Quality Systems F2Q06 (Qtr Ending Nov 3, 2005) Earnings Conference Call Transcript (QSII)

QUALITY SYSTEMS
November 3, 2005
3:30 pm CT

Operator:

Good afternoon. My name is (Christy) and I will be your conference facilitator today. At this time I would like to welcome everyone to the second quarter, fiscal 2006 earnings results conference call. All lines have been placed on mute to prevent any background noise.

After the speaker’s remarks there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you. Mr. Silverman, you may begin your conference.

Louis Silverman:

Thank you (Christy) and welcome everyone to Quality Systems’ fiscal 2006 second quarter conference call. Paul Holt, our CFO, Greg Flynn, our Executive Vice President and General Manager of the QSI division, and Patrick Cline, President of our NextGen Health Care Information Systems Division, will once again join me on this afternoon’s call.

Please note that the comments made on this call may include statements that are forward looking within the meaning of the securities laws, including without limitations statements related to anticipated industry trends, the company’s plans, products, and strategies, projected operating results, capital initiatives, and the implementation and potential impact of legal, regulatory, and accounting requirements.

Actual events or results may differ materially from our expectations and projections, and you should refer to our SEC filings, including our forms 8K, 10K, and 10Q for discussions of the risk factors, management discussion and analysis and other information that could impact our actual performance. We undertake no obligation to update any projections or forward looking statements in the future and also please continue to note that the company’s past performance is not necessarily indicative of future performance.

I’ll now provide summary qualitative and quantitative comments on the quarter, and Paul, Greg, and Pat will follow with additional details.

For the quarter the company set new revenue and earnings per share records.

In the September quarter revenue totaled $29.5 million, up approximately 39% over the prior year. Fully diluted earnings per share at 43 cents exceeded prior earnings of 28 cents per share by 54%. The quarter’s top line results were driven by a record revenue at the NextGen Division. The $25.5 million in revenue attained by the division for the quarter represents a 48% year over year increase. The QSI Division’s $4 million in quarterly revenue is about even with prior year performance.

Company profitability for the quarter was positively impacted by both divisions. The NextGen Division reported operating income of $9.9 million, a 62% increase over prior year, while the QSI Division’s reported operating income increased $160,000 on a year-over-year basis.

Also impacting overall company profitability was a nearly $300,000 year- over-year increase in interest income and a $900,000 year-over-year increase in corporate office expense levels. Note that approximately half of the year- over-year increase of corporate spending levels was driven by the contested proxy situation. More on that topic in a few minutes.

EDI revenue for the quarter came in at $3.2 million; up 23% over the prior year, though less than I would have liked to have seen. EDI grew 48% on a year-over-year basis at the NextGen Division and declined 6% on a year-over- year basis at the QSI Division. I’ll once again remind listeners that EDI revenue is reported as part of divisional revenue totals each quarter in each division.

Cash and cash equivalents were at $63.1 million at quarter end, up from $57.5 million last quarter.

Full time employee head count at quarter end was 455, up from 417 in the prior quarter, and 358 in the prior year. Taking revenue for the quarter, the 455 employees that we had at quarter end generated annualized revenue per full time employee of $260,000, which is at the higher end of our historical range.

A few items concerning our recent annual shareholder’s meeting and proxy contest:

On September 21st, 2005 the company held its annual shareholder meeting.

As many of you know, two of the four items to be voted on by the shareholders were the subject of a contesting proxy filing from shareholder and director Ahmed Hussein.

On October 11th, the company announced the certified results received from the independent inspector of elections, which confirmed the election of directors Patrick Cline, Maury DeWald, Vince Love, Sheldon Razin, and myself from the company’s slate and the election of Ahmed Hussein and Ibrahim Fawzy from the Hussein slate.

In addition, the proposed 2005 Stock Option and Incentive plan was approved by shareholders, as was the expansion in the number of authorized shares from 20 million to 50 million. Grant Thornton was ratified as the company’s auditors.

On October 26th, the company and those individual directors elected to the board from the company slate were informed that they were being sued by Mr. Hussein over the election results certified by the independent inspector of election. The complaint alleges that the results from the independent inspector of election included certain proxies that should not have been included in the final vote tabulation. The independent inspector certified the aforementioned results after hearing Mr. Hussein’s claim concerning the matter.

Attorneys representing the company as well as the individual main directors are currently preparing for upcoming hearings. As indicated in our 8K filings, the company believes that Mr. Hussein’s claims lack merit, and the results certified by the independent inspector of elections are conclusive of this matter. The company intends to defend itself vigorously.

Current and prospective shareholders should know that the company will continue to incur incremental expense as a result of Mr. Hussein’s filed complaint and may incur additional expense based on Mr. Hussein’s future actions, if any. It remains premature to speculate on the entirety of Mr. Hussein’s actions or the magnitude of the expense to be incurred by the company.

I am extremely appreciative of our operating team’s continued focus on the fundamentals of our business throughout the aforementioned processes.

The status of our ongoing acquisition evaluation process continues unchanged from prior calls.
During the quarter the company participated in the UBS and Sidoti conferences and held meetings with current and prospective investors in Houston, New York City, Philadelphia, Delaware, New Jersey, Boston, San Francisco, and San Diego.

I’m pleased to announce that for the fifth consecutive year QSI was named to the Forbes Magazine 200 best small companies list. This year we came in at number 11, up from number 32 in the prior year.

In closing my prepared comments for this afternoon’s call, it’s once again my pleasure to point out that the performance of the company for the quarter has exceeded our internal expectations and I’d once again like to thank each and every individual on our team for their leadership and performance during this quarter and beyond.

I also want to clearly point out again to current and/or prospective analysts and investors that while we’re pleased with the company’s performance during the quarter, there are absolutely no guarantees that the company or either of its divisions will exceed or even sustain their level of performance in future periods. It’s possible that our performance will encourage investors or analysts to set new short, medium, or long-term expectations for the company. And in response to this possibility, please continue to note that we do not give out financial guidance to the investment community, and we do not comment on the guidance advanced by members of the financial community.

I’ll now turn over the call to Paul Holt, our CFO.

Paul Holt:

Thanks Lou, and hello everyone. The September 2005 quarter reflected continued growth in our systems, sales, maintenance, and other revenue. Increases in sales of licenses to existing customers contributed to our consolidated systems sales number rising to $16.7 million this quarter, an increase of 44% compared to $11.6 million the prior year. License revenue from existing customers totaled approximately $2.3 million this quarter, that compares to $.9 million a year ago.

Maintenance and other revenue rose 34% to $12.9 million compared to $9.6 million in the prior year quarter. Our consolidated gross profit margin this quarter came in at a record 67.5%, up from 62.6% a year ago. The increase in our gross margin over last year is due to several factors; the largest two being a relatively lower amount of hardware and third party software and payroll expenses as a percentage of revenue compared to last year.

As I’ve often mentioned in numerous prior calls, our hardware and third party software included in systems sales varies from quarter to quarter depending upon the needs of customers. The inclusion of hardware and third party software in our sales arrangements is typically at the request of our customers and is not a priority focus for us. Also, despite making significant investments in our implementation, training, and support areas, our revenues grew at a faster rate, resulting in a benefit to our gross margin this year compared to last year.

Our total SG&A expense increased by approximately $3.5 million to $8.9 million this quarter, that compares to $5.4 million a year ago. $2.5 million of the increase was from the NextGen Division and consisted of increases of selling and administrative salaries and related benefits, sales commissions, travel expenses, and other general and administrative expenses. The balance of the increase was related to corporate expenses, including professional services, salaries, and related benefits.

Included in this quarter’s corporate expense was approximately half a million dollars in costs related to the company’s recent contested proxy election. SG&A expense as a percentage of revenue this quarter increased to 30.2%, compared to 25.5% in the prior, primarily due to the increases in SG&A expenses that I’ve just discussed.

The company’s effective income tax rate was slightly lower this quarter at 39%, compared to 40.3% a year ago. The primary cause for the lower rate this quarter was a relatively higher benefit related to R&D tax credits, as well as a new deduction, which went into effect this year called the Domestic Manufacturer’s Production Deduction.

In terms of our divisional performance, our NextGen Division again recorded a record software license and implementation revenues, resulting in 46% year over year growth in system sales in the division. System sales in the NextGen Division rose to $16.1 million this quarter, compared to $11 million a year ago. Continued growth of Next Gen’s base of installed users drove maintenance and other revenue in that division 49% higher than last year at $9.4 million, versus $6.3 million last year. Operating income in the NextGen Division was up 62% to $9,853,000, compared to $6,064,000 a year ago.

Our QSI Dental Division reported a year-over-year revenue increase of 2%, reporting revenue of $4,018,000, compared to $3,955,000 last year. Operating income for this division was $1,303,000.

Moving on to our balance sheet, our cash increased by approximately $5.6 million this quarter to $63.1 million, or $4.79 per share. That compares to $57.5 million or $4.38 at the end of the prior quarter.

Last quarter we mentioned that we intended to focus on our DSOs, and this quarter we did succeed in keeping our DSOs close to last quarter at 126 days versus 124 days last quarter. We intend to continue to focus on driving our DSOs lower over the next several quarters.

Our DSO by division this quarter was 80 days for the QSI Division and 133 for the NextGen Division. Our deferred maintenance and services revenue now stands at $30.1 million, an increase of $2.4 million compared to last quarter and $9.2 million compared to a year ago. Again, the primary driver of the growth in deferred revenue has been our deferred implementation and training services in the NextGen Division.

And for those of you who are tracking this, our non-cash expenses for the quarter break down as follows: $598,000 in total amortization expense; that’s $48,000 for QSI and $550,000 for NextGen and $317,000 in depreciation expense; that’s $40,000 for QSI, $277,000 for NextGen.

Deferred stock option compensation expense, which is a non-cash expense is $108,000. And our investing activities for the quarter were as follows: capitalized software, $792,000: $16,000 for the QSI Division and $776,000 for NextGen. Fixed assets, $481,000, that’s $107,000 for QSI and $374,000 for NextGen.
I want to thank you all for being on this call and for your continued interest in our company and I’ll now turn things over to Greg Flynn.

Greg Flynn:

Thank you Paul, and I’d like to as well thank all of you for your interest in our company. The QSI Division numbers have been reviewed by Lou and Paul already, so I won’t belabor that. As I do consistently point out, I would like to note the continued growth in the Next Gen, EDI business. As you know QSI Division staff are instrumental in facilitating this business.

Anticipating a question, I don’t see the QSI Division quarter noteworthy from any perspective of significant new trends.

Briefly, on the software development side, as I always report, the quarter saw us continue our integration and interface efforts with a number of products related to our CPS dental records package, from new phosphorous X-ray development technology to expanded X-ray interface offerings. We also continue to bring more information chairside to our dental practitioners through the CPS package. For example, the CPS package now enables notification if a chairside patient has reached their maximum insurance benefits coverage. This alerts the dentist regarding work that may be performed without insurance payment coverage. As I’ve stated before, the clear direction of dentistry is to combine clinical and financial information at the point of care, chairside, to be reviewed and utilized directly between the practitioner and patient.

As always, I’ll comment on our sales staffing and pipeline. Our sales staffing remains unchanged from last quarter, and our pipeline is approximately $3.5 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.

Now I’ll turn the call over to Pat Cline, our President of the NextGen Division. It’s superfluous of me to say, “Great quarter, Pat.