NEXTGEN HEALTHCARE, INC. - Quarter Report: 2011 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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 (State or other jurisdiction of incorporation or organization)		95-2888568 (IRS Employer Identification No.)
18111 Von Karman Avenue, Suite 700, Irvine, California		92612
(Address of principal executive offices)		(Zip Code)

(949) 255-2600
(Registrant’s telephone number, including area 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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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.

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Small reporting company o
				(Do not check if a smaller reporting company)

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

The number of outstanding shares of the Registrant’s common stock as of July 29, 2011 was 29,296,390 shares.

 

 

QUALITY SYSTEMS, INC.

TABLE OF CONTENTS
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

Item		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2011 and March 31, 2011 (unaudited)			3
Consolidated Statements of Income for the three months ended June 30, 2011 and 2010 (unaudited)			4
Consolidated Statements of Cash Flows for the three months ended June 30, 2011 and 2010 (unaudited)			5
Notes to Consolidated Financial Statements (unaudited)			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3. Quantitative and Qualitative Disclosures about Market Risks			42
Item 4. Controls and Procedures			42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			43
Item 1A. Risk Factors			43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			43
Item 3. Defaults Upon Senior Securities			43
Item 4. (Removed and Reserved)			43
Item 5. Other Information			43
Item 6. Exhibits			44
Signatures			45
EX-10.1
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
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

QUALITY SYSTEMS, INC.

(In thousands, except per share data)

(unaudited)

		June 30,				March 31,
		2011				2011
ASSETS
Current assets:
Cash and cash equivalents		$	124,054			$	116,617
Restricted cash			4,487				3,787
Marketable securities			1,110				1,120
Accounts receivable, net			148,907				139,772
Inventories			2,145				1,933
Deferred income taxes, net			10,397				10,397
Other current assets			8,232				8,768
Total current assets			299,332				282,394
Equipment and improvements, net			13,778				12,599
Capitalized software costs, net			15,738				15,150
Intangibles, net			17,919				16,890
Goodwill			48,624				46,721
Other assets			4,892				4,932
Total assets		$	400,283			$	378,686
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	6,145			$	6,686
Deferred revenue			80,027				76,695
Accrued compensation and related benefits			9,901				10,247
Income taxes payable			7,889				3,530
Dividends payable			10,229				10,162
Other current liabilities			17,368				29,316
Total current liabilities			131,559				136,636
Deferred revenue, net of current			1,106				1,099
Deferred income taxes, net			11,384				11,384
Deferred compensation			2,784				2,488
Other noncurrent liabilities			2,918				2,409
Total liabilities			149,751				154,016
Commitments and contingencies (Note 12)
Shareholders’ equity:
Common stock
$0.01 par value; authorized 50,000 shares; issued and outstanding 29,264 and 29,034 shares at June 30, 2011 and March 31, 2011, respectively			292				290
Additional paid-in capital			150,363				133,259
Retained earnings			99,877				91,121
Total shareholders’ equity			250,532				224,670
Total liabilities and shareholders’ equity		$	400,283			$	378,686

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

QUALITY SYSTEMS, INC.

(In thousands, except per share data)

(unaudited)

		Three Months Ended June 30,
		2011				2010
Revenues:
Software, hardware and supplies		$	28,911			$	24,756
Implementation and training services			5,472				4,308
System sales			34,383				29,064
Maintenance			31,502				25,536
Electronic data interchange services			12,092				9,764
Revenue cycle management and related services			11,881				10,772
Other services			10,584				7,791
Maintenance, EDI, RCM and other services			66,059				53,863
Total revenues			100,442				82,927
Cost of revenue:
Software, hardware and supplies			4,614				6,212
Implementation and training services			4,075				2,990
Total cost of system sales			8,689				9,202
Maintenance			3,854				3,454
Electronic data interchange services			7,962				6,709
Revenue cycle management and related services			8,826				8,145
Other services			5,597				4,349
Total cost of maintenance, EDI, RCM and other services			26,239				22,657
Total cost of revenue			34,928				31,859
Gross profit			65,514				51,068
Operating expenses:
Selling, general and administrative			29,386				26,238
Research and development costs			6,827				5,456
Amortization of acquired intangible assets			482				347
Total operating expenses			36,695				32,041
Income from operations			28,819				19,027
Interest income			82				60
Other expense, net			(38	)			(6	)
Income before provision for income taxes			28,863				19,081
Provision for income taxes			9,880				6,989
Net income		$	18,983			$	12,092
Net income per share:
Basic		$	0.65			$	0.42
Diluted		$	0.65			$	0.42
Weighted-average shares outstanding:
Basic			29,181				28,896
Diluted			29,400				29,057
Dividends declared per common share		$	0.35			$	0.30

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

QUALITY SYSTEMS, INC.

(In thousands)

(Unaudited)

		Three Months Ended June 30,
		2011				2010
Cash flows from operating activities:
Net income		$	18,983			$	12,092
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			1,244				962
Amortization of capitalized software costs			1,925				1,669
Amortization of other intangibles			901				765
Provision for bad debts			980				850
Share-based compensation			956				1,065
Deferred income tax benefit			—				(262	)
Tax benefit associated with stock options			852				175
Excess tax benefit from share-based compensation			(852	)			(175	)
Changes in assets and liabilities, net of amounts acquired:
Accounts receivable			(9,651	)			(4,924	)
Inventories			(212	)			(53	)
Income taxes receivable			—				2,953
Other current assets			57				278
Other assets			40				(323	)
Accounts payable			(571	)			1,181
Deferred revenue			3,245				(214	)
Accrued compensation and related benefits			(346	)			(1,355	)
Income taxes payable			4,359				3,843
Other current liabilities			(1,182	)			721
Deferred compensation			296				71
Other noncurrent liabilities			509				47
Net cash provided by operating activities			21,533				19,366
Cash flows from investing activities:
Additions to capitalized software costs			(2,513	)			(2,545	)
Additions to equipment and improvements			(2,423	)			(878	)
Purchase of IntraNexus			(3,279	)			—
Net cash used in investing activities			(8,215	)			(3,423	)
Cash flows from financing activities:
Excess tax benefit from share-based compensation			852				175
Proceeds from exercise of stock options			3,427				1,144
Dividends paid			(10,160	)			(8,665	)
Net cash used in financing activities			(5,881	)			(7,346	)
Net increase in cash and cash equivalents			7,437				8,597
Cash and cash equivalents at beginning of period			116,617				84,611
Cash and cash equivalents at end of period		$	124,054			$	93,208

QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(In thousands)

(Unaudited)

		Three Months Ended June 30,
		2011				2010
Supplemental disclosures of cash flow information:
Cash paid during the period for income taxes, net of refunds		$	4,668			$	276
Non-cash investing and financing activities:
Unrealized loss on marketable securities, net of tax		$	(10	)		$	—
Common stock issued at fair value for Opus earnout settlement		$	11,887			$	—
Effective April 29, 2011, the Company acquired IntraNexus in a transaction summarized as follows:
Fair value of net assets acquired		$	4,524
Cash paid			(3,279	)
Purchase price holdback			(125	)
Fair value of contingent consideration			(800	)
Liabilities assumed		$	320

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

QUALITY SYSTEMS, INC.

(In thousands, except shares and per share data)

(Unaudited)

1. 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 Inpatient Solutions, LLC (“NextGen IS” f/k/a Sphere), Opus Healthcare Solutions, LLC (“Opus”), IntraNexus, Inc. (“IntraNexus”) and Quality Systems India Healthcare Private Limited (“QSIH”) (collectively, the “Company”). All intercompany accounts and transactions have been eliminated.

Business Segments. The Company has prepared operating segment information in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“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 13.

Basis of Presentation. The accompanying unaudited consolidated financial statements as of June 30, 2011 and for the three months ended June 30, 2011 and 2010 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, 2011. Amounts related to disclosures of March 31, 2011 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.

Certain prior period amounts have been reclassified to conform with fiscal year 2012 presentation.

References to 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 clients 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 clients 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 collection 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.

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 maturities of 90 days or less at the time of purchase. 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 7) 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. Marketable securities are classified as available-for-sale and are recorded at fair value, based on quoted market rates when observable or valuation analysis when appropriate. Unrealized gains and losses, net of taxes, are reported as a component of shareholders’ equity. Realized gains and losses on investments are included as interest income.

The Company’s marketable securities consist of fixed-income municipal securities. Unrealized losses as of June 30, 2011 were $10, and unrealized losses as of March 31, 2011 were not significant.

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 clients 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 7).

Equipment and Improvements. Equipment and improvements are stated at cost less accumulated depreciation and amortization. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. 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 generally have the following ranges:

• Computers equipment		3-5 years
• Furniture and fixtures		5-7 years
• Leasehold improvements		lesser of lease term or estimated useful life of asset

Costs incurred to develop internal-use software during the application development stage are capitalized, stated at cost, and amortized using the straight-line method over the estimated useful lives of the assets, which is seven years. Application development stage costs generally include costs associated with internal-use software configuration, coding, installation and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized, whereas costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred.

Software Development Costs. Development costs incurred in the research and development of new software products and enhancements to existing software products for external use are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional external software 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, NextGen IS, Opus and IntraNexus acquisitions (see Notes 3 and 4). 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 an operating segment (referred to as a component). A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component.

The Company has determined that NextGen qualifies as a separate reporting unit while HSI and PMP are aggregated as one reporting unit (the Practice Solutions Division) and NextGen IS, Opus and IntraNexus are aggregated as a separate reporting unit (the Inpatient Solutions Division) for 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 the 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; however, 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 the Practice Solutions Division and Inpatient Solutions Division, 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 five-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 of the Company’s annual assessment date are as follows: (a) expected cash flow for the period from 2012 to 2017 plus a terminal year; (b) a discount rate ranging from 15.0% to 19.0% for the Practice Solutions Division and Inpatient Solutions Division, which are based on marketplace participant expectations; and (c) a debt-free net cash flow long-term growth rate of between 3% and 5%, 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 five and ten year periods and risk adjusted discount rates of between 10% and 25% 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, 2011. See Note 4.

Intangible Assets. Intangible assets consist of capitalized software costs, customer relationships, trade names and certain software technology. Intangible assets related to customer relationships, trade names, and software technology arose in connection with the acquisitions of HSI, PMP, NextGen IS, Opus and IntraNexus. 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.

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.

Foreign Currency Translation. The U.S. dollar is considered to be the functional currency for QSIH because it acts primarily as an extension of the Company’s operations. The determination of functional currency is primarily based on QSIH’s relative financial and operational dependence. Assets and liabilities are re-measured at current exchange rates, except for property and equipment, depreciation and investments, which are translated at historical exchange rates. Revenues and expenses are re-measured at weighted average exchange rates in effect during the year except for costs related to the above mentioned balance sheet items, which are translated at historical rates. Any resulting foreign currency translation adjustments are reported as a component of shareholders’ equity. The cumulative foreign currency translation adjustment as June 30, 2011 and March 31, 2011 was not significant. Foreign currency gains and losses are included in other expense in the consolidated statements of income. The net foreign currency loss for the three months ended June 30, 2011 was not significant.

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 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.

Share-based compensation is adjusted on a quarterly basis for changes to estimated forfeitures based on a review of historical forfeiture activity. To the extent that actual forfeitures differ, or are expected to differ, from the estimate, share-based compensation expense is adjusted accordingly. The effect of the forfeiture adjustments for three months ended June 30, 2011 and 2010 was not significant.

The following table shows total share-based compensation expense included in the consolidated statements of income for three months ended June 30, 2011 and 2010:

		Three Months Ended June 30,
		2011				2010
Costs and expenses:
Cost of revenue		$	49			$	68
Research and development costs			33				28
Selling, general and administrative			874				969
Total share-based compensation			956				1,065
Amounts capitalized in software development costs			—				(1	)
Amounts charged against earnings, before income tax benefit		$	956			$	1,064
Related income tax benefit			(358	)			(348	)
Decrease in net income		$	598			$	716

Recent Accounting Standards. In April 2010, FASB issued an amendment to stock compensation. The amendment clarifies that an employee stock-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. There was no material impact from the adoption of this guidance on the Company’s consolidated financial position or results of operations since the Company’s stock-based payment awards have an exercise price denominated in the same currency of the market in which the Company’s shares are traded.

In December 2010, FASB issued an amendment to goodwill impairment test. The amendments modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. There was no material impact from the adoption of this guidance on the Company’s consolidated financial position or results of operations since the Company does not have any reporting units with zero or negative carrying amounts.

In December 2010, FASB issued an amendment to the disclosure of supplementary pro forma information for business combinations. The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this guidance had no material impact on the Company’s consolidated financial position or results of operations but may have an effect on the required disclosures for future business combinations.

2. 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 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. The Company’s financial instruments, other than those presented in the disclosures below, include 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. 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, 2011 and March 31, 2011:

						Quoted Prices
						in Active				Significant
						Markets for				Other
		Balance at				Identical				Observable				Unobservable
		June 30,				Assets				Inputs				Inputs
		2011				(Level 1)				(Level 2)				(Level 3)
ASSETS
Cash and cash equivalents (1)		$	124,054			$	124,054			$	—			$	—
Restricted cash			4,487				4,487				—				—
Marketable securities (2)			1,110				1,110				—				—
		$	129,651			$	129,651			$	—			$	—
LIABILITIES
Contingent consideration related to acquisitions		$	1,616			$	—			$	—			$	1,616
		$	1,616			$	—			$	—			$	1,616

						Quoted Prices
						in Active				Significant
						Markets for				Other
		Balance at				Identical				Observable				Unobservable
		March 31,				Assets				Inputs				Inputs
		2011				(Level 1)				(Level 2)				(Level 3)
ASSETS
Cash and cash equivalents (1)		$	116,617			$	116,617			$	—			$	—
Restricted cash			3,787				3,787				—				—
Marketable securities (2)			1,120				1,120				—				—
		$	121,524			$	121,524			$	—			$	—
LIABILITIES
Contingent consideration related to acquisitions		$	13,658			$	—			$	12,743			$	915
		$	13,658			$	—			$	12,743			$	915

The Company’s contingent consideration liability is accounted for at fair value on a recurring basis and is adjusted to fair value when the carrying value differs from fair value. The categorization of the framework used to measure fair value of the contingent consideration liability is considered Level 3 due to the subjective nature of the unobservable inputs used. The fair values of the contingent consideration liability were $816 for NextGen IS and $800 for IntraNexus, which were estimated based on the probability of achieving certain business milestones and management’s forecast of expected revenues. See Note 3.

The following table presents activity in the Company’s financial assets and liabilities 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, 2011:

		Liabilities
Balance at April 1, 2011		$	915
Acquisition (Note 3)			800
Earnout payments			(99	)
Balance at June 30, 2011		$	1,616

Non-Recurring Fair Value Measurements

The Company has certain assets, including goodwill and other intangible assets, which are measured at fair value on a non-recurring basis and are adjusted to fair value only if an impairment charge is recognized. The categorization of the framework used to measure fair value of the assets is considered Level 3 due to the subjective nature of the unobservable inputs used. During the three months ended June 30, 2011, 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 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.

3. Business Combinations

On April 29, 2011, the Company acquired IntraNexus, a provider of Web-based integrated clinical and hospital information systems. The IntraNexus purchase price totaled $4,204, including contingent consideration payable over a three year period with a fair value of $800, which was estimated based on management’s forecast of expected revenues, but in no event shall exceed $1,650.

On February 10, 2010, the Company acquired Opus, a provider of clinical information systems to the small hospital inpatient market. The Opus purchase price totaled $21,113, which includes a fair value adjustment of $532 to goodwill and the contingent consideration liability that was recorded during the year ended March 31, 2011. The fair value of the total Opus contingent consideration of $12,048 was estimated at the time of purchase based on the probability of Opus achieving certain earnout payments to be paid over a two year period to the selling security holders and former stock option holders (“option holders”) of Opus if certain operational and strategic objectives were met.

On March 30, 2011, the Company entered into an amendment to the merger agreement to modify and accelerate payment of the earnout consideration under the merger agreement, resulting in a total payment of $12,250, payable in 143,000 shares of Company common stock to the selling security holders and $856 in cash to the option holders. The Company has no further obligation to pay earnout consideration related to the Opus acquisition.

The fair value of the Opus earnout settlement was $12,743, which is the fair value of the Opus contingent consideration recorded in other current liabilities as of March 31, 2011. In reviewing the final settlement, the Company identified an error in the initial purchase price allocation related to the fair value of the price collar provisions in the merger agreement. As a result, the Company recorded an adjustment of $532 to goodwill and contingent consideration liability to correct the initial purchase price allocation as of February 10, 2010. The Company has concluded that this correction is not material to any periods affected.

The Company accounted for the IntraNexus, Opus, and NextGen IS acquisitions as purchase business combinations 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. The estimated fair value of the acquired tangible and intangible assets and liabilities assumed were determined using multiple valuation approaches depending on the type of tangible or intangible asset acquired, including but not limited to the income approach, the excess earnings method as well as the relief from royalty method approach.

The total purchase price for IntraNexus is summarized as follows:

Cash paid		$	3,279
Purchase price holdback			125
Contingent consideration			800
Total purchase price		$	4,204

The following table summarizes the final allocation of the IntraNexus purchase price:

Fair value of the net tangible assets acquired and liabilities assumed:
Current assets (including accounts receivable of $464)		$	691
Accounts payable and accrued liabilities			(226	)
Deferred revenues			(94	)
Total net tangible assets acquired and liabilities assumed			371
Fair value of identifiable intangible assets acquired:
Customer relationships			1,100
Software technology			830
Goodwill (including assembled workforce of $120)			1,903
Total identifiable intangible assets acquired			3,833
Total purchase price		$	4,204

The pro forma effects of the IntraNexus, Opus and NextGen IS acquisitions would not have been material to the Company’s results of operations and is therefore not presented.

4. 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:

		March 31,								June 30,
		2011				Acquisitions				2011
NextGen Division
NextGen Healthcare Information Systems, Inc.		$	1,840			$	—			$	1,840
Total NextGen Division goodwill			1,840				—				1,840
Inpatient Solutions Division
Opus Healthcare Solutions, Inc.			13,537				—				13,537
NextGen Inpatient Solutions, LLC			1,020				—				1,020
IntraNexus, Inc.			—				1,903				1,903
Total Inpatient Solutions Division goodwill			14,557				1,903				16,460
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		$	46,721			$	1,903			$	48,624

5. Intangible Assets

In connection with the IntraNexus acquisition, the Company recorded $1,930 of intangible assets related to customer relationships and software technology. The Company is amortizing the customer relationships over 5 years and the software technology over 4 years.

In connection with the Opus acquisition, the Company recorded $13,250 of intangible assets related to customer relationships and software technology. The Company is amortizing the Opus customer relationships intangible asset over 4 years and the software technology over 8 years.

In connection with the NextGen IS acquisition, the Company recorded $275 of intangible assets related to customer relationships and software technology. The Company is amortizing the NextGen IS customer relationships intangible asset over 4 years and the software technology over 3 years.

In connection with the PMP acquisition, the Company recorded $3,817 of intangible assets related to customer relationships and trade name. The Company is amortizing the PMP customer relationships intangible asset over 9 years and trade name over 4 years.

In connection with the HSI acquisition, the Company recorded $5,620 of intangible assets related to customer relationships and trade name. The Company is amortizing the HSI customer relationships intangible asset over 6 years and trade name over 4 years.

The Company’s intangible assets, other than capitalized software development costs, with determinable lives are summarized as follows:

		June 30, 2011
		Customer								Software
		Relationships				Trade Name				Technology				Total
Gross carrying amount		$	11,306			$	637			$	12,949			$	24,892
Accumulated amortization			(4,321	)			(469	)			(2,183	)			(6,973	)
Net intangible assets		$	6,985			$	168			$	10,766			$	17,919

		March 31, 2011
		Customer								Software
		Relationships				Trade Name				Technology				Total
Gross carrying amount		$	10,206			$	637			$	12,119			$	22,962
Accumulated amortization			(3,879	)			(429	)			(1,764	)			(6,072	)
Net intangible assets		$	6,327			$	208			$	10,355			$	16,890

Activity related to the intangible assets for the three months ended June 30, 2011 and 2010 is summarized as follows:

		Customer								Software
		Relationships				Trade Name				Technology				Total
Balance as of April 1, 2011		$	6,327			$	208			$	10,355			$	16,890
Acquisition			1,100				—				830				1,930
Amortization (1)			(442	)			(40	)			(419	)			(901	)
Balance as of June 30, 2011		$	6,985			$	168			$	10,766			$	17,919

		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, 2011:

For the year ended March 31, 2012 (remaining nine months)		$	2,810
2013			3,611
2014			3,482
2015			2,441
2016 and beyond			5,575
Total		$	17,919

6. Capitalized Software Costs

The Company’s capitalized software development costs are summarized as follows:

		June 30,				March 31,
		2011				2011
Gross carrying amount		$	54,636			$	52,123
Accumulated amortization			(38,898	)			(36,973	)
Net capitalized software costs		$	15,738			$	15,150

Activity related to net capitalized software costs for the three months ended June 30, 2011 and 2010 is summarized as follows:

		2011				2010
Balance as of April 1		$	15,150			$	11,546
Capitalized			2,513				2,545
Amortization			(1,925	)			(1,669	)
Balance as of June 30		$	15,738			$	12,422

The following table represents the remaining estimated amortization of capitalized software costs as of June 30, 2011:

For the year ended March 31, 2012 (remaining nine months)		$	5,701
2013			6,107
2014			3,542
2015			388
Total		$	15,738

7. 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 on the accompanying consolidated balance sheets.

		June 30,				March 31,
		2011				2011
Accounts receivable, excluding undelivered software, maintenance and services		$	95,913			$	90,487
Undelivered software, maintenance and implementation services billed in advance, included in deferred revenue			59,790				56,002
Accounts receivable, gross			155,703				146,489
Allowance for doubtful accounts			(6,796	)			(6,717	)
Accounts receivable, net		$	148,907			$	139,772

Inventories are summarized as follows:

		June 30,				March 31,
		2011				2011
Computer systems and components, net of reserve for obsolescence of $264		$	2,137			$	1,925
Miscellaneous parts and supplies			8				8
Inventories		$	2,145			$	1,933

Equipment and improvements are summarized as follows:

		June 30,				March 31,
		2011				2011
Computer equipment		$	21,329			$	23,567
Furniture and fixtures			5,596				5,861
Leasehold improvements			3,950				4,434
			30,875				33,862
Accumulated depreciation and amortization			(17,097	)			(21,263	)
Equipment and improvements, net		$	13,778			$	12,599

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

		June 30,				March 31,
		2011				2011
Maintenance		$	11,328			$	11,108
Implementation services			56,147				52,197
Annual license services			9,776				10,127
Undelivered software and other			2,776				3,263
Deferred revenue		$	80,027			$	76,695
Deferred revenue, net of current		$	1,106			$	1,099

Accrued compensation and related benefits are summarized as follows:

		June 30,				March 31,
		2011				2011
Payroll, bonus and commission		$	3,990			$	5,014
Vacation			5,911				5,233
Accrued compensation and related benefits		$	9,901			$	10,247

Other current liabilities are summarized as follows:

		June 30,				March 31,
		2011				2011
Care services liabilities		$	4,487			$	3,787
Accrued EDI expense			2,344				2,801
Sales tax payable			1,179				589
Contingent consideration related to acquisitions			1,116				13,658
Accrued royalties			1,032				1,752
Customer deposits			908				962
Accrued travel			720				1,026
Outside commission payable			614				599
Self insurance reserve			603				475
Deferred rent			533				437
Professional services			448				155
Other accrued expenses			3,384				3,075
Other current liabilities		$	17,368			$	29,316

8. Income Tax

The provision for income taxes for the three months ended June 30, 2011 was approximately $9,880 as compared to approximately $6,989 for the same year ago period. The effective tax rates for the three months ended June 30, 2011 and 2010 were 34.2% and 36.6%, respectively. The provision for income taxes for the three months ended June 30, 2011 differs from the combined statutory rates primarily due to the impact of varying state income tax rates, tax-exempt interest income, and the qualified production activities deduction. The effective rate for the three months ended June 30, 2011 decreased as compared to the same prior year period primarily due to increased benefits from the qualified production activities deduction, research and development credits, which were not included in the provision for the same prior year period but included in the provision for the current year period, increased deductions related to incentive stock options that were exercised in the current quarter and fluctuations in the state effective tax rate.

Uncertain tax positions

As of June 30, 2011, the Company has provided a liability of $484 for unrecognized tax benefits related to various federal and state income tax matters. If recognized, $484 would impact the Company’s effective tax rate. The reserve for the three months ended June 30, 2011 decreased from the same year ago period by $175 due to the expiration of the statute of limitations of prior year tax positions of acquired companies.

The Company’s income tax returns filed for tax years 2007 through 2009 and 2006 through 2009 are subject to examination by the federal and state taxing authorities, respectively. The Company is currently under examination by the IRS and is under examination by one state income tax authority and pending examination by three additional state agencies. 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.

9. Earnings per Share

Pursuant to FASB ASC Topic 260, Earnings Per Share, or ASC 260, the Company provides dual presentation of “basic” and “diluted” earnings per share (“EPS”).

Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents and 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:

		Three Months Ended June 30,
		2011				2010
Net income		$	18,983			$	12,092
Basic net income per share:
Weighted-average shares outstanding — Basic			29,181				28,896
Basic net income per common share		$	0.65			$	0.42
Net income		$	18,983			$	12,092
Diluted net income per share:
Weighted-average shares outstanding — Basic			29,181				28,896
Effect of potentially dilutive securities			219				161
Weighted-average shares outstanding — Diluted			29,400				29,057
Diluted net income per common share		$	0.65			$	0.42

The computation of diluted net income per share does not include 78 and 253 options for the three months ended June 30, 2011 and 2010, respectively, because their inclusion would have an anti-dilutive effect on net income per share.

10. 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, 2011, there were 173,931 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. As of June 30, 2011, there were 667,595 outstanding options and 1,556,924 shares available for future grant related to this Plan.

A summary of stock option transactions during the three months ended June 30, 2011 and 2010 is as follows:

						Weighted-				Weighted-
						Average				Average				Aggregate
						Exercise				Remaining				Intrinsic
		Number of				Price				Contractual				Value
		Shares				per Share				Life (years)				(in thousands)
Outstanding, April 1, 2011			698,778			$	44.40				3.9
Granted			229,700				86.08				7.9
Exercised			(86,952	)			39.42				1.8			$	4,163
Forfeited/Canceled			—				—				—
Outstanding, June 30, 2011			841,526			$	56.29				5.0			$	26,097
Vested and expected to vest, June 30, 2011			819,212			$	56.14				5.0			$	25,530
Exercisable, June 30, 2011			273,873			$	36.23				2.2			$	13,986

The Company accounts for share-based compensation in accordance with ASC 718 and utilizes the Black-Scholes valuation model for estimating the fair value of share-based compensation with the following assumptions:

		Three Months				Three Months
		Ended				Ended
		June 30, 2011				June 30, 2010
Expected life		4.3 years				4.2 years
Expected volatility			41.2	%			44.6% - 44.7	%
Expected dividends			1.6	%			2.1	%
Risk-free rate			1.8	%			2.0% - 2.1	%

The weighted average grant date fair value of stock options granted during the three months ended June 30, 2011 and 2010 was $26.64 and $18.36 per share, respectively.

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 3.3% and 2.4% for employee options for the three months ended June 30, 2011 and 2010, respectively, and 0.0% for director options for the three months ended June 30, 2011 and 2010. Forfeiture rates will be adjusted over the requisite service period when actual forfeitures differ, or are expected to differ, from the estimate.

During the three months ended June 30, 2011, a total of 229,700 options were granted under the 2005 Plan at an exercise price equal to the market price of the Company’s common stock on the date of grant. A summary of stock options granted under the 2005 Plan during fiscal years 2012 and 2011 is as follows:

Number of

Vesting

Option Grant Date

Shares

Exercise Price

Terms (1)

Expires

May 31, 2011

229,700

$

86.08

Five years

May 31, 2019

Fiscal year 2012 option grants

229,700

November 29, 2010

10,000

$

64.32

Five years

November 29, 2018

August 3, 2010

5,000

55.24

Five years

August 3, 2018

June 4, 2010

25,000

56.29

Five years

June 4, 2018

June 2, 2010

15,000

58.62

Five years

June 2, 2018

Fiscal year 2011 option grants

55,000

Performance-Based Awards

On May 25, 2011, the Board of Directors approved its fiscal year 2012 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 300,000, of which 150,000 are reserved for the Company’s named executive officers and 150,000 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 2012. 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 under the Company’s equity incentive plans 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 $213 and $18 during the three months ended June 30, 2011 and 2010, respectively, using the assumptions below.

		Three Months				Three Months
		Ended				Ended
		June 30, 2011				June 30, 2010
Expected life		4.3 years				4.2 years
Expected volatility			41.2	%			44.4	%
Expected dividends			1.8	%			2.1	%
Risk-free rate			1.8	%			1.8	%

Non-vested stock option award activity, including employee stock options and performance-based awards, during the three months ended June 30, 2011 is summarized as follows:

						Weighted-
						Average
		Non-Vested				Grant-Date
		Number of				Fair Value
		Shares				per Share
Outstanding, April 1, 2011			401,518			$	16.17
Granted			229,700				26.64
Vested			(63,565	)			12.01
Forfeited/Canceled			—				—
Outstanding, June 30, 2011			567,653			$	20.87

As of June 30, 2011, $9,284 of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted-average period of 6.4 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, 2011 and 2010 was $764 and $936, 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 for the restricted stock units was estimated using the market price of its common stock on the date of grant. The fair value of these restricted stock units is amortized on a straight-line basis over the vesting period.

As of June 30, 2011, 17,146 restricted stock units have been awarded under this Plan and approximately $103 and $73 of compensation expense related to these restricted stock units was recorded during the three months ended June 30, 2011 and 2010, respectively. Restricted stock units activity for the three months ended June 30, 2011 is summarized as follows:

						Weighted-
						Average
						Grant-Date
		Number of				Fair Value
		Shares				per Share
Outstanding, April 1, 2011			11,448			$	54.18
Granted			—				—
Vested			—				—
Outstanding, June 30, 2011			11,448			$	54.18

As of June 30, 2011, $265 of total unrecognized compensation costs related to restricted stock units is expected to be recognized over a weighted-average period of 0.8 years. This amount does not include the cost of new restricted stock units that may be granted in future periods.

11. Concentration of Credit Risk

The Company had cash deposits at U.S. banks and financial institutions which exceeded federally insured limits at June 30, 2011. 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.

12. Commitments, Guarantees and Contingencies

Commitments and Guarantees

Software license agreements in both the QSI Dental Division and NextGen Division 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.

Certain standard sales agreements contain a money back guarantee providing for a performance guarantee that is already part of the software license agreement as well as training and support. The money back guarantee also warrants that the software will remain robust and flexible to allow participation in the federal health incentive programs. The specific elements of the performance guarantee pertain to aspects of the software, which the Company has already tested and confirmed to consistently meet using the Company’s existing software without any modifications or enhancements. To date, the Company has not incurred any costs associated with this guarantee and does not expect to incur significant costs in the future. Therefore, no accrual has been made for potential costs associated with this guarantee.

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 clients 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 certain legal claims by parties asserting that it has infringed certain intellectual property rights. The Company believes that these claims are without merit and the Company has defended them vigorously. However, in order to avoid the further legal costs and diversion of management resources it is reasonably possible that a settlement may be reached which could result in a liability to the Company. However, at this time it is not possible to estimate with reasonable certainty what amount, if any, may be incurred as a result of a settlement. Litigation is inherently uncertain and always difficult to predict. Refer to the discussion of infringement and litigation risks in the “Item 1A. Risk Factors” section of the Company’s most recent Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

13. 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.

During fiscal year 2011, as a result of certain organizational changes, the composition of the Company’s NextGen Division was revised to exclude the Company’s inpatient solutions entities (Opus and NextGen IS), both of which are now aggregated in the Company’s Inpatient Solutions Division. Following the reorganization, the Company now operates four reportable segments (not including Corporate), comprised of the NextGen Division, the Inpatient Solutions Division, the QSI Dental Division and the Practice Solutions Division.

Prior period segment results were revised accordingly to reflect the organizational changes. The results of operations related to the fiscal year 2010 acquisitions of Opus and NextGen IS are now included in the Inpatient Solutions Division. The results of operations related to the fiscal year 2009 acquisitions of HSI and PMP are included in the Practice Solutions 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 practices.

The NextGen Division, with headquarters in Horsham, Pennsylvania, provides integrated clinical, financial and connectivity solutions for ambulatory and dental provider organizations and focuses principally on developing and marketing products and services for medical practices.

The Inpatient Solutions Division, with its primary location in Austin, Texas, provides integrated clinical, financial and connectivity solutions for rural and community hospitals. The Inpatient Solutions Division is comprised of IntraNexus, Opus and NextGen IS.

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^pm software platform to execute its service offerings. The Practice Solutions Division is comprised of HSI and PMP.

The Divisions operate largely as stand-alone operations, with each Division maintaining its own distinct product lines, product platforms, development, implementation and support teams and branding. The 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 the Divisions.

In January 2011, QSIH was formed in Bangalore, India to function as the Company’s India-based captive to offshore technology application development and business processing services.

The accounting policies of the Company’s operating segments are the same as those described in Note 1, 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.

Operating segment data is as follows:

		Three Months Ended June 30,
		2011				2010
Revenue:
QSI Dental Division		$	5,096			$	5,352
NextGen Division			74,624				62,671
Inpatient Solutions Division			7,290				3,159
Practice Solutions Division			13,432				11,745
Consolidated revenue		$	100,442			$	82,927
Operating income:
QSI Dental Division		$	1,278			$	1,591
NextGen Division			29,325				22,554
Inpatient Solutions Division			3,062				235
Practice Solutions Division			2,041				187
Unallocated corporate expense (1)			(6,887	)			(5,540	)
Consolidated operating income		$	28,819			$	19,027