We upgrade our recommendation on Quality Systems ( QSII - Analyst Report ) to Neutral. Quality Systems offers an electronic health record (EHR) product and benefits from the migration of ambulatory and inpatient practices to EHR under the Federal Stimulus. Of late, however, growth of its pipeline metric has been on a falling trend along with progressively lower number of signed deals on a quarterly basis. While greenfield opportunities are shrinking, the replacement market is growing.

Revenue growth continues to be boosted by the strength of the NextGen division. Sales growth was notable in some segments and was driven by the growing client base. Quality Systems continues to expand its recurring revenue stream (estimated to be about 70% of total revenues in the first quarter of fiscal 2013), which provides further room for encouragement.

Quality Systems’ business model suffers from concentration in the sense that its physician practice offerings account for a large majority of revenues. Core ambulatory EHR providers, such as Quality Systems, will see shrinking opportunities for product sales to physician groups, as such groups are increasingly gobbled up by hospitals.

The company has undertaken 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.

The healthcare information systems and services market is competitive. The industry is highly fragmented and includes numerous players. The company competes with larger players such as Allscripts Healthcare Solutions ( MDRX - Analyst Report ) and Cerner Corporation ( CERN - Analyst Report ) , among others.

Our Neutral recommendation is supported by a short-term Zacks #3 Rank (Hold).