Transcript of the QSI Conference Call
Moderator: Louis Silverman
January 30, 2001
12: 00 pm CT


Operator: Good afternoon. My name is Marianne. And I will be your conference facilitator today. At this time I would like to welcome everyone to the fiscal 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. During this time, if you would like to ask a question, simply press the number 1 on your keypad, and questions will be taken in the order that 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, Marianne. I'd like to welcome everyone to Quality Systems' fiscal third quarter conference call.

On today's call I have here in our corporate headquarters Greg Flynn, Executive VP and General Manager of our QSI division, which includes our dental business, EDI business, and legacy medical systems operations, and Paul Holt, our CFO. Pat Cline, President of our MicroMed division, joins us remotely from our offices in Philadelphia.

Before we begin, let me point out that 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.

The actual results may differ materially from our expectations and projections. And you should refer to our SEC Forms 10K and 10Q for discussions of the risk factors which could impact our actual performance.

Overall, the company's third quarter ended up as a very very solid quarter for the company. As reflected in our release, the company generated $10.3 million in revenues, which was up 17% over the $8.8 million in the year prior and up 7% over the prior quarter of this fiscal year. It's the company's first $10 million quarter and therefore a record that we're real proud of.

Performance in the quarter was driven by strong performance in our MicroMed division, which was up 45% versus the prior year and 22% sequentially, and strong performance in our EDI business sector, which increased 33% over fiscal year 2000's same quarter and 8-1/2% sequentially. Both of those numbers were, again, records for the company.

Net income, also a record, was $966,000. And that was up 103% over the same quarter last year and up 30% sequentially. On an earnings per share basis, 16 cents was double the 8 cents earned in the year prior and up from the 12 cents earned last quarter.

Also, as we reflected in our release, we were active in our stock buy-back. We — that's managed by the company's board of directors. And we repurchased 227,400 shares during the quarter at a total cost of $1.8 million.

Our QSI division had a quarter that was not up to our past levels. Nor was it up to our own internal standards. Revenues were $4.1 million, which was down 9% versus year-prior and 10% versus quarter-prior. Despite that, the division remained quite profitable for us. And Paul Holt will give you some more texture on the divisional splits in his section of the call.

During the quarter we had some very significant infrastructure developments. And those include continued strong progress on the product development front.

Specifically, our Medical Practice Management Suite Version 2.6 moved into QA on schedule. And we're currently in the early stages of our full release of that product. We'll be showing our handheld wireless application for the first time at the HIMSS conference, which will be held in New Orleans in the very part — early part of February.

We piloted during the quarter a number of new product possibilities, let's say, in our EDI sector. And one of those products showed enough promise so that we are going to roll that into our regular product mix on a go-forward basis.

Relatedly, we announced recently one new partnership. That was with NEA. And that particular partnership represents an additional enhancement to our EDI offering.

Continuing on the topic of affiliations and partnerships for a minute, we've made a lot of progress in filling our funnel over the quarter. And we've been very active in looking at a wide range and large number of strategically significant possible opportunities.

This process only started for us corporately in the middle part of November. So I'm feeling real good about the progress we've made so far and happy that we've got one announced affiliation and, again, some very exciting prospects on the table that we're talking to. And hopefully we'll have some exciting news to follow.

During the quarter we finalized a strategy for a modular enhancement of our Dental Practice Management software. And we're well into Phase I of that project. Greg will have some details in his comments on the dental part of our business — the QSI part of our business.

Our NextMD.com and QSINET.com Internet initiatives continue to attract increasing numbers of paying clients. But both remain rather insignificant in terms of revenue or profit contributions for the company at this point in time.

A word on HIPAA, the general consensus here and within our competitors is that HIPAA regulations may help companies in our business. We are currently compliant with many of the known standards. We have a number of the other known compliance items in our current development queues. And as a company we remain committed to be ahead of any and all mandated guidelines.

It's also possible that our industry segment may benefit from some of the other news items that have been out recently regarding opportunities for electronic medical record products and other e-health products to reduce catastrophic events. Again, it's possible that those kinds of movements may help QSI and our competitors as well.

Other initiatives, we've continued the process of shifting resources a bit within the company. Specifically, we've moved one of our product development teams to MicroMed from QSI.

This occurred very late in the December quarter, so it's not in our divisional numbers, but will be next quarter. And the move should help accelerate our product development pace and product development delivery at MicroMed on a go-forward basis.

On the sales front, we've continued to move a number of people from positions without specific revenue-producing responsibilities to positions with specific revenue-producing expectations. And we've already seen some positive returns on some of those moves.

During the quarter and rolling into the early part of the March quarter that we're in currently, we successfully brought on a number of — a couple of individuals as additions to our MicroMed sales team, consistent with our goal to grow that team a bit on a go-forward basis.

Phase I of our new corporate Web site will be live within the next couple of weeks at the outside. And we've begun taking the QSI story out to the investment community more aggressively during the quarter. That will continue on a go-forward basis as well.

One of the interesting byproducts of those efforts has been looking at our competitors across a fairly wide variety of metrics. One of the calculations that I'd like to bring to the attention — to those on the call is a fairly interesting one, revenue per employee.

I'll certainly invite anyone to do their own calculations on that. But our calculations that we generate show that QSI has a 50% to 100% lead on many of our better known competitors.

I'll caution to say that we have not done an exhaustive look at every competitor out there. But, again, we've taken some of our better known ones and are feeling very very good about how we stack up against those folks.

We're also seeing in both the medical community and the investment community that people are becoming increasingly interested in developing relationships with companies who have positive earnings, positive cash flows, companies who have the money and confidence to reinvest in their business, and where the focus can be on building a long term success rather than navigating near term survival. We hope this thinking continues. And then if it does, we think it's a real good thing for QSI.

Overall, the QSI management team looks at this quarter very much like we've looked at the prior quarter, as a continuation of the positive trends of the past several quarters and as confirmation that we've got a lot more that we can do.

At this time, I'll turn things over to Paul Holt for additional comments on our financial statement.

Paul Holt: Greetings to those on the call. I'm quite pleased with our financial performance in the third quarter, with, as Lou mentioned, record-breaking revenues and earnings.

Our revenue growth this quarter was shared equally between new system sales and recurring revenue. Compared to the prior quarter, system sales were up by 9%, and recurring revenues were up 5%. Our total revenue is split 50/50 between recurring types of revenue and new system sales.

As Lou has mentioned, our system sales have been bolstered by strong growth in our MicroMed division, which posted system sales revenue of $4.7 million in the quarter, an increase of 39% from the year-ago quarter and 29% from the prior quarter.

Our recurring-type revenues, which include maintenance and EDI, were bolstered by a combination of growth in EDI services in the QSI division and a growth in maintenance revenue from the MicroMed division.

To give you a texture on each division, as has been mentioned, the MicroMed division reported a total revenue of $6.2 million, which is a 45% increase compared to the prior year and a 22% increase compared to the prior quarter.

Operating income of the MicroMed division totaled just over $1 million, which is an increase of 130% compared to the prior-year quarter and an increase of 63% compared to last quarter.

The QSI division reported revenue of $4.1 million. Operating income for the QSI division came in at $750,000, an increase of 22% from the prior-year quarter. However it is a 23% decrease from last quarter.

Our gross profit margins improved slightly in the quarter at 56.8%, compared to 54.8% last quarter. We've been gaining some benefits from economies of scale with the increase in our system sales.

As a percentage of revenue, our SG&A expense came in just a little over — above the September quarter at 34%, compared to 33.6% in the September quarter. The increase in the SG&A expenses were primarily related to the higher volume of activity that we've seen at the MicroMed division. Overall SG&A expense increased by $257,000 compared to the September quarter.

Okay, I'm going to change gears here and talk about a couple of items on our balance sheet, first off talk about cash. The company generated $1.2 million in cash from operations during the quarter.

However $400,000 of that was invested in capitalized software and equipment, and $1.8 million was used to repurchase our own shares. As a result, our cash and cash equivalents declined to $15.9 million at the end of December, compared to $16.9 million at the end of September.

Our accounts receivable balance came in at $15.9 million as of December 31, as compared to $15.1 million at the end of September. Our days sales outstanding came down to 141 days, compared to 143 days as of September. Although we've made some progress in this area, we are aggressively working to continue to bring down our DSOs.

And now I'd like to turn the call over to Greg Flynn, who will talk about the QSI division.

Greg Flynn: Thank you, Paul. In commenting on the revenue performance, it's a continuation, I think, of the dental industry themes that we discussed last quarter. The consolidator market remains challenged, which impacts of course their purchases in QSI software.

There are a number of positives for this quarter though that I'd like to point out. Lou mentioned the EDI growth that we experienced. Last quarter saw $1.35 million, approximately, in revenues from EDI, up 33% from the prior year's quarter, up 8.6% over the last quarter.

There are a number of new products on the horizon. We mentioned the NEA announcement. There are another — a number of other products we're looking at.

Additionally, we have embarked on Phase I, as mentioned, of our new product development for our dental legacy system. We are actually in the process of moving to new architecture on that product.

In particular, the first phases will see us make alterations to our reporting, improving that, as well as our user interface. We're rolling this out in a modular fashion so that our clients can incrementally over time take advantage of the new offerings.

We've also taken this time period really to focus on building and enhancing the strong relationships that we already have with our existing clients. We've realigned the roles of a number of our staff to really focus on client interaction and retention. And obviously we hope that will translate into further revenues as well.

We've made timely expense reductions here at QSI. If we look in this existing — past quarter we continued the trend toward expense reductions. We expect to see further reductions in the current quarter.

Despite the challenges, certainly the division remains profitable and cash flow positive. As we look to this quarter, we do so with an eye toward building our revenues and maintaining the look at our expenses.

I'll go ahead and turn this over now to Pat Cline, President of our MicroMed division.

Patrick Cline: Thanks, Greg. Hi, everyone. Obviously I'm very proud of the performance that MicroMed turned in last quarter.

During the quarter we executed 15 new contracts, including one, which was the largest contract in our history, with a payer organization covering 1.7 million people. They're rolling out NextGen to a number of clinics that they own. We also signed two contracts, our first two contracts, with the federal government during the quarter.

We signed an agreement also with a hospital that's very well known for their advancements in IT and one of the largest teaching institutions in the country. They intend to roll out NextGen EMR, our medical records system, to around 1500 physicians. Some of these contracts have significant potential for downstream revenues that we're pretty excited about.

As Lou mentioned, we're looking to make a formal announcement related to our progress in the handheld PC and palm arena at the HIMSS conference coming up in early February. That's one of the largest trade shows in our business.

Our pipeline stands at around $20 million, which is down slightly over prior quarters. But that has to do with not as many shows being done through the winter months and is very normal for us. We've got a couple of big shows coming up.

And to close, I like the outlook for the current quarter as our products continue to gain momentum and acceptance in the marketplace. At this point, I think — Lou, are we ready for questions?

Louis Silverman: We are ready for questions.

Patrick Cline: Operator?

Operator: At this time I would like to remind everyone, if you wish to ask a question, please press the number 1 on your telephone keypad.

Your first question comes from (Hun) (Sol).

(Hun) (Sol): Hi. Congratulations on your revenue milestone there. I was just wondering about the revenue breakdown. You have the sales of the systems and the recurring revenues. Do you see that sort of being even say moving forward for the next quarter or two?

Louis Silverman: Certainly we're looking for our recurring revenue stream to maintain and to, hopefully, increase as a result of some of the contracts that we execute — have executed in the past.

And then, you know, clearly the opportunity for us is to grow the new system sales, which we're feeling, particularly on the MicroMed side, very very good about, let's say, the leading indicators.

We're not at a place where we'd give out a lot of specific guidance. But, you know, in terms of the leading indicators — sales funnels, product positioning, market receptivity — we are feeling very optimistic about what our opportunity is to grow the top line on a go-forward basis. So relative to the dental segment, the QSI segment, we remain optimistic that there are some opportunities there.

But I think in the — you know, in the very near term, we're still battling a little bit with some difficulties in the dental sector. So we have — we're focusing a little bit more on the EDI there in the short term, but continue to feel like there are some opportunities for us in the longer term in that segment as well.

(Hun) (Sol): Okay, great. My second question is just about your EDI initiative. And, you know, that seems to be going quite well. And, you know, perhaps you could give me a little more specifics about that. And what differentiates, you know, your systems from competitors' systems?

Louis Silverman: There's a couple of things that I'd say. And then certainly Greg or Pat can feel free to pitch in.

Really we ought to talk about EDI and rename it Connectivity. And just to make it brief, it's connectivity from the offices or desktops of the practices where we have captured some real estate out to payers and patients.

And so the products and services that you can bring to bear there are getting claims information to payers, statements to patients, and any number of other communications devices from the doctor's office out to their patient base.

In terms of differentiating us, we feel like we are bringing a very comprehensive suite of services to the practices that we serve. We feel like we're aggressively — we not only feel like, we are aggressively adding to that suite of services. And it's both the comprehensive and evolving nature of that service suite that we think sets us apart from our competitors.

Greg Flynn: And just to expand slightly on that and give you an example, we really look on the EDI services to be a value-add vendor.

And one of the key ways we can do that is utilizing our practice management software as well in the solution. A simple example, we have the ability to post payments back directly into our software.

(Hun) (Sol): Oh, I see. Okay, great. Okay, that's it for me. Thanks so much then.

Louis Silverman: Thanks.

Greg Flynn: Thank you.

(Hun) (Sol): All right. Bye-bye.

Operator: Your next question comes from Mike (Crawford).

Mike (Crawford): Good morning, guys. Congratulations on a good quarter. The first question is for Pat Cline. Pat, could you give some more color on which payer organization, teaching hospital, and what government entities are buying the products?

Patrick Cline: At this point, I'm not prepared to go into any more detail, Mike, than I have. I think — and I hope to be able to do specific announcements related to some of those contracts in the near future. Many of our contracts carry confidentiality agreements. And we have something in for approval with one of our customer entities at this point.

With respect to our government contracts, I am specifically with one of those prohibited from announcing it. But we're extremely excited about the government opportunities. The contracts that we've signed both involve worldwide deployment of our NextGen EMR technology.

As you might know, the government is the largest employer in the country, employing some two-plus million people, I believe. And they have pretty significant healthcare needs and needed to track healthcare information for all government employees. So again, we're excited about it. And that's one of the ones that I mentioned has solid opportunities for downstream revenue.

Mike (Crawford): So the government contract, Pat, is one that's been signed, but you haven't started to deliver against yet?

Patrick Cline: No. Actually, by coincidence, we have our installers on site today.

Mike (Crawford): Okay. So we might see some revenue from that in this quarter of Q1 — or Q4.

Patrick Cline: Again, I'm not prepared to go into any more detail on that. We have some revenue that we did pick up last quarter. And there are pretty significant opportunities go-forward. I don't want to comment on which...

Mike (Crawford): That's fine. I don't want to get you in trouble.

Patrick Cline: ...specific quarter that it may fall. In fact, it may fall into many quarters.

Mike (Crawford): Okay. One more for you, Pat, could you talk a little bit about the handheld wireless applications at HIMSS?

Patrick Cline: Gee, Mike, I hate to keep telling you I don't want to go into a lot of detail. But this product hasn't been formally announced. We actually will make that announcement at the HIMSS conference.

I did mention on the last analysts' call that we've been working on palm and pocket PC technology for about 2-1/2 years. And we do feel that our solution is going to leapfrog a lot of the existing pocket PC sort of component technologies out there. But you'll need to wait for that detailed release.

Mike (Crawford): Okay. And maybe moving to the dental side — this is for I guess Lou or Greg — what about the clinical product suite? Is that starting to get more legs? Or is that something that the DPMs just can't really afford to buy right now?

Greg Flynn: ...a two-pronged question. We did not any CPS sales for the quarter. We are looking to repackage the product to make it more affordable. We have a number of initiatives underway here to do that.

Right now as it relates to consolidators, to answer the second part of the question, that's not an area that they currently are investing in. We do remain very positive about the product. We, again, think we're early into the market. We think it makes logical sense. We're looking for the right-priced solution to bring to bear to the market.

Mike (Crawford): Okay. What about some integration of some Interdent offices with QSI? Is that proceeding right now?

Greg Flynn: In terms of implementations of the offices?

Mike (Crawford): They acquired some new practices, I believe, in Q3. And I don't think they've been fully integrated yet into their compass.

Greg Flynn: That's correct. We're in the process of working with those offices.

Mike (Crawford): Okay. And then finally for Lou, are you going to give some guidance for Q4 and the next fiscal year?

Louis Silverman: We're not going to be giving out specific guidance that has, you know, specific revenue or earnings per share projections attached to it.

In some ways, I gave the guidance earlier, which is, from looking at the fundamentals of leading indicators for our business, we continue to remain real optimistic about where we are. But, you know, our decision corporately is that we're not going to be giving out specific guidance in advance for the next year or so.

Mike (Crawford): Okay.

Louis Silverman: I apologize for that. I know that makes your job a little bit more difficult. But that's where we are.

Mike (Crawford): Well with the backlog down at MicroMed, albeit before these shows, I mean...

Louis Silverman: We've got, I think — you know, anticipating your question a little bit, clearly our — as Pat mentioned, the backlog is down. It's for a couple of reasons. One is that — or the pipeline is down, let's say.

One of the reasons is that a number of — we had a very good quarter on the MicroMed side. And that — we spit out some of those things to where our pipeline actually showed up in our revenue line. And we like that flow a lot.

The last quarter of the calendar year, as Pat mentioned, is always a little bit slow on the convention front. And so that starts to ramp up right in here. You know, we've got the HIMSS conference in early February. The other big conference — or another big conference is the TEPR conference. I believe that's in May, Pat?

Patrick Cline: Yes, that's correct.

Louis Silverman: And so we're certainly aggressively looking to, you know, be out in the marketplace, expand our pipeline.

And we want to build that pipeline out to as — you know, to be as big as we can, because, you know, given the way the numbers work and the closure rates, the bigger the pipeline and the more people you have selling the better our number is going forward.

So clearly we're committed to continuing to invest in the business, invest in the sales and marketing side of our business, in addition to the product development side of the business, to make sure that we have the right products reaching the right markets. And that's our strategy and philosophy for sure.

Mike (Crawford): Okay. What about your share buy-back? How much do you have remaining on your current authorization?

Louis Silverman: Paul, do you have that number?

Paul Holt: Mike, I don't have that quite ready. But I can tell you we're authorized up to 10% of our shares. And just give me one moment here.

Cumulative to date, we're at 345,000 shares repurchased. We're authorized for approximately 600,000. So we've still go quite a ways to go.

Mike (Crawford): Okay. Thanks, Paul.

Louis Silverman: Thanks, Mike.

Operator: Your next question comes from Andrew (Shapiro).

Andrew (Shapiro): Hi. A few questions, then I'll back off and rejoin the queue and let others ask.

Can you tell me, what are the total shares outstanding at the end of the quarter and also today to give us a handle on any buy-back activity in January and also to know the weighted average shares that you used for your EPS? We can already expect them to come down further in this coming quarter?

Paul Holt: Andy, I can take that question for you. At the end of the quarter, we were at 5,981,000 shares outstanding.

Andrew (Shapiro): Wait, you went to fast. All right, 5, 9, what?

Paul Holt: Five million nine hundred and eighty-one thousand shares outstanding.

Andrew (Shapiro): Eighty-one, ninety-one?

Paul Holt: Five, nine, eight, one.

Andrew (Shapiro): Thank you. And where are you today and what you bought in January?

Paul Holt: Well in January we bought 3500 shares. So take 3500 out of that number, the 5,891,000, and that's where we stand to date.

Andrew (Shapiro): No option exercises that have boosted it?

Paul Holt: No.

Andrew (Shapiro): Okay. So around 5 point — around 6 million, 5.9 million, whatever.

Paul Holt: Correct.

Andrew (Shapiro): Thank you. The next question then is, you spoke of reallocating some sales force people from — into MicroMed. You also spoke of some people in non-sales areas, in dental I think, or maybe in both divisions, and being in more of revenue-generating or revenue-responsible positions.

Lou, you've been on here for I guess — since sometime in August. So it's been a few months now here. Could you provide, just for illustrative purposes, how many sales people you've got on the front today versus how many might have been on the front a few months ago just so we can get a feel for how many more bodies and individuals are being thrown at the war here?

Louis Silverman: Sure. Just to clarify just on your up-front comments, the movement that occurred from QSI to MicroMed was on the product development side, not the sales side.

Andrew (Shapiro): Right. I stand corrected. I just (unintelligible)...

Louis Silverman: ...just to clarify that. On the — in terms of feet on the street, so to speak, our sales force at this point on the MicroMed division is, I'd say, about 12 or 13 at this point, which is up from, I think, about 11 in the prior quarter.

We also have created at least one new profit center, where we have somebody that's out doing some consultative work, trying to create a little bit of new business for ourselves and himself on that side of our business.

We have two additional examples of that here at the QSI division, where we've got, I'd say, approximately 1/2 dozen people selling, which is up a little bit from where we were due to some, I'd say, reallocation of resources.

And then two places in particular where we have people that are — two departments in fact where we have people that have been more in a response mode for customers being more aggressive in their customer outreach and revenue generating. And that's one.

And the second is a place where we are in the process of creating a new profit center for somebody to go out and, again, do some market outreach that should generate some revenues for us. We're also formalizing some additional resources — additional sales resources, FTE in particular, to more aggressively market our EDI initiatives across both divisions.

So again, it's a broad number. I can give you the people that are titled sales reps. I gave you those hard numbers. We also have some people that are growing from — let's say some entrepreneurs who are growing businesses for us. And that expands the number of people that we have trying to generate our revenues considerably.

Andrew (Shapiro): Okay. Now you're — joining about four months ago, you inherited, you came in, and you have certain products that were under development. What you're talking about today sounds like there's a variety of new initiatives.

About what percent of your R&D efforts today would you say are in their final innings and were not in place, let's say, even four months ago? I'm just trying to get a feel for, we'll call it, product pipeline.

Louis Silverman: Pat, do you want to take that for your division?

Patrick Cline: Sure. We're focused from a development standpoint on releasing a number of new Internet-based solutions. These are extensions of some of our current functionalities.

For example, one of our modules serves core management care requirements to enable our users to effectively check eligibility and to manage referrals and authorizations between doctors, and payers, and so on. We're extending that out so it can be operated via the Net.

As we discussed briefly a few minutes ago, we've been working on our pocket PC and handheld-oriented technology for some time. And those things, I would say, are right around the corner from formal release.

And at the same time, we're developing core enhancements to our products. You know about the NextMD portal. We're continuing to evolve that look and feel and bring a number of features to that product beyond just the content that's out there.

And that is as we've discussed previously, the patient-to-physician communications, things like appointment requests and confirmations, bill review, bill payment, and these types of things.

All of the things that I mentioned are finished. And we're rolling them out, obviously, with a careful eye on security and doing some enhancements that are relative to the HIPAA regulations and things to better enable our customers to comply with those regs as the compliance dates come around the corner. So does that give you a feel for things, Andy?

Andrew (Shapiro): Yes, on the medical side. What's going on — or where things have been stagnate, pretty much on the dental side, what's happening there?

Greg Flynn: On the dental side I'll comment on two phases of our business. On the EDI side we have a number of new products scheduled to be released over the next 120 days.

We're working on the legacy system product for the first new releases of our Phase I architectural change. To release some of those offerings late March, early April is our target.

Andrew (Shapiro): Okay. Lou, could you expand a little bit further on why the revenue/employee metric, you think, is a more valuable metric than maybe what some other companies have done on the, you know, per-doctor kind of metrics that they've thrown out just so we can get a handle on you guys' internal thinking on this?

Louis Silverman: Sure. A couple of comments, one is that there's a lot of variability in how you define or how people could define users or installed base in the medical market.

We have kind of looked around and have added up some of the claims that are out there. And we've come up with a number that's, you know, roughly, you know, 4X to 5X the number of living breathing doctors that are out there in the US.

And so what we've tried to do, rather than try to figure out, gee, how many people are actually using our software — and, you know, we have certainly some knowledge of who we're selling to and how many desktops, and offices, and operatories (sic) we're installed in — we've tried to look at some of the more business fundamentals.

And so from a revenue — the revenue per employee number, I think, is interesting for a couple of reasons. One, it suggests from a financial management perspective the discipline with which folks run the company.

The second, it I think is informally a measure of how much of your product you're actually selling versus giving away. If you're giving away a lot of product, you need to have — you don't get any revenue for that. But you still need employees to support the installed base and quotes that you have.

And so I can't say it's necessarily a perfect measure or the only measure that you use. But we find it to be a very effective measure, again, for both the financial management and looking at really what's going on in terms of are your customer buying your product or are they simply using something that was given to them for free.

Andrew (Shapiro): So...

Louis Silverman: So again, it's not the only metric that we use to run our business. But it's a relatively new one that we've been using. And we think it tells a very very good and important story about what we're working on here at QSI.

Andrew (Shapiro): Well that explanation is helpful. I see your revenues. Could you give me the employee number to use for that metric?

Louis Silverman: Yes. You can use roughly around 215.

Andrew (Shapiro): Two fifteen, okay. We'll want to check with that on a progressive basis. I'll back off. I have some more questions, so please come back to us.

Louis Silverman: Okay. Thanks again, Andy.

Operator: Your next question comes from (Carlo) (Canal).

(Carlo) (Canal): Hi. A macro question and a micro question, the macro question is, are you finding your observations on your customers, the consolidators in the dental area, that their business is getting less worse, more worse? If you can, comment on that.

And then on the micro question, as it regards the receivables, is this a function of your customer mix? Why — have you ever — could you collect in 90 days? Or is that just impossible for your business?

Greg Flynn: Yes, on the consolidators, I'll give you a general gut feel. I think that's really the type of question. I think their status is relatively unchanged from where it was in the prior quarter. I think they have some work to go maybe to move out of these doldrums that they're in.

Certainly within that industry, I think we might see further consolidation, so less players that will be larger. I don't see it, again, better or worse. It's just kind of status-quo. And that's a gut reaction.

Louis Silverman: On the AR side — this is Lou — I think it's a combination of a whole bunch of factors. Certainly we push to get as aggressive of payment terms as we can.

We've realigned some of our internal incentive systems to make sure that the people that are out there selling and executing our deals are doing what they need to do so that we can collect our money in as timely a fashion as we can.

I think that — and clearly, you know, as Paul noted, our DSO number has moved down slightly from the prior quarter. We feel like we do have, you know, continued work to do to get the number down further.

And, you know, we've added some resources. We've changed-out some resources internally in that function. Again, we're doing some better things from a process perspective to help bring that number down.

And, you know, over time we are looking for that number to reduce significantly. It's not going to happen overnight. But it is our absolute goal to have that number down from where it is.

At the same time, we have — there are — without going into too much detail, there are situations that you run into where you have a significant opportunity to take on a new customer relationship. And sometimes those customer relationships have some particular financial requirements, let's say, or obstacles, or budget years that they're working with, or whatever.

And we try to make pragmatic decisions there that serve the interests of our company well and also, hopefully, bring us, you know, a partner-for-life, so to speak.

So there are times when the deal terms would be that — you know, the customer will have some — throw out some challenges for us. And we try to be able to take those in stride as well and make responsible decisions there.

So it's not a black or white thing. It's a whole quilt of both process, and policy, and perspective. And we're working on all of those fronts. And again, our internal expectation is that our numbers will continue to — the AR number is the only one we want to go down. So we want it to go down.

(Carlo) (Canal): I don't have all the data in front of me. Where were the DSOs say two years ago? Were they also in this range?

Louis Silverman: I don't have those numbers in front of me right now either. I can tell you that we — our DSOs, if you look broadly over a two-year period, I would say, have trended up. And we're looking to have that trend back down.

(Carlo) (Canal): Okay. Thank you.

Operator: Your next question comes from Bill (Haas).

Bill (Haas): Hi, guys. Congratulations on a good quarter. Can you hear me?

Patrick Cline: Yes. Thank you.

Louis Silverman: Thanks, Bill. Yes.

Bill (Haas): Just — most of my questions have been answered. Just a question — back to guidance, Lou, is that a standing policy that you guys are going to have? Or is that something that you're going to take under evaluation? Just so I don't misunderstand it, it sounded to me like you're not going to give any guidance for the rest of next year.

Louis Silverman: I'd say that's our current policy. And I'd say, as with all things relative to how much data we're going to give out to the investment community — you know, and I don't say this in any way to be glib — it's...

Bill (Haas): Sure.

Louis Silverman: ...always under advisement. And we continue to reflect on and discuss what's the right thing to do. So that's kind of a snapshot of where we are today.

I don't want to hint that we're going to change it in the near term. But I also don't want to give anybody the impression that we're locked in to that position in perpetuity.

We continue to evaluate, you know, what we think is the right thing to do. But at this point in time and at this point in time only, we're at a place where we're saying we don't anticipate giving out guidance. But, you know, again, it's not etched in concrete or perpetuity.

Bill (Haas): Good enough. Just one last question, on the recurring versus new going forward for 2000, if you guys have a revenue number in mind, what would you say that you have sold in already? And how much of that new business would you be after? Is it still the 50/50?

Louis Silverman: The way I'd like to answer your question is that I think it's dangerous to look on a percentage basis at the split between new and recurring.

I think what we'd like to do actually is have that split — have the percentage of our — and this is going to be an obvious statement — but the percentage of our revenue that's recurring decrease while the hard dollars increase. That means our new sales are going up.

So I think, you know, the way I think about it is to try to look at where we are on a recurring revenue basis and try to make some reasonable projections off of that to say, gee, based on sales that have been brought in and based on, you know, whatever assumptions you want to make, what does that recurring revenue line look like over time?

And then that leaves as the X factor, what do you project as the new sales on a go-forward basis? And then your percentages kind of fall out of that. So my point is, I wouldn't focus too much on the percentages. I'd focus more on the hard dollars and see where the percentages come out.

Bill (Haas): Yes. It's just that, you know, without any pipeline or figures, it's hard to figure out where you might be headed there. And so, you know, I'm just trying to get an idea of what you'd need to close to say even be at a run rate of where you are now for next year. But I guess that's good enough.

Louis Silverman: Thanks, Bill.

Bill (Haas): All right.

Operator: You have a follow-up question from Andrew (Shapiro).

Andrew (Shapiro): Hi. A few follow-ups, Lou, would it be possible — just a suggestion is that — we can't necessarily figure out what percentage recurring revenue is going to be.

And you can't figure out what the revenue is going to be, both from which — because this is a smaller company, and your system sales are fairly lumpy, and they could swing you one way or the other pretty heavily. Because I've been in this company for years.

Can you possibly provide some guidance from the deferred service revenue line item, as well as from the fact that you know kind of what your recurring revenue base is, and say, look, we know for the quarter we've got about this much in recurring revenue, and from a system sales point-of-view, that's a toss-up on a quarter-to-quarter basis? But at least your giving out some guidance.

Louis Silverman: I think I'm going to go back to the answer that I gave to Bill, which is, we'll continue to take — this is very helpful feedback. We'll continue to take it under...

Andrew (Shapiro): Great.

Louis Silverman: ...you know, under advisement. You know, again, I think the requests are real fair.

Andrew (Shapiro): Yes.

Louis Silverman: And we're not — you know, we're just in a little bit of a — I don't know — awkward position, where there's a big appetite for information and...

Andrew (Shapiro): Right.

Louis Silverman: And so we understand that. And certainly I'm happy to, you know, keep it on the list of things that we regularly look at and talk about at the — you know, at the board level and as a management team.

Andrew (Shapiro): Right. Because having been here long before you, I've seen this company have a variety of lumpy quarters. But it's all because of the unknown system sale that gets closed or doesn't close before the quarter.

But your recurring business is now getting to be big enough that that's a decent base that one could rely on. And then the rest of us will — you know, at least it's less for us to guess on.

Louis Silverman: Right.

Andrew (Shapiro): In terms of days sales outstanding, having been here for awhile, when I look back, it looks like about — a few years ago it was about 115 days, versus I think your, you know, 128 or the low one-thirties now. Is the DSOs similar on the medical versus dental side? Has the growth been in both divisions? Or is it just one type of division?

And, you know, (Carlo) asked a question regarding the consolidators. Concurrent with that question, I was wondering if it's a consolidator issue and credit quality issue or if it's on the medical side as that's grown to be a bigger sale thing.

Louis Silverman: Yes, I guess — again, we're going to try to not go into too much granularity on the exact splits in our DSOs by division.

But I can — just to respond to a couple of things that you mentioned, on the consolidator side, we certainly have good relationships with those guys. And we continue to, for, you know, I think fair and obvious reasons, monitor our credit situation with them.

We feel like — you know, we're certainly not without risk, you know, on this side of the business. But I feel like we're in pretty good shape there from a credit management perspective on the dental side of the business.

I think that, again, on a qualitative basis, our DSOs are higher on the MicroMed side than they are on the QSI side of our business. I'm certain of that. And part of that is the fact that that's been where the new sales action has been. And so there's been some movement there based on some of the deals that we've cut over time.

And so, again, there is — they are higher on the MicroMed side than they are on the Quality Systems' side — or the dental side. But we feel like we have opportunities on both sides of our business to improve where we are.

Andrew (Shapiro): Right. But if medical continues to grow at a faster pace than dental, which it has, and has now become a larger piece of the business on a revenue basis, then the consolidated progress one could make is all — is made a little bit more difficult. But it also is DSO growth that's away from the consolidators. It's not the cause of the growth.

Louis Silverman: The consolidators, I would say — to answer your question specifically, generally speaking, the growth in our DSO is not driven by the consolidator — by any issues at the dental consolidator level.

Andrew (Shapiro): Great. In terms of the new products and your dental initiatives, is the strategy and the focus here towards new products to the installed base or new products towards — since you dominate the consolidators already, new products towards, we'll call it a smaller sized client set, which is where the bulk of the fragmented dental market currently exists?

Greg Flynn: Currently our strategy is more focused on new products to our existing base and similar like-clients.

When — however, when we roll out our product, ultimately it will have an ASP orientation as well. It will be Internet-enabled. And we would look to use that as a vehicle to potentially go into the lower end of the market, as we call it.

Andrew (Shapiro): Okay. Lou, the clinical suite and the clinical product is a development product the company had for long time. It's out there. I know the adoption rate has been slow, partially high prices for the overall suite, and you're trying to thin it down or get the costs down here.

When do you make the make-or-break kind of decision with respect to this? Is there a large amount of fixed cost with infrastructure and your people there that are associated with that product?

Louis Silverman: The answer to your first question is, just to put it in some kind of context, I feel like we're looking at, on the outside, six months for kind of a make-or-break, to use your words, decision on that product.

And to reiterate a couple of things that Greg said, the product itself is a good product. The customers I've talked to, the prospects I've talked to all are in lock-step agreement that we have really good functionality and a very compelling product.

Our problem has been one of price. And so the development path, so to speak, here at the QSI division is to see how quickly and how effectively we can reformulate a product that we'd be happy to sell at a price that people would be happy to pay. And so I think that — well I can tell you internally we've given ourselves that kind of timetable to resolve this issue.

And to answer your second question, the team working on that product is not — you know, it's certainly far from 30% of our staff. We have, you know, a modest number of people that are associated with that product. And it's...

Andrew (Shapiro): Yes, right.

Louis Silverman: ...et cetera, et cetera.

Andrew (Shapiro): Now you guys have pretty — you've been pretty conservative about capitalizing software development costs, and thus you've expensed a lot of this through.

If you've expensed a large amount of the development of this stuff through, what prevents the product from being more affordable to the clients than accelerating adoption?

Patrick Cline: It's pretty hardware-intensive, to be straightforward on the answer to the question. It requires a lot of hard work, third party — I don't want to overstate it — but third party software, implementation services.

Andrew (Shapiro): Okay.

Patrick Cline: ...to look at.

Andrew (Shapiro): All right. That explains it then.

If we view your system sales as basically the sale of the razor and the recurring revenues that come from the installed base of razor blades, how soon after a good quarter of system sales, for example, this quarter or other past quarters, how soon before that bump in the system sales then reflect in, shall we say, a steady progression and rise in the razors or recurring sales? Is it three months, six months, or immediate?

Louis Silverman: It's not immediate. And I'd say that you should start looking for that a couple of quarters out. And it should ramp past that.

That's not an exact answer, because all the contract terms are a little bit different and the way we handle this is based on certain bogies relative to implementation, and installation, and things of that nature. So again, generally speaking, two quarters out the ramp starts and continues thereafter.

Andrew (Shapiro): Okay. One last question, then I'll back off and let others in. In terms of your competitive environment, is it still on the larger dental customers where you don't have much competition?

And also where do things stand on the medical side, in particular in the EMR offerings, in terms of a competitive environment, if you're making headway and, shall we say, proving some of the competitors' statements wrong?

Greg Flynn: On the large end of the dental business, we still see limited competition. Dentrix is a player in that arena. However we've not seen, again, in the larger opportunities significant competition there. There are other companies that have, you know, a small installed base in the large arena. But it remains fairly much as it's been, Andy.

Andrew (Shapiro): Yes.

Patrick Cline: On the medical side, Andy — this is Pat — I would say that we're proving the statements of most of our competitors wrong. We continue to do very well against all of our competition. I won't single one out.

But on the medical records side, we are seeing — even more so than practice management, we're seeing many many companies that are very long on hype and very short on substance. And that tends to come out in the competition.

And while you might argue that we're long on the substance and we haven't gotten out there and talked about the company and promoted the company adequately, and while I might agree with a lot of that position, I think you can look forward to us doing a better job in that area.

Andrew (Shapiro): Okay. I'll back off. I might have a few more questions, so come back to us if we're in the queue.

Operator: Your next question comes from Mike (Crawford).

Mike (Crawford): I just wanted to follow-up on the guidance issue. The sense I'm getting is that management might feel a little hamstrung in this regard in that I think you recognize that there's probably no better forum than a conference call such as this to provide some sort of loose expectations for coming periods, but that maybe it's something that the board needs to consider more. Is that — do you think that's a fair statement?

Louis Silverman: I'm not sure I exactly want to characterize it that way, Mike. I think that our management team and the board look at this issue frequently.

And as I said, you know, we — and because we're looking at it frequently, that means that we, you know, take the issue seriously and want to continue to try to do the right things that are representing the company's interests and also to try to help you guys out where we can.

So, you know, I don't want to pin this on any one group or any, you know, one individual. You know, I'd like to just leave it that the company — you know, I've given you a snapshot of where we are today.

We continue to look at it with, again, both the management team and the board working on the topic. And, you know, if our position changes down the road, you guys will be the second to know.

Mike (Crawford): All right. And...

Patrick Cline: I'd like to follow on very quickly. I'd also like to point out that it's not just a matter of policies or procedures internally.

But it's also very often difficult to provide accurate guidance, given that where we are revenue-wise and expense-wise, $100,000 on the top line can swing earnings by a penny. And it's very difficult, since a reasonable percentage of our revenues are new system sales, to predict exactly what quarter things will fall into.

Mike (Crawford): Okay. Thanks, Pat, for that clarification. If I could just come back one more time to whatever work you might be doing for the government, it sounds like the government is moving maybe similarly to some large auto manufactures to try and get portable electronic medical records for employees. Is that correct?

Patrick Cline: I would say that most very large employers are spending a heck of a lot of money on healthcare. And we feel pretty strongly that our solutions and solutions like this can help bring the costs of healthcare down and help large employers to track clinical data and better manage their costs.

I'd say one differentiation is that we're out there seeking out and working with paying customers and not giving millions of dollars worth of warrants away to get business.

Mike (Crawford): All right. Thanks, Pat.

Operator: You have a follow-up question from Andrew (Shapiro).

Andrew (Shapiro): You know, a few — a quarter or two ago, there was a discussion of some substantial cost-cutting that was coming around, offset by, we'll say, growing expenses in the MicroMed side that would fuel faster growth.

And it — you know, your revenues have been growing faster than the expenses. And so, you know, as percent of sales, you know, it's dropping. And your margins have increased.

What I just wanted to get a feel for is, are there any additional cost cuts that were put in place that we have yet to see the results of that are coming here in the March quarter or going forward?

And are they of a meaningful enough nature to be able to describe and that we would know to look for and hold one accountable to in the coming quarters?

Louis Silverman: Andy, this is Lou. On your question, I'd say that we continue the trend of making sure that our costs on the — let's say the non-growing side of our business at this point are well in line. And we're certainly facing a lot of — obviously unlimited opportunities to spend money to support our growth in the growing sectors of our business.

So I think that the trends that you alluded to, I think, are going to continue to be in force, at least through the next quarter, where we will have some cost shifting, if you will.

So I think on a net basis, you know, from my perspective, I think that, you know, we just have those trends continuing. You know, we certainly have done some things on the QSI side to make sure our costs continue to be in line. We also continue to do some things on the MicroMed side to continue to fuel our future growth.

So I think that — you know, all told, I think that — I don't think that the net there is going to — would meet your standard for anything that's so significant that we ought to, you know, talk about it in here.

I think there's some netting that's going on. And, you know, you should also know that we remain very determined to make sure that our revenues do grow materially faster than our expenses across the whole business. And so we watch that, you know, not only daily, it feels like hourly. And we take it very seriously.

Andrew (Shapiro): So we should look for a further reduction or a reduction in the absolute operating costs, but just a reduction as a percent of revenues.

Louis Silverman: It's — I think, generally speaking, that's right. I think that it's — you know, it's a little hard to get to, you know, an absolute declarative statement that expenses will not go down. For example, in this quarter we had some significant expenses related to some of the significant sales that we encountered.

And, you know, hopefully we'll — I'd love to repeat those again in the coming quarters. I'd love to have a number of other significant sales. But it took us some expense to land.

Andrew (Shapiro): Okay.

Louis Silverman: You know, we have trade shows that are in some quarters and not in other quarters. So, you know, it's very much a mix.

Again, I think that we — I'll just leave it that we manage our expenses, or we try to, very carefully. And we want to make sure to the extent that, you know, we have any control at all that revenues grow faster than expenses.

Andrew (Shapiro): Right. Well, I mean, I think your operating margins have gotten to be the highest level I think I've seen in years. And it looks like it's a combination of gross margin as well as finally size getting to possibly provide economies of scale on your operating costs.

So in terms of your gross margin bump this quarter, which was about 200 basis points, it looks like, from last quarter, is that primarily a function of more software? Or was there any particular trend that has fueled that?

Louis Silverman: Andy, a part of that is some of the economies of scale that you're talking about. As our systems sales revenue was higher this quarter, we didn't see that same increase in our — the costs relative to, for example, the people that we have out there installing these systems. So you see a little bit of that.

I don't think I saw a real big change in the mix between software and hardware in this quarter. I think we had a little bit more software than we had. So you're seeing some of that. And you're also seeing some economies of scale that have come in as a result of the growth in revenue.

Andrew (Shapiro): So installation goes through cost of goods sold?

Louis Silverman: Yes.

Andrew (Shapiro): Okay.

Louis Silverman: And I would say that, you know, just to add on to that, I would agree with Paul that there are, you know, some limited economies of scale that, you know, creep into our numbers.

But I guess I feel compelled to add in that, you know, we are going to — we're at a place where, you know, the more growth we have, the more staff we're going to, you know, need to add to support that growth. So it's not — I just want to caution you, it's not a linear kind of thing.

But we will be adding — if our growth keeps up, we will be adding staff. And, you know, we're not at a place where, you know, for example, we could support double the business with no staff additions. We're not even close to being in that kind of equation. So just to keep it some perspective for everybody...

Andrew (Shapiro): Okay. Thank you. I don't mean to get you out there in excess expectations land.

Louis Silverman: No, no. I appreciate that. I just wanted to provide a little extra context.

Andrew (Shapiro): Paul or Lou — I think this is more of a Paul question — deferred service revenue, what is that? Is that a form of a backlog? Is it mostly regarding recurring revenue? What does it generally relate to?

Louis Silverman: Andy, that's a combination of things. About 40% of that number, generally, is deferred maintenance revenue. That's maintenance that we've billed in advance and can't recognize the revenue until we actually — you know, we actually go through the period.

The rest of that is related to implementation hours, hours that a customer has purchased from us as part of their contract. It also includes interfaces that they've purchased from us that we have not actually performed yet. So I would certainly — you could define that as a type of a backlog.

Andrew (Shapiro): Okay. And it doesn't flow through and become accounts receivable until you move deferred service revenue into revenues, and that's when it flows into accounts receivable?

Louis Silverman: No, actually...

Andrew (Shapiro): Or does it go sooner?

Louis Silverman: No, it's sooner. If it's in deferred revenue, it means it's been billed. And some of it we've been paid for. And some of it we have not yet been paid for. But if it's in deferred revenue, it means it has been — it's been in our AR at some point in time.

Andrew (Shapiro): Okay, great. On the Web site, what is the enhancement? Or what are you doing with that? And when do you think this is going to be again?

Louis Silverman: The delivery date — I said in your opening comments that we're, on the outside, a couple of weeks away.

The enhancements will be an improved look and feel and, I think, an expanded or somewhat expanded investor relations site, some more succinct product descriptions. As I mentioned, it's kind of a Phase I of our Web site.

Again, the major contribution — the major change is going to be just a much better look and feel and some easier navigation for people to find information of interest to them. I'd say those are the basic elements.

Andrew (Shapiro): Okay.

Greg Flynn: It's temporary.

Andrew (Shapiro): And if — last question or comment, if we could, this last quarter it seems like you've made a lot of progress and, you know, you had really good numbers, et cetera.

And until last week, I believe, when you announced the new dental module or dental relationship that you had, I don't think you actually had an alliance or a large customer contract announcement for the entire quarter.

So if we could at least put on record, in this world of regulation FD in particular, if there's a means for which you folks can provide more regular communications of achievements and milestones — I know much of it is customer-authorized or customer-driven — then I think that would be very beneficial.

Louis Silverman: We certainly appreciate your comment. And we certainly agree with it. And we're — and know that we're working to bring that idea to fruition.

Andrew (Shapiro): Great. Thanks a lot.

Operator: At this time there are no further questions.

Louis Silverman: Well thank you, everybody, for joining the call. Thank you for your past and future support, look forward to talking to you next quarter, if not before.

Operator: Thank you for participating in today's conference. You may now disconnect.