Monday, October 19, 2009

Profit from Medical Records Company

Documentation Software Offers Growth Opportunities for Healthcare Providers
Written by Zachary Scheidt, Editor, Taipan's New Growth Investor

One of the biggest challenges that the medical records industry faces is the question of how digital records will actually help the physicians, hospitals or clinics that are being sold to.

Just imagine, you run a tight operation managing a group of six doctors with about a dozen nurses. Your patients have built a relationship with your practice and you are well respected in the community for the quality of service you offer. In order to keep those patients happy (and referring new business), you have to keep costs low. After all, most of the time when you invoice a patient, the insurance company cuts your pay to a fraction of what you should have received in the first place.

But you’re making a monthly profit, and managing to keep your nurses paid and happy and the quality of service a cut above your competition. And then this cocky sales guy walks in and wants you to buy some newfangled software program that puts all the medical records on a computer and gives your patients access to that information so they can take it across the street and share with your competition!

The logical question for any business owner at this point would be, what’s in it for me? Sure, I could clear out that cluttered records room with all the manila folders, but for today, that process still works. And imagine the hassle of training each of my doctors and nurses and the receptionist on the system. What a nightmare!

“Now if you want to talk about how to deal with those damn insurance companies with their seven-page requests for information, THEN I’ll talk to you.”

And that’s exactly where our New Growth Investment comes in. Our newest recommendation, Quality Systems Inc. (QSII:NASDAQ), offers more than just medical records keeping. In fact, the company sells two primary services to medical and dental practices across the U.S.

The first offering is known as “NextGen EPM” or Enterprise Practice Management software, which is essentially a tailored program that helps clinics, hospitals and physician groups monitor and improve the business side of their operations. The software covers issues such as appointment scheduling, referral tracking, a custom report writer, and patient financial management. These are all categories that when handled smoothly, end up directly affecting the bottom line.

The second offering is the “NextGen EMR” or Electronic Medical Records product. From an investor side, this is the area we are most excited about because it offers explosive growth potential. The system allows physicians to automatically create documents and letters, manage prescriptions and clinical images, and provide for patient education. So while the direct relationship to profitability is a little more difficult to see, a good salesperson should be able to explain how this product also leads to healthy profitability for the medical practice.

Quality Systems has a highly trained sales team that understands exactly how to explain that QSII’s products not only offer medical records for the good of individual patients, but their systems apply directly to the profitability of each of their clients. To further drive this point home, the company offers the products separately, but gives a significant discount to medical practices that buy both the Practice Management platform as well as the Electronic Medical Records platform. At this point roughly 75% of clients end up buying products in both categories.

Consecutive Growth Through Acquisitions and Consolidation

It’s quite impressive to see a string of consecutive quarters where the company has grown sales by double-digit percentages like clockwork. Investors are certainly happy with this setup as the stock has increased by roughly 400% over the past five years. And that increase was before medical record keeping was even in the news.

Part of the success in growing Quality Systems is due to a healthy balance between conservative financial discipline, and aggressive deal-making. We have spent plenty of time in the last two issues explaining how healthy companies can become corporate raiders and buy out struggling competitors for pennies on the dollar. I won’t be too redundant on the process today, but suffice it to say that there are unprecedented opportunities today for companies who have been careful to protect their assets and can now spend capital to make some strategic purchases.

QSII has been extremely opportunistic in using its healthy cash balance to buy out two struggling competitors last year. The acquisitions have added to sales growth and helped the company expand into new areas of the country. At the same time, QSII has been able to consolidate many of the redundant back office processes, making the new purchases much more efficient and profitable.

With more than $70 million in cold hard cash, and no debt on the books, you can bet that the company will be active in finding additional opportunities to expand its business. These opportunities could come in the form of hiring a larger sales team to reach out to more customers, or it could swoop in and just buy another existing practice and collect the revenue from this new company.

Guarantee Compliance with New Regulations

As physicians watch the three-ring circus in Washington, there is more uncertainty than ever as to what will be required. For the manager of an orthopedic practice, it might be unclear exactly what standards will be in place next year when it comes to record keeping for regulatory purposes.

That concern has caused many would-be customers to back off and take a “wait and see” attitude. After all, nothing could be worse than investing time and money into a new system and then finding out that it didn’t comply with the new regulations.

Quality Systems has developed a way to get around this uncertainty. Early this spring, the company announced that it would guarantee compliance with new regulations at no extra charge to clients. Since the NextGen product suite is set up as a “Software as a Service” or SaaS program, it is relatively easy for the company to make changes to the entire product suite and have the changes instantly reflected in customer databases. If for some reason QSII is not able to comply with federal standards, customers are entitled to a full refund.

The agreement is bold — and honestly it could mean some costly upgrades for QSII in the next few quarters. But the advantage from making this guarantee is incredible! At this point QSII has become the top dog because its customers don’t have to wait for Washington to get its act together. The brilliant move appears to be paying off as sales increased by 28% in the March quarter and should be even stronger when the company reports in just a week.

Pay Me Now and Pay Me Later

As a business owner (and that’s essentially what we are as investors), there is nothing better than a solid stream of revenue that continues month after month. Sure, there’s something exciting about landing a big contract with a lump sum, but I’d much rather have a dozen clients who continually write me monthly checks.

The management team at QSII feels the same way, and the company has opted to sell its product as a monthly license instead of a stand-alone one-time purchase. The benefits from this approach are twofold.

First, we’re in a tough period to convince any business to make a capital investment. It doesn’t matter whether you can double a company’s business over the next 12 months. If you’re asking for an investment of several thousand dollars, you might as well turn around and walk out. Most medical firms are hunkered down and watching their capital like a hawk.

But if you offer a medical practice an opportunity to become more efficient, and they only have to pay you a few hundred dollars a month — all of a sudden you have an audience. Many of these practices can immediately save enough on back office or administrative expenses to more than offset the price of QSII service.

The second reason this approach works well is because QSII now has a customer for life. Two years from now, QSII continues to accept the monthly payments after pulling in more than if the software had been purchased outright. At the same time, customers are highly unlikely to switch providers because the process would be such a pain.

At this point, 62% of Quality System’s revenue is in the form of recurring payments. The other 38% represents new customers who will quickly fall into that recurring category as they continue to make payments.

From a stockholder’s perspective, this is a beautiful arrangement. We have a steady source of revenue and it’s easy to see how quickly the company can grow as existing customers hold our business steady while the sales team beats a path to new clients.

And new clients are certainly available to court. According to a study by the Coker Group, between 80% and 90% of physician practices and hospital outpatient departments keep records on paper. That’s an incredible opportunity for QSII to capitalize on — and it means significant growth for us as investors.

Getting In on the Action

QSII is currently trading (at the time of writing) in the mid-50s as investors wait for the first quarter earnings report (the company’s fiscal year end is March 31). While analysts expect the company to earn roughly $2 per share this year, the medical reform bill should push that number higher as customers scramble to get their practices in compliance.

Quality Systems is expected to grow by 20%, but again, I think these estimates are a bit conservative given the uncertainty in Washington. The company hasn’t seen a quarter with less than 20% sales growth since the middle of 2007, so I find it hard to believe that at this important juncture, we will see such “typical” growth.

I would expect the company to report earnings north of $3 per share next year. I also think that the company will gain even more respect in the eyes of investors as the medical records industry begins to pick up more business. In short, it wouldn’t surprise me to see the stock trading north of $90 next summer as earnings expand and investors pile in with confidence.

In the meantime, QSII pays a healthy dividend so you actually get to collect money while you wait for the situation to pan out. With a strong balance sheet and healthy cash flow, don’t be surprised to see the dividend increased over the next two quarters.

And finally, there’s the potential for a much larger gain as management uses its cash reserves for acquisitions. If QSII is able to make two big purchases and squeeze significant profit out of each, the $3 per share could be just the beginning. It’s an exciting time to be involved in medical records, and QSII has a significant edge on the competition.

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