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Quality Systems Stays Neutral

Zacks Equity Research

We maintain our recommendation on Quality Systems (QSII) at Neutral. Quality Systems reported second quarter fiscal 2013 (ended September 30) adjusted earnings per share of 26 cents. It missed the Zacks Consensus Estimate by 2 cents and fell short of the year-ago earnings of 35 cents per share.

Net income in the second quarter was $15.7 million, down 23% on a year-over-year basis, primarily due to declining software license sales.

Revenues increased 8% year over year to $116.1 million in the second quarter. The company’s revenues missed the Zacks Consensus Estimate of $118 million.

System sales amounted to $32.3 million, down roughly 15% year over year. Revenues from the two subcomponents were $23.7 million (down 25.5% year over year) from Software, Hardware and Supplies and $8.5 million (up 40% on a year-over-year basis) from Implementation and Training Services.

Revenues from Maintenance, Electronic Data Interchange Services (EDI), Revenue Cycle Management and Other Services amounted to $83.9 million, up 20.4% year over year. Segment sales are reported under four separate headings. Maintenance revenues came in at $38.7 million, up 9.9% year over year. Electronic Data Interchange Services revenues were $15 million, up 25.4% year over year. Revenue Cycle Management sales surged 30% year over year to $14.5 million and revenues from Other Services amounted to $15.6 million, up 38% year over year.

Quality Systems runs a pure-play business model in an attractive industry with a large number of catalysts, which provoke frequent speculation about mergers and acquisitions. On the positive side, we observe the high proportion of recurring revenues. Of late, however, its pipeline metric has been on a falling trend.

The company has made multiple acquisitions to bolster organic growth. Its acquisitions are expected to facilitate its entry in the small hospital segment. We are concerned about execution risk emanating from Quality Systems’ entry into the rural inpatient market.

Moreover, competition is intense from well regarded players such as Athenahealth (ATHN), Allscripts Healthcare Solutions (MDRX), Cerner Corporation (CERN) and others. Price discounting is frequent, particularly at the lower end, and Software as a Service (SaaS) based model appears to have exacerbated pricing pressure.

Quality Systems has traditionally focused on providing solutions for physician practices. However, core ambulatory EHR providers such as Quality Systems will see opportunities for product sales shrink, as physician groups are increasingly absorbed into hospitals.

We have a long-term Neutral recommendation on the stock which carries a short-term Zacks #3 Rank (Hold).

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