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Executives

Steven Plochocki - President and Chief Executive Officer

Paul Holt - Chief Financial Officer

Pat Cline - President of NextGen Division

Donn Neufeld - Senior Vice President of QSI Division

Analysts

Charles Rhyee - Oppenheimer & Company

Ross Muken - Deutsche Bank

Newton Juhng - BB&T Capital Markets

Constantine Davides - JMP Securities

Atif Rahim - J.P. Morgan

Richard Close - Jefferies & Company

Sean Wieland - Piper Jaffray

Sandy Draper - Raymond James

Leo Carpio - Caris & Company

Eugene Mannheimer - Auriga

Quality Systems Inc. (QSII) F3Q09 Earnings Call January 30, 2009 4:30 PM ET

Operator

Ladies and gentlemen and welcome to the Quality Systems 2009 Third Quarter Results Conference Call on the 30 January, 2009. Throughout today’s recorded presentation all participants will be in a listen-only mode. (Operator Instructions) I will now hand the conference over to Steven Plochocki, please go ahead sir.

Steven Plochocki

Thank you very much and welcome everyone to the Quality Systems third quarter fiscal 2009 earnings call. Paul Holt, our CFO; Pat Cline, the President of our NextGen Division and Donn Neufeld, the Senior Vice President of our QSI Division, join me this morning as participants.

Please note that the comments made on this call may includes statements that are forward-looking within the meaning of the securities laws, including without limitation statements related to anticipated industry trends, the Company’s plans, products, perspectives and strategies, preliminary and/or projected and then capital equity initiatives, and the implementation of or potential impact legal of regulatory or accounting requirements.

I will now provide some summary comments on the quarter and then Paul, Donn and Pat will follow with additional details.

For the quarter, the company recorded revenue of $65.5 million this represents 36% growth versus prior year quarter. NextGen’s revenue for the quarter was a record $61.5 million up 40% over the prior year.

Aggregate NextGen operating income was up 28% over the prior year. The QSI Division reported revenue of $4 million and Donn will share with you more in terms of the continued progress of our joint marketing efforts with NextGen with federally qualified healthcare clinics.

Our corporate expenses came in at about $3.6 million down from $4.3 million in prior quarter, which included proxy related expenses if you remember, that were associated with our summer proxy content. Fully diluted earnings per share for the quarter were $0.46 per share up 15% over year ago.

Over the past quarter the company presented at the JMP Securities Conference, at Oppenheimer’s Conference and the Piper Jaffray as well. Two weeks from now, we will be presenting at the UBS Conference in New York City.

I will now turn it over to Paul and Paul can you take us through some of the financial information.

Paul Holt

Sure, thanks Steve. Hello everyone, as Steve mentioned, we’re pleased to report our consolidated revenue at $55.5 million representing a 36% increase over the prior year.

Our consolidated revenue growth not including our recent acquisitions of HSI and PMP was 21% on a year-over-year basis. Earnings per share of $0.46 and 15% above the $0.40 we reported a year ago. Consolidated system sales represent a 6% increase compared to the $23.7 million in our prior year quarter.

Consolidated maintenance EDI, revenue cycle management and other services revenue rose 66% to $40.5 million compared to $24.4 million in the prior year quarter. Excluding the revenue from a recently acquired revenue cycle management acquisitions, as categorical revenue rose 36% compared to the prior year. Total revenue in this category accounted for 62% of our total revenue this quarter versus 51% a year ago.

Our consolidated gross profit margin this quarter came in at 64.7% that’s down from 66.4% a year ago, the decrease in our gross margin over the last year was due primarily to the increase in our revenue cycle management services at lower margins as well as a proportional increase in the [annual] services and the percentage of our total revenue, these services carried lower margins compared to system sales.

Total SG&A expense increased by approximately $5.3 million to $18.6 million in the quarter compared to $13.3 million a year ago. Primary drivers of the increase included SG&A expenses associated with the new acquisitions of HSI and PMP, other SG&A expenses in the NextGen Division as well as higher year-over-year corporate expenses.

Interest income for the three months ended December 31, 2008 decreased to 328,000 compared to 710,000 a year ago. Our interest income this quarter was impacted by much lower interest rates earned under the cash investment. As of December, we had approximately $10.6 million in auction rate securities versus $12.7 million at the end of the last quarter. We are very happy to see a couple of auction rates sold this past quarter.

The Company’s effective income tax rate increased just slightly this quarter versus last year at 35.8%. The effective tax rate for this quarter was impacted primarily by the reenactment of the R&D tax credit statutes, which allowed us to record benefit for R&D tax credit.

Moving onto divisional performance system sales in the NextGen Division rose 7% to $24.4 million compared to $22.8 million a year ago. Continued growth in NextGen space of installed users, continued add-on purchases of licenses from existing customers as well as recent acquisitions of HSI and PMP continue to drive higher maintenance EDI and other revenue in that division.

Total maintenance EDI, revenue cycle management and other revenue grew 75% higher compared to last year at $37.1 million versus $21.2 million. Organic revenue in this category grew 41%.

Operating income in the NextGen Division was up 28% to $22,822,000 compared to $17,823,000 a year ago and our general division reported a year-over-year slight decline in year-over-year revenue of $2,969,000 compared to $4, 072,000 a year ago. Operating income for this division was $944,000.

Moving onto our balance sheet, our total cash and marketable securities declined by approximately $50.1 million this quarter to $57.5 million or $2.38 per share compared to $82.6 million or $2.92 at the end of the prior quarter. Note, that the company paid approximately $18 million, including the repayment of acquired debt from the PMP acquisition during the quarter.

Also note that the company paid a dividend of approximately $8.5 million or $0.30 per share in October 2008. The company’s Board of Directors have declared a $0.30 per share dividend for shareholders of record March 11, 2008 to be paid in early 2009.

As of December 31, $8,199,000 from the company’s marketable securities was included in long-term assets, due to the fact that these assets relate to auction-rate securities, which are no longer liquid, these are failed auctions for the securities.

In December 31 quarter, we’ve reduced our after-tax unrealized loss on our auction-rate securities to $17,000 versus $994,000 as of September 30.

This quarter, our DSO’s were unchanged compared to last quarter and the year ago quarter at 140 days. We did see some change in our unpaid deferred revenue and that resulted in our DSO’s net of amounts included in both accounts receivable and deferred revenue being up 11 days and 99 days this quarter. Our DSO’s by division were 82 days for the QSI Division and 143 for the NextGen Division.

Deferred maintenance and services revenue at $47.5 million was up $1.4 million from the prior quarter and up $6.3 million compared to the year-ago quarter. The amount of deferred maintenance revenue declined sequentially due to the timing of certain maintenance billings. Deferred annual licenses and implementation training in the NextGen Division however, continue to grow versus prior periods.

Finally, for those of you who are tracking this, our non-cash expenses for the quarter, breakdown as follows. Total amortization of capitalized software, $1,324, 000 million that breaks-down to $45,000 for QSI $1,279, 000 million for NextGen. Total depreciation expense $830, 000 as $84, 000 for QSI and $746,000 for NextGen.

Our investing activities for the quarter were as follows; capitalized software $1,315, 000 million in total and $57, 000 for QSI and $1,256, 000 million for NextGen. Fixed assets $616, 000 in total that is $173, 000 for QSI and $443, 000 for NextGen.

We had $463, 000 in stock option expense, that is a non-cash expense well and we also recorded $325, 000 in amortization expense of acquired intangibles related to the PMP and HSI acquisition.

I want to thank you all for being on this call again your interest in our company and I will turn things over to Donn Neufeld, Vice President and General Manager of our QSI Division.

Donn Neufeld

Thank you Paul and thanks to everyone on the call for your interest in our Company. The QSI Division numbers have been addressed in detail by Steve and Paul, but I’d like to make a couple of brief comments on other areas of interest within the division.

Again this quarter, we saw growth in new federally funded entities purchasing the QSI Electronic Dental Record along with the NextGen EPM and EMR. We had five new joint sales this quarter and two upgrades to the existing joint customers.

A note of our sales staffing and pipeline, our sales staffing remains unchanged from last quarter and our pipeline is approximately $5.6 million. Our pipeline is defined as sales situations where QSI is in the final three purchase choices and we believe that the sale will occur within 180 days.

With that I’ll turn it over to Pat Cline, President of our NextGen Division.

Pat Cline

Thanks Donn and good morning everyone. During the quarter, the company executed approximately 60 new agreements and our pipeline increased slightly to $86 million. Our sales force grew by 2 to 68 people at the end of the third quarter. One the market front, we are encouraged by the new administrations commitment to the adoption of electronic health records and some of the programs that I’m sure you’ve heard about, we temper that enthusiasm a little bit due to the general economic conditions.

We’re also encouraged by the improving performance of our revenue cycle management operations in the strong results that our customers are seeing more confident they like our software offerings are offerings in the RCM space, which are superior to anything else on the market.

In closing, I’d like to thank NextGen employees for their dedication and hard work and thanks to our customers for the confidence that they continue to express in our company, our products and our services. John we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Charles Rhyee - Oppenheimer & Company.

Charles Rhyee - Oppenheimer & Company

Oppenheimer & Company. Just a couple of questions here. First, Paul I think you’re talking about the revenues here in the NextGen Division, it looks like implementation and training service revenues were down in the quarter and am I thinking about that correctly? Can you sort of touch on why we might have seen that?

Paul Holt

Sure, well there is some seasonality to the implementation revenue in the December quarter and this particular quarter, the way the holidays fell out that was particularly, made things a little bit even more difficult for us to render some of those implementation services. This is a joint effort implemented systems and sometimes the calendar can get in the way. I thing Pat may have a couple of other comments on that as well.

Pat Cline

Yes, I would echo what Paul said with Thanksgiving and Christmas and New Years’ in particular Christmas and New Years falling kind of mid-week, a lot of customers don’t want to have trainers in their offices at that time that touch it down a little bit. The only other thing I would add is that over the last couple of years as I’ve said on one or two other calls, we have been really trying as a company to make our systems easier to use and easier to implement and I think we have seen some success in that area and in the past talked about some initiatives like our computer based training and those kinds of things.

So, while I think most of the slight decline is just the seasonality issue that we discussed. I hope that we’re also being successful and that our systems are requiring a little bit fewer hours to implement, because that in the longer-term is what will allow us to scale.

Charles Rhyee - Oppenheimer & Company

Great and another question here, I think you’re talking about the tax rate it looks like and that’s a little bit lower than we are looking for and I think Paul, you just mentioned some unrealized losses on the auction-rate securities and does that, do you get a tax benefit in the quarter from that? Is that why we see maybe down in our tax rate from last quarter or was that just the R&D credit?

Paul Holt

No, that really is the neutral thing for the unrealized loss on auction-rate securities that doesn’t point into the tax rate at all actually. What we’re seeing this quarter is the R&D tax credit being reenacted that allowed us to record a year-to-date benefit so to speak, because we haven’t been recording any balances in Q1 and Q2.

Charles Rhyee - Oppenheimer & Company

Okay, so then we should see the tax rate maybe either stay at this level as you’re continuing to or did you take the entire credit for year-to-date period?

Paul Holt

We took a year-to-date amount in this quarter. So, we did see that some benefit there that some extra benefit that we’re not going to see in the next quarter.

Charles Rhyee - Oppenheimer & Company

Okay, great and then my last question here, can you just, I know in the past, we’ve talked about deferred revenues and some of the reasons why changes in deferred revenue don’t relate to your reported revenues and I think one of the reasons you often talk about it, a lot of your implementations can occur in a relatively short period of time and so it never hits deferred revenue. In more and general can you talk give us sense on, so how much of your current quarter bookings are recorded as revenues typically?

Paul Holt

Well, in the recurrent side of the house is really very pretty well. EDI maintenance those kinds of things are on that pilot, but and then I’ll also add RCM business is also pretty much on automatic pilot. Obviously, a big portion of the system sales relates to revenues that we had sold during the quarter.

Charles Rhyee - Oppenheimer & Company

Do we see that like over 50% or can you give us some ballpark area?

Pat Cline

Well actually, Paul, correct me if I’m not stating this properly, but our recurring revenue now with our RCM business as a company, our recurring revenue is about 60% down.

Charles Rhyee - Oppenheimer & Company

Well, I understand that. Yes and I’m not disputing that, I’m just asking on the software portion?

Pat Cline

I wouldn’t want to get into the actual percentages, but I would say a majority of the systems that now, the implementation services typically have been sold and that stuff that has been recognized of the balance sheet. If you’re looking at just the license revenue that’s included in system sales, clearly a majority of that is what’s sold during the quarter.

Charles Rhyee - Oppenheimer & Company

Okay and my last question would be on the other line, you said there was additional software licenses sold, is that entire other line basically still software sales just not necessary to new customers?

Pat Cline

Are you are talking about other revenue?

Charles Rhyee - Oppenheimer & Company

Yes, other revenue in system sales line, I’m sorry in the EDI maintenance and other.

Pat Cline

What’s included in that line is our other types of services including annual licenses we sell, third-party annual licenses as well as some TNM services, consulting related services. We’ve also have some hosting services included in that category; it’s just a number of different things.

Operator

Your next question comes from Ross Muken.

Ross Muken - Deutsche Bank

Hi, it’s Ross Muken from Deutsche Bank. So, as we think about sort of the complexity around the stimulus package. I’m looking for your comments; specifically on what you think we’re going to see out of the government regarding sort of sterilization and how they’re going to sort of handle this whole idea of interoperability and are we going to see kind of the get together of people from your side of the table, from the government side of the table providers etc., and decide on sort of how we are going to move forward here and is that going to sort of the in between before we actually start to see whatever funding is available start to flow to the end customers?

Pat Cline

Well, that’s a monster question and we wish we have the answer to most of it. As we understand that now, in general terms, there is the 20 billion to be broken up into two pieces, 18 billion for hospitals and physicians, probably built around some kind of a pay for performance modeling and then 2 billion, which should come out sooner, when sooner is the defined, we don’t know yet. And then there is about, 1 billion in renovation for Health IT System, 550 million for Indian Health Services, which as most of you know or may not know, we’ve had a long established relationship within the Indian Health Services as a company and this should be a strong opportunity for us.

The answer to your question Ross is something that we are seeing very close to because we need to understand it as well, the information that I just cited to you was provided to us by our government liaison officer this morning, based on information and his understanding of events last night. So, we are seeing this close as we possibly can to it.

What we do now is that there is a desire to move fast but, we need to find that in terms of the government terms. We view that we might have some impact from this in the upcoming second half of our fiscal year to may be the latter half of our upcoming fiscal year, but that perhaps the calendar year 2011 is where we’re really going to see, excuse me 2010 is where we’re really going to see a greater impact. I don’t know if I’ve helped you at all there.

Ross Muken - Deutsche Bank

No, that’s helpful and sort of a follow up Steve. And as we think about this, what are your customers focused on now? Because here they’re seeing all this chatter, some of it particularly around maybe money’s being available; I mean is that causing them to think twice about implementing something today or going through kind of an RP process or thinking about a solution? And then also, is there any fear on your end that we see something from the government, where the government offers a competitive, free EMR maybe it’s the VA solution or something like that? And that is something that they view as a benefit for the low-end of the market or do you think if that’s something that’s pretty much a non-starter?

Paul Holt

Pat you want to address the customer issues?

Pat Cline

Yes, that’s right I will try to address both. On the customer front, we have found that a couple of customers have installed their purchases, because they misunderstand what the government seems to be that the direction that the government seems to be headed in. As Steve mentioned, by all the indications, the vast majority of the money that will flow to healthcare providers will be based upon quality reporting and health quality measures and sort of pay for performance or pay for performance reporting kinds of things.

We have not heard anything that says the government is going to hand a check to every doctor so that they can go out and buy systems may be they learnt a little bit from what they did with banks.

But, if that’s the case and if the government were to announce that had a date in time, let’s say next year, which is early indications are pointing to that there would be bonus payments to providers, if they can do can achieve certain quality or do certain reporting or report certain metrics then I think the benefits would accrue to companies like ours sooner, because people would need to purchase and go through an implementation cycle and collect the data in order to position themselves for those things, but we have again seen some customers who say, “hey I’m just going to hold off because I’ve heard the government is going to buy my system for me”.

And then to the second part of your question the Vista System there is also an indication that as part of bill and some folks say that it’s non-negotiable that the government will be offering the Vista System or a low cost system, but I will remind everybody that the Vista system has been free and part of the public domain and that’s something that the government did a couple of years ago.

So, while I don’t know the differences between the Pre-Vista System today and the Pre-Vista System a couple of years ago, it didn’t really have any impact and I don’t forecast that if the government makes a new Vista Type System available that it will have a big negative impact on companies like ours.

Operator

Your next question comes from Newton Juhng – BB&T Capital Markets.

Newton Juhng – BB&T Capital Markets

I did have a question regarding the production out of HSI, it looks like about a 17% sequential growth on the top line and we’ve talked in the past about up-sell of the service into your customer base. First of all, success breathes lots of questions. Do you see this type revenue growth a sustainable one? And then secondly, do you see PMP potentially generating similar types of growth in the future?

Pat Cline

Yes, I think that type of growth and in fact accelerated growth is sustainable, the cross-selling opportunities are and have been tremendous. We got a lot of very exciting deals in our pipeline and the deals that we have closed that are still coming online and being deployed, so we are encouraged by what we see.

Newton Juhng – BB&T Capital Markets

And with regard to your expectations on PMP?

Pat Cline

The same answer now PMP as you know, that transaction was just closed a couple of months ago here, but so it will be a little bit slower start than what you are starting to see from HSI, but yes we continue to feel as we did prior to pulling the trigger on that transaction that these companies can sustain tremendous organic growth.

Newton Juhng – BB&T Capital Markets

Okay, thanks for the color there Pat. Longer-term as revenue cycle management ramps up, if you need to build up more capacity and I know that you’re far from this point right now. Do you have the ability to expand your current facilities or would you be looking to new sites or even an offshore type of model?

Pat Cline

Well, we’re actually not too far from that point and that I just approved some additional build out of current facilities and capacity and those kinds of things based on what the growth that we’re seeing and what’s in our pipeline. As far as offshore, I think there are opportunities and we’ve taken advantage of some of those opportunities.

We don’t want to create certainly a sole offshore type of entity or an entity that does most of its business offshore, but there are a couple of growth type of things that we can and have offshore for quite sometime. And I think most companies in our business have seen and others use that same type of model.

Newton Juhng – BB&T Capital Markets

Switching gears here a little bit just to the sales cycle. We are wondering obviously you gave some commentary on some customers that are choosing to delay, but in general with the rest of your customers, are you seeing any lengthening of the sales cycle at all or in particular classes of customers small, medium, or large. Just kind of curious, what your thoughts are on that front?

Pat Cline

We haven’t seen anything material at the low-end in the mid-range, on the high-end, we have seen a little bit of lengthening not huge, but you may be familiar with the AJ study that recently came out that indicated that just about two-thirds of hospitals, health systems have indicated that they’re slowing or spending their IT investments in clinical investments and we have seen a little bit of that on the high-end.

However, all this discussion about pay for performance and various hospital-to-physician linkage and interoperability and infrastructure discussion has a lot of the forward thinking, health systems moving a little faster, so net-net, slightly longer.

Operator

Your next question comes from Constantine Davides - JMP Securities

Constantine Davides - JMP Securities

Paul I just wanted to or I guess Pat maybe go back to Charles’s question just around implementation revenue and I get that, there is some seasonality in that number, but that’s really the lowest number you guys have had since December 2005 and I just want to kind of understand, is there any kind of up-sell versus new account issue that’s going on there, something I might be missing?

Pat Cline

No, if there were anything materialized I would be happy to tell you about it, but there really isn’t. As I mentioned, directionally we are trying to make our systems easier to learn, easier to use, easier to adopt and you may see a little bit of our success in that area, but most of it is the seasonality and I don’t have all the numbers in front of me, but there is nothing that would jump off the page.

Paul Holt

I would add that, once you see our Q, you can see the details of what we have in deferred revenue, but we did grow the backlog if you will or the implementation services. So, I don’t think there is necessarily any kind of a slowdown. I think the other thing to mention here is that, we have had good success with selling, add-on licenses to existing customers, who have been successful with the product and have continued to low the product out and purchase additional licenses those folks typically don’t require the same amount of implementation services that somebody brand new might. So, I think you might want to factor some of that in as well.

Constantine Davides - JMP Securities

And I guess typically in any given quarter what or maybe the last few quarters what’s your mix of add-on versus, sort of Greenfield territory?

Paul Holt

I don’t have any exact percentages here, but we have had a pretty good success in the add-on category and I think we have had, directionally we have had more proportionally more licenses being sold to existing customers included in the mix. So, I just gave you direction, but I don’t have actual numbers.

Constantine Davides - JMP Securities

Okay and I guess one housekeeping item, Paul you didn’t disclose an operating cash flow number in the releases is that something you have handy?

Paul Holt

I don’t have it handy just stay tuned as we typically will have the Q out shortly

Constantine Davides - JMP Securities

Was it positive?

Paul Holt

Well, certainly. As I mentioned in my notes, our cash was down in the quarter, we are down $15 million, but you have to bear in mind we had $18 million leave the company related to the PMP acquisition. So, you also have to remember we are paying an $8.5 million dividend at the same time. So, certainly we had positive cash flow from operations, but we bought somebody.

Operator

Your next question comes from Atif Rahim - J.P. Morgan

Atif Rahim - J.P. Morgan

I guess my questions would be more towards patents, I am trying to follow-up on the previous question you answered and you said, directionally the percentage of I guess, new license you’d be selling within your customer base would be up and I think the number you’ve given in the past is two-thirds. So, would you be saying, it’s getting closer to 70, is that correct in the thinking? And then secondly, what’s your win rate and has it changed at all outside of your existing customer base? How is the competitive environment been there over the last few months? Thanks.

Pat Cline

On the two-thirds issue, it’s actually not the mix of sales to existing customers versus sales to new customers. The two-thirds number that I’ve cited in the past is the number of new customers that purchase both the electronic health record product and our practice management product; and that hasn’t changed, that number stayed pretty much the same. It has gone up to three quarters, in some quarters 80%, but it seems to stay in that band.

The actual percentage of new customer sales in dollar amounts or in numbers of sales to existing customers is not something that we breakdown, but we don’t see a big downturn in sales to new customers as I mentioned in my prepared comments, we signed approximately 60 new customers in the year ago quarter, the number was 50, though its down sequentially from last quarter.

So, nothing alarming relative to selling the new customers, I think there is a lot of good news in our increased sales to existing customers, because that’s evidence that our existing customers are productively using the product and are happy with it and they want to do more with it and are expanding and those kinds of things, so and no bad news there.

Atif Rahim - J.P. Morgan

Okay, understood and then in terms of the win rate given, you had more clients, is that a function of is your pipeline growing? Or are you winning more deals, as a percentage?

Pat Cline

I don’t think there has been any big change in our win rate. We’ve seen probably a little bit of a lower win rate at the low-end and probably a little bit more at the higher end, but I think they net out to be about the same. We have seen our competitors in this economic environment and based on what’s going on with some customers pulling back a little bit get more aggressive with discounting that makes a little tougher on everybody in the business, but nothing big on the win rate one way or the other.

Atif Rahim - J.P. Morgan

Okay and then just a quick question on RCM to the, contribution from those acquisition seems pretty impressive especially sequentially what’s your plan going forward? Do you think you can scale up your current position or would you be looking at more M&A within that area or any other areas for M&A going forward?

Pat Cline

Well, I think it makes good sense for us to make sure that the acquisitions that we completed are firing on all cylinders and we are very happy with both of those companies and the people, the management teams and the customer relationships, but as we said early on in this process, we think there are a lot of opportunities for synergies financial synergies and strategic synergies.

So, we want to make sure that we have those as positive as we can get them and if we feel comfortable with that and as we feel more comfortable with that I wouldn’t rule additional acquisitions out. Talking about the other side of my mouth, we do think that we can scale these companies and we are adding capacity based on what we see in the pipeline.

Atif Rahim - J.P. Morgan

Okay and just form these acquisitions, would this be mainly through stock, cash or debt any idea there?

Pat Cline

I think, we’d have to look at it at the time.

Atif Rahim - J.P. Morgan

Okay, all right thanks a lot and just the one quick follow-up, I mean a new question there actually on the guidance in the past year you said you might be giving out guidance at some point any update there?

Steven Plochocki

One of the things that we did talk about guidance back in August 21, at our Annual Analyst Meeting and one of the things that we’ve been observing over the last six to seven to eight months is the incredible changes that are taking place in the marketplace.

Macroeconomic trends and general market uncertainties approaching historic levels, the Board in-conjunction with Management, we made the decision Atif to not provide guidance for our upcoming fiscal year and there is too many changes taking place out there beyond our control.

We have full confidence in exercising our strategic plan, because we have been doing that pretty much on target as we had outlined it for upcoming year, but I’ve been with the Company as the CEO since August, but I’ve been on the Board for five years. I’ve seen more change in the last seven months than I’ve seen in the last five years and I think 2009 just across the Board in American business and generals it’s going to be a very complex year.

So, we’re going to steer away from direct guidance, but, we’ll be open, we’ll be available, we’ll be as honest and forth coming as possible and we’ll continue to be strong performers in this sector in executing the plans we put together.

Operator

Your next question comes from, Richard Close - Jefferies & Company.

Richard Close - Jefferies & Company

First, question I guess with the BRM on the maintenance number from your press release, it looks like we had a pretty big sequential bump in that number going from about $17.2 million up to the $19 million or $19.2 million in the December quarter, just as curious it seems like a pretty large increase and if you could give us some detail as to what drives that number specifically, the timing of when things flow into maintenance and anything around that?

Paul Holt

Maintenance is something that follows the sale of our software. Different customers may have negotiated different terms, more typically though they will start within 60 days of installation and I could just tell you in general that it is something that follows the sale of licenses. If you look at and I grant you that there is some variability in those numbers on a quarterly basis, but if you look at the year-over-year increase, it does make some good sense, based on the licenses that we’ve sold and the price that we charged for maintenance.

Richard Close - Jefferies & Company

Okay. So, I know you had a really big add-on license sale. I think, through the June quarter if I’m not mistaken and I was curious, would something like that drive an increase in maintenance this far out in the future hitting in the December quarter, was there some sort of large like license deal, I mean I guess that you could point to that would all of a sudden lead to a $2 million bump in that front?

Paul Holt

No, I wouldn’t, that’s too far out, I wouldn’t try to point to that. I would more point you to the overall growth in the number of licenses that are out there, which has been growing consentingly every quarter.

Richard Close - Jefferies & Company

Yes, I guess I’m looking at the software’s sales numbers for NextGen and it’s been pretty consistent in that 18.5 sort of range over the last three or four quarters and we haven’t necessary seen such a big jump in the maintenance. So, the system sales for NextGen being at around I think you said $24.4 million was that the number?

Paul Holt

Yes,

Richard Close - Jefferies & Company

Okay. So with the system sales being at $24.4 million, is it safe to say that software is around $18.5 million for the quarter?

Paul Holt

Well, which quarter you are talking about this quarter?

Richard Close - Jefferies & Company

Yes, third quarter, December quarter.

Paul Holt

Yes, if you want to back out the implementation services from the system sales line that would give you the what we’ve recognized in software license fees, not necessarily, that’s not going to tell you other factors which play into what we’re earning for maintenance, you have to remember that, our maintenance prices are based off the list prices software not necessarily what we actually sold the software for.

Richard Close - Jefferies & Company

Okay. So does that imply that there has been a higher level of discounting going on over the last couple quarters?

Paul Holt

I don’t have any kind of analysis that would point to that, so I really couldn’t tell you.

Pat Cline

This is Pat. I’ll follow on a little bit to that. I don’t think the discounting that we have done would be up materially. I think on a deal-by-deal basis, we’ve discounted the software to meet competition or come closer to competition, but not on an overall level.

We quarter-in and quarter-out, we find ourselves signing contracts with new customers at three times the price that some of our competitors are quoting that’s because many customers, the more sophisticated ones look at value and not just the price.

They look at things like the return on the investment not just the check they need to write. So, we don’t typically have a lot of pressure, but as I mentioned there has been a slight amount of increased pressure on the discounting side.

Richard Close - Jefferies & Company

Okay, that’s very helpful and then a quick question on the revenue cycle side of the business. Obviously, you have two companies that you’ve acquired; primarily focused on certain geographic areas, have you guys been successful in taking those services and expanding the footprints to a national level with the revenue cycle?

Pat Cline

We have, yes.

Richard Close - Jefferies & Company

Okay, great and then obviously a big merger within the industry, the Allscripts-Misys merger and it would be curious to hear your thoughts on whether you’re seeing maybe NextGen it is not being as successful in the Misys base as maybe previously prior to the acquisition or any changes on that front?

Pat Cline

I have not and I specifically asked this question to few of our sales people and a couple of sales managers. I have not seen any and they have not seen any material downturn in our replacement sales to the Misys base, but with that said, the universe of our sales into the Misys base wasn’t huge to begin with.

I would speculate that, we’ll be less successful going into the Misys base, with the advantage the AllScripts now has and I think AllScripts had a great advantage back when they had the relationship with IDX and when IDX was acquired by GE, that advantage went away and I think they once again have some low hanging fruit within the Misys customer base and it is terrific for them.

Operator

Your next question comes from Sean Wieland - Piper Jaffray

Sean Wieland - Piper Jaffray

A question on receivables, what kind of DSOs, do you see in the revenue cycle management business versus the core NextGen business?

Paul Holt

They are typically 50-60 days.

Sean Wieland - Piper Jaffray

So, on a net basis, I mean what DSOs, I know you said it was unchanged with 140 days, but could we look at it on a, DSOs in NextGen were 143, but if we backed out the revenue cycle management, was there an up-tick in DSOs excluding revenue cycle management?

Paul Holt

Yes, I don’t have that number right here handy, but I think it was in the order of a few days.

Sean Wieland - Piper Jaffray

Okay. So what’s going on there because that’s something that you guys have talked about wanting to bring down and it seems to keep going in the other direction?

Pat Cline

They were a couple of things. Directionally, yes we want to bring it down. Although, we are not very concerned about it, we have run in this band for quite some time. We had a fairly sizeable order that had extended payment terms that came in during the quarter, which will directly effect DSOs and we also had a couple of customers that held off on paying us until the very first couple of days in January that we couldn’t record in the December quarter, which had we gotten those payments a few days earlier would have brought the DSOs down as well. I don’t think there is a trend here; it’s just more of an anomaly with those couple of things.

Sean Wieland - Piper Jaffray

Okay, was that sizeable order than revenue recognized in the quarter?

Pat Cline

We were about to give the same answer Paul. So, go ahead.

Paul Holt

Yes, Pat mentioned in order extended payment terms that I just want to clarify, they are still within the range of payment terms that we typically offer, but they were lengthier than others I guess so to speak. So, I want to sort of make sure, we are not talking about when we say extended, branch has extended payments, we are not talking about something wild and crazy, where it’s still then the typical range, but more likely than some others.

Sean Wieland - Piper Jaffray

Okay. So then kind of as attention to that, have you seen any change in how customers are financing deals in terms of use of third-party financing in access to third-party financing? And have you seen any meaningful change in what groups are asking for non-payment terms?

Pat Cline

No real change in the financing with everything you hear about the credit markets you would expect a change, a more difficult time financing customers are having customers get their own financing, but we just haven’t seen it, we have been any customer that has wanted to finance their system, we have been able to put them in touch with our financial partners who are readily lending money and we haven’t heard that customers have had difficulty getting credit on their own.

Sean Wieland - Piper Jaffray

Okay last question, Pat, what do you see in terms of the pipeline of new sales reps that you’re looking at?

Pat Cline

We’ve seen an increase in the pipeline. I think that might have to do with some of the difficulties that a couple of our competitors have faced, have had, but we’re encouraged by a good pipeline of what we think are more talented people.

Sean Wieland - Piper Jaffray

So, I think you had two reps in the quarter, is that something that would be appropriate to put into our model?

Pat Cline

Well, I don’t want to, it is impossible for me to tell you what we’ll do in this quarter and next quarter, I have said directionally that, we want to continue to expand the sales force based on the opportunities that we see out there. Two is not an unreasonable number.

Operator

Your next question comes from Sandy Draper - Raymond James.

Sandy Draper - Raymond James

Most of my questions have been answered by this point, but maybe just another follow-up to what maybe Richard had took it on some of the other folks. Just want to make sure I understand this Paul, that when you’re looking at an add-on license sale versus a new customer sale, do all additional models and add-on sales to new customers go into the maintenance line? I just want to make sure that’s correct? It sounds like that’s what you said?

Paul Holt

Yes, well as I said on add-on license, certainly there is going to be maintenance associated with that license, which will go into maintenance.

Sandy Draper - Raymond James

Okay, I understand the maintenance will, but does the actual software license revenue, go into that maintenance line, because I guess my question maybe framing very simply what Richard was asking as well as, intuitively eventually software sales should grow at or above the rate than maintenance does. And so I’m just trying to understand, right now you guys are growing your maintenance lines faster than software and so I’m just wondering, if there is a way to adjust that because, there is a certain portion that maintenance line that’s actually software licenses not just monthly maintenance.

Paul Holt

There is no software license revenue in this line, that’s maintenance.

Sandy Draper - Raymond James

Okay. So then how does maybe just to understand then. How do you grow maintenance faster than you’re growing software?

Pat Cline

I think there are a couple of things you have to keep in mind. What we’re reporting as software revenue, is for the most part where we’re reporting under the residual message under SOP 97-2, which means any discounts that you have in the arrangement get applied against the software revenue that you’re recognizing.

So, I guess, what I am saying is it’s not correct, whatever revenue we recognized in the software line and take that times 18%, let’s just say and say that’s what I should have for maintenance. You have to remember that our list price of maintenance and also maintenance can be negotiated as well, what we charge simply for maintenance, but the maintenance is typically driven off the list price for software not what we’re recognizing as license fee revenue.

Sandy Draper - Raymond James

Okay. That helps a lot. Then my second question and this may have been asked and I may not have heard it, but obviously a lot of growth in the maintenance specifically the line that was significantly higher than what I would have expected was EDI. Is there anything from the acquisitions that maybe would have gone in there, but the step-up in EDI was the biggest we have seen? Or did you guys run a special program? Or anything that we could think about, why EDI specifically jumped up so much?

Paul Holt

I think we’ve been having some good success there in EDI, selling to the base of NextGen customers. I think to some degree, EDI has been something that we’ve been trying to do a better job of selling to our customers, our existing customers and we’d like to continue to do that to expand that base of customers. I think there is still, we know that there is still more room to go in terms of not just selling EDI services to a new customer, but going after that base of customers that NextGen customers that are out there, because it make sense.

I mean they are running our system, already they are using our practice management software to do their collections, why not go to the same company that you bought your software from to get those kinds of services from. So, I think it’s just for the most part, it is a testament to better success internally from selling to existing customers.

Sandy Draper - Raymond James

So, just one follow-up on that and I’ll stop. Can you give me the estimate on what’s your penetration of your existing customer base is with your EDI services?

Pat Cline

We don’t have that estimate. We have got internal sort of sales forecast and things, but I can tell you that the penetration is far lower than we think it can be and we think we have got a heck of a lot of room to run selling EDI and not just the existing EDI, but also we are starting to on additional offerings. So, we have got a lot of runway ahead of us.

Operator

Your next question comes from Leo Carpio - Caris & Company.

Leo Carpio - Caris & Company

Regarding the economy and the credit crunch, what type of impacts have you seen so far and is there any, is it concentrating on any particular market segment?

Pat Cline

I don’t think I have anything to add to the prior comments that I have made to summarize them. We have seen a little bit of a protracted sales cycle at the high-end, but noting huge. We have not seen customers’ have difficulty in securing credit at any end of the market. We have had some customers’ tighten up a little with their purchases just because they are kind of spooked about the economy.

There are some studies that have shown that hospitals, the large systems have pulled back a little bit, but some of that is tempered by the enthusiasm and what’s going on with all the discussion of various components of the stimulus bill and spending and government programs, some of which are already in place relative to pay for performance, pay for reporting, e-prescribing and some of them that are coming down the road that seem to be showing that customers that have these types of systems will fair far better financially as they report and improve quality.

So, I think the economy has stalled things a little bit. I think we have been very effective at managing through it as a company and we are encouraged by what we see relative to the future.

Leo Carpio - Caris & Company

Okay and then turning briefly also we’ve have we talked about Siemens lately or any update from that relationship?

Pat Cline

Relationship is going well. Siemens continues to place NextGen systems within their customer base and propose NextGen systems. We’re very happy with the relationship I believe if you ask Siemens they would be happy with the relationship, nobody sees that relationship ending anytime soon.

Leo Carpio - Caris & Company

Okay and then turning to the whole Obama Healthcare IT proposal. How quickly or what type of ramp up would you need to meet what we need to project or anticipate demand for systems?

Pat Cline

Well, not knowing what that demand will be, it’s impossible for me to say we will need this much time or that much time, but I will say that as a company we spend a good amount of time thinking about that and how we scale and looking at things like, how we could deliver two times, three times the number of systems should the demands be there.

We hope it will and we think we’ve got strategies in place. We think, we’re pretty well positioned and in fact better positioned than most of our competition to scale should that happened. We, as I mentioned, focused quite a lot on making the system far easier to implement. We’ve trained a number of, an increasing amount of implementation partners, should we need to call on them; we’ve done a lot with computer-based training and e-learning programs and those kinds of things. So again, we think we’re well positioned, but it’s impossible for me to tell you that we’ll need this much time.

Leo Carpio - Caris & Company

Okay and then lastly, due to the competitive environment, any competitor becoming more aggressive or just pretty much the same situation?

Pat Cline

Pretty much the same.

Operator

Your next question comes from Eugene Mannheimer – Auriga.

Eugene Mannheimer - Auriga

I have two questions; first I guess Pat related to your comment on the studies about hospitals curtailing spending. Have you seen this effect perhaps your stock related lead activity?

Pat Cline

We have not seen a downturn in lead activity. So, it’s tough for me Eugene to say that we have, let me say this, we have kicked-off and executed certain more aggressive marketing programs in the hospital space. We’ve not seen a downturn in hospital leads, but it’s not possible for me to guess that, “Gee is that a result of spending more and doing more in the way of marketing targeted toward hospitals while the general stocks lead situation might be down”. I just don’t know that answer.

Eugene Mannheimer - Auriga

Okay, fair enough and then, I guess in the way I guess can be construed as my asking for guidance, but I’m certainly with the layering on of the revenue cycle management pieces at lower margin. Is it fair to say that, this is something we should become accustomed to higher revenue type growth, but at lower margin?

Pat Cline

First Eugene, we don’t mind you asking for guidance and we’ll give you as much as possible. I think, we had mentioned that we’ve pulled back a little bit, but directionally we do want to give you more information than we’ve offered in the past and while we might not come out today and say, we think our fiscal’10 is going to be X dollars here and X dollars there, we do want directionally to give you more. So, I just wanted to paint that as a backdrop; and what was the primary part of your question Eugene, I am sorry.

Eugene Mannheimer – Auriga

Simply that, certainly with the layering on of the revenue cycle management components. Yes, should we become accustomed to modestly lower margins than we seen in the past?

Pat Cline

I hope not Eugene. I think our plan internally is to bring these companies that grant to do have traditionally lower margins inline with the rest of our business. Well, some might ask, how the heck are you’re going to do that based on the margins that you achieved in software licensing.

We think we’ve got a very effective plan to be able to get there, it’s not something we’ll do overnight, but we predict that our margins in the web cycle space will be far better than any other company in the space.

Steven Plochocki

All right, well then, I’m assuming that we’re done. One of the things I’d like to say before we conclude here is in concert with the line of questioning, it’s pretty clear that the marketplace right now, we have a bit of schizophrenia. We have market conditions to be concerned with. Overall, our market macroeconomic trends that have not been along these lines probably in most of our life times.

And then we have the other side where we have enormous incentives are geared towards deferred increased adoption of practice management and EMR. The incredible demands for revenue cycle management, the government support, the dollars pouring into the system, to reach a time line of 2014 where we can have enough critical mass of systemic healthcare to engage in a reform. So, you’ve got both of these things working at the same time.

My guess is that the compelling elements of pushing this forward will outweigh and defeat the economic elements over the next year to a year and a half and we will continue to see the further the expansion of people less electronic healthcare and that will move at a much faster pace than the economic conditions will slow it down and that’s our view on a going forward basis.

And we will continue to execute our plans to the utmost with extreme effort and extreme enthusiasm and in conclusion, we want to thank all of you for your support and I am sure as I get out of my travels this spring season. Clearly in New York in a couple of weeks at the UBS, I will see many of you out there.

Thanks again and thanks for your support. Bye now.

Operator

Ladies and gentlemen this concludes the Quality Systems 2009 Third Quarter Results Conference Call. Thank you for participating, you may now disconnect.

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Source: Quality Systems Inc F3Q09 (Qtr End 12/31/08) Earnings Call Transcript
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