On August 11, 2014, our shareholders approved an Employee Share Purchase Plan (the “Purchase Plan”) under which 4,000,000 shares of common stock were reserved for future grant. The Purchase Plan allows eligible employees to purchase shares through payroll deductions of up to 15% of total base salary at a price equal to 90% of the lower of the fair market values of the shares as of the beginning or the end of the corresponding offering period. Any shares purchased under the Purchase Plan are subject to a six-month holding period. Employees are limited to purchasing no more than 1,500 shares on any single purchase date and no more than $25,000 in total fair market value of shares during any one calendar year. As of December 31, 2015,2016, we have issued 95,190209,876 shares under the Purchase Plan and 3,904,8103,790,124 shares are available for future issuance.
We had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at December 31, 2015.2016. We are exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the institutions; however, we do not anticipate non-performance by these institutions.
Our software license agreements include a performance guarantee that our software products will substantially operate as described in the applicable program documentation for a period of 365 days after delivery. To date, we have not incurred any significant costs associated with our performance guarantee or other related warranties and do not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties. Certain arrangements also include performance guarantees related to response time, availability for operational use, and other performance-related guarantees. Certain arrangements also include penalties in the form of maintenance credits should the performance of the software fail to meet the performance guarantees. To date, we have not incurred any significant costs associated with these warranties and do not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties.
Our standard sales agreements contain an indemnification provision pursuant to which we shall indemnify, hold harmless, and reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with any United States patent, any copyright or other intellectual property infringement claim by any third-party with respect to our software. As we have not incurred any significant costs to defend lawsuits or settle claims related to these indemnification agreements, we believe that our estimated exposure on these agreements is currently minimal. Accordingly, we have no liabilities recorded for these indemnification obligations.
On October 7, 2013, a complaint was filed against our Company and certain of our officers and directors in the Superior Court of the State of California for the County of Orange, captioned Ahmed D. Hussein v. Sheldon Razin, Steven Plochocki, Quality Systems, Inc. and Does 1-10, inclusive, No. 30-2013-00679600-CU-NP-CJC, by Ahmed Hussein, a former director and significant shareholder of our Company. We filed a demurrer to the complaint, which the courtCourt granted on April 10, 2014. An amended complaint was filed on April 25, 2014. The amended complaint generally alleges fraud and deceit, constructive fraud, negligent misrepresentation and breach of fiduciary duty in connection with statements made to our shareholders regarding our financial condition and projected future performance. The amended complaint seeks actual damages, exemplary and punitive damages and costs. We filed a demurrer to the amended complaint. On July 29, 2014, the courtCourt sustained the demurrer with respect to the breach of fiduciary duty claim, and overruled the demurrer with respect to the fraud and deceit claims. On August 28, 2014, we filed an answer and also filed a cross-complaint against the plaintiff, alleging that the plaintiff breached fiduciary duties owed to the Company, Mr. Razin and Mr. Plochocki. Mr. Razin and Mr. Plochocki have dismissed their claims against Hussein, leaving QSI as the sole plaintiff in the cross-complaint. On June 26, 2015, we filed a motion for summary judgment, which the courtCourt granted on September 16, 2015, dismissing all claims against us. On September 23, 2015, the plaintiff filed an application for reconsideration of the Court's summary judgment order, which the courtCourt denied. On October 28, 2015, the plaintiff filed a motion for summary judgment, seeking to dismiss our cross-complaint. The hearingcross-complaint, which the Court denied on March 3, 2016. On May 9, 2016, the plaintiff'splaintiff filed a motion for summary adjudication, seeking to again dismiss our cross-complaint, which the Court denied on August 5, 2016. On August 5, 2016, the plaintiff filed a motion for judgment on the pleadings, seeking to again
On November 19, 2013, a putative class action complaint was filed on behalf of the shareholders of our Company other than the defendants against us and certain of our officers and directors in the United States District Court for the Central District of California by one of our shareholders. After the courtCourt appointed lead plaintiffs and lead counsel for this action, and recaptioned the action In re Quality Systems, Inc. Securities Litigation, No. 8L13-cv-01818-CJC(JPRx), lead plaintiffs filed an amended complaint on April 7, 2014. The amended complaint, which is substantially similar to the litigation described above under the caption “Hussein Litigation,” generally alleges that statements made to our shareholders regarding our financial condition and projected future performance were false and misleading in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and that the individual defendants are liable for such statements because they are controlling persons under Section 20(a) of the Exchange Act. The complaint seeks compensatory damages, court costs and attorneys' fees. We filed a motion to dismiss the amended complaint on June 20, 2014, which the courtCourt granted on October 20, 2014, dismissing the complaint with prejudice. Plaintiffs filed a motion for reconsideration of the Court's order, which the courtCourt denied on January 5, 2015. On January 30, 2015, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Ninth Circuit, captioned In re Quality Systems, Inc. Securities Litigation, No. 15-55173. Plaintiffs filed their opening brief and we answered. Oral argument is not yet scheduled.was held on December 5, 2016. The Court's decision remains pending. We believe that the plaintiffs' claims are without merit and continue to defend against them vigorously. At this time, we are unable to estimate the probability or the amount of liability, if any, related to this claim.
On January 24, 2014, a complaint was filed against our Company and certain of our officers and current and former directors in the United States District Court for the Central District of California, captioned Timothy J. Foss, derivatively on behalf of himself and all others similarly situated, vs. Craig A. Barbarosh, George H. Bristol, James C. Malone, Peter M. Neupert, Morris Panner, D. Russell Pflueger, Steven T. Plochocki, Sheldon Razin, Lance E. Rosenzweig and Quality Systems, Inc., No. SACV14-00110-DOC-JPPx, by Timothy J. Foss, a shareholder of ours. The complaint arises from the same allegations described above under the captions “Hussein Litigation” and “Federal Securities Class Action” and generally alleges breach of fiduciary duties, abuse of control and gross mismanagement by our directors, in addition to unjust enrichment and insider selling by individual directors. The complaint seeks compensatory damages, restitution and disgorgement of all profits, court costs, attorneys’ fees and implementation of enhanced corporate governance procedures. The parties have agreed to stay this litigation until the United States Court of Appeals for the Ninth Circuit issues a ruling on the pending appeal described above under the caption “Federal Securities Class Action”. We believe that the plaintiff’s claims are without merit and intend to defend against them vigorously. At this time, we are unable to estimate the probability or the amount of liability, if any, related to this claim.
13.14. Operating Segment Information
Effective July 1, 2016, we revised our reportable operating segments. As part of December 31, 2015, our Company has three reportableongoing reorganization efforts, we refined the measurement of our segment data to better reflect our current internal organizational structure whereby certain functions that formerly existed within each individual operating segment have changed. Our operating segments that arenow consist of the Software and Related Solutions segment and the RCM and Related Services segment, which is consistent with the disaggregated financial information used and evaluated regularly by our chief operating decision making groupmaker (consisting of our Chief Executive Officer, Interim Chief Financial OfficerOfficer) to assess performance and Chief Operating Officer) in deciding how to allocate resourcesmake decisions about the allocation of resources. Revenue and in assessing performance. The Hospital Solutions Division operatinggross profit are the key measures of segment data for the three and nine months ended December 31, 2015 are reflected through the date of disposition on October 22, 2015.
Operating segment data is as follows: |
| | | | | | | | | | | | | | | | |
| | | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | | 2015 | | 2014 | | 2015 | | 2014 |
| Revenues: | | | | | | | | |
| NextGen Division | | $ | 88,693 |
| | $ | 92,054 |
| | $ | 275,282 |
| | $ | 276,914 |
|
| RCM Services Division | | 22,994 |
| | 21,913 |
| | 67,989 |
| | 58,226 |
|
| QSI Dental Division | | 4,726 |
| | 4,480 |
| | 13,825 |
| | 13,379 |
|
| Hospital Solutions Division | | 619 |
| | 4,977 |
| | 7,469 |
| | 13,318 |
|
| Consolidated revenue | | $ | 117,032 |
| | $ | 123,424 |
| | $ | 364,565 |
| | $ | 361,837 |
|
| | | | | | | | | |
| Income (loss) from operations: | | |
| | | | | | |
| NextGen Division | | $ | 42,012 |
| | $ | 45,108 |
| | $ | 134,510 |
| | $ | 134,166 |
|
| RCM Services Division | | 4,838 |
| | 4,681 |
| | 13,334 |
| | 9,583 |
|
| QSI Dental Division | | 1,783 |
| | 1,523 |
| | 4,369 |
| | 3,859 |
|
| Hospital Solutions Division | | (2,103 | ) | | 372 |
| | (927 | ) | | (2,150 | ) |
| Corporate and unallocated | | (38,093 | ) | | (43,474 | ) | | (121,319 | ) | | (122,234 | ) |
| Consolidated operating income | | $ | 8,437 |
| | $ | 8,210 |
| | $ | 29,967 |
| | $ | 23,224 |
|
The major components of the Corporate and unallocated amounts are summarized in the table below:
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | | 2015 | | 2014 | | 2015 | | 2014 |
| Research and development costs | | $ | 14,518 |
| | $ | 18,468 |
| | $ | 49,584 |
| | $ | 51,602 |
|
| Amortization of capitalized software costs | | 2,499 |
| | 3,073 |
| | 7,428 |
| | 10,190 |
|
| Marketing expense | | 2,925 |
| | 3,328 |
| | 9,664 |
| | 9,439 |
|
| Other Corporate and overhead costs | | 18,151 |
| | 18,605 |
| | 54,643 |
| | 51,003 |
|
| Total Corporate and unallocated | | 38,093 |
| | 43,474 |
| | 121,319 |
| | 122,234 |
|
Assets by segment are not tracked orprofitability used by our chief operating decision making groupmaker to allocate resources or to assessmeasure segment operating performance and thusto make key business decisions. The revenues and gross profit of each segment are derived from distinct product and services within each segment. The Software and Related Solutions segment aggregates the revenues and gross profit of our software-related products and services, including software license and hardware, software-related subscription services, support and maintenance, EDI and data services, and certain professional services, such as implementation, training, and consulting. The RCM and Related Services segment aggregates the revenues and gross profit of our RCM services and certain related ancillary service offerings.
Certain functional roles that do not includedengage in the table above.
The amounts classifiedrevenue generating activities, such as Corporateproduct solutions and unallocated consist primarily ofstrategy, research and development, and certain corporate general and administrative costs, non-recurring acquisition and transaction-related costs, recurring post-acquisition amortization of certain acquired intangible assets and amortization of capitalized software costs, as well as costs of other centrally managed overhead and shared-services functions, including accounting and finance, human resources, marketing, and legal, are considered to be shared-services and research and development, that are not controlled by segment levelsegment-level leadership. Although the segments may derive direct benefits as a result of such costs,shared-services functions, our chief operating decision making groupmaker evaluates performance based upon stand-alone segment revenues and gross profit. Accordingly, the shared-services functions are not considered separate operating income, which excludes these Corporatesegments, and unallocated amounts.
Effective April 1, 2015, as partthe related operating expenses are not included within our operating segments disclosure. Additionally, total assets are managed at a consolidated level and thus are also not included within our operating segments disclosure. Accounting policies for each of our ongoing effortsoperating segments are the same as those applied to refine the measurement of our consolidated financial statements.
Operating segment data to better reflect an organizational structure whereby certain expenses managed by functional area leadership are no longer classified withinfor the operating segments but rather as a component of Corporatethree and unallocated, we no longer classify certain costs within the information servicesnine months ended December 31, 2016 and credit granting and collections functional areas, such as bad debt expense and other information services related general and administrative costs, within the operating segments. Such classification2015 is consistent with the disaggregated financial information used by our chief decision making group. We have retroactively reclassified the prior year operating incomesummarized in the table abovebelow. Prior period data has been retroactively reclassified to present all segment information on a comparable basis. The change in reportable segments has no impact to consolidated revenues and consolidated cost of revenue, nor does it affect our presentation of revenue and cost of revenue on the consolidated statements of comprehensive income.
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | | 2016 | | 2015 | | 2016 | | 2015 |
| Revenue: | | | | | | | | |
| Software and Related Solutions | | $ | 106,958 |
| | $ | 93,927 |
| | $ | 312,854 |
| | $ | 291,783 |
|
| RCM and Related Services | | 20,910 |
| | 22,486 |
| | 64,385 |
| | 65,313 |
|
Hospital Solutions(1) | | — |
| | 619 |
| | — |
| | 7,469 |
|
| Consolidated revenue | | $ | 127,868 |
| | $ | 117,032 |
| | $ | 377,239 |
| | $ | 364,565 |
|
| | | | | | | | | |
| Gross profit (loss): | | | | | | | | |
| Software and Related Solutions | | $ | 71,252 |
| | $ | 58,949 |
| | $ | 204,414 |
| | $ | 184,982 |
|
| RCM and Related Services | | 7,077 |
| | 7,769 |
| | 21,337 |
| | 20,792 |
|
Hospital Solutions(1) | | — |
| | (69 | ) | | — |
| | 2,569 |
|
Unallocated cost of revenue(2) | | (4,813 | ) | | (3,402 | ) | | (15,676 | ) | | (10,138 | ) |
| Consolidated gross profit | | $ | 73,516 |
| | $ | 63,247 |
| | $ | 210,075 |
| | $ | 198,205 |
|
(1) The former Hospital Solutions Division was divested in October 2015 and therefore, does not represent a distinct operating segment. Historical amounts for Hospital Solutions have not been revised.
(2) Consists of amortization of acquired software technology and amortization of capitalized software costs not allocated to the operating segments for the purposes of measuring performance.
15. Restructuring Plan
In fiscal year 2016, we initiated a three-phase plan intended to better position our organization for future success. We implemented a series of actions with the objective of achieving greater synergies and further integration of our products and services in support of our business strategies, and enabling a more efficient, integrated and client-centered delivery of the holistic solutions that we believe is required by our ambulatory care clients. We also transformed our management team with the appointment of a new chief executive officer, chief financial officer, chief technology officer, chief strategy officer, and chief client officer. In the first phase, we redesigned the organization to more effectively support the execution of our strategy. Under phase two of our reorganization, we will continue to build our infrastructure and enhance our healthcare information technology capabilities to drive future revenue growth. The third phase of the plan will consist of developing and marketing the services and solutions that we believe will accelerate revenue growth.
The overall plan also includes a multi-year initiative, called NextGen 2.0, to merge our business units into a more streamlined, functional-based organization structure and to realign our organizational structure by consolidating the sales, marketing, information services, and software development responsibilities into single, company-wide roles in order to achieve greater efficiency. As a result, our reportable segments have changed and may change again due to such changes in the organization of our business.
The first phase was completed in April 2016, when we announced a corporate restructuring plan, which was approved by our Board of Directors. During the three and nine months ended December 31, 2016, we recorded $231 and $4,685, respectively, of restructuring costs within operating expenses in our consolidated statements of comprehensive income. The restructuring costs consist primarily of payroll-related costs, such as severance, outplacement costs, and continuing healthcare coverage, associated with the involuntary separation of employees pursuant to a one-time benefit arrangement, which were accrued when it was probable that the benefits will be paid and the amount were reasonably estimable. The remaining restructuring liability as of December 31, 2016 was not significant. The restructuring plan is expected to be complete by the end of fiscal 2017.
14. Subsequent Events
On January 4, 2016, we entered into a $250,000 revolving credit agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A., as administrative agent, U.S. Bank National Association, as syndication agent, and certain other lenders. The initial draw down on the Credit Agreement was approximately $173,509. The Credit Agreement is secured by substantially all of our existing and future property and material domestic subsidiaries. The Credit Agreement provides a subfacility of up to $10,000 for letters of credit and a subfacility of up to $10,000 for swing-line loans. The Credit Agreement matures on January 4, 2021 and the full balance of the revolving loans and all other obligations under the agreement must be paid at that time.
The revolving loans under the Credit Agreement bear interest at our option of either, (a) a base rate based on the highest of (i) the rate of interest per annum publicly announced from time to time by JPMorgan Chase Bank, N.A., as its prime rate, (ii) the greater of (A) the federal funds effective rate and (B) the overnight bank funding rate (as determined by the Federal Reserve Bank of New York) plus 0.50% and (iii) the one-month LIBOR plus 1.00%) plus an applicable margin based on our leverage ratio from time to time, ranging from 0.50% to 1.50%, or (b) a LIBOR-based rate (subject to a floor of 0.00%) plus an applicable margin based on our leverage ratio from time to time, ranging from 1.50% to 2.50%. We will also pay a commitment fee of between 0.25% and 0.45%, payable quarterly in arrears, on the average daily unused amount of the revolving facility based on our leverage ratio from time to time.
The revolving loans are subject to customary representations, warranties and ongoing affirmative and negative covenants and agreements. The negative covenants include, among other things, limitations on indebtedness, liens, asset sales, mergers and acquisitions, investments, transactions with affiliates, dividends and other restricted payments, subordinated indebtedness and amendments to subordinated indebtedness documents and sale and leaseback transactions. The Credit Agreement also requires us to maintain a maximum leverage ratio and minimum fixed charge coverage ratio. The revolving loans under the Credit Agreement will be available for letters of credit, working capital and general corporate purposes.
Also on January 4, 2016, we completed our acquisition of HealthFusion Holdings, Inc. ("HealthFusion") pursuant to the Agreement and Plan of Merger (the “Merger Agreement"), dated October 30, 2015. HealthFusion provides Web-based, cloud computing software for physicians, medical billing service providers, and hospitals. Its flagship product, MediTouch, is a fully-integrated, cloud-based software suite consisting of clearinghouse, practice management, electronic health records, and patient portals with rich functionality to enable mobility, workflow automation, and advanced reporting and analytics aimed primarily at small-to-mid-size physician practices. The acquisition of HealthFusion is part of our strategy to expand its client base and cloud-based solution capabilities in the ambulatory market. Over time, we plan to expand the HealthFusion platform to satisfy the needs of practices of increasing size and complexity.
Total cash consideration paid was $165,000, subject to certain adjustments in accordance with the Merger Agreement. In addition, we may pay up to an additional $25,000 in cash in the form of an earnout, subject to HealthFusion achieving certain revenue targets through December 31, 2016. This acquisition was funded by our initial draw down of the Credit Agreement, a portion of which has been subsequently repaid from our cash on hand. We are in the process of determining the purchase price allocation for this acquisition.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q ("Report") and certain information incorporated herein by reference contain forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Quarterly Report, on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,” “will,” “should,” “would,” “could,” “may,” and similar expressions also identify forward-looking statements. These forward-looking statements include, without limitation, discussions of our product development plans, business strategies, future operations, financial condition and prospects, developments in and the impacts of government regulation and legislation, including, without limitation, The American Recovery and Reinvestment Act, ("ARRA"), the Patient Protection and Affordable Care Act, ("PPACA"), and the Medicare Access and CHIP Reauthorization Act of 2015, ("MACRA"), and market factors influencing our results. Our expectations, beliefs, objectives, intentions and strategies regarding our future results are not guarantees of future performance and are subject to risks and uncertainties, both foreseen and unforeseen, that could cause actual results to differ materially from results contemplated in our forward-looking statements. These risks and uncertainties include, but are not limited to, our ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation, and competition from larger, better-capitalized competitors. Many other economic, competitive, governmental and technological factors could affect our ability to achieve our goals, and interested persons are urged to review any risks that may be described in “Item 1A. Risk Factors” as set forth herein and other risk factors appearing in our most recent Annual Report on Form 10-K for the fiscal year ended March 31, 20152016 (“Annual Report”), as supplemented by additional risk factors, if any, in our interim filings on our Quarterly Reports on Form 10-Q, as well as in our other public disclosures and filings with the Securities and Exchange Commission ("SEC"). Because of these risk factors, as well as other variables affecting our financial condition and results of operations, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. We assume no obligation to update any forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of the filing of this Quarterly Report on Form 10-Q.Report.
This management's discussion and analysis of financial condition and results of operations ("MD&A") is provided as a supplement to the consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q.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 and a discussion on management’s strategy for driving revenue growth.
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 1, “Summary of Significant Accounting Policies,” of our notes to consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Company Overview. This section provides a more detailed description of our Company, its operating segments, a summary of our recent acquisition transactions and the products and services we offer.
Overview of Results of Operations and Results of Operations by Divisions. These sections provide our analysis and outlook for the significant line items on our consolidated statements of comprehensive income, as well as other information that we deem meaningful to understand our results of operations on both a consolidated basis and divisional basis.
Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows.
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., primarily through its NextGen Healthcare subsidiary, provides technology-based solutions and its wholly-owned subsidiaries operate as three business divisions (each, a "Division") which are comprised of: (i)services to the NextGen Division, (ii) the RCM Services Division, and (iii) the QSI Dental Division. The Hospital Solutions Division was sold to QuadraMed Affinity Corporation (part of the Harris Operating Group of Constellation Software Inc.) on October 22, 2015. We also have 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”), accountable care organizations, 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”).market in the United States. Our systems and servicessolutions provide our customersclients with the ability to redesign patient care and other workflow processes while improving productivity through the facilitation of managed access to patient information. UtilizingWe help promote healthy communities by empowering physician practice success and enriching the patient care experience while lowering the cost of healthcare.
We primarily derive revenue by developing and marketing software and services that automate certain aspects of practice management (“PM”) and electronic health records (“EHR”) for medical and dental practices. Our software can be licensed on a perpetual, on-premise basis, hosted in a private cloud or, in certain instances, as a software-as-a-service (“SaaS”) solution. We market and sell our proprietarysolutions through a dedicated sales force and to a much lesser extent, through resellers. Our clients include single and small practice physicians, networks of practices such as physician hospital organizations (“PHOs”), management service organizations (“MSOs”), accountable care organizations (“ACOs”), ambulatory care centers, community health centers and medical and dental schools. We also provide implementation, training, support and maintenance for software in combination with third party hardware and software solutions, our products enablecomplementary services such as revenue cycle management (“RCM”) and electronic data interchange (“EDI”).
We have a history of developing new and enhanced technologies. Over the integrationcourse of a varietynumber of administrativeyears, we have also made strategic acquisitions to complement and clinical information operations. Our scalable interoperability and population health offerings help to improve care collaboration, quality and safety. Enabled byenhance our interoperability and enterprise analytics solutions, data-driven patient population healthcare management decisions can assist in creating more desirable operational, clinical, and financial outcomes that substantiate the value of patient-centered and accountable care models.
The turbulenceproduct portfolio in the worldwide economy has impacted almost all industries. Whileambulatory care, RCM, and hospital markets.
Quality Systems, Inc. was incorporated in California in 1974. Our principal offices are located at 18111 Von Karman Ave., Suite 800, Irvine, California, 92612. Our websites are located at www.nextgen.com and www.qsii.com. We operate on a fiscal year ending on March 31.
Trends and Events in Our Business
We believe that the following trends and events as described below have contributed to our consolidated results of operations and may continue to impact our future results.
We believe healthcare is not immune to economic cycles, we believe it is more heavily influenced by U.S.-based regulatory and national health projects than by the cycles of our economy. The impact of the current economic conditions on our existing and prospective customers has been mixed. Various factors have had, and are anticipated to continue to have, a meaningful impact on the U.S. healthcare industry. Particularly, the healthcare industry has been significantly impacted by the Obama Administration's broad healthcare reform efforts, including the Health Information Technology for Economic and Clinical Health ("HITECH") portion of the American Recovery and Reinvestment Act of 2009 ("ARRA"HITECH Act") and the Patient Protection and Affordable Care Act ("PPACA"ACA") that providesprovided significant incentives to health care organizations for "Meaningful Use" adoption and interoperable electronic health record solutions, the mandate requiring individuals to obtain insurance, the individual state responses to the government-requested Medicaid expansion, the creation and operation of insurance exchanges, and the increasing focus of private businesses on moving their employee health benefit offerings to a more wellness-based health platform.solutions.
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 HITECH portion of 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, including the repeal of the sustainable growth rate (SGR)("SGR") formula in April 2015 as part of the Medicare Access and CHIP Reauthorization Act of 2015 ("MACRA"), and a movement towards a value-based, pay for performancepay-for-performance model and quality initiative efforts will also stimulate demand for robust electronic health record solutions as well as new healthcarehealth information technology solutions from bundled billing capabilities to patient engagement and population health management. We believe MACRA may be the most important of the three regulations for our market because it permanently changes how ambulatory healthcare providers are reimbursed by Medicare. It offers certainty and a timeline for the market’s move away from volume-based, fee-for-service models to value-based payment models that reward the delivery of lower cost, high quality care.
While we expect to benefit from the increasing demands for greater efficiency as well as government support for increased adoption of electronic health records, systems, the market for physician based electronic health records software is becoming increasingly saturated while physician group practices are rapidly being consolidated by hospital,hospitals, insurance payers and other entities. Hospital software providers are leveraging their position with their hospital customersclients to gain market share with hospital owned physician practices. Insurance providers and large physician groups are also consolidating physician offices creating additional opportunity for ambulatory software providers like us. Our strategy is to focus on addressing the growing needs of accountable care organizations around interoperability, patient engagements, population health, and collaborative care management, 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 includingand 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, such as the recently enacted MACRA, which promotes the transition from fee-for-service to value-based, pay-for-performance and patient-centric care and quality initiatives such as accountable care organizations. Key elements of our future software development will be to expand our interoperability capabilities enhancing the competitiveness of our software offerings, make our products more intuitive and easy to use, and to enhance the capability of our abilityMediTouch® Platform to allow us to deliver our software over the cloud to larger ambulatory care practices.
In addition to the activities described above, mergers and acquisitions have been important to our development. In September 2013 we acquired Mirth Corporation ("Mirth"), a global leader in health information technology that helps clients achieve interoperability. In April 2015, we acquired Gennius, Inc. ("Gennius"), a population health analytics company which we believe enhances and leverages our acquisition of Mirth by broadening our business intelligence capabilities in the growing population health and value based care areas. In January 2016, we completed the acquisition of HealthFusion Holdings, Inc. ("HealthFusion"), a cloud-based healthcare information technology (“HCIT”) company providing electronic health record (“EHR”) and practice management (“PM”) software primarily to the one-to-ten physician size market. We entered into a revolving credit agreement to fund the transaction. We believe the acquisition provided us with access to a market we were not in and provides us with technology that will accelerate our transition to the cloud.
We continue to evaluate the organizational structure of our company with the latest technology.objective of achieving greater synergies and further integration of our products and services, in support of our business strategies. In fiscal 2016, we initiated a three-phase plan to better position our organization for future success. In the first phase, we redesigned the organization to more effectively support the execution of our strategy. We also transformed our management team with the appointment of a new chief executive officer, chief financial officer, chief technology officer, chief strategy officer, and chief client officer. This first phase was completed in April 2016, when we announced a corporate restructuring plan intended to enable a more efficient, integrated and client-centered delivery of the holistic solutions that we believe is required by our ambulatory care clients. The restructuring plan includes merging our business units into a more streamlined, functional-based organization structure. We are now beginning phase two of our reorganization, which includes building and enhancing the capabilities that will drive future revenue growth. The third phase of the plan will consist of developing and marketing the services and solutions that we believe will accelerate revenue growth.
We also wanthave made and intend to continue making substantial investments in our infrastructure includingwhile continuing our strong commitment of service in support of our client satisfaction programs and maintaining reasonable expense discipline. Such investments include but are not limited to maintaining and expanding sales, marketing and product development activities in order to improve patient care and reduce healthcare costs, providing industry-leading, integrated clinical and administrative healthcare data systems, services, and expertise to clinical, medical, technology, and healthcare business professionals while continuing our strong commitment of superb service in support of our customer satisfaction programs. These investments in our infrastructure will continue while maintaining reasonable expense discipline.professionals. We also strive to add new customersclients and expand our relationship with existing customersclients through delivery of add-on and complementary products and
services and services. We believe that our customerthe client base that is usinguses our software on a daily basis is a strategic asset. Weasset, and we intend to leverage this strategic asset by expanding our product and service offerings towards this customerclient base.
On January 4, 2016,Led by our vision and mission, we completedare resetting our strategy and structure to deliver value to our clients. To achieve lower-cost, increased structural capability, our new management team is building an aligned, client-focused organization, supported by a recurring revenue stream and a large and diverse existing client base.
Our Strategy
We strive to be the trusted partner for clients of all size, integrating services, software and analytics into a consolidated solution. As a healthcare information technology and services company, we plan to continue investing in our current capabilities as well as building and/or acquiring new capabilities as we guide our clients from fee-for-service to fee-for-value payer reimbursement models. With approximately 90,000 providers using our solutions, we are enabling care and believe we can truly transform the delivery of care through the following strategic priorities:
Focus on the ambulatory client segment. In October 2015, we sold our Hospital Solutions Division to focus on our core ambulatory clients. Further, a recent operational reorganization better allows us to serve the needs of our ambulatory clients through a simpler, more nimble, and focused organization. We believe it is essential to protect, build and sell new capabilities within our ambulatory platform. We are focused on our core by increasing quality and the serviceability of our solutions. We intend to continue to enhance the capabilities of our NextGen Ambulatory flagship product.
Cloud transition. Through our acquisition of HealthFusion Holdings, Inc. ("HealthFusion") pursuant toin January 2016, we acquired a highly scalable, pure cloud-based and mobile-enabled platform that operates under the Agreement and Plan of Merger, dated October 30, 2015. HealthFusion provides Web-based, cloud computing software for physicians, medical billing service providers, and hospitals. Its flagship product, MediTouch, is a fully-integrated, cloud-based software suite consisting of clearinghouse, practice management, electronic health records, and patient portals with rich functionality to enable mobility, workflow automation, and advanced reporting and analytics aimed primarily at small-to-mid-size physician practices. The acquisition of HealthFusion is part of our strategy to expand its client base and cloud-based solution capabilities in the ambulatory market. Over time, we plantradename MediTouch®. We intend to expand the HealthFusioncapability of this platform to satisfyserve the needsrequirements of practiceslarger ambulatory practices. When combined with our Mirth-branded products, we can offer our clients a full suite of increasing sizecloud-based solutions that better enable our clients to focus on care delivery.
Solutions selling. We believe there is significant opportunity to extend the solutions we offer existing and complexity.new clients through value added services such as RCM, EDI, interoperability solutions and professional services. This will evolve our relationships from being a seller of products and services to delivering a consistent solution suite and experience for our clients.
Population health software and services. We are evaluatingmigrating into applications, analytics and services that we believe will enable our clients to be successful in managing the impacthealth of HealthFusion’s existing cloud-based product onpatient populations. We are establishing strong development partners within our ongoing efforts to developcore client base, participating in shared-risk contracts, and release our NextGen Now cloud-based platform. Our assessment may lead usworking together to determine thatpopulation health solutions.
More effective use of capital. From cessation of the HealthFusion product, which is already a production-ready and sellable solution, may representdividend, leveraging our balance sheet for future opportunities, to managing our cost structure, we are transforming our capital strategy. Our recent reorganization was formulated to result in a more prudent investment in our technical future than continuing with the NextGen Now development plans. If we decide to abandon further development of the previously capitalized NextGen Now platform or certain components thereof, a material impairment of the asset may result.efficient, integrated and streamlined organization.
Critical Accounting Policiesand 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.America ("GAAP"). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect theour 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, accounts receivable reserves, software development costs, contingent consideration liabilities, goodwill, and intangible assets) for reasonableness.disclosures. We base our assumptions, estimates and judgments on historical experience, current trends, and on various other assumptions that management believesfactors we believe to be reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. On a regular basis, we review the results of which form the basis for makingaccounting policies and update our assumptions, estimates, and judgments, about the carrying values of assetsas needed, to ensure that our consolidated financial statements are presented fairly and liabilities that may not be readily apparent from other sources.in accordance with GAAP. Actual results maycould differ materially from theseour estimates under different assumptions or conditions. To the extent that there are material differences between our estimates and actual results, our financial condition or results of operations will be affected.
We describe our significant accounting policies in Note 2, “Summary of Significant Accounting Policies,” of our notes to consolidated financial statements included in our Annual Report. We discuss our critical accounting policies and estimates in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report. There have been no material changes in our significant accounting policies or critical accounting policies and estimates since the endfiscal year ended March 31, 2016.
Results of Operations
The following table sets forth the percentage of revenue represented by each item in our consolidated statements of comprehensive income for the three and nine months ended December 31, 2016 and 2015 (certain percentages below may not sum due to rounding): |
| | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Revenues: | | | | | | | |
| Software license and hardware | 13.3 | % | | 13.8 | % | | 13.0 | % | | 14.3 | % |
| Software related subscription services | 17.6 |
| | 10.0 |
| | 16.9 |
| | 10.0 |
|
| Total software, hardware and related | 30.9 |
| | 23.8 |
| | 29.9 |
| | 24.3 |
|
| Support and maintenance | 31.2 |
| | 33.8 |
| | 31.0 |
| | 34.4 |
|
| Revenue cycle management and related services | 15.7 |
| | 18.5 |
| | 16.4 |
| | 17.2 |
|
| Electronic data interchange and data services | 17.0 |
| | 17.6 |
| | 17.4 |
| | 16.8 |
|
| Professional services | 5.1 |
| | 6.3 |
| | 5.3 |
| | 7.3 |
|
| Total revenues | 100.0 |
| | 100.0 |
| | 100.0 |
| | 100.0 |
|
| Cost of revenue: | | | | | | | |
| Software license and hardware | 4.4 |
| | 5.6 |
| | 5.1 |
| | 5.5 |
|
| Software related subscription services | 7.3 |
| | 4.7 |
| | 7.2 |
| | 4.8 |
|
| Total software, hardware and related | 11.8 |
| | 10.3 |
| | 12.3 |
| | 10.3 |
|
| Support and maintenance | 5.7 |
| | 6.4 |
| | 5.5 |
| | 6.5 |
|
| Revenue cycle management and related services | 10.5 |
| | 12.3 |
| | 11.1 |
| | 12.0 |
|
| Electronic data interchange and data services | 9.9 |
| | 10.6 |
| | 10.1 |
| | 10.2 |
|
| Professional services | 4.6 |
| | 6.3 |
| | 5.2 |
| | 6.6 |
|
| Total cost of revenue | 42.5 |
| | 46.0 |
| | 44.3 |
| | 45.6 |
|
| Gross profit | 57.5 |
| | 54.0 |
| | 55.7 |
| | 54.4 |
|
| Operating expenses: | | | | | | | |
| Selling, general and administrative | 29.4 |
| | 33.7 |
| | 32.1 |
| | 31.8 |
|
| Research and development costs, net | 15.4 |
| | 12.4 |
| | 14.9 |
| | 13.6 |
|
| Amortization of acquired intangible assets | 2.0 |
| | 0.8 |
| | 2.1 |
| | 0.7 |
|
| Restructuring costs | 0.2 |
| | — |
| | 1.2 |
| | — |
|
| Total operating expenses | 47.0 |
| | 46.8 |
| | 50.3 |
| | 46.1 |
|
| Income from operations | 10.5 |
| | 7.2 |
| | 5.4 |
| | 8.2 |
|
| Interest income | — |
| | 0.1 |
| | — |
| | 0.1 |
|
| Interest expense | (0.5 | ) | | — |
| | (0.6 | ) | | — |
|
| Other expense, net | — |
| | — |
| | — |
| | — |
|
| Income before provision for income taxes | 10.0 |
| | 7.2 |
| | 4.7 |
| | 8.3 |
|
| Provision for income taxes | 1.8 |
| | 1.0 |
| | 1.0 |
| | 2.3 |
|
| Net income | 8.2 | % | | 6.2 | % | | 3.7 | % | | 6.0 | % |
Revenues
The following table presents our consolidated revenues for the three and nine months ended December 31, 2016 and 2015 (in thousands): |
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Revenues: | | | | | | | |
| Software license and hardware | $ | 16,995 |
| | $ | 16,150 |
| | $ | 48,966 |
| | $ | 52,026 |
|
| Software related subscription services | 22,546 |
| | 11,705 |
| | 63,911 |
| | 36,388 |
|
| Total software, hardware and related | 39,541 |
| | 27,855 |
| | 112,877 |
| | 88,414 |
|
| | | | | | | | |
| Support and maintenance | 39,924 |
| | 39,519 |
| | 116,905 |
| | 125,408 |
|
| Revenue cycle management and related services | 20,048 |
| | 21,594 |
| | 62,037 |
| | 62,630 |
|
| Electronic data interchange and data services | 21,790 |
| | 20,643 |
| | 65,527 |
| | 61,413 |
|
| Professional services | 6,565 |
| | 7,421 |
| | 19,893 |
| | 26,700 |
|
| Total revenues | $ | 127,868 |
| | $ | 117,032 |
| | $ | 377,239 |
| | $ | 364,565 |
|
We generate revenue from sales of licensing rights and subscriptions to our software products, hardware and third party software products, support and maintenance services, revenue cycle management and related services ("RCM"), electronic data interchange and data services (“EDI”), and professional services, such as implementation, training, and consulting performed for clients who use our products.
Consolidated revenue for the three months ended December 31, 2016 increased $10.8 million compared to the prior year period, which was driven primarily by subscription sales of the MediTouch® cloud-based system acquired from HealthFusion in January 2016 and lower level of sales credits and related reserves, which were partially offset by lower RCM revenue due to lower net new bookings.
Consolidated revenue for the nine months ended December 31, 2016 increased $12.7 million compared to the prior year period as a result of $27.5 million higher subscriptions related mostly to sales of the MediTouch® cloud-based system, partially offset by lower software license and hardware revenue, lower professional services revenue, and lower support and maintenance revenue. The decline in software license and hardware revenue was mostly caused by a shift in market dynamics toward cloud-based solutions and away from perpetual license arrangements, which has also resulted in lower demand for our professional services, including implementation, training, and consulting services. The decline in support and maintenance is due primarily to the disposition of the former Hospital Solutions Division in October 2015 and net attrition in products sold with accompanying maintenance.
RCM revenue decreased $1.5 million and $0.6 million for the three and nine months ended December 31, 2016 and 2015, respectively, due to lower net new bookings. EDI revenue increased $1.1 million and $4.1 million for the three and nine months ended December 31, 2016 and 2015, respectively, due to addition of new clients and further penetration of our existing client base.
Recurring service revenue, consisting of software related subscription services, support and maintenance, RCM, and EDI, represented 81.6% and 79.9% of total revenue for the three months ended December 31, 2016 and 2015, respectively. For the nine months ended December 31, 2016 and 2015, recurring service revenue represented 81.7% and 78.4%, respectively, of total revenue.
We expect to benefit from the growth of a replacement market driven by an expected consolidation of electronic health records vendors. We also anticipate the creation of new opportunities in connection with the evolution of healthcare from a fee-for-services reimbursement model to a pay-for-performance model around the management of patient populations. Our acquisitions of Gennius and Mirth provided us with new products and services around population health, collaborative care management, interoperability and enterprise analytics to address these market dynamics. While it remains difficult to assess the relative impact or the timing of positive and negative trends affecting the aforementioned market opportunities, we believe we are well positioned to remain a leader in serving the evolving market needs for healthcare information technology.
Gross Profit
The following table presents our consolidated cost of revenue and gross profit for the three and nine months ended December 31, 2016 and 2015 (in thousands): |
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Total cost of revenue | $ | 54,352 |
| | $ | 53,785 |
| | $ | 167,164 |
| | $ | 166,360 |
|
| Gross profit | 73,516 |
| | 63,247 |
| | 210,075 |
| | 198,205 |
|
| Gross margin % | 57.5 | % | | 54.0 | % | | 55.7 | % | | 54.4 | % |
Cost of revenue consists primarily of compensation expense, including share-based compensation, for personnel that deliver our products and services. Cost of revenue also includes amortization of capitalized software costs and acquired technology, third party consultant and outsourcing costs, costs associated with our EDI business partners and clearinghouses, hosting service costs, third party software costs and royalties, and other costs directly associated with delivering our products and services. Refer to Note 5, "Intangible Assets" and Note 6, "Capitalized Software Costs" of our notes to consolidated financial statements included elsewhere in this Report for additional information on current period amortization of capitalized software costs and acquired technology and an estimate of future expected amortization.
Share-based compensation expense included in cost of revenue was $0.1 million and $0.1 million for the three months ended December 31, 2016 and 2015, respectively, and is included in the amounts in the table above. Share-based compensation expense included in cost of revenue was $0.5 million and $0.3 million for the nine months ended December 31, 2016 and 2015, respectively, and is included in the amounts in the table above.
Gross profit for the three months ended December 31, 2016 increased $10.3 million compared to the prior year period due primarily to higher revenues as discussed above and a lower level of sales credits and related reserves, which were offset by a $0.6 million increase in cost of revenue. Cost of revenue increased due to amortization of the software technology intangible asset acquired from HealthFusion, partially offset by lower amortization of previously capitalized software development costs and lower payroll costs associated with delivering support and maintenance and professional services. The gross margin percentage increased to 57.5% for the three months ended December 31, 2016 compared to 54.0% in the prior year period.
Gross profit for the nine months ended December 31, 2016 increased $11.9 million compared to the prior year period due also to higher revenues as discussed above, offset by a $0.8 million increase in cost of revenue. Cost of revenue increased due to amortization of the software technology intangible asset acquired from HealthFusion, partially offset by lower payroll costs associated with delivering support and maintenance and professional services. The gross margin percentage increased to 55.7% for the nine months ended December 31, 2016 compared to 54.4% in the prior year period.
Selling, General and Administrative Expense
The following table presents our consolidated selling, general and administrative expense for the three and nine months ended December 31, 2016 and 2015 (in thousands):
|
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Selling, general and administrative | $ | 37,542 |
| | $ | 39,395 |
| | $ | 120,913 |
| | $ | 115,962 |
|
| Selling, general and administrative, as a percentage of revenue | 29.4 | % | | 33.7 | % | | 32.1 | % | | 31.8 | % |
Selling, general and administrative expense consist of compensation expense, including share-based compensation, for management and administrative personnel, selling and marketing expense, facilities costs, depreciation, professional service fees, including legal and accounting services, acquisition and transaction-related costs, and other general corporate and administrative expenses.
Share-based compensation expense included in selling, general and administrative expenses was $1.6 million and $0.6 million for the three months ended December 31, 2016 and 2015, respectively, and is included in the amounts in the table above. Share-based compensation expense included in selling, general and administrative expenses was $4.0 million and $1.7 million for the nine months ended December 31, 2016 and 2015, respectively, and is included in the amounts in the table above.
Selling, general and administrative expenses decreased $1.9 million for the three months ended December 31, 2016 compared to the prior year period primarily because we incurred $3.7 million of acquisition-related costs related to the acquisition of HealthFusion in the prior year period, a $1.8 million loss on the disposition of the former Hospital Solutions Division in the prior year period, and recorded a current period benefit of $2.0 million related to fair value adjustments of the HealthFusion contingent
consideration, which were partially offset by higher legal expense related shareholder litigation and additional selling, general and administrative expense associated with the acquisition of HealthFusion.
Selling, general and administrative expenses increased $5.0 million for the nine months ended December 31, 2016 compared to the prior year period primarily due to $3.4 million of fair value adjustments of the HealthFusion contingent consideration recorded in the current period, higher legal expense related shareholder litigation, and additional selling, general and administrative expense associated with the acquisition of HealthFusion, partially offset by lower payroll costs associated with the corporate restructuring plan (refer to Note 15, "Restructuring Plan" of our notes to consolidated financial statements included elsewhere in this Report for additional information) and the disposition of the Hospital Solutions Division in October 2015.
Research and Development Costs, net
The following table presents our consolidated net research and development costs, capitalized software costs, and gross expenditures prior to capitalization, for the three and nine months ended December 31, 2016 and 2015 (in thousands): |
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Gross expenditures | $ | 20,766 |
| | $ | 19,435 |
| | $ | 62,601 |
| | $ | 61,188 |
|
| Capitalized software costs | (1,052 | ) | | (4,917 | ) | | (6,371 | ) | | (11,604 | ) |
| Research and development costs, net | $ | 19,714 |
| | $ | 14,518 |
| | $ | 56,230 |
| | $ | 49,584 |
|
| | | | | | | | |
| Research and development costs, as a percentage of revenue | 15.4 | % | | 12.4 | % | | 14.9 | % | | 13.6 | % |
| Capitalized software costs as a percentage of gross expenditures | 5.1 | % | | 25.3 | % | | 10.2 | % | | 19.0 | % |
Gross research and development expenditures, including costs expensed and costs capitalized, consist of compensation expense, including share-based compensation, for research and development personnel, certain third-party consultant fees, software maintenance costs, and other costs related to new product development and enhancement to our existing products. We intend to continue to invest heavily in research and development expenses as we continue to bring additional functionality and features to the medical community and develop a new integrated inpatient and outpatient, web-based software platform.
The capitalization of software development costs results in a reduction to our reported net research and development costs. Our software capitalization rate, or capitalized software costs as a percentage of gross expenditures, has varied historically and may continue to vary based on the nature and status of specific projects and initiatives in progress. Although changes in software capitalization rates have no impact on our overall cash flows, it results in fluctuations in the amount of software development costs being expensed up front and the amount of net research and development costs reported in our consolidated statement of comprehensive income.
Share-based compensation expense included in research and development costs was $0.3 million and $0.1 million for the three months ended December 31, 2016 and 2015, respectively, and is included in the amounts in the table above. Share-based compensation expense included in research and development costs was $0.7 million and $0.3 million for the nine months ended December 31, 2016 and 2015, respectively, and is included in the amounts in the table above.
Net research and development costs for the three months ended December 31, 2016 increased $5.2 million compared to the prior year period primarily as a result of a $3.9 million decline in capitalized software costs and a $1.3 million increase in our gross expenditures. Net research and development costs for the nine months ended December 31, 2016 increased $6.6 million compared to the prior year period primarily as a result of a $5.2 million decline in capitalized software costs and a $1.4 million increase in our gross expenditures. The acquisition of HealthFusion contributed $1.2 million and $2.8 million of net research and development costs for the three and nine months ended December 31, 2016, respectively. Such increase was partially offset by lower gross expenditures from the discontinuation of the NextGen Now development project during the fourth quarter of fiscal year 2015.2016 and lower personnel costs associated with the restructuring plan.
Company Overview
Quality Systems, Inc. was incorporatedThe reduction in Californiacapitalized software costs for the three and nine months ended December 31, 2016 is due to a decline in 1974. Our principal offices are located at 18111 Von Karman Ave., Suite 700, Irvine, California, 92612. We operate on a fiscal year ending on March 31.
Our Company was founded with an early focus on providing information systems to dental group practices. This focus area would later become the QSI Dental Division. In the mid-1980s, we capitalized on the increasing focus on medical cost containment and further expanded our information processing systems to serve the ambulatory market. In the mid-1990s, we made two acquisitions that accelerated our penetrationrate of the ambulatory marketsoftware capitalization compared to the prior year periods, which reflects differences in the nature and formedstatus of our projects and initiatives during a given period that affects the basisamount of development costs that may be capitalized, the discontinuation of the NextGen Now development project, and the recent releases of the next major version of our core software products.
Amortization of Acquired Intangible Assets
The following table presents our amortization of acquired intangible assets for the NextGen Division. Inthree and nine months ended December 31, 2016 and 2015 (in thousands): |
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Amortization of acquired intangible assets | $ | 2,568 |
| | $ | 897 |
| | $ | 7,889 |
| | $ | 2,692 |
|
Amortization of acquired intangible assets included in operating expense consist of the last few years, weamortization related to our customer relationships, trade name, and contracts intangible assets acquired ViaTrack Systems, LLC ("ViaTrack") and Matrix Management Solutions, LLC ("Matrix") as part of our strategybusiness combinations. Refer to enhanceNote 5, "Intangible Assets" of our EDInotes to consolidated financial statements included elsewhere in this Report for an estimate of future expected amortization.
Amortization of acquired intangible assets for the three and RCM services capabilities. More recently,nine months ended December 31, 2016 increased $1.7 million and $5.2 million, respectively, compared to the prior year periods due to additional amortization of the customer relationships and trade name intangible assets related to the acquisition of HealthFusion. Refer to Note 5, "Business Combinations" of our notes to consolidated financial statements included elsewhere in this Report for additional information.
Restructuring Costs
During the three and nine months ended December 31, 2016, we acquired Mirth Corporation ("Mirth")recorded $0.2 million and Gennius, Inc ("Gennius"), both$4.7 million, respectively, of which operate underrestructuring costs within operating expenses in our consolidated statements of comprehensive income. The restructuring costs resulted from a restructuring plan that we announced in April 2016, and such costs consist primarily of payroll-related costs, such as severance, outplacement costs, and continuing healthcare coverage, associated with the NextGen Division. Mirth enhances our current enterprise interoperability initiatives and broadens our accountable and collaborative care, population health, disease management and clinical data exchange offerings. Genniusinvoluntary separation of employees pursuant to a one-time benefit arrangement. The remaining restructuring liability as of December 31, 2016 was not significant. The restructuring plan is expected to be complete by the end of fiscal 2017.
The restructuring is part of a three-phase plan initiated in fiscal year 2016 that was intended to better position our organization for future success. In the first phase, we restructured the organization to more effectively support the execution of our strategy. We believe that the restructuring will reduce our costs and improve our financial performance. As we begin phase two of our reorganization, we will continue to build our infrastructure and enhance our current enterprise healthcare data analytics competencies while broadening business intelligenceinformation technology capabilities for addressing new value-based care requirements. In October 2015, we sold our Hospital Solutions Division in an effort to focus on our core ambulatory business. Today, we servedrive future revenue growth. The third phase of the ambulatory, RCMplan will consist of developing and marketing the services and dental markets through each ofsolutions that we believe will accelerate revenue growth.
The overall plan also includes a multi-year initiative, called NextGen 2.0, to merge our three business Divisions.
A growing number of customers are simultaneously utilizing software or services from more than one of our Divisions. In an effort to further enhance our ability to cross sell products and services between Divisions, we are in the process of further integrating our products to provideunits into a more robuststreamlined, functional-based organization structure and comprehensive platform to offerrealign our customers. To achieve greater efficiency and integration within our operations, we have consolidated our divisionalorganizational structure by consolidating the sales, marketing, information services, and software development responsibilities into single, company-wide roles. The Divisions also share the resourcesroles in order to achieve greater efficiency.
Refer to Note 15, "Restructuring Plan" of our “corporate office,” which includes a variety of accountingnotes to consolidated financial statements included elsewhere in this Report for additional information.
Interest and other administrative functions. We continue to evaluate the organizational structure of the Company with the objective of achieving greater synergiesOther Income and further integration of our products and services, including software implementation and customer support functions.Expense
The NextGen Division and QSI Dental Division develop and market software that is designed to automate and streamline a number of the administrative functions required for operating a medical or dental, such as patient scheduling and billing. Since practice management software systems have already been implemented by the vast majority of both the medical and dental practices, we actively compete in a replacement market by leveraging the benefits of our interoperable electronic health records software. With
the addition of Gennius and Mirth, our combined solutions enrich the already strong collaborative, connected care support and set the stage for data synchronization and enterprise analytics, interoperability growth and expansion of our current accountable and collaborative care, population health, disease management and clinical data exchange offering. These Divisions also develop and market software that automates patient records in physician practices, community health centers and hospital settings. In this patient records area of our business, we are typically competing to replace paper-based patient record alternatives as opposed to replacing previously purchased systems. The RCM Services Division provides technology solutions and outsourcing services to cover the full spectrum of healthcare providers' RCM needs, with a primary focus on outsourced billing and collection services.
QSIH, located in Bangalore, India, functions as our India-based captive entity to offshore technology application development and business processing services. Our employee base in Bangalore has grown to over 450 employees with a primary focus on software development activities.
We continue to pursue product and service enhancement initiatives within each of our Divisions. The majority of such expenditures are currently targeted to the product lines and customer base of the NextGen Division.
The following table reflectspresents our reported segment revenue breakdown by Division and segment revenue growth (decline) as compared to the prior year periodinterest expense for the three and nine months ended December 31, 20152016 and 2014. Operating results for the Hospital Solutions Division are included in the table below through the date of disposition.2015 (in thousands):
|
| | | | | | | | | | | | |
| | | Segment Revenue Breakdown |
| | | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | | 2015 | | 2014 | | 2015 | | 2014 |
| NextGen Division | | 75.9 | % | | 74.6 | % | | 75.6 | % | | 76.5 | % |
| RCM Services Division | | 19.6 | % | | 17.8 | % | | 18.6 | % | | 16.1 | % |
| QSI Dental Division | | 4.0 | % | | 3.6 | % | | 3.8 | % | | 3.7 | % |
| Hospital Solutions Division | | 0.5 | % | | 4.0 | % | | 2.0 | % | | 3.7 | % |
| Consolidated | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Interest income | $ | — |
| | $ | 60 |
| | $ | 9 |
| | $ | 406 |
|
| Interest expense | (629 | ) | | (11 | ) | | (2,445 | ) | | (14 | ) |
| Other expense, net | (4 | ) | | (43 | ) | | (146 | ) | | (147 | ) |
|
| | | | | | | | | | | | |
| | | Segment Revenue Growth (Decline) |
| | | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | | 2015 | | 2014 | | 2015 | | 2014 |
| NextGen Division | | (3.7 | )% | | 8.7 | % | | (0.6 | )% | | 66.6 | % |
| RCM Services Division | | 4.9 | % | | 30.9 | % | | 16.8 | % | | 70.7 | % |
| QSI Dental Division | | 5.5 | % | | (8.6 | )% | | 3.3 | % | | 33.1 | % |
| Hospital Solutions Division | | (87.6 | )% | | 5.1 | % | | (43.9 | )% | | 30.6 | % |
| Consolidated | | (5.2 | )% | | 11.1 | % | | 0.8 | % | | 64.0 | % |
NextGen Division. The NextGen Division, with headquarters in Horsham, Pennsylvania and significant locations in Atlanta, Georgia and Costa Mesa, California, provides integrated clinical, financial and connectivity solutions for ambulatory and dental provider organizations. The NextGen Division's major product categories include the NextGen® ambulatory product suite and interoperability solutions.
The NextGen® ambulatory product suite features an integrated and interoperable solution that streamlines the business of running a practice as well as patient care with standardized, real-time clinical and administrative workflows within a physician’s practice. Major ambulatory product lines include NextGen® EHR ("Electronic Health Record"), NextGen® PM ("Practice Management"), NextGen® Population Health (including NextGen® Care), NextGen® Analytics, NextGen® Patient Portal ("NextMD.com"), NextGen® Document Management, NextGen® ePrescribing, NextGen® Mobile, and NextGen® NextPen. The interoperability solutions consist of NextGen® EHR Connect, NextGen® Health Information Exchange ("HIE"), and NextGen® Share. The NextGen Division also offers hosting services, NextGuard data protection services, professional consulting services, such as strategic governance models and operational transformation, technical consulting services, such as data conversions or interface development, and physician consulting services. The NextGen Division products utilize Microsoft Windows technology and can operate in a client-server environment as well as via private intranet, the Internet, or in an ASP environment. The NextGen Division also provides EDI services, which include electronic submission of claims to insurance providers as well as automated patient statements.
On September 9, 2013, we acquired Mirth, a global leader in health information technology that helps customers achieve interoperability. Operating results associated with Mirth products and services are included in the NextGen Division. The acquisition of Mirth enhances our current enterprise interoperability initiatives and broadens our accountable and collaborative care, population
health, disease management and clinical data exchange offerings. Mirth offers a wide variety of products and services utilized by both users of Mirth open code technology as well as a large base of domestic and international paying customers. Product offerings available from Mirth include Mirth Connect, Mirth Results, Mirth Match, Mirth Mail, Mirth Appliance, and Mirth Care Enterprise. As a direct result of the Mirth acquisition, we introduced NextGen®ShareInterest income relates primarily to our customer basemarketable securities. Interest expense relates to our revolving credit agreement that was entered into in November 2013. As our first offering that integrates technologies from both NextGen Healthcare and Mirth, NextGen® Share provides the ability to securely and easily share patient charts and other data with other practices using NextGen Internet based software.
On March 11, 2015, we acquired Gennius, a provider of healthcare data analytics. Gennius's operations are managed under the NextGen Division. The acquisition of Gennius is expected to enhance our current enterprise analytics competencies while broadening business intelligence capabilities for addressing new value-based care requirements.
RCM Services Division. The RCM Services Division, with locations in St. Louis, Missouri, North Canton, Ohio, South Jordan, Utah and Hunt Valley, Maryland, provides technology solutions and consulting services to cover the full spectrum of healthcare providers' RCM needs, from patient access through claims denials, with a primary focus on billing and collection services in order to optimize customers' revenue cycle results, improve cash flow, and decrease accounts receivable days. The RCM Services Division combines a high-touch service modelJanuary 2016 and the NextGen® PM software platformrelated amortization of deferred debt issuance costs. Refer to execute its service offerings, which include billingNote 7, “Line of Credit” of our notes to consolidated financial statements included elsewhere in this Report for additional information. Other expense and collections, claims submissions and reconciliation, coding services, electronic remittance and payment posting, accounts receivable management, patient customer service, advance analytics, charge entry and capture, enrollment credentialing, and software setup, hosting and support.
QSI Dental Division. The QSI Dental Division, co-located with our corporate headquarters in Irvine, California, focuses on developing, marketing and supporting software suites sold to dental group organizations located throughout the United States. The QSI Dental Division sells additional licenses to its legacy products as existing customers expand their operations and also sells its practice management and clinical software solutions to new and existing customers primarily as a cloud-based SaaS model, known as QSIDental Web ("QDW"). QDW is marketedincome relates primarily to multi-location dental group practices in whichnet realized gains and losses on our marketable securities.
Interest expense for the QSI Dental Division has historically been a dominant player. When sold under a SaaS model, QDW offers a lower cost of ownership as it is a cloud-based solution that provides users with access to vital data from any web-enabled device. Further, QSI Dental sells its electronic dental charting software in conjunction with NextGen® PMthree and EHR, which is marketed as NextGen® EDR (“Electronic Dental Record”) to federally qualified health centers (“FQHC”) and other safety-net clinics, as further defined below.
The QSI Dental Division participates jointly with the NextGen Division in providing software and services to safety-net clinics like FQHCs and other safety-net health centers, including public health centers, community health centers, free clinics, as well as rural and tribal health centers. FQHCs and other safety-net clinics are community-based organizations that are funded by the federal government, which provide medical and dental services to underprivileged and underserved communities. The Patient Protection and Affordable Care Act, which was signed into law in March 2010, reserved $11 billion over a multi-year period for FQHCs, creating unprecedented opportunities for FQHCs growth and the formation of new FQHCs. When combined and used in tandem, NextGen® EHR, NextGen® EDR, and NextGen® PM are capable of providing an integrated patient record, which is a unique product in this marketplace that is accessible by both physicians and dentists. In May 2013, NextGen® EDR version 4.3 was ONC-ATCB certified by the Certification Commission for Health Information ("CCHIT®") as a complete EHR and demonstrated compliance with all clinical quality measures for eligible providers.
The QSI Dental Division's legacy practice management software suite, known as Clinical Product Suite (“CPS”), uses a UNIX® operating system and can be fully integrated with the customer server-based practice management software offered by each of our Divisions. When integrated and delivered with the NextGen® PM solution, CPS is re-branded as NextGen® EDR and incorporates a wide range of clinical tools including, but not limited to, periodontal charting and digital imaging of X-ray and inter-oral camera images, that are integrated as part of the electronic patient record. The QSI Dental Division also develops, markets, and provides EDI services to dental practices, including electronic submission of claims to insurance providers as well as automated patient statements.
Overview of Our Results
Consolidated revenue increased 0.8%, or $2.7 million, in the nine months ended December 31, 2016 increased $0.6 million and $2.4 million, respectively, compared to the prior year. The increase is primarily related to the interest expense associated with our revolving credit agreement
and the amortization of deferred debt issuance costs. As of December 31, 2016, we had $25.0 million in outstanding loans under the revolving credit agreement.
All other fluctuations in interest and other income and expense are not deemed significant.
Provision for Income Taxes
The following table presents our provision for income taxes for the three and nine months ended December 31, 2016 and 2015 as (in thousands): |
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Provision for income taxes | $ | 2,342 |
| | $ | 1,141 |
| | $ | 3,950 |
| | $ | 8,233 |
|
| Effective tax rate | 18.3 | % | | 13.5 | % | | 22.2 | % | | 27.3 | % |
The effective rate for the three months ended December 31, 2016 increased compared to the prior year period. The change isperiod primarily due to the resultimpact of a 16.4% increaselower qualifying production activity deductions in software related subscription services revenues, a 14.9% increase in RCM and related services revenues,the current period, certain non-deductible acquisition-related costs, and a 9.1% increase in EDI and data services revenue, partiallydiscrete valuation allowance, offset by a 14.0% decrease in software licensefederal and hardware revenuestate research and a 19.8% decrease in professional services revenue. development credit and other discrete adjustments.
The increase in subscription services revenue reflects growth in subscriptions related to our interoperability and patient portal product offerings. The increase in RCM and related services revenues are the result of new customer additions and organic growth. The growth in EDI and data services revenue has come from new customers and from further penetration of our existing customer base. The decline in software license and hardware revenue reflects the increasingly saturated markets in which our core software products are sold, and the decline in professional services revenue is due to lower implementation and training revenue resulting from the recent decline in system sales and lower consulting services revenue due to reduced demand from customers.
Consolidated gross profit as a percentage of revenue increased to 54.4%effective rate for the nine months ended December 31, 20152016 decreased compared to 53.8% in the prior year period primarily due to improved profitability fromfavorable discrete adjustments for federal and state research and development credit, offset by non-deductible acquisition-related costs, lower qualifying production activity deductions in the current period, and other discrete adjustments.
Net Income
The following table presents our net income (in thousands) and net income per share and for the three and nine months ended December 31, 2016 and 2015: |
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Net income | $ | 10,486 |
| | $ | 7,302 |
| | $ | 13,826 |
| | $ | 21,979 |
|
| Net income per share: | | | | | | | |
| Basic | $ | 0.17 |
| | $ | 0.12 |
| | $ | 0.22 |
| | $ | 0.36 |
|
| Diluted | $ | 0.17 |
| | $ | 0.12 |
| | $ | 0.22 |
| | $ | 0.36 |
|
As a result of the foregoing changes in revenue and expense, net income for the three and nine months ended December 31, 2016 decreased $3.2 million and $8.2 million, respectively, compared to the prior year period.
Operating Segment Information
Effective July 1, 2016, we revised our reportable operating segments. As part of our ongoing reorganization efforts, we refined the measurement of our segment data to better reflect our current internal organizational structure whereby certain functions that formerly existed within each individual operating segment have changed. Our operating segments now consist of the Software and Related Solutions segment and the RCM and relatedRelated Services segment, which is consistent with the disaggregated financial information used and evaluated by our chief operating decision maker (consisting of our Chief Executive Officer) to assess performance and make decisions about the allocation of resources. Revenue and gross profit are the key measures of segment profitability used by our chief operating decision maker to measure segment operating performance and to make key business decisions. The revenues and gross profit of each segment are derived from distinct product and services within each segment. The Software and Related Solutions segment aggregates the revenues and gross profit of our software-related products and services, including software license and hardware, software-related subscription services, support and maintenance, EDI and data services, and certain professional services, resulting from more effectivesuch as implementation, training, and consulting. The RCM and Related Services segment aggregates the revenues and gross profit of our RCM services and certain related ancillary service offerings.
Operating segment data for the three and nine months ended December 31, 2016 and 2015 is summarized in the table below. Prior period data has been retroactively reclassified to present all segment information on a comparable basis. The change in reportable segments has no impact to consolidated revenues and consolidated cost management.of revenue, nor does it affect our presentation of revenue and cost of revenue on the consolidated statements of comprehensive income.
|
| | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2016 | | 2015 | | 2016 | | 2015 |
| Revenue: | | | | | | | |
| Software and Related Solutions | $ | 106,958 |
| | $ | 93,927 |
| | $ | 312,854 |
| | $ | 291,783 |
|
| RCM and Related Services | 20,910 |
| | 22,486 |
| | 64,385 |
| | 65,313 |
|
Hospital Solutions(1) | — |
| | 619 |
| | — |
| | 7,469 |
|
| Consolidated revenue | $ | 127,868 |
| | $ | 117,032 |
| | $ | 377,239 |
| | $ | 364,565 |
|
| | | | | | | | |
| Gross profit: | | | | | | | |
| Software and Related Solutions | $ | 71,252 |
| | $ | 58,949 |
| | $ | 204,414 |
| | $ | 184,982 |
|
| RCM and Related Services | 7,077 |
| | 7,769 |
| | 21,337 |
| | 20,792 |
|
Hospital Solutions(1) | — |
| | (69 | ) | | — |
| | 2,569 |
|
Unallocated cost of revenue(2)
| (4,813 | ) | | (3,402 | ) | | (15,676 | ) | | (10,138 | ) |
| Consolidated gross profit | $ | 73,516 |
| | $ | 63,247 |
| | $ | 210,075 |
| | $ | 198,205 |
|
(1) The former Hospital Solutions Division was divested in October 2015 and therefore, does not represent a distinct operating incomesegment. Historical amounts for Hospital Solutions have not been revised.
(2) Consists of amortization of acquired software technology and amortization of capitalized software costs not allocated to the operating segments for the purposes of measuring performance.
Software and Related Solutions
Software and Related Solutions revenue for the three months ended December 31, 2016 increased 29.0%, or $6.7$13.0 million inand gross profit increased $12.3 million compared to the prior year period. Software and Related Solutions revenue for the nine months ended December 31, 2015 as compared to the prior year period. The increase is mostly due to a 1.9%, or $3.72016 increased $21.1 million increase inand gross profit resulting from the increase in total revenues and improvements in profitability noted above and a decrease of 3.9%, or $2.0increased $19.4 million in research and development costs attributed mostly to higher rates of capitalization of software costs related to the development of enhancements to our ambulatory software products during the nine months ended December 31, 2015 as compared to the prior year period.
NextGen DivisionThe increase in revenues for the three months ended December 31, 2016 was driven by an increase in our software related subscription services attributed mostly to the acquisition of HealthFusion in January 2016 and an increase in EDI revenue from the addition of new clients and further penetration of our existing client base, which were partially offset by a decline in professional services revenue, resulting from a recent decline in demand for our core software products and related services.
NextGen Division revenue decreased by 0.6%The increase in revenues for the nine months ended December 31, 2015, as2016 was also driven by an increase in our software related subscription services attributed mostly to the acquisition of HealthFusion in January 2016 and an increase in EDI revenue from the addition of new clients and further penetration of our existing client base, which were partially offset by a decline in software license and hardware and professional services revenue, resulting from a shift in market dynamics toward cloud-based solutions and away from perpetual license arrangements, resulting in lower client demand for our core software products and related support and maintenance, implementation, training, and consulting services.
The increase in gross profit for the three and nine months ended December 31, 2016 is due primarily to the aforementioned increases in revenue, which were offset by an increase in cost of revenue. Cost of revenue increased due to amortization of the software technology intangible asset acquired from HealthFusion, partially offset by lower amortization of previously capitalized software development costs and lower payroll costs associated with delivering support and maintenance and professional services. Gross profit for the three months ended December 31, 2016 was also positively impacted due to a lower level of sales credits and related reserves compared to the prior year period. Divisional software license and hardware revenue decreased by 11.8% and professional services revenue decreased by 22.9%, offset by an increase of 18.5% in software related subscription services revenue, an increase of 8.4% in EDI and data services revenue, and an increase of 1.7% in support and maintenance revenue. As noted above, the increase in subscription services revenue reflects growth in interoperability subscriptions as well as subscriptions related to our NextGen® Patient Portal product offering while the decrease in software license and hardware revenue and professional services revenue reflects the increasingly saturated markets in which our core software products and services are sold.
NextGen Division operating income (excluding Corporate and unallocated amounts) increased by 0.3% in the nine months ended December 31, 2015, as compared to the prior year period. Although overall operating expenses decreased by 11.4%, or $5.4 million, primarily as a result of lower sales commissions associated with a decline in new system sales and a decrease in other personnel related costs resulting from improved operational efficiency, such benefit was mostly offset by a $5.0 million decline in divisional gross profit caused primarily by a decrease in high-margin software license sales.
Our goals for the NextGen DivisionSoftware and Related Solutions include further enhancement of our existing products, including expansion of our software and service offerings that support pay-for-performance initiatives around accountable care organizations, bringing greater ease of use and intuitiveness to our software products, enhancing our managed cloud and hosting services to lower our clients' total cost of ownership, expanding our interoperability and enterprise analytics capabilities, and further development and enhancements of our portfolio of specialty focused templates within our electronic health records software. We intend to remain at the forefront of upcoming new regulatory requirements, including meaningful use requirements for stimulus payments and recent healthcare reform that is driving the transition towards pay-for-performance, value-based reimbursement models. We believe that the expanded requirements for continued eligibility for incentive payments under meaningful use rules will result in an expanded
replacement market for electronic health records software. We also intend to continue selling additional software and services to existing customers,clients, expanding penetration of connectivity and other services to new and existing customers,clients, and capitalizing on growth and cross selling opportunities within RCM and Related Services. Our acquisition of HealthFusion will allow us expand our client base and cloud-based solution capabilities in the RCM Services Division.ambulatory market and meet the needs of practices of increasing size and complexity. Our acquisitions of Mirth and Gennius improve our competitiveness in the markets and provide new customersclients and expanded markets for the NextGen DivisionSoftware and Related Solutions and also support our strategy to focus on accountable care organizations around interoperability, patient engagements, population health and collaborative care management, and enterprise analytics. We believe we are well-positionedwell-positioned within the evolving healthcare market to deliver products and services that address the growing importance of quality collaborative care and shift from fee-for-service to value-based, pay-for-performance care.
The NextGen Division’s growth isWe believe that our operating results are attributed to a strong brand name and reputation within the marketplace for healthcare information technology software and services and investments in sales and marketing activities, including new marketing campaigns, Internet advertising investments, tradeshow attendance and other expanded advertising and marketing expenditures.
RCM and Related Services Division
RCM and Related Services Division revenue increased 16.8%, or $9.8for the three months ended December 31, 2016 decreased $1.6 million compared to the prior period due to lower net new bookings. Gross profit for the three months ended December 31, 2016 decreased $0.7 million due to the decline in revenues, partially offset by a reduction in employee-related costs.
RCM and Related Services revenue for the nine months ended December 31, 2015. The RCM Services Division benefited mostly from2016 decreased $0.9 million compared to the prior year period due to lower net new customer additions duringbookings. Gross profit for the nine months ended December 31, 2015 as well as organic growth achieved through cross selling RCM services to existing NextGen Division customers.
Divisional operating income (excluding Corporate and unallocated amounts)2016 increased 39.1%, or $3.8$0.5 million in the nine months ended December 31, 2015 as compared to the prior year period primarily due to an increase in divisional gross profit,lower employee related costs, partially offset by higher operating expense related mostly to higher sales commissions associated with the growtha decline in revenue noted above.revenue.
The Company believesWe believe that a significant opportunity exists to continue cross selling RCM services to our existing customers.clients. The portion of existing NextGen customersclients who are using the RCM Services Division's services is approximately 10%. Management isWe are actively pursuing efforts to achieve faster growth from expanded efforts to leverage theour existing NextGen Division's sales force towards selling RCM services. We also believe that ongoing increases in the complexity of medical billing and collections processes, including the migration to value-based reimbursement models, will create additional opportunities for our RCM Services Division.
QSI Dental Division
QSI Dental Division revenue increased 3.3%, or $0.4 million in the nine months ended December 31, 2015 primarily due to a $0.3 million increase in software license and hardware revenue and a $0.3 million increase in software related subscription services, offset by a $0.3 million decrease in support and maintenance revenue.
Divisional operating income (excluding Corporate and unallocated amounts) increased 13.2%, or $0.5 million, in the nine months ended December 31, 2015 as compared to the prior year period primarily due to the increase in divisional gross profit associated with the increase in higher-margin software license and software related subscription services revenue noted above.
The QSI Dental Division is well-positioned to sell to the FQHCs market and intends to continue leveraging the NextGen Division's sales force to sell its dental electronic medical records software to practices that provide both medical and dental services, such as FQHCs, which are receiving grants as part of the ARRA. Our goal for the QSI Dental Division is to continue to invest in the new cloud-based QDW platform while aggressively marketing QDW to both new and existing customers.
Hospital Solutions Division
On October 22, 2015, we closed an Asset Purchase Agreement with Quadramed Affinity Corporation in which we sold and assigned substantially all assets and liabilities of the Hospital Solutions Division (“Hospital disposition”). We believe that the Hospital disposition will allow us to focus our efforts and resources on our core ambulatory business. The results of operations included within this management's discussion and analysis reflect the operating results of the Hospital Solutions Division through the date of disposition.
Hospital Solutions Division revenue decreased 43.9% in the nine months ended December 31, 2015. Revenue was primarily impacted by a 70.4% decrease in software, hardware and related revenue and a 48.2% decrease in professional services revenue. These decreases are primarily the result of reduced demand for implementation, training, and consulting services due to a decline in new software sales and because software license and hardware sales and software related subscriptions services revenue in the prior year period were favorably impacted by decreases in reserves for sales credits. Additionally, the Hospital disposition partially contributed to the overall decrease in revenue as compared to the prior year period.
Divisional operating loss (excluding Corporate and unallocated amounts) was $0.9 million for the nine months ended December 31, 2015 as compared to a $2.2 million loss for the prior year period. The improvement in operating results is due mostly to a decrease in selling, general and administrative expenses associated mostly to decline in divisional headcount.
A $1.8 million loss (including related incremental direct costs) on the Hospital disposition was recorded in the nine months ended December 31, 2015 and is reflected as a component of selling, general and administrative expense on our consolidated statements of comprehensive income.
Corporate and unallocated amounts (costs not allocated to the operating segments)
Research and development costs decreased by 3.9% to $49.6 million for the nine months ended December 31, 2015 as compared to $51.6 million for the prior year period attributed mostly to higher rates of capitalization of software costs related to the development of enhancements to our ambulatory software products. Capitalized software costs increased to $11.6 million as compared to $9.5 million for the prior year period while gross expenditures, including both amounts expensed and capitalized, remained consistent with the prior year period. The table below provides a summary of the amount of software costs capitalized in proportion to the amount of gross expenditures for the three and nine months December 31, 2015 and 2014:
|
| | | | | | | |
| | Nine Months Ended December 31, |
| | 2015 | | 2014 |
| Gross expenditures | $ | 61,188 |
| | $ | 61,137 |
|
| Capitalized software costs | (11,604 | ) | | (9,535 | ) |
| Research and development costs, as reported | $ | 49,584 |
| | $ | 51,602 |
|
| |
| |
|
| Capitalized software costs as a percentage of gross expenditures | 19.0 | % | | 15.6 | % |
Amortization of capitalized software costs decreased by 27.1% to $7.4 million for the nine months ended December 31, 2015 as compared to $10.2 million for the prior year period. The decrease in amortization of capitalized software costs is due to certain products being fully amortized. Amortization of capitalized software costs are reflected as cost of revenue on our consolidated statements of comprehensive income. Refer to Note 6, “Capitalized Software Costs” of our notes to the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for an estimate of future amortization of capitalized software costs.
Other Corporate and overhead costs increased by $3.6 million to $54.6 million for the nine months ended December 31, 2015 as compared to $51.0 million for the prior year period primarily due to higher bad debt expense and acquisition related costs. In addition, higher utilization of online advertising and media placement has resulted in a 2.4% increase in marketing expense to $9.7 million for the nine months ended December 31, 2015 as compared to $9.4 million for the prior year period.
Comparison of the Three Months Ended December 31, 2015 and December 31, 2014
Net Income. Our net income for the three months ended December 31, 2015 was $7.3 million, or $0.12 per share on both a basic and fully diluted basis. In comparison, we had net income of $6.7 million, or $0.11 per share on both a basic and fully diluted basis for the three months ended December 31, 2014. The $0.6 million increase in net income for the three months ended December 31, 2015 as compared to the prior year period was primarily attributed to the following:
a $4.0 million decrease in research and development costs due to higher rates of capitalization of software costs related to the development of enhancements to our ambulatory software products combined with lower gross expenditures, including both amounts expensed and capitalized, related to lower costs as a result of the Hospital disposition and lower third-party consulting costs, and
a $2.1 million decrease in selling, general and administrative costs due primarily to lower shareholder litigation expense, offset by higher acquisition related costs and the loss on Hospital disposition, partially offset by
a $5.8 million decrease in gross profit due mostly to a decrease in high-margin software license sales.
Revenues. Revenue for the three months ended December 31, 2015 decreased 5.2% to $117.0 million from $123.4 million for the three months ended December 31, 2014. NextGen Division revenue decreased 3.7% to $88.7 million compared to $92.1 million in the three months ended December 31, 2014; RCM Services Division revenue increased 4.9% to $23.0 million from $21.9 million; QSI Dental Division revenue increased 5.5% to $4.7 million from $4.5 million; and Hospital Solutions Division revenue decreased 87.6% to $0.6 million from $5.0 million in the three months ended December 31, 2014.
Software, Hardware and Related. Revenue from consolidated software, hardware and related sales for the three months ended December 31, 2015 decreased 16.3% to $27.9 million from $33.3 million in the prior year period.
The following table summarizes software, hardware and related sales on a consolidated and divisional basis for the three months ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | |
| | | Software License and Hardware | | Software Related Subscription Services | | Total Software, Hardware and Related |
| Three Months Ended December 31, 2015 | | | | | | |
| NextGen Division | | $ | 15,663 |
| | $ | 11,220 |
| | $ | 26,883 |
|
| RCM Services Division | | 3 |
| | — |
| | 3 |
|
| QSI Dental Division | | 526 |
| | 395 |
| | 921 |
|
| Hospital Solutions Division | | (42 | ) | | 90 |
| | 48 |
|
| Consolidated | | $ | 16,150 |
| | $ | 11,705 |
| | $ | 27,855 |
|
| Three Months Ended December 31, 2014 | | | | | | |
| NextGen Division | | $ | 19,210 |
| | $ | 10,645 |
| | $ | 29,855 |
|
| RCM Services Division | | 143 |
| | 222 |
| | 365 |
|
| QSI Dental Division | | 435 |
| | 284 |
| | 719 |
|
| Hospital Solutions Division | | 1,640 |
| | 713 |
| | 2,353 |
|
| Consolidated | | $ | 21,428 |
| | $ | 11,864 |
| | $ | 33,292 |
|
Software, hardware and related sales for the NextGen Division decreased by $3.0 million in the three months ended December 31, 2015 compared to the prior year period due primarily to a $3.5 million, or 18.5%, decrease in software license and hardware revenue, offset by an increase of $0.6 million, or 5.4%, in software related subscription services revenue resulting from growth in both our interoperability subscriptions and subscriptions related to our NextGen® Patient Portal product offering. The decline in NextGen Division software license and hardware revenue is principally due to increasing levels of market saturation for core electronic health record and practice management solutions. The NextGen Division’s software license and hardware revenue accounted for 58.3% of divisional software, hardware and related revenue during the three months ended December 31, 2015 compared to 64.3% during the prior year period.
The RCM Services Division was not a significant contributor to consolidated software, hardware and related revenue for both the three months ended December 31, 2015 and 2014 as a result of the nature of the division's product and service offering.
Total software, hardware and related sales for the QSI Dental Division increased 28.1%, or $0.2 million, in the three months ended December 31, 2015 versus the same period last year primarily due to higher software license sales and increases in software related subscription services, such as QDW, the Division's cloud-based software solution. QDW is sold primarily as a SaaS solution for which revenue is recognized over an extended period of time rather than upfront.
At the Hospital Solutions Division, software, hardware and related revenue decreased 98.0%, or $2.3 million in the three months ended December 31, 2015 versus the same period last year primarily due to the Hospital disposition in October 2015.
We expect to benefit, over time, from growth in the replacement market, driven by an expected consolidation of electronic health records vendors. We also anticipate the creation of new opportunities in connection with the evolution of healthcare from a fee-for-services reimbursement model to a pay-for-performance model around the management of patient populations. Our acquisitions of Gennius and Mirth provided us with new products and services around population health, collaborative care management, interoperability and enterprise analytics to address these market dynamics. While it remains difficult to assess the relative impact or the timing of positive and negative trends affecting the aforementioned market opportunities, we believe we are well positioned to remain a leader in serving the evolving market needs for healthcare information technology.
Support and Maintenance, RCM, EDI and Professional Services. For the three months ended December 31, 2015, our consolidated revenue from RCM and related services and EDI and data services increased by 5.9%, and 8.4%, respectively, compared to the prior year period. Consolidated revenue from support and maintenance decreased by 8.2% compared to the prior year period as a result of increases in sales credits and related reserves and net customer attrition. Professional services revenue decreased by 2.9% compared to the prior year period due to lower demand for related system sales.
The following table summarizes support and maintenance, RCM and related services, EDI and data services and professional services revenue by category on a consolidated and divisional basis for the three months ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | | |
| | | Support and Maintenance | | RCM and Related Services | | EDI and Data Services | | Professional Services |
| Three Months Ended December 31, 2015 | | | | | | | | |
| NextGen Division | | $ | 36,984 |
| | $ | — |
| | $ | 18,806 |
| | $ | 6,020 |
|
| RCM Services Division | | 55 |
| | 21,594 |
| | 422 |
| | 920 |
|
| QSI Dental Division | | 2,006 |
| | — |
| | 1,395 |
| | 404 |
|
| Hospital Solutions Division | | 474 |
| | — |
| | 20 |
| | 77 |
|
| Consolidated | | $ | 39,519 |
| | $ | 21,594 |
| | $ | 20,643 |
| | $ | 7,421 |
|
| Three Months Ended December 31, 2014 | | | | | | | | |
| NextGen Division | | $ | 38,285 |
| | $ | — |
| | $ | 17,633 |
| | $ | 6,281 |
|
| RCM Services Division | | 152 |
| | 20,392 |
| | 216 |
| | 788 |
|
| QSI Dental Division | | 2,166 |
| | — |
| | 1,178 |
| | 417 |
|
| Hospital Solutions Division | | 2,442 |
| | — |
| | 24 |
| | 158 |
|
| Consolidated | | $ | 43,045 |
| | $ | 20,392 |
| | $ | 19,051 |
| | $ | 7,644 |
|
Support and maintenance revenue at the NextGen Division for the three months ended December 31, 2015 decreased by 3.4% to $37.0 million from $38.3 million as a result of increases in sales credits and related reserves and net customer attrition. NextGen Division EDI and data services revenue grew 6.7% to $18.8 million compared to $17.6 million in the prior year period. The growth in NextGen EDI revenue has come from new customers and from further penetration of the division’s existing customer base. Professional services revenue for the NextGen Division, which consists primarily of implementation and training and consulting services, decreased 4.2% to $6.0 million in the three months ended December 31, 2015 from $6.3 million in the prior year period due to the softening demand for related system sales, as noted above.
For the three months ended December 31, 2015, RCM and related services revenue increased to $21.6 million compared to $20.4 million in the prior year period. The growth in RCM revenue is primarily attributable to organic growth achieved through cross selling RCM services to existing NextGen Division customers as well as the addition of new customers.
QSI Dental Division support and maintenance for the three months ended December 31, 2015 decreased by $0.2 million as compared to the prior year period due primarily to a shift in customer preference to subscription-based software services as opposed to software licenses that require support and maintenance. Professional services revenue remained consistent while EDI and data services revenue at the QSI Dental Division increased to $1.4 million for the three months ended December 31, 2015 from $1.2 million in the prior year period.
For the Hospital Solutions Division, support and maintenance revenue decreased by $2.0 million, or 80.6%, and professional services revenue decreased by $0.1 million, or 68.9%, for the three months ended December 31, 2015 as compared to the prior year period primarily due to the Hospital disposition in October 2015.
We intend to continue to promote support and maintenance, RCM and related services, and EDI and data services to both new and existing customers.
Cost of Revenue. Cost of revenue for the three months ended December 31, 2015 decreased to $53.8 million from $54.4 million in the prior year period and the cost of revenue as a percentage of revenue increased to 46.0% from 44.0%. The increase in cost of revenue as a percentage of revenue principally reflects the decline in high-margin software license sales.
The following table details revenue and cost of revenue on a consolidated and divisional basis for the three months ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | |
| | | Three Months Ended December 31, |
| | | 2015 | | % | | 2014 | | % |
| NextGen Division | | | | | | | | |
| Revenue | | $ | 88,693 |
| | 100.0 | % | | $ | 92,054 |
| | 100.0 | % |
| Cost of revenue | | 32,497 |
| | 36.6 | % | | 30,678 |
| | 33.3 | % |
| Gross profit | | $ | 56,196 |
| | 63.4 | % | | $ | 61,376 |
| | 66.7 | % |
| RCM Services Division | | | | | | | | |
| Revenue | | $ | 22,994 |
| | 100.0 | % | | $ | 21,913 |
| | 100.0 | % |
| Cost of revenue | | 15,105 |
| | 65.7 | % | | 14,757 |
| | 67.3 | % |
| Gross profit | | $ | 7,889 |
| | 34.3 | % | | $ | 7,156 |
| | 32.7 | % |
| QSI Dental Division | | | | | | | | |
| Revenue | | $ | 4,726 |
| | 100.0 | % | | $ | 4,480 |
| | 100.0 | % |
| Cost of revenue | | 2,093 |
| | 44.3 | % | | 2,114 |
| | 47.2 | % |
| Gross profit | | $ | 2,633 |
| | 55.7 | % | | $ | 2,366 |
| | 52.8 | % |
| Hospital Solutions Division | | | | | | | | |
| Revenue | | $ | 619 |
| | 100.0 | % | | $ | 4,977 |
| | 100.0 | % |
| Cost of revenue | | 688 |
| | 111.1 | % | | 2,954 |
| | 59.4 | % |
| Gross profit (loss) | | $ | (69 | ) | | (11.1 | )% | | $ | 2,023 |
| | 40.6 | % |
| Unallocated cost of revenue | | $ | 3,402 |
| | N/A |
| | $ | 3,857 |
| | N/A |
|
| Consolidated | | | | | | | | |
| Revenue | | $ | 117,032 |
| | 100.0 | % | | $ | 123,424 |
| | 100.0 | % |
| Cost of revenue | | 53,785 |
| | 46.0 | % | | 54,360 |
| | 44.0 | % |
| Gross profit | | $ | 63,247 |
| | 54.0 | % | | $ | 69,064 |
| | 56.0 | % |
Gross profit margin for the NextGen Division decreased to 63.4% for the three months ended December 31, 2015 as compared to 66.7% for the prior year period due to a decrease in high-margin software sales. Gross profit margin for the RCM Services Division increased to 34.3% as compared to 32.7% for the prior year period primarily due to improved management of headcount and related costs. The Hospital Solutions Division experienced a gross loss of 11.1% for the three months ended December 31, 2015 primarily due to the Hospital disposition in October 2015.
The following table details the individual components of cost of revenue and gross profit (loss) as a percentage of total revenue on a consolidated and divisional basis for the three months ended December 31, 2015 and 2014:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Software License and Hardware | | Software Related Subscription Services | | Support and Maintenance | | RCM and Related Services | | EDI and Data Services | | Professional Services | | Total Cost of Revenue | | Gross Profit (Loss) |
| Three Months Ended December 31, 2015 | | | | | | | | | | | | | | | | |
| NextGen Division | | 3.3 | % | | 6.1 | % | | 7.1 | % | | 0.0 | % | | 12.7 | % | | 7.4 | % | | 36.6 | % | | 63.4 | % |
| RCM Services Division | | 0.0 | % | | 0.0 | % | | 0.1 | % | | 62.5 | % | | 1.6 | % | | 1.5 | % | | 65.7 | % | | 34.3 | % |
| QSI Dental Division | | 3.8 | % | | 1.7 | % | | 14.2 | % | | 0.0 | % | | 17.0 | % | | 7.6 | % | | 44.3 | % | | 55.7 | % |
| Hospital Solutions Division | | 3.5 | % | | 12.7 | % | | 87.8 | % | | 0.0 | % | | 1.4 | % | | 5.7 | % | | 111.1 | % | | (11.1 | )% |
| Consolidated | | 5.6 | % | | 4.7 | % | | 6.4 | % | | 12.3 | % | | 10.6 | % | | 6.4 | % | | 46.0 | % | | 54.0 | % |
| Three Months Ended December 31, 2014 | | | | | | | | | | | | | | | | |
| NextGen Division | | 3.5 | % | | 5.3 | % | | 5.5 | % | | 0.0 | % | | 11.9 | % | | 7.1 | % | | 33.3 | % | | 66.7 | % |
| RCM Services Division | | 0.0 | % | | 0.0 | % | | 0.3 | % | | 65.0 | % | | 0.8 | % | | 1.2 | % | | 67.3 | % | | 32.7 | % |
| QSI Dental Division | | 3.9 | % | | 1.1 | % | | 14.6 | % | | 0.0 | % | | 18.2 | % | | 9.4 | % | | 47.2 | % | | 52.8 | % |
| Hospital Solutions Division | | 0.1 | % | | 4.7 | % | | 32.4 | % | | 0.0 | % | | 0.4 | % | | 21.8 | % | | 59.4 | % | | 40.6 | % |
| Consolidated | | 5.9 | % | | 4.2 | % | | 6.0 | % | | 11.5 | % | | 9.7 | % | | 6.7 | % | | 44.0 | % | | 56.0 | % |
Cost of software license and hardware decreased to 5.6% of total revenue during the three months ended December 31, 2015 as compared to 5.9% for the prior year period, which is mainly the result of the full amortization of certain software products, leading to a decrease in related amortization of capitalized software costs. The decline in cost of software license and hardware was offset by an increase in cost of support and maintenance, which increased to 6.4% of total revenue for the three months ended December 31, 2015 as compared to 6.0% for the prior year period, attributable to headcount growth and higher related payroll and benefits expense associated with delivering our products and services at the NextGen Division.
Cost of RCM and related services increased to 12.3% of total revenue and cost of EDI and data services increased to 10.6% of total revenue for the three months ended December 31, 2015 as compared to 11.5% and 9.7%, respectively, for the prior year period. The increase in such costs as a percentage of total revenue is attributed to RCM and related services revenue and EDI and data services revenue each comprising a larger proportion of total revenues in comparison to the prior year period.
Cost of software related subscription services also increased to 4.7% of total revenue for the three months ended December 31, 2015 compared to 4.2% for the prior year period, which is primarily a result of an increase in the absolute level of payroll and benefit expenses associated with delivering our products and services due to headcount additions required to support revenue growth.
We experienced a decline in cost of professional services, which decreased to 6.4% of total revenue during the three months ended December 31, 2015 as compared to 6.7% for the prior year period, due to lower headcount in the Hospital Solutions Division as a result of the disposition and improved cost and utilization management in the NextGen Division.
As a result of the foregoing events and activities, our gross profit percentage decreased to 54.0% for the three months ended December 31, 2015 versus 56.0% for the prior year period.
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended December 31, 2015 decreased 5.0% to $39.4 million as compared to $41.5 million for the prior year period. The decrease in selling, general and administrative expenses consists primarily of:
$4.6 million decrease in legal expense related mostly to lower shareholder litigation defense costs;
$0.8 million decrease in sales commissions expense related to the recent decline in new system sales;
$0.6 million decrease in equipment and depreciation expense;
$0.5 million decrease in consulting and outside services costs; and
$1.1 million net decrease in other selling, general and administrative expenses, offset by
$3.7 million increase in acquisition related costs; and
$1.8 million loss (including related incremental direct costs) on the Hospital disposition.
Share-based compensation expense was approximately $0.6 million for both of the three months ended December 31, 2015 and 2014 and is included in the aforementioned amounts. Selling, general and administrative expenses as a percentage of revenue decreased from 33.6% in the three months ended December 31, 2014 to 33.7% in the three months ended December 31, 2015.
Research and Development Costs. Research and development costs for the three months ended December 31, 2015 and 2014 were $14.5 million and $18.5 million, respectively. Research and development costs as a percentage of revenue decreased to 12.4% in the three months ended December 31, 2015 from 15.0% for the prior year period. The decrease in research and development expenses is primarily due to higher rates of capitalization of software costs related to the development of enhancements to our ambulatory software products combined with lower gross expenditures, including both amounts expensed and capitalized, related to lower costs as a result of the Hospital disposition and lower third-party consulting costs.
The capitalization of software development costs results in a reduction to reported research and development costs. For the three months ended December 31, 2015 and 2014, our additions to capitalized software were $4.9 million and $3.2 million, respectively. For the three months ended December 31, 2015 and 2014, total gross research and development expenditures, including both amounts expensed and capitalized, was $19.4 million and $21.7 million, respectively.
We intend to continue to invest heavily in research and development to enhance our software to meet the Meaningful Use definitions under the ARRA and continue to bring additional functionality and features to the medical community.
Amortization of Acquired Intangible Assets. Amortization included in operating expenses related to acquired intangible assets remained consistent at $0.9 million for the three months ended December 31, 2015 compared to the prior year period.
Provision for Income Taxes. The provision for income taxes for the three months ended December 31, 2015 and 2014 was $1.1 million and $1.5 million, respectively. The effective tax rates were 13.5% and 17.9% for the three months ended December 31, 2015 and 2014, respectively. Both periods reflect approximately three quarters of a full fiscal year impact of the federal research and development tax credit due to the timing of the expiration and retroactive reinstatement of the credit. The effective rate for the three months ended December 31, 2015 decreased as compared to the prior year period primarily due to a favorable impact of the qualifying production activity deduction in the three months ended December 31, 2015.
Comparison of the Nine Months Ended December 31, 2015 and December 31, 2014
Net Income. Our net income for the nine months ended December 31, 2015 was $22.0 million, or $0.36 on both a basic and fully diluted basis. In comparison, we earned $16.6 million, or $0.28 and $0.27 per share on a basic and fully diluted basis, respectively, for the nine months ended December 31, 2014. The $5.4 million increase in net income for the nine months ended December 31, 2015 as compared to the prior year period was primarily attributed to the following: Services.
a $3.7 million increase in consolidated gross profit due to improved profitability from software related subscription services, RCM and related services, EDI and data services, and professional services, and
a $2.0 million decrease in research and development expenses due to higher rates of capitalization of software costs related to the development of enhancements to our ambulatory software products, and
a $0.9 million decrease in selling, general and administrative costs due primarily to lower shareholder litigation expense, offset by higher acquisition related costs and the loss on Hospital disposition, partially offset by
an increase of $1.6 million in the provision for income taxes, principally reflecting the increase in pretax income.
Revenue. Revenue for the nine months ended December 31, 2015 increased 0.8% to $364.6 million from $361.8 million for the nine months ended December 31, 2014. NextGen Division revenue decreased 0.6% to $275.3 million from $276.9 million in the nine months ended December 31, 2014, RCM Services Division revenue increased 16.8% to $68.0 million from $58.2 million, QSI Dental Division revenue increased 3.3% to $13.8 million from $13.4 million, and Hospital Solutions Division revenue decreased 43.9% to $7.5 million from $13.3 million in the prior year period.
Software, Hardware and Related. Revenue from consolidated software, hardware and related sales for the nine months ended December 31, 2015 decreased 3.7% to $88.4 million from $91.8 million in the prior year period.
The following table summarizes software, hardware and related sales on a consolidated and divisional basis for the nine months ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | |
| | | Software License and Hardware | | Software Related Subscription Services | | Total Software, Hardware and Related |
| Nine Months Ended December 31, 2015 | | | | | | |
| NextGen Division | | $ | 49,861 |
| | $ | 33,505 |
| | $ | 83,366 |
|
| RCM Services Division | | 234 |
| | 743 |
| | 977 |
|
| QSI Dental Division | | 1,863 |
| | 996 |
| | 2,859 |
|
| Hospital Solutions Division | | 68 |
| | 1,144 |
| | 1,212 |
|
| Consolidated | | $ | 52,026 |
| | $ | 36,388 |
| | $ | 88,414 |
|
| Nine Months Ended December 31, 2014 | | | | | | |
| NextGen Division | | $ | 56,544 |
| | $ | 28,284 |
| | $ | 84,828 |
|
| RCM Services Division | | 345 |
| | 242 |
| | 587 |
|
| QSI Dental Division | | 1,590 |
| | 677 |
| | 2,267 |
|
| Hospital Solutions Division | | 2,026 |
| | 2,063 |
| | 4,089 |
|
| Consolidated | | $ | 60,505 |
| | $ | 31,266 |
| | $ | 91,771 |
|
NextGen Division software, hardware and related sales decreased by $1.5 million primarily due to a $6.7 million, or 11.8%, decrease in software license and hardware sales during the nine months ended December 31, 2015 versus the same period last year, which is the result of lower sales to both new and existing customers and reflects the increasing levels of market saturation for core electronic health record and practice management solutions. The decrease in software license and hardware sales was partially offset by a $5.2 million, or 18.5%, increase in software related subscription services during the nine months ended December 31, 2015 versus the same period last year as a result of the growth in both our interoperability subscriptions and subscriptions related to our NextGen® Patient Portal product offering. The NextGen Division’s software license and hardware revenue accounted for 59.8% of divisional software, hardware and related revenue during the nine months ended December 31, 2015 compared to 66.7% during the prior year period.
The RCM Services Division was not a significant contributor to consolidated software, hardware and related revenue for both the nine months ended December 31, 2015 and 2014 as a result of the nature of the division's product and service offering.
Total software, hardware and related sales for the QSI Dental Division increased 26.1%, or $0.6 million, in the nine months ended December 31, 2015 compared to the same period last year, driven mostly by a 47.1% growth in sales of software related subscription services. The growth in software related subscription services versus the same period last year is primarily due to a shift in customer preference from software licenses to software related subscription services, such as QDW, the Division's cloud-based software solution. QDW is sold primarily as a SaaS solution for which revenue is recognized over an extended period of time rather than upfront.
At the Hospital Solutions Division, total software, hardware and related sales decreased 70.4%, or $2.9 million, to $1.2 million in the nine months ended December 31, 2015 as compared to $4.1 million in the prior year period. This decrease is primarily the result of the Hospital disposition in October 2015 as well as higher volume of sales credits for both software license and hardware sales and software related subscriptions services in the nine months ended December 31, 2015 as compared the prior year period.
Support and Maintenance, RCM, EDI and Professional Services. For the nine months ended December 31, 2015, our consolidated revenue from RCM and related services and EDI and data services increased by 14.9%, and 9.1%, respectively compared to the prior year period. Consolidated revenue from support and maintenance decreased by 0.5% compared to the prior year period as a result of net customer attrition. Professional services revenue decreased by 19.8% compared to the prior year period due to lower demand for related system sales.
The following table summarizes support and maintenance, RCM and related services, EDI and data services and professional services revenue by category on a consolidated and divisional basis for the nine months ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | | |
| | | Support and Maintenance | | RCM and Related Services | | EDI and Data Services | | Professional Services |
| Nine Months Ended December 31, 2015 | | | | | | | | |
| NextGen Division | | $ | 113,957 |
| | $ | — |
| | $ | 56,195 |
| | $ | 21,764 |
|
| RCM Services Division | | 263 |
| | 62,630 |
| | 1,262 |
| | 2,857 |
|
| QSI Dental Division | | 5,925 |
| | — |
| | 3,895 |
| | 1,146 |
|
| Hospital Solutions Division | | 5,263 |
| | — |
| | 61 |
| | 933 |
|
| Consolidated | | $ | 125,408 |
| | $ | 62,630 |
| | $ | 61,413 |
| | $ | 26,700 |
|
| Nine Months Ended December 31, 2014 | | | | | | | | |
| NextGen Division | | $ | 112,014 |
| | $ | — |
| | $ | 51,862 |
| | $ | 28,212 |
|
| RCM Services Division | | 430 |
| | 54,517 |
| | 596 |
| | 2,095 |
|
| QSI Dental Division | | 6,209 |
| | — |
| | 3,724 |
| | 1,180 |
|
| Hospital Solutions Division | | 7,332 |
| | — |
| | 94 |
| | 1,801 |
|
| Consolidated | | $ | 125,985 |
| | $ | 54,517 |
| | $ | 56,276 |
| | $ | 33,288 |
|
Support and maintenance revenue at the NextGen Division for the nine months ended December 31, 2015 increased by 1.7% to $114.0 million from $112.0 million for the prior year period primarily due to additional revenues from both new and existing customers as well as declines in sales credits and related reserves. NextGen Division EDI and data services revenue grew 8.4% to $56.2 million compared to $51.9 million in the prior year period. The growth in NextGen EDI revenue has come from new customers and from further penetration of the division’s existing customer base. Professional services revenue for the NextGen Division, which consists primarily of implementation and training and consulting services, decreased 22.9% to $21.8 million in the nine months ended December 31, 2015 from $28.2 million in the prior year period due to the softening demand for related system sales, as noted above.
For the nine months ended December 31, 2015, RCM and related services revenue increased to $62.6 million compared to $54.5 million in the prior year period. The growth in RCM revenue is primarily attributable to organic growth achieved through cross selling RCM services to existing NextGen Division customers as well as the addition of new customers.
QSI Dental Division support and maintenance revenue for the nine months ended December 31, 2015 decreased by $0.3 million as compared to the prior year period due primarily to a shift in customer preference to subscription-based software services as opposed to software licenses that require support and maintenance. EDI and data services revenue and professional services revenue at the QSI Dental Division remained consistent for the nine months ended December 31, 2015 compared to the prior year period.
For the Hospital Solutions Division, support and maintenance revenue for the nine months ended December 31, 2015 decreased by $2.1 million, or 28.2%, as compared to the prior year period. Professional services revenue decreased by $0.9 million, or 48.2%, as compared to the prior year period due to lower demand for system sales and related implementation, training, and consulting services. The Hospital disposition in October 2015 also partially contributed to the overall decrease in revenue as compared to the prior year period.
Cost of Revenue. Cost of revenue for the nine months ended December 31, 2015 decreased by 0.6% to $166.4 million from $167.3 million in the prior year period and the cost of revenue as a percentage of revenue decreased to 45.6% from 46.2%. The decrease in cost of revenue as a percentage of revenue reflects a $2.8 million decrease in amortization of capitalized software costs as compared to the prior year period due to certain software products becoming fully amortized.
The following table details revenue and cost of revenue on a consolidated and divisional basis for the nine months ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | |
| | | Nine Months Ended December 31, |
| | | 2015 | | % | | 2014 | | % |
| NextGen Division | | | | | | | | |
| Revenue | | $ | 275,282 |
| | 100.0 | % | | $ | 276,914 |
| | 100.0 | % |
| Cost of revenue | | 98,866 |
| | 35.9 | % | | 95,459 |
| | 34.5 | % |
| Gross profit | | $ | 176,416 |
| | 64.1 | % | | $ | 181,455 |
| | 65.5 | % |
| RCM Services Division | | | | | | | | |
| Revenue | | $ | 67,989 |
| | 100.0 | % | | $ | 58,226 |
| | 100.0 | % |
| Cost of revenue | | 45,630 |
| | 67.1 | % | | 41,633 |
| | 71.5 | % |
| Gross profit | | $ | 22,359 |
| | 32.9 | % | | $ | 16,593 |
| | 28.5 | % |
| QSI Dental Division | | | | | | | | |
| Revenue | | $ | 13,825 |
| | 100.0 | % | | $ | 13,379 |
| | 100.0 | % |
| Cost of revenue | | 6,825 |
| | 49.4 | % | | 6,818 |
| | 51.0 | % |
| Gross profit | | $ | 7,000 |
| | 50.6 | % | | $ | 6,561 |
| | 49.0 | % |
| Hospital Solutions Division | | | | | | | | |
| Revenue | | $ | 7,469 |
| | 100.0 | % | | $ | 13,318 |
| | 100.0 | % |
| Cost of revenue | | 4,901 |
| | 65.6 | % | | 10,723 |
| | 80.5 | % |
| Gross profit | | $ | 2,568 |
| | 34.4 | % | | $ | 2,595 |
| | 19.5 | % |
| Unallocated cost of revenue | | $ | 10,138 |
| | N/A |
| | $ | 12,690 |
| | N/A |
|
| Consolidated | | | | | | | | |
| Revenue | | $ | 364,565 |
| | 100.0 | % | | $ | 361,837 |
| | 100.0 | % |
| Cost of revenue | | 166,360 |
| | 45.6 | % | | 167,323 |
| | 46.2 | % |
| Gross profit | | $ | 198,205 |
| | 54.4 | % | | $ | 194,514 |
| | 53.8 | % |
Gross profit margin for the NextGen Division decreased to 64.1% for the nine months ended December 31, 2015 compared to 65.5% for the prior year period primarily due to a decrease in high-margin software license sales. Gross profit margin for the RCM Services Division increased to 32.9% as compared to 28.5% for the prior year period primarily due to improved management of headcount and related costs. The gross profit margin for the Hospital Solutions Division of 34.4% for the nine months ended December 31, 2015 benefited from a significant decline in cost of revenue due mostly to lower payroll and related benefits costs, in connection with reductions in headcount and the Hospital disposition in October 2015.
The following table details the individual components of cost of revenue and gross profit as a percentage of total revenue on a consolidated and divisional basis for the nine months ended December 31, 2015 and 2014:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Software License and Hardware | | Software Related Subscription Services | | Support and Maintenance | | RCM and Related Services | | EDI and Data Services | | Professional Services | | Total Cost
of Revenue | | Gross Profit |
| Nine Months Ended December 31, 2015 | | | | | | | | | | | | | | | | |
| NextGen Division | | 3.4 | % | | 6.0 | % | | 6.6 | % | | 0.0 | % | | 12.3 | % | | 7.6 | % | | 35.9 | % | | 64.1 | % |
| RCM Services Division | | 0.0 | % | | 0.0 | % | | 0.1 | % | | 64.1 | % | | 1.5 | % | | 1.4 | % | | 67.1 | % | | 32.9 | % |
| QSI Dental Division | | 4.1 | % | | 1.9 | % | | 14.5 | % | | 0.0 | % | | 17.8 | % | | 11.1 | % | | 49.4 | % | | 50.6 | % |
| Hospital Solutions Division | �� | 2.7 | % | | 8.3 | % | | 48.8 | % | | 0.0 | % | | 0.3 | % | | 5.5 | % | | 65.6 | % | | 34.4 | % |
| Consolidated | | 5.5 | % | | 4.8 | % | | 6.5 | % | | 12.0 | % | | 10.2 | % | | 6.6 | % | | 45.6 | % | | 54.4 | % |
| Nine Months Ended December 31, 2014 | | | | | | | | | | | | | | | | |
| NextGen Division | | 3.2 | % | | 5.0 | % | | 5.0 | % | | 0.0 | % | | 11.9 | % | | 9.4 | % | | 34.5 | % | | 65.5 | % |
| RCM Services Division | | 0.0 | % | | 0.0 | % | | 0.2 | % | | 69.0 | % | | 0.9 | % | | 1.4 | % | | 71.5 | % | | 28.5 | % |
| QSI Dental Division | | 4.9 | % | | 2.2 | % | | 14.9 | % | | 0.0 | % | | 17.8 | % | | 11.2 | % | | 51.0 | % | | 49.0 | % |
| Hospital Solutions Division | | 0.2 | % | | 6.8 | % | | 38.9 | % | | 0.0 | % | | 0.4 | % | | 34.2 | % | | 80.5 | % | | 19.5 | % |
| Consolidated | | 6.2 | % | | 4.2 | % | | 5.8 | % | | 11.1 | % | | 9.9 | % | | 9.0 | % | | 46.2 | % | | 53.8 | % |
During the nine months ended December 31, 2015, cost of software license and hardware decreased to 5.5% of revenue compared to 6.2% for the prior year period, which is mainly the result of the full amortization of certain software products, leading to a decrease in related amortization of capitalized software costs. The decline in cost of software license and hardware was offset by a increases in cost of software related subscription services and support and maintenance, which increased to
4.8% and 6.5%, respectively, for the nine months ended December 31, 2015 as compared to 4.2% and 5.8%, respectively, for the prior year period, attributable to headcount growth and higher related payroll and benefits expense associated with delivering our products and services at the NextGen Division.
Cost of RCM and related services increased to 12.0% of total revenue and cost of EDI and data services increased to 10.2% of total revenue for the nine months ended December 31, 2015 as compared to 11.1% and 9.9%, respectively, for the prior year period. The increase in such costs as a percentage of total revenue is attributed to RCM and related services revenue and EDI and data services revenue each comprising a larger proportion of total revenues in comparison to the prior year period.
For the Hospital Solutions Division, gross profit as a percentage of total revenue increased significantly to 34.4% for the nine months ended December 31, 2015 from 19.5% for the prior year period primarily attributed to a significant decline in cost of professional services, which decreased to 5.5% of revenue during the nine months ended December 31, 2015 compared to 34.2% for the prior year period, due to lower headcount and improved cost and utilization management. The NextGen Division also experienced a decline in cost of professional services to 7.6% of revenue during the nine months ended December 31, 2015 compared to 9.4% for the prior year period also due to lower headcount and improved cost and utilization management. The absolute level of professional services costs decreased by $8.8 million, of which $4.8 million of the decrease is related to the NextGen Division and $4.1 million relates to the Hospital Solutions Division.
As a result of the foregoing events and activities, our gross profit percentage increased to 54.4% for the nine months ended December 31, 2015 versus 53.8% for the same prior year period.
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the nine months ended December 31, 2015 decreased 0.8% to $116.0 million as compared to $116.9 million for the prior year period. The decrease in selling, general and administrative expenses consists primarily of:
$3.1 million decrease in legal expense related mostly lower shareholder litigation defense costs;
$1.6 million decrease in sales commission expense related to the recent decline in new system sales;
$1.3 million decrease in consulting and outside services costs;
$0.9 million decrease in equipment and depreciation expense;
$0.8 million decrease in facilities costs as the prior year period included certain lease termination fees; and
$0.3 million net decrease in other selling and administrative expenses, offset by
$3.2 million increase in acquisition related costs;
$2.1 million increase in bad debt expense because the prior year period included a net bad debt benefit (i.e., a credit) to earnings, related to aggressive working capital management in that period; and
$1.8 million loss (including related incremental direct costs) on the Hospital disposition.
Share-based compensation expense was approximately $1.7 million and $2.1 million for the nine months ended December 31, 2015 and 2014, respectively, and is included in the aforementioned amounts. Selling, general and administrative expenses as a percentage of revenue decreased from 32.3% in the nine months ended December 31, 2014 to 31.8% in the nine months ended December 31, 2015.
Research and Development Costs. Research and development costs for the nine months ended December 31, 2015 and 2014 were $49.6 million and $51.6 million, respectively. Research and development costs as a percentage of revenue decreased to 13.6% in the nine months ended December 31, 2015 from 14.3% for the prior year period. The decrease in research and development expenses is primarily due to higher rates of capitalization of software costs related to the development of enhancements to our ambulatory software products.
The capitalization of software development costs results in a reduction to reported research and development costs. For the nine months ended December 31, 2015 and 2014, our additions to capitalized software were $11.6 million and $9.5 million, respectively. For the nine months ended December 31, 2015 and 2014, total gross research and development expenditures including both amounts expensed and capitalized was $61.2 million and $61.1 million, respectively.
Amortization of Acquired Intangible Assets. Amortization included in operating expenses related to acquired intangible assets decreased to $2.7 million for the nine months ended December 31, 2015 from $2.8 million in the prior year period.
Provision for Income Taxes. The provision for income taxes for the nine months ended December 31, 2015 and 2014 was $8.2 million and $6.7 million, respectively. The effective tax rate was 27.3% and 28.6% for the nine months ended December 31, 2015 and 2014, respectively. The effective rate for the nine months ended December 31, 2015 decreased as compared to the prior year period primarily due to a favorable impact of the qualifying production activity deduction in the nine months ended December 31, 2015.
Liquidity and Capital Resources
The following table presents selected financial statistics and information for the nine months ended December 31, 20152016 and 20142015 (in thousands):
| | | | Nine Months Ended December 31, | Nine Months Ended December 31, |
| | 2015 | | 2014 | 2016 | | 2015 |
| Cash and cash equivalents and marketable securities | $ | 104,813 |
| | $ | 124,822 |
| $ | 23,994 |
| | $ | 104,813 |
|
| Net increase (decrease) in cash and cash equivalents and marketable securities | $ | (25,772 | ) | | $ | 11,021 |
| |
| Unused portion of revolving credit agreement(1) | | 225,000 |
| | — |
|
| Total liquidity | | $ | 248,994 |
| | $ | 104,813 |
|
| | | | | |
| Net income | $ | 21,979 |
| | $ | 16,589 |
| $ | 13,826 |
| | $ | 21,979 |
|
| Net cash provided by operating activities | $ | 27,292 |
| | $ | 58,706 |
| $ | 81,423 |
| | $ | 27,292 |
|
| Number of days of sales outstanding (1) | 72 |
| | 78 |
| |
Our investment policy is determined by our Board of Directors. We currently maintain ourExcess cash, if any, may be invested in very liquid short term assets including tax exempt and taxable money market funds, certificates of deposit and short term municipal bonds with average maturities of 365 days or less at the time of purchase. Our Board of Directors continues to review alternate uses for our cash including an expansion of our investment policy and other items. Any or all of these programs could significantly impact our investment income in future periods.