Balancing Risks and Rewards in Pursuit of a High...

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Balancing Risks and Rewards in Pursuit of a High Growth Strategy

Summary The CEO of Health Information Provider Corporation (HIPCO), Michael P. Cohen, has been analyzing the financials of the company for the last three hours and feeling confident that it has done well since the private equity deal last year with Magnum Capital Group. In preparation for the first annual meeting with the HIPCO Board of Directors since the deal took place, Cohen is meeting with his entire executive team to come up with an ambitious, yet viable and sustainable strategic plan to ensure robust growth in profitability and corporate value over the next five years. As a highly focused and growing business, HIPCO is currently a 75% privately held corporation located in Denver, CO. With fast changing markets, emerging and dynamic competitive business models, uncertain regulatory environment within the healthcare industry, and rapidly evolving technological breakthroughs in information management, Cohen understands that while it is a complex market space to work in, it also offers vast potential to be creative and entrepreneurial. The task before him is to find innovative ways to expand the business and create value for the private equity owners who would want to exit this venture with a standard 30% to 40% return on their investment. Firm and Industry Background Founded in 2002, the company offers an enterprise-wide solution to the secure exchange of protected health information between healthcare organizations and other entities, including other providers, government agencies, payers, third-party requestors, and patients. HIPCO is one of two major competitors in a specific niche of the healthcare IT industry. Until recently, three firms occupied this niche, but in 2015 competitor MedPortal, the largest firm, merged with HealthInfo, another competitor. With the merger, MedPortal revenues exceed $450 million. HIPCO revenues are substantially less, under $40 million, but growing in excess of 20% annually. Although there are only two major niche competitors in this segment of the healthcare IT market, these firms compete with much larger healthcare IT firms such as Cerner, Epic, McKesson, and Allscripts that provide a full range of clinical and financial software and services for hospitals. The offerings from these larger firms enable hospitals to perform their own disclosure functions and therefore effectively compete with MedPortal and HIPCO. These larger firms have revenues in the $1 billion to $5 billion range. The demand for these services grew out of the Health Insurance Portability and Accountability Act (HIPAA), passed by the US Congress in 1996, which provided an effective compliance date of April 14, 2003 for the Privacy Rule. The HIPAA Privacy Rule regulates the use and disclosure of Protected Health Information (PHI) held by "covered entities" (generally, health care clearinghouses, employer sponsored health plans, health insurers, and medical service providers that engage in certain transactions). PHI is any information held by a covered entity that concerns health status, provision of health care, or payment for health care that can be linked to an individual.


Hospitals and other healthcare providers are frequently asked to release patient information. The requestors can be attorneys requiring medical information for legal cases; health insurers attempting to confirm medical services provided to the insured; government auditors conducting audits of patient records (Medicare, Medicaid); etc. However, release of the wrong patient information can present significant risk exposure for the hospital. Over the ten-year period from 2003 through 2013, the U.S. Department of Health and Human Services (HHS) received 91,000 complaints of HIPAA violations, in which 22,000 led to enforcement actions of varying kinds (from settlements to fines) and 521 led to referrals to the U.S. Department of Justice (criminal actions). Examples of significant breaches of protected information and other HIPAA violations include:

• The largest loss of data that affected 4.9 million people by Tricare Management of Virginia in 2011

• The largest fine of $4.3 million levied against Cignet Health of Maryland in 2010 for ignoring patients' requests to obtain copies of their own records and repeated disregard of federal officials' inquiries

A single breach of patient information can cost between $8,000 and $300,000, involving a provision of credit or identity theft monitoring services to victims, forensic and legal fees, as well as reputational harm and loss of goodwill for the medical institution. Beyond this expense and exposure, HHS raised the fines and penalties in 2013 to $50,000 per breach. The risks of a PHI breach have grown substantially as hospitals merge and also acquire medical practices. These institutions typically have different PHI disclosure policies and procedures that can lead to confusion and inconsistencies in the release of information. Furthermore, the merged facilities most likely have different electronic medical systems that contribute to the problem. Finally, Medicare and private health insurers increasingly reimburse healthcare providers based on patient outcomes and other quality measures. These metrics require significantly greater access to patient medical records, and with the increased volume of requests, the exposure to PHI breaches also grows. To avoid this exposure, healthcare providers are increasingly outsourcing the release of this information to firms such as HIPCO since the regulations are complex and changing. Hospitals can choose to have an on-site staffing model where HIPCO employees are stationed in the hospital and function as hospital employees, responding to requests for information. Generally there will be 1-5 staff on site to handle this responsibility. While this is the typical arrangement, some hospitals use the remote model where information requests are fulfilled remotely by staff at HIPCO’s headquarters. Another possible arrangement is the shared model where the providers employ their own staff but utilize HIPCO platform.


HIPCO Business Model Given the nature of its business as a service provider, HIPCO offers two core value propositions to its clients which distinguish it from the competition: (i) the quality of the field and remote staff and (ii) the unique functionality of its technology. With respect to staff, HIPCO excels in training and retention of its employees. HIPCO customer-facing staff have 17% annual turnover in an industry that typically experiences 40% turnover. This is achieved through better pay and benefits, greater promotional opportunities, a hands-on management style, and a more thorough screening and selection process. Lower turnover means more knowledgeable staff, highly satisfied customers, and lower recruitment and training costs. HIPCO’s other advantage is technology. Specifically, HIPCO’s platform has a proprietary application that is able to use Optical Character Reader (OCR) technology to identify any anomalies in the patient’s medical record. This enables HIPCO to confirm that each page of the patient’s medical record does, in fact, belong to that patient. This ensures virtually 100% accuracy in the release of information, which is a substantial competitive advantage for HIPCO. This accuracy also reduces the risk of a breach of private information. KLAS reports are the principal measure of customer satisfaction in the IT healthcare industry, and HIPCO has achieved some of the highest industry ratings in 13 of the 15 categories. All of HIPCO’s clients said they would hire the company again. The primary reasons given by clients for the high level of satisfaction are the quality of services, knowledgeable and responsive employees and innovative technology. HIPCO has been among the top rated disclosure management companies in KLAS reports. Revenue Generation Cycle A typical transaction described below illustrates the revenue generation cycle. The HIPCO transaction can involve a law firm, an insurance company, a government agency such as Centers for Medicare and Medicaid Services (CMS), or other local, state and federal agencies that are seeking a patient’s medical record information. As an example, a law firm may be seeking information about injuries sustained by a client and will request a copy of the client’s medical record. This service can be provided either remotely via HIPCO’s central support office or by HIPCO staff housed in an office in the hospital. The HIPCO employee retrieves the medical record and confirms its contents as belonging to the correct patient based on HIPCO’s unique OCR technology, which assures 99.9% patient identity accuracy, best in the industry. The hospital contracts this out to HIPCO for operational and cost efficiency reasons. In addition, this outsourcing has the added benefit of relieving the hospital of the responsibility and potential liability for release of unauthorized patient data.


HIPCO’s revenues from a typical transaction originate from either or both of the two parties to which it provides services: 1. Client - the hospital that outsources the disclosure management service to HIPCO 2. Customer - the entity that is seeking the patient information.

The clients include hospitals, physician medical practices, physical therapy organizations, and other medical field entities. The current customer base includes: lawyers, record retrieval services, governments, patients, and insurance companies. Typically, all payments come from the client (i.e., the hospital) and are based on a state mandated fee schedule. HIPCO can charge additional fees to the hospital if the state where the hospital is located has a fee structure that is insufficient to cover costs of retrieval. HIPCO negotiates additional payments to ensure a reasonable level of profitability. On the other hand, if the state fees are less restrictive, HIPCO can contract to share the gross margin with the hospital to help the provider offset costs embedded in PHI disclosure. In addition, the customer (e.g., law firm) pays HIPCO for the retrieval service, based upon the state fee structure unless HIPCO and the customer both agree on a different fee structure. This may happen to simplify the billing process, to encourage greater volume or to include other services in the contract that are not subject to state pricing limits. Some states may allow HIPCO to charge per page on a sliding scale. For example, $10 for the first page, $5 for the next, and $.50 per page thereafter (or as little as $.01 per page thereafter), and others dictate a set amount for the full medical record. However, as stated above, HIPCO can make separate fee agreements with customers. In general, HIPCO will not provide the requested documents without payment up front. Given this transaction structure, there is negligible risk of mounting outstanding accounts receivable for HIPCO, except on a few occasions related to audits from some insurance firms.


TransactionModel


Portfolios of Services Offered Specifically, HIPCO provides a suite of products in two distinct services areas: 1. Disclosure management and 2. Health information exchange solutions for hospitals and health systems. Disclosure Management: HIPCO offers proven solutions that mitigate risk when disclosing confidential, patient-identifiable health information. HIPCO safeguards the healthcare organization against breach by meeting increasingly complex regulatory requirements around patient privacy and health information technology—ensuring the secure, efficient and compliant exchange of Protected Health Information (PHI).

• The Data on Demand (DoD) Online solution, the leading product for the firm, is a web-based solution that is delivered through various service delivery models, including staffed, shared, remote, and customized workflow processes that suit each health care organization’s needs. HIPCO also offers other complimentary solutions that leverage its expertise in technology and people such as audit compliance and tracking solutions;

• PayReport, an online payer audit management program for audit tracking and

reporting;

• Disclosure Online, enables healthcare organizations to enforce disclosure policies, as well as track, manage, and report disclosures across the healthcare enterprise; and

• Breach ID, a breach assessment tool to help the organization determine if a

breach has occurred. Health information exchange (HIE) is the mobilization of health care information electronically across organizations within a region, community or hospital system. HIE provides the capability to electronically move clinical information among different health care information systems. The company’s HIE solutions include:

• HIPCOPortal, a patient portal that allows hospitals to provide a gateway for patients to view, download, and transmit instructions, information on referrals, and other requested health records;

• HIPCODirect, a SaaS-based platform for the secure direct sharing of

protected health records for purposes of increasing efficiency and effectiveness of changeover of care among healthcare providers; social security administration portals for determination of disability; and


• CMS Audit View for Centers for Medicare and Medicaid Services audits. It

also provides various document management solutions, including record warehousing as well as EMR retrieval, transfer, and data backup services.

Looking Ahead for Sustainable Growth and Value Creation Given the dynamic market place and the private equity investors’ expectations for a reasonably high return on their investment, HIPCO has to identify ways to maintain its competitive advantage as well as be innovative and entrepreneurial to make moves in newer strategic directions. Specifically, Cohen plans to ask the executive team to recommend ways to increase revenues by a multiple of 2.5 over the next five years. Challenges HIPCO is in a rapidly changing and growing industry that is continually buffeted by new regulatory requirements for its clients (i.e., the hospitals) as well as advances in technology. However, growth in regulations and more accountable care as required by insurers will increase the demand for patient information retrieval. Entry and exit to this competitive market space is easy given that it is a service business, and tangible capital assets with huge financial outlays are not limiting factors for new entrants,. New competitors with innovative software and data management algorithms along with strong technological and/or financial assets from other verticals are always a real threat. As the labor market tightens, HIPCO will also be faced with the potential for higher turnover and higher labor costs. Finally, HIPCO is faced with a single niche competitor that’s 10 times its size in revenue. In addition, it must contend with large healthcare software companies (Epic, Cerner, McKesson, and Allscripts) that have significantly deeper R&D resources, strong brands, and a broader customer base. Of course regulatory uncertainty, especially surrounding Obamacare and other health insurance exchanges, adds another layer of complexity. While encountering these challenges, HIPCO has certain strengths that, properly deployed, make it a formidable competitor and may provide opportunities for expansion into new markets and development of new capabilities. These have been noted previously and include the following:

• The quality of its field staff and the low turnover rate improve client satisfaction and reduce hiring and training costs.

• The highest industry rating in the category of Release of Information services. • Its unique application of Optical Character Recognition technology provides

HIPCO with the highest degree of accuracy in the industry.


Opportunities While HIPCO is a U.S. company (in a highly regulated U.S. healthcare market), there may be some additional ways that HIPCO can add revenue and create higher margins. The company has discussed, in passing, the following potential opportunities:

• international possibilities (although each country would have its own regulations along with different needs and fee structures),

• higher incentives to salespeople • extending the use of their technologies and services into other sectors, such as

the financial industry, state, local, and federal government agencies. While these might be promising areas, Cohen is determined to go into only those new areas that will not dilute the rich organizational culture. To help explore the possibilities Cohen has developed following matrix to streamline management team discussions:


While some in the IT group opposed it, several members in the management group have suggested in the past that HIPCO should consider licensing its proprietary technology to other organizations for uses in other industries/niches/sectors. By licensing their technologies they would receive income streams without the overhead of labor, facilities, benefits, and other expenses related to in-house sales, sales teams, support personnel, and additional fixed and variable costs. However, they would have the expense of monitoring their licensees and there is always the risk of leakage of technology. Cohen would like to have a lively discussion around the possibilities that HIPCO can grow horizontally, through acquisitions in their market and expansion of its customer and client base, and vertically, by adding new market niches through related (and unrelated) diversification. This might be facilitated by hiring employees with expertise in new areas, or people who bring additional contacts and relationships in HIPCO’s core businesses. But part of this is venturing into unchartered territory and facing several unknowns along with market uncertainties. Some team members with somewhat greater risk-taking spirit would argue in favor of entrepreneurial segments, applications, and industries that HIPCO has yet to attack or discover. The healthcare industry in the United States is growing and the need for HIPCO’s services will grow along with it. However, if HIPCO doesn’t grasp new opportunities it can become a stagnant player in the market. The opportunities are real because of an aging population, as well as an expanding population due to both birth rates and immigration. Can HIPCO add to its service offerings even beyond those mentioned above? Can it use its expertise to give home healthcare and hospice providers more onsite information? Can it provide healthcare transportation providers needed information in order to make safe transport more likely? Can it give easier access for hospital based healthcare providers the ability to make house calls with all the information they need on a mobile device? Can it develop new secure software applications for the healthcare industry and other industries as well? Well-informed and well thought out answers to the questions above may enable HIPCO to become a sustainable company for years to come while achieving revenue growth rates of approximately 25% per year and increasing profit margins for the next four to five years. While Cohen is well aware of the need to at least double HIPCO’s current revenues within the next 4 to 5 years, he wants to minimize the risks inherent in fast growth. He wants to adopt a balanced approach -- growing organically (in expansion of existing business and garnering new business) and through acquisitions -- to achieve this goal. He is hoping to be able to devise an innovative and viable strategy and present to the Board a concrete implementation plan for HIPCO to reach, and perhaps surpass, its objective of raising revenue and profit margins enough for the equity holders to realize their expected returns from the private equity deal reached last year.


APPENDIX

Financial Statements: The com

pany’s 2010-2014 financial statements (balance sheet, incom

e statement and statem

ent of cash flows) are

presented below.

Balance Sheet

2014 2013

2012 2011

2010 A

ssets

Current assets:

C

ash 1,674,035.32

5,683,859.40 3,659,139.88

2,830,592.26 1,092,123.04

Accounts receivable

2,316,469.80 1,933,206.98

1,664,307.40 1,054,515.26

1,100,289.82 Prepaid Expenses

609,138.42 329,004.06

186,397.52 81,274.86

53,587.34 Total C

urrent Assets

4,599,643.54 7,946,070.44

5,509,844.80 3,966,382.38

2,246,000.20

Property and equipm

ent

3,903,533.22 2,758,995.76

2,151,669.82 1,576,048.12

Accum

ulated depreciation

-2,038,789.84 -1,539,179.02

-1,191,427.12 -891,206.80

Property and equipment, net

2,643,183.48 1,864,743.38

1,219,816.74 960,242.70

684,841.32 O

ther assets:

Loan receivable-employee or stockholders

70,336.26 68,989.88

21,007.54 20,605.16

Deposits

37,676.22 31,393.90

31,742.00 30,635.16

31,542.58 Intangible assets, net

30,655,072.50 3,576,938.72

664,635.00 382,285.78

G

oodwill, net

17,147,062.62

D

eferred financing fees, net 442,822.14

Total other assets 48,282,633.48

3,678,668.88 765,366.88

433,928.48 52,147.74

Total assets 55,525,460.50

13,489,482.70 7,495,028.42

5,360,553.56 2,982,989.26

Liabilities and Stockholders' E

quity

C

urrent liabilities:

Accounts payable

2,301,700.92 1,431,265.66

1,246,004.48 1,170,151.72

1,174,805.64

Accrued expenses

2,298,758.00 1,548,644.98

978,684.92 683,540.96

575,417.56 A

ccrued income taxes

271,400.00

C

urrent portion of obligations under capital leases

2,830.82 13,919.28

33,858.92 60,113.92

31,937.88 C

urrent portion of long-term debt

371,700.00 560,011.48

D

ue to related party, current portion 4,245,855.94

664,613.76

Total current liabilities 9,492,245.68

4,218,455.16 2,258,548.32

1,913,806.60 1,782,161.08

Obligation under capital leases, less

current portion 12,511.54

13,919.28

48,795.36 32,978.64

Long-term debt, net of current portion

14,403,375.00 1,661,333.80

D

ue to related party, less current portion 5,435,788.00

99,769.00

Total liabilities 29,343,920.22

5,979,557.96 2,272,467.60

1,962,601.96 1,815,139.72

Stockholders' Equity:

C

omm

on stock, no par value

Additional paid-in capital

23,647,603.56 1,815,976.34

3,210,154.60 4,309,275.04

4,505,753.30 A

ccumulated deficit

-911,323.44

-3,337,903.76 R

etained earnings 2,533,936.72

5,822,319.42 2,012,406.22

Loans received from stockholders

-128,371.02

Total stockholders' equity 26,181,540.28

7,509,924.74 5,222,560.82

3,397,951.60 1,167,849.54

Total Liabilities and Stockholders' Equity 55,525,460.50

13,489,482.70 7,495,028.42

5,360,553.56 2,982,989.26

!!

!Income Statem

ents

2014

2013 2012

2011 2010

Sales 41,042,903.96

32,892,769.04 26,316,345.84

20,331,754.00 16,112,053.94

Direct C

osts 26,473,435.70

21,322,925.68 16,955,558.06

12,796,586.70 10,397,359.96

Gross Profit

14,569,468.26 11,569,843.36

9,360,787.78 7,535,167.30

5,714,693.98

O

perating Expenses:

Sales and marketing

2,889,277.20 2,095,006.22

1,818,446.08 1,304,767.30

1,618,326.34 Inform

ation Technology 1,757,178.12

1,464,211.26 1,248,495.46

1,101,504.04 903,674.68

General and adm

inistrative 10,090,033.68

3,270,368.82 2,856,564.06

2,310,674.82 1,945,248.88

Total operating expenses 14,736,489.00

6,829,586.30 5,923,505.60

4,716,946.16 4,467,249.90

Income from

operations before depreciation and am

ortization -167,020.74

4,740,257.06 3,437,282.18

2,818,221.14 1,247,444.08

Depreciation and am

ortization 2,517,631.48

904,709.54 519,918.62

385,410.42 179,962.98

Income from

operations -2,684,652.22

3,835,547.52 2,917,363.56

2,432,810.72 1,067,481.10

Other incom

e (expense):

Interest income

6,376.72 10,735.64

8,729.64 6,925.42

3,178.92 Interest expense

-338,707.20 -36,369.96

-15,933.54 -13,155.82

-19,136.06 G

ain on sale of property and equipment

13,570.00

Incom

e tax expense 271,400.00

Net Incom

e (loss) -3,288,382.70

3,809,913.20 2,923,729.66

2,426,580.32 1,051,523.96

!

Statement of C

ash Flows

2014 2013

2012 2011

2010 C

ash Flows from

operating activities:

Net incom

e (loss) -3,288,382.70

3,809,913.20 2,923,729.66 2,426,580.32 1,051,523.96

Adjustm

ents to reconcile net income to net cash provided by operating activities:

D

epreciation 587,320.22

499,610.82 397,060.56

300,220.32 179,962.98

Am

ortization 1,953,617.44

405,098.72 122,858.06

85,190.10 W

rite-off of intangible assets 54,159.64

G

ain on sale of property and equipment

-13,570.00

Allow

ance for doubtful accounts -1,430.16

47,853.72 17,977.30

Transaction expenses paid by parent com

pany 1,611,166.10

(Increase) decrease in assets:

A

ccounts receivable -381,832.66

-334,479.26 -627,769.44

45,774.56 -329,245.96

Loan receivable 70,336.26

-1,346.38 -47,982.34

-402.38 -518.02

Deposits

-6,282.32 348.10

-1,106.84 907.42

58,158.66 Prepaid expenses

-300,416.20 -126,723.74

-88,895.30 -21,787.52

-1,475.00 Increase (decrease) in liabilities:

A

ccounts payable 870,435.26

185,261.18 75,852.76

-4,653.92 368,764.16

Accrued expenses

750,113.02 568,436.68

295,143.96 108,123.40

-41,035.68 A

ccrued income taxes

271,400.00

Due to related parties

-648,526.82 764,382.76

Net C

ash provided by operating activities 1,541,677.08

5,818,355.80 3,053,298.38 2,939,952.30 1,286,135.10

Cash flow

s from investing activities:

Purchase of property and equipm

ent -1,348,909.92 -1,138,361.34

-609,434.60 -467,046.36

-447,966.94 A

cquisition of Firm 1

-483,549.84

Proceeds from sale of property and equipm

ent

13,570.00

Acquisition of Firm

2

-468,634.64

A

cquisition of Firm 3

-961,733.04

Net cash used in investing activities

-1,348,909.92 -2,100,094.38 -1,064,499.24 -950,596.20

-447,966.94

C

ash flows from

financing activities:

Repaym

ent of long-term debt

-2,314,270.28 -138,654.72

Repaym

ents of line of credit

-117,375.78

Repaym

ents of capital lease obligations -15,427.32

-33,858.92 -61,131.08

-54,408.62 -88,538.94

Distributions to stockholders

-2,468,765.32 -1,565,278.26 -1,130,095.44 -233,353.26

-84,618.98 Issuance of com

mon stock

44,250.00

30,975.00 36,875.00

Capital C

ontributions 595,871.68

N

et cash used in financing activities -4,202,591.24 -1,693,541.90 -1,160,251.52

-250,886.88 -290,533.70

Net Increase in cash

-4,009,824.08 2,024,719.52

828,547.62 1,738,469.22 547,634.46

Cash, beginning of year

5,683,859.40 3,659,139.88

2,830,592.26 1,092,123.04 544,488.58

Cash, end of year

1,674,035.32 5,683,859.40

3,659,139.88 2,830,592.26 1,092,123.04

Supplem

ental disclosure of cash flow inform

ation:

Cash paid during the year for:

Interest

233,970.40 28,718.84

15,933.54 13,155.82

19,136.06 Supplem

ental disclosure of noncash financing activities:

Equipm

ent acquired by capital lease 16,850.40

98,401.38

86,082.18 Issuance of debt related to the acquisition of Firm

3

2,360,000.00

Stock issued in exchange for notes receivable

128,371.02

!!

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