Cerner's poor 1Q performance raises concerns for healthcare IT market

Execs cite deteriorating reimbursement, intensifying competition

Cerner Corporation issued an earnings warning April 3, sending a shiver down the corporate spine of the IT industry. The diminished performance is a reflection of toughening economic times for the healthcare IT market in general, as well as intensifying competition, according to the company. The problems do not extend, however, to the RIS/PACS sector, said Hemant Goel, enterprise vice president for radiology.

Some buying of overarching healthcare information systems has been delayed, accounting for much of the expected shortfall. But while hospitals may be postponing purchases of full-scale IT solutions, they are still buying bits and pieces of systems, particularly PACS, according to Goel.

Although detailed financial figures will not be available until April 17, Cerner's first quarter performance on the radiology side compared favorably with first quarter results in previous years.

"PACS is still pretty new, and there's a desire to gain all the benefits one can with output efficiency, financial savings, and productivity increases. So the market will continue to spend on these types of solutions," he said. "But on the overall HIS solutions, there has been a bit of a slowdown."

Preliminary information shows that Cerner's first quarter revenue was between $189 and $192 million. Earlier the company had told analysts to expect revenues between $205 and $210 million. Earnings have been hurt even more, with per share projections pegged at 13¢ to 15¢ versus previous analyst estimates of 38¢.

The underlying cause of the drop in both projected revenue and earnings is a lower than expected number of new bookings, which account for about 15% of the company's revenue. Although expected to reach $200 million, actual new bookings in the first quarter will come in somewhere between $145 and $150 million.

The company started seeing higher volatility in client decision-making about a month ago, but executives believed enough deals were in the works to meet analyst estimates. In the last two weeks of the quarter, however, when buying in healthcare IT typically closes, new bookings fell short.

Neal Patterson, chairman and CEO, ascribed the shortfall to a combination of external and internal factors. Although hospitals' economic condition had stabilized and started to improve in 1999, it is again facing deficits in reimbursement from Medicaid and tightening purse strings from Medicare as well as private payers. This makes hospitals and integrated delivery networks skittish about committing to large capital investments.

Another reason was heightened competition. Patterson expects this to continue for another 18 months, as rival IT vendors offer deep discounts to freeze their client base.

Cerner was hit particularly hard in the first quarter by the loss of Kaiser Permanente. The largest healthcare delivery organization in the country, with 8.4 million members, Kaiser reported in February that it was partnering with Epic Systems of Madison, WI, on a three-year development plan that would establish an IT system for sharing clinical, administrative, and research data across the Kaiser Foundation Health Plan and Hospitals.

"Kaiser represented a large opportunity for Cerner. We had committed a significant amount of executive time and expenses to pursuing that opportunity," Patterson said. "While we had not included that in our guidance to investors, it would have made a significant impact in the first quarter and for the entire year."

Internal factors also contributed to Cerner's unsatisfactory first quarter performance. One was the reorganization of the company to be more client-centric. At the beginning of 2003, the company created five regional divisions-North Atlantic, Southeast, Great Lakes, Mid-America, and West-each with its own president and executive team so clients would have easier and quicker access to Cerner executives, Goel said. Although the company does not believe the reorganization significantly affected sales activity, the strategy did demand the time and attention of the executive team.

Cerner also has committed resources to an opportunity in the U.K. By the end of the year, the National Health Service is expected to contract for IT systems for all public hospitals, clinics, and general physician practices in the country. Cerner believes it is in position to capture a large portion of this business. Pursuing this opportunity, which promises to benefit investors well into the next decade, is having a negative short-term impact, because it requires increasing investment over the next three quarters. By concentrating on the U.K., Cerner has not kept up with business development plans in the rest of Europe.

The earnings warning sent stock prices tumbling April 3 to $18.42 per share, down more than 40% from the previous day. Stock prices slid even more, to around $17 on April 8, amid concerns about a still challenging competitive and economic environment. Cerner remains upbeat, however, about its near- and long-term future.

While pricing on existing product lines will fluctuate in relation to market saturation, Cerner will not respond to competitors' price-cutting with discounts of its own, believing that competing on the merits of its technologic solutions and the benefits they deliver is a better long-term strategy. The company also intends to build on its dominant marketplace position.