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QSII > SEC Filings for QSII > Form 10-K on 30-May-2013All Recent SEC Filings

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Form 10-K for QUALITY SYSTEMS, INC


30-May-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein, the matters discussed in this management's discussion and analysis of financial condition and results of operations ("MD&A"), including discussions of our product development plans, business strategies and market factors influencing our results, may include forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation and competition from larger, better-capitalized competitors. Many other economic, competitive, governmental and technological factors could 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, as well as in our other public disclosures and filings with the Securities and Exchange Commission ("SEC"). Overview
This 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. Our MD&A is organized as follows:
•         Management Overview. This section provides a general description of our
          Company and operating segments, a discussion as to how we derive our
          revenue, background information on certain trends and developments
          affecting our Company, a summary of our acquisition transactions and a
          discussion on management's strategy for driving revenue growth.


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•         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, "Summary of Significant
          Accounting Policies," of our notes to consolidated financial statements
          included elsewhere 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
          income, 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 and discussions of our contractual
          obligations and commitments as of March 31, 2013.


•         New 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. and its wholly-owned subsidiaries operate as four business divisions (each, a "Division") which are comprised of: (i) the QSI Dental Division, (ii) the NextGen Division, (iii) the Hospital Solutions Division (formerly Inpatient Solutions) and (iv) the RCM Services Division (formerly Practice Solutions). In fiscal year 2011, we opened a captive entity in India called Quality Systems India Healthcare Private Limited ("QSIH"). We primarily derive revenue by developing and marketing 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 along with comprehensive systems implementation, maintenance and support and add on complementary services such as revenue cycle management ("RCM") and electronic data interchange ("EDI"). Our systems and services provide our clients with the ability to redesign patient care and other workflow processes while improving productivity through the facilitation of managed access to patient information. Utilizing our proprietary software in combination with third-party hardware and software solutions, our products enable the integration of a variety of administrative and clinical information operations.
In the last few years, we have continued to acquire companies that were established developers of software and services for the inpatient market to operate under the Hospital Solutions Division. On May 1, 2012, we acquired Poseidon, a provider of emergency department software. On July 26, 2011, we acquired CQI, a provider of hospital systems for surgery management. On April 29, 2011, we acquired IntraNexus, a provider of Web-based integrated clinical and hospital information systems. On February 10, 2010, we acquired Opus, a provider of Web-based clinical solutions to hospital systems and integrated health networks nationwide and on August 12, 2009 we acquired Sphere, a provider of financial information systems to the small hospital inpatient market. These acquisitions are part of our strategy to continue to expand in the small hospital market and to add new clients by taking advantage of cross selling opportunities between the ambulatory and inpatient markets. On November 14, 2011, we acquired ViaTrack, a developer and provider of information technologies that enhance EDI offerings. This acquisition provides a platform to pursue significant opportunities that exist to add EDI services to our portfolio of offerings in the Inpatient market and is operating under the QSI Dental Division.
On April 15, 2012, we acquired Matrix, a value-added reseller for NextGen Healthcare, that provides RCM services, healthcare IT solutions and training, implementation and support centered on NextGen® technology, to its clients nationwide. The acquisition will enable our RCM Services Division to expand its footprint among private and hospital-based physicians and groups by leveraging Matrix's RCM expertise.
In January 2011, QSIH was formed in Bangalore, India to function as our India-based captive to offshore technology application development and business processing services.
We have benefited and hope to continue to benefit from the increased demands on healthcare providers for greater efficiency and lower costs, financial incentives from the ARRA to physicians who adopt electronic health records, as well as increased adoption rates for electronic health records and other technology in the healthcare arena. We also believe that healthcare reform and the movement towards pay for performance/quality initiatives will also stimulate demand for robust electronic health record solutions as well as new HIT solutions from bundled billing capabilities to patient engagement and population health management.
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 hospital, insurance payers and other entities. Hospital software providers are leveraging their position with their hospital customers 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 such as NextGen. Our strategy is to focus addressing upcoming 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 including ICD-10 and meaningful use requirements for stimulus payments. 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 intend to continue the development and enhancement of our software solutions to support healthcare reform and the


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transition from fee for service to pay for performance/quality initiatives such as accountable care organizations. Key elements of our future software development will be to continue to integrate our ambulatory and inpatient products, making our products more intuitive and easy to use, and enhancing our ability to deliver our software over the cloud with the latest technology. We also want to continue investments in our infrastructure including but not limited to product development, sales, marketing, implementation and support, to continue efforts to make infrastructure investments within an overall context of maintaining reasonable expense discipline, to add new clients through maintaining and expanding sales, marketing and product development activities and to expand our relationship with existing clients through delivery of add-on and complementary products and services while continuing our gold-standard commitment of service in support of our client satisfaction programs. We believe that our growing customer base that is using our software on a daily basis is a strategic asset, and we intend to expand our product and service offerings towards this customer base in order to leverage this strategic asset. 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 (including but not limited to those related to revenue recognition, uncollectible accounts receivable, software development cost, intangible assets and self-insurance accruals) for reasonableness. We base our estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe that the significant accounting policies, as described in Note 2 of our 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. We believe the following table depicts the most critical accounting policies that affect our consolidated financial statements:

Revenue Recognition               Judgments and Uncertainties

We generate revenue from the      A typical system contract contains multiple
sale of licensing rights to       elements of the items discussed. Revenue earned
use our software products         on software arrangements involving multiple
sold directly to end-users        elements is allocated to each element based on
and value-added resellers, or     the relative fair values of those elements. The
VARs. We also generate            fair value of an element is based on
revenue from sales of             vendor-specific objective evidence ("VSOE").
hardware and third party          The Company limits its assessment of VSOE for
software, implementation,         each element to either the price charged when
training, software                the same element is sold separately or the
customization, EDI,               price established by management having the
post-contract support             relevant authority to do so, for an element not
(maintenance) and other           yet sold separately. VSOE calculations are
services, including RCM and       updated and reviewed quarterly or annually
hosting services, performed       depending on the nature of the product or
for clients who license our       service. The Company generally establishes VSOE
products.                         for the related undelivered elements based on
                                  the bell-shaped curve method. Maintenance VSOE
Revenue from implementation       for the Company's largest clients is based on
and training services is          stated renewal rates only if the rate is
recognized as the                 determined to be substantive and falls within
corresponding services are        the Company's customary pricing practices.
performed. Maintenance
revenue is recognized ratably     When evidence of fair value exists for the
over the contractual              delivered and undelivered elements of a
maintenance period. RCM           transaction, then discounts for individual
revenue is derived from           elements are aggregated and the total discount
services fees, which include      is allocated to the individual elements in
amounts charged for ongoing       proportion to the elements' fair value relative
billing and other related         to the total contract fair value.
services and are generally
billed to the client as a         When evidence of fair value exists for the
percentage of total               undelivered elements only, the residual method
collections. We do not            is used. Under the residual method, the Company
recognize revenue for             defers revenue related to the undelivered
services fees until these         elements in a system sale based on VSOE of fair
collections are made as the       value of each of the undelivered elements and
services fees are not fixed       allocates the remainder of the contract price
or determinable until such        net of all discounts to revenue recognized from
time. Contract accounting is      the delivered elements. If VSOE of fair value
applied where services            of any undelivered element does not exist, all
include significant software      revenue is deferred until VSOE of fair value of
modification, development or      the undelivered element is established or the
customization.                    element has been delivered.

                                  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 physical or electronic shipment and
                                  transfer of title. In certain transactions
                                  where collection risk is high, the revenue is
                                  deferred until collection occurs or becomes
                                  probable. If the fee is not fixed or
                                  determinable, then the revenue recognized in
                                  each period (subject to application of other
                                  revenue recognition criteria) will be the
                                  lesser of the aggregate of amounts due and
                                  payable or the amount of the arrangement fee
                                  that would have been recognized if the fees
                                  were being recognized using the residual
                                  method. Fees which are considered fixed or
                                  determinable at the inception of the Company's
                                  arrangements must include the following

characteristic:


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                                  ¤  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.

                                  Effect if Actual Results Differ from
                                  Assumptions

                                  Although we believe that our approach to
                                  estimates and judgments as described herein is
                                  reasonable, actual results could differ and we
                                  may be exposed to increases or decreases in
                                  revenue that could be material.

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

                                  Effect if Actual Results Differ from
                                  Assumptions
                                  Although we believe that our approach to
                                  estimates and judgments as described herein is
                                  reasonable, actual results could differ and we
                                  may be exposed to increases or decreases in
                                  required reserves that could be material.

Software Development Costs        Judgments and Uncertainties

Development costs incurred in     We periodically reassess the estimated economic
the research and development      life and the recoverability of such capitalized
of new software products and      software costs. If a determination is made that
enhancements to existing          capitalized amounts are not recoverable based
software products for             on the estimated cash flows to be generated
external use are expensed as      from the applicable software, any remaining
incurred until technological      capitalized amounts are written off.
feasibility has been
established. After                Effect if Actual Results Differ from
technological feasibility is      Assumptions
established, any additional
external software development     Although we believe that our approach to
costs are capitalized and         estimates and judgments as described herein is
amortized on a straight-line      reasonable, actual results could differ and we
basis over the estimated          may be exposed to increases or decreases in
economic life of the related      revenue that could be material.
product, which is typically
three years.

Goodwill                          Judgments and Uncertainties

                                  The Company tests goodwill for impairment
                                  annually during its first fiscal quarter,
                                  referred to as the annual test date. The
                                  Company 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. Impairment
                                  testing for goodwill is performed at a
                                  reporting-unit level, which is defined as an
                                  operating segment or one level below an
                                  operating segment (referred to as a
                                  component). A component of an operating segment
                                  is a reporting unit if the component
                                  constitutes a business for which discrete
                                  financial information is available and segment
                                  management regularly reviews the operating
                                  results of that component.

                                  Effect if Actual Results Differ from
                                  Assumptions


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In fiscal 2013 we adopted the new provisions issued by the Financial Accounting Standards Board ("FASB"), that intended to simplify goodwill impairment testing. The updated guidance permits us to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we conduct a two-step quantitative goodwill impairment test. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their carrying values. If the carrying amount of the reporting unit exceeds the reporting unit's fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. The amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. During the quarter ended December 31, 2012 and subsequently at March 31, 2013, certain events and circumstances indicated the possibility that the carrying value of goodwill could potentially be impaired. Refer to the

                                  "Impairment of Goodwill" section within the
                                  "Comparison of the Fiscal Years Ended March 31,
                                  2013 and March 31, 2012" discussion below for
                                  information regarding the impairment of
                                  goodwill at March 31, 2013.

                                  We do not believe there is a reasonable
                                  likelihood that there will be a material change
                                  in the future estimates or assumptions we use
                                  to test for impairment losses on goodwill.
                                  However, if actual results are not consistent
                                  with our estimates or assumptions, we may be
                                  exposed to future impairment charges that could
                                  be material.

Business Combinations -
Purchase Price Allocations        Judgments and Uncertainties

During the last three fiscal      In accordance with the accounting for business
years, we completed five          combinations, we allocate the purchase price of
acquisitions: Poseidon,           acquired businesses to the tangible and
Matrix, ViaTrack, CQI and         intangible assets acquired and liabilities
IntraNexus.                       assumed based on estimated fair values. Our
                                  purchase price allocation methodology contains
                                  uncertainties because it requires management to
                                  make assumptions and to apply judgment to
                                  estimate the fair value of acquired assets and
                                  liabilities. Management estimates the fair
                                  value of assets and liabilities based upon
                                  quoted market prices, the carrying value of the
                                  acquired assets and widely accepted valuation
                                  techniques, including discounted cash flows and
                                  market multiple analyses. Unanticipated events
                                  or circumstances may occur which could affect
                                  the accuracy of our fair value estimates,
                                  including assumptions regarding industry
                                  economic factors and business strategies.

                                  Effect if Actual Results Differ from
                                  Assumptions

                                  We do not believe there is a reasonable
                                  likelihood that there will be a material change
                                  in the future estimates or assumptions we use
                                  to complete the purchase price allocation and
                                  estimate the fair value of acquired assets and
                                  liabilities. However, if actual results are not
                                  consistent with our estimates or assumptions,
                                  we may be exposed to losses or gains that could
                                  be material.

Intangible Assets                 Judgments and Uncertainties

Intangible assets consist of      These intangible assets are recorded at fair
trade names and contracts,        value and are stated net of accumulated
customer relationships, and       amortization. The Company currently amortizes
software technology, all is       the intangible assets using a method that
which arose in connection         reflects the pattern in which the economic
with the acquisitions             benefits of the intangible asset are consumed.
completed during the last
three fiscal years.

                                  Effect if Actual Results Differ from
                                  Assumptions

                                  Although we believe that our approach to
                                  estimates and judgments as described herein is
. . .
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