Electronic medical record (EMR) software provider and Motley Fool Stock Advisor pick Quality Systems
A history of enmity
There's a long history of activist shareholders spurring companies to unlock value, and recent events are no exception. Think of Carl Ichan's efforts to get Blockbuster
At Quality Systems, shareholder activism dates back to 1999 when two dissidents -- Ahmed Hussein (18% owner of the company) and Lawndale Capital (10%) -- forced changes on Quality Systems' formerly insider-controlled board. Former CEO Sheldon Razin, himself owner of more than 20% of the company, was forced to step down, although he remained as co-chairman. The company then implemented strict governance and independence standards and killed its poison-pill plan.
Unfortunately, those concessions did not lead to harmony. The new board tended to divide into Hussein and Razin camps, and internal squabbling and deadlocked votes were the norm. At last September's annual meeting, a new slate of directors was nominated over Hussein's protests and the former directors were swept out by shareholders.
The board was also expanded to nine members, adding CEO Louis Silverman and NextGen division President Patrick Cline -- gentlemen who have worked with Razin for many years.
He said/she said
What's better than an annual proxy? Why, two, of course -- one from Quality Systems and one from Hussein.
The official proxy proposes expelling Hussein from the board, citing disagreement with his public statements. In addition, the proxy makes special mention of Hussein's noncompliance with SEC regulations concerning timely option-grant filings. According to CEO Silverman, the challenges Hussein presents to the company could result in an unknown magnitude of incremental expenses.
In other words, the company seems to want to scare shareholders into believing Hussein will hurt their stock.
Hussein has offered a tit-for-tat response in his proxy. Although he acknowledged his failure to file with the SEC, he claimed it was because historically the company had always handled filing duties for directors. He then states that, "the Board has lost all semblance of independence" and has taken action contrary to the best interests of both the company and its shareholders -- specifically with excessive compensation practices and dilutive options grants.
In other words, Hussein seems to want to scare shareholders into believing the current board under Razin is hurting their stock.
Sorting it all out
Although I don't come down firmly on Hussein's side, all this infighting and its results have me spooked. Originally, the company's definition of an "independent director" excluded any previous employee. It has been changed to exclude only those who have been employed by Quality Systems during the past three years. So Razin is considered an "independent director" even though he founded the company, served as CEO from 1974 to 2000, and owns more than 20% of the shares. Forgive me for thinking that odd.
And then there are the questions concerning executive compensation. According to Hussein's proxy, CEO Silverman, VP Cline, and CFO Paul Holt have been granted raises averaging more than 39%, and have had their potential annual bonuses raised to 100% of their base salary from 50%.
Now, I don't find this particularly galling because the stock has been a stellar performer -- up nearly 700% since 2002 and 500% since Fool co-founder Tom Gardner identified the company for Motley Fool Stock Advisor subscribers. But couple the salary increases with a board that granted 87% of available options in the last year and now seeks 1.2 million more and you've got an individual investor (me) who is wary enough to vote against the current board on item two (seeking approval of the new option plan). If you're a shareholder, I urge you to do the same.
The Foolish bottom line
Tom was right to identify this company as a market-beater more than two years ago because of its defined niche, accelerating sales growth, and strong free cash flow. And the company has had a great run -- helping Tom's Stock Advisor recommendations beat the market by nearly 50 percentage points. Although the company should continue to perform, the shares are largely fully valued now and management's current focus on squabbles instead of on the rapidly growing business makes me a nervous owner.
For more market-beating investment ideas and continuing analysis of those companies, take a 30-day free trial to Motley Fool Stock Advisor . David and Tom Gardner will send you two investment ideas every month, and they are currently beating the market by more than 30 percentage points. Click here to learn more.
Fool contributor Jim Gillies owns shares of Quality Systems but is also short Dec. 2005 $55 calls on those shares. To his knowledge, his health records are still kept in a manila folder.
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