NextGen Healthcare, Inc.
Q4 2006 Earnings Call Transcript

Published: 10 Jun 2006

[Operator:]

Good afternoon. At this time, I would like to welcome everyone to the Quality Systems fourth quarter and year-end 2006 conference call. (Operator Instructions) Now, I would like to turn the call over to Lou Silverman, Chief Executive Officer. Sir, you may begin.

[Lou Silverman:]

Thank you, Operator. Welcome, everyone, to Quality Systems fiscal 2006 Q4 and fiscal year end conference call. Paul Holt our CFO; Greg Flynn, Executive Vice President and General Manager of the QSI Division; and Pat Cline, President of the NextGen Healthcare Information Systems Division will once again join me on this afternoon's call. Please note that the comments made on this call may include statements that are forward-looking within the meaning of the securities laws, including without limitation

[Paul Holt:]

Thanks, Lou, and hello everyone. The March 2006 quarter reflected growth in both systems sales, maintenance, EDI and other services. The company recognized approximately $2.5 million in revenue this quarter from our first significant sale at Siemens, which had been deferred during the quarter ended December 31, 2005. The balance of the $4 million aforementioned transaction with Siemens will be recognized in the next few quarters. Consolidated system sales rose to $20.6 million this quarter, an increase of 45% compared to $14.2 million in the prior year quarter. Continued growth of NextGen's customer base contributed to maintenance, EDI and other services revenue rising 31% to $14.9 million compared to $11.4 million in the prior year quarter. Our consolidated gross profit margin this quarter came in at a record 68.9%, up from 64.3% a year ago. The increase in our gross margin over last year is primarily due to a relatively lower amount of hardware and third-party software as a percentage of revenue compared to last year. While we have noted that the last several quarters results have continued a general trend of relatively lower amounts of hardware and third-party software, hardware and third-party software hinge on the needs of our customers and is not a priority focus for us. Total SG&A expense increased by approximately $2.6 million in the March quarter at $10.6 million compared to $8.6 million a year ago. $1.9 million of the increase was from the NextGen Division and consisted of increases in selling and administrative salaries and related benefits, commissions, travel expenses and other general administrative expenses. The balance of the increase was primarily a $0.7 million increase in corporate-related expenses, including professional services and salaries and related benefits. The increase in corporate expenses was driven by the accounting department staffing expenses as well as incremental legal fees related to the legal action pursued by Mr. Hussein. SG&A expense as a percentage of revenue this quarter decreased to 29.8% compared to 31.3% in the prior year, primarily due to the fact that the increases in NextGen's SG&A expenses and corporate expenses were relatively slower than the growth in revenue during the same period. The company's effective income tax rate was significantly higher this quarter compared to the prior year, at 38.7% compared to 31.3% last year. During the prior year quarter, the company recognized an incremental approximately $0.5 million in tax credits from prior periods which had not been recognized previously, resulting in a substantially lower rate last year. These tax credits were recognized based on the results of an audit of the company's tax returns in the prior year by the State of California. The effective tax rate for the March 31 2006 quarter includes both R&D tax credits for this year, as well as a new deduction which went into effect this year called The Domestic Manufacturers Production Deduction. Our effective tax rate for the full-year ended March 31 2006 is 38.5% compared to 36.8% last year. In terms of divisional performance, our NextGen Division again recorded record software license revenues, resulting in a 45% year-over-year growth rate in system sales for the division. System sales in the NextGen Division rose to $20 million this quarter compared to $13.8 million a year ago. Continued growth in NextGen's base of installed users drove maintenance EDI and other revenue in that division 46% higher than last year, at approximately $11.8 million versus $8.1 million last year. Operating income in the NextGen Division was up 74% to $13.785 million compared to $7.916 million a year ago. The QSI General Division reported a year-over-year increase of 4%, reporting revenue of $3,826,000 compared to $3,689,000 last year. Operating income for the division was $651,000. QSI Division EDI revenue was $1,202,000 for the quarter, compared to $1,190,000 a year ago. Before I move on to the balance sheet, note that the company is going to begin expensing stock options consistent with our adoption of FAS-123R, beginning with the upcoming June quarter. Had we been expensing stock options during the quarter ended March 31, 2006, we would have added approximately $748,000 in pre-tax compensation expense related to stock options. That is not including forfeitures. While I will not attempt to predict the timing of future option grants, if any, I will say that as of today, no events have occurred which would make the June quarter materially different from the $748,000 in expense which would have been reported in the March quarter. Also note that we announced a revised director compensation package in our recent Form 8-K, which is likely to impact option expense in the September quarter. Finally, the adoption of FAS-123R may have an impact on our effective tax rate going forward. Moving on to our balance sheet. Our cash this quarter decreased by approximately $18 million, declining to $57.2 million, or $2.14 per share, compared to $75.2 million, or $2.83 per share at the end of the prior quarter. The reason for the drop in cash was the payment of a one-time special dividend of approximately $23.4 million, which was paid in March of 2006. Not including the dividends payment, cash would have increased by $5.4 million. This quarter, we succeeded in driving our DSO’s lower compared to last quarter at 115 days, versus 129 days last quarter. Some of the credit for the drop in DSO’s was related to the revenue recognized from the Siemens sale, which had been paid during the December quarter. Our DSO’s by division this quarter, 88 days for the QSI Division and 118 for the NextGen Division. Our deferred revenue balance increased to $35.9 million. That is up $1.8 million from the prior quarter, and up $10.5 million compared to a year ago. Primary drivers of the growth in deferred revenue compared to a year ago is both deferred implementation and training services, as well as maintenance services in the NextGen Division. As I always do, I am going to give out our non-cash expenses for the quarter, beginning with amortization expense

[Greg Flynn:]

Thank you, Paul, and thanks to all of you for your interest in our company. The QSI Division and EDI numbers have been discussed in detail already by Lou and Paul, so I would like to take my portion of the call to note various non-financial achievements for the division in the last quarter. In February, we held a successful dental users’ meeting, with the clients attending representing more than 500 office locations. It was a very upbeat meeting. Product sales resulted and future potential sales have been added to our pipeline. On the product development front, working in consort with several of our clients, we added some significant features in the past quarter. For example, we have now enabled the client to utilize the Internet for patient pre-registration. The patient enters their healthcare information in advance -- including their prior history -- over the Web, and then when they arrive at the office, they simply add their electronic signature and they are ready to be seen. Also, we have a live project where patients are using a kiosk in the office to self-register at the time of their arrival. We also added functionality to make our CPS, our dental records product, even more usable and user-friendly to large-scaled environments, which of course is the typical QSI client environment. In addition, we developed an interface to a third-party vendor to allow for outsource collection management by our clients. We are now in a beta phase with this project. All of these products and initiatives are consistent with our philosophy of minimizing labor intensity for our clients while maximizing their patient's experience in the office. I am proud of the efforts by all of our staff on these and other projects, and would like to thank them all on this call. As per usual, I will comment on our sales staffing and pipeline. Our sales staffing remains unchanged from last quarter, and our pipeline is approximately $3.5 million. We define our pipeline as sales situations where QSI is in the final three purchase choices, and we believe that the sale will occur within 180 days. With that, I will tee it up for Pat Cline, President of our NextGen Division. Congratulations, Pat, on the quarter and year, to you and your team.

[Pat Cline:]

Thanks, Greg. I am very pleased and excited that NextGen set another record last quarter. During the fourth quarter, we executed about 65 contracts with new customers. At the current pace of sales and implementations, NextGen is being embraced by a new customer on average of about every business day. Our sales force has again increased in size to a total of 43 people, and our pipeline has increased slightly to a little over $60 million. The mix of EPM to EMR customers last quarter continued to be similar to prior quarters, with the slight edge going to the EMR. Interestingly though, about four out of five new customers last quarter purchased both our EMR product and our EPM product. During the quarter, we announced our new Community Health Solution, which is a software product that allows any number of medical practices, whether or not they have NextGen systems, to exchange and maintain patient health information. This solution is already being used productively in live environments, and has been purchased by a number of new customers recently as well. As in the past, I will not get into making revenue forecasts related to the product, but I think it is a terrific product, a terrific advancement for our company with solid potential. The market for NextGen products remains very strong and we see that for the foreseeable future. In closing, I would like to thank NextGen's excellent employees and also our excellent customers for their continued support. Operator, we are ready for questions.

[Operator:]

(Operator Instructions) Your first question comes from George Hill.

[George Hill:]

Thanks, guys. Just a couple of housekeeping questions to start. The $2.5 million in Siemens revenue, did that fall entirely in NextGen system revenue in the quarter?

[Paul Holt:]

George, we are not getting into the exact details of where that revenue is being allocated. We elected to just mention the total amount of revenue being recognized and what was still deferred.

[George Hill:]

Okay, I appreciate the call on that. A couple other questions, I will just rattle them off real quick. Can you give us some color on the pricing of the new community product model?

[Pat Cline:]

I can try. The pricing is based on the number of practices and the number of providers, and in some cases may be based upon the number of health transactions that are exchanged, so it is going to be a little bit fuzzy. Typically, it is going to run somewhere in the neighborhood of $40 or $50 per provider, per month, and in the range of a couple hundred thousand dollars to initially put the product in.

[George Hill:]

Lastly, can you just talk about the difference in the company's resources dedicated to the Siemens agreement in this quarter versus the last quarter? I saw that you guys are getting pretty prominent displays, placing with them down at the [Temper] conference. Just maybe how you were able to free up resources this quarter to get back to market.

[Lou Silverman:]

I would say there is no significant difference.

[George Hill:]

Okay, all right. Thank you.

[Operator:]

Your next question comes from Richard Close.

[Richard Close:]

I was wondering if you can comment -- you had mentioned that four or five were buying both the practice management and the EMR -- maybe what you think is driving that? What was that in the December quarter as well?

[Pat Cline:]

It is actually four out of five. In most prior quarters, we saw the number of customers run about two-thirds, or 66% or 65% or 70%, as opposed to north of 80%. Frankly, I do not know the answer, but it could be a couple of things. One is that I think forward-thinking medical practices are increasingly realizing that there are benefits to having their practice management software functions truly integrated with their clinical functions, and there are many reasons for that. Many of our competitors do not offer this feature, though many of them claim to have it. Another possibility is that there are more customers in the market for both EMR and EPM, as the EMR market continues to heat up and as practices replace their older or legacy practice management systems.

[Richard Close:]

Just to follow-up on that, would you say it is just more people kicking the tires, so to speak, or are you tending to see more people actually geared towards purchasing a system?

[Pat Cline:]

There are a lot of serious buyers in the market. We are but one player in a relatively large market, or at least a market that has grown far larger over the last couple of years. As I mentioned, we are selling a new system and bringing in a new practice live on the product on average of every business day. Between what we are selling and what our competitors are selling, I think the market of serious buyers is pretty robust.

[Richard Close:]

Maybe commentary with respect to the average size of the practices that you are signing up, possibly on a doc base?

[Pat Cline:]

I do not have that answer in front of me. It does tend to move quarter-to-quarter. In some quarters, we will sell an increased number of larger, multi-million dollar deals. In other quarters, depending on what marketing campaigns we might be running, we might sell some of the smaller practices. Our products fit all the way, from a solo practice up to practices or networks with thousands of providers. Our sweet spot traditionally has been the mid-range, the 50-, 75-, 100-, 200-provider practice, or group or network, but over the last couple of years, we have made tremendous strides in moving both up market to the very large organizations, and have some prominent ones we are proud to call customers. Also, we have made efforts to move to the smaller practice market, and have done a reasonable job in that endeavor as well.

[Richard Close:]

Thank you. Congratulations.

[Operator:]

Your next question comes from Sean Weiland.

[Sean Weiland:]

Thank you. First on Siemens, was there any additional business signed with Siemens in the quarter that would have been added to the $4 million, or was there any new Siemens contract signed?

[Lou Silverman:]

One of the things we want to get back to is not having a separate Siemens scorecard each and every quarter, so we felt that we owed a little bit of granularity to everybody on the $4 million piece of business that was discussed on the last call. We like to look at our customer base as a whole and our revenue totals in its entirety, as opposed to looking at how much was with what particular customer or customers. So at this point, barring any unforeseen events that cause us to change our opinion, we are going to go back to not going contract-by-contract, blow-by-blow.

[Sean Weiland:]

Okay, that's fine. Paul, you mentioned something about the tax rate changing. Can you comment about that a little bit? Which direction do you think it is going?

[Paul Holt:]

Yes, without really quantifying anything, the impact may result in a slight up-tick in our effective tax rate, but I cannot quantify it at this point in time.

[Lou Silverman:]

Just to tie up that loose end, Sean, your question related to the adoption of FAS 123R, right?

[Sean Weiland:]

Right. So it’s slight -- less than 10%, less than 5%?

[Paul Holt:]

It is a little tricky to really predict with any accuracy what our effective tax rate is going to be related to this, because in part, it depends on the option exercise activity of the option holders. I know you are looking for a little bit more than that but unfortunately, I am having a hard time giving it to you, other than the direction, which would be up.

[Sean Weiland:]

Pat, this market is changing pretty quickly right now. A lot of moving parts with CCHIT coming, and potential changes to Stark Laws. A lot of excitement in the market. I would just like to kind of get inside your head for two minutes and learn your perspective of where you think this business is going. In a year, in two years, how do you see this market changing?

[Pat Cline:]

Let me sum it up for you quickly and tell you that I am really excited.

[Sean Weiland:]

Okay. Anything else?

[Pat Cline:]

Well, if you are looking for more, I think the Stark relaxation will be, or can be, a positive for the market. I think we will fare very, very well relative to the CCHIT certification. I think the market is heating up. As I mentioned earlier, there are I think more serious buyers in the market, whereas a few years ago you saw more tire-kickers. I believe that, looking a few years out, most medical practices will own electronic health record systems. I believe today we are at more like a 20% penetration rate, so a few of those things might be behind my excitement. I guess I will add one other thing before I conclude on that, and that is that I think NextGen is very well-positioned with respect to competition and our abilities. We are going to do our darnedest to maintain the lead that we think we have.

[Sean Weiland:]

You mentioned earlier building out your small practice capabilities -- can you be a little bit more specific on what you are doing there to drive business in smaller practices?

[Pat Cline:]

Well, we have been working with pricing models. We have been working with hosting so that we take some of the capital equipment purchase cost off of the shoulders of the small practice. We have been working on some software changes, taking out features that small practices, or hiding, more appropriately, features that small practices are not in need of, like large practices. We have worked on our training and implementation programs and put things in place, such as computer-based training and remote- and Web-based training, to take the price of the systems down but also at the same time maintain profitability.

[Sean Weiland:]

Great. Thank you very much.

[Operator:]

Your next question comes from Gene Mannheimer.

[Gene Mannheimer:]

Thank you. Nice quarter, guys. Just two quick ones here. On Siemens, you say you recognized that $2.5 million out of the $4 million. Can you quantify for us what the margin was on that revenue this quarter?

[Paul Holt:]

No, Gene, we will not be giving out margin on incremental pieces of business.

[Gene Mannheimer:]

Okay. Next one, on the small practice strategy, you just touched on that. Can you quantify that for us in terms of either new bookings, a number of demos, size of pipeline, win rate -- any more color along those lines?

[Pat Cline:]

I think our win rate in the smaller practice market is relatively low because we are, at this point, priced on the high-side compared to a number of our competitors who specialize in that market. I do not know the number of demos that we have performed. I will, as I have said in the past on past calls, emphasize that this is a broadening of our focus, not a change of our focus. We are still very much focused in the mid- to high-range, and high-end, very large practices, group practices, multi-specialty groups and large networks, geographic networks of practices. Broadening our focus brings us into the smaller practice. It is not really a shift of strategy.

[Gene Mannheimer:]

Thanks very much, guys. Congrats.

[Operator:]

Your next question comes from Chris Sansone.

[Chris Sansone:]

Yes, I just wanted to fill in some blanks on some of the numbers that you gave us. First off, the $665,000, that was the amortization number on the non-cash items?

[Paul Holt:]

Yes, amortization of capitalized software expense.

[Chris Sansone:]

Okay, and then the depreciation was $300,000?

[Paul Holt:]

Yes, we are talking about consolidated figures, $379,000.

[Chris Sansone:]

Okay. Then you had the investments, the capitalized software was $970,000?

[Paul Holt:]

$956,000.

[Chris Sansone:]

There were two different numbers -- one was $60 million and the other was $3.5 million, in terms of I thought that you were referring to pipeline, but…

[Greg Flynn:]

Pipeline grew to a little bit north of $60 million.

[Lou Silverman:]

The $3.5 million was the QSI pipeline.

[Chris Sansone:]

Oh, the QSI pipeline. Okay. Thank you.

[Operator:]

Your next question comes from Vlad Artamonov.

[Vlad Artamonov:]

Most of my questions have been asked, but I have one left. A few weeks ago, there were industry awards given out. Normally I saw you guys getting a few, and this year you were not on any of the lists. Is this going to be a headwind going forward to selling your software?

[Pat Cline:]

No. You are referring to the TEPR Awards, I believe. A couple of years ago, almost three years ago, NextGen made a decision not to participate in that competition, for what we feel are valid reasons. In the prior years, we typically would take first place among about 120 or 130 companies entering. We took first place for many, many years. This year, as well as last year, we elected not to compete for those awards. You have seen our performance over the last year. It has been generally record-setting, so no, I do not think we are against a headwind.

[Vlad Artamonov:]

What is the rationale behind that decision?

[Pat Cline:]

I would rather not go into that at this point. There are some politics behind it that I would rather not discuss. You may know that we did take first honors, or first place -- I guess they call it “Best of Class” -- in the recent Microsoft awards with a number of our products. One of our customers also recently won the Davies Awards. We are still participating in some contests, and the ones that we enter, we tend to once again do very, very well. I think the people who are in the market for systems look at all the awards that we win, and not so much the ones that we do not.

[Operator:]

You have a follow-up question from Richard Close.

[Richard Close:]

Yes, just a couple quick ones. Lou, I was wondering if you could give us the legal expenses that you guys had in the quarter?

[Lou Silverman:]

Again, Richard, we have not broken that out blow-by-blow, so the answer is we will not be breaking that out on this call.

[Richard Close:]

Would that be in the footnotes, or anything like that, of the 10-K?

[Lou Silverman:]

It is all really bundled into corporate expenses.

[Richard Close:]

Also, with respect to going forward, are you guys going to be providing the option expense in your presentations going forward?

[Lou Silverman:]

To be honest, Richard, we have not really gotten all the way through that at this point in time. It is certainly a discussion that we have to have internally. Historically in our filings we have had that data in some footnotes, so we will figure out what we are going to do with that internally but we have not made a decision one way or the other at this point in time.

[Richard Close:]

Final question here would be with respect to people who are out there looking, evaluating different systems, I think you guys mentioned that there are hundreds -- sometimes it seems like thousands of providers out there of medical records. Do you feel the size and the track record and history of your company is increasingly contributing to your win rate or is it about the same?

[Pat Cline:]

I would say about the same, although our size, our track record, the stability of the company, our reputation, and the industry has for quite some time contributed to our win rate.

[Richard Close:]

Thank you. Congratulations, again.

[Operator:]

You have a follow-up question from George Hill.

[George Hill:]

I will ask a couple of the generic ones. Any change in the competitive environment that you have noticed in the last quarter, most notably with Allscripts buying A4 and with Cerner coming to the market with PowerWorks?

[Lou Silverman:]

No, not really George.

[George Hill:]

Lou, one of the comments you made is after a recent meeting, the company was going to focus more on organic growth versus acquisitions. Can you talk about what this means from an operational perspective and from a financial perspective?

[Lou Silverman:]

Yes, as a clarification, we have always prioritized organic growth over acquisitions, so that would be an incorrect interpretation of my comments. Really what I am talking about is that we had done in the past a modest amount of outbound searching for non-option deal flow. At its zenith, it was not all that heavy of a commitment, but we have dialed that down even a little bit further, to the point where I think it is fair to say that our principal force of acquisition candidates to evaluate will be opportunities brought to us as opposed to opportunities that we go out and find on our own. That is really the recalibration that was done.

[George Hill:]

Can you talk a little bit more about the pricing models that you would think about experimenting with in the smaller practices?

[Pat Cline:]

No, I appreciate the question, but I think I have gone into about as much detail on that as I want to, given that our competitors have access to the transcript of this call.

[George Hill:]

Fair enough. Thanks again.

[Pat Cline:]

You're welcome.

[Operator:]

Once again, if you would like to ask a question, please press star, then the number one on your telephone keypad. We will pause for just a moment. Once again, that is star, one, if you would like to ask a question. You have no further questions at this time.

[Lou Silverman:]

Thank you, Operator. Thanks everyone on the call, for your interest and participation, and we hope to see you down the road.

[Operator:]

This concludes today's conference call. You may now all disconnect.