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 December 31, 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
Incorporation or Organization)

 

(I.R.S. Employer
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, a non-accelerated filer or a smaller reporting company. 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

 Small reporting company

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 28,370,778 shares of Common Stock, $0.01 par value, as of February 4, 2009.




PART I
CONSOLIDATED FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

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

 

 

 

 

 

 

 

 

 

 

December 31,
2008

 

March 31,
2008

 

 

 


 


 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

55,428

 

$

59,046

 

Restricted cash

 

 

1,383

 

 

 

Marketable securities

 

 

2,450

 

 

2,500

 

Accounts receivable, net

 

 

100,267

 

 

76,585

 

Inventories, net

 

 

1,253

 

 

1,024

 

Income tax receivable

 

 

513

 

 

 

Net current deferred tax assets

 

 

6,059

 

 

6,397

 

Other current assets

 

 

4,172

 

 

4,596

 

 

 



 



 

Total current assets

 

 

171,525

 

 

150,148

 

 

 

 

 

 

 

 

 

Marketable securities

 

 

8,199

 

 

20,124

 

Equipment and improvements, net

 

 

6,369

 

 

4,773

 

Capitalized software costs, net

 

 

9,550

 

 

8,852

 

Intangibles, net

 

 

8,760

 

 

 

Goodwill

 

 

28,717

 

 

1,840

 

Other assets

 

 

2,074

 

 

2,171

 

 

 



 



 

Total assets

 

$

235,194

 

$

187,908

 

 

 



 



 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

4,472

 

$

4,685

 

Deferred revenue

 

 

47,190

 

 

44,389

 

Accrued compensation and related benefits

 

 

9,341

 

 

8,346

 

Income taxes payable

 

 

 

 

1,541

 

Dividends payable

 

 

8,511

 

 

6,861

 

Other current liabilities

 

 

9,895

 

 

4,394

 

 

 



 



 

Total current liabilities

 

 

79,409

 

 

70,216

 

 

 

 

 

 

 

 

 

Deferred revenue, net of current

 

 

355

 

 

506

 

Net deferred tax liabilities

 

 

2,977

 

 

1,575

 

Deferred compensation

 

 

1,724

 

 

1,906

 

 

 



 



 

Total liabilities

 

 

84,465

 

 

74,203

 

 

 



 



 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

 

 

$0.01 par value; authorized 50,000 shares; issued and outstanding 28,371 and 27,448 shares at December 31, 2008 and March 31, 2008, respectively

 

 

284

 

 

274

 

Additional paid-in capital

 

 

101,513

 

 

75,556

 

Retained earnings

 

 

48,932

 

 

38,071

 

Accumulated other comprehensive loss, net of tax

 

 

 

 

(196

)

 

 



 



 

Total shareholders’ equity

 

 

150,729

 

 

113,705

 

 

 



 



 

Total liabilities and shareholders’ equity

 

$

235,194

 

$

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

 

Nine Months Ended

 

 

 


 


 

 

 

December 31,
2008

 

December 31,
2007

 

December 31,
2008

 

December 31,
2007

 

 

 


 


 


 


 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

$

22,336

 

$

20,591

 

$

65,002

 

$

55,844

 

Implementation and training services

 

 

2,675

 

 

3,115

 

 

9,746

 

 

9,545

 

 

 



 



 



 



 

System sales

 

 

25,011

 

 

23,706

 

 

74,748

 

 

65,389

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

 

19,152

 

 

14,861

 

 

53,522

 

 

40,862

 

Electronic data interchange services

 

 

8,008

 

 

5,739

 

 

21,663

 

 

16,169

 

Revenue cycle management and related services

 

 

6,835

 

 

256

 

 

13,319

 

 

612

 

Other services

 

 

6,473

 

 

3,528

 

 

16,432

 

 

12,236

 

 

 



 



 



 



 

Maintenance, EDI, revenue cycle management and other services

 

 

40,468

 

 

24,384

 

 

104,936

 

 

69,879

 

 

 



 



 



 



 

Total revenue

 

 

65,479

 

 

48,090

 

 

179,684

 

 

135,268

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

 

3,030

 

 

2,984

 

 

9,912

 

 

7,949

 

Implementation and training services

 

 

2,143

 

 

2,638

 

 

7,783

 

 

7,469

 

 

 



 



 



 



 

Total cost of system sales

 

 

5,173

 

 

5,622

 

 

17,695

 

 

15,418

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

 

2,826

 

 

3,131

 

 

8,856

 

 

9,292

 

Electronic data interchange services

 

 

5,541

 

 

4,162

 

 

15,688

 

 

11,413

 

Revenue cycle management and related services

 

 

4,475

 

 

166

 

 

8,912

 

 

402

 

Other services

 

 

5,085

 

 

3,067

 

 

12,398

 

 

8,940

 

 

 



 



 



 



 

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

 

 

17,927

 

 

10,526

 

 

45,854

 

 

30,047

 

 

 



 



 



 



 

Total cost of revenue

 

 

23,100

 

 

16,148

 

 

63,549

 

 

45,465

 

 

 



 



 



 



 

Gross profit

 

 

42,379

 

 

31,942

 

 

116,135

 

 

89,803

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

18,601

 

 

13,283

 

 

52,136

 

 

39,114

 

Research and development costs

 

 

3,624

 

 

2,874

 

 

10,085

 

 

8,362

 

 

 



 



 



 



 

Total operating expenses

 

 

22,225

 

 

16,157

 

 

62,221

 

 

47,476

 

 

 



 



 



 



 

Income from operations

 

 

20,154

 

 

15,785

 

 

53,914

 

 

42,327

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

328

 

 

710

 

 

1,042

 

 

2,094

 

Other income

 

 

 

 

953

 

 

 

 

953

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

 

20,482

 

 

17,448

 

 

54,956

 

 

45,374

 

Provision for income taxes

 

 

7,332

 

 

6,234

 

 

20,193

 

 

16,548

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

13,150

 

$

11,214

 

$

34,763

 

$

28,826

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.46

 

$

0.41

 

$

1.25

 

$

1.06

 

Diluted

 

$

0.46

 

$

0.40

 

$

1.23

 

$

1.04

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

28,340

 

 

27,362

 

 

27,913

 

 

27,261

 

Diluted

 

 

28,473

 

 

27,696

 

 

28,275

 

 

27,739

 

Dividends declared per common share

 

$

0.30

 

$

0.25

 

$

0.85

 

$

0.75

 

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)

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 


 

 

 

December 31,
2008

 

December 31,
2007

 

 

 


 


 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

34,763

 

$

28,826

 

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

 

 

 

 

 

 

 

Depreciation

 

 

2,165

 

 

1,755

 

Amortization of capitalized software costs

 

 

3,787

 

 

3,089

 

Amortization of other intangibles

 

 

677

 

 

 

Gain on life insurance proceeds, net

 

 

 

 

(755

)

Provision for bad debts

 

 

1,218

 

 

30

 

Reduction in inventory obsolescense

 

 

(13

)

 

 

Share-based compensation

 

 

1,591

 

 

2,956

 

Deferred income taxes

 

 

85

 

 

(1,119

)

Tax benefit from exercise of stock options

 

 

3,120

 

 

1,357

 

Excess tax benefit from share-based compensation

 

 

(2,948

)

 

(1,295

)

Loss on disposal of equipment and improvements

 

 

96

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

(20,695

)

 

(8,991

)

Inventories

 

 

(216

)

 

(158

)

Income tax receivable

 

 

(341

)

 

 

Other current assets

 

 

842

 

 

1,009

 

Other assets

 

 

153

 

 

54

 

Accounts payable

 

 

(924

)

 

572

 

Deferred revenue

 

 

2,570

 

 

1,843

 

Accrued compensation and related benefits

 

 

(34

)

 

899

 

Income taxes payable

 

 

(1,541

)

 

2,584

 

Other current liabilities

 

 

3,078

 

 

(408

)

Deferred compensation

 

 

(182

)

 

(48

)

 

 



 



 

Net cash provided by operating activities

 

 

27,251

 

 

32,200

 

 

 



 



 

Cash flows from investing activities:

 

 

 

 

 

 

 

Additions to capitalized software costs

 

 

(4,485

)

 

(4,474

)

Additions to equipment and improvements

 

 

(2,085

)

 

(1,672

)

Proceeds from sale of marketable securities

 

 

12,275

 

 

35,100

 

Purchases of marketable securities

 

 

 

 

(83,500

)

Proceeds from life insurance policy, net

 

 

 

 

755

 

Purchase of HSI, including direct transaction costs

 

 

(8,241

)

 

 

Purchase of PMP, including direct transaction costs

 

 

(16,934

)

 

 

 

 



 



 

Net cash used in investing activities

 

 

(19,470

)

 

(53,791

)

 

 



 



 

Cash flows from financing activities:

 

 

 

 

 

 

 

Excess tax benefit from share-based compensation

 

 

2,948

 

 

1,295

 

Proceeds from the exercise of stock options

 

 

11,173

 

 

3,895

 

Dividends paid

 

 

(22,252

)

 

(13,614

)

Loan repayments

 

 

(3,268

)

 

 

 

 



 



 

Net cash used in financing activities

 

 

(11,399

)

 

(8,424

)

 

 



 



 

Net decrease in cash and cash equivalents

 

 

(3,618

)

 

(30,015

)

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

 

59,046

 

 

60,028

 

 

 



 



 

 

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

55,428

 

$

30,013

 

 

 



 



 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

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

 

$

18,339

 

$

13,895

 

 

 



 



 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

Unrealized gain on marketable securities, net of income tax

 

$

196

 

$

 

 

 



 



 

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

 

 

 

 

 

 

 

Fair value of net assets assumed

 

$

20,609

 

$

 

Cash paid for HSI stock

 

 

(8,241

)

 

 

Common stock issued for HSI stock

 

 

(7,350

)

 

 

 

 



 



 

Liabilities assumed

 

$

5,018

 

$

 

 

 



 



 

 

 

 

 

 

 

 

 

Effective October 28, 2008, the Company acquired PMP in a transaction summarized as follows:

 

 

 

 

 

 

 

Fair value of net assets assumed

 

$

23,859

 

$

 

Cash paid for PMP stock

 

 

(16,934

)

 

 

Common stock issued for PMP stock

 

 

(2,750

)

 

 

 

 



 



 

Liabilities assumed

 

$

4,175

 

$

 

 

 



 



 

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 December 31, 2008 and for the three and nine months ended December 31, 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. On October 28, 2008, the Company acquired Practice Management Partners, Inc. (PMP), 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. The Company has established VSOE for the related maintenance element based on the bell shape curve method. Maintenance VSOE for the Company’s largest customers is based on stated renewal rates only if the rate is determined to be substantive and falls within the Company’s customary pricing practices.

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.

5



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 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

6



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.

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 (RCM) 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 and ARS put option rights. Marketable securities are recorded at fair value, based on quoted market rates or valuation analysis when appropriate. 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 December 31, 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. Under their respective terms, the securities will continue to accrue interest and be auctioned until the auction succeeds, the issuer calls the securities or the securities mature.

In February 2008, the Company began to experience failed auctions on its ARS and ARPS. To determine their estimated fair values at December 31, 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.

7



The Company’s auction rate securities are managed by UBS Financial Services Inc. (UBS). On November 13, 2008, the Company entered into an Auction Rate Security Rights Agreement (the Rights Agreement) with UBS, whereby the Company accepted UBS’ offer to purchase the Company’s ARS investments at any time during the period from June 30, 2010 through July 2, 2012. As a result, the Company has obtained an asset, ARS put option rights, whereby the Company has a right to “put” the ARS back to UBS. The Company expects to exercise its ARS put option rights and put its ARS back to UBS on June 30, 2010, the earliest date allowable under the Rights Agreement.

As of September 30, 2008, the Company had the intent and ability to hold these securities until anticipated recovery. As a result, the Company recognized the unrealized loss through September 30, 2008 as a temporary impairment in other comprehensive income within shareholders’ equity.

By accepting the Rights Agreement, the Company can no longer assert that it has the intent to hold the auction rate securities until anticipated recovery. Therefore, the Company recognized an other-than-temporary impairment charge of approximately $133 in the third quarter of fiscal year 2009. The charge was measured as the difference between the par value and market value of the ARS on November 13, 2008, the date the Company accepted the Rights Agreement. However as the Company will be permitted to put the ARS back to UBS at par value, the Company accounted for the ARS put option rights as a separate asset that was measured at its fair value, resulting in a gain of approximately $133 recorded on November 13, 2008, the date the Company accepted the Rights Agreement. As a result of the Company’s acceptance of the Rights Agreement, the Company has elected to reclassify its investments in auction rate securities as trading securities, as defined by SFAS No. 115 “Accounting in Certain Investments in Debt and Equity Securities”, on the date of  the Company’s acceptance of the Rights Agreement. The Company is required to assess the fair value of these two individual assets and to record corresponding changes in fair value in each reporting period through the Consolidated Statements of Income until the ARS put option rights are exercised and the ARS are redeemed or sold.

The estimated fair value of the ARS put option rights and the unrealized loss on the ARS as of December 31, 2008 was determined to be immaterial. The Company expects that the future charges in the fair value of the ARS put option rights will be largely offset by the fair value movements in the ARS. Since the ARS put option rights represent the right to sell the securities back to UBS at par, the Company will be required to periodically assess the economic ability of UBS to meet that obligation in assessing the fair value of the ARS put option rights. The Company will continue to classify the ARS as long-term investments until June 30, 2009, one year prior to the expected settlement.

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

8



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 and PMP acquisitions, which closed on May 20, 2008 and October 28, 2008, respectively (see Notes 6, 7 and 8). 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 and PMP 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 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 December 31, 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 nine month periods ended December 31, 2008 and 2007.

9



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 


 


 

 

 

December 31,
2008

 

December 31,
2007

 

December 31,
2008

 

December 31,
2007

 

 

 


 


 


 


 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

$

28

 

$

119

 

$

181

 

$

391

 

Research and development

 

 

38

 

 

184

 

 

223

 

 

635

 

Selling, general and administrative

 

 

397

 

 

618

 

 

1,187

 

 

1,930

 

 

 



 



 



 



 

Total share-based compensation

 

$

463

 

$

921

 

$

1,591

 

$

2,956

 

Amounts capitalized in software development costs

 

 

(4

)

 

(9

)

 

(22

)

 

(31

)

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts charged against earnings, before income tax benefit

 

$

459

 

$

912

 

$

1,569

 

$

2,925

 

 

 



 



 



 



 

Amount of related income tax benefit recognized in earnings

 

$

127

 

$

234

 

$

537

 

$

771

 

 

 



 



 



 



 

3.       Recent Accounting Pronouncements

In November 2008, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 08-6, “Equity Method Investment Accounting Considerations” or EITF 08-6. EITF 08-6 clarifies the accounting for certain transactions and impairment considerations involving equity method investments. EITF 08-6 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company does not currently have any investments that are accounted for under the equity method and therefore EITF 08-6 will not have a significant impact on the Company’s consolidated financial statements.

In November 2008, the FASB ratified EITF Issue No. 08-7, “Accounting for Defensive Intangible Assets” or EITF 08-7. EITF 08-7 clarifies the accounting for certain separately identifiable intangible assets which an acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. EITF 08-7 requires an acquirer in a business combination to account for a defensive intangible asset as a separate unit of accounting which should be amortized to expense over the period the asset diminishes in value. EITF 08-7 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company is currently in the process of evaluating the impact the new EITF will have on its consolidated financial statements.

In October 2008, the FASB issued Staff Position 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 was effective upon issuance. The Company has considered the FSP in its determination of estimated fair values of its ARS for the fiscal year 2009.

In June 2008, the FASB issued FSP No. Emerging Issue Task Force (“EITF”) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”. FSP No. 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. We do 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 financial data 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. We do not expect the adoption of SFAS No. 162 to have a material impact on our consolidated financial statements.

In April 2008, the FASB finalized FSP No. 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 FASB SFAS No. 142, Goodwill and Other Intangible Assets. 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

10



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 SFAS 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 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

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.

11



The following table summarizes the Company’s financial assets measured at fair value on a recurring basis in accordance with SFAS 157 as of December 31, 2008:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of
December 31,
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

 

$

55,428

 

$

55,428

 

$

 

$

 

Restricted cash

 

 

1,383

 

 

1,383

 

 

 

 

 

Marketable securities (1)

 

 

10,649

 

 

 

 

 

 

10,649

 

 

 



 



 



 



 

 

 

$

67,460

 

$

56,811

 

$

 

$

10,649

 

 

 



 



 



 



 


 

 

(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 $10,649 or 15.8% 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 December 31, 2008:

 

 

 

 

 

 

 

Investment in
Marketable
Securities

 

 

 


 

Balance at March 31, 2008

 

$

22,624

 

Transfer to/out of Level 3

 

 

 

Proceeds from sale

 

 

(12,275

)

Unrealized gains, before income tax benefit

 

 

300

 

 

 



 

Balance at December 31, 2008

 

$

10,649

 

 

 



 

Upon execution of the Rights Agreement (see Note 2), the Company elected to fair value the ARS put option rights under SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities”. The Company fair valued the ARS put option rights at the inception of the Rights Agreement and is required to do so each reporting period, with corresponding changes in fair value being reported through current period earnings. The fair value of the ARS put option rights as of December 31, 2008 was determined to be immaterial.

12



 

 

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.

 

 

 

 

 

 

 

 

 

 

December 31,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Accounts receivable, excluding undelivered software, maintenance and services

 

$

72,292

 

$

50,417

 

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

 

 

31,290

 

 

28,696

 

 

 



 



 

Accounts receivable, gross

 

 

103,582

 

 

79,113

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts

 

 

(3,315

)

 

(2,528

)

 

 



 



 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

$

100,267

 

$

76,585

 

 

 



 



 

 

 

 

 

 

 

 

 

Inventories are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

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

 

$

1,229

 

$

992

 

Miscellaneous parts and supplies

 

 

24

 

 

32

 

 

 



 



 

Inventories, net

 

$

1,253

 

$

1,024

 

 

 



 



 

 

 

 

 

 

 

 

 

Accrued compensation and related benefits are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Bonus and commission

 

$

5,824

 

$

5,443

 

Vacation

 

 

3,517

 

 

2,903

 

 

 



 



 

 

 

 

 

 

 

 

 

Accrued compensation and related benefits

 

$

9,341

 

$

8,346

 

 

 



 



 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Maintenance

 

$

6,850

 

$

10,175

 

Implementation services

 

 

29,388

 

 

25,929

 

Annual license services

 

 

8,564

 

 

6,532

 

Undelivered software and other

 

 

2,743

 

 

2,259

 

 

 



 



 

 

 

 

 

 

 

 

 

Deferred Revenue

 

$

47,545

 

$

44,895

 

 

 



 



 

13



Other current liabilities are summarized as follows:

 

 

 

 

 

 

 

 

 

 

December 31,
2008

 

March 31,
2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Care services liabilities

 

$

1,292

 

$

 

Accrued EDI expenses

 

 

1,152

 

 

 

Sales tax payable

 

 

842

 

 

765

 

Customer deposits

 

 

542

 

 

621

 

Professional fees

 

 

505

 

 

600

 

Deferred rent

 

 

493

 

 

607

 

Commission payable

 

 

590

 

 

346

 

Accrued royalties

 

 

549

 

 

216

 

Other accrued expenses

 

 

3,930

 

 

1,239

 

 

 



 



 

Other current liabilities

 

$

9,895

 

$

4,394

 

 

 



 



 


 

 

6.

Business Combinations

Acquisition of Healthcare Strategic Initiatives

On May 20, 2008, the Company acquired Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (HSI), a full-service healthcare revenue management company, resulting in HSI becoming a wholly-owned subsidiary of QSI. HSI’s results of operations have been included in the consolidated financial statements since the date of acquisition.

This acquisition is a part of the Company’s growth strategy for NextGen Practice Solutions. HSI will operate under the umbrella of NextGen Practice Solutions. Founded in 1996, HSI currently provides RCM services to healthcare 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, payor credentialing, and information technology. The Company intends to cross sell both software and RCM services to the acquired customer bases of HSI and NextGen.

The purchase price totaled approximately $15,591 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

 

 

241

 

 

 



 

Total purchase price

 

$

15,591

 

 

 



 

The acquisition of HSI was 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 $10,839 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 December 31, 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.

14



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

 

 

10,839

 

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

 

 

(4,369

)

Long-term debt

 

 

(649

)

 

 



 

Net assets acquired

 

$

15,591

 

 

 



 

The pro forma effects of this acquisition would not have been material to our results of operations for the three and nine months ended December 31, 2008 or 2007 and therefore are not presented.

Acquisition of Practice Management Partners, Inc.

On October 28, 2008, the Company, through its NextGen subsidiary, acquired Practice Management Partners, Inc. (PMP), a full-service healthcare revenue management company, resulting in PMP becoming a wholly-owned subsidiary of NextGen and, ultimately QSI. PMP’s results of operations have been included in the consolidated financial statements since the date of acquisition.

This acquisition is also part of the Company’s growth strategy for NextGen Practice Solutions. PMP will operate under the umbrella of NextGen Practice Solutions. Founded in 2001, PMP provides RCM services to healthcare providers, primarily in the Mid-Atlantic region. The Company intends to cross sell both software and RCM services to the acquired customer base of PMP and NextGen.

The purchase price totaled approximately $19,684 plus up to approximately $3,000 in incentives tied to future performance. The purchase price consisted of $16,622 in cash and $2,750 in restricted QSI common stock, subject to restrictions on resale lapsing over a two year period, and transaction related costs. The value of the 67,733 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 October 27, 2008. The total purchase price for PMP is as follows:

 

 

 

 

 

Cash

 

$

16,622

 

Common stock

 

 

2,750

 

Direct transaction costs

 

 

312

 

 

 



 

Total purchase price

 

$

19,684

 

 

 



 

The acquisition of PMP is accounted for as a purchase business combination as defined in SFAS 141. Under the purchase method of accounting, the purchase price was allocated to PMP’s tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of October 28, 2008. The fair value of the assets acquired and liabilities assumed represents management’s estimate of fair value. The Company is amortizing the customer relationships intangible asset over nine years and the trade name over four years. The $16,038 assigned to goodwill is not 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 December 31, 2008, the maximum potential future consideration pursuant to such arrangements, to be resolved over the following two years, is $3,000. Any such payments would result in increases in goodwill.

15



The following table summarizes the allocation of the purchase price:

 

 

 

 

 

Current assets (including cash of $125 and accounts receivable of $2,029)

 

$

2,518

 

Equipment and improvements and other long-term assets

 

 

1,485

 

 

 



 

Total tangible assets acquired

 

 

4,003

 

Customer relationships

 

 

3,559

 

Trade name

 

 

259

 

Goodwill

 

 

16,038

 

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

 

 

(1,882

)

Long-term liabilies and debt, including deferred tax liability

 

 

(2,293

)

 

 



 

Net assets acquired

 

$

19,684

 

 

 



 

The pro forma effects of this acquisition would not have been material to our results of operations for the three and nine months ended December 31, 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:

 

 

 

 

 

 

 

December 31,
2008

 

 

 


 

 

 

 

 

 

NextGen Healthcare Information Systems, Inc

 

$

1,840

 

Healthcare Strategic Initiatives

 

 

10,839

 

Practice Management Partners

 

 

16,038

 

 

 



 

Total

 

$

28,717

 

 

 



 


 

 

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 December 31, 2008

 

 

 


 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net

 

 

 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

Customer Relationships

 

$

8,799

 

$

(605

)

$

8,194

 

Trade Name

 

 

638

 

 

(72

)

 

566

 

 

 



 



 



 

Total

 

$

9,437

 

$

(677

)

$

8,760

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

The following represents the change in intangible assets recorded for the nine months ended December 31, 2008:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer
Relationships

 

Trade Name

 

Total

 

 

 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

Balance as of April 1, 2008

 

$

 

$

 

$

 

Acquisition

 

 

8,799

 

 

638

 

 

9,437

 

Amortization

 

 

(605

)

 

(72

)

 

(677

)

 

 



 



 



 

Balance as of December 31, 2008

 

$

8,194

 

$

566

 

$

8,760

 

 

 



 



 



 

16



The following table represents the remaining estimated amortization of intangible assets, other than capitalized software development costs, with determinable lives as of December 31, 2008:

 

 

 

 

 

 

 

 

For the year ending March 31,

 

 

 

 

 

 

 

2009

 

 

 

 

$

359

 

2010

 

 

 

 

 

1,428

 

2011

 

 

 

 

 

1,428

 

2012

 

 

 

 

 

1,428

 

2013

 

 

 

 

 

1,317

 

2014 and beyond

 

 

 

 

 

2,800

 

 

 

 

 

 



 

Total

 

 

 

 

$

8,760

 

 

 

 

 

 



 


 

 

9.

Intangible Assets – Capitalized Software Development Costs

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

 

 

 

 

 

 

 

 

 

 

December 31,

 

March 31,

 

 

 

2008

 

2008

 

 

 


 


 

 

 

 

 

 

 

 

 

Gross carrying amount

 

$

32,130

 

$

27,645

 

Accumulated amortization

 

 

(22,580

)

 

(18,793

)

 

 



 



 

Net capitalized software development

 

$

9,550

 

$

8,852

 

 

 



 



 

Aggregate amortization expense during the nine and twelve month period

 

$

3,787

 

$

4,149

 

 

 



 



 

Activity related to net capitalized software costs for the nine month period ended December 31, 2008 and 2007 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

December 31,

 

 

 

2008

 

2007

 

 

 


 


 

Beginning of the period

 

$

8,852

 

$

6,982

 

Capitalization

 

 

4,485

 

 

4,474

 

Amortization

 

 

(3,787

)

 

(3,089

)

 

 



 



 

End of the period

 

$

9,550

 

$

8,367

 

 

 



 



 

The following table represents the remaining estimated amortization of capitalized software development costs with determinable lives as of December 31, 2008:

 

 

 

 

 

 

 

 

For the year ending March 31,

 

 

 

 

 

 

 

2009

 

 

 

 

$

1,457

 

2010

 

 

 

 

 

4,624

 

2011

 

 

 

 

 

2,645

 

2012

 

 

 

 

 

824

 

 

 

 

 

 



 

Total

 

 

 

 

$

9,550

 

 

 

 

 

 



 


 

 

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 December 31, 2008, there were 573,091 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 2,400,000 shares of Common Stock have been reserved for the issuance

17



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 December 31, 2008, 1,753,338 shares were available for future grant under the 2005 Plan. As of December 31, 2008, there were 323,331 outstanding options related to this Plan.

A summary of stock option transactions during the nine months ended December 31, 2008 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

298,331

 

 

 

$

38.71

 

 

4.87

 

 

 

 

 

 

 

Exercised

 

(620,743

)

 

 

$

18.00

 

 

2.27

 

 

 

$

15,074

 

 

Forfeited/Canceled

 

(84,900

)

 

 

$

25.93

 

 

3.44

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding, December 31, 2008

 

896,422

 

 

 

$

31.14

 

 

3.76

 

 

 

$

11,260

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest, December 31, 2008

 

883,838

 

 

 

$

31.10

 

 

3.75

 

 

 

$

11,133

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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:

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

December 31, 2008

 

December 31, 2007

 

 

 




 

Expected life

 

4.01 years

 

3.75 years

 

Expected volatility

 

42.0% - 46.7

%

42.37% - 44.81

%

Expected dividends

 

2.9% - 3.5

%

2.67% - 2.99

%

Risk-free rate

 

1.07% - 3.4

%

3.07% - 5.09

%

During the nine months ended December 31, 2008, 298,331 options were granted under the 2005 Plan. During the nine months ended December 31, 2007, 200,500 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 nine months ended December 31, 2008 and 2007 was $11.22 per share and $12.78 per share, respectively.

On November 5, 2008, the Board of Directors granted a total of 80,141 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 ($42.20 per share). The options vest in four equal annual installments beginning November 5, 2009 and expire on November 5, 2013.

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 September 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.

18



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 (such new employee grants not being subject to the earnings and revenue criteria set forth above). Based on performance versus established plan targets, $29 related to the performance plan was recorded for the nine months ended December 31, 2008.

Non-vested stock option award activity, including awards for the nine month period ended December 31, 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

 

298,331

 

 

$

11.22

 

 

Vested

 

(227,272

)

 

$

7.70

 

 

Forfeited/Canceled

 

(84,900

)

 

$

10.17

 

 

 

 


 

 

 

 

 

 

Non-vested, December 31, 2008

 

635,595

 

 

$

10.93

 

 

 

 


 

 

 

 

 

 

As of December 31, 2008, $5,669 of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted average period of 4.1 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 nine months ended December 31, 2008 and 2007 was $1,750 and $714 respectively.

 

 

11.

Income Taxes

The provision for income taxes for the nine months ended December 31, 2008 was approximately $20,193 as compared to $16,548 for the year ago period. The effective tax rates for the nine months ended December 31, 2008 and 2007 were 36.7% and 36.5%, respectively. The provision for income taxes for the nine months ended December 31, 2008 differs from the combined statutory rates primarily due to the impact of varying state income tax rates, tax-exempt interest income, research and development tax credit and the qualified production activities deduction. The provision for income taxes for the nine months ended December 31, 2007 differs primarily from the combined statutory rates due to the impact of the varying state income tax rates, federal and state research and development tax credits, qualified production activities deduction, and exclusions for company-owned life insurance proceeds and tax-exempt interest income.

Uncertain tax positions

As of December 31, 2008, the Company has provided a liability of $473 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 December 31, 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. Two of the applications were re-filed under the automatic consent provisions and therefore no longer require an unrecognized tax

19



benefit reserve. The decrease in the reserve had no impact on the tax provision. 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 December 31, 2008 by approximately $406 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

13,150

 

$

11,214

 

$

34,763

 

$

28,826

 

Basic net income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average of common shares outstanding

 

 

28,340

 

 

27,362

 

 

27,913

 

 

27,261

 

 

 



 



 



 



 

Basic net income per common share

 

$

0.46

 

$

0.41

 

$

1.25

 

$

1.06

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

13,150

 

$

11,214

 

$

34,763

 

$

28,826

 

Diluted net income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average of common shares outstanding

 

 

28,340

 

 

27,362

 

 

27,913

 

 

27,261

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of potentially dilutive securities (options)

 

 

133

 

 

334

 

 

362

 

 

478

 

 

 



 



 



 



 

Weighted average of common shares outstanding – diluted

 

 

28,473

 

 

27,696

 

 

28,275

 

 

27,739

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per common share

 

$

0.46

 

$

0.40

 

$

1.23

 

$

1.04

 

 

 



 



 



 



 

The computation of diluted net income per share does not include 507,983 and 475,522 options for the three and nine months ended December 31, 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 382,850 and 278,850 options for the three and nine months ended December 31, 2007, respectively, 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 gains on marketable securities of  $0 and $196 for the three and nine months ended December 31, 2008, respectively. There were no other comprehensive income items for the three and nine months ended December 31, 2007.

20



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

13,150

 

$

11,214

 

$

34,763

 

$

28,826

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on marketable securities, net of tax

 

 

 

 

 

 

196

 

 

 

 

 



 



 



 



 

Comprehensive income

 

$

13,150

 

$

11,214

 

$

34,959

 

$

28,826

 

 

 



 



 



 



 


 

 

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 results of operations related to the HSI and PMP acquisitions are included in the NextGen 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 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, St. Louis, Missouri and Hunt Valley, Maryland 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 December 31, 2008 relates to the Company’s NextGen division including HSI and PMP.

 

 


a

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

21



Operating segment data is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

3,969

 

$

4,072

 

$

12,149

 

$

12,060

 

NextGen Division

 

 

61,510

 

 

44,018

 

 

167,535

 

 

123,208

 

 

 



 



 



 



 

Consolidated revenue

 

$

65,479

 

$

48,090

 

$

179,684

 

$

135,268

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

944

 

$

650

 

$

2,872

 

$

2,996

 

NextGen Division

 

 

22,821

 

 

17,823

 

 

62,057

 

 

47,425

 

Unallocated corporate expenses

 

 

(3,611

)

 

(2,688

)

 

(11,015

)

 

(8,094

)

 

 



 



 



 



 

Consolidated operating income

 

$

20,154

 

$

15,785

 

$

53,914

 

$

42,327

 

 

 



 



 



 



 


 

 

15.

Concentration of Credit Risk

The Company had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at December 31, 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 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.

22



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 them vigorously; however, in order to avoid 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 Event

On January 28, 2009, 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 March 11, 2009 and the cash dividend is expected to be distributed to shareholders on or about April 3, 2009.

23



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, 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. We have established VSOE for the related maintenance element based on the bell shape curve method. Maintenance VSOE for our largest customers is based on stated renewal rates only if the rate is determined to be substantive and falls within our customary pricing practices.

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

24



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.

 

 

§

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.

25



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.

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 and ARS put option rights. Marketable securities are recorded at fair value, based on quoted market rates or on valuation analysis when appropriate. 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 (see Note 4 of our Condensed Notes to the Consolidated Financial Statements: “Fair Value Measurement”). 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.

The Company’s ARS are managed by UBS Financial Services Inc. (UBS). On November 13, 2008, the Company entered into an Auction Rate Security Rights Agreement (the Rights Agreement) with UBS, whereby the Company accepted UBS’ offer to purchase the Company’s ARS investments at any time during the period of June 30, 2010 through July 2, 2012. As a result, the Company has obtained an asset, ARS put option rights, whereby the Company has a right to “put” the ARS back to UBS. The Company expects to exercise its ARS put option rights and put its ARS back to UBS on June 30, 2010, the earliest date allowable under the Rights Agreement.

As the Company will be permitted to put the ARS back to UBS at par value, the Company has accounted for the ARS put option rights as a separate asset that was initially measured and will continue to be measured at its fair value. The Company is required to assess the fair value of these two individual assets and to record corresponding changes in fair value in each

26



reporting period through the Consolidated Statements of Operations until the ARS put option rights are exercised and the ARS are redeemed or sold. Since the ARS put option rights represent the right to sell the securities back to UBS at par, the Company will be required to periodically assess the economic ability of UBS to meet that obligation in assessing the fair value of the ARS put option rights.

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 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.

Research and Development Tax Credits. Management’s treatment of research and development tax credits represented a significant estimate which affected the effective income tax rate for the Company for the nine months ended December 31, 2008 and 2007. Research and development credits taken by the Company involve certain assumptions and judgments regarding qualified expenses under Internal Revenue Code Section 41. These credits are subject to examination by the federal and state taxing authorities.

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 nine months ended December 31, 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.

27



Company Overview

Quality Systems Inc., comprised of the QSI Division (QSI Division) and wholly-owned subsidiaries, NextGen Healthcare Information Systems, Inc. (NextGen Division), Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (HSI) and Practice Management Partners (PMP) (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 also provides revenue cycle management services (RCM) through its Practice Solutions division of NextGen. Operationally, HSI and PMP are considered and administered as part of the NextGen Division.

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, St. Louis, Missouri and Hunt Valley, Maryland focuses principally on developing and marketing products and services for medical practices.

Both divisions develop and market practice management software which is designed to automate and streamline a number of the administrative functions required for operating a medical or dental practice. Examples of practice management software functions include scheduling and billing capabilities. It is important to note that in both the medical and dental environments, practice management software systems have already been implemented by the vast majority of practices. Therefore, we actively compete for the replacement market.

In addition, both divisions develop and market software that automates the patient record. 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.

 

 


1

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

 

 

2

Windows NT is a registered trademark of the Microsoft Corporation.

28



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 93.9% of our revenue for the third quarter of fiscal 2009 compared to 91.5% in the third quarter of fiscal 2008. The QSI Division accounted for 6.1% and 8.5% of revenue in the third quarter of fiscal 2009 and 2008, respectively. The NextGen Division’s year over year revenue grew 39.7% and 28.6% in the third quarter of fiscal 2009 and 2008, respectively, while the QSI Division’s year over year revenue declined 2.5% and 4.6% in the third 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 acquired St. Louis-based Healthcare Strategic Initiatives (HSI), a full-service healthcare revenue management company. HSI will operate under the umbrella of NextGen Practice Solutions. Founded in 1996, HSI currently provides revenue cycle management services to 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. The Company intends to cross sell both software and RCM services to the acquired customer base of HSI and NextGen.

On October 28, 2008, we acquired Maryland-based Practice Management Partners, Inc. (PMP), a full-service healthcare revenue cycle management company. This acquisition is also part of the Company’s growth strategy for NextGen Practice Solutions. Similarly to HSI, PMP will operate under the umbrella NextGen Practice Solutions. Founded in 2001, PMP provides physician billing and technology management services to healthcare providers, primarily in Mid-Atlantic region. The Company intends to cross sell both software and RCM services to the acquired customer base of PMP and NextGen.

The acquisitions of both HSI and PMP are a part of the Company’s growth strategy for NextGen Practice Solutions.

Results of Operations

Overview of results

 

 

§

Consolidated revenue grew 32.8% in the nine months ended December 31, 2008 versus the same period in 2007 and 20.8% in the nine months ended December 31, 2007 versus the same period in 2006. For the nine months ended December 31, 2008, revenue was positively impacted by the HSI and PMP acquisitions, which companies generated $10.7 million for the period May 21, 2008 to December 31, 2008 and $2.6 million of revenue for the period October 29, 2008 to December 31, 2008, respectively.

 

 


3

NextGen is a registered trademark of NextGen Healthcare Information Systems, Inc.

 

 

4

NextMD is a registered trademark of NextGen Healthcare Information Systems, Inc.

29



 

 

§

Consolidated income from operations grew 27.4% in the nine months ended December 31, 2008 versus the same period in 2007 and grew 12.2% in the nine months ended December 31, 2007 versus 2006. For the nine months ended December 31, 2008, operating income was positively impacted by an increase in 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; we also experienced higher selling, general and administrative expenses. Higher selling, general and administrative expenses were impacted negatively by $4.2 million of expenses incurred in conjunction with the proxy contest involving our election of directors at our 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.

 

 

§

While the Company expects to benefit from the increasing demands for greater efficiency as well as government support for increased adoption of electronic medical records, the current economic environment combined with unpredictability of the federal government’s plans to promote increased adoption of electronic medical records makes the near term achievement of such benefits and, ultimately, their impact on system sales, uncertain.

NextGen Division

 

 

§

Our NextGen Division’s revenue grew 36.0% in the nine months ended December 31, 2008 versus 2007 and 23.3% in the nine months ended December 31, 2007 versus 2006. Divisional operating income (which excludes unallocated corporate expenses) grew 30.9% in the nine months ended December 31, 2008 versus 2007 and 16.0% in the nine months ended December 31, 2007 versus 2006.

 

 

§

HSI contributed $10.7 million to NextGen’s revenue from the date of its acquisition on May 20, 2008 to December 31, 2008. HSI’s operating income added $0.6 million to NextGen’s operating income during the same period.

 

 

§

PMP contributed $2.6 million to NextGen’s revenue from the date of its acquisition on October 28, 2008 to December 31, 2008. PMP’s operating income had minimal impact to NextGen’s operating income during the same period.

 

 

§

During the nine months ended December 31, 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, 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 0.7% in the nine months ended December 31, 2008 versus the same period in 2007 and decreased 1.0% in the nine months ended December 31, 2007 versus the same period in 2006. The Division experienced a 4.1% decrease in operating income (excluding unallocated corporate expenses) in the nine months ended December 31, 2008 versus the same period in 2007 as compared to a 15.0% decrease in operating income in the nine months ended December 31, 2007 versus the same period in 2006. For the nine months ended December 31, 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. The QSI division also intends to leverage the NextGen sales force to sell its dental EMR software to practices that provide both medical and dental services such as Federal Qualified Health Centers. The Division has had limited success in this area in recent quarters.

30



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
December 31,

 

Nine Months Ended
December 31,

 

 

 


 


 

 

 

2008

 

2007

 

2008

 

2007

 

 

 


 


 


 


 

Revenues:

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

34.1

%

42.8

%

36.2

%

41.3

%

Implementation and training services

 

4.1

 

6.5

 

5.4

 

7.1

 

 

 


 


 


 


 

System sales

 

38.2

 

49.3

 

41.6

 

48.3

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

29.3

 

30.9

 

29.8

 

30.2

 

Electronic data interchange services

 

12.2

 

11.9

 

12.1

 

12.0

 

Revenue cycle management and related services

 

10.4

 

0.5

 

7.4

 

0.5

 

Other services

 

9.9

 

7.4

 

9.1

 

9.0

 

 

 


 


 


 


 

Maintenance, EDI, revenue cycle management and other services

 

61.8

 

50.7

 

58.4

 

51.7

 

 

 


 


 


 


 

Total revenue

 

100.0

 

100.0

 

100.0

 

100.0

 

 

 


 


 


 


 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Software, hardware and supplies

 

4.6

 

6.2

 

5.5

 

5.9

 

Implementation and training services

 

3.3

 

5.5

 

4.4

 

5.5

 

 

 


 


 


 


 

Total cost of system sales

 

7.9

 

11.7

 

9.9

 

11.4

 

 

 

 

 

 

 

 

 

 

 

Maintenance

 

4.3

 

6.5

 

4.9

 

6.9

 

Electronic data interchange services

 

8.5

 

8.7

 

8.7

 

8.4

 

Revenue cycle management and related services

 

6.8

 

0.4

 

5.0

 

0.3

 

Other services

 

7.8

 

6.3

 

6.9

 

6.6

 

 

 


 


 


 


 

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

 

27.4

 

21.9

 

25.5

 

22.2

 

 

 


 


 


 


 

Total cost of revenue

 

35.3

 

33.6

 

35.4

 

33.6

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

64.7

 

66.4

 

64.6

 

66.4

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

28.4

 

27.6

 

29.0

 

28.9

 

Research and development

 

5.5

 

6.0

 

5.6

 

6.2

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

30.8

 

32.8

 

30.0

 

31.3

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Interest income

 

0.5

 

1.5

 

0.6

 

1.5

 

Other income

 

 

2.0

 

 

0.7

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

31.3

 

36.3

 

30.6

 

33.5

 

Provision for income taxes

 

11.2

 

13.0

 

11.2

 

12.2

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

Net income

 

20.1

%

23.3

%

19.4

%

21.3

%

 

 


 


 


 


 

For the Three-Month Periods Ended December 31, 2008 versus 2007

Net Income. The Company’s net income for the three months ended December 31, 2008 was $13.2 million or $0.46 per share on a basic and $0.46 per share on a fully diluted basis. In comparison, we earned $ 11.2 million or $0.41 per share on a basic and $0.40 per share on a fully diluted basis for the three months ended December 31, 2007. The increase in net income for the three months ended December 31, 2008 was a result of the following:

 

 

a 36.2% increase in consolidated revenue, including $7.5 million in RCM revenue from our recently acquired entities;

 

 

a 39.7% increase in NextGen Division revenue which accounted for 93.9% of consolidated revenue;

31



 

 

offset by a shift in revenue mix with increased maintenance, EDI 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 related to higher than usual legal expenses, primarily as a result of certain legal matters related to intellectual property infringement claims in the NextGen division.

Revenue. Revenue for the three months ended December 31, 2008 increased 36.2% to $65.5 million from $48.1 million for the three months ended December 31, 2007. NextGen Division revenue increased 39.7% from $44.0 million in the three months ended December 31, 2007 to $61.5 million in the three months ended December 31, 2008, while the QSI Division revenue decreased by 2.5% during the three months ended December 31, 2008 over the prior year period. NextGen revenue is inclusive of approximately $4.9 million in revenue from HSI and $2.6 million in revenue from PMP.

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 December 31, 2008, increased 5.5% to $25.0 million from $23.7 million in the prior year period.

Our increase in revenue from sales of systems was principally the result of a 5.5% increase in category revenue at our NextGen Division. Divisional sales in this category grew from $22.8 million during the three months ended December 31, 2007 to $24.4 million during the three months ended December 31, 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 December 31, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

103

 

$

309

 

$

220

 

$

632

 

NextGen Division

 

 

21,046

 

 

878

 

 

2,455

 

 

24,379

 

 

 



 



 



 



 

Consolidated

 

$

21,149

 

$

1,187

 

$

2,675

 

$

25,011

 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended December 31, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

179

 

$

307

 

$

371

 

$

857

 

NextGen Division

 

 

18,510

 

 

1,595

 

 

2,744

 

 

22,849

 

 

 



 



 



 



 

Consolidated

 

$

18,689

 

$

1,902

 

$

3,115

 

$

23,706

 

 

 



 



 



 



 

NextGen Division software license revenue increased 13.7% between the three months ended December 31, 2008 and the prior year period. The Division’s software revenue accounted for 86.3% of divisional system sales revenue during the three months ended December 31, 2008. For the three month period ended December 31, 2007, divisional software revenue as a percentage of divisional system sales revenue was 81.0%. Software license revenue growth continues to be an area of primary emphasis for the NextGen Division.

During the three months ended December 31, 2008, 3.6% of NextGen’s system sales revenue was represented by hardware and third party software compared to 7.0% in the prior year period. 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.

32



Implementation and training revenue related to system sales at the NextGen Division declined 10.5% in the three months ended December 31, 2008 compared to the three months ended December 31, 2007. 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 implementation and training staff increased during the three months ended December 31, 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 decreased 26.3% in the three months ended December 31, 2008 versus the same period ended December 31, 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 December 31, 2008, company-wide revenue from maintenance, EDI, revenue cycle management (RCM) and other services grew 66.0% to $40.5 million from $24.4 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 December 31, 2008 grew 32.9% to $17.4 million from $13.1 million in the prior year period, while EDI revenue grew 44.3% to $6.7 million compared to $4.6 million during the prior year period. RCM grew to $6.8 million primarily as a result of the HSI and PMP acquisitions. Other services revenue for the three months ended December 31, 2008 increased 94.0% to $6.3 million from $3.2 million in the prior year period, primarily due to increases in third party annual software licenses, consulting services and hosting services revenue. QSI Division maintenance, EDI and other revenue remained consistent at $3.3 million in the three months ended December 31, 2008 as compared to $3.2 million in the three months ended December 31, 2007.

The following table details revenue included in the maintenance, EDI and other category for the three month periods ended December 31, 2008 and 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 











 

 

Maintenance

 

EDI

 

Revenue Cycle
Management

 

Other

 

Total

 

 

 


 


 


 


 


 

Three months ended December 31, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

1,784

 

$

1,348

 

$

 

$

205

 

$

3,337

 

NextGen Division

 

 

17,368

 

 

6,660

 

 

6,835

 

 

6,268

 

 

37,131

 

 

 



 



 



 



 



 

Consolidated

 

$

19,152

 

$

8,008

 

$

6,835

 

$

6,473

 

$

40,468

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended December 31, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QSI Division

 

$

1,795

 

$

1,123

 

$

 

$

297

 

$

3,215

 

NextGen Division

 

 

13,066

 

 

4,616

 

 

256

 

 

3,231