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Quality Systems Inc. (QSII - Analyst Report) reported fourth quarter fiscal 2013 (ended Mar 31) adjusted (excluding one-time items) earnings per share of 21 cents. It missed the Zacks Consensus Estimate of 28 cents. Adjusted earnings exclude impairment burden of $17.4 million on goodwill of Hospital Division.

Net loss in the fiscal fourth quarter was $4.1 million (or a loss of 7 cents a share) compared with a net profit of $15.1 million (or earnings of 25 cents per share) in the year-ago quarter.

Adjusted earnings per share were 99 cents for fiscal 2013 missing the Zacks Consensus Estimate of $1.07. 

Revenues

Revenues increased 2% year over year to $111.3 million in the fiscal fourth quarter. The company’s revenues missed the Zacks Consensus Estimate of $118 million. For fiscal 2013, revenues rose 7% to $460.2 million falling short of the Zacks Consensus Estimate of $467 million. 

Segment-wise Results

System sales amounted to $24.3 million, down about 30.3% year over year. Revenues from the two subcomponents were $17.1 million (down 35.6% year over year) from Software, Hardware and Supplies and $7.2 million (down 13.4% 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 $87 million, up 17.3% year over year. Segment sales are reported under four separate headings. Maintenance revenues came in at $40 million, up 11.6% year over year. Electronic data interchange services revenues were $15.7 million, up 19.7% year over year. Revenue Cycle Management sales surged 34.3% year over year to $15.3 million and revenues from other services amounted to $16 million, up 16.1% year over year.

Margin

Gross margin declined to 56.6% in the fiscal fourth quarter compared to 61.5% in the prior-year quarter. Operating margin went into the red at (1.9)% from 21.4% in the year-ago quarter. The decline in margin is due to reduction in the high-margin System sales in the reported quarter.

The selling, general and administrative expenses climbed 12% year over year to $38.3 million in the quarter while research and development expenditure declined 7.6% year over year to $8.2 million.

Balance Sheet

Quality Systems ended the fiscal fourth quarter with cash, cash equivalents and marketable securities of $106 million, down 21.2% year over year.

Our Take

Quality Systems runs a pure-play business model in an 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, the condition of the pipeline metric has not always been encouraging.

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 - Analyst Report), Cerner Corporation (CERN - Analyst Report) 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. While fresh projects have shrunk in number, the replacement market is growing.

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.

Currently, the stock retains a Zacks Rank #3 (Hold). However, we are more positive about other stocks such as Merge Healthcare Incorporated (MRGE - Analyst Report) which carries a Zacks Rank #2 (Buy) and is expected to do well.

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