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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange
Act Of 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 2002
Or
[ ] Transition Report Pursuant To Section 13 Or 15(d) Of The Securities
Exchange Act Of 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission File Number: 0-21031
QUADRAMED CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1992861
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
12110 SUNSET HILLS ROAD, SUITE 600, RESTON, VIRGINIA 20190
(Address of Principal Executive Offices) (Zip Code)
(703) 709-2300
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$0.01 Par Value
Per Share
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes __ No X
Indicate by check mark whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Act. Yes __ No X
On July 31, 2003, 27,530,815 shares of the Registrant's common stock,
$0.01 par value per share, were outstanding.
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Explanatory Note
Financial statement information and related disclosures included in this
filing reflect, where appropriate, changes as a result of the restatement
(refer to note 2 to the condensed consolidated financial statements).
Statements used in this Form 10-Q containing the words (i) "now", "currently",
"present", "to date", and words of similar import, and (ii) "knowledge", and
words of similar import, are used to refer to conditions existing on the filing
date of this Form 10-Q. We direct you to refer to the other reports we file
with the Securities and Exchange Commission ("SEC") from time to time after the
date of this report for our more current information, including "Risk Factors
that May Impact Future Operating Results".
QUADRAMED CORPORATION
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Interim Condensed Consolidated Balance Sheets as of
September 30, 2002 and December 31, 2001..................... 2
Interim Condensed Consolidated Statements of Operations for
the three and nine months ended September 30, 2002 and 2001.. 3
Interim Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2002 and 2001................ 4
Notes to Interim Condensed Consolidated Financial Statements... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 35
Item 4. Controls and Procedures.......................................... 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 36
Item 2. Submission of Matters to Vote of Securities Holders.............. 37
Item 3. Other Matters.................................................... 37
Item 4. Exhibits and Reports on Form 8-K................................. 37
Signatures............................................................... 38
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
- ------ -------------------------------
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
September 30, December 31,
ASSETS 2002 2001
-------- --------
Current assets
Cash and cash equivalents $ 21,795 $ 29,799
Short-term investments 2,380 2,414
Accounts receivable, net of allowance for doubtful
accounts of $4,061 and $4,239, respectively 27,935 33,165
Unbilled receivables 3,426 3,825
Notes and other receivables 23 282
Prepaid expenses and other current assets 7,743 7,285
--------- ---------
Total current assets 63,302 76,770
--------- ---------
Restricted cash 4,448 4,356
Property and equipment, net of accumulated
depreciation and amortization of $15,528 and
$12,634, respectively 6,739 7,323
Capitalized software development costs, net of
accumulated amortization of $7,113 and $6,511,
respectively 6,205 6,214
Goodwill 23,508 14,721
Other intangible assets, net of accumulated
amortization of $12,643 and $10,784, respectively 9,947 8,634
Other long-term assets 6,952 7,115
--------- ---------
Total assets $ 121,101 $ 125,133
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses $ 2,376 $ 893
Accrued payroll and related 4,762 6,402
Other accrued liabilities 6,734 6,245
Deferred revenue 38,950 30,721
--------- ---------
Total current liabilities 52,822 44,261
Convertible subordinated debentures 73,719 73,719
Other long-term liabilities 3,644 2,932
--------- ---------
Total liabilities 130,185 120,912
Stockholders' equity (deficit)
Preferred stock, $0.01 par, 5,000 shares authorized,
zero shares issued and outstanding -- --
Common stock, $0.01 par, 50,000 shares authorized,
26,957 and 26,493 shares issued and outstanding,
respectively 270 265
Additional paid-in-capital 275,547 273,320
Deferred compensation (1,022) (1,085)
Accumulated other comprehensive loss (285) (468)
Accumulated deficit (283,594) (267,811)
--------- ---------
Total stockholders' equity (deficit) (9,084) 4,221
--------- ---------
Total liabilities and stockholders' equity
(deficit) $ 121,101 $ 125,133
========= =========
The accompanying notes are an integral part of these interim condensed
consolidated financial statements.
2
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenue
Services $ 23,045 $ 26,808 $ 70,397 $ 75,936
Licenses 7,133 7,696 21,953 24,427
-------- -------- -------- --------
Total revenue 30,178 34,504 92,350 100,363
-------- -------- -------- --------
Cost of revenue
Cost of services 13,539 12,167 36,496 37,578
Cost of licenses 2,150 1,759 6,266 5,884
-------- -------- -------- --------
Total cost of revenue 15,689 13,926 42,762 43,462
-------- -------- -------- --------
Gross margin 14,489 20,578 49,588 56,901
-------- -------- -------- --------
Operating expenses
General and administration 13,153 10,803 30,469 30,464
Sales and marketing 6,016 4,987 16,744 15,654
Research and development 4,706 3,531 12,289 10,840
Amortization, impairment and other
operating charges 773 5,142 2,258 8,254
-------- -------- -------- --------
Total operating expenses 24,648 24,463 61,760 65,212
-------- -------- -------- --------
Loss from operations (10,159) (3,885) (12,172) (8,311)
-------- -------- -------- --------
Other income (expense)
Interest expense (1,066) (1,492) (3,192) (4,777)
Interest income 144 367 521 2,118
Gain on sale of assets -- 7,088 -- 7,032
Other income (expense), net (375) (272) (940) (192)
-------- -------- -------- --------
Other income (expense) (1,297) 5,691 (3,611) 4,181
-------- -------- -------- --------
Income (loss) before income taxes and
extraordinary item (11,456) 1,806 (15,783) (4,130)
Provision for income taxes -- -- -- (81)
-------- -------- -------- --------
Income (loss) before extraordinary item (11,456) 1,806 (15,783) (4,211)
Gain on redemption of debentures -- 10,505 -- 12,907
-------- -------- -------- --------
Net income (loss) $(11,456) $ 12,311 $(15,783) $ 8,696
======== ======== ======== ========
Income (loss) per share
Basic before extraordinary item $ (0.43) $ 0.07 $ (0.60) $ (0.16)
Extraordinary item -- 0.41 -- 0.50
-------- -------- -------- --------
Basic after extraordinary item $ (0.43) $ 0.48 $ (0.60) $ 0.34
======== ======== ======== ========
Diluted before extraordinary item $ (0.43) $ 0.07 $ (0.60) $ (0.16)
Extraordinary item -- 0.39 -- 0.50
-------- -------- -------- --------
Diluted after extraordinary item $ (0.43) $ 0.46 $ (0.60) $ 0.34
======== ======== ======== ========
Weighted average shares outstanding
Basic 26,950 25,403 26,390 25,560
======== ======== ======== ========
Diluted 26,950 27,057 26,390 25,560
======== ======== ======== ========
The accompanying notes are an integral part of these interim condensed
consolidated financial statements.
3
QUADRAMED CORPORATION
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine months ended
September 30,
----------------------------
2002 2001
-------- --------
Cash provided by operating activities $ 5,830 $ 11,590
-------- --------
Cash flows from investing activities
Increase in restricted cash (92) --
Purchase of available-for-sale securities (367) (511)
Proceeds from the sale of available-for-sale
securities 316 12,730
Acquisitions of businesses (11,930) --
Decrease in restricted cash -- 1,079
Purchase of property and equipment (1,508) (1,944)
Proceeds from sale of assets -- 8,124
Payments for capitalized software development costs (1,700) (1,185)
-------- --------
Cash (used in) provided by investing activities (15,281) 18,293
-------- --------
Cash flows from financing activities
Repayments of debt (438) (28,471)
Purchases of treasury stock -- (821)
Proceeds from exercise of common stock options 1,885 323
-------- --------
Cash provided by (used in) financing activities 1,447 (28,969)
-------- --------
Net (decrease) increase in cash and cash equivalents (8,004) 914
Cash and cash equivalents, beginning of period 29,799 27,368
-------- --------
Cash and cash equivalents, end of period $ 21,795 $ 28,282
======== ========
The accompanying notes are an integral part of these interim condensed
consolidated financial statements.
4
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
1. NATURE OF OPERATIONS
--------------------
QuadraMed Corporation along with all significant business divisions and
subsidiaries, (the "Company" or "QuadraMed") is dedicated to improving
healthcare delivery by providing innovative healthcare information technology
and services. From clinical to patient information management and revenue cycle
to health information management, QuadraMed delivers real-world solutions that
help healthcare professionals deliver outstanding patient care with optimum
efficiency. QuadraMed was reincorporated in Delaware in 1996, having been
originally incorporated in California in 1993. QuadraMed is managed in four
distinct business segments which are as follows: Enterprise Division, Health
Information Management Software Division, Health Information Management
Services Division and Financial Services Division.
2. QUADRAMED CORPORATION AND BASIS OF PRESENTATION
-----------------------------------------------
Unaudited Interim Results
-------------------------
The condensed consolidated financial statements at September 30, 2002 and
December 31, 2001 and for the three and nine months ended September 30, 2002
and 2001 have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP"). The interim financial
information is unaudited, but reflects all adjustments that are, in the opinion
of management, necessary for a fair presentation of QuadraMed's condensed
consolidated financial position, operating results, and cash flows for the
interim periods. The preparation of condensed consolidated financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the condensed consolidated financial statements and the reported
amounts of revenues and expenses during the reporting periods.
These condensed consolidated financial statements have been prepared in
accordance with the instructions for a report on Form 10-Q as required by the
SEC, and therefore, do not include all information and notes normally provided
in annual financial statements. As a result, these condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, together with management's discussion
and analysis of financial condition and results of operations, contained in
QuadraMed's annual report on Form 10-K/A for the fiscal year ended December 31,
2001. The results of operations for the three and nine months ended September
30, 2002 are not necessarily indicative of the results for the fiscal year
ending December 31, 2002 or any other further periods.
Reclassifications
-----------------
Adoption of EITF No. 01-14
--------------------------
Certain reclassifications have been made to the 2001 interim condensed
consolidated financial statements to conform to the 2002 presentation.
Specifically, the September 30, 2001, financial statements have been
reclassified to comply with Financial Accounting Standards Board ("FASB")
Emerging Issues Task Force ("EITF") No. 01-14, Income Statement
Characterization of Reimbursements for 'Out-of-Pocket' Expenses Incurred. As
such, QuadraMed has reclassified prior year amounts to include billable out-of-
pocket reimbursable expenses in both license and service revenues and cost of
licenses and services, respectively. The adoption of EITF No. 01-14 does not
impact either income (loss) from operations or net income (loss) but does
increase revenue and cost of revenues and reduces gross margin percentages as
shown in the following tables:
5
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
Three months ended Nine months ended
September 30, 2001 September 30, 2001
-------------------------- ---------------------------
Services Licenses Total Services Licenses Total
-------- -------- ----- -------- -------- -----
Revenue
Reported revenue $26,808 $ 7,696 $34,504 $75,936 $24,427 $100,363
Less impact of EITF
No. 01-14 839 264 1,103 2,773 702 3,475
------- ------- ------- ------- ------- --------
Pro-forma revenue $25,969 $ 7,432 $33,401 $73,163 $23,725 $ 96,888
======= ======= ======= ======= ======= ========
Cost of revenue
Reported cost of
revenue $12,167 $ 1,759 $13,926 $37,578 $ 5,884 $ 43,462
Less impact of EITF
No. 01-14 839 264 1,103 2,773 702 3,475
------- ------- ------- ------- ------- --------
Pro-forma cost of
revenue $11,328 $ 1,495 $12,823 $34,805 $ 5,182 $ 39,987
======= ======= ======= ======= ======= ========
Gross margin percentage
Reported gross margin
percentage 54.6% 77.1% 59.6% 50.5% 75.9% 56.7%
Impact of EITF
No. 01-14 1.8 2.8 2.0 1.9 2.3 2.0
------- ------- ------- ------- ------- --------
Pro-forma gross margin
percentage 56.4% 79.9% 61.6% 52.4% 78.2% 58.7%
======= ======= ======= ======= ======= ========
Change In Classification Of Certain Service and License Revenues And
--------------------------------------------------------------------
Related Costs
- -------------
In previously reported periods, the Company's license revenue and
associated cost of license revenue included in the Statement of Operations
consisted of fees for the licensing of the Company's software products,
hardware, maintenance, hosted services, customer training and consulting
services. In these Interim Condensed Consolidated Statements of Operations,
license revenue and cost of license revenue for both 2002 and 2001 have been
reclassified to include only fees and costs, respectively associated with the
licensing of the Company's software products. The table below presents the
impact of the reclassification of licenses and services for the three and nine-
month periods ended September 30, 2001 (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------------------- --------------------------
2001 2001 2001 2001
(Reclassified) (Reclassified)
---- ------------ ---- -------------
Revenue
Services $ 11,656 $ 26,808 $ 34,120 $ 75,936
Licenses 22,848 7,696 66,243 24,427
-------- -------- -------- --------
$ 34,504 $ 34,504 $100,363 $100,363
======== ======== ======== ========
Cost of revenue
Services $ 8,500 $ 12,167 $ 26,196 $ 37,578
Licenses 5,426 1,759 17,266 5,884
-------- -------- -------- --------
$ 13,926 $ 13,926 $ 43,462 $ 43,462
======== ======== ======== ========
Restatement
-----------
In 2002, management of QuadraMed discovered accounting and reporting
errors within its Quarterly Report on Form 10-Q as filed for the three months
ended March 31, 2002 and its Annual Report on Form 10-K as filed for the years
ended December 31, 2001, 2000 and 1999. These errors resulted in management
determining that the reports for these years needed to be restated. In June
2003, QuadraMed amended and restated its 2001 Annual Report on Form 10-K/A
including the years ended 2001, 2000 and 1999 and all respective quarters.
This report is also being filed simultaneously with the restatement of
QuadraMed's Quarterly Report on Form 10-Q/A for the three months ended March
31, 2002.
6
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
3. RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 143, Accounting for Asset Retirement Obligations. The statement
-------------------------------------------
addresses financial accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset
retirement costs. The provisions of SFAS No. 143 are required to be applied
starting with fiscal years beginning after June 15, 2002. QuadraMed expects
that implementation of the new standard will not have a significant impact on
its financial condition, results of operations, and cash flows.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
-----------------------------
Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
- ---------------------------------------------------------------------
Corrections. This statement updates and clarifies existing pronouncements
- -----------
relating to the classification and reporting of gains and losses from the
extinguishment of debt, the treatment of sale-leaseback transactions and also
makes technical corrections to existing pronouncements. The provisions of SFAS
No. 145 are required to be applied starting with fiscal years beginning after
May 15, 2002. QuadraMed anticipates that implementation of this new standard
will not have a significant impact on its financial condition, results of
operations and cash flows.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
--------------------
Associated with Exit or Disposal Activities, effective for exit or disposal
- -------------------------------------------
activities initiated after December 31, 2002. Under SFAS 146 a liability for
the cost associated with an exit or disposal activity is recognized when the
liability is incurred. Under prior guidance, a liability for such costs could
be recognized at the date of commitment to an exit plan. SFAS 146 also requires
that the liability be measured and recorded at fair value. Accordingly, the
adoption of this standard may affect the timing of recognizing future
restructuring costs as well as the amounts recognized. QuadraMed will adopt the
provisions of SFAS 146 prospectively for all restructuring activities initiated
after December 31, 2002.
In November 2002, the FASB reached a consensus on EITF No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables. The guidance
- --------------------------------------------------------------
in EITF 00-21 is effective for revenue arrangements entered into in fiscal
years beginning after June 15, 2003. This issue addresses certain aspects of
the accounting by a vendor for arrangements under which it will perform
multiple revenue-generating activities. Specifically, EITF 00-21 addresses how
to determine whether an arrangement involving multiple deliverables contains
more than one earnings process and, if it does, how to divide the arrangement
into separate units of accounting consistent with the identified earning
processes for revenue recognition purposes. EITF 00-21 also addresses how
arrangement consideration should be measured and allocated to the separate
units of accounting in the arrangement. The Company is evaluating the effect
of this issue on its financial statements.
In November 2002, the FASB issued FIN 45, Guarantor's Accounting and
--------------------------
Disclosure Requirements for Guarantees, including indirect Guarantees of
- ------------------------------------------------------------------------
Indebtedness of Others. FIN 45 requires that QuadraMed recognizes the fair
- ----------------------
value for guarantee and indemnification arrangements issued or modified by
QuadraMed after December 31, 2002, if these arrangements are within the scope
of the interpretation. In addition, QuadraMed must continue to monitor the
conditions that are subject to the guarantees and indemnifications, as required
under previously existing generally accepted accounting principles, in order to
identify if a loss has occurred. If QuadraMed determines it is probable that a
loss has occurred then any such estimable loss would be recognized under those
guarantees and indemnifications. Some of the software licenses granted by
QuadraMed contain provisions that indemnify licensees of QuadraMed's software
from damages and costs resulting from claims alleging that QuadraMed's software
infringes the intellectual property rights of a third party. QuadraMed has
historically received only a limited number of requests for indemnification
under these provisions and has not been required to make material payments
pursuant to these provisions. Accordingly, QuadraMed has not recorded a
liability related to these indemnification provisions. QuadraMed will be
required to implement the provisions of FIN 45 as of January 1, 2003 and does
not believe that FIN 45 will have a material impact on its financial position,
results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
--------------------------
Compensation - Transition and Disclosure, effective for fiscal years ending
- ----------------------------------------
after December 15, 2002. SFAS 148 amends SFAS 123, to provide alternative
methods of transition to the voluntary fair value method of accounting for
stock-based employee compensation. SFAS 148 also amends the disclosure
provisions of SFAS 123 to require that disclosure of the pro forma effect of
using the fair value method of accounting for stock-based employee compensation
7
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
be displayed in tabular format within a Company's summary of significant
accounting policies. The disclosure provisions of SFAS 148 are effective for
fiscal years ending after December 5, 2002 and have been incorporated into
these financial statements and accompanying footnotes.
4. ACQUISITIONS AND DIVESTITURES
-----------------------------
Acquisitions
------------
Acquisition of Outstanding Shares of Pharmacy Data Systems, Inc.
----------------------------------------------------------------
On June 11, 2002, QuadraMed acquired all of the outstanding shares of
Pharmacy Data Systems, Inc. ("PDS"), a leader in advanced pharmacy, nursing,
and physician information systems, for $10.7 million, assumed liabilities of
$1,237,000 and acquisition costs of $262,000. The interim condensed
consolidated financial statements include the results of operations of PDS
since June 11, 2002. In connection with this acquisition, QuadraMed recorded
an in-process research and development charge of $400,000.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition (in thousands):
Assets:
Current assets $ 856
Property and equipment 100
Goodwill 7,893
Other intangible assets (including
in-process research and development) 3,350
-------
12,199
Liabilities:
Current liabilities (including
acquisition costs) 1,499
-------
Net purchase price $10,700
=======
Other intangible assets of $3.4 million included in-process research and
development, acquired technology, maintenance and other agreements and
trademarks. Capitalized intangible assets are subject to amortization periods
of one to five years. PDS is included within the Enterprise Segment of
QuadraMed.
Acquisition of the Assets of Cascade Health Information Software, Inc.
----------------------------------------------------------------------
On May 31, 2002, QuadraMed acquired the assets of Cascade Health
Information Software, Inc., ("Cascade") a leading provider of software for the
coding and abstracting of patient medical records, which was a subsidiary of
Transcend Services, Inc. for $935,000, assumed liabilities of $346,000 and
acquisition costs of $33,000. The purchase price was allocated $882,000 to
goodwill, $222,000 to intangible assets (including maintenance agreements and
existing technology), and $210,000 to other tangible net assets. Cascade is
included within the HIMS Software Segment of QuadraMed.
Pro forma results of operations for these business acquisitions have not
been presented because the effects were not material to the consolidated
financial statements on either an individual or aggregate basis.
Divestitures
------------
Sale of EZ-CAP Assets
---------------------
On August 16, 2001, QuadraMed and its wholly-owned subsidiary, QuadraMed
Operating Corporation, entered into an asset purchase agreement for the sale of
certain assets and related products used to conduct the EZ-CAP managed care
software business to OAO Transition, LLC, a Delaware limited liability company
("OAO Transition"), and OAO Technology Solutions, Inc., a Delaware corporation
(individually and collectively "OAO"). The transaction closed on August 31,
8
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
2001. QuadraMed received net proceeds from the sale of $8.1 million and
recorded a gain of $7.1 million during 2001. In addition, as part of the
agreement, QuadraMed received $1.5 million in payments based on EZ-CAP's
revenue growth and customer retention following the close of the transaction
which was recorded as an additional gain on sale in October 2002. Income
associated with the EZ-CAP operations for the three and nine months ended
September 30, 2001 was $69,000 and $1.6 million, respectively.
Sale of Electronic Remittance Advice Product Line
-------------------------------------------------
On March 31, 2001, QuadraMed sold its Electronic Remittance Advice product
line. QuadraMed recorded proceeds from the sale of $24,000, and a loss after
applicable taxes of $57,000.
5. IMPAIRMENT OF INVESTMENT IN MARKETABLE SECURITIES
-------------------------------------------------
In compliance with SFAS No. 115, Accounting for Certain Debt and Equity
--------------------------------------
Investments, and internal policy, QuadraMed recorded an impairment charge in
- -----------
December 2000 of $4.1 million to the VantageMed Corporation ("VantageMed")
investment to its then fair market value. In the nine-month period ended
September 30, 2002, QuadraMed recorded additional impairment charges totaling
$443,000. The additional charges result from the continuing decline in
VantageMed's stock price, its deteriorating cash position, instability in
management, and the non-liquid market for VantageMed shares. As of September
30, 2002, QuadraMed owns 599,425 shares of VantageMed or 7.1% of its
outstanding stock, with a fair value of $108,000.
6. GOODWILL AND OTHER INTANGIBLE ASSETS
------------------------------------
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
-----------------------------
Assets, effective for fiscal years beginning after December 15, 2001. Under
- ------
SFAS 142, goodwill and intangible assets deemed to have indefinite lives are to
be separately disclosed on the balance sheet, and no longer amortized but
subject to annual impairment tests. With the adoption of SFAS 142, QuadraMed
ceased amortization of goodwill as of January 1, 2002. Prior to this point,
goodwill was amortized using the straight-line method over its estimated useful
life.
SFAS 142 requires that goodwill be tested for impairment at the reporting
unit level (i.e., business segments) upon adoption and at least annually
thereafter using a two-step impairment analysis. In accordance with SFAS 142,
QuadraMed performed the first of the required two-step impairment tests of
goodwill and indefinite-lived assets as of January 1, 2002. In performing the
first step of this analysis, QuadraMed first assigned its assets and
liabilities, including existing goodwill and other intangible assets, to its
identified reporting units to determine their carrying value. For this purpose,
QuadraMed's reporting units equated to its five business segments then in
place. QuadraMed's reporting units equate to its business segments since this
is the lowest level of QuadraMed at which operating plans are prepared and
operating profitability is measured for assessing management performance. See
note 9 for more information regarding QuadraMed's business segments. Based on
an analysis by an independent third party appraiser, QuadraMed then estimated
the fair value of each reporting unit with significant goodwill utilizing
various valuation techniques including the Income Approach and the Market
Approach. The Income Approach provides an estimation of the fair value of a
reporting unit based on the discounted cash flows derived from the reporting
unit's estimated remaining life plus the present value of any residual value.
The Market Approach indicates the fair value of a reporting unit based upon a
comparison to publicly-traded companies in similar lines of business. Step one
of this analysis was then completed by comparing the carrying value of each
the-analyzed reporting units to its fair value. This comparison resulted in the
fair values of the analyzed reporting units exceeding the carrying values of
the net assets. In addition, the independent third party appraiser performed a
cursory review of the three unappraised reporting units utilizing the Income
Approach to estimate the total market value for QuadraMed Corporation as a
whole. The result was an estimated value for the Company that was less than
the market capitalization as of January 1, 2002. Accordingly, no indicators of
impairment existed. As a result, QuadraMed did not perform step two as
described by SFAS 142.
9
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
The following schedule shows the Company's reported net income (loss) for
periods prior to the adoption of SFAS No. 142 as adjusted to add back goodwill
amortization as if SFAS No. 142 had been adopted during these periods (in
thousands, except per share data):
Three months Nine months
ended ended
September 30, September 30,
2001 2001
---- ----
Income (loss) before extraordinary item $ 1,806 $ (4,211)
Add back: goodwill amortization 1,318 3,981
---------- ----------
Adjusted income (loss) before extraordinary item $ 3,124 $ (230)
========== ==========
Reported net income $ 12,311 $ 8,696
Add back: goodwill amortization 1,318 3,981
---------- ----------
Adjusted net income $ 13,629 $ 12,677
========== ==========
Basic income (loss) per share before
extraordinary item
Income (loss) per share $ 0.07 $ (0.16)
Goodwill 0.05 0.16
---------- ----------
Adjusted income per share before
extraordinary item $ 0.12 $ --
========== ==========
Diluted income (loss) per share before
extraordinary item
Income (loss) per share $ 0.07 $ (0.16)
Goodwill 0.05 0.16
---------- ----------
Adjusted income per share before
extraordinary item $ 0.12 $ --
========== ==========
Basic income per share
Income per share $ 0.48 $ 0.34
Goodwill 0.05 0.16
---------- ----------
Adjusted income per share $ 0.53 $ 0.50
========== ==========
Diluted income per share
Income per share $ 0.46 $ 0.34
Goodwill 0.05 0.16
---------- ----------
Adjusted income per share $ 0.51 $ 0.50
========== ==========
10
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
Except for capitalized software development costs, other intangible assets
are amortized on a straight-line basis over a period of five to ten years.
Capitalized software development costs are amortized on a straight-line basis
generally over a period of five years. These assets are reviewed annually for
impairment and written down to net realizable value, if necessary, in
accordance with SFAS No. 144, Impairment of Long-Lived Assets.
-------------------------------
Amortization of other intangible assets, including capitalized software
development costs, for the three months ended September 30, 2002 and 2001 was
$1.4 million and $453,000, respectively. Amortization of intangibles for the
nine months ended September 30, 2002 and 2001 was $3.5 million and $1.8
million, respectively. Goodwill amortization included in the amounts for the
three and nine months ended September 30, 2001 was $933,000 and $3.6 million,
respectively.
7. NET INCOME (LOSS) PER SHARE
---------------------------
Basic net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted net income (loss) per share is computed by dividing net income
(loss) by the sum of the weighted average number of common shares and common
equivalent shares outstanding during the period. Common equivalent shares
consist of shares issuable upon the exercise of stock options (using the
treasury stock method) and convertible subordinated debentures (using the as-
converted method). Common equivalent shares are excluded from the diluted
computation only if their effect is anti-dilutive. As QuadraMed recorded a net
loss before extraordinary item for each of the three and nine months ended
September 30, 2002, and the nine months ended September 30, 2001, no common
equivalent shares are included in the diluted weighted average common shares
for those periods.
The following table sets forth the computation of the number of weighted
average common and common equivalent shares used in diluted net income per
share for the three months ended September 30, 2001 (in thousands):
Three months ended
September 30, 2001
------------------
Weighted average common shares outstanding 25,403
Effect of dilutive stock options and warrants 1,654
--------
Weighted average common and common equivalent shares 27,057
========
8. COMPREHENSIVE INCOME (LOSS)
---------------------------
The components of comprehensive income (loss) for the three and nine
months ended September 30, 2002 and 2001 are as follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) $(11,456) $ 12,311 $(15,783) $ 8,696
Unrealized gain on available-for-sale
securities, net of taxes 47 26 28 27
Amortization of unrecognized pension
costs, net of taxes 52 669 155 783
-------- -------- -------- --------
Comprehensive income (loss) $(11,357) $ 13,006 $(15,600) $ 9,506
======== ======== ======== ========
11
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
9. SEGMENT REPORTING
-----------------
QuadraMed aligns its operations into four business segments for management
reporting purposes. These segments are based on product functionality and
shared target markets. This alignment allows management to more accurately
measure financial performance by product/division and to establish greater
management accountability. QuadraMed's business segments are (i) the
Enterprise Division, (ii) the Health Information Management Software Division,
(iii) the Health Information Management Services Division, and (iv) the
Financial Services Division. QuadraMed reports the Enterprise Division, the
Health Information Management Software Division, the Health Information
Management Services Division, and the Financial Services Division as reportable
segments in accordance with SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. The accounting policies of the operating
segments are the same as those described in the summary of significant
accounting policies described in the Notes to the Financial Statements
contained in QuadraMed's 2001 Restated and Amended Annual Report on Form 10-
K/A. The financial results for these operating segments for prior periods have
been reclassified on an estimated basis to conform to the current period
presentation.
Results of operations for these business segments are provided to
QuadraMed's Chief Operating Decision Maker (CODM), who is the Chairman of the
Board and Chief Executive Officer.
12
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
Summary financial data by business segment as reported to the CODM is
presented below for the three and nine months ended September 30, 2002 and 2001
(in thousands):
Three months ended September 30, 2002
-------------------------------------------------------------
HIM HIM Financial Consolidated
Description Enterprise Software Services Services Other (1) Total
- ----------------- ---------- -------- -------- -------- --------- -----
Total revenues $ 15,343 $ 7,164 $ 4,587 $ 2,181 $ 903 $ 30,178
Gross margin (loss)(2)$ 10,580 $ 3,182 $ 1,269 $ 644 $(1,186) $ 14,489
Interest income
(expense), net $ (315) $ (213) $ (68) $ (25) $ (301) $ (922)
Segment assets $ 40,374 $35,188 $ 9,324 $ 4,959 $31,256 $121,101
Total depreciation
and amortization(3) $ 574 $ 1,113 $ 37 $ 146 $ 787 $ 2,657
- -------------------------
(1) Other includes specialty products, non-allocated expenses for bad debt,
legal costs, restructuring charges, and divested product lines.
(2) Gross margin represents segment results before interest, taxes, and
corporate overhead allocations.
(3) Total depreciation and amortization is comprised of equipment depreciation
and capitalized software amortization reflected in gross margin, debt-
offering costs as reflected in interest expense, and amortization of other
intangibles, excluding capitalized software development costs, which are
reflected separately in the above schedule.
Three months ended September 30, 2001 (4)
-------------------------------------------------------------
HIM HIM Financial Consolidated
Description Enterprise Software Services Services Other (1) Total
- ----------------- ---------- -------- -------- -------- --------- -----
Total revenues $ 15,238 $ 7,302 $ 4,749 $ 4,473 $ 2,742 $ 34,504
Gross margin (loss)(2)$ 9,758 $ 5,349 $ 649 $ 3,322 $ 1,500 $ 20,578
Interest income
(expense), net $ (333) $ (351) $ (94) $ (64) $ (283) $ (1,125)
Segment assets $ 28,337 $33,063 $ 9,928 $ 6,092 $43,724 $121,144
Total depreciation
and amortization(3) $ 606 $ 1,521 $ 312 $ 184 $ 417 $ 3,040
- ----------------------------
(1) Other includes specialty products, non-allocated expenses for bad debt,
legal costs, restructuring charges, and divested product lines including
$1.3 million in revenues for EZ-CAP.
(2) Gross margin represents segment results before interest, taxes, and
corporate overhead allocations.
(3) Total depreciation and amortization is comprised of equipment depreciation
and capitalized software amortization reflected in gross margin, debt-
offering costs as reflected in interest expense, and goodwill and
amortization of other intangibles, excluding capitalized software
development costs, which are reflected separately in the above schedule.
(4) September 30, 2001 results have been reclassified to reflect the current
period business segment presentation.
13
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
Nine months ended September 30, 2002
-------------------------------------------------------------
HIM HIM Financial Consolidated
Description Enterprise Software Services Services Other (1) Total
- ----------------- ---------- -------- -------- -------- --------- -----
Total revenues $ 46,194 $21,004 $ 13,278 $ 8,667 $ 3,207 $ 92,350
Gross margin (loss)(2)$ 30,365 $11,847 $ 3,217 $ 4,335 $ (176) $ 49,588
Interest income
(expense), net $ (862) $ (702) $ (201) $ (106) $ (800) $ (2,671)
Segment assets $ 40,374 $35,188 $ 9,324 $ 4,959 $ 31,256 $121,101
Total depreciation
and amortization(3) $ 1,250 $ 2,760 $ 106 $ 405 $ 2,628 $ 7,149
- -----------------------------
(1) Other includes specialty products, non-allocated expenses for bad debt,
legal costs, restructuring charges and divested product lines.
(2) Gross margin represents segment results before interest, amortization of
intangibles, taxes, and corporate overhead allocations.
(3) Total depreciation and amortization is comprised of equipment depreciation
and capitalized software amortization reflected in gross margin, debt-
offering costs as reflected in interest expense and amortization of other
intangibles, excluding capitalized software development costs, which are
reflected separately in the above schedule.
Nine months ended September 30, 2001 (4)
-------------------------------------------------------------
HIM HIM Financial Consolidated
Description Enterprise Software Services Services Other (1) Total
- ----------------- ---------- -------- -------- -------- --------- -----
Total revenues $43,827 $19,923 $15,481 $10,745 $10,387 $100,363
Gross margin (loss)(2)$25,920 $13,659 $ 3,680 $ 7,259 $ 6,383 $ 56,901
Interest income
(expense), net $ (606) $ (715) $ (218) $ (134) $ (986) $ (2,659)
Segment assets $28,337 $33,063 $ 9,928 $ 6,092 $43,724 $121,144
Total depreciation
and amortization(3) $ 1,738 $ 4,507 $ 946 $ 527 $ 1,718 $ 9,436
- -------------------------------
(1) Other includes specialty products, non-allocated expenses for bad debt,
legal costs, restructuring charges and divested product lines including
$5.4 million in revenues for EZ-CAP.
(2) Gross margin represents segment results before interest, amortization of
intangibles, taxes, and corporate overhead allocations.
(3) Total depreciation and amortization is comprised of equipment depreciation
and capitalized software amortization reflected in gross margin, debt-
offering costs as reflected in interest expense, and goodwill and
amortization of other intangibles, excluding capitalized software
development costs, which are reflected separately in the above schedule.
(4) September 30, 2001 results have been reclassified to reflect the current
period business segments presentation.
10. MAJOR CUSTOMERS
---------------
For the three and nine months ended September 30, 2002 and 2001, no single
customer accounted for more than 10% of total revenues however, for the three
and nine months ended September 30, 2002 and 2001 sales to the U. S. government
accounted for 25.1% and 22.8% respectively of HIM Software Division revenues.
11. SUBSEQUENT EVENTS
-----------------
In October 2002, a series of securities law class action complaints were
filed in the United States District Court, California Northern District,
against QuadraMed and certain of its officers and directors. The plaintiffs in
these actions allege, among other things, violations of the Securities Exchange
Act of 1934 due to issuing a series of allegedly false and misleading
statements concerning its business and financial condition between May 11, 2000
and August 11, 2002. The complaints seek unspecified monetary damages and
other relief. These matters are at an early stage. No responses to the
complaints have yet been filed, and no discovery has taken place. QuadraMed
intends to defend itself vigorously against these allegations. On December 31,
2002, the Court entered an order consolidating all related securities class
actions against the Company.
14
QUADRAMED CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
September 30, 2002
On December 31, 2002, QuadraMed announced the closing of the sale of its
HIM Services Division to Precyse Solutions, LLC. QuadraMed received $14
million in cash (of which $1.5 million is to be held in escrow for 18 months)
and a $300,000 promissory note with a two-year term. As a result of the sale,
QuadraMed recorded a fourth quarter 2002 after-tax gain of $8.8 million.
On February 28, 2003, QuadraMed reported that the SEC has issued a formal
non-public order of investigation concerning QuadraMed's accounting and
financial reporting practices for the period beginning January 1, 1998.
QuadraMed intends to continue to cooperate with the SEC and has complied with
the SEC's requests for information. QuadraMed cannot predict when the SEC will
conclude its inquiry, or the outcome and impact thereof.
On March 4, 2003, QuadraMed's common stock was delisted from the Nasdaq
National Market. The delisting constitutes a "Repurchase Event" under the
provisions of the QuadraMed's Convertible Subordinated Debentures. Upon such
an event, the Subordinated Indenture grants to each debenture holder the right,
at the holder's option, to require QuadraMed to repurchase all or any of the
holder's debentures. On April 16, 2003, QuadraMed announced that it had
executed an agreement with certain of its bondholders to refinance its
outstanding 5.25% Convertible Subordinated Debentures due 2005 (the "2005
Debt"). On April 17, 2003, under the terms of the refinance agreement,
QuadraMed issued $71.0 million of its Senior Secured Notes due 2008 (the "2008
Debt"). The proceeds from the issuance of the 2008 Debt were used to
repurchase $61.8 million (plus $1.5 million in accrued interest) of the 2005
Debt which became subject to repurchase by QuadraMed as a result of its
delisting from the Nasdaq National Market on March 4, 2003. Accordingly, the
net proceeds to QuadraMed as a result of the issuance of the 2008 Debt less the
costs (including fees) associated with the repurchase of the 2005 Debt was $7.6
million, with $11.9 million of the 2005 Debt remaining outstanding.
Additionally, the repurchase right on the 2005 Debt remaining outstanding
expired on April 17, 2003. The 2008 Debt bears interest at an initial rate of
10% which will be reduced to 9% upon the relisting of QuadraMed's common stock
on the Nasdaq, including Nasdaq SmallCap or U.S. National Market and is secured
by certain intellectual property of QuadraMed. As part of the transaction,
QuadraMed also issued 11,303,842 detachable warrants with the 2008 Debt. The
warrants have a term of five years, have an exercise price of $0.01 per share
and are subject to certain anti-dilution provisions including dilution from the
issuance of shares in settlement of existing litigation. The 2008 Debt contains
certain events of default. These events include: failure to timely repay
principal or interest owed on the debentures, default under any other
borrowing, and bankruptcy.
15
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
Cautionary Statement on Risks Associated With Forward-Looking Statements
------------------------------------------------------------------------
You should read the following discussion in conjunction with our Interim
Condensed Consolidated Financial Statements and related Notes. This Report
contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 that are subject to risks and
uncertainties. The words "believe", "expect", "anticipate", "predict",
"intend", "plan", "estimate", "may", "will", "should", "could", and similar
expressions and their negatives are intended to identify such statements.
Forward-looking statements are not guarantees of future performance and are to
be interpreted only as of the date on which they are made. We undertake no
obligation to update or revise any forward-looking statement. You should not
place undue reliance on these forward-looking statements. Our actual results
could differ materially from those anticipated in these forward-looking
statements for many reasons, including the risks faced by us described below
and elsewhere in this Report, and in other documents we file with the SEC from
time to time.
Restatement
-----------
In 2002, we discovered accounting and reporting errors within our
Quarterly Report on Form 10-Q as filed for the three months ended March 31,
2002 and our Annual Report on Form 10-K as filed for the years ended December
31, 2001, 2000 and 1999. These errors resulted in us determining that the
reports for these years needed to be restated. In June 2003, we amended and
restated our Annual Report on Form 10-K/A including the years ended 2001, 2000
and 1999 and all respective quarters. This report is also being filed
simultaneously with the restatement of our Quarterly Report on Form 10-Q/A for
the three months ended March 31, 2002.
The following table of interim condensed consolidated statement of
operations data summarizes the effects of the restatement for the three and
nine-month periods ended September 30, 2001 (in thousands, except per share
amounts):
Three months ended Nine months ended
September 30, 2001 September 30, 2001
------------------------ -------------------------
(As Reported) (Restated) (As Reported) (Restated)
Revenue (1) $ 33,138 $ 34,504 $ 94,539 $100,363
Gross margin (1) $ 23,534 $ 20,578 $ 64,193 $ 56,901
Income (loss) from operations $ 2,634 $ (3,885) $ 211 $ (8,311)
Loss from continuing operations$ (2,076) $ -- $ (6,922) $ --
Net income $ 15,411 $ 12,311 $ 14,140 $ 8,696
Basic net income per share $ 0.60 $ 0.48 $ 0.55 $ 0.34
Diluted net income per share $ 0.60 $ 0.46 $ 0.55 $ 0.34
Comprehensive income $ 15,426 $ 13,006 $ 14,080 $ 9,506
- -----------------------------
(1) Restated amounts for the three and nine months ended September 30, 2001
include $1.3 million and $6.4 million in revenue, respectively, $625,000
and $2.0 million in cost of revenue, respectively, from operations that
were previously reported as discontinued operations.
Significant Accounting Policies and Estimates
- ---------------------------------------------
Our significant accounting policies have a considerable impact on
Management's Discussion and Analysis.
Principles of Consolidation
---------------------------
These consolidated financial statements, which include our accounts and
all our significant business divisions and subsidiaries, have been prepared in
conformity with (i) GAAP; and (ii) the rules and regulations of the SEC. All
significant intercompany accounts and transactions between us and our
subsidiaries are eliminated in consolidation.
Use of Estimates
----------------
Management's discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. In preparing these financial
statements, we make estimates, assumptions, and judgments that affect the
16
reported amounts of assets and liabilities, contingent assets and liabilities,
revenues, and expenses. Significant estimates and assumptions have been made
regarding revenue recognition, the allowance for doubtful account, investments,
capitalized software, income taxes, restructuring, pensions and other benefits,
and contingencies and litigation and intangibles, primarily goodwill and
customer lists, resulting from our purchase business combinations. We base our
estimates, assumptions, and judgments on historical experience and on various
other assumptions believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Uncertainties inherent in these estimates include projections of future
operating results and the discount rates used to determine the net present
values of these future results and useful lives of the acquired assets as well
as technological advances. In addition, for our fixed-price contracts, we make
significant estimates within percentage-of-completion accounting, including
estimating total costs to be incurred as calculated on a labor hour basis. We
periodically review and test our estimates, specifically those related to the
valuations of intangibles including acquired software, goodwill, customer
lists, trademarks and other intangibles, and capitalized software. Actual
results may differ materially from these estimates.
Revenue Recognition
-------------------
Our revenue in the ordinary course of business is principally generated
from two sources: (i) licensing arrangements and (ii) services.
Our license revenue consists of fees for licenses of our software and
hosted services. Cost of license revenue primarily includes product, delivery
and royalty costs and facilities costs. Our services revenue consists of
maintenance, customer training and consulting services and fees for providing
management services such as accounts receivable and payment collection
outsourcing, specialized staffing, analytical services and seminars. Cost of
services consists primarily of salaries, benefits, and allocated costs related
to providing such services, labor costs for engineers performing implementation
services and technical support and training personnel.
We license our products through our direct sales force. Our license
agreements for such products do not provide for a right of return, and
historically product returns have not been significant.
We recognize revenue on our software products in accordance with Statement of
Position ("SOP") 97-2, Software Revenue Recognition, as amended by SOP 98-9,
----------------------------
Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
-----------------------------------------------------
Transactions; SOP 81-1, Accounting for Performance of Construction-Type and
- ------------ ---------------------------------------------------
Certain Production-Type Contracts; and Staff Accounting Bulletin ("SAB") 101,
- ---------------------------------
Revenue Recognition in Financial Statements.
- -------------------------------------------
We recognize revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery of the product has
occurred; no significant obligations by us with regard to implementation
remain; the fee is fixed and determinable; and, collectibility is probable.
Delivery is considered to have occurred when title and risk of loss have been
transferred to the customer, which generally occurs when media containing the
licensed programs is provided to a common carrier. We consider all
arrangements with payment terms extending beyond 180 days to be not fixed and
determinable, and revenue is recognized as payments become due from the
customer. If collectibility is not considered probable, revenue is recognized
when the fee is collected.
SOP 97-2, as amended, generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. Revenue recognized from multiple-
element arrangements is allocated to undelivered elements of the arrangement,
such as maintenance, support and professional services, based on the relative
fair values of the elements specific to us. Our determination of fair value of
each element in multi-element arrangements is based on vendor-specific
objective evidence ("VSOE"). We limit our assessment of VSOE for each element
to either the price charged when the same element is sold separately or the
price established by management, having the relevant authority to do so, for an
element not yet sold separately.
If evidence of fair value of all undelivered elements exists but evidence
does not exist for one or more delivered elements, then revenue is recognized
using the residual method. Under the residual method, the fair value of the
undelivered elements is deferred and the remaining portion of the arrangement
fee is recognized as revenue. Revenue from hosted applications is recognized
ratably over the term of the arrangement. The proportion of revenue recognized
upon delivery may vary from quarter to quarter depending upon the relative mix
of licensing arrangements and the availability of VSOE of fair value for
undelivered elements.
17
Certain of our perpetual and time-based licenses include unspecified
additional products and/or payment terms that extend beyond 12 months. We
recognize revenue from perpetual and time-based licenses that include
unspecified additional software products ratably over the term of the
arrangement.
Contract accounting is utilized for services revenues from fixed-price
contracts and those requiring significant software modification, development or
customization. In such instances, the arrangement fee is accounted for in
accordance with SOP 81-1, whereby the arrangement fee is recognized, generally
using the percentage-of-completion method measured on labor input costs. If
increases in projected costs-to-complete are sufficient to create a loss
contract, the entire estimated loss is charged to operations in the period the
loss first becomes known. The complexity of the estimation process and
judgment related to the assumptions, risks and uncertainties inherent with the
application of the percentage-of-completion method of accounting affect the
amounts of revenue and related expenses reported in its consolidated financial
statements. A number of internal and external factors can affect its
estimates, including labor rates, utilization, changes to specification and
testing requirements and collectibility of unbilled receivables.
Service revenues from software maintenance and support are recognized
ratably over the maintenance term, which in most cases is one year. Service
revenues from training, consulting and other service elements are recognized as
the services are performed.
Service revenues from providing management services such as accounts
receivable and payment collection outsourcing are recognized in accordance with
SAB 101. When all criteria for revenue recognition, as noted above, have been
met, revenue is recognized upon invoicing. If collectibility is not considered
probable, revenue is recognized when the fee is collected.
Accounts Receivable and Allowance for Doubtful Accounts
-------------------------------------------------------
Accounts receivable consist primarily of amounts due us from our normal
business activities. We maintain an allowance for doubtful accounts to reflect
the expected non-collection of accounts receivable based on past collection
history and specific risks identified within our portfolio. If the financial
condition of our customers were to deteriorate resulting in an impairment of
their ability to make payments, or if payments from customers are significantly
delayed, additional allowances might be required.
Intangible Assets
-----------------
Goodwill. In June 2001, the FASB issued Financial SFAS No. 142, Goodwill
-------- --------
and Other Intangible Assets, effective for fiscal years beginning after
- ---------------------------
December 15, 2001. Under SFAS 142, goodwill and intangible assets deemed to
have indefinite lives are to be separately disclosed on the balance sheet, and
no longer amortized but subject to annual impairment tests. With the adoption
of SFAS 142, we ceased amortization of goodwill as of January 1, 2002. Prior to
this point, goodwill was amortized using the straight-line method over its
estimated useful life.
SFAS 142 requires that goodwill be tested for impairment at the reporting
unit level (i.e., business segments) upon adoption and at least annually
thereafter using a two-step impairment analysis. In accordance with SFAS 142,
we performed the first of the required two-step impairment tests of goodwill
and indefinite-lived assets as of January 1, 2002. In performing the first step
of this analysis, we first assigned our assets and liabilities, including
existing goodwill and other intangible assets, to our identified reporting
units to determine their carrying value. For this purpose, our reporting units
equated to our five business segments then in place. Our reporting units equate
to our business segments since this is the lowest level of QuadraMed at which
operating plans are prepared and operating profitability is measured for
assessing management performance. See note 9 for more information regarding
our business segments. Based on an analysis by an independent third party
appraiser, we then estimated the fair value of each reporting unit with
significant goodwill utilizing various valuation techniques including the
Income Approach and the Market Approach. The Income Approach provides an
estimation of the fair value of a reporting unit based on the discounted cash
flows derived from the reporting unit's estimated remaining life plus the
present value of any residual value. The Market Approach indicates the fair
value of a reporting unit based upon a comparison to publicly-traded companies
in similar lines of business. Step one of this analysis was then completed by
comparing the carrying value of each the-analyzed reporting units to its fair
value. This comparison resulted in the fair values of the analyzed reporting
units exceeding the carrying values of the net assets. In addition, the
independent third party appraiser performed a cursory review of the three
unappraised reporting units utilizing the Income Approach to estimate the total
market value for QuadraMed Corporation as a whole. The result was an estimated
18
value for the Company that was less than the market capitalization as of
January 1, 2002. Accordingly, no indicators of impairment existed. As a
result, we did not perform step two as described by SFAS 142.
Capitalized Software. Software development costs are capitalized upon the
--------------------
establishment of technological feasibility. In accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
- ------------------------------------------------------------------------------
Marketed, we establish technological feasibility upon completion of a detailed
- --------
program design determined on a project-by-project basis, which substantiates
that the computer software product can be produced in accordance with its
design specifications. Software development costs are capitalized based upon
an assessment of their recoverability. This assessment requires considerable
judgment by management with respect to various factors, including, but not
limited to, anticipated future gross margins, estimated economic lives, and
changes in software and hardware technology. Amortization is based on the
greater of the ratio that current revenues bear to the total and anticipated
future revenues for the applicable product, or the straight-line method over
the remaining estimated economic life of the product, generally five years, and
is charged to cost of licenses.
Other Intangible Assets. Other intangible assets primarily relate to
-----------------------
acquired software, trademarks and customer lists acquired in our purchase
business combinations. On January 1, 2002, we adopted the provisions of SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which
--------------------------------------------------------------
generally requires impairment losses to be recorded on long-lived assets
(excluding goodwill) used in operations, such as property, equipment and
improvements, and intangible assets, when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amount of the assets. The provisions of this statement
did not have a significant impact on our financial condition or operating
results.
Recent Accounting Pronouncements
- --------------------------------
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
--------------------
Retirement Obligations. The statement addresses financial accounting and
- ----------------------
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The provisions of SFAS No.
143 are required to be applied starting with fiscal years beginning after June
15, 2002. We expect that implementation of the new standard will not have a
significant impact on our financial condition, results of operations, and cash
flows.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
-----------------------------
Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
- ---------------------------------------------------------------------
Corrections. This statement updates and clarifies existing pronouncements
- -----------
relating to the classification and reporting of gains and losses from the
extinguishment of debt, the treatment of sale-leaseback transactions and also
makes technical corrections to existing pronouncements. The provisions of SFAS
No. 145 are required to be applied starting with fiscal years beginning after
May 15, 2002. We anticipate that implementation of this new standard will not
have a significant impact on our financial condition, results of operations and
cash flows.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
--------------------
Associated with Exit or Disposal Activities, effective for exit or disposal
- -------------------------------------------
activities initiated after December 31, 2002. Under SFAS 146 a liability for
the cost associated with an exit or disposal activity is recognized when the
liability is incurred. Under prior guidance, a liability for such costs could
be recognized at the date of commitment to an exit plan. SFAS 146 also requires
that the liability be measured and recorded at fair value. Accordingly, the
adoption of this standard may affect the timing of recognizing future
restructuring costs as well as the amounts recognized. We will adopt the
provisions of SFAS 146 prospectively for all restructuring activities initiated
after December 31, 2002.
In November 2002, the FASB reached a consensus on Emerging Issues Task
Force ("EITF") No. 00-21, Accounting for Revenue Arrangements with Multiple
-------------------------------------------------
Deliverables. The guidance in EITF 00-21 is effective for revenue arrangements
- ------------
entered into in fiscal years beginning after June 15, 2003. This issue
addresses certain aspects of the accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. Specifically,
EITF 00-21 addresses how to determine whether an arrangement involving multiple
deliverables contains more than one earnings process and, if it does, how to
divide the arrangement into separate units of accounting consistent with the
identified earning processes for revenue recognition purposes. This issue also
addresses how arrangement consideration should be measured and allocated to the
separate units of accounting in the arrangement. We are evaluating the effect
implementation of this new guidance will have on our financial condition,
results of operations and cash flows.
In November 2002, the FASB issued FIN 45, Guarantor's Accounting and
--------------------------
Disclosure Requirements for Guarantees, including indirect Guarantees of
- ------------------------------------------------------------------------
Indebtedness of Others. FIN 45 requires that we recognize the fair value for
- ----------------------
19
guarantee and indemnification arrangements issued or modified by us after
December 31, 2002, if these arrangements are within the scope of the
interpretation. In addition, we must continue to monitor the conditions that
are subject to the guarantees and indemnifications, as required under
previously existing generally accepted accounting principles, in order to
identify if a loss has occurred. If we determine it is probable that a loss has
occurred then any such estimable loss would be recognized under those
guarantees and indemnifications. Some of the software licenses granted by us
contain provisions that indemnify licensees of our software from damages and
costs resulting from claims alleging that our software infringes the
intellectual property rights of a third party. We have historically received
only a limited number of requests for indemnification under these provisions
and have not been required to make material payments pursuant to these
provisions. Accordingly, we have not recorded a liability related to these
indemnification provisions. We will be required to implement the provisions of
FIN 45 as of January 1, 2003 and do not believe that FIN 45 will have a
material impact on our financial position, results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
--------------------------
Compensation - Transition and Disclosure, effective for fiscal years ending
- ----------------------------------------
after December 15, 2002. SFAS 148 amends SFAS 123, to provide alternative
methods of transition to the voluntary fair value method of accounting for
stock-based employee compensation. SFAS 148 also amends the disclosure
provisions of SFAS 123 to require that disclosure of the pro forma effect of
using the fair value method of accounting for stock-based employee compensation
be displayed in tabular format within a Company's summary of significant
accounting policies. We have not yet adopted SFAS 148 and accordingly, the
accompanying financial statements reflect the required disclosures of SFAS 123.
Acquisitions
- ------------
In the quarter ended June 30, 2002, we completed two acquisitions,
Pharmacy Data Systems, Inc. and Cascade Health Information Software, Inc.
PDS is a leader in advanced pharmacy information systems. PDS develops
and installs advanced pharmacy, nursing, and physician information systems
designed to reduce medication errors, control costs, and improve patient care.
PDS will form the core of the newly created Affinity Pharmacy Division.
Financial results for PDS are reported as part of the Enterprise Division.
We expect the following strategic benefits from the acquisition of PDS:
o Provide the Enterprise Division's Affinity product with an integrated
pharmacy solution to meet the increasing demand for Computerized Physician
Order Entry (CPOE) technology that administers the entire medication
management process from ordering through dispensing.
o Provide the opportunity to sell Affinity systems to PDS's customers, most
of which are not currently our customers.
Cascade Software is a leading provider of state-of-the-art software for
the coding and abstracting of patient medical records. We will combine the
Cascade assets to our growing suite of Healthcare Information Management
Software products.
We expect that the Cascade acquisition will bring the strategic benefit of
providing the opportunity to sell Quantim Health Information Software products
to Cascade's customers, most of which are not currently our customers.
Results of Operations
- ---------------------
Revenue
-------
Services. Service revenue consists of consulting, maintenance,
--------
installation, hardware, reimbursable expenses and other service revenue.
Service revenue was $23.0 million in the three months ended
September 30, 2002, a decrease of $3.8 million, or 14.0% from $26.8 million for
the corresponding period of 2001. For the nine months ended September 30,
2002, service revenue decreased $5.5 million, or 7.3% to $70.4 million from
$75.9 million in the corresponding period of 2001.
20
Licenses. License revenue consists of license and third-party software
--------
sales. License revenue in the three months ended September 30, 2002 was $7.1
million, a decrease of $563,000 or 7.3% from $7.7 million in the corresponding
period of 2001. For the nine months ended September 30, 2002, license revenue
was $21.9 million compared to $24.4 million in the first nine months of 2001.
License revenue for the nine months ended September 30, 2001 included $5.4
million of revenue from EZ-CAP. On a comparative basis, license revenue for
the first nine months of 2002 increased $2.9 million, or approximately 15%.
Cost of Revenue
---------------
Cost of Services. Cost of services consists of salaries and related
----------------
expenses associated with services performed for customer support and consulting
services as well as third-party hardware costs. Cost of services for the
quarter ended September 30, 2002 of $13.5 million was $1.4 million greater than
the $12.2 million in the corresponding period of 2001. The gross margin earned
on services revenue in 2002 was 41.2%, compared to 54.6% in the same quarter of
2001. For the nine months ended September 30, 2002, cost of services decreased
2.9% to $36.5 million from $37.6 million in the same period of 2001. As a
percentage of service revenue, the gross margin earned on services was 48.2% in
the first nine months of 2002 compared with 50.5% in the same period of 2001.
As fixed costs did not decrease as significantly as revenues for the
comparative periods, gross margin percentages are down.
Cost of Licenses. Cost of licenses consists of third party royalties,
----------------
amortization of capitalized software and documentation and production costs of
our software. Cost of licenses in the three months ended September 30, 2002
was $2.2 million, a 69.9% gross margin on licenses, compared to $1.8 million
and 77.1% gross margin on licenses, for the same period of 2001. For the nine
months ended September 30, 2002, cost of licenses increased by 6.5% to $6.3
million from $5.9 million for the same period of 2001. The gross margin on
licenses was 71.5% in the first nine months of 2002 compared to 75.9% in the
corresponding period of 2001. The nine months ended September 30, 2001
included revenue and associated expenses from the EZ-CAP product line that was
sold in August 2001.
Operating Expenses
------------------
General and Administration. General and administration expense consists
--------------------------
of compensation and benefit costs for executive, finance, legal, information
technology, and administrative personnel. General and administration expense in
the three months ended September 30, 2002 was $13.2 million compared to $10.8
million in the same period of 2001. As a percentage of revenue, general and
administration expense was 43.6% for the three months ended September 30, 2002
as compared to 31.3% in the same quarter of 2001. For the nine months ended
September 30, 2002, general and administration expense remained consistent at
$30.5 million with the same period in 2001. As a percentage of total revenue,
general and administration expense increased to 33.0% for the nine months ended
September 30, 2002 from 30.4% in the first nine months of 2001.
Sales and Marketing. Sales and marketing expense includes costs
-------------------
associated with our sales and marketing personnel and product marketing
personnel and consists primarily of compensation and benefits, commissions and
bonuses, promotional and advertising expenses. Sales and marketing expense in
the three months ended September 30, 2002 was $6.0 million compared to $5.0
million in the corresponding period of 2001. As a percentage of revenue, sales
and marketing expense was 19.9% for the three months ended September 30, 2002
as compared to 14.5% in the same quarter of 2001. For the nine months ended
September 30, 2002, sales and marketing expense increased 7.0% to $16.7 million
from $15.7 million in the first nine months of 2001. As a percentage of total
revenue, sales and marketing expense increased to 18.1% for the nine months
ended September 30, 2002 from 15.6% in the first nine months of 2001. The
increase in sales and marketing was due principally to an increase in personnel
and other operating expenses primarily driven by increased revenues in the
Enterprise Division.
Research and Development. Research and development expense includes costs
------------------------
associated with the development of new products, enhancements of existing
products for which technological feasibility has not been achieved, and quality
assurance activities, and primarily includes compensation and benefits expense.
Research and development costs for the three months ended September 30, 2002
were $4.7 million compared to $3.5 million in the same period of 2001. As a
percentage of revenue, research and development costs were 15.6% for the three
months ended September 30, 2002 compared to 10.2% in the same quarter of 2001.
For the nine months ended September 30, 2002 and 2001, research and development
costs increased 13.4% to $12.3 million. The level of research and development
investments increased in the first nine months of 2002 with the funding of
development for our Affinity Clinical and Quantim products. During the first
nine months of 2002, we capitalized $2.5 million in development costs on
21
products qualifying for capitalization under the definition of technological
feasibility compared to $345,000 of capitalized development costs in the
corresponding period of 2001.
Amortization, Impairment and Other Operating Charges. Amortization of
----------------------------------------------------
intangible assets decreased to $773,000 in the three months ended September 30,
2002 from $5.1 million in the same period of 2001. For the nine months ended
September 30, 2001, amortization of intangible assets decreased to $2.3 million
from $8.3 million in the first nine months of 2001. The reduction in
amortization of intangible assets in the first nine months of 2002 primarily
resulted from our January 1, 2002 adoption of SFAS No. 142 which eliminates the
amortization of goodwill but requires annual impairment testing. As a result,
we no longer amortized goodwill during the three and nine months ended
September 30, 2002, but continued to amortize other intangible assets. There
were no impairment charges recognized for the nine months ended September 30,
2002 and 2001.
Additionally, we wrote off in-process research and development costs in
the nine months ended September 30, 2002 totaling $400,000 associated with our
acquisition of PDS in June 2002. There were no corresponding charges in the
same period of 2001.
The three and nine months ended September 30, 2001, also included a $3.6
million charge related to a convertible promissory note from Purkinje. As part
of a recapitalization plan, Purkinje exchanged preferred stock for all of its
outstanding convertible promissory notes. We believed that the value of this
preferred stock was zero and, accordingly, we recorded a $3.6 million charge in
Third Quarter 2001.
Other Income (Expense)
---------------------
Interest Expense, Net. Interest expense, net of interest income, was
---------------------
$922,000 and $1.1 million in the three months ended September 30, 2002 and
2001, respectively. For the nine months ended September 30, 2002 and 2001, net
interest expense was $2.7 million in each period. The increase in net interest
expense from period to period primarily reflects the effect of a decline in
interest rates earned on cash and investments.
Gain on Sale of Assets. During the nine months ended September 30, 2001,
----------------------
we sold the business assets related to our EZ-CAP product line, resulting in a
gain of $7.1 million.
Other Income (Expense), Net. Other expense, net of other income, was
---------------------------
$375,000 for the three months ended September 30, 2002 compared with $272,000
in the same period of 2001. For the nine months ended September 30, 2002, net
other expense was $940,000 compared with $192,000 in the first nine months of
2001. The most significant contributor to other expense during the three and
nine-month periods ended September 30, 2002 is the continued impairment of our
investment in VantageMed Corporation ("VantageMed"). For the nine-month period
in 2002, charges totaling $467,000 have been recorded for impairment of this
investment compared with $85,000 in the first nine months of 2001.
Income Taxes
------------
Provision for Income Taxes. There was no provision for income taxes for
--------------------------
the three months ended September 30, 2002 and 2001. For the nine months ended
September 30, 2001 a provision of $81,000 was made resulting primarily from
state and alternative minimum tax liabilities on certain of our legal entities.
There was no corresponding provision in the first nine months of 2002. For
financial reporting purposes, a 100% valuation allowance has been recorded
against our deferred tax assets under SFAS No. 109.
Extraordinary Item
------------------
Gain on Redemption of Bonds. During the first nine months of 2001, we
---------------------------
repurchased approximately $41.3 million in subordinated convertible debentures
(the "Debentures") on the open market for a total of $28.4 million in cash,
resulting in a gain of $12.9 million.
Liquidity And Capital Resources
- -------------------------------
The following section discusses the effects of changes in our balance
sheets, cash flows, and commitments on our liquidity and capital resources.
22
Balance Sheet and Cash Flows
----------------------------
Cash and cash equivalents were $21.8 million as of September 30, 2002 and
$29.8 million as of December 31, 2001, a decrease of $8.0 million or 26.9%
during the period. Cash flows provided by operating activities were $5.8
million for the nine months ended September 30, 2002. These amounts primarily
resulted from a net loss of $15.8 million for the nine months ended September
30, 2002, offset by $7.2 million in non-cash depreciation and amortization
charges, $400,000 in write-offs of in-process research and development, and a
net decrease of $14.0 million in working capital (excluding the change in cash
and cash equivalents). Cash outflows for investing activities of $15.3 million
primarily reflected the cash outlay of $11.9 million for the purchase of
Cascade and PDS and $1.5 and $1.7 million in fixed asset and capitalized
software expenditures, respectively. In addition, we issued $1.9 million in
common stock as a result of option exercises.
We expect that cash provided by operating activities may fluctuate in
future periods as a result of a number of factors, including fluctuations in
our operating results, specifically the timing of when we recognize revenue,
our accounts receivable collections, and the timing of other payments. In
addition, cash used in investing activities may fluctuate due to the
acquisition activity, capitalization of our software development efforts and
costs associated with our investments in fixed assets and information
technology. For additional discussion, see the Risk Factors section.
Commitments
-----------
As of September 30, 2002, we had $73.7 million in outstanding 5.25%
Convertible Subordinated Debentures due 2005 (the "2005 Debt"), which bear
interest at 5.25% per annum. On April 16, 2003, we announced that we had
executed an agreement with certain of our bondholders to refinance our 2005
Debt. On April 17, 2003, under the terms of the refinance agreement, we issued
$71.0 million of our Senior Secured Notes due 2008 (the "2008 Debt"). The
proceeds from the issuance of the 2008 Debt were used to repurchase $61.8
million (plus $1.5 million in accrued interest) of the 2005 Debt which became
subject to repurchase by us as a result of our delisting from the Nasdaq
National Market on March 4, 2003. Accordingly, the net proceeds to us as a
result of the issuance of the 2008 Debt less the costs (including fees)
associated with the repurchase of the 2005 Debt was $7.6 million, with $11.9
million of the 2005 Debt remaining outstanding. Additionally, the repurchase
right on the 2005 Debt remaining outstanding expired on April 17, 2003. The
2008 Debt bears interest at an initial rate of 10% which will be reduced to 9%
upon the relisting of QuadraMed's common stock on the Nasdaq SmallCap or
National Market and is secured by certain intellectual property of QuadraMed.
However, we may be obligated to redeem the 2005 and 2008 debentures earlier
than the maturity dates based upon certain events of default occurring as
defined within the debenture agreements. These events include: failure to
timely repay principal or interest owed on the debentures, default under any
other borrowing, and bankruptcy.
In addition, as of September 30, 2002, we had approximately $33.6 million
in minimum operating lease commitments that will primarily be repaid through
2011. Finally, we have a Supplemental Executive Retirement Plan ("SERP") that
will require total payments from 2008 through 2027 estimated at $7.8 million.
We owe annual premiums of $483,000 on the SERP through 2005 to fund our
obligations.
We expect that cash provided by operating activities may fluctuate in
future periods as a result of a number of factors, including fluctuations in
our operating results, specifically the timing of when we recognize revenue,
our accounts receivable collections and the timing of other payments. In
addition, cash used in investing activities may fluctuate due to the
capitalization of our software development efforts, which are expected to
increase in 2003, and costs associated with our investments in fixed assets and
information technology. For additional discussion, see the Risk Factors
section.
We believe that we will have sufficient liquidity and capital resources to
fund our scheduled debt and other obligations through at least fiscal 2003.
Business Risks
- --------------
Factors that have affected our results of operations in the past and are
likely to affect our results of operations in the future, include the
following:
23
Our Vendors, Suppliers and Customers May React Adversely to the Lack of
-----------------------------------------------------------------------
Timely SEC Filings of Our Historical Financial Statements.
- ---------------------------------------------------------
Our future success depends in large part on the support of our vendors and
suppliers, who may react adversely to the lack of timely SEC filings of our
historical financial statements. The restatement of our historical financial
statements has resulted in negative publicity about us, which may cause some of
our potential customers to defer purchases of our products. Our vendors and
suppliers may re-examine their willingness to do business with us, to develop
critical interfaces for us or to supply software and services if they lose
confidence in our ability to fulfill our commitments.
We Are Currently the Target of Securities Litigation and May Be the Target
--------------------------------------------------------------------------
of Further Actions, Which May Be Costly and Time Consuming to Defend.
- --------------------------------------------------------------------
In October 2002, a series of securities law class action complaints were
filed in the United States District Court, California Northern District,
against us and certain of our officers and directors. The plaintiffs in these
actions allege, among other things, violations of the Securities Exchange Act
of 1934 due to issuing a series of allegedly false and misleading statements
concerning our business and financial condition between May 11, 2000 and August
11, 2002. The complaints seek unspecified monetary damages and other relief.
The ultimate outcome of these matters cannot presently be determined and
may require significant commitment of our financial and management resources
and time, which may seriously harm our business, financial condition and
results of operations. We cannot assure you that any of the allegations
discussed above can be resolved without costly and protracted litigation, and
the outcome may have a materially adverse impact upon our financial position,
results of operations and cash flows.
In addition, securities class action litigation has often been brought
against a company following a decline in the market price of its securities.
The uncertainty of the currently pending investigation and litigation could
lead to more volatility in our stock price. We may in the future be the target
of securities class action claims similar to those described above.
We Are Subject to a Formal SEC Inquiry as a Result of the Restatement of
------------------------------------------------------------------------
Our Financial Statements.
- ------------------------
Following our August 12, 2002 announcement that it we intended to restate
prior period financial statements, the staff of the San Francisco District
Office of the SEC requested certain information concerning the anticipated
restatement as part of an informal, preliminary inquiry. We provided that
information, and expect to provide additional information now that the
restatement is completed. We intend to continue to cooperate with the SEC in
the event it requests other information. We cannot predict whether such
information will be requested, when the SEC will conclude its inquiry, or the
outcome or impact thereof.
On February 28, 2003, we reported that the SEC had issued a formal non-
public order of investigation concerning our accounting and financial reporting
practices for the period beginning January 1, 1998. We intend to continue to
cooperate with the SEC and comply with the SEC's requests for information. We
cannot predict when the SEC will conclude its inquiry, or the outcome and
impact thereof.
Our Common Stock Has Been Delisted from the Nasdaq Stock Market.
---------------------------------------------------------------
We received a notice from the Nasdaq Stock Market that we are required to
file Forms 10-Q for the quarters ended June 30, and September 30, 2002 as well
as restated financial statements for the years ended December 31, 2001, 2000
and 1999 and the quarter ended March 31, 2002. Our trading symbol as of August
22, 2002 was amended from "QMDC" to "QMDCE", as a result of the delinquent
filings. We requested an appeals hearing before a Nasdaq Listing
Qualifications Panel (the "Panel"). The Panel notified us on February 6, 2003,
that Nasdaq would continue to list our common shares on the Nasdaq Stock Market
until February 28, 2003, by which date we must file our Quarterly Report on
Form 10-Q for the interim periods ended June 30, 2002 and September 30, 2002
and our amended SEC filings for the years ended December 31, 2001, 2000 and
1999 and the interim period ended March 31, 2002. Further, we were required to
file timely all other annual and periodic reports with the SEC and evidence our
continued compliance with all requirements for continued listing on the Nasdaq
National Market upon the filing of these documents as well as an ability to
sustain compliance with those requirements over the long term. We were unable
to meet these requirements in a timely manner, and on March 4, 2003, our common
24
stock was delisted from the Nasdaq Stock Market. Although we intend to return
to compliance, we can offer no assurances that we will be relisted on the
Nasdaq Stock Market.
The delisting constitutes a "Repurchase Event" under the provisions of our
Convertible Subordinated Debentures. Upon such an event, our Debentures
provide the holders with the individual option to redeem the Debentures (see
below).
Our Debentures Have Been Partially Refinanced with Notes that Are Subject
-------------------------------------------------------------------------
to New Terms.
- ------------
We issued Debentures through a public offering on May 1, 1998 that mature
on May 1, 2005 in the principal amount of $115 million (the "2005 Notes"). Our
net proceeds from the offering were $110.8 million. The 2005 Notes bear
interest at 5.25% per annum and are convertible into common stock at any time
prior to the redemption or final maturity, initially at the conversion price of
$33.25 per share (resulting in an initial conversion ratio of 30.075 shares per
$1,000 principal amount).
We are obligated to provide holders of the 2005 Notes with notice of and
the holders have the individual option to redeem the 2005 Notes should we, (i)
cease to be traded on a U.S. national securities exchange or cease to be
approved for trading on a U.S. automated over-the-counter securities market; or
(ii) experience defined Changes of Control, including a merger in which we are
not the surviving entity or our shareholders do not control 50% of the new
entity, the sale of substantially all of our assets, a liquidation, or if there
is a substantial change in the board of directors over a two-year period.
Additionally, we are obligated to redeem the 2005 Notes upon defined Events of
Default, including failure to timely repay principal or interest under the 2005
Notes, default under any other borrowing, and bankruptcy. On March 4, 2003,
our common stock was delisted from the Nasdaq Stock Market, and a repurchase
event was triggered.
On April 17, 2003, QuadraMed Corporation closed the partial refinancing of
its 2005 Notes. In conjunction with its repurchase of $61.8 million of its
outstanding 2005 Notes pursuant to its offer to repurchase such Notes
previously announced on March 19, 2003, the Company issued $71 million of its
Senior Secured Notes due 2008 (the "2008 Notes"), together with warrants to
purchase 11,303,842 shares of the Company's common stock. Investors in the
2008 Notes included certain holders of 2005 Notes as well as new investors.
Additional warrants to purchase 2,047,978 shares of the Company's common stock
will be issued to holders of the 2008 Notes if the Company does not file a
registration statement within 90 days after receiving a request from the
holders on or after the date that is 270 days after April 17, 2003, the date of
issuance of the 2008 Notes. The Company also issued warrants to purchase
282,596 shares of the Company's common stock to Philadelphia Brokerage
Corporation as consideration in connection with the transaction. The warrants
have a term of five years, have an exercise price of $0.01 per share and are
subject to certain anti-dilution provisions including dilution from any
issuance of shares in settlement of existing litigation.
The 2008 Notes bear an initial interest rate of 10%, which interest rate
is required to be reduced to 9% upon the listing of the Company's common stock
for trading on a U.S. national securities exchange or upon the common stock's
relisting on the Nasdaq National Market or the Nasdaq SmallCap Market. The
terms of the 2008 Notes provide that interest is initially payable 6% in cash
and 4% in additional notes for the first year and payable entirely in cash
thereafter. The 2008 Notes are also secured by certain intellectual property
of the Company.
Provisions in Our Certificate of Incorporation and Bylaws and Delaware Law
--------------------------------------------------------------------------
Could Delay or Discourage a Takeover which Could Adversely Affect the Price of
- ------------------------------------------------------------------------------
Our Common Stock.
- ----------------
Our board of directors has the authority to issue up to 5 million shares
of preferred stock and to determine the price, rights, preferences, privileges,
and restrictions, including voting rights, of those shares without any further
vote or action by holders of our common stock. If preferred stock is issued,
the voting and other rights of the holders of our common stock may be subject
to, and may be adversely affected by, the rights of the holders of our
preferred stock. The issuance of preferred stock may have the effect of
delaying or preventing a change of control of the Company that could have been
at a premium price to our stockholders.
Certain provisions of our certificate of incorporation and bylaws could
discourage potential takeover attempts and make attempts to change management
by stockholders difficult. Our board of directors, which is classified into
three classes of directors serving staggered, three-year terms, has the
authority to impose various procedural and other requirements that could make
it more difficult for our stockholders to effect certain corporate actions. In
25
addition, our certificate of incorporation provides that directors may be
removed only by the affirmative vote of the holders of two-thirds of the shares
of our capital stock entitled to vote. Any vacancy on our board of directors
may be filled only by a vote of the majority of directors then in office.
Further, our certificate of incorporation provides that the affirmative vote of
two-thirds of the shares entitled to vote, voting together as a single class,
subject to certain exceptions, is required for certain business combination
transactions. These provisions, and certain other provisions of our
certificate of incorporation, could have the effect of delaying or preventing
(i) a tender offer for our common stock or other changes of control of the
Company that could be at a premium price, or (ii) changes in our management.
In addition, certain provisions of Delaware law could have the effect of
delaying or preventing a change in control of the Company. Section 203 of the
Delaware General Corporation Law, for example, prohibits a Delaware corporation
from engaging in any business combination with any interested stockholder for a
period of three years from the date the person became an interested stockholder
unless certain conditions are met.
The Trading Price of Our Common Stock Has Been, and Is Expected to
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Continue to Be, Volatile.
- ------------------------
The Nasdaq SmallCap Market on which our common stock was listed, the "Pink
Sheets" over-the-counter market, where our stock currently trades, and stock
markets in general, have historically experienced extreme price and volume
fluctuations that have affected companies unrelated to their individual
operating performance. The trading price of our common stock has been and is
likely to continue to be volatile due to such factors as:
o Variations in quarterly results of operations;
o Announcements of new products or acquisitions by our competitors;
o Governmental regulatory action;
o Resolution of pending or unasserted litigation, including the existing
shareholder lawsuits;
o Developments or disputes with respect to proprietary rights; and
o General trends in our industry and overall market conditions.
Movements in prices of equity securities in general may also affect the
market price of our common stock.
Future Sales of a Substantial Number of Shares of Our Common Stock Could
------------------------------------------------------------------------
Cause the Price of the Stock to Decrease or Fluctuate Substantially.
- -------------------------------------------------------------------
Our existing stockholders hold a significant number of shares of common
stock that may be sold in the future under Rule 144 of the Securities Act or
through the exercise of registration rights. Sales of a substantial number of
the aforementioned shares in the public markets or the prospect of such sales
could adversely affect or cause substantial fluctuations in the market price of
our common stock and debt securities and impair our ability to raise additional
capital through the sale of our securities.
Future Sales of Our Common Stock in the Public Market or Option Exercises
-------------------------------------------------------------------------
and Sales Could Lower Our Stock Price.
- -------------------------------------
A substantial number of the unissued shares of our common stock are
subject to stock options and our outstanding 2005 Notes may be converted into
shares of common stock. We cannot predict the effect, if any, that future
sales of shares of common stock, or the availability of shares of common stock
for future sale, will have on the market price of our common stock. Sales of
substantial amounts of common stock, including shares issued upon the exercise
of stock options or the conversion of our outstanding 2005 Notes, or the
perception that such sales could occur, may adversely affect prevailing market
prices for our common stock.
26
We Face Product Development Risks Associated with Rapid Technological
---------------------------------------------------------------------
Changes.
- -------
The healthcare software market is highly fragmented and characterized by
ongoing technological developments, evolving industry standards, and rapid
changes in custo