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Computer Programs & Systems Inc. (NASDAQ:CPSI)

Q3 2008 Earnings Call

October 24, 2008 9:00 am ET

Executives

David A. Dye – Chairman

J. Boyd Douglas – Chief Executive Officer, President

Darrell G. West – Chief Financial Officer

Michael S. Jones – Chief Operating Officer and Exec. VP

Analysts

Jeremy Frazer – William Blair & Company

Jamie Stockton – Morgan Keegan

Thomas Carpenter – Hilliard Lyons

Bret Jones – Leerink Swann

Leo Carpio – Caris & Company

Richard Close – Jefferies & Co.

Operator

Ladies and gentlemen welcome to the Computer Programs and Systems third quarter earnings call. (Operator Instructions). I would now like to turn the conference over to Mr. Boyd Douglas, President and CEO.

Boyd Douglas

Thank you [Chris], good morning everyone and thank you for joining us. During this conference call we may make statements regarding future operating plans, expectations and performance that constitute forward looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

We caution you any such forward looking statements are only predictions and are not guarantees of future performance. Actual results might differ materially from those projected in the forward looking statements as a result of risk, uncertainties and other factors. Including those described in our public releases and reports filed with the Securities and Exchange Commission, including but not limited to our recent annual report on the Form 10-K.

We also caution investors that the forward looking information provided in this call represents our outlook only as of this date. And we undertake no obligation to update or revise any forward looking statements to reflect events or developments after the date of this call.

Joining me on the call this morning is Darrell West our Chief Financial Officer. Darrell and I have about five minutes of prepared comments and then we will be glad to take your questions.

In the third quarter we installed our financial and patient accounting system in seven hospitals, our core clinical departmental applications at four facilities, eight hospitals implemented nursing point of care and five customers went live with ImageLink PACS.

Add on sales to existing clients made up 22% of total revenue. At this time we expect to install our financial and patient accounting system at nine facilities in the fourth quarter. We anticipate ten new installations of our core clinical departmental module, nine nursing point of care implementations and six ImageLink installs.

In business management solutions during the third quarter we executed eight new accounts receivable management contracts. One of which was for full accounts receivable services, six for private pay collection and one for insurance follow up services. During the third quarter, revenue from this segment of our business grew 12% year-over-year. Demand for our business management solutions continues to be strong, and we’re very pleased with our operations in this segment of our business.

On the sales front there’s been no significant change in the competitive landscape. Our move to the Linux operating system, CCHIT approval and our full suite of business management services, continue to give us a distinct advantage over our competition.

The current economic and credit conditions that the country is currently experiencing are not having an effect on our operations at this time. Our customers continue to pursue their strategic plans and IT objectives. And as you can tell from our third quarter results and our fourth quarter guidance we are confident that we will finish the year with a strong performance.

We have now completed 98 installations of the Linux operating system at our client sites. We anticipate installing an additional 30 by the end of the fourth quarter. The migration to the Linux operating system continues to go extremely well. And should be signed – should be seen as a sign of our commitment and ability for a valid customer base with the latest technology at an affordable price.

In closing we continue to be extremely pleased with our performance and feel like we’re in a great position within our marketplace. We are expecting a particularly strong fourth quarter and are happy about the momentum as it carries us into 2009.

At this time I would like to turn things over to Darrell for a few comments on the financials.

Darrell West

Thanks Boyd. Our DSOs were 45 days from the third quarter up two days from the second quarter. Cash provided from operations for the quarter was $2.8 million compared with $4.3 million last year.

Free cash flow was $2.6 million for the quarter compared with $4 million for the prior year quarter. We define free cash flow as net cash provided by operating activities less capital expenditures.

CapEx for the quarter was $209,000 compared with $234,000 for the prior year quarter. Depreciation for the quarter was $404,000 compared with $443,000 in the prior year. Cash collections were $29 million for the third quarter, compared with $28.7 million in 2007.

We recognized stock compensation expense of $229,000 in the third quarter of 2008 and anticipate a charge of $229,000 in the fourth quarter. Our effective tax rate for 2008 is 37.8%. Our headcount at quarter end was 863, an increase of three for the quarter.

[Chris] we would like to open the call for questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Corey Tobin – William & Blair Company

Jeremy Frazer – William Blair & Company

This is Jeremy for Corey by the way. Just wanted to get on the strong results, I know last quarter you talked about record number of decisions and I didn’t notice any comments along those lines this quarter. Although it appears just from the change in backlog that you had another strong quarter. I’m wondering if you could kind of give us a little bit of perspective about how this quarter compared to last quarter in terms of the strength you saw.

Boyd Douglas

Well it certainly wasn’t and I think I even said on the last call as well. You know, certainly didn’t expect to do that again. It was just a tremendous quarter, last quarter as far as contract signings. But it was a strong one as you can tell from the backlog, so we’re pleased to see that the momentum has continued.

Jeremy Frazer – William Blair & Company

And is there anything you can point to, as you talk to your sales people about why these last two quarters have been so strong. Relative to the last few prior to that, is there any high level trends you’re seeing that have changed?

Boyd Douglas

No there really haven’t, you know, I think this is just, demonstrates as well as any, probably any two quarters we’ve seen, that we just have natural ebbs and flows within this market. And we’re kind of on a high right now and a lot of people are making decisions and we’re earning a lot of that business.

Jeremy Frazer – William Blair & Company

And just shifting gears to items on the expense line, outsourcing margins, it looks like they improved nicely in the quarter. I wonder if, A, what’s going on there and, B, do you feel that it’s sustainable going forward? And then I also have question about the tax rate, it seems like that ticked down a little bit and I’m wondering if that’s sustainable as well?

Darrell West

On the tax rate, that dropped some from a actual filing a settlement of our 2007 tax return. It ended up a little bit better than we had anticipated. Some tax credits related to the hurricane a number of years ago were extended and we had not anticipated that happening. So that improved our tax rate some and we should see. The number that I gave, the 37.8% ,should be pretty close to what we’ll see for the year.

And as far as on the outsourcing margins, we certainly were pleased with that. I don’t know that you can fill a whole lot more improvement there because you know, as we talked about before every time we add a new contract that is people intensive so we certainly have to have people. So, certainly done everything we can to improve that margin, but I wouldn’t see any significant improvement.

Operator

Your next question comes from Jamie Stockton – Morgan Keegan.

Jamie Stockton – Morgan Keegan

I was wondering how did the bad debt expense trend from the June quarter to September quarter and what’s your outlook there?

Darrell West

Bad debt expense for the quarter was only $75,000 which was down significantly from the previous two quarters. We had had some trouble with a couple of specific accounts earlier in the year. And have not seen I guess any significant deterioration in our AR at this point. And expect that this quarter’s $75,000 should, is what we’re projecting for the fourth quarter as well.

Jamie Stockton – Morgan Keegan

On the tax rate next year, any outlook there?

Darrell West

It should most likely move back up to around 39%.

Jamie Stockton – Morgan Keegan

And on the stock option expense could you just give us the breakdown, with individual and [inaudible]?

Darrell West

Yes in operations it was $75,000 in expense, $50,000 for sales and marketing and $105,000 in G&A. That was for the quarter as well as, that was third quarter numbers as well as what we’re projecting for fourth quarter.

Jamie Stockton – Morgan Keegan

And I guess the only other thing that I, was there any, in your systems sales, you know, the mix between software and hardware, was there anything going on there during the quarter?

Darrell West

Hardware was up significantly during the quarter and that increase had to do with the volume of installations that were going in on the fourth quarter. Hardware is typically sold a month ahead of an install. And so we have a couple of large installs going in on the fourth quarter that the hardware is included in the third quarter to increase that number significantly.

Jamie Stockton – Morgan Keegan

And so the mix is probably going to shift back towards software in the fourth quarter?

Darrell West

Yes, we should have smaller hardware sales in the fourth quarter.

Operator

Your next question comes from Tom Carpenter – Hilliard Lyons.

Tom Carpenter – Hilliard Lyons

Can you help us understand what’s going on out there? Are you seeing more decisions being made, are you guys flipping some big competitors, is there strength in certain geographies. Just maybe help us understand what’s contributing to the good results and the strong outlook?

Boyd Douglas

I certain credit a little bit to everything that you mentioned. There are certainly more decisions being made and our win rate, while we don’t talk about it specifically, we’re extremely pleased with that. We’ve made a lot of progress there and we are having some success with some of the smaller vendors replacing their systems.

Tom Carpenter – Hilliard Lyons

Are there certain geographies that you’re seeing more strength in? I know you guys have moved some sales people out west a couple of years ago. Are you seeing particular strength there, is it more in the traditional?

Boyd Douglas

It’s pretty much even throughout the country.

Tom Carpenter – Hilliard Lyons

And when you see the folks getting the feedback from the sales people, and some of the sales where you’re involved, can you give us an idea of what you’re hearing out there, why at community hospital level that sales cycles aren’t lengthening? Because you are starting to hear from chatter out there, you’ve seen reports in papers that at least at the bigger hospital side they are starting to delay bigger projects?

Boyd Douglas

Well as far as certainly the sales cycle has lengthened. I think we’ve seen that over the last six to eight quarters. And that’s kind of part of the reason we were so slow at the end of last year and the beginning of this year. I think you saw that sales cycle lengthen.

But there were still new ones coming in through the process, into the sales pipeline so you’re starting to see some of that flush out. The good news is we’re still seeing some come in on the front end of the pipeline, even now.

And we have not seen any of our hospitals, delay because of the credit crisis or anything like that that’s out there. You might have picked up from the numbers, we did have one particularly large install that was going to go in in September and they started October, but that was not related to financial issues at the hospital. It was some other issues that were going on at the hospital, within the hospital. Sales cycle has lengthened certainly, but again we’re not seeing people put off decisions or installations so far.

Tom Carpenter – Hilliard Lyons

And can you just refresh our memory, as seeing at this point in time I guess near the end of October, are all of those slots that you have for the fourth quarter, are they still at this time, I know you guys have to get stuff in advance and the doctors, the IT and the nurses get all the people trained there. Are those hard numbers that are already all slotted?

Boyd Douglas

We really don’t expect to have any more in the fourth quarter if that’s what you’re asking. You know, the numbers I gave earlier as far as, you know, we’re going to put in nine facilities in the fourth quarter, ten clinicals and nine point of cares and six ImageLinks. We’re pretty full if a small one popped out we might be able to do it if it was a financials only or something like that.

But I really think we’re about where we’re certainly very pleased with the fourth quarter with the installs where we are. And pretty much in by just talking to us now signing contracts, we are pointing them towards first quarter January, February timeframe.

Tom Carpenter – Hilliard Lyons

Okay but I guess flipping it over, because of the lead time that the hospital needed to get everything ready, these are things that are already hard dates?

Boyd Douglas

Yes.

Operator

Your next question comes from Bret Jones – Leerink Swann.

Bret Jones – Leerink Swann

Just a couple of quick questions, I know you sort of already touched upon this with the not seeing an effect from the credit market. Can you talk just generally when looking at your hospitals, your hospital customers, how much is that, how much is there, how many of those deals are generally focused, or utilizing financing as opposed to just funding for future cash flow operations Do you have a sense of that?

Boyd Douglas

You know we talked about that a lot and our best guess is about half probably use some kind of financing to do it. Whether that’s us, as you know we finance several of the deals. They use third party financing, particularly the financing that our hospitals use is dedicated to healthcare in a lot of cases. Even rural healthcare, rural community hospitals, they don’t use the traditional credit markets that everybody is probably more familiar with. And then again the other 50% usually pay for a system out of operations.

Bret Jones – Leerink Swann

Do you see a shift in that at all in the last couple of months let’s say as opposed to even you know going back farther. Just in the last couple of months would you say you’ve seen any change in that at all?

Boyd Douglas

No we haven’t.

Bret Jones – Leerink Swann

No increase in financing, okay and so if we think that, if we look at the operational health of your customers, and I’m sure this is something you track pretty closely. I know you’ve had issues with bad debt and I know you’re watching, you said their financials pretty closely, what do you worry about the most Is it admissions or a rise in bad debt from an operational standpoint for your customers or no?

Boyd Douglas

You know probably the thing Medicare funding to the hospitals and they seem to be doing okay right now. As you know we talked about that a lot, the Medicare prescription drug bill passed a significant increase and that’s why we saw the big jump in 2005 in our new system sales and there really hasn’t been any significant changes since then.

Obviously a cut in the Medicare funding, should we get a new administration and they start to do that, would not be favorable. They come in and increase funding we’re liable to see a pretty good sized jump like we did in 2005. So it really just – that’s probably the single factor that we look at.

What we’ve seen you know over 30 years of doing business, these hospitals aren’t going to close. So the communities that they’re in are going to find a way to keep them open, keep the doors open and fortunately for us the computer system is pretty important in a hospital to keep the doors open and get the bills out and take care of the patients. Right behind the power company we’re right on up there as far as importance to them.

Bret Jones – Leerink Swann

I understand, well I guess I’m just struggling with why all of a sudden we’re seeing a pickup in business. I know the sales cycle is, like you said, is lengthened for the last, you know, six to eight quarters and it’s still around the same length right now. What would all of a sudden now, why would we start to see the pick up really in Q2 and Q3 and even into Q4. Why are these deals closing now as opposed to before?

Is it simply that customers who have been holding off – we’re seeing more of what I would term to be a budget shift that a real shift in underlying business or am I going about this thinking that’s not what's going on?

Boyd Douglas

I think some of it is pent up demand and some of it, I don’t know that we have an explanation for it. I know that on a lot of these calls I’ve talked about everybody wants to point to why is it increasing? Why does it decrease? And we talk about Medicare funding because that’s probably the single thing that you can somewhat point to, and see some similarities.

But I’ve always said sometimes it’s just the way it is in our marketplace. And we’ve seen this, these natural ebbs and flows now and for 30 years it’s been like this and when you get these number of deals, what 15, 20 deals a quarter that are 10, 15, 20 deals that are being decided.

Sometimes if there’s 20 in a quarter or two then that obviously makes a significant difference, especially if we’re firing on all cylinders like we are and we’re happy with our win rate it really speaks to the new system though.

Operator

Your next question is from Leo Carpio – Caris & Company

Leo Carpio – Caris & Company

I have a couple of quick questions. First we’re beating up this whole credit crunch horse which is unfortunate; it’s probably glue by now. Regarding your small hospitals you mentioned that 50% of them receive financing. Can you give us some color in terms of who provides them the financing, is it like the GE Capitals of the world or small rural entities or small banks? Just try to get some color there.

Boyd Douglas

We do see some GE Capital. A little bit, I wouldn’t say, certainly that’s not really prevalent. You know the entities we’re familiar with really focus on healthcare and some of them even are specific as healthcare IT, community hospital vendors.

And we’ve got three or four names that we’ll give to a customer if they don’t have something but they’re relatively small operations. But for whatever reason they’ve carved their niche in this market, I guess kind of like we have and so it’s names you probably haven’t necessarily heard of.

Leo Carpio – Caris & Company

And in terms of the small hospital finances, in some ways they’re showing a lot of resilience here. Is it just something primarily that Medicare funding has been stable the last few years that’s helping them out at this point?

Boyd Douglas

I think that certainly is a factor in it, although when we were talking two or three quarters ago, Medicare funding hadn’t increased. But I guess if you kind of look at things from a bigger picture maybe it isn’t so bad after all compared to what other industries are going through.

Leo Carpio – Caris & Company

And then besides your systems what particular healthcare IT products and services are they looking for? Are they looking for the core clinical, are they looking for revenue cycle management, or are they just buying the entire package up front?

Boyd Douglas

We see it all. Some people are really interested in revenue cycle management and they maybe on the smaller vendors and having a hard time billing and collecting and things like that. And they really need help there, and our revenue cycle products can certainly help them there.

Some are moving towards the EMR and want to move to a fully paperless system, get the doctors using CPOE, obviously there’s – none of those factors have gone away in our market so there’s still a push to the EMR. It may not be as prevalent in the media right now, because I guess they’re busy talking about the credit crunch and all the other things going on. But there’s still a desire by hospitals to get as much electronic as they can.

Leo Carpio – Caris & Company

Okay and just last question, it sounds like for the fourth quarter you’re pretty much fully booked, any thoughts about adding capacity in early ’09? I think we talked about this in the past, that you could reallocate some of your current staff to provide some extra slack capacity. But at what point do you decide I have to staff up again?

Boyd Douglas

Yes I wouldn’t say we are there yet. We’re happy with our capacity; we’ve got a full quarter and we’re going to make $0.41 a share. And we do have other resources that we can tap into should we even need more so it’s not something that we’re really ramping up at this time.

We have – in the last call I think I told you we were planning on hiring two classes, a financial software class, a clinical software class and then since then we’ve also added another financial software class that actually started Monday. So we’re hiring where we need to in areas that we need to beef up a little bit.

Operator

Your next question is from Richard Close - Jefferies & Co.

Richard Close – Jefferies & Co.

Just curious if you could talk a little bit about the budget process of the community hospitals that you serve. What is the typical fiscal year end for the hospitals?

Boyd Douglas

Yes I’d really say it’s probably in thirds and I will ask Darrell his opinion, I think you've got a third that had a June 30 year end and you've got about a third that was September 30 year end and then you got about a third that are on the calendar year.

Richard Close – Jefferies & Co.

Okay, and how closely do you guys work with them in terms of, do they give you a sense of, as they’re going through the budget process, whether IT allocation maybe is increasing or decreasing or holding the same?

Boyd Douglas

As far as to our current customers, we work very closely with them. The closer we can get to that process the better and that’s what our account managers in our sales department do. They visit each site at least twice a year and work with them through the budget process and talk to them about the modules they haven’t purchased yet and what the overall goals of that hospital are.

We try to encourage our hospitals to have a strategic plan IT wise for the hospital and we certainly have people here that can help them with that planning. And we kind of help guide them along the way and when it’s time to purchase new applications we’ll help them formulate a budget for those items. So we work very closely with current customers, obviously with prospective customers it’s not nearly as close because we don’t have the relationship with them until we earn their business.

Richard Close – Jefferies & Co.

And then you touched upon this a little bit earlier, definitely a need for an IT and it’s a high priority. With the community hospitals what would you say is their highest priority from maybe a capital spending perspective?

Boyd Douglas

Every situation is different. I mean we run into a lot that are in the process say right now, but they may put it off because they realize they’ve got to expand their bed capacity. Whether it’s more emergency rooms or more OR suites, so it’s not uncommon to see a construction project kind of leap ahead.

We may be on track for a nine month sales process with an install two or three months after that. So we’re looking 12 months out to do an install and then all of a sudden they’ll call us and say our board has gotten together and we really need to add a new wing or add some physician offices or whatever.

And then we’ll kind of take a back seat to that, so I would say that’s the single thing, that if something leaps of IT it’s certainly new construction and that’s usually pretty badly needed at this time.

Richard Close – Jeffries & Co.

But with respect to, I guess your earlier comments saying about, I think it was one half coming out of cash flow from operations from the hospitals in terms of spending on IT. If that’s the case you’re not necessarily competing with respect to the capital project?

Boyd Douglas

That’s correct, certainly not. That is correct.

Richard Close – Jeffries & Co.

Okay and then one just final question here, and thanks for your time. You have 640 client hospitals, how much or what do you think your penetration rate is? If you look at all your customers, how penetrated are you within that base?

Boyd Douglas

You’re talking about with clinical sales and things like that?

Richard Close – Jeffries & Co.

Yes.

Boyd Douglas

You know I don’t have those numbers right here in front of me, off the top of my head. Clinical we’re about 65% penetrated, point of care we’re 35%, maybe 40% penetrated and then physician apps are less than that, maybe 10% penetrated.

Richard Close – Jeffries & Co.

With respect to the third quarter installs and fourth quarter expectations for installs, what’s the breakdown between new customers and existing customers and I apologize if I missed that earlier?

Boyd Douglas

Well we’re putting in nine new financial and patient accounting systems so those are all new customers. We’re doing 10 clinical customers and I don’t have the breakdown of those nine how many. If history dictates probably half of those, probably four or five of those are full system installs of the nine and then so that means we’ve got four or five others, or five or six others, that are add on clinical.

And kind of same with the nursing point of care. Probably I would guess out of the nine new facilities, maybe three or four are putting in point of care and then the balance of them are existing customers that are adding point of care to what they’ve already got.

Operator

(Operator Instructions). Our next question comes from the line of Corey Tobin – William Blair & Company

Jeremy Frazer – William Blair & Company

Just one quick follow up Darrell your free cash flow is tracked up here fairly close to net income in the first – since year-to-date. Just wondering if that’s anything within your billing, your normal course of billing collection cycle that would cause that to change over the next couple of quarters or do you anticipate it’s going to track normally?

Darrell West

We saw that number go down some this quarter and it’s not unusual. Many times with our customers, their – a lot of their funding does come from states as well. And a lot of times in the third quarter in September states will sometimes not issue Medicaid payments. They’ll delay them until the beginning of the following fiscal year in October for those and so a lot of times they have to plan their cash flow relative to what’s going on in their state. And sometimes we get pushed back in the third quarter on receiving payment from them, but going forward we anticipate to be in line with where we’ve been historically.

Jeremy Frazer – William Blair & Company

Yes I know over a 12 month period you expect that to be fairly, moved at parity I would think, right?

Boyd Douglas

Yes.

Operator

Mr. Douglas there seems to be no further questions at this time. I will turn the call back to you. Please continue with your presentation.

Boyd Douglas

I just want to thank everyone for joining us on the call this morning and I hope you have a good weekend, thank you very much.

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