Document


 
 
 
 
 

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

FORM 10-Q


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

For the quarterly period ended September 30, 2017

or

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

Commission file number: 001-12537

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

California
(State or other jurisdiction of incorporation or organization)

18111 Von Karman Avenue, Suite 800, Irvine, California
(Address of principal executive offices)
95-2888568
(IRS Employer Identification No.)

92612
(Zip Code)
 
(949) 255-2600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes þ    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Small reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o    No þ
The number of outstanding shares of the Registrant’s common stock as of October 24, 2017 was 63,671,536 shares.


 
 
 
 
 




QUALITY SYSTEMS, INC.

TABLE OF CONTENTS
FORM 10-Q
FOR THE THREE MONTHS ENDED September 30, 2017

 
Item    
Page
 
 
 
 
PART I. FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
Item 3.
Item 4.
 
PART II. OTHER INFORMATION
 
Item 1.
Item 1A.
Item 3.
Item 4.
Item 5.
Item 6.
 




2



PART I. FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS.

QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
 
September 30, 2017
 
March 31, 2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
26,553

 
$
37,673

Restricted cash and cash equivalents
6,488

 
4,916

Accounts receivable, net
81,712

 
83,407

Inventory
147

 
158

Income taxes receivable
2,871

 
2,679

Prepaid expenses and other current assets
15,369

 
17,969

Total current assets
133,140

 
146,802

Equipment and improvements, net
27,681

 
27,426

Capitalized software costs, net
21,024

 
13,607

Deferred income taxes, net
10,289

 
11,265

Intangibles, net
86,746

 
69,213

Goodwill
216,530

 
185,898

Other assets
18,650

 
19,010

Total assets
$
514,060

 
$
473,221

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
6,813

 
$
4,618

Deferred revenue
52,285

 
52,383

Accrued compensation and related benefits
17,602

 
24,513

Income taxes payable

 
405

Other current liabilities
31,913

 
46,775

Total current liabilities
108,613

 
128,694

Deferred revenue, net of current
1,191

 
1,394

Deferred compensation
6,438

 
6,629

Line of credit
55,000

 
15,000

Other noncurrent liabilities
17,315

 
16,461

Total liabilities
188,557

 
168,178

Commitments and contingencies (Note 13)


 


Shareholders' equity:
 
 
 
Common stock
 
 
 
$0.01 par value; authorized 100,000 shares; issued and outstanding 63,685 and 62,455 shares at September 30, 2017 and March 31, 2017, respectively
637

 
625

Additional paid-in capital
237,110

 
228,549

Accumulated other comprehensive loss
(457
)
 
(358
)
Retained earnings (1)
88,213

 
76,227

Total shareholders' equity
325,503

 
305,043

Total liabilities and shareholders' equity
$
514,060

 
$
473,221

___________________________________
(1) Includes cumulative-effect adjustment related to the adoption of ASU 2016-09, as defined in Note 1. See Note 1 for additional details.

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

3



QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Software license and hardware
$
14,267

 
$
17,182

 
$
27,067

 
$
31,971

Software related subscription services
24,988

 
21,490

 
48,894

 
41,365

Total software, hardware and related
39,255

 
38,672

 
75,961

 
73,336

Support and maintenance
41,693

 
38,974

 
82,809

 
76,981

Revenue cycle management and related services
21,002

 
20,936

 
42,405

 
41,989

Electronic data interchange and data services
22,998

 
21,613

 
46,310

 
43,737

Professional services
7,659

 
6,971

 
16,044

 
13,328

Total revenues
132,607

 
127,166

 
263,529

 
249,371

Cost of revenue:
 
 
 
 
 
 
 
Software license and hardware
4,848

 
6,427

 
10,221

 
13,547

Software related subscription services
10,699

 
8,675

 
21,129

 
17,762

Total software, hardware and related
15,547

 
15,102

 
31,350

 
31,309

Support and maintenance
7,435

 
7,036

 
15,058

 
13,604

Revenue cycle management and related services
14,853

 
14,359

 
30,214

 
28,590

Electronic data interchange and data services
13,574

 
12,807

 
26,732

 
25,570

Professional services
7,346

 
6,693

 
14,570

 
13,739

Total cost of revenue
58,755

 
55,997

 
117,924

 
112,812

Gross profit
73,852

 
71,169

 
145,605

 
136,559

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
40,977

 
42,790

 
83,954

 
83,371

Research and development costs, net
19,527

 
18,292

 
39,516

 
36,516

Amortization of acquired intangible assets
2,012

 
2,617

 
4,059

 
5,321

Restructuring costs

 
701

 

 
4,454

Total operating expenses
62,516

 
64,400

 
127,529

 
129,662

Income from operations
11,336

 
6,769

 
18,076

 
6,897

Interest income
12

 
1

 
21

 
9

Interest expense
(840
)
 
(803
)
 
(1,517
)
 
(1,816
)
Other income (expense), net
15

 
(55
)
 
(7
)
 
(142
)
Income before provision for income taxes
10,523

 
5,912

 
16,573

 
4,948

Provision for income taxes
2,493

 
1,925

 
4,647

 
1,608

Net income
$
8,030

 
$
3,987

 
$
11,926

 
$
3,340

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation, net of tax
(85
)
 
29

 
(99
)
 
(93
)
Unrealized gain on marketable securities, net of tax

 

 

 
10

Comprehensive income
$
7,945

 
$
4,016

 
$
11,827

 
$
3,257

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.13

 
$
0.06

 
$
0.19

 
$
0.05

Diluted
$
0.13

 
$
0.06

 
$
0.19

 
$
0.05

Weighted-average shares outstanding:
 
 
 
 
 
 
 
Basic
63,513

 
61,658

 
63,077

 
61,420

Diluted
63,530

 
62,052

 
63,089

 
61,704

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

4



QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
11,926

 
$
3,340

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
5,374

 
5,106

Amortization of capitalized software costs
2,571

 
4,819

Amortization of other intangibles
11,267

 
11,378

Amortization of debt issuance costs
538

 
538

Loss on disposal of equipment and improvements
45

 
175

Provision for bad debts
3,868

 
1,969

Provision for inventory obsolescence
36

 
224

Share-based compensation
5,132

 
3,177

Deferred income taxes
18

 
180

Excess tax deficiency from share-based compensation
346

 

Change in fair value of contingent consideration

 
5,830

Restructuring costs

 
701

Changes in assets and liabilities, net of amounts acquired:
 
 
 
Accounts receivable
(120
)
 
13,649

Inventory
(25
)
 
(22
)
Accounts payable
1,323

 
(5,834
)
Deferred revenue
(929
)
 
(5,572
)
Accrued compensation and related benefits
(7,302
)
 
(4,179
)
Income taxes
(348
)
 
17,213

Deferred compensation
(191
)
 
437

Other assets and liabilities
4,565

 
3,256

Net cash provided by operating activities
38,094

 
56,385

Cash flows from investing activities:
 
 
 
Additions to capitalized software costs
(9,624
)
 
(5,319
)
Additions to equipment and improvements
(5,423
)
 
(4,989
)
Proceeds from sales and maturities of marketable securities

 
9,291

Payments for acquisitions, net of cash acquired
(58,892
)
 

Net cash used in investing activities
(73,939
)
 
(1,017
)
Cash flows from financing activities:
 
 
 
Proceeds from line of credit
50,000

 

Principal repayments on line of credit
(10,000
)
 
(57,000
)
Payment of contingent consideration related to acquisitions
(18,817
)
 

Proceeds from issuance of shares under employee plans
4,320

 
702

Cancellation of shares related to tax withholdings for vesting of equity awards
(778
)
 

Net cash provided by (used in) financing activities
24,725

 
(56,298
)
Net decrease in cash and cash equivalents
(11,120
)
 
(930
)
Cash and cash equivalents at beginning of period
37,673

 
27,176

Cash and cash equivalents at end of period
$
26,553

 
$
26,246


5



QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(In thousands)
(Unaudited)
 
Six Months Ended September 30,
 
2017
 
2016
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes
$
5,396

 
$
3,977

Cash refunds from income taxes
713

 
19,762

Cash paid for interest
933

 
1,443

Non-cash investing and financing activities:
 
 
 
Tenant improvement allowance from landlord
$
1,442

 
$
3,094

Unpaid additions to equipment and improvements
117

 
488


On April 14, 2017, we acquired Entrada in a transaction summarized as follows:
 
 
 
Fair value of net assets acquired
$
35,293

 
$

Cash paid, net of cash acquired
(33,856
)
 

Liabilities assumed
$
1,437

 
$


On August 16, 2017, we acquired EagleDream in a transaction summarized as follows:
 
 
 
Fair value of net assets acquired
$
27,895

 
$

Cash paid, net of cash acquired
(25,036
)
 

Liabilities assumed
$
2,859

 
$



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

6



QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except shares and per share data)
(Unaudited)
1. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include the accounts of Quality Systems, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). Each of the terms “we,” “us,” or “our” as used herein refers collectively to the Company, unless otherwise stated. All intercompany accounts and transactions have been eliminated.
Business Segments. We have determined that the Company operates in one segment as of June 30, 2017. We have made such determination by first identifying our Chief Executive Officer as our chief operating decision maker ("CODM") and considering the measures used by our CODM to allocate resources. Our CODM utilizes consolidated revenue and consolidated operating results to assess performance and make decisions about allocation of resources.
Previously, through the end of fiscal year 2017, we operated under two reportable segments, consisting of the Software and Related Solutions segment and the RCM and Related Services segment, which was consistent with the disaggregated financial information used and evaluated by our CODM to assess performance and make decisions about the allocation of resources. However, as part of our reorganization efforts that were substantially complete as of the end of fiscal year 2017, our internal organizational structure whereby certain functions that formerly existed within each individual operating segment has continued to evolve. Our former Chief Operating Officer was previously responsible for leading the operations of our former RCM and Related Services business while our former Chief Client Officer led our client success organization, consisting of the Software and Related Solutions business and other functions, such as sales and marketing. Upon the resignation of our former Chief Operating Officer in April 2017 and concurrent appointment of our former Chief Client Officer as Chief Operating Officer, our entire portfolio of software and services were aligned under our new Chief Operating Officer in an effort to provide our clients with an even more simplified experience and more effectively deliver a consolidated financial solution to our clients, rather than components of a solution. As a result of such changes in our internal organization structure, the CODM now operates the Company as a single functional organization. The CODM measures company-wide performance by reviewing consolidated revenue and operating results and evaluates the impact of allocating resources to overall profit and margins on a consolidated basis.
Basis of Presentation. The accompanying unaudited consolidated financial statements as of September 30, 2017 and for the three and six months ended September 30, 2017 have been prepared in accordance with the requirements of Quarterly Report on Form 10-Q and Article 10 of the Securities and Exchange Commission Regulation S-X and therefore do not include all information and notes 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 our Annual Report on Form 10-K for the fiscal year ended March 31, 2017. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments which are necessary for a fair statement 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 amounts in the consolidated financial statement sections are in thousands, except shares and per share data, unless otherwise specified.
Significant Accounting Policies. There have been no material changes to our significant accounting policies from those disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2017.
Share-Based Compensation. The following table shows total share-based compensation expense included in the consolidated statements of comprehensive income for the three and six months ended September 30, 2017 and 2016:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Costs and expenses:
 
 
 
 
 
 
 
Cost of revenue
$
290

 
$
166

 
$
427

 
$
315

Research and development costs, net
513

 
334

 
874

 
417

Selling, general and administrative
2,288

 
1,418

 
3,831

 
2,445

Total share-based compensation
3,091

 
1,918

 
5,132

 
3,177

Income tax benefit
(1,144
)
 
(695
)
 
(1,860
)
 
(1,107
)
Decrease in net income
$
1,947

 
$
1,223

 
$
3,272

 
$
2,070



7



Recent Accounting Standards. Recent accounting pronouncements requiring implementation in future periods are discussed below or in the notes, where applicable.
In May 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-09, Compensation–Stock Compensation (Topic 718): Scope of Modification Accounting ("ASU 2017-09"). ASU 2017-09 clarifies the changes to terms or conditions of a share-based payment award that require an entity to apply modification accounting. ASU 2017-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early application is permitted and prospective application is required. ASU 2017-09 is effective for us in the first quarter of fiscal 2019, and we currently do not expect the adoption of this new standard to have a material impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles–Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of Step two of the goodwill impairment test. Instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. ASU 2017-04 is effective prospectively for annual and interim periods beginning after December 15, 2019, and early adoption is permitted on goodwill impairment tests performed on testing dates after January 1, 2017. ASU 2017-04 is effective for us in the fourth quarter of fiscal 2020, and we currently do not expect the adoption of this new standard to have a material impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted in two scenarios as identified in the new standard. ASU 2017-01 is effective for us in the first quarter of fiscal 2019, and we currently do not expect the adoption of this new standard to have a material impact on our consolidated financial statements.
In November 2016, the FASB issued Accounting Standards Update ("ASU") 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-18 provides guidance on the classification of restricted cash and cash equivalents in the statement of cash flows. Although it does not provide a definition of restricted cash or restricted cash equivalents, it states that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. ASU 2016-18 is effective for us in the first quarter of fiscal 2019, and we do not expect the adoption of this new standard to have a material impact on our consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory ("ASU 2016-16"). ASU 2016-16 requires the recognition of current and deferred income taxes for intra-entity asset transfers when the transaction occurs. ASU 2016-16 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted. ASU 2016-16 is effective for us in the first quarter of fiscal 2019, and we are currently in the process of evaluating the potential impact of adoption of this updated authoritative guidance on our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to add and clarify guidance on the classification of certain cash receipts and cash payments in the statement of cash flows to eliminate diversity in practice related to how such cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. ASU 2016-15 is effective for us in the first quarter of fiscal 2019, and we do not expect the adoption of this new standard to have a material impact on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 simplifies the accounting for and reporting on share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The amendments in this update are to be applied differently upon adoption with certain amendments being applied prospectively, retrospectively and under a modified retrospective transition method. We adopted ASU 2016-09 in the first quarter of fiscal 2018. As permitted by ASU 2016-09, we have made an accounting policy election to account for forfeitures as they occur, which was adopted on a modified retrospective basis and resulted in a cumulative-effect adjustment of $0.1 million to retained earnings and additional paid-in capital as of April 1, 2017. ASU 2016-09 also eliminates additional paid-in capital pools and requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled, which was adopted on a prospective basis. The requirements to recognize previously unrecognized excess tax benefits on a modified retrospective basis did not have an impact on our consolidated financial statements. Upon adoption of ASU 2016-09, excess tax benefits and tax deficiencies are recognized in the income statement, and the tax effects of exercised or vested awards are treated as discrete items in the period they occur. The provisions of ASU 2016-09 could have an impact to our future income tax expense, including increased volatility in our effective tax rate on a quarter by quarter basis due to a number of factors, including fluctuations in the stock price and the timing of stock option exercises and vesting of restricted share

8



awards. Additionally, ASU 2016-09 addresses presentation of excess tax benefits and deficiencies and employee taxes paid related to shares withheld for tax withholdings purposes on the statement of cash flows, including a requirement to present excess tax benefits and deficiencies as an operating activity in the same manner as other cash flows related to income taxes on the statement of cash flows, which will be adopted on a prospective basis, and presentation of employee taxes paid related to shares withheld for tax withholdings purposes as a financing activity, which is consistent with our current presentation and thus did not impact our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which is intended to improve financial reporting about leasing transactions. The new guidance will require lessees to recognize on their balance sheets the assets and liabilities for the rights and obligations created by leases and to disclose key information about the leasing arrangements. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, with early adoption permitted. ASU 2016-02 is effective for us in the first quarter of fiscal 2020. We are currently in the process of evaluating the potential impact of adoption of this updated authoritative guidance on our consolidated financial statements.
In May 2014, the FASB, along with the International Accounting Standards Board, issued ASU 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition.  ASU 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using International Financial Reporting Standards and GAAP.  The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard also requires additional disclosure about revenue and provides improved guidance for multiple element arrangements. In July 2015 decision, the FASB issued ASU 2015-14, Deferral of Effective Date ("ASU 2015-14") to delay the effective date by one year. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606) –Principal versus Agent Consideration ("ASU 2016-08"). In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing ("ASU 2016-10”). In May 2016, the FASB issued ASU 2016-11, Revenue from Contracts with Customers (Topic 606) and Derivatives and Hedging (Topic 815) – Rescission of SEC Guidance Because of ASU 2014-09 and 2014-16 ("ASU 2016-11") and ASU 2016-12, Revenue from Contracts with Customers (Topic 606) –Narrow Scope Improvements and Practical Expedients ("ASU 2016-12"). The new ASUs do not change the core principle of the guidance in Topic 606 (as amended by ASU 2014-09), but rather help to provide further interpretive clarifications on the new guidance in ASU 2014-09. ASU 2014-09, as amended by ASU 2015-14, is effective for us in the first quarter of fiscal 2019. Companies are permitted to adopt this new guidance following either a full retrospective or modified retrospective approach. 
We have completed our assessment of the potential impacts to our business processes, systems, and internal controls that could result from the implementation of the new revenue guidance. Based on our assessment, we currently believe that the impact on our consolidated financial statements could be material. We expect that revenue related to hardware, EDI, maintenance, and certain subscriptions would remain substantially unchanged, and we are the process of evaluating the impact of the new revenue guidance on our other revenue streams. Due to the complexity of our revenue recognition, a significant amount of work remains as we continue to evaluate all potential impacts of the new revenue guidance, and develop and implement the necessary changes to our current accounting systems, processes, and internal controls. Accordingly, our preliminary assessments are subject to change. We expect that the new revenue guidance will result in additional complexity to our revenue recognition, including the use of an increased amount of significant judgments and estimates, particularly as it relates to our RCM services revenue, as compared to our current revenue recognition.
Additionally, certain incremental costs incurred to obtain contracts with customers, such as sales commissions, are within the scope of the new revenue guidance and are required to be capitalized and amortized to expense over the remaining performance periods of the contracts. Currently, our sales commission are capitalized and amortized to expense over the related period of revenue recognition. Although the amortization period of capitalized sales commissions may differ upon adoption of the new revenue guidance, we do not expect the adoption of this new revenue standard to have a material impact on our consolidated financial statements with respect to the capitalization and amortization of sales commissions.
We currently expect to implement the new revenue guidance when it becomes effective for us in the first quarter of fiscal 2019 utilizing the modified retrospective transition method. Under this transition method, prior period amounts will not be adjusted and the cumulative effect from prior periods of applying the new revenue guidance will be recognized in our consolidated balance sheets as of the date of adoption, including an adjustment to retained earnings.
We do not believe that any other recently issued, but not yet effective accounting standards, if adopted, would have a material impact on our consolidated financial statements.


9



2. Fair Value Measurements

The following tables set forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis at September 30, 2017 and March 31, 2017:
 
Balance at
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Unobservable Inputs (Level 3)
 
September 30,
2017
 
 
 
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents (1)
$
26,553

 
$
26,553

 
$

 
$

Restricted cash and cash equivalents
6,488

 
6,488

 

 

 
$
33,041

 
$
33,041

 
$

 
$

 
Balance at
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Unobservable Inputs (Level 3)
 
March 31,
2017
 
 
 
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents (1)
$
37,673

 
$
37,673

 
$

 
$

Restricted cash and cash equivalents
4,916

 
4,916

 

 

 
$
42,589

 
$
42,589

 
$

 
$

LIABILITIES
 
 
 
 
 
 
 
Contingent consideration related to acquisitions (2)
$
18,817

 
$

 
$
18,817

 
$

 
$
18,817

 
$

 
$
18,817

 
$

___________________________________
(1) Cash equivalents consist primarily of money market funds.
(2) The contingent consideration liability as of March 31, 2017 relates to the acquisition of HealthFusion, which was settled during the quarter ended June 30, 2017. The measurement period of the contingent consideration liability ended on December 31, 2016, and thus the actual revenue achievement rate was utilized to compute the ending contingent consideration liability as of March 31, 2017. Accordingly, the contingent consideration liability was reflected under a Level 2 valuation hierarchy because the fair value was determined based on other significant observable inputs.
We believe that the fair value of other financial assets and liabilities, including accounts receivable, accounts payable, and line of credit, approximate their respective carrying values due to their nominal credit risk.

Non-Recurring Fair Value Measurements
We have certain assets, including goodwill and other intangible assets, which are measured at fair value on a non-recurring basis and are adjusted to fair value only if an impairment charge is recognized. The categorization of the framework used to measure fair value of the assets is considered to be within the Level 3 valuation hierarchy due to the subjective nature of the unobservable inputs used. During the three and six months ended September 30, 2017, no adjustments were recorded.

3. Business Combinations
Entrada Acquisition
On April 14, 2017, we completed our acquisition of Entrada, Inc. ("Entrada") pursuant to the terms of the Agreement and Plan of Merger, dated April 11, 2017 (the "Agreement"). Based in Nashville, TN, Entrada is a leading provider of cloud-based solutions that are reshaping the way care is delivered by leveraging the power of mobile whenever and wherever care happens. Entrada’s best-in-class mobile application integrates with multiple clinical platforms and all major electronic health record systems. Entrada enables organizations to maximize their existing technology investments while simultaneously enhancing physician and staff productivity. The acquisition of Entrada and its cloud-based, mobile application is part of our commitment to deliver systematic solutions that meet its clients' transforming work requirements to become increasingly nimble and mobile. 
The preliminary purchase price totaled $33,958, which included preliminary working capital and other customary adjustments. The acquisition was primarily funded by a draw against our revolving credit agreement (see Note 7).
We accounted for the Entrada acquisition as a purchase business combination using the acquisition method of accounting. The preliminary purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based on their preliminary estimated fair values as of the acquisition date. The preliminary fair values of acquired assets and liabilities assumed represent management’s estimate of fair value and are subject to change if additional information, such as changes to deferred

10



taxes and/or working capital, becomes available. We expect to finalize the purchase price allocation as soon as practicable within the measurement period, but not later than one year following the acquisition date.

The preliminary estimated fair value of the acquired tangible and intangible assets and liabilities assumed were determined using multiple valuation approaches depending on the type of tangible or intangible asset acquired, including but not limited to the income approach, the excess earnings method and the relief from royalty method approach.
In connection with the Entrada acquisition, we recorded $15,400 of intangible assets related to customer relationships, trade names and software technology. We are amortizing the Entrada customer relationships over 10 years and trade names and software technology over 5 years. The weighted average amortization period for the total amount of intangible assets acquired is 6.1 years.

The preliminary amount of goodwill represents the excess of the preliminary purchase price over the preliminary net identifiable assets acquired and liabilities assumed. Goodwill primarily represents, among other factors, the value of synergies expected to be realized and the assemblage of all assets that enable us to create new client relationships, neither of which qualify as separate amortizable intangible assets. Goodwill arising from the acquisition of Entrada is not deductible for tax purposes and is allocated to our single reportable segment. 
The total preliminary purchase price for the Entrada acquisition is summarized as follows:
Initial purchase price
$
34,000

Preliminary working capital and other adjustments
(42
)
Total preliminary purchase price
$
33,958

 
April 14, 2017
Preliminary fair value of the net tangible assets acquired and liabilities assumed:
 
Acquired cash and cash equivalents
$
102

Accounts receivable, net
1,835

Prepaid expense and other current assets
145

Equipment and improvements, net
134

Capitalized software costs, net
364

Deferred income taxes, net
1,041

Accounts payable
(639
)
Accrued compensation and related benefits
(120
)
Deferred revenues
(234
)
Other liabilities
(444
)
Total preliminary net tangible assets acquired and liabilities assumed
2,184

Preliminary fair value of identifiable intangible assets acquired:
 
Goodwill
16,374

Software technology
10,500

Customer relationships
3,300

Trade name
1,600

Total preliminary identifiable intangible assets acquired
31,774

Total preliminary purchase price
$
33,958

The pro forma effects of the Entrada acquisition would not have been material to the Company's results of operations and are therefore not presented.
EagleDream Health Acquisition
On August 16, 2017, we completed the acquisition of EagleDream Health, Inc. ("EagleDream") pursuant to the Agreement and Plan of Merger (the “Merger Agreement"), dated July 31, 2017. Headquartered in Rochester, NY, EagleDream is a cloud-based analytics company that drives meaningful insight across clinical, financial and administrative data to optimize practice performance.
The preliminary purchase price totaled $25,609, which included preliminary working capital and other customary adjustments. The acquisition was partially funded by a draw against our revolving credit agreement (see Note 7).
We accounted for the EagleDream acquisition as a purchase business combination using the acquisition method of accounting. The preliminary purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based on their

11



preliminary estimated fair values as of the acquisition date. The preliminary fair values of acquired assets and liabilities assumed represent management’s estimate of fair value and are subject to change if additional information, such as changes to deferred taxes and/or working capital, becomes available. We expect to finalize the purchase price allocation as soon as practicable within the measurement period, but not later than one year following the acquisition date.

The preliminary estimated fair value of the acquired tangible and intangible assets and liabilities assumed were determined using multiple valuation approaches depending on the type of tangible or intangible asset acquired, including but not limited to the income approach, the excess earnings method and the relief from royalty method approach.
In connection with the EagleDream acquisition, we recorded $13,400 of intangible assets related to customer relationships and software technology. We are amortizing the EagleDream customer relationships over 8 years and software technology over 5 years. The weighted average amortization period for the total amount of intangible assets acquired is 5.1 years.

The preliminary amount of goodwill represents the excess of the preliminary purchase price over the preliminary net identifiable assets acquired and liabilities assumed. Goodwill primarily represents, among other factors, the value of synergies expected to be realized and the assemblage of all assets that enable us to create new client relationships, neither of which qualify as separate amortizable intangible assets. Goodwill arising from the acquisition of EagleDream is not deductible for tax purposes and is allocated to our single reportable segment. 
The total preliminary purchase price for the EagleDream acquisition is summarized as follows:
Initial purchase price
$
26,000

Preliminary working capital and other adjustments
(391
)
Total preliminary purchase price
$
25,609

 
August 16, 2017

Preliminary fair value of the net tangible assets acquired and liabilities assumed:
 
Acquired cash and cash equivalents
$
573

Accounts receivable
217

Prepaid expense and other current assets
20

Accounts payable
(115
)
Accrued compensation and related benefits
(271
)
Deferred revenues
(394
)
Deferred income taxes, net
(1,957
)
Other liabilities
(122
)
Total preliminary net tangible assets acquired and liabilities assumed
(2,049
)
Preliminary fair value of identifiable intangible assets acquired:
 
Goodwill
14,258

Software technology
12,800

Customer relationships
600

Total preliminary identifiable intangible assets acquired
27,658

Total preliminary purchase price
$
25,609

The pro forma effects of the EagleDream acquisition would not have been material to the Company's results of operations and are therefore not presented.

4. Goodwill
We test goodwill for impairment annually during our first fiscal quarter, referred to as the annual test date.  We will also test for impairment between annual test dates if an event occurs or circumstances change that would indicate the carrying amount may be impaired. We have not identified any events or circumstances as of September 30, 2017 that would require an interim goodwill impairment test.
We do not amortize goodwill as it has been determined to have an indefinite useful life. The carrying amount of goodwill as of September 30, 2017 was $216,530, which reflects the acquisitions of Entrada and EagleDream (see Note 3). The carrying amount of goodwill as of March 31, 2017 was $185,898.


12



5. Intangible Assets
Our definite-lived intangible assets, other than capitalized software development costs, are summarized as follows, and reflects the acquisitions of Entrada and EagleDream (see Note 3):
 
September 30, 2017
 
Customer Relationships
 
Trade Name and Contracts
 
Software Technology
 
Total
Gross carrying amount
$
54,450

 
$
7,080

 
$
91,110

 
$
152,640

Accumulated amortization
(32,349
)
 
(2,770
)
 
(30,775
)
 
(65,894
)
Net intangible assets
$
22,101

 
$
4,310

 
$
60,335

 
$
86,746

 
March 31, 2017
 
Customer Relationships
 
Trade Name and Contracts
 
Software Technology
 
Total
Gross carrying amount
$
50,550

 
$
5,480

 
$
67,810

 
$
123,840

Accumulated amortization
(28,972
)
 
(2,088
)
 
(23,567
)
 
(54,627
)
Net intangible assets
$
21,578

 
$
3,392

 
$
44,243

 
$
69,213

Amortization expense related to customer relationships and trade name and contracts recorded as operating expenses in the consolidated statements of comprehensive income was $2,012 and $2,617 for the three months ended September 30, 2017 and 2016, respectively. Amortization expense related to software technology recorded as cost of revenue was $3,807 and $3,030 for the three months ended September 30, 2017 and 2016, respectively.
Amortization expense related to customer relationships and trade name and contracts was $4,059 and $5,321 for the six months ended September 30, 2017 and 2016, respectively. Amortization expense related to software technology was $7,208 and $6,057 for the six months ended September 30, 2017 and 2016, respectively.
The following table summarizes the remaining estimated amortization of definite-lived intangible assets as of September 30, 2017:
 
Amortization Expense Recorded As:
 
Operating Expense
 
Cost of Revenue
 
Total
For the year ended March 31,
 
 
 
 
 
2018 (remaining six months)
3,874

 
8,256

 
12,130

2019
5,577

 
16,511

 
22,088

2020
4,580

 
16,511

 
21,091

2021
3,731

 
12,628

 
16,359

2022
2,593

 
4,840

 
7,433

2023 and beyond
6,056

 
1,589

 
7,645

Total
$
26,411

 
$
60,335

 
$
86,746


6. Capitalized Software Costs
Our capitalized software costs are summarized as follows:
 
September 30,
2017
 
March 31,
2017
Gross carrying amount
$
111,180

 
$
104,948

Accumulated amortization
(90,156
)
 
(91,341
)
Net capitalized software costs
$
21,024

 
$
13,607

Amortization expense related to capitalized software costs was $1,300 and $2,448 for the three months ended September 30, 2017 and 2016, respectively, and is recorded as cost of revenue in the consolidated statements of comprehensive income.
Amortization expense related to capitalized software costs was $2,571 and $4,819 for the six months ended September 30, 2017 and 2016, respectively.

13



The following table presents the remaining estimated amortization of capitalized software costs as of September 30, 2017. The estimated amortization is comprised of (i) amortization of released products and (ii) the expected amortization for products that are not yet available for sale based on their estimated economic lives and projected general release dates.
For the year ended March 31,
 
2018 (remaining six months)
$
4,700

2019
9,100

2020
4,700

2021
2,524

Total
$
21,024


7. Line of Credit
On January 4, 2016, we entered into a $250,000 revolving credit agreement (“Credit Agreement”) with JP Morgan Chase Bank, N.A., as administrative agent, U.S. Bank National Association, as syndication agent, and certain other lenders. The Credit Agreement is secured by substantially all of our existing and future property and material domestic subsidiaries. The Credit Agreement provides a subfacility of up to $10,000 for letters of credit and a subfacility of up to $10,000 for swing-line loans. The Credit Agreement matures on January 4, 2021 and the full balance of the revolving loans and all other obligations under the agreement must be paid at that time. The revolving loans under the Credit Agreement will be available for letters of credit, working capital and general corporate purposes. We were in compliance with all covenants under the Credit Agreement as of September 30, 2017.
As of September 30, 2017, we had $55,000 in outstanding loans and $195,000 of unused credit under the Credit Agreement. As of March 31, 2017, we had $15,000 in outstanding loans under the Credit Agreement.
Interest expense related to the Credit Agreement was $520 and $740 for the three months ended September 30, 2017 and 2016, respectively. Amortization of deferred debt issuance costs was $269 for both the three months ended September 30, 2017 and 2016.
Interest expense related to the Credit Agreement was $927 and $1,272 for the six months ended September 30, 2017 and 2016, respectively. Amortization of deferred debt issuance costs was $538 for both the six months ended September 30, 2017 and 2016, respectively.

8. Composition of Certain Financial Statement Captions

Accounts receivable may include amounts invoiced for undelivered products and services at each period end. Undelivered products and services are included as a component of the deferred revenue balance on the accompanying consolidated balance sheets.
 
September 30,
2017
 
March 31,
2017
Accounts receivable, gross
$
90,753

 
$
93,377

Sales return reserve
(6,413
)
 
(7,213
)
Allowance for doubtful accounts
(2,628
)
 
(2,757
)
Accounts receivable, net
$
81,712

 
$
83,407


Inventory is comprised of computer systems and components.

Prepaid expenses and other current assets are summarized as follows:
 
September 30,
2017
 
March 31,
2017
Prepaid expenses
$
13,651

 
$
14,884

Other current assets
1,718

 
3,085

Prepaid expenses and other current assets
$
15,369

 
$
17,969



14



Equipment and improvements are summarized as follows:
 
September 30,
2017
 
March 31,
2017
Computer equipment
$
26,120

 
$
22,014

Internal-use software
13,290

 
13,053

Furniture and fixtures
12,025

 
10,472

Leasehold improvements
17,258

 
16,360

Equipment and improvements, gross
68,693

 
61,899

Accumulated depreciation and amortization
(41,012
)
 
(34,473
)
Equipment and improvements, net
$
27,681

 
$
27,426


The current portion of deferred revenues are summarized as follows:
 
September 30,
2017
 
March 31,
2017
Professional services
$
22,084

 
$
21,889

Software license, hardware and other
11,579

 
12,680

Support and maintenance
10,203

 
9,691

Software related subscription services
8,419

 
8,123

Deferred revenue
$
52,285

 
$
52,383


Accrued compensation and related benefits are summarized as follows:
 
September 30,
2017
 
March 31,
2017
Payroll, bonus and commission
$
8,869

 
$
15,836

Vacation
8,733

 
8,677

Accrued compensation and related benefits
$
17,602

 
$
24,513



15



Other current and noncurrent liabilities are summarized as follows:
 
September 30,
2017
 
March 31,
2017
Care services liabilities
$
6,488

 
$
4,957

Customer credit balances and deposits
3,964

 
4,124

Accrued consulting and outside services
3,006

 
2,496

Accrued self insurance expense
2,502

 
1,697

Accrued EDI expense
2,469

 
2,490

Deferred rent and lease obligations
2,275

 
2,427

Accrued outsourcing costs
1,678

 
1,588

Accrued legal expense
1,245

 
853

User group meeting deposits
1,157

 

Accrued hosting costs
951

 
401

Accrued royalties
721

 
2,033

Employee benefit plan withholdings
671

 
739

Sales tax payable
494

 
448

Contingent consideration and other liabilities related to acquisitions

 
18,817

Other accrued expenses
4,292

 
3,705

Other current liabilities
$
31,913

 
$
46,775

 
 
 
 
Deferred rent and lease obligations
$
11,660

 
$
11,402

Uncertain tax positions
5,305

 
4,762

Other liabilities
350

 
297

Other noncurrent liabilities
$
17,315

 
$
16,461


9. Income Taxes
The provision for income taxes for the three months ended September 30, 2017 and 2016 was $2,493 and $1,925, respectively. The effective tax rates were 23.7% and 32.6% for the three months ended September 30, 2017 and 2016, respectively. The effective rate for the three months ended September 30, 2017 decreased compared to the prior year period primarily due to a favorable decline in the amount of certain non-deductible acquisition related costs and the current period reduction in state taxes.
The provision for income taxes for the six months ended September 30, 2017 and 2016 was $4,647 and $1,608, respectively. The effective tax rates were 28.0% and 32.5% for the six months ended September 30, 2017 and 2016, respectively. The effective rate for the six months ended September 30, 2017 decreased compared to the prior year period primarily due to a favorable decline in the amount of certain non-deductible acquisition related costs, the current period reduction in state taxes, and the impact of excess tax deficiencies from share-based compensation recorded in the period.
Additionally, we adopted ASU 2016-09 (see Note 1), which requires excess tax expense and benefits to be recorded in the income statement (income tax expense and/or benefit). Prior to adoption of ASU 2016-09, such amounts were recorded to additional paid-in capital and did not impact the effective tax rate.
The deferred tax assets and liabilities have been shown net in the accompanying consolidated balance sheets as noncurrent. We expect to receive the full benefit of the deferred tax assets recorded with the exception of certain state credits, state net operating loss carryforwards, and foreign accumulated minimum tax credits, for which we have recorded a valuation allowance.
Uncertain tax positions
We had liabilities of $5,305 and $4,762 for unrecognized tax benefits related to various federal, state and local income tax matters as of September 30, 2017 and March 31, 2017, respectively. If recognized, this amount would reduce our effective tax rate.
We are no longer subject to U.S. federal income tax examinations for tax years before fiscal years ended 2014. With a few exceptions, we are no longer subject to state or local income tax examinations for tax years before fiscal years ended 2013. We do 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.


16



10. Earnings per Share

The dual presentation of “basic” and “diluted” earnings per share is provided below. Share amounts below are in thousands.
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Earnings per share — Basic:
 
 
 
 
 
 
 
Net income
$
8,030

 
$
3,987

 
$
11,926

 
$
3,340

Weighted-average shares outstanding — Basic
63,513

 
61,658

 
63,077

 
61,420

Net income per common share — Basic
$
0.13

 
$
0.06

 
$
0.19

 
$
0.05

 
 
 
 
 
 
 
 
Earnings per share — Diluted:
 
 
 
 
 
 
 
Net income
$
8,030

 
$
3,987

 
$
11,926

 
$
3,340

Weighted-average shares outstanding
63,513

 
61,658

 
63,077

 
61,420

Effect of potentially dilutive securities
17

 
394

 
12

 
284

Weighted-average shares outstanding — Diluted
63,530

 
62,052

 
63,089

 
61,704

Net income per common share — Diluted
$
0.13

 
$
0.06

 
$
0.19

 
$
0.05


The computation of diluted net income per share does not include 2,567 and 2,565 options to acquire shares of common stock for the three and six months ended September 30, 2017, 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 3,230 and 2,997 options to acquire shares of common stock for the three and six months ended September 30, 2016, respectively, because their inclusion would have an anti-dilutive effect on net income per share.

11. Share-Based Awards
Employee Stock Option and Incentive Plans
In October 2005, our shareholders approved a stock option and incentive plan (the “2005 Plan”) under which 4,800,000 shares of common stock were reserved for the issuance of awards, including 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 our employees and directors may, at the discretion of the Board of Directors ("Board") or a duly designated compensation committee, be granted certain share-based awards. In the case of option awards granted under the 2005 Plan, the exercise price of each option is determined based on the date of grant and expire no later than 10 years from the date of grant. Awards granted pursuant to the 2005 Plan are subject to the vesting schedule or performance metrics set forth in the agreements pursuant to which they are granted. Upon a change of control of our Company, as such term is defined in the 2005 Plan, awards under the 2005 Plan will fully vest under certain circumstances. The 2005 Plan expired on May 25, 2015. As of September 30, 2017, there were 702,860 outstanding options under the 2005 Plan.
In August 2015, our shareholders approved a stock option and incentive plan (the “2015 Plan”) under which 11,500,000 shares of common stock were reserved for the issuance of awards, including incentive stock options and non-qualified stock options, stock appreciation rights, restricted stock awards and restricted stock unit awards, performance stock awards and other share-based awards. In August 2017, our shareholders approved an amendment to our 2015 Equity Incentive Plan, (the “Amended 2015 Plan”), to, among other items, increase the number of shares of common stock reserved for issuance thereunder by 6,000,000. The Amended 2015 Plan provides that our employees and directors may, at the discretion of the Board of Directors or a duly designated compensation committee, be granted certain share-based awards. In the case of option awards granted under the Amended 2015 Plan, the exercise price of each option is determined based on the date of grant and expire no later than 10 years from the date of grant. Awards granted pursuant to the Amended 2015 Plan are subject to the vesting schedule or performance metrics set forth in the agreements pursuant to which they are granted. Upon a change of control of our Company, as such term is defined in the Amended 2015 Plan, awards under the Amended 2015 Plan will fully vest under certain circumstances. As of September 30, 2017, there were 1,989,375 outstanding options, 1,619,002 outstanding shares of restricted stock awards, 114,916 outstanding shares of performance stock awards, and 11,352,428 shares available for future grant under the Amended 2015 Plan.

17



The following table summarizes the stock option transactions during the six months ended September 30, 2017:
 
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
per Share
 
Weighted-
Average
Remaining
Contractual
Life (years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding, April 1, 2017
 
2,885,415

 
$
15.41

 
6.2
 
$
3,150

Granted
 
334,000

 
16.03

 
7.7
 
 
Exercised
 
(216,405
)
 
16.62

 
6.2
 
$
119

Forfeited/Canceled
 
(310,775
)
 
17.75

 
5.1
 


Outstanding, September 30, 2017
 
2,692,235

 
$
16.44

 
6.0
 
$
4,012

Vested and expected to vest, September 30, 2017
 
2,440,400

 
$
16.64

 
5.9
 
$
2,885

Exercisable, September 30, 2017
 
921,280

 
$
20.10

 
4.6
 
$
768


We utilize the Black-Scholes valuation model for estimating the fair value of share-based compensation with the following assumptions:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
Expected term
5.6 years
 
6.6 years
 
5.6 - 5.7 years
 
6.0 - 6.6 years
Expected volatility
37.2%
 
36.9%
 
37.2% - 37.7%
 
36.9% - 37.4%
Expected dividends
—%
 
—%
 
—%
 
—%
Risk-free rate
1.9%
 
1.2%
 
1.9%
 
1.2% - 1.5%
The weighted-average grant date fair value of stock options granted during the six months ended September 30, 2017 and 2016 was $6.11 and $4.92 per share, respectively.
During the six months ended September 30, 2017, a total of 334,000 options to purchase shares of common stock were granted under the Amended 2015 Plan at an exercise price equal to the market price of our common stock on the date of grant, as summarized below:
Option Grant Date
 
Number of Shares
 
Exercise Price
 
Vesting Terms (1)
 
Expiration

 

 

 

 

June 13, 2017
 
249,000

 
$
16.37

 
Four years
 
June 13, 2025
May 24, 2017
 
60,000

 
$
14.57

 
Four years
 
May 24, 2025
August 4, 2017
 
25,000

 
$
16.13

 
Four years
 
August 4, 2025
__________________________________
(1) Options vest in equal annual installments on each grant anniversary date commencing one year following the date of grant.
Non-vested stock option award activity during the six months ended September 30, 2017 is summarized as follows:
 
 
Non-Vested
Number of
Shares
 
Weighted-
Average
Grant-Date
Fair Value
per Share
Outstanding, April 1, 2017
 
2,073,295

 
$
5.09

Granted
 
334,000

 
6.11

Vested
 
(430,190
)
 
4.86

Forfeited/Canceled
 
(206,150
)
 
4.57

Outstanding, September 30, 2017
 
1,770,955

 
$
4.98


18



As of September 30, 2017, $7,590 of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted-average period of 3.1 years. This amount does not include the cost of new options that may be granted in future periods or any changes in our forfeiture percentage. The total fair value of options vested during the six months ended September 30, 2017 and 2016 was $2,092 and $1,486, respectively.
Restricted stock awards activity during the six months ended September 30, 2017 is summarized as follows:
 
 
Number of
Shares
 
Weighted-
Average
Grant-Date
Fair Value
per Share
Outstanding, April 1, 2017
 
902,948

 
$
12.92

Granted
 
1,081,374

 
15.57

Vested
 
(288,304
)
 
12.57

Canceled
 
(77,016
)
 
13.81

Outstanding, September 30, 2017
 
1,619,002

 
$
14.79

Share-based compensation expense related to restricted stock awards was $2,207 and $972 for the three months ended September 30, 2017 and 2016, respectively. Share-based compensation expense related to restricted stock awards was $3,746 and $1,517 for the six months ended September 30, 2017 and 2016, respectively.
The weighted-average grant date fair value for the restricted stock awards was estimated using the market price of the common stock on the date of grant. The fair value of the restricted stock awards is amortized on a straight-line basis over the vesting period, which is generally between one to three years.
As of September 30, 2017, $20,842 of total unrecognized compensation costs related to restricted stock awards is expected to be recognized over a weighted-average period of 2.4 years. This amount does not include the cost of new restricted stock awards that may be granted in future periods.
On December 29, 2016, the Compensation Committee of the Board granted 123,082 performance stock awards to certain executive officers, of which 114,916 shares are currently outstanding. The performance stock awards vest in four equal increments on each of the first four anniversaries of the grant date, subject in each case to the executive officer’s continued service and achievement of certain Company performance goals, including strong Company stock price performance. Share-based compensation expense related to the performance stock awards was $77 and $150 for the three and six months ended September 30, 2017, respectively.
Employee Share Purchase Plan
On August 11, 2014, our shareholders approved an Employee Share Purchase Plan (the “Purchase Plan”) under which 4,000,000 shares of common stock were reserved for future grant.  The Purchase Plan allows eligible employees to purchase shares through payroll deductions of up to 15% of total base salary at a price equal to 90% of the lower of the fair market values of the shares as of the beginning or the end of the corresponding offering period.  Any shares purchased under the Purchase Plan are subject to a six-month holding period.  Employees are limited to purchasing no more than 1,500 shares on any single purchase date and no more than $25,000 in total fair market value of shares during any one calendar year. As of September 30, 2017, we have issued 290,649 shares under the Purchase Plan and 3,709,351 shares are available for future issuance.
Share-based compensation expense recorded for the employee share purchase plan was $80 and $81 for the three months ended September 30, 2017 and 2016, respectively. Share-based compensation expense recorded for the employee share purchase plan was $177 and $207 for the six months ended September 30, 2017 and 2016, respectively.

12. Concentration of Credit Risk
We had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at September 30, 2017. We are exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the institutions; however, we do not anticipate non-performance by these institutions.

13. Commitments, Guarantees and Contingencies
Commitments and Guarantees
Our software license agreements include a performance guarantee that our software products will substantially operate as described in the applicable program documentation for a period of 365 days after delivery. To date, we have not incurred any significant costs associated with our performance guarantee or other related warranties and do not expect to incur significant

19



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, we have not incurred any significant costs associated with these warranties and do not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties.
We have historically offered short-term rights of return in certain sales arrangements. If we are 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 we are 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.
Our standard sales agreements contain an indemnification provision pursuant to which we 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 our software. As we have not incurred any significant costs to defend lawsuits or settle claims related to these indemnification agreements, we believe that our estimated exposure on these agreements is currently minimal. Accordingly, we have no liabilities recorded for these indemnification obligations.
Hussein Litigation
On October 7, 2013, a complaint was filed against our Company and certain of our officers and directors in the Superior Court of the State of California for the County of Orange, captioned Ahmed D. Hussein v. Sheldon Razin, Steven Plochocki, Quality Systems, Inc. and Does 1-10, inclusive, No. 30-2013-00679600-CU-NP-CJC, by Ahmed Hussein, a former director and significant shareholder of our Company.  We filed a demurrer to the complaint, which the Court granted on April 10, 2014. An amended complaint was filed on April 25, 2014. The amended complaint generally alleges fraud and deceit, constructive fraud, negligent misrepresentation and breach of fiduciary duty in connection with statements made to our shareholders regarding our financial condition and projected future performance. The amended complaint seeks actual damages, exemplary and punitive damages and costs. We filed a demurrer to the amended complaint. On July 29, 2014, the Court sustained the demurrer with respect to the breach of fiduciary duty claim, and overruled the demurrer with respect to the fraud and deceit claims. On August 28, 2014, we filed an answer and also filed a cross-complaint against Hussein, alleging that he breached fiduciary duties owed to the Company, Mr. Razin and Mr. Plochocki. Mr. Razin and Mr. Plochocki have dismissed their claims against Hussein, leaving QSI as the sole plaintiff in the cross-complaint. On June 26, 2015, we filed a motion for summary judgment with respect to Hussein’s claims, which the Court granted on September 16, 2015, dismissing all of Hussein’s claims against us. On September 23, 2015, Hussein filed an application for reconsideration of the Court's summary judgment order, which the Court denied. Hussein filed a renewed application for reconsideration of the Court’s summary judgment order on August 3, 2017. Argument on the renewed application for reconsideration is scheduled for October 26, 2017.
On October 28, 2015, May 9, 2016, and August 5, 2016, Hussein filed a motion for summary judgment, motion for summary adjudication, and motion for judgment on the pleadings, respectively, seeking to dismiss our cross-complaint. The Court denied each motion. Trial on our cross-complaint began June 12, 2017. On July 26, 2017, the Court issued a statement of decision granting Hussein’s motion for judgment on our cross-complaint. We believe the Court’s decision on our cross-complaint was erroneous and we are evaluating a potential appeal. At this time, we are unable to estimate the probability or the amount of liability, if any, related to this claim.
Federal Securities Class Action
On November 19, 2013, a putative class action complaint was filed on behalf of the shareholders of our Company other than the defendants against us and certain of our officers and directors in the United States District Court for the Central District of California by one of our shareholders. After the Court appointed lead plaintiffs and lead counsel for this action, and recaptioned the action In re Quality Systems, Inc. Securities Litigation, No. 8:13-cv-01818-CJC-JPR, lead plaintiffs filed an amended complaint on April 7, 2014. The amended complaint, which is substantially similar to the litigation described above under the caption “Hussein Litigation,” generally alleges that statements made to our shareholders regarding our financial condition and projected future performance were false and misleading in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and that the individual defendants are liable for such statements because they are controlling persons under Section 20(a) of the Exchange Act. The complaint seeks compensatory damages, court costs and attorneys' fees. We filed a motion to dismiss the amended complaint on June 20, 2014, which the Court granted on October 20, 2014, dismissing the complaint with prejudice. Plaintiffs filed a motion for reconsideration of the Court's order, which the Court denied on January 5, 2015. On January 30, 2015, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Ninth Circuit, captioned In re Quality Systems, Inc. Securities Litigation, No. 15-55173. Oral argument was held on December 5, 2016. On July 28, 2017, the Ninth Circuit issued a decision reversing and remanding the District Court's order on our motion to dismiss. On September 5, 2017, we filed a petition for rehearing en banc, which was denied on September 29, 2017. We believe that the plaintiffs' claims are without merit and continue to defend against them vigorously, including by evaluating potential challenges to the Ninth Circuit decision. At this time, we are unable to estimate the probability or the amount of liability, if any, related to this claim.

20



Shareholder Derivative Litigation
On January 24, 2014, a complaint was filed against our Company and certain of our officers and current and former directors in the United States District Court for the Central District of California, captioned Timothy J. Foss, derivatively on behalf of himself and all others similarly situated, vs. Craig A. Barbarosh, George H. Bristol, James C. Malone, Peter M. Neupert, Morris Panner, D. Russell Pflueger, Steven T. Plochocki, Sheldon Razin, Lance E. Rosenzweig and Quality Systems, Inc., No. SACV14-00110-DOC-JPPx, by Timothy J. Foss, a purported shareholder of ours. The complaint arises from the same allegations described above under the captions “Hussein Litigation” and “Federal Securities Class Action” and generally alleges breach of fiduciary duties, abuse of control and gross mismanagement by our directors, in addition to unjust enrichment and insider selling by individual directors. The complaint seeks compensatory damages, restitution and disgorgement of all profits, court costs, attorneys’ fees and implementation of enhanced corporate governance procedures. The parties have agreed to stay this litigation until the United States Court of Appeals for the Ninth Circuit issues a ruling on the pending appeal described above under the caption “Federal Securities Class Action,” and will meet and confer to discuss process going forward.
On September 28, 2017, a complaint was filed against our Company and certain of our current and former officers and directors in the United States District Court for the Central District of California, captioned Kusumam Koshy, derivatively on behalf of Quality Systems Inc. vs. Craig Barbarosh, George H. Bristol, James C. Malone, Peter M. Neupert, Morris Panner, D. Russell Pflueger, Steven T. Plochocki, Sheldon Razin, Lance E. Rosenzweig, Paul A. Holt, and Quality Systems, Inc., No. 8:17-cv-01694, by Kusumam Koshy, a purported shareholder of ours. The complaint alleges breach of fiduciary duties and abuse of control, as well as unjust enrichment and insider selling by individual directors arising out of the allegations described above under the captions “Hussein Litigation” and “Federal Securities Class Action,” QSI’s adoption of revised indemnification agreements, and the resignation of certain officers of the Company. The complaint seeks restitution and disgorgement, court costs and attorneys’ fees, and enhanced corporate governance reforms and internal control procedures.
We believe that the plaintiffs’ claims are without merit and intend to defend against them vigorously. At this time, we are unable to estimate the probability or the amount of liability, if any, related to this claim.
Other Regulatory Matters
In April 2017, we received a request for documents and information from the U.S. Attorney's Office for the District of Vermont pursuant to a Civil Investigative Demand (“CID”). The CID relates to an investigation concerning the certification we obtained for our software under the U.S. Department of Health and Human Services' Electronic Health Record Incentive Program. Given the highly-regulated nature of our industry, we may, from time to time, be subject to subpoenas, requests for information, or investigations from various government agencies. It is our practice to respond to such matters in a cooperative, thorough and timely manner. We are currently responding to this CID and intend to cooperate fully with the government. Requests and investigations of this nature may lead to the assertion of claims or the commencement of legal proceedings against us, as well as other material liabilities.  In addition, our responses to the CID require time and effort, which can result in additional cost to us. At this time, we are unable to estimate the probability or the amount of liability, if any, related to this claim.

14. Restructuring Plan
In fiscal year 2016, as part of our reorganization efforts, we recorded $7,078 of restructuring costs within operating expenses in our consolidated statements of net income and comprehensive income. The restructuring plan was substantially complete by the end of fiscal 2017. The restructuring costs consisted primarily of payroll-related costs, such as severance, outplacement costs, and continuing healthcare coverage, associated with the involuntary separation of employees pursuant to a one-time benefit arrangement, which were accrued when it was probable that the benefits would be paid and the amounts were reasonably estimable. Also included in restructuring costs were certain facilities-related costs associated with accruals for the remaining lease obligations at certain locations, including Solana Beach, Costa Mesa, and a portion of Horsham with contractual lease terms ending between January 2018 and September 2023. We have vacated each of the locations or portions thereof and are actively marketing the locations for sublease. We estimated the remaining lease obligations at fair value as of the cease-use date for each location based on the future contractual lease obligations, reduced by projected sublease rentals that could be reasonably obtained for the locations after a period of marketing, and adjusted for the effect deferred rents that have been recognized under the lease. The effect of discounting future cash flows using a credit-adjusted risk free rate was not significant. Sublease income and commencement dates were estimated based on data available from rental activity in the local markets. Significant judgment was required to estimate the remaining lease obligations at fair value and actual results could vary from the estimates, resulting in potential future adjustments to amounts previously recorded. As of September 30, 2017, the remaining lease obligation, net of estimated projected sublease rentals, was $1,579.

Item 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q ("Report") and certain information incorporated herein by reference contain forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Report, other than statements that are purely historical, are forward-looking statements. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,” “will,” “should,” “would,” “could,” “may,” and similar expressions also identify forward-looking statements. These forward-looking statements include, without limitation, discussions of our product development plans, business strategies, future operations, financial condition and prospects, developments in and the impacts of government regulation and legislation, including, without limitation, The American Recovery and Reinvestment Act, the Patient Protection and Affordable Care Act, and the Medicare Access and CHIP Reauthorization Act of 2015, and market factors influencing our results. Our expectations, beliefs, objectives, intentions and strategies regarding our future results are not guarantees of future performance and are subject to risks and uncertainties, both foreseen and unforeseen, that could cause actual results to differ materially from results contemplated in our forward-looking statements. These risks and uncertainties include, but are 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 affect our ability to achieve our goals, and interested persons are urged to review any risks that may be described in “Item 1A. Risk Factors” as set forth herein and other risk factors appearing in our most recent Annual Report on Form 10-K for the fiscal year ended March 31, 2017 (“Annual Report”), as supplemented by additional risk factors, if any, in our interim filings on our Quarterly Reports on Form 10-Q, as well as in our other public disclosures and filings with the Securities and Exchange Commission ("SEC"). Because of these risk factors, as well as other variables affecting our financial condition and results of operations, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. We assume no obligation to update any forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of the filing of this Report.
This management's discussion and analysis of financial condition and results of operations ("MD&A") is provided as a supplement to the consolidated financial statements and notes thereto included elsewhere in this Report in order to enhance your understanding of our results of operations and financial condition and should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and related notes thereto included elsewhere in this Report. Historical results of operations, percentage margin fluctuations and any trends that may be inferred from the discussion below are not necessarily indicative of the operating results for any future period.
Company Overview
Quality Systems, Inc., known to our clients as NextGen Healthcare, provides software, services and analytics solutions to the ambulatory care market. We are a healthcare information technology and services company that delivers the foundational capabilities to organizations that want to promote healthy communities. Our technology provides a customizable platform that empowers physician practice success, enriches the patient care experience and lowers the cost of healthcare.
We primarily derive revenue by developing and marketing software and services that automate certain aspects of practice management (“PM”) and electronic health records (“EHR”) for ambulatory care practices. In addition, our software and services facilitate interoperability. Our software can be licensed and delivered on-premise or in the cloud as software-as-a-service (“SaaS”). Our services include maintenance and support, professional services, and complementary services such as managed cloud services, revenue cycle management (“RCM”) and electronic data interchange (“EDI”). We market and sell our solutions through a dedicated sales force and to a much lesser extent, through resellers. Our clients span the entire ambulatory market from large multi-specialty to small single specialty practices and include networks of practices such as physician hospital organizations (“PHOs”), management service organizations (“MSOs”), accountable care organizations (“ACOs”), ambulatory care centers and community health centers.
Quality Systems, Inc. was incorporated in California in 1974. Our principal offices are located at 18111 Von Karman Ave., Suite 800, Irvine, California, 92612. Our websites are located at www.nextgen.com and www.qsii.com. We operate on a fiscal year ending on March 31.
Trends and Events in Our Business
We believe that the following trends and events as described below have contributed to our consolidated results of operations and may continue to impact our future results.
We believe healthcare is more heavily influenced by regulatory and national health projects than by the cycles of our economy. The healthcare industry has been significantly impacted by the Obama Administration's broad healthcare reform efforts, including the Health Information Technology for Economic and Clinical Health portion of the American Recovery and Reinvestment Act of 2009

21



("HITECH Act") and the Patient Protection and Affordable Care Act ("ACA") that provided significant incentives to health care organizations for "Meaningful Use" adoption and interoperable electronic health record solutions.
We also believe that healthcare reform, including the repeal of the sustainable growth rate (SGR) formula as part of the Medicare Access and CHIP Reauthorization Act of 2015 ("MACRA"), and a movement towards a value-based, pay-for-performance model and quality initiative efforts will stimulate demand for robust electronic health record solutions as well as new health information technology solutions from bundled billing capabilities to patient engagement and population health management. We believe MACRA may be the most important of the three regulations for our market because it permanently changes how ambulatory healthcare providers are reimbursed by Medicare. It offers certainty and a timeline for the market’s move away from volume-based, fee-for-service models to value-based payment models that reward the delivery of lower cost, high quality care.
While we expect to benefit from the increasing demands for greater efficiency as well as government support for increased adoption of electronic health records, the market for physician based electronic health records software is becoming increasingly saturated while physician group practices are rapidly being consolidated by hospitals, insurance payers and other entities. Hospital software providers are leveraging their position with their hospital clients to gain market share with hospital owned physician practices. Insurance providers and large physician groups are also consolidating physician offices creating additional opportunity for ambulatory software providers like us. Our strategy is to focus on addressing the growing needs of accountable care organizations around interoperability, patient engagements, population health, and data analytics.
We believe that our core strength lies in the central role our software products and services play in the delivery of healthcare by the primary physician in an ambulatory setting. We intend to remain at the forefront of upcoming new regulatory requirements and meaningful use requirements for stimulus payments. We intend to continue the development and enhancement of our software solutions to support healthcare reform, such as the recently enacted MACRA, which promotes the transition from fee-for-service to value-based, pay-for-performance and patient-centric and quality initiatives such as accountable care organizations. Key elements of our future software development will be to expand our interoperability capabilities enhancing the competitiveness of our software offerings, make our products more intuitive and easy to use, and to enhance the capability of our MediTouch® Platform to allow us to deliver our software over the cloud to larger ambulatory care practices.
We have a history of enhancing our solutions through both organic and inorganic activities. Over the last few years, we have entered into strategic transactions to complement and enhance our product portfolio in the ambulatory care market. In October 2015, we divested our former Hospital Solutions division. In January 2016, we acquired HealthFusion Holdings, Inc. ("HealthFusion"), in April 2017, we acquired Entrada, Inc. ("Entrada"), and in August 2017, we acquired EagleDream Health, Inc. ("EagleDream").
We have and intend to continue investments in our infrastructure, including but not limited to maintaining and expanding sales, marketing and product development activities to improve patient care and reduce healthcare costs, providing industry-leading, integrated clinical and administrative healthcare data systems, services, and expertise to clinical, medical, technology, and healthcare business professionals while continuing our strong commitment of service in support of our client satisfaction programs. These investments in our infrastructure will continue while maintaining reasonable expense discipline. We strive to add new clients and expand our relationship with existing clients through delivery of add-on and complementary products and services and believe that our client base that is using our software on a daily basis is a strategic asset. We intend to leverage this strategic asset by expanding our product and service offerings towards this client base.
Led by our vision and mission, we are resetting our strategy and structure to deliver value to our clients. To achieve a lower-cost, increased capability structure, our new management team is building what we believe is an aligned, client-focused organization, supported by a recurring revenue stream and a large and diverse existing client base.
Our Strategy
We strive to be the trusted partner for clients of all sizes, integrating services and software into a consolidated solution that enables an efficient and effective caregiver and patient experience while driving positive financial outcomes. As a healthcare information technology and services company, we plan to continue investing in our current capabilities as well as building and/or acquiring new capabilities as we guide our clients through an evolving healthcare marketplace that is transitioning from fee-for-service to fee-for-value reimbursement models. With approximately 90,000 providers using our solutions, we are enabling care and believe we can truly transform the delivery of care through the following strategic priorities:
Focus on the ambulatory client segment. In October 2015, we sold our former Hospital Solutions division to focus on our core ambulatory clients. Further, a recent operational reorganization better allows us to serve the needs of our ambulatory clients through a simpler, more nimble, and focused organization. We believe it is essential to protect, build and sell new capabilities within our ambulatory client segment. We are focused on our core by increasing quality and the serviceability of our solutions. We intend to continue to enhance the capabilities of our NextGen Ambulatory flagship product. At the same time, we intend to expand the capability of the highly scalable, pure cloud-based and mobile-enabled MediTouch® platform.

22



Platform as a service. With the introduction of our API 2.0 framework and our continued leverage of the Mirth interoperability platform, we will continue our evolution to plug and play extensibility and information sharing that allows our customers to innovate and deploy high-fidelity extensions to our core applications without the costs, risks (security, performance, etc.) or complexity commonly associated with direct binding. We have also introduced platform-enabled automation capabilities to empower our clients to drive cost out of their processes while supporting their needs to implement the highly personalized workflows that are required to support value based care. Our acquisition of Entrada and its cloud-based, mobile application in April 2017 demonstrates our commitment to innovation that becomes essential for practitioners by improving their clinical productivity with documentation support services that seamlessly integrate into their electronic health record. We believe there is significant opportunity to extend the solutions we offer existing and new clients through value-added services such as RCM and EDI.
Population health software and services. We are migrating into applications, analytics and services that will enable our clients to proactively manage the health of patient populations. We are establishing strong development partnerships with our most innovative customers who are actively participating in shared-risk contracts, and working together with them to create progressive population health capabilities. We support extraordinary information sharing capabilities vital to managing patient populations through our interoperability offerings.
Critical Accounting Policies and Estimates
The discussion and analysis of our consolidated financial statements 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 ("GAAP"). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, revenue and expenses, and related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends, and other factors we believe to be reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. On a regular basis, we review the accounting policies and update our assumptions, estimates, and judgments, as needed, to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. Actual results could differ materially from our estimates under different assumptions or conditions. To the extent that there are material differences between our estimates and actual results, our financial condition or results of operations will be affected.
We describe our significant accounting policies in Note 2, “Summary of Significant Accounting Policies,” of our notes to consolidated financial statements included in our Annual Report. We discuss our critical accounting policies and estimates in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report. There have been no material changes in our significant accounting policies or critical accounting policies and estimates since the fiscal year ended March 31, 2017.


23



Results of Operations
The following table sets forth the percentage of revenue represented by each item in our consolidated statements of comprehensive income for the three and six months ended September 30, 2017 and 2016 (certain percentages below may not sum due to rounding):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Software license and hardware
10.8
%
 
13.5
%
 
10.3
%
 
12.8
%
Software related subscription services
18.8

 
16.9

 
18.6

 
16.6

Total software, hardware and related
29.6

 
30.4

 
28.8

 
29.4

Support and maintenance
31.4

 
30.6

 
31.4

 
30.9

Revenue cycle management and related services
15.8

 
16.5

 
16.1

 
16.8

Electronic data interchange and data services
17.3

 
17.0

 
17.6

 
17.5

Professional services
5.8

 
5.5

 
6.1

 
5.3

Total revenues
100.0

 
100.0

 
100.0

 
100.0

Cost of revenue:
 
 
 
 
 
 
 
Software license and hardware
3.7

 
5.1

 
3.9

 
5.4

Software related subscription services
8.1

 
6.8

 
8.0

 
7.1

Total software, hardware and related
11.7

 
11.9

 
11.9

 
12.6

Support and maintenance
5.6

 
5.5

 
5.7

 
5.5

Revenue cycle management and related services
11.2

 
11.3

 
11.5

 
11.5

Electronic data interchange and data services
10.2

 
10.1

 
10.1

 
10.3

Professional services
5.5

 
5.3

 
5.5

 
5.5

Total cost of revenue
44.3

 
44.0

 
44.7

 
45.2

Gross profit
55.7

 
56.0

 
55.3

 
54.8

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
30.9

 
33.6

 
31.9

 
33.4

Research and development costs, net
14.7

 
14.4

 
15.0

 
14.6

Amortization of acquired intangible assets
1.5

 
2.1

 
1.5

 
2.1

Restructuring costs

 
0.6

 

 
1.8

Total operating expenses
47.1

 
50.6

 
48.4

 
52.0

Income from operations
8.5

 
5.3

 
6.9

 
2.8

Interest expense
(0.6
)
 
(0.6
)
 
(0.6
)
 
(0.7
)
Other income (expense), net

 

 

 
(0.1
)
Income before provision for income taxes
7.9

 
4.6

 
6.3

 
2.0

Provision for income taxes
1.9

 
1.5

 
1.8

 
0.6

Net income
6.1
%
 
3.1
%
 
4.5
%
 
1.3
%



24



Revenues
The following table presents our consolidated revenues for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Software license and hardware
$
14,267

 
$
17,182

 
$
27,067

 
$
31,971

Software related subscription services
24,988

 
21,490

 
48,894

 
41,365

Total software, hardware and related
39,255

 
38,672

 
75,961

 
73,336

 
 
 
 
 
 
 
 
Support and maintenance
41,693

 
38,974

 
82,809

 
76,981

Revenue cycle management and related services
21,002

 
20,936

 
42,405

 
41,989

Electronic data interchange and data services
22,998

 
21,613

 
46,310

 
43,737

Professional services
7,659

 
6,971

 
16,044

 
13,328

Total revenues
$
132,607

 
$
127,166

 
$
263,529

 
$
249,371

We generate revenue from sales of licensing rights and subscriptions to our software products, hardware and third party software products, support and maintenance services, revenue cycle management and related services ("RCM"), electronic data interchange and data services (“EDI”), and professional services, such as implementation, training, and consulting performed for clients who use our products.
Consolidated revenue for the three months ended September 30, 2017 increased $5.4 million compared to the prior year due to increases across each of our revenue streams, except software license and hardware. Software related subscription services increased $3.5 million, which was driven by sales associated with the acquisition of Entrada in April 2017 and higher sales of our MediTouch® cloud-based subscriptions and our interoperability and patient portal offerings as we continue to expand our client base. The $2.7 million increase in support and maintenance is primarily due to lower sales credits in the current year, addition of new customers, and annual increases to support and maintenance fees that are generally tied to changes in the Consumer Price Index (CPI). The $0.7 million increase in professional services is mostly associated with the acquisition of Entrada in April 2017, offset by lower sales of professional services due to lower client demand for our core software products and related implementation, training, and consulting services. EDI revenue increased $1.4 million, which was primarily related to higher EDI services sold with our MediTouch® cloud-based solutions, addition of new clients, and further penetration of our existing client base. The $2.9 million decline in software license and hardware reflects the increasingly saturated end-market for electronic health records software.
Consolidated revenue for the six months ended September 30, 2017 increased $14.2 million compared to the prior year due to increases across each of our revenue streams, except software license and hardware. Software related subscription services increased $7.5 million, which was driven by sales associated with the acquisition of Entrada in April 2017 and higher sales of our MediTouch® cloud-based subscriptions and our interoperability, patient portal, and QSIDental Web offerings as we continue to expand our client base. The $5.8 million increase in support and maintenance is primarily due to lower sales credits in the current year, addition of new customers, and annual increases to support and maintenance fees that are generally tied to changes in the Consumer Price Index (CPI). The $2.7 million increase in professional services is mostly associated with the acquisition of Entrada in April 2017, offset by lower sales of professional services due to lower client demand for our core software products and related implementation, training, and consulting services. EDI revenue increased $2.6 million, which was primarily related to higher EDI services sold with our MediTouch® cloud-based solutions, addition of new clients, and further penetration of our existing client base. RCM services revenue increased $0.4 million from the addition of new clients and organic growth achieved through cross selling and ramping up of RCM services provided to our existing clients, offset by customer attrition. The $4.9 million decline in software license and hardware reflects the increasingly saturated end-market for electronic health records software.
Recurring service revenue, consisting of software related subscription services, support and maintenance, RCM, and EDI, represented 83% and 81% of total revenue for the three months ended September 30, 2017 and 2016, respectively. For the six months ended September 30, 2017 and 2016, recurring service revenue, represented 84% and 82%, respectively, of total revenue.
Our goals include further enhancement of our existing products, including expansion of our software and service offerings that support pay-for-performance initiatives around accountable care organizations, bringing greater ease of use and intuitiveness to our software products, enhancing our managed cloud and hosting services to lower our clients' total cost of ownership, expanding our interoperability and enterprise analytics capabilities, and further development and enhancements of our portfolio of specialty focused templates within our electronic health records software.

25



We intend to remain at the forefront of upcoming new regulatory requirements, including meaningful use requirements for stimulus payments and recent healthcare reform that is driving the transition towards pay-for-performance, value-based reimbursement models. We believe that the expanded requirements for continued eligibility for incentive payments under meaningful use rules will result in an expanded replacement market for electronic health records software. We also intend to continue selling additional software and services to existing clients, expanding penetration of connectivity and other services to new and existing clients, and capitalizing on growth and cross selling opportunities. We continue to expand our client base and cloud-based solution capabilities in the ambulatory market to meet the needs of practices of increasing size and complexity, and focus our strategy on accountable care organizations around interoperability, patient engagements, population health and collaborative care management, and enterprise analytics. Our software and service offerings offer clients a full suite of cloud-based solutions that better enable our clients to focus on care delivery. We believe we are well-positioned within the evolving healthcare market to deliver products and services that address the growing importance of quality collaborative care and shift from fee-for-service to value-based, pay-for-performance care. We also believe that a significant opportunity exists to continue cross selling RCM services to our existing clients as the portion of existing clients who are using RCM services is approximately 10%. We are actively pursuing efforts to achieve faster growth from expanded efforts to leverage our existing sales force towards selling RCM services. We also believe that ongoing increases in the complexity of medical billing and collections processes, including the migration to value-based reimbursement models, will create additional opportunities.
While it remains difficult to assess the relative impact or the timing of positive and negative trends affecting the aforementioned market opportunities, we believe we are well positioned to remain a leader in serving the evolving market needs for healthcare information technology. We believe that our operating results are attributed to a strong brand name and reputation within the marketplace for healthcare information technology software and services and investments in sales and marketing activities, including new marketing campaigns, Internet advertising investments, tradeshow attendance and other expanded advertising and marketing expenditures.
Gross Profit
The following table presents our consolidated cost of revenue and gross profit for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Total cost of revenue
$
58,755

 
$
55,997

 
$
117,924

 
$
112,812

Gross profit
73,852

 
71,169

 
145,605

 
136,559

Gross margin %
55.7
%
 
56.0
%
 
55.3
%
 
54.8
%
Cost of revenue consists primarily of compensation expense, including share-based compensation, for personnel that deliver our products and services. Cost of revenue also includes amortization of capitalized software costs and acquired technology, third party consultant and outsourcing costs, costs associated with our EDI business partners and clearinghouses, hosting service costs, third party software costs and royalties, and other costs directly associated with delivering our products and services. Refer to Note 5, "Intangible Assets" and Note 6, "Capitalized Software Costs" of our notes to consolidated financial statements included elsewhere in this Report for additional information on current period amortization of capitalized software costs and acquired technology and an estimate of future expected amortization.
Share-based compensation expense included in cost of revenue was $0.3 million and $0.2 million for the three months ended September 30, 2017 and 2016, and is included in the amounts in the table above. Share-based compensation expense included in cost of revenue was $0.4 million and $0.3 million for the six months ended September 30, 2017 and 2016, and is included in the amounts in the table above.
Gross profit for the three months ended September 30, 2017 increased $2.7 million compared to the prior year period due primarily to $5.4 million higher revenues as discussed above, offset by a $2.8 million increase in cost of revenue. Gross profit for the six months ended September 30, 2017 increased $9.0 million compared to the prior year period due primarily to $14.2 million higher revenues as discussed above, offset by a $5.1 million increase in cost of revenue. The increase in cost of revenue for both the three and six months ended September 30, 2017 compared to the prior year period is the result of higher costs associated with the acquisition of Entrada in April 2017, higher amortization of the software technology intangible asset acquired from Entrada, and higher personnel costs associated with delivering support and maintenance and RCM services, partially offset by lower amortization of previously capitalized software development cost. The gross margin percentage remained consistent for both the three and six months ended September 30, 2017 compared to the prior year period.

26



Selling, General and Administrative Expense
The following table presents our consolidated selling, general and administrative expense for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Selling, general and administrative
$
40,977

 
$
42,790

 
$
83,954

 
$
83,371

Selling, general and administrative, as a percentage of revenue
30.9
%
 
33.6
%
 
31.9
%
 
33.4
%
Selling, general and administrative expense consist of compensation expense, including share-based compensation, for management and administrative personnel, selling and marketing expense, facilities costs, depreciation, professional service fees, including legal, consulting, and accounting services, acquisition and transaction-related costs, and other general corporate and administrative expenses.
Share-based compensation expense included in selling, general and administrative expenses was $2.3 million and $1.4 million for the three months ended September 30, 2017 and 2016, respectively, and is included in the amounts in the table above. Share-based compensation expense included in selling, general and administrative expenses was $3.8 million and $2.4 million for the six months ended September 30, 2017 and 2016, respectively, and is included in the amounts above.
Selling, general and administrative expenses decreased $1.8 million for the three months ended September 30, 2017 compared to the prior year due to $3.0 million of fair value adjustments related to the HealthFusion contingent consideration recorded in the prior year period, offset by higher incremental costs associated with Entrada acquired in April 2017 and an increase in bad debt expense associated with our continued efforts to resolve aged customer receivable balances.
Selling, general and administrative expenses increased $0.6 million for the six months ended September 30, 2017 compared to the prior year period primarily due to higher incremental costs associated with Entrada acquired in April 2017, an increase in bad debt expense associated with our continued efforts to resolve aged customer receivable balances, and higher consulting costs associated with our assessment and implementation of the new revenue standard (ASC 606, Revenue From Contracts With Customers), including implementation of a new accounting system module, offset by $5.4 million of fair value adjustments related to the HealthFusion contingent consideration recorded in the prior year period.
Research and Development Costs, net
The following table presents our consolidated net research and development costs, capitalized software costs, and gross expenditures prior to capitalization, for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Gross expenditures
$
23,903

 
$
20,663

 
$
49,140

 
$
41,835

Capitalized software costs
(4,376
)
 
(2,371
)
 
(9,624
)
 
(5,319
)
Research and development costs, net
$
19,527

 
$
18,292

 
$
39,516

 
$
36,516

 
 
 
 
 
 
 
 
Research and development costs, as a percentage of revenue
14.7
%
 
14.4
%
 
15.0
%
 
14.6
%
Capitalized software costs as a percentage of gross expenditures
18.3
%
 
11.5
%
 
19.6
%
 
12.7
%
Gross research and development expenditures, including costs expensed and costs capitalized, consist of compensation expense, including share-based compensation for research and development personnel, certain third-party consultant fees, software maintenance costs, and other costs related to new product development and enhancement to our existing products. We intend to continue to invest heavily in research and development expenses as we continue to bring additional functionality and features to the medical community and develop a new integrated inpatient and outpatient, web-based software platform.
The capitalization of software development costs results in a reduction to our reported net research and development costs. Our software capitalization rate, or capitalized software costs as a percentage of gross expenditures, has varied historically and may continue to vary based on the nature and status of specific projects and initiatives in progress. Although changes in software capitalization rates have no impact on our overall cash flows, it results in fluctuations in the amount of software development costs being expensed up front and the amount of net research and development costs reported in our consolidated statement of net income and comprehensive income.

27



Share-based compensation expense included in research and development costs was $0.5 million and $0.3 million for the three months ended September 30, 2017 and 2016, respectively, and is included in the amounts in the table above. Share-based compensation expense included in research and development costs was $0.9 million and $0.4 million for the six months ended September 30, 2017 and 2016, respectively, and is included in the amounts above.
Net research and development costs for the three months ended September 30, 2017 increased $1.2 million compared to the prior year period, which is due to a $3.2 million increase in our gross expenditures, offset by $2.0 million higher capitalization of software costs. Net research and development costs for the six months ended September 30, 2017 increased $3.0 million compared to the prior year, which is due to a $7.3 million increase in our gross expenditures, offset by $4.3 million higher capitalization of software costs. The increase in both gross expenditures and capitalization of software costs are related to the development of the next major versions of our core software products and enhancements to our existing products, for which we incurred a higher level of personnel and third party development costs. Additionally, the acquisition of Entrada in April 2017 and an increase in our research and development headcount contributed to the increases in gross expenditures. Our software capitalization rate fluctuates due to differences in the nature and status of our projects and initiatives during a given year, which affects the amount of development costs that may be capitalized.
Amortization of Acquired Intangible Assets
The following table presents our amortization of acquired intangible assets for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Amortization of acquired intangible assets
$
2,012

 
$
2,617

 
$
4,059

 
$
5,321

Amortization of acquired intangible assets included in operating expense consist of the amortization related to our customer relationships, trade name, and contracts intangible assets acquired as part of our business combinations. Refer to Note 5, "Intangible Assets" of our notes to consolidated financial statements included elsewhere in this Report for an estimate of future expected amortization.
Amortization of acquired intangible assets for the three and six months ended September 30, 2017 declined $0.6 million and $1.3 million, respectively, compared to prior year period due to certain acquired intangible assets being fully amortized during the year, partially offset by the incremental amortization associate with intangible assets acquired from Entrada and EagleDream.
Restructuring Costs
During the three and six months ended September 30, 2016, we recorded $0.7 million and $4.5 million, respectively, of restructuring costs within operating expenses in our consolidated statements of comprehensive income. The restructuring costs resulted from a restructuring plan that we announced in April 2016, and such costs consist primarily of payroll-related costs, such as severance, outplacement costs, and continuing healthcare coverage, associated with the involuntary separation of employees pursuant to a one-time benefit arrangement. The restructuring plan was substantially complete by the end of fiscal 2017, and thus we did not incur additional restructuring costs during the three and six months ended September 30, 2017.
Interest and Other Income and Expense
The following table presents our interest expense for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Interest income
$
12

 
$
1

 
$
21

 
$
9

Interest expense
(840
)
 
(803
)
 
(1,517
)
 
(1,816
)
Other expense, net
15

 
(55
)
 
(7
)
 
(142
)
Interest expense relates to our revolving credit agreement that was entered into in January 2016 and the related amortization of deferred debt issuance costs. Refer to Note 7, “Line of Credit” of our notes to consolidated financial statements included elsewhere in this Report for additional information.
The fluctuations in our interest expense is caused by changes in outstanding balances under our revolving credit agreement in the current year compared to prior year. As of September 30, 2017, we had $55.0 million in outstanding balances under the revolving

28



credit agreement, compared to an outstanding balance of $15.0 million as of March 31, 2017 and $48.0 million as of September 30, 2016. All other fluctuations in interest and other income and expense are not deemed significant.
Provision for Income Taxes
The following table presents our provision for income taxes for the three and six months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Provision for income taxes
$
2,493

 
$
1,925

 
$
4,647

 
$
1,608

Effective tax rate
23.7
%
 
32.6
%
 
28.0
%
 
32.5
%
The effective rate for the three months ended September 30, 2017 decreased compared to the prior year period primarily due to a favorable decline in the amount of certain non-deductible acquisition related costs and the current period reduction in state taxes.
The effective rate for the six months ended September 30, 2017 decreased compared to the prior year period primarily due to a favorable decline in the amount of certain non-deductible acquisition related costs, the current period reduction in state taxes and the impact of excess tax deficiencies from share-based compensation recorded in the period.
Net Income
The following table presents our net income (in thousands) and net income per share and for the three and six months ended September 30, 2017 and 2016:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
8,030

 
$
3,987

 
$
11,926

 
$
3,340

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.13

 
$
0.06

 
$
0.19

 
$
0.05

Diluted
$
0.13

 
$
0.06

 
$
0.19

 
$
0.05

As a result of the foregoing changes in revenue and expense, net income for the three and six months ended September 30, 2017 increased $4.0 million and $8.6 million, respectively, compared to the prior year period.


29



Liquidity and Capital Resources
The following table presents selected financial statistics and information for the six months ended September 30, 2017 and 2016 (in thousands):
 
Six Months Ended September 30,
 
2017
 
2016
Cash and cash equivalents
$
26,553

 
$
26,246

Unused portion of revolving credit agreement(1)
195,000

 
202,000

Total liquidity
$
221,553

 
$
228,246

 
 
 
 
Net income
$
11,926

 
$
3,340

Net cash provided by operating activities
$
38,094

 
$
56,385

_________________________
(1) As of September 30, 2017, we had outstanding loans of $55.0 million under our $250.0 million revolving credit agreement.
Our principal sources of liquidity are our cash generated from operations, driven mostly by our net income and working capital management, our cash and cash equivalents, and our revolving credit agreement.
Cash and Cash Equivalents
As of September 30, 2017, our cash and cash equivalents balance of $26.6 million reflects an $11.1 million decrease compared to $37.7 million as of March 31, 2017. This decrease primarily reflects $58.9 million of net cash paid for the acquisitions of Entrada and EagleDream, which were partially funded by $50.0 million of additional borrowings under our revolving credit agreement, offset by $10.0 million of principal repayments. Additionally, we paid $18.8 million to settle the contingent consideration liability related to the acquisition of HealthFusion. Our outstanding loans under our revolving credit agreement was $55.0 million as of September 30, 2017.
We may continue to use a portion of our funds as well as available financing from our revolving credit agreement for future acquisitions or other similar business activities, although the specific timing and amount of funds to be used is not currently determinable. We intend to expend some of our available funds for the development of products complementary to our existing product line as well as new versions of certain of our products. These developments are intended to take advantage of more powerful technologies and to increase the integration of our products.
Our investment policy is determined by our Board of Directors. Excess cash, if any, may be invested in very liquid short term assets including tax exempt and taxable money market funds, certificates of deposit and short term municipal bonds with average maturities of 365 days or less at the time of purchase. Our Board of Directors continues to review alternate uses for our cash including an expansion of our investment policy and other items. Any or all of these programs could significantly impact our investment income in future periods.
We believe that our cash and cash equivalents on hand at September 30, 2017, together with our cash flows from operations and liquidity provided by our revolving credit agreement, will be sufficient to meet our working capital and capital expenditure requirements for the next twelve months.
Cash Flows from Operating Activities
The following table summarizes our consolidated statements of cash flows for the six months ended September 30, 2017 and 2016 (in thousands):
 
Six Months Ended September 30,
 
2017
 
2016
Net income
$
11,926

 
$
3,340

Non-cash expenses
29,195

 
34,097

Cash from net income, as adjusted
$
41,121

 
$
37,437

 
 
 
 
Change in other assets and liabilities
(3,027
)
 
18,948

Net cash provided by operating activities
$