**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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** |
|--------|--------|----------------------------------------------------------------------------------------------|

 

**Forthe quarterly period ended September 30, 2002**

 

**or**

 

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

 

**For the transition periodfrom             to             .**

 

**Commission File Number: 001-16079**

 

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| **PracticeWorks,  Inc.**                                        |
|-----------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)          |
|                                                            |   |   |
| **Delaware**                                                    |   | **52-2259090** |
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification 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 check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý

 

The number of outstanding shares of the Registrant’s common stock, parvalue $.01 per share, was 17,687,772 as of November 11, 2002.

 

 

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**PRACTICEWORKS, INC.**

 

**INDEX TO CONTENTS**

 

**DESCRIPTION OF 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 |
|                                     | Item 4 — | Controls and Procedures |
| **PART II — Other Information**     |
|                                     | Item 1 — | Legal Proceedings |
|                                     | Item 2 — | Changes in Securities  and Use of Proceeds |
|                                     | Item 4 — | Submission of  Matters to a Vote of Security Holders |
|                                     | Item 6 — | Exhibits and  Reports on Form 8-K |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM1. FINANCIAL STATEMENTS**

 

**PRACTICEWORKS,INC.**

**UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
|                                                                                                                                                                                                                                                                                  |   | **September  30,  2002** |       | **December  31,  2001** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                                                                                                                                                                                                                                                  |   |                     | ** ** |                    | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                            |   |                     | ** ** |                    | ** ** |
| Current:                                                                                                                                                                                                                                                                              |   |                     |       |                    |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                                            |   | $                        | 28,785     |                    | $          | 6,555 |   |
| Accounts  receivable-trade, net of allowance of $594 and $1,408, respectively                                                                                                                                                                                                         |   | 6,792                    |       | 6,306                   |       |
| Other  receivables                                                                                                                                                                                                                                                                    |   | 1,696                    |       | 1,462                   |       |
| Deferred  income tax assets                                                                                                                                                                                                                                                           |   | 458                      |       | 632                     |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                                                                            |   | 1,705                    |       | 1,401                   |       |
| Total  current assets                                                                                                                                                                                                                                                                 |   | 39,436                   |       | 16,356                  |       |
| Property  and equipment, net of accumulated depreciation of $6,971 and $5,195,  respectively                                                                                                                                                                                          |   | 6,377                    |       | 7,123                   |       |
| Goodwill                                                                                                                                                                                                                                                                              |   | 48,784                   |       | 45,412                  |       |
| Other  intangible assets, net of accumulated amortization of $6,427 and $3,865,  respectively                                                                                                                                                                                         |   | 17,660                   |       | 17,462                  |       |
| Deferred  income tax assets                                                                                                                                                                                                                                                           |   | 4,967                    |       | 4,725                   |       |
| Investment  in and advances to affiliate                                                                                                                                                                                                                                              |   | 4,612                    |       | —                  |       |
| Other  assets                                                                                                                                                                                                                                                                         |   | 1,303                    |       | 215                     |       |
|                                                                                                                                                                                                                                                                                  |   | $                        | 123,139    |                    | $          | 91,293 |   |
|                                                                                                                                                                                                                                                                                  |   |                     |       |                    |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                                                        |   |                     | ** ** |                    | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                                                 |   |                     |       |                    |       |
| Accounts  payable                                                                                                                                                                                                                                                                     |   | $                        | 3,035      |                    | $          | 3,010 |   |
| Accrued  expenses                                                                                                                                                                                                                                                                     |   | 4,831                    |       | 6,768                   |       |
| Accrued  restructuring costs                                                                                                                                                                                                                                                          |   | 358                      |       | 845                     |       |
| Deferred  revenue and customer deposits                                                                                                                                                                                                                                               |   | 11,350                   |       | 12,476                  |       |
| Current  portion of long-term debt                                                                                                                                                                                                                                                    |   | 1,150                    |       | 4,379                   |       |
| Total  current liabilities                                                                                                                                                                                                                                                            |   | 20,724                   |       | 27,478                  |       |
| Long-term  debt, less current portion                                                                                                                                                                                                                                                 |   | 2,583                    |       | 20,258                  |       |
| Other  liabilities                                                                                                                                                                                                                                                                    |   | 732                      |       | —                  |       |
| Total  liabilities                                                                                                                                                                                                                                                                    |   | 24,039                   |       | 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 $367 and $126 and is net of  $1,155 and $1,380 unamortized discount |   | 4,412                    |       | 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, 17,687,622 and 11,022,743  issued and outstanding                                                                                                                                                                              |   | 177                      |       | 110                     |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                           |   | 117,775                  |       | 35,518                  |       |
| Deferred  compensation                                                                                                                                                                                                                                                                |   | (758                     | )          | (821                    | )          |
| Accumulated  deficit                                                                                                                                                                                                                                                                  |   | (22,579                  | )          | (25,428                 | )          |
| Accumulated  other comprehensive income (loss)                                                                                                                                                                                                                                        |   | 73                       |       | (25                     | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                      |   | 94,688                   |       | 9,354                   |       |
|                                                                                                                                                                                                                                                                                  |   |                     |       |                    |       |
|                                                                                                                                                                                                                                                                                  |   | $                        | 123,139    |                    | $          | 91,293 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

 

3

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**PRACTICEWORKS,INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**ANDCOMPREHENSIVE INCOME (LOSS)**

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

 
|                                                                   |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                   |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Revenues:                                                              |   |                                   |   |                                  |   |   |   |   |   |
| Recurring                                                              |   | $                                      | 13,920 |                                  | $      | 11,395 |   | $ | 40,795 |   | $ | 30,045 |   |
| Non-recurring                                                          |   | 7,087                                  |   | 4,810                                 |   | 20,182 |   | 13,033 |   |
| Total  revenues                                                        |   | 21,007                                 |   | 16,205                                |   | 60,977 |   | 43,078 |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Operating  expenses:                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Purchases  for resale                                                  |   | 3,968                                  |   | 2,714                                 |   | 10,828 |   | 6,075 |   |
| Selling,  general and administrative                                   |   | 12,295                                 |   | 12,092                                |   | 37,554 |   | 34,628 |   |
| Research  and development                                              |   | 698                                    |   | 494                                   |   | 2,625 |   | 1,521 |   |
| Amortization  of goodwill                                              |   | —                                 |   | 6,026                                 |   | — |   | 16,708 |   |
| Depreciation  and amortization of other intangibles                    |   | 1,860                                  |   | 1,391                                 |   | 5,339 |   | 2,986 |   |
| Restructuring  and other non-recurring (credits) charges               |   | —                                 |   | —                                |   | (143 | ) | 2,184 |   |
| Total  operating expenses                                              |   | 18,821                                 |   | 22,717                                |   | 56,203 |   | 64,102 |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Operating  income (loss)                                               |   | 2,186                                  |   | (6,512                                | )      | 4,774 |   | (21,024 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Other  (income) expense:                                               |   |                                   |   |                                  |   |   |   |   |   |
| Interest  income                                                       |   | (192                                   | )      | (12                                   | )      | (235 | ) | (41 | ) |
| Interest  expense                                                      |   | 95                                     |   | 690                                   |   | 1,271 |   | 1,831 |   |
| Other  interest expense - debt extinguishment costs                    |   | —                                 |   | —                                |   | 889 |   | — |   |
| Total  other (income) expense:                                         |   | (97                                    | )      | 678                                   |   | 1,925 |   | 1,790 |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Net  income (loss)                                                     |   | 2,283                                  |   | (7,190                                | )      | 2,849 |   | (22,814 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Dividends:                                                             |   |                                   |   |                                  |   |   |   |   |   |
| Accrued  and accretive preferred stock dividends                       |   | 157                                    |   | 1,397                                 |   | 2,711 |   | 3,047 |   |
| Deemed  dividend related to redemption of series A preferred stock     |   | —                                 |   | —                                |   | 7,625 |   | — |   |
| Total  dividends                                                       |   | 157                                    |   | 1,397                                 |   | 10,336 |   | 3,047 |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Net  income (loss) available to common stockholders                    |   | $                                      | 2,126  |                                  | $      | (8,587 | ) | $ | (7,487 | ) | $ | (25,861 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Comprehensive  income (loss):                                          |   |                                   |   |                                  |   |   |   |   |   |
| Net  income (loss)                                                     |   | $                                      | 2,283  |                                  | $      | (7,190 | ) | $ | 2,849 |   | $ | (22,814 | ) |
| Foreign  currency translation adjustments                              |   | 81                                     |   | 261                                   |   | 97 |   | (119 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Total  comprehensive income (loss)                                     |   | $                                      | 2,364  |                                  | $      | (6,929 | ) | $ | 2,946 |   | $ | (22,933 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| **Per share data:**                                                    |   |                                   |   |                                  |   |   |   |   |   |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Net  income (loss):                                                    |   |                                   |   |                                  |   |   |   |   |   |
| Basic                                                                  |   | $                                      | 0.13   |                                  | $      | (0.78 | ) | $ | 0.20 |   | $ | (2.54 | ) |
| Diluted                                                                |   | 0.12                                   |   | (0.78                                 | )      | 0.19 |   | (2.54 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Dividends:                                                             |   |                                   |   |                                  |   |   |   |   |   |
| Basic  and diluted                                                     |   | (0.01                                  | )      | (0.15                                 | )      | (0.74 | ) | (0.34 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Net  income (loss) available to common stockholders:                   |   |                                   |   |                                  |   |   |   |   |   |
| Basic                                                                  |   | 0.12                                   |   | (0.93                                 | )      | (0.54 | ) | (2.88 | ) |
| Diluted                                                                |   | 0.11                                   |   | (0.93                                 | )      | (0.54 | ) | (2.88 | ) |
|                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Weighted  average shares outstanding used in computing per share data: |   |                                   |   |                                  |   |   |   |   |   |
| Basic                                                                  |   | 17,624                                 |   | 9,215                                 |   | 13,956 |   | 8,978 |   |
| Diluted                                                                |   | 19,269                                 |   | 9,215                                 |   | 15,356 |   | 8,978 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

 

4

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**PRACTICEWORKS,INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(INTHOUSANDS, EXCEPT SHARE AMOUNTS)**

 
|                                                                                                            |   | **Nine  Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                            |   | **2002**                              |   | **2001** |   |
|                                                                                                            |   |                                  |   |   |   |
| CASH  PROVIDED BY (USED IN) OPERATING ACTIVITIES:                                                               |   |                                  |   |   |   |
| Net  income (loss)                                                                                              |   | $                                     | 2,850  |   | $ | (22,814 | ) |
| Adjustments  to reconcile net income (loss) to cash provided by (used in) operating  activities:                |   |                                  |   |   |   |
| Restructuring  and other non-recurring charges                                                                  |   | —                                |   | (944 | ) |
| Depreciation  and amortization                                                                                  |   | 6,721                                 |   | 19,884 |   |
| Provision  for doubtful accounts                                                                                |   | (50                                   | )      | 797 |   |
| Other                                                                                                           |   | (68                                   | )      | — |   |
| Changes  in current assets and liabilities, net of acquisitions:                                                |   |                                  |   |   |   |
| Trade  and other receivables                                                                                    |   | (1,095                                | )      | 698 |   |
| Prepaid  expenses and other current assets                                                                      |   | (290                                  | )      | (126 | ) |
| Accounts  payable and accrued expenses                                                                          |   | (1,522                                | )      | 2,610 |   |
| Deferred  revenue and customer deposits                                                                         |   | (1,111                                | )      | (356 | ) |
| Cash  provided by (used in) operating activities                                                                |   | 5,435                                 |   | (251 | ) |
|                                                                                                            |   |                                  |   |   |   |
| CASH  USED IN INVESTING ACTIVITIES:                                                                             |   |                                  |   |   |   |
| Cash  paid for acquisitions                                                                                     |   | (3,335                                | )      | (3,893 | ) |
| Property  and equipment expenditures                                                                            |   | (1,304                                | )      | (1,330 | ) |
| Cash  paid for intangible assets                                                                                |   | (1,952                                | )      | (1,523 | ) |
| Investment  in and advances to affiliate                                                                        |   | (4,616                                | )      | — |   |
| Other                                                                                                           |   | (147                                  | )      | 9 |   |
| Cash used  in investing activities                                                                              |   | (11,354                               | )      | (6,737 | ) |
|                                                                                                            |   |                                  |   |   |   |
| CASH  PROVIDED BY FINANCING ACTIVITIES:                                                                         |   |                                  |   |   |   |
| Proceeds  from issuance of common stock, net                                                                    |   | 63,788                                |   | 1,410 |   |
| Principal  payments on long-term debt                                                                           |   | (22,653                               | )      | (114 | ) |
| Redemption  of series A preferred stock                                                                         |   | (15,000                               | )      | — |   |
| Borrowings  of long-term debt                                                                                   |   | 1,282                                 |   | — |   |
| Proceeds  from exercise of stock options and warrants                                                           |   | 791                                   |   | — |   |
| Proceeds  from sale of series C convertible redeemable preferred stock, net                                     |   | —                                |   | 4,741 |   |
| Net cash  advances from VitalWorks Inc.                                                                         |   | —                                |   | 344 |   |
| Payment  of loan costs                                                                                          |   | —                                |   | (183 | ) |
| Other                                                                                                           |   | (13                                   | )      | — |   |
| Cash  provided by financing activities                                                                          |   | 28,195                                |   | 6,198 |   |
|                                                                                                            |   |                                  |   |   |   |
| Effect  of exchange rate changes on cash and cash equivalents                                                   |   | (46                                   | )      | (11 | ) |
|                                                                                                            |   |                                  |   |   |   |
| Net  increase (decrease) in cash and cash equivalents                                                           |   | 22,230                                |   | (801 | ) |
| Cash and  cash equivalents, beginning of period                                                                 |   | 6,555                                 |   | 3,979 |   |
| Cash and  cash equivalents, end of period                                                                       |   | $                                     | 28,785 |   | $ | 3,178 |   |
|                                                                                                            |   |                                  |   |   |   |
|                                                                                                            |   |                                  |   |   |   |
| NONCASH  INVESTING AND FINANCING TRANSACTIONS:                                                                  |   |                                  |   |   |   |
| Issuance  of common stock and warrant for redemption of series A preferred stock                                |   | $                                     | 19,053 |   | $ | — |   |
| Issuance  of PracticeWorks common stock for acquisitions                                                        |   | 1,502                                 |   | 2,080 |   |
| Issuance  of VitalWorks common stock for acquisitions                                                           |   |                                  |   | 2,297 |   |
| Issuance  of PracticeWorks common stock to settle obligations                                                   |   | 900                                   |   |   |   |
| Issuance  of notes payable for acquisitions                                                                     |   | 336                                   |   | 771 |   |
| Issuance  of series A convertible redeemable preferred stock for InfoSoft acquisition,  net of discount         |   | —                                |   | 21,000 |   |
| Issuance  of series B convertible redeemable preferred stock for Medical Dynamics  acquisition, net of discount |   | —                                |   | 3,812 |   |
| 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                                                                                                  |   | $                                     | 1,066  |   | $ | 648 |   |

 

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.On March 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 PracticeWorksor the Company means PracticeWorks, a division of VitalWorks, for periods priorto the Spin-Off, and PracticeWorks, Inc. for periods after the Spin-Off.

 

The information presented at September 30,2002, and for the three and nine months ended September 30, 2002 and 2001 isunaudited, however, in the opinion of management, it includes all normalrecurring adjustments necessary for a fair presentation of the consolidatedfinancial position, results of operations and cash flows of PracticeWorks forthe periods presented. All significant intercompany balances and transactionshave been eliminated in consolidation. The results of operations for the threeand nine month periods ended September 30, 2002 are not necessarily indicativeof the results to be expected for the full year. Certain information infootnote disclosures normally included in annual financial statements preparedin accordance with  accounting principles generally accepted in the UnitedStates has been condensed or omitted pursuant to the rules and regulations ofthe Securities and Exchange Commission. The condensed consolidated financialstatements, notes thereto and other information should be read in conjunctionwith the historical consolidated financial statements and related notes theretoincluded in PracticeWorks Annual Report on Form 10-K for the year endedDecember 31, 2001 (the “Form 10-K”). The results of operations forthe period from January 1, 2001 through March 5, 2001 are not reflectiveof PracticeWorks 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**

 

Asreported in the Form 10-K, the Company completed four acquisitions in 2001. Theaggregate consideration for such acquisitions was approximately$37.5 million, consisting of PracticeWorks series A and B convertibleredeemable preferred stock valued at $24.8 million, $5.5 million incash, $2.6 million in notes payable, $2.3 million in PracticeWorkscommon stock, and $2.3 million in VitalWorks common stock. The Companyrecorded total goodwill of $34.7 million.

 

InJanuary 2002, the Company completed an acquisition with aggregate cashconsideration of approximately $2.2 million, including approximately$100,000 in transaction costs. The results of the acquired operations have beenincluded in the Company’s results of operations since the date of acquisition.This acquisition added approximately 700 providers to the customer base in theUnited Kingdom. The Company identified and assigned a preliminary value anduseful 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.

 

Thefollowing unaudited pro forma information presents the results of operations ofthe Company as if the material acquisitions had occurred as of the beginning ofeach of the periods presented. The pro forma information is not necessarilyindicative of what would have occurred had the acquisitions been made as ofsuch periods, nor is it indicative of future results of operations. The proforma amounts give effect to appropriate adjustments for the fair value of theassets acquired, amortization of intangibles, interest expense and incometaxes.

 
| **(In thousands, except per share data)**                              |   | **Nine Months  Ended  September 30,  2001** |   |
|------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                   |   |                                        |   |
| PRO FORMA AMOUNTS                                                      |   |                                        |   |
|                                                                   |   |                                        |   |
| Revenues                                                               |   | $                                           | 44,452 |   |
|                                                                   |   |                                        |   |
| Net loss                                                               |   | (23,907                                     | )      |
|                                                                   |   |                                        |   |
| Net loss available to common stockholders                              |   | (27,667                                     | )      |
|                                                                   |   |                                        |   |
| Net loss available to common stockholders per  share basic and diluted |   | (3.08                                       | )      |
|                                                                        |        |                                             |        |  |

 

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 RecentAccounting Pronouncements), the Company ceased the amortization of goodwill.Had this Standard been applicable to the prior periods presented herein,amortization of goodwill would have been reduced by $6.0 million and$16.7 million for the three and nine months ended September 30, 2001,respectively. The following table presents net loss and net loss available tocommon stockholders together with applicable earnings per share information asif the new accounting standard had been adopted as of the dates presented.Additionally, the table presents a reconciliation of these adjusted amounts tothe amounts previously reported.

 
|                                                    |   | **Three  Months Ended  September 30, 2001** |   | **Nine  Months Ended  September 30, 2001** |   |
|---------------------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                                    |   | **(In thousands, except per share data)**   |   |
| Net loss, as previously reported                        |   | $                                           | (7,190 | )                                          | $      | (22,814 | ) |
| Goodwill amortization, net of tax                       |   | 6,026                                       |   | 16,708                                     |   |
| Net loss, as adjusted                                   |   | (1,164                                      | )      | (6,106                                     | )      |
| Accrued and accretive preferred dividends               |   | 1,397                                       |   | 3,047                                      |   |
| Net loss available to common stockholders, as  adjusted |   | $                                           | (2,561 | )                                          | $      | (9,153 | ) |
|                                                    |   |                                        |   |                                       |   |
| Per share data - basic and diluted, as adjusted         |   |                                        |   |                                       |   |
| Net loss, as previously reported                        |   | $                                           | (0.78  | )                                          | $      | (2.54 | ) |
| Goodwill amortization, net of tax                       |   | 0.65                                        |   | 1.86                                       |   |
| Net loss, as adjusted                                   |   | (0.13                                       | )      | (0.68                                      | )      |
| Accrued and accretive preferred dividends               |   | (0.15                                       | )      | (0.34                                      | )      |
| Net loss available to common stockholders, as  adjusted |   | $                                           | (0.28  | )                                          | $      | (1.02 | ) |

 

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

 

InJune 2002, the Company acquired a minority interest in PracticeWares, Inc.(“PracticeWares”), a dental supply company, for $1.0 million. Additionally, the Company advanced $3.5 million in the form of a loan, half ofwhich the Company expects to be repaid when PracticeWares enters into afinancing arrangement with a senior lender.  The Company also has theoption, under certain conditions, to acquire the remaining equity interest inPracticeWares it does not own.  The investment is being accounted forusing the equity method of accounting.  The Company’s share of the resultsof operations for PracticeWares for the current period was immaterial.

 

Inconnection with the investment, the Company entered into a long-termdistribution agreement with PracticeWares under which PracticeWares is offeringits dental supplies to PracticeWorks customers in exchange for royalty paymentsto the Company on these sales.  PracticeWares also entered into along-term license agreement with the Company for the use of its e-commercesoftware.

 

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

 

**RESTRUCTURING**

 

Asreported in the Form 10-K, the Company announced plans in the fourthquarter of 2001 to consolidate substantially all of its domestic operationsinto one facility. The plan entailed the closure of two facilities, reductionof scope of operations in a third facility and termination of approximately 110employees company wide. The Company added 50 employees in Atlanta in the firstquarter of 2002 to absorb the functions of the closed locations. During thesecond quarter of 2002, the Company negotiated to terminate the lease of aclosed facility and recorded a reduction in the restructuring reserve of$220,000.  The remaining closed facilities have operating leases withvarious expiration dates through 2005. The other costs of the restructuringwere paid in the first half of 2002. The following table sets forth changes inthe restructuring reserve during the three and nine months ended September 30,2002:

 
|                                                            |   | **Reserve  Balance  December 31,  2001** |   | **Additions/  Adjustments  To Reserve** |   | **Costs  Applied  Against  Reserves** |   | **Reserve  Balance  June 30,  2002** |   | **Additions/  Adjustments  To Reserve** |   | **Costs  Applied  Against  Reserves** |   | **Reserve  Balance  September 30,  2002** |   |
|-----------------------------------------------------------------|--------|------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|--------|-------------------------------------------|--------|
|                                                            |   | **(In  thousands)**                      |   |
| Facility closure and consolidation                              |   | $                                        | 727    |                                    | $      | (220                                  | )      | $                                    | (103   | )                                       | $      | 404                                   |   | $                                         | — |   | $ | (46 | ) | $ | 358 |   |
| Compensation costs for severance andother  termination benefits |   | 118                                      |   | (5                                      | )      | (113                                  | )      | —                               |   | —                                  |   | —                                |   | —                                    |   |
|                                                            |   |                                     |   |                                    |   |                                  |   |                                 |   |                                    |   |                                  |   |                                      |   |
| Total                                                           |   | $                                        | 845    |                                    | $      | (225                                  | )      | $                                    | (216   | )                                       | $      | 404                                   |   | $                                         | — |   | $ | (46 | ) | $ | 358 |   |

 

7

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**OTHER NON-RECURRING CHARGES**

 

Duringthe three months ended September 30, 2002 and 2001, the Company did not incurany other non-recurring charges.  Duringthe nine months ended September 30, 2002, the Company recorded a nominal amountof non-recurring credits and charges related to the 2001 restructuring thatwere not eligible for accrual at the time the restructuring was announced.  During the nine months ended September 30,2001, the Company recorded other non-recurring charges of approximately $3.1million related primarily to professional fees, printing and similar costs inconnection with completion of the Spin-Off.  These charges were offset byreductions of $944,000 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 itsoutstanding debt 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 debt extinguishment costs were recorded asother interest expense in accordance with SFAS No. 145 (see Note 10).

 

**NOTE 7. STOCKHOLDERS EQUITY AND PREFERRED STOCK**

 

**COMMON STOCK**

 

Basicearnings per share is computed on the weighted-average number of common sharesoutstanding during each period.  Diluted earnings per share is based onthe weighted-average number of shares outstanding plus net incremental sharesarising out of stock options, warrants and convertible securitiesoutstanding.  The following table is a reconciliation of theweighted-average share amounts used in calculating earnings per share:

 

 
|                                                  |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                  |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
| **In thousands**                                      |   |                                   |   |                                  |   |   |   |   |   |
|                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Basic  common shares outstanding                      |   | 17,624                                 |   | 9,215                                 |   | 13,956 |   | 8,978 |   |
|                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Dilutive  effect of common stock options and warrants |   | 1,645                                  |   | —                                |   | 1,400 |   | — |   |
|                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Diluted  common shares outstanding                    |   | 19,269                                 |   | 9,215                                 |   | 15,356 |   | 8,978 |   |

 

For the three months ended September 30, 2002,approximately 205,000 shares of common stock issuable under stock options andwarrants were not included in the calculation of fully diluted earnings pershare, because the exercise prices were above the average market price. Additionally, the diluted number of shares excludes approximately 153,000shares of common stock issuable upon conversion of the series B preferredstock, because such inclusion was antidilutive.  For the three monthsended September 30, 2001, approximately 3.9 million shares of common stockissuable under stock options and warrants were not included in the calculationof fully diluted earnings per share, of which 3.4 million were above theaverage market price.  Additionally, the diluted number of shares excludesapproximately 975,000 shares of common stock that were issuable upon conversionof the series A preferred stock, approximately 147,000 shares of commonstock issuable upon conversion of the series B preferred stock andapproximately 482,000 shares of common stock that were contingently issuable toWebMD Corporation, because such inclusion was antidilutive.

 

Forthe nine months ended September 30, 2002, approximately 745,000 shares ofcommon stock 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 ofshares excludes approximately 153,000 shares of common stock issuable uponconversion of the series B preferred stock, because such inclusion wasantidilutive.  For the nine months ended September 30, 2001, approximately3.9 million shares of common stock issuable under stock options and warrantswere not included in the calculation of fully diluted earnings per share, ofwhich 3.4 million were above the average market price .  Additionally, thediluted number of shares excludes approximately 975,000 shares of common stockthat were issuable upon conversion of the series A preferred stock,approximately 147,000 shares of common stock issuable upon conversion of theseries B preferred stock and approximately 482,000 shares of common stock thatwere contingently issuable to WebMD Corporation, because such inclusion wasantidilutive.

 

InJune 2002, the Company completed a public offering of 4,523,026 shares ofits common stock, priced at $15.50 per share, of which 3,750,000 shares wereoffered by the Company and 773,026 shares were offered by existingstockholders.  At the closing, the Company also sold an additional 678,454shares pursuant to the exercise by the underwriters of their over-allotmentoption. As a result, the Company received proceeds of $63.8 million (net ofunderwriting discounts and other expenses of the offering).  The Companyused $20.6 million of the proceeds to repay the outstanding balance on itscredit facility and $15.0 million as partial consideration for the redemptionof its series A preferred stock.  The balance of the proceeds have andwill be used to fund working capital requirements and for general corporatepurposes and to pursue possible acquisitions or strategic investments incomplementary businesses, technologies and products.

 

8

----

 

**WARRANTS**

 

Aspreviously disclosed in the Form 10-K, the Company issued to FINOVA warrants topurchase approximately 198,000 shares of common stock.  In May 2002,FINOVA exercised all of its warrants in a cashless transaction and the Companyissued approximately 105,000 shares of common stock.

 

Asdiscussed in more detail below, the Company issued to Ceramco warrants topurchase 450,000 shares of common stock at a price of $15.50 per share.

 

**SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK**

 

InJune 2002, in connection with the Offering, the Company redeemed the series Apreferred stock.  The Company paid $15.0 million in cash, issued 967,742shares of common stock valued at $15.0 million and issued a warrant to purchase450,000 shares of common stock that had a fair value of approximately $4.1million.  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.  InJune 2002, Crescent converted its remaining 44,000 preferred shares into339,932 shares of the Company’s common stock.  The Company no longer hasany series C preferred stock outstanding.

 

**NOTE 8. SEGMENT INFORMATION**

 

SFASNo. 131 establishes standards for the way in which public companies are todisclose certain information about operating segments in their financialreports. It also establishes standards for related disclosures about productsand services, geographic areas, and major 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 two segments:United States operations and international operations. The internationaloperations include primarily Europe, and to a much lesser extent, Australia andCanada.

 

TheCompany’s Chief Operating Decision Maker evaluates performance based onmeasures of segment revenues and operating results.

 

Informationabout the Company’s operations by operating segment follows (in thousands):

 

 
|              |   | **Three Months Ended September 30, 2002** |   | **Three Months Ended September 30, 2001** |   |
|-------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
|              |   | **United States**                         |   | **International**                         |   | **Consolidated** |   | **United States** |   | **International** |   | **Consolidated** |   |
|              |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Revenues          |   | $                                         | 18,949 |                                      | $      | 2,058 |   | $ | 21,007 |   | $ | 14,878 |   | $ | 1,327 |   | $ | 16,205 |   |
|              |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Net income (loss) |   | 2,134                                     |   | 149                                       |   | 2,283 |   | (6,779 | ) | (411 | ) | (7,190 | ) |
|              |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Total assets      |   | 114,726                                   |   | 8,413                                     |   | 123,139 |   | 86,340 |   | 5,833 |   | 92,173 |   |
|                   |        |                                           |        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 
|              |   | **Nine Months Ended September 30, 2002** |   | **Nine Months Ended September 30, 2001** |   |
|-------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
|              |   | **United  States**                       |   | **International**                        |   | **Consolidated** |   | **United States** |   | **International** |   | **Consolidated** |   |
|              |   |                                     |   |                                     |   |   |   |   |   |   |   |   |   |
| Revenues          |   | $                                        | 54,997 |                                     | $      | 5,980 |   | $ | 60,977 |   | $ | 39,379 |   | $ | 3,699 |   | $ | 43,078 |   |
|              |   |                                     |   |                                     |   |   |   |   |   |   |   |   |   |
| Net income (loss) |   | 2,499                                    |   | 350                                      |   | 2,849 |   | (21,910 | ) | (904 | ) | (22,814 | ) |
|              |   |                                     |   |                                     |   |   |   |   |   |   |   |   |   |
| Total assets      |   | 114,726                                  |   | 8,413                                    |   | 123,139 |   | 86,340 |   | 5,833 |   | 92,173 |   |
|                   |        |                                          |        |                                          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

**NOTE 9. LEGAL PROCEEDINGS**

 

Pursuantto the Agreement and Plan of Distribution, executed in connection with theSpin-Off (the "Agreement"), PracticeWorks agreed to assume any andall contingent liability arising from the definitive resolution of thelitigation filed on June 21, 2000 against VitalWorks by Joseph Hafner inthe United States District Court in and for the Eastern District ofPennsylvania. The lawsuit was settled by agreement among the litigants inFebruary 2002, and all claims against VitalWorks have been dismissed withprejudice and without admission of liability or wrongdoing. Under theAgreement, PracticeWorks remained liable for a share of settlement costs overand above insurance coverage. PracticeWorks and VitalWorks have agreed on thefinal disposition and allocation of that liability and the resolution wasimmaterial to the financial statements.

 

9

----

 

**NOTE 10. RECENT ACCOUNTING PRONOUNCEMENTS**

 

InJune 2001, the Financial Accounting Standards Board ("FASB")issued SFAS No. 141, Business Combinations, and No. 142, Goodwill andOther Intangible Assets. SFAS No. 141 supercedes Accounting PrinciplesBoard Opinion ("APB") No. 16, Business Combinations, and eliminatesthe pooling 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 the intangibleasset arises from contractual or other rights, or (2) whether theintangible asset is separable or divisible from the acquired entity and capableof being sold, transferred, licensed, returned or exchanged. The Company hasadopted the provisions of SFAS No. 141 for business combinationsconsummated subsequent to September 30, 2001, and the remaining provisions wereadopted 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 thereafteror more frequently when events or circumstances indicate that an impairment mayhave occurred.  Concurrent with adoptionof this Standard on January 1, 2002, the Company ceased the amortizationof goodwill. The Company completed the initial impairment test during the secondquarter of 2002 and no impairment was recorded.  As previously indicated,the Company will perform the annual impairment test as of October 1 ofeach year.  The Company is in theprocess of performing the annual impairment analysis and does not anticipaterecording an impairment.  Further, inaccordance with SFAS No. 142, as a result of the recent significant decline inthe Company’s stock price, the Company will perform an additional impairmentanalysis as of November 1, 2002.  TheCompany does not anticipate recording an impairment as a result of theanalysis.

 

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 debt extinguishment costs during thesecond quarter of 2002 in conjunction with the repayment of the credit facilitywith FINOVA (see Note 6) in accordance with this Standard.

 

InJuly 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated withExit or Disposal Activities, and nullified EITF Issue No. 94-3. SFAS 146requires that a liability for a cost associated with an exit or disposalactivity be recognized when the liability is incurred, whereas EITF No 94-3 hadrecognized the liability at the commitment date to an exit plan. The Company isrequired to adopt the provisions of SFAS 146 effective for exit or disposalactivities initiated after December 31, 2002. The Company is currentlyevaluating the impact of the adoption of this statement.

 

**NOTE 11.  SUBSEQUENTEVENTS**

 

In October 2002, the Company acquired TeamManagement Systems Limited (“TMS”), a United Kingdom company that has been apremier provider of information technology to dental practices for over 13years and one of the original pioneers in the UK general dental software industry. The Company also acquired substantially all the netassets and business of OMS Comp, a New York-based company that has providedsoftware and services to oral and maxillofacial surgeons for the past tenyears. Total consideration for both acquisitions was approximately $9.0 millionpaid from existing resources.

 

On November 5, 2002, the Board of Directors ofthe Company adopted a stockholder rights plan and declared a dividend of onepreferred stock purchase right (a “Right”) for each outstanding share of theCompany’s common stock.  The dividend ispayable on November 18, 2002 to the stockholders of record on that date.

 

Initially, each Right would entitle its holderto purchase 1/100th of a share of the Company’s newly designated Series DParticipating Cumulative Preferred Stock at an exercise price of $40.  If a person acquires 15 percent or more ofthe Company’s common stock in a transaction that was not approved by the Board,each right, other than those owned by the acquiring person, would insteadentitle the holder to purchase $80.00 worth of the Company’s common stock forthe $40.00 exercise price.  Undercertain circumstances in connection with tender offers and other acquisitionsof the Company that are not approved by the Board, the Rights may be exercisedto acquire shares of the acquiring person at half the acquisition purchaseprice.

 

The rights will expire on November 6, 2012,but the Company may redeem the rights at certain earlier times at a price(subject to certain adjustments) of $0.001 per Right.  After the Rights are triggered, the Board also may exchange oneshare of common stock for each Right.

 

10

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**ITEM 2. MANAGEMENTSDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

PracticeWorks, Inc.(PracticeWorks or we) is a provider of software-based information technologysystems and related services for dentists, orthodontists and oral andmaxillofacial surgeons. Our offerings include practice management applications,recently-introduced cosmetic imaging and digital radiography systems, ongoingmaintenance, support, and training, electronic data interchange, or EDI, services,and internet-based services, including business-to-business e-commerceservices, and website development and hosting. These applications and servicesare designed to automate the provider’s practice, resulting in greaterefficiency, lower costs and higher quality care. As of September 30, 2002, wehad an installed base of approximately 72,000 providers, including 52,000dentists, 5,000 orthodontists and 4,000 oral and maxillofacial surgeons in theUnited States and an additional 11,000 providers outside the United States.

 

Prior to March 5, 2001, we operated as adivision of VitalWorks Inc. ("VitalWorks"), formerly InfoCureCorporation. On March 5, 2001, VitalWorks completed the pro ratadistribution ("Spin-Off") of all of the outstanding shares of PracticeWorkscommon stock to VitalWorks’ stockholders. A substantial part of our growth has been achieved through acquisitions.From July 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 September 30, 2002.Additionally, we acquired the dental imaging software technology formerly ownedby Dicom Imaging Systems, Inc., and we became the preferred U.S.distributor for Trophy Dental, the leading manufacturer of dental digitalradiography systems and intra-oral X-ray equipment worldwide.  In June2002, we acquired a minority interest in PracticeWares, Inc. (“PracticeWares”),a dental supply company, and entered into a distribution agreement under whichPracticeWares will offer its dental supplies to our customers.  In October 2002, we acquired Team ManagementSystems Limited (“TMS”), a United Kingdom company that has been a premierprovider of information technology to dental practices for over 13 years andone of the original pioneers in the UK general dental software industry. Wealso acquired substantially all the net assets and business of OMS Comp, a NewYork-based company that has provided software and services to oral and maxillofacialsurgeons for the past ten years.

 

***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.

 

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

 

 
|              |   | **Three Months Ended September 30, 2002** |   | **Three Months Ended September 30, 2001** |   |
|-------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
|              |   | **United States**                         |   | **International**                         |   | **Consolidated** |   | **United States** |   | **International** |   | **Consolidated** |   |
|              |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Revenues          |   | $                                         | 18,949 |                                      | $      | 2,058 |   | $ | 21,007 |   | $ | 14,878 |   | $ | 1,327 |   | $ | 16,205 |   |
|              |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Net income (loss) |   | 2,134                                     |   | 149                                       |   | 2,283 |   | (6,779 | ) | (411 | ) | (7,190 | ) |
|              |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Total assets      |   | 114,726                                   |   | 8,413                                     |   | 123,139 |   | 86,340 |   | 5,833 |   | 92,173 |   |
|                   |        |                                           |        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 
|              |   | **Nine Months Ended September 30, 2002** |   | **Nine Months Ended September 30, 2001** |   |
|-------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
|              |   | **United  States**                       |   | **International**                        |   | **Consolidated** |   | **United States** |   | **International** |   | **Consolidated** |   |
|              |   |                                     |   |                                     |   |   |   |   |   |   |   |   |   |
| Revenues          |   | $                                        | 54,997 |                                     | $      | 5,980 |   | $ | 60,977 |   | $ | 39,379 |   | $ | 3,699 |   | $ | 43,078 |   |
|              |   |                                     |   |                                     |   |   |   |   |   |   |   |   |   |
| Net income (loss) |   | 2,499                                    |   | 350                                      |   | 2,849 |   | (21,910 | ) | (904 | ) | (22,814 | ) |
|              |   |                                     |   |                                     |   |   |   |   |   |   |   |   |   |
| Total assets      |   | 114,726                                  |   | 8,413                                    |   | 123,139 |   | 86,340 |   | 5,833 |   | 92,173 |   |
|                   |        |                                          |        |                                          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

11

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**Consolidated Results of Operations**

 

**Three and Nine Months Ended September 30, 2002 Compared toThree and Nine Months Ended September 30, 2001**

 

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

*** ***
|          |   | **Three  months ended September 30,** |   |
|---------------|--------|---------------------------------------|--------|
|          |   | **2002**                              |   | **Percent  of total** |   | **2001** |   | **Percent  of total** |   | **Dollar  change** |   | **Percent  change** |   |
|          |   |                                  |   |   |   |   |   |   |   |   |   |   |   |
| Recurring     |   | $                                     | 13,920 |   | 66.3 | % | $ | 11,395 |   | 70.3 | % | $ | 2,525 |   | 22.2 | % |
| Non-recurring |   | 7,087                                 |   | 33.7 |   | 4,810 |   | 29.7 |   | 2,277 |   | 47.3 |   |
| Total         |   | $                                     | 21,007 |   | 100.0 | % | $ | 16,205 |   | 100.0 | % | $ | 4,802 |   | 29.6 |   |

 
|          |   | **Nine  months ended September 30,** |   |
|---------------|--------|--------------------------------------|--------|
|          |   | **2002**                             |   | **Percent  of total** |   | **2001** |   | **Percent  of total** |   | **Dollar  change** |   | **Percent  change** |   |
|          |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Recurring     |   | $                                    | 40,795 |   | 66.9 | % | $ | 30.045 |   | 69.7 | % | $ | 10,750 |   | 35.8 | % |
| Non-recurring |   | 20,182                               |   | 33.1 |   | 13.033 |   | 30.3 |   | 7,149 |   | 54.9 |   |
| Total         |   | $                                    | 60,977 |   | 100.0 | % | $ | 43,078 |   | 100.0 | % | $ | 17,899 |   | 41.6 |   |

 

 

*Total Revenues.*    Totalrevenues for the three months ended September 30, 2002 increased as a result oforganic growth of $4.5 million and revenues of $273,000 attributable toacquisitions completed in the third quarter of 2001 and the first quarter of2002.  Total revenues for the nine months ended September 30, 2002increased as a result of organic growth of $13.6 million and revenues of$4.3 million attributable to acquisitions, consisting primarily of$2.4 million related to the InfoSoft acquisition completed in the firstquarter of 2001.

 

*Recurring Revenues.*    Recurringrevenues are derived from contractual arrangements for maintenance and supportservices and subscriptions to our software and support and from electronicservices. Recurring revenues for the three months ended September 30, 2002increased primarily as a result of increased electronic services revenue of$1.2 million, increased subscription revenue of $813,000 and increasedmaintenance revenue of $484,000. The increases in subscriptions and electronicservices revenues for the three months ended September 30, 2002 are largelyvolume related and include the effects of increased numbers of upgrade and newcustomers entering into subscription agreements and expansion of e-servicesoffered to existing customers. The increase in maintenance revenue is directlyattributable to increased sales of our core practice management applications,primarily in the orthodontic and oral surgery markets, and to a lesser extent,increased classic customers entering into maintenance contracts.

 

Recurringrevenues for the nine months ended September 30, 2002 increased primarily as aresult of increased electronic services revenue of $5.4 million, whichincludes $1.3 million attributable to acquisitions, increased subscriptionrevenue of $2.5 million and increased maintenance revenue of $2.8 million.The increases in subscriptions and electronic services revenues for the ninemonths ended September 30, 2002 are largely volume related and include theeffects of increased numbers of upgrade and new customers entering intosubscription agreements and expansion of e-services offered to existingcustomers. The increase in maintenance revenue is largely acquisition related.

 

*Non-recurring Revenues.*    Non-recurringrevenues include one-time sales of licenses and systems, and fees for trainingand implementation services. Non-recurring revenues for the three months endedSeptember 30, 2002 increased primarily as a result of our new digital imagingproduct offerings including related hardware and, to a lesser extent, increasesin training and implementation revenues.  These increases are attributableto growth in our basic business as existing and new customers avail themselvesof our new product offerings and continue to implement our core practicemanagement applications, primarily by subscription.

 

Non-recurringrevenues for the nine months ended September 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 and third quarter of 2002 for our new digital radiography productofferings.

 

12

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

 

 
|                                                |   | **Three months ended September 30,** |   |
|-----------------------------------------------------|--------|--------------------------------------|--------|
|                                                |   | **2002**                             |   | **Percent  of sales** |   | **2001** |   | **Percent  of sales** |   | **Dollar  change** |   | **Percent  change** |   |
|                                                |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Purchases for resale                                |   | $                                    | 3,968  |   | 18.9 | % | $ | 2,714 |   | 16.7 | % | $ | 1,254 |   | 46.2 | % |
| Selling, general and  administrative                |   | 12,295                               |   | 58.5 |   | 12,092 |   | 74.6 |   | 203 |   | 1.7 |   |
| Research and development                            |   | 698                                  |   | 3.3 |   | 494 |   | 3.0 |   | 204 |   | 41.3 |   |
| Amortization of goodwill                            |   | —                               |   | — |   | 6,026 |   | 37.2 |   | (6,026 | ) | (100.0 | ) |
| Depreciation and  amortization of other intangibles |   | 1,860                                |   | 8.9 |   | 1,391 |   | 8.6 |   | 469 |   | 33.7 |   |
| Restructuring and other  non-recurring charges      |   | —                               |   | — |   | — |   | — |   | — |   | — |   |
| Interest expense                                    |   | 95                                   |   | 0.5 |   | 690 |   | 4.3 |   | (595 | ) | (86.2 | ) |
|                                                     |        |                                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                |   | **Nine months ended September 30,** |   |
|-----------------------------------------------------|--------|-------------------------------------|--------|
|                                                |   | **2002**                            |   | **Percent  of sales** |   | **2001** |   | **Percent  of sales** |   | **Dollar  change** |   | **Percent  change** |   |
|                                                |   |                                |   |   |   |   |   |   |   |   |   |   |   |
| Purchases for resale                                |   | $                                   | 10,828 |   | 17.8 | % | $ | 6,075 |   | 14.1 | % | $ | 4,753 |   | 78.2 | % |
| Selling, general and  administrative                |   | 37,554                              |   | 61.6 |   | 34,628 |   | 80.4 |   | 2,926 |   | 8.4 |   |
| Research and development                            |   | 2,625                               |   | 4.3 |   | 1,521 |   | 3.5 |   | 1,104 |   | 72.6 |   |
| Amortization of goodwill                            |   | —                              |   | — |   | 16,708 |   | 38.8 |   | (16,708 | ) | (100.0 | ) |
| Depreciation and  amortization of other intangibles |   | 5,339                               |   | 8.8 |   | 2,986 |   | 6.9 |   | 2,353 |   | 78.8 |   |
| Restructuring and other  non-recurring charges      |   | (143                                | )      | (0.2 | ) | 2,184 |   | 5.1 |   | (2,327 | ) | (106.5 | ) |
| Interest expense                                    |   | 1,271                               |   | 2.1 |   | 1,831 |   | 4.3 |   | (560 | ) | (30.6 | ) |
|                                                     |        |                                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Purchases for Resale.*    Purchases for resaleinclude costs of processing, forms and postage for EDI claims and statementsand other electronic services, purchases of hardware, outsourced hardwaremaintenance, third-party software and other items for resale in connection withthe sales of new systems and software. Purchases for resale for the threemonths ended September 30, 2002, compared to the three months ended September30, 2001, increased primarily due to increased costs related to new digitalradiography product offerings.  As apercentage of sales, purchases for resale increased primarily as a result of achange in revenue mix reflecting our new digital radiography product offeringsand the growth in electronic services.

 

Similarly,purchases for resale for the nine months ended September 30, 2002, compared tothe nine months ended September 30, 2001

 

13

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increased primarilydue to the growth in electronic services, and, to a slightly lesser extent,increased hardware costs related to new cosmetic imaging and digitalradiography product offerings. As a percentage of sales, purchases for resaleincreased primarily as a result of a change in revenue mix reflecting increasedelectronic services and our new imaging product offerings.

 

*Selling, General and Administrative,or SG&A.*    SG&A expense includes salaries and benefits,product maintenance and support, variable commissions and bonuses, marketing,travel, communications, facilities, insurance and other administrative expenses.SG&A expense excludes research and development, depreciation andamortization, restructuring and non-recurring charges. SG&A expense for thethree months ended September 30, 2002, compared to the three months endedSeptember 30, 2001, increased primarily due to overall growth in the businessincluding the net effect of acquisitions that increased personnel costs by$366,000.  Bank charges increased $151,000 reflecting increased volume andincreased use of customer credit card billings. These increases were offset bya decrease in facility and utility costs of $362,000 as a result of closing all domestic locations other thanAtlanta and Baltimore.

 

SG&Aexpense for the nine months ended September 30, 2002, compared to the ninemonths ended September 30, 2001, increased to support a 42% increase inrevenue.  Personnel costs increased $2.4million and facility costs increased $358,000, both attributable primarily toacquisitions and net of restructuring efforts. We also incurred increasedmarketing and advertising costs of $516,000 related in part to the continuationof the PracticeWorks branding campaign, new product introductions andattendance at industry trade shows and increased bank charges of $486,000 frommonthly customer credit card billings, offset by a decrease in bad debt expenseof $947,000 due to improved cash collections and accounts receivable managementand decreased VAR commission expense of $113,000 as a result of reductions inthe reseller network.

 

*Research and Development.*    Researchand development expense consists primarily of salaries and benefits, supplies,facilities and other administrative expenses associated with ongoing programsthat focus on advancing our core practice management applications and othertechnologies, developing new products, and enhancing the quality andperformance of our classic products. Research and development expense increasedfor the three months ended September 30, 2002, compared to the same period in2001, primarily due to an increase in the number of supported productsresulting from acquisitions. Excluding acquired capitalized software costs,software costs capitalized totaled $452,000 and $475,000 for the three monthsended September 30, 2002 and 2001, respectively.

 

Similarly,research and development expense increased for the nine months ended September30, 2002, compared to the same period in 2001, primarily due to an increase inthe number of supported products resulting from acquisitions. Excludingacquired capitalized software costs, software costs capitalized totaled $1.2million and $1.0 million for the nine months ended September 30, 2002 and 2001,respectively.

 

Wecapitalize development costs incurred from the time a new product reachestechnological feasibility until it is available for general release. Thefluctuations of capitalized costs in 2002 compared to 2001 reflect the changesin the number of supported products and the state of development of a varietyof projects, including new electronic services applications and major upgradeversions of several practice management applications that are part of our coreproduct offerings.

 

*Depreciation and Amortization ofOther Intangibles.*    Depreciation and amortizationof other intangibles increased for the three and nine months ended September30, 2002, compared to the three and nine months ended September 30, 2001, dueprincipally to increases of $327,000 and $1.8 million, respectively, inamortization of acquired technology, capitalized software development costs andother intangibles, and increases of $140,000 and $600,000, respectively, indepreciation of acquired and purchased fixed assets. Amortization of goodwillceased as of January 1, 2002 but was $6.0 million and $16.7 million forthe three and nine months ended September 30, 2001, respectively.

 

*Restructuring and OtherNon-recurring Charges.*    In the three months endedSeptember 30, 2002 and 2001, there were no restructuring or other non-recurringcharges.

 

Inthe nine months ended September 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 nine months ended September 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. *In conjunction withour recently completed offering and the extinguishment of our credit facility,we recorded a charge of $889,000 to write-off the carrying value of ourunamortized loan costs.

 

*Interest Expense.*    Interestexpense for the three and nine months ended September 30, 2002 decreased as adirect result of the repayment of the FINOVA credit facility.

 

*Income Taxes.*    Forall periods presented we did not record a provision for income taxes.  Forthe three and nine months ended September 30, 2002, we generated pre-tax incomefor financial reporting purposes of approximately $2.3 million and $2.8 millionand taxable income (loss) of approximately $545,000 and $(2.1) million,respectively. The financial reporting results differ from those for taxpurposes primarily due to book versus tax differences in goodwill amortizationand depreciation. The effective income tax rate for this period differed fromthe statutory rate due to state income taxes and the recognition of a deferredincome tax asset valuation allowance. At September 30, 2002 we have NOLcarryforwards totaling $30.4 million that will be available to offsetfuture taxable income. These NOLs expire at various times through 2022.  Additionally, we have credit carryforwardsof approximately $300,000 that will be available to offset future taxes.

 

Ourdeferred tax assets at September 30, 2002 relating to temporary differenceswere approximately $5.4 million. Total deferred tax assets at September30, 2002, including the NOL and credit carryforwards and temporary differencesin the book and tax bases of assets and liabilities aggregate$17.0 million. As of September 30, 2002, we had recorded a total deferredincome tax asset valuation allowance of approximately $11.6 million toreduce the total deferred tax assets to the amount that we believe is morelikely than not to be realized.

 

We reported net deferred taxassets at September 30, 2002 of approximately $5.4 million, essentiallyrepresenting amounts attributable to us based solely on reversing temporarydifferences as recorded by VitalWorks through the spin-off date. We haveprepared projections that indicate

14

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that our NOLs would be absorbed prior to theirexpiration. However, we havenot recorded the benefit of the NOL utilizationin the financial statements since projections over multiple years areinherently imprecise. Management believes that it is more likely than not thatthe unreserved portion of our deferred tax assets will be realized based on ourfinancial projections, sales backlog, continued quarter-over-quarteroperational improvements across substantially all business lines for each ofthe fiscal quarters of 2001 and 2002, and available tax strategies. Thesefactors indicate we will generate taxable income within the next one to twoyears sufficient to realize the tax benefits represented by these futuredeductible temporary differences.

 

*Net Income (Loss).*    Asa result of the foregoing, we had net income of $2.3 million and $2.8 millionfor the three and nine months ended September 30, 2002, compared to a net lossof $(7.2) million and $(22.8) million for the three and nine months endedSeptember 30, 2001, respectively.

 

*Accrued and Accretive Dividends onPreferred Stock.*    For the three months endedSeptember 30, 2002, we recorded accrued and accretive dividends related to theseries B convertible redeemable preferred stock of $157,000 to recognizethe 6.0% dividend and amortization of the $1.5 million estimated valuationdiscount, as compared to $93,000 for the three months ended September 30,2001.  The series B convertibleredeemable preferred stock was outstanding for approximately two months duringthe three month period ended September 30, 2001.  For the three months ended September 30, 2001, we recordedaccrued and accretive dividends of $1.1 million related to the series Aconvertible redeemable preferred stock and $234,000 related to the series Cconvertible redeemable preferred stock. There were no shares outstanding of the series A and series Cconvertible redeemable preferred stock during the three month period endedSeptember 30, 2002.

 

Forthe nine months ended September 30, 2002, we recorded accrued and accretivedividends related to the series A convertible redeemable preferred stockof $1.9 million to recognize the 6.5% dividend and amortization of the$11.0 million estimated valuation discount, as compared to $2.4 millionfor the nine months ended September 30, 2001. Additionally, during the secondquarter of 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 nine months ended September 30, 2002, we recorded accrued and accretivedividends of $467,000 related to the series B convertible redeemablepreferred stock, as compared to $93,000 for the nine months ended September 30,2001.  The series B convertibleredeemable preferred stock was outstanding for approximately two months duringthe nine month period ended September 30, 2001.  For the nine months ended September 30, 2002, we recordedaccretive dividends of $308,000 related to the series C convertibleredeemable preferred stock, as compared to $533,000 for the nine months endedSeptember 30, 2001.  The series A and series C convertibleredeemable preferred stock were each outstanding for approximately four monthsduring the nine month period ended September 30, 2001 and approximately sixmonths during the nine month period ended September 30, 2002.

 

**Liquidity and Capital Resources**

 

Ourprincipal capital requirements have been to fund:

 

•acquisitions;

 

•working capital;

 

•software development costs; and

 

•capital expenditures for furniture, fixtures andequipment.

 

AtSeptember 30, 2002, we had cash and cash equivalents of $28.8 million andworking capital of $18.7 million (including the effect of deferred revenueand customer deposits of $11.4 million). Net cash provided by operatingactivities was $5.4 million for the nine months ended September 30, 2002,an improvement from cash used in operating activities of $(251,000) for thesame period in 2001. The improvement in operating cash flow results from thegrowth in recurring revenue attributable to our change to a subscriptionpricing model, operating savings attributable to the successful integration ofthe completed acquisitions and increased growth of our business. Operating cashflow has been favorably impacted by the increased number of customertransactions that are paid by credit card or automatic bank draft and fromcontinued improvement in our accounts receivable collections, as evidenced bythe decrease in days sales outstanding from 40 at September 30, 2001 to 29 atSeptember 30, 2002.  In order tocapitalize on the strong interest in our new digital radiography products, weplan to increase our investment in sales and marketing infrastructure andpromotional efforts by approximately $2.0 million on an annualized basisbeginning in the fourth quarter of 2002.

 

Foreach of the periods presented, the majority of our cash used for investing hasbeen for acquisitions.  In the first quarter of 2002 we completed anacquisition and funded the $2.2 million purchase price from the proceeds ofborrowings together with our current cash balance. In June 2002, we acquired aminority interest in PracticeWares for $1.0 million in cash and loaned thisaffiliate $3.5 million.  We expect to be repaid one half of this loan oncePracticeWares enters into a financing arrangement with a senior lender. In October 2002, we completed two acquisitions and funded the $9.0 millionpurchase price from existing resources. The remainder of our investing activities have consisted of capitalexpenditures for equipment, software development costs and other intangibles.For the remainder of 2002 we expect to incur capital expenditures of $500,000 relatedto property and equipment and $400,000 related to capitalized software, and weplan to fund these additions from operating cash flows.  For 2003, we expect to incur capitalexpenditures of $3.0 million related to property and equipment and $1.5 millionrelated to capitalized software.  Weplan to fund these additions from operating cash flows.

 

During2002 our financing activities consisted of the following:

 

•                  Completion of a public offering of our common stockraising approximately $63.8 million net of the underwriters discount and otheroffering expenses;

•                  Repayment of the outstanding principal related to ourcredit facility of approximately $21.7 million;

•                  Redemption of the series A convertible redeemablepreferred stock.

 

During2001 our financing activities consisted primarily of the sale of our common andpreferred stock, the proceeds of which were used to fund our acquisitions andoperations.  During the fourth quarter of 2001, FINOVA CapitalCorporation, our primary lender, agreed to defer the scheduled principalpayment that was originally due during the first quarter of 2002. Principalpayments of 5.0% per quarter commenced in the

 

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second quarter of2002.  We used $20.6 million of proceeds from the public offering to repayall of the remaining outstanding principal under the facility in June 2002.

 

Wepreviously had three series of preferred stock outstanding.  Concurrent with the offering, we redeemed all of the outstanding series Ashares and accrued dividends for $15.0 million in cash, 967,742 shares of ourcommon stock and a warrant to purchase 450,000 shares of our common stock. Theseries B shares have a liquidation preference of $5.2 million, accruedividends at 6.0% per annum and are convertible into our common stock at thethen applicable conversion price (or approximately 153,000 shares at September30, 2002). The shares are redeemable at the option of the holder afterAugust 8, 2006. In connection with the offering, Crescent International Limited(Crescent) holder of the series C preferred stock, converted the remaining44,000 shares of the series C shares into 339,932 shares of our commonstock.  Crescent had previously converted 56,000 shares into 432,641 sharesof our common stock. We no longer have any series C preferred stockoutstanding.

 

Assumingour series B preferred stock issuance is not converted, our future contractualcash obligations, excluding interest and dividends, are as follows:

 
|                      |   | **2002  (October-December)** |       | **2003**   |       | **2004**  |       | **2005** |       | **2006**   |       |
|---------------------------|--------|------------------------------|------------|------------|------------|-----------|------------|----------|------------|------------|------------|
| ***(In thousands)***      |   |                         |       |       |       |      |       |     |       |       |       |
| Long-term debt            |   | $                            | 214        |       | $          | 1,078     |       | $        | 1,070      |       | $          | 452 |   | $ | 434 |   |
| Capital lease obligations |   | 36                           |       | 95         |       | 31        |       | 3        |       | —     |       |
| Operating leases          |   | 469                          |       | 1,881      |       | 1,639     |       | 1,526    |       | 1,432      |       |
| Preferred stock           |   | —                       |       | —     |       | —    |       | —   |       | 5,199      |       |
|                      |   |                         |       |       |       |      |       |     |       |       |       |
|                      |   |                         | ** ** |       | ** ** |      | ** ** |     | ** ** |       | ** ** |
| **Total**                 |   | **$**                        | **719**    | ** ** | **$**      | **3,054** | ** ** | **$**    | **2,740**  | ** ** | **$**      | **1,981** | ** ** | **$** | **7,065** | ** ** |

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

In June 2001, the FASB issued SFASNo. 141, Business Combinations, and SFAS No. 142, Goodwill and OtherIntangible Assets, effective for fiscal years beginning after December 15,2001.  The new Standards prohibit the use of the pooling of interestsmethod of accounting for business combinations initiated after September 30,2001. Acquired intangible assets will be required to be recognized apart fromgoodwill if the acquired intangible assets meet certain criteria. Otherintangible assets will continue to be amortized over their useful lives. Underthe new standards, goodwill will no longer be amortized but will be subject toannual impairment tests.

 

Pursuantto SFAS No. 142, we did not amortize the goodwill generated from anyacquisitions closed subsequent to July 1, 2001. Additionally, onJanuary 1, 2002, we discontinued the amortization of the goodwillgenerated from acquisitions closed prior to July 1, 2001. For the threeand nine months ended September 30, 2001, goodwill amortization amounted to$5.9 million, or $0.65 per share, and $10.7 million, or $1.20 per sharerespectively. As required by this new Standard, we completed the initialimpairment test during the second quarter of 2002 and no impairment wasrecorded.  The Company completed the initial impairment test during thesecond quarter of 2002 and no impairment was recorded.  As previouslyindicated, we will perform the annual impairment test as of October 1 ofeach year.  We are in the process ofperforming the annual impairment analysis and we do not anticipate recordingany impairment as a result of this analysis. Further, as required by SFAS No. 142, as a result of the recentsignificant decline in our stock price, we will perform an additionalimpairment analysis as of November 1, 2002. We do not anticipate recording an impairment as a result of thisanalysis.

 

InOctober 2001, the FASB issued SFAS No. 144, Accounting for the Impairmentor Disposal of Long-Lived Assets, effective for fiscal years beginning afterDecember 15, 2001. This statement supercedes SFAS No. 121, Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposedof and Accounting Principles Board (APB) Opinion No. 30, Reporting theResults of Operations - Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions for segments of a business to be disposed of. SFAS No. 144retains the requirements of SFAS No. 121 relating to recognition andmeasurement of an impairment loss and resolves certain implementation issuesresulting from SFAS No. 121. The adoption of this Standard did not have animpact on our earnings and financial position.

 

In May 2002, the FASB issued SFASNo. 145, Recision of FASB Statements No. 4, 44 and 64, Amendmentof FASB Statement No. 13 and Technical Corrections. SFAS 145rescinded SFAS No. 4 which required all gains and losses fromextinguishment 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 debtextinguishment costs during the second quarter of 2002 of approximately$889,000 in conjunction with the repayment of the credit facility in accordancewith this Standard.

 

InJuly 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated withExit or Disposal Activities and nullified EITF Issue No. 94-3. SFAS 146requires that a liability for a cost associated with an exit or disposalactivity be recognized when the liability is incurred, whereas EITF No. 94-3had recognized the liability at the commitment date to an exit plan. We arerequired to adopt the provisions of SFAS 146 effective for exit or disposalactivities initiated after December 31, 2002. We are currently evaluating theimpact of the adoption of this statement.

 

**CAUTIONARY LANGUAGE REGARDING FORWARD-LOOKING STATEMENTS**

 

Thisdiscussion contains forward-looking statements that reflect managements currentassumptions and estimates of future performance, the development and timing ofPracticeWorks release of new applications and services, the rate of adoption ofits new applications and services by new and existing customers, its success inestablishing business relationships, the growth of its business, and generaleconomic conditions. You can find many of these statements by looking for wordssuch as believes, expects, anticipates, estimates, plans, intends or similarexpressions. Any forward-looking statements are subject to risks, uncertaintiesand assumptions that may cause actual results and future trends to differmaterially from those projected, stated, or implied by the forward-lookingstatements. PracticeWorks results and the accuracy of the forward-lookingstatements could be affected by many factors, including, in particular, thosediscussed above and those discussed in the section entitled Risk Factors andelsewhere in PracticeWorks Annual Report on Form 10-K for the year endedDecember 31, 2001.

 

16

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**ITEM 3. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Ouroutstanding debt is either at a fixed rate or is  non-interest bearing with imputed interest.  We do not tradein derivative financial instruments.

 

Wealso conduct operations in the United Kingdom, Sweden, Canada and Australia.Accordingly, we are subject to risk from exchange rate fluctuations betweensuch local currencies and the U.S. dollar. For the three and nine months endedSeptember 30, 2002, 10% of our total revenues, compared to 8% and 9% respectively for the comparable periods of 2001,were earned outside the United States and collected in the local currency.Related operating expenses were also paid in such corresponding localcurrencies. We do not conduct any currency hedging activities.

 

Thefinancial statements of our non-U.S. subsidiaries are translated into U.S.dollars using current rates of exchange, with gains or losses included in theaccumulated other comprehensive income (loss) account, a component ofstockholders equity. As of September 30, 2002, we have recorded a cumulativetranslation adjustment of $72,000.

 

Wehave no off-balance sheet arrangements, investments or guarantees.

 

Thetraded price of our common stock influences the valuation of stock optiongrants and the effects these grants have on pro forma earnings disclosed in ourfinancial statements. The stock price also influences the computation of thedilutive effect of outstanding stock options to determine diluted earnings pershare. The stock price also affects our employees perceptions of variousprograms that involve our common stock.

 

**ITEM4.  CONTROLSAND PROCEDURES**

 

The Company carried out an evaluation, underthe supervision and with the participation of the Company’s management,including the Company’s President and Chief Executive Officer along with theCompany’s Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures pursuant toExchange Act Rule 13a-14 under the Securities Exchange Act of 1934, as amended (the“Exchange Act”). Based upon that evaluation, the Company’s Chief ExecutiveOfficer along with the Company’s Chief Financial Officer concluded that as ofSeptember 30, 2002 the Company’s disclosure controls and procedures (1) areeffective in timely alerting them to material information relating to theCompany (including its consolidated subsidiaries) required to be included inthe Company’s periodic SEC filings and (2) are adequate to ensure thatinformation required to be disclosed by the Company in the reports filed orsubmitted by the Company under the Exchange Act is recorded, processed andsummarized and reported within the time periods specified in the SEC’s rulesand forms.

 

There have been no significant changes in theCompany’s internal controls or in other factors that could significantly affectinternal controls subsequent to the date the Company carried out itsevaluation.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS**

 

Fromtime to time, we are involved in various legal proceedings incident to theordinary course of our business. We are not a party to any legal proceedingswhich we believe are material, and we are unaware of any contemplated materialactions against us.

 

**ITEM 2. CHANGESIN SECURITIES AND USE OF PROCEEDS**

 

On July 15, 2002, the Company issued 52,107shares of our Common Stock to three individuals who were principal stockholdersof Crunchy Frog Software, Inc.  Theshares were issued in satisfaction of an obligation to pay $900,092.00 on July15, 2002, as an earn-out amount arising from a merger of Crunchy Frog with theCompany’s predecessor on December 22, 1999. The Company had the option of satisfying the earn-out amount with cashor stock.  We believe the offering andsale of the shares is exempt from registration under Section 4(2) of the 1933Securities Act.  The principalstockholders who in 1999 acquired the rights to any stock or cash earn-outunder the merger agreement were accredited investors.  The certificates representing the securities issued by theCompany contained a legend to the effect that such securities were notregistered under the Act and may not be transferred except pursuant to aneffective registration statement or pursuant to an exemption from suchregistration requirement.

 

 

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

 

We held our annual meeting of stockholders onJuly 25, 2002.  The stockholders votedon the election of two Class I directors and two Class II directors, as morefully described in our definitive Proxy Statement, dated June 27, 2002.  The votes were as follows:

 
|                 |   | **For**    |   | **Against** |   | **Abstain** |   |
|----------------------|--------|------------|--------|-------------|--------|-------------|--------|
|                 |   |       |   |        |   |        |   |
| James C.  Davis      |   | 11,574,405 |   | 0           |   | 1,770,207   |   |
| William  R. Jellison |   | 13,267,817 |   | 0           |   | 76,795      |   |
| James K.  Price      |   | 11,582,749 |   | 0           |   | 1,761,863   |   |
| Raymond  H. Welsh    |   | 13,273,863 |   | 0           |   | 70,749      |   |

 

The stockholders also voted upon theratification of Ernst & Young LLP as our independent auditors for fiscalyear 2002.  Stockholders voted13,221,132 shares for and 118,858 shares against such ratification.  Stockholders abstained from voting 4,621shares on the proposal.

 

**ITEM 6. EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)Exhibits:

 

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

 

17

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(b)Reports on Form 8-K:

 

We filed aCurrent Report on Form 8-K dated September 13, 2002 under item 5 reporting theaddition of a seventh member to the Board of Directors.

 

We filed aCurrent Report on Form 8-K dated November 5, 2002 under item 5 reporting theadoption of a Stockholders Rights Plan and the declaration of a dividend of onestock purchase right for each share of common stock outstanding on November 18,2002, the record date for the dividend.

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on this 14th day of November, 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)* |

 

18

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**CERTIFICATIONS**

 

I, James K. Price, Chief Executive Officer ofPracticeWorks Inc., certify that:

 

1.               Ihave reviewed this quarterly report on Form 10-Q of PracticeWorks, Inc.;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b.              evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c.               presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based upon our evaluation as of theEvaluation Date;

 

5.               Theregistrant’s other certifying officers and I have disclosed, based upon ourmost recent evaluation, to the registrant’s auditors and the audit committee ofthe registrant’s board of directors (or persons performing the equivalentfunction):

 

a.               allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.               Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  | November 14, 2002 | By:    | /s/ James K. Price      |
|--------|-------------------|--------|-------------------------|
|   |              | Title: | Chief Executive Officer |

 

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**CERTIFICATIONS**

 

I, James A. Cochran, Chief Financial Officer ofPracticeWorks Inc., certify that:

 

1.               Ihave reviewed this quarterly report on Form 10-Q of PracticeWorks, Inc.;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b.              evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c.               presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based upon our evaluation as of theEvaluation Date;

 

5.               Theregistrant’s other certifying officers and I have disclosed, based upon ourmost recent evaluation, to the registrant’s auditors and the audit committee ofthe registrant’s board of directors (or persons performing the equivalentfunction):

 

a.               allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.               Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | November 14, 2002 | By:    | /s/ James A. Cochran    |
|--------|-------------------|--------|-------------------------|
|   |              | Title: | Chief Financial Officer |

 

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