Transcript
of the QSI Conference Call
Leader: Louis Silverman
January 24, 2002
ID# 2962896
Operator:
Good afternoon. My name is Dusty and I will be your conference facilitator today. At this time,
I would like to welcome everyone to the Quality Systems' 2002 Third Quarter Earnings Conference Call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks there
will be a question and answer period. If you would like to ask a question during this time, simply
press the number one on your telephone keypad and questions will be taken in the order they are
received. If you would like to withdraw your question, press the pound key.
Thank you. Mr. Silverman, you may begin your conference.
LOUIS SILVERMAN:
Thank you, operator, and thanks to everybody on the line for joining Quality Systems' Third Quarter Fiscal 2002 Conference Call. Once again, I'm joined by Greg Flynn, Executive Vice President and General Manager of our QSI Division; Paul Holt our CFO; and Pat Cline, President of our NextGen Healthcare Information Systems Division, which develops and markets our NextGen product line.
Comments made on this call may include statements that are forward-looking within the meaning of the securities laws including statements related to anticipated industry trends, the company's plans and strategies, and projected operating results. Actual results may differ materially from our expectations and projections, and you should refer to our SEC documents 10K and 10Q for discussions of the risk factors that could impact our actual performance.
For the fiscal third quarter, the company had record revenues of $11 million, which was up 7% over the prior year. Earnings per share at 22 cents was also a record and represents the 38% increase over the same quarter prior year. EBITDA at $2.6 million was also a record for the company.
Driving these figures was a return to record setting revenue performance at our NextGen unit. They turned in revenues of $6.7 million for the quarter, up 7% versus year prior. And a similar return to record setting revenues in our EDI/ Connectivity unit which came in at $1.6 million in revenues, up 15% against the year prior. We also had the benefit of record operating income at our QSI Division, which turned in operating income of $1.4 million in the quarter up 88% over year prior.
Collections activity in the quarter was very strong. We're pleased to report that our DSO has dropped to 106 days from 121 days in the prior quarter and 141 days in the same quarter prior year. Our collections group, aided by strong efforts in our operating units, did a terrific job in this area during the quarter.
Relatedly, cash, cash equivalents and short-term investments increased to $23.7 million during the quarter. Note that our increase in cash did not overpower the drop in interest rates leading to a year over year decline in interest income from $261,000.00 to $147,000.00. For those of you tracking these items, trailing 12 EBITDA is at $9.4 million and annualized revenue per employee stood at $192,000.00 for the quarter.
Significant non-financial events since our last earnings call include the initiation and near completion transitioning use of the Micromed name to NextGen Healthcare Information Systems. We're getting all of the I's dotted and the T's crossed in this process, and that's going to take an extra couple of months here.
But, we are now in the marketplace with a very much more streamlined naming approach and are now selling our NextGen product line which is developed and marketed by NextGen Healthcare Information Systems. This eliminates a lot of confusion that we've faced for the past few years where we've had Clinitec, a wholly owned subsidiary of QSI, D/B/A Micromed selling NextGen.
Our PDA product was featured in an approximately one-third-page article in Investors Business Daily during the quarter. That article appeared to bring a significant amount of new attention to the company. Our PDA continued to get good reviews in its beta process, and we project that we'll be bringing this product out to the market beginning in the current quarter.
The latest versions of our NextGen EPM 2.75 and EMR 3.7 software are near rollout, and Phase I and Phase II products coming out of our QSI Division's Project Sequoia have hit commercial release and have been sold to a number of existing clients.
That concludes my opening remarks, and at this time I'd like to turn things over to Paul Holt for additional comments on our financial statements.
PAUL HOLT:
Thanks, Lou. Greetings to those on the call. I'm very happy to report another record quarter of earnings results and excellent operating cash flows. I'm going to add a couple of details to Lou's comments concerning revenue. An important component of our revenue growth has stemmed from our recurring revenue base, which consists primarily of maintenance and EDI revenue. This is in part due to our growing customer base.
This past quarter, we posted our tenth straight increase in quarterly recurring revenue, which is $5.6 million represents a 9% increase from the year ago quarter. Also commenting on profitability, our company's net after tax profit represented 12.5% of revenue, this is a record for the company and is among the highest margins in our industry.
As Lou mentioned, our efforts at improving our cash collections have been successful in driving down our DSO's to 106 days compared to 121 days in the prior quarter, and 141 days in the year ago quarter.
During this quarter, we generated around $2.6 million in cash from operations. That's the equivalent of 42 cents per share. Outstanding performance. I'd like to take the opportunity to commend our credit and collections department for some great work this quarter.
One of the drivers of our record setting profitability has been the decline in our SG&A expenses. Total SG&A expense declined by 13% compared to the year ago quarter, and represented 27% of revenue compared to 33% of revenue in the prior year quarter.
Expense reductions in the QSI Division, combined with a very controlled approach to investments being made in the NextGen Division, has kept our overall SG&A expenses in check. In fact, overall SG&A expenses this quarter were the lowest we've reported in several years. To be fair in describing the reduction in SG&A, the number of trade shows attended, as well as the amount of travel expenses and bad debt provisions were lower this quarter and contributed to the decline in our SG&A expense. We do not expense the level of travel and trade show expenses to continue at this level.
Our gross profit margin at 55.6% remained within our historical range of between 55% and 57%.
Commenting on the divisional performance, the NextGen Division continues to win new customers and expand its customer base, while reporting it's highest ever quarterly revenue of $6.7 million, and near record operating income of $1,166,000.00. NextGen's expanding customer base is contributing to the strong growth in maintenance and EDI revenue which is a growing component of NextGen's revenue. EDI revenue in the Next Division was up more than 20% over the prior quarter, ending at $261,000.00.
The QSI Division produced revenues of $4.4 million which represents a 7% increase over the prior year quarter, as Lou has mentioned. The QSI Division has been able to dramatically increase its contribution to profits by reducing it's operating expenses, while at the same time growing revenue.
I'll make one comment on investment income. Investment income in this quarter declined by 44% compared to the prior year quarter. We've felt the sharp decline in short term interest rates, although I can say that we have been able to offset part of this by the growth in our interest bearing assets, which now stand at $23.7 million; that's the equivalent of $3.87 a share.
At this time, I'd like to thank all of you for being on this call and your interest in this company. And I'm going to turn things over to Greg Flynn who's going to give you an update on the QSI Division.
GREG FLYNN:
Thank you, Paul. Good day to you all. Revenues at the QSI Division, while still less than we would have liked, improved over recent prior quarters. Additionally as said, our operating income was approximately $1.41 million for the quarter, an 88% increase over the prior year quarter, and, in fact, a record for operating income on a quarterly basis for the division.
We are proud of this achievement in a continued challenging environment in the large dental group and consolidator market, and view the results as an affirmation of our cost containment, client retention, and new product introduction initiatives.
On the EDI side of our business, we saw a growth in our sales to existing QSI clients, as well as revenue growth, in particular, to the NextGen client base. As Lou said, this quarter represented record revenues for this element of our business, and we intend to push business forward here with continued focus on the potential business within NextGen, as well as new product offerings across the board.
On the CPS front, I'm pleased to report that there was expansion of the product's use on several metrics. Of particular note was the purchase of CPS by the national organization I have mentioned on previous calls. They will be implementing CPS on a statewide basis in another state, largely as a result, I believe, of the successful rollout of the products at their initial sites.
We are excited by the long-term prospects of working with this organization, and obviously view their further rollout of our CPS product, after their initial testing, as a vote of confidence for both the application and our services.
To report as I have on recent calls on our Sequoia software initiatives, this quarter saw our new developments out of beta and actively marketed to a targeted set of our clients. During the quarter, four clients purchased our Data Miner reporting product, and five clients also purchased our new Enhanced User Interface screens. We are pleased by this early acceptance of this new functionality. We view these enhancements/ modernizations, to our products as important to both client retention and potential new systems sales.
To comment on the sales pipeline, as I have been asked on previous calls, it has moderately increased at $5.5 million. I would like to take this opportunity to thank you on the call for your support of our company and the QSI Division, and to thank those dedicated and loyal QSI Division employees whose efforts on many fronts have helped us to achieve these results.
Now, I would like to turn the call over to Pat Cline, President of our NextGen Division. And Pat, congratulations on NextGen's quarter.
PAT CLINE:
Thanks, Greg. Congratulations to you too. Nice job. Hi, everyone. On the last call I mentioned that I thought the NextGen Division could return to a record setting pace and I'm happy that we did that. I will confess that I'm disappointed that we didn't break the record by a wider margin, and will commit that we continue to be focused on breaking records by a wider margin.
During the third quarter we executed 21 new agreements. That is, 21 agreements with new customers and about 25 agreements in all. I'm pleased also with NextGen's growth in EDI revenues which are up over 250% over the same quarter a year ago, and I'll also say that we see still a lot of room to run in that area.
Our income from operations, as you've been told, went up 30% over the prior quarter, which is close to a record. On the product front, we're nearing the release of new EMR and EPM versions. EMR is Electronic Medical Records; EPM is our Enterprise Practice Management system. The releases are 3.7 and 2.75, respectively. Both are very large new releases with a significant number of new features.
As Lou mentioned, our PDA has not yet gone to general release. We're continuing to finalize NextGen EMR 3.7, which is the version that NextGen PDA requires. And I think Lou also mentioned that all of these will be released this quarter.
On the sales and marketing side, we've got the largest healthcare IT conference which is called HIMSS coming up next week in Atlanta. We're debuting a new tradeshow booth and also starting the rollout of a brand new marketing campaign. Many of you know that these types of shows are one of our best sources of leads.
We're also working actively on the marketing front on a new website and on our placement with search engines. We've seen a dramatic increase in the number of leads that we're getting via the Internet, so we're focusing on that area.
Our pipeline's up slightly to $26 million. I think last quarter was about $25, so we're relatively stable. We've added two new sales reps from the last time we talked, so we're up to 17 people within the sales force. It's taking a little bit longer for us to bring a couple of the people that we've got in the sales force up to speed; people that have joined us within the last six to nine months, and we're also focusing on that issue. We'll either get them brought up to speed or we'll trade up.
In closing, we're looking to a strong quarter this quarter and a strong close to fiscal 2002. I'd also like to thank the employees of NextGen for their continued effort and commitment. Lou?
LOU SILVERMAN:
Operator, we are now ready for questions.
OPERATOR:
Okay. At this time, I would like to remind everyone once again to press the number one on your telephone keypad if you'd like to ask a question. And your first question comes from Lance Stringham of Red Chip Review.
LANCE STRINGHAM:
Good morning, everyone. I think I missed the revenue number for EDI.
LOU SILVERMAN:
The EDI revenue number for the quarter was $1.56 million, and $1.3 million of that was in the QSI Division, the balance in the NextGen Division.
LANCE STRINGHAM:
Okay. And then can you comment on customer retention during the quarter for EDI?
LOU SILVERMAN:
You're referencing our last quarter call where we reported the loss of significant customer and - -
LANCE STRINGHAM:
Right.
LOU SILVERMAN:
This quarter we had no such losses.
LANCE STRINGHAM:
Okay. Just wanted to confirm that. And then last quarter there was also some NextGen or MicroMed deals that were deferred. Of the 21 agreements with new customers that you guys signed this quarter, how many of those were deferrals from the prior quarter?
PAT CLINE:
Well, many of those deals were in the pipeline the prior quarter. I think on the last call I probably mentioned one contract which was actually executed that was deferred because the customer had some credit issues, and at the time we had hoped to be able to resolve those issues. It was a very large agreement. Unfortunately, we were not able to resolve those issues. We could not get that customer credit approved, so we did not book that deal, have not booked that deal, and will not book that deal.
LANCE STRINGHAM:
Okay. And then my last question for now, did you guys buy back any shares during the quarter?
LOU SILVERMAN:
We did not, Lance
LANCE STRINGHAM:
Okay. All right. Congratulations on the fine quarter.
LOU SILVERMAN:
Thanks very much.
OPERATOR:
Your next question comes from Mike Crawford of B. Riley and Company.
MIKE CRAWFORD:
Good morning. Lou, I think you mentioned that you have a growing customer base, but you didn't give a number on how many customers you had. Is there something like that handy?
LOU SILVERMAN:
I'm not sure I mentioned that, and I'm not sure it's handy. Greg or Pat? We really don't track that on a quarterly basis, Mike.
MIKE CRAWFORD:
Okay. Okay, so, with the continued growth at NextGen now, that has probably attributed to a decline in the gross margin, and I think the EBIT margins of the two divisions would be in the - - what is that in the 30% something range for QSI and 10% range for NextGen? Is that something we should look to continue going forward?
LOU SILVERMAN:
I'll let Paul pull up his EBIT numbers and he'll get back to you on that.
MIKE CRAWFORD:
Okay. Well, maybe in the meantime, Lou, could you just talk a little bit about some - - if you could quantify your expectations regarding the PDA product?
LOU SILVERMAN:
In terms of our expectations, as I think we've established on prior calls, Mike, we feel that the PDA product is an important product from the perspective of extending the interest, viability and sales appeal, so to speak, of our NextGen EMR product.
On it's own, the PDA will be a moderately priced product. The sales of which are not likely to materially impact our financial performance in any quarter in our near term future, but rather it's just continued expansion in the development of our product, and we think it will help the adoption rates of the EMR product overall. Keep in mind that the EMR product line industry- wide is a very, very under penetrated market segment, and so anything that is added to the product and aids and accelerates adoption rate is a good thing for us and helps us, and to be fair, perhaps others, sell more EMR product.
Again, we're not looking to the PDA product itself to single handedly change our revenue or profit performance in NextGen or the company, but we do think that it's a very valuable addition to the product line to help spur added sales and added interest in EMR adoption.
MIKE CRAWFORD:
Okay. And then, I guess, my final question, while I guess Paul looks into the other one, is on your cash balance now, it's getting near $24 million. It seems to me you can buy back 10% of your stock and it would be immediately accretive to earnings even at prices above here. And how come the board is not moving on that and what kind of conversations have been going on with the board regarding returning some of that capital, because your return on non-cash assets is like 32%?
LOU SILVERMAN:
It's hard for me to comment or speak for the board, Mike, but I would say that the issues of what to do with our cash - be it stock buy back or where the cash is invested continues to be discussed at the board level. Management has put its two cents worth in on numerous occasions. Those are topics that the board has reserved the right to exercise final decision on, and we are where we are on that.
I think that your comments are well placed and with all due respect, other people have also raised similar comments, but on the stock buy back specifically we certainly are, as you know, encumbered during significant parts of our quarters by being locked up in terms of waiting for an earnings release and not wanting to do anything too close to quarter end.
Those kinds of issues combined with overall board preference has got us in the not unpleasant position of having a significant cash balance, but I do acknowledge that a lot of people would like to see some things done differently with the cash than has been the case.
MIKE CRAWFORD:
Okay, thanks. So, then that's it for my questions, but I am curious as to your thought on the gross margins.
LOU SILVERMAN:
The way I look at gross margins and the way I would suggest people look at them is that our gross margins end up in a relatively narrow band, generally speaking 55% to 57% plus or minus a little bit, and we move within that band just based on quarter to quarter changes in our mix of hardware vs. software, and our mix of EDI, and new sales versus maintenance, etcetera, etcetera.
So, my sense is that as long as we're in that 55% to 57% band there's really no significant gross margin event. And I'd say that from our perspective we don't see anything in the near term future that would take us out of that gross margin band.
MIKE CRAWFORD:
Yeah, you know, I actually misspoke a little bit about just only gross but operating because it seems to me that NextGen has around a 10% operating margin and that's growing faster.
PAUL HOLT:
Mike, this is Paul. Actually, last quarter it was 17.5%.
MIKE CRAWFORD:
Oh, it was? Okay. Thanks, Paul.
PAUL HOLT:
And, you know, that is about the band that the NextGen Division has operated in. We've talked on the call about the timing of trade shows and the level of travel expenses and how we don't expect that to stay in this range, but we've also talked about how we would like to set additional records on the revenue side. We don't like to talk a lot about projections and expectations here, but I don't think we would expect those percentages to come down.
LOU SILVERMAN:
And I would add, Mike, that - - this is Lou, that nowhere in our plans do we envision working to have the NextGen operating income margin numbers get all the way up to where QSI is at this point. We have too much to do in that world. There's too much opportunity out there. We need to continue to invest in our product development and our infrastructure.
So, we are very pleased to be operating at a significant operating income margin, particularly vis a vis our competitors, and vis a vis our history, but at the same time we do have a lot of projects to invest in and a lot of infrastructure to build to continue to be able to maintain our very strong positioning in the vibrant markets that we play in.
MIKE CRAWFORD:
Okay. Thank you.
OPERATOR:
Your next question is from Andrew Shapiro of Lawndale Capital Management.
ANDREW SHAPIRO:
Hi, good morning. I have a few questions. I actually have a bunch of questions. I'll ask a few and then back out into the queue again if you'd come back to me. My first is I was late to the call and for some reason it wasn't in the press release this time. Would you mind just giving me the break out again on the NextGen Division revenue and operating income, and the same for Quality Systems, the QSI Division?
PAUL HOLT:
Hi, Andy. This is Paul. NextGen revenue was $6.7 million, and QSI revenue was $4.4 million.
ANDREW SHAPIRO:
Yep.
PAUL HOLT:
And then you've got operating income for NextGen at $1,166,000.00.
ANDREW SHAPIRO:
1166?
PAUL HOLT:
Yes.
ANDREW SHAPIRO:
And 141 was dental?
PAUL HOLT:
Yes.
ANDREW SHAPIRO:
Okay. Actually, dental and EDI, right?
PAUL HOLT:
No, just dental, and the dental's portion of EDI. EDI's revenue is in two places.
ANDREW SHAPIRO:
Oh, EDI now is split into part of NextGen and part of QSI's - -
PAUL HOLT:
And has been for several quarters, Andy.
ANDREW SHAPIRO:
Okay, great. Now, if I could, is to focus on I guess on the corporate side, and if you could help break out the issues on the two divisions because they may differ, is I'm trying to get a handle on the fabulous operating leverage that you've been gaining with your revenues rising faster than your SG&A expenses have risen. And, in fact, you're SG&A expenses have dropped and dropped even more this quarter.
Last quarter I asked on the call about whether or not the cuts were done and if they were, you know, we'd start seeing a grandfathering and we looked like we got the benefit of another quarter. On the dental and on the medical side, or NextGen side, if can you break out, do you feel that the SG&A levels are adequate, are going to be - - there's more cost cutting than the QSI Division to be had. I understand you'll invest in NextGen further, but as a percentage of revenue, do you expect in that division operating leverage to further expand as well?
LOU SILVERMAN:
Andy, on the QSI side, you're right we did report that expense cuts were pretty well done, we thought, at the QSI Division, and I'd say that that continued to be largely true in the quarter. We had a couple of tune up things that we did in the quarter from a headcount perspective in this particular division, but the other drivers on the SG&A line gave us t some one time benefits, if you will, as Paul suggested, across both divisions, actually. Travel expense for a variety of reasons came in lower than we had expected and we won't question the good news, but as Paul reported we don't feel that that's a sustainable trend. We also had fairly modest trade show expenditures in the quarter, which had a lot to do with just the calendar and less to do with any dramatic or draconian cuts in that line item across both divisions.
So, at the QSI Division specifically, I think we are where we are. I don't envision any significant additional cuts to any of the SG&A items that we have in our back pockets that are coming attractions so to speak.
And on the NextGen Division, again, I think we pretty well covered this. We have a lot of things we want to invest in, and we did get some nice leverage this quarter in the line items that Paul and I have talked about, but some of those we view as k one timers and we don't see them being sustained.
ANDREW SHAPIRO:
Okay. So, for modeling purposes, can you give a little bit of help? Do you expect the SG&A levels either on the corporate level or on the divisional levels to be going back up to where they were last quarter which was about 33 on an aggregate basis, or somewhere les than that or somewhere more than that?
LOU SILVERMAN:
Again, we have preferred to not give specific guidance, but let me try to answer your question this way. If we look back as a percentage of revenues over the three quarters prior to this one, the SG&A percentage company as a whole is between 29.7% and 31.9%. So, a fairly tight band and without giving specific guidance, I think that it's fair to say that where we've been historically would be a reasonable prediction for where we might end up in the near term future.
ANDREW SHAPIRO:
Okay. That would argue the incremental SG&A expenses would be well in excess of your incremental revenue growth in the coming quarters then? I mean I understand how it would trend up, but if you were to go back up to those levels, that would be, you know, greater incremental SG&A growth than there would be on the revenue growth. Is that kind of within the realm of your projections?
LOU SILVERMAN:
I'm not sure I agree with your numbers, and I'm not sure how you got to that conclusion because we haven't really talked about revenue growth.
ANDREW SHAPIRO:
Well, you're at 27% - - SG&A is 27% of your revenues this quarter which is a low number, and if it went back up towards the historical norms, then SG&A is going to grow faster than your revenue growth was expected to be.
LOU SILVERMAN:
Well, I would say SG&A would have gone up 10% let's say - -
ANDREW SHAPIRO:
And revenues would only go up 8%.
LOU SILVERMAN:
Well, you're assuming - - if revenues go up 8, you'd be correct. If they went up 10, then there would be a tie.
ANDREW SHAPIRO:
Then your SG&A would be only 27% of revenues in the coming quarter, and the cuts as a percent of sales kind of (UNINTELLIGIBLE). That's what I'm trying to - -
LOU SILVERMAN:
What I was trying to get at, Andy, is I think that as a percentage of revenues - -
ANDREW SHAPIRO:
Yeah.
LOU SILVERMAN:
I think it would be a fair expectation stopping, short of given guidance - -
ANDREW SHAPIRO:
Right.
LOU SILVERMAN:
That we'll be back in our historical band.
ANDREW SHAPIRO:
Right, and I'm trying to avoid pinning you on the wall regarding revenue guidance, and I'm trying to avoid actually percentage of revenues, and trying to just get at an absolute dollar value focus on your SG&A which is a more predictable and, you know, surroundable number.
And can you give us a little bit of, you know, you've got certain shows you know are on the calendar. You're either going to pay for them or you're not going to go to them, and you have other particular SG&A - -
LOU SILVERMAN:
I think you've got our best shot on that one, Andy. I think we're going to be in our historical band.
ANDREW SHAPIRO:
Okay. I'll pass, and please come back to me. I have more questions.
LOU SILVERMAN:
Great. Thanks.
OPERATOR:
Your next question is from Gordon McBean of Roth Capital Partners.
GORDON MCDEAN:
Good morning, gentlemen. My question I will direct to Greg and Lou. And it is more looking for a macro trend in the consolidator market on the QSI site. Just any feel - - not trying to tie you down on anything there also, just a feel for what you see in that - - among the consolidators.
GREG FLYNN:
What I've seen is there is some fluidity there, and I'm choosing the word carefully. There has been some movement on the consolidators' part actually to divest themselves of as some of their groups. That isn't necessarily bad news, without getting into particulars forfrom QSI because many of those groups are on a QSI system, and, in fact, since they were receiving service through their consolidator purchase systems from us on a stand-alone basis.
In terms of growth amongst the consolidators at this point we really have not seen acquisitions out there. As you know, their stocks are depressed. There was some investment into Monarch. We haven't seen the net result of that to a significant extent at this point. I'd kind of say status quo with the intuition that things cannot in my mind remain status quo forever. I'm not trying to give you a circular answer, but it's kind of treading along at this point.
GORDON MCDEAN:
Okay. Thank you very much.
OPERATOR:
Your next question comes from Zach Macadoo of MCM Associates.
ZACH MACADOO:
Hi, guys. Great quarter.
LOU SILVERMAN:
Thank you very much.
PAT CLINE:
Thank you.
ZACH MACADOO:
I was just wondering if you've seen any change in the competitive environment?
LOU SILVERMAN:
Why don't we start with Pat on that one, and move over to Greg.
PAT CLINE:
No more so than previous quarters. We expect to get a lot of good competitive intelligence, if you will, at the upcoming HIMSS show next week, but no, no big changes in the competitive landscape.
GREG FLYNN:
On the dental side, at the low end market in our smaller groups there's a variety of players such as Dentrix, Practice Works. Assuming you're familiar with their attempt to move into the large practice market; we have not seen significant encroachment amongst our client base. We don't tend to actively participate in new systems sales to the low end, as you know.
On the higher end, we have had, without being too particular either about the clients or the competitors, we've had attempted encroachment that I think actually we've had a reasonable degree of success in the last couple of quarters at this point deflecting.
ZACH MACADOO:
Okay. It seems that Practice Works has made a little progress on it's ASP model on the dental side, and I was jus wondering if you've seen any, you know, ASP models on the doctor side?
PAT CLINE:
Yes, there are a few ASP models on the medical side. A couple of them look pretty interesting and are starting to gather some market share primarily on the very low end which is not a segment of the market that we have historically approached, and it's not a segment of the market that we intend to approach in the short term.
ZACH MACADOO:
Okay. Well, thank you very much.
PAT CLINE:
Thank you.
OPERATOR:
Your next question is from Fred Toney of Med Cap partners. Fred, your line is open.
FRED TONEY:
Good morning, guys. Could you just elaborate a little bit more on the competitive situation - - or the competitive landscape with the NextGen product and what you expect to see at HIMSS coming up this next week? And I've got a couple of other question as well.
PAT CLINE:
Well, we don't expect a lot of changes. On the medical records side we hear a little bit of rumor about one competitor that might be acquired, but outside of that we're not expecting anything earth shattering. That particular competitor hasn't been a factor lately anyway.
On the practice management side, other than one or two newer ASP vendors on the low end not much of a change expected in that area. We hear a lot of rumors about announcements on acquisitions, but while I might be one to listen to them, I'm not one to pass them on. So, we'll have to wait and see. It may be an exciting week next week, though.
FRED TONEY:
So, you're not seeing any additional or waning of competitive pressures for NextGen at this point?
PAT CLINE:
No. I would say things remain fairly status quo. There are always new competitors coming out of the ground as others wane, and we seem to keep on the steady pace along the way, which is the good news. As new competitors come out of the ground, we watch them very carefully. We think a couple of them have very flawed business strategies. Ones that we have seen fail time and time again over the last 20 or so years. But, they'll come into the market, make a big splash, spend a lot of money, and very often go away.
FRED TONEY:
Okay. Secondly, with regard to the EMR product, who are you selling that to? Who is the primary sales contact point when you go in to make that sale?
PAT CLINE:
Well, the answer varies, but in a typical 10 to 20 or 30 doctor practice on the medical records side, the decision makers are the docs and you deal with either an executive or an administrator of the practice in the contract negotiation, or a CEO with respect to who signs the contract.
That, frankly, tends to be true on the high end as well. You may have more people involved in the decision. It's a more complex sale; a more protracted sale. But, one common factor, I would say, is the docs generally make the decisions. Very few administrative types are willing to overturn the docs' opinion with respect to a medical record system that they think they can use.
FRED TONEY:
And what's the average size practice that that's being sold to?
PAT CLINE:
Our sweet spot is north of 10 physicians up to 50 or 60 physicians. We have many, many customers that are larger than that, and we are targeting them. Our product plays very well in the high end or enterprise marketplace. But, I would say that's our sweet spot.
FRED TONEY:
Okay. Lastly, switching gears on the buy back - - share buy back program, when is the last time you made open market purchases and how much is left under the existing program?
PAUL HOLT:
The last time we made purchases was back in the December quarter of a year ago.
FRED TONEY:
Okay. So, it's been more than a year?
LOU SILVERMAN:
And in terms of how much is left on the authorization, it turns out that we had a buy back authorization expire some time in the summer, I believe, and then towards the latter part of October of '01, we put out a press release announcing that we had, in essence, reestablished a buy back authorization for up to 5% of the outstanding.
FRED TONEY:
And so a full 5% of the outstanding is still available under the existing program?
LOU SILVERMAN:
That is correct.
FRED TONEY:
And there are no price parameters related to that? Or there are no restrictions on where you can buy that?
LOU SILVERMAN:
That is correct.
FRED TONEY:
Okay. Thank you very much.
LOU SILVERMAN:
Thank you.
OPERATOR:
Your next question comes from David Rogers of Capital Investment Corp.
DAVID ROGERS:
Hi, guys. Thanks a lot, and congratulations on the quarter. Two questions. One, just a point of clarification on the travel and tradeshow expenses, is that a seasonal phenomenon or related to 9/11 and people not traveling?
LOU SILVERMAN:
Pat, you might want to answer some of this.
PAT CLINE:
It's both. Part of it's seasonal. You've got, of course, Thanksgiving and Christmas, and not only are prospective customers less willing to see sales people during that time of year, existing customers are also less willing to have their staff trained the few days prior and the few days after those holidays. I would say early in the quarter, the September 11th thing certainly had a lot to do with slow travel, at least going into the middle of the quarter. And as somebody mentioned previously on the call we also had a little bit of a reduced tradeshow schedule.
DAVID ROGERS:
Was that comparable to like the same quarter, you know, Q3 a year ago. Were you down or - -
LOU SILVERMAN:
Yes. That was our primary reference point, David.
DAVID ROGERS:
Okay.
LOU SILVERMAN:
Vis-a-vis the prior year.
DAVID ROGERS:
Okay, good. Second thing is I guess I need a little bit more clarification on do you have an estimate of how much of the sales in Q3 this record phenomena that might have been pushed from Q2 to Q3 because of, you know, delays maybe related to 9/11? And how much of Q3's record revenues could be perceived as sort of being obscuring the upward trend?
LOU SILVERMAN:
We did chat a little bit about that earlier on the call, and just to give a little additional texture there, David, it's really hard to peg a particular number. As Pat had mentioned, particularly on the NextGen side, a large percentage of the deals closed in this quarter were in the queue for - - in the funnel for last quarter - - for the September quarter, but in terms of being able to tell you exactly how many would have closed in the prior quarter if it weren't for the national events of that time, it's really difficult to say.
DAVID ROGERS:
Okay.
LOU SILVERMAN:
Specifically, as Pat referenced, we did allude to one particular deal in the quarter that was a little - -
DAVID ROGERS:
Had something to do with financing, right?
LOU SILVERMAN:
In the end after all was said and done it turned out there was a financing issue there, and so that one, as Pat said, wasn't booked then and wasn't booked in this quarter. So, that one went away.
DAVID ROGERS:
Well, just for those of us who were doing modeling, we just wanted to have a little better idea with regard to growth trends.
LOU SILVERMAN:
Yes.
DAVID ROGERS:
Okay. Thanks.
OPERATOR:
Your next question is from Neil Bradsher of Whitehall Asset Management.
NEIL BRADSHER:
That's Whitehall Asset Management. Good quarter, guys.
LOU SILVERMAN:
Thank you.
PAT CLINE:
Thank you.
NEIL BRADSHER:
I wonder, Pat, if you would mind just doing a big more of an overview on where you think the EMR market is at this point in terms of its growth rate and the shift from early adopter into much more mass adoption, what your current expectations are on that? And, you know, whether you think that that represents something that you're beginning to get real visibility on in terms of the potential for accelerated revenues on your part or if it's really still out there floating in the ether?
PAT CLINE:
Well, I would say, Neil, it's somewhere between the two. We are still in an early adopter phase, but as we watch all the analyst reports and surveys and they'll be another one done next week, a lot of folks - - a lot of potential customers are paying attention to clinical systems and saying that their dollars are largely going to be spent on clinical systems. We think the medical record market is beginning or will begin to heat up very shortly. We think there are a lot of drivers. We've talked about HIPAA on prior calls and there's a heck of a lot of interest. But, frankly, we are still in the early adopter phase and I don't have a heck of a lot of visibility as to when we'll come out of that early adopter phase.
I believe we're positioned in the ambulatory practice environment as having the number one electronic medical record offering. And when the market heats up, I think we're well positioned to take advantage of it.
As we successfully deploy the product and can point to more success stories, that's only going to help as well. I'm sorry I can't quantify it any more than that for you.
NEIL BRADSHER:
That is actually very helpful. And my guess is you'll know even more after next week. But, in terms of - - I don't see the stuff, but I'm sure you do - - the people out there who look at these things, the consultants and so forth, what kind of total dollar size do they look and saying the market is right now and what kind of growth rate is it right now?
PAT CLINE:
Frankly, I don't know those numbers off the top of my head, and I have seen two or three conflicting analyst reports. I'm talking to analysts early next week at the HIMSS conference. I think the market is a couple of billion-dollar market in clinical systems, and I think it's about that size today. Some of the analysts agree with that; some say it's much bigger. But, it also depends, Neil, how you draw the fence around it. If you include clinical systems on the inpatient side the market is much, much larger. There's a 35% or 40% saturation in the hospital or the inpatient environment for clinical systems. Once you move to the outpatient side, the market is much smaller, but expected to get quite large.
NEIL BRADSHER:
Okay. That's very helpful. And then just back to Lou - - this subject's been touched on repeatedly, but is it fair to summarize the discussion on the operating margin trends as that you've gotten most of the operating margin improvement that you're going to get as a result of rationalizing the QSI organization and moderating the investment rate at New Gen, and that going forward any incremental operating margin growth will really be driven by revenue leverage?
LOU SILVERMAN:
I would say that's largely true, but I would say that the way we are running our respective divisions is we take great care to look at where we've been and where we're going, and so if we had a significant change in the climate for better for worse in either of our divisions, it would change our internal investment rate, so to speak, to run the businesses differently.
Right now, just to put it in qualitative terms, we're continuing to invest fairly heavily on the NextGen side. That's where our growth has been and that's, at least right now based on our best crystal ball, that's where we see the best growth prospects.
So, for a little more granularity, we are behaving in a similar fashion in our EDI/ Connectivity segment where we see continued strong growth opportunities. We've got to catch them. We've got to prosecute those, but we are investing at least reasonably significantly in that area.
And we have pared back our investment in the QSI Division to be proportionate to the growth prospects that we see in the near term in that division. But, any change in our perception, again, for better or for worse, across any of those three business lines will cause us to fairly significantly change how we are investing in those businesses.
I would also say that we are not engaged in flavor of the month investment strategies. We're not cutting staff in one quarter and adding staff back in the next in a very disorganized fashion. We are trying to be measured and careful on how we approach things, but also very careful to invest where there's growth and where we've proven we can get it.
NEIL BRADSHER:
Okay. Is there kind of a limit on operating margin where you'd feel you'd probably be under investing if the margin gets to a certain number? I think Paul said that your margin number is now the highest in the industry or maybe that was in one of your comments, and is there a number that even if the revenues accelerate you wouldn't want to get above because you'd rather put all the money back into more R&D and more sales?
LOU SILVERMAN:
There probably is a number. I can't tell you that we've gone through the calculations internally to figure out where that cap is, but I would say that my bias is to invest as aggressively as we can afford to invest in our growth areas and still provide a significant and increasing return to our shareholders.
I can tell you that internally there's a large number of people who feel like we're under investing now. Externally, there may be some people who think we're over investing now. So, as you are well aware, it's not a perfect science, but to try to take another angle on your question, I'm not trying to climb to 15 or 17 or 19% from our current 12.5%. I don't have any near term specific targets that I'm going after. We're trying to go quarter by quarter, brick by brick, to invest where we can to make sure that our customers, our staff and our shareholders have a long and vibrant future with us.
NEIL BRADSHER:
It sounds like you're handling the balancing act well to me. Moving on to another subject, I was quite impressed with the DSO and you did cite that earlier. Do you think that you can make any more progress on DSO? DSO has always been an issue in this industry because the nature of their client base and so forth, but do you think there's kind of any more room or have you pulled that down as much as you can?
LOU SILVERMAN:
I'm going to assume that our credit and collections staff is listening on the call, so I will say to them that absolutely we have a lot more progress that we can make. But, more broadly, I would say that I feel like we're pretty close to, and perhaps even a little better than I expected us to, be able to get to. I think that we would do well to hang in where we are plus or minus even two or three DSO days.
I've said on prior calls that 110 seems like a pretty good place to get to based on what I can see and how we're handling our accounting. And I'm tickled to be at 106. I'd love to hold it. I'd love to improve on it, but I don't want to give people an indication that I think we can take another ten days off next quarter. If we do, great, but I think we're at a very, very good and strong place in our collections process right now.
NEIL BRADSHER:
I haven't looked at any industry numbers recently, but my sense is that's not really out of line with the industry numbers. Is that's right or do you have any detail on that?
PAUL HOLT:
No, that's correct. There are several of our competitors that actually have higher DSO's than we do, and there's a few that are a little lower than ours. But, generally speaking, we're not outside of the range in our industry - - a normal range.
NEIL BRADSHER:
Okay. Well, again, good quarter. I would second earlier comments about that's an awfully nice pile of cash. Hope you do something good with it, and good luck to you going forward.
LOU SILVERMAN:
Thanks for your comments, Neil.
OPERATOR:
I would like to take this opportunity to remind everyone if you would like to ask a question, please press the number one on your telephone keypad. Gentlemen, you do have a follow up question from Andrew Shapiro.
LOU SILVERMAN:
Okay, great.
ANDREW SHAPIRO:
Hi, thank you. It's nice to have so many people on the calls. It's better than the old lonely days here. Many of the questions got asked, but I have a few remaining. While we were on the topic of the DSO's, you came out on the call a bit is that a portion of the deferred service revenue number, which is in the liability side, is in the receivables making actually the receivables higher than they might otherwise, you know, be. But, it's offset there in the liability side. Can you give a handle about how much or what portion of the deferred service revenue amount is in the receivable line?
And I also noticed that it dropped as a percentage of sales of this last quarter. I was wondering if that was correlated to related to part of the receivable drop?
PAUL HOLT:
Andy, generally speaking, roughly 60% of the deferred revenue number is related to services, and the balance is related to maintenance. And then of those services, roughly speaking - - now I'm giving you very rough - -
ANDREW SHAPIRO:
That's fine.
PAUL HOLT:
Here, roughly two-thirds of that is sitting in accounts receivable.
ANDREW SHAPIRO:
Okay. So, two-thirds of 60%.
