendment of the next sentence duly adopted either by the Board or the shareholders. The exact number of directors shall be nine (9) until changed as provided in this Section 2. Section 3. ELECTION AND TERM OF OFFICE. The directors shall be elected at each annual meeting of the shareholders, but if any such meeting is not held or the directors are not elected thereat, the directors may be elected at any special meetings of shareholders held for that purpose. Each director shall hold office until the next annual meeting and until a successor had been elected and qualified. -10- Section 4. VACANCIES. Any director may resign effective upon giving written notice to the Chairman of the Board, the President, the Secretary or the Board, unless the notice specifies a later time for the effectiveness of such resignation. If the resignation is effective at a future time, a successor may be elected to take office when the resignation becomes effective. Vacancies in the Board, except those existing as a result of a removal of a director, may be filled by a majority of the remaining directors, though less than a quorum, or by a sole remaining director, and each director so elected shall hold office until the next annual meeting and until such director's successor has been elected and qualified. A vacancy or vacancies in the Board shall be deemed to exist in case of the death, resignation or removal of any director, or if the authorized number of directors be increased, or if the shareholders fail, at any annual or special meeting of shareholders at which any director or directors are elected, to elect the full authorized number of directors to be voted for at that meeting. The Board may declare vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony. The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors. Any such election by written consent other than to fill a vacancy created by removal requires the consent of a majority of the outstanding shares entitled to vote. Any such election by written consent to fill a vacancy created by removal requires unanimous consent. No reduction of the authorized number of directors shall have the effect of removing any director prior to the expiration of the director's term of office. Section 5. PLACE OF MEETING. Regular or special meetings of the Board shall be held at any place within or without the State of California which have been designated from time to time by the Board. In the absence of such designation, regular meetings shall be held at the principal executive office of the corporation. Section 6. REGULAR MEETINGS. Immediately following each annual meeting of shareholders the Board shall hold a regular meeting for the purpose of organization, election of officers and the transaction of other business. Other regular meetings of the Board shall be held without call on such dates and at such times as may be fixed by the Board. Call and notice of all regular meetings of the Board are hereby dispensed with. -11- Section 7. SPECIAL MEETINGS. Special meetings of the Board for any purpose or purposes may be called at any time by the Chairman of the Board, the President, any Vice President, the Secretary or by any two directors. Special meetings of the Board shall be held upon four days written notice or forty-eight hours notice given personally or by telephone, including a voice messaging system or other system or technology designed to record and communicate messages, telegraph, facsimile, electronic mail, or other electronic means. Any such notice shall be addressed or delivered to each director at such director's address as it is shown upon the records of the corporation or as may have been given to the corporation by the director for purposes of notice or, if such address is not shown on such records or is not readily ascertainable, at the place in which the meetings of the directors are regularly held. Notice by mail shall be deemed to have been given at the time a written notice is deposited in the United States mails, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or is delivered to a common carrier for transmission, or actually transmitted by the person giving the notice by electronic means, to the recipient. Oral notice shall be deemed to have been given at the time it is communicated, in person or by telephone or wireless, to the recipient or to a person at the office of the recipient who the person giving the notice has reason to believe will promptly communicate it to the recipient, or when communicated to a voice messaging system or other system or technology designed to record and communicate messages where the person giving the notice has reason to believe the recipient will promptly receive the message. Section 8. QUORUM. A majority of the authorized number of directors constitutes a quorum of the Board for the transaction of business, except to adjourn as provided in Section 11 of this Article. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the Board, unless a greater number be required by law or by the Articles of Incorporation, except as provided in the next sentence. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting. Section 9. PARTICIPATION IN MEETINGS BY CONFERENCE TELEPHONE. Members of the Board may participate in a meeting through use of conference telephone, electronic video screen communication, or other communications equipment. Participation in a meeting through use of conference telephone constitutes presence in person at that meeting as long as all members participating in the meeting are able to hear one another. Participation in the meeting through the use of electronic video screen communication or other communications equipment, other than conference telephone, constitutes presence in person at that meeting if all of the following apply: -12- (A) Each member participating in the meeting can communicate with all of the other members concurrently. (B) Each member is provided the means of participating in all matters before the board, including, without limitation, the capacity to propose, or to interpose an objection to, a specific action to be taken by the corporation. (C) The corporation adopts and implements some means of verifying both of the following: (i) A person participating in the meeting is a director or other person entitled to participate in the Board meeting; and (ii) All actions of, or votes by, the Board are taken or cast only by the directors and not by persons who are not directors. Section 10. WAIVER OF NOTICE. Notice of a meeting need not be given to any director who signs a waiver of notice or a consent to holding the meeting or an approval of the minutes thereof, whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to such director. All such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Section 11. ADJOURNMENT. A majority of the directors present, whether or not a quorum is present, may adjourn any directors' meeting to another time and place. Notice of the time and place of holding an adjourned meeting need not be given to absent directors if the time and place be fixed at the meeting adjourned, except as provided in the next sentence. If the meeting is adjourned for more than 24 hours, notice of any adjournment to another time or place shall be given prior to the time of the adjourned meeting to the directors who were not present at the time of the adjournment. Section 12. FEES AND COMPENSATION. Directors and members of committee may receive such compensation, if any, for their services, and such reimbursement for expenses, as may be fixed or determined by the Board. Section 13. ACTION WITHOUT MEETING. Any action required or permitted to be taken by the Board may be taken without a meeting if all members of the Board shall individually or collectively consent in writing to such action. Such consent or consents shall have the same effect as a unanimous vote of the Board and shall be filed with the minutes of the proceedings of the Board. Section 14. RIGHTS OF INSPECTION. Every director shall have the absolute right at any reasonable time to inspect and copy all books, records and documents of every kind and to inspect the physical properties of the corporation and also of its subsidiary corporations, domestic or foreign. Such inspection by a -13- director may be made in person or by agent or attorney and includes the right to copy and obtain extracts. Section 15. COMMITTEES. The Board may appoint one or more committees, each consisting of two or more directors, and delegate to such committees any of the authority of the Board except with respect to: (a) The approval of any action for which the General Corporation Law also requires shareholders' approval or approval of the outstanding shares; (b) The filling of vacancies in the Board or on any committee; (c) The fixing of compensation of the directors for serving on the Board or on any committee; (d) The amendment or repeal of bylaws or the adoption of new bylaws; (e) The amendment or repeal of any resolution of the Board which by its express terms is not so amendable or repealable; (f) A distribution to the shareholders of the corporation except at a rate or in a periodic amount or within a price range determined by the Board; or (g) The appointment of other committee of the Board or the members thereof. Any such committee must be designated, and the members or alternate members thereof appointed, by resolution adopted by a majority of the authorized number of directors and any such committee may be designated an Executive Committee or by such other name as the Board shall specify. Alternate members of a committee may replace any absent member at any meeting of the committee. The Board shall have the power to prescribe the manner in which proceedings of any such committee shall be conducted. In the absence of any such prescription, such committee shall have the power to prescribe the manner in which its proceedings shall be conducted. Unless the Board or such committee shall otherwise provide, the regular and special meetings and other actions of any such committee shall be governed by the provisions of this Article applicable to meetings and actions of the Board. Minutes shall be kept of each meeting of each committee. ARTICLE IV OFFICERS Section 1. OFFICERS. The officers of the corporation shall be a President, a Secretary and a Chief Financial Officer. The corporation may also have, at the discretion of the Board, a Chairman of the Board, one or more Vice Presidents, one or more Assistant Secretaries, one or more Assistant -14- Treasurers, and such other officers as may be elected or appointed in accordance with the provisions of Section 3 of this Article. Section 2. ELECTION. The officers of the corporation, except such officers as may be elected or appointed in accordance with the provisions of Section 3 or Section 5 of this Article, shall be chosen annually by, and shall serve at the pleasure of, the Board, and shall hold their respective offices until their resignation, removal, or other disqualification from service, or until their respective successors shall be elected. Section 3. SUBORDINATE OFFICERS. The Board may elect, and may empower the President to appoint, such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority and perform such duties as are provided in these Bylaws or as the Board may from time to time determine. Section 4. REMOVAL AND RESIGNATION. Any officer may be removed, either with or without cause, by the Board at any time or, except in the case of an officer chosen by the Board, by any officer upon whom such power of removal may be conferred by the Board. Any such removal shall be without prejudice to the rights, if any, of the officer under any contract of employment of the officer. Any officer may resign at any time by giving written notice to the corporation, but without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 5. VACANCIES. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these Bylaws for regular election or appointment to such office. Section 6. CHAIRMAN OF THE BOARD. The Chairman of the Board, if there shall be such an officer, shall, if present, preside at all meetings of the Board and exercise and perform such other powers and duties as may be from time to time assigned by the Board. Section 7. PRESIDENT. Subject to such powers, if any, as may be given by the Board to the Chairman of the Board, if there be such an officer, the President is the general manager and chief executive -15- officer of the corporation and has, subject to the control of the Board, general supervision, direction and control of the business and officers of the corporation. The President shall preside at all meetings of the shareholders and, in the absence of the Chairman of the Board, or if there be none, at all meetings of the Board. The President has the general powers and duties of management usually vested in the office of president and general manager of a corporation and such other powers and duties as may be prescribed by the Board. Section 8. VICE PRESIDENTS. In the absence or disability of the President, the Vice Presidents in order of their rank as fixed by the Board or, if not ranked, the Vice President designated by the Board, shall perform all the duties of the President and, when so acting, shall have all the powers of, and be subject to all the restrictions upon, the President. The Vice Presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the Board. Section 9. SECRETARY. The Secretary shall keep or cause to be kept, at the principal executive office and such other place as the Board may order, a book of minutes of all meetings of shareholders, the Board and its committees, with the time and place of holding, whether regular or special, and if special, how authorized, the notice thereof given, the names of those present at Board and committee meetings, the number of shares present or represented at shareholders' meetings, and the proceedings thereof. The Secretary shall keep, or cause to be kept, a copy of the Bylaws of the corporation at the principal executive office or business office in accordance with Section 213 of the California General Corporation Law. The Secretary shall keep, or cause to be kept, at the principal executive office or at the office of the corporation's transfer agent or registrar, if one be appointed, a share register, or a duplicate share register, showing the names of the shareholders and their addresses, the number and classes of shares held by each, the number and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation. The Secretary shall give, or cause to be given, notice of all meetings of the shareholders and of the Board and any committees thereof required by these Bylaws or by law to be given, shall keep the seal of the corporation in safe custody, and shall have such other powers and perform such other duties as may be prescribed by the Board. Section 10. CHIEF FINANCIAL OFFICER. The Chief Financial Officer of the corporation shall keep and maintain, or cause to be kept and maintained, adequate and correct accounts of the properties and business transactions of the corporation, and shall send or cause to be sent to the shareholders of the corporation such financial statements and reports as are by law or these Bylaws required to be sent to them. The books of account shall at all times be open to inspection by any director. -16- The Chief Financial Officer shall deposit all moneys and other valuables in the name and to the credit of the corporation with such depositaries as may be designated by the Board. The Chief Financial Officer shall disburse the funds of the corporation as may be ordered by the Board, shall render to the President and the directors, whenever they request it, an account of all transactions as Chief Financial Officer and of the financial condition of the corporation, and shall have such other powers and perform such other duties as may be prescribed by the Board. ARTICLE V OTHER PROVISIONS Section 1. INSPECTION OF CORPORATE RECORDS. (a) A shareholder or shareholders holding at least five percent in the aggregate of the outstanding voting shares of the corporation or who hold at least one percent of such voting shares and have filed a Schedule 14A with the United States Securities and Exchange Commission shall have an absolute right to do either or both of the following: (i) Inspect and copy the record of shareholders' names and addresses and shareholdings during usual business hours upon five business days' prior written demand upon the corporation; or (ii) Obtain from the transfer agent, if any, for the corporation, upon written demand and upon the tender of its usual charges for such a list (the amount of which charges shall be stated to the shareholder by the transfer agent upon request), a list of the shareholders' names and addresses who are entitled to vote for the election of directors and their shareholdings, as of the most recent record date for which it has been compiled or as of a date specified by the shareholder subsequent to the date of demand. The list shall be made available on or before the later of five business days after the demand is received or the date specified therein as the date as of which the list is to be compiled. (b) The record of shareholders shall also be open to inspection and copying by any shareholder or holder of a voting trust certificate at any time during usual business hours upon written demand on the corporation, for a purpose reasonably related to such holder's interest as a shareholder or holder of a voting trust certificate. (c) The accounting books and records and minutes of proceedings of the shareholders and the Board and committees of the Board shall be open to inspection upon written demand on the corporation of any shareholder or holder of voting trust certificate at any reasonable time during usual business hours, for a purpose reasonably related to such holder's interests as a shareholder or as a holder of such voting trust certificate. (d) Any inspection and copying under this Article may be made in person or by agent or attorney. -17- Section 2. INSPECTION OF BYLAWS. The corporation shall keep in its principal executive office in the State of California, or if its principal executive office is not in such State at its principal business office in such State, the original or a copy of these Bylaws as amended to date, which shall be open to inspection by shareholders at all reasonable times during office hours. If the principal executive office of the corporation is located outside the State of California and the corporation has no principal business office in such state, it shall upon the written request of any shareholder furnish to such shareholder a copy of these Bylaws as amended to date. Section 3. ENDORSEMENT OF DOCUMENTS; CONTRACTS. Subject to provisions of applicable law, any note, mortgage, evidence of indebtedness, contract, share certificate, conveyance or other instrument in writing and any assignment or endorsements thereof executed or entered into between the corporation and any other person, when signed by the Chairman of the Board, the President or any Vice President and the Secretary, any Assistant Secretary, the Chief Financial Officer or any Assistant Chief Financial Officer of the corporation is not invalidated as to the corporation by any lack of authority of the signing officers in the absence of actual knowledge on the part of the other person that the signing officers had no authority to execute the same. Any such instruments may be signed by any other person or persons and in such manner as from time to time shall be determined by the Board, and, unless so authorized by the Board, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or amount. Section 4. CERTIFICATES OF STOCK. Every holder of shares of the corporation shall be entitled to have a certificate signed in the name of the corporation by the Chairman of the Board, the President or a Vice President and by the Chief Financial Officer or an Assistant Chief Financial Officer or the Secretary or an Assistant Secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificate may be facsimile. If any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if such person were an officer, transfer agent or registrar at the date of issue. Certificates for shares may be issued prior to full payment under such restrictions and for such purposes as the Board may provide; provided, however, that on any certificate issued to represent any partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated. Except as provided in this Section, no new certificate for shares shall be issued in lieu of an old one unless the latter is surrendered and cancelled at the same time. The Board may, however, if any certificate for shares is alleged to have been lost, stolen or destroyed, authorize the issuance of a new certificate in lieu thereof, and the corporation may require that the -18- corporation be given a bond or other adequate security sufficient to indemnify it against any claim that may be made against it (including expense or liability) on account of the alleged loss, theft or destruction of such certificate or the issuance of such new certificate. Section 5. REPRESENTATION OF SHARES OF OTHER CORPORATIONS. The President or any other officer or officers authorized by the Board or the President are each authorized to vote, represent and exercise on behalf of the corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of the corporation. The authority herein granted may be exercised either by any such officer in person or by any other person authorized so to do by proxy or power of attorney duly executed by said officer. Section 6. STOCK PURCHASE PLANS. The corporation may adopt and carry out a stock purchase plan or agreement or stock option plan or agreement providing for the issue and sale for such consideration as may be fixed of its unissued shares, or of issued shares acquired or to be acquired, to one or more of the employees or directors of the corporation or of a subsidiary or to a trustee on their behalf and for the payment for such shares in installments or at one time, and may provide for aiding any such persons in paying for such shares by compensation for services rendered, promissory notes or otherwise. Any such stock purchase plan or agreement or stock option plan or agreement may include, among other features, the fixing of eligibility for participation therein, the class and price of shares to be issued or sold under the plan or agreement, the number of shares which may be subscribed for, the method of payment therefor, the reservation of title until full payment therefor, the effect of the termination of employment, an option or obligation on the part of the corporation to repurchase the shares upon termination of employment (subject to the provisions of Chapter 5 of the California General Corporation Law), restrictions upon transfer of the shares, the time limits of and termination of the plan, and any other matters, not in violation of applicable law, as may be included in the plan as approved or authorized by the Board or any committee of the Board. Section 7. CONSTRUCTION AND DEFINITIONS. Unless the context otherwise requires, the general provisions, rules of construction and definitions contained in the General Provisions of the California Corporations Code and in the California General Corporation Law shall govern the construction of these Bylaws. Section 8. AMENDMENTS. These Bylaws may be amended or repealed either by approval of the outstanding shares (as defined in Section 152 of the California General Corporation Law) or by the approval of the Board; provided, however, that after the issuance of shares, a bylaw specifying or changing a fixed number of directors or the maximum or minimum number or changing from a fixed to a variable number of directors or vice versa may be adopted only by approval of the outstanding -19- shares, and a bylaw reducing the fixed number or the minimum number of directors to a number less than five shall be subject to the provisions of Section 212 (a) of the California General Corporation Law. ARTICLE VI INDEMNIFICATION Section 1. DEFINITIONS. For the purposes of this Article, "agent" means any person who is or was a director, officer, employee or other agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or was a director, officer, employee or agent of a foreign or domestic corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation; "proceeding" means any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative; and "expenses" includes without limitation attorneys fees and any expenses of establishing a right to indemnification under Sections 4 or 5 (d) of this Article. Section 2. INDEMNIFICATION IN ACTIONS BY THIRD PARTIES. The corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any proceeding (other than an action by or in the right of the corporation to procure a judgment in its favor) by reason of the fact that such person is or was an agent of the corporation, against expenses, judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with such proceeding if such person acted in good faith and in a manner such person reasonably believed to be in the best interests of the corporation and, in the case of a criminal proceeding, had no reasonable cause to believe the conduct of such person was unlawful. The termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in the best interests of the corporation or that the person had reasonable cause to believe that the person's conduct was unlawful. Section 3. INDEMNIFICATION IN ACTIONS BY OR IN THE RIGHT OF THE CORPORATION. The corporation shall have the power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person is or was an agent of the corporation, against expenses actually and reasonably incurred by such person in connection with the defense or settlement of such action if such person acted in good faith, in a manner such person believed to be in the best interests of the corporation and its shareholders. No indemnification shall be made under this Section 3: (a) In respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation in the performance of such person's duty -20- to the corporation and its shareholders, unless and only to the extent that the court in which such proceeding is or was pending shall determine upon application that, in view of all the circumstance of the case, such person is fairly and reasonably entitled to indemnity for the expenses which such court shall determine; (b) Of amounts paid in settling or otherwise disposing of a pending action, without court approval; or (c) Of expenses incurred in defending a pending action which is settled or otherwise disposed of without court approval. Section 4. INDEMNIFICATION AGAINST EXPENSES. To the extent that an agent of the corporation has been successful on the merits in defense of any proceeding referred to in Sections 2 or 3 of this Article or in defense of any claim, issue or matter therein, the agent shall be indemnified against expenses actually and reasonably incurred by the agent in connection therewith. Section 5. REQUIRED DETERMINATIONS. Except as provided in Section 4 of this Article, any indemnification under this Article shall be made by the corporation only if authorized in the specific case, upon a determination that indemnification of the agent is proper in the circumstances because the agent has met the applicable standard of conduct set forth in Sections 2 or 3 of this Article, by: (a) A majority vote of a quorum consisting of directors who are not parties to such proceeding; (b) If such a quorum of directors is not obtainable, by independent legal counsel in a written opinion; (c) Approval of the shareholders, with the shares owned by the person to be indemnified not being entitled to vote thereon; or (d) The court in which such proceeding is or was pending upon application made by the corporation or the agent or the attorney or other person rendering services in connection with the defense, whether or not such application by the agent, attorney or other person is opposed by the corporation. Section 6. ADVANCE OF EXPENSES. Expenses incurred in defending any proceeding may be advanced by the corporation prior to the final disposition of such proceeding upon receipt of an undertaking by or on behalf of the agent to repay such amount if it shall be determined ultimately that the agent is not entitled to be indemnified as authorized in this Article. -21- Section 7. OTHER INDEMNIFICATION. No provision made by the corporation to indemnify its or its subsidiary's directors or officers for the defense of any proceeding, whether contained in the Articles of Incorporation, Bylaws, a resolution of shareholders or directors, an agreement or otherwise, shall be valid unless consistent with this Article. Nothing contained in this Article shall affect any right to indemnification to which persons other than such directors and officers may be entitled by contract or otherwise. Section 8. FORMS OF INDEMNIFICATION NOT PERMITTED. No indemnification or advance shall be made under this Article, except as provided in Sections 4 or 5 (d), in any circumstance where it appears: (a) That it would be inconsistent with a provision of the Articles of Incorporation, these Bylaws, a resolution of the shareholders or an agreement in effect at the time of the accrual of the alleged cause of action asserted in the proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or (b) That it would be inconsistent with any condition expressly imposed by a court in approving a settlement. Section 9. INSURANCE. The corporation shall have power to purchase and maintain insurance on behalf of any agent of the corporation against any liability asserted against or incurred by the agent in such capacity or arising out of the agent's status as such whether or not the corporation would have the power to indemnify the agent against such liability under the provisions of this Article. Section 10. NONAPPLICABILITY TO FIDUCIARIES OF EMPLOYEE BENEFIT PLANS. This Article does not apply to any proceeding against any trustee, investment manager or other fiduciary of an employee benefit plan in such person's capacity as such, even though such person may also be an agent of the corporation as defined in Section 1 of this Article. The corporation shall have power to indemnify such trustee, investment manager or other fiduciary to the extent permitted by subdivision (f) of Section 207 of the California General Corporation Law. Section 11. INDEMNIFICATION MANDATORY. The corporation shall indemnify each director, officer, employee or agent of the corporation to the fullest extent that the corporation has power to indemnify such persons under applicable provisions of California law and the Articles of Incorporation of the corporation with respect to any matter which might be subject to indemnification under this Article VI. Any repeal or modification of the provisions of this Article VI shall not adversely affect any rights or -22- protections of any director, officer, employee or agent of the corporation existing at the time of such repeal or modification. -23- EXHIBIT A Quality Systems, Inc. Corporate Governance Provisions (as made part of Bylaws) 1. At least a majority of the members of the board of directors (the "Board") shall be independent directors as defined below. An "independent director" means a person other than an officer or employee of the Company or its subsidiaries or any other individual having a relationship, which, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The following persons shall not be considered independent: (a) a director who is, or at any time during the past three years was, employed by the Company or by any parent or subsidiary of the Company; (b) a director who accepted or who has a family member (as defined below) who accepted any payments from the Company or any parent or subsidiary of the Company in excess of $60,000 during the current or any of the past three fiscal years, other than the following: (i) compensation for Board or Board committee service; (ii) payments arising solely from investments in the Company's securities; (iii) compensation paid to a family member who is a non-executive employee of the Company or a parent or subsidiary of the Company; (iv) benefits under a tax-qualified retirement plan, or non-discretionary compensation; or (v) loans permitted under Section 13(k) of the Exchange Act of 1934; (c) a director who is a family member of an individual who is or at any time during the past three years was, employed by the Company or by any parent or subsidiary of the Company as an executive officer; (d) a director who is, or has a family member who is, a partner in, or a controlling shareholder or an executive officer of, any organization to which the Company made, or from which the Company received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient's consolidated gross revenues for that year, or $200,000, whichever is more, other than the following: (i) payments arising solely from investments in the Company's securities; or (ii) payments under non-discretionary charitable contribution matching programs; (e) a director of the Company who is, or has a family member who is, employed as an executive officer of another entity where at any time during the past three years any of the officers of the Company serve on the compensation committee of such other entity; or -24- (f) a director who is, or has a family member who is, a current partner of the Company's outside auditor, or was a partner or employee of the Company's outside auditor who worked on the Company's audit at any time during any of the past three years. A "family member" for these purposes means a person's spouse, parents, children and siblings, whether by blood, marriage or adoption, or anyone residing in such person's home. 2. There shall be an Audit committee of the Board, composed entirely of independent directors, which shall oversee the Company's financial reporting process and internal controls, review compliance with laws and accounting standards, recommend the appointment of public accountants, and provide a direct channel of communication to the Board for public accountants, internal auditors and finance officers. 3. There shall be a Nominating Committee of the Board, composed entirely of independent directors, which shall be responsible for the evaluation and nomination of Board members. 4. There shall be a Compensation Committee of the Board, composed entirely of independent directors, which shall be responsible for (i) ensuring that senior management will be accountable to the Board through the effective application of compensation policies, and (ii) monitoring the effectiveness of both senior management and the Board (including committees thereof). The Compensation Committee shall establish compensation policies applicable to the Company's executive officers. A fair summary of such policies and the relationship of corporate performance to executive compensation, including the factors and criteria upon which the Chief Executive Officer's compensation was based, shall be disclosed to shareholders in the Company's proxy statement for the annual meeting. 5. There shall be a Transaction Committee of the Board, composed entirely of independent directors, which shall be responsible for reviewing all related-party transactions involving the Company, and considering and making recommendations to the full Board with respect to all proposals involving (i) a change in control, or (ii) the purchase or sale of assets constituting more than 10% of the Company's total assets. Additionally, the Transaction Committee shall be responsible for reviewing all transactions or proposed transactions that trigger the Company's Shareholder Rights Plan, if any. 6. If at any time the Chairman of the Board shall be an executive officer of the Company, or for any other reason shall not be an independent director, a non-executive Lead Director shall be selected by the independent directors. The Lead Director shall be one of the independent directors, shall be a member of the Audit Committee and of the Executive Committee, if there is such a committee, and shall be responsible for coordinating the activities of the independent directors. He shall assist the Board in assuring compliance with these corporate governance procedures and policies, and shall coordinate, develop the agenda for, and moderate executive sessions of the Board's independent directors. Such executive sessions shall be held immediately following each regular meeting of the -25- Board, and may be held at other times as designated by the Lead Director. The Lead Director shall approve, in consultation with the other Independent Directors, the retention of consultants who report directly to the Board. If at any time the Chairman of the Board is one of the independent directors, then he or she shall perform the duties of the Lead Director. 7. The foregoing provisions are adopted as part of the Bylaws of the Company and cannot be amended or repealed without either (a) approval by the shareholders of the Company, or (b) approval by a two-thirds majority of all the authorized number of directors of the Company including two-thirds of the independent directors, and cannot be amended or repealed prior to the 1999 Annual Meeting of the Company. Any inconsistent provisions of the Bylaws are hereby modified to be consistent with these provisions. The foregoing provisions, insofar as they establish eligibility to serve as a director or as a committee member, shall not have the effect of removing any director or committee member from office but shall be given effect at the next election of directors and the next selection of committee members, as the case may be, in calendar year 1999 and thereafter. The foregoing provisions shall not be construed to limit or restrict the effective exercise of statutory cumulative voting rights by any shareholder, but the Nominating Committee shall not nominate candidates for election to the Board except as may be consistent with such provisions, and no corporate funds may be expended for the solicitation of proxies which are inconsistent with the foregoing provisions. -26- EX-10.6.1 4 d64225_ex10-6.txt FORM OF INDEMNIFICATION AGREEMENT Exhibit 10.6.1 QUALITY SYSTEMS, INC. INDEMNIFICATION AGREEMENT This Indemnification Agreement (this "Agreement") is made as of _____________, by and between QUALITY SYSTEMS, INC., a California corporation (the "Company"), and ____________ ("Indemnitee"). RECITALS WHEREAS, the Company and Indemnitee recognize the increasing difficulty in obtaining quality directors' and officers' liability insurance, the significant increases in the cost of such insurance and the general reductions in the coverage of such insurance; WHEREAS, the Company and Indemnitee further recognize the substantial increase in corporate litigation in general, subjecting officers and directors to expensive litigation risks at the same time as the availability and coverage of cost effective liability insurance has been severely limited; and WHEREAS, the Company desires to attract and retain the services of highly qualified individuals, such as Indemnitee, to serve as officers and directors of the Company and to indemnify its officers and directors so as to provide them with the maximum protection permitted by law. NOW, THEREFORE, in consideration for Indemnitee's services as an officer or director of the Company (as the case may be), the Company and Indemnitee hereby agree as follows: 1. Indemnification. (a) Third Party Proceedings. The Company shall indemnify Indemnitee if Indemnitee is or was a party or is threatened to be made a party to any threatened, pending or completed action, suit, proceeding or any alternative dispute resolution mechanism, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Company) by reason of the fact that Indemnitee is or was a director, officer, employee or agent of the Company, or any subsidiary of the Company, or by reason of the fact that Indemnitee is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including reasonable attorneys' fees and costs), judgments, fines and amounts paid in settlement (if such settlement is approved in advance by the Company, which approval shall not be unreasonably withheld) actually and reasonably incurred by Indemnitee in connection with such action, suit or proceeding if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe Indemnitee's conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that Indemnitee did not act in good faith and in a manner which Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had reasonable cause to believe that Indemnitee's conduct was unlawful. (b) Proceedings By or in the Right of the Company. The Company shall indemnify Indemnitee if Indemnitee is or was a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Company or any subsidiary of the Company to procure a judgment in its favor by reason of the fact that Indemnitee is or was a director, officer, employee or agent of the Company, or any subsidiary of the Company, or by reason of the fact that Indemnitee is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including reasonable attorneys' fees and costs) and, to the fullest extent permitted by law, amounts paid in settlement actually and reasonably incurred by Indemnitee in connection with the defense or settlement of such action or suit if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, except that no indemnification shall be made in respect of any claim, issue or matter as to which Indemnitee shall have been adjudged to be liable to the Company unless and only to the extent that the Superior Court of the State of California or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnity for such expenses which the Superior Court of the State of California or such other court shall deem proper. (c) Mandatory Payment of Expenses. To the extent that Indemnitee has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this Section 1, or in defense of any claim, issue or matter therein, Indemnitee shall be indemnified against expenses (including reasonable attorneys' fees and costs) actually and reasonably incurred by Indemnitee in connection therewith. 2. Agreement to Serve. In consideration of the protection afforded by this Agreement, if Indemnitee is a director of the Company he agrees to serve at least for the 90 days after the effective date of this Agreement as a director and not to resign voluntarily during such period without the written consent of a majority of the Board of Directors. If Indemnitee is an officer of the Company not serving under an employment contract, he agrees to serve in such capacity at least for the 90 days after the effective date of this Agreement and not to resign voluntarily during such period without the written consent of a majority of the Board of Directors. Following the applicable period set forth above, Indemnitee agrees to continue to serve in such capacity at the will of the Company (or under separate agreement, if such agreement exists) so long as he is duly appointed or elected and qualified in accordance with the applicable provisions of the Bylaws of the Company or any subsidiary of the Company or until such time as he tenders his resignation in writing. Nothing contained in this Agreement is intended to create in Indemnitee any right to continued employment. 3. Expenses; Indemnification Procedure. (a) Advancement of Expenses. The Company shall advance all expenses incurred by Indemnitee in connection with the investigation, defense, settlement or appeal of any civil or criminal action, suit or proceeding referenced in Section 1(a) or (b) hereof (but not - 2 - amounts actually paid in settlement of any such action, suit or proceeding). Indemnitee hereby undertakes to repay such amounts advanced only if, and to the extent that, it shall ultimately be determined that Indemnitee is not entitled to be indemnified by the Company as authorized hereby. The advances to be made hereunder shall be paid by the Company to Indemnitee within thirty (30) days following delivery of a written request therefor by Indemnitee to the Company. (b) Notice/Cooperation by Indemnitee. Indemnitee shall, as a condition precedent to his or her right to be indemnified under this Agreement, give the Company written notice as soon as practicable of any claim for which Indemnitee will or could seek indemnification under this Agreement. In addition, Indemnitee shall give the Company such information and cooperation as it may reasonably require and as shall be within Indemnitee's power. (c) Procedure. Any indemnification and advances provided for in Section 1 and this Section 3 shall be made no later than thirty (30) days after receipt of the written request of Indemnitee. If a claim under this Agreement, under any statute, or under any provision of the Company's Articles of Incorporation or Bylaws providing for indemnification, is not paid in full by the Company within thirty (30) days after a written request for payment thereof has first been received by the Company, Indemnitee may, but need not, at any time thereafter bring an action against the Company to recover the unpaid amount of the claim and, subject to Section 8 and 10(g) of this Agreement, Indemnitee shall also be entitled to be paid for the expenses (including reasonable attorneys' fees and costs) of bringing such action. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in connection with any action, suit or proceeding in advance of its final disposition) that Indemnitee has not met the standards of conduct which make it permissible under applicable law for the Company to indemnify Indemnitee for the amount claimed. However, Indemnitee shall be entitled to receive interim payments of expenses pursuant to Section 3(a) unless and until such defense may be finally adjudicated by court order or judgment from which no further right of appeal exists. It is the parties' intention that if the Company contests Indemnitee's right to indemnification, the question of Indemnitee's right to indemnification shall be for a court of competent jurisdiction to decide, and neither the failure of the Company (including its Board of Directors, any committee or subgroup of the Board of Directors, independent legal counsel, or its stockholders) to have made a determination that indemnification of Indemnitee is proper in the circumstances because Indemnitee has met the applicable standard of conduct required by applicable law, nor an actual determination by the Company (including it Board of Directors, any committee or subgroup of the Board of Directors, independent legal counsel, or its stockholders) that Indemnitee has not met such applicable standard of conduct, shall create a presumption that Indemnitee has or has not met the applicable standard of conduct. (d) Notice to Insurers. If, at the time of the receipt of a notice of a claim pursuant to Section 3(b) hereof, the Company has director and officer liability insurance in effect, the Company shall give prompt notice of the commencement of such proceeding to the insurers in accordance with the procedures set forth in the respective policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts payable as a result of such proceeding in accordance with the terms of such policies. - 3 - (e) Selection of Counsel. In the event the Company shall be obligated under Section 3(a) hereof to pay the expenses of any proceeding against Indemnitee, the Company, if appropriate, shall be entitled to assume the defense of such proceeding, with counsel approved by Indemnitee (which approval shall not be unreasonably withheld), upon the delivery to Indemnitee of written notice of its election to do so. After delivery of such notice, approval of such counsel by Indemnitee and the retention of such counsel by the Company, the Company will not be liable to Indemnitee under this Agreement for any fees of counsel subsequently incurred by Indemnitee with respect to the same proceeding, provided that (i) Indemnitee shall have the right to employ his counsel in any such proceeding at Indemnitee's expense; and (ii) if (A) the employment of counsel by Indemnitee has been previously authorized by the Company, (B) Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Company and Indemnitee in the conduct of any such defense, or (C) the Company shall not, in fact, have employed counsel to assume the defense of such proceeding, then the fees and expenses of Indemnitee's counsel shall be at the expense of the Company. 4. Additional Indemnification Rights; Nonexclusivity. (a) Scope. Notwithstanding any other provision of this Agreement, the Company hereby agrees to indemnify the Indemnitee to the fullest extent permitted by the California General Corporation Law (the "CGCL"), notwithstanding that such indemnification is not specifically authorized by the other provisions of this Agreement, the Company's Articles of Incorporation, the Company's Bylaws or by statute. In the event of any change, after the date of this Agreement, in any applicable law, statute, or rule which expands the right of a California corporation to indemnify a member of its board of directors or an officer, such changes shall be, ipso facto, within the purview of Indemnitee's rights and Company's obligations, under this Agreement. In the event of any change in any applicable law, statute or rule which narrows the right of a California corporation to indemnify a member of its board of directors or an officer, such changes, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement shall have no effect on this Agreement or the parties' rights and obligations hereunder. (b) Nonexclusivity. The indemnification provided by this Agreement shall not be deemed exclusive of any rights to which Indemnitee may be entitled under the Company's Articles of Incorporation, its Bylaws, any agreement, any vote of stockholders or disinterested Directors, the CGCL, or otherwise, both as to action in Indemnitee's official capacity and as to action in another capacity while holding such office. The indemnification provided under this Agreement shall continue as to Indemnitee for any action taken or not taken while serving in an indemnified capacity even though he may have ceased to serve in such capacity at the time of any action, suit or other covered proceeding. 5. Partial Indemnification. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of the expenses, judgments, fines or penalties actually and reasonably incurred by him in the investigation, defense, appeal or settlement of any civil or criminal action, suit or proceeding, but not, however, for the total amount thereof, the Company shall nevertheless indemnify Indemnitee for the portion of such expenses, judgments, fines or penalties to which Indemnitee is entitled. - 4 - 6. Mutual Acknowledgement. Both the Company and Indemnitee acknowledge that in certain instances, Federal law or applicable public policy may prohibit the Company from indemnifying its directors and officers under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee. 7. Officer and Director Liability Insurance. The Company shall, from time to time, make the good faith determination whether or not it is practicable for the Company to obtain and maintain a policy or policies of insurance with reputable insurance companies providing the officers and directors of the Company with coverage for losses from wrongful acts, or to ensure the Company's performance of its indemnification obligations under this Agreement. Among other considerations, the Company will weigh the costs of obtaining such insurance coverage against the protection afforded by such coverage. In all policies of director and officer liability insurance, Indemnitee shall be named as an insured in such a manner as to provide Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Company's directors, if Indemnitee is a director; or of the Company's officers, if Indemnitee is not a director of the Company but is an officer. Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain such insurance if the Company determines in good faith that such insurance is not reasonably available, if the premium costs for such insurance are disproportionate to the amount of coverage provided, if the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or if Indemnitee is covered by similar insurance maintained by a subsidiary or parent of the Company. 8. Exceptions. Any other provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement: (a) Claims Initiated by Indemnitee. To indemnify or advance expenses to Indemnitee with respect to proceedings or claims initiated or brought voluntarily by Indemnitee and not by way of defense, except with respect to proceedings brought to establish or enforce a right to indemnification under this Agreement or any other statute or law or otherwise as required under Section 145 of the CGCL, but such indemnification or advancement of expenses may be provided by the Company in specific cases if the Board of Directors has approved the initiation or bringing of such suit; or (b) Lack of Good Faith. To indemnify Indemnitee for any expenses incurred by the Indemnitee with respect to any proceeding instituted by Indemnitee to enforce or interpret this Agreement, if a court of competent jurisdiction determines that each of the material assertions made by the Indemnitee in such proceeding was not made in good faith or was frivolous; or (c) Insured Claims. To indemnify Indemnitee for expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes or penalties, and amounts paid in settlement) which have been paid directly to Indemnitee by an insurance carrier under a policy of officers' and directors' liability insurance maintained by the Company; or - 5 - (d) Claims Under Section 16(b). To indemnify Indemnitee for expenses and the payment of profits arising from the purchase and sale by Indemnitee of securities in violation of Section 16(b) of the Securities Exchange Act of 1934, as amended, or any similar successor statute. 9. Construction of Certain Phrases. (a) For purposes of this Agreement, references to the "Company" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that if Indemnitee is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, Indemnitee shall stand in the same position under the provisions of this Agreement with respect to the resulting or surviving corporation as Indemnitee would have with respect to such constituent corporation if its separate existence had continued. (b) For purposes of this Agreement, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on Indemnitee with respect to an employee benefit plan; and references to "serving at the request of the Company" shall include any service as a director, officer, employee or agent of the Company which imposes duties on, or involves services by, such director, officer, employee or agent with respect to an employee benefit plan, its participants, or beneficiaries; and if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan, Indemnitee shall be deemed to have acted in a manner "not opposed to the best interests of the Company" as referred to in this Agreement. 10. Miscellaneous. (a) Choice of Law. This Agreement shall be governed by and its provisions construed in accordance with the laws of the State of California , as applied to contracts between California residents entered into and to be performed entirely within California without regard to the conflict of law principles thereof. (b) Consent to Jurisdiction. The Company and Indemnitee each hereby irrevocably consent to the jurisdiction of the courts of the State of California for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be brought only in the state courts of the State of California . (c) Amendment and Termination. No amendment, modification, termination or cancellation of this Agreement shall be effective unless it is in writing signed by both the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. - 6 - (d) Entire Agreement. This Agreement sets forth the entire understanding between the parties hereto and supersedes and merges all previous written and oral negotiations, commitments, understandings and agreements relating to the subject matter hereof between the parties hereto. (e) Successors and Assigns. This Agreement shall be binding upon the Company and its successors and assigns, and shall inure to the benefit of Indemnitee and Indemnitee's estate, heirs and legal representatives. (f) Severability. Nothing in this Agreement is intended to require or shall be construed as requiring the Company to do or fail to do any act in violation of applicable law. The Company's inability, pursuant to court order, to perform its obligations under this Agreement shall not constitute a breach of this Agreement. If this Agreement or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify Indemnitee to the full extent permitted by any applicable portion of this Agreement that shall not have been invalidated, and the balance of this Agreement not so invalidated shall be enforceable in accordance with its terms. (g) Attorneys' Fees. In the event that any action is instituted by Indemnitee under this Agreement to enforce or interpret any of the terms hereof, Indemnitee shall be entitled to be paid all court costs and expenses, including reasonable attorneys' fees, incurred by Indemnitee with respect to such action, unless as a part of such action, the court of competent jurisdiction determines that each of the material assertions made by Indemnitee as a basis for such action were not made in good faith or were frivolous. In the event of an action instituted by or in the name of the Company under this Agreement or to enforce or interpret any of the terms of this Agreement, Indemnitee shall be entitled to be paid all court costs and expenses, including reasonable attorneys' fees, incurred by Indemnitee in defense of such action (including with respect to Indemnitee's counterclaims and cross-claims made in such action), unless as a part of such action the court determines that each of Indemnitee's material defenses to such action were made in bad faith or were frivolous. (h) Notice. All notices, requests, demands and other communications required or permitted under this Agreement shall be in writing and shall be delivered personally by hand or by courier, mailed by United States first-class mail, postage prepaid, sent by facsimile or sent by electronic mail directed to the party to be notified at the address, facsimile number or electronic mail address indicated for such person on the signature page hereof, or at such other address, facsimile number or electronic mail address as such party may designate by ten (10) days' advance written notice to the other parties hereto. All such notices and other communications shall be deemed given upon personal delivery, on the date of mailing, upon confirmation of facsimile transfer or when directed to the electronic mail address set forth on signature page hereof. (i) Period of Limitations. No legal action shall be brought and no cause of action shall be asserted by or in the right of the Company against Indemnitee, Indemnitee's estate, spouse, heirs, executors or personal or legal representatives after the expiration of two years from the date of accrual of such cause of action, and any claim or cause of action of the Company shall be extinguished and deemed released unless asserted by the timely filing of a - 7 - legal action within such two-year period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action, such shorter period shall govern. (j) Subrogation. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company effectively to bring suit to enforce such rights. (k) Counterparts. This Agreement may be executed in one or more counterparts, each of which shall constitute an original. - 8 - IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. QUALITY SYSTEMS, INC. By:________________________________________ Its:_______________________________________ Address: 18191 Von Karman Avenue, Suite 450 Irvine, CA 92612 Facsimile #: 949-255-2610 Email: pholt@qsii.com (Corporate Secretary) AGREED TO AND ACCEPTED: "Indemnitee" _____________________________________ Signature _____________________________________ Print Name Address: _____________________________________ _____________________________________ _____________________________________ Facsimile #:_________________________ Email:_______________________________ - 9 - EX-10.10.1 5 d64225_ex10-10.txt AMENDED & RESTATED 1998 STOCK OPTION PLAN Exhibit 10.10.1 QUALITY SYSTEMS, INC. AMENDED AND RESTATED 1998 STOCK OPTION PLAN NOTICE: QUALIFIED OPTIONS UNDER THIS PLAN BEAR RESTRICTIONS GOVERNED BY SECTION 422 OF THE INTERNAL REVENUE CODE. PLAN PARTICIPANTS ARE URGED TO READ SECTION 422 AND TO UNDERSTAND THE RESTRICTIONS CONTAINED THEREIN. NOT ALL SECTION 422 RESTRICTIONS ARE REFERENCED IN THIS PLAN. OPTIONS GRANTED HEREUNDER MAY BEAR RESTRICTIONS IMPOSED BY FEDERAL AND STATE SECURITIES LAWS. PLAN PARTICIPANTS ARE URGED TO CONSULT WITH THEIR TAX AND LEGAL ADVISORS CONCERNING THE NATURE AND RESTRICTIONS UPON THE OPTIONS GOVERNED HEREBY. 1. Purposes. (a) The purpose of the Plan is to provide a means by which selected Employees, Directors and Consultants of the Company and its Affiliates, may be given an opportunity to benefit from increases in value of the stock of the Company through the granting of Incentive Stock Options and Nonstatutory Stock Options, as defined below. (b) The Company, by means of the Plan, seeks to retain the services of persons who are now Employees, Directors or Consultants of the Company or its Affiliates, to secure and retain the services of new Employees, Directors and Consultants, and to provide incentives for such persons to exert maximum efforts for the success of the Company and its Affiliates. (c) The Company intends that the Options issued under the Plan shall, in the discretion of the Board or any Committee to which responsibility for administration of the Plan has been delegated pursuant to Section 3(c), be either Incentive Stock Options or Nonstatutory Stock Options. All Options shall be separately designated Incentive Stock Options or Nonstatutory Stock Options at the time of grant, and in such form as issued pursuant to Section 6, and a certificate or certificates will be issued for shares purchased on exercise of such Options. 2. Definitions. (a) "Affiliate" means any parent corporation or subsidiary corporation, whether now or hereafter existing, as those terms are defined in Sections 424(e) and (f) respectively, of the Code. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means a Committee appointed by the Board in accordance with Section 3(c) of the Plan. (e) "Company" means Quality Systems, Inc., a California corporation. (f) "Consultant" means any person, including an advisor, engaged by the Company or an Affiliate to render consulting or advisory services and who is compensated for such services, provided that the term "Consultant" shall not include Directors who are paid only a director's fee by the Company or who are not compensated by the Company for their services as Directors. (g) "Continuous Status as an Employee, Director or Consultant" means the employment or relationship as a Director or Consultant is not interrupted or terminated. The Board, in its sole discretion, may determine whether Continuous Status as an Employee, Director or Consultant shall be considered interrupted in the case of: (i) any leave of absence approved by the Board, including sick leave, military leave or any other personal leave; provided, however, that for purposes of Incentive Stock Options, any such leave may not exceed three (3) months, unless reemployment upon the expiration of such leave is guaranteed by contract, Company policies or statute; or (ii) transfers between locations of the Company or between the Company, Affiliates or their successors. (h) "Director" means a member of the Board. (i) "Employee" means any person, including Officers and Directors, employed by the Company or any Affiliate of the Company. Neither service as a Director nor payment of a director's fee by the Company shall be sufficient to constitute "employment" by the Company. (j) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (k) "Fair Market Value" means, as of any date, the value of the Common Stock of the Company determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System, the Fair Market Value of a share of Common Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such system or exchange on the day the Option is granted, as reported in the Wall Street Journal or such other source as the Board deems reliable; (ii) If the Common Stock is quoted on the NASDAQ System (but not on the National Market System thereof) or is regularly quoted by a recognized securities dealer but selling prices are not reported, the Fair Market Value of a share of Common Stock shall be the mean between the closing bid and asked prices for the Common Stock on the day the Option is granted, as reported in the Wall Street Journal or such other source as the Board deems reliable; -2- (iii) In the absence of an established market for the Common Stock, the Fair Market Value shall be determined in good faith by the Board. (l) "Incentive Stock Option" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder. (m) "Non-Employee Director" shall mean a Director who: (i) Is not currently an officer (as defined in Rule 16a-1(f) of the Exchange Act) of the Company or a parent or subsidiary of the Company, or otherwise currently employed by the Company or a parent or subsidiary of the Company; (ii) Does not receive compensation, either directly or indirectly, from the Company or a parent or subsidiary of the Company, for services rendered as a consultant or in any capacity other than as a Director, except for an amount that does not exceed the dollar amount for which disclosure would be required pursuant to Rule 404(a) of the Exchange Act; (iii) Does not possess an interest in any other transaction for which disclosure would be required pursuant to Rule 404(a) of the Exchange Act; and (iv) Is not engaged in a business relationship for which disclosure would be required pursuant to Rule 404(b) of the Exchange Act. (n) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (o) "Officer" means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. (p) "Option" means a stock option granted pursuant to the Plan. (q) "Option Agreement" means a written agreement between the Company and an Optionee evidencing the terms and conditions of an individual Option grant. Each Option Agreement shall be subject to the terms and conditions of the Plan. (r) "Optionee" means an Employee, Director or Consultant who holds an outstanding Option. (s) "Participant" means an Employee, Director or Consultant who is granted Options. (t) "Plan" means this 1998 Stock Option Plan. (u) "Rule 16b-3" means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan. (v) "Securities Act" means the Securities Act of 1933, as amended. -3- 3. Administration. (a) The Plan shall be administered by the Board unless and until the Board delegates administration to a Committee, as provided in Section 3(c). (b) The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan: (i) To determine from time to time which of the persons eligible under the Plan shall be granted Options; when and how Options shall be granted; whether an Option will be an Incentive Stock Option or a Nonstatutory Stock Option, the provisions of each Option granted (which need not be identical), including the vesting schedule for the Options, and the number of shares underlying such Options to be granted to each such person; (ii) To construe and interpret the Plan and Options granted under it, and to establish amend and revoke rules and regulations for its administration. The Board, in the exercise of this power, may correct any defect, omission or inconsistency in the Plan or in any Option Agreement, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective; (iii) To amend the Plan as provided in Section 12; and (iv) Generally, to exercise such powers and to perform such acts as the Board deems necessary or advisable to promote the best interests of the Company. (c) The Board may delegate administration of the Plan to a committee composed of not fewer than two (2) members of the Board (the "Committee"), all of the members of which Committee shall be Non-Employee Directors. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board (and references in this Plan to the Board shall thereafter be to the Committee), subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. 4. Shares Subject to the Plan. Subject to the provisions of Section 11 relating to adjustments upon changes in stock, the stock that may be issued pursuant to Options shall not exceed in the aggregate One Million (1,000,000) shares of the Company's Common Stock. If any Option shall for any reason expire or otherwise terminates, in whole or in part, without having been exercised in full, the stock not acquired under such Option shall revert to and again become available for issuance under the Plan. 5. Eligibility. (a) Incentive Stock Options may be granted only to Employees. Nonstatutory Stock Options may be granted only to Employees, Directors or Consultants. -4- (b) A Director shall be eligible for the benefits of the Plan provided that such Director's participation conforms to the requirements of Rule 16b-3, if applicable. (c) No person shall be eligible for the grant of an Incentive Stock Option if, at the time of grant, such person owns (or is deemed to own pursuant to Section 424(d) of the Code) stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or of any of its Affiliates unless the exercise price of such Incentive Stock Option is at least one hundred ten percent (110%) of the Fair Market Value of such stock at the date of grant. 6. Option Provisions. Each Option shall be in such form and shall contain such terms and conditions as the Board shall deem appropriate. The provisions of separate Options need not be identical, but each Option shall include (through incorporation of provisions hereof by reference in the Option or otherwise) the substance of each of the following provisions: (a) Term. No Option shall be exercisable after the expiration of ten (10) years from the date it was granted. In addition, any option granted to a person who owns (or is deemed to own pursuant to Section 424(d) of the Code) stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or of any Affiliate may not be made exercisable after the expiration of five (5) years from the date the Option is granted. (b) Price. The exercise price of each Incentive Stock Option shall be not less than one hundred percent (100%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted. Notwithstanding the foregoing, the exercise price of any Incentive Stock Option granted hereunder to any stockholder possessing at least 10% of the total combined voting power of all classes of stock of the Company shall be not less than one hundred ten percent (110%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted. (c) Consideration. The purchase price of stock acquired pursuant to an Option shall be paid, to the extent permitted by applicable statutes and regulations, either (i) in cash at the time the Option is exercised, (ii) at the discretion of the Board or the Committee, either at the time of the grant or exercise of the Option, by delivering to the Company other shares of Common Stock of the Company (provided that the shares have been held for the period required to avoid a charge to the Company's reported earnings), (iii) at the discretion of the Board or the Committee, either at the time of the grant or exercise of the Option, by delivering to the Company all or any part of an Option granted under this Plan for a cashless exercise (provided that such cashless exchange will not result in a charge to the Company's reported earnings), or (iv) by tendering any other form of legal consideration that may be acceptable to the Board. (d) Transferability. An Incentive Stock Option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during the lifetime of the person to whom the Incentive Stock Option is granted only by such person. A Nonstatutory Stock Option granted to an Optionee subject to Section 16 of the Exchange Act on the date of grant shall not be transferable except by will or by the laws of descent and distribution, and shall -5- be exercisable during the lifetime of the person to whom the Option is granted only by such person. A Nonstatutory Stock Option granted to an Optionee who is not subject to Section 16 of the Exchange Act on the date of grant may not be transferable except by will or by the laws of descent and distribution, unless otherwise permitted by the Board, and shall be exercisable during the lifetime of the person to whom the Option is granted only by such person or, subsequent to any permitted transfer, only by a permitted transferee. The person to whom the Option is granted may, by delivering written notice to the Company, in a form satisfactory to the Company, designate a third party who, in the event of the death of the Optionee or in the case of a permitted transfer of a Nonstatutory Stock Option during the Optionee's lifetime, shall thereafter be entitled to exercise the Option. (e) Vesting. The total number of shares of stock subject to an Option may, but need not, be allotted in periodic installments (which may, but need not, be equal). The Option Agreement may provide that from time to time during each of such installment periods, the Option may become exercisable ("vest") with respect to some or all of the shares allotted to that period, and may be exercised with respect to some or all of the shares allotted to such period and/or any prior period as to which the Option became vested but was not fully exercised. The Option may be subject to such other terms and conditions on the time or times when it may be exercised (which may be based on performance or other criteria) as the Board may deem appropriate. The provisions of this Section 6(e) are subject to any Option provisions governing the minimum number of shares as to which an Option may be exercised. (f) Termination of Employment or Relationship as a Director or Consultant Other than by Disability or Death. In the event that an Optionee's Continuous Status as an Employee, Director or Consultant is terminated either by the voluntary resignation by the Optionee or for cause by the Company, all Options granted to the Optionee shall terminate immediately. In the event an Optionee's Continuous Status as an Employee, Director or Consultant is terminated without cause by the Company, the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination) but only within such period of time ending on the earlier of (i) the date thirty (30) days after the termination of the Optionee's Continuous Status as an Employee, Director or Consultant (or such longer period specified in the Option Agreement), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, at the date of termination, the Optionee is not entitled to exercise his or her entire Option or the Option terminated as specified above, the shares covered by the unexercisable portion of the Option or terminated Option shall revert to and again become available for issuance under the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified in the Option Agreement, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. (g) Disability of Optionee. In the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates as a result of the Optionee's disability, the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination), but only within such period of time ending on the earlier of (i) the date three hundred sixty-five (365) days following such termination (or such longer period specified in the Option Agreement), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, at the date of termination, the Optionee is not entitled to exercise his -6- or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. (h) Death of Optionee. In the event of the death of an Optionee during, or within a period specified in the Option after the termination of, the Optionee's Continuous Status as an Employee, Director or Consultant, the Option may be exercised (to the extent the Optionee was entitled to exercise the Option at the date of death) by the Optionee's estate, by a person who acquired the right to exercise the Option by bequest or inheritance or by a person designated to exercise the option upon the Optionee's death pursuant to Section 6(d), but only within the period ending on the earlier of (i) the date three hundred sixty-five (365) days following the date of death (or such longer period specified in the Option Agreement), or (ii) the expiration of the term of such Option as set forth in the Option Agreement. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after death, the Option is not exercised within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. 7. Cancellation and Regrant of Option. The Board or the Committee shall have the authority to effect, at any time and from time to time, (i) the repricing of any outstanding Options under the Plan, and/or (ii) with the consent of the affected holders of Options, the cancellation of any outstanding Options under the Plan and the grant in substitution therefor of new Options under the Plan covering the same or different numbers of shares of stock, but having an exercise price per share not less than one hundred percent (100%) of the Fair Market Value in the case of an Incentive Stock Option or, in the case of a ten percent (10%) stockholder (as described in Section 5(c)) not less than one hundred ten percent (110%) of the Fair Market Value in the case of an Incentive Stock Option. 8. Covenants of the Company. (a) During the terms of the Options, the Company shall keep available at all times the number of shares of stock which would be issuable under such outstanding Options. (b) The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares of stock upon exercise of the Options; provided, however, that this undertaking shall not require the Company to register under the Securities Act either the Plan, any Options or any stock issued or issuable pursuant to any such Options. If, after reasonable efforts, the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability for failure to issue and sell stock upon exercise of such Options unless and until such authority is obtained. -7- 9. Use of Proceeds from Stock. Proceeds from the sale of Common Stock upon exercise of the Options shall constitute general funds of the Company. 10. Miscellaneous. (a) Neither an Optionee nor any person to whom an Option is transferred under Section 6(d) shall be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to such Option unless and until such person has satisfied all requirements for exercise of the Option pursuant to its terms. (b) Nothing in the Plan or any Option granted pursuant thereto shall confer upon any Employee, Director, Consultant or other holder of Options any right to continue in the employ of the Company or any Affiliate (or to continue acting as a Director or Consultant) or shall affect the right of the Company or any Affiliate to terminate the employment or relationship as a Director or Consultant of any Employee, Director, Consultant or other holder of Options with or without cause. (c) To the extent that the aggregate Fair Market Value (determined at the time of grant) of stock with respect to which Incentive Stock Options are granted are exercisable for the first time by an Optionee during any calendar year under all plans of the Company and its Affiliates exceeds One Hundred Thousand Dollars ($100,000), the Options or portions thereof which exceed such limit (according to the order in which they were granted) shall be treated as Nonstatutory Stock Options. (d) The Company may require any person to whom an Option is granted, or any person to whom an Option is transferred under Section 6(d), as a condition of exercising any Option, (1) to give written assurances satisfactory to the Company as to such person's knowledge and experience in financial and business matters and/or to employ a purchaser representative reasonably satisfactory to the Company who is knowledgeable and experienced in financial and business matters, and that he or she is capable of evaluating, alone or together with the purchaser representative, the merits and risks of exercising the Option; and (2) to give written assurances satisfactory to the Company stating that such person is acquiring the stock subject to the Option for such person's own account and not with any present intention of selling or otherwise distributing the stock. The foregoing requirements, and any assurances given pursuant to such requirements, shall be inoperative if (i) the issuance of the shares upon the exercise or acquisition of stock under the Option has been registered under a then currently effective registration statement under the Securities Act, or (ii) as to any particular requirement, a determination is made by counsel for the Company that such requirement need not be met in the circumstances under the then applicable securities laws. The Company may, upon advice of counsel to the Company, place legends on stock certificates issued under the Plan as such counsel deems necessary or appropriate in order to comply with applicable securities laws, including, but not limited to, legends restricting the transfer of the stock. (e) To the extent provided by the terms of an Option Agreement, the person to whom an Option is granted may, at the discretion of the Board, satisfy any mandatory federal, state or -8- local tax withholding obligation relating to the exercise or acquisition of stock under an Option by any of the following means or by a combination of such means: (1) tendering cash payment; (2) authorizing the Company to withhold shares from the shares of the Common Stock otherwise issuable to the Participant as a result of the exercise or acquisition of stock under the Option provided that such arrangement will not result in a charge to the Company's reported earnings; or (3) delivering to the Company owned and unencumbered shares of the Common Stock of the Company that have been held for the period required to avoid a charge to the Company's reported earnings. The exercise of the Option may be conditioned upon the receipt by the Company of satisfactory evidence of the Participant's satisfaction of any withholding obligations. 11. Adjustments Upon Changes in Stock. (a) Subject to any required action by stockholders, the number and type of (i) shares which have been authorized for issuance under this Plan but as to which Options have not yet been granted or that have been returned to the Plan upon cancellation or expiration of an Option, and (ii) shares which may be purchased upon the exercise of each outstanding Option, shall be appropriately changed and proportionately increased or decreased upon the occurrence of any change, increase or decrease in the number and type of issued shares of Common Stock of the Company, without receipt of consideration by the Company, which change results from a stock split, stock dividend, merger, consolidation, reorganization, reincorporation, recapitalization, combination of shares, change in corporate structure or other like capital adjustment. As a result of the foregoing adjustment, appropriate adjustment shall be made in the number and type of shares for which Options may be granted under this Plan and, upon the exercise of each then outstanding Option, the holders of such Options shall receive the number and type of securities which the holders would have received had the Options been exercised on the date preceding such change, increase or decrease. In the event of any such adjustment, the exercise price for each share shall be likewise adjusted in inverse proportion to the increase or decrease in the number of shares purchasable. (b) In the event of: (1) a dissolution, liquidation or sale of substantially all of the assets of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; or (3) a reverse merger in which the Company is the surviving corporation but the shares of the Company's Common Stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, then to the extent permitted by applicable law: (i) any surviving corporation shall assume any Options outstanding under the Plan or shall substitute similar Options for those outstanding under the Plan, or (ii) such Options shall continue in full force and effect. In the event any surviving corporation refuses to assume or continue such Options, or to substitute similar options for those outstanding under the Plan, then, with respect to Options held by persons then performing services as Employees, Directors or Consultants, the time during which such Options vest may, at the discretion of the Board, be accelerated and the Options terminated if not exercised prior to such event. -9- 12. Amendment of the Plan. (a) The Board at any time, and from time to time, may amend the Plan provided that the implementation of such amendment by the Company complies with all applicable law. (b) The Board may in its sole discretion submit any amendment to the Plan for stockholder approval, including, but not limited to, amendments to the Plan intended to satisfy the requirements of Section 162(m) of the Code and the regulations promulgated thereunder regarding the exclusion of performance-based compensation from the limit on corporate deductibility of compensation paid to certain executive officers. (c) It is expressly contemplated that the Board may amend the Plan in any respect the Board deems necessary or advisable to provide eligible Employees, Directors or Consultants with the maximum benefits provided or to be provided under the provisions of the Code and the regulations promulgated thereunder relating to Incentive Stock Options and/or to bring the Plan and/or Incentive Stock Options granted under it into compliance therewith. (d) Rights and obligations under any Option granted before amendment of the Plan shall not be altered or impaired by any amendment of the Plan unless (i) the Company requests the consent of the person to whom the Option was granted, and (ii) such person consents in writing. 13. Termination or Suspension of the Plan. (a) The Board may suspend or terminate the Plan at any time. Unless sooner terminated, the Plan shall terminate on December 31, 2007, which shall be within ten (10) years from the date the Plan is adopted by the Board or approved by the stockholders of the Company, whichever is earlier. No Options may be granted under the Plan while the Plan is suspended or after it is terminated. (b) Rights and obligations under any Option granted while the Plan is in effect shall not be altered or impaired by suspension or termination of the Plan, except with the consent of the person to whom the Option was granted. 14. Effective Date of Plan. The Plan shall become effective as determined by the Board, but no Options granted under the Plan shall be exercised unless and until the Plan has been approved by the stockholders of the Company, which approval shall be within twelve (12) months before or after the date the Plan is adopted by the Board. 15. Financial Information. The Company will provide to each Optionee financial statements of the Company at least annually in accordance with Section 260.140.46 of Title 10 of the California Code of Regulations. -10- EX-10.19 6 d64225_ex10-19.txt LEASE AGREEMENT OFFICE LEASE LAKESHORE TOWERS LAKESHORE TOWERS LIMITED PARTNERSHIP PHASE II, a California limited partnership, as Landlord, and QUALITY SYSTEMS, INC., a California corporation, as Tenant, LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] TABLE OF CONTENTS
Page ---- ARTICLE 1 PREMISES, BUILDING, PROJECT, AND COMMON AREAS ............................ 1 1.1 Premises, Building, Project and Common Areas .................................. 1 1.1.1 The Premises ......................................................... 1 1.1.2 The Building and The Project ......................................... 1 1.1.3 Common Areas ......................................................... 1 1.2 Verification of Rentable Square Feet and Usable Square Feet of Premises, Building, and Project ......................................................... 2 ARTICLE 2 LEASE TERM ............................................................... 2 2.1 Lease Term .................................................................... 2 ARTICLE 3 BASE RENT ................................................................ 2 ARTICLE 4 ADDITIONAL RENT .......................................................... 2 4.1 General Terms ................................................................. 2 4.2 Definitions of Key Terms Relating to Additional Rent .......................... 3 4.2.1 Base Year ............................................................ 3 4.2.2 Building Direct Expenses ............................................. 3 4.2.3 Building Operating Expenses .......................................... 3 4.2.4 Building Tax Expenses ................................................ 3 4.2.5 Direct Expenses ...................................................... 3 4.2.6 Expense Year ......................................................... 3 4.2.7 Operating Expenses.................................................... 3 4.2.7.1 Inclusions to Operating Expenses ............................ 3 4.2.7.2 Exclusions to Operating Expenses ............................ 4 4.2.8 Taxes ................................................................ 7 4.2.8.1 Tax Expenses ................................................ 7 4.2.8.2 Other Costs ................................................. 8 4.2.8.3 Base Taxes .................................................. 8 4.2.9 Tenant's Share ....................................................... 8 4.3 Allocation of Direct Expenses ................................................. 8 4.4 Calculation and Payment of Additional Rent .................................... 9 4.4.1 Statement of Actual Building Direct Expenses and Payment by Tenant ............................................................... 9 4.4.2 Statement of Estimated Building Direct Expenses ...................... 9 4.5 Taxes and Other Charges for Which Tenant Is Directly Responsible .............. 9 4.6 Landlord's Books and Records .................................................. 10 4.7 Security Deposit .............................................................. 10 4.7.1 Security Deposit ..................................................... 10 4.7.2 Landlord's Transfer of Security Deposit on Transfer of Real Property ............................................................. 11 4.7.3 Restoration of Security Deposit ...................................... 11 4.7.4 Interest on Security Deposit ......................................... 11 4.7.5 Return of Security Deposit ........................................... 11 ARTICLE 5 USE OF PREMISES .......................................................... 11 5.1 Permitted Use ................................................................. 11 5.2 Prohibited Uses ............................................................... 11
-i- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] TABLE OF CONTENTS (continued)
Page ---- ARTICLE 6 SERVICES AND UTILITIES .................................................. 11 6.1 Standard Tenant Services ..................................................... 11 6.2 Overstandard Tenant Use ...................................................... 12 6.2.1 Non-Electrical Usage ................................................ 12 6.2.2 Electrical Usage .................................................... 12 6.3 Interruption of Use .......................................................... 13 ARTICLE 7 REPAIRS ................................................................. 13 ARTICLE 8 ADDITIONS AND ALTERATIONS ............................................... 13 8.1 Landlord's Consent to Alterations ............................................ 13 8.2 Manner of Construction ....................................................... 13 8.2.1 Conditions to Alterations ........................................... 13 8.2.2 Base Building Changes ............................................... 14 8.3 Payment for Improvements ..................................................... 14 8.4 Payment For Initial Alterations .............................................. 14 8.5 Construction Insurance ....................................................... 15 8.6 Landlord's Property .......................................................... 15 8.7 Communications and Computer Lines ............................................ 15 ARTICLE 9 COVENANT AGAINST LIENS .................................................. 16 ARTICLE 10 INSURANCE ............................................................... 16 10.1 Indemnification and Waiver ................................................... 16 10.2 Tenant's Compliance With Landlord's Fire and Casualty Insurance .............. 16 10.3 Tenant's Insurance ........................................................... 16 10.4 Form of Policies ............................................................. 17 10.5 Subrogation .................................................................. 17 10.6 Additional Insurance Obligations ............................................. 17 ARTICLE 11 DAMAGE AND DESTRUCTION .................................................. 18 11.1 Repair of Damage to Premises by Landlord ..................................... 18 11.1.1 Damage to Building .................................................. 18 11.1.2 Damage to Premises .................................................. 18 11.2 Landlord's Option to Repair .................................................. 18 11.3 Tenant's Option to Cause Early Expiration .................................... 19 11.4 Waiver of Statutory Provisions ............................................... 19 ARTICLE 12 NONWAIVER ............................................................... 19 ARTICLE 13 CONDEMNATION ............................................................ 20 ARTICLE 14 ASSIGNMENT AND SUBLETTING ............................................... 20 14.1 Transfers .................................................................... 20 14.2 Landlord's Consent ........................................................... 21 14.3 Transfer Premium ............................................................. 21 14.4 Landlord's Option as to Subject Space ........................................ 22 14.5 Effect of Transfer ........................................................... 22 14.6 Occurrence of Default ........................................................ 23 14.7 Non-Transfers ................................................................ 23
-ii- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] TABLE OF CONTENTS (continued)
Page ---- ARTICLE 15 SURRENDER OF PREMISES; OWNERSHIP AND REMOVAL OF TRADE FIXTURES .......................................................... 23 15.1 Surrender of Premises ........................................................ 23 15.2 Removal of Tenant Property by Tenant ......................................... 23 ARTICLE 16 HOLDING OVER ............................................................ 24 ARTICLE 17 ESTOPPEL CERTIFICATES ................................................... 24 ARTICLE 18 SUBORDINATION ........................................................... 24 ARTICLE 19 DEFAULTS; REMEDIES ...................................................... 25 19.1 Events of Default ............................................................ 25 19.2 Remedies Upon Default ........................................................ 25 19.3 Subleases of Tenant .......................................................... 26 19.4 Efforts to Relet ............................................................. 26 19.5 Landlord Default ............................................................. 27 ARTICLE 20 COVENANT OF QUIET ENJOYMENT ............................................. 27 ARTICLE 21 INTENTIONALLY DELETED ................................................... 27 ARTICLE 22 SIGNS ................................................................... 27 22.1 Tenant's Entry Door Signage .................................................. 27 22.2 Prohibited Signage and Other Items ........................................... 27 22.3 Building Directory ........................................................... 27 ARTICLE 23 COMPLIANCE WITH LAW ..................................................... 27 23.1 Applicable Laws .............................................................. 27 23.2 Hazardous Materials .......................................................... 28 23.3 Warranties; Notice of Release and Investigation .............................. 28 23.4 Indemnification .............................................................. 28 23.5 Remediation Obligations; Tenant's Rights on Cleanup by Landlord .............. 29 23.6 Definition of "Hazardous Material" ............................................. 29 ARTICLE 24 LATE CHARGES............................................................. 29 ARTICLE 25 LANDLORD'S RIGHT TO CURE DEFAULT; PAYMENTS BY TENANT .................................................................. 30 25.1 Landlord's Cure .............................................................. 30 25.2 Tenant's Reimbursement ....................................................... 30 ARTICLE 26 ENTRY BY LANDLORD ....................................................... 30 ARTICLE 27 TENANT PARKING .......................................................... 31 27.1 Parking In General ........................................................... 31 27.2 Landlord Reservations ........................................................ 31 27.3 Visitor Validations .......................................................... 31 27.4 Parking Pass System .......................................................... 31 ARTICLE 28 MISCELLANEOUS PROVISIONS ................................................ 31 28.1 Terms; Captions .............................................................. 31 28.2 Binding Effect ............................................................... 32 28.3 No Air Rights ................................................................ 32 28.4 Modification of Lease ........................................................ 32 28.5 Transfer of Landlord's Interest .............................................. 32
-iii- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] TABLE OF CONTENTS (continued)
Page ---- 28.6 Prohibition Against Recording ................................................ 32 28.7 Landlord's Title ............................................................. 32 28.8 Relationship of Parties ...................................................... 32 28.9 Application of Payments ...................................................... 32 28.10 Time of Essence .............................................................. 32 28.11 Partial Invalidity ........................................................... 32 28.12 No Warranty .................................................................. 33 28.13 Landlord Exculpation ......................................................... 33 28.14 Entire Agreement ............................................................. 33 28.15 Right to Lease ............................................................... 33 28.16 Force Majeure ................................................................ 33 28.17 Waiver of Redemption by Tenant ............................................... 33 28.18 Notices ...................................................................... 33 28.19 Joint and Several ............................................................ 34 28.20 Authority .................................................................... 34 28.21 Attorneys' Fees .............................................................. 34 28.22 GOVERNING LAW; WAIVER OF TRIAL BY JURY ....................................... 34 28.23 Submission of Lease .......................................................... 35 28.24 Brokers ...................................................................... 35 28.25 Independent Covenants ........................................................ 35 28.26 Project or Building Name and Signage ......................................... 35 28.27 Counterparts ................................................................. 35 28.28 Confidentiality .............................................................. 35 28.29 Development of the Project ................................................... 35 28.29.1 Subdivision ......................................................... 35 28.29.2 The Other Improvements .............................................. 35 28.29.3 Construction of Project and Other Improvements ...................... 36 28.30 Building Renovations ......................................................... 36 28.31 No Violation ................................................................. 36 28.32 No Discrimination ............................................................ 36 28.33 Definition of Landlord ....................................................... 36 28.34 Tenant Representation With Respect to the General Electric Pension Trust ..... 36
-iv- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EXHIBITS A OUTLINE OF PREMISES B PROJECT LEGAL DESCRIPTION C DIRECT EXPENSES ALLOCATION D RULES AND REGULATIONS E FORM OF TENANT'S ESTOPPEL CERTIFICATE -i- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] LIST OF DEFINED TERMS Page ---- Accountant ............................................................. 10 Additional Rent ........................................................ 3 Additional Required Work ............................................... 14 Affiliate .............................................................. 23 Alterations ............................................................ 13 Applicable Laws ........................................................ 28 Base Building .......................................................... 14 Base Building Systems .................................................. 14 Base Rent .............................................................. 2 Base Year .............................................................. 3 BOMA ................................................................... 8 Brokers ................................................................ 35 Building ............................................................... 1 Building Common Areas .................................................. 1 Building Direct Expenses ............................................... 3 Building Hours ......................................................... 12 Building Operating Expenses ............................................ 3 Building Tax Expenses .................................................. 3 CC&Rs .................................................................. 1 CEW Report ............................................................. 28 Common Areas ........................................................... 1 Comparable Buildings ................................................... 1 Contemplated Effective Date ............................................ 22 Contemplated Transfer Space ............................................ 22 Control ................................................................ 23 Direct Expenses ........................................................ 3 Electricity Usage Standard ............................................. 12 Environmental Laws ..................................................... 28 Estimate ............................................................... 9 Estimate Statement ..................................................... 9 Estimated Excess ....................................................... 9 Excess ................................................................. 9 Expense Year ........................................................... 3 Force Majeure .......................................................... 33 Hazardous Material ..................................................... 29 Holidays ............................................................... 12 HVAC ................................................................... 11 Initial Alterations .................................................... 15 Intention to Transfer Notice ........................................... 22 Lakeshore Towers ....................................................... 1 Landlord ............................................................... 1 Landlord Parties ....................................................... 16 Landlord Repair Notice ................................................. 18 Lease .................................................................. 1 Lease Commencement Date ................................................ 2 Lease Expiration Date .................................................. 2 Lease Term ............................................................. 2 Lease Year ............................................................. 2 Lines .................................................................. 15 Mail ................................................................... 34 Management Fee Cap ..................................................... 6 Nine Month Period ...................................................... 22 Notices ................................................................ 34 Operating Expenses ..................................................... 3 Original Improvements .................................................. 17 Other Improvements ..................................................... 35 -i- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Parking Structure ...................................................... 31 Premises ............................................................... 1 Project ................................................................ 1 Project Common Areas ................................................... 1 Proposition 13 ......................................................... 7 Renovations ............................................................ 36 Rent ................................................................... 3 rentable square feet ................................................... 2 Repair Notice .......................................................... 19 Security Deposit ....................................................... 10 Statement .............................................................. 9 Subject Space .......................................................... 20 Summary ................................................................ 1 Tax Expenses ........................................................... 7 Tenant ................................................................. 1 Tenant Auditor.......................................................... 10 Tenant's Share ......................................................... 8 Tenant's Transfer Costs ................................................ 22 Transfer Notice ........................................................ 20 Transfer Premium ....................................................... 22 Transferee ............................................................. 20 Transfers .............................................................. 20 usable square feet ..................................................... 2 -ii- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] LAKESH0RE TOWERS OFFICE LEASE This Office Lease (the "Lease"), dated as of the date set forth in Section 1 of the Summary of Basic Lease Information (the "Summary"), below, is made by and between LAKESH0RE TOWERS LIMITED PARTNERSHIP PHASE IV, a California limited partnership ("Landlord"), and QUALITY SYSTEMS, INC., a California corporation ("Tenant"). SUMMARY OF BASIC LEASE INFORMATION TERMS OF LEASE DESCRIPTION - -------------- ----------- 1. Date: September 15,2004 2. Premises (Article 1). 2.1 Building: Lakeshore Towers Building II 18191 Von Karman Avenue Irvine, California 2.2 Premises: Approximately 11,996 rentable (10,643 usable) square feet of space located on the fourth floor of the Building and commonly known as Suite 450, as further set forth in Exhibit A to the Lease. 3. Lease Term (Article 2). 3.1 Length of Term of Lease of Premises: Three (3) years and one (1) month. 3.2 Lease Commencement Date: May 1, 2005. 3.3 Lease Expiration Date: May 31, 2008. 4. Base Rent (Article 3): Annual Monthly Rental Rate Annual Installment per Rentable Period Base Rent of Base Rent Square Foot ------------ ------------ ------------ May 2005* through May 2006 $323,892.00 $26,991.00 $27.00 June 2006 through May 2007 $331,089.60 $27,590.80 $27.60 June 2007 through May 2008 $338,287.20 $28,190.60 $28.20 * Notwithstanding the foregoing, no monthly Base Rent shall be due for May 2005. 5. Base Year Calendar year 2005 (Article 4): 6. Tenant's Share Approximately 9.38% (Article 4): 7. Permitted Use General office use consistent with a (Article 5): first-class office building. -1- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 8. Security Deposit $28,190.60 (Article 4): 9. Parking 43 unreserved parking spaces in the (Article 27): Parking Structure and four (4) reserved parking spaces in the Building's subterranean parking area at the rates set forth below. In addition, Tenant shall have the right to use an additional thirteen (13) unreserved parking spaces in the Parking Structure at the rates provided below subject to Tenant's advising Landlord not less than thirty (30) days in advance of the date Tenant desires to use such additional unreserved parking spaces. Tenant may also use additional unreserved parking spaces in the Parking Structure subject to availability of such spaces and payment of Landlord's then current parking charges for unreserved spaces or Fifty Dollars ($50) per unreserved space, whichever is greater. To the extent available, Tenant may convert up to five (5) of its unreserved parking spaces to reserved parking spaces in the Parking Structure at the reserved rate set forth below.
Parking Parking Structure Parking Structure Building Space Fees: Unreserved Reserved Rate Reserved Rate Rate Per Space Per Space Per Space Per Month Per Month Per Month ----------------- ----------------- ------------- $50.00 $125.00 $145.00
10. Address of Tenant Quality Systems, Inc. (Section 28.18): 18191 Yon Kannan Avenue, Suite 450 Irvine, California 92612 (Prior to and After Lease Commencement Date) 11. Address of Landlord (Section 28.18): See Section 28.18 of the Lease. 12. Broker(s) Kern Olson Real Estate Services (Section 28.24): 4101 Birch Street, Suite 150 Newport Beach, California 92660 Attention: James F. Kern and Cushman & Wakefield of California, Inc, 1920 Main Street, Suite 600 Irvine, California 92614 Attention: Jeffrey L. Osborn -2- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] ARTICLE 1 PREMISES, BUILDING, PROJECT, AND COMMON AREAS 1.1 Premises, Building, Project and Common Areas. 1.1.1 The Premises. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the premises set forth in Section 2.2 of the Summary (the "Premises"). The outline of the Premises is set forth in Exhibit A attached hereto. The parties hereto agree that the lease of the Premises is upon and subject to the terms, covenants and conditions herein set forth, and Tenant, covenants as a material part of the consideration for this Lease to keep and perform each and all of such terms, covenants and conditions by it to be kept and performed and that this Lease is made upon the condition of such performance. The parties hereto hereby acknowledge that the purpose of Exhibit A is to show the approximate location of the Premises in the "Building," as that term is defined in Section 1.1.2, below, only, and such Exhibit is not meant to constitute an agreement, representation or warranty as to the construction of the Premises, the precise area thereof or the specific location of the "Common Areas," as that term is defined in Section 1.1.3, below, or the elements thereof or of the accessways to the Promises or the "Project," as that term is defined in Section 1.1.2, below. Except as specifically set forth in Section 8.4 below, Landlord shall not be obligated to provide or pay for any improvement work or services related to the improvement of the Premises. Tenant also acknowledges that neither Landlord nor any agent of Landlord has made any representation or warranty regarding the condition of the Premises, the Building or the Project or with respect to the suitability of any of the foregoing for the conduct of Tenant's business, except as specifically set forth in this Lease and the Tenant Work Letter. Tenant acknowledges that it is currently in possession of the Premises and Tenant accepts the Premises in its current "AS IS" condition and Tenant confirms that the Premises and the Building are in good and sanitary order, condition and repair. 1.1.2 The Building and The Project. The Premises are a part of the building set forth in Section 2.1 of the Summary (the "Building"). The Building is part of an office project known as "Lakeshore Towers". The term "Project", as used in this Lease, shall mean (i) the land on which the Project is located which land is described in Exhibit B hereto, (ii) the Building, (iii) the Common Areas, (iv) the other buildings located in the Project, and (v) at Landlord's discretion, any additional real property, areas, land, buildings or other improvements added thereto outside of the Project. 1.1.3 Common Areas. Tenant shall have the non-exclusive right to use in common with Project tenants the Project Common Areas and the non-exclusive right to use in common with other Building tenants the Building this Lease. As Common Areas, subject to the rules and regulations referred to in Article 5 of used herein those portions of the Project which are provided, from time to time, for use in common by Landlord, Tenant and any other tenants of the Project and such other portions of the Project designated by Landlord, in its discretion, including certain areas designated for the exclusive use of certain tenants, or to be shared by Landlord and certain tenants, are collectively referred to herein as the "Common Areas". The Common Areas shall consist of the "Project Common Areas" and the "Building Common Areas." The term "Project Common Areas", as used in this Lease, shall mean (i) the portion of the Project designated as such by Landlord and (ii) all common areas designated in that certain Declaration of Covenants, Conditions and Restrictions and Reservation of Easements for the Lakeshore Towers, dated October 17, 1989, recorded October 23, 1989, as Instrument No. 89569018 of the Official Records of Orange County, California (the "CC&Rs"). The term "Building Common Areas", as used in this Lease, shall mean the portions of the Common Areas located within the Building designated as such by Landlord. The manner in which the Common Areas are maintained and operated shall be at the sole discretion of Landlord, provided that Landlord shall maintain and operate same in a manner consistent with that of other first-class, high-rise office buildings in the John Wayne Airport area which are comparable in size (containing at least 200,000 rentable square feet), quality of construction, and services and amenities to the Building (the "Comparable Buildings") and the use thereof shall be subject to such rules, regulations and restrictions as Landlord may make from time to time. Landlord reserves the right to close temporarily, make alterations or additions to, or change the location of elements of the Project and the Common Areas. -1- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 1.2 Verification of Rentable Square Feet and Usable Square Feet of Premises, Building, and Project. For purposes of this Lease, "rentable square feet" and "usable square feet" shall be calculated pursuant to "BOMA," as that term is defined in Section 4.2.9, below. In the event that the rentable area of the Premises, the Building and/or the Project shall hereafter change due to subsequent alterations and/or other modifications to the Premises, the Building and/or the Project, the rentable area of the Premises, the Building and/or the Project, as the case may be, shall be appropriately adjusted as of the date of such alteration and/or other modification, based upon the written verification by Landlord's space planner of such revised rentable area. In the event of any such adjustment to the rentable area of the Premises, the Building and/or the Project, all amounts, percentages and figures appearing or referred to in this Lease based upon such rentable area (including, without limitation, the amount of the "Rent," as that term is defined in Article 4 of this Lease) shall be modified in accordance with such determination. ARTICLE 2 LEASE TERM 2.1 Lease Term. The terms and provisions of this Lease shall be effective as of the date of this Lease. The term of this Lease (the "Lease Term") shall be as set forth in Section 3.1 of the Summary and shall commence on the date set forth in Section 3.2 of the Summary (the "Lease Commencement Date") The term of this Lease shall terminate on the date set forth in Section 3.3 of the Summary (the "Lease Expiration Date") unless this Lease is sooner terminated as hereinafter provided. For purposes of this Lease, the term "Lease Year" shall mean each consecutive twelve (12) month period during the Lease Term, commencing on the Lease Commencement Date. For example, the first Lease Year will commence on May 1, 2005 and end on April 30, 2006. ARTICLE 3 BASE RENT Tenant shall pay, without prior notice or demand, to Landlord or Landlord's agent at the management, office of the Project, or, at Landlord's option, at such other place as Landlord may from time to time designate in writing, by a check for currency which, at the time of payment, is legal tender for private or public debts in the United States of America, base rent ("Base Rent") as set forth in Section 4 of the Summary, payable in equal monthly installments as set forth in Section 4 of the Summary in advance on or before the first day of each and every calendar month during the Lease Term, without any setoff or deduction whatsoever. The Base Rent for June 2005 shall be paid at the time of Tenant's execution of this Lease. If any Base Rent payment date (including the Lease Commencement Date) falls on a day of the month other than the first day of such month or if any payment of Base Rent is for a period which is shorter than one month, the Base Rent for any fractional month shall accrue on a daily basis for the period from the date such payment is due to the end of such calendar month or to the end of this Lease Term at a rate per day which is equal to 1/365 of the applicable annual Base Rent. All other payments or adjustments required to be made under the terms of this Lease that require proration on a time basis shall be prorated on the same basis. ARTICLE 4 ADDITIONAL RENT 4.1 General Terms. In addition to paying the Base Rent specified in Article 3 of this Lease, Tenant shall pay "Tenant's Share" of the annual "Building Direct Expenses," as those terms are defined in Sections 4.2.9 and 4.2.2 of this Lease, respectively, which are in excess of the amount of Building Direct Expenses for the "Base Year," as that term is defined in Section 4.2.1, below; provided, however, that in no event shall any decrease in Building Direct Expenses for any "Expense Year," as that term is defined in Section 4.2.6 below, below Building Direct Expenses for the Base Year entitle Tenant to any decrease in Base Rent or any credit against sums due under this Lease. Such payments by Tenant, together with any and all other amounts payable by Tenant to Landlord pursuant to the terms of this Lease, are hereinafter collectively referred to as the "Additional Rent", and the Base Rent and the Additional Rent are herein collectively referred to as "Rent." All amounts due under this Article 4 as Additional Rent shall be payable for the same periods and in the same manner as the Base Rent; provided, however, -2- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Additional Rent on account of Tenant's Share of Building Direct Expenses shall not be due or payable during the first Lease Year. Without limitation on other obligations of Tenant which survive the expiration of the Lease Term, the obligations of Tenant to pay the Additional Rent provided for in this Article 4 shall survive the expiration of the Lease Term. 4.2 Definitions of Key Terms Relating to Additional Rent. As used in this Article 4, the following terms shall have the meanings hereinafter set forth: 4.2.1 Base Year. "Base Year" shall mean the period set forth in Section 5 of the Summary. 4.2.2 Building Direct Expenses. "Building Direct Expenses" shall mean "Building Operating Expenses" and "Building Tax Expenses", as those terms are defined in Sections 4.2.3 and 4.2.4, below, respectively. 4.2.3 Building Operating Expenses. "Building Operating Expenses" shall mean the portion of "Operating Expenses," as that term is defined in Section 4.2.7 below, allocated to the tenants of the Building pursuant to the terms of Section 4.3.1 below. 4.2.4 Building Tax Expenses. "Building Tax Expenses" shall mean that portion of "Tax Expenses", as that term is defined in Section 4.2.8 below, allocated to the tenants of the Building pursuant to the terms of Section 4.3.1 below. 4.2.5 Direct Expenses. "Direct Expenses" shall mean "Operating Expenses" and "Tax Expenses." 4.2.6 Expense Year. "Expense Year" shall mean each calendar year in which any portion of the Lease Term falls, through and including the calendar year in which the Lease Term expires, provided that Landlord, upon notice to Tenant, may change the Expense Year from time to time to any other twelve (12) consecutive month period, and, in the event of any such change. Tenant's Share of Building Direct Expenses shall be equitably adjusted for any Expense Year involved in any such change. 4.2.7 Operating Expenses. 4.2.7.1 Inclusions to Operating Expenses. "Operating Expenses" shall mean all expenses, costs and amounts of every kind and nature which Landlord pays during any Expense Year because of or in connection with the ownership, management, maintenance, security, repair, replacement) restoration or operation of the Project, or any portion thereof, subject to the terms and provisions of Section 4.2.7. Without limiting the generality of the foregoing, Operating Expenses shall specifically include any and all of the following: (i) the cost of supplying all utilities, the cost of operating, repairing, maintaining, and renovating the utility, telephone, mechanical, sanitary, storm drainage, and elevator systems, and the cost of maintenance and service contracts in connection therewith; (ii) the cost of licenses, certificates, permits and inspections and the cost of contesting any governmental enactments which may affect Operating Expenses, and the costs incurred in connection with any governmentally mandated transportation system management program or similar program; (iii) the cost of earthquake insurance and all other insurance carried by Landlord in connection with the Project as reasonably determined by Landlord (and Landlord represents that it shall carry earthquake insurance during the Base Year); (iv) the cost of landscaping, relamping, and all supplies, tools, equipment and materials used in the operation, repair and maintenance of the Project, or any portion thereof; (v) the cost of non-capital (as determined pursuant to generally accepted accounting principles) parking area repair, restoration, and maintenance; -3- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] (vi) fees and other costs, including reasonable management fees, consulting fees, legal fees and accounting fees, of all contractors and consultants in connection with the management, operation, maintenance and repair of the Project; (vii) payments under any equipment rental agreements and the fair rental value of any management office space; (viii) subject to Section 4.2.7.2(vi) below, wages, salaries and other compensation and benefits, including taxes levied thereon, of all persons engaged in the operation, maintenance and security of the Project; (ix) operation, repair and maintenance of all systems and equipment and components thereof of the Project; (x) the cost of janitorial, alarm, security and other services, replacement of wall and floor coverings, ceiling tiles and fixtures in common areas, maintenance and replacement of curbs and walkways, and repair to roofs and reroofing; (xi) amortization (including interest on the unamortized cost) over the useful life, determined in accordance with generally accepted accounting principles, of the cost of acquiring or the rental expense of personal property used in the maintenance, operation and repair of the Project, or any portion thereof; (xii) the cost of capital improvements or other costs incurred in connection with the Project (A) which are intended to effect economies in the operation or maintenance of the Project, or any portion thereof (but only to the extent of the annual cost savings reasonably anticipated by Landlord), (B) that are required to comply with present or anticipated reasonable conservation programs, (C) which are replacements of nonstructural items located in the Common Areas required to keep the Common Areas in good order or condition, or (D) that are required under any governmental law or regulation enacted after the date of this Lease; provided, however, that any capital expenditure shall be amortized (including interest on the amortized cost) over its useful life reasonably determined in accordance with generally accepted accounting principles; (xiii) costs, fees, charges or assessments imposed by, or resulting from any mandate imposed on Landlord by, any federal, state or local government for fire and police protection, trash removal, community services, or other services which do not constitute "Tax Expenses" as that term is defined in Section 4.2.8, below; and (xiv) payments under any easement, license, operating agreement, declaration, restrictive covenant, or instrument pertaining to the sharing of costs by the Building with oilier buildings in the Project. 4.2.7.2 Exclusions to Operating Expenses. Notwithstanding the provisions of Section 4.2.7.1 above, for purposes of this Lease, Operating Expenses shall not, however, include: (i) costs, including marketing costs, legal fees, space planners' fees, advertising and promotional expenses, and brokerage fees incurred in connection with the original construction or development, or original or future leasing of the Project, and costs, including permit, license and inspection costs, incurred with respect to the installation of tenant improvements made for new tenants initially occupying space in the Project after the Lease Commencement Date or incurred in renovating or otherwise improving, decorating, painting or redecorating vacant space for tenants or other occupants of the Project (excluding, however, such costs relating to any Common Areas or parking facilities); (ii) except as set forth in Sections 4.2.7.1 (xi), (xii), and (xiii) above, depreciation, interest and principal payments on mortgages and other debt -4- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] costs, if any, penalties and interest, costs of capital repairs and alterations, and costs of capital improvements and equipment; (iii) costs for which the Landlord is reimbursed by any tenant or occupant of the Project or by insurance by its carrier or any tenant's carrier or by anyone else, and electric power costs for which any tenant directly contracts with the local public service company; (iv) any bad debt loss, rent loss, or reserves for bad debts or rent loss; (v) costs associated with the operation of the business of the partnership or entity which constitutes the Landlord, as the same arc distinguished from the costs of operation of the Project (which shall specifically include, but not be limited to, accounting costs associated with the operation of the Project). Costs associated with the operation of the business of the partnership or entity which constitutes the Landlord include costs of partnership accounting and legal matters, costs of defending any lawsuits with any mortgagee (except as the actions of the Tenant may be in issue), costs of selling, syndicating, financing, mortgaging or hypothecating any of the Landlord's interest in the Project, and costs incurred in connection with any disputes between Landlord and its employees, between Landlord and Project management, or between Landlord and other tenants or occupants, and Landlord's general corporate overhead and general and administrative expenses; (vi) the wages and benefits of any employee who does not devote substantially all of his or her employed time to the Project unless such wages and benefits are prorated to reflect time spent on operating and managing the Project vis-a-vis time spent on matters unrelated to operating and managing the Project; provided, that in no event shall Operating Expenses for purposes of this Lease include wages and/or benefits attributable to personnel above the level of Project manager; (vii) amounts paid as ground rental for the Project by the Landlord; (viii) except for a Project management fee to the extent allowed pursuant to item (xiii), below, overhead and profit increment paid to the Landlord or to subsidiaries or affiliates of the Landlord for services in the Project to the extent the same exceeds the costs of such services rendered by qualified, first-class unaffiliated third parties on a competitive basis; (ix) any compensation paid to clerks, attendants or other persons in commercial concessions operated by the Landlord, provided that any compensation paid to any concierge at the Project shall be includable as an Operating Expense; (x) rentals and other related expenses incurred in leasing air conditioning systems, elevators or other equipment which if purchased the cost of which would be excluded from Operating Expenses as a capital cost, except equipment not affixed to the Project which is used in providing janitorial or similar services and, further excepting from this exclusion such equipment rented or leased to remedy or ameliorate an emergency condition in the Project; (xi) all items and services for which Tenant or any other tenant in the Project reimburses Landlord or which Landlord provides selectively to one or more tenants (other than Tenant) without reimbursement; (xii) costs, other than those incurred in ordinary maintenance and repair, for sculpture, paintings, fountains or other objects of art; (xiii) fees payable by Landlord for management of the Project in excess of five percent (5%) (the "Management. Fee Cap") of Landlord's gross -5- LAKRSHORE TOWERS BUILDING II [Quality Systems, Inc.] rental revenues, adjusted and grossed up to reflect a one hundred percent (100%) occupancy of the Building with all tenants paying rent, including base rent, pass-throughs, and parking fees (but excluding the cost of after hours services or utilities) from the Project for any calendar year or portion thereof; (xiv) any costs expressly excluded from Operating Expenses elsewhere in this Lease; (xv) rent for any office space occupied by Project management personnel to the extent the size or rental rate of such office space exceeds the size or fair market rental value of office space occupied by management personnel of the Comparable Buildings in the vicinity of the Building, with adjustment where appropriate for the size of the applicable project; (xvi) costs arising from the negligence or willful misconduct of Landlord or its agents, employees, vendors, contractors, or providers of materials or services; (xvii) costs (A) incurred to comply with laws relating to the removal of Hazardous Material (as defined at Section 23.6 below) which was in existence in the Building or on the Project prior to the Lease Commencement Date, and was of such a nature that a federal, State or municipal governmental authority, if it then had knowledge of the presence of such Hazardous Material, in the state, and under the conditions that it then existed in the Building or on the Project, would have then required the removal of such Hazardous Material or other remedial or containment action with respect thereto; and (B) costs incurred to remove, remedy, contain, or treat Hazardous Material, which hazardous material is brought into the Building or onto the Project after the date hereof by Landlord or any other tenant of the Project and is of such a nature, at that time, that a federal, State or municipal governmental authority, if it had then had knowledge of the presence of such Hazardous Material, in the state, and under the conditions, that it then exists in the Building or on the Project, would have then required the removal of such Hazardous Material or other remedial or containment action with respect thereto; (xviii) costs arising from Landlord's charitable or political contributions; (xix) any gifts provided to any entity whatsoever, including, but not limited to, Tenant, other tenants, employees, vendors, contractors, prospective tenants and agents; (xx) the cost of any magazine, newspaper, trade or other subscriptions; (xxi) any amount paid to Landlord or to subsidiaries or affiliates of the Landlord for services in the Project to the extent the same exceeds the cost of such services rendered by qualified, first-class unaffiliated third parties on a competitive basis; (xxii) costs arising from Landlord's failure to comply with any applicable governmental laws or regulations in existence at the time of the Lease Commencement Date; (xxiii) costs relating to categories of expenses for the Project parking areas which were not included in Operating Expenses during the Base Year, except to the extent the Base Year is retroactively adjusted to include such categories; and (xxiv) any entertainment expenses and travel expenses of Landlord, its employees, agents, partners and affiliates. -6- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] If Landlord is not furnishing any particular work or service (the cost of which, if performed by Landlord, would be included in Operating Expenses) to a tenant who has undertaken to perform such work or service in lieu of the performance thereof by Landlord, Operating Expenses shall be deemed to be increased by an amount equal to the additional Operating Expenses which would reasonably have been incurred during such period by Landlord if it had at its own expense furnished such work or service to such tenant. If the Project is not at least ninety-five percent (95%) occupied during all or a portion of the Base Year or any Expense Year, Landlord shall make an appropriate adjustment to the components of Operating Expenses for such year to determine the amount of Operating Expenses that would have been incurred had the Project been ninety-five percent (95%) occupied; and the amount so determined shall be deemed to have been the amount of Operating Expenses for such year. Operating Expenses for the Base Year shall not include market-wide labor-rate increases due to extraordinary circumstances, including, but not limited to, boycotts and strikes, and utility rate increases due to extraordinary circumstances including, but not limited to, conservation surcharges, boycotts, embargoes or other shortages, or amortized costs relating to capital improvements. 4.2.8 Taxes. 4.2.8.1 Tax Expenses. "Tax Expenses" shall mean all federal, state, county, or local governmental or municipal taxes, fees, charges or other impositions of every kind and nature, whether general, special, ordinary or extraordinary (including, without limitation, real estate taxes, general and special assessments, transit taxes, leasehold taxes or taxes based upon the receipt of rent, including gross receipts or sales taxes applicable to the receipt of rent, unless required to be paid by Tenant, personal property taxes imposed upon the fixtures, machinery, equipment, apparatus, systems and equipment, appurtenances, furniture and other personal property used in connection with the Project, or any portion thereof), which shall be paid or accrued during any Expense Year (without regard to any different fiscal year used by such governmental or municipal authority) because of or in connection with the ownership, leasing and operation of the Project, or any portion thereof including the parking areas. Tax Expenses shall include, without limitation: (i) any tax on the rent, right to rent or other income from the Project, or any portion thereof, or as against the business of leasing the Project, or any portion thereof; (ii) any assessment, tax, fee, levy or charge in addition to, or in substitution, partially or totally, of any assessment, tax, fee, levy or charge previously included within the definition of real property tax, it being acknowledged by Tenant and Landlord that Proposition 13 was adopted by the voters of the State of California in the June 1978 election ("Proposition 13") and that assessments, taxes, fees, levies and charges may be imposed by governmental agencies for such services as fire protection, street, sidewalk and road maintenance, refuse removal and for other governmental services formerly provided without charge to property owners or occupants, and, in further recognition of the decrease in the level and quality of governmental services and amenities as a result of Proposition 13, Tax Expenses shall also include any governmental or private assessments or the Project's contribution towards a governmental or private cost-sharing agreement for the purpose of augmenting or improving the quality of services and amenities normally provided by governmental agencies; (iii) any assessment, tax, fee, levy, or charge allocable to or measured by the area of the Premises or the Rent payable hereunder, including, without limitation, any business or gross income tax or excise tax with respect to the receipt of such rent, or upon or with respect to the possession, leasing, operating, management, maintenance, alteration, repair, use or occupancy by Tenant of the Premises, or any portion thereof; (iv) any assessment, tax, fee, levy or charge, upon this transaction or any document to which Tenant is a party, creating or transferring an interest or an estate in the Premises; and -7- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] (v) all of the real estate taxes and assessments imposed upon or with respect to the Building and Project. To the extent such taxes are not currently known, Landlord shall reasonably estimate the taxes and the Base Year Tax Expenses shall be adjusted accordingly upon receipt of the actual tax adjustment based upon such reassessment. 4.2.8.2 Other Costs. Any costs and expenses including, without limitation, reasonable attorneys' and consultants' fees) incurred in attempting to protest, reduce or minimize Tax Expenses shall be included in Tax Expenses in the Expense Year such expenses are incurred. Tax refunds shall be credited against Tax Expenses and refunded to Tenant regardless of when received, based on the Expense Year to which the refund is applicable; provided, however, in no event shall the amount to be refunded Tenant for any such Expense Year exceed the total amount paid by Tenant as Additional Rent under this Article 4 for such Expense Year. If Tax Expenses for any period during the Lease Term or any extension thereof are increased after payment thereof for any reason, including, without limitation, error or reassessment by applicable governmental or municipal authorities, Tenant shall pay Landlord upon demand Tenant's Share of any such increased Tax Expenses included by Landlord as Building Tax Expenses pursuant to the terms of this Lease. Notwithstanding anything to the contrary contained in this Section 4.2.8 (except as set forth in Section 4.2.8.1, above), there shall be excluded from Tax Expenses (i) all excess profits taxes, franchise taxes, gift taxes, capital stock taxes, inheritance and succession taxes, estate taxes, federal and state income taxes, and other taxes to the extent applicable to Landlord's general or net income (as opposed to rents, receipts or income attributable to operations at the Project), (ii) any items included as Operating Expenses, and (iii) any items paid by Tenant under Section 4.5 of this Lease. 4.2.8.3 Base Taxes. The amount of Tax Expenses for the Base Year attributable to the valuation of the Project, inclusive of tenant improvements, shall be known as the "Base Taxes." If in any comparison year subsequent to the Base Year the amount of Tax Expenses decreases below the amount of Base Taxes for the Premises, then for purposes of all subsequent comparison years, including the comparison year in which such decrease in Tax Expenses occurred, the Base Taxes and therefore the Base Year shall be decreased by an amount equal to the decrease in Tax Expenses. 4.2.9 Tenant's Share. "Tenant's Share" shall mean the percentages set forth in Section 6 of The Summary. Tenant's Share is calculated by multiplying the number of rentable square feet of the Premises as set forth in Section 2 of the Summary, by 100, and dividing the applicable product by the rentable square feet in the Building. The rentable square feet in the Premises and Building is measured pursuant to the Building Owners and Managers Association Standard Method for Measuring Floor Area in Office Buildings, ANSI/BOMA Z65.1 - 1996 ("BOMA"), provided that the rentable square footage of the Building shall include all of, and the rentable square footage of the Premises therefore shall include a portion of, the square footage of the ground floor Common Areas located within the Building and the Common Area and occupied space of the portion of the Building or Project, dedicated to the service of the Building. In the event either the rentable square feet of the Premises and/or the total rentable square feet of the Building is remeasured, Tenant's Share for the Premises shall be appropriately adjusted, and, as to the Expense Year in which such change occurs, Tenant's Share for the Premises for such Expense Year shall be determined on the basis of the number of days during such Expense Year that each such Tenant's Share was in effect. 4.3 Allocation of Direct Expenses. The parties acknowledge that the Building is a part of a multi-building project and that the costs and expenses incurred in connection with the Project (i.e. the Direct Expenses) should be shared between the tenants of the Building and the tenants of the other buildings in the Project. Accordingly, as set forth in Section 4.2 above, Direct Expenses (which consist of Operating Expenses and Tax Expenses) are determined annually for the Project as a whole, and a portion of the Direct Expenses, which portion shall be determined by Landlord in accordance with the CC&Rs, shall be allocated to the tenants of the Building (as opposed to the tenants of any other buildings in the Project) and such portion shall be the Building Direct Expenses for purposes of this Lease (such allocation in accordance with the CC&Rs is further described in Exhibit C hereto). Such portion of Direct Expenses allocated to the tenants of the Building shall include all Direct Expenses attributable solely to the Building and an equitable portion of the Direct Expenses attributable to the Project as a whole. -8- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 4.4 Calculation and Payment of Additional Rent. If for any Expense Year ending or commencing within the Lease Term, the applicable Tenant's Share of Building Direct Expenses for such Expense Year exceeds the applicable Tenant's Share of Building Direct Expenses applicable to the Base Year for the Premises, then Tenant shall pay to Landlord, in the manner set forth in Section 4.4.1, below, and as Additional Rent, an amount equal to the excess (the "Excess). 4.4.1 Statement of Actual Building Direct Expenses and Payment by Tenant. Landlord shall give to Tenant following the end of each Expense Year, a statement (the "Statement") which shall state the Building Direct Expenses incurred or accrued for such preceding Expense Year and which shall indicate the amount of the Excess. Upon receipt of the Statement for each Expense Year commencing or ending during the Lease Term, if an Excess is present, Tenant shall pay, with its next installment of Base Rent due, the full amount of the Excess for such Expense Year, less the amounts, if any, paid during such Expense Year as "Estimated Excess," as that term is defined in Section 4.4.2, below, and if Tenant paid more as Estimated Excess than the actual Excess, Tenant shall receive a credit in the amount of Tenant's overpayment against Rent next due under this Lease. The failure of Landlord to timely furnish the Statement for any Expense Year shall not prejudice Landlord or Tenant from enforcing its rights under this Article 4. Even though the Lease Term has expired and Tenant has vacated the Premises, when the final determination is made of Tenant's Share of Building Direct Expenses for the Expense Year in which this Lease terminates, if an Excess is present, Tenant shall immediately pay to Landlord such amount, and if Tenant paid more as Estimated Excess than the actual Excess, Landlord shall, within thirty (30) days, deliver a check, payable to Tenant in the amount of the overpayment. The provisions of this Section 4.4.1 shall survive the expiration or earlier termination of the Lease Term. 4.4.2 Statement of Estimated Building Direct Expenses. In addition, Landlord shall give Tenant a yearly expense estimate statement (the "Estimate Statement") which shall set forth Landlord's reasonable estimate (the "Estimate") of what the total amount of Building Direct Expenses for the then-current Expense Year shall be and the estimated excess (the "Estimated Excess") as calculated by comparing the Building Direct Expenses for such Expense Year, which shall be based upon the Estimate, to the amount of Building Direct Expenses for the Base Year. The failure of Landlord to timely furnish the Estimate Statement for any Expense Year shall not preclude Landlord from enforcing its rights to collect any Estimated Excess under this Article 4, nor shall Landlord be prohibited from revising any Estimate Statement or Estimated Excess theretofore delivered to the extent necessary. Thereafter, Tenant shall pay, with its next installment of Base Rent due, a fraction of the Estimated Excess for the then-current Expense Year (reduced by any amounts paid pursuant to the last sentence of this Section 4.4.2). Such fraction shall have as its numerator the number of months which have elapsed in such current Expense Year, including the month of such payment, and twelve (12) as its denominator. Until a new Estimate Statement is furnished (which Landlord shall have the right to deliver to Tenant at any time), Tenant shall pay monthly, with the monthly Base Rent installments, an amount equal to one-twelfth (1/12) of the total Estimated Excess set forth in the previous Estimate Statement delivered by Landlord to Tenant. 4.5 Taxes and Other Charges for Which Tenant Is Directly Responsible. 4.5.1 Tenant shall be liable for and shall pay ten (10) days before delinquency, taxes levied against Tenant's equipment, furniture, fixtures and any other personal property located in or about the Premises. If any such taxes on Tenant's equipment, furniture, fixtures and any other personal property are levied against Landlord or Landlord's property or if the assessed value of Landlord's property is increased by the inclusion therein of a value placed upon such equipment, furniture, fixtures or any other personal property and if Landlord pays the taxes based upon such increased assessment, which Landlord shall have the right to do regardless of the validity thereof but only under proper protest if requested by Tenant, Tenant shall upon demand repay to Landlord the taxes so levied against Landlord or the proportion of such taxes resulting from such increase in the assessment, as the case may be. 4.5.2 If the tenant improvements in the Premises, whether installed and/or paid for by Landlord or Tenant and whether or not affixed to the real properly so as to become a part thereof, are assessed for real property tax purposes at a valuation higher than the valuation at which tenant improvements conforming to Landlord's "building standard" in other space in the -9- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Building are assessed, then the Tax Expenses levied against Landlord or the property by reason of such excess assessed valuation shall be deemed to be taxes levied against personal property of Tenant and shall be governed by the provisions of Section 4.5.1, above; provided that Landlord uniformly applies such excess assessed valuation for (he same period uniformly to all tenants in the Building. 4.5.3 Notwithstanding any contrary provision herein, Tenant shall pay prior to delinquency any (i) rent tax or sales tax, service tax, transfer tax or value added tax, or any other applicable tax on the rent or services herein or otherwise respecting this Lease, (ii) taxes assessed upon or with respect to the possession, leasing, operation, management, maintenance, alteration, repair, use or occupancy by Tenant of the Premises or any portion of the Project, including the Project parking facility, or (iii) taxes assessed upon this transaction or any document to which Tenant is a party creating or transferring an interest or an estate in the Premises. 4.6 Landlord's Books and Records. Within six (6) months after receipt of a Statement by Tenant, if Tenant disputes the amount of Additional Rent set forth in the Statement, an independent certified public accountant (which accountant is a member of a nationally recognized accounting firm, has previous experience in reviewing financial operating records of landlords of office buildings, and is retained by Tenant on a non-contingency fee basis)(the "Tenant Auditor"), designated and paid for by Tenant, may, alter reasonable notice to Landlord and at reasonable times, inspect Landlord's records with respect to the Statement at Landlord's offices, provided that Tenant is not then in default under this Lease and Tenant has paid all amounts required to be paid under the applicable Estimated Statement and Statement, as the case may be. In connection with such inspection, Tenant and Tenant's agents must agree in advance to follow Landlord's reasonable rules and procedures regarding inspections of Landlord's records, and shall execute a commercially reasonable confidentiality agreement regarding such inspection. Tenant's failure to dispute the amount of Additional Rent set forth in any Statement within six (6) months following Tenant's receipt of such Statement shall be deemed to be Tenant's approval of such Statement and Tenant, thereafter, waives the right or ability to dispute the amounts set forth in such Statement. If after such inspection, Tenant still disputes such Additional Rent, a determination as to the proper amount shall be made, at Tenant's expense, by an independent certified public accountant (the "Accountant") selected by Landlord and subject to Tenant's reasonable approval; provided that if such certification by the Accountant proves that Direct Expenses were overstated by more than five percent (5%), then the cost of the Accountant, and the cost of such determination certification, shall be paid for by Landlord. Any reimbursement amounts determined to be owing by Landlord to Tenant or by Tenant to Landlord shall be (i) in the case of amounts owing from Tenant to Landlord, paid within thirty (30) days following such determination, and (ii) in the case of amounts owing from Landlord to Tenant, credited against the next payment of Rent due Landlord under the terms of this Lease, or if the Lease Term has expired, paid to Tenant within thirty (30) days following such determination, In no event shall this Section 4.6 be deemed to allow any review of any of Landlord's records by any subtenant of Tenant. Tenant agrees that this Section 4,6 shall be the sole method to be used by Tenant to dispute the amount of any Direct Expenses payable or not payable by Tenant pursuant to the terms of this Lease, and Tenant hereby waives any other rights at law or in equity relating thereto. 4.7 Security Deposit. 4.7.1 Security Deposit. Upon execution of this Lease, Tenant shall deposit or cause to be deposited with Landlord a cash sum in the amount equal Twenty-Eight Thousand One Hundred Ninety and 60/100 Dollars ($28,190.60) (the "Security Deposit"). Landlord shall hold the Security Deposit as security for the performance of Tenant's obligations under this Lease. If Tenant defaults on any provision of this Lease, Landlord may, after such notice as may be required under this Lease and without prejudice to any other remedy it has, apply all or a part of the Security Deposit to: 4.7.1.1 Any Rent or other sum in default; or 4.7.1.2 Any expense, loss, or damage that Landlord may suffer because of Tenant's default. -10- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 4.7.2 Landlord's Transfer of Security Deposit on Transfer of Real Property. If Landlord disposes of its interests in the Premises, Landlord may deliver or credit the Security Deposit to Landlord's successor-in-interest in the Premises and thereupon be relieved of further responsibility with respect to the Security Deposit. 4.7.3 Restoration of Security Deposit. If Landlord applies any portion of the Security Deposit pursuant to Section 4.7.1 above, Tenant shall, within thirty (30) days after demand by Landlord, deposit with Landlord an amount sufficient to restore the Security Deposit to its original amount. 4.7.4 Interest on Security Deposit. Tenant is not entitled to any interest on the Security Deposit. 4.7.5 Return of Security Deposit. If Tenant performs every provision of this Lease to be performed by Tenant, the unused portion of the Security Deposit shall be returned to Tenant or the last assignee of Tenant's interest under this Lease within thirty (30) days following the expiration or termination of the Lease Term. ARTICLE 5 USE OF PREMISES 5.1 Permitted Use. Tenant shall use the Premises solely for the Permitted Use set forth in Section 7 of the Summary and Tenant shall not use or permit the Premises or the Project to be used for any other purpose or purposes whatsoever without the prior written consent of Landlord, which maybe withheld in Landlord's sole discretion. 5.2 Prohibited Uses. Tenant further covenants and agrees that Tenant shall not use, or suffer or permit any person or persons to use, the Premises or any part thereof for any use or purpose contrary to the provisions of the Rules and Regulations set forth in Exhibit D, attached hereto, or in violation of the laws of the United States of America, the State of California, or the ordinances, regulations or requirements of the local municipal or county governing body or other lawful authorities having jurisdiction over the Project including, without limitation, any such laws, ordinances, regulations or requirements relating to hazardous materials or substances, as those terms are defined by applicable laws now or hereafter in effect. Tenant shall not do or permit anything to be done in or about the Premises which will in any way obstruct or interfere with the rights of other tenants or occupants of the Building or Project, or injure or annoy them or use or allow the Premises to he used for any improper, unlawful or objectionable purpose, nor shall Tenant cause, maintain or permit any nuisance in, on or about the Premises. Tenant shall comply with, and Tenant's rights and obligations under the Lease and Tenant's use of the Premises shall be subject and subordinate to, all recorded easements, covenants, conditions, and restrictions now or hereafter affecting the Project. ARTICLE 6 SERVICES AND UTILITIES 6.1 Standard Tenant Services. Landlord shall provide the following services on all days (unless otherwise stated below) during the Lease Term. 6.1.1 Subject to limitations imposed by all governmental rules, regulations and guidelines applicable thereto, Landlord shall provide heating, ventilation and air conditioning ("HVAC") when necessary for normal comfort for normal office use in the Premises from 8:00 A.M. to 6:00 P.M. Monday through Friday, and on Saturdays from 8:00 A.M. to Twelve Noon (collectively, the "Building Hours"), except for the date of observation of New Year's Day, Independence Day, Labor Day, Memorial Day, Thanksgiving Day, Christmas Day and, at Landlord's discretion, other locally or nationally recognized holidays (collectively, the "Holidays). 6.1.2 Landlord shall provide adequate electrical wiring and facilities for connection to Tenant's lighting fixtures and incidental use equipment, provided that (i) the connected electrical load of the incidental use equipment docs not. exceed an average of six (6) watts per usable square foot of the Premises, and (ii) the connected electrical load of Tenant's -11- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] lighting fixtures does not exceed an average of two (2) walls per usable square foot of the Premises, which electrical usage shall be subject to applicable laws and regulations, including Title 24. Tenant shall bear the cost of replacement of lamps, starters and ballasts for non-Building standard lighting fixtures within the Premises. 6.1.3 Landlord shall provide city water from the regular Building outlets for drinking, lavatory and toilet purposes in the Building Common Areas. 6.1.4 Landlord shall provide janitorial services to the Premises and window washing services in a manner consistent with Comparable Buildings. 6.1.5 Landlord shall provide nonexclusive, non-attended automatic passenger elevator service during the Building Hours, shall have one elevator available at all other times, including on the Holidays. 6.1.6 Landlord shall provide nonexclusive freight elevator service subject to scheduling by Landlord. Tenant shall cooperate fully with Landlord at all times and abide by all regulations and requirements that Landlord may reasonably prescribe for the proper functioning and protection of the HVAC, electrical, mechanical and plumbing systems. 6.2 Overstandard Tenant Use. 6.2.1 Non-Electrical Usage. Tenant shall not, without Landlord's prior written consent, use heat-generating machines, machines other than normal fractional horsepower office machines, or equipment or lighting other than Building standard lights in the Premises, which may affect the temperature otherwise maintained by the air conditioning system or increase the water normally furnished for the Premises by Landlord pursuant to the terms of Section 6.1 of this Lease. If Tenant uses water, heat or air conditioning in excess of that supplied by Landlord pursuant to Section 6.1 of this Lease, Tenant shall pay to Landlord, upon billing, the actual cost of such excess consumption, the cost of the installation, operation, and maintenance of equipment which is installed in order to supply such excess consumption, and the cost of the increased wear and tear on existing equipment caused by such excess consumption; and Landlord may install devices to separately meter any increased use and in such event Tenant shall pay the cost of such increased use directly to Landlord, on demand, at the rates charged by the public utility company furnishing the same, including the cost of such additional metering devices. If Tenant desires to use HVAC during non-Building Hours, Tenant shall give Landlord such prior notice, if any, as Landlord shall from time to time establish as appropriate, of Tenant's desired use in order to supply HVAC, and Landlord shall supply HVAC to the Premises. The cost of after-hours HVAC is currently Sixty Dollars ($60) per hour, per floor. Such cost shall increase hereafter to the extent of increases in the direct and indirect costs to Landlord of providing such HVAC services. The cost of HVAC supplied by Landlord during non-Building Hours shall be paid by Tenant as Additional Rent. 6.2.2 Electrical Usage. If in any month Tenant uses electricity (not including any electricity consumed in connection with the operation of the Building's main HVAC system) in excess of the "Electricity Usage Standard" (as defined below), Tenant shall pay to Landlord, upon billing, Landlord's cost of such excess consumption and the reasonable cost of the installation, operation, and maintenance of equipment which is required to be installed to supply such excess capacity and/or consumption to Tenant. For purposes hereof, the "Electricity Usage Standard" shall be an average of five (5) watts per rentable square foot of the Premises of actual consumption, on a monthly Business Hours basis. Tenant's use of electricity shall not exceed the capacity of the feeders to the Project or the risers or wiring installation (which capacity is eight (8) watts per rentable square fool) and Tenant shall promptly discontinue any such excess use promptly following receipt of notice of the same from Landlord. In those cases where Landlord proposes to install equipment to be paid for by Tenant or otherwise is proposing to require Tenant to pay for any cost related to such excess consumption, Tenant may require Landlord, as a condition of such charge by Landlord, to reasonably demonstrate that Landlord's actions and such charges are consistent with the requirement of this Lease, -12- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 6.3 Interruption of Use. Tenant agrees that Landlord shall not be liable for damages, by abatement of Rent or otherwise, for failure to furnish or delay in furnishing any service (including telephone and telecommunication services), or for any diminution in the quality or quantity thereof, when such failure or delay or diminution is occasioned, in whole or in part, by breakage, repairs, replacements, or improvements, by any strike, lockout or other labor trouble, by inability to secure electricity, gas, water, or other fuel at the Building or Project after reasonable effort to do so, by any riot or other dangerous condition, emergency, accident or casualty whatsoever, by act or default of Tenant or other parties, or by any other cause beyond Landlord's reasonable control; and such failures or delays or diminution shall never be deemed to constitute an eviction or disturbance of Tenant's use and possession of the Premises or relieve Tenant from paying Rent or performing any of its obligations under this Lease. Furthermore, Landlord shall not be liable under any circumstances for a loss of, or injury to, property or for injury to, or interference with, Tenant's business, including, without limitation, loss of profits, however occurring, through or in connection with or incidental to a failure to furnish any of the services or utilities as set forth in this Article 6. ARTICLE 7 REPAIRS Tenant shall, at Tenant's own expense, keep the Premises, including all improvements, fixtures and furnishings therein, and the floor or floors of the Building on which the Premises are located, in good order, repair and condition at all times during the Lease Term. In addition, Tenant shall, at Tenant's own expense, but under the supervision and subject to the prior approval of Landlord, and within any reasonable period of time specified by Landlord, promptly and adequately repair all damage to the Premises and replace or repair all damaged, broken, or worn fixtures and appurtenances, except for damage caused by ordinary wear and tear or beyond the reasonable control of Tenant; provided however, that, at Landlord's option, or if Tenant fails to make such repairs, Landlord may, but need not, make such repairs and replacements, and Tenant shall pay Landlord the cost thereof, including a percentage of the cost thereof (to be uniformly established for the Building and/or the Project) sufficient to reimburse Landlord for all overhead, general conditions, fees and other costs or expenses arising from Landlord's involvement with such repairs and replacements forthwith upon being billed for same. Landlord may, but shall not be required to, enter the Premises at all reasonable times to make such repairs, alterations, improvements or additions to the Premises or to the Project or to any equipment located in the Project as Landlord shall desire or deem necessary or as Landlord may be required to do by governmental or quasi-governmental authority or court order or decree. Tenant hereby waives any and all rights under and benefits of subsection 1 of Section 1932 and Sections 1941 and 1942 of the California Civil Code or under any similar law, statute, or ordinance now or hereafter in effect. ARTICLE 8 ADDITIONS AND ALTERATIONS 8.1 Landlord's Consent to Alterations. Tenant may not make any improvements, alterations, additions or changes to the Premises or any mechanical, plumbing or HVAC facilities or systems pertaining to the Premises (collectively, the "Alterations") without first procuring the prior written consent of Landlord to such Alterations, which consent shall be requested by Tenant not less than thirty (30) days prior to the commencement thereof, and which consent shall not be unreasonably withheld by Landlord, provided it shall be deemed reasonable for Landlord to withhold its consent to any Alteration which adversely affects the structural portions or the systems or equipment of the Building or is visible from the exterior of the Building. The construction of the initial improvements to the Premises shall be governed by the terms of the Tenant Work Letter and not the terms of this Article 8. 8.2 Manner of Construction. 8.2.1 Conditions to Alterations. Landlord may impose, as a condition of its consent to any and all Alterations or repairs of the Premises or about the Premises, such requirements as Landlord in its reasonable discretion may deem desirable, including, but not limited to, (i) the requirement that Tenant utilize for such purposes only contractors, subcontractors, materials, mechanics and materialmen selected by Tenant from a list provided and approved by Landlord, and (ii) the requirement that upon Landlord's request, Tenant shall, at -13- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Tenant's expense, remove such Alterations upon the expiration or any early termination of the Lease Term. Tenant shall construct such Alterations and perform such repairs in a good and workmanlike manner, in conformance with any and all applicable federal, state, county or municipal laws, rules and regulations and pursuant to a valid building permit, issued by the City of Irvine, all in conformance with Landlord's construction rules and regulations; provided, however, that prior to commencing to construct any Alteration, Tenant shall meet with Landlord to discuss Landlord's design parameters and code compliance issues. In performing the work of any such Alterations, Tenant shall have the work performed in such manner as not to obstruct access to the Project or any portion thereof, by any other tenant of the Project, and so as not to obstruct the business of Landlord or other tenants in the Project. Tenant shall not use (and upon notice from Landlord shall cease using) contractors, services, workmen, labor, materials or equipment that, in Landlord's reasonable judgment, would disturb labor harmony with the workforce or trades engaged in performing other work, labor or services in or about the Building or the Common Areas. In addition to Tenant's obligations under Article 9 of this Lease, upon completion of any Alterations, Tenant agrees to cause a Notice of Completion to be recorded in the office of the Recorder of the County of Orange in accordance with Section 3093 of the Civil Code of the State of California or any successor statute, and Tenant shall deliver to the Project construction manager a reproducible copy of the "as built" drawings of the Alterations, as well as all permits, approvals and other documents issued by any governmental agency in connection with the Alterations. 8.2.2 Base Building Changes. In the event any Alterations which Tenant proposes to make to the Premises require or give rise to governmentally-required changes ("Additional Required Work") to the Base Building, Landlord and Tenant shall work together to eliminate, if possible, or otherwise minimize the Additional Required Work. Absent elimination of such Additional Required Work or a mutually acceptable allocation of such changes as between Landlord and Tenant, the cost of such changes shall be borne by Tenant. As used herein, (i) "Base Building" means the structural portions of the Building, the Base Building Systems, the public restrooms, elevators, exit stairwells and the systems and equipment located in the internal core of the Building, and (ii) "Base Building Systems" means all systems and equipment (including plumbing, HVAC, electrical fire/life/safety elevator and security systems) that serve all or part of the Building. 8.3 Payment for Improvements. Except as otherwise provided in Section 8.4 below with respect to the Initial Alterations (as defined below) if payment is made directly to contractors, Tenant shall (i) comply with Landlord's requirements for final lien releases and waivers in connection with Tenant's payment for work to contractors, and (ii) cause its contractors to sign Landlord's standard contractor's rules and regulations. If Tenant orders any work directly from Landlord, Tenant shall pay to Landlord an amount equal to five percent (5%) of the cost of such work to compensate Landlord for all overhead, general conditions, fees and other costs and expenses arising from Landlord's involvement with such work, If Tenant does not order any work directly from Landlord, Tenant shall reimburse Landlord for Landlord's reasonable, actual, out-of-pocket costs and expenses actually incurred in connection with Landlord's review of such work. 8.4 Payment For Initial Alterations. Notwithstanding anything herein to the contrary, Landlord shall reimburse Tenant in the maximum amount of Fifty-Three Thousand Four Hundred Fifty Dollars ($53,450) for costs incurred for painting of painted walls in the Premises and carpeting in the Premises (the "Initial Alterations") subject to the following conditions: 8.4.1 The cost of the Initial Alterations shall be incurred and the installation of the Initial Alterations shall occur between April 1, 2005 and July 31, 2005; 8.4.2 The Initial Alterations shall be Alterations for purposes of this Lease and shall be subject to the terms and provisions of this Lease including Article 8; 8.4.3 The Initial Alterations shall equal or exceed in quality Landlord's then Building standard for carpeting and paint; -14- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 8.4.4 Tenant shall provide to Landlord such evidence as Landlord may reasonably require to confirm the actual out-of-pocket cost and expense actually incurred for the Initial Alterations; and 8.4.5 Landlord shall provide the Initial Alterations reimbursement to Tenant within thirty (30) days after the later of (i) completion and/or installation of initial Alterations and (ii) receipt of final lien releases and waivers or, at Landlord's option, conditional lien releases and waivers for the Initial Alterations. Nothing herein shall impose on Landlord any liability or responsibility for the Initial Alterations. 8.5 Construction Insurance. In addition to the requirements of Article 10 of this Lease, in the event that Tenant makes any Alterations, prior to the commencement of such Alterations, Tenant shall provide Landlord with evidence that Tenant carries "Builder's All Risk" insurance in an amount approved by Landlord covering the construction of such Alterations, and such other insurance as Landlord may reasonably require, it being understood and agreed that all of such Alterations shall be insured by Tenant pursuant to Article 10 of this Lease immediately upon completion thereof. In addition, in connection with any Alteration, Landlord may, in its discretion, require Tenant to obtain a lien and completion bond or some alternate form of security satisfactory to Landlord in an amount sufficient to ensure the lien-free completion of such Alterations and naming Landlord as a co-obligee. 8.6 Landlord's Property. All Alterations, improvements, fixtures, equipment and/or appurtenances which may be installed or placed in or about the Premises, from time to time, shall be at the sole cost of Tenant and shall be and become the property of Landlord, except that Tenant may remove any Alterations, improvements, fixtures and/or equipment which Tenant can substantiate to Landlord have not been paid for with any Tenant improvement allowance funds provided to Tenant by Landlord, provided Tenant repairs any damage to the Premises and Building caused by such removal and returns the affected portion of the Premises to a building standard tenant improved condition as determined by Landlord. Furthermore, Landlord may, by written notice to Tenant prior to the end of the Lease Term, or given following any earlier termination of this Lease, require Tenant, at Tenant's expense, to remove any such Alterations or improvements and to repair any damage to the Premises and Building caused by such removal and returns the affected portion of the Premises to a building standard tenant improved condition as determined by Landlord. If Tenant fails to complete such removal and/or to repair any damage caused by the removal of any Alterations or improvements in the Premises and return the affected portion of the Premises to a building standard tenant improved condition as reasonably determined by Landlord, Landlord may do so and may charge the cost thereof to Tenant. Tenant hereby protects, defends, indemnifies and holds Landlord harmless from any liability, cost, obligation, expense or claim of lien in any manner relating to the installation, placement, removal or financing of any such Alterations, improvements, fixtures and/or equipment in, on or about the Premises, which obligations of Tenant, shall survive the expiration or earlier termination of this Lease. 8.7 Communications and Computer Lines. Tenant may install, maintain, replace, remove or use any communications or computer wires and cables (collectively, the "Lines") in or serving the Premises, provided that (i) Tenant shall obtain Landlord's prior, written consent, use an experienced and qualified contractor approved in writing by Landlord, and comply with all of the other provisions of Articles 7 and 8 of this Lease, (ii) an acceptable number of spare Lines and space for additional Lines shall he maintained for existing and future occupants of the Project, as determined in Landlord's reasonable opinion, (iii) the Lines therefor (including riser cables) shall be appropriately insulated to prevent excessive electromagnetic fields or radiation, and shall be surrounded by a protective conduit reasonably acceptable to Landlord, (iv) any new or existing Lines servicing the Premises shall comply with all applicable governmental laws and regulations, (v) as a condition to permitting the installation of new Lines, Landlord may require that Tenant remove existing Lines located in or serving the Premises and repair any damage in connection with such removal, and (vi) Tenant shall pay all costs in connection therewith. Landlord reserves the right to require that Tenant remove any Lines located in or serving the Premises which are installed in violation of these provisions, or which are at any time in violation of any laws or represent a dangerous or potentially dangerous condition. -15- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] ARTICLE 9 COVENANT AGAINST LIENS Tenant shall keep the Project, and Premises free from any liens or encumbrances arising out of the work performed, materials furnished or obligations incurred by or on behalf of Tenant, and shall protect, defend, indemnify and hold Landlord harmless from and against any claims, liabilities, judgments or costs (including, without limitation, reasonable attorneys' fees and costs) arising out of same or in connection therewith. Tenant shall give Landlord notice at least twenty (20) days prior to the commencement of any such work on the Premises (or such additional time as may be necessary under applicable laws) to afford Landlord the opportunity of posting and recording appropriate notices of non-responsibility. Tenant shall remove any such lien or encumbrance by bond or otherwise within ten (10) days after notice by Landlord, and if Tenant shall fail to do so, Landlord may pay the amount necessary to remove such lien or encumbrance, without being responsible for investigating the validity thereof. The amount so paid shall be deemed Additional Rent under this Lease payable upon demand, without limitation as to other remedies available to Landlord under this Lease. Nothing contained in this Lease shall authorize Tenant to do any act which shall subject Landlord's title to the Building or Premises to any liens or encumbrances whether claimed by operation of law or express or implied contract, Any claim to a lien or encumbrance upon the Building or Premises arising in connection with any such work or respecting the Premises not performed by or at the request of Landlord shall be null and void, or at Landlord's option shall attach only against Tenant's interest in the Premises and shall in all respects be subordinate to Landlord's title to the Project, Building and Premises. ARTICLE 10 INSURANCE 10.1 Indemnification and Waiver. Tenant hereby assumes all risk of damage to property or injury to persons in, upon or about the Premises from any cause whatsoever (including, but not limited to, any personal injuries resulting from a slip and fall in, upon or about the Premises) and agrees that Landlord, its partners, subpartners and their respective officers, agents, servants, employees, and independent contractors (collectively, "Landlord Parties") shall not be liable for, and are hereby released from any responsibility for, any damage either to person or property or resulting from the loss of use thereof, which damage is sustained by Tenant or by other persons claiming through Tenant. Tenant shall indemnity, defend, protect, and hold harmless the Landlord Parties from any and all loss, cost, damage, expense and liability (including without limitation court costs and reasonable attorneys' fees) incurred in connection with or arising from any cause in, on or about the Premises (including, but not limited to, a slip and fall), any acts, omissions or negligence of Tenant or of any person claiming by, through or under Tenant, or of the contractors* agents, servants, employees, invitees, guests or licensees of Tenant or any such person, in, on or about the Project or any breach of the terms of this Lease, either prior to, during, or after the expiration of the Lease Term, provided that the terms of the foregoing indemnity shall not apply to the gross negligence or willful misconduct of Landlord. Should Landlord be named as a defendant in any suit brought against Tenant in connection with or arising out of Tenant's occupancy of the Premises, Tenant shall pay to Landlord its costs and expenses incurred in such suit, including without limitation, its actual professional fees such as reasonable appraisers', accountants' and attorneys' fees. The provisions of this Section 10.1 shall survive the expiration or sooner termination of this Lease with respect to any claims or liability arising in connection with any event occurring prior to such expiration or termination. 10.2 Tenant's Compliance With Landlord's Fire and Casualty Insurance. Tenant shall, at Tenant's expense, comply with all insurance company requirements pertaining to the use of the Premises. If Tenant's conduct or use of the Premises causes any increase in the premium for such insurance policies then Tenant shall reimburse Landlord for any such increase. Tenant, at Tenant's expense, shall comply with all rules, orders, regulations or requirements of the American Insurance Association (formerly the National Board of Fire Underwriters) and with any similar body. 10.3 Tenant's Insurance. Tenant shall maintain the following coverages in the following amounts. -16- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 10.3.1 Commercial General Liability Insurance covering the insured against claims of bodily injury, personal injury and property damage (including loss of use thereof) arising out of Tenant's operations, and contractual liabilities (covering the performance by Tenant of its indemnity agreements) including a Broad Form endorsement covering the insuring provisions of this Lease and the performance by Tenant of the indemnity agreements set forth in Section 10.1 of this Lease, for limits of liability not less than: Bodily Injury and $5,000,000 each occurrence Property Damage Liability $5,000,000 annual aggregate Personal Injury Liability $5,000,000 each occurrence $5,000,000 annual aggregate 0% Insured's participation 10.3.2 Physical Damage Insurance covering (i) all office furniture, business and trade fixtures, office equipment, free-standing cabinet work, movable partitions, merchandise and all other items of Tenant's property on the Premises installed by, for, or at the expense of Tenant, (ii) improvements which exist in the Premises as of the Lease Commencement Date (excluding the Base Building) (the "Original Improvements"), and (iii) all other improvements, alterations and additions to the Premises. Such insurance shall be written on an "all risks" of physical loss or damage basis, for the full replacement cost value (subject to reasonable deductible amounts) new without deduction for depreciation of the covered items and in amounts that meet any co-insurance clauses of the policies of insurance and shall include coverage for damage or other loss caused by fire or other peril including, but not limited to, vandalism and malicious mischief, theft, water damage of any type, including sprinkler leakage, bursting or stoppage of pipes, and explosion, and providing business interruption coverage for a period of one year. 10.3.3 Worker's Compensation and Employer's Liability or other similar insurance pursuant to all applicable state and local statutes and regulations. 10.4 Form of Policies. The minimum limits of policies of insurance required of Tenant under this Lease shall in no event limit the liability of Tenant under this Lease. Such insurance shall (i) name Landlord, and any other party the Landlord so specifies, as an additional insured, including Landlord's managing agent, if any; (ii) specifically cover the liability assumed by Tenant under this Lease, including, but not limited to, Tenant's obligations under Section 10.1 of this Lease; (iii) be issued by an insurance company having a rating of not less than A-X in Best's Insurance Guide or which is otherwise acceptable to Landlord and licensed to do business in the State of California; (iv) be primary insurance as to all claims thereunder and provide that any insurance carried by Landlord is excess and is non-contributing with any insurance requirement of Tenant; (v) be in form and content reasonably acceptable to Landlord; and (vi) provide that said insurance shall not be canceled or coverage changed unless thirty (30) days' prior written notice shall have been given to Landlord and any mortgagee of Landlord. Tenant shall deliver said policy or policies or certificates thereof to Landlord on or before the Lease Commencement Date and at least thirty (30) days before the expiration dates thereof. In the event Tenant shall fail to procure such insurance, or to deliver such policies or certificate, Landlord may, at its option, procure such policies for the account of Tenant, and the cost thereof shall be paid to Landlord within five (5) days after delivery to Tenant of bills therefor. 10.5 Subrogation. Landlord and Tenant intend that their respective property loss risks shall be borne by insurance carriers to the extent above provided, and Landlord and Tenant hereby agree to look solely to, and seek recovery only from, their respective insurance carriers in the event of a property loss to the extent that such coverage is agreed to be provided hereunder. The parties each hereby waive all rights and claims against each other for such losses, and waive all rights of subrogation of their respective insurers, provided such waiver of subrogation shall not affect the right to the insured to recover thereunder. The parties agree that their respective insurance policies are now, or shall be, endorsed such that the waiver of subrogation shall not affect the right of the insured to recover thereunder, so long as no material additional premium is charged therefor. 10.6 Additional Insurance Obligations. Tenant shall carry and maintain during the entire Lease Term, at Tenant's sole cost and expense, increased amounts of the insurance -17- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] required to be carried by Tenant pursuant to this Article 10 and such other reasonable types of insurance coverage and in such reasonable amounts covering the Premises and Tenant's operations therein, as may be reasonably requested by Landlord, but in no event in excess of the amounts and types of insurance then being required of tenants in Comparable Buildings occupying comparable space and engaged in a similar use as Tenant. ARTICLE 11 DAMAGE AND DESTRUCTION 11.1 Repair of Damage to Premises by Landlord. 11.1.1 Damage to Building. Tenant shall promptly notify Landlord of any damage to the Premises resulting from fire or any other casualty. If the Premises or any Common Areas serving or providing access to the Premises shall be damaged by fire or other casualty, Landlord shall promptly and diligently, subject to reasonable delays for insurance adjustment or other matters beyond Landlord's reasonable control, and subject to all other terms of this Article 11, restore the Base Building and such Common Areas. Such restoration shall be to substantially the same condition of the Base Building and the Common Areas prior to the casualty, except for modifications required by zoning and building codes and other laws or by the holder of a mortgage on the Building or Project or any other modifications to the Common Areas deemed desirable by Landlord, which are consistent with the character of the Project, provided that access to the Premises and any restrooms serving the Premises shall not be materially impaired. 11.1.2 Damage to Premises. Upon the occurrence of any damage to the Premises, upon notice (the "Landlord Repair Notice") to Tenant from Landlord, Tenant shall assign to Landlord (or to any party designated by Landlord) all insurance proceeds payable to Tenant under Tenant's insurance required under Section 10.3.2(ii) and (iii) of this Lease, and Landlord shall repair any injury or damage to the Original Improvements installed in the Premises and shall return such Original Improvements to their original condition; provided that if the cost of such repair by Landlord exceeds the amount of insurance proceeds received by Landlord from Tenant's insurance carrier, as assigned by Tenant, the cost of such repairs shall be paid by Tenant to Landlord prior to Landlord's commencement of repair of the damage. In the event that Landlord does not deliver the Landlord Repair Notice within sixty (60) days following the date the casualty becomes known to Landlord, Tenant shall, at its sole cost and expense, repair any injury or damage to the Original Improvements installed in the Premises and shall return such Original Improvements to their original condition. Whether or not Landlord delivers a Landlord Repair Notice, prior to the commencement of construction, Tenant shall submit to Landlord, for Landlord's review and approval, all plans, specifications and working drawings relating thereto, and Landlord shall select the contractors to perform such improvement work. Landlord shall not be liable for any inconvenience or annoyance to Tenant or its visitors, or injury to Tenant's business resulting in any way from such damage or the repair thereof; provided however, that if such fire or other casualty shall have damaged the Premises or Common Areas necessary to Tenant's occupancy, and the Premises are not occupied by Tenant as a result thereof, then during the time and to the extent the Premises are unfit for occupancy, the Rent shall be abated in proportion to the ratio that the amount of rentable square feet of the Premises which is unfit for occupancy for the purposes permitted under this Lease bears to the total rentable square feet of the Premises. In the event that Landlord shall not deliver the Landlord Repair Notice, Tenant's right to rent abatement pursuant to the preceding sentence shall terminate as of the date which is reasonably determined by Landlord to be the date Tenant should have completed repairs to the Premises assuming Tenant used reasonable due diligence in connection therewith. 11.2 Landlord's Option to Repair. Notwithstanding the terms of Section 11.1 of this Lease, Landlord may elect not to rebuild and/or restore the Premises, Building and/or Project, and instead terminate this Lease, by notifying Tenant in writing of such termination within sixty (60) days after the date of discovery of the damage, such notice to include a termination date giving Tenant sixty (60) days to vacate the Premises, but Landlord may so elect only if the Building or Project shall be damaged by fire or other casualty or cause, whether or not the Premises are affected, and one or more of the following conditions is present: (i) in Landlord's reasonable judgment, repairs cannot reasonably be completed within one hundred eighty (180) -18- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] days after the date of discovery of the damage (when such repairs are made without the payment of overtime or other premiums); (ii) the holder of any mortgage on the Building or Project or ground lessor with respect to the Building or Project shall require that the insurance proceeds or any portion thereof be used to retire the mortgage debt, or shall terminate the ground lease, as the case may be; (iii) the damage is not fully covered by Landlord's insurance policies; (iv) Landlord decides to rebuild the Building or Common Areas so that they will be substantially different structurally or architecturally; or (v) the damage occurs during the last twelve (12) months of the Lease Term. In the event Landlord does not terminate this Lease as set forth above, and in Landlord's reasonable judgment, (A) the repairs cannot be completed within such one hundred eighty (180) days, as set forth in (i) above, or (B) if the damage occurs during the last twelve (12) months of the Lease Term and the repairs cannot be completed within one hundred twenty (120) days after the date of discovery of the damage, Landlord shall provide Tenant with written notice ("Extended Repair Notice") of the time within which such repairs may be completed, in Landlord's reasonable judgment. 11.3 Tenant's Option to Cause Early Expiration. If damage to the Project, Building or Premises causes the Premises to be unusable for their intended purposes and Landlord advises Tenant in the Extended Repair Notice that (i) repairs cannot be completed within one hundred eighty days (180) days after the date of discovery of the damage, or (ii) if the damage occurs during the last twelve (12) months of the Lease Term, repairs cannot be completed within one hundred twenty (120) days after the date of discovery of the damage, Tenant may elect to cause the Expiration Date to be accelerated. Such election shall be made in writing to Landlord within thirty (30) days after receipt of the Extended Repair Notice. Tenant's election to accelerate the Expiration Date shall be made by written notice to Landlord within thirty(30) days after receipt of Landlord's Notice and shall specify the new Expiration Date, which date shall not be later than forty-five (45) days after Tenant's receipt of the Extended Repair Notice. 11.4 Waiver of Statutory Provisions. The provisions of this Lease, including this Article 11, constitute an express agreement between Landlord and Tenant with respect to any and all damage to, or destruction of, all or any part of the Premises, the Building or the Project, and any statute or regulation of the State of California, including, without limitation, Sections 1932(2) and 1933(4) of the California Civil Code, with respect to any rights or obligations concerning damage or destruction in the absence of an express agreement between the parties, and any other statute or regulation, now or hereafter in effect, shall have no application to this Lease or any damage or destruction to all or any part of the Premises, the Building or the Project. ARTICLE 12 NONWAIVER No provision of this Lease shall be deemed waived by either party hereto unless expressly waived in a writing signed thereby. The waiver by either party hereto of any breach of any term, covenant or condition herein contained shall not be deemed to be a waiver of any subsequent breach of same or any other term, covenant or condition herein contained. The subsequent acceptance of Rent hereunder by Landlord shall not be deemed to be a waiver of any preceding breach by Tenant of any term, covenant or condition of this Lease, other than the failure of Tenant to pay the particular Rent so accepted, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such Rent. No acceptance of a lesser amount than the Rent herein stipulated shall be deemed a waiver of Landlord's right to receive the full amount due, nor shall any endorsement or statement on any check or payment or any letter accompanying such check or payment be deemed an accord and satisfaction, and Landlord may accept such check or payment without prejudice to Landlord's right to recover the full amount due. No receipt of monies by Landlord from Tenant after the termination of this Lease shall in any way alter the length of the Lease Term or of Tenant's right of possession hereunder, or after the giving of any notice shall reinstate, continue or extend the Lease Term or affect any notice given Tenant prior to the receipt of such monies, it being agreed that after the service of notice or the commencement of a suit, or after final judgment for possession of the Premises, Landlord may receive and collect any Rent due, and the payment of said Rent shall not waive or affect said notice, suit or judgment. -19- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] ARTICLE 13 CONDEMNATION If the whole or any material part of the Premises, Building or Project shall be taken by power of eminent domain or condemned by any competent authority for any public or quasi-public use or purpose, or if any adjacent property or street shall be so taken or condemned, or reconfigured or vacated by such authority in such manner as to require the use, reconstruction or remodeling of any material part of the Premises, Building or Project, or if Landlord shall grant a deed or other instrument in lieu of such taking by eminent domain or condemnation, Landlord shall have the option to terminate this Lease effective as of the date possession is required to be surrendered to the authority. If more than twenty-five percent (25%) of the rentable square feet of the Premises is taken, or if access to the Premises is substantially impaired, in each case for a period in excess of one hundred eighty (180) days, Tenant shall have the option to terminate this Lease effective as of the date possession is required to be surrendered to the authority. Tenant shall not because of such taking assert any claim against Landlord or the authority for any compensation because of such taking and Landlord shall be entitled to the entire award or payment in connection therewith, except that Tenant shall have the right to file any separate claim available to Tenant for any taking of Tenant's personal property and fixtures belonging to Tenant and removable by Tenant upon expiration of the Lease Term pursuant to the terms of this Lease, and for moving expenses, so long as such claims do not diminish the award available to Landlord, its ground lessor with respect to the Building or Project or its mortgagee, and such claim is payable separately to Tenant. All Rent shall be apportioned as of the date of such termination. If any part of the Premises shall be taken, and this Lease shall not be so terminated, the Rent shall be proportionately abated. Tenant hereby waives any and all rights it might otherwise have pursuant to Section 1265.130 of the California Code of Civil Procedure. Notwithstanding anything to the contrary contained in this Article 13, in the event of a temporary taking of all or any portion of the Premises for a period of one hundred eighty (180) days or less, then this Lease shall not terminate but the Base Rent and the Additional Rent shall be abated for the period of such taking in proportion to the ratio that the amount of rentable square feet of the Premises taken bears to the total rentable square feet of the Premises. Landlord shall be entitled to receive the entire award made in connection with any such temporary taking. ARTICLE 14 ASSIGNMENT AND SUBLETTING 14.1 Transfers. Tenant shall not, without the prior written consent of Landlord, assign, mortgage, pledge, hypothecate, encumber, or permit any lien to attach to, or otherwise transfer, this Lease or any interest hereunder, permit any assignment, or other transfer of this Lease or any interest hereunder by operation of law, sublet the Premises or any part thereof, or enter into any license or concession agreements or otherwise permit the occupancy or use of the Premises or any part thereof by any persons other than Tenant and its employees and contractors (all of the foregoing are hereinafter sometimes referred to collectively as "Transfer(s)" and any person to whom any Transfer is made or sought to be made is hereinafter sometimes referred to as a "Transferee"). If Tenant desires Landlord's consent to any Transfer, Tenant shall notify Landlord in writing, which notice (the "Transfer Notice") shall include (i) the proposed effective date of the Transfer, which shall not be less than thirty (30) days nor more than one hundred eighty (180) days after the date of delivery of the Transfer Notice, (ii) a description of the portion of the Premises to be transferred (the "Subject Space"), (iii) all of the terms of the proposed Transfer and the consideration therefor, including calculation of the "Transfer Premium", as that term is defined in Section 14.3 below, in connection with such Transfer, the name and address of the proposed Transferee, and a copy of all existing executed and/or proposed documentation pertaining to the proposed Transfer, including all existing operative documents to be executed to evidence such Transfer or the agreements incidental or related to such Transfer, (iv) current financial statements of the proposed Transferee certified by an officer, partner or owner thereof, business credit and personal references and history of the proposed Transferee and any other information reasonably required by Landlord which will enable Landlord to determine the financial responsibility, character, and reputation of the proposed Transferee, nature of such Transferee's business and proposed use of the Subject Space, and (v) an executed estoppel certificate from Tenant in the form attached hereto as Exhibit E. Any Transfer made without Landlord's prior written consent shall, at Landlord's option, be null, void and of no effect, and shall, at Landlord's option, constitute a default by Tenant under this Lease. Whether or not Landlord consents to any proposed Transfer, Tenant shall pay Landlord's -20- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] reasonable review and processing fees, as well as any reasonable professional fees (including, without limitation, attorneys', accountants', architects', engineers' and consultants' fees) incurred by Landlord, within thirty (30) days after written request by Landlord, in an amount not to exceed One Thousand Five Hundred Dollars ($1,500) in the aggregate, for a Transfer in the ordinary course of business (for purposes hereof, a Transfer shall be deemed not to be in the "ordinary course of business" if Landlord is required to review documentation related to such Transfer on more than two (2) separate occasions). 14.2 Landlord's Consent. Landlord shall not unreasonably withhold or delay its consent to any proposed Transfer of the Subject Space to the Transferee on the terms specified in the Transfer Notice. Without limitation as to other reasonable grounds for withholding consent, the parties hereby agree that it shall be reasonable under this Lease and under any applicable law for Landlord to withhold consent to any proposed Transfer where one or more of the following apply: 14.2.1 The Transferee is of a character or reputation or engaged in a business which is not consistent with the quality of the Building or the Project; 14.2.2 The Transferee intends to use the Subject Space for purposes which are not permitted under this Lease; 14.2.3 The Transferee is either a governmental agency or instrumentality thereof; 14.2.4 The Transferee is not a party of reasonable financial worth and/or financial stability in light of the responsibilities to be undertaken in connection with the Transfer on the date consent is requested; 14.2.5 The proposed Transfer would cause a violation of another lease for space in the Project, or would give an occupant of the Project a right to cancel its lease; or 14.2.6 Either the proposed Transferee, or any person or entity which directly or indirectly, controls, is controlled by, or is under common control with, the proposed Transferee, (i) occupies space in the Project at the time of the request for consent, or (ii) is negotiating with Landlord or has negotiated with Landlord during the six (6) month period immediately preceding the date Landlord receives the Transfer Notice, to lease space in the Project. If Landlord consents to any Transfer pursuant to the terms of this Section 14.2, Tenant may within six (6) months after Landlord's consent, but not later than the expiration of said six-month period, enter into such Transfer of the Premises or portion thereof, upon the same terms and conditions as are set forth in the Transfer Notice furnished by Tenant to Landlord pursuant to Section 14.1 of this Lease, provided that if there are any changes in the terms and conditions from those specified in the Transfer Notice (i) such that Landlord would initially have been entitled to refuse its consent to such Transfer under this Section 14.2, or (ii) which would cause the proposed Transfer to be more favorable to the Transferee than the terms set forth in Tenant's original Transfer Notice, Tenant shall again submit the Transfer to Landlord for its approval and other action under this Article 14. Notwithstanding anything to the contrary in this Lease, if Tenant or any proposed Transferee claims that Landlord has unreasonably withheld or delayed its consent under Section 14.2 or otherwise has breached or acted unreasonably under this Article 14, their sole remedies shall be a suit for declaratory judgment and an injunction for the relief sought, and Tenant hereby waives all other remedies, including, without limitation, any right at law or equity to terminate this Lease, on its own behalf and, to the extent permitted under all applicable laws, on behalf of the proposed Transferee. 14.3 Transfer Premium. If Landlord consents to a Transfer as a condition thereto which the parties hereby agree is reasonable, Tenant shall pay to Landlord one hundred percent (100%) of any "Transfer Premium," as that term is defined in this Section 14.3, received by Tenant from such Transferee. "Transfer Premium" shall mean all rent, additional rent or other consideration payable by such Transferee in connection with the Transfer in excess of the Base Rent and Additional Rent payable by Tenant under this Lease during the term of the Transfer (on a per rentable square foot basis if less than all of the Premises is transferred), after deducting the reasonable expenses incurred by Tenant for (i) any changes, alterations and improvements to the Premises in connection with the Transfer, (ii) any free base rent reasonably provided to the -21- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Transferee in connection with the Transfer, (iii) any brokerage commissions in connection with the Transfer, and (iv) twenty-five percent (25%) of the amount of any Base Rent and Additional Rent paid by Tenant to Landlord with respect to the Subject Space during the period commencing on the later of (a) the date Tenant contracts with a reputable broker to market the Subject Space, and (b) the date Tenant vacates the Subject Space, until the commencement of the term of the Transfer (collectively, "Tenant's Transfer Costs"). "Transfer Premium" shall also include, but not be limited to, key money, bonus money or other cash consideration paid by Transferee to Tenant in connection with such Transfer, and any payment in excess of fair market value for services rendered by Tenant to Transferee or for assets, fixtures, inventory, equipment, or furniture transferred by Tenant to Transferee in connection with such Transfer. The determination of the amount of Landlord's applicable share of the Transfer Premium shall be made on a monthly basis as rent or other consideration is received by Tenant under the Transfer. For purposes of calculating the Transfer Premium on a monthly basis, (i) Tenant's Transfer Costs shall be deemed to be expended by Tenant in equal monthly amounts over the entire term of the Transfer and (ii) the Rent paid for the Subject Space by Tenant shall be computed after adjusting such rent to the actual effective rent to be paid, taking into consideration any and all leasehold concessions granted in connection therewith, including, but not limited to, any rent credit and tenant improvement allowance. For purposes of calculating any such effective rent all such concessions shall be amortized on a straight-line basis over the relevant term. 14.4 Landlord's Option as to Subject Space. Notwithstanding anything to the contrary contained in this Article 14, in the event Tenant contemplates a Transfer of all or a portion of the Premises (or in the event of any other Transfer or Transfers entered into by Tenant as a subterfuge in order to avoid the terms of this Section 14.4), Tenant shall give Landlord notice (the "Intention to Transfer Notice") of such contemplated transfer (whether or not such contemplated transfer or any of the terms of such contemplated transfer have been determined). The Intention to Transfer Notice shall specify the portion of the rentable amount of square feet of the Premises which Tenant intends to transfer (the "Contemplated Transfer Space"), the contemplated date of commencement of the contemplated transfer (the "Contemplated Effective Date") and the contemplated length of the term of such contemplated transfer, and shall specify that such Intention to Transfer Notice is delivered to Landlord pursuant to this Section 14.4 in order to allow Landlord to elect to recapture the Contemplated Transfer Space for the term set forth in the Intention to Transfer Notice. Thereafter, Landlord shall have the option, by giving written notice to Tenant within thirty (30) days after receipt of any Intention to Transfer Notice, to recapture the Contemplated Transfer Space. Such recapture shall cancel and terminate this Lease with respect to such Contemplated Transfer Space as of the Contemplated Effective Date until the last day of the term of the contemplated transfer is set forth in the Intention to Transfer Notice. In the event of a recapture by Landlord, this Lease shall be cancelled with respect to less than the entire Premises, the Rent reserved herein shall be prorated on the basis of the number of rentable square feet retained by Tenant in proportion to the number of rentable square feet contained in the Premises, and this Lease as so amended shall continue thereafter in full force and effect, and upon request of either party, the parties shall execute written confirmation of the same. If Landlord declines, or fails to elect in a timely manner, to recapture such Contemplated Transfer Space under this Section 14.4, then, subject to the other terms of this Article 14, for a period of nine (9) months (the "Nine Month Period") commencing on the last day of such thirty (30) day period, Landlord shall not have any right to recapture the Contemplated Transfer Space with respect to any transfer made during the Nine Month Period, provided that any such transfer is substantially on the terms set forth in the Intention to Transfer Notice and, provided further, that any such transfer shall be subject to the remaining terms of this Article 14. If such a transfer is not so consummated within the Nine Month Period (or if the transfer is so consummated, then upon the expiration of the term of any transfer of such Contemplated Transfer Space consummated within such Nine Month Period), Tenant shall again be required to submit a new Intention to Transfer Notice to Landlord with respect to any contemplated transfer, as provided above in this Section 14.4. 14.5 Effect of Transfer. If Landlord consents to a Transfer, (i) the terms and conditions of this Lease shall in no way be deemed to have been waived or modified, (ii) such consent shall not be deemed consent to any further Transfer by either Tenant or a Transferee, (iii) Tenant shall deliver to Landlord, promptly after execution, an original executed copy of all documentation pertaining to the Transfer in form reasonably acceptable to Landlord, (iv) Tenant shall furnish upon Landlord's request a complete statement, certified by an independent certified public accountant, or Tenant's chief financial officer, setting forth in detail the computation of -22- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] any Transfer Premium Tenant has derived and shall derive from such Transfer, and (v) no Transfer relating to this Lease or agreement entered into with respect thereto, whether with or without Landlord's consent, shall relieve Tenant or any guarantor of the Lease from any liability under this Lease, including, without limitation, in connection with the Subject Space. Landlord or its authorized representatives shall have the right at all reasonable times to audit the books, records and papers of Tenant relating to any Transfer, and shall have the right to make copies thereof. If the Transfer Premium respecting any Transfer shall be found understated, Tenant shall, within thirty (30) days after demand, pay the deficiency, and if understated by more than five percent (5%), Tenant shall pay Landlord's costs of such audit. 14.6 Occurrence of Default. Any Transfer hereunder shall be subordinate and subject to the provisions of this Lease, and if this Lease shall be terminated during the term of any Transfer, Landlord shall have the right to: (i) treat such Transfer as canceled and repossess the Subject Space by any lawful means, or (ii) require that such Transferee attorn to and recognize Landlord as its landlord under any such Transfer. If Tenant shall be in default under this Lease, Landlord is hereby irrevocably authorized, as Tenant's agent and attorney-in-fact, to direct any Transferee to make all payments under or in connection with the Transfer directly to Landlord (which Landlord shall apply towards Tenant's obligations under this Lease) until such default is cured. Such Transferee shall rely on any representation by Landlord that Tenant is in default hereunder, without any need for confirmation thereof by Tenant. Upon any assignment, the assignee shall assume in writing all obligations and covenants of Tenant thereafter to be performed or observed under this Lease. No collection or acceptance of rent by Landlord from any Transferee shall be deemed a waiver of any provision of this Article 14 or the approval of any Transferee or a release of Tenant from any obligation under this Lease, whether theretofore or thereafter accruing. In no event shall Landlord's enforcement of any provision of this Lease against any Transferee be deemed a waiver of Landlord's right to enforce any term of this Lease against Tenant or any other person. If Tenant's obligations hereunder have been guaranteed, Landlord's consent to any Transfer shall not be effective unless the guarantor also consents to such Transfer. 14.7 Non-Transfers. Notwithstanding anything to the contrary contained in this Article 14, an assignment or subletting of all or a portion of the Premises to an entity which is controlled by, controls, or is under common control with, Tenant (an "Affiliate"), shall not be deemed a Transfer under this Article 14, provided that Tenant notifies Landlord of any such assignment or sublease and promptly supplies Landlord with any documents or information requested by Landlord regarding such assignment or sublease or such Affiliate, and further provided that such assignment or sublease is not a subterfuge by Tenant to avoid its obligations under this Lease. "Control", as used in this Section 14.7, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person or entity, whether by the ownership of voting securities, by contract or otherwise. ARTICLE 15 SURRENDER OF PREMISES; OWNERSHIP AND REMOVAL OF TRADE FIXTURES 15.1 Surrender of Premises. No act or thing done by Landlord or any agent or employee of Landlord during the Lease Term shall be deemed to constitute an acceptance by Landlord of a surrender of the Premises unless such intent is specifically acknowledged in writing by Landlord. The delivery of keys to the Premises to Landlord or any agent or employee of Landlord shall not constitute a surrender of the Premises or effect a termination of this Lease, whether or not the keys are thereafter retained by Landlord, and notwithstanding such delivery Tenant shall be entitled to the return of such keys at any reasonable time upon request until this Lease shall have been properly terminated. The voluntary or other surrender of this Lease by Tenant, whether accepted by Landlord or not, or a mutual termination hereof, shall not work a merger, and at the option of Landlord shall operate as an assignment to Landlord of all subleases or subtenancies affecting the Premises or terminate any or all such sublessees or subtenancies. 15.2 Removal of Tenant Property by Tenant. Upon the expiration of the Lease Term, or upon any earlier termination of this Lease, Tenant shall, subject to the provisions of this Article 15, quit and surrender possession of the Premises to Landlord in as good order and condition as when Tenant took possession and as thereafter improved by Landlord and/or -23- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Tenant, reasonable wear and tear and repairs which are specifically made the responsibility of Landlord hereunder excepted. Upon such expiration or termination, Tenant shall, without expense to Landlord, remove or cause to be removed from the Premises all debris and rubbish, and such items of furniture, equipment, business and trade fixtures, free-standing cabinet work, movable partitions and other articles of personal property owned by Tenant or installed or placed by Tenant at its expense in the Premises, and such similar articles of any other persons claiming under Tenant, as Landlord may, in its sole discretion, require to be removed, and Tenant shall repair at its own expense all damage to the Premises and Building resulting from such removal. ARTICLE 16 HOLDING OVER If Tenant holds over after the expiration of the Lease Term or earlier termination thereof, with or without the express or implied consent of Landlord, such tenancy shall be from month-to-month only, and shall not constitute a renewal hereof or an extension for any further term, and in such case Rent shall be payable at a monthly rate equal to the product of (i) the Rent applicable during the last rental period of the Lease Term under this Lease, and (ii) a percentage equal to 150%. Such month-to-month tenancy shall be subject to every other applicable term, covenant and agreement contained herein. Nothing contained in this Article 16 shall be construed as consent by Landlord to any holding over by Tenant, and Landlord expressly reserves the right to require Tenant to surrender possession of the Premises to Landlord as provided in this Lease upon the expiration or other termination of this Lease. The provisions of this Article 16 shall not be deemed to limit or constitute a waiver of any other rights or remedies of Landlord provided herein or at law. If Tenant fails to surrender the Premises upon the termination or expiration of this Lease, in addition to any other liabilities to Landlord accruing therefrom, Tenant shall protect, defend, indemnify and hold Landlord harmless from all loss, costs (including reasonable attorneys' fees) and liability resulting from such failure, including, without limiting the generality of the foregoing, any claims made by any succeeding tenant founded upon such failure to surrender and any lost profits to Landlord resulting therefrom. ARTICLE 17 ESTOPPEL CERTIFICATES Within ten (10) business days following a request in writing by Landlord, Tenant shall execute, acknowledge and deliver to Landlord an estoppel certificate, which, as submitted by Landlord, shall be substantially in the form of Exhibit E, attached hereto (or such other form as may be required by any prospective mortgagee or purchaser of the Project, or any portion thereof), indicating therein any exceptions thereto that may exist at that time, and shall also contain any other information reasonably requested by Landlord or Landlord's mortgagee or prospective mortgagee. Any such certificate may be relied upon by any prospective mortgagee or purchaser of all or any portion of the Project. Tenant shall execute and deliver whatever other instruments may be reasonably required for such purposes. At any time during the Lease Term, Landlord may require Tenant to provide Landlord with a current financial statement and financial statements of the two (2) years prior to the current financial statement year. Such statements shall be prepared in accordance with generally accepted accounting principles and, if such is the normal practice of Tenant, shall be audited by an independent certified public accountant. Failure of Tenant to timely execute, acknowledge and deliver such estoppel certificate or other instruments shall constitute an acceptance of the Premises and an acknowledgment by Tenant that statements included in the estoppel certificate are true and correct, without exception. ARTICLE 18 SUBORDINATION This Lease shall be subject and subordinate to all present (including that certain Ground Lease (Parcel 8), dated January 1, 1998, between Lakeshore LLC, as lessor, and Landlord, as lessee) and future ground or underlying leases of the Building or Project and to the lien of any mortgage, trust deed or other encumbrances now or hereafter in force against the Building or Project or any part thereof, if any, and to all renewals, extensions, modifications, consolidations and replacements thereof, and to all advances made or hereafter to be made upon the security of such mortgages or trust deeds, unless the holders of such mortgages, trust deeds or other encumbrances, or the lessors under such ground lease or underlying leases, require in writing that this Lease be superior thereto. -24- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Tenant covenants and agrees in the event any proceedings are brought for the foreclosure of any such mortgage or deed in lieu thereof (or if any ground lease is terminated), to attorn, without any deductions or set-offs whatsoever, to the lienholder or purchaser or any successors thereto upon any such foreclosure sale or deed in lieu thereof (or to the ground lessor), if so requested to do so by such purchaser or lienholder or ground lessor, and to recognize such purchaser or lienholder or ground lessor as the lessor under this Lease, provided such lienholder or purchaser or ground lessor shall agree to accept this Lease and not disturb Tenant's occupancy, so long as Tenant timely pays the Rent and observes and performs the terms, covenants and conditions of this Lease to be observed and performed by Tenant. Landlord's interest herein may be assigned as security at any time to any lienholder. Tenant shall, within ten (10) days of request by Landlord, execute such further instruments or assurances as Landlord may reasonably deem necessary to evidence or confirm the subordination or superiority of this Lease to any such mortgages, trust deeds, ground leases or underlying leases. Tenant waives the provisions of any current or future statute, rule or law which may give or purport to give Tenant any right or election to terminate or otherwise adversely affect this Lease and the obligations of the Tenant hereunder in the event of any foreclosure proceeding or sale. ARTICLE 19 DEFAULTS; REMEDIES 19.1 Events of Default. The occurrence of any of the following shall constitute a default of this Lease by Tenant: 19.1.1 Any failure by Tenant to pay any Rent or any other charge required to be paid under this Lease, or any part thereof, when due unless such failure is cured within five (5) days after notice; or 19.1.2 Except where a specific time period is otherwise set forth for Tenant's performance in this Lease, in which event the failure to perform by Tenant within such time period shall be a default by Tenant under this Section 19.1.2, any failure by Tenant to observe or perform any other provision, covenant or condition of this Lease to be observed or performed by Tenant where such failure continues for thirty (30) days after written notice thereof from Landlord to Tenant; provided that if the nature of such default is such that the same cannot reasonably be cured within a thirty (30) day period, Tenant shall not be deemed to be in default if it diligently commences such cure within such period and thereafter diligently proceeds to rectify and cure such default; or 19.1.3 Abandonment or vacation of all or a substantial portion of the Premises by Tenant and Tenant is otherwise in default under this Lease; or 19.1.4 The failure by Tenant to observe or perform according to the provisions of Articles 5, 14, 17 or 18 of this Lease where such failure continues for more than five (5) days after notice from Landlord, provided however, such notice shall be in addition to, and not in lieu of, the periods for performance set forth in such Articles of this Lease; or 19.1.5 Tenant's failure to occupy the Premises within ten (10) days after the Lease Commencement Date. The notice periods provided herein are in lieu of, and not in addition to, any notice periods provided by law. 19.2 Remedies Upon Default. Upon the occurrence of any event of default by Tenant, Landlord shall have, in addition to any other remedies available to Landlord at law or in equity (all of which remedies shall be distinct, separate and cumulative), the option to pursue any one or more of the following remedies, each and all of which shall be cumulative and nonexclusive, without any notice or demand whatsoever. 19.2.1 Terminate this Lease, in which event Tenant shall immediately surrender the Premises to Landlord, and if Tenant fails to do so, Landlord may, without prejudice to any other remedy which it may have for possession or arrearages in rent, enter upon and take possession of the Premises and expel or remove Tenant and any other person who may be -25- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] occupying the Premises or any part thereof, without being liable for prosecution or any claim or damages therefor; and Landlord may recover from Tenant the following: (i) The worth at the time of award of the amount of any unpaid rent which has been earned at the time of such termination; plus (ii) The worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iii) The worth at the time of award of the amount by which the unpaid rent for the balance of the Lease Term after the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iv) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, specifically including but not limited to, brokerage commissions and advertising expenses incurred, and any special concessions made to obtain a new tenant; and (1) At Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable law. The term "rent" as used in this Section 19,2 shall be deemed to be and to mean all sums of every nature required to be paid by Tenant pursuant to the terms of this Lease, whether to Landlord or to others. As used in Paragraphs 19.2. l(i) and (ii), above, the "worth at the time of award" shall be computed by allowing interest at the rate set forth in Article 25 of this Lease, but in no case greater than the maximum amount of such interest permitted by law. As used in Paragraph 19.2.l (iii) above, the "worth at the time of award" shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). 19.2.2 Landlord shall have the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if lessee has the right to sublet or assign, subject only to reasonable limitations). Accordingly, if Landlord does not elect to terminate this Lease on account of any default by Tenant, Landlord may, from time to time, without terminating this Lease, enforce all of its rights and remedies under this Lease, including the right to recover all rent as it becomes due. 19.2.3 Landlord shall at all times have the rights and remedies (which shall be cumulative with each other and cumulative and in addition to those rights and remedies available under Sections 19.2.1 and 19.2.2, above, or any law or other provision of this Lease), without prior demand or notice except as required by applicable law, to seek any declaratory, injunctive or other equitable relief, and specifically enforce this Lease, or restrain or enjoin a violation or breach of any provision hereof. 19.3 Subleases of Tenant. Whether or not Landlord elects to terminate this Lease on account of any default by Tenant, as set forth in this Article 19, Landlord shall have the right to terminate any and all subleases, licenses, concessions or other consensual arrangements for possession entered into by Tenant and affecting the Premises or may, in Landlord's sole discretion, succeed to Tenant's interest in such subleases, licenses, concessions or arrangements. In the event of Landlord's election to succeed to Tenant's interest in any such subleases, licenses, concessions or arrangements, Tenant shall, as of the date of notice by Landlord of such election, have no further right to or interest in the rent or other consideration receivable thereunder. 19.4 Efforts to Relet. No re-entry or repossession, repairs, maintenance, changes, alterations and additions, reletting, appointment of a receiver to protect Landlord's interests hereunder, or any other action or omission by Landlord shall be construed as an election by Landlord to terminate this Lease or Tenant's right to possession, or to accept a surrender of the Premises, nor shall same operate to release Tenant in whole or in part from any of Tenant's obligations hereunder, unless express written notice of such intention is sent by Landlord to -26- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] Tenant. Tenant hereby irrevocably waives any right otherwise available under any law to redeem or reinstate this Lease. 19.5 Landlord Default. Notwithstanding anything to the contrary set forth in this Lease, Landlord shall not be in default in the performance of any obligation required to be performed by Landlord pursuant to this Lease unless (i) in the event such default is with respect to the payment of money, Landlord fails to pay such unpaid amounts within five (5) business days of written notice from Tenant that the same was not paid when due, or (ii) in the event such default is other than the obligation to pay money, Landlord fails to perform such obligation within thirty (30) days after the receipt of notice from Tenant specifying in detail Landlord's failure to perform; provided, however, if the nature of Landlord's obligation is such that more than thirty (30) days are required for its performance, then Landlord shall not be in default under this Lease if it shall commence such performance within such thirty (30) day period and thereafter diligently pursue the same to completion. Upon any such default by Landlord under this Lease, Tenant may, except as otherwise specifically provided in this Lease to the contrary, exercise any of its rights provided at law or in equity. ARTICLE 20 COVENANT OF QUIET ENJOYMENT Landlord covenants that Tenant, on paying the Rent, charges for services and other payments herein reserved and on keeping, observing and performing all the other terms, covenants, conditions, provisions and agreements herein contained on the part of Tenant to be kept, observed and performed, shall, during the Lease Term, peaceably and quietly have, hold and enjoy the Premises subject to the terms, covenants, conditions, provisions and agreements hereof without interference by any persons lawfully claiming by or through Landlord. ARTICLE 21 [INTENTIONALLY DELETED] ARTICLE 22 SIGNS 22.1 Tenant's Entry Door Signage. Tenant's identifying signage shall be provided by Landlord, at Tenant's cost, and such signage shall be comparable to that used by Landlord for other similar floors in the Building and shall comply with Landlord's then-current Building standard signage program. 22.2 Prohibited Signage and Other Items. Any signs, notices, logos, pictures, names or advertisements which are installed and that have not been separately approved by Landlord may be removed without notice by Landlord at the sole expense of Tenant. Tenant may not install any signs on the exterior or roof of the Project or the Common Areas. Any signs, window coverings, or blinds (even if the same are located behind the Landlord-approved window coverings for the Building), or other items visible from the exterior of the Premises or Building, shall be subject to the prior approval of Landlord, in its sole discretion. 22.3 Building Directory. A building directory will be located in the lobby of the Building. Tenant shall have the right, at Tenant's sole cost and expense, to designate five (5) name strips to be displayed under Tenant's entry in such directory for the Premises. ARTICLE 23 COMPLIANCE WITH LAW 23.1 Applicable Laws. Tenant shall not do anything or suffer anything to be done in or about the Premises or the Project which will in any way conflict with any law, statute, ordinance or other governmental rule, regulation or requirement now in force or which may hereafter be enacted or promulgated ("Applicable Laws"). At its sole cost and expense, Tenant -27- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] shall promptly comply with all such Applicable Laws which relate to (i) Tenant's use of the Premises, (ii) the Alterations in the Premises, or (iii) the Base Building, but as to the Base Building, only to the extent such obligations are triggered by Tenant's Alterations or Tenant's use of the Premises for non-general office use. Should any standard or regulation now or hereafter be imposed on Landlord or Tenant by a state, federal or local governmental body charged with the establishment, regulation and enforcement of occupational, health or safety standards for employers, employees, landlords or tenants, then Tenant agrees, at its sole cost and expense, to comply promptly with such standards or regulations. Tenant shall be responsible, at its sole cost and expense, to make all alterations to the Premises as are required to comply with the governmental rules, regulations, requirements or standards described in this Article 23. The judgment of any court of competent jurisdiction or the admission of Tenant in any judicial action, regardless of whether Landlord is a party thereto, that Tenant has violated any of said governmental measures, shall be conclusive of that fact as between Landlord and Tenant, 23.2 Hazardous Materials. Tenant shall not cause or permit any Hazardous Material to be generated, brought into, used, stored, or disposed of in or about the Premises, Building or Project by Tenant or its agents, employees, contractors, subtenants, or invitees, except for such substances that are required in the ordinary course of Tenant's business conducted on the Premises or are otherwise approved by Landlord. Tenant shall: 23.2.1 Use, store, and dispose of all such Hazardous Material in strict compliance with all applicable statutes, ordinances, and regulations in effect during the Lease Term that relate to public health and safety and protection of the environment ("Environmental Laws"), including those Environmental Laws identified in Section 23.6; and 23.2.2 Comply at all times during the Lease Term with all Environmental Laws. 23.3 Warranties; Notice of Release and Investigation. Tenant acknowledges receipt of that certain Report for Phases IV and V Site Characterization dated April 24, 1991, CEW Project No. 87-42254-01 prepared by Converse Environmental West, for Parker Hannifin Corporation (as amended and updated "CEW Report") concerning certain contamination of ground water lying under or about or otherwise affecting the Project. Landlord warrants and represents to Tenant that, to Landlord's actual knowledge without independent investigation or inquiry, as of the date of this Lease: 23.3.1 Except as provided in the CEW Report, there has been no release onto or under the Project of any Hazardous Material in violation of any Environmental Law; 23.3.2 The Building shall contain no PCBS, PCB- contaminated electrical equipment, or asbestos-containing materials; and 23.3.3 Except as provided in the CEW Report, Landlord has received no notice that the Project is in violation of any Environmental Law. If, during the Lease Term (including any extensions), either Landlord or Tenant becomes aware of (i) any actual or threatened release of any Hazardous Material on, under, or about the Premises, Building or Project, or (ii) any inquiry, investigation, proceeding, or claim by any government agency or other person regarding the presence of Hazardous Material on, under, or about the Premises, Building or Project, that party shall give the other party written notice of the release or investigation within five (5) days after learning of it and shall simultaneously furnish to the other party copies of any claims, notices of violation, reports, or other writings received by the party providing notice that concern the release or investigation. 23.4 Indemnification. Landlord and Tenant shall, at that party's sole expense and with counsel reasonably acceptable to the other party, indemnify, defend, and hold harmless the other party and the other party's shareholders, directors, officers, employees, partners, affiliates, and agents with respect to all losses arising out of or resulting from the release of any Hazardous Material in or about the Premises, Building or Project, or the violation of any Environmental Law, by that party or that party's employees, agents, contractors, or invitees. This indemnification includes all losses, liabilities, obligations, penalties, fines, claims, actions (including remedial or enforcement actions of any kind and administrative or judicial proceedings, orders, or judgments), damages (including consequential and punitive damages), -28- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] and costs (including attorney, consultant, and expert fees and expenses) resulting from the release or violation. This indemnification shall survive the expiration or termination of this Lease. 23.5 Remediation Obligations; Tenant's Rights on Cleanup by Landlord. If the presence of any Hazardous Material brought onto the Premises, Building or Project by either Landlord or Tenant or by Landlord's or Tenant's employees, agents, contractors, or invitees results in contamination of the Premises, Building or Project, that party shall promptly take all necessary actions, at the party's sole expense, to return the Premises, Building or Project to the condition that existed before the introduction of such Hazardous Material. Tenant shall first obtain Landlord's approval of the proposed remedial action, which shall not be unreasonably withheld or delayed. This provision does not limit the indemnification obligations set forth in Section 23.4 above. If Landlord undertakes any cleanup, detoxification, or similar action, whether or not required by any government or quasi-government agency, as a result of the presence, release, or disposal in or about the Building or Project of any Hazardous Material, and that action requires that Tenant be denied access to the Premises or Tenant is otherwise unable to conduct its business on the Premises for a period of greater than twenty-four (24) hours, Base Rent shall be abated for the period that Tenant is unable to conduct its business at the Premises. Subject to Section 23.4, the costs of any Hazardous Material testing, cleanup or remediation undertaken by Landlord during the Lease Term shall be borne by Landlord, shall not be included in Operating Expenses and shall not be the obligation of Tenant. 23.6 Definition of "Hazardous Material". As used herein, the term "Hazardous Material" shall mean any hazardous or toxic substance, material, or waste that is or becomes regulated by the United States, the State of California, or any local government authority having jurisdiction over the Building or Project. Hazardous Material includes: 23.6.1 Any "hazardous substance," as that term is defined in the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) (42 United States Code Sections 9601-9675); 23.6.2 "Hazardous waste," as that term is defined in the Resource Conservation and Recovery Act of 1976 (RCRA) (42 United States Code Sections 6901-6992k); 23.6.3 Any pollutant, contaminant, or hazardous, dangerous, or toxic chemical, material, or substance, within the meaning of any other applicable federal, state, or local law, regulation, ordinance, or requirement (including consent decrees and administrative orders imposing liability or standards of conduct concerning any hazardous, dangerous, or toxic waste, substance, or material, now or hereafter in effect); 23.6.4 Petroleum products; 23.6.5 Radioactive material, including any source, special nuclear, or byproduct material as defined in 42 United States Code Sections 2011-2297g-4; 23.6.6 Asbestos in any form or condition; and 23.6.7 Polychlorinated biphenyls (PCBS) and substances or compounds containing PCBS. ARTICLE 24 LATE CHARGES If any installment of Rent or any other sum due from Tenant shall not be received by Landlord or Landlord's designee within five (5) business days after Tenant's receipt of written notice from Landlord that said amount is due, then Tenant shall pay to Landlord a late charge equal to five percent (5%) of the overdue amount plus any reasonable attorneys' fees incurred by Landlord by reason of Tenant's failure to pay Rent and/or other charges when due hereunder. The late charge shall be deemed Additional Rent and the right to require it shall be in addition to all of Landlord's other rights and remedies hereunder or at law and shall not be construed as liquidated damages or as limiting Landlord's remedies in any manner. In addition to the late charge described above, any Rent -29- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] or other amounts owing hereunder which are not paid within ten (10) days after the date they are due shall bear interest from the date when due until paid at a rate per annum equal to ten percent (10%) per year or, if less, the highest rate permitted by applicable law. ARTICLE 25 LANDLORD'S RIGHT TO CURE DEFAULT; PAYMENTS BY TENANT 25.1 Landlord's Cure. All covenants and agreements to be kept or performed by Tenant under this Lease shall be performed by Tenant at Tenant's sole cost and expense and without any reduction of Rent, except to the extent, if any, otherwise expressly provided herein. If Tenant shall fail to perform any obligation under this Lease, and such failure shall continue in excess of the time allowed under Section 19.1.2, above, unless a specific time period is otherwise stated in this Lease, Landlord may, but shall not be obligated to, make any such payment or perform any such act on Tenant's part without waiving its rights based upon any default of Tenant and without releasing Tenant from any obligations hereunder. 25.2 Tenant's Reimbursement. Except as may be specifically provided to the contrary in this Lease, Tenant shall pay to Landlord, upon delivery by Landlord to Tenant of statements therefor: (i) sums equal to expenditures reasonably made and obligations incurred by Landlord in connection with the remedying by Landlord of Tenant's defaults pursuant to the provisions of Section 25.1; (ii) sums equal to all losses, costs, liabilities, damages and expenses referred to in Article 10 of this Lease; and (iii) sums equal to all expenditures made and obligations incurred by Landlord in collecting or attempting to collect the Rent or in enforcing or attempting to enforce any rights of Landlord under this Lease or pursuant to law, including, without limitation, all reasonable legal fees and other amounts so expended. Tenant's obligations under this Section 25.2 shall survive the expiration or sooner termination of the Lease Term. ARTICLE 26 ENTRY BY LANDLORD Landlord reserves the right at all reasonable times and upon reasonable notice to Tenant (except in the case of an emergency) to enter the Premises to (i) inspect them; (ii) show the Premises to prospective purchasers, or to current or prospective mortgagees, ground or underlying lessors or insurers, or prospective tenants; (iii) post notices of nonresponsibility; or (iv) alter, improve or repair the Premises or the Building, or for structural alterations, repairs or improvements to the Building or the Building's systems and equipment. Notwithstanding anything to the contrary contained in this Article 26, Landlord may enter the Premises at any time to (A) perform services required of Landlord, including janitorial service; (B) take possession due to any breach of this Lease in the manner provided herein; and (C) perform any covenants of Tenant which Tenant fails to perform. Landlord may make any such entries without the abatement of Rent, except as otherwise provided in this Lease, and may take such reasonable steps as required to accomplish the stated purposes. Tenant hereby waives any claims for damages (other than personal injury and property damage to the extent caused by Landlord's negligence or willful misconduct in connection with an entry by Landlord into the Premises) or for any injuries or inconvenience to or interference with Tenant's business, lost profits, any loss of occupancy or quiet enjoyment of the Premises, and any other loss occasioned thereby. For each of the above purposes, Landlord shall at all times have a key with which to unlock all the doors in the Premises, excluding Tenant's vaults, safes and special security areas designated in advance by Tenant. In an emergency, Landlord shall have the right to use any means that Landlord may deem proper to open the doors in and to the Premises. Any entry into the Premises by Landlord in the manner hereinbefore described shall not be deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or an actual or constructive eviction of Tenant from any portion of the Premises. No provision of this Lease shall be construed as obligating Landlord to perform any repairs, alterations or decorations except as otherwise expressly agreed to be performed by Landlord herein. -30- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] ARTICLE 27 TENANT PARKING 27.1 Parking In General. Tenant shall have the right, but not the obligation, to rent from Landlord, commencing on the Lease Commencement Date, up to the amount of parking spaces set forth in Section 9 of the Summary, on a monthly basis throughout the Lease Term, which parking spaces shall pertain to the Project parking structure ("Parking Structure") and, with respect to Building reserved parking spaces, in the Building subterranean reserved parking area. The location of the reserved parking spaces shall be mutually agreed upon by Landlord and Tenant. Tenant shall pay Landlord for automobile parking spaces at the time Base Rent is due on a monthly basis at the prevailing rate set forth in Section 9 of the Summary. In addition, Tenant shall be responsible for the full amount of any taxes imposed by any governmental authority in connection with the renting of such parking spaces by Tenant or the use of Parking Structure by Tenant. Tenant's continued right to use the parking spaces is conditioned upon Tenant abiding by all rules and regulations which are prescribed from time to time for the orderly operation and use of the Parking Structure and in the Building subterranean reserved parking area, including any sticker or other identification system established by Landlord, Tenant's cooperation in seeing that Tenant's employees and visitors also comply with such rules and regulations and Tenant not being in default under this Lease. 27.2 Landlord Reservations. So long as Tenant's use is not adversely and materially affected (and it is deemed not to be adversely and materially affected if reasonably comparable substitute parking is made available), Landlord specifically reserves the right to change the size, configuration, design, layout and all other aspects of the Parking Structure and in the Building subterranean parking area, at any time and Tenant acknowledges and agrees that Landlord may, without incurring any liability to Tenant and without any abatement of Rent under this Lease, from time to time, close-off or restrict access to the Parking Structure and in the Building subterranean parking area, for purposes of permitting or facilitating any such construction, alteration or improvements. Landlord may delegate its responsibilities hereunder to a parking operator in which case such parking operator shall operate the Parking Structure and any other parking facilities at the Project in a first class manner and shall have all the rights of control attributed hereby to the Landlord. The parking spaces used by Tenant pursuant to this Article 27 are provided to Tenant solely for use by Tenant's own personnel and such spaces may not, except in the case of a Transfer approved by Landlord pursuant to Article 14 above, be transferred, assigned, subleased or otherwise alienated by Tenant without Landlord's prior approval. 27.3 Visitor Validations. Tenant may validate visitor parking by such method or methods as Landlord may establish, at the validation rate from time to time generally applicable to visitor parking. 27.4 Parking Pass System. Landlord shall install as part of the security system for the Building an access card recognition system for the Parking Structure and the Building subterranean reserved parking area. The number of parking facility access cards available to Tenant shall equal the number of parking spaces rented by Tenant. Effective on the first day of a calendar month, on at least thirty (30) days' prior notice to Landlord, Tenant may decrease or increase the number of parking spaces which it rents in the Parking Structure or the Building subterranean reserved parking area subject to the maximum number of parking spaces in each such facility as set forth in the Summary. Tenant shall pay the deposit established by Landlord for the Building and Parking Structure access cards which deposit shall initially be Fifteen Dollars ($15) per card. ARTICLE 28 MISCELLANEOUS PROVISIONS 28.1 Terms; Captions. The words "Landlord" and "Tenant" as used herein shall include the plural as well as the singular. The necessary grammatical changes required to make the provisions hereof apply either to corporations or partnerships or individuals, men or women, as the case may require, shall in all cases be assumed as though in each case fully expressed. -31- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] The captions of Articles and Sections are for convenience only and shall not be deemed to limit, construe, affect or alter the meaning of such Articles and Sections. 28.2 Binding Effect. Subject to all other provisions of this Lease, each of the covenants, conditions and provisions of this Lease shall extend to and shall, as the case may require, bind or inure to the benefit not only of Landlord and of Tenant, but also of their respective heirs, personal representatives, successors or assigns, provided this clause shall not permit any assignment by Tenant contrary to the provisions of Article 14 of this Lease. 28.3 No Air Rights. No rights to any view or to light or air over any property, whether belonging to Landlord or any other person, are granted to Tenant by this Lease. If at any time any windows of the Premises are temporarily darkened or the light or view therefrom is obstructed by reason of any repairs, improvements, maintenance or cleaning in or about the Project, the same shall be without liability to Landlord and without any reduction or diminution of Tenant's obligations under this Lease. 28.4 Modification of Lease. Should any current or prospective mortgagee or ground lessor for the Building or Project require modification of this Lease, which modification will not cause an increase in cost or expense to Tenant or in any other way materially and adversely change the rights and obligations of Tenant hereunder, then and in such event, Tenant agrees that this Lease may be so modified and agrees to execute whatever documents are reasonably required therefor and to deliver the same to Landlord within ten (10) days following a request therefor. At the request of Landlord or any mortgagee or ground lessor, Tenant agrees to execute and acknowledge a short form of lease and deliver the same to Landlord within ten (10) days following the request therefor. 28.5 Transfer of Landlord's Interest. Tenant acknowledges that Landlord has the right to transfer all or any portion of its interest in the Project or Building and in this Lease, and Tenant agrees that in the event of any such transfer, Landlord shall automatically be released from all liability under this Lease and Tenant agrees to look solely to such transferee for the performance of Landlord's obligations hereunder after the date of transfer and such transferee shall be deemed to have fully assumed and be liable for all obligations of this Lease to be performed by Landlord, including the return of any Security Deposit, and Tenant shall attorn to such transferee. 28.6 Prohibition Against Recording. Except as provided in Section 28.4 of this Lease, neither this Lease, nor any memorandum, affidavit or other writing with respect thereto, shall be recorded by Tenant or by anyone acting through, under or on behalf of Tenant. 28.7 Landlord's Title. Landlord's title is and always shall be paramount to the title of Tenant. Nothing herein contained shall empower Tenant to do any act which can, shall or may encumber the title of Landlord. 28.8 Relationship of Parties. Nothing contained in this Lease shall be deemed or construed by the parties hereto or by any third party to create the relationship of principal and agent, partnership, joint venturer or any association between Landlord and Tenant. 28.9 Application of Payments. Landlord shall have the right to apply payments received from Tenant pursuant to this Lease, regardless of Tenant's designation of such payments, to satisfy any obligations of Tenant hereunder, in such order and amounts as Landlord, in its sole discretion, may elect. 28.10 Time of Essence. Time is of the essence with respect to the performance of every provision of this Lease in which time of performance is a factor. 28.11 Partial Invalidity. If any term, provision or condition contained in this Lease shall, to any extent, be invalid or unenforceable, the remainder of this Lease, or the application of such term, provision or condition to persons or circumstances other than those with respect to which it is invalid or unenforceable, shall not be affected thereby, and each and every other term, provision and condition of this Lease shall be valid and enforceable to the fullest extent possible permitted by law. -32- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 28.12 No Warranty. In executing and delivering this Lease, Tenant has not relied on any representations, including, but not limited to, any representation as to the amount of any item comprising Additional Rent or the amount of the Additional Rent in the aggregate or that Landlord is furnishing the same services to other tenants, at all, on the same level or on the same basis, or any warranty or any statement of Landlord which is not set forth herein or in one or more of the exhibits attached hereto. 28.13 Landlord Exculpation. The liability of Landlord or the Landlord Parties to Tenant for any default by Landlord under this Lease or arising in connection herewith or with Landlord's operation, management, leasing, repair, renovation, alteration or any other matter relating to the Project or the Premises shall be limited solely and exclusively to an amount which is equal to the interest of Landlord in the Building, provided that in no event shall such liability extend to any sales or insurance proceeds received by Landlord or the Landlord Parties in connection with the Project, Building or Premises. Neither Landlord nor any of the Landlord Parties shall have any personal liability therefor, and Tenant hereby expressly waives and releases such personal liability on behalf of itself and all persons claiming by, through or under Tenant. The limitations of liability contained in this Section 28.13 shall inure to the benefit of Landlord's and the Landlord Parties' present and future partners, beneficiaries, officers, directors, trustees, shareholders, agents and employees, and their respective partners, heirs, successors and assigns. Under no circumstances shall any present or future partner of Landlord (if Landlord is a partnership) or trustee or beneficiary (if Landlord or any partner of Landlord is a trust) have any liability for the performance of Landlord's obligations under this Lease. Notwithstanding any contrary provision herein, neither Landlord nor the Landlord Parties shall be liable under any circumstances for injury or damage to, or interference with, Tenant's business, including but not limited to, loss of profits, loss of rents or other revenues, loss of business opportunity, loss of goodwill or loss of use, in each case, however occurring. 28.14 Entire Agreement. It is understood and acknowledged that there are no oral agreements between the parties hereto affecting this Lease and this Lease constitutes the parties' entire agreement with respect to the leasing of the Premises and supersedes and cancels any and all previous negotiations, arrangements, brochures, agreements and understandings, if any, between the parties hereto or displayed by Landlord to Tenant with respect to the subject matter thereof, and none thereof shall be used to interpret or construe this Lease. None of the terms, covenants, conditions or provisions of this Lease can be modified, deleted or added to except in writing signed by the parties hereto. 28.15 Right to Lease. Landlord reserves the absolute right to effect such other tenancies in the Project as Landlord in the exercise of its sole business judgment shall determine to best promote the interests of the Building or Project. Tenant does not rely on the fact, nor does Landlord represent, that any specific tenant or type or number of tenants shall, during the Lease Term, occupy any space in the Building or Project. 28.16 Force Majeure. An actual delay or stoppage resulting from fire, earthquake, explosion, flood, hurricane, the elements, acts of God or the public enemy, war, invasion, insurrection, rebellion, riots, industry-wide labor strikes or lock-outs (which objectively preclude Landlord or Tenant from obtaining from any reasonable source, labor or substitute materials at a reasonable cost necessary for performing its respective obligations hereunder), or governmental acts, and other causes beyond the reasonable control of the party obligated to perform, except with respect to the obligations imposed with regard to Rent and other charges to be paid by Tenant pursuant to this Lease (collectively, a "Force Majeure"), notwithstanding anything to the contrary contained in this Lease, shall excuse the performance of such party for a period equal to any such prevention, delay or stoppage and, therefore, if this Lease specifies a time period for performance of an obligation of either party, that time period shall be extended by the period of any delay in such party's performance caused by a Force Majeure. 28.17 Waiver of Redemption by Tenant. Tenant hereby waives, for Tenant and for all those claiming under Tenant, any and all rights now or hereafter existing to redeem by order or judgment of any court or by any legal process or writ, Tenant's right of occupancy of the Premises after any termination of this Lease. 28.18 Notices. All notices, demands, statements, designations, approvals or other communications (collectively, "Notices") given or required to be given by either party to the -33- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] other hereunder or by law shall be in writing, shall be (A) sent by United States certified or registered mail, postage prepaid, return receipt requested ("Mail"), (B) transmitted by telecopy, if such telecopy is promptly followed by a Notice sent by Mail, (C) delivered by a nationally recognized overnight courier with verification of delivery requested, or (D) delivered personally. Any Notice shall be sent, transmitted, or delivered, as the case may be, to Tenant at the appropriate address set forth in Section 10 of the Summary, or to such other place as Tenant may from time to time designate in a Notice to Landlord, or to Landlord at the addresses set forth below, or to such other places as Landlord may from time to time designate in a Notice to Tenant. Any Notice will be deemed given (i) three (3) days after the date it is posted if sent by Mail, (ii) the date the telecopy is transmitted if transmitted before 5:00 p.m. Pacific Time on a business day, otherwise on the next business day, (iii) the date the overnight courier delivery is made, or (iv) the date personal delivery is made (if made on a business day, otherwise on the next business day). As of the date of this Lease, any Notices to Landlord must be sent, transmitted, or delivered, as the case may be, to the following addresses: Lakeshore Towers Limited Partnership Phase IV 18101 Von Karman Avenue, Suite 1220 Irvine, CA 92612 Attention: Building Manager and LTLP IV Corp. c/o GE Investments 2029 Century Park East, Suite 2000 Los Angeles, CA 90067 Attention: Asset Manager 28.19 Joint and Several. If there is more than one Tenant, the obligations imposed upon Tenant under this Lease shall be joint and several. 28.20 Authority. If Tenant is a corporation, trust or partnership, each individual executing this Lease on behalf of Tenant hereby represents and warrants that Tenant is a duly formed and existing entity qualified to do business in California and that Tenant has full right and authority to execute and deliver this Lease and that each person signing on behalf of Tenant is authorized to do so. In such event, Tenant shall, within ten (10) days after execution of this Lease, deliver to Landlord satisfactory evidence of such authority and, if a corporation, upon demand by Landlord, also deliver to Landlord satisfactory evidence of (i) good standing in Tenant's state of incorporation and (ii) qualification to do business in California. 28.21 Attorneys' Fees. In the event that either Landlord or Tenant should bring suit for the possession of the Premises, for the recovery of any sum due under this Lease, or because of the breach of any provision of this Lease or for any other relief against the other, then all costs and expenses, including reasonable attorneys' fees, incurred by the prevailing party therein shall be paid by the other party, which obligation on the part of the other party shall be deemed to have accrued on the date of the commencement of such action and shall be enforceable whether or not the action is prosecuted to judgment. 28.22 GOVERNING LAW; WAIVER OF TRIAL BY JURY. This Lease shall be construed and enforced in accordance with the laws of the State of California. IN ANY ACTION OR PROCEEDING ARISING THEREFROM, LANDLORD AND TENANT HEREBY CONSENT TO (I) THE JURISDICTION OF ANY COMPETENT COURT WITHIN THE STATE OF CALIFORNIA, (II) SERVICE OF PROCESS BY ANY MEANS AUTHORIZED BY CALIFORNIA LAW, AND (III) IN THE INTEREST OF SAVING TIME AND EXPENSE, TRIAL WITHOUT A JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER OF THE PARTIES HERETO AGAINST THE OTHER OR THEIR SUCCESSORS IN RESPECT OF ANY MATTER ARISING OUT OF OR IN CONNECTION WITH THIS LEASE, THE RELATIONSHIP OF LANDLORD AND TENANT, TENANT'S USE OR OCCUPANCY OF THE PREMISES, AND/OR ANY CLAIM FOR INJURY OR DAMAGE, OR ANY EMERGENCY OR STATUTORY REMEDY. IN THE EVENT LANDLORD COMMENCES ANY SUMMARY PROCEEDINGS OR ACTION FOR NONPAYMENT OF BASE RENT OR ADDITIONAL RENT, TENANT SHALL NOT INTERPOSE ANY COUNTERCLAIM OF ANY NATURE OR DESCRIPTION (UNLESS -34- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] SUCH COUNTERCLAIM SHALL BE MANDATORY) IN ANY SUCH PROCEEDING OR ACTION, BUT SHALL BE RELEGATED TO AN INDEPENDENT ACTION AT LAW. 28.23 Submission of Lease. Submission of this instrument for examination or signature by Tenant does not constitute a reservation of, option for or option to lease, and it is not effective as a lease or otherwise until execution and delivery by both Landlord and Tenant. 28.24 Brokers. Landlord and Tenant hereby warrant to each other that they have had no dealings with any real estate broker or agent in connection with the negotiation of this Lease, excepting only the real estate brokers or agents specified in Section 12 of the Summary (the "Brokers"), and that they know of no other real estate broker or agent who is entitled to a commission in connection with this Lease. Each party agrees to indemnify and defend the other party against and hold the other party harmless from any and all claims, demands, losses, liabilities, lawsuits, judgments, costs and expenses (including without limitation reasonable attorneys' fees) with respect to any leasing commission or equivalent compensation alleged to be owing on account of any dealings with any real estate broker or agent, other than the Brokers, occurring by, through, or under the indemnifying party. 28.25 Independent Covenants. This Lease shall be construed as though the covenants herein between Landlord and Tenant are independent and not dependent and Tenant hereby expressly waives the benefit of any statute to the contrary and agrees that if Landlord fails to perform its obligations set forth herein, Tenant shall not be entitled to make any repairs or perform any acts hereunder at Landlord's expense or to any setoff of the Rent or other amounts owing hereunder against Landlord. 28.26 Project or Building Name and Signage. Landlord shall have the right at any time to change the name of the Project or Building and to install, affix and maintain any and all signs on the exterior and on the interior of the Project or Building as Landlord may, in Landlord's sole discretion, desire. Tenant shall not use the words "Lakeshore" or the name of the Project or Building or use pictures or illustrations of the Project or Building in advertising or other publicity or for any purpose other than as the address of the business to be conducted by Tenant in the Premises, without the prior written consent of Landlord. 28.27 Counterparts. This Lease may be executed in counterparts with the same effect as if both parties hereto had executed the same document. Both counterparts shall be construed together and shall constitute a single lease. 28.28 Confidentiality. Tenant acknowledges that the content of this Lease and any related documents are confidential information. Tenant shall keep such confidential information strictly confidential and shall not disclose such confidential information to any person or entity other than Tenant's financial, legal, and space planning consultants. 28.29 Development of the Project. 28.29.1 Subdivision. Landlord reserves the right to further subdivide all or a portion of the Project. Tenant agrees to execute and deliver, upon demand by Landlord and in the form requested by Landlord, any additional documents needed to conform this Lease to the circumstances resulting from such subdivision. 28.29.2 The Other Improvements. If portions of the Project or property adjacent to the Project (collectively, the "Other Improvements") are owned by an entity other than Landlord, Landlord, at its option, may enter into an agreement with the owner or owners of any or all of the Other Improvements to provide (i) for reciprocal rights of access and/or use of the Project and the Other Improvements, (ii) for the common management, operation, maintenance, improvement and/or repair of all or any portion of the Project and the Other Improvements, provided that Tenant's rights under this Lease are not materially impaired, (iii) for the allocation of a portion of the Direct Expenses to the Other Improvements and the operating expenses and taxes for the Other Improvements to the Project, and (iv) for the use or improvement of the Other Improvements and/or the Project in connection with the improvement, construction, and/or excavation of the Other Improvements and/or the Project. Nothing contained herein shall be deemed or construed to limit or otherwise affect Landlord's right to convey all or any portion of the Project or any other of Landlord's rights described in this Lease. -35- LAKESHORE TOWERS BUILDING II [Quality Systems, lnc.] 28.29.3 Construction of Project and Other Improvements. Tenant acknowledges that portions of the Project and/or the Other Improvements may be under construction following Tenant's occupancy of the Premises, and that such construction may result in levels of noise, dust, obstruction of access, etc. which are in excess of that present in a fully constructed project. Tenant hereby waives any and all rent offsets or claims of constructive eviction which may arise in connection with such construction. 28.30 Building Renovations. It is specifically understood and agreed that Landlord has no obligation and has made no promises to alter, remodel, improve, renovate, repair or decorate the Premises, Building, or any part thereof and that no representations respecting the condition of the Premises or the Building have been made by Landlord to Tenant except as specifically set forth herein or in the Tenant Work Letter. However, Tenant hereby acknowledges that Landlord is currently renovating or may during the Lease Term renovate, improve, alter, or modify (collectively, the "Renovations") the Project, the Building and/or the Premises. Except for (i) emergencies, or (ii) repairs, alterations, improvements or additions required by governmental or quasi-governmental authorities or court order or decree, such Renovations shall be performed in a manner so as not to materially interfere with Tenant's access to the Premises or Parking Area. Subject to the forgoing, Tenant hereby agrees that such Renovations shall in no way constitute a constructive eviction of Tenant nor entitle Tenant to any abatement of Rent. Landlord shall have no responsibility and shall not be liable to Tenant for any injury to or interference with Tenant's business arising from the Renovations, nor shall Tenant be entitled to any compensation or damages from Landlord for loss of the use of the whole or any part of the Premises or of Tenant's personal property or improvements resulting from the Renovations, or for any inconvenience or annoyance occasioned by such Renovations. 28.31 No Violation. Tenant hereby warrants and represents that neither its execution of nor performance under this Lease shall cause Tenant to be in violation of any agreement, instrument, contract, law, rule or regulation by which Tenant is bound, and Tenant shall protect, defend, indemnify and hold Landlord harmless against any claims, demands, losses, damages, liabilities, costs and expenses, including, without limitation, reasonable attorneys' fees and costs, arising from Tenant's breach of this warranty and representation. 28.32 No Discrimination. Tenant covenants by and for itself, its successors and assigns, and all persons claiming under or through them, and this Lease is made and accepted upon and subject to the following conditions: That there shall be no discrimination against or segregation of any person or group of persons, on account of sex, marital status, age, race, color, religion, creed, national origin or ancestry, in the leasing, subleasing, renting, transferring, use, occupancy, tenure or enjoyment of the Premises herein leased, nor shall Tenant itself, or any person claiming under or through it, establish or permit such practice or practices of discrimination or segregation with reference to the selection, location, number, use or occupancy of tenant's lessees, sublessees, subtenants or vendees in the Premises. 28.33 Definition of Landlord. The term "Landlord," as used in this Lease, so far as covenants or obligations on the part of Landlord are concerned, shall be limited to mean and include only the owner or owners, at the time such covenant or obligation is to be performed, of the Building or the lessees under any ground lease of the Building, if any. 28.34 Tenant Representation With Respect to the General Electric Pension Trust. Tenant is not aware of any ownership relationship between Tenant and the General Electric Pension Trust or its affiliates, except to the extent Tenant is a publicly traded company and the General Electric Pension Trust or its affiliates may own shares of Tenant's stock. -36- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] IN WITNESS WHEREOF, Landlord and Tenant have caused this Lease to be executed the day and date first above written. "Landlord": LAKESHORE TOWERS LIMITED PARTNERSHIP PHASE IV, a California limited partnership By: LTLP IV CORP., a Delaware corporation, the sole General Partner of Lakeshore Towers Limited Partnership Phase IV By: /s/ ILLEGIBLE --------------------------------- Its: President "Tenant": QUALITY SYSTEMS, INC., a California corporation By: /s/ Lou Silverman ------------------------------------ Its: LOU SILVERMAN, CHAIRMAN By ____________________________________ Its _________________________________ -37- LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EXHIBIT A LAKESHORE TOWERS OUTLINE OF PREMISES [GRAPHIC OMMITED] EXHIBIT A - Page 1 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EXHIBIT B LAKESHORE TOWERS PROJECT LEGAL DESCRIPTION Parcels 1 through 7 of Parcel Map 89-274 in the City of Irvine, County of Orange, State of California as recorded in Book 267, Pages 18-26 of Parcel Maps. EXHIBIT B - Page 1 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EXHIBIT C LAKESHORE TOWERS DIRECT EXPENSES ALLOCATION Common Area Expenses as defined in Paragraph 2.12 of the CC&Rs shall be assessed to the various buildings in the Project pursuant to paragraph 10 of the CC&Rs. Paragraph 10.5 of the CC&Rs provides for allocation of assessments in an equitable manner based on relative gross square footage of the buildings. The ratios are as follows: - -------------------------------------------------------------------------------- Building I - Office 401,789 sq. ft. 45.6% Building I - Retail 6,000 sq. ft. 0.7% Restaurant 12,100 sq. ft. 1.4% Sporting Club 89,940 sq. ft. 10.2% Building II 129,206 sq. ft. 14.7% Building III 241,505 sq. ft. 27.4% TOTAL 880,540 sq. ft. 100.0% - -------------------------------------------------------------------------------- EXHIBIT C - Page 1 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EXHIBIT D LAKESHORE TOWERS RULES AND REGULATIONS Tenant shall faithfully observe and comply with the following Rules and Regulations. Landlord shall not be responsible to Tenant for the nonperformance of any of said Rules and Regulations by or otherwise with respect to the acts or omissions of any other tenants or occupants of the Project. In the event of any conflict between the Rules and Regulations and the other provisions of this Lease, the latter shall control. 1. Tenant shall not alter any lock or install any new or additional locks or bolts on any doors or windows of the Premises without obtaining Landlord's prior written consent. Tenant shall bear the cost of any lock changes or repairs required by Tenant. Two keys will be furnished by Landlord for the Premises, and any additional keys required by Tenant must be obtained from Landlord at a reasonable cost to be established by Landlord. Upon the termination of this Lease, Tenant shall restore to Landlord all keys of stores, offices, and toilet rooms, either furnished to, or otherwise procured by, Tenant and in the event of the loss of keys so furnished, Tenant shall pay to Landlord the cost of replacing same or of changing the lock or locks opened by such lost key if Landlord shall deem it necessary to make such changes. 2. All doors opening to public corridors shall be kept closed at all times except for normal ingress and egress to the Premises. 3. Landlord reserves the right to close and keep locked all entrance and exit doors of the Building during such hours as are customary for comparable buildings in the Irvine, California area. Tenant, its employees and agents must be sure that the doors to the Building are securely closed and locked when leaving the Premises if it is after the normal hours of business for the Building. Any tenant, its employees, agents or any other persons entering or leaving the Building at any time when it is so locked, or any time when it is considered to be after normal business hours for the Building, may be required to sign the Building register. Access to the Building may be refused unless the person seeking access has proper identification or has a previously arranged pass for access to the Building. Landlord will furnish passes to persons for whom Tenant requests same in writing. Tenant shall be responsible for all persons for whom Tenant requests passes and shall be liable to Landlord for all acts of such persons. Landlord and his agents shall in no case be liable for damages for any error with regard to the admission to or exclusion from the Building of any person. In case of invasion, mob, riot, public excitement, or other commotion, Landlord reserves the right to prevent access to the Building or the Project during the continuance thereof by any means it deems appropriate for the safety and protection of life and property. 4. No furniture, freight or equipment of any kind shall be brought into the Building without prior notice to Landlord. All moving activity into or out of the Building shall be scheduled with Landlord and done only at such time and in such manner as Landlord designates. Landlord shall have the right to prescribe the weight, size and position of all safes and other heavy property brought into the Building and also the times and manner of moving the same in and out of the Building. Safes and other heavy objects shall, if considered necessary by Landlord, stand on supports of such thickness as is necessary to properly distribute the weight. Landlord will not be responsible for loss of or damage to any such safe or property in any case. Any damage to any part of the Building, its contents, occupants or visitors by moving or maintaining any such safe or other property shall be the sole responsibility and expense of Tenant. 5. No furniture, packages, supplies, equipment or merchandise will be received in the Building or carried up or down in the elevators, except between such hours, in such specific elevator and by such personnel as shall be designated by Landlord. 6. The requirements of Tenant will be attended to only upon application at the management office for the Project or at such office location designated by Landlord. Employees of Landlord shall not perform any work or do anything outside their regular duties unless under special instructions from Landlord. 7. No sign, advertisement, notice or handbill shall be exhibited, distributed, painted or affixed by Tenant on any part of the Premises or the Building without the prior written consent of the Landlord. Tenant shall not disturb, solicit, peddle, or canvass any occupant of the Project and shall cooperate with Landlord and its agents of Landlord to prevent same. EXHIBIT D - Page 1 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] 8. The toilet rooms, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed, and no foreign substance of any kind whatsoever shall be thrown therein. The expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by the tenant who, or whose servants, employees, agents, visitors or licensees shall have caused same. 9. Tenant shall not overload the floor of the Premises, nor mark, drive nails or screws, or drill into the partitions, woodwork or drywall or in any way deface the Premises or any part thereof without Landlord's prior written consent. Tenant shall not purchase spring water, ice, towel, linen, maintenance or other like services from any person or persons not approved by Landlord. 10. Except for vending machines intended for the sole use of Tenant's employees and invitees, no vending machine or machines other than fractional horsepower office machines shall be installed, maintained or operated upon the Premises without the written consent of Landlord. 11. Tenant shall not use or keep in or on the Premises, the Building, or the Project any kerosene, gasoline or other inflammable or combustible fluid, chemical, substance or material. 12. Tenant shall not without the prior written consent of Landlord use any method of heating or air conditioning other than that supplied by Landlord. 13. Tenant shall not use, keep or permit to be used or kept, any foul or noxious gas or substance in or on the Premises, or permit or allow the Premises to be occupied or used in a manner offensive or objectionable to Landlord or other occupants of the Project by reason of noise, odors, or vibrations, or interfere with other tenants or those having business therein, whether by the use of any musical instrument, radio, phonograph, or in any other way. Tenant shall not throw anything out of doors, windows or skylights or down passageways. 14. Tenant shall not bring into or keep within the Project, the Building or the Premises any animals, birds, aquariums, or, except in areas designated by Landlord, bicycles or other vehicles. 15. No cooking shall be done or permitted on the Premises, nor shall the Premises be used for the storage of merchandise, for lodging or for any improper, objectionable or immoral purposes. Notwithstanding the foregoing, Underwriters' laboratory-approved equipment and microwave ovens may be used in the Premises for heating food and brewing coffee, tea, hot chocolate and similar beverages for employees and visitors, provided that such use is in accordance with all applicable federal, state, county and city laws, codes, ordinances, rules and regulations. 16. The Premises shall not be used for manufacturing or for the storage of merchandise except as such storage may be incidental to the use of the Premises provided for in the Summary. Tenant shall not occupy or permit any portion of the Premises to be occupied as an office for a messenger-type operation or dispatch office, public stenographer or typist, or for the manufacture or sale of liquor, narcotics, or tobacco in any form, or as a medical office, or as a barber or manicure shop, or as an employment bureau without the express prior written consent of Landlord. Tenant shall not engage or pay any employees on the Premises except those actually working for such tenant on the Premises nor advertise for laborers giving an address at the Premises. 17. Landlord reserves the right to exclude or expel from the Project any person who, in the judgment of Landlord, is intoxicated or under the influence of liquor or drugs, or who shall in any manner do any act in violation of any of these Rules and Regulations. 18. Tenant, its employees and agents shall not loiter in or on the entrances, corridors, sidewalks, lobbies, courts, halls, stairways, elevators, vestibules or any Common Areas for the purpose of smoking tobacco products or for any other purpose, nor in any way obstruct such areas, and shall use them only as a means of ingress and egress for the Premises. 19. Tenant shall not waste electricity, water or air conditioning and agrees to cooperate fully with Landlord to ensure the most effective operation of the Building's heating and air conditioning system, and shall refrain from attempting to adjust any controls. 20. Tenant shall store all its trash and garbage within the interior of the Premises. No material shall be placed in the trash boxes or receptacles if such material is of such nature that it may not be disposed of in the ordinary and customary manner of removing and disposing of trash and garbage in Irvine, California without violation of any law or ordinance governing such disposal. All EXHIBIT D - Page 2 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] trash, garbage and refuse disposal shall be made only through entry-ways and elevators provided for such purposes at such times as Landlord shall designate. 21. Tenant shall comply with all safety, fire protection and evacuation procedures and regulations established by Landlord or any governmental agency. 22. Any persons employed by Tenant to do janitorial work shall be subject to the prior written approval of Landlord, and while in the Building and outside of the Premises, shall be subject to and under the control and direction of the Building manager (but not as an agent or servant of such manager or of Landlord), and Tenant shall be responsible for all acts of such persons. 23. No awnings or other projection shall be attached to the outside walls of the Building without the prior written consent of Landlord, and no curtains, blinds, shades or screens shall be attached to or hung in, or used in connection with, any window or door of the Premises other than Landlord standard drapes. All electrical ceiling fixtures hung in the Premises or spaces along the perimeter of the Building must be fluorescent and/or of a quality, type, design and a warm white bulb color approved in advance in writing by Landlord. Neither the interior nor exterior of any windows shall be coated or otherwise sunscreened without the prior written consent of Landlord. Tenant shall abide by Landlord's regulations concerning the opening and closing of window coverings which are attached to the windows in the Premises, if any, which have a view of any interior portion of the Building or Building Common Areas. 24. The sashes, sash doors, skylights, windows, and doors that reflect or admit light and air into the halls, passageways or other public places in the Building shall not be covered or obstructed by Tenant, nor shall any bottles, parcels or other articles be placed on the windowsills. 25. Tenant must comply with requests by the Landlord concerning the informing of their employees of items of importance to the Landlord. 26. Tenant must comply with the State of California "No-Smoking" law set forth in California Labor Code Section 6404.5, and any local "No-Smoking" ordinance which may be in effect from time to time and which is not superseded by such State law. 27. Tenant hereby acknowledges that Landlord shall have no obligation to provide guard service or other security measures for the benefit of the Premises, the Building or the Project. Tenant hereby assumes all responsibility for the protection of Tenant and its agents, employees, contractors, invitees and guests, and the property thereof, from acts of third parties, including keeping doors locked and other means of entry to the Premises closed, whether or not Landlord, at its option, elects to provide security protection for the Project or any portion thereof. Tenant further assumes the risk that any safety and security devices, services and programs which Landlord elects, in its sole discretion, to provide may not be effective, or may malfunction or be circumvented by an unauthorized third party, and Tenant shall, in addition to its other insurance obligations under this Lease, obtain its own insurance coverage to the extent Tenant desires protection against losses related to such occurrences. Tenant shall cooperate in any reasonable safety or security program developed by Landlord or required by law. 28. All office equipment of any electrical or mechanical nature shall be placed by Tenant in the Premises in settings approved by Landlord, to absorb or prevent any vibration, noise and annoyance. 29. Tenant shall not use in any space or in the public halls of the Building, any hand trucks except those equipped with rubber tires and rubber side guards. 30. No auction, liquidation, fire sale, going-out-of-business or bankruptcy sale shall be conducted in the Premises without the prior written consent of Landlord. 31. No tenant shall use or permit the use of any portion of the Premises for living quarters, sleeping apartments or lodging rooms. 32. Tenant shall have the exclusive right to use its reserved parking spaces, if any, from 8:00 A.M. to 6:00 P.M. Monday through Friday. Landlord reserves the right at any time to change or rescind any one or more of these Rules and Regulations, or to make such other and further reasonable Rules and Regulations as in Landlord's judgment may from time to time be necessary for the management, safety, care and cleanliness of the Premises, Building, the Common Areas and the Project, and for the preservation of EXHIBIT D - Page 3 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] good order therein, as well as for the convenience of other occupants and tenants therein. Landlord may waive any one or more of these Rules and Regulations for the benefit of any particular tenants, but no such waiver by Landlord shall be construed as a waiver of such Rules and Regulations in favor of any other tenant, nor prevent Landlord from thereafter enforcing any such Rules or Regulations against any or all tenants of the Project. Tenant shall be deemed to have read these Rules and Regulations and to have agreed to abide by them as a condition of its occupancy of the Premises. EXHIBIT D - Page 4 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EXHIBIT E LAKESHORE TOWERS FORM OF TENANT'S ESTOPPEL CERTIFICATE The undersigned as Tenant under that certain Office Lease (the "Lease") made and entered into as of ___________, ________ by and between ____________ as Landlord, and the undersigned as Tenant, for Premises on the____________floor(s) of the office building located at ________,____________, California___________, certifies as follows: 1. Attached hereto as Exhibit A is a true and correct copy of the Lease and all amendments and modifications thereto. The documents contained in Exhibit A represent the entire agreement between the parties as to the Premises. 2. The undersigned currently occupies the Premises described in the Lease, the Lease Term commenced on ____________________, and the Lease Term expires on __________________, and the undersigned has no option to terminate or cancel the Lease or to purchase all or any part of the Premises, the Building and/or the Project. 3. Base Rent became payable on________________________. 4. The Lease is in full force and effect and has not been modified, supplemented or amended in any way except as provided in Exhibit A. 5. Tenant has not transferred, assigned, or sublet any portion of the Premises nor entered into any license or concession agreements with respect thereto except as follows: 6. Tenant shall not modify the documents contained in Exhibit A without the prior written consent of Landlord's mortgagee. 7. All monthly installments of Base Rent, all Additional Rent and all monthly installments of estimated Additional Rent have been paid when due through _________________________________. The current monthly installment of Base Rent is $___________________________________. 8. All conditions of the Lease to be performed by Landlord necessary to the enforceability of the Lease have been satisfied and Landlord is not in default thereunder. In addition, the undersigned has not delivered any notice to Landlord regarding a default by Landlord thereunder. 9. No rental has been paid more than thirty (30) days in advance and no security has been deposited with Landlord except as provided in the Lease. 10. As of the date hereof, there are no existing defenses or offsets, or, to the undersigned's knowledge, claims or any basis for a claim, that the undersigned has against Landlord. 11. If Tenant is a corporation or partnership, each individual executing this Estoppel Certificate on behalf of Tenant hereby represents and warrants that Tenant is a duly formed and existing entity qualified to do business in California and that Tenant has full right and authority to execute and deliver this Estoppel Certificate and that each person signing on behalf of Tenant is authorized to do so. 12. There are no actions pending against the undersigned under the bankruptcy or similar laws of the United States or any state. 13. Other than in compliance with all applicable laws and incidental to the ordinary course of the use of the Premises, the undersigned has not used or stored any hazardous substances in the Premises. 14. To the undersigned's knowledge, all tenant improvement work to be performed by Landlord under the Lease has been completed in accordance with the Lease and has been accepted by EXHIBIT E - Page 1 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] the undersigned and all reimbursements and allowances due to the undersigned under the Lease in connection with any tenant improvement work have been paid in full. The undersigned acknowledges that this Estoppel Certificate may be delivered to Landlord or to a prospective mortgagee or prospective purchaser, and acknowledges that said prospective mortgagee or prospective purchaser will be relying upon the statements contained herein in making the loan or acquiring the property of which the Premises are a part and that receipt by it of this certificate is a condition of making such loan or acquiring such property. Executed at________________on the______________day of_____________,___________. "Tenant": ________________________________________ a ______________________________________ By:_____________________________________ Its:____________________________________ By: ____________________________________ Its: ___________________________________ EXHIBIT E - Page 2 LAKESHORE TOWERS BUILDING II [Quality Systems, Inc.] EX-23.1 7 d64225_ex23-1.txt CONSENT OF INDEPENDENT REGISTERED PUB ACCT FIRM EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have issued reports dated June 3, 2005, accompanying the consolidated financial statements and schedule and management's assessment of the effectiveness of internal control over financial reporting included in the Annual Report of Quality Systems, Inc. on Form 10-K for the year ended March 31, 2005. We hereby consent to the incorporation by reference of said report in the Registration Statements of Quality Systems, Inc. on Forms S-8 (File No. 33-31949, effective November 6, 1989, File No. 333-63131, effective September 10, 1998 and File No. 333-67115, effective November 12, 1998). /s/ Grant Thornton LLP Irvine, California June 3, 2005 EX-31.1 8 d64225_ex31-1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 31.1 CERTIFICATION OF CEO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Louis Silverman, certify that: 1. I have reviewed this Form 10-K of Quality Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/ LOUIS E. SILVERMAN -------------------------- Date: June 3, 2005 Louis E. Silverman, President and Chief Executive Officer EX-31.2 9 d64225_ex31-2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER Exhibit 31.2 CERTIFICATION OF CEO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Paul A. Holt, certify that: 1. I have reviewed this Form 10-K of Quality Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/ PAUL HOLT ----------------- Date: June 3, 2005 Paul A. Holt, Secretary and Chief Financial Officer EX-32.1 10 d64225_ex32-1.txt SECTION 1350 CERTIFICATIONS 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 annual report on Form 10-K of Quality Systems, Inc. (the "Company") for the quarterly period ended March 31, 2004 (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: June 3 , 2005 By:/s/ LOUIS SILVERMAN --------------------------------------------- Louis Silverman Chief Executive Officer (principal executive officer) Dated: June 3, 2005 By:/s/ PAUL HOLT --------------------------------------------- Paul Holt Chief Financial Officer (principal financial officer) A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signatures that appear in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----