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Quality Systems Inc. (QSII - Analyst Report) reported first-quarter fiscal 2014 (ended Jun 30) earnings per share of 22 cents, down 15.4% year over year. However, results met the Zacks Consensus Estimate. Net income declined 16.8% in the quarter to $12.9 million.

Revenues

Revenues decreased 7% year over year to $109.5 million in the first quarter. The company’s revenues also missed the Zacks Consensus Estimate of $116 million.

On an encouraging note, lead generation jumped 172% in the quarter. Moreover, sales pipeline grew 6% on a sequential basis to $150.1 million, the first time in several quarters.

Segment-wise Results

System sales amounted to $22.5 million, down about 40.6% year over year. However, on a sequential basis, the rate of decline in system sales slowed 7%. Revenues from the two subcomponents were $16.0 million (down 38% year over year) from Software and Hardware and $6.6 million (down 45% 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 8.2% year over year. Maintenance revenues came in at $38.6 million, flat year over year. Electronic data interchange services revenues were $16.7 million, up 21.0% year over year. Revenue Cycle Management sales increased 11.1% year over year to $16.0 million and revenues from other services amounted to $15.7 million, up 15.4% year over year.

Margin

Gross margin dropped 290 basis points (bps) year over year in the fiscal first quarter to 56.2%. Selling, general and administrative expenses dipped 4.4% year over year to $35.1 million in the quarter and research and development expenditure declined a whopping 34.9% year over year to $5.6 million.

Although reported operating expense declined 9.7% year over year to $41.9 million in the quarter, adjusted operating margin (excluding amortization-related expenses) contracted 190 bps year over year to 18.9%.

Balance Sheet

Quality Systems ended the quarter with cash, cash equivalents and marketable securities of $130.0 million, up 10.2% sequentially.

Our Take

We are disappointed with Quality Systems’ first-quarter results with both earnings and revenues missing the year-ago level. The core Systems business continues to face significant headwinds but the rate of decline seems to have eased somewhat. Moreover, the company continues to refrain from providing guidance due to ongoing restructuring efforts and uncertainty regarding future pipeline adoption. Although there were certain positive developments in the quarter, such as pipeline growth, lead generation and lower operating expenses, management needs to address a number of operational issues to bring the company back on track.

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

The stock carries a Zacks Rank #5 (Strong Sell). While we strongly recommend to avoid this stock until we see clear signs of improvement, medical information services provider Medidata Solutions (MDSO - Snapshot Report), carrying an Zacks Rank #1 (Strong Buy), is worth considering.

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