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Computer Programs and Systems, Inc. (NASDAQ:CPSI)

Q2 2008 Earnings Call

July 25, 2008 9:00 am ET

Executives

J. Boyd Douglas - President and Chief Executive Officer

Darrell G. West - Chief Financial Officer

Analysts

Jeremy Lopez - William Blair & Co.

Bret Jones - Leerink Swann

Robert Dodd - Morgan, Keegan & Co.

Richard Close - Jefferies Financials & Co.

Jeff Schmidt - Sidoti & Co.

Operator

Welcome to the Computer Programs and Systems second quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Boyd Douglas, President and Chief Executive Officer.

J. Boyd Douglas

During this conference call we may make statements regarding future operating plans, expectations, and performance that constitute forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. We caution you that any such forward-looking statements are only predictions and are not guarantees of future performance.

Actual results might differ materially from those projected in the forward-looking statements as a result of risk, uncertainties, and other factors including those described in our public releases and reports filed with the Securities and Exchange Commission including, but not limited to our recent annual report on Form 10-K. We also caution investors that the forward-looking information provided in this call represents our outlook only as of this date and we undertake no obligation to update or revise any forward-looking statements to reflect events or developments after the date of this call.

Joining me on the call this morning is Darrell West, our Chief Financial Officer. Darrell and I have a few minutes of prepared comments, and then we’ll be glad to take your questions.

In the second quarter we installed our Financial and Patient Accounting System in five hospitals, our core clinical departmental applications at four facilities, eight hospitals implemented Nursing Point of Care, and three customers went live with Image Linked PACS. Add-on sales to existing clients made up 24% of our total revenue. At this time, we expect to install our Financial and Patient Accounting System at eight facilities in the third quarter. We anticipate five new installations of our core clinical departmental modules, nine Nursing Point of Care implementations, and five Image Linked installs.

In business management solutions during the second quarter we executed seven new accounts receivable management contracts, one of which was for full accounts receivable services, five for private pay collections, and one for insurance followup services. During the second quarter, revenue from this segment of our business grew 15% year over year. Demand for our business management solutions continues to be strong and we are very pleased with our operations in this segment of our business.

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

We are very pleased to have experienced such a significant turn-around in our marketplace. Our sales pipeline is strong and we expect the increased demand to continue into the third quarter. As I have said many times before, often there is no single catalyst that we can point to which signifies a rebound in our market. This is precisely the case now. There has been no notable change to Medicare or Medicaid reimbursement policies, yet during the last quarter, a record number of HIS purchasing decisions were made.

We are extremely pleased with our sales performance during the last quarter, and we feel that we are positioned quite well to take full advantage of the HIS decisions that we anticipate being made in the third quarter.

I am also happy to report that we now have completed 63 installations of the Linux operating system at our clients’ sites. We anticipate installing an additional 30 by the end of the third quarter. This conversion has gone extremely well, and as you can tell by the numbers, has been a huge success with our customer base and with potential clients.

In summary, I would like to reiterate that we are very pleased with our performance during the second quarter and we are excited about our prospects for the upcoming quarter. We are firing on all cylinders and we are well positioned in our marketplace with our products, services, and most importantly, our industry leading support.

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

Darrell G. West

Our DSOs were 43 days for the second quarter, down 1 day from the first quarter and below our normal range of 45 to 60 days. Cash provided from operations for the quarter was $5.2 million compared with $5.2 million from the previous year. Free cash flow was $4.9 million for the second quarter compared with $4.9 million for the prior year quarter. We define free cash flow as net cash provided by operating activities less capital expenditures. CapEx for the quarter was $266,000 compared with $308,000 for the prior year quarter. Appreciation for the quarter was $487,000 compared with $528,000 last year. Cash collections were $30.4 million for the second quarter compared with $27.6 million for 2007.

We recognized stock compensation expense of $229,000 in the second quarter and an anticipated charge of $229,000 in the third quarter of 2008. Our effective tax rate is anticipated to be 39.2%. Our headcount at quarter end was 860, a decrease of 27 for the quarter.

We would like to open the calls to questions at this time.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from Jeremy Lopez - William Blair & Co.

Jeremy Lopez - William Blair & Co.

First of all, wanted a key-in on some of the quotes in the press release that talked about demand and some of the comments you made; you had talked about a number of record decisions, I’m wondering if you can give us more color on that in terms of quantifying in terms of number of new footprints versus add-on sales; do you have any thoughts there about how you see that shaking out next quarter and in the past quarter?

J. Boyd Douglas

Well, first of all, in the press release and in my comments today, I’m talking about new systems though; it was not add-on sales. As far as the decisions that were made, as you know, probably almost a year ago we quit giving the numbers on how many decisions were made and how many contracts and things like that because we thought it was hurting us competitively, but it certainly, as far as the number of decisions, it was the most decisions that we’ve seen in a quarter in several years now.

Jeremy Lopez - William Blair & Co.

And would you say the quality of those decisions in terms of the amount of products decided on, is it higher than in the past as well or are these starting out like the typical contracts where you start out small and they build over the years?

J. Boyd Douglas

No actually we saw quite a few that were larger than what we’re seeing; so, we are pleased with that as well. And certainly I want to mention that we were very pleased with our wind writing again without going into more specifics, but we were very pleased with the wind writing.

Jeremy Lopez - William Blair & Co.

And as you look at, I know you won’t guide one quarter out, but in terms of visibility as you look out on your business, would you say that you are more confident that this is sustainable, this kind of level of business is sustainable, beyond Q3 and into maybe even 2009 or at this point, are you not willing to make a stamp like that?

J. Boyd Douglas

I’d rather not make a stamp like that.

Jeremy Lopez - William Blair & Co.

In terms of headcount, you said you went down 20 to 25, I think it is 27 specifically; is there any appetite to slow that attrition or may be even increase whether it be in sales or in the install team?

J. Boyd Douglas

We’re steady in sales, but it is on the install teams we have hired in all three of our divisions, in the financial support services, clinical support services, and technology services. We’re hiring in all three of those areas and we currently have people in class now.

Jeremy Lopez - William Blair & Co.

And do you think that hiring will continue or do you not foresee a need for that?

J. Boyd Douglas

Right now today I would say we would probably continue.

Operator

Your next question comes from Bret Jones - Leerink Swann.

Bret Jones - Leerink Swann

I just wanted to kind of hit on what you’re drawing your confidence from, and I know you said that you can’t pinpoint specific areas as far as there hasn’t been a change in Medicare reimbursement, but as you evaluate the financial health of your customers, I know that was an issue last quarter with the spike in bad debt, is there some fundamental change where bad debt may have gone down within the hospitals themselves giving them the confidence to go ahead and start making these purchasing decisions?

J. Boyd Douglas

Not that we know of. I really don’t think the financial condition of our customers has changed one way or another, and that’s why, I’ve said in several calls before, I’m not sure that that’s the whole reason we are going through a slowdown. This market, we’ve been doing this for a long time and the natural ebbs and flows of this market sometimes go without really any real explanation, but the financials at any of our typical hospitals have not changed at all.

Bret Jones - Leerink Swann

So, when you talk to your customers you’re not hearing any common theme as to why all of a sudden they are pulling the trigger now?

J. Boyd Douglas

That is correct.

Bret Jones - Leerink Swann

Can we talk about bad debt for a second; was there a dramatic improvement; I know record collections, so I assume there wasn’t a reversal this quarter, that was there for that one that you were taking at the big bet, that charge for quarter?

J. Boyd Douglas

No, there was not a reversal and we actually increased our expense; from the first quarter it was down a little bit but it was still in the $600,000 range which is up above normal. We did have one large account that we wrote off, and I do anticipate that in the third quarter that number is going to go back down to a more normal level for us.

Bret Jones - Leerink Swann

So that was just a one client specific issue that was driving this quarter’s bad debt also or is it multiple…

Darrell G. West

It was just the one client that drove the bad debt.

Bret Jones - Leerink Swann

One client, okay great.

Operator

Your next question comes from Robert Dodd - Morgan, Keegan & Co.

Robert Dodd - Morgan, Keegan & Co.

We are coming to the end of the third quarter is the end of the fiscal year for the hospital; how certain are you that this isn’t just some of your potential customers, some of your prospects finding themselves perhaps flushed with a little bit of extra cash at the end of their year and spending it; what’s your level of confidence that it’s not just a short-term benefit from that versus going into that, how much can it carry forward into Q4 of this year let alone 2009?

J. Boyd Douglas

I don’t know; certainly there’s a reason we only give guidance one quarter out and I’ll start by saying that, so I don’t know that I can put a number on the confidence, but as we move through this and when we do so on a large number of contracts, typically that will push the installs back a little bit more than the 60 to 90 days that we get, so we’ve got some installs slated for fourth quarter already; and the pipeline is strong. The number of prospects that are out there that we think are close to making decisions is strong and we feel good about our position in a lot of those deals. They are not signed on the dotted line yet which is exactly why we only give the guidance one quarter out, but we feel good about the schedule, where it is now, and we feel good about the near-term prospects of the pipeline and the prospects that we’ve got.

Operator

Your next question comes from Richard Close - Jefferies Financials & Co.

Richard Close - Jefferies Financials & Co.

I was curious on the add-on sales; it seemed to tick-up I guess as a percentage if I’m not mistaken, did you say 24%?

J. Boyd Douglas

Yes.

Richard Close - Jefferies Financials & Co.

So, I guess it was 20% in the first quarter after a couple quarters; anything that’s primarily driving that specifically?

J. Boyd Douglas

That’s just a function of new system sales and how many we have, and we didn’t install but five hospitals in the quarter; so, consequently that leaves more slots open to do add-on sales, so that will make that number go higher when we don’t do as many installs. I would anticipate next quarter that that number won’t be as high.

Richard Close - Jefferies Financials & Co.

And you look at maybe I guess the new footprints in the second quarter, you look at I guess your expectations for the third quarter, is there anything you can draw upon those customers, any qualities on those customers that are maybe different than other customers that you have, I guess bifurcation in the type of customers that you’re serving?

J. Boyd Douglas

No, there’s no change at all, it’s just the typical rural community hospital; the majority of them are under 100 beds.

Richard Close - Jefferies Financials & Co.

And then are you seeing any success out west; I know you expanded out there a couple of years ago, may be seeing increased interest from a different geographic area?

J. Boyd Douglas

We are; several of these sites are out west, so we’re certainly pleased with our performance out there and that was obviously a good move for us.

Richard Close - Jefferies Financials & Co.

And then, with respect to your customers and you mentioned I guess the roll-out or the installations of the Linux, can you talk a little bit about how all that’s progressing and the success there, and then how penetrated are you on that front?

J. Boyd Douglas

Obviously, that continues to go well. We now have, looking back at the number 63 installations of that system in place and we’re expecting to do 30 more this quarter, so that’s 90 out of our 600 or so customers. The ones that are installed, the 63, and the upcoming 30 is the combination of existing customers that are upgrading their systems from the UNIX based system to Linux and getting a new server in the process, and obviously every new install that we do is going in with Linux.

Richard Close - Jefferies Financials & Co.

In order of magnitude, is that a significant process in terms of your converting over to that, the Linux implementation, and then, are you seeing when you do that that you’re getting additional add-on sales for different products at the same time? Is that driving may be some additional purchasing?

J. Boyd Douglas

They kind of go hand in hand. A lot of times we see if someone is adding say Point of Care, they may need more processing power; so, in order to install Point of Care, they’ve got to go ahead and install a new server with Linux. Their existing server, they may have been running it the last 5 or 6 years and it’s time for server upgrade anyway. So we’ll upgrade their server and then maybe a month later we’ll come in and install Point of Care for example. So, they’re kind of intertwined into both. As far as what the hospital has to go through, we’ve now converted 60 of them; we’ve got that process down and are very good at it, and it requires minimal downtime on their part, and there’s really not a huge use of resources on the hospital’s part to convert over.

Richard Close - Jefferies Financials & Co.

And then on the R&D front, what was R&D, and then I guess I can figure out as a percentage of revenue?

Darrell G. West

Richard, that’s not a number that I have readily available, but I will look into that and get you…

Richard Close - Jefferies Financials & Co.

Okay I will follow up with you. Maybe on a higher level, how do you guys feel about your level of R&D spending and is there anything coming around the corner product-wise or upgrade-wise, that you are maybe planning for an increase; do you feel like you’re at the right level of R&D spending to stay competitive in the marketplace?

J. Boyd Douglas

Absolutely, we’ve only got one version of our system, so obviously it’s in our best interest to keep that competitive, and the way that really works is a directive from the board. Mike and I have as much leeway as we need to hire as many programers or developers or whatever we need to do to keep ourselves competitive and stay forefront of the community hospital marketplace. We have no problems with that at all. The reason we don’t keep that number or do anything there; out of our 860 employees, a lot of those are involved in some way or another in research and development. Just in our product development division, purely developers, all they do is develop, is 127 employees. That’s just the people that are developing the software; that’s not the ones that are going out doing the user needs assessments and things like that; we get that from all areas of the company where there are people from software; Mike spends a lot of his time doing it; I spend a lot of my time coming out with new systems.

The second part of your question, I don’t see any significant projects on the scale of like a PACS or anything in the near future where we would spend a lot of money on.

Richard Close - Jefferies Financials & Co.

And then just getting back to the record number of decisions, I think you mentioned that that is the most that has occurred in several years; maybe if you could sort of directionally tell us like the order of magnitude in terms of visit; like 5% or 10% higher than the previous record level.

J. Boyd Douglas

5% to 10% would be probably a pretty good number.

Operator

Your next question comes from Jeff Schmidt - Sidoti & Co.

Jeff Schmidt - Sidoti & Co.

Any comments on what you are seeing in the length of the deal process over the past quarter, and maybe you guys seemed to have a pretty good quarter with bookings; can you comment how long those deals were in the pipeline.

J. Boyd Douglas

I would say average about a year in the pipeline, that’s the process which we talked about before, has been lengthened, and we decided, I guess, slowly over time because it is lengthening and the pipeline was building a little bit; we got a sudden burst of a significant number of them now. It’s optimistic as we are and as full as the schedule is, I certainly don’t think we’ll have that many decisions again this quarter; that’s just kind of how our marketplace works; we’ll have a sudden burst and then it’ll go back down, but we feel good about it.

Jeff Schmidt - Sidoti & Co.

Can you talk about maybe your latest discussions with the dividends, it seems pretty healthy with these free cash flow levels, but as far as bringing that number up even if you do more than the $1.44 on free cash.

J. Boyd Douglas

I would say in general the feeling of the board is that until we get the EPS up to the $1.44, we’ll probably leave it where it is certainly, hope that we’ve calmed all fears then as also a lot of angst about whether we don’t cut the dividend or not, and frankly if you go back and look a year ago, our cash is up, I think, $4.5 million from a year ago after paying out the dividends that we paid. So, we’ve got a very strong cash position and certainly are glad to be able to pay the dividend to our shareholders.

Jeff Schmidt - Sidoti & Co.

Yeah. Definitely seems that way.

Operator

Your next question is a follow-up from Jeremy Lopez - William Blair & Co.

Jeremy Lopez - William Blair & Co.

I wanted to circle back and talk about margins a bit. We’ve seen actually very nice up-tick in the support and maintenance gross margins and they are just kind of chugging along now around almost 64%. I am wondering what’s driving that, I guess, slow-tick hire, could it be in any way due to the Linux platform easier to support internally; I am wondering what your thoughts on that and the sustainability of that metric going forward.

J. Boyd Douglas

The largest driver there is actually headcount and with the slowdown in business and a decrease in headcount, we see improved efficiencies or improved margins in support maintenance. With the third quarter hiring, the couple of classes that we’re adding, that number may drop a point, but it should stay in that 64-65 range in the third quarter.

Jeremy Lopez - William Blair & Co.

And I missed the stock count number for Q2; I got the Q3, the one from the outlook, but I am wondering what the Q2 number was.

J. Boyd Douglas

It was the same; 229,000.

Operator

Your last question is a follow-up from Bret Jones - Leerink Swann.

Bret Jones - Leerink Swann

Can you break the stock comp up into the specific line items?

Darrell G. West

In administration it’s $104,000, sales and marketing $50,000, and then in cost of sales, it is $75,000.

Bret Jones - Leerink Swann

And if we circle back on where the strength for Q3 is coming from, is that specifically from the deals that you signed in Q2 or are these deals that have built up and they’ve been holding off on implementation; I thought there would be a longer lag of actually turning it into revenue; from having a strong demand in Q2, I would have thought that would be more of a Q4 implementation cycle.

J. Boyd Douglas

They were contracts that were signed in Q2. Typically, it only takes 60 to 90 days from contract signed to when we recognize the revenue and when we do the install.

Bret Jones - Leerink Swann

And then lastly, the installs; you said you were adding installs; are you having a team, I believe you were at 4 before.

J. Boyd Douglas

No. We’re just building back up; we’ve let attrition take its course for the last 18 months now; so we’re just kind of building in on that. We’re still the same number of install teams and install capacity. I think it’s confusing that I’ll maybe clear up a little bit. Just because we’ve been letting that headcount go down, but we’ve got a lot of people and everybody here is hired in the entry level positions and comes through support. So, for example, we’ve got teams of people that do nothing but education; and those people are certainly capable; there are from software; and they help us out with support calls, those people are capable of doing installs as well. So, while we let the headcount go down, it’s not a one-to-one correlation of what we have left in installs because there are other people in the other areas of the company we can pull from when we need those resources to do the installs.

Operator

Mr. Douglas, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

J. Boyd Douglas

We appreciate everyone’s time this morning and hope you all have a great weekend. Thank you for your interest in CPSI.

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Source: Computer Programs and Systems, Inc. Q2 2008 Earnings Call Transcript
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