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On Nov 14, we have upgraded our recommendation on Quality Systems Inc. (QSII - Analyst Report) to Neutral from Underperform. Despite the revenues and earnings miss from in the second quarter of fiscal 2014, we are optimistic about QSII given the continued strength in its NextGen division as well as the expected benefit from its Mirth acquisition.

Why Upgraded?

On Oct 25, Quality Systems reported more than 30% fall in earnings to $12.3 million or 21 cents per share in the fiscal 2014-second quarter from $18.0 million or 30 cents in the same quarter of fiscal 2013 (excluding acquisition costs, amortization of acquired intangible assets, and proxy contest expense). With this, QSII missed the Zacks Consensus Estimate by a couple of cents.

Revenues decreased 4% year over year to $111.1 million in the quarter, driven by significant decline in System sales revenues. Revenues also missed the Zacks Consensus Estimate of $114 million. Total bookings (excluding Revenue Cycle Management or RCM) rose 22.8% to $32.9 million from $26.8 million in the last year quarter.

Following the release of second quarter results, the Zacks Consensus Estimate for 2014 earnings fell 9.6% to 85 cents per share. The Zacks Consensus Estimate for 2015 earnings also dipped 5.5% to $1.03 per share. Quality Systems now has a Zacks Rank #3 (Hold).

QSII has done well on growing demand from providers, who have to meet the Meaningful Use criteria under the federal stimulus program. Its revenue growth continues to be boosted by the strength of the NextGen division.

In the second quarter, Quality Systems completed the development, testing and preparation for the NextGen Ambulatory Electronic Health Record (EHR) 5.8 as well as NextGen Practice Management 5.8. This will help the company’s clients meet ICD-10 and Meaningful Use Stage 2 requirements.

QSII also expects to benefit from its acquisition of Mirth Corporation, which contributed about $0.6 million in revenues and $3.6 million in bookings in the fiscal 2014-second quarter.

However, Quality Systems is not well positioned to capitalize on opportunities in the growing EHR replacement market, which is expected to grow significantly in late-2014.

Moreover, we are concerned about competitors’ attempt to grab Quality Systems’ market share through lower prices or services that are differentiated from those offered by the company.

Other Stocks to Look For

While there are no stocks to look for in the medical information systems industry, we consider stocks from the medical products industry that are performing well.  They include Hill-Rom Holdings, Inc. (HRC - Snapshot Report), INSYS Therapeutics, Inc. (INSY - Snapshot Report) and NuVasive, Inc. (NUVA - Snapshot Report). All of them carry a Zacks Rank #1 (Strong Buy).

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