NEXTGEN HEALTHCARE, INC. - Quarter Report: 2010 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-12537

QUALITY SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

California		95-2888568
(State or Other Jurisdiction of		(IRS Employer
Incorporation or Organization)		Identification No.)

18111 Von Karman Avenue, Suite 600, Irvine, California		92612
(Address of principal executive offices)		(Zip Code)

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 twelve 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 ninety days.   Yes   þ   No   o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes   þ   No   o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   o   No   þ

Indicate the number of shares outstanding of each of the Registrant’s classes of Common Stock as of the latest practicable date. 28,911,098 shares of Common Stock, $0.01 par value, outstanding as of July 29, 2010

 

 

QUALITY SYSTEMS, INC.

FORM 10-Q
For the Quarterly Period Ended June 30, 2010

INDEX

Item				Page
Part I.		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Balance Sheets as of June 30, 2010 and March 31, 2010 (unaudited)			3
		Consolidated Statements of Income for the three months ended June 30, 2010 and 2009 (unaudited)			4
		Consolidated Statements of Cash Flows for the three months ended June 30, 2010 and 2009 (unaudited)			5
		Notes to Consolidated Financial Statements (unaudited)			6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3.		Quantitative and Qualitative Disclosures About Market Risks			31
Item 4.		Controls and Procedures			31
Part II.		OTHER INFORMATION
Item 1.		Legal Proceedings			33
Item 1A.		Risk Factors			33
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			33
Item 3.		Defaults Upon Senior Securities			33
Item 4.		Reserved			33
Item 5.		Other Information			33
Item 6.		Exhibits			34
		Signatures			35
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

PART I
CONSOLIDATED FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

		June 30, 2010				March 31, 2010
ASSETS
Current assets:
Cash and cash equivalents		$	93,208			$	84,611
Restricted cash			2,253				2,339
Marketable securities			7,700				7,158
Accounts receivable, net			111,532				107,458
Inventories, net			1,393				1,340
Income taxes receivable			—				2,953
Deferred income taxes, net			5,479				5,678
Other current assets			7,950				8,684
Total current assets			229,515				220,221
Equipment and improvements, net			8,348				8,432
Capitalized software costs, net			12,422				11,546
Intangibles, net			19,380				20,145
Goodwill			46,189				46,189
Other assets			3,970				3,647
Total assets		$	319,824			$	310,180
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	4,523			$	3,342
Deferred revenue			63,565				64,109
Accrued compensation and related benefits			7,596				8,951
Income taxes payable			3,843				—
Dividends payable			8,673				8,664
Other current liabilities			16,941				16,220
Total current liabilities			105,141				101,286
Deferred revenue, net of current			804				474
Deferred income taxes, net			10,398				10,859
Deferred compensation			1,954				1,883
Other noncurrent liabilities			7,436				7,389
Total liabilities			125,733				121,891
Commitments and contingencies (Note 14)
Shareholders’ equity:
Common stock
$0.01 par value; authorized 50,000 shares; issued and outstanding 28,911 and 28,879 shares at June 30, 2010 and March 31, 2010, respectively			289				289
Additional paid-in capital			124,655				122,271
Retained earnings			69,147				65,729
Total shareholders’ equity			194,091				188,289
Total liabilities and shareholders’ equity		$	319,824			$	310,180

The accompanying notes are an integral part of these consolidated financial statements.

QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

		Three Months Ended June 30,
		2010				2009
Revenues:
Software, hardware and supplies		$	24,756			$	17,776
Implementation and training services			4,308				3,457
System sales			29,064				21,233
Maintenance			25,536				21,640
Electronic data interchange services			9,764				8,161
Revenue cycle management and related services			10,772				8,992
Other services			7,791				6,612
Maintenance, EDI, RCM and other services			53,863				45,405
Total revenues			82,927				66,638
Cost of revenue:
Software, hardware and supplies			6,212				2,704
Implementation and training services			2,990				2,881
Total cost of system sales			9,202				5,585
Maintenance			3,454				3,025
Electronic data interchange services			6,709				5,890
Revenue cycle management and related services			8,145				6,522
Other services			4,349				4,867
Total cost of maintenance, EDI, RCM and other services			22,657				20,304
Total cost of revenue			31,859				25,889
Gross profit			51,068				40,749
Operating expenses:
Selling, general and administrative			26,238				20,093
Research and development costs			5,456				3,977
Amortization of acquired intangible assets			347				357
Total operating expenses			32,041				24,427
Income from operations			19,027				16,322
Interest income			60				78
Other income (expense)			(6	)			58
Income before provision for income taxes			19,081				16,458
Provision for income taxes			6,989				6,112
Net income		$	12,092			$	10,346
Net income per share:
Basic		$	0.42			$	0.36
Diluted		$	0.42			$	0.36
Weighted-average shares outstanding:
Basic			28,896				28,492
Diluted			29,057				28,635
Dividends declared per common share		$	0.30			$	0.30

The accompanying notes are an integral part of these consolidated financial statements.

QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

		Three Months Ended June 30,
		2010				2009
Cash flows from operating activities:
Net income		$	12,092			$	10,346
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			962				886
Amortization of capitalized software costs			1,669				1,440
Amortization of other intangibles			765				357
Provision for bad debts			850				852
Share-based compensation			1,065				462
Deferred income tax benefit			(262	)			(514	)
Tax benefit associated with stock options			175				797
Excess tax benefit from share-based compensation			(175	)			(797	)
Changes in assets and liabilities:
Accounts receivable			(4,924	)			(3,212	)
Inventories			(53	)			(26	)
Income taxes receivable			2,953				4,534
Other current assets			278				788
Other assets			(323	)			292
Accounts payable			1,181				(751	)
Deferred revenue			(214	)			(1,476	)
Accrued compensation and related benefits			(1,355	)			(1,059	)
Income taxes payable			3,843				—
Other current liabilities			721				2,345
Deferred compensation			71				250
Other noncurrent liabilities			47				—
Net cash provided by operating activities			19,366				15,514
Cash flows from investing activities:
Additions to capitalized software costs			(2,545	)			(1,420	)
Additions to equipment and improvements			(878	)			(1,669	)
Net cash used in investing activities			(3,423	)			(3,089	)
Cash flows from financing activities:
Excess tax benefit from share-based compensation			175				797
Proceeds from exercise of stock options			1,144				2,554
Dividends paid			(8,665	)			(8,532	)
Net cash used in financing activities			(7,346	)			(5,181	)
Net increase in cash and cash equivalents			8,597				7,244
Cash and cash equivalents at beginning of period			84,611				70,180
Cash and cash equivalents at end of period		$	93,208			$	77,424
Supplemental disclosures of cash flow information:
Cash paid during the period for income taxes, net of refunds		$	276			$	1,278

The accompanying notes are an integral part of these consolidated financial statements.

QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)
(UNAUDITED)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements as of June 30, 2010 and for the three months ended June 30, 2010 and 2009, have been prepared in accordance with the requirements of Form 10-Q and Article 10 of Regulation S-X, and therefore do not include all information and notes which would be presented were such consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These consolidated financial statements should be read in conjunction with the audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2010. Amounts related to disclosures of March 31, 2010 balances within these interim consolidated financial statements were derived from the aforementioned Form 10-K. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments which are necessary for a fair presentation of the results of operations and cash flows for the periods presented. The results of operations for such interim periods are not necessarily indicative of results of operations to be expected for the full year.

2. Summary of Significant Accounting Policies

Principles of Consolidation. The consolidated financial statements include the accounts of Quality Systems, Inc. and its wholly-owned subsidiaries, which consists of NextGen Healthcare Information Systems (“NextGen”), Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (“HSI”), Practice Management Partners, Inc. (“PMP”), NextGen Sphere, LLC (“Sphere”), and Opus Healthcare Solutions, Inc. (“Opus”). All significant intercompany accounts and transactions have been eliminated.

Business Segments. The Company has prepared operating segment information in accordance with FASB ASC Topic 280, Segment Reporting, or ASC 280, which requires that companies disclose “operating segments” based on the manner in which management disaggregates the Company’s operations for making internal operating decisions. See Note 12.

Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with GAAP.

Certain prior period amounts have been reclassified to conform with fiscal year 2011 presentation.

References to dollar amounts in the consolidated financial statement sections are in thousands, except shares and per share data, unless otherwise specified.

Revenue Recognition. The Company recognizes revenue for system sales pursuant to FASB ASC Topic 985-605, Software, Revenue Recognition, or ASC 985-605. The Company generates revenue from the sale of licensing rights to its software products directly to end-users and value-added resellers, or VARs. The Company also generates revenue from sales of hardware and third party software, implementation, training, Electronic Data Interchange (“EDI”), post-contract support (maintenance), and other services, including revenue cycle management (“RCM”), performed for customers who license its products.

A typical system contract contains multiple elements of the above items. FASB ASC Topic 985-605-25, Software, Revenue Recognition, Multiple Elements, or ASC 985-605-25, requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. The fair value of an element must be based on vendor specific objective evidence (“VSOE”). The Company limits its assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. VSOE calculations are updated and reviewed quarterly or annually depending on the nature of the product or service. The Company has established VSOE for the related undelivered elements based on the bell-shaped curve method. Maintenance VSOE for the Company’s largest customers is based on stated renewal rates only if the rate is determined to be substantive and falls within the Company’s customary pricing practices.

When evidence of fair value exists for the delivered and undelivered elements of a transaction, then discounts for individual elements are aggregated and the total discount is allocated to the individual elements in proportion to the elements’ fair value relative to the total contract fair value.

When evidence of fair value exists for the undelivered elements only, the residual method, provided for under ASC 985-605, is used. Under the residual method, the Company defers revenue related to the undelivered elements in a system sale based on VSOE of fair value of each of the undelivered elements, and allocates the remainder of the contract price net of all discounts to revenue recognized from the delivered elements. If VSOE of fair value of any undelivered element does not exist, all revenue is deferred until VSOE of fair value of the undelivered element is established or the element has been delivered.

The Company bills for the entire system sales contract amount upon contract execution except for maintenance which is billed separately. Amounts billed in excess of the amounts contractually due are recorded in accounts receivable as advance billings. Amounts are contractually due when services are performed or in accordance with contractually specified payment dates. Provided the fees are fixed or determinable and collection is considered probable, revenue from licensing rights and sales of hardware and third party software is generally recognized upon physical or electronic shipment and transfer of title. In certain transactions where collections risk is high, the cash basis method is used to recognize revenue. If the fee is not fixed or determinable, then the revenue recognized in each period (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the

arrangement fee that would have been recognized if the fees were being recognized using the residual method. Fees which are considered fixed or determinable at the inception of the Company’s arrangements must include the following characteristics:

•		The fee must be negotiated at the outset of an arrangement, and generally be based on the specific volume of products to be delivered without being subject to change based on variable pricing mechanisms such as the number of units copied or distributed or the expected number of users.
•		Payment terms must not be considered extended. If a significant portion of the fee is due more than 12 months after delivery or after the expiration of the license, the fee is presumed not fixed or determinable.

Revenue from implementation and training services is recognized as the corresponding services are performed. Maintenance revenue is recognized ratably over the contractual maintenance period.

Contract accounting is applied where services include significant software modification, development or customization. In such instances, the arrangement fee is accounted for in accordance with FASB ASC Topic 605-35, Revenue Recognition, Construction-Type and Production-Type Contracts, or ASC 605-35. Pursuant to ASC 605-35, the Company uses the percentage of completion method provided all of the following conditions exist:

•		the contract includes provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement;
•		the customer can be expected to satisfy its obligations under the contract;
•		the Company can be expected to perform its contractual obligations; and
•		reliable estimates of progress towards completion can be made.

The Company measures completion using labor input hours. Costs of providing services, including services accounted for in accordance with ASC 605-35, are expensed as incurred.

If a situation occurs in which a contract is so short term that the financial statements would not vary materially from using the percentage-of-completion method or in which the Company is unable to make reliable estimates of progress of completion of the contract, the completed contract method is utilized.

Product returns are estimated in accordance with FASB ASC Topic 605-15, Revenue Recognition, Products, or ASC 605-15. The Company also ensures that the other criteria in ASC 605-15 have been met prior to recognition of revenue:

•		the price is fixed or determinable;
•		the customer is obligated to pay and there are no contingencies surrounding the obligation or the payment;
•		the customer’s obligation would not change in the event of theft or damage to the product;
•		the customer has economic substance;
•		the amount of returns can be reasonably estimated; and
•		the Company does not have significant obligations for future performance in order to bring about resale of the product by the customer.

The Company has historically offered short-term rights of return in certain sales arrangements. If the Company is able to estimate returns for these types of arrangements, revenue is recognized, net of an allowance for returns, and these arrangements are recorded in the consolidated financial statements. If the Company is unable to estimate returns for these types of arrangements, revenue is not recognized in the consolidated financial statements until the rights of return expire.

Revenue related to sales arrangements that include the right to use software stored on the Company’s hardware is accounted for under FASB ASC Topic 985-605-05, Software, Revenue Recognition, Hosting Arrangements, or ASC 985-605-05, which requires that for software licenses and related implementation services to continue to fall under ASC 985-605-05, the customer must have the contractual right to take possession of the software without incurring a significant penalty and it must be feasible for the customer to either host the software themselves or through another third party. If an arrangement is not deemed to be accounted for under ASC 985-605-05, the entire arrangement is accounted for as a service contract in accordance with ASC 985-605-25. In that instance, the entire arrangement would be recognized during the period that the hosting services are being performed.

From time to time, the Company offers future purchase discounts on its products and services as part of its sales arrangements. Pursuant to FASB ASC Topic 985-605-55, Software, Revenue Recognition, Flowchart of Revenue Recognition on Software Arrangements, or ASC 985-605-55, such discounts that are incremental to the range of discounts reflected in the pricing of the other elements of the arrangement, that are incremental to the range of discounts typically given in comparable transactions, and that are significant, are treated as an additional element of the contract to be deferred. Amounts deferred related to future purchase options are not recognized until either the customer exercises the discount offer or the offer expires.

RCM service revenue is derived from services fees, which include amounts charged for ongoing billing and other related services, and are generally billed to the customer as a percentage of total collections. The Company does not recognize revenue for services fees until these collections are made, as the services fees are not fixed or determinable until such time.

Revenue is divided into two categories, “system sales” and “maintenance, EDI, RCM and other services.” Revenue in the system sales category includes software license fees, third party hardware and software, and implementation and training services related to purchase of the Company’s software systems. Revenue in the maintenance, EDI, RCM and other services category includes maintenance, EDI, RCM services, follow on training and implementation services, annual third party license fees, hosting services and other services revenue.

Cash and Cash Equivalents. Cash and cash equivalents generally consist of cash, money market funds and short-term U.S. Treasury securities with original maturities of less than 90 days. The money market fund in which the Company holds a portion of its cash invests in only investment grade money market instruments from a variety of industries, and therefore bears relatively low market risk. The average maturity of the investments owned by the money market fund is approximately two months.

Restricted Cash. Restricted cash consists of cash which is being held by HSI acting as agent for the disbursement of certain state social services programs. The Company records an offsetting “Care Services liability” (see also Note 4) when it initially receives such cash from the government social service programs and relieves both restricted cash and the Care Services liability when amounts are disbursed. HSI earns an administrative fee which is based on a percentage of funds disbursed on behalf of certain government social service programs.

Marketable Securities and ARS Put Option Rights. Marketable securities are recorded at fair value, based on quoted market rates or valuation analysis when appropriate.

The Company’s investments at June 30, 2010 and March 31, 2010 are in tax exempt municipal Auction Rate Securities (“ARS”), which are classified as either current or non-current marketable securities depending on the liquidity and timing of expected realization of such securities. The ARS are rated by one or more national rating agencies and have contractual terms of up to 30 years, but generally have interest rate reset dates that occur every 7, 28 or 35 days. Despite the underlying long-term maturity of ARS, such securities were priced and subsequently traded as short-term investments because of the interest rate reset feature. If there are insufficient buyers, the auction is said to “fail” and the holders are unable to liquidate the investments through auction. A failed auction does not result in a default of the debt instrument. Under their respective terms, the securities will continue to accrue interest and be auctioned until the auction succeeds, the issuer calls the securities or the securities mature. In February 2008, the Company began to experience failed auctions on its ARS.

The Company’s ARS are held by UBS Financial Services Inc. (“UBS”). On November 13, 2008, the Company entered into an Auction Rate Security Rights Agreement (the “Rights Agreement”) with UBS, whereby the Company accepted UBS’s offer to purchase the Company’s ARS investments at any time during the period of June 30, 2010 through July 2, 2012. As a result, the Company had obtained an asset, ARS put option rights, whereby the Company had a right to “put” the ARS back to UBS.

Prior to signing the Rights Agreement, the Company had asserted that it had the intent and ability to hold these securities until anticipated recovery and classified its ARS as held for sale securities. By accepting the Rights Agreement, the Company could no longer assert that it has the intent to hold the auction rate securities until anticipated recovery and consequently elected to reclassify its investments in ARS as trading securities, as defined by FASB ASC Topic 320, Investments — Debt and Equity Securities, or ASC 320, on the date of Company’s acceptance of the Rights Agreement. As trading securities, the ARS were carried at fair value with changes recorded through earnings.

To determine the estimated fair values of the ARS, factors including credit quality, assumptions about the likelihood of redemption, observable market data such as yields or spreads of fixed rate municipal bonds and other trading instruments issued by the same or comparable issuers, were considered. The Company had valued the ARS as the approximate midpoint between various fair values, measured as the difference between the par value of the ARS and the fair value of the securities, discounted by the credit risk of the broker and other factors such as the Company’s historical experience to sell ARS at par.

As the Company was permitted to put the ARS back to UBS at par value, the Company accounted for the ARS put option right as a separate asset that was measured at its fair value with changes recorded through earnings. The Company had valued the ARS put option right as the approximate midpoint between various fair values, measured as the difference between the par value of the ARS and the fair value of the securities, discounted by the credit risk of the broker and other factors such as the Company’s historical experience to sell ARS at par.

On June 30, 2010, the earliest date allowable under the Rights Agreement, the Company exercised its ARS put option rights and put its ARS back to UBS. The ARS were sold and settled on July 1, 2010 at 100% of the $7,700 par value. The Company has determined that the par value of $7,700 approximates the fair value of its ARS investments and ARS put option rights on June 30, 2010.

Allowance for Doubtful Accounts. The Company provides credit terms typically ranging from thirty days to less than twelve months for most system and maintenance contract sales and generally does not require collateral. The Company performs credit evaluations of its customers and maintains reserves for estimated credit losses. Reserves for potential credit losses are determined by establishing both specific and general reserves. Specific reserves are based on management’s estimate of the probability of collection for certain troubled accounts. General reserves are established based on the Company’s historical experience of bad debt expense and the aging of the Company’s accounts receivable balances, net of deferred revenue and specifically reserved accounts. Accounts are written off as uncollectible only after the Company has expended extensive collection efforts.

Included in accounts receivable are amounts related to maintenance and services which were billed, but which had not yet been rendered as of the end of the period. Undelivered maintenance and services are included as a component of deferred revenue (see also Note 4).

Inventories. Inventories consist of hardware for specific customer orders and spare parts, and are valued at lower of cost (first-in, first-out) or market. Management provides a reserve to reduce inventory to its net realizable value.

Equipment and Improvements. Equipment and improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of equipment and improvements are provided over the estimated useful lives of the assets, or the related lease terms if shorter, by the straight-line method. Useful lives range as follows:

•		Computers and electronic test equipment		3-5 years

•		Furniture and fixtures		5-7 years
•		Leasehold improvements		lesser of lease term or estimated useful life of asset

Software Development Costs. Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional development costs are capitalized in accordance with FASB ASC Topic 985-20, Software, Costs of Computer Software to be Sold, Leased or Marketed, or ASC 985-20. Such capitalized costs are amortized on a straight-line basis over the estimated economic life of the related product, which is typically three years. The Company provides support services on the current and prior two versions of its software. Management performs an annual review of the estimated economic life and the recoverability of such capitalized software costs. If a determination is made that capitalized amounts are not recoverable based on the estimated cash flows to be generated from the applicable software, any remaining capitalized amounts are written off.

Goodwill. Goodwill is related to NextGen and the HSI, PMP, Sphere, and Opus acquisitions, which closed on May 20, 2008, October 28, 2008, August 12, 2009, and February 10, 2010, respectively (see Notes 5 and 6). In accordance with FASB ASC Topic 350-20, Intangibles — Goodwill and Other, Goodwill, or ASC 350-20, the Company tests goodwill for impairment annually at the end of its first fiscal quarter, referred to as the annual test date. The Company will also test for impairment between annual test dates if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Impairment testing for goodwill is performed at a reporting-unit level, which is defined as an operating segment or one level below and operating segment (referred to as a component). A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component.

The Company has determined that NextGen, HSI, and PMP each qualify as a separate reporting unit level while Sphere and Opus are aggregated as one reporting unit at which goodwill impairment testing is performed.

Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The estimate of fair value of each of the Company’s reporting units is based on projection of revenues, cost of services, other expenses and cash flows considering historical and estimated future results, general economic and market conditions as well as the impact of planned business and operational strategies. The Company determines its fair value estimates using assumptions it believes to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Actual results may differ from those estimates. The valuations employ present value techniques to measure fair value and consider market factors.

For HSI, PMP, Sphere, and Opus, fair value was determined based upon a combination of various valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management’s 5-year forecasts, a market approach, which is based upon pricing multiples at which similar companies have been sold, and a cost approach where an analysis of assets and liabilities is performed to restate each to fair value, then determining enterprise value from the difference between current assets and current liabilities. Key assumptions used to determine the fair value of each reporting unit as the Company’s annual assessment date were: (a) expected cash flow for the period from 2011 to 2016 plus a terminal year; (b) a discount rate of 18%-25%, which is based on marketplace participant expectations; and (c) a debt-free net cash flow long-term growth rate of 4% which is based on expected levels of growth for nominal GDP and inflation.

The estimated fair value of NextGen was determined using an estimate of future cash flows over both 5 and 10 year periods and risk adjusted discount rates of between 10 and 25 percent to compute a net present value of discounted future cash flows.

An impairment loss would generally be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. Based on its analysis, the Company has determined that there was no impairment to its goodwill as of June 30, 2010. See also Note 6.

Intangible Assets. Intangible assets consist of capitalized software costs, customer relationships, trade names and certain intellectual property. Intangible assets related to customer relationships, trade names, and software technology arose in connection with the acquisition of HSI, PMP, Sphere, and Opus. These intangible assets were recorded at fair value and are stated net of accumulated amortization. Intangible assets are amortized over their remaining estimated useful lives, ranging from 3 to 9 years. The Company’s amortization policy for intangible assets is based on the principles in FASB ASC Topic 350-30, Intangibles — Goodwill and Other, General Intangibles Other than Goodwill, or ASC 350-30, which requires that the amortization of intangible assets reflect the pattern that the economic benefits of the intangible assets are consumed.

Long-Lived Assets. The Company assesses the recoverability of long-lived assets at least annually or whenever adverse events or changes in circumstances indicate that impairment may have occurred in accordance with FASB ASC Topic 360-10, Property, Plant, and Equipment, Impairment or Disposal of Long-Lived Assets, or ASC 360-10. If the future undiscounted cash flows expected to result from the use of the related assets are less than the carrying value of such assets, impairment has been incurred and a loss is recognized to reduce the carrying value of the long-lived assets to fair value, which is determined by discounting estimated future cash flows.

Management periodically reviews the carrying value of long-lived assets to determine whether or not impairment to such value has occurred and has determined that there was no risk of impairment to its long-lived assets as of June 30, 2010. In addition to the recoverability assessment, the Company routinely reviews the remaining estimated lives of its long-lived assets.

Income Taxes. The Company accounts for income taxes in accordance with FASB ASC Topic 740, Income Taxes, or ASC 740. Income taxes are provided based on current taxable income and the future tax consequences of temporary differences between the basis of assets and liabilities for financial and tax reporting. The deferred income tax assets and liabilities represent the future state and federal tax return

consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred income taxes are also recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future income taxes. At each reporting period, management assesses the realizable value of deferred tax assets based on, among other things, estimates of future taxable income, and adjusts the related valuation allowance as necessary. Management makes a number of assumptions and estimates in determining the appropriate amount of expense to record for income taxes. These assumptions and estimates consider the taxing jurisdiction in which the Company operates as well as current tax regulations. Accruals are established for estimates of tax effects for certain transactions and future projected profitability of the Company’s businesses based on management’s interpretation of existing facts and circumstances.

Self-Insurance Liabilities. Effective January 1, 2010, the Company became self-insured with respect to healthcare claims, subject to stop-loss limits. The Company accrues for estimated self-insurance costs and uninsured exposures based on claims filed and an estimate of claims incurred but not reported as of each balance sheet date. However, it is possible that recorded accruals may not be adequate to cover the future payment of claims. Adjustments, if any, to estimated accruals resulting from ultimate claim payments will be reflected in earnings during the periods in which such adjustments are determined. Periodically, the Company reevaluates the adequacy of the accruals by comparing amounts accrued on the balance sheets for anticipated losses to an updated actuarial loss forecasts and third party claim administrator loss estimates and makes adjustments to the accruals as needed. The self-insurance accrual is included in other current liabilities. If any of the factors that contribute to the overall cost of insurance claims were to change, the actual amount incurred for the self-insurance liabilities would be directly affected.

Advertising Costs. Advertising costs are charged to operations as incurred. The Company does not have any direct-response advertising. Advertising costs are included in selling, general and administrative expenses.

Marketing Assistance Agreements. The Company has entered into marketing assistance agreements with certain existing users of the Company’s products, which provide the opportunity for those users to earn commissions if they host specific site visits upon the Company’s request for prospective customers that directly result in a purchase of the Company’s software by the visiting prospects. Amounts earned by existing users under this program are treated as a selling expense in the period when earned.

Share-Based Compensation. FASB ASC Topic 718 Compensation — Stock Compensation, or ASC 718, requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. Expected term is estimated using historical exercise experience. Volatility is estimated by using the weighted-average historical volatility of the Company’s Common Stock, which approximates expected volatility. The risk free rate is the implied yield available on the U.S Treasury zero-coupon issues with remaining terms equal to the expected term. The expected dividend yield is the average dividend rate during a period equal to the expected term of the option. Those inputs are then entered into the Black Scholes model to determine the estimated fair value. The value of the portion of the award that is ultimately expected to vest is recognized ratably as expense over the requisite service period in the Company’s consolidated statements of income.

The following table shows total stock-based compensation expense included in the consolidated statements of income for the three months ended June 30, 2010 and 2009.

		Three Months Ended June 30,
		2010				2009
Costs and expenses:
Cost of revenue		$	68			$	13
Research and development			28				19
Selling, general and administrative			969				430
Total share-based compensation			1,065				462
Amounts capitalized in software development costs			(1	)			(13	)
Amounts charged against earnings, before income tax benefit		$	1,064			$	449
Related income tax benefit			(348	)			(797	)
(Increase) decrease in net income		$	716			$	(348	)

Newly Adopted Accounting Standards

In January 2010, the FASB issued Accounting Standards Update, or ASU, 2010-06, Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements, or ASU 2010-06, to require additional disclosures about recurring or nonrecurring fair value measurements, including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. The standard also clarifies existing disclosures about the level of disaggregation, valuation techniques and inputs to fair value measurements. The provisions of ASU 2010-06 are effective for interim and annual reporting periods beginning after December 15, 2009, except for the Level 3 reconciliation disclosures that are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted the provisions of ASU 2010-06 regarding Level 1 and Level 2 fair value measurements during the quarter ended June 30, 2010. As the Company did not have any transfers between Level 1 and Level 2 fair value measurement, the adoption of this standard did not have a material effect on the Company’s consolidated financial statements. The Company does not expect the future adoption of the provisions for Level 3 reconciliation to have a significant impact on its consolidated financial statements.

Recently Issued Accounting Standards

In September 2009, the FASB reached a consensus on ASU 2009-13, Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements, or ASU 2009-13, and ASU 2009-14, Software (Topic 985) — Certain Revenue Arrangements That Include Software Elements, or ASU 2009-14. ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: (a) VSOE or (b) third-party evidence, or TPE, before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. The residual method of allocating arrangement consideration has been eliminated. ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. These new updates are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of these ASUs will have on its consolidated financial statements.

3. Fair Value Measurements

The Company applies ASC 820 with respect to fair value measurements of (a) nonfinancial assets and liabilities that are recognized or disclosed at fair value in the Company’s consolidated financial statements on a recurring basis (at least annually) and (b) all financial assets and liabilities. As defined by ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company estimates fair value utilizing market data or assumptions that market participants would use in pricing the asset or liability in a current transaction, including assumptions about risk and the risks inherent in the inputs to the valuation technique. ASC 820 prioritizes the inputs used in measuring fair value into the following hierarchy (with Level 1 as the highest priority):

Level 1		Quoted market prices in active markets for identical assets or liabilities;
Level 2		Observable inputs other than those included in Level 1 (for example, quoted prices for similar assets in active markets or quoted prices for identical assets in inactive markets); and
Level 3		Unobservable inputs reflecting management’s own assumptions about the inputs used in estimating the value of the asset.

Recurring Fair Value Measurements

The fair value hierarchy requires the use of observable market data when available. The financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The following tables sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis at June 30, 2010 and March 31, 2010:

						Quoted Prices
						in Active				Significant
						Markets for				Other
						Identical				Observable				Unobservable
		Balance at				Assets				Inputs				Inputs
		June 30, 2010				(Level 1)				(Level 2)				(Level 3)
Cash and cash equivalents		$	93,208			$	93,208			$	—			$	—
Restricted cash			2,253				2,253				—				—
Marketable securities (1)			7,700				—				—				7,700
		$	103,161			$	95,461			$	—			$	7,700

						Quoted Prices
						in Active				Significant
						Markets for				Other
						Identical				Observable				Unobservable
		Balance at				Assets				Inputs				Inputs
		March 31, 2010				(Level 1)				(Level 2)				(Level 3)
Cash and cash equivalents		$	84,611			$	84,611			$	—			$	—
Restricted cash			2,339				2,339				—				—
Marketable securities (2)			7,158				—				—				7,158
ARS put option rights (3)			548				—				—				548
		$	94,656			$	86,950			$	—			$	7,706

On June 30, 2010, the earliest date allowable under the Rights Agreement, the Company exercised its ARS put option rights and put its ARS back to UBS. The ARS were sold and settled on July 1, 2010 at 100% of the $7,700 par value. The Company has determined that the par value of $7,700 approximates the fair value of its ARS investments and ARS put option rights on June 30, 2010. The resulting net loss for the fair value adjustment on June 30, 2010 of $6 is included in other income (expense).

The following table presents activity in the Company’s assets measured at fair value using significant unobservable inputs (Level 3), as defined by ASC 820, as of and for the three months ended June 30, 2010:

Balance at March 31, 2010		$	7,706
Transfer in/(out) of Level 3			—
Proceeds from sale (at par)			—
Recognized loss			(6	)
Balance at June 30, 2010		$	7,700

Non-Recurring Fair Value Measurements

The Company has certain assets, including inventories, tangible fixed assets, goodwill and other intangible assets, which are measured at fair value on a non-recurring basis and are adjusted to fair value only when the carrying values are more than the fair values. The categorization of the framework used to price the assets is considered a Level 3, due to the subjective nature of the unobservable inputs used to determine the fair value. During the three months ended June 30, 2010, there were no adjustments to fair value of such assets.

Fair Value of Financial Instruments

The estimated fair value of financial instruments is determined using the best available market information and appropriate valuation methodologies. However, considerable judgment is necessary in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts that the Company could realize in a current market exchange, or the value that ultimately will be realized upon maturity or disposition. The use of different market assumptions may have a material effect on the estimated fair value amounts. The Company’s financial instruments, other than those presented in the disclosures above, include cash and cash equivalents, accounts receivables, accounts payable, and accrued liabilities. The carrying value of these assets and liabilities approximates fair value because of the short-term nature of these instruments.

4. Composition of Certain Financial Statement Captions

Accounts receivable include amounts related to maintenance and services that were billed but not yet rendered at each period end. Undelivered maintenance and services are included as a component of the deferred revenue balance.

		June 30, 2010				March 31, 2010
Accounts receivable, excluding undelivered software, maintenance and services		$	77,936			$	72,500
Undeliverable software, maintenance and implementation services billed in advance, included in deferred revenue			38,664				39,447
Accounts receivable, gross			116,600				111,947
Allowance for doubtful accounts			(5,068	)			(4,489	)
Accounts receivable, net		$	111,532			$	107,458

Inventories are summarized as follows:

		June 30, 2010				March 31, 2010
Computer systems and components, net of reserve for obsolescence of $237		$	1,384			$	1,322
Miscellaneous parts and supplies			9				18
Inventories, net		$	1,393			$	1,340

Equipment and improvements are summarized as follows:

		June 30, 2010				March 31, 2010
Computer and electronic test equipment		$	19,213			$	18,599
Furniture and fixtures			5,357				5,136
Leasehold improvements			2,012				1,969
			26,582				25,704
Accumulated depreciation and amortization			(18,234	)			(17,272	)
Equipment and improvements, net		$	8,348			$	8,432

Current and non-current deferred revenue are summarized as follows:

		June 30, 2010				March 31, 2010
Maintenance		$	11,830			$	13,242
Implementation services			41,130				38,137
Annual license services			7,293				8,214
Undelivered software and other			3,312				4,516
Deferred revenue		$	63,565			$	64,109
Deferred revenue, net of current		$	804			$	474

Accrued compensation and related benefits are summarized as follows:

		June 30, 2010				March 31, 2010
Payroll, bonus and commission		$	2,542			$	4,185
Vacation			5,054				4,766
Accrued compensation and related benefits		$	7,596			$	8,951

Other current liabilities are summarized as follows:

		June 30, 2010				March 31, 2010
Contingent consideration related to acquisition		$	4,900			$	5,275
Care services liabilities			2,251				2,336
Accrued EDI expense			2,065				2,000
Sales tax payable			992				506
Customer deposits			898				1,036
Accrued royalties			607				926
Commission payable			521				468
Users Group Meeting (UGM)			449				8
Deferred rent			449				641
Self insurance reserve			425				516
Professional services			384				391
Other accrued expenses			3,000				2,117
Other current liabilities		$	16,941			$	16,220

5. Business Combinations

On February 10, 2010, the Company acquired Opus, a provider of clinical information systems to the small hospital inpatient market, and on August 12, 2009, the Company acquired Sphere, a provider of financial information systems to the small hospital inpatient market.

The Company accounted for these acquisitions as a purchase business combination as defined in FASB ASC Topic 805, Business Combinations, or ASC 805. Under the acquisition method of accounting, the purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The fair value of the assets acquired and liabilities assumed represent management’s estimate of fair value.

6. Goodwill

In accordance with ASC 350-20, the Company does not amortize goodwill as the goodwill has been determined to have an indefinite useful life.

Goodwill consists of the following:

		June 30, 2010				March 31, 2010
NextGen Division
Opus Healthcare Solutions, Inc.		$	13,005			$	13,005
NextGen Sphere, LLC			1,020				1,020
NextGen Healthcare Information Systems, Inc.			1,840				1,840
Total NextGen Division goodwill			15,865				15,865
Practice Solutions Division
Practice Management Partners, Inc.			19,485				19,485
Healthcare Strategic Initiatives			10,839				10,839
Total Practice Solutions Division goodwill			30,324				30,324
Total goodwill		$	46,189			$	46,189

7. Intangible Assets

The Company had the following intangible assets, other than capitalized software development costs, with determinable lives as of June 30, 2010:

		Customer								Software
		Relationships				Trade Name				Technology				Total
Gross carrying amount		$	10,206			$	637			$	12,119			$	22,962
Accumulated amortization			(2,664	)			(309	)			(609	)			(3,582	)
Net intangible assets		$	7,542			$	328			$	11,510			$	19,380

Activity related to the intangible assets for the quarter ended June 30, 2010 is as follows:

		Customer								Software
		Relationships				Trade Name				Technology				Total
Balance as of April 1, 2010		$	7,849			$	368			$	11,928			$	20,145
Amortization (1)			(307	)			(40	)			(418	)			(765	)
Balance as of June 30, 2010		$	7,542			$	328			$	11,510			$	19,380

The following table represents the remaining estimated amortization of intangible assets with determinable lives as of June 30, 2010:

For the year ended March 31,
2011 (remaining nine months)		$	2,490
2012			3,320
2013			3,184
2014			3,055
2015 and beyond			7,331
Total		$	19,380

8. Capitalized Software Costs

The Company had the following amounts related to capitalized software development costs:

		June 30, 2010				March 31, 2010
Gross carrying amount		$	43,974			$	41,429
Accumulated amortization			(31,552	)			(29,883	)
Net capitalized software costs		$	12,422			$	11,546

Activity related to net capitalized software costs for the quarter ended June 30, 2010 is as follows:

Balance as of April 1, 2010		$	11,546
Capitalized			2,545
Amortization			(1,669	)
Balance as of June 30, 2010		$	12,422

The following table represents the remaining estimated amortization of capitalized software costs as of June 30, 2010:

For the year ended March 31,
2011 (remaining nine months)		$	4,768
2012			4,516
2013			2,743
2014			395
2015 and beyond			—
Total		$	12,422

9. Share-Based Awards

Employee Stock Option Plans

In September 1998, the Company’s shareholders approved a stock option plan (the “1998 Plan”) under which 4,000,000 shares of Common Stock were reserved for the issuance of options. The 1998 Plan provides that employees, directors and consultants of the Company may, at the discretion of the Board of Directors or a duly designated compensation committee, be granted options to purchase shares of Common Stock. The exercise price of each option granted was determined by the Board of Directors at the date of grant, and options under the 1998 Plan expire no later than ten years from the grant date. Options granted will generally become exercisable in accordance with the terms of the agreement pursuant to which they were granted. Certain option grants to directors became exercisable three months from the date of grant. Upon an acquisition of the Company by merger or asset sale, each outstanding option may be subject to accelerated vesting under certain circumstances. The 1998 Plan terminated on December 31, 2007. As of June 30, 2010, there were 290,080 outstanding options related to this Plan.

In October 2005, the Company’s shareholders approved a stock option and incentive plan (the “2005 Plan”) under which 2,400,000 shares of Common Stock were reserved for the issuance of awards, including stock options, incentive stock options and non-qualified stock

options, stock appreciation rights, Restricted Stock, Unrestricted Stock, Restricted Stock units, performance shares, performance units (including performance options) and other share-based awards. The 2005 Plan provides that employees, directors and consultants of the Company may, at the discretion of the Board of Directors or a duly designated compensation committee, be granted awards to acquire shares of Common Stock. The exercise price of each option award shall be determined by the Board of Directors at the date of grant in accordance with the terms of the 2005 Plan, and under the 2005 Plan awards expire no later than ten years from the grant date. Options granted will generally become exercisable in accordance with the terms of the agreement pursuant to which they were granted. Upon an acquisition of the Company by merger or asset sale, each outstanding option may be subject to accelerated vesting under certain circumstances. The 2005 Plan terminates on May 25, 2015, unless terminated earlier by the Board of Directors. At June 30, 2010, 1,728,893 shares were available for future grant under the 2005 Plan. As of June 30, 2010, there were 532,447 outstanding options related to this Plan.

A summary of stock option transactions during the three months ended June 30, 2010 is as follows:

										Weighted-
						Weighted-				Average				Aggregate
						Average				Remaining				Intrinsic
		Number of				Exercise				Contractual				Value
		Shares				Price				Life				(in thousands)
Outstanding, April 1, 2010			871,963			$	43.15				4.51			$	15,945
Granted			40,000			$	57.16				7.93
Exercised			(32,707	)		$	35.01				2.67			$	752
Forfeited/Canceled			(56,729	)		$	56.00				1.59
Outstanding, June 30, 2010			822,527			$	43.27				4.33			$	12,355
Vested and expected to vest, June 30, 2010			805,591			$	43.12				4.30			$	12,218
Exercisable, June 30, 2010			309,539			$	33.14				2.31			$	7,692

The Company continues to utilize the Black-Scholes valuation model for estimating the fair value of share-based compensation after the adoption of ASC 718 with the following assumptions:

		Three Months
		Ended
		June 30, 2010
Expected life		4.2 years
Expected volatility			44.6% - 44.7	%
Expected dividends			2.1	%
Risk-free rate			2.0% - 2.1	%

During the three months ended June 30, 2010 and 2009, 40,000 and zero (-0-) options were granted, respectively, under the 2005 Plan. The Company issues new shares to satisfy option exercises. Based on historical experience of option cancellations, the Company has estimated an annualized forfeiture rate of 2.4% for employee options and 0.0% for director options. Forfeiture rates will be adjusted over the requisite service period when actual forfeitures differ, or are expected to differ, from the estimate. The weighted-average grant date fair value of stock options granted during the three months ended June 30, 2010 was $18.36 per share. The expected dividend yield is the average dividend rate during a period equal to the expected life of the option.

On June 4, 2010, the Board of Directors granted a total of 25,000 options under the Company’s 2005 Plan to selected employees at an exercise price equal to the market price of the Company’s Common Stock on the date of grant ($56.29 per share). The options vest in five equal annual installments beginning June 4, 2011 and expire on June 4, 2018.

On June 2, 2010, the Board of Directors granted a total of 15,000 options under the Company’s 2005 Plan to a selected employee at an exercise price equal to the market price of the Company’s Common Stock on the date of grant ($58.62 per share). The options vest in five equal annual installments beginning June 2, 2011 and expire on June 2, 2018.

Performance-Based Awards

On May 26, 2010, the Board of Directors approved its fiscal 2011 equity incentive program for certain employees to be awarded options to purchase the Company’s Common Stock. The maximum number of options available under the equity incentive program plan is 280,000, of which 115,000 are reserved for the Company’s Named Executive Officers and 165,000 for non-executive employees of the Company. Under the program, executives are eligible to receive options based on meeting certain target increases in earnings per share performance and revenue growth during fiscal year 2011. Under the program, the non-executive employees are eligible to receive options based on satisfying certain management established criteria and recommendations of senior management. The options shall be issued pursuant to one of the Company’s shareholder approved option plans, have an exercise price equal to the closing price of the Company’s shares on the date of grant, a term of eight years, and vesting in five equal annual installments commencing one year following the date of grant.

Compensation expense associated with the performance based awards are initially based on the number of options expected to vest after assessing the probability that certain performance criteria will be met. Cumulative adjustments are recorded quarterly to reflect subsequent changes in the estimated outcome of performance-related conditions. The Company utilized the Black-Scholes option valuation model and recorded stock compensation expense related to the performance based awards of approximately $18 during the quarter ended June 30, 2010.

The following assumptions were utilized for performance based awards under the Company’s 2011 incentive plan:

		Three Months
		Ended
		June 30, 2010
Expected life		4.2 years
Expected volatility			44.4	%
Expected dividends			2.1	%
Risk-free rate			1.8	%

Non-vested stock option award activity, including employee stock options and performance-based awards, for the three months ended June 30, 2010, is summarized as follows:

						Weighted-
		Non-Vested				Average
		Number of				Fair Value
		Shares				Price
Outstanding, April 1, 2010			610,836			$	15.26
Granted			40,000			$	18.36
Vested			(81,119	)		$	11.54
Forfeited/Canceled			(56,729	)		$	19.13
Outstanding, June 30, 2010			512,988			$	15.66

As of June 30, 2010, $6,276 of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted-average period of 5.54 years. This amount does not include the cost of new options that may be granted in future periods or any changes in the Company’s forfeiture percentage. The total fair value of options vested during the three months ended June 30, 2010 and 2009 was $936 and $645, respectively.

Restricted Stock Units

On May 27, 2009, the Board of Directors approved its Outside Director Compensation Plan, whereby each non-employee Director is to be awarded shares of Restricted Stock units upon election or re-election to the Board. The Restricted Stock units are awarded under the 2005 Plan. Such Restricted Stock units vest in two equal, annual installments on the first and second anniversaries of the grant date and are nontransferable for one year following vesting. Upon each vesting of the award, one share of Common Stock shall be issued for each Restricted Stock unit. The weighted-average grant date fair value of $54.57 for the Restricted Stock units was estimated using the market price of its Common Stock on the grant dates of August 13, 2009 and January 27, 2010. The fair value of these Restricted Stock units is amortized on a straight-line basis over the vesting period. As of June 30, 2010, 9,146 Restricted Stock units were issued and approximately $73 of compensation expense was recorded under this Plan during the quarter ended June 30, 2010.

As of June 30, 2010, $290 of total unrecognized compensation costs related to Restricted Stock units is expected to be recognized over a weighted-average period of 1.12 years. This amount does not include the cost of new Restricted Stock units that may be granted in future periods or any changes in the Company’s forfeiture percentage. During the quarter ended June 30, 2010, no Restricted Stock units vested.

10. Income Taxes

The provision for income taxes for the three months ended June 30, 2010 was approximately $6,989 as compared to approximately $6,112 for the year ago period. The effective tax rates for the three months ended June 30, 2010 and 2009 were 36.6% and 37.1%, respectively. The provision for income taxes for the three months ended June 30, 2010 differs from the combined statutory rates primarily due to the impact of varying state income tax rates, tax-exempt interest income, the qualified production activities deduction and state research and development tax credits. The effective rate for the three months ended June 30, 2010 decreased from the prior year primarily due to fluctuations in the state effective tax rate, increased benefits from the qualified production activities deduction, and the expiration of the federal research and development tax credit statute, which occurred at the end of the fourth quarter of fiscal year 2010 and therefore was not included in the current year first quarter provision.

Uncertain tax positions

As of June 30, 2010, the Company has provided a liability of $659 for unrecognized tax benefits related to various federal and state income tax matters. If recognized, $659 would impact the Company’s effective tax rate. The reserve for the three months ended June 30, 2010 increased from the year ago period by $592 due to the addition of prior year tax positions of acquired companies.

The Company’s income tax returns filed for tax years 2006 through 2008 and 2005 through 2008 are subject to examination by the federal and state taxing authorities, respectively. The Company is currently not under examination by the Internal Revenue Service or any state income tax authority. The Company does not anticipate that total unrecognized tax benefits will significantly change due to the settlement of audits or the expiration of statute of limitations within the next twelve months.

11. Earnings Per Share

Basic net income per share is based upon the weighted-average shares of Common Stock outstanding. Diluted net income per share is based on the assumption that the Company’s outstanding options are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase Common Stock at the average market price during the period. The following table reconciles the weighted-average shares outstanding for basic and diluted net income per share for the periods indicated (in thousands):

		Three Months Ended June 30,
		2010				2009
Net income		$	12,092			$	10,346
Basic net income per share:
Weighted-average shares outstanding — Basic			28,896				28,492
Basic net income per common share		$	0.42			$	0.36
Net income		$	12,092			$	10,346
Diluted net income per share:
Weighted-average shares outstanding — Basic			28,896				28,492
Effect of potentially dilutive securities			161				143
Weighted-average shares outstanding — Diluted			29,057				28,635
Diluted net income per common share		$	0.42			$	0.36

The computation of diluted net income per share does not include 253,000 and 244,000 options for the three months ended June 30, 2010 and 2009, respectively, because their inclusion would have an anti-dilutive effect on net income per share.

12. Operating Segment Information

The Company has prepared operating segment information in accordance with ASC 280 to report components that are evaluated regularly by its chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.

As a result of certain organizational changes during fiscal year 2010, the composition of the Company’s NextGen Division was revised to exclude the former NextGen Practice Solutions unit and the Company’s RCM entities (HSI and PMP), both of which are now administered and aggregated in the Company’s Practice Solutions Division. Following the reorganization, the Company operates three reportable operating segments (not including Corporate), comprised of the NextGen Division, the QSI Dental Division and the Practice Solutions Division.

Prior period segment results were revised to reflect this reorganization for the Company’s NextGen Division and Practice Solution Division. The results of operations related to the HSI and PMP acquisitions are included in the Practice Solutions Division. The results of operations related to the Opus and Sphere acquisitions are included in the NextGen Division.

The QSI Dental Division, co-located with the Company’s Corporate Headquarters in Irvine, California, currently focuses on developing, marketing and supporting software suites sold to dental and certain niche medical practices. In addition, the Division supports a number of medical clients that utilize the Division’s UNIX^® based medical practice management software product.

The NextGen Division, with headquarters in Horsham, Pennsylvania, and significant locations in Atlanta, Georgia and Austin, Texas, focuses principally on developing and marketing products and services for medical practices.

The Practice Solutions Division, with locations in St. Louis, Missouri and Hunt Valley, Maryland, focuses primarily on providing physician practices with RCM services, primarily billing and collection services for medical practices. This Division combines a web-delivered SaaS model and the NextGen^epm software platform to execute its service offerings.

The three Divisions operate largely as stand-alone operations, with each Division maintaining its own distinct product lines, product platforms, development, implementation and support teams, sales staffing and branding. The three Divisions share the resources of the Company’s “corporate office” which includes a variety of accounting and other administrative functions. Additionally, there are a small but growing number of clients who are simultaneously utilizing software or services from more than one of its three Divisions.

The accounting policies of the Company’s operating segments are the same as those described in Note 2 of our Notes to Consolidated Financial Statements, “Summary of Significant Accounting Policies,” except that the disaggregated financial results of the segments reflect allocation of certain functional expense categories consistent with the basis and manner in which Company management internally disaggregates financial information for the purpose of assisting in making internal operating decisions. Certain corporate overhead costs, such as executive and accounting department personnel-related expenses, are not allocated to the individual segments by management. Management evaluates performance based on stand-alone segment operating income. Because the Company does not evaluate performance based on return on assets at the operating segment level, assets are not tracked internally by segment. Therefore, segment asset information is not presented.

Operating segment data is as follows:

		Three Months Ended June 30,
		2010				2009
Revenue:
QSI Dental Division		$	5,352			$	3,856
NextGen Division			65,830				52,430
Practice Solutions Division			11,745				10,352
Consolidated revenue		$	82,927			$	66,638
Operating income:
QSI Dental Division		$	1,591			$	664
NextGen Division			22,789				19,094
Practice Solutions Division			187				285
Unallocated corporate expense			(5,540	)			(3,721	)
Consolidated operating income		$	19,027			$	16,322

All of the recorded goodwill at June 30, 2010 relates to the Company’s NextGen Division and Practice Solutions Division. As a result of the reorganization discussed above, the goodwill relating to the fiscal year 2009 acquisitions of HSI and PMP is now recorded in the Practice Solutions Division. The goodwill relating to the acquisitions of Opus and Sphere is recorded in the NextGen Division.

13. Concentration of Credit Risk

The Company had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at June 30, 2010. The Company is exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the institutions; however, the Company does not anticipate non-performance by these institutions.

14. Commitments, Guarantees and Contingencies

Commitments and Guarantees

Software license agreements in both the QSI and NextGen Divisions include a performance guarantee that the Company’s software products will substantially operate as described in the applicable program documentation for a period of 365 days after delivery. To date, the Company has not incurred any significant costs associated with its performance guarantee or other related warranties and does not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties. Certain arrangements also include performance guarantees related to response time, availability for operational use, and other performance-related guarantees. Certain arrangements also include penalties in the form of maintenance credits should the performance of the software fail to meet the performance guarantees. To date, the Company has not incurred any significant costs associated with these warranties and does not expect to incur significant warranty costs in the future. Therefore, no accrual has been made for potential costs associated with these warranties.

The Company has historically offered short-term rights of return in certain sales arrangements. If the Company is able to estimate returns for these types of arrangements and all other criteria for revenue recognition have been met, revenue is recognized and these arrangements are recorded in the consolidated financial statements. If the Company is unable to estimate returns for these types of arrangements, revenue is not recognized in the consolidated financial statements until the rights of return expire, provided also, that all other criteria of revenue recognition have been met.

The Company’s standard sales agreements in the NextGen Division contain an indemnification provision pursuant to which it shall indemnify, hold harmless, and reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with any United States patent, any copyright or other intellectual property infringement claim by any third party with respect to its software. The QSI Dental Division arrangements occasionally utilize this type of language as well. As the Company has not incurred any significant costs to defend lawsuits or settle claims related to these indemnification agreements, the Company believes that its estimated exposure on these agreements is currently minimal. Accordingly, the Company has no liabilities recorded for these indemnification obligations.

The Company has entered into marketing assistance agreements with existing users of the Company’s products which provide the opportunity for those users to earn commissions if they host specific site visits upon the Company’s request for prospective customers that

directly result in a purchase of the Company’s software by the visiting prospects. Amounts earned by existing users under this program are treated as a selling expense in the period when earned.

Litigation

The Company has experienced legal claims by parties asserting that it has infringed their intellectual property rights. The Company believes that these claims are without merit and intends to defend against them vigorously; however, the Company could incur substantial costs and diversion of management resources defending any infringement claim — even if it is ultimately successful in the defense of such matter. Litigation is inherently uncertain and always difficult to predict. The Company refers you to the discussion of infringement and litigation risks in the Risk Factors section of the Company’s Annual Report on Form 10-K.

15. Subsequent Events

On July 28, 2010, the Board of Directors approved a quarterly cash dividend of $0.30 per share on the Company’s outstanding shares of Common Stock, payable to shareholders of record as of September 17, 2010 with an expected distribution date on or about October 5, 2010.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, the matters discussed in this management’s discussion and analysis of financial condition and results of operations, or MD&A, including discussions of our product development plans, business strategies and market factors influencing our results, may include forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could affect our ability to achieve our goals, and interested persons are urged to review any risks that may be described in “Item 1A. Risk Factors” as set forth herein and other risk factors appearing in our most recent filing on our Annual Report on Form 10-K, as supplemented by additional risk factors, if any, in our interim filings on our Quarterly Report on Form 10-Q, as well as in our other public disclosures and filings with the Securities and Exchange Commission.

This MD&A is provided as a supplement to the consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q, in order to enhance your understanding of our results of operations and financial condition and the following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Historical results of operations, percentage margin fluctuations and any trends that may be inferred from the discussion below are not necessarily indicative of the operating results for any future period.

Our MD&A is organized as follows:

	•		Management Overview. This section provides a general description of our Company and operating segments, a discussion as to how we derive our revenue, background information on certain trends and developments affecting our Company, a summary of our acquisition transactions and a discussion on management’s strategy for driving revenue growth.
	•		Critical Accounting Policies and Estimates. This section discusses those accounting policies that are considered important to the evaluation and reporting of our financial condition and results of operations, and whose application requires us to exercise subjective or complex judgments in making estimates and assumptions. In addition, all of our significant accounting policies, including our critical accounting policies, are summarized in Note 2 of our Notes to Consolidated Financial Statements, “Summary of Significant Accounting Policies,” included in this Quarterly Report on Form 10-Q.
	•		Company Overview. This section provides a more detailed description of our Company, operating segments, products and services offered.
	•		Overview of Results of Operations and Results of Operations by Operating Divisions. These sections provide our analysis and outlook for the significant line items on our consolidated statements of income, as well as other information that we deem meaningful to understand our results of operations on both a consolidated basis and an operating division basis.
	•		Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows.
	•		New Accounting Pronouncements. This section provides a summary of the most recent authoritative accounting standards and guidance that have either been recently adopted by our Company or may be adopted in the future.

Management Overview

Quality Systems, Inc., including its wholly-owned subsidiaries, is comprised of the QSI Dental Division; the NextGen Division, which consists of NextGen Healthcare Information Systems, Inc. (“NextGen”), NextGen Sphere, LLC (“Sphere”) and Opus Healthcare Solutions, Inc. (“Opus”); and the Practice Solutions Division, which consists of Lackland Acquisition II, LLC dba Healthcare Strategic Initiatives (“HSI”) and Practice Management Partners, Inc. (“PMP”) (collectively, the “Company”, “we”, “our”, or “us”). The Company develops and markets healthcare information systems that automate certain aspects of medical and dental practices, networks of practices such as physician hospital organizations (“PHOs”) and management service organizations (“MSOs”), ambulatory care centers, community health centers, and medical and dental schools. The Company also provides revenue cycle management (“RCM”) services through the Practice Solutions Division.

The turbulence in the worldwide economy has impacted almost all industries. While healthcare is not immune to economic cycles, we believe it is more resilient than most segments of the economy. The impact of the current economic conditions on our existing and prospective clients has been mixed. We continue to see organizations that are doing fairly well operationally; however, some organizations with a large dependency on Medicaid populations are being impacted by the challenging financial condition of the many state governments in whose jurisdictions they conduct business. A positive factor for U.S. healthcare is the fact that the Obama Administration is pursuing broad healthcare reform aimed at improving issues surrounding healthcare. The American Recovery and Reinvestment Act (“ARRA”), which became law on February 17, 2009, includes more than $20 billion to help healthcare organizations modernize operations through the acquisition of health care information technology. While we are unsure of the immediate impact from the ARRA, the long-term potential could be significant.

On May 20, 2008, we acquired HSI, a full-service healthcare RCM company. HSI operates under the umbrella of the Company’s Practice Solutions Division. Founded in 1996, HSI provides RCM services to providers including health systems, hospitals, and physicians in private practice with an in-house team of more than 200 employees, including specialists in medical billing, coding and compliance, payor credentialing, and information technology.

On October 28, 2008, we acquired PMP, a full-service healthcare RCM company. This acquisition is also part of our growth strategy for our Practice Solutions Division. Similar to HSI, PMP operates under the umbrella of the Company’s Practice Solutions Division. Founded in 2001, PMP provides physician billing and technology management services to healthcare providers, primarily in the Mid-Atlantic region.

On August 12, 2009, we acquired Sphere, a provider of financial information systems to the small hospital inpatient market. This acquisition is also part of our strategy to expand into the small hospital market and to add new customers by taking advantage of cross selling opportunities between the ambulatory and inpatient markets.

On February 10, 2010, we acquired Opus, a provider of clinical information systems to the small hospital inpatient market. Founded in 1987 and headquartered in Austin, Texas, Opus delivers web-based clinical solutions to hospital systems and integrated health networks nationwide. This acquisition complements and will be integrated with the assets of Sphere. Both companies are established developers of software and services for the inpatient market and will operate under the Company’s NextGen Division.

Our strategy is, at present, to focus on providing software and services to medical and dental practices. The key elements of this strategy are to continue development and enhancement of select software solutions in target markets, to continue investments in our infrastructure including but not limited to product development, sales, marketing, implementation, and support, to continue efforts to make infrastructure investments within an overall context of maintaining reasonable expense discipline, to add new customers through maintaining and expanding sales, marketing and product development activities, and to expand our relationship with existing customers through delivery of add-on and complementary products and services and to continue our gold standard commitment of service in support of our customers.

Critical Accounting Policies and Estimates

The discussion and analysis of our consolidated financial statements and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate estimates, including but not limited to those related to revenue recognition, valuation of marketable securities, ARS put option rights, uncollectible accounts receivable, software development cost, intangible assets and self-insurance accruals, for reasonableness. We base our estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We describe our significant accounting policies in Note 2, “Summary of Significant Accounting Policies,” of our Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010. We discuss our critical accounting policies and estimates in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010. There have been no material changes in our significant accounting policies or critical accounting policies and estimates since the end of fiscal year 2010.

Company Overview

The Company is comprised of the QSI Dental Division, the NextGen Division, and the Practice Solutions Division. Operationally, HSI and PMP are considered and administered as part of the Practice Solutions Division while Opus and Sphere operate under the NextGen Division. We primarily derive revenue by developing and marketing healthcare information systems that automate certain aspects of medical and dental practices, networks of practices such as PHOs and MSOs, ambulatory care centers, community health centers, and medical and dental schools along with comprehensive systems implementation, maintenance and support and add on complementary services such as RCM and EDI. Our systems and services provide our clients with the ability to redesign patient care and other workflow processes while improving productivity through facilitation of managed access to patient information. Utilizing our proprietary software in combination with third party hardware and software solutions, our products enable the integration of a variety of administrative and clinical information operations.

The Company, a California corporation formed in 1974, was founded with an early focus on providing information systems to dental group practices. In the mid-1980’s, we capitalized on the increasing focus on medical cost containment and further expanded our information processing systems to serve the medical market. In the mid-1990’s, we made two acquisitions that accelerated our penetration of the medical market. These two acquisitions formed the basis for the NextGen Division. Today, we serve the medical and dental markets through our NextGen Division and QSI Dental Division.

Historically, the Company has operated principally through two operating divisions: QSI Dental Division and NextGen Division. Through our acquisitions of HSI and PMP in 2008, we continued to strengthen our RCM service offerings. During fiscal year 2010, as a result of certain organizational changes, the composition of the Company’s NextGen Division was revised to exclude the former NextGen Practice Solutions unit and the Company’s RCM entities (HSI and PMP), both of which are now administered and aggregated in the Company’s Practice Solutions Division. Following the reorganization, the Company now operates three reportable operating segments (not including Corporate), comprised of the NextGen Division, the QSI Dental Division and the Practice Solutions Division. As a result, our results for the quarter ended June 30, 2009 have been re-casted to reflect this change.

The following table breaks down our reported segment revenue and segment revenue growth by division for the three months ended June 30, 2010 and 2009:

		Segment Revenue Breakdown								Segment Revenue Growth
		For the Three Months Ended June 30,								For the Three Months Ended June 30,
		2010				2009				2010				2009
QSI Dental Division			6.5	%			5.8	%			38.8	%			(5.2	)%
NextGen Division			79.3	%			78.7	%			25.6	%			2.5	%
Practice Solutions Division			14.2	%			15.5	%			13.5	%			N/A
Consolidated			100.0	%			100.0	%			24.4	%			20.7	%

The QSI Dental Division, co-located with our Corporate Headquarters in Irvine, California, currently focuses on developing, marketing and supporting software suites sold to dental and certain niche medical practices. In addition, the Division supports a number of medical clients that utilize its UNIX^® based medical practice management software product and Software as a Service, or SaaS model, based NextDDS financial and clinical software.

The QSI Dental Division’s practice management software suite utilizes a UNIX^® operating system. Its Clinical Product Suite (“CPS”) utilizes a Windows NT^® operating system and can be fully integrated with the practice management software from each Division. CPS incorporates a wide range of clinical tools including, but not limited to, periodontal charting and digital imaging of X-ray and inter-oral camera images as part of the electronic patient record. The Division develops, markets, and manages our EDI/connectivity applications. The QSInet Application Service Provider (“ASP/Internet”) offering is also developed and marketed by the Division.

In July 2009, we licensed source code from PlanetDDS, Inc. that will allow us to deliver hosted, web-based SaaS model practice management and clinical software solutions to the dental industry. The software solution will be marketed primarily to the multi-location dental group practice market in which the Division has historically been a dominant player. This new software solution (NextDDS) brings the QSI Dental Division to the forefront of the emergence of internet based applications and cloud computing and represents a significant growth opportunity for the Division to sell both to its existing customer base as well as new customers.

The NextGen Division, with headquarters in Horsham, Pennsylvania, and significant locations in Atlanta, Georgia and Austin, Texas, provides integrated clinical, financial and connectivity solutions for ambulatory, inpatient and dental provider organizations.

The NextGen Division develops and sells proprietary electronic medical records software and practice management systems under the NextGen product name. Major product categories of the NextGen suite include Electronic Health Records (“NextGen^ehr”), Enterprise Practice Management (“NextGen^epm”), Enterprise Appointment Scheduling (“NextGen^eas”), Enterprise Master Patient Index (“NextGen^epi”), NextGen Image Control System (“NextGen^ics”), Managed Care Server (“NextGen^mcs”), Electronic Data Interchange, System Interfaces, Internet Operability (“NextGen^web”), a Patient-centric and Provider-centric Web Portal solution (“NextMD.com”), NextGen Express, a scaled-down version of NextGen^ehr designed for small practices and NextGen Community Health Solution (“NextGen^chs”). The NextGen Division also offers optional NextGen Hosting Solutions to new and existing customers. NextGen products utilize Microsoft Windows technology and can operate in a client-server environment as well as via private intranet, the Internet, or in an ASP environment.

The Practice Solutions Division, with locations in St. Louis, Missouri and Hunt Valley, Maryland, focuses primarily on providing physician practices with RCM services, primarily billing and collection services for medical practices. This Division combines a web-delivered SaaS model and the NextGen^epm software platform to execute its service offerings. We intend to transition our customer base onto the NextGen platform within the next two years. The Practice Solutions Division provides technology solutions and consulting services to cover the full spectrum of providers’ revenue cycle needs from patient access to claims denials.

The three Divisions operate largely as stand-alone operations, with each Division maintaining its own distinct product lines, product platforms, development, implementation and support teams, sales staffing and branding. The three Divisions share the resources of our “corporate office,” which includes a variety of accounting and other administrative functions. Additionally, there are a small but growing number of clients who are simultaneously utilizing software or services from more than one of our three Divisions.

The Divisions develop and market practice management software that is designed to automate and streamline a number of the administrative functions required for operating a medical or dental practice. Examples of practice management software functions include scheduling and billing capabilities. It is important to note that in both the medical and dental environments, practice management software systems have already been implemented by the vast majority of practices. Therefore, we actively compete for the replacement market.

In addition, the Divisions develop and market software that automates the patient record. Adoption rates for this software, commonly referred to as clinical software, are relatively low. Therefore, we are typically competing to replace paper-based patient record alternatives as opposed to replacing previously purchased systems.

We make available EDI capabilities and connectivity services to our customers. The EDI/connectivity capabilities encompass direct interfaces between our products and external third party systems, as well as transaction-based services. EDI products are intended to automate a number of manual, often paper-based or telephony intensive communications between patients and/or providers and/or payors. Two of the more common EDI services are forwarding insurance claims electronically from providers to payors and assisting practices with issuing statements to patients. Most client practices utilize at least some of these services from us or one of our competitors. Other EDI/connectivity services are used more sporadically by client practices. We typically compete to displace incumbent vendors for claims and statements accounts and attempt to increase usage of other elements in our EDI/connectivity product line. In general, EDI services are only sold to those accounts utilizing software from either the QSI Dental or NextGen Divisions.

We continue to pursue product and service enhancement initiatives within each Division. The majority of such expenditures are currently targeted to the NextGen Division product line and client base.

Overview of Our Results

•		Consolidated revenue increased 24.4% and income from operations grew by 16.6% in the three months ended June 30, 2010 versus the same period in 2009. For the three months ended June 30, 2010, revenue was positively impacted by growth in recurring revenue, including maintenance, EDI and RCM revenue, which grew 18.0%, 19.6% and 19.8%, respectively, offset by higher corporate expenses.
•		Income from operations was negatively impacted by a shift in revenue mix with an increased share of hardware, EDI, and RCM revenue, resulting in a decline in our gross profit margin. We also experienced higher selling, general and administrative expenses primarily due to higher selling related expenses incurred in preparation for the ARRA, which was enacted in February 2009, as well as higher corporate related expenses.
•		We do not believe the revenue mix changes noted above represent a change in the overall purchasing environment. On top of the potential benefits from the ARRA, we have benefited and hope to continue to benefit from the increased demands on healthcare providers for greater efficiency and lower costs, as well as increased adoption rates for electronic medical records and other technology in the healthcare arena.
•		While we expect to benefit from the increasing demands for greater efficiency as well as government support for increased adoption of electronic health records, the current economic environment, combined with unpredictability of the federal government’s plans to promote increased adoption of electronic medical records, makes the near term achievement of such benefits and, ultimately, their impact on system sales, uncertain.

NextGen Division

•		NextGen Division revenue increased 25.6% in the three months ended June 30, 2010 and divisional operating income (excluding unallocated corporate expenses) increased 19.4% as compared to the prior year period. Organic revenue growth in the NextGen Division was 18.9% for the three months ended June 30, 2010.
•		The acquisitions of Opus and Sphere in fiscal year 2010 added approximately $3.2 million in revenue for the three months ended June 30, 2010 as compared to the same period a year ago.
•		Recurring revenue, consisting of maintenance and EDI revenue increased 20.1% to $32.2 million from $26.8 million in the same period a year ago and accounted for 48.9% of total NextGen Division revenue during the three months ended June 30, 2010. In the same period a year ago, recurring revenue represented 51.1% of total divisional revenue.
•		During the three months ended June 30, 2010, we added staffing resources in anticipation of future growth from the ARRA. We intend to continue doing so in future periods to maximize our opportunities from the ARRA.
•		Our goals include taking maximum advantage of future benefits related to the ARRA and continuing to further enhance and expand the marketing and sales of our existing products, developing new products for targeted markets, continuing to add new customers, selling additional software and services to existing customers, expanding penetration of connectivity and other services to new and existing customers, and capitalizing on growth and cross selling opportunities within the Practice Solutions Division and the recently acquired acute care software product lines.

QSI Dental Division

•		QSI Dental Division revenue increased 38.8% in the three months ended June 30, 2010 and divisional operating income (excluding unallocated corporate expenses) increased $1.5 million, or 139.6%, from the three months ended June 30, 2009.
•		An increase in system sales revenue was the chief contributor to the operating income results in the quarter.
•		In July 2009, we licensed source code from PlanetDDS, Inc. that will allow us to deliver hosted, web-based SaaS practice management and clinical software solutions to the dental industry. The software solution will be marketed primarily to the multi-location dental group practice market in which the QSI Dental Division has historically been a dominant player. This new software solution (NextDDS) brings the QSI Dental Division to the forefront of the emergence of internet based applications and cloud computing and represents a significant growth opportunity for us to sell both to our existing customer base as well as new customers.
•		Our goal for the QSI Dental Division is to maximize profit performance given the constraints represented by a relatively weak purchasing environment in the dental group practice market while taking advantage of opportunities with the new NextDDS product. The QSI Dental Division also intends to leverage the NextGen Division’s sales force to sell its dental electronic medical records software to practices that provide both medical and dental services such as Federal Qualified Health Centers, which are receiving grants as part of the ARRA.

Practice Solutions Division

•		Practice Solutions Division revenue increased 13.4% in the three months ended June 30, 2010 and divisional operating income (excluding unallocated corporate expenses) decreased 34.4% from the three months ended June 30, 2009. The Practice Solutions Division also benefited from organic growth achieved through cross selling RCM services to existing NextGen Division customers.
•		Operating income as a percentage of revenue declined to approximately 1.6% of revenue versus 2.8% of revenue primarily as a result of a smaller amount of software sales to RCM customers compared to the prior year as well as costs related to transitioning to the NextGen platform including training of staff and initial set up and other costs related to achieving higher production volumes.

The following table sets forth for the periods indicated the percentage of net revenue represented by each item in our consolidated statements of income (certain percentages below may not sum due to rounding):

		Three Months Ended June 30,
(Unaudited)		2010				2009
Revenues:
Software, hardware and supplies			29.9	%			26.7	%
Implementation and training services			5.2				5.2
System sales			35.0				31.9
Maintenance			30.8				32.5
Electronic data interchange services			11.8				12.2
Revenue cycle management and related services			13.0				13.5
Other services			9.4				9.9
Maintenance, EDI, RCM and other services			65.0				68.1
Total revenues			100.0				100.0
Cost of revenue:
Software, hardware and supplies			7.5				4.1
Implementation and training services			3.6				4.3
Total cost of system sales			11.1				8.4
Maintenance			4.2				4.5
Electronic data interchange services			8.1				8.8
Revenue cycle management and related services			9.8				9.8
Other services			5.2				7.3
Total cost of maintenance, EDI, RCM and other services			27.3				30.4
Total cost of revenue			38.4				38.8
Gross profit			61.6				61.2
Operating expenses:
Selling, general and administrative			31.6				30.2
Research and development costs			6.6				6.0
Amortization of acquired intangible assets			0.4				0.5
Total operating expenses			38.6				36.7
Income from operations			22.9				24.5
Interest income			0.1				0.1
Other income (expense)			0.0				0.1
Income before provision for income taxes			23.0				24.7
Provision for income taxes			8.4				9.2
Net income			14.6	%			15.5	%

Comparison of the Three Months Ended June 30, 2010 and June 30, 2009

Net Income. The Company’s net income for the three months ended June 30, 2010 was $12.1 million or $0.42 per share on a basic and fully diluted basis. In comparison, we earned $10.3 million or $0.36 per share on a basic and fully diluted basis for the three months ended June 30, 2009. The increase in net income for the three months ended June 30, 2010 was achieved primarily through the following:

•		a 24.4% increase in consolidated revenue, including an increase of $13.4 million in revenue from our NextGen Division, an increase of $1.5 million from our QSI Dental Division, and an increase of $1.4 million in revenue from our Practice Solutions Division;
•		a 25.6% increase in NextGen Division revenue, which accounted for 79.4% of consolidated revenue;
•		an increase of recurring revenue, including RCM, maintenance, and EDI revenue, offset by a decline in our gross profit margin due primarily to both a shift in revenue mix with increased hardware and RCM revenue, and
•		an increase in selling, general and administrative expenses as a percentage of revenue related to higher selling and corporate expenses.

Revenue. Revenue for the three months ended June 30, 2010 increased 24.4% to $82.9 million from $66.6 million for the three months ended June 30, 2009. NextGen Division revenue increased 25.6% to $65.8 million from $52.4 million in the three months ended June 30, 2009 while QSI Dental Division revenue increased 38.8% during that same period to $5.4 million from $3.9 million and Practice Solutions Division revenue increased 13.4% during that same period to $11.7 million from $10.4 million.

System Sales. Revenue earned from Company-wide sales of systems for the three months ended June 30, 2010 increased 36.9% to $29.1 million from $21.2 million in the prior year period.

Our increase in revenue from sales of systems was principally the result of a 32.5% increase in category revenue at our NextGen Division whose sales in this category increased from $20.3 million during the three months ended June 30, 2009 to $26.9 million during the three months ended June 30, 2010. This increase was driven by higher sales of ambulatory practice management and health records software to both new and existing clients, as well as increases in revenue related to implementation and training services.

The following table breaks down our reported system sales into software, hardware, third party software, supplies, and implementation and training services components by division (in thousands):

						Hardware, Third				Implementation
						Party Software				and Training				Total System
		Software				and Supplies				Services				Sales
Three months ended June 30, 2010
QSI Dental Division		$	874			$	883			$	236			$	1,993
NextGen Division			19,610				3,236				4,020				26,866
Practice Solutions Division			153				—				52				205
Consolidated		$	20,637			$	4,119			$	4,308			$	29,064
Three months ended June 30, 2009
QSI Dental Division		$	182			$	253			$	209			$	644
NextGen Division			15,987				1,096				3,193				20,276
Practice Solutions Division			258				—				55				313
Consolidated		$	16,427			$	1,349			$	3,457			$	21,233

NextGen Division software license revenue increased 22.7% in the three months ended June 30, 2010 versus the same period last year. The Division’s software revenue accounted for 73.0% of divisional system sales revenue during the three months ended June 30, 2010, compared to 78.8% during the same period a year ago. Software license revenue growth continues to be an area of primary emphasis for the NextGen Division. The Opus acquisition contributed approximately $0.9 million to the NextGen Division’s software license revenue during the three months ended June 30, 2010.

During the three months ended June 30, 2010, 12.0% of NextGen Division’s system sales revenue was represented by hardware and third party software compared to 5.4% during same period a year ago. The increase in hardware and third party software revenue was a result of previously backordered hardware that was shipped during the quarter ended June 30, 2010. The number of customers who purchase hardware and third party software and the dollar amount of hardware and third party software revenue fluctuates each quarter depending on the needs of customers. The inclusion of hardware and third party software in the Division’s sales arrangements is typically at the request of our customers.

Implementation and training revenue related to system sales at the NextGen Division increased 25.9% in the three months ended June 30, 2010 compared the prior year period. The amount of implementation and training services revenue is dependent on several factors, including timing of customer implementations, the availability of qualified staff, and the mix of services being rendered. The number of implementation and training staff increased during the three months ended June 30, 2010 versus 2009 in order to accommodate the increased amount of implementation services sold in conjunction with increased software sales. In order to achieve growth in this area, additional staffing increases and additional training facilities are anticipated, though actual future increases in revenue and staff will depend upon the availability of qualified staff, business mix and conditions, and our ability to retain current staff members.

The NextGen Division’s growth has come in part from investments in sales and marketing activities including a revamped NextGen.com Web site, new NextGen logo, new marketing campaigns, trade show attendance, and other expanded advertising and marketing expenditures. We have also benefited from winning numerous industry awards for the NextGen Division’s flagship NextGen^ehr and NextGen^epm software products and the increasing acceptance of electronic medical records technology in the healthcare industry.

For the QSI Dental Division, total system sales increased $1.4 million, or 209.5%, to $2.0 million in the three months ended June 30, 2010 as compared to $0.6 million the prior year period. Systems sales in the QSI Dental Division were positively impacted by greater joint sales of dental and medical software to Federally Qualified Health Centers. In addition, the Division began selling the SaaS based NextDDS product during fiscal year 2010.

For the Practice Solutions Division, total system sales decreased by 34.5% in the three months ended June 30, 2010 as compared to the prior year period. Systems sales revenue within the Practice Solutions Division is composed of sales to existing RCM customers only.

Maintenance, EDI, RCM and Other Services. For the three months ended June 30, 2010, Company-wide revenue from maintenance, EDI, RCM and other services grew 18.6% to $53.9 million from $45.4 million in the prior year period. The increase in this category resulted primarily from an increase in maintenance, EDI and other services revenue from the NextGen Division and RCM revenue from the Practice Solutions Division. Total NextGen Division maintenance revenue for the three months ended June 30, 2010 grew 19.2% to $23.7 million from $19.9 million in the same prior year period while EDI revenue grew 22.7% to $8.5 million compared to $7.0 million during the same prior year period. Other services revenue for the NextGen Division for the three months ended June 30, 2010, which consists primarily of third party annual software license renewals, and hosting services increased 26.6% to $6.8 million from $5.3 million in the same prior year period, primarily due to increases in third party annual software licenses, consulting services and hosting services revenue.

QSI Dental Division maintenance, EDI and other revenue remained fairly consistent at $3.4 million in the three months ended June 30, 2010 as compared to $3.2 million in the three months ended June 30, 2009. For the three months ended June 30, 2010, RCM revenue grew $1.8 million to $10.8 million compared to $9.0 million in the prior year period.

The following table details maintenance, EDI, RCM, and other services revenue by category for the three months ended June 30, 2010 and 2009 (in thousands):

		Maintenance				EDI				RCM				Other				Total
Three months ended June 30, 2010
QSI Dental Division		$	1,837			$	1,224			$	—			$	298			$	3,359
NextGen Division			23,661				8,540				—				6,763				38,964
Practice Solutions Division			38				—				10,772				730				11,540
Consolidated		$	25,536			$	9,764			$	10,772			$	7,791			$	53,863
Three months ended June 30, 2009
QSI Dental Division		$	1,781			$	1,203			$	—			$	228			$	3,212
NextGen Division			19,856				6,958				—				5,340				32,154
Practice Solutions Division			3				—				8,992				1,044				10,039
Consolidated		$	21,640			$	8,161			$	8,992			$	6,612			$	45,405

The growth in maintenance revenue for the NextGen Division has come from new customers that have been added each quarter, existing customers who have purchased additional licenses, and our relative success in retaining existing maintenance customers. NextGen’s EDI revenue growth has come from new customers and from further penetration of the Division’s existing customer base. The growth in RCM revenue has come from new customers that have been acquired from cross selling opportunities with the NextGen customer base. We intend to continue to promote maintenance, EDI and RCM services to both new and existing customers.

Cost of Revenue. Cost of revenue for the three months ended June 30, 2010 increased 23.1% to $31.9 million from $25.9 million in the three months ended June 30, 2009 and the cost of revenue as a percentage of revenue decreased slightly to 38.4% from 38.9% due to the fact that the rate of growth in cost of revenue grew slower than the aggregate revenue growth rate for the Company.

The following table details revenue and cost of revenue on a consolidated and divisional basis for the three months ended June 30, 2010 and 2009 (in thousands):

		Three Months Ended June 30,
		2010				%				2009				%
QSI Dental Division
Revenue		$	5,352				100.0	%		$	3,856				100.0	%
Cost of revenue			2,392				44.7	%			1,791				46.4	%
Gross profit		$	2,960				55.3	%		$	2,065				53.6	%
NextGen Division
Revenue		$	65,830				100.0	%		$	52,430				100.0	%
Cost of revenue			21,064				32.0	%			16,604				31.7	%
Gross profit		$	44,766				68.0	%		$	35,826				68.3	%
Practice Solutions Division
Revenue		$	11,745				100.0	%		$	10,352				100.0	%
Cost of revenue			8,403				71.5	%			7,494				72.4	%
Gross profit		$	3,342				28.5	%		$	2,858				27.6	%
Consolidated
Revenue		$	82,927				100.0	%		$	66,638				100.0	%
Cost of revenue			31,859				38.4	%			25,889				38.9	%
Gross profit		$	51,068				61.6	%		$	40,749				61.1	%