QSII Downgraded to Underperform

We are downgrading our recommendation on Quality Systems ( QSII - Analyst Report ) to Underperform. The company reported earnings per share of 26 cents in the first-quarter of fiscal 2013, missing the Zacks Consensus Estimate of 36 cents. Net income dropped 18.4% year over year to $15.5 million, primarily due to an increase in incurred costs.

Revenues were up 17.8% year over year to $118.3 million in the reported quarter. In spite of registering record revenues, the company missed the Zacks Consensus Estimate of $121 million.

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. Of late however, growth of its pipeline metric has seen a falling trend along with progressively fewer signed deals on a quarterly basis.

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 ) , Allscripts Healthcare Solutions ( MDRX - 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.

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

Our Underperform recommendation on the stock carries a Zacks #5 Rank, which translates into a short-term Strong Sell rating.