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Quality Systems Inc. Benefits From HITECh Act Of 2009

|Includes:CERN, MCK, MDRX, Quality Systems, Inc. (QSII)

More often than not, when you go to your doctor's office the receptionist goes to a file room to retrieve your medical information. It's not always that easy though. If you are not a regular patient, odds are the office has to have your record mailed to them from another institution in order for them to proceed with your care. It's time consuming and costly. The numbers add up quickly and the cost is passed on to you, the consumer.

Keeping track of patients' medical records and billing has always plagued the healthcare industry. Surprisingly, in this age of all things digital, most of that work is still done manually. Congress recognized the need to keep up with the explosive growth in this area of patient care by passing the HITECH Act in 2009. The act allocated $19.2 billion towards improving healthcare by digitizing patients' complete medical records and, in the process, inadvertently gave a boost to companies that offer software services that manage the automation of digital medical records and billing systems within the parameters governed by HIPAA privacy and security regulations. This is where companies like Quality Systems Inc. (NASDAQ: QSII) come in.

QSII operates in the emerging growth Electronic Medical Health Records space or EMR. The company specializes in digitizing medical records for doctors and hospitals alleviating inefficiencies in searching for and indexing patients' records. The company also provides maintenance and support for the software systems that it installs, collecting a recurring revenue fee for ongoing maintenance. Its Next Gen business, which provides electronic records and financial management for small physician practices, accounts for about 75 percent of QSII revenue. Sales to hospitals and dental practices are a minority of revenue. Recurring maintenance revenues for providing support for installed systems make up almost 50 percent of total revenues.

Although Quality Systems has a dominant EMR product for the individual physician market, it has been struggling to make inroads into the hospital market which is reflected in its relatively lower revenue contribution in this segment. Competition is increasing in the space with a number of competitive solutions in market from much larger players like Allscripts Healthcare Solutions Inc. (NASDAQ: MDRX), McKesson Corporation (NYSE: MCK) and Cerner Corporation (NASDAQ: CERN).

QSII's compound revenue growth over a nine year period, 2003-2012, was a healthy 26 percent. Operating cash flow over the same period has also been healthy, at 22 percent. QSII has only had a dividend in place for the last 5 years and growth has averaged 9 percent per annum. While this rate is reasonable, the fact that it is lower than the operating cash flow growth rate suggests there may be room for dividend growth over time as operating cash flow growth increases.

Unfortunately QSII stock price tanked in 2012, losing almost 50 percent of its value going from from $35 down to $17.50. The stock is currently trading up at $18.36. The company had a rough 2012, with consistently missed estimates, suspended revenue and profit guidance due to some of these mishaps. QSII revenue was flat to slightly down for the year. The fact that maintenance and recurring revenue is strongly up, while new product sales are down, represents deferred rather than cancelled orders. While the company's pipeline is still healthy, QSII appears to be taking longer to close some deals with clients.

The bottom line is that the Obama administration has recognized that there are huge benefits to the health care system in moving to the EMR platform. The administration has offered financial incentives to physicians and hospitals to digitize their electronic health care records to the tune of almost $20 billion. If healthcare entities (hospitals and physicians) fail to change over to EMR by 2015, they will be penalized which will include loss of Medicare reimbursements. As a result, the health care sector is highly incentivized to move to EMR. This will contribute to acceleration in growth for companies that provide EMR solutions. QSII is a business in a rapidly growing market which will be further incentivized by government programs to drive EMR. This will create a strong tail wind for the business over the next few years and will drive profitability.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.