** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

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**FORM 10-Q**

 
| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

# **For the quarterlyperiod ended June 30, 2002**

 

**or**

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

 

**For thetransition period from                   to                    .**

 

**Commission FileNumber: 001-16079**

 

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**PracticeWorks, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                  |   | **52-2259090**                       |
|---------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction ofincorporation or organization) |   | (I.R.S. EmployerIdentification  No.) |
| **1765 The Exchange, Suite 200 Atlanta,  Georgia**            |   | **30339**                            |
| (Address of principal executive offices)                      |   | (Zip code)                           |

 

**(770) 850-5006**

(Registrant’s telephone number,including area code)

 

                Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

                The number ofoutstanding shares of the Registrant’s common stock, par value $.01 per share,was 17,619,051 as of July 31, 2002.

 

 

 

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**PRACTICEWORKS, INC.**

 

**INDEX TOCONTENTS**

 

**DESCRIPTIONOF CONTENTS**

 

 

 
| **PART I — Financial  Information** |
|------------------------------------------|
|                                     | Item 1 — | Condensed Consolidated  Financial Statements |   |
|                                     | Item  2 — | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                     | Item  3 — | Quantitative  and Qualitative Disclosures About Market Risk |   |
| **PART II — Other Information**     |
|                                     | Item 1 — | Legal Proceedings |   |
|                                     | Item  2 — | Changes  in Securities and Use of Proceeds |   |
|                                     | Item 3 — | Defaults Upon  Senior Securities |   |
|                                     | Item  4 — | Submission  of Matters to a Vote of Security Holders |   |
|                                     | Item 5 — | Other Information |   |
|                                     | Item 6 — | Exhibits and  Reports on Form 8–K |   |
|                                     |   |   |   |
|                                          |  |  |  |  |  |

 

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**PRACTICEWORKS,INC.**

**UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**

**(INTHOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)**

** **
|                                                                                                                                                                                                                                                                                  |   | **June  30,** |       | **December  31,** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|------------|-------------------|------------|
|                                                                                                                                                                                                                                                                                  |   | **2002**      |       | **2001**          | ** ** |
|                                                                                                                                                                                                                                                                                  |   |          | ** ** |              | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                            |   |          | ** ** |              | ** ** |
| Current:                                                                                                                                                                                                                                                                              |   |          |       |              |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                                            |   | $             | 27,980     |              | $          | 6,555 |   |
| Accounts  receivable-trade, net of allowance of $611 and $1,408, respectively                                                                                                                                                                                                         |   | 6,664         |       | 6,306             |       |
| Other  receivables                                                                                                                                                                                                                                                                    |   | 1,409         |       | 1,462             |       |
| Deferred  income tax assets                                                                                                                                                                                                                                                           |   | 390           |       | 632               |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                                                                            |   | 1,537         |       | 1,401             |       |
| Total  current assets                                                                                                                                                                                                                                                                 |   | 37,980        |       | 16,356            |       |
| Property  and equipment, net of accumulated depreciation of $6,597 and $5,195,  respectively                                                                                                                                                                                          |   | 6,521         |       | 7,123             |       |
| Goodwill                                                                                                                                                                                                                                                                              |   | 48,458        |       | 45,412            |       |
| Other  intangible assets, net of accumulated amortization of $5,159 and $3,865,  respectively                                                                                                                                                                                         |   | 18,241        |       | 17,462            |       |
| Deferred  income tax assets                                                                                                                                                                                                                                                           |   | 4,967         |       | 4,725             |       |
| Investment  in and advances to affiliate                                                                                                                                                                                                                                              |   | 4,550         |       | -                 |       |
| Other  assets                                                                                                                                                                                                                                                                         |   | 1,293         |       | 215               |       |
|                                                                                                                                                                                                                                                                                  |   | $             | 122,010    |              | $          | 91,293 |   |
|                                                                                                                                                                                                                                                                                  |   |          |       |              |       |
| **LIABILITIES AND STOCKHOLDERS'  EQUITY**                                                                                                                                                                                                                                             |   |          | ** ** |              | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                                                 |   |          |       |              |       |
| Accounts  payable                                                                                                                                                                                                                                                                     |   | $             | 3,642      |              | $          | 3,010 |   |
| Accrued  expenses                                                                                                                                                                                                                                                                     |   | 5,471         |       | 6,768             |       |
| Accrued  restructuring costs                                                                                                                                                                                                                                                          |   | 404           |       | 845               |       |
| Deferred  revenue and customer deposits                                                                                                                                                                                                                                               |   | 12,430        |       | 12,476            |       |
| Current  portion of long-term debt                                                                                                                                                                                                                                                    |   | 1,077         |       | 4,379             |       |
| Total  current liabilities                                                                                                                                                                                                                                                            |   | 23,024        |       | 27,478            |       |
| Long-term  debt, less current portion                                                                                                                                                                                                                                                 |   | 2,832         |       | 20,258            |       |
| Other  liabilities                                                                                                                                                                                                                                                                    |   | 742           |       | -                 |       |
| Total  liabilities                                                                                                                                                                                                                                                                    |   | 26,598        |       | 47,736            |       |
|                                                                                                                                                                                                                                                                                  |   |          |       |              |       |
| Commitments  and contingencies                                                                                                                                                                                                                                                        |   |          |       |              |       |
|                                                                                                                                                                                                                                                                                  |   |          |       |              |       |
| Preferred  stock, $0.01 par value; 20,000,000 shares authorized:                                                                                                                                                                                                                      |   |          |       |              |       |
| Series A  6.5% convertible redeemable preferred; 2001 liquidation preference and  redemption value $32,000; shares issued and outstanding 0 and 32,000, 2001  carrying value includes accrued dividends of $1,697 and is net of $9,205  unamortized discount                          |   | -             |       | 24,492            |       |
| Series B  6.0% convertible redeemable preferred; liquidation preference and redemption  value $5,199 and $5,198; shares issued and outstanding 955,779 and 955,593;  carrying value includes accrued dividends of $285 and $126 and is net of  $1,230 and $1,380 unamortized discount |   | 4,254         |       | 3,944             |       |
| Series C  convertible redeemable preferred; 2001 liquidation preference and redemption  value $5,000; shares issued and outstanding 0 and 100,000; 2001 carrying  value includes $767 accrued redemption premium                                                                      |   | -             |       | 5,767             |       |
|                                                                                                                                                                                                                                                                                  |   |          |       |              |       |
| Stockholders'  equity:                                                                                                                                                                                                                                                                |   |          |       |              |       |
| Common  stock $0.01 par value, 100,000,000 authorized,17,561,895 and 11,022,743  issued and outstanding                                                                                                                                                                               |   | 176           |       | 110               |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                           |   | 116,631       |       | 35,518            |       |
| Deferred  compensation                                                                                                                                                                                                                                                                |   | (779          | )          | (821              | )          |
| Accumulated  deficit                                                                                                                                                                                                                                                                  |   | (24,861       | )          | (25,428           | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                                                 |   | (9            | )          | (25               | )          |
| Total  stockholders' equity                                                                                                                                                                                                                                                           |   | 91,158        |       | 9,354             |       |
|                                                                                                                                                                                                                                                                                  |   |          |       |              |       |
|                                                                                                                                                                                                                                                                                  |   | $             | 122,010    |              | $          | 91,293 |   |

 

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

 

3

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** **

**PRACTICEWORKS,INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND**

**ANDCOMPREHENSIVE INCOME (LOSS)**

**(INTHOUSANDS, EXCEPT PER SHARE AMOUNTS)**

** **

** **
|                                                                  |   | **Three  Months Ended** |   | **Six  Months Ended** |   |
|-----------------------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                                                  |   | **June  30,**           |   | **June  30,**         |   |
|                                                                  |   | **2002**                |   | **2001**              |   | **2002** |   | **2001** |   |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Revenues:                                                             |   |                    |   |                  |   |   |   |   |   |
| Recurring                                                             |   | $                       | 13,644 |                  | $      | 10,415 |   | $ | 26,875 |   | $ | 18,650 |   |
| Non-recurring                                                         |   | 7,291                   |   | 4,641                 |   | 13,095 |   | 8,223 |   |
| Total  revenues                                                       |   | 20,935                  |   | 15,056                |   | 39,970 |   | 26,873 |   |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Operating  expenses:                                                  |   |                    |   |                  |   |   |   |   |   |
| Purchases  for resale                                                 |   | 3,850                   |   | 1,914                 |   | 6,860 |   | 3,361 |   |
| Selling,  general and administrative                                  |   | 12,433                  |   | 12,324                |   | 25,259 |   | 22,536 |   |
| Research  and development                                             |   | 848                     |   | 301                   |   | 1,927 |   | 1,027 |   |
| Amortization  of goodwill                                             |   | -                       |   | 5,946                 |   | - |   | 10,682 |   |
| Depreciation  and amortization of other intangibles                   |   | 1,838                   |   | 1,017                 |   | 3,479 |   | 1,595 |   |
| Restructuring  and other non-recurring (credits) charges              |   | (224                    | )      | 64                    |   | (143 | ) | 2,184 |   |
| Total  operating expenses                                             |   | 18,745                  |   | 21,566                |   | 37,382 |   | 41,385 |   |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Operating  income (loss)                                              |   | 2,190                   |   | (6,510                | )      | 2,588 |   | (14,512 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Interest  expense:                                                    |   |                    |   |                  |   |   |   |   |   |
| Interest  expense                                                     |   | 497                     |   | 487                   |   | 1,133 |   | 1,112 |   |
| Other  interest expense - debt extinguishment costs                   |   | 889                     |   | -                     |   | 889 |   | - |   |
| Total  interest expense                                               |   | 1,386                   |   | 487                   |   | 2,022 |   | 1,112 |   |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Net  income (loss)                                                    |   | 804                     |   | (6,997                | )      | 566 |   | (15,624 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Dividends:                                                            |   |                    |   |                  |   |   |   |   |   |
| Accrued  and accretive preferred stock dividends                      |   | 1,111                   |   | 1,317                 |   | 2,554 |   | 1,650 |   |
| Deemed  dividend related to redemption of series A preferred stock    |   | 7,625                   |   | -                     |   | 7,625 |   | - |   |
| Total  dividends                                                      |   | 8,736                   |   | 1,317                 |   | 10,179 |   | 1,650 |   |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Net loss  available to common stockholders                            |   | $                       | (7,932 | )                     | $      | (8,314 | ) | $ | (9,613 | ) | $ | (17,274 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Comprehensive  income (loss):                                         |   |                    |   |                  |   |   |   |   |   |
| Net  income (loss)                                                    |   | $                       | 804    |                  | $      | (6,997 | ) | $ | 566 |   | $ | (15,624 | ) |
| Foreign  currency translation adjustments                             |   | 223                     |   | (206                  | )      | 16 |   | (380 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Total  comprehensive income (loss)                                    |   | $                       | 1,027  |                  | $      | (7,203 | ) | $ | 582 |   | $ | (16,004 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| **Per share data:**                                                   |   |                    |   |                  |   |   |   |   |   |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Net  income (loss):                                                   |   |                    |   |                  |   |   |   |   |   |
| Basic                                                                 |   | $                       | 0.06   |                  | $      | (0.77 | ) | $ | 0.05 |   | $ | (1.76 | ) |
| Diluted                                                               |   | 0.06                    |   | (0.77                 | )      | 0.04 |   | (1.76 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Dividends:                                                            |   |                    |   |                  |   |   |   |   |   |
| Basic  and diluted                                                    |   | (0.68                   | )      | (0.15                 | )      | (0.85 | ) | (0.19 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Net loss  available to common stockholders:                           |   |                    |   |                  |   |   |   |   |   |
| Basic  and diluted                                                    |   | (0.62                   | )      | (0.92                 | )      | (0.80 | ) | (1.95 | ) |
|                                                                  |   |                    |   |                  |   |   |   |   |   |
| Weighted  average shares outstanding used in computingper share data: |   |                    |   |                  |   |   |   |   |   |
| Basic                                                                 |   | 12,873                  |   | 9,036                 |   | 12,055 |   | 8,860 |   |
| Diluted                                                               |   | 14,575                  |   | 9,036                 |   | 13,361 |   | 8,860 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

** **

4

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**PRACTICEWORKS,INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(INTHOUSANDS, EXCEPT SHARE AMOUNTS)**

 
|                                                                                           |   | **Six  Months Ended** |   |
|------------------------------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                                           |   | **June  30,**         |   |
|                                                                                           |   | **2002**              |   | **2001** |   |
|                                                                                           |   |                  |   |   |   |
| CASH  PROVIDED BY (USED IN) OPERATING ACTIVITIES:                                              |   |                  |   |   |   |
| Net  income (loss)                                                                             |   | $                     | 566    |   | $ | (15,624 | ) |
| Adjustments  to reconcile net income (loss) to cash provided by(used in) operating activities: |   |                  |   |   |   |
| Restructuring  and other non-recurring charges                                                 |   | -                     |   | (944 | ) |
| Depreciation  and amortization                                                                 |   | 4,814                 |   | 12,277 |   |
| Provision  for doubtful accounts                                                               |   | (50                   | )      | 697 |   |
| Changes  in current assets and liabilities, net of acquisitions:                               |   |                  |   |   |   |
| Trade  and other receivables                                                                   |   | (680                  | )      | 913 |   |
| Prepaid  expenses and other current assets                                                     |   | (123                  | )      | (156 | ) |
| Accounts  payable and accrued expenses                                                         |   | (1,158                | )      | 2,643 |   |
| Deferred  revenue and customer deposits                                                        |   | (20                   | )      | (67 | ) |
| Cash  provided by (used in) operating activities                                               |   | 3,349                 |   | (261 | ) |
|                                                                                           |   |                  |   |   |   |
| CASH  USED IN INVESTING ACTIVITIES:                                                            |   |                  |   |   |   |
| Cash  paid for acquisitions                                                                    |   | (3,001                | )      | (2,413 | ) |
| Property  and equipment expenditures                                                           |   | (850                  | )      | (444 | ) |
| Cash  paid for intangible assets                                                               |   | (1,487                | )      | (2,238 | ) |
| Investment  in and advances to affiliate                                                       |   | (4,545                | )      | - |   |
| Other                                                                                          |   | (80                   | )      | (123 | ) |
| Cash  used in investing activities                                                             |   | (9,963                | )      | (5,218 | ) |
|                                                                                           |   |                  |   |   |   |
| CASH  PROVIDED BY FINANCING ACTIVITIES:                                                        |   |                  |   |   |   |
| Proceeds  from issuance of common stock, net                                                   |   | 63,867                |   | 1,410 |   |
| Principal  payments on long-term debt                                                          |   | (22,436               | )      | (54 | ) |
| Redemption  of series A preferred stock                                                        |   | (15,000               | )      | - |   |
| Borrowings  of long-term debt                                                                  |   | 1,282                 |   | - |   |
| Proceeds  from exercise of stock options and warrants                                          |   | 334                   |   | - |   |
| Proceeds  from sale of series C preferred stock, net                                           |   | -                     |   | 4,741 |   |
| Net cash  advances from VitalWorks Inc.                                                        |   | -                     |   | 344 |   |
| Payment  of loan costs                                                                         |   | -                     |   | (183 | ) |
| Other                                                                                          |   | 24                    |   | - |   |
| Cash  provided by financing activities                                                         |   | 28,071                |   | 6,258 |   |
|                                                                                           |   |                  |   |   |   |
| Effect  of exchange rate changes on cash and cash equivalents                                  |   | (32                   | )      | (10 | ) |
|                                                                                           |   |                  |   |   |   |
| Net  increase in cash and cash equivalents                                                     |   | 21,425                |   | 769 |   |
| Cash and  cash equivalents, beginning of period                                                |   | 6,555                 |   | 3,979 |   |
| Cash and  cash equivalents, end of period                                                      |   | $                     | 27,980 |   | $ | 4,748 |   |
|                                                                                           |   |                  |   |   |   |
| NONCASH  INVESTING AND FINANCING TRANSACTIONS:                                                 |   |                  |   |   |   |
| Issuance  of common stock and warrant for redemption of series A preferred stock               |   | $                     | 19,053 |   | $ | - |   |
| Issuance  of common stock for acquisitions                                                     |   | 1,502                 |   | - |   |
| Issuance  of notes payable for acquisitions                                                    |   | 336                   |   | 771 |   |
| Issuance  of series A preferred stock for InfoSoft acquisition, net of discount                |   | -                     |   | 21,000 |   |
| Issuance  of 8,754,937 shares of common stock in exchange for net assets at date of  Spin-Off  |   | -                     |   | 26,600 |   |
|                                                                                           |   |                  |   |   |   |
| ADDITIONAL  CASH FLOW INFORMATION:                                                             |   |                  |   |   |   |
| Interest  paid                                                                                 |   | $                     | 1,046  |   | $ | 165 |   |

 

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

 

 

5

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**PRACTICEWORKS, INC.****NOTES TO UNAUDITED CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION**

                PracticeWorks,Inc. is a provider of software-based information technology systems and relatedservices for dentists, orthodontists and oral and maxillofacial surgeonsthroughout the United States, and, on a more limited basis, in Europe, Canadaand Australia. The Company’s offerings include practice managementapplications, recently-introduced cosmetic imaging and digital radiographysystems, ongoing maintenance and support and training, electronic datainterchange, or EDI, services and other electronic services. These systems andservices are designed to increase the quality and reduce the cost of providingcare by allowing dental professionals to manage their practices moreefficiently and reduce the administrative burdens created by an increasinglycomplex healthcare environment.

 

Priorto March 5, 2001, PracticeWorks, Inc. operated as a division ofVitalWorks Inc. (“VitalWorks”), formerly InfoCure Corporation. OnMarch 5, 2001, VitalWorks completed the pro rata distribution (“Spin-Off”)of all of the outstanding shares of PracticeWorks common stock to VitalWorksstockholders. For purposes of these financial statements the term“PracticeWorks” or the “Company” means PracticeWorks, a division of VitalWorks,for periods prior to the Spin-Off, and PracticeWorks, Inc. for periodsafter the Spin-Off.

 

                The information presented at June 30,2002, and for the three and six months ended June 30, 2002 and 2001 isunaudited, however, in the opinion of management, includes all normal recurringadjustments necessary for a fair presentation of the consolidated financialposition, results of operations and cash flows of PracticeWorks for the periodspresented. All significant intercompany balances and transactions have beeneliminated in consolidation. The results of operations for the three and sixmonth periods ended June 30, 2002 are not necessarily indicative of the resultsto be expected for the full year. Certain information in footnote disclosuresnormally included in annual financial statements prepared in accordancewith  accounting principles generallyaccepted in the United States has been condensed or omitted pursuant to therules and regulations of the Securities and Exchange Commission. The condensedconsolidated financial statements, notes thereto and other information shouldbe read in conjunction with the historical consolidated financial statementsand related notes thereto included in PracticeWorks’ Annual Report onForm 10-K for the year ended December 31, 2001 (the “Form 10-K”).The results for the period through March 5, 2001 are not reflective ofPracticeWorks as a stand-alone entity, but as an operating division ofVitalWorks. Accumulated deficit reflects activity from March 5, 2001.Certain prior period amounts have been reclassified to conform to the currentpresentation.

 

**NOTE 2. BUSINESS COMBINATIONS**

 

                As reported in PracticeWorks’Form 10-K, the Company completed four acquisitions in 2001. The aggregateconsideration for such acquisitions was approximately $37.5 million,consisting of PracticeWorks series A and B convertible redeemablepreferred stock valued at $24.8 million, $5.5 million in cash,$2.6 million in notes payable, $2.3 million in PracticeWorks commonstock, and $2.3 million in VitalWorks common stock. The Company recordedtotal goodwill of $34.7 million.

 

                In January 2002, the Companycompleted an acquisition with aggregate cash consideration of approximately$2.2 million, including approximately $100,000 in transaction costs. Theresults of the acquired entity’s operations have been included since the dateof acquisition. This acquisition added approximately 700 providers to thecustomer base in the United Kingdom. The Company identified and assigned apreliminary value and useful life to the following intangible assets: 
| Capitalized software           |   | $       | 189,000 |     | 4 years |   |
|--------------------------------|--------|---------|---------|----------|---------|--------|
| Customer maintenance contracts |   | 364,000 |    | 8 years  |    |
| Customer relationships         |   | 945,000 |    | 10 years |    |

 

 

Additionally, theCompany recorded total goodwill of $400,000, which will not be deductible forincome tax purposes.

 

                The following unaudited pro formainformation presents the results of operations of the Company as if thematerial acquisitions had occurred as of the beginning of each of the periodspresented. The pro forma information is not necessarily indicative of whatwould have occurred had the acquisitions been made as of such periods, nor isit indicative of future results of operations. The pro forma amounts giveeffect to appropriate adjustments for the fair value of the assets acquired,amortization of intangibles, interest expense and income taxes. 
| **(In  thousands, except per share data)**                                    |   | **Six  Months  Ended June 30,  2001** |   |
|-------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                          |   |                                  |   |
| PRO FORMA AMOUNTS                                                             |   |                                  |   |
|                                                                          |   |                                  |   |
| Revenue                                                                       |   | $                                     | 28,247 |   |
|                                                                          |   |                                  |   |
| Net loss                                                                      |   | (16,717                               | )      |
|                                                                          |   |                                  |   |
| Net loss available to common stockholders                                     |   | (19,080                               | )      |
|                                                                          |   |                                  |   |
| Net loss available to common stockholders per share  — basic and diluted |   |                                  | (2.15  | ) |

 

 

6

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**NOTE 3. GOODWILL AMORTIZATION**

 

Inconnection with the adoption of Statement of Financial Accounting Standards(“SFAS”) No. 142, effective January 1, 2002 (see Recent AccountingPronouncements), the Company ceased the amortization of goodwill. Had thisStandard been applicable to the prior periods presented herein, amortization ofgoodwill would have been reduced by $5.9 million and $10.7 millionfor the three and six months ended June 30, 2001, respectively. The followingtable presents net loss and net loss available to common stockholders togetherwith applicable earnings per share information as if the new accountingstandard had been adopted as of the dates presented. Additionally, the tablepresents a reconciliation of these adjusted amounts to the amounts previouslyreported.

 
|                                                    |   | **Three Months Ended**                    |   | **Six Months Ended** |   |
|---------------------------------------------------------|--------|-------------------------------------------|--------|----------------------|--------|
|                                                    |   | **June 30, 2001**                         |   | **June 30, 2001**    |   |
|                                                    |   | **(In thousands, except per share data)** |   |
| Net loss, as  previously reported                       |   | $                                         | (6,997 | )                    | $      | (15,624 | ) |
| Goodwill  amortization, net of tax                      |   | 5,946                                     |   | 10,682               |   |
| Net loss, as  adjusted                                  |   | (1,051                                    | )      | (4,942               | )      |
| Accrued and  accretive preferred dividends              |   | 1,317                                     |   | 1,650                |   |
| Net loss available  to common stockholders, as adjusted |   | $                                         | (2,368 | )                    | $      | (6,592 | ) |
|                                                    |   |                                      |   |                 |   |
| Per share data —  basic and diluted, as adjusted   |   |                                      |   |                 |   |
| Net loss, as  previously reported                       |   | $                                         | (0.77  | )                    | $      | (1.76 | ) |
| Goodwill  amortization, net of tax                      |   | 0.66                                      |   | 1.21                 |   |
| Net loss, as  adjusted                                  |   | (0.11                                     | )      | (0.55                | )      |
| Accrued and  accretive preferred dividends              |   | (0.15                                     | )      | (0.19                | )      |
| Net loss available  to common stockholders, as adjusted |   | $                                         | (0.26  | )                    | $      | (0.74 | ) |
|                                                    |   |                                      |   |                 |   |

**NOTE 4.  INVESTMENT IN AND ADVANCES TO AFFILIATE**

 

                In June 2002, the Companyacquired a minority interest in PracticeWares, Inc. (“PracticeWares”), a dentalsupply company, for $1.0 million. Additionally, the Company advanced $3.5 million in the form of a loan,half of which the Company expects to be repaid when PracticeWares enters into afinancing arrangement with a senior lender. The Company also has the option, under certain conditions, to acquirethe remaining equity interest in PracticeWares it does not own.  The investment is being accounted for usingthe equity method of accounting.  TheCompany’s share of the results of operations for PracticeWares for the currentperiod were immaterial.

 

In connection with the investment, the Companyentered into a long-term distribution agreement with PracticeWares under whichPracticeWares will be able to offer its dental supplies to PracticeWorkscustomers in exchange for royalty payments to the Company on these sales.  PracticeWares also entered into a long-termlicense agreement with the Company for the use of its e-commerce software.

 

**NOTE 5. RESTRUCTURING AND OTHER NON-RECURRING CHARGES**

 

**RESTRUCTURING**

 

                As reported in PracticeWorks’Form 10-K for the year ended December 31, 2001, the Company announcedplans in the fourth quarter of 2001 to consolidate substantially all of itsdomestic operations into one facility. The plan entailed the closure of twofacilities, reducing the scope of operations in a third facility andtermination of approximately 110 employees company wide. The Company added 50 employeesin Atlanta in the first quarter of 2002 to absorb the functions of the closedlocations. During the second quarter of 2002, the Company negotiated toterminate the lease of a closed facility and recorded a reduction in therestructuring reserve of $220,000.  Theremaining closed facilities have operating leases with various expiration datesthrough 2005. The other costs of the restructuring were paid in the first halfof 2002. The following table sets forth changes in the restructuring reserveduring the three and six months ended June 30, 2002:

 

 
|                                                          |   | **Reserve  Balance December 31, 2001** |   | **Additions/  Adjustments To Reserve** |   | **Costs  Applied Against Reserves** |   | **Reserve  Balance March 31, 2002** |   | **Additions/  Adjustments To Reserve** |   | **Costs  Applied Against Reserves** |   | **Reserve  Balance June 30, 2002** |   |
|---------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|-------------------------------------|--------|-------------------------------------|--------|----------------------------------------|--------|-------------------------------------|--------|------------------------------------|--------|
|                                                          |   | **(In  thousands)**                    |   |
| Facility closure and consolidation                            |   | $                                      | 727    |                                   | $      | —                              |   | $                                   | (10    | )                                      | $      | 717                                 |   | $                                  | (220   | ) | $ | (93 | ) | $ | 404 |   |
| Compensation costs for severance andother terminationbenefits |   | 118                                    |   | (7                                     | )      | (64                                 | )      | 47                                  |   | 2                                      |   | (49                                 | )      | —                             |   |
|                                                          |   |                                   |   |                                   |   |                                |   |                                |   |                                   |   |                                |   |                               |   |
| Total                                                         |   | $                                      | 845    |                                   | $      | (7                                  | )      | $                                   | (74    | )                                      | $      | 764                                 |   | $                                  | (218   | ) | $ | (142 | ) | $ | 404 |   |

 

 

7

----

 

 

 

**OTHER NON-RECURRING CHARGES**

 

                During the three and six months endedJune 30, 2002, the Company recorded a nominal amount of non-recurring creditsand charges related to the 2001 restructuring that were not eligible foraccrual at the time the restructuring was announced. During the three and sixmonths ended June 30, 2001, the Company recorded other non-recurring charges ofapproximately $698,000 and $3.1 million, respectively, related primarily toprofessional fees, printing and similar costs in connection with completion ofthe Spin-Off.  These charges were offsetby reductions of $634,000 and $944,000, for the three and six months ended June30, 2001, respectively, for the negotiation to terminate the lease of a closedfacility and reductions in severance and other termination benefits resultingfrom the early departure of employees eligible to receive these payments.

 

**NOTE 6. DEBT EXTINGUISHMENT COSTS**

 

InJune 2002, the Company completed a public offering of its common stock (the“Offering”) and with a portion of the proceeds repaid all of its outstandingdebt to its senior lender, FINOVA Capital Corporation (“FINOVA”).  Consequently, the Company incurred debtextinguishment costs of approximately $889,000 representing the write-off ofunamortized loan costs.  The debtextinguishment costs were recorded as other interest expense in accordance withSFAS No. 145 (see Note 10).

 

**NOTE 7. STOCKHOLDERS’ EQUITYAND PREFERRED STOCK**

** **

**COMMON STOCK**

 

Basic earnings per share iscomputed on the weighted-average number of common shares outstanding duringeach period.  Diluted earnings per shareis based on the weighted-average number of shares outstanding plus netincremental shares arising out of stock options, warrants and convertiblesecurities outstanding.  The followingtable is a reconciliation of the weighted-average share amounts used incalculating earnings per share:
|                                                  |   |                    |   |                  |   |   |   |   |   |
|-------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|--------|--------|--------|--------|
|                                                  |   | **Three  Months Ended** |   | **Six  Months Ended** |   |
|                                                  |   | **June  30,**           |   | **June  30,**         |   |
|                                                  |   | 2002                    |   | 2001                  |   | 2002   |   | 2001   |   |
| In  thousands                                         |   |                    |   |                  |   |   |   |   |   |
|                                                  |   |                    |   |                  |   |   |   |   |   |
| Basic  common shares outstanding                      |   | 12,873                  |   | 9,036                 |   | 12,055 |   | 8,860  |   |
|                                                  |   |                    |   |                  |   |   |   |   |   |
| Dilutive  effect of common stock options and warrants |   | 1,702                   |   | —                |   | 1,306  |   | — |   |
|                                                  |   |                    |   |                  |   |   |   |   |   |
| Diluted  common shares outstanding                    |   | 14,575                  |   | 9,036                 |   | 13,361 |   | 8,860  |   |
|                                                  |   |                    |   |                  |   |   |   |   |   |

 

Forthe three months ended June 30, 2002, approximately 214,000 shares of commonstock issuable under stock options and warrants were not included in thecalculation of fully diluted earnings per share, because the exercise priceswere above the average market price. Additionally, the diluted number of shares excludes approximately151,000 shares of common stock issuable upon conversion of the series Bpreferred stock, because such inclusion was antidilutive.  For the three months ended June 30, 2001,approximately 3.8 million shares of common stock issuable under stock optionsand warrants were not included in the calculation of fully diluted earnings pershare, of which 3.5 million were excluded because the exercise prices wereabove the average market price . Additionally, the diluted number of shares excludes approximately975,000 shares of common stock issuable upon conversion of the series Apreferred stock and approximately 482,000 shares of common stock contingentlyissuable to WebMD Corporation, because such inclusion was antidilutive.

 

Forthe six months ended June 30, 2002, approximately 1.2 million shares of commonstock issuable under stock options and warrants were not included in thecalculation of fully diluted earnings per share, because the exercise priceswere above the average market price. Additionally, the diluted number of shares excludes approximately151,000 shares of common stock issuable upon conversion of the series Bpreferred stock, because such inclusion was antidilutive.  For the six months ended June 30, 2001,approximately 3.8 million shares of common stock issuable under stock optionsand warrants were not included in the calculation of fully diluted earnings pershare, of which 3.5 million were excluded because the exercise prices wereabove the average market price . Additionally, the diluted number of shares excludes approximately975,000 shares of common stock issuable upon conversion of the series Apreferred stock and approximately 482,000 shares of common stock contingentlyissuable to WebMD Corporation, because such inclusion was antidilutive.

 

In June 2002,the Company completed a public offering of 4,523,026 shares of its commonstock, priced at $15.50 per share, of which 3,750,000 shares were offered bythe Company and 773,026 shares were offered by existing stockholders.  At the closing, the Company also sold anadditional 678,454 shares pursuant to the exercise by the underwriters of theirover-allotment option. As a result, the Company received proceeds of $63.9million (net of underwriting discounts and other expenses of the offering).  The Company used $20.6 million of theproceeds to repay the outstanding balance on its credit facility and $15.0million as partial consideration for the redemption of its series A preferredstock.  The balance of the proceeds willbe used to fund working capital requirements and for general corporate purposesand to pursue possible acquisitions or strategic investments in complementarybusinesses, technologies and products.

 

###### **WARRANTS**

 

 

8

----

 

 

                As previously disclosed in the Form 10-K, the Companyissued to FINOVA warrants to purchase approximately 198,000 shares of commonstock.  In May 2002, FINOVA exercisedall of its warrants in a cashless transaction and the Company issuedapproximately 105,000 shares of common stock.

 

**SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK**

 

**               **In June 2002, in connection with the Offering, the Company redeemed theseries A preferred stock.  The Companypaid $15.0 million in cash, issued 967,742 shares of common stock valued at$15.0 million and issued a warrant to purchase 450,000 shares of common stockthat had a fair value of approximately $4.1 million.  The Company recorded a deemed dividend of $7.6 million inconjunction with the redemption of these shares.

 

**SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK**

 

InMarch 2002, Crescent International Limited (“Crescent”) converted36,000 shares of the series C preferred stock into 278,126 shares of theCompany’s common stock. In April 2002, Crescent converted an additional 20,000preferred shares into 154,515 shares of the Company’s common stock.  In June 2002, Crescent converted itsremaining 44,000 preferred shares into 339,932 shares of the Company’s commonstock.  The Company no longer has anyseries C preferred stock outstanding.

 

**NOTE 8. SEGMENT INFORMATION**

 

                SFAS No. 131 establishes standardsfor the way in which public companies are to disclose certain information aboutoperating segments in their financial reports. It also establishes standardsfor related disclosures about products and services, geographic areas, andmajor customers.

 

TheCompany historically reported results from operations in two segments:recurring revenue and non-recurring revenue. Concurrent with the adoption ofSFAS No. 141 and No. 142, and the completion of an acquisition in theUnited Kingdom in January 2002, the Company revised the segment reportingto more closely align with how the Company is managed by the Chief OperatingDecision Maker. The results from operations are now reported using twosegments: United States operations and international operations. Theinternational operations include primarily Europe, and to a much lesser extent,Australia and Canada.

 

TheCompany’s President and Chief Executive Officer evaluates performance based onmeasures of segment revenues and operating results.

 

Information about the Company’s operations by operating segment follows (inthousands):

 

 
|               |   | **Three  Months Ended********June 30, 2002** |   | **Three  Months Ended********June 30, 2001** |   |
|--------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|               |   | **United  States**                           |   | **International**                            |   | **Consolidated** |   | **United  States** |   | **International** |   | **Consolidated** |   |
|               |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Revenues           |   | $                                            | 19,033 |                                         | $      | 1,902 |   | $ | 20,935 |   | $ | 13,848 |   | $ | 1,208 |   | $ | 15,056 |   |
|               |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Net  income (loss) |   | 757                                          |   | 47                                           |   | 804 |   | (6,496 | ) | (501 | ) | (6,997 | ) |
|               |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Total  assets      |   | 114,701                                      |   | 7,309                                        |   | 122,010 |   | 82,828 |   | 5,071 |   | 87,899 |   |
|                    |        |                                              |        |                                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 
|              |   | **Six  Months Ended********June 30, 2002** |   | **Six  Months Ended********June 30, 2001** |   |
|-------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|              |   | **United  States**                         |   | **International**                          |   | **Consolidated** |   | **United  States** |   | **International** |   | **Consolidated** |   |
|              |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Revenues          |   | $                                          | 36,048 |                                       | $      | 3,922 |   | $ | 39,970 |   | $ | 24,501 |   | $ | 2,372 |   | $ | 26,873 |   |
|              |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Net income (loss) |   | 365                                        |   | 201                                        |   | 566 |   | (15,131 | ) | (493 | ) | (15,624 | ) |
|              |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Total assets      |   | 114,701                                    |   | 7,309                                      |   | 122,010 |   | 82,828 |   | 5,071 |   | 87,899 |   |
|                   |        |                                            |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

**NOTE 9. LEGAL PROCEEDINGS**

 

Pursuantto the Agreement and Plan of Distribution, executed in connection with theSpin-Off (the “Agreement”), PracticeWorks agreed to assume any and allcontingent liability arising from the definitive resolution of the litigationfiled on June 21, 2000 against VitalWorks by Joseph Hafner in the United StatesDistrict Court in and for the Eastern District of Pennsylvania. The lawsuit wassettled by agreement among the litigants in February 2002, and all claimsagainst VitalWorks have been dismissed with prejudice and without admission ofliability or wrongdoing. Under the Agreement, PracticeWorks remained liable fora share of settlement costs over and above insurance coverage. PracticeWorksand VitalWorks have agreed on the final disposition and allocation of thatliability and the resolution was immaterial to the financial statements.

 

 

9

----

 

 

**NOTE 10. RECENT ACCOUNTING PRONOUNCEMENTS**

 

InJune 2001, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 141, “Business Combinations,” and No. 142, “Goodwill and OtherIntangible Assets.” SFAS No. 141 supercedes Accounting Principles BoardOpinion (“APB”) No. 16, “Business Combinations,” and eliminates thepooling of interests method of accounting for business combinations. SFASNo. 141 also changes the criteria for recognizing intangible assets apartfrom goodwill and states the following criteria should be considered indetermining the recognition of intangible assets: (1) whether theintangible asset arises from contractual or other rights, or (2) whetherthe intangible asset is separable or divisible from the acquired entity andcapable of being sold, transferred, licensed, returned or exchanged. TheCompany has adopted the provisions of SFAS No. 141 for businesscombinations consummated subsequent to June 30, 2001 and the remainingprovisions were adopted on January 1, 2002.

 

SFASNo. 142 supercedes APB No. 17, “Intangible Assets,” and requiresgoodwill and other acquired intangible assets that have an indefinite usefullife to no longer be amortized; however, these assets must undergo an initialtest of impairment and be reviewed for impairment at least annually thereafter.Concurrent with adoption of this Standard on January 1, 2002, the Companyceased the amortization of goodwill. The Company completed the initialimpairment test during the second quarter of 2002 and no impairment wasrecorded.  The Company will perform theannual impairment test as of October 1 of each year.

 

InOctober 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” which supercedes SFASNo. 121, “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to be Disposed Of.” SFAS No. 144 addresses financialaccounting and reporting for the impairment of long-lived assets and forlong-lived assets to be disposed of. SFAS No. 144 retains the fundamentalprovisions of SFAS No. 121 for: (1) recognition and measurement ofthe impairment of long-lived assets to be held and used; and(2) measurement of long-lived assets to be disposed of by sale. SFASNo. 144 is effective for fiscal years beginning after December 15,2001. The Company’s adoption of this Standard did not have an impact on itsfinancial statements.

 

InMay 2002, the FASB issued SFAS No. 145, “Rescission of FASB StatementsNo. 4, 44 and 64, Amendment of FASB Statement No. 13 andTechnical Corrections.” SFAS 145 rescinded SFAS No. 4 which requiredall gains and losses from extinguishment of debt to be aggregated and, ifmaterial, classified as an extraordinary item, net of related income taxeffect. As a result, the criteria in Opinion 30 will now be used toclassify these gains and losses. The Company adopted this Standard effectiveApril 1, 2002.  The Company recorded debtextinguishment costs in conjunction with the repayment of the credit facilitywith FINOVA (see Note 6) in accordance with this Standard.

 

                    In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and nullified EITF Issue No. 94-3. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No 94-3 had recognized the liability at the commitment date to an exit plan. The Company is required to adopt the provisions of SFAS 146 effective for exit or disposal activities initiated after December 31, 2002. The Company is currently evaluating the impact of the adoption of this statement.

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

 

**OVERVIEW**

 

PracticeWorks, Inc.(“PracticeWorks” or “we”) is a provider of software-based informationtechnology systems and related services for dentists, orthodontists and oraland maxillofacial surgeons. Our offerings include practice managementapplications, recently-introduced cosmetic imaging and digital radiographysystems, ongoing maintenance, support, and training, and internet-basedservices, including electronic data interchange, or EDI, services,business-to-business e-commerce services, and website development and hosting.These applications and services are designed to automate the provider’spractice, resulting in greater efficiency, lower costs and higher quality care.As of June 30, 2002, we had an installed base of approximately 72,000providers, including 52,000 dentists, 5,000 orthodontists and 4,000 oral andmaxillofacial surgeons in the United States and an additional 11,000 providersoutside the United States.

 

Priorto March 5, 2001, we operated as a division of VitalWorks Inc.(“VitalWorks”), formerly InfoCure Corporation. On March 5, 2001,VitalWorks completed the pro rata distribution (“Spin-Off”) of all of theoutstanding shares of PracticeWorks common stock to VitalWorks stockholders.

 

Asubstantial part of our growth has been achieved through acquisitions. FromJuly 10, 1997 through December 31, 2000, VitalWorks completed 18acquisitions that were attributed to us in the Spin-Off. Subsequent to theSpin-Off, we completed five acquisitions through June 30, 2002. Additionally,we acquired the dental imaging software technology formerly owned by DicomImaging Systems, Inc., and we became the preferred U.S. distributor forTrophy Dental, the leading manufacturer of dental digital radiography systemsand intra-oral X-ray equipment worldwide. In June 2002, we acquired a minority interest in PracticeWares, Inc.(“PracticeWares”), a dental supply company, and entered into a distributionagreement under which PracticeWares will offer its dental supplies to ourcustomers.

 

***Segment and Market Information***

 

Wehave previously reported our results from operations in two segments: recurringrevenues and non-recurring revenues. Concurrent with the adoption of SFASNo. 141 and No. 142, and the completion of an acquisition in theUnited Kingdom in January 2002, we have revised our segment reporting tomore closely align with how we manage and view our business. Our results fromoperations are now reported using two segments: U.S. and internationaloperations. The international operations include primarily Europe, and to amuch lesser extent, Australia and Canada.

 

10

----

 

 

Informationabout our operations by operating segment follows (in thousands):

 

 
|               |   | **Three  Months Ended********June 30, 2002** |   | **Three  Months Ended********June 30, 2001** |   |
|--------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|               |   | **United  States**                           |   | **International**                            |   | **Consolidated** |   | **United  States** |   | **International** |   | **Consolidated** |   |
|               |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Revenues           |   | $                                            | 19,033 |                                         | $      | 1,902 |   | $ | 20,935 |   | $ | 13,848 |   | $ | 1,208 |   | $ | 15,056 |   |
|               |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Net  income (loss) |   | 757                                          |   | 47                                           |   | 804 |   | (6,496 | ) | (501 | ) | (6,997 | ) |
|               |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Total  assets      |   | 114,701                                      |   | 7,309                                        |   | 122,010 |   | 82,828 |   | 5,071 |   | 87,899 |   |
|                    |        |                                              |        |                                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

 
|               |   | **Six  Months Ended********June 30, 2002** |   | **Six  Months Ended********June 30, 2001** |   |
|--------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|               |   | **United  States**                         |   | **International**                          |   | **Consolidated** |   | **United  States** |   | **International** |   | **Consolidated** |   |
|               |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Revenues           |   | $                                          | 36,048 |                                       | $      | 3,922 |   | $ | 39,970 |   | $ | 24,501 |   | $ | 2,372 |   | $ | 26,873 |   |
|               |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Net  income (loss) |   | 365                                        |   | 201                                        |   | 566 |   | (15,131 | ) | (493 | ) | (15,624 | ) |
|               |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Total  assets      |   | 114,701                                    |   | 7,309                                      |   | 122,010 |   | 82,828 |   | 5,071 |   | 87,899 |   |
|                    |        |                                            |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

**Consolidated Results of Operations**

 

**Three and Six Months Ended June 30, 2002 Compared to Threeand Six Months Ended June 30, 2001**

 

***Revenues (Dollars in thousands)***

*** ***
|          |   |                            |   |                          |   |     |   |         |   |       |   |        |   |     |   |         |   |     |   |         |   |       |   |        |       |
|---------------|--------|---------------------------------|--------|-------------------------------|--------|----------|--------|--------------|--------|------------|--------|-------------|--------|----------|--------|--------------|--------|----------|--------|--------------|--------|------------|--------|-------------|------------|
|          |   | **Three months ended June 30,** |   | **Six months ended June 30,** |   |
|          |   |                            |   | **Percent**                   |   |     |   | **Percent**  |   | **Dollar** |   | **Percent** |   |     |   | **Percent**  |   |     |   | **Percent**  |   | **Dollar** |   | **Percent** | ** ** |
|          |   | **2002**                        |   | **of total**                  |   | **2001** |   | **of total** |   | **change** |   | **change**  |   | **2002** |   | **of total** |   | **2001** |   | **of total** |   | **change** |   | **change**  |       |
|          |   |                            |   |                          |   |     |   |         |   |       |   |        |   |     |   |         |   |     |   |         |   |       |   |        |       |
| Recurring     |   | $                               | 13,644 |                          | 65.2   | **%**    | $      | 10,415       |   | 69.2       | %      | $           | 3,229  |     | 31.0   | %            | $      | 26,875   |   | 67.2         | %      | $          | 18,650 |        | 69.4       | % | $ | 8,225 |   | 44.1 | % |
| Non-recurring |   | 7,291                           |   | 34.8                          |   | 4,641    |   | 30.8         |   | 2,650      |   | 57.1        |   | 13,095   |   | 32.8         |   | 8,223    |   | 30.6         |   | 4,872      |   | 59.2        |       |
| Total         |   | $                               | 20,935 |                          | 100.0  | %        | $      | 15,056       |   | 100.0      | %      | $           | 5,879  |     | 39.0   |         | $      | 39,970   |   | 100.0        | %      | $          | 26,873 |        | 100.0      | % | $ | 13,097 |   | 48.7 |   |

 

*Total Revenues.*    Total revenues for the three months ended June30, 2002 increased as a result of organic growth of $5.4 million andrevenues of $500,000 attributable to acquisitions completed in the thirdquarter of 2001 and the first quarter of 2002. Total revenues for the six months ended June 30, 2002 increased as aresult of organic growth of $9.1 million and revenues of $4.0 millionattributable to acquisitions, consisting primarily of $2.4 million relatedto the InfoSoft acquisition completed in the first quarter of 2001.

 

*Recurring Revenues.*    Recurring revenues are derived from contractualarrangements for maintenance and support services and subscriptions to oursoftware and support and from electronic services. Recurring revenues for thethree months ended June 30, 2002 increased primarily as a result of increasedelectronic services revenue of $1.5 million, increased subscription revenueof $900,000 and increased maintenance revenue of $880,000. The increases insubscriptions and electronic services revenues for the three months ended June30, 2002 are largely volume related and include the effects of increasednumbers of upgrade and new customers entering into subscription agreements andexpansion of e-services offered to existing customers. The increase inmaintenance revenue is attributable equally to acquisitions and organic growth.

 

Recurringrevenues for the six months ended June 30, 2002 increased primarily as a resultof increased electronic services revenue of $4.2 million, which includes$1.3 million attributable to acquisitions, increased subscription revenueof $1.7 million and increased maintenance revenue of $2.3 million. Theincreases in subscriptions and electronic services revenues for the six monthsended June 30, 2002 are largely volume related and include the effects ofincreased numbers of upgrade and new customers entering into subscriptionagreements and expansion of e-services offered to existing customers. Theincrease in maintenance revenue is largely acquisition related.

 

*Non-recurring Revenues.*    Non-recurring revenues include one-time sales oflicenses and systems, and fees for training and implementation services. Non-recurringrevenues for the three months ended June 30, 2002 increased primarily as aresult of our new digital imaging product offerings including related hardwareand, to a lesser extent, increases in training and implementation revenues.  These increases are attributable to growthin our basic business as existing and new customers avail themselves of our newproduct offerings and continue to implement our core practice managementapplications, primarily by subscription.

 

Non-recurringrevenues for the six months ended June 30, 2002 increased as a result ofrelatively comparable increases in training and implementation revenues andsoftware sales attributable to growth in our basic business as existing and newcustomers implement our core practice management applications, primarily bysubscription. Revenue growth was also influenced by increased demand during thefirst quarter of 2002 from orthodontic customers and increased demand duringthe second quarter of 2002 for our new digital imaging product offerings.

 

 

11

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***Costs and Expenses (Dollars in thousands)***

 

 
|                                                |   | **Three months ended June 30,** |   | **Six months ended June 30,** |   |
|-----------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                |   |                            |   | **Percent**                   |   |   |   | **Percent** |   | **Dollar** |   | **Percent** |   |   |   | **Percent** |   |   |   | **Percent** |   | **Dollar** |   | **Percent** |   |
|                                                |   | **2002**                        |   | **of sales**                  |   | **2001** |   | **of sales** |   | **change** |   | **change** |   | **2002** |   | **of sales** |   | **2001** |   | **of sales** |   | **change** |   | **change** |   |
|                                                |   |                            |   |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchases for resale                                |   | $                               | 3,850  |                          | 18.4   | % | $ | 1,914 |   | 12.7 | % | $ | 1,936 |   | 101.1 | % | $ | 6,860 |   | 17.2 | % | $ | 3,361 |   | 12.5 | % | $ | 3,499 |   | 104.1 | % |
| Selling, general and administrative                 |   | 12,433                          |   | 59.4                          |   | 12,324 |   | 81.9 |   | 109 |   | 0.9 |   | 25,259 |   | 63.2 |   | 22,536 |   | 83.9 |   | 2,723 |   | 12.1 |   |
| Research and development                            |   | 848                             |   | 4.1                           |   | 301 |   | 2.0 |   | 547 |   | 181.7 |   | 1,927 |   | 4.8 |   | 1,027 |   | 3.8 |   | 900 |   | 87.6 |   |
| Amortization of goodwill                            |   | —                          |   | —                        |   | 5,946 |   | 39.5 |   | (5,946 | ) | (100.0 | ) | — |   | — |   | 10,682 |   | 39.7 |   | (10,682 | ) | (100.0 | ) |
| Depreciation and  amortization of other intangibles |   | 1,838                           |   | 8.8                           |   | 1,017 |   | 6.8 |   | 821 |   | 80.7 |   | 3,479 |   | 8.7 |   | 1,595 |   | 5.9 |   | 1,884 |   | 118.1 |   |
| Restructuring and other non-recurring charges       |   | (224                            | )      | (1.1                          | )      | 64 |   | 0.4 |   | (288 | ) | (450.0 | ) | (143 | ) | (0.4 | ) | 2,184 |   | 8.1 |   | (2,327 | ) | (106.5 | ) |
| Total interest expense                              |   | 1,386                           |   | 6.6                           |   | 487 |   | 3.2 |   | 899 |   | 184.6 |   | 2,022 |   | 5.1 |   | 1,112 |   | 4.1 |   | 910 |   | 81.8 |   |
|                                                     |        |                                 |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

*Purchases for Resale.*    Purchases for resale include costs ofprocessing, forms and postage for EDI claims and statements and otherelectronic services, purchases of hardware, outsourced hardware maintenance,third-party software and other items for resale in connection with the sales ofnew systems and software. Purchases for resale for the three months ended June30, 2002, compared to the three months ended June 30, 2001, increased primarilydue to the growth in electronic services, and, to a slightly lesser extent,increased costs related to new digital radiography product offerings. As apercentage of sales, purchases for resale increased primarily as a result of achange in revenue mix reflecting increased electronic services and our newimaging product offerings.

 

Similarly,purchases for resale for the six months ended June 30, 2002, compared to thesix months ended June 30, 2001, increased primarily due to the growth inelectronic services, and, to a slightly lesser extent, increased hardware costsrelated to new cosmetic imaging and digital radiography product offerings. As apercentage of sales, purchases for resale increased primarily as a result of achange in revenue mix reflecting increased electronic services and our newimaging product offerings.

 

*Selling, General and Administrative,or SG&A.*    SG&Aexpense includes salaries and benefits, product maintenance and support,variable commissions and bonuses, marketing, travel, communications,facilities, insurance and other administrative expenses. SG&A expenseexcludes research and development, depreciation and amortization, restructuringand non-recurring charges. SG&A expense for the three months ended June 30,2002, compared to the three months ended June 30, 2001, increased primarily dueto overall growth in the business including the net effect of acquisitions thatincreased personnel costs $313,000 and facility costs $102,000.  Bank charges increased $102,000 reflectingincreased volume and increased use of customer credit card billings. Theseincreases were offset by a decrease in bad debt expense of $330,000 due toimproved cash collections and accounts receivable management and decreasedcommission expense of $127,000 related to the termination of certain VARarrangements during 2001.

 

SG&A expense for the sixmonths ended June 30, 2002, compared to the six months ended June 30, 2001,increased primarily due to personnel costs of $1.9 million and facility costsof $473,000, both attributable primarily to acquisitions and net ofrestructuring efforts. We also incurred increased marketing and advertisingcosts of $380,000 related in part to the continuation of the PracticeWorksbranding campaign, new product introductions and attendance at industry tradeshows and increased bank charges of $335,000 from monthly customer credit cardbillings, offset by a decrease in bad debt expense of $847,000 due to improvedcash collections and accounts receivable management and decreased travel of$113,000 as a result of the 2001 restructuring.

 

*                Research and Development.*    Research and development expense consistsprimarily of salaries and benefits, supplies, facilities and otheradministrative expenses associated with ongoing programs that focus onadvancing our core practice management applications and other technologies,developing new products, and enhancing the quality and performance of ourclassic products. Research and development expense increased for the threemonths ended June 30, 2002, compared to the same period in 2001, primarily dueto an increase in the number of supported products resulting from acquisitions.Excluding acquired capitalized software costs, software costs capitalized forthe three months ended June 30, 2002 totaled $401,000 and for the three monthsended June 30, 2001 totaled $430,000.

 

Similarly,research and development expense increased for the six months ended June 30,2002, compared to the same period in 2001, primarily due to an increase in thenumber of supported products resulting from acquisitions. Excluding acquiredcapitalized software costs, software costs capitalized for the six months endedJune 30, 2002 totaled $792,000 and for the six months ended June 30, 2001totaled $546,000.

 

Wecapitalize development costs incurred from the time a new product reachestechnological feasibility until it is available for general release. The higherlevel of capitalized costs in 2002 compared to 2001 reflects the increase inthe number of supported products and the state of development of a variety ofprojects, including new electronic services applications and major upgrade versionsof several practice management applications that are part of our core productofferings.

 

*                Depreciation and Amortization of OtherIntangibles.*    Depreciationand amortization of other intangibles increased for the three and six

 

 

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months ended June 30,2002, compared to the three and six months ended June 30, 2001, due principallyto $645,000 and $1.5 million, respectively, in amortization of acquiredtechnology and capitalized software development costs, and $202,000 and$458,000, respectively, in depreciation of acquired and purchased fixed assets.Amortization of goodwill ceased as of January 1, 2002 but was $5.9 millionand $10.7 million for the three and six months ended June 30, 2001,respectively.

 

*                Restructuring and Other Non-recurringCharges.*    Inthe three months ended June 30, 2002, we recorded a reduction in restructuringand other non-recurring charges of $224,000 primarily related to thenegotiation to terminate the lease of a closed facility, and for the threemonths ended June 30, 2001, we incurred approximately $698,000 in non-recurringcharges relating primarily to professional fees, printing and similar costs inconnection with the completion of the spin-off from VitalWorks, offset by areduction in restructuring costs of $264,000 related to the negotiation toterminate the lease of a closed facility and $370,000 reduction in severanceand other termination benefits resulting from the early departure of employeeseligible to receive these payments.

 

Inthe six months ended June 30, 2002, we recorded a reduction in restructuringand other non-recurring charges of $143,000 primarily related to thenegotiation during the second quarter of 2002 to terminate the lease of aclosed facility, and for the six months ended June 30, 2001, we incurredapproximately $3.1 million in non-recurring charges relating primarily toprofessional fees, printing and similar costs in connection with the completionof the spin-off from VitalWorks, offset by a reduction in restructuring costsof $944,000 related to the negotiation to terminate various leases of closedfacilities and reduction in severance and other termination benefits resultingfrom the early departure of employees eligible to receive these payments.

 

*                Debt Extinguishment Costs. *Inconjunction with our recently completed offering and the extinguishment of ourcredit facility, we recorded a charge of $889,000 to write-off the carryingvalue of our unamortized loan costs.

 

*                Interest Expense.*    Interest expense for the three and six monthsended June 30, 2002 remained consistent compared to the same periods of 2001 asthe effect of slight increases in the average outstanding debt in 2002 wereoffset by decreases in the prime interest rate.

 

*                Income Taxes.*    For all periods presented we did not record aprovision for income taxes.  For thethree and six months ended June 30, 2002, we generated pre-tax income forfinancial reporting purposes of approximately $804,000 and $566,000 and netoperating losses, or NOLs, for tax purposes of approximately $1.2 millionand $2.8 million, respectively. The financial reporting results differ fromthose for tax purposes primarily due to book versus tax differences in goodwillamortization and depreciation. The effective income tax rate for this perioddiffered from the statutory rate due to state income taxes and the recognitionof a deferred income tax asset valuation allowance. At June 30, 2002 we haveNOL carryforwards totaling $34.0 million that will be available to offsetfuture taxable income. These NOLs expire at various times through 2022.

 

                Our deferred tax assets at June 30, 2002relating to temporary differences were approximately $5.4 million. Totaldeferred tax assets at June 30, 2002, including the NOL carryforwards andtemporary differences in the book and tax bases of assets and liabilitiesaggregate $18.7 million. As of June 30, 2002, we had recorded a totaldeferred income tax asset valuation allowance of approximately$13.3 million to reduce the total deferred tax assets to the amount thatwe believe is more likely than not to be realized.

 

                We reported net deferred tax assets atJune 30, 2002 of approximately $5.4 million, essentially representingamounts attributable to us based solely on reversing temporary differences asrecorded by VitalWorks through the spin-off date. We have prepared projectionsthat indicate that our NOLs would be absorbed prior to their expiration.However, we have not recorded the benefit of the NOL utilization in thefinancial statements since projections over multiple years are inherentlyimprecise. Management believes that it is more likely than not that theunreserved portion of our deferred tax assets will be realized based on ourfinancial projections, sales backlog, continued quarter-over-quarteroperational improvements across all business lines for each of the fiscalquarters of 2001 and 2002, and available tax strategies. These factors indicatewe will generate taxable income within the next one to two years sufficient torealize the tax benefits represented by these future deductible temporarydifferences.

 

*                Net Income (Loss).*    As a result of the foregoing, we had net incomeof $804,000 and $566,000 for the three and six months ended June 30, 2002,compared to a net loss of $7.0 million and $15.6 million for the three andsix months ended June 30, 2001, respectively.

 

*                Accrued and Accretive Dividends onPreferred Stock.*    Forthe three months ended June 30, 2002, we recorded accrued and accretivedividends related to the series A convertible redeemable preferred stockof $867,000 to recognize the 6.5% dividend and amortization of the$11.0 million estimated valuation discount, as compared to $1.1 millionfor the three months ended June 30, 2001. Additionally, during the three monthsended June 30, 2002 we recorded a charge of $7.6 million as a result of theredemption of all of our series A convertible redeemable preferred stock.  For the three months ended June 30, 2002, werecorded accrued and accretive dividends of $156,000 related to theseries B convertible redeemable preferred stock that was not outstandingduring the three months ended June 30, 2001. For the three months ended June30, 2002, we recorded accretive dividends of $88,000 related to theseries C convertible redeemable preferred stock, as compared to $247,000for the three months ended June 30, 2001.

 

Forthe six months ended June 30, 2002, we recorded accrued and accretive dividendsrelated to the series A convertible redeemable preferred stock of$1.9 million to recognize the 6.5% dividend and amortization of the$11.0 million estimated valuation discount, as compared to $1.4 millionfor the six months ended June 30, 2001. Additionally, during the three monthsended June 30, 2002 we recorded a charge of $7.6 million as a result of theredemption of all of our series A convertible redeemable preferred stock.  For the six months ended June 30, 2002, werecorded accrued and accretive dividends of $310,000 related to theseries B convertible redeemable preferred stock that was not outstandingduring the six months ended June 30, 2001. For the six months ended June 30,2002, we recorded accretive dividends of $308,000 related to the series Cconvertible redeemable preferred stock, as compared to $299,000 for the sixmonths ended June 30, 2001.  Theseries A and series C convertible preferred stock were eachoutstanding for approximately four months during the six-month period ended June30, 2001.

 

**Liquidity and Capital Resources**

 

                Our principal capital requirements havebeen to fund:

 

•acquisitions;

 

•workingcapital;

 

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•softwaredevelopment costs; and

 

•capitalexpenditures for furniture, fixtures and equipment.

 

                At June 30, 2002, following thesuccessful completion of our public offering, we had total cash and cashequivalents of $28.0 million and working capital of $15.0 million(including the effect of deferred revenue and customer deposits of$12.4 million). Net cash provided by operating activities was$3.3 million for the six months ended June 30, 2002, an improvement fromcash used in operating activities of $261,000 for the same period in 2001. Theimprovement in operating cash flow results from the growth in recurring revenueattributable to our change to a subscription pricing model, operating savingsattributable to the successful integration of the completed acquisitions andincreased growth of our business. Operating cash flow has been favorablyimpacted by the increased number of our customers’ transactions that are paidby credit card or automatic bank draft and from continued improvement in ouraccounts receivable collections, as evidenced by the decrease in days salesoutstanding from 40 at June 30, 2001 to 29 at June 30, 2002.

                For each of the periods presented, the majority of our cashused for investing has been for acquisitions. In the first quarter of 2002 we completed a small acquisition and fundedthe $2.6 million purchase price from proceeds of borrowings together withour current cash balance. Additionally in June 2002, we acquired a minorityinterest in PracticeWares for $1.0 million in cash and loaned this affiliate$3.5 million.  We expect to be repaidone half of this loan once PracticeWares enters into a financing arrangementwith a senior lender.  The remainder ofour investing activities have consisted of capital expenditures for equipment,software development costs and other intangibles. For the remainder of 2002 weexpect to incur capital expenditures of $1.4 million related to propertyand equipment and $800,000 related to capitalized software, and we plan to fundthese additions from operating cash flows.

 

                During 2002 our financing activitiesconsisted of the following:

 

•                  Completionof a public offering of our common stock raising approximately $63.9 millionnet of the underwriters’ discount and other offering expenses;

•                  Repaymentof the outstanding principal related to our credit facility of approximately$21.7 million;

•                  Redemptionof the series A convertible redeemable preferred stock.

 

During2001 our financing activities consisted primarily of the sale of our preferredstock, the proceeds of which were used to fund our acquisitions andoperations.  During the fourthquarter of 2001, FINOVA Capital Corporation, our primary lender, agreed todefer the scheduled principal payment that was originally due during the firstquarter of 2002. Principal payments of 5.0% per quarter commenced in the secondquarter of 2002.  We used $20.6 millionof proceeds from the public offering to repay all of the remaining outstandingprincipal under the facility in June 2002.

 

                We previously had three series ofpreferred stock outstanding.  Concurrent with the offering, we redeemed all of the outstandingseries A shares and accrued dividends for $15.0 million in cash, 967,742shares of our common stock and a warrant to purchase 450,000 shares of ourcommon stock. The series B shares have a liquidation preference of$5.2 million, accrue dividends at 6.0% per annum and are convertible intoour common stock at the then applicable conversion price (or approximately151,000 shares at June 30, 2002). The shares are redeemable at the option ofthe holder after August 8, 2006. In connection with the offering, CrescentInternational Limited (“Crescent”) holder of the series C preferredstock, converted the remaining 44,000 shares of the series C shares into339,932 shares of our common stock. Crescent had previously converted 56,000 shares into 432,641 shares ofour common stock.  There were no sharesof the series C preferred stock outstanding at June 30, 2002.

 

                Assuming our series B preferred stockissuance is not converted, our future contractual cash obligations, excludinginterest and dividends, are as follows:
|                      |   | **2002  (July-December)** |   | **2003** |   | **2004** |   | **2005** |   | **2006** |       |
|---------------------------|--------|---------------------------|--------|----------|--------|----------|--------|----------|--------|----------|------------|
| ***(In  thousands)***     |   |                      |   |     |   |     |   |     |   |     |       |
| Long-term debt            |   | $                         | 373    |     | $      | 866      |   | $        | 787    |     | $          | 169 |   | $ | 151 | ** ** |
| Capital lease obligations |   | 72                        |   | 93       |   | 29       |   | 2        |   | —   | ** ** |
| Operating leases          |   | 943                       |   | 1,609    |   | 1,501    |   | 1,243    |   | 1,184    | ** ** |
| Preferred stock           |   | —                    |   | —   |   | —   |   | —   |   | 5,199    | ** ** |
|                      |   |                      |   |     |   |     |   |     |   |     |       |
|                      |   |                      |   |     |   |     |   |     |   |     |       |
| Total                     |   | $                         | 1,388  |     | $      | 2,568    |   | $        | 2,317  |     | $          | 1,414 |   | $ | 6,534 | ** ** |
|                      |   |                      |   |     |   |     |   |     |   |     |       |

 

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

                In June 2001, the FASB issued SFASNo. 141, “Business Combinations,” and SFAS No. 142, “Goodwill andOther Intangible Assets,” effective for fiscal years beginning afterDecember 15, 2001.  The newStandards prohibit the use of the pooling of interests method of accounting forbusiness combinations initiated after June 30, 2001. Acquired intangibleassets will be required to be recognized apart from goodwill if the acquiredintangible assets meet certain criteria. Other intangible assets will continueto be amortized over their useful lives. Under the new standards, goodwill willno longer be amortized but will be subject to annual impairment tests.

 

                Pursuant to SFAS No. 142, we didnot amortize the goodwill generated from any acquisitions closed subsequent toJuly 1, 2001. Additionally, on January 1, 2002, we discontinued theamortization of the goodwill generated from acquisitions closed prior toJuly 1, 2001. For the three and six months ended June 30, 2001, goodwillamortization amounted to $5.9 million, or $0.65 per share, and $10.7million, or $1.20 per share respectively. As required by this new Standard, wecompleted the initial impairment test during the second quarter of 2002 and noimpairment was recorded.  We will performthe annual impairment test as of October 1 of each year.

 

 

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                In October 2001, the FASB issued SFASNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”,effective for fiscal years beginning after December 15, 2001. Thisstatement supercedes SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to Be Disposed of” and AccountingPrinciples Board (“APB”) Opinion No. 30, “Reporting the Results ofOperations - Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions” forsegments of a business to be disposed of. SFAS No. 144 retains therequirements of SFAS No. 121 relating to recognition and measurement of animpairment loss and resolves certain implementation issues resulting from SFASNo. 121. The adoption of this Standard did not have an impact on ourearnings and financial position.

 

                In May 2002, the FASB issued SFASNo. 145, “Recision of FASB Statements No. 4, 44 and 64,Amendment of FASB Statement No. 13 and Technical Corrections.”SFAS 145 rescinded SFAS No. 4 which required all gains and lossesfrom extinguishment of debt to be aggregated and, if material, classified as anextraordinary item, net of related income tax effect. As a result, the criteriain Opinion 30 will now be used to classify these gains and losses. Weadopted this Standard effective April 1, 2002. We recorded debt extinguishment costs of approximately $889,000 inconjunction with the repayment of the credit facility in accordance with thisStandard.

 

                    In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and nullified EITF Issue No. 94-3. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No. 94-3 had recognized the liability at the commitment date to an exit plan. We are required to adopt the provisions of SFAS 146 effective for exit or disposal activities initiated after December 31, 2002. We are currently evaluating the impact of the adoption of this statement.

 

 

**CAUTIONARY LANGUAGE REGARDING FORWARD-LOOKING STATEMENTS**

 

                This discussion contains forward-lookingstatements that reflect management’s current assumptions and estimates offuture performance, the development and timing of PracticeWorks’ release of newapplications and services, the rate of adoption of its new applications andservices by new and existing customers, its success in establishing businessrelationships, the growth of its business, and general economic conditions. Youcan find many of these statements by looking for words such as “believes,” “expects,”“anticipates,” “estimates,” “plans,” “intends” or similar expressions. Anyforward-looking statements are subject to risks, uncertainties and assumptionsthat may cause actual results and future trends to differ materially from thoseprojected, stated, or implied by the forward-looking statements. PracticeWorks’results and the accuracy of the forward-looking statements could be affected bymany factors, including, in particular, those discussed above and thosediscussed in the section entitled “Risk Factors” and elsewhere inPracticeWorks’ Annual Report on Form 10-K for the year endedDecember 31, 2001.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

                Our primary market risks include fluctuations in interestrates and variability in interest rate spread relationships, such as prime toLIBOR spreads.  Approximately$1.3 million of our outstanding debt at June 30, 2002  has variable rate interest based on LIBORplus 300 basis points.  The effect of ahypothetical one percentage point increase of this variable rate debt wouldresult in a decrease of approximately $13,000 in our annual pre-tax net incomeassuming no further changes in the amount of borrowings subject to variablerate interest from amounts outstanding at June 30, 2002. Our remaining debtoutstanding is non-interest bearing with imputed interest.  We do not trade in derivative financialinstruments.

 

                We also conduct operations in the UnitedKingdom, Sweden, Canada and Australia. Accordingly, we are subject to risk fromexchange rate fluctuations between such local currencies and the U.S. dollar.For the three and six months ended June 30, 2002, 9% and 10% of our totalrevenues, respectively, compared to 8% and 9% respectively for the comparableperiods of 2001, were earned outside the United States and collected in thelocal currency. Related operating expenses were also paid in such correspondinglocal currencies. PracticeWorks does not conduct any currency hedgingactivities.

 

                The financial statements of our non-U.S.subsidiaries are translated into U.S. dollars using current rates of exchange,with gains or losses included in the accumulated other comprehensive income(loss) account, a component of stockholder’s equity. As of June 30, 2002, we haverecorded a cumulative translation adjustment of $9,000.

 

                We have no off-balance sheetarrangements, investments or guarantees.

 

                The traded price of our common stockinfluences the valuation of stock option grants and the effects these grantshave on pro forma earnings disclosed in our financial statements. The stockprice also influences the computation of the dilutive effect of outstandingstock options to determine diluted earnings per share. The stock price alsoaffects our employees’ perceptions of various programs that involve our commonstock.

 

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

                From time to time, we are involved in various legalproceedings incident to the ordinary course of our business. We are not a partyto any legal proceedings which we believe are material, and we are unaware ofany contemplated material actions against us.

 

**ITEM 2. CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

On April 29, 2002, we issued 104,534 shares of commonstock to FINOVA Capital Corporation in connection with its exercise of warrantsto purchase common stock.  We believethis offering and sale is exempt from registration under Section 4(2) of the1933 Securities Act.  The purchaser isan “accredited investor” within the meaning of Rule 501 promulgated under theSecurities Act.  The certificatesrepresenting the shares contain a legend to the effect that such securitieswere not registered under the Securities Act and may not be transferred exceptpursuant to an effective registration statement or pursuant to an exemptionfrom such registration requirement.

 

 

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On June 13, 2002, we issued to Ceramco Inc., a subsidiary of DENTSPLYInternational, Inc., 967,742 shares of our common stock and a warrant topurchase 450,000 shares of common stock (subject to adjustment for dividends,reclassifications and combinations) in an exchange for cancellation of all32,000 shares of our Series A Convertible Preferred Stock outstanding.  The warrants may be exercised at any timeover a seven-year period ending June 13, 2009, at an exercise price of $15.50per share of common stock.  We believethis offering and sale is exempt from registration under Section 4(2) of the1933 Securities Act.  The purchaser isan “accredited investor” within the meaning of Rule 501 promulgated under theSecurities Act.  The certificatesrepresenting the shares and the warrants contain a legend to the effect thatsuch securities were not registered under the Securities Act and may not betransferred except pursuant to an effective registration statement or pursuantto an exemption from such registration requirement.

 

On June 12, 2002 the Company and selling stockholders closed anunderwritten public offering of 5,201,480 shares of our Common Stock (including678,454 shares pursuant to the underwriters’ exercise of its over-allotmentoption).  William Blair & Companywas the lead representative for the underwriters.  The shares were registered on a Registration Statement on FormS-3 filed with the Securities and Exchange Commission (“SEC”) and orderedeffective by the SEC on June 7, 2002 (Commission File No. 333-87650).

 

Of the 5,201,480 shares sold in the offering,4,428,454 were newly-issued shares sold by the Company and 773,026 shares weresold by the selling stockholders.  Theper share price of the public offering was $15.50 yielding gross proceeds of$80.6 million less underwriting discounts and commissions of $0.93 per share or$4.84 million.  The Company’s share ofthe underwriting discounts and commissions was $4.1 million.  In addition, the Company incurredapproximately $650,000 in expenses related to this offering, including expensesrelated to the selling stockholders’ sale of shares.  The Company’s net proceeds, after deducting underwritingdiscounts and commissions and offering expenses, was $63.9 million.  The Company used $20.9 million of its netproceeds to retire its line of credit, including accrued interest, with FINOVACapital and $15.0 million in payment of part of the consideration given to theholder of its Series A Convertible Preferred Stock in exchange for thecancellation of those shares. The Company used $1.0 million for a minorityinterest in PracticeWares, and used $3.5 million as an advance to this entity.

 

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

                None.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

                None.

 

**ITEM 5. OTHER INFORMATION**

 

                None.

 

**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

 

        (a)Exhibits:

 

99.           Certification pursuant to 18 U.S.C.Section 1350.

 

        (b)Reports on Form 8-K:

 

We filed a CurrentReport on Form 8-K dated April 4, 2002 reporting a change in our certifyingaccountants under Item 4.

 

We filed a Current Report on Form 8-K dated May 6, 2002 under Item 5reporting our press release announcing a public offering.

 

We filed a Current Report on Form 8-K dated June 12, 2002 under Item 5reporting the closing of our public offering.

 

 

**SIGNATURES**

 

                Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized on this 14thday of August, 2002.

 
|   | PRACTICEWORKS,  INC.                           |
|--------|------------------------------------------------|
|   |                                           |
|   | /s/  JAMES  K. PRICE                 |
|   | James  K. Price                                |
|   | *President and Chief Executive Officer*        |
|   | *(Principal Executive Officer)*                |
|   |                                           |
|   | */s/  *JAMES  A. COCHRAN             |
|   | James  A. Cochran                              |
|   | *Senior Vice President and*                    |
|   | *Chief Financial Officer*                      |
|   | *(Principal Financial and Accounting Officer)* |
|   |                                           |
|   |                                           |

 

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QuickLinksPART I. FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTSITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONSITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKPART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGSITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDSITEM 3. DEFAULTS UPON SENIOR SECURITIESITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 5. OTHER INFORMATIONITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

 

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