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Quality Systems (QSII - Analyst Report) reported third quarter fiscal 2013 (ended December 31) adjusted (excluding one-time items) earnings per share of 26 cents. It missed the Zacks Consensus Estimate by 2 cents.

Net income in the fiscal third quarter was $15.6 million (or 26 cents a share), down 26% on a year-over-year basis, primarily due to lower software license sales. 

Revenues

Revenues increased 2% year over year to $114.5 million in the fiscal third quarter. The company’s revenues missed the Zacks Consensus Estimate of $119 million.

Segment-wise Results

System sales amounted to $29.2 million, down about 29.9% year over year. Revenues from the two subcomponents were $21.9 million (down 37.6% year over year) from Software, Hardware and Supplies and $7.3 million (up 10.8% 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 $85.3 million, up 20% year over year. Segment sales are reported under four separate headings. Maintenance revenues came in at $39.5 million, up 8.9% year over year. Electronic data interchange services revenues were $15.2 million, up 25.7% year over year. Revenue Cycle Management sales surged 34.7% year over year to $15 million and revenues from other services amounted to $15.6 million, up 34.5% year over year.

Margin

Gross margin declined to 59.3% in the fiscal third quarter compared to 66% in the prior-year quarter. Operating margin dropped to roughly 20.4% from 28.8% 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 7.4% year over year to $35.5 million in the quarter while research and development expenditure declined 5.9% year over year to $7.8 million.

Balance Sheet

Quality Systems ended the fiscal third quarter with cash, cash equivalents and marketable securities of $106.9 million, down 17.9% year over year.

Our Take

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. On the positive side, we observe the high proportion of recurring revenues. Of late, however, growth of its pipeline metric has seen a falling trend.

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 see opportunities for product sales shrink, as physician groups are increasingly absorbed into hospitals.

Quality Systems currently carries a Zacks Rank #4 (Sell).

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