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| QSII > SEC Filings for QSII > Form 10-Q on 3-Nov-2009 | All Recent SEC Filings |
3-Nov-2009
Quarterly Report
• Critical Accounting Policies and Estimates. This section discusses those accounting policies that are considered important to the evaluation and reporting of our financial condition and results of operations, and whose application requires us to exercise subjective or complex judgments in making estimates and assumptions. In addition, all of our significant accounting policies, including our critical accounting policies, are summarized in Note 2 of our Condensed Notes to Consolidated Financial Statements included in this Report.
• Company Overview. This section provides a more detailed description of our Company, operating segments, products and services offered.
• Overview of Results of Operations and Results of Operations by Operating Divisions. These sections provide our analysis and outlook for the significant line items on our consolidated statements of operations, as well as other information that we deem meaningful to understand our results of operations on both a consolidated basis and an operating division basis.
• Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows.
• Recent Accounting Pronouncements. This section provides a summary of the most recent authoritative accounting standards and guidance that have either been recently adopted by our Company or may be adopted in the future.
Management Overview
Quality Systems Inc., comprised of the QSI Division ("QSI Division"), a
wholly-owned subsidiary, NextGen Healthcare Information Systems, Inc. ("NextGen
Division" or "NextGen"), Lackland Acquisition II, LLC dba Healthcare Strategic
Initiatives ("HSI"), and Practice Management Partners, Inc. ("PMP")
(collectively, the "Company", "we", "our", or "us") develops and markets
healthcare information systems that automate certain aspects of medical and
dental practices, networks of practices such as physician hospital organizations
("PHOs") and management service organizations ("MSOs"), ambulatory care centers,
community health centers, and medical and dental schools. The Company also
provides revenue cycle management ("RCM") services through the Practice
Solutions Unit of NextGen. Operationally, our Practice Solutions operations are
conducted through HSI and PMP, and are considered and administered as part of
the NextGen Division.
The turbulence in the worldwide economy has impacted almost all industries.
While healthcare is not immune to economic cycles, we believe it is more
resilient than most segments of the economy. The impact of the current economic
conditions on our existing and prospective clients has been mixed. We continue
to see organizations that are doing fairly well operationally, however, some
organizations with a large dependency on Medicaid populations are being impacted
by the challenging financial condition of the many state governments in whose
jurisdictions they conduct business. A positive factor for U.S. healthcare is
the fact that the Obama administration is pursuing broad healthcare reform aimed
at improving issues surrounding healthcare. The American Recovery and
Reinvestment Act (ARRA), which became law on February 17, 2009, includes more
than $20 billion to help healthcare organizations modernize operations through
the acquisition of health care information technology. While we are unsure of
the immediate impact from the ARRA, the long-term potential to our industry
could be significant.
On May 20, 2008, we acquired HSI, a full-service healthcare RCM company. HSI
operates under the umbrella of NextGen Practice Solutions. Founded in 1996, HSI
currently provides RCM services to providers including health systems,
hospitals, and physicians in private practice with an in-house team of more than
200 employees including specialists in medical billing, coding and compliance,
payor credentialing, and information technology.
On October 28, 2008, we acquired PMP, a full-service healthcare RCM company.
This acquisition is also part of our growth strategy for NextGen Practice
Solutions. Similar to HSI, PMP operates under the umbrella of NextGen Practice
Solutions. Founded in 2001, PMP provides physician billing and technology
management services to healthcare providers, primarily in the Mid-Atlantic
region.
On August 12, 2009, we acquired Sphere Health Systems, Inc, a service provider
of information systems to healthcare facilities. This acquisition is also part
of our strategy to add new customers by expanding the features and functionality
of our products.
Our strategy is, at present, to focus on providing software and services to
medical and dental practices. The key elements of this strategy are to:
• continue development and enhancement of select software solutions in target
markets,
• continue investments in our infrastructure including but not limited to product development, sales, marketing, implementation, and support,
• continue efforts to make infrastructure investments within an overall context of maintaining reasonable expense discipline,
• add new customers through maintaining and expanding sales, marketing and product development activities, and
• expand our relationship with existing customers through delivery of new products and services.
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. The preparation of these consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenue and expenses, and related disclosures of
contingent assets and liabilities. On an on-going basis, we evaluate estimates
for reasonableness, including but not limited to those related to:
• revenue recognition,
• valuation of marketable securities and ARS put option rights,
• uncollectible accounts receivable,
• share based compensation,
• software development cost,
• income taxes, and
• business combination and goodwill.
We base our estimates on historical experience and on various other assumptions
that management believes to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that may not be readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
We believe revenue recognition, valuation of marketable securities and ARS put
option rights, the allowance for doubtful accounts, capitalized software costs,
share-based compensation,
income taxes and business combinations are among the most critical accounting
policies that affect our consolidated financial statements. We believe that our
significant accounting policies, as described in Note 2 of our Condensed Notes
to the Consolidated Financial Statements, "Summary of Significant Accounting
Policies", should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Revenue Recognition. We currently recognize system sales revenue pursuant to
FASB ASC Topic 985-605 Software, Revenue Recognition, or ASC 985-605. We
generate revenue from the sale of licensing rights to use our software products
sold directly to end-users and value-added resellers, or VARs. We also generate
revenue from sales of hardware and third party software, implementation,
training, software customization, EDI, post-contract support (maintenance) and
other services, including RCM services, performed for customers who license our
products.
A typical system contract contains multiple elements of the above items. FASB
ASC Topic 985-605-25, Software, Revenue Recognition, Multiple Elements, or ASC
985-605-25, as amended, requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair values of those elements. The fair value of an element must be
based on vendor specific objective evidence ("VSOE"). We limit our assessment of
VSOE for each element to either the price charged when the same element is sold
separately or the price established by management having the relevant authority
to do so, for an element not yet sold separately. VSOE calculations are updated
and reviewed at the end of each quarter or annually depending on the nature of
the product or service. We have established VSOE for the related undelivered
elements based on the bell-shaped curve method. Maintenance VSOE for our largest
customers is based on stated renewal rates only if the rate is determined to be
substantive and falls within our customary pricing practices.
When evidence of fair value exists for the undelivered elements only, the
residual method, provided for under ASC-985-605, is used. Under the residual
method, we defer revenue related to the undelivered elements in a system sale
based on VSOE of fair value of each of the undelivered elements, and allocate
the remainder of the contract price net of all discounts to revenue recognized
from the delivered elements. Undelivered elements of a system sale may include
implementation and training services, hardware and third party software,
maintenance, future purchase discounts, or other services. If VSOE of fair value
of any undelivered element does not exist, all revenue is deferred until VSOE of
fair value of the undelivered element is established or the element has been
delivered.
We bill for the entire system sales contract amount upon contract execution,
except for maintenance which is billed separately. Amounts billed in excess of
the amounts contractually due are recorded in accounts receivable as advance
billings. Amounts are contractually due when services are performed or in
accordance with contractually specified payment dates. Provided the fees are
fixed or determinable and collection is considered probable, revenue from
licensing rights and sales of hardware and third party software is generally
recognized upon shipment and transfer of title. In certain transactions whose
collections risk is high, the cash basis method is used to recognize revenue. If
the fee is not fixed or determinable, then the revenue recognized in each period
(subject to application of other revenue recognition criteria) will be the
lesser of the aggregate of amounts due and payable or the amount of the
arrangement fee that would have been recognized if the fees were being
recognized using the residual method. Fees which are considered fixed or
determinable at the inception of our arrangements must include the following
characteristics:
• The fee must be negotiated at the outset of an arrangement, and generally be
based on the specific volume of products to be delivered without being subject
to change based on variable pricing mechanisms such as the number of units
copied or distributed or the expected number of users; and
• Payment terms must not be considered extended. If a significant portion of the fee is due more than 12 months after delivery or after the expiration of the license, the fee is presumed not fixed or determinable.
Revenue from implementation and training services is recognized as the
corresponding services are performed. Maintenance revenue is recognized ratably
over the contractual maintenance period.
Contract accounting is applied where services include significant software
modification, development or customization. In such instances, the arrangement
fee is accounted for in accordance with FASB ASC Topic 605-35, Construction-Type
and Production-Type Contracts, or ASC 605-35. Pursuant to ASC 605-35, the
Company uses the percentage of completion method provided all of the following
conditions exist:
Pursuant to ASC 605-35, we use the percentage of completion method provided all
of the following conditions exist:
• The contract includes provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement;
• The customer can be expected to satisfy its obligations under the contract;
• We can be expected to perform our contractual obligations; and
• Reliable estimates of progress towards completion can be made.
We measure completion using labor input hours. Costs of providing services,
including services accounted for in accordance with ASC 605-35, are expensed as
incurred.
If a situation occurs in which a contract is so short term that the consolidated
financial statements would not vary materially from using the
percentage-of-completion method or in which we are unable to make reliable
estimates of progress of completion of the contract, the completed contract
method is utilized.
Product returns are estimated in accordance with FASB ASC Topic 605-15, Revenue
Recognition, Products, or ASC 605-15. The Company also ensures that the other
criteria in ASC 605-15 have been met prior to recognition of revenue:
• The price is fixed or determinable;
• The customer is obligated to pay and there are no contingencies surrounding the obligation or the payment;
• The customer's obligation would not change in the event of theft or damage to the product;
• The customer has economic substance;
• The amount of returns can be reasonably estimated; and
• We do not have significant obligations for future performance in order to bring about resale of the product by the customer.
We have historically offered short-term rights of return of less than 30 days in
certain sales arrangements. If we are able to estimate returns for these types
of arrangements, revenue is recognized and these arrangements are recorded in
the consolidated financial statements. If we are unable to estimate returns for
these types of arrangements, revenue is not recognized in our consolidated
financial statements until the rights of return expire.
Revenue related to sales arrangements which include the right to use software
stored on the Company's hardware are accounted for under FASB ASC Topic
985-605-05, Software, Revenue Recognition, Hosting Arrangements, or ASC
985-605-05, which requires that for software licenses and related implementation
services to continue to fall under ASC 985-605-05, the customer must have the
contractual right to take possession of the software without incurring a
significant penalty and it must be feasible for the customer to either host the
software themselves or through another third party. If an arrangement is not
deemed to be accounted for under ASC 985-605-05, the entire arrangement is
accounted for as a service contract in accordance with ASC 985-605-25. In that
instance, the entire arrangement would be recognized as the hosting services are
being performed.
RCM revenue is derived from services fees, which include amounts charged for
ongoing billing and other related services and are generally billed to the
customer as a percentage of total collections. We do not recognize revenue for
services fees until these collections are made as the services fees are not
fixed or determinable until such time.
From time to time, we offer future purchase discounts on our products and
services as part of our sales arrangements. Pursuant to ASC 985-605-55,
discounts which are incremental to the range of discounts reflected in the
pricing of the other elements of the arrangement, which are incremental to the
range of discounts typically given in comparable transactions, and which are
significant, are treated as an additional element of the contract to be
deferred. Amounts deferred related to future purchase options are not recognized
until either the customer exercises the discount offer or the offer expires.
Revenue is divided into two categories, "system sales" and "maintenance, EDI,
RCM and other services". Revenue in the system sales category includes software
license fees, third party hardware and software, and implementation and training
services related to purchase of the Company's software systems. The majority of
the revenue in the system sales category is related to the sale of software.
Revenue in the maintenance, EDI, RCM and other services category includes,
maintenance, EDI, RCM, follow on training and implementation services, annual
third party license fees, hosting services and other revenue.
Valuation of marketable securities and ARS put option rights. Marketable
securities are recorded at fair value, based on quoted market rates or on
valuation analysis when appropriate. The cost of marketable securities sold is
based upon the specific identification method. In addition, the Company
classifies marketable securities as current or non-current
based upon whether such assets are reasonably expected to be realized in cash or
sold or consumed during the normal operating cycle of the business. Realized
gains or losses and other-than-temporary declines in the fair value of
marketable securities are determined on a specific identification basis and
reported in interest and other income, net, as incurred.
The fair value of our marketable securities has been estimated by management
based on certain assumptions of what market participants would use in pricing
the asset in a current transaction, or level 3 - unobservable inputs in
accordance with FASB ASC Topic 820-10 Fair Value Measurements and
Disclosures-Overall, or ASC 820-10(see Note 4 of our Condensed Notes to the
Consolidated Financial Statements: "Fair Value Measurements"). Management used a
model to estimate the fair value of these securities that included certain level
2 inputs as well as assumptions, including a liquidity discount, based on
management's judgment, which are highly subjective and therefore considered
level 3 inputs in the fair value hierarchy. The estimate of the fair value of
the marketable securities could change based on market conditions.
Our ARS are held by UBS Financial Services Inc. ("UBS"). On November 13, 2008,
we entered into an Auction Rate Security Rights Agreement (the Rights Agreement)
with UBS, whereby we accepted UBS' offer to purchase our ARS investments at any
time during the period of June 30, 2010 through July 2, 2012. As a result we had
obtained an asset, ARS put option rights, whereby we have a right to "put" the
ARS back to UBS. We expect to exercise our ARS put option rights and put our ARS
back to UBS on June 30, 2010, the earliest date allowable under the Rights
Agreement.
As we will be permitted to put the ARS back to UBS at par value, we have
accounted for the ARS put option rights as a separate asset that was initially
measured and will continue to be measured at its fair value. We are required to
assess the fair value of these two individual assets and to record corresponding
changes in fair value in each reporting period through the Consolidated
Statements of Income until the ARS put option rights are exercised and the ARS
are redeemed or sold. Since the ARS put option rights represent the right to
sell the securities back to UBS at par, we will be required to periodically
assess the economic ability of UBS to meet that obligation in assessing the fair
value of the ARS put options rights.
Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts
for estimated losses resulting from the inability of our customers to make
required payments. We perform credit evaluations of our customers and maintain
reserves for estimated credit losses. Reserves for potential credit losses are
determined by establishing both specific and general reserves. Specific reserves
are based on management's estimate of the probability of collection for certain
troubled accounts. General reserves are established based on our historical
experience of bad debt expense and the aging of our accounts receivable balances
net of deferred revenue and specifically reserved accounts. If the financial
condition of our customers were to deteriorate resulting in an impairment of
their ability to make payments, additional allowances would be required.
Software Development Costs. Development costs incurred in the research and
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established with the completion
of a working model of the enhancement or product, any additional development
costs are capitalized in accordance with FASB ASC Topic 985-20, Software, Costs
of Computer Software to be Sold, Leased or Marketed, or ASC 985-20. Such
capitalized costs are amortized on a straight line basis over the estimated
economic life of the related product, which is generally three years. We perform
an annual review of the recoverability of such capitalized software costs. At
the time a determination is made that capitalized amounts are not recoverable
based on the estimated cash flows to be generated from the applicable software,
any remaining capitalized amounts are written off.
Share-Based Compensation. We apply the provisions of FASB ASC Topic 718
Compensation - Stock Compensation, or ASC 718, which requires the measurement
and recognition of compensation expense for all share-based payment awards made
to employees and directors based on estimated fair values. ASC 718 requires us
to estimate the fair value of share-based payment awards on the date of grant
using an option-pricing model. We estimated the expected term of the option
using historical exercise experience. We estimate volatility by using the
weighted average historical volatility of our common stock, which we believe
approximates expected volatility. The risk free rate is the implied yield
available on the U.S Treasury zero-coupon issues with remaining terms equal to
the expected term. The expected dividend yield is the average dividend rate
during a period equal to the expected term of the option. Those inputs are then
entered into the option pricing model to determine the estimated fair value. The
value of the portion of the award that is expected to vest is recognized as
expense over the requisite service period in our consolidated statement of
income.
Research and Development Tax Credits. Management's treatment of research and
development tax credits represented a significant estimate which affected the
effective income tax rate for us for the quarter ended September 30, 2009.
Research and development credits taken by us involve
certain assumptions and judgments regarding qualified expenses under Internal
Revenue Code ("IRC") Section 41. These credits are subject to examination by the
federal and state taxing authorities.
Qualified Production Activities Deduction. Management's treatment of this
deduction represented an estimate that affected the effective income tax rate
for us for the quarters ended September 30, 2009 and 2008. The deduction taken
by us involved certain assumptions and judgments regarding the allocation of
indirect expenses as prescribed under IRC Section 199.
Goodwill. Our goodwill is related to the NextGen Division and the HSI, PMP and
Sphere acquisitions, which closed on May 20, 2008, October 28, 2008 and
August 12, 2009, respectively (see Notes 6, 7 and 8 of our Condensed Notes to
Consolidated Financial Statements). We test goodwill for impairment annually at
the end of our first fiscal quarter for the NextGen Division, HSI, PMP and
Sphere, referred to as the annual test date or between annual test dates if an
event occurs or circumstances change that would indicate the carrying amount may
be impaired. Impairment testing for goodwill is performed at a reporting unit
level and an impairment loss would generally be recognized when the carrying
amount of the reporting unit's net assets exceeds the estimated fair value of
the reporting unit.
Business Combinations. In accordance with business combination accounting under
FASB ASC Topic 805, Business Combinations, or ASC 805 we allocate the purchase
price of acquired businesses to the tangible and intangible assets acquired and
liabilities assumed based on estimated fair values. Such allocations require
management to make significant estimates and assumptions, especially with
respect to intangible assets acquired. Management's estimates of fair value are
based upon assumptions believed to be reasonable. These estimates are based on
information obtained from management of the acquired companies and are
inherently uncertain. Critical estimates in valuing certain of the intangible
assets include, but are not limited to:
• future expected cash flows from acquired businesses; and
• the acquired company's brand and market position.
Unanticipated events and circumstances may occur which may affect the accuracy
or validity of such assumptions, estimates or actual results and we will
continue to evaluate events and circumstances on an ongoing basis.
Company Overview
Quality Systems Inc., comprised of the QSI Division, NextGen Division, HSI and
PMP, develops and markets healthcare information systems that automate certain
aspects of medical and dental practices, networks of practices such as physician
hospital organizations ("PHOs") and management service organizations ("MSOs"),
ambulatory care centers, community health centers, and medical and dental
schools. The Company also provides revenue cycle management ("RCM") services
through the Practice Solutions Unit of NextGen. Operationally, our Practice
. . .
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