Quality Systems F3Q08 (Qtr End 12/31/07) Earnings Call Transcript

Quality Systems Inc. (QSII)

F3Q08 (Qtr End 12/31/07) Earnings Call

February 05, 2008 4:30 pm ET

Executives

Louis Silverman - President and CEO

Paul Holt - CFO

Pat Cline - President of NextGen Healthcare Information Systems Division

Analysts

Brett Jones

Mike

Sean Wieland

Richard Close

Andy Draper

Chris Sassouni

Atif Rahim

Presentation

Operator

Good afternoon. My name is Jonathan and I will be your conference operator today. At this time I would like to welcome everyone to the fiscal third quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions) Thank you. Mr. Silverman, you may begin your conference.

Louis Silverman

Thank you, Jonathan. Welcome everyone to the Quality Systems third quarter fiscal 2008 earnings call. Paul Holt, our CFO; and Pat Cline, President of our NextGen Healthcare Information Systems Division, join me as participants 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 limitation statements related to anticipated industry trends, the company's plans, products, prospectus and strategies, preliminary and/or projected operating results, capital and equity initiatives, and the implementation of or 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 prior SEC filings, including our Forms 8-K, 10-K and 10-Q, 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.

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

For the quarter, the company recorded revenue of $48.1 million, which is a new record for the company. On a year-over-year basis, total company revenue increased approximately 25%.

NextGen's revenue for the quarter was a record $44 million up 29% over the prior year. The QSI high division recorded $4.1 million which was down approximately 4.6% over the prior year fully diluted earnings per share for the quarter.

The record $0.40 per share was up from $0.32 in the year ago quarter. Note that the quarter's financial performance is impacted by a net $0.03 per share increase as result of life insurance proceeds and associated compensation expenses related to the recent passing of Mr. Greg Flynn, our former Executive Vice President and General Manager.

To take care of a couple of housekeeping items relevant to the QSI division, divisional sales staffing is at for FTEs and the division sales pipeline is approximately $3.9 million. As a reminder the QSI division's pipeline is defined as sales situations where QSI is included among the final three purchase choices and where we believe that the sale will occur within 180 days.

As previously announced our Board approved another quarterly $0.25 per share dividend to be paid to shareholders of record as of March 14, 2008, with an anticipated distribution date of April 7, 2008.

Regarding investor conferences, during the quarter the company presented at the Piper Jaffray and CIBC conferences and in January the company presented at the J.P. Morgan conference in San Francisco. During the remainder of the current quarter the company has scheduled to present at the UBS, Raymond James and Sidoti conferences.

Regarding acquisitions, we continue to review potentially interesting acquisition opportunities that come to our attention.

In closing my prepared comments for this call, I want to again clearly point out that there are no guarantees that the company or either of its divisions will meet or exceed past, present or expected levels of performance in future. It is possible that investors or analysts will set new short, medium or long-term expectations for the company.

In response to this possibility, please continue to note that we do not give our financial guidance to the investments community and we do not comment on guidance advanced by members of the financial community.

I will now turn things over to Paul Holt, our CFO.

Paul Holt

Thanks Lou and hello everyone. Consolidated system sales of $23.7 million this quarter represents an increase of 25% compared to $19 million in the prior year quarter. Our consolidated maintenance EDI and other services revenue rose 25% to $24.4 million compared to $19.5 million in the year ago quarter.

Consolidated gross profit margin this quarter came in at 66.4%, down slightly from 67% a year ago. The decrease in our gross margin over last year was due primarily to a relatively larger amount of hardware and third-party software as a percentage of system sales.

Our total SG&A expenses increased by approximately $2.7 million to $13.3 million in the quarter that compares to $10.6 million a year ago. The increase in SG&A expenses compared to the prior year was primarily due to $1.9 million in higher compensation expenses due to increased headcounts, $0.6 million in increased selling-related expenses, $0.5 million in higher corporate expenses and that was offset by a decline of $0.3 million in other general and administrative expenses.

SG&A expenses, as a percentage of revenue this quarter increased to 27.6%. That's roughly unchanged but slightly higher compared to the year-ago quarter which was 27.5%.

Interest income in the three months ended December 31, 2007 decreased to $710,000 compared to $935,000 in the year ago quarter. Interest income this quarter was declined primarily due to a greater portion of funds invested in tax-favored auction-rate securities, which offer lower interest rates but higher after-tax yields compared to money market or short-term US Treasuries.

The company's effective income tax rate was roughly unchanged compared to the year-ago quarter at 35.7% compared to 35.6% a year ago. The effective rate for our current quarter was impacted by the receipt of tax free insurance proceeds during the quarter as well as an increase in deductions for qualified production activities.

The addition of tax-exempt interest income and deductions relate to incentive stock options. Prior year quarter included the reenactment of federal R&D tax credit statutes which occurred during the quarter resulting in a catch-up of the prior two quarters R&D tax credit.

Moving to divisional performance system sales in our NextGen division rose 28% to $22.8 million this quarter compared to $17.9 million a year ago. Continued growth in NextGen's base of installed users drove maintenance, EDI and other revenue in that division 30% higher than last year at $21.2 million versus $16.3 million a year ago.

Operating income in the NextGen division was up 33% to $17,823,000 compared to $13,423,000 a year ago. The dental division reported a year-over-year decline of 5% reporting revenue of $4.72 million compared to $4.266 million a year ago. Operating income for the QSI division was $650,000.

Moving on to our balance sheet, our cash and marketable securities increased by approximately $5.5 million this quarter to $78.4 million or $2.86 per share, compared to $72.9 million or $2.67 at the end of the prior quarter. Note that the company paid a dividend of approximately $6.8 million or $0.25 per share in October of 2007 and again in January of 2008.

The Board of Directors has also declared an additional $0.25 per share dividend to shareholders of record on March 14 of 2008 to be paid in early April 2008. This quarter, our DSOs were unchanged compared to the prior quarter at 138 days. DSO's in the year-ago quarter was 140. DSOs net amount included in both the accounts receivable and deferred revenue was also unchanged compared to the prior quarter at 90 days. DSO's by division was 96 days for the QSI division and 142 days for the NextGen division.

Deferred maintenance and services revenue at $41.3 million was up $1.4 million from the prior quarter and up $0.7 million compared to the prior year. And as a customer we do -- I am going to provide our non-cash expenses for the quarter which breakdown as follows.

Total amortization expenses, $1.85 million, $33,000 for QSI and $1.52 million for NextGen. Total depreciation expenses, $616,000 at $64,000 for QSI and $552,000 for NextGen. Stock option compensation which is a non-cash expense was $921,000 in the quarter.

And our investing activities were as follows: capitalized software, $1.447 million, that's $62,000 for QSI and $1.385 million for NextGen, fixed assets, $487,000 that's $30,000 for QSI and $457,000 for NextGen.

Again I want to thank you all for being on our call and your interest in our company. And I'll turn things over to Pat Cline, President of our NextGen division, who will provide you an update on NextGen.

Pat Cline

Thank you, Paul. I am very pleased with NextGen's record sharing performance. During the quarter, we executed about 52 agreements and our pipeline is increased to over $80 million. As I have reported on our last call the size of our sales force is reduced somewhat from -- well, it was reduced to somewhat last quarter.

Our sales force currently stands at 58 people, directionally, we want to continue to increase the number of sales people but we feel it's critical to maintain top quality as we do. NextGen continues to compete very effectively in the marketplace when in key deals against our competition and our market continues to be robust.

I would like to once again thank NextGen employees for their dedication to customer service and I would like to thank our customers for the confidence that they place in our company.

Jonathan, we are ready for questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Brett Jones.

Brett Jones

Hi, good afternoon. I was wondering if we could -- [against] the declining gross margin a little bit more, you mentioned that primary driver was hardware, I was wondering: if you could quantify that a little bit?

Paul Holt

Brett, we get into a lot more detail on the Q, which is going to be filed shortly. So, I guess, if I could just point you in that direction for now and do you have anything more you can follow-up.

Brett Jones

Or maybe you can just speak maybe -- was there increased pricing pressure compared to last year? Or: what you're seeing recently in the most recent quarters?

Pat Cline

Yes, Brett, I can speak from our competitive standpoint. We, over the last few quarters, as I have mentioned on the last call or two, we have seen our competition get a little more aggressive with pricing and while we haven't changed our list pricing where we have reacted on a case-by-case basis where it strategically makes sense to do so, but I think the decline in margin is more attributable not so much to any abnormal level of discounting, but to the mix as Paul mentioned just a little bit of hardware with the margins that we get, relative to hardware as you can imagine can swing the gross margin number a little bit.

Brett Jones

So, would you say that the number of these strategic relationships where you might discount: have those gone up? Or: are those pretty much the same?

Pat Cline

Over the last few quarters, we have seen a little bit of a trench where we might meet competition a little bit more but now I actually looked at this a few days ago looked year-over-year actually went back a few years and didn't see anything meaningful.

Brett Jones

Alright, great, thank you. I am sorry, Pat: did you say that there were 50 new agreements signed in the quarter?

Pat Cline

Yes.

Brett Jones

And so that's down from 70, and 70 in the quarter before that would you see the average deal side has gone up since sales were up…

Pat Cline

The average deal size has gone up, I mentioned also on a prior call that some practices were waiting to see what the local health system hospital or other organization was going to do relative to the Stark relaxation and Safe Harbor. But at the same time fortunately we have seen some of those large health systems and organizations making purchases. So, the number of deals is down, but the average deals are, it just considerably up.

Brett Jones

Okay. So that's primarily Stark driven?

Pat Cline

Well, it's difficult to say, we do continue to see the more interest or heightened level of interest related to the Stark relaxation and Safe Harbor some of our large accounts have that in mind as they make the purchase yes.

Brett Jones

Right, great, thank you very much.

Pat Cline

Thank you.

Operator

Your next question comes from the line of Ross Muken.

Mike

Hi guys, this is [Mike] in for Ross, congratulations on the quarter.

Louis Silverman

Thank you.

Unidentified Analyst

I saw a dull below -- if you talked about in terms of pricing, some of your competitors they are more aggressive on pricing: could you talk about what ends market in terms of big deals versus the small deals where you seen the pricing pressure?

Paul Holt

I haven't done or we haven't done an analysis on that, but it seems to be in our suite spot which is the mid range and high end where we see our competition giving more aggressive, but again it's not that bigger of a change.

Unidentified Analyst

Okay. And then just in terms of implementation times what [controversies] you see in terms of, be able to implement the overall suite: is it times going up or down? Or: any type of trends you can talk about there?

Pat Cline

The trends are long-term, but it's becoming easier-and-easier to implement our systems as we focus on that issue and to develop quick start tools, methodologies and better training programs, computer based training and those kinds of things. So it's an area that where we focus for number of years and the long-term trend is it gets easier and we implement faster.

Unidentified Analyst

Okay. And then just one more final question that Lou mentioned that you guys will continue to look to acquisitions if there is any thing attractive. Is there is any one kind of technology or customer area that you are looking to potentially be positive if something come up?

Pat Cline

Right now we're keeping our eyes open, ears open, and options open. So, I think, we preferred to look on all kind of broad range of things as opposed to focus on one place or another. Overtime, I have talked about interest in potential market share acquisitions as one example of something we might be interested in and second example would be opportunities to expand and deepen the relationships that we have with the customers that we know and they know us so the variety of service of opportunities that exist in that area. Well, if they comes up in discussions frequently from your guys end of the table as revenue cycle management and I would certainly keep that on the list, but I think the broad theme is that from interest and search perspective we'd like to keep our options open but those are couple of areas that are on the list for us.

Unidentified Analyst

Great, thanks guys. Congratulations again.

Pat Cline

Thank you.

Operator

And the next question comes from the line of Sean Wieland.

Sean Wieland

Hi, thank you. First question on the Sales force, Pat? Can you remind us: where are your sales and number of reps you had last quarter?

Pat Cline

I believe that number Sean was 67.

Sean Wieland

Okay. So, did you say 58, this quarter?

Pat Cline

58 that's correct.

Sean Wieland

Okay. So, can you give us a little insight as to what's going on there?

Pat Cline

Well, I am not sure, as I mentioned it's important to us that we maintain quality not just in terms of reps ability to sale but also with respect to their integrity and honesty and their care for the customer and while we lost a couple of reps that I would have liked to keep most of the turnover was caused or most of the turnover decisions were made by the company.

Generally, it's the weaker sales reps who are let go: the ones that are not performing well enough. So shrinking the sales force a little bit as we strive for that quality really doesn't have a significant impact on sales as you can see from the performance in the quarter.

Again directionally, we want to grow that sales force and 58 is at this point what I see as a good jumping off point for most of or at least many quarters in 07 that's about whether the number was and we think we've showed up to the quality we've got a number of terrific performers and a number of new folks that we think we'll be bringing to the company in short order.

Sean Wieland

Okay. I am just trying to get a little more clarity on this. So, a year ago you also had 58 reps and it looks over the three quarters you added about 9 reps and now you are back down to where you were the incremental mind reps are those reps still here or it would they bet highest and they are gone.

Pat Cline

Well, it's going to be a combination and I don't have the sort of person-by-person details in front of me but now we made what I would characterize is very good hires in the last year and we've made as all companies do what I would characterizes as a few lousy hires and I think we are being prudent and taking the -- once we are either that we are on board prior to this period that we are discussing they are not performing and reading them out or making decisions quickly enough on the once without coming up the speed fast enough.

Louis Silverman

Hi Sean, this is Louis that helps that at all -- there was no strategic initiative put in place to downsize the sales force. This is really more of a sales management issue and as Pat mentioned our objective is continue to be, to increase the sales force. So, but there was no, if you are thinking about what there are corporate [authority] downsizing I think that the answer is no.

Sean Wieland

Okay. In the beginning of the year you talked about goal year end of having 70 reps: can you update that?

Pat Cline

I think, I am going to stop sort of updating it, I think, we will finish the year in this regard in better shape, but I am doubtful we will hit the 70 mark.

Paul Holt

And we've also said consistently Sean that whatever sales, what are the goals we put in place there, sales for headcounts at no time where we interested in sacrificing quality for quantity in that, the main a key part of our overall sales staffing and hiring strategy.

Sean Wieland

Okay. One another question CCHIT certification: can you update us on where you are with that? And I believe you have the '08 certification done and: how is that helping you in the build?

Paul Holt

Actually the '08 certification process has not commenced, no company has the '08 certification, but we have. We are one of the few companies to have '07 certifications as certification as many of our competitors still talk about their '06 certifications. It has helped us in the market the Starks exemption states pretty clearly that in order to qualify for Safe Harbor your solution has to be certified within the last 12 months and many of these sophisticated purchases out there I understand that and look toward the products that have been certified in the last 12 months is oppose to those that claim that they are certified under the more relaxed criteria.

We continue to try to drive the criteria and raise the bar because we feel confidently that we can shine in that regard where our competitors will fall down. So, we look forward to going through the process in '08, but we are not there yet.

Sean Wieland

Okay. And then one last question it relates to that on Starks. Would it be possible for you to quantify the impact that you have seen in the quarter because of un-Stark related deals?

Paul Holt

No it really wouldn't be possible. I wish that it was possible, I would love to have that information as well, but there are so many factors that go into these decisions for health systems but all we have is sort of anecdotal evidence.

Sean Wieland

Well, of the 50 contracts that you have signed can you -- is there may be ballpark number of -- that were brought by hospitals?

Paul Holt

I also don't have that in front of me, but typically out of that number of agreements they are going to be 10 or so percent that might be large deals and some subset of that that would be hospital deals.

Sean Wieland

Alright, thank you very much.

Paul Holt

Thank you

Operator

And your next question comes from the line of Richard Close

Richard Close

Yeah, I just, I guess follow on to some of Sean's questions, with respect to the sales force: how would you characterize the tenure today maybe average tenure versus at the beginning of the fiscal year: has it gone up or is it about the same?

Pat Cline

I would say it’s probably about the same.

Richard Close

Okay. So in net-net you have lost maybe some experienced people, I don't know, I guess, maybe some super experienced people, but also some of the new guys.

Paul Holt

As I mentioned there are couple, let me say two of the nine that I would have like to have kept experienced tenure people and there are number of others that we didn't feel were performing up to par and I like in it to meeting to wheat the garden so everything else can grow appropriately.

Richard Close

Okay. And then, when we're talking, I guess, 50 new agreements, but your pipeline is bigger you have less sales people are you seeing -- are your sales people -- do you have to, I guess a different qualities in sales people nowadays with the with the changes in the Stark maybe some larger deals in your pipeline, sales people there has to be more focused in on selling hospitals it's sort of a different animal so to speak.

Pat Cline

What is the slightly different animal but I'd like to think that most of our talented sales people can sell at that level and most of them do so at that level I don't know whether the 50 deals and the larger rapid selling price is a long-term trend we'll have to wait and see, but frankly whether we do $10 to $3 million deals or a $31 million deals or $6,500,000 deals I probably like to see 50 deals, 60deals in a quarter and like to see selling price continued to come up, as large health systems make purchases for hundreds of providers at a time that are easier to deal with from an implementation standpoint and the contract management standpoint and the maintenance standpoint. So, I don't think there is any bad news in this.

Richard Close

Okay. And then, may be: if you could characterize, I guess, NextGen sales to existing customers versus the new customers? I mean: have you had good response from people coming back to the while sort of speak?

Pat Cline

Absolutely our sales to existing customers continue to go well and continue to trend up over time and I think that's good evidence that our system works out there and as customers implement what they have got, they come back for more.

Richard Close

Okay, thank you.

Pat Cline

Thank you.

Operator

And your next question comes from the line Andy Draper.

Andy Draper

Thank you. I have got a couple of questions Pat on this: if could you give the NextGen high point?

Pat Cline

Yes just over $80 million.

Andy Draper

Okay. And then a question I think for Paul, the maintenance line has bumped up pretty nicely looking back over the last two years its done the same, I guess: do you sort of do a step up in the December quarter for higher rates or so? I am just trying to understand: why the maintenance line tends to jump up in the December quarter?

Paul Holt

Well, I wouldn't, there is no lot of seasonality to that maintenance number, its moving up because we are adding to the number of customer, is it in number of customers that already on the system are taking on more licenses and in the form of add-on purchases and those things are bumping up our maintenance numbers as well. Beyond that I think that's, it's really mostly what there is to say about that number.

Andy Draper

Okay, great. And there is a final question, may be for Pat, Pat have you seen any -- the increasing interest in hosting there is obviously one of your competitors they went public, it gotten away so a lot of attention with the whole hosting and Stark was service model, is that something you guys are having to respond to or you are getting more questions and just about to give your thoughts there? Thanks.

Pat Cline

We have had a significant amount of interest in hosting for quite sometime in fact I would venture I guess the north of 10,000 NextGen providers are operating in a hosted fashion today. Hosting is something that NextGen offers as an alternative to practices going out and spending a lot of money on their own environment, their own servers and so forth and its something that we're happy to do.

If you were talking about Athena Health and their public offering, I'm not so sure they are direct competitor, we compete with them from time-to-time, but they are more of the revenue cycle management company and while there is some crossover, there are really two different markets.

Andy Draper

Great that's helpful, thanks.

Pat Cline

Thank you.

Operator

Your next question comes from the line of Chris Sassouni

Chris Sassouni

Yes: could you give us some update on the implementation of the contract or payment that you signed with Health Management Associates?

Paul Holt

I'm not aware of probably enough details on that to go into with you but we have terrific relationship with that organization. A press release that I'd refer folks to if they are unaware of that relationship and the additional purchase that's HMA made some quarters ago. But as far as I know the implementation is going well and certainly, if it's not, we'll be all over to get it turned around. Generally, those are the types of customers that we speak about that roll a certain number out do well with them and purchase more NextGen's customer base is comprised in addition to having small practices and mid-range practices of certainly the largest health systems and national providers of care hospital systems health systems in the country do so, we hope that this add-on purchases and what happens to maintenance and ongoing services continues.

Chris Sassouni

Would it be fair to say that: given the way that the implementations of these kinds of contracts go that at least some of the revenues in this quarter were attributable to that contract?

Louis Silverman

Chris, we try very hard not to keep individual [forth] on individual contract in individual quarters, each dollar table runs the same way and that's been our policy that continues to be our policy.

Chris Sassouni

Okay, thank you.

Operator

Your next question comes from the line of Atif Rahim.

Atif Rahim

Stark related sales, particularly: if there is any geography you're seeing on strengthen norm in particular? And then secondly: the competitive pressure that you noted in selected clients, is that perhaps more on the Stark related sales or some of the smaller deals that constitute majority of your sales?

Pat Cline

We saw a little bit of lead from the western states relative to their interest regarding Stark relaxation and purchasing or donating or subsidizing the purchases of Electronic Health Record Systems. But we are seeing heightened level of interest in all geographies stands at the first part of your question.

To the second part of your question, now we've seen competitors at the low-end get more aggressive, generally we are not all that eager to do price matching or discounting very heavily at the-low end and we've seen competitors, other competitors at the high-end get more aggressive, I think, if I were a competitor of NextGen and I wanted to take the focus off of NextGen superior solutions, I would try to bring the discussions to price pretty quickly and I think we are just seeing that more often.

Atif Rahim

Okay. And then, in terms of the high time going up, I guess, stuff: is that a function of most Stark-related deals which allows end price?

Paul Holt

I took a look at the pipeline, because I had the same question and I didn't see any material change in mix.

Atif Rahim

Okay. And then, my final question and may be I missed from the call, but SG&A seems to have gone up to well as number of sales people is down. Is there any reason for that being up still in that 20% plus range? And, maybe if the timing isn’t sure during the quarter; would you expect that to go down any chance next quarter?

Paul Holt

Well, I think, the commission or revenues were up in the quarter. So, you may have had a drop in the number of sales folks that we talked about, but that could be part of the timing I don't have the exact details and all that, but the commission of our sales were higher and so there was a correspondence increase in the commission expense just to sales folks.

Pat Cline

And we have got a couple of other pieces to SG&A that are corporate related and what not just don't really -- really not anything to do with the number of sales folks that we have with the company.

Atif Rahim

Okay. That's great, thank you.

Operator

And you have no further questions at this time.

Louis Silverman

Alright. Well, we appreciate everybody's attendance on the call and interest in the company and we'll talk to you again soon. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect.

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