UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

 

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended September 30, 2008

 

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-13801

QUALITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)

 

 

 

 

 

 

California

 

95-2888568

 

 

(State or Other Jurisdiction of

 

(I.R.S. Employer

 

 

Incorporation or Organization)

 

Identification No.)

 

 

 

 

 

 

 

18111 Von Karman Avenue, Suite 600, Irvine California 92612

 

 

 

 

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (949) 255-2600

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes x No o

Indicate by check mark whether the Registrant is a large accelerated filers, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12B-2 of the Exchange Act. (Check one): Large accelerated filer o           Accelerated filer x           Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicate the number of shares outstanding of each of the Registrant’s classes of Common Stock as of the latest practicable date 28,303,045shares of Common Stock, $0.01 par value, as of October 15, 2008.




PART I
CONSOLIDATED FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

67,880

 

$

59,046

 

Restricted cash

 

 

2,002

 

 

 

Marketable securities

 

 

 

 

2,500

 

Accounts receivable, net

 

 

90,250

 

 

76,585

 

Inventories, net

 

 

1,080

 

 

1,024

 

Income tax receivable

 

 

5,526

 

 

 

Net current deferred tax assets

 

 

6,395

 

 

6,397

 

Other current assets

 

 

4,425

 

 

4,596

 

 

 



 



 

Total current assets

 

 

177,558

 

 

150,148

 

 

 

 

 

 

 

 

 

Marketable securities

 

 

12,702

 

 

20,124

 

Equipment and improvements, net

 

 

5,142

 

 

4,773

 

Capitalized software costs, net

 

 

9,559

 

 

8,852

 

Intangibles, net

 

 

5,267

 

 

 

Goodwill

 

 

12,659

 

 

1,840

 

Other assets

 

 

2,220

 

 

2,171

 

 

 



 



 

Total assets

 

$

225,107

 

$

187,908

 

 

 



 



 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

4,095

 

$

4,685

 

Deferred revenue

 

 

45,844

 

 

44,389

 

Accrued compensation and related benefits

 

 

8,771

 

 

8,346

 

Income taxes payable

 

 

 

 

1,541

 

Dividends payable

 

 

8,460

 

 

6,861

 

Other current liabilities

 

 

12,408

 

 

4,394

 

 

 



 



 

Total current liabilities

 

 

79,578

 

 

70,216

 

 

 

 

 

 

 

 

 

Deferred revenue, net of current

 

 

271

 

 

506

 

Net deferred tax liabilities

 

 

1,792

 

 

1,575

 

Deferred compensation

 

 

1,966

 

 

1,906

 

 

 



 



 

Total liabilities

 

 

83,607

 

 

74,203

 

 

 



 



 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Common stock
$0.01 par value; authorized 50,000 shares; issued and outstanding 28,292 and 27,448 shares at September 30, 2008 and March 31, 2008, respectively

 

 

283

 

 

274

 

Additional paid-in capital

 

 

97,976

 

 

75,556

 

Retained earnings

 

 

44,235

 

 

38,071

 

Accumulated other comprehensive loss, net of tax

 

 

(994

)

 

(196

)

 

 



 



 

Total shareholders’ equity

 

 

141,500

 

 

113,705

 

 

 



 



 

Total liabilities and shareholders’ equity

 

$

225,107

 

$

187,908

 

 

 



 



 

The accompanying condensed notes to these unaudited consolidated financial statements are an integral part of these consolidated statements.

2



QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

September 30,
2008

 

September 30,
2007

 

September 30,
2008

 

September 30,
2007

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

$

21,297

 

$

18,514

 

$

42,666

 

$

35,253

 

Implementation and training services

 

 

3,486

 

 

3,182

 

 

7,071

 

 

6,430

 

 

 



 



 



 



 

System sales

 

 

24,783

 

 

21,696

 

 

49,737

 

 

41,683

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

 

17,234

 

 

13,442

 

 

34,370

 

 

26,001

 

Electronic data interchange services

 

 

6,985

 

 

5,406

 

 

13,655

 

 

10,430

 

Revenue cycle management and related services

 

 

4,527

 

 

222

 

 

6,484

 

 

356

 

Other services

 

 

5,452

 

 

4,380

 

 

9,959

 

 

8,708

 

 

 



 



 



 



 

Maintenance, EDI, revenue cycle management and other services

 

 

34,198

 

 

23,450

 

 

64,468

 

 

45,495

 

 

 



 



 



 



 

Total revenue

 

 

58,981

 

 

45,146

 

 

114,205

 

 

87,178

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

 

3,395

 

 

2,477

 

 

6,882

 

 

4,966

 

Implementation and training services

 

 

2,626

 

 

2,423

 

 

5,640

 

 

4,832

 

 

 



 



 



 



 

Total cost of system sales

 

 

6,021

 

 

4,900

 

 

12,522

 

 

9,798

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

 

2,947

 

 

3,033

 

 

6,030

 

 

6,159

 

Electronic data interchange services

 

 

5,256

 

 

3,742

 

 

10,147

 

 

7,251

 

Revenue cycle management and related services

 

 

3,132

 

 

138

 

 

4,437

 

 

236

 

Other services

 

 

3,866

 

 

2,962

 

 

7,313

 

 

5,873

 

 

 



 



 



 



 

Total cost of maintenance, EDI, revenue cycle management and other services

 

 

15,201

 

 

9,875

 

 

27,927

 

 

19,519

 

 

 



 



 



 



 

Total cost of revenue

 

 

21,222

 

 

14,775

 

 

40,449

 

 

29,317

 

 

 



 



 



 



 

Gross profit

 

 

37,759

 

 

30,371

 

 

73,756

 

 

57,861

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

18,283

 

 

13,188

 

 

33,535

 

 

25,831

 

Research and development costs

 

 

3,342

 

 

2,688

 

 

6,461

 

 

5,488

 

 

 



 



 



 



 

Total operating expenses

 

 

21,625

 

 

15,876

 

 

39,996

 

 

31,319

 

 

 



 



 



 



 

Income from operations

 

 

16,134

 

 

14,495

 

 

33,760

 

 

26,542

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

340

 

 

645

 

 

714

 

 

1,384

 

 

 



 



 



 



 

Income before provision for income taxes

 

 

16,474

 

 

15,140

 

 

34,474

 

 

27,926

 

Provision for income taxes

 

 

5,975

 

 

5,468

 

 

12,861

 

 

10,314

 

 

 



 



 



 



 

 

Net income

 

$

10,499

 

$

9,672

 

$

21,613

 

$

17,612

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.38

 

$

0.35

 

$

0.78

 

$

0.65

 

Diluted

 

$

0.37

 

$

0.35

 

$

0.77

 

$

0.64

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

27,930

 

 

27,287

 

 

27,699

 

 

27,211

 

Diluted

 

 

28,211

 

 

27,718

 

 

28,014

 

 

27,696

 

Dividends declared per common share

 

$

0.30

 

$

0.25

 

$

0.55

 

$

0.50

 

The accompanying condensed notes to these unaudited consolidated financial statements are an integral part of these consolidated statements.

3



QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 


 

 

 

September 30,
2008

 

September 30,
2007

 

 

 


 


 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

21,613

 

$

17,612

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

1,335

 

 

1,139

 

Amortization of capitalized software costs

 

 

2,463

 

 

2,004

 

Amortization of other intangibles

 

 

353

 

 

 

Provision for bad debts

 

 

914

 

 

220

 

Reduction in inventory obsolescense

 

 

(13

)

 

 

Share-based compensation

 

 

1,128

 

 

2,035

 

Deferred income taxes

 

 

744

 

 

(828

)

Tax benefit from exercise of stock options

 

 

3,153

 

 

1,421

 

Excess tax benefit from share-based compensation

 

 

(3,002

)

 

(1,186

)

Loss on disposal of equipment and improvements

 

 

96

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

(12,403

)

 

(4,649

)

Inventories

 

 

(43

)

 

(194

)

Other current assets

 

 

387

 

 

570

 

Other assets

 

 

(37

)

 

(259

)

Accounts payable

 

 

(1,001

)

 

(1,432

)

Deferred revenue

 

 

1,210

 

 

488

 

Accrued compensation and related benefits

 

 

(21

)

 

(519

)

Income taxes payable

 

 

(7,067

)

 

765

 

Other current liabilities

 

 

5,534

 

 

1,802

 

Deferred compensation

 

 

60

 

 

238

 

 

 



 



 

Net cash provided by operating activities

 

 

15,403

 

 

19,227

 

 

 



 



 

Cash flows from investing activities:

 

 

 

 

 

 

 

Additions to capitalized software costs

 

 

(3,170

)

 

(3,027

)

Additions to equipment and improvements

 

 

(1,470

)

 

(1,185

)

Proceeds from sale of marketable securities

 

 

8,600

 

 

 

Purchases of marketable securities

 

 

 

 

(46,000

)

Purchase of HSI, including direct transaction costs

 

 

(8,221

)

 

 

 

 



 



 

Net cash used in investing activities

 

 

(4,261

)

 

(50,212

)

 

 



 



 

Cash flows from financing activities:

 

 

 

 

 

 

 

Excess tax benefit from share-based compensation

 

 

3,002

 

 

1,186

 

Proceeds from the exercise of stock options

 

 

10,798

 

 

3,471

 

Dividends paid

 

 

(13,850

)

 

(6,780

)

Loan repayments

 

 

(2,258

)

 

 

 

 



 



 

Net cash used in financing activities

 

 

(2,308

)

 

(2,123

)

 

 



 



 

Net increase (decrease) in cash and cash equivalents

 

 

8,834

 

 

(33,108

)

Cash and cash equivalents at beginning of period

 

 

59,046

 

 

60,028

 

 

 



 



 

Cash and cash equivalents at end of period

 

$

67,880

 

$

26,920

 

 

 



 



 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid during the period for income taxes, net of refunds

 

$

15,442

 

$

9,142

 

 

 



 



 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

Unrealized loss on marketable securities

 

$

(798

)

$

 

 

 



 



 

Effective May 20, 2008, the Company acquired HSI in a transaction summarized as follows:

 

 

 

 

 

 

 

Fair value of net assets assumed

 

$

20,589

 

$

 

Cash paid for HSI stock

 

 

(8,221

)

 

 

Common stock issued for HSI stock

 

 

(7,350

)

 

 

 

 



 



 

Liabilities assumed

 

$

5,018

 

$

 

 

 



 



 

The accompanying condensed notes to these unaudited consolidated financial statements are an integral part of these consolidated statements.

4



QUALITY SYSTEMS, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 

 

1.

Basis of Presentation

The accompanying unaudited consolidated financial statements as of September 30, 2008 and for the three and six months ended September 30, 2008 and 2007, have been prepared in accordance with the requirements of Form 10-Q and Article 10 of Regulation S-X, and therefore do not include all information and footnotes which would be presented were such consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). These consolidated financial statements should be read in conjunction with the audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2008. Amounts related to disclosures of March 31, 2008 balances within these interim consolidated financial statements were derived from the aforementioned Form 10-K. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments which are necessary for a fair presentation of the results of operations and cash flows for the periods presented. The results of operations for such interim periods are not necessarily indicative of results of operations to be expected for the full year.

References to dollar amounts in this financial statement section are in thousands, except share and per share data, unless otherwise specified.

 

 

2.

Summary of Significant Accounting Policies

Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. On May 20, 2008, the Company acquired Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (HSI), a full-service healthcare revenue management company. All significant intercompany accounts and transactions have been eliminated.

Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

Certain prior year amounts have been reclassified to conform with fiscal year 2009 presentation.

Revenue Recognition. The Company recognizes system sales 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, 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 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 quarterly or annually depending on the nature of the product or service.

When evidence of fair value exists for the delivered and undelivered elements of a transaction, then discounts for individual elements are aggregated and the total discount is allocated to the individual elements in proportion to the elements’ fair value relative to the total contract fair value.

When evidence of fair value exists for the undelivered elements only, the residual method, provided for under SOP 98-9, is used. Under the residual method, the Company defers revenue related to the undelivered elements in a system sale based on VSOE of fair value of each of the undelivered elements, and allocates the remainder of the contract price net of all discounts to revenue recognized from the delivered elements. 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 system sales contract amount upon contract execution except for maintenance which is billed separately. 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

5



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 collections risk is high, the cash basis method is used to recognize revenue. If the fee is not fixed or determinable, then the revenue recognized in each period (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the arrangement fee that would have been recognized if the fees were being recognized using the residual method. Fees which are considered fixed or determinable at the inception of the Company’s arrangements must include the following characteristics:

 

 

§

The fee must be negotiated at the outset of an arrangement, and generally be based on the specific volume of products to be delivered without being subject to change based on variable pricing mechanisms such as the number of units copied or distributed or the expected number of users.

 

 

§

Payment terms must not be considered extended. If a significant portion of the fee is due more than 12 months after delivery or after the expiration of the license, the fee is presumed not fixed and determinable.

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:

 

 

§

the 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;

 

 

§

the customer can be expected to satisfy its obligations under the contract;

 

 

§

the Company can be expected to perform its contractual obligations; and

 

 

§

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.

Individual product returns are estimated in accordance with Statement of Financial Accounting Standards No. 48, “Revenue Recognition When Right of Return Exists” (SFAS 48). The Company also ensures that the other criteria in SFAS 48 have been met prior to recognition of revenue:

 

 

§

the price is fixed or determinable;

 

 

§

the customer is obligated to pay and there are no contingencies surrounding the obligation or the payment;

 

 

§

the customer’s obligation would not change in the event of theft or damage to the product;

 

 

§

the customer has economic substance;

 

 

§

the amount of returns can be reasonably estimated; and

 

 

§

the Company does not have significant obligations for future performance in order to bring about resale of the product by the customer.

The Company has historically offered short-term rights of return in certain sales arrangements. If the Company is able to estimate returns for these types of arrangements, revenue is recognized and these arrangements are recorded in the consolidated financial statements. If the Company is unable to estimate returns for these types of arrangements, revenue is not recognized in the consolidated financial statements until the rights of return expire.

Revenue related to sales arrangements which include the right to use software stored on the Company’s hardware is accounted for under the Emerging Issues Task Force Issue (EITF) No. 00-3 “Application of AICPA Statement of Position 97-2 to arrangements that include the right to use software stored on another entity’s hardware”. EITF No. 00-3 requires that for software licenses and related implementation services to continue to fall under SOP No. 97-2, the customer must have the contractual right to take possession of the software without incurring a significant penalty and it must be feasible for the customer to either host the software themselves or through another third party. If an arrangement is not deemed to be accounted

6



for under SOP 97-2, the entire arrangement is accounted for as a service contract in accordance with EITF Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables”. In that instance, the entire arrangement would be recognized as the hosting services are being performed.

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 5100.50, 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.

Revenue cycle management service revenue is derived from services fees, which include amounts charged for ongoing billing and other related services, and are generally billed to the customer as a percentage of total collections. The Company does not recognize revenue for services fees until these collections are made, as the services fees are not fixed and determinable until such time.

Revenue is divided into two categories, “system sales” and “maintenance, EDI, revenue cycle management 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. The majority of the revenue in the system sales category is related to the sale of software. Revenue in the maintenance, EDI, revenue cycle management and other services category includes maintenance, EDI, revenue cycle management services, follow on training and implementation services, annual third party license fees, hosting services and other revenue.

Cash and cash equivalents. Cash and cash equivalents generally consist of cash, money market funds and short-term U.S. Treasury securities with original 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 relatively low market risk. The average maturity of the investments owned by the money market fund is approximately two months.

Restricted cash. Restricted cash consists of cash which is being held by HSI acting as agent for the disbursement of certain state social services programs. The Company records an offsetting “Care Services liability” (see also Note 5) when it initially receives such cash from the government social service programs and relieves both restricted cash and the Care Services liability when amounts are disbursed. HSI earns an administrative fee which is based on a percentage of funds disbursed on behalf of certain government social service programs.

Marketable securities. Marketable securities are classified as available-for-sale and accordingly are recorded at fair value, based on quoted market rates or valuation analysis when appropriate, with unrealized gains and losses reflected as a separate component of shareholders’ equity titled accumulated other comprehensive income (loss), net of tax, until realized or until a determination is made that an other-than-temporary decline in market value has occurred. Factors considered in assessing whether an other-than-temporary impairment has occurred include: the nature of the investment; whether the decline in fair value is attributable to specific adverse conditions affecting the investment; the financial condition of the investee; the severity and the duration of the impairment; and whether the Company has the ability to hold the investment to maturity. If it is determined that an other-than-temporary impairment has occurred, the investment is written down to its market value at the end of the period in which it is determined that an other-than-temporary decline has occurred. In addition, the Company classifies marketable securities as current or non-current based upon whether such assets are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.

The Company’s investments at September 30, 2008 and March 31, 2008 are in tax exempt municipal Auction Rate Securities (ARS) which are classified as either current or non-current marketable securities on the Company’s Consolidated Balance Sheets, depending on the liquidity and timing of expected realization of such securities. A small portion of the Company’s portfolio is invested in closed-end funds which invest in tax exempt municipal auction rate securities. These instruments are known as Auction Rate Preferred Securities (ARPS). The ARS are rated by one or more national rating agencies and have contractual terms of up to 30 years, but generally have interest rate reset dates that occur every 7, 28 or 35 days. Despite the underlying long-term maturity of ARS, such securities were priced and subsequently traded as short-term investments because of the interest rate reset feature. If there are insufficient buyers, the auction is said to “fail” and the holders are unable to liquidate the investments through auction. A failed auction does not result in a default of the debt instrument. The securities will continue to accrue interest and be auctioned until the auction succeeds, the issuer calls the securities or the securities mature.

7



In February 2008, the Company began to experience failed auctions on its ARS and ARPS. To determine their estimated fair values at September 30, 2008, factors including credit quality, assumptions about the likelihood of redemption, observable market data such as yields or spreads of fixed rate municipal bonds or other trading instruments issued by the same or comparable issuers were considered. Based on this analysis, a temporary impairment loss of $798, net of income tax benefit, which represents the approximate midpoint between various impairment values based on the analysis above, was recorded to accumulated other comprehensive loss in the accompanying consolidated financial statements as of September 30, 2008. If the Company sells any of the ARS or ARPS, prior to maturity, at an amount below original purchase value, or if it becomes probable that the Company will not receive 100% of the principal and interest from the issuer of any ARS or ARPS, the Company will be required to recognize an other-than-temporary impairment charge against net income.

Allowance for Doubtful Accounts. The Company provides credit terms typically ranging from thirty days to less than twelve months for most system and maintenance contract sales and generally does not require collateral. The Company performs credit evaluations of its customers and maintains reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management’s estimate of the probability of collection for certain troubled accounts. General reserves are established based on the Company’s historical experience of bad debt expense and the aging of the Company’s accounts receivable balances net of deferred revenues and specifically reserved accounts. Accounts are written off as uncollectible only after the Company has expended extensive collection efforts.

Included in accounts receivable are amounts related to maintenance and services which were billed, but which had not yet been rendered as of the end of the period. Undelivered maintenance and services are included on the accompanying Consolidated Balance Sheets in deferred revenue (see also Note 5).

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, by the straight-line method. Useful lives range as follows:

 

 

 

§

Computers and electronic test equipment

3-5 years

§

Furniture and fixtures

5-7 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 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 provides support services on the current and prior two versions of its software. Management performs an annual review of the estimated economic life and the recoverability of such capitalized software costs. If 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). Goodwill is related to the NextGen Division and the HSI acquisition, which closed on May 20, 2008 (see also Note 6). 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. Relating to NextGen Division’s goodwill, 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, 2008 (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. The Company will perform its impairment test on HSI as of June 30, 2009 or earlier if deemed necessary.

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). Management periodically reviews the carrying value of long-lived assets, including identifiable

8



intangible assets with definite lives, to determine whether or not impairment to such value has occurred and has determined that there was no impairment at September 30, 2008.

Income Taxes. Income taxes are provided based on current taxable income and the future tax consequences of temporary differences between the basis of assets and liabilities for financial and tax reporting. The deferred income tax assets and liabilities represent the future state and federal 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 are also recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future income taxes. At each reporting period, management assesses the realizable value of deferred tax assets based on, among other things, estimates of future taxable income, and adjusts the related valuation allowance as necessary. In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes – an Interpretation of SFAS No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold of more-likely-than-not and measurement of a tax position taken or expected to be taken in an enterprise’s tax return. Management makes a number of assumptions and estimates in determining the appropriate amount of expense to record for income taxes. These assumptions and estimates consider the taxing jurisdiction in which the Company operates as well as current tax regulations. Accruals are established for estimates of tax effects for certain transactions and future projected profitability of the Company’s businesses based on management’s interpretation of existing facts and circumstances. The Company adopted FIN 48 effective April 1, 2007. See Note 11.

Share-Based Compensation

Statement of Financial Accounting Standard No. 123R, “Share-Based Payment” (SFAS 123R), requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. Expected term is estimated using historical exercise experience. Volatility is estimated by using the weighted average historical volatility of our common stock, which approximates expected volatility. The risk free rate is the implied yield available on the U.S Treasury zero-coupon issues with remaining terms equal to the expected term. The expected dividend yield is the average dividend rate during a period equal to the expected term of the option. Those inputs are then entered into the Black Scholes model to determine the estimated fair value. The value of the portion of the award that is ultimately expected to vest is recognized ratably as expense over the requisite service period in the Company’s Consolidated Statements of Income.

The following table shows total stock-based employee compensation expense included in the Consolidated Statement of Income for the three and six month periods ended September 30, 2008 and 2007.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

September 30,
2008

 

September 30,
2007

 

September 30,
2008

 

September 30,
2007

 

 

 


 


 


 


 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

$

78

 

$

129

 

$

153

 

$

272

 

Research and development

 

 

81

 

 

215

 

 

185

 

 

451

 

Selling, general and administrative

 

 

262

 

 

615

 

 

790

 

 

1,312

 

 

 



 



 



 



 

Total share-based compensation

 

$

421

 

$

959

 

$

1,128

 

 

2,035

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts capitalized in software development costs

 

 

(8

)

 

(9

)

 

(18

)

 

(21

)

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts charged against earnings, before income tax benefit

 

$

413

 

$

950

 

$

1,110

 

$

2,014

 

 

 



 



 



 



 

Amount of related income tax benefit recognized in earnings

 

$

129

 

$

252

 

$

310

 

$

537

 

 

 



 



 



 



 


 

 

3.

Recent Accounting Pronouncements

In October 2008 the FASB issued FSP SFAS No. 157-3, “Determining the Fair Value of a Financial Asset When The Market for That Asset Is Not Active”, or FSP 157-3, to clarify the application of the provisions of SFAS 157 in an inactive market and how an entity would determine fair value in an inactive market. FSP 157-3 is effective immediately and applies to the Company’s September 30, 2008 consolidated financial statements.

9



In June 2008, the FASB issued FSP Emerging Issue Task Force (“EITF”) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”. FSP EITF 03-6-1 concluded that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of basic earnings per share (“EPS”) pursuant to the two-class method. This FSP becomes effective on April 1, 2009. Early adoption of the FSP is not permitted; however, it will apply retrospectively to EPS data for all periods presented in the financial statements or in financial data. The company does not currently anticipate that this FSP will have a material impact on our EPS data in fiscal year 2010 or on EPS for any prior periods presented in the Company’s consolidated financial statements upon adoption.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162).SFAS 162 defines the order in which accounting principles that are generally accepted should be followed. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”. The company does not expect the adoption of SFAS 162 to have a material impact on our consolidated financial statements.

In April 2008, the FASB finalized Staff Position (FSP) 142-3, “Determination of the Useful Life of Intangible Assets”. The position amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142. The position applies to intangible assets that are acquired individually or with a group of other assets and both intangible assets acquired in business combinations and asset acquisitions. FSP 142-3 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Management is currently evaluating the impact of the pending adoption of FSP 142-3 on the consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (Revised 2007), “Business Combinations” (SFAS 141R). SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations. SFAS 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest at their fair values as of the acquisition date. In addition, SFAS 141(R) requires expensing of acquisition-related and restructure-related costs, remeasurement of earn out provisions at fair value, measurement of equity securities issued for purchase at the date of close of the transaction and non-expensing of in-process research and development related intangibles. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. This pronouncement will be applied by the Company when it becomes effective and when or if the Company effectuates a business combination post adoption, otherwise there is no impact on the Company’s consolidated financial statements.

 

 

4.

Fair Value Measurement

Effective April 1, 2008, the Company implemented the requirements of SFAS No. 157, Fair Value Measurements (SFAS 157) for its financial assets and liabilities. SFAS 157 refines the definition of fair value, expands disclosure requirements about fair value measurements and establishes specific requirements as well as guidelines for a consistent framework to measure fair value. SFAS 157 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. Further, SFAS 157 requires the Company to maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements. SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. This hierarchy requires the use of observable market data when available. These two types of inputs have created the following fair value hierarchy:

Level 1 – Quoted market prices in active markets for identical assets or liabilities;

Level 2 – Observable inputs other than those included in Level 1. For example, quoted prices for similar assets in active markets or quoted prices for identical assets in inactive markets; and

10



Level 3 – Unobservable inputs reflecting management’s own assumptions about the inputs used in estimating the value of the asset.

The adoption of SFAS 157 did not have a material impact on the Company’s consolidated financial position or results of operations.

On February 12, 2008, the FASB amended the implementation of SFAS 157 related to non-financial assets and liabilities until fiscal periods beginning after November 15, 2008. As a result, the Company has not applied the above fair value procedures to its goodwill and long-lived asset impairment analyses during the current period. The Company believes that the adoption of SFAS 157 for non-financial assets and liabilities will not have a material impact on its consolidated financial position or results of operations.

The following table summarizes the Company’s financial assets measured at fair value on a recurring basis in accordance with SFAS 157 as of September 30, 2008:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of
September 30,
2008

 

Quoted Prices in
Active Markets
For Identical
Assets (Level 1)

 

Significant
Other Observable
Inputs (Level 2)

 

Unobservable
Inputs (Level 3)

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

67,880

 

$

67,880

 

$

 

$

 

Restricted cash

 

 

2,002

 

 

2,002

 

 

 

 

 

Marketable securities(1)

 

 

12,702

 

 

 

 

 

 

12,702

 

 

 



 



 



 



 

 

 

$

82,584

 

$

69,882

 

$

 

$

12,702

 

 

 



 



 



 



 


 

 

(1)

Marketable securities consist of ARS.

The fair value of the Company’s ARS has been estimated by management based on its assumptions of what market participants would use in pricing the asset in a current transaction, or level 3 - unobservable inputs in accordance with SFAS 157, and represents $12,702 or 15.4% of total financial assets measured at fair value in accordance with SFAS 157. Management used a model to estimate the fair value of these securities that included certain level 2 inputs as well as assumptions, including a liquidity discount, based on management’s judgment, which are highly subjective and therefore considered level 3 inputs in the fair value hierarchy. The estimate of the fair value of the ARS could change based on market conditions. For additional information on cash and cash equivalents, restricted cash or marketable securities, see Note 2.

The following table presents the Company’s assets measured at fair value using significant unobservable inputs (Level 3) as defined by SFAS 157 at September 30, 2008:

 

 

 

 

 

 

 

Investment in
Marketable
Securities

 

 

 


 

 

 

 

 

 

Balance at March 31, 2008

 

$

22,624

 

Transfers to/out of Level 3

 

 

 

Proceeds from sale

 

 

(8,600

)

Unrealized losses recorded to other comprehensive income, before income tax benefit

 

 

(1,322

)

 

 



 

Balance at September 30, 2008

 

$

12,702

 

 

 



 


 

 

5.

Composition of Certain Financial Statement Captions

Accounts receivable include amounts related to maintenance and services which were billed but not yet rendered as of the end of the period. Undelivered maintenance and services are included on the accompanying Consolidated Balance Sheets as part of the deferred revenue balance.

11



 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Accounts receivable, excluding undelivered software, maintenance and services

 

$

60,111

 

$

50,417

 

Undelivered software, maintenance and implementation services billed in advance, included in deferred revenue

 

 

33,325

 

 

28,696

 

 

 



 



 

Accounts receivable, gross

 

 

93,436

 

 

79,113

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts

 

 

(3,186

)

 

(2,528

)

 

 



 



 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

$

90,250

 

$

76,585

 

 

 



 



 

 

 

 

 

 

 

 

 

Inventories are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Computer systems and components, net of reserve for obsolescence of $210 and $223, respectively

 

$

1,058

 

$

992

 

Miscellaneous parts and supplies

 

 

22

 

 

32

 

 

 



 



 

Inventories, net

 

$

1,080

 

$

1,024

 

 

 



 



 

 

 

 

 

 

 

 

 

Accrued compensation and related benefits are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Bonus and commission

 

$

5,492

 

$

5,443

 

Vacation

 

 

3,279

 

 

2,903

 

 

 



 



 

 

 

 

 

 

 

 

 

Accrued compensation and related benefits

 

$

8,771

 

$

8,346

 

 

 



 



 

 

 

 

 

 

 

 

 

Short and long-term deferred revenue are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Maintenance

 

$

8,176

 

$

10,175

 

Implementation services

 

 

28,152

 

 

25,929

 

Annual license services

 

 

6,684

 

 

6,532

 

Undelivered software and other

 

 

3,103

 

 

2,259

 

 

 



 



 

 

 

 

 

 

 

 

 

Deferred Revenue

 

$

46,115

 

$

44,895

 

 

 



 



 

 

 

 

 

 

 

 

 

12


Other current liabilities are summarized as follows:

 

 

 

 

 


 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Customer deposits

 

$

3,081

 

$

621

 

Accrued EDI expenses

 

 

1,677

 

 

 

Care services liabilties

 

 

2,002

 

 

 

Sales tax payable

 

 

966

 

 

765

 

Professional fees

 

 

871

 

 

600

 

Deferred rent

 

 

514

 

 

607

 

Commission payable

 

 

425

 

 

346

 

Accrued royalties

 

 

382

 

 

216

 

Other accrued expenses

 

 

2,490

 

 

1,239

 

 

 



 



 

Other current liabilities

 

$

12,408

 

$

4,394

 

 

 



 



 


 

 

6.

Business Combinations

On May 16, 2008, the Company entered into an agreement to acquire Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (HSI), a full-service healthcare revenue management company. The acquisition was made under the terms of an Agreement and Plan of Merger resulting in HSI becoming a wholly-owned subsidiary of QSI. The closing of the HSI acquisition occurred on May 20, 2008. HSI’s results of operations have been included in the consolidated financial statements since the date of acquisition.

The purchase price totaled approximately $15,571 plus up to approximately $1,650 in incentives tied to future performance. The purchase price consisted of approximately equal parts of cash and restricted QSI common stock, subject to restrictions on resale lapsing over a two year period, and transaction related costs. The value of the 232,081 shares of common stock issued was determined based on a formula which took the average of the closing price of QSI’s common shares during the 45 day trading period ending on May 19, 2008. The total purchase price for HSI is as follows:

 

 

 

 

 

Cash

 

$

8,000

 

Common stock

 

 

7,350

 

Direct transaction costs

 

 

221

 

 

 



 

Total purchase price

 

$

15,571

 

 

 



 

The acquisition of HSI is accounted for as a purchase business combination as defined in Statement of Financial Accounting Standards No. 141, “Business Combinations” (SFAS 141). Under the purchase method of accounting, the purchase price was allocated to HSI’s tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of May 20, 2008. The fair value of the assets acquired and liabilities assumed represent management’s estimate of fair value. The Company is amortizing the customer relationships intangible asset over six years and the trade name over four years. The $10,819 assigned to goodwill is expected to be deductible for tax purposes. See Note 6 and 7 for a discussion of goodwill and intangibles acquired. As stated above, the Company has agreed to pay additional consideration in future periods, based upon the attainment by the acquired entity of defined operating objectives. In accordance with SFAS 141, the Company does not accrue contingent consideration obligations prior to attainment of these objectives. At September 30, 2008, the maximum potential future consideration pursuant to such arrangements, to be resolved over the following two years, is $1,650. Any such payments would result in increases in goodwill.

The following table summarizes the allocation of the purchase price:

 

 

 

 

 

Current assets (including restricted cash of $1,470 and accounts receivable of $2,176)

 

$

3,808

 

Equipment and improvements and other long-term assets

 

 

342

 

 

 



 

Total tangible assets acquired

 

 

4,150

 

Customer relationships

 

 

5,241

 

Trade name

 

 

379

 

Goodwill

 

 

10,819

 

Current liabilties, including long-term debt due within one year

 

 

(4,369

)

Long-term debt

 

 

(649

)

 

 



 

Net assets acquired

 

$

15,571

 

 

 



 

The pro forma effects of this acquisition would not have been material to our results of

13



operations for the three and six months ended September 30, 2008 or 2007 and therefore are not presented.

 

 

7.

Intangible Assets – Goodwill

In accordance with SFAS 142, the Company does not amortize goodwill as the goodwill has been determined to have indefinite useful life.

Goodwill consists of the following:

 

 

 

 

 

 

 

September 30,
2008

 

 

 


 

 

 

 

 

 

NextGen Healthcare Information Systems, Inc

 

$

1,840

 

Healthcare Strategic Initiatives

 

 

10,819

 

 

 



 

Total

 

$

12,659

 

 

 



 


 

 

8.

Intangible Assets – Customer Relationships and Trade Name

The Company had the following amounts related to intangible assets, net, other than capitalized software development costs, with determinable lives:

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2008

 

 

 


 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net

 

 

 


 


 


 

 

 

 

 

 

 

 

 

Customer Relationships

 

$

5,241

 

$

(318

)

$

4,923

 

Trade Name

 

 

379

 

 

(35

)

 

344

 

 

 



 



 



 

Total

 

$

5,620

 

$

(353

)

$

5,267

 

 

 



 



 



 

The following represents the change in intangible assets recorded for the six months ended September 30, 2008:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer
Relationships

 

Trade Name

 

Total

 

 

 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

Balance as of April 1, 2008

 

$

 

$

 

$

 

Acquisition

 

 

5,241

 

 

379

 

 

5,620

 

Amortization

 

 

(318

)

 

(35

)

 

(353

)

 

 



 



 



 

Balance as of September 30, 2008

 

$

4,923

 

$

344

 

$

5,267

 

 

 



 



 



 

The following table represents the remaining estimated amortization of intangible assets, other than capitalized software development costs, with determinable lives as of September 30, 2008:

 

 

 

 

 

For the year ending March 31,

 

 

 

 

2009

 

$

484

 

2010

 

 

968

 

2011

 

 

968

 

2012

 

 

968

 

2013

 

 

886

 

2014 and beyond

 

 

993

 

 

 



 

Total

 

$

5,267

 

 

 



 


 

 

9.

Intangible Assets – Capitalized Software Development Costs

The Company had the following amounts related to capitalized software development costs with definite lives:

14



 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

March 31,
2008

 

 

 


 


 

 

 

Gross carrying amount

 

$

30,815

 

$

27,645

 

Accumulated amortization

 

 

(21,256

)

 

(18,793

)

 

 



 



 

Net capitalized software development

 

$

9,559

 

$

8,852

 

 

 



 



 

Aggregate amortization expense during the six and twelve month period

 

$

2,463

 

$

4,149

 

 

 



 



 

Activity related to net capitalized software costs for the six month period ended September 30, 2008 and 2007 is as follows:

 

 

 

 

 

 

 

 

 

 

September 30,
2008

 

September 30,
2007

 

 

 


 


 

Beginning of the period

 

$

8,852

 

$

6,982

 

Capitalization

 

 

3,170

 

 

3,027

 

Amortization

 

 

(2,463

)

 

(2,004

)

 

 



 



 

End of the period

 

$

9,559

 

$

8,005

 

 

 



 



 

The following table represents the remaining estimated amortization of capital software development costs with determinable lives as of September 30, 2008:

 

 

 

 

 

 

 

 

For the year ending March 31,

 

 

 

 

 

 

 

2009

 

 

 

 

$

2,671

 

2010

 

 

 

 

 

4,186

 

2011

 

 

 

 

 

2,315

 

2012

 

 

 

 

 

387

 

 

 

 

 

 



 

Total

 

 

 

 

$

9,559

 

 

 

 

 

 



 


 

 

10.

Employee Stock Option Plans

In September 1998, the Company’s shareholders approved a stock option plan (the “1998 Plan”) under which 4,000,000 shares of Common Stock were 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, and options under the 1998 Plan expire no later than ten years from the grant date. Options granted will generally become exercisable in accordance with the terms of the agreement pursuant to which they were granted. Certain option grants to directors became exercisable three months from 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 terminated on December 31, 2007. As of September 30, 2008, there were 584,091 outstanding options related to this Plan.

In October 2005, the Company’s shareholders approved a stock option and incentive plan (the “2005 Plan”) under which 1,200,000 shares of Common Stock have been reserved for the issuance of awards, including stock options, incentive stock options and non-qualified stock options, stock appreciation rights, restricted stock, unrestricted stock, restricted stock units, performance shares, performance units (including performance options) and other share-based awards. The 2005 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 awards to purchase shares of Common Stock. The exercise price of each award granted shall be determined by the Board of Directors at the date of grant in accordance with the terms of the 2005 Plan, and under the 2005 Plan awards expire no later than ten years from the grant date. Options granted will generally become exercisable in accordance with the terms of the agreement pursuant to which they were granted. Upon an acquisition of the Company by merger or asset sale, each outstanding award may be subject to accelerated vesting under certain circumstances. The 2005 Plan terminates on May 25, 2015, unless sooner terminated by the Board. At September 30, 2008, 956,810 shares were available for future grant under the 2005 Plan. As of September 30, 2008, there were 243,190 outstanding options related to this Plan.

A summary of stock option transactions during the six months ended September 30, 2008 is as follows:

15



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of
Shares

 

Weighted
Average
Exercise Price

 

Weighted Average
Remaining
Contractual Life

 

Aggregate
Intrinsic Value
(in thousands)

 

 

 


 


 


 


 

Outstanding, April 1, 2008

 

1,303,734

 

$

22.81

 

3.40

 

 

 

 

Granted

 

218,190

 

$

37.42

 

4.80

 

 

 

 

Exercised

 

(609,743

)

$

17.71

 

2.25

 

$

14,969

 

Forfeited/Canceled

 

(84,900

)

$

25.93

 

3.44

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 

Outstanding, September 30, 2008

 

827,281

 

$

30.10

 

3.91

 

$

10,199

 

 

 


 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest, September 30, 2008

 

816,254

 

$

30.07

 

3.90

 

$

10,087

 

 

 


 

 

 

 

 

 

 

 

 

 

 

The Company continues to utilize the Black-Scholes valuation model for estimating the fair value of stock-based compensation after the adoption of SFAS 123R. The following assumptions were utilized for options granted during the period:

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

September 30, 2008

 

September 30, 2007

 

 

 


 

 

 

 

 

 

 

Expected life

 

4.01 years

 

3.75 years

 

Expected volatility

 

42.0% - 43.4%

 

43.17% - 44.81%

 

Expected dividends

 

2.9% - 3.5%

 

2.67% - 2.99%

 

Risk-free rate

 

3.0% - 3.4%

 

4.06% - 5.09%

 

During the six months ended September 30, 2008, 218,190 options were granted under the 2005 Plan. During the six months ended September 30, 2007, 159,500 options were granted under the 1998 Plan. The Company issues new shares to satisfy option exercises. Based on historical experience of option cancellations, the Company has estimated an annualized forfeiture rate of 2.0% for employee options and 0.0% for director options. Forfeiture rates will be adjusted over the requisite service period when actual forfeitures differ, or are expected to differ, from the estimate. The weighted average grant date fair value of stock options granted during the six months ended September 30, 2008 and 2007 was $10.76 per share and $12.86 per share, respectively.

On September 9, 2008, the Board of Directors granted a total of 35,000 options under the Company’s 2005 Plan to non-management directors pursuant to the Company’s previously announced compensation plan for non-management directors, at an exercise price equal to the market price of the Company’s common stock on the date of grant ($45.61 per share). The options vest in four equal annual installments beginning September 9, 2009 and expire on August 9, 2015.

On August 18, 2008, the Board of Directors granted a total of 50,000 options under the Company’s 2005 Plan to an employee at an exercise price equal to the market price of the Company’s common stock on the date of grant ($40.08 per share). The options vest in four equal annual installments beginning August 18, 2009 and expire on August 18, 2013.

On August 11, 2008, the Board of Directors granted a total of 25,000 options under the Company’s 2005 Plan to selected employees at an exercise price equal to the market price of the Company’s common stock on the date of grant ($40.71 per share). The options vest in four equal annual installments beginning August 11, 2009 and expire on August 11, 2013.

On June 13, 2008, the Board of Directors granted a total of 108,190 options under the Company’s 2005 Plan to selected employees at an exercise price equal to the market price of the Company’s common stock on the date of grant ($32.79 per share). The options vest in four equal annual installments beginning June 13, 2009 and expire on June 13, 2013.

On May 31, 2008, the Board of Directors approved a performance-based equity incentive program for employees to be awarded options to purchase the Company’s common stock based on meeting certain target increases in earnings per share performance and revenue growth during fiscal year 2009. Under the program, options may also be granted as an incentive to prospective employees to join the Company. If earned, the options shall be issued pursuant to one of the Company’s shareholder approved option plans, have an exercise price equal to the closing price of the Company’s shares on the date of grant, a term of five years, vesting in four equal installments commencing one year following the date of grant. The maximum number of options available under the performance-based equity incentive program plan is 285,000, of which 20,000 is reserved for new employees. Based on performance versus established plan targets, $29 related to the performance plan was recorded for the six months ended September 30, 2008.

16



Non-vested stock option award activity, including awards for the six month period ended September 30, 2008, is summarized as follows:

 

 

 

 

 

 

 

 

 

Non-vested
Number of
Shares

 

Weighted-
Average Grant
Date Fair Value
per Share

 

 

 


 

Non-vested, April 1, 2008

 

649,436

 

$

9.57

 

Granted

 

218,190

 

$

10.76

 

Vested

 

(225,772

)

$

7.69

 

Forfeited/Canceled

 

(84,900

)

$

10.17

 

 

 


 

 

 

 

Non-vested, September 30, 2008

 

556,954

 

$

10.70

 

 

 


 

 

 

 

As of September 30, 2008, $5,670 of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted average period of 4.27 years. This amount does not include the cost of new options that may be granted in future periods or any changes in the Company’s forfeiture percentage. The total fair value of shares vested during the six months ended September 30, 2008 and 2007 was $1,736 and $1,132, respectively.

 

 

11.

Income Taxes

The provision for income taxes for the six months ended September 30, 2008 was approximately $12,861 as compared to approximately $10,314 for the year ago period. The effective tax rates for the six months ended September 30, 2008 and 2007 were 36.3% and 36.1%, respectively. The provision for income taxes for the six months ended September 30, 2008 differ from the combined statutory rates primarily due to the impact of varying state income tax rates, tax-exempt interest income, and the qualified production activities deduction. The effective rate for the six months ended September 30, 2008 increased from the prior year primarily due to the expiration of the Federal research and development tax credit statute which occurred in the fourth quarter of fiscal year 2008 and therefore was not included in the current quarter provision.

Uncertain tax positions

As of September 30, 2008, the Company has provided a liability of $628 for unrecognized tax benefits related to various federal and state income tax matters. If recognized, there would be no material impact to the Company’s effective tax rate. The reserve has not materially changed for the quarter ended September 30, 2008.

The Company is under routine examination by two states. The Company does not anticipate that total unrecognized tax benefits will significantly change due to the settlement of audits or the expiration of statute of limitations within the next twelve months. The Company has filed three applications to change tax accounting methods. It is reasonably possible that the Company will receive consent to change these accounting methods within the next twelve months which would reduce the unrecognized tax benefit balance as of September 30, 2008 by approximately $561 with no impact on the tax provision.

 

 

12.

Net Income Per Share

The following table reconciles the weighted average shares outstanding for basic and diluted net income per share for the periods indicated. Basic net income per share is based upon the weighted average number of common shares outstanding. Diluted net income per share is based on the assumption that the Company’s outstanding options are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

17



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
September 30,

 

Six Months Ended
September 30,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,499

 

$

9,672

 

$

21,613

 

$

17,612

 

Basic net income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average of common shares outstanding

 

 

27,930

 

 

27,287

 

 

27,699

 

 

27,211

 

 

 



 



 



 



 

Basic net income per common share

 

$

0.38

 

$

0.35

 

$

0.78

 

$

0.65

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,499

 

$

9,672

 

$

21,613

 

$

17,612

 

Diluted net income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average of common shares outstanding

 

 

27,930

 

 

27,287

 

 

27,699

 

 

27,211

 

Effect of potentially dilutive securities (options)

 

 

281

 

 

431

 

 

315

 

 

485

 

 

 



 



 



 



 

Weighted average of common shares outstanding - diluted

 

 

28,211

 

 

27,718

 

 

28,014

 

 

27,696

 

 

 



 



 



 



 

Diluted net income per common share

 

$

0.37

 

$

0.35

 

$

0.77

 

$

0.64

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The computation of diluted net income per share does not include 394,148 and 328,049 options for the three and six months ended September 30, 2008, respectively, because their inclusion would have an anti-dilutive effect on net income per share.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The computation of diluted net income per share does not include 245,000 options for the three and six months ended September 30, 2007, because their inclusion would have an anti-dilutive effect on net income per share.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13. Other Comprehensive Income

Comprehensive income includes all changes in Shareholders’ Equity during a period except those resulting from investments by owners and distributions to owners. The components of accumulated other comprehensive income, net of income tax, consist of unrealized losses on marketable securities of $264 and $798 for the three and six months ended September 30, 2008, respectively. There were no other comprehensive income items for the three and six months ended ended September 30, 2007.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
September 30,

 

Six Months Ended
September 30,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,499

 

$

9,672

 

$

21,613

 

$

17,612

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on marketable securities, net of tax

 

 

(264

)

 

 

 

(798

)

 

 

 

 



 



 



 



 

Comprehensive income

 

$

10,235

 

$

9,672

 

$

20,815

 

$

17,612

 

 

 



 



 



 



 

14.    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 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 the Company’s “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 the Company’s two divisions.

The QSI Division, co-located with the Company’s Corporate Headquarters in Irvine, California, currently focuses on developing, marketing and supporting software suites sold to dental and

18



certain niche medical practices. In addition, the division supports a number of medical clients that utilize the division’s UNIXa based medical practice management software product. The NextGen Division, with headquarters in Horsham, Pennsylvania, and significant locations in Atlanta, Georgia and St. Louis, Missouri, focuses principally on developing and marketing products and services for medical practices.

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. All of the recorded goodwill at September 30, 2008 relates to the Company’s NextGen division.

Operating segment data is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
September 30,

 

Six Months Ended
September 30,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

4,113

 

$

4,006

 

$

8,180

 

$

7,988

 

NextGen Division

 

 

54,868

 

 

41,140

 

 

106,025

 

 

79,190

 

 

 



 



 



 



 

Consolidated revenue

 

$

58,981

 

$

45,146

 

$

114,205

 

$

87,178

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

952

 

$

1,290

 

$

1,928

 

$

2,346

 

NextGen Division

 

 

19,301

 

 

15,698

 

 

39,236

 

 

29,601

 

Unallocated corporate expenses

 

 

(4,119

)

 

(2,493

)

 

(7,404

)

 

(5,405

)

 

 



 



 



 



 

Consolidated operating income

 

$

16,134

 

$

14,495

 

$

33,760

 

$

26,542

 

 

 



 



 



 



 

15.     Concentration of Credit Risk

The Company had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at September 30, 2008. The Company is exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the institutions; however, the Company does not anticipate non-performance by these institutions.

16.     Commitments, Guarantees and Contingencies

Commitments and Guarantees

Software license agreements in both the QSI and NextGen Divisions include a performance guarantee that the Company’s software products will substantially operate as described in the applicable program documentation for a period of 365 days after delivery. To date, the Company has not incurred any significant costs associated with these warranties and does not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties. Certain arrangements also include performance guarantees related to response time, availability for operational use, and other performance-related guarantees. Certain arrangements also include penalties in the form of maintenance credits should the performance of the software fail to meet the performance guarantees. To date, the Company has not incurred any significant costs associated with these warranties and does not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties.

The Company has historically offered short-term rights of return in certain sales arrangements. If the Company is able to estimate returns for these types of arrangements and all other criteria for revenue recognition have been met, revenue is recognized and these arrangements are recorded in the consolidated financial statements. If the Company is unable to estimate returns for these types of arrangements, revenue is not recognized in the

 

 


 

a       UNIX is a registered trademark of the AT&T Corporation.

19



consolidated financial statements until the rights of return expire, provided also, that all other criteria of revenue recognition have been met.

The Company’s standard sales agreements in the NextGen Division contain an indemnification provision pursuant to which it shall indemnify, hold harmless, and 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 its software. The QSI Division arrangements occasionally utilize this type of language as well. As the Company has not incurred any significant costs to defend lawsuits or settle claims related to these indemnification agreements, the Company believes that its estimated exposure on these agreements is currently minimal. Accordingly, the Company has no liabilities recorded for these indemnification obligations.

From time to time, the Company offers future purchase discounts on its products and services as part of its sales arrangements. 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.

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 the Company’s request for prospective customers which directly result in a purchase of the Company’s software by the visiting prospects. Amounts earned by existing users under this program are treated as a selling expense in the period when earned.

Contingencies

The Company has experienced certain legal claims by parties asserting that it infringed certain intellectual property rights. Management believes that these claims are without merit and have defended against them vigorously; however, in order to avoid the further legal costs and diversion of management resources it is reasonably possible that a settlement may be reached which could result in a liability to the Company. However, at this time it is not possible to estimate with reasonable certainty what amount, if any may be incurred as a result of a settlement. Litigation is inherently uncertain and always difficult to predict.

17.     Subsequent Events

On October 30, 2008, the Board of Directors approved a regular quarterly dividend of thirty cents ($0.30) per share payable on its outstanding shares of common stock. The cash dividend record date is December 15, 2008 and the cash dividend is expected to be distributed to shareholders on or about January 5, 2009.

On October 15, 2008, the Company and NextGen entered into an Agreement and Plan of Merger (Agreement) to acquire Practice Management Partners, Inc. (PMP), which closed on October 28, 2008. As a result of the Agreement, PMP became a wholly owned subsidiary of NextGen. The purchase price consisted of approximately $19,000 at closing plus up to $3,000 tied to the future performance of PMP. The $19,000 consists of approximately $16,250 in cash and $2,750 in the Company’s unregistered common stock.

20


Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Except for the historical information contained herein, the matters discussed in this quarterly report may include forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact our ability to achieve our goals, and interested persons are urged to review any new risks which may be described in “Risk Factors” set forth herein and other risk factors appearing in our most recent filing on Form 10-K, as supplemented by additional risk factors, if any, in our interim filings on Form 10-Q, as well as in our other public disclosures and filings with the Securities and Exchange Commission.

The following discussion should be read in conjunction with, and is qualified in its entirety by, the Consolidated Financial Statements and related notes thereto included elsewhere in this report. Historical results of operations, percentage profit 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 and Estimates. 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 consolidated 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 but not limited to those related to revenue recognition, valuation of marketable securities, uncollectible accounts receivable, intangible assets, software development cost, and income taxes 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, valuation of marketable securities, the allowance for doubtful accounts, capitalized software costs, share-based compensation, income taxes and intangible assets are among the most critical accounting policies and estimates that impact our consolidated financial statements. We believe that our significant accounting policies, as described in Note 2 of our Condensed Notes to Consolidated Financial Statements, “Summary of Significant Accounting Policies”, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Revenue Recognition. We currently recognize system sales revenue pursuant to SOP 97-2, as amended by SOP 98-9. We generate revenue from the sale of licensing rights to use our software products sold directly to end-users and value-added resellers (VARs). We also generate revenue from sales of hardware and third party software, and implementation, training, software customization, EDI, post-contract support (maintenance) and other services performed for customers who license our products.

A typical system contract contains multiple elements of the above items. SOP 97-2, as amended, requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. The fair value of an element must be based on vendor specific objective evidence (VSOE). We limit our assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. VSOE calculations are updated and reviewed at the end of each quarter or annually depending on the nature of the product or service.

When evidence of fair value exists for the delivered and undelivered elements of a transaction, then discounts for individual elements are aggregated and the total discount is allocated to the individual elements in proportion to the elements’ fair value relative to the total contract fair value.

When evidence of fair value exists for the undelivered elements only, the residual method, provided for under SOP 98-9, is used. Under the residual method, we defer revenue related to the undelivered elements in a system sale based on VSOE of fair value of each of the undelivered elements, and allocate the remainder of the contract price net of all discounts to revenue recognized from the delivered elements. Undelivered elements of a system sale may include implementation and training services, hardware and third party software, maintenance, future purchase discounts, or other services. If VSOE of fair value of any undelivered element does not exist, all revenue is deferred until VSOE of fair value of the undelivered element is established or the element has been delivered.

We bill for the entire system sales contract amount upon contract execution except for maintenance which is billed separately. 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 whose collections risk is high, the cash basis method is used to recognize revenue. If the fee is not fixed or determinable, then the revenue recognized in each period (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the arrangement fee that would have been recognized if the fees were being recognized using the residual method. Fees which are considered fixed or determinable at the inception of our arrangements must include the following characteristics:

 

 

§

The fee must be negotiated at the outset of an arrangement, and generally be based on the specific volume of products to be delivered without being subject to change based on variable pricing mechanisms such as the number of units copied or distributed or the expected number of users.

21



 

 

§

Payment terms must not be considered extended. If a significant portion of the fee is due more than 12 months after delivery or after the expiration of the license, the fee is presumed not fixed and determinable.

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, we use the percentage of completion method provided all of the following conditions exist:

 

 

The 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;

 

 

The customer can be expected to satisfy its obligations under the contract;

 

 

We can be expected to perform our contractual obligations; and

 

 

Reliable estimates of progress towards completion can be made.

We measure completion using labor input hours. Costs of providing services, including services accounted for in accordance with SOP 81-1, are expensed as incurred.

If a situation occurs in which a contract is so short term that the consolidated financial statements would not vary materially from using the percentage-of-completion method or in which we are unable to make reliable estimates of progress of completion of the contract, the completed contract method is utilized.

Product returns are estimated in accordance with Statement of Financial Accounting Standards No. 48, “Revenue Recognition When Right of Return Exists” (SFAS 48). The Company also ensures that the other criteria in SFAS 48 have been met prior to recognition of revenue:

 

 

§

The price is fixed or determinable;

 

 

§

The customer is obligated to pay and there are no contingencies surrounding the obligation or the payment;

 

 

§

The customer’s obligation would not change in the event of theft or damage to the product;

 

 

§

The customer has economic substance;

 

 

§

The amount of returns can be reasonably estimated; and

 

 

§

We do not have significant obligations for future performance in order to bring about resale of the product by the customer.

We have historically offered short-term rights of return of less than 30 days in certain sales arrangements. If we are able to estimate returns for these types of arrangements, revenue is recognized and these arrangements are recorded in the consolidated financial statements. If we are unable to estimate returns for these types of arrangements, revenue is not recognized in our consolidated financial statements until the rights of return expire.

Revenue related to sales arrangements which include the right to use software stored on the Company’s hardware are accounted for under the Emerging Issues Task Force Issue No. 00-3 “Application of AICPA Statement of Position 97-2 to arrangements that include the right to use software stored on another entity’s hardware”. EITF No. 00-3 requires that for software licenses and related implementation services to continue to fall under SOP No. 97-2, the customer must have the contractual right to take possession of the software without incurring a significant penalty and it must be feasible for the customer to either host the software themselves or through another third party. If an arrangement is not deemed to be accounted for under SOP 97-2, the entire arrangement is accounted for as a service contract in accordance with EITF Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables”. In that instance, the entire arrangement would be recognized as the hosting services are being performed.

Revenue cycle management service revenue is derived from services fees, which include amounts charged for ongoing billing and other related services and are generally billed to the customer as a percentage of total collections. The Company does not recognize revenue for services fees until these collections are made as the services fees are not fixed and determinable until such time.

22



From time to time, we offer future purchase discounts on our products and services as part of our sales arrangements. Pursuant to AICPA TPA 5100.51, discounts which are incremental to the range of discounts reflected in the pricing of the other elements of the arrangement, which are incremental to the range of discounts typically given in comparable transactions, and which are significant, are treated as an additional element of the contract to be deferred. Amounts deferred related to future purchase options are not recognized until either the customer exercises the discount offer or the offer expires.

Revenue is divided into two categories, “system sales” and “maintenance, EDI, revenue cycle management 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. The majority of the revenue in the system sales category is related to the sale of software. Revenue in the maintenance, EDI, revenue cycle management and other services category includes, maintenance, EDI, revenue cycle management, follow on training and implementation services, annual third party license fees, hosting services and other revenue.

Valuation of marketable securities. Marketable securities are classified as available-for-sale and accordingly are recorded at fair value, based on quoted market rates or on valuation analysis when appropriate, with unrealized gains and losses reflected as a separate component of shareholders’ equity titled accumulated other comprehensive income (loss), net of tax, until realized or until a determination is made that an other-than-temporary decline in market value has occurred. Factors considered in assessing whether an other-than-temporary impairment has occurred include: the nature of the investment; whether the decline in fair value is attributable to specific adverse conditions affecting the investment; the financial condition of the investee; the severity and the duration of the impairment; and whether the Company has the ability to hold the investment to maturity. When it is determined that an other-than-temporary impairment has occurred, the investment is written down to its market value at the end of the period in which it is determined that an other-than-temporary decline has occurred. The cost of marketable securities sold is based upon the specific identification method. In addition, the Company classifies marketable securities as current or non-current based upon whether such assets are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. Realized gains or losses and other-than-temporary declines in the fair value of marketable securities are determined on a specific identification basis and reported in interest and other income, net, as incurred.

The fair value of our marketable securities has been estimated by management based on certain assumptions of what market participants would use in pricing the asset in a current transaction, or level 3 - unobservable inputs in accordance with SFAS 157. Management used a model to estimate the fair value of these securities that included certain level 2 inputs as well as assumptions, including a liquidity discount, based on management’s judgment, which are highly subjective and therefore considered level 3 inputs in the fair value hierarchy. The estimate of the fair value of the marketable securities could change based on market conditions.

Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We perform credit evaluations of our customers and maintain reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management’s estimate of the probability of collection for certain troubled accounts. General reserves are established based on our historical experience of bad debt expense and the aging of our accounts receivable balances net of deferred revenue and specifically reserved accounts. If the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments, additional allowances would be required.

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 with the completion of a working model of the enhancement or product, any additional development costs are capitalized in accordance with 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, which is generally 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.

Share-Based Compensation. We apply the provisions of Statement of Financial Accounting Standard No. 123R, “Share-Based Payment” (SFAS 123R) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and

23



directors based on estimated fair values. SFAS 123R requires us to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. During fiscal year 2009, we estimate the expected term of the option using historical exercise experience. Prior to using the simplified method, we estimated the expected term of an option. We estimate volatility by using the weighted average historical volatility of our common stock, which we believe approximates expected volatility. The risk free rate is the implied yield available on the U.S Treasury zero-coupon issues with remaining terms equal to the expected term. The expected dividend yield is the average dividend rate during a period equal to the expected term of the option. Those inputs are then entered into the Black Scholes model to determine the estimated fair value. The value of the portion of the award that is expected to vest is recognized as expense over the requisite service period in our consolidated statement of income.

Qualified Production Activities Deduction. Management’s treatment of this deduction represented an estimate that affected the effective income tax rate for the Company for the six months ended September 30, 2008 and 2007. The deduction taken by the Company involved certain assumptions and judgments regarding the allocation of indirect expenses as prescribed under Internal Revenue Code Section 199.

Business Combinations. In accordance with business combination accounting under Statement of Financial Accounting Standards No. 141, Business Combinations”, we allocate the purchase price of acquired businesses to the tangible and intangible assets acquired and liabilities assumed based on estimated fair values. Such allocations require management to make significant estimates and assumptions, especially with respect to intangible assets acquired. Management’s estimates of fair value are based upon assumptions believed to be reasonable. These estimates are based on information obtained from management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets include, but are not limited to, (i) future expected cash flows from acquired businesses and (ii) the acquired company’s brand and market position. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.

Company Overview

Quality Systems Inc., comprised of the QSI Division (QSI Division) and wholly-owned subsidiaries, NextGen Healthcare Information Systems, Inc. (NextGen Division) and Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (HSI) (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 what is today the NextGen Division. Today, we serve the medical and dental markets through our two divisions.

The two divisions operate largely as stand-alone operations with each division maintaining its own distinct product lines, product platforms, development, implementation and support teams, sales staffing, and branding. The two divisions share the resources of the “corporate office” which includes a variety of accounting and other administrative functions. Additionally, there are a small number of clients who are simultaneously utilizing software from each of our two divisions.

The QSI Division, co-located with our corporate headquarters in Irvine, California, currently focuses on developing, marketing and supporting software suites sold to dental and certain niche medical practices. In addition, the Division supports a number of medical clients that utilize the Division’s UNIX1 based medical practice management software product.

The NextGen Division, with headquarters in Horsham, Pennsylvania, and significant locations in Atlanta, Georgia and St. Louis, Missouri, 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

 

 


 

1        UNIX is a registered trademark of the AT&T Corporation.

24



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. Adoption of this software, commonly referred to as clinical software, is in its relatively early stages. Therefore, we are typically competing to replace paper-based patient record alternatives as opposed to replacing previously purchased systems.

Electronic Data Interchange (EDI)/connectivity products are intended to automate a number of manual, often paper-based or telephony intensive communications between patients and/or providers and/or payors. Two of the more common EDI services are forwarding insurance claims electronically from providers to payors and assisting practices with issuing statements to patients. Most practices utilize at least some of these services from us or one of our competitors. Other EDI/connectivity services are used more sporadically by client practices. We typically compete to displace incumbent vendors for claims and statements accounts, and attempt to increase usage of other elements in our EDI/connectivity product line. In general, EDI services are only sold to those accounts utilizing software from one of our divisions.

The QSI Division’s practice management software suite utilizes a UNIX operating system. Its Clinical Product Suite (CPS) utilizes a Windows NT2 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 this Division.

Our NextGen Division develops and sells proprietary electronic medical records software and practice management systems under the NextGen®3 product name. Major product categories of the NextGen suite include Electronic Medical Records (NextGenemr), Enterprise Practice Management (NextGenepm), Enterprise Appointment Scheduling (NextGeneas), Enterprise Master Patient Index (NextGenepi), NextGen Image Control System (NextGenics), Managed Care Server (NextGenmcs), Electronic Data Interchange, System Interfaces, Internet Operability (NextGenweb), a Patient-centric and Provider-centric Web Portal solution (NextMD4.com), NextGen Express, a version of NextGenemr designed for small practices and NextGen Community Health Solution (NextGenchs). Beginning in the fiscal year ended March 31, 2008, the NextGen Division began offering optional NextGen Hosting Solutions to new and existing customers. NextGen also introduced a formal rollout of a new revenue cycle management service in fiscal year 2008. 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 and revenue cycle management revenue, the NextGen Division accounted for approximately 93.0% of our revenue for the second quarter of fiscal 2009 compared to 91.1% in the second quarter of fiscal 2008. The QSI Division accounted for 7.0% and 8.9% of revenue in the second quarter of fiscal 2009 and 2008, respectively. The NextGen Division’s year over year revenue grew at 33.4% and 22.9% in the second quarter of fiscal 2009 and 2008, respectively, while the QSI Division’s year over year revenue remained unchanged in the second quarter of fiscal years 2009 and 2008, respectively.

In addition to the aforementioned software solutions which we offer through our two divisions, we also offer comprehensive hardware and software installation services, maintenance and support services, revenue cycle management and system training services.

On December 11, 2007, the Company announced the formal public launch of NextGen Practice Solutions, a business division devoted to providing physician practices with cost effective revenue cycle management services. This division combines a web-delivered Software as a Service (SaaS) model and the NextGen EPM software platform to execute its service offerings. Clients may also deploy NextGen EMR as part of their Practice Solutions implementation.

On May 20, 2008, we closed the acquisition of St. Louis based Healthcare Strategic Initiatives (HSI), a full-service healthcare revenue management company. This acquisition is a part of the Company’s growth strategy for NextGen Practice Solutions. HSI will operate under the umbrella

 

 


2

Windows NT is a registered trademark 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.

25



of NextGen Practice Solutions. Founded in 1996, HSI currently provides revenue cycle management services to thousands of providers including health systems, hospitals, and physicians in private practice with an in-house team of more than 200 employees including specialists in medical billing, coding and compliance, payer credentialing, and information technology.

On October 28, 2008, we closed the acquisition of Maryland based Practice Management Partners, Inc. (PMP), a full-service healthcare revenue cycle management company. Founded in 2001, PMP provides physician billing and technology management services to hundreds of healthcare providers, primarily in Mid-Atlantic region.

Results of Operations

Overview of results

 

 

§

Consolidated revenue grew 31.0% in the six months ended September 30, 2008 versus the same period in 2007 and 18.6% in the six months ended September 30, 2007 versus the same period in 2006. For the six months ended September 30, 2008, revenue was positively impacted by the HSI acquisition, which generated $5.9 million for the period May 21, 2008 to September 30, 2008.

 

 

§

Consolidated income from operations grew 27.2% in the six months ended September 30, 2008 versus the same period in 2007 and grew 5.6% in the six months ended September 30, 2007 versus 2006. For the six months ended September 30, 2008, operating income was positively impacted by an increase in revenue offset by shift in revenue mix with increased hardware, maintenance and revenue cycle management revenue resulting in a decline in our gross profit margin; we also experienced higher selling, general and administrative expenses. Higher selling, general and administrative expenses were impacted negatively by $1.2 million of proxy related expenses incurred in conjunction with the 2008 Annual Shareholder’s Meeting and higher than usual legal expenses, primarily as a result of our contested proxy election and certain legal matters related to intellectual property infringement claims in the NextGen division.

 

 

§

We have benefited and hope to continue to benefit from the increased demands on healthcare providers for greater efficiency and lower costs, as well as increased adoption rates for electronic medical records and other technology in the healthcare arena.

 

 

NextGen Division

 

 

§

Our NextGen Division’s revenue grew 33.9% in the six months ended September 30, 2008 versus 2007 and 20.6% in the six months ended September 30, 2007 versus 2006. Divisional operating income (which excludes unallocated corporate expenses) grew 32.7% in the six months ended September 30, 2008 versus 2007 and 7.8% in the six months ended September 30, 2007 versus 2006. For the six months ended September 30, 2008, operating income was positively impacted by our revenue growth.

 

 

§

HSI contributed $5.9 million to NextGen’s revenue during from May 20, 2008, the close date, to September 30, 2008. HSI’s operating income had minimal impact to NextGen’s operating income the same period.

 

 

§

During the six months ended September 30, 2008, we added staffing resources to most of our client-interfacing departments, and intend to continue doing so in future quarters.

 

 

§

Our goals include continuing to further enhance and expand the marketing and sales of 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 and other services to new and existing customers, and capitalizing on growth and cross selling opportunities within the Practice Solutions arena.

 

 

QSI Division

 

 

§

Our QSI Division revenue increased 2.4% in the six months ended September 30, 2008 versus the same period in 2007 and grew 1.6% in the six months ended September 30, 2007 versus the same period in 2006. The Division experienced 17.8% decrease in operating income (excluding unallocated corporate expenses) in the six months ended September 30, 2008 versus the same period in 2007 as compared to a 8.0% increase in operating income in the six months ended September 30, 2007 versus the same period in 2006. For the six months ended September 30, 2008, operating income was negatively impacted by an increase in selling, general and administrative expense.

 

 

§

Our goals for the QSI Division include maximizing profit performance given the constraints represented by a relatively weak purchasing environment in the dental group practice market.

 

26


The following table sets forth for the periods indicated the percentage of revenues represented by each item in our Consolidated Statements of Income (unaudited).

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
September 30,

 

Six Months Ended
September 30,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

Revenues:

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

36.1

%

41.0

%

37.4

%

40.4

%

Implementation and training services

 

5.9

 

7.1

 

6.2

 

7.4

 

 

 


 


 


 


 

System sales

 

42.0

 

48.1

 

43.6

 

47.8

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

29.2

 

29.8

 

30.1

 

29.8

 

Electronic data interchange services

 

11.9

 

12.0

 

11.9

 

12.0

 

Revenue cycle management and related services

 

7.7

 

0.0

 

5.7

 

0.0

 

Other services

 

9.2

 

10.2

 

8.7

 

10.4

 

 

 


 


 


 


 

Maintenance, EDI, revenue cycle management and other services

 

58.0

 

51.9

*

56.4

 

52.2

 

 

 


 


 


 


 

Total revenue

 

100.0

 

100.0

 

100.0

 

100.0

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

5.8

 

5.5

 

6.0

 

5.7

 

Implementation and training services

 

4.4

 

5.4

 

4.9

 

5.5

 

 

 


 


 


 


 

Total cost of system sales

 

10.2

 

10.9

 

10.9

 

11.2

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

5.0

 

6.7

 

5.3

 

7.1

 

Electronic data interchange services

 

8.9

 

8.3

 

8.9

 

8.3

 

Revenue cycle management and related services

 

5.3

 

0.0

 

3.9

 

0.0

 

Other services

 

6.6

 

6.9

 

6.4

 

7.0

 

 

 


 


 


 


 

Total cost of maintenance, EDI, revenue cycle management and other services

 

25.8

 

21.9

 

24.5

 

22.4

 

 

 


 


 


 


 

Total cost of revenue

 

36.0

 

32.7

 

35.4

 

33.6

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

64.0

 

67.3

 

64.6

 

66.4

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

31.0

 

29.2

 

29.4

 

29.6

 

Research and development

 

5.7

 

6.0

 

5.7

 

6.3

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

27.3

 

32.1

*

29.5

 

30.5

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Interest income

 

0.6

 

1.4

 

0.6

 

1.6

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

27.9

 

33.5

*

30.1

 

32.0

*

Provision for income taxes

 

10.1

 

12.1

 

11.3

 

11.8

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Net income

 

17.8

%

21.4

%

18.8

%

20.2

%

 

 


 


 


 


 


 

 

*

does not add due to rounding

For the Three-Month Periods Ended September 30, 2008 versus 2007

Net Income. The Company’s net income for the three months ended September 30, 2008 was $10.5 million or $0.38 per share on a basic and $0.37 per share on a fully diluted basis. In comparison, we earned $ 9.7 million or $0.35 per share on a basic and fully diluted basis for the three months ended September 30, 2007. The increase in net income for the three months ended September 30, 2008 was a result of the following:

 

 

a 30.7% increase in consolidated revenue;

 

 

a 33.9% increase in NextGen Division revenue which accounted for 93.0% of consolidated revenue;

 

 

offset by a shift in revenue mix with increased hardware, maintenance and revenue cycle management revenue resulting in a decline in our gross profit margin; and

 

 

an increase in selling, general and administrative expenses as a percentage of revenue. Approximately $1.2 million in expenses related to the contested proxy election which occurred in conjunction with the 2008 Annual Shareholders’ Meeting.

27



Revenue. Revenue for the three months ended September 30, 2008 increased 30.7% to $59.0 million from $45.1 million for the three months ended September 30, 2007. NextGen Division revenue increased 33.4% from $41.1 million in the three months ended September 30, 2007 to $54.9 million in the three months ended September 30, 2008, and the QSI Division revenue increased by 2.7% during the three months ended September 30, 2008 over the prior year period. NextGen revenue is inclusive of approximately $4.2 million in revenue from HSI.

We divide revenue into two categories, “system sales” and “maintenance, EDI, revenue cycle management 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. The majority of the revenue in the system sales category is related to the sale of software. Revenue in the maintenance, EDI, revenue cycle management and other services category includes maintenance, EDI, revenue cycle management follow-on training and implementation services, annual third party license fees, hosting and other revenue. Maintenance revenue includes amounts initially deferred in conjunction with new customer arrangements and subsequently amortized and billings to existing customers.

System Sales. Revenue earned from company-wide sales of systems for the three months ended September 30, 2008, increased 14.2% to $24.8 million from $21.7 million in the prior year period.

Our increase in revenue from sales of systems was principally the result of a 13.7% increase in category revenue at our NextGen Division. Divisional sales in this category grew from $21.0 million during the three months ended September 30, 2007 to $23.9 million during the three months ended September 30, 2008. This increase was driven by higher sales of NextGenemr and NextGenepm software to both new and existing clients, as well as increases in sales of hardware, third party software and supplies and implementation and training services.

The following table breaks down our reported system sales into software, hardware, third party software, supplies, and implementation and training services components by division:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 









 

 

Software

 

Hardware, Third
Party Software
and Supplies

 

Implementation
and Training
Services

 

Total System
Sales

 

 

 


 


 


 


 

Three months ended September 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

235

 

$

404

 

$

278

 

$

917

 

NextGen Division

 

 

18,673

 

 

1,985

 

 

3,208

 

 

23,866

 

 

 



 



 



 



 

Consolidated

 

$

18,908

 

$

2,389

 

$

3,486

 

$

24,783

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

217

 

$

258

 

$

225

 

$

700

 

NextGen Division

 

 

16,713

 

 

1,326

 

 

2,957

 

 

20,996

 

 

 



 



 



 



 

Consolidated

 

$

16,930

 

$

1,584

 

$

3,182

 

$

21,696

 

 

 



 



 



 



 

NextGen Division software license revenue increased 11.7% between the three months ended September 30, 2008 and the prior year period. The Division’s software revenue accounted for 78.2% of divisional system sales revenue during the three months ended September 30, 2008. For the three month period ended September 30, 2007, divisional software revenue as a percentage of divisional system sales revenue was 79.6%. Software license revenue growth continues to be an area of primary emphasis for the NextGen Division.

During the three months ended September 30, 2008, 8.3% of NextGen’s system sales revenue was represented by hardware and third party software compared to 6.3% in the prior year period. During the three months ended September 30, 2008, there was a shift in the revenue mix with increased revenue coming from hardware revenue. The number of customers who purchase hardware and third party software and the dollar amount of hardware and third party software revenue fluctuates each quarter depending on the needs of customers. The inclusion of hardware and third party software in the Division’s sales arrangements is typically at the request of the customer and is not a priority focus for us.

Implementation and training revenue related to system sales at the NextGen Division grew 8.5% in the three months ended September 30, 2008 compared to the three months ended September 30, 2007 and increased 10.5% in the three months ended September 30, 2007 compared to the period year period 2006. The amount of implementation and training services revenue in any given quarter is dependent on several factors, including timing of customer implementations, the availability of qualified staff, and the mix of services being rendered. The number of

28



implementation and training staff increased during the three months ended September 30, 2008 versus 2007 in order to accommodate the increased amount of implementation services sold in conjunction with increased software sales. In order to achieve growth in this area, additional staffing increases and additional training facilities 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.

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 and the apparent increasing acceptance of electronic medical records technology in the healthcare industry.

For the QSI Division, total system sales increased $0.2 million or 31.0% in the three months ended September 30, 2008 versus the same period ended September 30, 2007. We do not presently foresee any material changes in the business environment for the Division with respect to the weak purchasing environment in the dental group practice market that has existed for the past several years.

Maintenance, EDI, Revenue Cycle Management and Other Services. For the three months ended September 30, 2008, company-wide revenue from maintenance, EDI, revenue cycle management and other services grew 45.8% to $34.2 million from $23.5 million in the prior year period. The increase in this category resulted from an increase in maintenance, EDI, revenue cycle management and other services revenue from the NextGen Division. Total NextGen Division maintenance revenue for the three months ended September 30, 2008 grew 33.2% to $15.5 million from $11.6 million in the prior year period, while EDI revenue grew 38.7% to $5.9 million compared to $4.2 million during the prior year period. Revenue cycle management grew $4.3 million primarily as a result of the HSI acquisition. Other services revenue for the three months ended September 30, 2008 increased 26.0% to $5.1 million from $4.1 million in the prior year period, primarily due to increases in consulting services, annual licenses and hosting services revenue. QSI Division maintenance, EDI and other revenue remained approximately unchanged in the three months ended September 30, 2008 as compared to the prior year period

The following table details revenue included in the maintenance, EDI and other category for the three month periods ended September 30, 2008 and 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 











 

 

Maintenance

 

EDI

 

Revenue Cycle
Management

 

Other

 

Total

 

 

 


 


 


 


 


 

Three months ended September 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

1,759

 

$

1,121

 

$

 

$

316

 

$

3,196

 

NextGen Division

 

 

15,475

 

 

5,864

 

 

4,527

 

 

5,136

 

 

31,002

 

 

 



 



 



 



 



 

Consolidated

 

$

17,234

 

$

6,985

 

$

4,527

 

$

5,452

 

$

34,198

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

1,824

 

$

1,179

 

$

 

$

303

 

$

3,306

 

NextGen Division

 

 

11,618

 

 

4,227

 

 

222

 

 

4,077

 

 

20,144

 

 

 



 



 



 



 



 

Consolidated

 

$

13,442

 

$

5,406

 

$

222

 

$

4,380

 

$

23,450

 

 

 



 



 



 



 



 

The growth in maintenance revenue for the NextGen Division has come from new customers that have been added each quarter, existing customers who have purchased additional licenses, and our relative success in retaining existing maintenance customers. NextGen’s EDI revenue growth has come from new customers and from further penetration of the Division’s existing customer base. We intend to continue to promote maintenance and EDI services to both new and existing customers.

The following table provides the number of billing sites which were receiving maintenance services as of the last business day of the quarters ended September 30, 2008 and 2007 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, and changes in billing protocols for certain clients can cause period to period changes in the number of billing sites.

29



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 






 

 

 

NextGen

 

QSI

 

Consolidated

 

 

 


 


 


 

 

 

Maintenance

 

EDI

 

Maintenance

 

EDI

 

Maintenance

 

EDI

 

 

 




 




 




 

September 30, 2007

 

 

1,035

 

 

890

 

 

257

 

 

178

 

 

1,292

 

 

1,068

 

Billing sites added

 

 

206

 

 

270

 

 

10

 

 

40

 

 

216

 

 

310

 

Billing sites removed

 

 

(42

)

 

(97

)

 

(18

)

 

(45

)

 

(60

)

 

(142

)

 

 






 






 






 

September 30, 2008

 

 

1,199

 

 

1,063

 

 

249

 

 

173

 

 

1,448

 

 

1,236

 

 

 






 






 






 

Cost of Revenue. Cost of revenue for the three months ended September 30, 2008 increased 43.6% to $21.2 million from $14.8 million in the quarter ended September 30, 2007 and the cost of revenue as a percentage of revenue increased to 36.0% from 32.7% due to the fact that the rate of growth in cost of revenue grew faster than the aggregate revenue growth rate for the Company.

The increase in our consolidated cost of revenue as a percentage of revenue between the three months ended September 30, 2008 and the three months ended September 30, 2007 is primarily attributable to an increase in the level of hardware and third party software in the NextGen division, increase in payroll and related benefits and EDI costs in both divisions, offset by a decrease in other expense as a percentage of revenue. Other expense, which consists of outside service costs, amortization of software development costs and other costs, decreased to 7.0% of total revenue during the three months ended September 30, 2008 from 9.8% of total revenue during the three months ended September 30, 2007.

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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hardware,
Third Party
Software

 

Payroll and
related
Benefits

 

EDI

 

Other

 

Total Cost
of Revenue

 

Gross
Profit

 

 

 


 


 


 


 


 


 

Three months ended September 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

 

9.2

%

 

19.2

%

 

16.3

%

 

2.6

%

 

47.3

%

 

52.7

%

NextGen Division

 

 

4.5

%

 

14.5

%

 

8.7

%

 

7.4

%

 

35.1