Healthcare Trends: Everything You Wanted to Know The Year in Review And Outlook for 2010

of 11 Healthcare Trends: Everything You Wanted to Know The Year in Review And Outlook for 2010 By Ted Stack Last year was a historic year, both for our country and for the healthcare industry. The inauguration of Barack Obama as our 44th President and first African- American President was a time of great hope and promise. Unfortunately, the nation was knee-deep in the worst recession in more than 75 years. As predicted, early on in 2009 the healthcare agenda was put on the back burner while the administration worked on a broader stimulus package to prevent the economy from slipping into a deeper recession. In the third quarter of 2009, Healthcare returned as the number one issue currently being debated in Congress. The impact of the economic recession was, and is, severe. The healthcare industry, often thought to be recession proof, showed that it is in fact vulnerable to the general economic realities of our nation. The good news in all this bad news is that the revenue cycle management and healthcare information technology (HCIT) sectors were far better off then virtually every other sector (see figure 1). Figure 1 Stock Price Performance of Selected Sectors, Last Twelve Months as of October 2009. An unhealthy economy is, no doubt, unhealthy for the healthcare industry. Many economists believe that we are on the road to economic recovery. Wall Street is showing positive signs with the S&P Index at 1,097 as of January 25, 2010, compared to 798 on March 31, 2009, an increase of 37%. However, we believe Main Street is still feeling the pains of the recession, with unemployment reaching an all time high of 10.0% in December 2009, compared to 7.7% in January 2009. One of the biggest factors impacting the healthcare provider markets is the access to both tax-exempt and taxable debt to finance growth and expansion. Many providers were faced with situations where lenders were tightening credit, or even calling credit. The direct impact on the medical billing industry has been the lack of flexible credit to fund both organic and acquisition growth.

of 11 We have seen a dramatic turnaround in hospital operating performance in the second quarter of 2009, with an expected continuation throughout 2010. The median profit margin of U.S. hospitals increased from near zero in the third quarter of 2008 to more than 8% in the second quarter of 2009, according to an analysis of hospital financial performance published by Thomson Reuters. The study claims that economic recovery has been broad-based, with all classes of hospitals small, medium, and large community hospitals; teaching hospitals, and major teaching hospitals showing positive median margins. The Thomson Reuters analysis found that median total operating margins were at 0.37% in the third quarter of 2008. In the second quarter of 2009, all classes of hospitals had positive operating margins, reaching an average of 8.4%. MEDICAL BILLING INDUSTRY TRENDS IN 2009 Through all the economic turmoil, the medical billing industry survived 2009 and, like many industries, is continuing to grow stronger through adoption of new work-flow management and technology tools. I am sure many companies would view 2009 as a year of treading water - lots of movement but not really going anywhere. In light of the economic times, treading water was much more attractive than the alternative: sinking. In evaluating the past year, several areas come to mind that are worthy of discussion. Before getting to the trends that are shaping the industry, let s take the time to stop and consider the definition of the broader physician revenue cycle industry. We are often asked to comment on the size of the physician revenue cycle market (the Market.) As we look at it, there are several component sectors, including medical billing, that define the Market (see figure 2). Figure 2 Components of the Physician Revenue Cycle Market and Key Industry Themes / Drivers.

of 11 I am sure that most HBMA members consider medical billing companies to be the center of the revenue-cycle universe as the primary relationship holder with a provider. However, we view the market as an evolving co-dependent set of technology and services that will continue to evolve based on the external influences impacting providers. Why? Because the majority of the growth in the industry will come from other sectors outside of medical billing. The majority of HBMA member companies are now providing at least two of the above technologies/services. In our opinion, there is no question that the largest areas of growth in the next two years will come from electronic medical record (EMR) implementation and physician coding. Both sectors growth is being driven by external influences. EMR adoption is being accelerated by the American Recovery and Reinvestment Act of 2009 (ARRA) which was signed in February 2009. Part of the stimulus appropriates approximately $19 billion to investment in healthcare information technology, which would almost double the current market size over the next six years (2010-2015). Approximately $17 billion will come from Medicare and Medicaid financial incentives to healthcare providers, to encourage adoption of a qualified electronic health record (EHR) system, and another $2 billion is immediately available through grants and loans used to support HCIT infrastructure initiatives, develop standards, build infrastructure for information exchange, and enhance patient privacy and security guidelines. Figure 3 Cost of ICD-10 Implementation by Physician Group Size. The ARRA provides for incentive payments of up to $44,000 for physicians and beginning in 2011 a minimum of $2 million for hospitals that can demonstrate meaningful use of an electronic health record. The Meaningful Use and Certification and Adoption workgroups of the HIT Policy Committee have met several times and have developed a timeline for more detailed criteria starting in 2011 with detailed criteria on data capture and sharing. Physician coding has been integral to the medical-billing process since the inception of the industry. The increased focus on compliance and the imminent adoption of ICD-10 is going to significantly change the process of coding. The impact of the adoption of ICD-10 is substantial. Not only does the new code set include five times as many codes as the ICD-9 code set, but the different arrangement of codes will require more documentation, revised forms, retraining of staff and physicians, and changes to software and other information technology. Changes in reimbursement patterns may also result from the increased specificity of the new code set.

of 11 Figure 3 Cost of ICD-10 Implementation by Physician Group Size. The adoption of ICD-10 will also require the implementation of the next generation version of the nine Health Insurance Portability and Accountability Act (HIPAA) electronic transaction standards, known as 5010. As recommended by the National Committee on Vital and Health Statistics, 5010 must be completely implemented prior to the adoption of ICD-10, because the ICD-10 code set cannot operate with the current HIPAA transaction standards (4010). Implementing these two requirements the next generation HIPAA transaction standards (5010) and the ICD-10 code sets will result in many potential costs to physicians. Among these costs are staff education and training, changes in health plan contracts, coverage determinations, increased documentation, changes to superbills, information technology system changes, and possible cash flow disruption. Based on a study commissioned by eleven organizations, including the American Academy of Dermatology, the American Academy of Professional Coders, the American Association of Neurological Surgeons, the American Association of Orthopaedic Surgeons, the American Clinical Laboratory Association, the American College of Physicians, the American Medical Association, the American Optometric Association, the American Physical Therapy Association, the American Society of Anesthesiologists, and the Medical Group Management Association, the estimated cost of implementing ICD-10 will range from $83,000 for a small practice of three physicians up to $2.7 million for a large practice of 100 physicians. With change comes opportunity and growth for the companies positioned to assist physicians with the change to ICD-10. Those companies that have the technology to offer coding only services will be best positioned to take advantage of the opportunity.

of 11 Figure 5 Year-to-Date Stock Price Performance of Selected HCIT Companies. INTEGRATION OF TECHNOLOGY & SERVICE The software as a service (SAS) revolution remains alive and well in the physician revenue-cycle markets. The financial markets support this notion, as companies that are viewed as technology-focused, those which are collectively expected to grow at an annual rate of 11% per year, are commanding significantly higher valuations. More and more companies are making the strategic move to combined medical billing/software product offerings. Figure 6 Selected List of Companies Offering Medical Billing and Software Products. We see this trend continuing as the adoption of clinical systems accelerates the need for a more intimate knowledge of the providers and office workflow. The economics of providing both billing and technology supports a higher level of clientservice resource that will become instrumental in the successful installation and adoption of new clinical technology. The technology is not the limiting factor of growth; rather, timely installations centered on new efficient work-flow design and cost have been the two limiting factors. The government has eased the cost burden, while it will be up to the technology vendors to solve the installation and use issues. We see leveraging the billing relationship as one of the primary means to accomplish this.

of 11 Figure 7 Participating Companies and their CEOs. Figure 8 Results of Falcon Capital Partners Survey. GROWTH IN THE MIDDLE CLASS I am sure that for some veterans of the physician medical-billing industry it may seem like ground-hog day. Since the inception of independent billing for physicians,

of 11 every 10 years the industry goes through a period of increased consolidation. We are in the midst of one of these periods today. We estimate that there are over 20 companies with revenues in excess of $25 million, with five of those having revenue over $100 million. In 2008, a $15.2 million company would have been considered in the top 25 largest medical billing companies. The top 10 companies in the industry in 2007 were $1.04 billion, compared to $1.49 billion today. In last year s annual review, many of the larger companies with revenues over $100 million shared their views with us on the industry direction. This year we focused our attention on the growing middle class: companies with between $25 million and $100 million in revenue. It should be said that there is nothing middle class about these companies. They are all top performers in their markets. These companies all share one common characteristic: they are high-growth oriented. In order to gain some insight into this growing segment of the medical billing industry, we asked several of the CEOs of companies with revenue between $25 and $100 million to participate in a survey. The following companies participated: ABEO; AdvantEdge Healthcare Solutions; Medrium; Origin Healthcare Solutions; Orion HealthCorp; Springfield Service Corporation; and Zotec Partners. In order to gain additional insight into these high-growth companies, we asked the companies the following questions: 1. What was your estimated 2009 revenue? 2. Do you own your own technology? 3. What are your salary and benefits as a percent of revenue? 4. What is your general feeling of growth prospects for the industry? 5. What is your general feeling of regulatory pressures for the industry? 6. What is your technology spend as a percent of total expenses? 7. What percent of FTE's are outsourced / offshore? Figure 9 Healthcare M&A Transactions by Year. We believe the companies that participated in the survey are very representative of all the companies in the $25 to $100 million revenue range. If you compare these companies to the rest of the industry, a couple of key statistics jump out: 1. The majority own their own technologies

of 11 2. The technology spend as a percentage of expenses is significantly higher than the industry average 3. Salary as a percentage of revenue is lower than industry averages; and perhaps most interesting 4. 100% of the CEOs are feeling positive about the growth prospects of the industry. This view is not expressed by smaller companies. MERGER AND ACQUISITION ACTIVITY M&A activity in the medical billing sector in 2009 tracked with the rest of the healthcare industry M&A activity. In 2007 and early 2008, M&A activity in the medical billing industry was centered on platform investments by private equity and strategic buyers. We would deem 2009 the year of the tuck-in acquisition. As shown in Figure 10, M&A deal volume and average deal size were both down from 2008. Figure 10 M&A Activity in the Medical Billing Industry. Valuations were also down from their historically high levels in late 2007 and early 2008. We attribute the decreases to tight credit markets. Average combined senior and subordinated debt available for middle-market and lower middle-market transactions fell from a high of five to six times historical EBITDA to two to three times trailing twelve-month EBITDA. The average valuation in 2009 was 6.2 times 12-month trailing EBITDA, with a range of 3.5 times to 8.4 times. OUTLOOK FOR 2010 These are truly uncertain times on the regulatory front for physicians. Congress has shifted its attention back to healthcare reform, and it seems certain that there will be some form of healthcare reform passed in 2010. As noted by our CEOs who were surveyed, two-thirds believe that the regulatory environment will be neutral or negative. Even before healthcare reform gets decided, Congress will have to deal with fixing the sustainable growth rate formula (SGR), an issue it has been unable to solve for many years.

of 11 Figure 10 National Health Expenditure Projections, 2010-2019. As in the past, there will be specialties that are winners and losers. We anticipate continued reimbursement pressure in many of the diagnostic specialties, including radiology and cardiology. The primary-care and emergency-medicine markets will continue to have more favorable reimbursement trends. Health expenditures are forecasted to continue to rise well ahead of inflation at a compounded annual growth rate (CAGR) of 6.8% over the next ten years. Physician and clinical services were estimated to be approximately 21% of total healthcare expenditures. We anticipate another short-term one-year fix for the SGR, with the most likely scenario being a 0.5% to 1% increase in physician payments. As the healthcare reform debate continues into 2010, a more permanent fix to the SGR will most likely be included in the final reform bill. The industry, especially vendors, will continue to deal with ICD-10 planning and implementation issues. This issue will gain more focus later in the year, as the reality of dealing with the switch begins to hit home. The response to providers requests for assistance in fulfilling Medicare s PQRI and 2% e-prescribing incentive program bonus payment requirements will be an opportunity for differentiation among medical billing companies. We expect to see a continued trend towards faster growth in companies focused on office-based specialties fueled by the need for integrated clinical and practice management systems and regulatory requirement pressures (PQRI, e-prescribing, red-flag-rule implementation and ICD-10). We also expect to see some additional consolidation and or recapitalizations of companies in the over $25 million categories, creating a few more companies close to, or over, the $100 million mark. If the public markets continue to remain strong for healthcare IT/service companies, we may even see a couple of companies consider IPOs. On the M&A front, we would expect the market to remain active in 2010, with the estimated deal volume expected at 2009 levels. Valuations for the industry as a whole should also remain at 2009 levels. Companies that have built scale in the office-based markets will become more desirable to larger strategic buyers looking to offer a diversified portfolio of specialties, or a customer base to leverage for

of 11 clinical systems sales. As in the past, we expect that the innovative companies will embrace the challenges presented by the external environment and find new areas of growth and opportunity. Happy New Year to all! Ted Stack is managing director at Falcon Capital Partners in Radnor, Pennsylvania. He can be reached at 610-989-8900. The website is www.falconllc.com. Advertisement. Click ad for larger detail Click here to visit advertiser's website