NextGen Healthcare Inc (NXGN) 2014 Q3 法說會逐字稿

Welcome to Quality Systems, Incorporated, fiscal 2014 third-quarter results conference call. Hosting the call today from Quality Systems is Steve Plochocki, President and Chief Executive Officer. Today's call is being recorded.

(Operator Instructions) It is now my pleasure to in turn the floor over to Steve Plochocki, President and Chief Executive Officer. You may begin.

Thank you, Jackie. Welcome, everyone, to Quality Systems fiscal 2014 third-quarter results call. With me this morning are Paul Holt, our CFO; Dan Morefield, our Chief Operating Officer; Monte Sandler, the Executive Vice President of RCM Services; and Gary Voydanoff, the Executive Vice President of Sales and Marketing.

Please note that the comments made on this call may include statements that are forward-looking within the meaning of securities laws, including, without limitation, statements related to anticipated industry trends; the Company's plans, products, perspective, and strategies, preliminary and projected; and capital equity initiatives to the implementation of potential impacts of legal, regulatory, or accounting principles. I will provide some opening comments and then turn it over to the other members of the team.

While we are disappointed in the performance of late in our hospital services division, we believe in its long-term prospects and, to this end, are investing accordingly. With the impairment now behind us, we are encouraged by cross-selling opportunities, particularly as the demand for revenue cycle services increases in light of the fast-approaching ICD-10 deadlines.

Additionally, we are gaining traction since our acquisition Mirth and its connectivity solutions are paving the way as our healthcare system shifts from fee-for-service to value-based, such as the evolving accountable care organization models. Our breadth and depth make it possible for our clients to succeed in this rapidly changing space.

NextGen Healthcare became one of the first electronic health vendors in the nation to achieve ONC-HIT 2014 Edition Certification as a complete EHR for both ambulatory and inpatient settings. This certification included meeting criteria for both ICD-10 and Meaningful Use Stage 2.

As the healthcare information technology sector continues to evolve and new models arise, we play a key role in helping our clients adapt and keep pace with these aggressive requirements of MU certification and coding changes. This is a promise we have made to our customers and we will continue to keep it.

October 1, the date for ICD-10 compliance, is rapidly approaching. As a result, we have developed ICD-10-compliant Meaningful Use Stage 2 ready solutions and resources to help our clients succeed. Sharing some key educational and testing portions of our ICD-10 transition solutions and knowledge with the industry will help providers move towards successful transition into this modern era of healthcare.

2014 will create tailwinds as healthcare continues to automate and reform. We have RCM, fueled by ICD-10 coding requirements. Our Mirth products are fueled by the movement from fee-for-service to value-based modeling such as ACOs; implementation and training services to upgrade clients to Stage 2; and a replacement market fueled by Stage 2 certification requirements.

Smaller vendors simply don't have the infrastructure to make the investments to progress to Stage 2 or Stage 3. The government has already extended Stage 2 to 2016 and delayed Stage 3 to 2017.

The reason for this is clear. Out of more than 2,200 products the nearly 1,400 complete EHRs that were certified for Stage 1 meaningful use criteria today only 75 products and 21 complete EHRs are certified for Stage 2. We fit in that category.

So we are busily upgrading our clients of Stage 2 and ICD-10 compliance, keeping them well ahead of the game. I will now turn it over to Paul.

Thanks, Steve, and hello, everyone. Let me first make note of a couple of the most significant contributors to this quarter's results, just to give you some context to the numbers that we just reported.

The first was our weaker-than-expected revenue and operating performance coming from our hospital solutions unit, which pursuant to accounting rules required us to perform a review of our long-lived assets for potential impairment. The conclusion of that process resulted in a $26 million non-cash charge related to the impairment of all remaining hospital-related intangible assets, including capitalized software development costs.

$20.1 million of the charge was allocated to cost of revenue, while approximately $5.9 million was included in our SG&A and operating expense lines. While we are disappointed in our near-term results, we remain committed to delivering to our hospital customers as well as improving our operating performance moving forward.

The second significant contributor to this quarter's results was the release of our new ambulatory version 5.8/8.3, which supports new ICD-10 billing codes as well as MU2 requirements. The release of this version resulted in both increased amortization expense as well as significantly reduced capitalization of development costs after the release. Amortization of capitalized software expense, which is included in cost of revenue, grew by approximately $1.4 million on a sequential basis, while capitalization of development costs declined by approximately $4.4 million sequentially.

While both these items have no impact on our cash flows, they do impact our GAAP earnings. The combination of both these changes reduced earnings per share by approximately $0.06 compared to the prior quarter.

And now moving on to my normal discussion around revenue and operating results. Our consolidated revenue this quarter was $108.9 million versus $111.1 million last quarter, with the decline driven primarily by a $2.2 million decline in hospital segment revenue and a $2.8 million decline in implementation and training revenue.

The decline in our hospital segment revenue was driven by both lower sales, as well as reserves for returns and credits. The downturn in implementation service revenue was driven partly by the timing of our user group meeting, holidays, and some segment of customers requiring delays in services pending their own internal preparation for our release of 5.8/8.3, as well as some reduced demand coming from the downturn in system sales.

Partially offsetting these declines was the growth in RCM revenues as well as incremental Mirth-related revenue, which Mirth-related revenue grew to approximately $2.6 million versus $0.6 million just last quarter.

Our total bookings of software and services, including RCM, grew to $41.6 million. That's up from approximately $38.2 million last quarter and $39.6 million a year ago. We are seeing increased bookings related to Mirth products and services, as well as upgrade services for our new version 5.8/8.3 release.

Moving to year-over-year performance, our consolidated December quarter revenue of $108.9 million was down 5% over the prior year, $114.5 million, primarily due to a decline in systems sales of $10 million, or 34%, which is partially mitigated by an increase in services, maintenance, RCM, EDI, and other services revenue of $4.3 million or 5%. Our recurring revenue represented approximately 82% of total revenue compared to 75% a year ago.

Our consolidated gross profit margin this quarter came in at 34.7%, including the impact of the impairment. That's down from the year-ago quarter of 59.3%. Excluding the impact of the impairment, our Q3 fiscal 2014 gross margin was 53.2%.

Our gross margin was down primarily due to the decline in higher-margin software versus prior year as well as a decline in implementation and training profitability tied to a combination of the buildout of resource we performed in anticipation of expected demand for upgrade assistance combined with the near-term slowdown in revenue I referenced earlier.

Our SG&A increased by approximately $1.4 million to $36.9 million in the third quarter compared to $35.5 million a year ago. This increase is driven primarily by salaries, benefits, commissions, and other administrative expenses, as well as a full quarter of Mirth results which was partially offset by a reduction in bad debt expense. The reduction in bad debt expense reflects the impact of heightened focus on working capital management as further evidenced by decline in accounts receivable days outstanding to 106 for the current quarter versus 121 a year ago.

Our R&D expense increased $13.2 million versus $7.8 million a year ago. The increase in net expense reflects a number of factors, including a $2.9 million increase in gross investment in R&D combined with a reduction in capitalized software costs of $2.5 million. The decline in capitalization costs is driven by increased use of developed methodologies, which are not capitalizable under accounting rules, as well as the cessation of capitalization of software development costs in the hospital business due to the impairment.

Our commitment to the continued investment in product development is going to continue and even expand with our Mirth acquisition, which is opening up new opportunities to accelerate our product development efforts. Our effective tax rate for the December quarter was 34.4% compared with 32.9% during the prior-year quarter. The current rate increased mostly due to an increase of state-blended rates and the non-deductibility of certain aspects of our impairment charge.

On a GAAP basis, our fully-diluted earnings per share for our fiscal 2014 third quarter was a loss of $0.21. This compares to earnings of $0.26 which we reported a year ago. Our year-over-year decline in earnings per share was driven primarily by an impairment charge in our hospital unit, lower system sales, as well as increased R&D expenses.

On a non-GAAP basis our fully diluted earnings per share was $0.11 and that is a decline of 62% from the $0.29 we reported a year ago. This was principally driven again by a decline of system sales, increases in R&D expenses, and reduced capitalized software charges.

Our cash and cash equivalents, plus marketable securities, was at $94 million at the end of our December quarter. That's up $9.7 million from $84.3 million at the start of the quarter, primarily due to our outstanding collections performance this quarter which reduced our total accounts receivable by approximately $13.2 million here in the quarter.

I also note that our cash flows from operations grew to $27.7 million this quarter compared to $16.3 million a year ago and deferred revenue grew to $72.7 million. That's up from $66.8 million just last quarter, reflecting in part the impact of the Mirth acquisition.

Again, for those of you who are tracking this, I am going to provide some selected non-cash expenses for the quarter, small list. Total amortization of capitalized software $4.1 million, amortization of intangible assets $2.4 million, total depreciation expense $2.1 million, stock comp expense $0.7 million.

Now investing activities for the quarter -- internally-generated capitalized software $3.6 million and fixed assets $2.8 million.

Finally, I would also like to mention that Quality Systems has announced that its Board of Directors has declared a quarterly cash dividend of $0.175 per share on the Company's outstanding shares of common stock payable to shareholders of record as of March 14, 2014, with an anticipated distribution date of April 4, 2014.

Thank you for your interest in our company. I will now turn things over to Dan Morefield.

Thanks, Paul, and hello, everybody. In November we had a very successful user group meeting in Las Vegas, Nevada, with record attendance of over 4,800 people. To kick off the conference we announced the general release of the NextGen KDM version 8.3, which is a content module that completes the preparation for ICD-10 and Meaningful Use Stage 2 of our ambulatory product.

More than just a regulatory release, the new KDM has new content for many specialties such as cardiology, orthopedics, ophthalmology, and obstetrics, just to name a few. In addition, we also announced our new interoperability platform NextGen share. NextGen share is a platform for delivering cloud services to existing NextGen ambulatory customers.

Features of this service include such things as secure electronic referrals among the participating NextGen clients. NextGen shares the first joint solution utilizing Mirth's tool since we acquired Mirth Corporation in September of last year.

During the last quarter we announced the release of Mirth Connect 3.0 health integration engine. Mirth Connect 3.0 adds hundreds of new features to mirth Connect 2.2, such as the new internal messaging engine that focuses on guaranteed delivery, performance, and configurability.

The Q3 revenue from implementation was below expectations and a number of factors contributed to the quarter-over-quarter decline. These include the remix of work-in-progress tools from larger long-term implementations to small practice implementations and the decline in new business sales during the prior quarters. Additionally, we usually see some fluctuations in demand for services this last quarter due to the holidays.

On a more positive note, we had some of our enterprise clients make significant license purchases during the quarter. This further supports our belief that our client base will be the leaders in the practice consolidation movement and the physician-led ACL models. As we anticipated, coming out of our UGM we started building a strong service revenue pipeline as clients began preparing and engaging in the Meaningful Use 2 and ICD-10 transition plans.

In just a few weeks, between our user group and the end of the quarter, there were bookings of over $3 million in that segment. The sales activity in our service lines continued to build in the early part of January and we are confident that trend will carry forward throughout this year.

Moving on to hospital solutions and some comments on the impairment. The impairment review stems from the operating results of the hospital solutions, which has performed below internal expectations and has experienced the slowing of system sales while the Company continues to significantly invest in customer satisfaction, development, and infrastructure.

Under accounting rules, when indicators of potential impairment are identified companies are required to conduct a review of the carrying amounts of goodwill and other long-lived assets to determine if an impairment exists. Notwithstanding the impairment, the Company has made good progress in working through its backlog on implementations as it helps its clients prepare -- as it helps our clients prepare to attest for Meaningful Use Stage 2 and the effective adoption of ICD-10.

Accordingly, we have begun to reduce the resources in the division as our earlier investments continue to improve customer satisfaction in a more sustainable, scalable manner. As a reminder, in the fall of 2013 NextGen inpatient clinicals version 2.6 became compliant with the ONC 2014 Edition criteria and was certified as a complete electronic health record, a complete EHR, by the Certification Commission of Health Information Technology, an ONC-authorized certification body.

The certification was in accordance with the applicable hospital certification criteria adopted by the Secretary of Health and Human Resources. The ONC 2014 Edition criteria supports both Stage 1 and Stage 2 Meaningful Use Measures required to qualify eligible providers and hospitals for funding under the American Recovery and Reinvestment Act. The certification enhances Quality Systems' competitive position within the healthcare information technology sector.

With that, I'm going to turn the call over to Monty Sandler.

Thanks, Dan. Good morning, everyone. RCM Services revenues for the third quarter was $17.4 million, representing a 7% growth over the prior-year quarter. Operating income was $2.5 million, 19% above prior year.

We remain on record pace for bookings and continue to see strong interest in the market for multiple product sales bundled as part of our recurring revenue RCM service offering. Our backlog of signed deals not implemented is up significantly over last year as our team implements recent bookings. And our RCM pipeline continues to grow as our customers in the overall market learn more about our comprehensive service offering.

Our efforts to expand our RCM services into our small hospital and dental customer markets continue to advance as part of our overall corporate strategy. We continue to work with providers that remain concerned about their financial future as a result of pressures from ACA reforms, the looming implementation of ICD-10, decline in reimbursements and risk contracting. Our tailored RCM services driven by people, process, and technology make us a great solution to help providers position themselves successfully for future healthcare reimbursement models.

Thank you for your time and interest in our company. I will now turn it over to Gary.

Thanks, Monte. Glad to be with you once again. The strategy to adapt our sales and marketing efforts to the ever-changing market continues. The rapidly changing conditions mean that we have to make some course corrections, but it's evident that repositioning ourselves for the RCM market, cross-selling our products into our client base, focusing on the growing population health interest, and beginning to move the Mirth technology into and outside of our base is the right course.

The march towards the ICD-10 and Meaningful Use 2 deadlines continues, which in turn drives our growing RCM and professional services pipeline. While we had a higher percentage of net new sales this quarter, we are confident, as are many of the industry analysts, that the replacement market will build as vendors fail to meet regulatory requirements.

We are excited as we begin the process of spinning up the Mirth sales and marketing efforts. Mirth has grown organically, basically by word of mouth, and now we have the opportunity to really tell their success story. Our sales teams are beginning the training process and the marketing message and the campaigns are ramping up. They are very encouraged by our first full quarter with the Mirth team.

The products are rock solid and we are already seeing interest from our NextGen client base and net new prospects with respect to the Mirth technology stack. Cross-selling Mirth into our client base is in its infancy. When we begin to grow -- and as we expect it to grow in fiscal year 2015 as the sales team is trained and has begun their outreach into the base. Several new opportunities have already been brought to the Mirth team from the NextGen sales team and they are working on joint opportunities now.

We have also begun initial hiring for members of the Mirth outside sales team to actively call on the enterprise healthcare segment. We have also started giving key clients and potential prospects and partners a look at our architecture platform, and the feedback is great. Combined with Mirth technology, the product roadmap is energizing the enterprise clients and client advisory boards partly to shape our future.

Marketing continues to focus on generating new business opportunities for NextGen Healthcare. Year-over-year marketing leads have grown significantly for our core products: RCM Services, ACO Solutions. We have seen 158% growth in leads in Q3 versus the same quarter one year ago. Our investment in this area continues to deliver a healthy return on investment as leads are converted to opportunities in the sales pipeline.

Our strategic messaging demonstrates the value and business results NextGen Solutions will deliver to the healthcare market. The lead generation and cross-selling effort is having a very positive impact on the RCM pipeline. The overall pipeline sits at $153 million, and as we stated last quarter, this now represents the combined ambulatory RCM, Mirth, and dental pipelines.

The drop in our quarter-over-quarter pipeline can be attributed to the drop in the inpatient short-term funnel as the division has been almost exclusively focused on the implementation, account management, and support of our inpatient sales backlog. As always, I would like to mention some of the notable success stories from last quarter. Two contracts in particular stand out as they reflect the growth of our ambulatory enterprise clients, their satisfaction with our software, and the positive impact of our cross-selling efforts.

Virtua, a four-hospital health system based in Marlton, New Jersey, continued to expand their NextGen relationship, signing a significant RCM services agreement. In addition, we signed long-term agreements with Adelante Healthcare and Family Health Center of Boone County. Adventist Health System continues to expand their ambulatory market footprint and signed another large ambulatory license order.

And kudos to the Mirth team for signing notable orders with Quality Health Network, a Colorado-based HIE. This deal, by the way, is a competitive replacement which the Mirth team is seeing as an emerging trend for them.

Accountable Care Associates signed an order for much of the Mirth technology stack; Mirth's Results, Mirth match, Analytics, and Connect. Lastly, the Defense Health Clinical Systems office of the Department of Defense signed a significant license renewal with Mirth.

Finally, the Company executed 100 new arrangements on a consolidated basis versus 104 last quarter. 87% of the new arrangements were greenfield and 13% were replacements. Discounting did not materially change in the quarter and as of 12/30/2013 there are 151 quota-carrying sales and management positions. There was no material increase in the ambulatory staff over Q2.

We look to continue to add headcount to support our expanding Mirth and RCM sales effort. Thank you all for your time and continued interest in our company.

Jackie, I would like to turn it over to you now for questions.

(Operator Instructions) Charles Rhyee, Cowen and Company.

Thanks, guys. You know, I wanted to talk about the inpatient business here. Obviously, one real question is how much of the pipeline last quarter would you have attributed to the hospital business?

And then, secondly, obviously this division has struggled here for some time now and had led you to write off a lot of the value here. Can you kind of sort of give us a sense on what has really gone wrong here for you guys? Why has this not kind of come together better than it has? Thanks.

Charles, this is Dan. First of all, let me respond on your pipeline question. As a general rule, we are not going to break out that level of specificity.

As was earlier stated, it was the bulk of -- the reduction in our pipeline was principally attributed to the decline in pipeline in the hospital solutions group. As far as the hospital solutions as a whole, as was mentioned before, we got out of that gate fast and sold significantly more than we could implement. And so we have been focusing a lot of our efforts on implementation and client satisfaction and investing into our software for those purposes, as well as bringing to market software for a Meaningful Use 2 and ICD-10 compliance.

So this was a market that was -- that continues to be important to us. The one thing that we see at this point is that our investments in that over the last couple quarters are taking hold and we believe that we can start reducing some of those investments as we see the results of our efforts in the past.

Is it right to understand that when you take this charge here, this impairment test of goodwill, is it right to think that you are assuming that this division though is not going to be really contributing much over the near to medium term? Is that the right way to think about it?

Well, I think the acknowledgment that the units -- we have been running operating losses in that unit and that it was a reflection of the investments that we have been making. And so when you are looking at that and you have to assess the value of long-term assets, the accounting rules require that you have to look -- you do look out, you do forecasting, and you have to assess the value and whether or not you need to impair.

So I think the fact that we had to take that charge is just a simple fact that the unit has been very unprofitable here in the near term. And we have to acknowledge that.

Okay, that's fair. And then one last question, Dan.

Obviously, you don't want to breakout the specificity on the pipeline, but can you give us a sense sequentially how maybe the pipeline looked for the ambulatory side of NextGen? Thanks.

Charles, this is Gary. So once again, we are not going to breakout individual parts of the pipeline, but as I mentioned in my statement that we have had very positive RCM growth. And that says the sales team has certainly been repositioning and refocusing their efforts on that services market, which I think you know industrywide is growing very rapidly. So we are very encouraged there.

Great, thank you.

David Larsen, Leerink Swan.

Can you talk about 5.8 and 8.3 product and what sort of incremental value that delivers to your physician customers? Our checks indicate that your product, your legacy product is excellent but it can be a little bit complicated, like a lot of bells and whistles. Can you just sort of talk about that please? Thanks.

Sure, David. This is Gary Voydanoff. I will talk to that one. So what we have been really focused on with 5.8 and 8.3, 8.3 being the clinical side and the components there, is really the user experience and making the system more user-friendly and easier. More based on individual preference setting by the end user so that you can modify it and enhance it to your own taste very quickly and easily.

So the physicians that are working on the product that we work with in concert with our advisory group really liked that type of workflow that we are providing. So we are really looking to add simplicity to the system and that has been the goal. I think we are hitting that mark and our clients have been happy with where we are going.

It's just kind of a logical transition to where we are going in the future with making systems much more easy to use, fundamentally simpler, and, as you know, industrywide the satisfaction by physicians in all the reports is pretty high, so we are really addressing that.

It also fills in some additional gaps, as Dan mentioned, with clinical content. Again, we are fortunate to have a lot of client partners that like to be engaged with us to further deepen and build the clinical content, so it meets today's demands.

There are certainly things in the release that we mentioned around regulatory requirements, ICD-9 -- or ICD-10 in particular. That was very important for us. Continuing to enhance it with respect to tracking and trending measures, clinical performance, and all those things go towards what's going on with Meaningful Use and the entire ACO industry, so I think we are excited with those things.

Another really important component that Dan mentioned was the NextGen share component, and I think it's really important that we made a statement very early on with Mirth that we were going to use the Mirth tools to really benefit our client base and provide connectivity at really no cost in this case. So now we have a huge network of NextGen customers, 80,000 providers that can be connected, that can share information, can share referrals, have mail capability, secure mail and other capabilities that we really haven't seen in the market today. And we are going to continue to leverage and build off of that network, and I can tell you our clients are excited.

Another piece that we released at our UGM was our first patient mobile application, so now we continue to extend our applications out to the patient side now. We think, again, in the long-term that's an area we're going to continue to build on and explore. Certainly opportunities for revenue in that area in the future.

And I think the last thing I would point out with 5.8 and 8.3 was really the drive for quality. Again, we wanted to make sure we had a rocksolid release that was at the highest quality we have delivered. I think we are pretty confident in what we are seeing in the results in the clients that are upgrading right now that it might be one of our best releases that we've ever done. So I think that's how I would characterize 5.8 and 8.3.

Great, and then just one more. The bookings number, I think $41.6 million, does that include RCM and had that number previously included RCM?

No, David, that did not -- previously we did not include RCM, so you are correct, the bookings number that we provided this quarter and going forward will be inclusive of our RCM bookings.

Okay, great. Then for the 5.8 and 8.3, Gary, of the 4,400 group practices that you have as clients how many actually have that new solution, roughly?

David, it's hard to tell right now. I know we are still -- since we just released it in mid-November and then we had holidays where we had not a lot of folks wanting to go through those enhancements and upgrades, so it's really just starting to ramp up now. I think we are at the low end.

Okay, under 5%, right about that?

Sure.

Okay, thank you.

Michael Cherny, ISI Group.

Good morning, guys. Just a couple housekeeping questions, first, and I apologize if I missed this. Do you guys give the full segment breakdown in operating results in terms of revenue and EBIT?

I can provide that. This is Paul. Are you ready?

So ambulatory revenue $83.9 million; RCM revenue $17.4 million; hospital revenue $2.5 million; and gentle $5.1 million. Those are all the revenue statistics.

Next up would be the operating income. Ambulatory $22.6 million; RCM $2.5 million; hospital a loss of $5.0 million; and dental $0.4 million.

Okay. Thanks, Paul, that's helpful. And then just another modeling question.

In terms of the R&D line, the significant new product rollouts you guys have had, you obviously had the step up in expense. How should we think about -- obviously without you guys giving specific guidance -- but the trending of that line. Is this the new normal in terms of what we should expect from expense perspective or will it go back to a more normalized rate like we've seen for the last number of quarters?

This is Paul. So the amortization piece, that is going to become more of a normalized rate. That's not something that going to be moving around a lot. However, on the capitalized software piece, that's a component of exactly what projects are being worked on and so that one I'm not going to suggest any particular guidance there.

But directionally it was -- certainly you saw a pretty big change this quarter, but it would be hard for me to really guide you or direct you there in any particular direction. But clearly whatever change would have to be off of the run -- where we are at today, the run rate that we are at today, if that makes any sense.

Thanks. And then just tying into that, more of a thought process question related to the cost base. You've talked in the past about rightsizing the business, pursuing some restructuring programs given the growth environment. Can you talk may be about some of the specific areas you are targeting? Any results you had and kind of how you are measuring the success of those restructuring programs?

This is Dan. Those were pieces that we talked before and that question has come up in the past on these earnings calls. What we have said is that we are not giving out those specific kind of details, but the other thing we have said is that a purpose for rightsizing the organization is the ability to invest in the higher growth sections of it.

And so we are seeing some of that in research and development.

We've seen a little bit of that in the past in hospital solutions, the catch up there. Certainly we are investing in RCM and we continue to invest into Mirth. So we are not going to provide specifics on that and again that's just a reminder to the group that our purpose for doing that is giving us the capability to invest in other parts of the organization.

Thanks.

Ricky Goldwasser, Morgan Stanley.

This is actually (inaudible) in for Ricky Goldwasser. Thanks for taking our questions.

I guess the November 30 deadline for the transaction combination report on strategic alternatives has come and gone by. Is the committee still pursuing a consideration of strategic alternatives and could you speak to timing of that?

First off, Ricky, the transaction committee is charged with undertaking an objective evaluation of the Company's strategy, direction, and alternative. We do not believe that it is appropriate to comment on internal Board or committee initiatives or strategic deliberations. We do not intend to provide market updates on the status of any such ongoing internal deliberations.

We will, of course, publicly disclose any material events or developments when appropriate and as required by the securities laws. That's a long way of saying that the Board and management are always assessing strategic direction and, quite honestly, we are in the process right now of developing our plans for our upcoming fiscal year. As you know, our fiscal year begins April 1, so this is our normal planning process and more normal planning time.

Thanks, and just a couple of quick questions on just the operating business. We saw the sequential decline in maintenance revenues and were wondering if this reflects any loss of clients on the ambulatory side from hospital consolidation.

And then, secondly, is the increasing demand for SaaS-based solutions, particularly in the ambulatory side? Are you seeing that impact system sales and demand for your products?

This is Paul. I will take the maintenance one and then I think Gary will take the second one. So the issue, the sequential decline in maintenance was strictly around the hospital piece. We had some -- set aside some reserves there and we had some write offs that impacted the maintenance line inside the hospital unit to the tune of about $0.7 million. So if you factor that in, take that into consideration there on the maintenance.

I will turn Gary over to the other.

This is Gary. To speak to the SaaS question, I think that the total number of arrangements we have done has been very consistent and I would say the number of -- the percentages of SaaS arrangements within that have also been fairly consistent. I think what we have certainly had an uptick in as we look at our arrangements is our RCM agreements. No question that our sales team, as I mentioned earlier, we really refocused them and repositioned everything we do around that service side.

So the fact that we have begun now offering clinical and financial services together in a model that just provides dynamite outcomes and results, that's where we are really seeing the market trending and where the uptick or the change has been. Not so much in the SaaS area.

Thank you, I will step back in line.

Jamie Stockton, Wells Fargo.

Good morning, thanks for taking my questions. Gary, maybe just to stick with you for a minute. You guys have talked about leads being up significantly year over year I think for probably five or six quarters.

When you look at the data that you are seeing internally and then you look at system sales not really inflecting yet, how do you reconcile those? Or how do you get a good feel for whether or not that significant growth in leads year over year is ultimately going to translate into a pickup in system sales?

Jamie, what I think is really happening is NextGen, fortunately, is still top of mind with a lot of people. And so all of the things we have been doing in marketing geared around digital marketing have really brought more and more people to our website and to ask us about what's going on with NextGen, tell us about all your different products.

So leads and all of those various contacts that are coming to us are on really a wide, wide variety of topics, everything from population health to what's going on in patient mobile to actually somebody looking for a new system. So the breadth of the products is pretty wide so we get contacts and leads around all of those. Then obviously from there you are going to have some sort of conversion of those into actual opportunities.

But the lead process and the things that we are doing out there to generate and keep NextGen top of mind are really what we have been talking about in terms of leads and it continues to be positive. So that's a good trend. If it was going the other way it would just mean that people are kind of relegating us to the backseat somewhere, but that's not happening.

We are still engaged in new opportunities and people are wanting to know what we are doing. They want to know about 5.8/8.3, population health, what we are doing on the ACO market, and all those things. So I think there's going to be -- it's part of what this market is right now. We still think there's going to be a lot of pent-up demand and opportunities in that replacement area. I think people are doing their homework and they have continued to look at vendors like ourselves.

Okay. Do you think that we should pay more attention to the pipeline number just as a better gauge of potential for inflection of system sales in our next couple of quarters?

You know, that is a good question, but I don't know that the pipeline in terms of where we have been at for RCM and ambulatory as overall remaining steady. I think that just tells us we are staying the course. The market has been what it has been for probably the last three, four quarters.

Okay. Just one more question for you, Gary. The comment that you made about the showing key clients the new architecture, is there any update that you guys can give us on what the timeline looks like for rolling out kind of the integrated inpatient and ambulatory single database web-based solution that you have talked about in the past?

Jamie, this is Dan and I will take a shot at that. We have publicly said on a number of occasions that our intent on the NextGen, the NG 7 platform is that we will have the first product rollout on that on the upcoming fiscal year. That we will announce that relatively early in that year and that that product will be single database, SaaS cloud-enabled. All the component pieces that you referred to.

We are not at this point ready to announce the specific product and the specific submarket it will address, but again that is something we have said in the past and continue to say that our intent is to begin to bring that out in our next fiscal year.

Okay. Then, Dan -- this will be my last question. The implementation and training component of your business I think you said that you are building up some capacity there maybe to deal with ICD-10 and at the same time you got slammed with a little lower utilization during the quarter.

How should we think about it, or how do you think about the target for margins on that business in the long term? Because the gross margin is obviously very negative this quarter. That will be the last question for me.

Sure. Last quarter had two important components in our services line. The first one is we did keep our overall resources relatively high in anticipation of the need of utilizing those resources in the next three or four quarters as our clients upgrade to the next version and get in preparation for ICD-10.

And so we had a combination of, one, it was important to make sure we had the right level of resources trained, ready to go. We are beginning to see significant amount of bookings surrounding that as clients are now paying a lot more attention on the upgrade process for both those reasons.

The other piece, from a margin perspective, is of course there is more fluctuation in the fourth calendar quarter and we saw a little bit of that. So those two pieces combined in the lower margins and those two pieces we would expect to see reversed in the future based upon macro market trends and the upgrading of our client base.

Thank you.

George Hill, Deutsche Bank.

Paul or Steve, just a question. I wanted to make sure I heard you guys right on the pipeline.

It sounds like the pipeline mix is changing from less higher-margin software business to more lower-margin services business. I guess did I hear that right in the change in the pipeline mix? And I guess how should we think about that and how it impacts the long-term outlook for margins?

I will let Gary take this, but -- this is Steve. Obviously, over the years as we have been adding additional products and service lines to the Company we have been adding them and incorporating them into our pipeline. So we do have a broader mix in our pipeline today.

As we indicated earlier, we really don't segment all those pieces out as a policy. We just simply don't do that. Gary, you want to add any color to the pipeline?

Yes, I would to say that, again while that RCM business is certainly growing and we want to continue to grow it rapidly, I will also say that our current clients and many prospects still have a big appetite for license sales. And so even in areas such as, for example, population health; we came out with our first release of population health. We had both a SaaS and a license purchase model and it has been very evident that folks want to lean towards the purchase model, the license model.

So while we -- and even as we get into newer architectures we are going to consider both types of models at all times because I think you have to have a hybrid approach to all of these products. All organizations aren't the same and you can't fit them all into the same box, so I think we will continue to see a nice mix of service growth and licensed growth.

Okay, that's a fair answer that question. I appreciate that. Then maybe just a follow-up question on Mirth.

It seems like Mirth is posting pretty good growth. How should we think about who Mirth is taking share from? And I guess can you give us any stats on what is the current customer penetration of your RCM services as we think about the EMR and EPM footprint?

This is Gary. I will take a stab at both of those. So Mirth has been -- I think we are still trying to get a handle a bit because they are in so many different areas. There's really some exciting stories that I think we will be able to tell.

But you can see right now, or what is kind of evident, that a lot of the interest they are getting is from existing HIEs, health information exchanges, that are out there that have not had a good experience with their initial technology partner. And so Mirth is starting to see replacement opportunity or for those organizations that want to buy the Mirth tools to improve how they are currently servicing their clients, so that's exciting.

You know, as I mentioned, we are starting to cross-sell into NextGen opportunities. We have already seen new prospects from group practices to ACOs that are interested in seeing how Mirth can really help them connect in their community across all systems and that's the advantage that it really brings us. There are a lot of nice things that we see within the Mirth business.

They have been well known for their Mirth Connect product that had an Open Source and a commercial business, and those downloads of those products continue to increase. They have -- their website visits since they have become part of NextGen are way up. Renewal rates are at a high level and their new leads as well are coming way up.

So from the Mirth side of the house they have got a wide variety of products but some very interesting things that are exciting. What was the second part of the question? It was (multiple speakers)

This is Monte. I guess I would just disclose, similar to previous comments, the penetration in the existing ambulatory base remains less than 10% but growing. Keep in mind, not only are we growing inside that base, but we are also competing and growing on net new customers as well. So our growth comes from both areas and we remain focused to serve both segments of the market.

Okay. You talked about taking share. Is there anybody in particular that you guys are seeing as a vulnerable kind of vendor to take share from or is it more the legacy, like the outsourced mom-and-pop types, that are losing share?

I'm sorry, is that referring to Mirth or RCM?

Just referring to Mirth.

Oh, referring to Mirth. I think, without naming names, they are traditional vendors that we are seeing those activities from.

Appreciate the color. Thank you.

Gavin Weiss, JPMorgan.

Thanks for taking my question. I think if I heard you correctly you responded to Dave earlier that only about 5% of customers have upgraded so far or have signed up for upgrades. Is that correct?

This is Dan. We have actually -- we don't actually have the specific numbers, but the one indication that I do remember off the top of my head is we have over 800 of our clients have already certified formally that they are ready for the upgrade and have started the process.

So while I don't have the actual numbers that have completed that, we are seeing the upgrade process basically very much just as we anticipated it and maybe even above the anticipation or happening faster than we had originally anticipated it. So it got off to a little bit of a slow start in late November, but again I think what we are seeing is our clients have done the preparation and the early part of that funnel is very, very strong.

Okay, that's very helpful. And where are you in terms of the expenses related to the buildout of the infrastructure for the upgrade cycle?

The expenses have been incurred. You are talking about the internal expenses associated with those, Gavin?

Yes, exactly.

Yes, so I refer back to my comments earlier about services that we have those expenses baked in. We have trained our staff. We have upgraded and have the personnel and staff necessary to effectively help our clients upgrade. And to do so, both in a great manner for them and a profitable manner for us.

Okay, great. Steve, you mentioned last week that you are interested in growing the RCM segment through M&A. First, do you see any viable opportunities out there right now? And, second, is that really the preference still for quality to build through acquired technology or do you think you can develop some of these technologies in house?

Gavin, our game plan has always been a byproduct of both. We have a large development core that's working on a series of different projects and then, of course, as we have stated repeatedly, our acquisition targets sit in the area of revenue cycle management. We want to expand our capabilities in that area.

Analytics and tools that can help the accountable care organizations progress into more value-based modeling, which we think is going to be a pattern over the next several years. These are two areas that we're looking to expand in, but we also have projects internally.

I think Monte cited on the last call or the previous to last call that we have already developed a bit of an infrastructure to start doing some work in revenue cycle management in the hospital area as well as the dental area. So we are not waiting for the right acquisition; we are progressing. But the right acquisition, if it's there, we are interested.

Okay, great. Thanks for the color.

Richard Close, Avondale Partners.

Yes, thank you for taking the question. Just really quick, obviously hospital solutions has been a disappointment since the multiple of acquisitions that you guys have had. I think on this quarter we are on a run rate for $10 million that's down from I think two fiscal years ago being at roughly $30 million if I'm not mistaken.

So as we think about other acquisitions, either in your pipeline or something like Mirth, how do you convey to the market that you guys I guess are capable of taking these acquisitions and integrating them or growing them after you have completed the transaction?

Richard, this is Dan. Let me respond to you on that. Certainly we are disappointed with the results of our hospital solutions performance and we have been pretty straightforward about that.

On the other side of the coin, we have a history of exceptional performance on acquisitions in this organization going back a number of years. And so as anyone who has been or has done a lot of acquisitions, and I think in my career I've been involved in I think 29 of them now, you don't get 100% success rate on all of them. You look at those places where you didn't get what you thought they were, you were going to get, and you learn from that and you continue to go forward.

But we look at some of our acquisitions we've done in the RCM space and those have been very successful. We look at the early results from Mirth and we think those are very successful. We certainly look at some of the acquisitions that we have done in the ambulatory space going back a number of years to form NextGen and the component pieces and bringing them together and integrating them. Those have been extremely successful.

So I think it's a combination of performance over time. I think we have the skills to be able to do that and, therefore, it remains an important part of our go-forward strategy, as Steve outlined earlier.

Okay, thank you.

Donald Hooker, KeyBanc.

Great, thank you. So I think I picked up $153 million of pipeline. Did you -- like last quarter did you give any detail around like Mirth and dental and other stuff within that, or is that the entire pipeline?

That is the entire -- this is Gary, Donald. So that's the entire pipeline. Last quarter, when we talked about pipeline, we did mention that we were adding in the dental and Mirth. We had mentioned last quarter what those components were and then that going forward we would report the entire pipeline only.

Got you. Okay, thank you. Then following the RCM services segment, doing very well obviously, ahead of ICD-10, is it really ICD-10 that is driving that? And so I guess maybe as we think beyond ICD-10, how might you guys towards the end of this calendar year? Does that change your marketing strategy in RCM?

This is Monte. So, look, I think there are a lot of contributing factors. As they contribute to the growth of RCM, certainly ICD-10 anticipation and preparation is one. You actually -- I think you will see we are working on some marketing strategies in the near term that will continue to drive that.

But it's certainly not the only one. Medicine continues to become more complicated. Providers are forced to adopt new technologies, Meaningful Use guidelines, other regulatory guidelines, and quite honestly, it's just becoming more and more difficult for providers to manage all of these components of their business.

And so with our solution we allow them to simplify their lives, focus on the clinical side of their practice, treating patients, and allow us to focus on our core competency, which is optimizing revenue. So a lot of contributing factors and ICD-10 really is just one of those.

Got you, just one last quick one. I guess nobody had mentioned about some of the changing timelines in Meaningful Use. I was curious if that had -- if you think that might have any sort of extension to your sales cycle in calendar 2014 and 2015.

This is Gary. As of yet I really haven't seen anything in the market per se and the opportunities that we are pursuing on the ground where folks are saying, hey, we are not sure what the timelines are really going to be or how it impacts us. So I would say right now there really hasn't been any kind of meaningful impact.

We think maybe there is some in the hospital sector little bit that has caused some of the delays or maybe a little more tire kicking for a while, but as they try and determine their strategies and where their existing vendor is going to end up in many cases in terms of regulatory and certification. So maybe that's the only place that we've really seen it affect us.

Okay, thank you.

Bret Jones, Oppenheimer.

Good morning, thank you for taking the questions. I wanted to circle back on the cost structure. I know you guys touched on it a little bit and you don't want to go into explicit detail and I can understand that. I just want to understand what is your view of the total cost structure.

Revenues have been down. Costs are continuing to tick up. You are talking about decreasing investments in some areas of the business to redirect that into higher growth areas. On a net basis do you think you are the right cost structure now or should we expect to see some kind of cost savings in the future?

This is Dan. The overall cost structure of the organization; we continue to take a close look at that, especially in our current planning cycle. It's one of the things that we are spending a lot of attention on is understanding how we fund the overall investments on our higher growth areas going forward.

So as we have not provided guidance on this issue and going forward, one of the things that we continue to look at is how do we fund these higher growth margins? We know and we've talked a lot about our next-generation platform and our ability to fund that, so the message is that we will do what is necessary to continue the growth of the organization. And we will also, though, spend a great deal of time making sure that we are optimizing the expense structure to give us the best opportunity to invest in high-growth areas going forward.

To that end, if we think about R&D, you have had significant product launches this year and you've got another one coming up pretty shortly. Do you think that the R&D spending level should actually abate a little bit as we go forward?

This is Paul. No, I would not make that assumption. I think we have a lot of opportunities ahead of us to further build out the next generation in platforms, no pun intended, as well as some of the other areas inside Mirth. And we have just got a lot of opportunities, a lot of things to do, so I would not make that assumption.

I think, as Dan mentioned, I think what we are doing is making sure that we want to spend wisely and appropriately and reviewing the things that are most important. As any good business person should do or good business folks should do is make sure that we are not leaving things on the table, not wasting things that aren't critical to us and making sure that we are putting our resources where -- getting the bang out of the buck for the resources that we are consuming.

Fair enough. I wanted to switch gears on to the RCM business a little bit. We saw a step up in the cost of services there, pretty equivalent actually to the revenue increase quarter over quarter. And I was just wondering is that just a reflection of investments ahead of bringing on some of this backlog or was there a true margin step back this quarter?

This is Monte. Look, I think the shift was marginal at best. We certainly are implementing a large backlog of business so I think that contributes. I think there was also one more payroll day and one less revenue day in the quarter, so that contributes -- but nothing materially changed.

Okay, great. Thank you.

Jeff Garro, William Blair and Company.

Good morning, guys. Thanks for taking the question. I just wanted to ask a couple quick ones on Mirth. First, just as a reminder, which revenue line and which division does Mirth fit in?

This is Paul. So we have Mirth revenue inside the ambulatory line at this point from a segment point of view. And from a revenue category, the majority of -- large majority of Mirth's revenues are in subscriptions and other recurring service revenues at this point.

But Mirth has a broad suite of products and services, so going forward there will be some in some other revenue category lines, including systems sales. But for now a majority of it is in the other recurring service revenue line.

Got it. Then looking at the ambulatory division revenue, it seems that it was down sequentially and then, if we were to back out Mirth, down even further. So I was hoping for a little more discussion on the different strengths and weaknesses you are seeing in that division if we take out the recent acquisition.

If you take out the recent acquisition, as we talked about the biggest side in hitting in systems sales lines, we talked about the implementation and training revenue that we had there as well as a very modest, small decline in the software side. However, that was very modest. It was the majority I would attribute to the implementation and training and revenue line.

Fair enough and then one final question. Are the trends that you are seeing in the ambulatory division any different in the pipeline than what you just described for the revenue line?

This is Gary. I don't think there is -- that pretty much follows. I don't think there's anything different.

Great. Thanks again, guys.

Jackie, we will take one more question please.

Mohan Naidu, Stephens.

Thank you, guys, for squeezing me in. This is Mohan from Stephens. And so one quick question on the small hospital segment. Can you guys talk a little bit about what is going on really in the market itself? Are there any changes? Are there still left a lot of small hospitals who want to buy the EHR products there?

Mohan, this is Dan. What we are seeing in that market is that there is still a good deal of greenfield in that market; a number of small hospitals that have not yet adopted. The biggest thing that we see is that these small hospitals find it difficult to adopt, both from a financial perspective and having the internal IT to be able to support the upgrade and maintain the upgrade.

So the overall market I think we see that there's still some demand in there. We see that a number of the competitors in the environment are taking a look at the timing associated with their Meaningful Use upgrades. But overall we see the market as being very much the same, which is there is still demand out there; however, the overall strength or the financial strength of the market remains pretty weak.

That's one of the reasons that we are continuing to focus on the RCM side and invest a little bit in the RCM side for the small hospital market, because we believe that combining the RCM component will help these small hospitals in their fiscal side of the house in collecting receivables and being more profitable. So that is again why we are looking at bringing RCM into a greater alliance with our overall hospital strategy.

Thanks a lot, Dan. That's great color.

Okay. Well, thank you all for joining us. And just in summary, as we plan for our upcoming fiscal year we find interesting components heading into this new fiscal year. As you know, when the government first outlined Stage 1, 2, and 3 and then ICD-9, -10, and -11 and the movement towards those areas, as you can see we are sitting right in the middle of that as a sector right now.

ICD-10 enacts on October 1. The penalty phase for the stage program begins in 2015. The government has extended Stage 2 to 2016. They've delayed Stage 3 to 2017.

So when you take a look from the beginning of these announcements to where we think we are going to finish up with these stage accelerations and the ICD-9 coding acceleration, we are sitting as a sector right in the middle. And what we see as we head into our new fiscal year is that we here at Quality Systems have some tailwinds that are going to help us out.

One, RCM is clearly going to be fueled, as outlined by Monte, by ICD-10. If that date stays true to October 1, we believe we will see acceleration of that area over the next two to three quarters.

Mirth products will be fueled by the value-based modeling that are emerging in accountable care organizations and I believe we have nearly 600 certified ACOs today. And as you know, we have a large installed base group of physicians and physicians are leading the charge on ACOs.

We also see that we are -- one of the benefits to a company like us is we are early to the party. Our Stage 2 certification and ICD-10 compliance, which we have already achieved, is putting our customers and our client base in an optimal competitive position as they move through this upcoming year.

As I cited earlier, I was talking to you about the statistics, which are overwhelming and I will save them again, is that of the 2,200 products and 1,400 complete EHRs certified for Stage 1 Meaningful Use criteria, only 75 products and 21 complete EHRs are certified for Stage 2 as we sit here in January. That's a fraction of the Stage 1.

So that, again, we believe is going to add -- create a replacement market that will be fueled by perhaps a very large percentage of the Stage 1 certified software products not being capable of meeting Stage 2 or ICD-10. So we see tailwinds heading into our upcoming year; we are encouraged.

We are progressing in the inpatient area. We've got a lot of the bad news in pain behind us in inpatient and we are very confident in our upcoming year.

Again, thank you and we look forward to seeing you in our travels. Take care.

Thank you. This does conclude today's teleconference. If you would like to listen to a replay of today's conference, please dial 800-585-8367 and refer to conference ID number 34711885. A webcast archive of this call can also be found at www.QSII.com.

Please disconnect your lines at this time and have a wonderful day.