NextGen Healthcare Inc (NXGN) 2004 Q2 法說會逐字稿

Good afternoon. My name is Casey and I'll be your conference facilitator today. At this time I would like to welcome everyone to the Quality Systems Second Quarter 2004 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 session. If you would like to ask a question during this time, simply press "*" and then number "1" on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you, I would now like to turn the call over to Mr. Louis Silverman. President and CEO of Quality Systems. Sir, you may begin your conference.

Thank you, Casey and welcome everyone. Participating with me on today's call are Greg Flynn, Executive Vice President and General Manager of our QSI division, Paul Holt our CFO and Pat Cline, President of NextGen Healthcare Information Systems division.

Please note that comments made on this call may include statements that are forward-looking statements within the meaning of the securities laws including without limitation, statements related to anticipated industry trend, the companies plan, products, strategies and projected operating results.

Actual results may differ materially from our expectations and projections and you should refer to our SEC filings including our Forms 10K and 10Q for discussions of the risk factors, management's discussion and analysis and other information that could impact our actual performance. We undertake no obligation to update such projections of forward-looking statements in the future. Please also note the company's past performance is not necessarily indicative of future performance.

For the 13th time in the last 14-quarter, the company achieved record revenue performance. For the quarter, the company also set a new earnings record. First quarter revenues totaled $17.6 million, up 35% over prior year. Fully diluted earnings per share 37 cents per share exceed prior year by 37%. As noted in our press release, the quarter's top and bottom line results were largely driven by strong performance at our NextGen Healthcare Information Systems. The $13.5 million in revenue obtained by the division for the quarter represents an approximate 57% increase on a year-over-year basis. Operating income at NextGen came in 80% ahead of the prior year's total.

Our EDI unit narrowly set a revenue record in at $2 million showed growth of 15% on a year-over-year basis, which incorporated 60% year-over-year growth at the NextGen division and relatively flat year-over-year performance within the QSI Division.

The QSI Division's revenues was $4.2 million were within our historical band. Divisional operating margins rebound nicely from prior quarter's performance and 31% operating margin that the division did turn in contributed nicely to overall company performance.

Corporate expenses were higher in the quarter than the prior two or three quarters. Cash and cash equivalents increased to a record $40.6 million during the quarter up from $39 million in the prior quarter and $29.8 million in the prior year. Head count at quarter end was $293. Which taken with revenues for the quarter generated annualized revenue per employee of $241,000 also a record.

There were no stock repurchases during the quarter. And people should note that the company's repurchase authorization expired on September 24, 2003, it's Date Company's 2003 annual shareholder meeting. We continue to methodically evaluate selected acquisition opportunities the final exist, it's a little less robust than I would like it to be, but time and effort continues to be spent on this each quarter.

At presents the company is not scheduled to participate in any investor conference through the end of the calendar year, however our investor relations group is putting together a calendar for an East coast trip in November, New York City is the current target location. Since our last call the company was named to the Forbes list of 200 best small companies for the third consecutive year.

This year we moved to number 36 from that list, up from 158 in 2001 and number 77 last year. In October, the October 2003 issue of business 2.0 a publication affiliated with Fortune magazine published its list of fast growing technology companies and we're pleased to see QSI coming in at number nine on that list.

Last week I had the opportunity to travel to the NextGen user group meeting this year held in Palm springs, California. The more than 700 attendees at this year's conference was up from 425 just a couple of years ago. Listening to the high energy clients talk about their successes, their perspectives and also their suggestion about what we can do more of and better is an extremely inspirational experience for me and has been each year. I would like to thank all the clients to who attended as well as other clients for their continued support confidence.

In closing remark, my prepared remarks for this morning's call, I would like to point out that the performance for the company during the September quarter as was the case in the June quarter and in particular the performance of the NextGen division for those two quarters exceed our internal expectation.

I want to express my appreciation to each and every member of our team for their contribution to these results and I also want to take a moment and again clearly point out the current and/or prospective investors that while we were extremely pleased with the quarter's performance, there are absolutely guarantees that the company or either of its division will sustain or exceed the level of performance turned in during this quarter in future periods. I'll now turn the call over to Paul Holt our CFO for additional financial picture on the quarter.

Thank you, Lou and thanks all of you who are joining us today. This quarter was continued growth in both systems sales as well as maintenance and other revenues. Systems sales grew to 10 million this quarter that's an increase of 47% over the prior year.

While maintenance and other revenues grew to $7.6 million that's an increase of 23% over the prior year. Our growth and maintenance and other revenue was driven primarily by the continued growth in the NextGen base of installed users, which drove maintenance and other revenue in that division to higher levels.

Our gross profit margins this quarter came in around the middle of our historical range at 57.5% of revenue. As I've often mentioned the primary factor in gross margins is the level of hardware and third party software content including in our systems sales. This was well within our historical band of hardware and third party software content.

SG&A expenses as the percentage of revenue was slightly higher this quarter 27% compared to 26.5% in the prior year. Total SG&A expense increased to 4.8 million in this quarter compared to 3.4 million a year ago. The largest contributor to increase in SG&A expense was an increase in cylinder Lloyd expenses at NextGen as well as higher corporate related expenses.

R&D expense grew 23% compared to the year ago quarter at 1.5 million compared to 1.2. All this increase in R&D was related towards increased investment in the NextGen product line.

Our company's effective income tax rate was roughly unchanged compared to the year ago quarter that's 39.3%. This rate was impacted slightly by the effect of bearing state income tax rate.

Moving over to divisional performance. The NextGen division report its highest ever revenue in operating income numbers $13,452,000 and $3,847,000 respectively. Total operating income of $3,847,000 represent an increase of 80% compared to the prior year. Operating margins of that division were 28.6%. Deal division reported revenue of $4,991,000 and operating income of $1,286,000. This division continues to provide a significant contributions to the profits of the company.

Moving on to the balance sheet, I'm just going to talk are areas I used to talk about which is receivables, preferred revenue and cash. Our DSO this quarter moved up to 110 days compared to 107 last quarters. For those of you who are track this, our DSOs by division are 78 days for the QSI Division and 120 or NextGen. NextGen's DSOs were within the range we've report in the last several quarters while the QSI Division's DSO number was modestly higher.

On a consolidated basis NextGen's share of the accounts receivable has been growing, which has contributed to the slight rise we have in consolidated DSOs. Reflecting the growth and the customer base at NextGen, deferred maintenance and services revenue grew this quarter to 15.1 million compared to 14 million at the start of the quarter.

Quarter end cash as was mentioned equates to $60.57 per share, that compares to $6.33 per share at the start of the quarter. And for those who are track this amortization expense, total amortization expense for the quarter was $357,000 that was 61,000 at QSI and 306,000 at NextGen. Our depreciation expense figures were 41,000 QSI and 173,000 at NextGen.

Our investing activities during the quarters were a follows. 554,000 in capitalized software for NextGen and 73,000 in cap software for QSI. Fixed assets investments were 2,000 for QSI and 167,000 at NextGen. I'd like to thank you all for being on this call, if you're interested in our company. I would like to turn things over to Greg Flynn, Executive Vice President and General Manager of the QSI Division who will provide an update on his division.

Thank you, Paul, and good day to you all. I don't want to belabor the numbers that you've already heard. Revenues for the quarter were approximately $4.2 million. We have a strong operating income component at approximately 31%, up from approximately 26% in the prior quarter and our EDI sales growth to the NextGen client base showed a year-over-year growth of approximately 60%. I'm pleased with the QSI Division contribution to our numbers.

Let me focus on some highlights for the division and the quarter. There were four sales of our CPS product, that's our dental equivalent of the EMR, Electronic Medical Records product to existing and new users of this technology. Our particular note was the joint sale of QSI CPS and the NextGen EPM that's their practice management product to a large progressive community health center.

We view the community health center federally qualified health center market as a strong potential market for QSI and NextGen for such sales because the buyers often have a need for both medical and dental software solutions. We have some interesting opportunities at this time in our current sales pipeline.

The quarter also saw the sale of phase one of the a rollout of our dental practice management software system to a very significant health system. We are beginning implementation of this rollout as we speak. The quarter also saw continued sales of our Enhanced User Interface product.

We term it EUI. Our data base reporting product known as Data Minor and our laser form software product. The quarter also marked the first sale of a new product introduction. Our QSI scan, QSI image capability. This exciting new offer allows users to manage digital images whether they be X-rays interlope or scanned, directly with the QSI practice management system without the need for the full CPS product.

It is a light version of CPS, if you will. We feel that this offering will allow our clients to ease into the full digital office concept by starting with digital imaging and adding the electronic charting, pair yo and other functions at a later time.

With some new opportunity, QSI sales pipeline has grown to 3.9 million. We define our pipeline as sales situations where QSI is in the final three purchase choices and we believe that the sale will occur within 180 days. Our sales staff and level remains unchanged from last quarter.

As always, I would like to thank our shareholders for their support. Further, I would like to congratulate Lou, Paul and Pat on their contributions. It's really fun for me to work with a great team. On a more personal note I would like to thank the QSI division staff for their ongoing efforts.

I've worked shoulder to shoulder with some of these individuals for more than 20 years. Thank you all for your loyalty, contribution and execution on our business goals. Now I'll turn it over to Pat Cline President of our NextGen division.

Thanks. Hello, everyone. Obviously I'm very pleased that NextGen reported its eighth consecutive record quarter. Last quarter we signed 34 agreements, 24 of these were with new customers. Our sales force now numbers 23 people and we look forward to continuing our growth in this area of the company and in other areas of the company.

The company entered the fall trade show season with a couple of meetings behind us. It's been interesting that some of these meetings are reporting that attendance is down but at the NextGen booth we're receiving a record number of leads. I attended one show personally and observed that our booth was full as many competitors are while many competitors booths were relatively empty.

Our sales force -- our sales pipeline, rather, has grown to about $33 million. As Lou mentioned we just had a very successful NextGen user's meeting in Palm Springs with over 2700 people attending and in addition to Lou's observation I mentioned that we showed a number of new product enhancements and reviewed our future product strategy with our customers and we came away knowing that we're on the right track, our strategy was, I would say, overwhelmingly validated.

I'm pleased to announce that once again NextGen just received the highest overall score in the AC group's 2003 mid year report of EMR vendors. So once again, the awards continue. I'll close by saying that I think that 80% year-over-year profit growth is an awesome performance and I would like to thank the entire NextGen team for helping to achieve these results. I think with that, operator, we're ready for questions.

At this time I would like to remind everyone in order to ask a question, please press * and then number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Mike Crawford with B. Riley and Company.

Few quick questions. Pat, you said the pipeline is 33 million how does that compare with the prior quarter and prior year?

I think, Mike, last quarter as I remember, it was about 31. It may have been 31 or 32, something like that. It's a slight growth. And I don't recall what it was a year ago.

OK. And this, I don't know, it might be for Paul, but maintenance revenues jumped up pretty makable during the quarter. Is there anything behind that? Or is that just consistent with the growing business base?

Yes, Mike. This is Paul. What's included in there are a number of things including maintenance, EDI and other miscellaneous type revenues. So we've got a number of factors going on. I would really attribute it mostly to a larger base of NextGen customers out there. I mean we saw growth in the EDI side, we saw growth in maintenance and we saw growth across the board.

There's no reason to believe that wouldn't continue to be pretty much a step function from your business level a couple of quarters ago?

What do you mean a step function? You mean -

Well, you have your existing business and then whatever time it takes the new business to layer into the maintenance?

There is -- you're talking about follow-on type of revenues?

Right.

Yes, we don't, we're not in the -- I can't really give any forward type guidance out. But just talk about what's happened and we'll allow you to make your own conclusions.

Is the reason you can't give forward guidance is?

Well, we've elected to not give forward guidance, Mike.

Then, Lou, the $89,000 in interest income on $40 million, that's 0.9% return? Am I doing the math right?

You would be pretty close.

Then your return on non-cash assets is closer to 44%. So is there any progress on deploying this capital better or doing something with this? Rather having it sit there earning next to nothing?

There obviously are a range of alternatives that the company has in addressing what to do with the cash, ranging from continuing to evaluate acquisitions which I talked a bit about in my prepared comments. Other things that a company generically, obviously could consider would be things like dividends or any other number of other alternatives.

As I mentioned, we're continuing to look on a methodical basis at acquisitions. I don't want to over promise on that particular front. But we do have our antenna up and eyes open. And as I have reported in several prior calls, the board continues to evaluate its position and the company's options relative to alternatives for deploying that cash. As they deliberate, I would simply observe that having cash is not the worst problem a company could have, but certainly the board is aware of its need to continually evaluate the most appropriate use of that asset.

OK. Thanks. The final question is the board member who quit, was he indeed returned -- re-elected to the board?

Emad Zikry did in fact resign from the board and was in fact re-elected by the shareholders at the September 24th meeting.

OK. Thanks, Lou.

Thanks, Mike.

Our next question comes from Sean Wyland with WR Hamburg

Hello, guys. Can you talk a little bit about some macro level drivers of the NextGen sales both in the quarter and then looking forward now that HIPAA is in our rear view mirror, do you see the landscape changing at all?

I'll start with the last part of your question, no, I really don't see the landscape changing now that as you put it HIPAA is in the rear view mirror. HIPAA, in my opinion, will continue to be a driver over the next couple of quarters, though not quite as big a driver.

As you know, practices got a little bit of a reprieve or as you may know, practices got a little bit of reprieve with certain enforcement delays and things and there still are some practices that are dealing with competitor systems that aren't yet HIPAA compliant.

On the macro level, the medical records business continues to heat up. Still an infant market, still in my opinion an explosive market. There are certain HIPAA drivers associated with the EMR side of the market, but other drivers would include proof of solid return on investments, more and more success stories, government push, various industry group, groups pushing.

There are a lot of drivers pushing the quality pushes on the EMR side. On the practice management side, as you probably know, it's a replacement market. But there are certain drivers, people are moving increasingly from the older legacy systems to newer client server and internet based technologies. And because of our technology and our very feature-rich product and the fact that we have world class EMR taking competitor market share and practice management market as well.

OK. Pat, what was the breakout of the 34 deals of practice management versus EMR sales? And combined deals?

Of the new contracts, there were eight practice management only contracts. There were seven EMR only contracts. And nine combination contracts.

OK. And what's the average deal size for new deals now?

Oh, boy, I would have to have a calculator in front of me to do that one. I'm going to guess that it's probably in that particular quarter, somewhere around a few hundred thousand mark. Maybe Paul can quickly do that math for me on the other end.

Do you see the deal size going up?

It varies so much quarter to quarter, because one quarter we may do close to 50 new contracts and another quarter we may do 25 or 30 new contracts so it swings pretty widely.

Where do you stand on the sales force in NextGen now?

We have 23 people, which is reasonably flat although it continues to be our goal to grow the sales force. We need to do two things. One is keep a focus on making sure that all the sales represents that are out there are productive and that is in essence fire on all cylinders. If we get that to happen, we think great things will happen. And in addition to that, we're going to -- I believe in the current quarter, we're looking to hire two new sales people. You'll have to check me on the next conference call as to whether we were successful or not.

Well, seems to me your guys are firing on all cylinders. So congratulations.

We're doing well, but we still have a couple of sales people that we need to bring along. There's a lot of dry powder there and there's no bad news.

Are there any segments of the market, either, you know, that you think you can do a better job penetrating, or do you think you're pretty well covered, you know, geographically and specialty-wise, do you think you're seeing all the opportunities or do you think you're missing some opportunities?

I think we're missing many opportunities. But we're trying to control our growth, our year-over-year growth has been tremendous, but we don't want to get ahead of ourselves, chasing every market segment and every opportunity that's out there.

There are opportunities for related markets. There are opportunities internationally. There are opportunities additional opportunities within the government, specialties, certain specialties that we're not really attacking. There's more that we could do with respect to marketing. Again, it's an infant market that is I believe just starting to explode. So there are quite a lot of opportunities out there that we can be and hopefully will be pursuing.

OK. All right. Thank you very much.

Your next question comes from Brandon Osten with Sprott Securities.

Hello, good morning, guys. Good quarter. Just some quick questions. First, on the tax rates what would be the right number going forward? Because it kind of bounced around towards the end of next year. Is 39 the steady state now?

Brandon, this is Paul. It's a little difficult to predict that exactly. Because some of that, as you know, we talked, a we do have a couple of factors there. We've got R&D tax credits, but the effect of those can vary depending upon how much income we're reporting. As this quarter we reported also when he a higher amount of pretax income.

And so the effect of that R&D tax credit was slightly lower because we're actually reporting more income. So if our income was to grow in the future, you know, that would reduce some of the impact. So I'm kind of hesitant to try to give out ranges of tax rates, but you know, this past quarter although I wouldn't put -- well, I'm really hesitant to start giving out numbers.

Sure. No problem. But is 39 a roof?

Difficult, a little difficult to say, but as you can see, that is at the higher end of our range. I guess that's -

On the deferred revenues, you guys don't typically do this so I'm not necessarily expecting the answer, but is there any sense of a split between how much of the deferred revenues is maintenance and how much of the deferred revenues are sort of sales that have been done that we have not, you know, had a chance to recognize yet?

Brandon, historically, we haven't given out a breakout of what's in that deferred revenue sheet, but we do talk about it. I can tell you qualitatively that what's in there is maintenance and various service that the company provides that we haven't rendered yet.

Yes, just seems to be going up a little too fast to be maintenance alone at this point.

Right, right. Yes. No it's certainly services have been a big contributor to the growth of what -- of that deferred revenue amount.

OK. In terms of, I think you guys have broken this in the past, but in terms of accounts receivable, how much of that is you guys have some deferred revenues that are in receivable or at least you have in the past.

Yes.

Can you give us sort of a sense of what percentage of accounts receivable haven't actually been billed out yet?

You mean how much of accounts receivable is also in deferred revenue?

Yes.

That is a footnote that we have in our 10Q composition of accounts receivable. Yes, have I that number. Last quarter it was 7,656,000 and 8,632,000 this quarter.

OK. And are those numbers, have those bills gone out at this point? Or are they -- because.

No, those bills have gone out. That's not an un-billed receivable. That's something that we, you know, it's sitting on our receivables because we sent a bill out.

No, I meant because it's in deferred revenue, so it has not been recognized as revenue yet though, right?

Correct.

So in your view the receivable -- these receivables, you've not yet provided the services.

Correct.

They're kind of build out in advance of the services being provided.

Exactly.

On the gross margins again, they seem to be a bit down from last quarter, but still pretty strong, you know, how high can those get to?

Well, you know, the only --my comment on that would be just if you look at the last couple of years you can see that there a band that that margin of --pretty much stays within and that is anywhere between 56 and 60%, it's been a fairly tight band and we're pretty much around the average, maybe a little above the average, but we're not too far away from what we've seen over the last couple of years.

And on the NextGen division and Pat, maybe you can give me some color here, how do you guys feel about sort of the direction of growth in the business right now? Like, you're saying that there are opportunities out there that you're just not able to capitalize because of scope.

You're controlling growth. Is there, I guess, more business than you guys can take on reasonably at this point? So you know there's a sense that you're capable of maintaining, you know, a growth rate over right now, you're over 50%, but over like 40% or over 35% going forward? Like is the business there for you guys to do regardless of whether or not you can execute on it?

We feel very good about the business and very good about the market. And I feel strongly that the market will continue to grow. Again, the question is can we execute and we'll see.

Is the nature of part of the sales cycles calls that you're getting? Or are you guys having to -- is there a push strategy or is there a pull nature to the NextGen division?

We do virtually no cold calling, telephone calling, knocking on doors or those types of things. We generate leads through various mechanisms like shows from time to time we'll do a mailing, magazine advertising.

Internet advertising and based on those types of marketing programs and initiatives leads come to us and we get the sales people to first qualify them and then hopefully follow up on them. From time to time we've had difficulty keeping on top of all the leads that we have. We've had to get on some sales reps from time to time to make sure they actually follow up the leads because they have more leads than they can handle.

And that seems to come and go with different marketing programs and trade show seasons and those kinds of things. But when you have a problem where you have too few sales reps to follow up all the leads that you have, it's a no brainer to, A, grow your sales force, and B, that you're doing something right on the marketing side.

And last quarter you guys gave us a bit of a sense of how much revenues you thought were HIPAA related. It wasn't a big number, but do you have a sense of what the number was this quarter?

No I really don't.

And last question for Paul, the amortization of 357, that's all amortization of capitalize software, right?

Yes.

And then depreciation is all the capital assets, right?

Fixed assets, correct.

OK. Great. Thanks a lot. Good job, guys.

Thank you.

Your next question comes from Gene Manheimer with Ross Capital Partners.

Yes. Congratulations on another great quarter. I had just a couple more questions. The EDI division, can you just repeat the revenues there and the breakout between QSI and NextGen?

Well, Paul is pulling that information together, Gene, I just want to clarify something we have clarified on a number of prior calls, that we talk about the EDI business as a line of business, but the revenues are subsumed into quarter, the divisional revenue totals. So we are happy to break out the contribution that EDI made to each of the divisional revenue totals. Paul will give you that number now.

Great. That would be fine.

OK. Gene. The total consolidated EDI numbers were a million 991, that broke up to a million 339 for QSI and 652,000 for NextGen.

OK. Other question. Operating margins certainly improving now they're solidly in the low 20s. This is the best, looks like the best I've seen for a long time. Would you say this is a trend going forward? Or are you still targeting about 20% operating margins?

As we have pointed out a number of times, Gene, we have scrupulously avoided giving out guidance in hard dollars or percentages. If you look historically, you'll see that as you point out, the 22% and change that we achieved this quarter was similar to what was achieved last quarter and certainly is on the high end of where we've been over the last couple of years. That's how I would look at it.

OK. Thanks. Lou. And then QSI Division looks like it breathes some signs of life this quarter. When previously had been flat on the slight decline. Are you seeing a resurgence in the consolidated market that might lead to renewed growth in the QSI Division?

In my opinion, the consolidated market still remains relatively flat. What I'm seeing is an adoption of our -- of new products within our client base additionally there are some new client opportunities that I would not term consolidaters.

OK. That's great. Thanks again. Great quarter, guys.

Thank you.

Thank you.

Your next question comes from Steve Dalynski (ph) with Copper Arch Capital.

Hello, good afternoon, guys. Can you tell us what the organic growth was in each area of the business?

We don't have any growth, the last acquisition that was done was in 1996 and 1997. So I would term all of our growth organic.

OK. That's helpful. And then in terms of, know you guys don't want to give guidance, but you've been, it looks to me in just sort of, you know, stay with me here for a second, but it looks like you've been putting off about $1.5 million sequentially in revenue per quarter and if you sort of extrapolate that out at the current run rate you get to about a 9% top line growth for next year and analysts are sitting out there with 16% growth and I -and you say you're at the high end of the margin. So I'm just trying to work through and talk through the issues, you know, with respect to those sort of dynamics, you know, and as it relates to guidance.

The addition, the deltas in revenue that you cite would hold up for the last couple of quarters. I would urge you, as you try to model, to go back over a longer period of time you will see some more variability to that, to that line on the income statement.

Are there, I guess what I was looking for, are there qualitative things you can point to that would point to an acceleration, you know, some of the competitors and getting to my next question, some of the competitors out there have -- sort of seemed to stall. Maybe it relates to, you know, sort of your, what you think the organic growth rates are in each market that you compete in? Maybe that would help me get there.

We're a relatively small company in our space. As Pat mentioned, and I think Greg alluded to as well, although it varies by division. There are some opportunities out there for us to go after. At least from where I said the market dynamics are important but not as important as our continued execution.

And our success on a go forward basis is really largely an execution issue and it's -- I know what I hoped for but I'm reluctant to project definitively that we're going to achieve what we hope. So it's -- our status as a small company, at least from my perspective, means the bet on future performance is largely on our ability to execute as opposed to what's going on in the marketplace. Marketplace will help us, but we operate as if we're not going to get much help from the marketplace and simply have to rely on our own resourcefulness and execution to achieve whatever it is we achieve.

OK. And then last question, just and it refers back to a question someone asked earlier, on the AR what is the un-billed portion of that?

I didn't quote an un-billed portion there. All of that discussion is around -- was around items that have already been billed. So I don't want to -- I wouldn't want you to think we've got a bunch of un-billed receivables out there.

Steve Dalynski OK. Are there any unbilled in AR.

No.

OK. Great. Thank you, guys.

Thanks.

Our next question comes from Shy Gerson with Kasara (ph) Capital.

Just sort of a more broad overview kind of question on the EMR market. Can you just kind of give us a flavor as to the size of the market in terms of number of practices, ball park figure that are out there? And then kind of potential dollar value ball park figure of that market?

There are well over 100,000 practices we think that are targets for this technology, these products. I think the market is somewhere around 10 percent saturated. So 90% of those are wide open. I think somewhere in the neighborhood of 500,000 or 550,000 providers.

There are many more providers than that, but that's the group that we think are reasonable targets for this technology. As the market place matures and heats up, pricing on some of this stuff will come down. And the number of sales made over any given period should go way up. It's pretty tough to tell you exactly how that's going to translate as far as dollar value or what the market will do on a per year basis, but I would say the market for clinical information systems is in the billions, not the millions.

OK. Sort of touching on your point, can you talk a little bit about the competitive environment. I know there hasn't been too much out there until now. It sounds like some guys are obviously moving into the space with the potential on how penetrated it is compared to the practice management side. What are you guys seeing on the competitive front?

No real change in the competitive landscape. There are competitors out there, both on the practice management side. There's quite a number of them. And on the EMR side where there are fewer but they're formidable. We do compete for most sales that we make. Typically we'll be in the finals and hopefully we win our share. You've got companies like epic at the high end. GE, sort of at the lower end and a few in the middle. The EMR market. Our sweet spot has been larger practices, 10, 15 doctors and up.

I'm sorry, 10 to 15 doctors and up.

10 to 15 and up.

OK.

We do many that are 50 or 60. Some that are 100. Some that are 400 or 500. Our system is very scalable, designed for large enterprise. Because of that and because of our pricing model, we haven't chosen to really go after the one and two doctor practices, though that will change in the future again as the marketplace matures.

If you can just kind of talk about the cycle, the EMR cycle if we looked at as a baseball game and it was a nine inning game, what inning would you say we're in right now?

Top of the second.

OK. Thank you very much.

Thank you.

Your next question comes from Keith Nay with Lon Dale Capital.

Yes. Good morning. Lou you mentioned that Mr. Zikry recently rejoined the board. Were there any changes to the lead director role or to the committee composition versus what you had in your recently filed proxy?

Keith, the board met yesterday. And discussed those topics. I have not yet been fully debriefed on all of the conclusions that the board drew at that meeting. So I would prefer to get back to you on that on a later call. So I can be 100% certain of anything I'm telling you. I know it was discussed yesterday as you certainly know and others on the call may know, our board of directors does not include members of management.

Right.

On it so again, have I not yet been 100% fully debriefed on that part of the discussion. So I would like to respectfully defer that until a later call.

OK. Then maybe this question would be easier. Because based on what was disclosed in the proxy. As of, I think, March 31st that one of the directors, Mr. Hussein had some objections to the committee composition and other issues. Has he continued to object to his various concerns or is that received it?

To the best my knowledge and the way I would characterize the current situation is that the board is working as a unit to address the committee composition and other elements on a go forward basis. I know of a fair amount of time was spent on the topic yesterday and it is my belief that -- let me say more clearly, it is my opinion that all parties are working together to address the topic that you raise, that of lead director and committee composition.

Understood. Thank you.

Thanks.

Your next question comes from Neil Bradshire with Broad Wood Capital.

I'll add my congratulations on a good quarter. It seems that a lot of people are trying to get a sense of what the growth opportunity is for you going forward and of course you don't provide guidance for reasons you've explained many times in the past.

But I wonder if you know, we can get a better sense of it a couple of ways. One, I would note that if one looks in percentage terms, it seems that there's a lot of stability in the growth and that's actual dragging the corporate average up because each of the businesses is more stable. Also it seems that the operating margin at the QSI Division is stable but the operating margin at NextGen has steadily been rising over time and that's been increasing the corporate average margin. Are those statements all basically true?

I would -- first of all, there are a lot of statements there, Neil. So most of them, I believe, are accurate assessments of the history. I will confess that the first part of your statement, I didn't quite follow and a couple of the other people who are sitting with me didn't either?

I'm sorry about that. Well, let me get to what I was getting to then, which is I think you've been asked earlier and maybe I'll just ask it again about market sizes. And in the past, I think you've actually provided a kind of a current number, for example, for the EMR market and growth rate based on what industry consultants are saying. Do you have numbers like that handy?

No, I don't.

OK.

I've mentioned what I think the size of the market is. Again, it's billions and not millions and I've mentioned roughly -

Yes, that's an eventual potential market, right, Pat?

No, I believe that if everything were added into things today that you'll see that number. Now you would have to move into the acute care side and look at a lot of services and consulting and I would have a hard time breaking out our particular market niche, which is mid range practices, EMR, am what tore only kind of a thing. And I'm just not prepared to do that for you on this call.

OK.

We also have broken out just to take you down memory lane here, Neil, we also have talked about that referenced industry studies that suggest that the practice management market turns over at something around 15% a year.

Right.

With that, I think you've got the accumulated history of industry statistics we've given out on prior calls.

OK. Going back to one other question earlier that relates to this issue also which is the push from HIPAA. Pat, did you say there has been some push from HIPAA and that push declines, you think, going forward? I think I heard you say that, but at the same time you mentioned other pushes. Is that a correct characterization of what you said?

Yes, I think so. I don't think we've done some overwhelming amount of business because of HIPAA. And I don't see that some large amount of our business will go away as more people meet the transaction standards.

So you wouldn't characterize NextGen's growth recently as being primarily HIPAA driven then, if I heard correctly?

That's correct. I would say that without HIPAA, we likely would have posted similar numbers.

I see. OK. Then you list someday other opportunities. One in particular intrigues me. I think you mentioned international, Pat, is that correct?

Yes.

Could you just talk about that a little bit? Because it does strike me that with EMR this industry really for the first time is moving into an area in which there's a lot of international opportunity as opposed to records on the financial side which are much more unique to the U.S. health care system. Can you just talk a little bit about that opportunity and when you might choose to pursue that?

We have been engaging in what I'll call exploratory activity relative to the international markets for approximately a year now. We are keeping our ear on the railroad track so to speak and engaging certain consultants to help us look at opportunities. One side of the coin says you've got a market that is in its infancy and that is huge here in the U.S., you're a small company don't spread yourself thin.

The other side of the coin is if there is a huge market internationally and we think that there is, don't wait until the window closes to get into it. So we're trying to be our normal conservative selves and evaluate and make sure when we make a decision it's the right decision. We're looking at partnership opportunities, which is one thing that I happen to think is viable to take advantage of some of the international markets. I don't see NextGen or QSI opening offices in other countries or hiring full-time people in other countries in the very near term. That's about as close as I can guide you at this point.

And would you agree, Pat, that with EMR, the industry is really moving into new ground in terms of its international capabilities.

Yes.

So that's really a change versus what we've seen before. And then, Lou, you characterize the acquisition situation at the beginning of the call that you're continuing to look and on past calls, I think you've characterized what the issues were in terms of whether or not you're seeing good opportunities whether or not the prices were reasonable. Can you just go through some of those?

Yes, I would, I think you've done it, Neil, those have been the issues and those continue to be the issues and the challenges.

So there's not a lot around and the ones that are, are asking a lot.

Yes, I think that's fair.

OK. Good. Well, I wish to remain. But good luck finding them. I think that covers it. Thank you.

Thank you very much, Neil.

Your next question comes from Fred Toney with Med Cap Partners.

Good morning, guys. A couple of follow-up questions. Could you give us the numbers just comparative numbers for the QSI Division and NextGen sales for the year ago quarter and also for the just the sequentially the June '03 quarter?

Yes, that's no problem, this is Paul, I'm just pulling that information up for you.

Maybe while you're doing that, Pat, do you define your sales pipeline the same way Greg defined it?

No we don't. Our sales pipeline is what our sales force thinks we have a 50% or better shot of closing within the next 120 days.

OK. Who makes that call? The sales person or you?

The sales people and their regional sales managers are responsible for reviewing their accounts and putting them on that list.

50% or better within the next 120 days?

Right. And I'll confess we never quite meet that 50% are better of the ones that are actually on the list actual closing within 120 days. As I've mentioned on prior call, the sales team tends to be overly optimistic. What the pipeline gives you some relatively to the opportunities that fit that criteria as to whether it's growing or shrinking or staying the same. But outside of that it's of little value.

Is it typically like more than 40%.

I would have to go back and do a historical analysis. It's not something I could come up with off the top of my head.

OK. Are you ready for some numbers? I'm going to start with the QSI Division prior year. 4,403,000. Current I'm talking revenues. Current quarter 4,190,000 operating income, 100,137 a year ago 100,286 this quarter. Last quarter for QSI, 4,000,064. And 1,000,064 in operating income. That's QSI. NextGen, year ago, 8,000,591. Operating income 2,000,138. Last quarter, 12,000,242. And 3,000,359 operating income. This quarter, NextGen, 613,452 in revenues an 3847 in operating income. Operator ?

Your next question can you is a follow-up from Neil Bradshire (ph) with Broadwood Capital.

Yes. This a sort of again a complicated numbers question altogether. I I'll try not to jump around too much this time. One of the things that struck me about the margin trends in the quarter is that the operating margin was once again about 22% as it was last quarter which is at the upper end of the range as you said. But that had happen despite the fact that the gross margin was in the middle of the range.

And If I put that together with the trend over time for your operating margins to be driven up by the growth of NextGen as a percentage of total and also by the growth of operating margin at NextGen, then it strikes me that this implies that you allowed the operating expenses, the non-cogs expenses at NextGen to grow at a lower rate than revenues by significant degree. Is that basically correct? And is that strategic? And is there a target margin for NextGen that you're going to just reinvest rather than letting it go above?

Neil, I'd say that there's an assumption in your question when you say we allowed or -

Or intended, perhaps.

I would say that we have tried very hard to let's start with NextGen, reinvest in NextGen on a regular planned measured basis. I think in prior calls we viewed the expression trying to lead with revenues and follow with expenses.

From my perspective what's occurred in the last couple of quarters is that the NextGen revenues have growth faster than we've expected them to grow, which is a pleasant problem to have. And it's creating on a--it's creating a bit of a misperception if you will when you look at expense on a percentage basis. But we have been adding staff virtually across the board at NextGen each quarter.

And we hope to be able to continue to do that as part of reinvesting in the company, be it continuing to look at sales candidates, adding to our development staff, adding to our support and implementation staff et cetera, et cetera.

So we have historically grown our staff, which is our major overhead expense and we hope, we anticipate continuing to do that and hope that continue to hope that revenues will outrun our expense increases. But we're trying to be conservative in what we bite off on the expense side. But that's not to say that we're not reinvesting at all.

No, no, I didn't mean to imply that, but I think the last part of what you just said, do you hope that revenue increases that NextGen would continue to outrun expense increases. Do you mean on a percentage basis?

I would be comfortable just, this is a philosophical as far as the quantitative discussion. I'm not looking for additional margin improvement. Operating margin improvement at NextGen or even at the company. I would be comfortable continuing to reinvest. I think for the company as a whole, the margin that we're incurring is actually pretty good. NextGen is both divisions are better than pretty good from an operating income perspective.

And relative to NextGen specifically, we're not trying to manage the business to get additional margin improvement at the bottom line. Our goal is to increase hard dollar revenue growth, hard dollar profit growth. Keeps the margins at a reasonable range, but we're not aspiring to grow the percentage nor are we particularly focused on that.

OK. Great. That's very helpful. Thank you.

Thanks.

You have a follow-up question from Fred Toney with MedCap Partners.

Hello, guys. Pat, one other area of questions you mentioned epic and G.E. and other competitors in between. Are you seeing anything change from either of those players new product offerings or more competitive or less competitive for them or other competitors?

No. We're not. No real change with either one of them.

OK. In terms of how much HIPAA drives your business or was driving your business, as a manager, how do you really know how much impact HIPAA has had or will continue to have?

Well, the real answer is really don't. You keep your ears open and listen to your sales force and to your customers and I'm a manager that gets personally involved with sales and with many other areas, most other areas of the company.

And I'm out there talking to our prospective customers and you hear that we came to you or called you because our current vendor is either not going to be HIPAA compliant or they're forcing us to go to a particular clearing house at some greater cost than we paid previously and therefore because we're upset about that, we called you. I'm sure there were a couple of those last quarter and probably three or four the quarter before. But there's really no yardstick with which to measure that.

OK. Fair enough. Thanks a lot.

OK.

At this time, gentlemen, there are no further questions.

I would like to thank everyone for their interest and participation. And we'll see you next quarter.

Ladies and gentlemen, this concludes today's teleconference, you may now disconnect.