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

Feb. 5.08 | About: Quality Systems, (QSII)

Quality Systems Inc. (NASDAQ:QSII)

F3Q08 (Qtr End 12/31/07) EarningsCall

February 05, 2008 4:30 pm ET

Executives

Louis Silverman - President andCEO

Paul Holt - CFO

Pat Cline - President of NextGenHealthcare Information Systems Division

Analysts

Brett Jones

Mike

Sean Wieland

Richard Close

Andy Draper

Chris Sassouni

Atif Rahim

Operator

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

Louis Silverman

Thank you, Jonathan. Welcome everyoneto the Quality Systems third quarter fiscal 2008 earnings call. Paul Holt, ourCFO; and Pat Cline, President of our NextGen Healthcare Information SystemsDivision, join me as participants on this afternoon's call.

Please note that the commentsmade on this call may include statements that are forward-looking within themeaning of the securities laws, including without limitation statements relatedto anticipated industry trends, the company's plans, products, prospectus andstrategies, preliminary and/or projected operating results, capital and equityinitiatives, and the implementation of or potential impact of legal, regulatoryand accounting requirements.

Actual events or results maydiffer materially from our expectations and projections, and you should referto our prior SEC filings, including our Forms 8-K, 10-K and 10-Q, fordiscussions of the risk factors, management discussion and analysis and otherinformation that could impact our actual performance. We undertake noobligation to update any projections or forward-looking statements in thefuture.

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

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

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

The record $0.40 per share was upfrom $0.32 in the year ago quarter. Note that the quarter's financialperformance is impacted by a net $0.03 per share increase as result of lifeinsurance proceeds and associated compensation expenses related to the recentpassing of Mr. Greg Flynn, our former Executive Vice President and GeneralManager.

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

As previously announced our Boardapproved another quarterly $0.25 per share dividend to be paid to shareholdersof 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 CIBCconferences and in January the company presented at the J.P. Morgan conferencein San Francisco.During the remainder of the current quarter the company has scheduled topresent at the UBS, Raymond James and Sidoti conferences.

Regarding acquisitions, wecontinue to review potentially interesting acquisition opportunities that cometo our attention.

In closing my prepared commentsfor this call, I want to again clearly point out that there are no guaranteesthat the company or either of its divisions will meet or exceed past, presentor expected levels of performance in future. It is possible that investors oranalysts 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 theinvestments community and we do not comment on guidance advanced by members ofthe financial community.

I will now turn things over toPaul Holt, our CFO.

Paul Holt

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

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

Our total SG&A expensesincreased by approximately $2.7 million to $13.3 million in the quarter thatcompares to $10.6 million a year ago. The increase in SG&A expensescompared to the prior year was primarily due to $1.9 million in highercompensation expenses due to increased headcounts, $0.6 million in increasedselling-related expenses, $0.5 million in higher corporate expenses and thatwas offset by a decline of $0.3 million in other general and administrativeexpenses.

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

Interest income in the threemonths ended December 31, 2007 decreased to $710,000 compared to $935,000 in the year agoquarter. Interest income this quarter was declined primarily due to a greaterportion of funds invested in tax-favored auction-rate securities, which offerlower interest rates but higher after-tax yields compared to money market orshort-term US Treasuries.

The company's effective incometax 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 wasimpacted by the receipt of tax free insurance proceeds during the quarter aswell as an increase in deductions for qualified production activities.

The addition of tax-exemptinterest income and deductions relate to incentive stock options. Prior yearquarter included the reenactment of federal R&D tax credit statutes whichoccurred during the quarter resulting in a catch-up of the prior two quartersR&D tax credit.

Moving to divisional performance systemsales in our NextGen division rose 28% to $22.8 million this quarter comparedto $17.9 million a year ago. Continued growth in NextGen's base of installedusers drove maintenance, EDI and other revenue in that division 30% higher thanlast 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 comparedto $13,423,000 a year ago. The dental division reported a year-over-yeardecline of 5% reporting revenue of $4.72 million compared to $4.266 million ayear ago. Operating income for the QSI division was $650,000.

Moving on to our balance sheet, our cash and marketable securitiesincreased by approximately $5.5 million this quarter to $78.4 million or $2.86per 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 $0.25per share in October of 2007 and again in January of 2008.

The Board of Directors has alsodeclared an additional $0.25 per share dividend to shareholders of record onMarch 14 of 2008 to be paid in early April 2008. This quarter, our DSOs wereunchanged compared to the prior quarter at 138 days. DSO's in the year-agoquarter was 140. DSOs net amount included in both the accounts receivable anddeferred 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 NextGendivision.

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

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

And our investing activities wereas 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 forbeing on our call and your interest in our company. And I'll turn things overto Pat Cline, President of our NextGen division, who will provide you an updateon NextGen.

Pat Cline

Thank you, Paul. I am verypleased with NextGen's record sharing performance. During the quarter, weexecuted 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 reducedsomewhat from -- well, it was reduced to somewhat last quarter.

Our sales force currently standsat 58 people, directionally, we want to continue to increase the number ofsales 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 keydeals against our competition and our market continues to be robust.

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

Jonathan, we are ready forquestions.

Question-and-Answer Session

Operator

Your first question comes fromthe line of Brett Jones.

Brett Jones

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

Paul Holt

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

Brett Jones

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

Pat Cline

Yes, Brett, I can speak from ourcompetitive standpoint. We, over the last few quarters, as I have mentioned onthe last call or two, we have seen our competition get a little more aggressivewith pricing and while we haven't changed our list pricing where we havereacted 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 anyabnormal level of discounting, but to the mix as Paul mentioned just a littlebit of hardware with the margins that we get, relative to hardware as you canimagine can swing the gross margin number a little bit.

Brett Jones

So, would you say that the numberof 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, wehave seen a little bit of a trench where we might meet competition a little bitmore but now I actually looked at this a few days ago looked year-over-yearactually went back a few years and didn't see anything meaningful.

Brett Jones

Alright, great, thank you. I amsorry, Pat: did you say that there were 50 new agreements signed in thequarter?

Pat Cline

Yes.

Brett Jones

And so that's down from 70, and70 in the quarter before that would you see the average deal side has gone upsince sales were up…

Pat Cline

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

Brett Jones

Okay. So that's primarily Starkdriven?

Pat Cline

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

Brett Jones

Right, great, thank you verymuch.

Pat Cline

Thank you.

Operator

Your next question comes from theline of Ross Muken.

Mike

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

Louis Silverman

Thank you.

Unidentified Analyst

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

Paul Holt

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

Unidentified Analyst

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

Pat Cline

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

Unidentified Analyst

Okay. And then just one morefinal question that Lou mentioned that you guys will continue to look toacquisitions if there is any thing attractive. Is there is any one kind oftechnology or customer area that you are looking to potentially be positive ifsomething come up?

Pat Cline

Right now we're keeping our eyesopen, ears open, and options open. So, I think, we preferred to look on allkind of broad range of things as opposed to focus on one place or another.Overtime, I have talked about interest in potential market share acquisitionsas one example of something we might be interested in and second example wouldbe opportunities to expand and deepen the relationships that we have with thecustomers that we know and they know us so the variety of service ofopportunities that exist in that area. Well, if they comes up in discussionsfrequently from your guys end of the table as revenue cycle management and Iwould certainly keep that on the list, but I think the broad theme is that frominterest and search perspective we'd like to keep our options open but thoseare 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 fromthe line of Sean Wieland.

Sean Wieland

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

Pat Cline

I believe that number Sean was67.

Sean Wieland

Okay. So, did you say 58, thisquarter?

Pat Cline

58 that's correct.

Sean Wieland

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

Pat Cline

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

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

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

Sean Wieland

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

Pat Cline

Well, it's going to be acombination and I don't have the sort of person-by-person details in front ofme but now we made what I would characterize is very good hires in the lastyear and we've made as all companies do what I would characterizes as a few lousyhires and I think we are being prudent and taking the -- once we are eitherthat we are on board prior to this period that we are discussing they are notperforming and reading them out or making decisions quickly enough on the oncewithout coming up the speed fast enough.

Louis Silverman

Hi Sean, this is Louis that helpsthat at all -- there was no strategic initiative put in place to downsize thesales force. This is really more of a sales management issue and as Patmentioned our objective is continue to be, to increase the sales force. So, butthere 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 theyear you talked about goal year end of having 70 reps: can you update that?

Pat Cline

I think, I am going to stop sortof updating it, I think, we will finish the year in this regard in bettershape, but I am doubtful we will hit the 70 mark.

Paul Holt

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

Sean Wieland

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

Paul Holt

Actually the '08 certificationprocess 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 asmany of our competitors still talk about their '06 certifications. It hashelped us in the market the Starks exemption states pretty clearly that inorder to qualify for Safe Harbor your solution has to be certified within thelast 12 months and many of these sophisticated purchases out there I understandthat and look toward the products that have been certified in the last 12months is oppose to those that claim that they are certified under the morerelaxed criteria.

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

Sean Wieland

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

Paul Holt

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

Sean Wieland

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

Paul Holt

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

Sean Wieland

Alright, thank you very much.

Paul Holt

Thank you

Operator

And your next question comes fromthe line of Richard Close

Richard Close

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

Pat Cline

I would say it’s probably aboutthe same.

Richard Close

Okay. So in net-net you have lostmaybe some experienced people, I don't know, I guess, maybe some superexperienced 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 experiencedtenure people and there are number of others that we didn't feel wereperforming up to par and I like in it to meeting to wheat the garden soeverything else can grow appropriately.

Richard Close

Okay. And then, when we'retalking, I guess, 50 new agreements, but your pipeline is bigger you have lesssales people are you seeing -- are your sales people -- do you have to, I guessa different qualities in sales people nowadays with the with the changes in theStark maybe some larger deals in your pipeline, sales people there has to bemore focused in on selling hospitals it's sort of a different animal so tospeak.

Pat Cline

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

Richard Close

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

Pat Cline

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

Richard Close

Okay, thank you.

Pat Cline

Thank you.

Operator

And your next question comes fromthe line Andy Draper.

Andy Draper

Thank you. I have got a couple ofquestions 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 thinkfor Paul, the maintenance line has bumped up pretty nicely looking back overthe last two years its done the same, I guess: do you sort of do a step up inthe 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 lotof seasonality to that maintenance number, its moving up because we are addingto the number of customer, is it in number of customers that already on thesystem are taking on more licenses and in the form of add-on purchases andthose things are bumping up our maintenance numbers as well. Beyond that Ithink that's, it's really mostly what there is to say about that number.

Andy Draper

Okay, great. And there is a finalquestion, may be for Pat, Pat have you seen any -- the increasing interest inhosting there is obviously one of your competitors they went public, it gottenaway 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 questionsand just about to give your thoughts there? Thanks.

Pat Cline

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

If you were talking about AthenaHealth 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 cyclemanagement company and while there is some crossover, there are really twodifferent markets.

Andy Draper

Great that's helpful, thanks.

Pat Cline

Thank you.

Operator

Your next question comes from theline of Chris Sassouni

Chris Sassouni

Yes: could you give us someupdate on the implementation of the contract or payment that you signed withHealth Management Associates?

Paul Holt

I'm not aware of probably enoughdetails on that to go into with you but we have terrific relationship with thatorganization. A press release that I'd refer folks to if they are unaware ofthat relationship and the additional purchase that's HMA made some quartersago. But as far as I know the implementation is going well and certainly, ifit's not, we'll be all over to get it turned around. Generally, those are thetypes of customers that we speak about that roll a certain number out do wellwith them and purchase more NextGen's customer base is comprised in addition tohaving small practices and mid-range practices of certainly the largest healthsystems and national providers of care hospital systems health systems in thecountry do so, we hope that this add-on purchases and what happens tomaintenance 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 atleast some of the revenues in this quarter were attributable to that contract?

Louis Silverman

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

Chris Sassouni

Okay, thank you.

Operator

Your next question comes from theline of Atif Rahim.

Atif Rahim

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

Pat Cline

We saw a little bit of lead fromthe western states relative to their interest regarding Stark relaxation andpurchasing or donating or subsidizing the purchases of Electronic Health RecordSystems. But we are seeing heightened level of interest in all geographiesstands at the first part of your question.

To the second part of yourquestion, 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 veryheavily at the-low end and we've seen competitors, other competitors at thehigh-end get more aggressive, I think, if I were a competitor of NextGen and Iwanted to take the focus off of NextGen superior solutions, I would try tobring the discussions to price pretty quickly and I think we are just seeingthat more often.

Atif Rahim

Okay. And then, in terms of thehigh time going up, I guess, stuff: is that a function of most Stark-relateddeals 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 questionand may be I missed from the call, but SG&A seems to have gone up to wellas number of sales people is down. Is there any reason for that being up still in that 20% plusrange? And, maybe if the timing isn’t sure during the quarter; would you expectthat to go down any chance next quarter?

Paul Holt

Well, I think, the commission orrevenues were up in the quarter. So, you may have had a drop in the number ofsales folks that we talked about, but that could be part of the timing I don'thave the exact details and all that, but the commission of our sales werehigher and so there was a correspondence increase in the commission expensejust to sales folks.

Pat Cline

And we have got a couple of otherpieces 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 thecompany.

Atif Rahim

Okay. That's great, thank you.

Operator

And you have no further questionsat this time.

Louis Silverman

Alright. Well, we appreciateeverybody's attendance on the call and interest in the company and we'll talkto you again soon. Thank you very much.

Operator

This concludes today's conferencecall. You may now disconnect.

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