<PAGE> 1
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[ X ] SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
______________________
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[ ] SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ___________________
Commission file number 0-13801
_______
QUALITY SYSTEMS, INC.
_________________________________________________________________
(Exact name of registrant as specified in its charter)
California 95-2888568
_______________________________ ___________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
17822 East 17th Street, Tustin, California 92780
__________________________________________ __________
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (714) 731-7171
______________
NOT APPLICABLE
________________________________________________________________
(Former name, former address and former fiscal year, if changed,
since last year)
Indicate by check mark whether the issuer (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 XX No
---- ----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
6,233,266 shares of Common Stock, $.01 par value,
as of August 5, 1998
<PAGE 2>
PART I. CONSOLIDATED FINANCIAL INFORMATION.
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Item 1. Financial Statements.
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QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, March 31,
ASSETS 1998 1998
----------- -----------
<S> <C> <C>
Current Assets: (unaudited)
Cash and cash equivalents $12,032 $16,107
Short-term investments 942 973
Accounts receivable, less allowance for doubtful
accounts of $551 and $521, respectively 9,631 9,946
Inventories 907 1,328
Other current assets 691 574
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Total current assets 24,203 28,928
Equipment and Improvements, net 1,819 1,790
Capitalized Software Costs, net 2,229 2,183
Deferred Tax Asset 3,413 3,105
Excess of Cost Over Net
Assets of Acquired Business, net 2,707 2,793
Other Assets, net 2,054 2,117
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Total assets $36,425 $40,916
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,515 $ 1,327
Acquisition obligation - 5,676
Deferred service revenue 2,605 2,244
Estimated costs to complete
system installations 582 592
Other current liabilities 3,034 3,636
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Total current liabilities 7,736 13,475
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Commitments and Contingencies
Shareholders' Equity:
Common stock, $0.01 par value, 20,000
shares authorized, 6,243 and 5,988
shares issued and outstanding, respectively 62 60
Additional paid-in capital 35,780 33,931
Accumulated deficit (7,153) (6,550)
------- -------
Total shareholders' equity 28,689 27,441
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Total liabilities and shareholders' equity $36,425 $40,916
======= =======
</TABLE>
See notes to consolidated financial statements.
<PAGE 3>
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net Revenues:
Sales of computer systems,
upgrades and supplies $ 3,930 $ 4,710
Maintenance and other services 3,295 2,463
------- -------
7,225 7,173
Cost of Products and Services 4,040 3,567
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Gross Profit 3,185 3,606
Selling, General and
Administrative Expenses 3,328 2,537
Research and Development Costs 905 828
Purchased In-Process
Research and Development - 4,720
------- -------
Loss from Operations (1,048) (4,479)
Investment Income 176 276
------- -------
Loss before Benefit from Income Taxes (872) (4,203)
Benefit from Income Taxes (269) (1,468)
------- -------
Net Loss $ (603) $(2,735)
======= =======
Net Loss per Share, basic and diluted $(0.10) $(0.46)
======= =======
</TABLE>
See notes to consolidated financial statements.
<PAGE 4>
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss $ (603) $(2,735)
Adjustments to reconcile net
loss to net cash provided by (used in)
operating activities:
Purchased in-process
research and development - 4,720
Depreciation and amortization 600 396
Loss (Gain) on short-term investments 31 (27)
Deferred income taxes (217) (1,771)
Changes, net of amounts acquired, in:
Accounts receivable 315 (1,292)
Inventories 421 9
Other current assets (78) (117)
Other assets (34) (53)
Accounts payable 188 101
Deferred service revenue 361 (42)
Estimated costs to complete
system installations (10) (43)
Income taxes payable and taxes
related to equity accounts (683) 119
Other current liabilities (49) 469
------------ -------------
Net Cash Provided by (Used in)
Operating Activities 242 (266)
------------ -------------
Cash Flows from Investing Activities:
Net additions to
equipment and improvements (167) (341)
Additions to capitalized software costs (333) (300)
Purchase of net assets of MicroMed
Healthcare Information Systems, Inc. (3,840) (5,259)
Change in other assets 8 200
------------ ------------
Net Cash Used in Investing Activities (4,332) (5,700)
------------ ------------
See notes to consolidated financial statements.
<PAGE 5>
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(in thousands)
<CAPTION>
Three Months Ended June 30,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows from Financing Activities:
Purchase of Common Stock $ - $ (34)
Proceeds from
exercise of stock options 15 6
------------ ------------
Net Cash Provided by
(Used in) Financing Activities 15 (28)
------------ ------------
Net Decrease in Cash and Cash Equivalents (4,075) (5,994)
Cash and Cash Equivalents,
beginning of period 16,107 21,852
------------ ------------
Cash and Cash Equivalents, end of period $12,032 $15,858
============ ============
</TABLE>
Supplemental Information - During the three months ended June 30, 1998 and
1997, the Company made income tax payments of $624 and $186, respectively.
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------
Detail of business acquired in 1998 1997
purchase transaction: ------------ ------------
<S> <C> <C>
Purchased In-Process
Research and Development $ - $ 4,720
Fair Value of Assets Acquired (net of
previous investment, if any) - 1,216
Liabilities Assumed - (677)
Common Stock Issued in the Acquisition (1,836) -
Retirement of Acquisition Obligation 5,676 -
------------ ------------
Cash Paid for the Acquisition,
net of cash acquired $ 3,840 $ 5,259
============ ============
</TABLE>
See notes to consolidated financial statements.
<PAGE 6>
QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
- ------ ---------------------
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the requirements of Form 10-Q and, therefore,
do not include all information and footnotes which would be presented were
such financial statements prepared in accordance with generally accepted
accounting principles, and should be read in conjunction with the audited
financial statements presented in the Company's Annual Report for the
fiscal year ended March 31, 1998. In the opinion of management, the
accompanying financial statements reflect all adjustments which are
necessary for a fair presentation of the results of operations for the
interim 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.
NOTE 2 - ACQUISITION OF MICROMED HEALTHCARE INFORMATION SYSTEMS, INC.
- ------ ------------------------------------------------------------
On May 15, 1997, the Company acquired substantially all of the assets of
MicroMed Healthcare Information Systems, Inc. ("MicroMed"), a developer and
marketer of proprietary information systems utilizing a graphical user
interface client-server platform for medical group practices. The purchase
price consists of an initial cash payment of $4.8 million paid at the
closing of the transaction and an additional payment, based upon certain
operating results of MicroMed for the twelve-month period ended March 31,
1998, of $5.7 million due no later than June 29, 1998. The additional
payment consisted of $3.8 million in cash and 245,454 shares of the
Company's Common Stock valued at $1.8 million, or $7.48 per share. The
shares of Common Stock may not be sold or otherwise transferred in any
manner until June 1999.
NOTE 3 - STOCK REPURCHASE
- ------ ----------------
In February 1997, the Company's Board of Directors authorized the
repurchase on the open market of up to 10% of the Company's outstanding
Common Stock at various times through February 1998, subject to compliance
with applicable laws and regulations. On February 9, 1998, the Company's
Board of Directors extended this authorization through February 9, 1999.
The timing and amount of any repurchase is at the discretion of the
Company's management. The Company's management could, in the exercise of
its judgment, repurchase fewer shares than authorized. During the three
months ended June 30, 1998, the Company did not repurchase any shares.
Since the inception of the repurchase authorization through August 5, 1998,
49,900 shares have been repurchased at a cost of $329,000.
<PAGE 7>
NOTE 4 - INCOME TAXES
- ------ ------------
The benefit from income taxes for the three months ended June 30, 1998 and
1997 differ from the expected combined statutory rate primarily due to the
impact of non-deductible amortization of certain intangible assets acquired
in the May 1996 acquisition of Clinitec International, Inc. and the effect
of varying state income tax rates.
NOTE 5 - NET LOSS PER SHARE
- ------ ------------------
The net loss per share, basic and diluted, for each of the three months
ended June 30, 1998 and 1997 was computed using the weighted average number
of shares actually outstanding during the periods of 6,002,000 and
5,998,000, respectively, and any common share equivalents were excluded
because their impact would have been anti-dilutive.
NOTE 6 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- ------ -----------------------------------------
In October 1997, the American Institute of Certified Public Accounts issued
Statement of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP
97-2"), which was later amended in part by SOP 98-4, "Deferral of the
Effective Date of a Provision of SOP 97-2, Software Revenue Recognition"
("SOP 98-4"). As of April 1, 1998, the Company has adopted SOP 97-2, as
amended by SOP 98-4. SOP 97-2 provides guidance on applying generally
accepted accounting principles in recognizing revenue on software
transactions and supersedes the guidance contained in SOP 91-1 which the
Company has heretofore been following. The Company generates revenues from
licensing rights to use its software products directly to end users. The
Company also generates revenues from sales of hardware and third party
software, and implementation, training, software customization and post-
contract support ("maintenance") services performed for customers who
license the Company's products. A typical system contract contains
multiple elements of two or more of the above items. In accordance with
SOP 97-2, revenue is allocated to each element of the contract based on
evidence of each element's fair market value. Provided the fees are fixed
and determinable and collection is considered probable, revenue from
licensing rights and sales of hardware and third party software are
recognized upon shipment. Revenue from implementation, training and
software customization services is recognized as the corresponding services
are performed. Maintenance revenue is recognized ratably over the
contractural maintenance period. The adoption of SOP 97-2 has, in certain
circumstances, resulted in the deferral of some portion of contract
revenues that would have otherwise been recognized under SOP 91-1. During
the quarter ended June 30, 1998, the impact of adopting SOP 97-2 as of
April 1, 1998, was to reduce net revenues by $443,000, increase the loss
from operations by $314,000, and increase the net loss by $187,000, or
$0.03 per share on a basic and diluted basis.
<PAGE 8>
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130"). This statement establishes
standards for the reporting of comprehensive income and its components.
Comprehensive income, as defined, includes all changes in equity (net
assets) during a period from non-owner sources. For the three months ended
June 30, 1998 and 1997, there were no differences between the net loss, as
reported, and comprehensive income/loss.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information" ("SFAS No. 131"). This statement
establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes
standards for related disclosure about products and services, geographic
areas and major customers. The Company has not yet determined the impact,
if any, of adopting this new standard. The disclosures prescribed by SFAS
No. 131 are effective for fiscal years beginning after December 15, 1997,
but are not required for interim periods in the initial year of
application.
<PAGE 9>
Item 2. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations.
--------------------------
Except for the historical information contained herein, the matters
discussed in this Quarterly Report on Form 10-Q, including discussions of
the Company's product development plans and business strategies and market
factors influencing the Company's results, are forward-looking statements
that involve certain risks and uncertainties. Actual results may differ
from those anticipated by the Company as a result of various factors, both
foreseen and unforeseen, including, but not limited to, the Company's
ability to continue to develop new products and increase systems sales in a
market characterized by rapid technological evolution, consolidation, and
competition from larger, better capitalized competitors. Many other
economic, competitive, governmental and technological factors could impact
the Company's ability to achieve its goals and interested persons are urged
to review the risks described below, as well as in the Company's other
public disclosures and filings with the Securities and Exchange Commission.
COMPANY OVERVIEW.
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiaries, Clinitec
International, Inc. ("Clinitec") and MicroMed Healthcare Information
Systems, Inc. ("MicroMed"), (collectively, the "Company") develop and
market healthcare information systems that automate medical and dental
group practices, physician hospital organizations ("PHOs"), management
service organizations ("MSOs"), and community health centers. In response
to the growing need for more comprehensive, cost-effective information
solutions for physician and dental practices, the Company's systems provide
its clients with the ability to redesign patient care and other workflow
processes, improve productivity, reduce information processing and
administrative costs, and provide multi-site access to patient information.
The Company's proprietary software systems include general patient
information, electronic medical records, appointment scheduling, billing,
insurance claims submission and processing, managed care plan
implementation and referral management, treatment outcome studies,
treatment planning, drug formularies, dental charting, and letter
generation. In addition to providing fully integrated software information
solutions to its clients, the Company offers comprehensive hardware and
software installation services, maintenance and support services, system
training services, and electronic insurance claims submission services.
The Company currently has an installed base of more than 500 healthcare
information systems serving PHOs, MSOs, group practices, specialty
practices, dental schools and other healthcare organizations, each of which
consists of from one to 250 physicians or dentists. The Company believes
that as healthcare providers are increasingly required to reduce costs
while maintaining the quality of healthcare, the Company will be able to
capitalize on its strategy of providing fully integrated information
systems and superior client service.
<PAGE 10>
QSI was founded with an early focus on providing information systems and
services primarily for dental group practices. QSI's initial "turnkey"
systems were designed to improve productivity while reducing information
processing costs and personnel requirements. In the mid-1980's, QSI
capitalized on the opportunity presented by the increasing pressure of cost
containment on physicians and healthcare organizations and further expanded
its information processing systems into the broader medical market. Today,
QSI primarily develops and markets integrated character-based healthcare
information systems utilizing a UNIX* operating system for both the medical
and dental markets ("Legacy Product"). These expandable systems operate on
a stand-alone basis or in a networked environment.
Augmenting its medical practice management software system, QSI added
Clinitec's electronic medical records software, NextGen**, to its product
line in 1995 and completed its acquisition of Clinitec in May 1996.
NextGen allows healthcare providers to create and maintain medical records
using a series of user-definable clinical "templates". Data is generally
captured using a light pen or a mouse, and entries are then turned into
sentences and/or paragraphs to create documentation. NextGen also supports
the scanning and annotation of paper documents, photographs and X-rays, and
contains many other advanced features. NextGen is marketed both in
conjunction with the Company's practice management software offerings as
well as on a stand-alone basis where NextGen may interface with other
practice management systems. With the addition of NextGen, the Company
believes that it currently provides a comprehensive information management
solution for the medical marketplace.
In September 1996, QSI entered into a software licensing and development
agreement to utilize and market a computerized oral health records system
for dental practitioners ("Charting Product"). QSI continues to modify and
expand the product's source code to meet the needs of large dental groups
and has interfaced this charting system with the dental Legacy Product.
The dental charting software incorporates specific clinical information
associated with tooth and perio charting, video image management (including
interfacing with digital X-ray equipment and intra-oral cameras),
periodontal screening and recording ("PSR") examination results and patient
education, and maintains chart notes in both text and audio form. The
system is being developed with a client-server architecture; a GUI design
utilizing either Windows 95*** or Windows NT*** operating system platforms;
and, a platform independent relational database that is ANSI SQL-compliant.
In addition, the dental charting software can be integrated with components
from the NextGen electronic medical records system to form the base for a
chartless, paperless dental office environment.
Further augmenting its medical practice management system product line, the
Company purchased MicroMed in May 1997. MicroMed develops and markets
proprietary medical practice management systems. MicroMed's practice
management system ("Windows Product") has been developed with a client-
server architecture; a GUI design utilizing either Windows 95 or Windows NT
operating system platforms; and, a platform independent relational database
that is ANSI SQL-compliant. MicroMed's product is designed to provide a
flexible, enterprise-wide solution employing a master patient index.
* UNIX is a registered trademark of AT&T Corporation.
** NextGen is a registered trademark of Clinitec International, Inc.
*** Microsoft Windows, Windows NT and Windows 95 are registered
trademarks of Microsoft Corporation.
<PAGE 11>
RISK FACTORS.
COMPETITION.
The market for healthcare information systems is intensely competitive and
the Company faces significant competition from a number of different
sources. The electronic medical records market, in particular, is subject
to rapid changes in technology and the Company expects that competition in
this portion of the market will increase as new competitors enter the
marketplace. In addition, several of the Company's competitors have
significantly greater name recognition as well as substantially greater
financial, technical, product development and marketing resources than the
Company.
The industry is highly fragmented and includes numerous competitors, none
of which the Company believes dominates the overall market for either group
practice management or clinical systems. Furthermore, the Company also
competes indirectly and to varying degrees with other major healthcare
related companies, information management companies generally, and other
software developers which may more directly enter the markets in which the
Company competes.
There can be no assurance that future competition or new product
introductions will not have a material adverse effect on the Company's
business, financial condition and results of operations. Competitive
pressures and other factors, such as new product introductions by the
Company or its competitors, may result in price erosion that could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In addition, the Company believes that once a healthcare provider has
chosen a particular healthcare information system vendor, the provider
will, for a period of time, be more likely to rely on that vendor for its
future information system requirements. Furthermore, if the healthcare
industry continues to undergo further consolidation as it has recently
experienced, each sale of the Company's systems will assume even greater
importance to the Company's business, financial condition and results of
operations. The Company's inability to make initial sales of its systems
to either newly formed groups and/or healthcare providers that are
replacing or substantially modifying their healthcare information systems
could have a material adverse effect on the Company's business, financial
condition and results of operations. If new systems sales do not
materialize, maintenance service revenues can be expected to decrease over
time due to the effect of failure to capture new maintenance revenues
therefrom in combination with attrition of existing maintenance revenues
associated with the Company's current clients whose systems become obsolete
or are replaced by competitors' products.
FLUCTUATION IN QUARTERLY OPERATING RESULTS.
The Company's revenues and operating results have in the past fluctuated,
and may in the future fluctuate, from quarter to quarter and period to
period as a result of a number of factors including, without limitation:
the size and timing of orders from clients; the length of sales cycles and
installation processes; the ability of the Company's clients to obtain
financing for the purchase of the Company's products; changes in pricing
policies or price reductions by the Company or its competitors; the timing
<PAGE 12>
of new product announcements and product introductions by the Company or
its competitors; the availability and cost of system components; the
financial stability of major clients; market acceptance of new products,
applications and product enhancements; the Company's ability to develop,
introduce and market new products, applications and product enhancements
and to control costs; the Company's success in expanding its sales and
marketing programs; deferrals of client orders in anticipation of new
products, applications or product enhancements; changes in Company
strategy; personnel changes; and general economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with minimal backlog.
As a result, sales in any quarter are dependent on orders booked and
shipped in that quarter and are not predictable with any degree of
certainty. Furthermore, the Company's systems can be relatively large and
expensive and individual systems sales can represent a significant portion
of the Company's revenues for a quarter such that the loss of even one such
sale can have a significant adverse impact on the Company's quarterly
profitability. Clients often defer systems purchases until the Company's
quarter end, so quarterly results generally cannot be predicted and
frequently are not known until the quarter has concluded. The Company's
initial contact with a potential customer depends in significant part on
the customer's decision to replace, or substantially modify, its existing
information system. How and when to implement, replace or substantially
modify an information system are major decisions for healthcare providers.
Accordingly, the sales cycle for the Company's systems can vary
significantly and typically ranges from three to 12 months from initial
contact to contract execution/shipment and the installation cycle is
typically two to four months from contract execution/shipment to completion
of installation.
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can
cause significant variations in operating results from quarter to quarter.
As a result, the Company believes that interim period-to-period comparisons
of its results of operations are not necessarily meaningful and should not
be relied upon as indications of future performance. Further, the Company's
historical operating results are not necessarily indicative of future
performance for any particular period.
Through March 31, 1998, the Company recognized revenue in accordance with
the provisions of the American Institute of Certified Public Accountants
("AICPA") Statement of Position No. 91-1, "Software Revenue Recognition"
("SOP 91-1"). The AICPA has recently adopted Statement of Position No. 97-
2, "Software Revenue Recognition" ("SOP 97-2"), that supersedes SOP 91-1
and became effective for the Company on April 1, 1998. There can be no
assurance that application and subsequent interpretations of this
pronouncement by the Company, its independent auditors or the Securities
Exchange Commission will not further modify the Company's revenue
recognition policies, or that such modifications would not have a material
adverse effect on the operating results reported in any particular quarter.
There can be no assurance that the Company will not be required to adopt
changes in its licensing or services practices to conform to SOP 97-2, or
that such changes, if adopted, would not result in delays or cancellations
of potential sales of the Company's products.
<PAGE 13>
Due to all of the foregoing factors, it is possible that in some future
quarter the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially adversely affected.
ACQUISITIONS.
During the past two years, the Company has made two significant
acquisitions of relatively new companies each of which has products
utilizing newer technology than the Company's Legacy Product and each
company having a limited sales history. Acquisitions involve a number of
special risks, including possible adverse effects on the Company's
operating results, diversion of management's attention, failure to retain
key acquired personnel, amortization of acquired intangible assets, and
risks associated with unanticipated events or liabilities, some or all of
which could have a material adverse effect on the Company's business,
results of operations and financial condition. Customer dissatisfaction or
performance problems at a single acquired business can also have an adverse
effect on the reputation of the Company.
DEPENDENCE ON PRINCIPAL PRODUCT AND NEW PRODUCT DEVELOPMENT.
The Company currently derives substantially all of its net revenues from
sales of its healthcare information systems and related services. The
Company believes that a primary factor in the market acceptance of its
systems has been its ability to meet the needs of users of healthcare
information systems. The Company's future financial performance will
depend in large part on the Company's ability to continue to meet the
increasingly sophisticated needs of its clients through the timely
development, successful introduction and implementation of new and enhanced
versions of its systems and other complementary products. The Company has
historically expended a significant amount of its net revenues on product
development and believes that significant continuing product development
efforts will be required to sustain the Company's growth.
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing or new products, or that products or product
enhancements will be developed and implemented in a timely manner, meet the
requirements of healthcare providers or achieve market acceptance. If new
products or product enhancements do not achieve market acceptance, the
Company's business, operating results and financial condition could be
adversely affected. At certain times in the past, the Company has also
experienced delays in purchases of its products by clients anticipating the
launch of new products by the Company. There can be no assurance that
material order deferrals in anticipation of new product introductions will
not occur.
TECHNOLOGICAL CHANGE.
The software market generally is characterized by rapid technological
change, changing customer needs, frequent new product introductions and
evolving industry standards. The introduction of products incorporating
new technologies and the emergence of new industry standards could render
the Company's existing products obsolete and unmarketable. There can be no
assurance that the Company will be successful in developing and marketing
new products that respond to technological changes or evolving industry
standards. New product development depends upon significant research and
<PAGE 14>
development expenditures which depend ultimately upon sales growth. Any
material weakness in revenues or research funding could impair the
Company's ability to respond to technological advances in the marketplace
and remain competitive. If the Company is unable, for technological or
other reasons, to develop and introduce new products in a timely manner in
response to changing market conditions or customer requirements, the
Company's business, results of operations and financial condition will be
materially adversely affected.
In response to increasing market demand, the Company is currently
developing new generations of its software products designed for the
client-server and Internet/intranet environments. There can be no assurance
that the Company will successfully develop these new software products or
that these products will operate successfully on the principal client-
server operating systems, which include UNIX, Microsoft Windows, Windows NT
and Windows 95, or that any such development, even if successful, will be
completed concurrently with or prior to introduction by competitors of
products designed for the client-server and Internet/intranet environments.
Any such failure or delay could adversely affect the Company's competitive
position or could make the Company's current products obsolete.
YEAR 2000 COMPLIANCE.
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The
Year 2000 issue is whether the computer systems will properly recognize
date sensitive information when the year changes to 2000. This Year 2000
problem creates risk for the Company from unforeseen problems in its own
computer systems and from third parties with whom the Company deals on
financial transactions nationwide.
The Company's Windows Product, NextGen and Charting Product are designed to
be Year 2000 compliant. However, there can be no assurance that such
products do not contain undetected errors or defects associated with Year
2000 date functions. The Company is currently evaluating the impact of
Year 2000 issues upon its medical and dental Legacy Product software and,
pending the conclusion of its evaluation, the impact of such Year 2000
issues upon the Company and its financial performance is uncertain.
The Company has begun to review software used internally by the Company in
all support systems to determine whether they are Year 2000 compliant. The
Company plans to have formal Year 2000 initiatives developed to address any
conversion update or upgrade necessary to become Year 2000 compliant on
software currently used by the Company. Any new software or support
systems implemented in the future will be Year 2000 compliant or will have
updates or upgrades available before the Year 2000 to enable the system to
be Year 2000 compliant. Management is currently assessing the Year 2000
compliance expense and related potential effect on the Company's earnings.
LITIGATION.
On April 22, 1997, a purported class action was filed in California
Superior Court on behalf of all persons who purchased the Company's Common
Stock between June 26, 1995 and July 3, 1996. The complaint alleges that
the Company and certain of its officers and directors, as well as other
defendants not affiliated with the Company, violated sections of the
California Corporations Code by issuing positive statements about the
Company that allegedly were knowingly false, in part, in order to assist
<PAGE 15>
the Company and certain of its officers and directors in selling Common
Stock at an inflated price in the Company's March 5, 1996 public offering
and at other points during the period specified. On May 14, 1997, a second
purported class action was filed in the same court essentially repeating
the allegations of the April 22, 1997 suit. On July 1, 1997, a third
purported class action was filed in the United States District Court
repeating essentially the same factual allegations as the April 22, 1997
suit and purports to state claims under the Federal securities laws. The
Company and its named officers and directors deny all allegations of
wrongdoing made against them in these suits, consider the allegations
groundless and without merit, and intend to vigorously defend against these
actions.
The pending federal and state securities actions are in the early states of
procedure. Consequently, at this time it is not reasonably possible to
estimate the damage, or the range of damages, if any, that the Company
might incur in connection with such actions. However, the uncertainty
associated with substantial unresolved litigation may be expected to have
an adverse impact on the Company's business. In particular, such
litigation could impair the Company's relationships with existing customers
and its ability to obtain new customers. Defending such litigation will
likely result in a diversion of management's time and attention away from
business operations, which could have a material adverse effect on the
Company's business, results of operations and financial condition. Such
litigation may also have the effect of discouraging potential acquirors from
bidding for the Company or reducing the consideration such acquirors would
otherwise be willing to pay in connection with an acquisition.
PROPRIETARY TECHNOLOGY.
The Company is heavily dependent on the maintenance and protection of its
intellectual property and relies largely on license agreements,
confidentiality procedures and employee nondisclosure agreements to protect
its intellectual property. The Company's software is not patented and
existing copyright laws offer only limited practical protection. There can
be no assurance that the legal protections and precautions taken by the
Company will be adequate to prevent misappropriation of the Company's
technology or that competitors will not independently develop technologies
equivalent or superior to the Company's. Further, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an
extent as do the laws of the United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no
assurance that others will not assert infringement or trade secret claims
against the Company with respect to its current or future products or that
any such assertion will not require the Company to enter into a license
agreement or royalty arrangements with the party asserting the claim. As
competing healthcare information systems increase in complexity and overall
capabilities and the functionality of these systems further overlaps,
providers of such systems may become increasingly subject to infringement
claims. Responding to and defending any such claims may distract the
attention of Company management and have a material adverse effect on the
Company's business, financial condition and results of operations. In
addition, claims may be brought against third parties from which the
Company purchases software, and such claims could adversely affect the
Company's ability to access third party software for its systems.
<PAGE 16>
ABILITY TO MANAGE GROWTH.
The Company has recently experienced a period of growth and increased
personnel which has placed, and will continue to place, a significant
strain on the Company's resources. The Company anticipates expanding its
overall software development, marketing, sales, client management and
training capacity. In the event the Company is unable to identify, hire,
train and retain qualified individuals in such capacities within a
reasonable timeframe, such failure could have a material adverse effect on
the Company. In addition, the Company's ability to manage future
increases, if any, in the scope of its operations or personnel will depend
on significant expansion of its research and development, marketing and
sales, management and administrative, and financial capabilities. The
failure of the Company's management to effectively manage expansion in its
business could have a material adverse effect on the Company's business,
results of operations and financial condition.
DEPENDENCE UPON KEY PERSONNEL.
The Company's future performance also depends in significant part upon the
continued service of its key technical and senior management personnel,
many of whom have been with the Company for a significant period of time.
The Company does not maintain key man life insurance on any of its
employees. Because the Company has a relatively small number of employees
when compared to other leading companies in the same industry, its
dependence on maintaining its employees is particularly significant. The
Company is also dependent on its ability to attract and retain high quality
personnel, particularly highly skilled software engineers for applications
development. The industry is characterized by a high level of employee
mobility and aggressive recruiting of skilled personnel. There can be no
assurance that the Company's current employees will continue to work for
the Company. Loss of services of key employees could have a material
adverse effect on the Company's business, results of operations and
financial condition. Furthermore, the Company may need to grant additional
stock options to key employees and provide other forms of incentive
compensation to attract and retain such key personnel.
PRODUCT LIABILITY.
Certain of the Company's products provide applications that relate to
patient clinical information. Any failure by the Company's products to
provide accurate and timely information could result in claims against the
Company. The Company maintains insurance to protect against claims
associated with the use of its products, but there can be no assurance that
its insurance coverage would adequately cover any claim asserted against
the Company. A successful claim brought against the Company in excess of
its insurance coverage could have a material adverse effect on the
Company's business, financial condition and results of operations. Even
unsuccessful claims could result in the Company's expenditure of funds in
litigation and management time and resources.
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess
of its insurance coverage, that the Company's insurance will cover such
claims or that appropriate insurance will continue to be available to the
Company in the future at commercially reasonable rates. Such claims could
have a material adverse affect on the Company's business, financial
condition and results of operations.
<PAGE 17>
UNCERTAINTY IN HEALTHCARE INDUSTRY; GOVERNMENT REGULATION.
The healthcare industry is subject to changing political, economic and
regulatory influences that may affect the procurement processes and
operation of healthcare facilities. During the past several years, the
healthcare industry has been subject to an increase in governmental
regulation of, among other things, reimbursement rates and certain capital
expenditures. In the past, various legislators have announced that they
intend to examine proposals to reform certain aspects of the U.S.
healthcare system including proposals which may increase governmental
involvement in healthcare, lower reimbursement rates and otherwise change
the operating environment for the Company's clients. Healthcare providers
may react to these proposals and the uncertainty surrounding such proposals
by curtailing or deferring investments, including those for the Company's
systems and related services. Cost-containment measures instituted by
healthcare providers as a result of regulatory reform or otherwise could
result in greater selectivity in the allocation of capital funds. Such
selectivity could have an adverse effect on the Company's ability to sell
its systems and related services. The Company cannot predict what impact,
if any, such proposals or healthcare reforms might have on its business,
financial condition and results of operations.
The Company's software may be subject to regulation by the FDA as a medical
device. Such regulation could require the registration of the applicable
manufacturing facility and software/hardware products, application of
detailed recordkeeping and manufacturing standards, and FDA approval or
clearance prior to marketing. An approval or clearance could create delays
in marketing, and the FDA could require supplemental filings or object to
certain of these applications, the result of which could have a material
adverse effect on the Company's business, financial condition and results
of operations.
<PAGE 18>
RESULTS OF OPERATIONS.
The following table sets forth for the periods indicated, the percentage of
net revenues represented by each item in the Company's consolidated
statements of operations.
<TABLE>
<CAPTION>
Three Months
Ended
June 30,
-----------------
1998 1997
------- -------
<S> <C> <C>
Net Revenues:
Sales of computer systems,
upgrades and supplies 54.4 % 65.7 %
Maintenance and other services 45.6 34.3
------- -------
100.0 100.0
Cost of Products and Services 55.9 49.7
------- -------
Gross Profit 44.1 50.3
Selling, General and
Administrative Expenses 46.1 35.4
Research and Development Costs 12.5 11.5
Purchased In-Process
Research and Development - 65.8
------- -------
Loss from Operations (14.5) (62.4)
Investment Income 2.4 3.8
------- -------
Loss before Benefit from Income Taxes (12.1) (58.6)
Benefit from Income Taxes (3.7) (20.5)
------- -------
Net Loss (8.4)% (38.1)%
======= =======
</TABLE>
<PAGE 19>
For the Three-Month Periods Ended June 30, 1998 and 1997.
- ---------------------------------------------------------
The Company incurred a net loss of $(603,000), or $(0.10) per share on a
basic and diluted basis, for the three months ended June 30, 1998. In
comparison, after recognizing a $4.7 million charge for purchased in-
process research and development in connection with the MicroMed
acquisition, the Company incurred a net loss of $(2.7) million, or $(0.46)
per share on a basic and diluted basis, for the three months ended June 30,
1997. Excluding the charge, net of the related income tax benefit, net
income and basic and diluted income per share for the three months ended
June 30, 1997 would have been $256,000, and $0.04, respectively.
Net Revenues. Net revenues for the three months ended June 30, 1998 were
relatively unchanged at $7.2 million as compared to the three months ended
June 30, 1997. Sales of computer systems, upgrades and supplies decreased
16.6% to $3.9 million from $4.7 million while net revenues from maintenance
and other services grew 33.8% to $3.3 million from $2.5 million during the
comparable periods. The decrease in net revenues from sales of computer
systems, upgrades and supplies was principally due to the impact of
adopting SOP 97-2 as of April 1, 1998 resulting in the deferral of certain
revenues from system contracts executed and shipped during the quarter
combined with the effect of an overall decrease in new system sales during
the quarter. The increase in maintenance and other services net revenue
resulted principally from an increase in such revenues for QSI which has a
larger client base from which to generate maintenance and other service
revenue than the more recently formed Clinitec and MicroMed organizations,
each of which also contributed, to a lesser degree, to the increase in such
revenues.
Cost of Products and Services. Cost of products and services for the three
months ended June 30, 1998 increased 13.3% to $4.0 million from $3.6
million for the three months ended June 30, 1997 while cost of products and
services as a percentage of net revenues increased to 55.9% from 49.7%
during the comparable periods. The increase in cost of products and
services in amount during the June 30, 1998 quarter as compared to the June
30, 1997 quarter results from the effect of increased product development,
customer service, support, and training personnel at both Clinitec and
MicroMed during the June 30, 1998 quarter as compared to the June 30, 1997
quarter together with a change in the mix of new system sales toward
systems with higher hardware content in the fiscal 1999 quarter offset in
part by the overall decrease in net revenues from sales of computer systems
and upgrades. The increase in cost of products and services as a
percentage of net revenues results from the growth of the Clinitec and
MicroMed infrastructures together with the changing mix of sales both taken
in conjunction with the negligible net revenue growth in the June 1998
quarter as compared to the June 1997 quarter.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended June 30, 1998 increased
31.2% to $3.3 million from $2.5 million for the three months ended June 30,
1997 primarily as a result of: the inclusion of such MicroMed expenses for
the entire quarter ended June 30, 1998 as compared to only that portion of
the corresponding period ended June 30, 1997 following the May 1997
MicroMed acquisition; and, an increase in Clinitec's and MicroMed's selling
efforts, sales personnel and administrative infrastructure offset in part
by a decrease in such costs for QSI. In addition, primarily as a result of
the negligible net revenue growth in conjunction with the increased
<PAGE 20>
Clinitec and MicroMed infrastructures, selling, general and administrative
expenses as a percentage of net revenues increased to 46.1% from 35.4% for
the respective periods.
Research and Development Costs. Research and development costs for the
three months ended June 30, 1998 increased 9.3% to $905,000 from $828,000
for the three months ended June 30, 1997. The increase is the result of
increased research and development efforts by Clinitec as well as
consolidation of MicroMed's research and development costs for the entire
quarter ended June 30, 1998 as compared to only that portion of such
expenses for the June 30, 1997 quarter which were incurred following the
May 1997 purchase of the MicroMed business. Research and development costs
as a percentage of net revenues increased to 12.5% as compared to 11.5% for
the respective periods as a result of the increased research and
development efforts in conjunction with the negligible net revenue growth
between the periods.
Purchased In-Process Research and Development. In connection with the
acquisition of MicroMed in May 1997, MicroMed's in-process research and
development for which technological feasibility had not been established
was valued in excess of $4.7 million. After allocating the purchase price
paid to identifiable tangible and certain intangible assets, the remaining
unallocated portion of $4.7 million was allocated to MicroMed's in-process
research and development. In accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed," software development costs must
be expensed until technological feasibility has been established.
Accordingly, the $4.7 million value allocated to MicroMed's purchased in-
process research and development was expensed during the quarter ended June
30, 1997. There was no similar acquisition transaction in the June 30,
1998 quarter.
Investment Income. Investment income for the three months ended June 30,
1998 decreased 36.2% to $176,000 from $276,000 for the three months ended
June 30, 1997 primarily as a result of a decrease in average funds
available for investment during the quarter ended June 30, 1998. The
decrease in available funds is primarily the result of the payment made to
acquire the MicroMed business in May 1997 together with funds used to fund
the growth of Clinitec and MicroMed.
Benefit from Income Taxes. The benefit from income taxes for the three
months ended June 30, 1998 was $269,000 as compared to $1.5 million for the
three months ended June 30, 1997. The benefit from income taxes for the
three months ended June 30, 1998 and 1997 differ from the expected combined
statutory rate because of the impact of non-deductible amortization of
certain intangible assets acquired in the May 1996 acquisition of Clinitec
and the effect of varying state income tax rates.
LIQUIDITY AND CAPITAL RESOURCES.
- --------------------------------
Cash and cash equivalents decreased $4.1 million for the three months ended
June 30, 1998 primarily as a result of the final cash payment in connection
with the MicroMed acquisition. Correspondingly, cash and cash equivalents
decreased $6.0 million for the three months ended June 30, 1997 principally
as a result of the initial cash payment in connection with the MicroMed
acquisition.
<PAGE 21>
Net cash provided by operating activities for the three months ended June
30, 1998 was $242,000 consisting primarily of the Company's net loss
adjusted for the principal non-cash operating expenses of depreciation and
amortization plus increases in accounts payable and deferred service
revenue and decreases in accounts receivable and inventory offset by
decreases in deferred income taxes and income taxes payable. Net cash used
in operating activities for the three months ended June 30, 1997 was
$266,000 consisting primarily of the Company's net loss adjusted for the
principal non-cash operating expenses of depreciation, amortization and the
$4.7 million charge for the MicroMed purchased in-process research and
development, plus an increase in other current liabilities offset by the
deferred tax benefit from the charge for purchased in-process research and
development and an increase in accounts receivable.
Net cash used in investing activities for the three months ended June 30,
1998 was $4.3 million consisting principally of $3.8 million used for the
final cash payment for the MicroMed business, plus additions to equipment
and improvements and capitalized software. Net cash used in investing
activities for the three months ended June 30, 1997 was $5.7 million
consisting principally of $5.3 million, including a $550,000 operating loan
made by QSI to MicroMed prior to the acquisition, used for the initial
payment in connection with the MicroMed acquisition plus additions to
equipment and improvements and capitalized software.
Net cash provided by (used in) financing activities for the three months
ended June 30, 1998 and 1997 was negligible.
In February 1997, the Company's Board of Directors authorized the
repurchase on the open market of up to 10% of the Company's outstanding
Common Stock at various times through February 1998, subject to compliance
with applicable laws and regulations. On February 9, 1998, the Company's
Board of Directors extended this authorization through February 9, 1999.
The timing and amount of any repurchase is at the discretion of the
Company's management. The Company's management could, in the exercise of
its judgment, repurchase fewer shares than authorized. During the three
months ended June 30, 1998, the Company did not repurchase any shares.
Since the inception of the repurchase authorization through August 5, 1998,
49,900 shares have been repurchased at a cost of $329,000.
At June 30, 1998, the Company had cash and cash equivalents of $12.0
million and short-term investments of $942,000. Short-term investments
include a $732,000 investment in a fund which trades in special situation
securities. There can be no assurance that the markets for these
securities will not change, causing a loss of principal.
In March 1996, QSI raised $20.2 million to be used for general corporate
purposes, including the financing of product sales growth, development of
new products, working capital requirements, an increase in its ownership
interest in Clinitec, and the possible acquisitions of complementary
businesses and technologies. The Company continues to evaluate potential
investment opportunities and in May 1997 acquired substantially all of the
assets of MicroMed for cash payments made in May 1997 and June 1998
totaling $8.6 million, 245,454 shares of the Company's Common Stock issued
in June 1998 valued at $1.8 million, or $7.48 per share, and related net
acquisition costs and loans made to MicroMed prior to the acquisition
totaling $527,000. The shares of Common Stock issued in connection with
the MicroMed acquisition may not be sold or otherwise transferred in any
manner until June 1999.
<PAGE 22>
Except for Company's intention to expend funds for the development of
complementary products to its existing product line, alternative versions
of certain of its products for the client-server environment to take
advantage of more powerful technologies and to enable a more seamless
integration of the Company's products, the Company has no other significant
capital commitments and currently anticipates that additions to equipment
and improvements for fiscal 1999 will be comparable to fiscal 1998.
The Company believes that its cash and cash equivalents and short-term
investments on hand at June 30, 1998, together with the cash flows from
operations, if any, will be sufficient to meet its working capital and
capital expenditure requirements for the next year.
YEAR 2000 COMPLIANCE.
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The
Year 2000 issue is whether the computer systems will properly recognize
date sensitive information when the year changes to 2000. This Year 2000
problem creates risk for the Company from unforeseen problems in its own
computer systems and from third parties with whom the Company deals on
financial transactions nationwide.
The Company's Windows Product, NextGen and Charting Product are designed to
be Year 2000 compliant. However, there can be no assurance that such
products do not contain undetected errors or defects associated with Year
2000 date functions. The Company is currently evaluating the impact of
Year 2000 issues upon its medical and dental Legacy Product software and,
pending the conclusion of its evaluation, the impact of such Year 2000
issues upon the Company and its financial performance is uncertain.
The Company has begun to review software used internally by the Company in
all support systems to determine whether they are Year 2000 compliant. The
Company plans to have formal Year 2000 initiatives developed to address any
conversion update or upgrade necessary to become Year 2000 compliant on
software currently used by the Company. Any new software or support
systems implemented in the future will be Year 2000 compliant or will have
updates or upgrades available before the Year 2000 to enable the system to
be Year 2000 compliant. Management is currently assessing the Year 2000
compliance expense and related potential effect on the Company's earnings.
<PAGE 23>
PART II. OTHER INFORMATION.
-------- ------------------
Item 2. Changes in Securities and Use of Proceeds.
- ------- ------------------------------------------
In June 1998, the Company issued 245,454 shares of its Common Stock to a
single accredited investor as defined in Rule 501(a) of the Securities Act
of 1933, as amended (the "Act"), in connection with the acquisition of
MicroMed Healthcare Information Systems, Inc. The issuance of such shares
was made in reliance upon the exemptive provisions of Section 4(2) and Rule
506 of the Act.
Item 6. Exhibits and Reports on Form 8-K.
- ------- ---------------------------------
(a) Exhibits:
---------
The Exhibits listed on the accompanying Index to Exhibits
on page 25 are filed as part of this report.
(b) Reports on Form 8-K:
--------------------
None.
<PAGE 24>
SIGNATURES.
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
QUALITY SYSTEMS, INC.
<TABLE>
<S> <C>
Date August 11, 1998 By /s/ Sheldon Razin
--------------- ----------------------------------
Sheldon Razin
President and Chairman
of the Board of Directors;
Principal Executive Officer
Date August 11, 1998 By /s/ Robert G. McGraw
--------------- ----------------------------------
Robert G. McGraw
Chief Financial Officer;
Principal Accounting Officer
</TABLE>
<PAGE 25>
INDEX TO EXHIBITS
Sequential
Page
Exhibit No.
------- ----------
27.0 Financial Data Schedule, is filed herewith. 26
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-END> JUN-30-1998
<CASH> 12,032,000
<SECURITIES> 942,000
<RECEIVABLES> 9,631,000
<ALLOWANCES> 0
<INVENTORY> 907,000
<CURRENT-ASSETS> 24,203,000
<PP&E> 1,819,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 36,425,000
<CURRENT-LIABILITIES> 7,736,000
<BONDS> 0
0
0
<COMMON> 62,000
<OTHER-SE> 28,627,000
<TOTAL-LIABILITY-AND-EQUITY> 36,425,000
<SALES> 3,930,000
<TOTAL-REVENUES> 7,225,000
<CGS> 0
<TOTAL-COSTS> 4,040,000
<OTHER-EXPENSES> 4,233,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (872,000)
<INCOME-TAX> (269,000)
<INCOME-CONTINUING> (603,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (603,000)
<EPS-PRIMARY> (0.10)
<EPS-DILUTED> (0.10)
</TABLE>
