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On Jan 31, 2013, we retained Quality Systems (QSII - Analyst Report), a provider of electronic health records in the ambulatory and inpatient settings, at Neutral after the company missed Zacks Consensus Estimates for both revenues and earnings for the fiscal third quarter 2013.

Why the Retention?

Quality Systems reported, on Jan 24, third quarter fiscal 2013 (ended December 31) adjusted earnings per share of 26 cents, which missed the Zacks Consensus Estimate of 28 cents. Net income in the fiscal third quarter was $15.6 million, down 26% on a year-over-year basis, primarily due to lower high-margin software sales. Revenues increased 2% year over year to $114.5 million in the fiscal third quarter, which missed the Zacks Consensus Estimate of $119 million.

Over the last 30 days, the Zacks Consensus Estimate for fiscal 2013 has dropped 1.8% to $1.10. Moreover, the Zacks Consensus Estimate for fiscal 2014 has declined 2.4% to $1.23 during the same timeframe.

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, the company’s pipeline metric has roughly stabilized on a sequential 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. Further Quality Systems faces strong competition from low-cost cloud-based competitors such as Athenahealth (ATHN - Analyst Report).

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.

Other Stocks to Consider

The stock carries a Zacks Rank #3 (Hold). Merge Healthcare Incorporated (MRGE - Analyst Report) and Mettler-Toledo International Inc. (MTD - Snapshot Report) are Zacks Rank #2 (Buy) stocks which are expected to do well.

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