Physician groups and hospitals are scrambling to prepare for ICD-10 ahead of its October 2014 go-live date. The shift to the new international standard for cataloging patient health has providers increasingly embracing solutions from health care IT companies like Cerner (NASDAQ: CERN).
ICD-10 and Meaningful Use
ICD-10, with more than 130,000 different codes used to describe illness and injury, is far more complicated than ICD-9, which includes less than 18,000 medical health codes. The ability to share, aggregate and analyze increasingly detailed patient information, referred to as Meaningful Use, is critical to supporting a patient-centered care model.
The incentive to embrace the shift is significant. The HITECH provision in the Affordable Care Act serves as both a carrot and stick to accelerating adoption and use of electronic health records.
Providers implementing and using technology to improve patient outcomes are receiving incentives from the Centers for Medicare and Medicaid, or CMS. Alternatively, CMS will cut payments by 1%-3% for those that fail to demonstrate meaningful use by 2015.
In order to meet those goals, substantial investments are being made to implement IT solutions and train people to use them. All that activity is expected to increase the amount spent on health care IT to $184.5 billion in 2020 from $89.7 billion in 2012.
Cerner's accelerating revenue and profit
Cerner is positioning its hardware, software and consulting solutions as a one-stop shop for health care IT. As a result, Cerner's sales have accelerated as providers have implemented solutions to meet Meaningful Use stage 1 and ahead of Meaningful Use stage 2 next year.
The company estimates its share of client IT spend will grow from 19% last year to between 21%-25% by 2020, leading to compounded sales growth of 10% to 17.4% annually. And the larger installed base is providing the company with a more predictable revenue stream tied to higher margin service, maintenance, and consulting solutions.
Last quarter, $508 million of Cerner's $727.8 million in third-quarter sales came from those businesses, with services sales totaling $342 million, up 23% from a year ago. That led to gross margins of 83.6%, up from 77.9% last year. Operating margins similarly improved, allowing Cerner to post adjusted EPS of $0.35 in the quarter, up 17% from a year ago.
Competitors are battling for business
But Cerner isn't alone in providing systems to collect, exchange, and analyze patient information. Drug distributor McKesson (NYSE:MCK) and Allscripts Healthcare Solutions (NASDAQ:MDRX) are among those public companies competing for spending at institutional providers, such as hospitals. Both McKesson and Allscripts have won solid market share in small and mid-sized accounts, and McKesson's Technology Solutions Group, with $3.4 billion in sales, is the biggest of the three in terms of revenue.
However, McKesson and Allscripts haven't been successful in toppling enthusiasm for Cerner in large institutions, such as hospitals. Despite McKesson rolling out its next generation Paragon system, and Allscripts buying hospital IT provider Eclipsys in 2010, Cerner has continued to gain share and close the gap to the market leader, privately held Epic, in the over 200 bed hospital market. According to industry research firm KLAS, Cerner has narrowed Epic's 5:1 win ratio among hospitals in 2010 to 2:1 in 2012.
The Foolish final take
Cerner has a big opportunity to leverage ICD-10 and Meaningful Use stage 2 and stage 3 in the coming years. But the company's ability to post similarly strong results hinges on staying ahead of competitors Epic, McKesson, and Allscripts. However, with health care shifting toward outcome-based care, the opportunity presented to capture, catalog, and interpret patient health may offer significant long term opportunities for the company and investors.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC, an institutional research firm serving mutual and hedge funds. E.B. Capital's clients may or may not have positions in the stocks mentioned. Todd also owns Gundalow Advisors, LLC, a high net worth advisory focusing on ETF strategies. Gundalow's clients do not own any shares in the companies mentioned. The Motley Fool recommends McKesson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.