TWST: With the recession and impending healthcare program, how is the healthcare IT industry situated presently?

Mr. Close: If you look across the healthcare industry, healthcare technology vendors and service providers are probably the best-positioned out of any sub- segment in the healthcare industry to flourish over the next several years.

TWST: Why is that?

Mr. Close: The reason is obviously the stimulus, part of President Obama's healthcare reform. The intention is to streamline costs in addition to improving access or giving access to healthcare to those that are uninsured. Expansion to those uninsured or underinsured will be possible partly due to the cost savings expected from adopting healthcare technology, Electronic Health Records that will streamline the healthcare delivery system.

TWST: How will other field segments fare?

Mr. Close: Clearly, you have several segments of healthcare IT, the hospital sub-segment, the physician's office, family practice physicians and the payors. Clearly, payors have adopted technology to a great degree over the years. Hospitals clearly have been adopting technology over the years. You can see that in the size of companies like McKesson (MCK), their healthcare IT division, Cerner (CERN), which has pretty significant revenues. The least active in adoption of technology has been the physician's office. Hospitals have been using financial systems and some clinical systems for a number of years, and in a lot of cases are in the process of adopting clinical solutions like Electronic Health Record. They may not be completely there, but have made progress toward adopting those systems. Contrast this with physicians, where we are talking about a mom-and-pop business scenario. A lot of physicians practice in small groups where they are individual doctors or may be a group of two or three doctors practicing together. These groups have not spent a lot of money on technology to automate their business.

TWST: As the healthcare program from the Obama Administration hasn't been finalized yet, the requirement details for the components are still up in the air. What's going on in the healthcare IT industry as they wait for that?

Mr. Close: We don't really see any major changes coming out of the Obama health plan as it relates to healthcare IT. Obviously, the reform is working its way through the House and the Senate at this time, and we are not sure exactly what the final bill will look like. Uncertainty that people have with investing in healthcare today is primarily because we don't know what the final bill is going to say. With respect to healthcare IT, we do have a known entity with the stimulus bill that was passed back several months ago. So healthcare IT is not necessarily dependent on the current healthcare bill as it was funded out of the ARRA Act, which is the stimulus legislation to move towards adopting healthcare technology.

TWST: What is the supply/demand balance now?

Mr. Close: With respect to the stimulus, what is "meaningful use," the timetables to healthcare technology adoption and the incentives that are being paid to spur adoption has created questions that have potentially delayed purchases in the short run, although ultimately we believe will spur adoption once clarity exists. In our discussion with technology vendors and healthcare providers, there has been some positive movement in terms of interest, kicking the tires, people beginning evaluating systems. Despite this, we have not seen a whole lot of buying or people lining up at the doors of vendors to purchase systems. I think demand clearly is going to increase over time. I think the stimulus and focusing on adopting healthcare technology by hospitals and physicians is positive. And clearly the stimulus is a "hand at the back" pushing providers to adopt technology. These incentives are real and will positively impact the demand at some point. Now clearly over the last year, last 12 months, our economy has gone into recession and it has been pretty volatile from the standpoint of the financial markets. And there has definitely been hesitancy to spending a lot of money on new systems. We have seen the budget tightening or freezes loosen up over the last several months a little bit, and previously delayed deals may be completed due to better economic situation compared to the environment in the first quarter. But again, we haven't necessarily seen a huge positive impact from the stimulus at this point. We do anticipate that you will have positive movement as we progress through the remainder of 2009 and into 2010.

TWST: What do you foresee as the emerging trends when the economy recovers?

Mr. Close: If the economy recovers, what is that going to do? That will positively impact demand as well because doctors and hospitals will feel more financially sound. If you look at non-profit hospitals, they have investment income; they get donations. With the bad economy their investments have gone down. Contributions from individuals in their communities - donations have probably gone down and negatively impacted their hospital endowments. All this alters how you operate your business. How much money do you spend on initiatives? In a bad economy you are going to pull back spending to some degree on things like technology systems. The stimulus lessens that pressure a little bit because it's free money. The stimulus incentives allow the physician or hospital to go out and spend money on systems. In a bad economy the provider would be pulling back on these purchasing decisions until the economy improves. Hospitals had a difficult time with the freezing of the credit markets. The improvement in the credit markets has probably helped hospitals finance the system purchasing, thus allowing some of the delayed deals we mentioned earlier close. On the physicians' side, these are small businesses where these physicians operate in small practices of two to three doctors per group. Because they are small businesses, they are influenced by the current economy, the state of their brokerage accounts. They make purchasing decisions for their practice based on their personal financial situation. They may say, "Oh, I was down 30%, 40% last year like everyone else, so I do not have the money to spend on IT systems and adopting Electronic Medical Records." The stimulus does help physicians out if they are able to adopt it in the first year in 2011-2012. They are going to be getting $18,000 in that initial year, which helps defray some of the costs. As the economy improves, hospitals, physicians, individual physicians are going to feel better about their financial standing and be more likely to go out and start spending on the systems.

TWST: As you talk to management, what's your level of confidence at the moment?

Mr. Close: The management teams that we talk to are definitely optimistic on the opportunities going forward based on the stimulus and the incentives for hospitals and physicians to adopt. You can build very rosy scenarios if you assume an accelerated level of adoption by hospitals and physicians. There are not many industries, too, that have a demand scenario or an adoption scenario as rosy as the healthcare IT sector at this point. Now with that being said, a lot of the management teams have focused on the stimulus and the opportunities that exist. Since the turn in the market at the beginning of March, people have really looked past current earnings, the March quarter and June quarters. We'll see what happens with the remainder of the June quarter's earnings but today people have discounted the current environment and really focused in on what happens in 2010 and beyond.

TWST: What is investor interest in this space like?

Mr. Close: On investor interest there is good amount of interest related to the fact that the stimulus is out there for the taking. We have talked to investors that have not normally looked at healthcare IT. They might be healthcare investors that are looking to remain invested in healthcare without the risks associated with healthcare reform that exist in other sub-segments of healthcare. We've seen generalists beginning to look at the area in an increasing fashion based on the opportunities of the stimulus. Investor interest is high from various investor groups. Additionally, technology investors have gravitated towards the area looking at the opportunities with the stimulus, not to mention the amount of growth that you might be able to achieve. Tech investors are still invested in the tech area but playing the health segment.

TWST: What are you advising investors to do?

Mr. Close: Right now we've been, for the last several months, relatively cautious on the healthcare IT sector based on the impact of the economic environment. Despite our cautiousness, the stocks have taken a run upward with the overall change in market sentiment, with people going towards higher beta names and, as a result, the healthcare IT stocks have definitely moved to the upside. Although the economy is improving from the near grinding halt earlier this year, I still believe this is a challenging business purchasing environment over the next couple of quarters. We've been telling investors not to chase these names at this point because some of the stocks have doubled from the lows of the year. We would look at pullbacks to provide entry points to get more aggressive on shares. Despite our short-term cautiousness, an investor can build a favorable longer-term scenario as the stimulus kicks in. Again, investors should be opportunistic in taking positions in these names.

TWST: Are there any stand-out companies that you're encouraging people to consider chasing?

Mr. Close: One name we do like hasn't necessarily moved that much with the stimulus, athenahealth (ATHN). Athenahealth has consistently gained market share over that last handful of years. It hasn't necessarily played a roll in the Electronic Health Records area to date, which is one of the primary components of the stimulus package. However, over the last year it has rolled out an Electronic Health Record offering called athenaClinicals. The company recently announced a nice-sized deal that looks to be the largest in the company's history. Of note, the deal includes the clinical or Electronic Health Records component. This is a big statement on athena's efforts in the electronic healthcare record area. Athena operates as a software-as-a-service, where all their clients are on the same network. This method is really an efficient way to roll out the technology to a lot of the physicians who practice in small groups, one to three doctors per group. These groups do not have a lot of technology being used in operating their practices. Additionally, they do not have the time and capital to deal with technology that is implemented on site. These physicians just want to see their patients; they can turn the record keeping and billing and collections over to athena. It's a very good company, I think, with a lot of runway, a lot of good revenue visibility, very safe model.

TWST: What about on the hospital side?

Mr. Close: At the hospital side, I would say Cerner is pretty well-positioned. We have a hold rating on Cerner at this time. Cerner has a pretty sizable customer base, serving a lot of hospitals here in the US. Hospitals have started the process event prior to the stimulus of implementing computer physician order entry systems, Electronic Health Records and various clinical technologies. Cerner is one of the largest players in that area, so they have a pretty extensive customer base. If hospitals are going to be getting money - and I think they are eligible for up to $4 million base - and then can get additional funds based on the number of Medicare discharges that they have, Cerner is well- positioned to benefit. With Cerner having such a large base, their customers are going to be receiving funds. To some degree, they probably go back and use those funds to buy additional systems.

TWST: Conversely, are there any names that worry you at the moment?

Mr. Close: There wouldn't be any names I have necessarily been worried about. We look at the stimulus opportunity as a rising tide that can lift all boats. When customers are going to be receiving money, whether it's hospitals or physicians, it's a positive scenario for all the major players. I definitely believe that there is a case here with all the healthcare IT names, that investors can realize steady revenue and earnings growth assisted by the stimulus. Investors just need to be careful in terms of where you buy these stocks in our opinion. A lot of these stocks have had great price appreciation despite mixed financial results. Investors need to pick points to enter these names. I think you can make money definitely over the next couple of years in the sector as a whole.

TWST: How do you think the healthcare stimulus or the healthcare program developed by Obama will affect innovative companies in this space?

Mr. Close: I wouldn't anticipate that it really negatively impacts companies' ability to innovate. This is because on a go-forward basis, healthcare reform should foster innovation because it will be continuously evolving and new tools will be developed to assist providers in meeting requirements. I do believe that the leaders will be the public companies, as they have greater access to capital to bring new products to market. All the major companies should be able to meet those expectations and requirements.

TWST: Are there any companies doing really interesting things at the moment?

Mr. Close: Yes, one company. It hasn't necessarily benefited from the stimulus, but one company, HMS Holdings (HMSY). Their focus is on fraud, waste and abuse in the healthcare system, primarily in the state Medicaid area. They offer the federal government and state governments program integrity services that look to cut waste and abuse in the Medicaid program. On healthcare reform, one of the cornerstones of healthcare reform efforts is finding fraud, waste and abuse in the system, combined with cost savings through the adoption of healthcare IT. So HMSY is a market leader in terms of the fraud, waste and abuse. They are also a dominant player in reducing the number of errors in Medicaid plans. HMS is in a great position right now with state governments facing budget shortfalls. The selling environment for their services over the next several years is favorable, and it's been a very good performer here year-to-date.

TWST: Thank you. (MRR)

RICHARD CLOSE Managing Director, Equity Research Jefferies & Company, Inc. 520 Madison Avenue, 10th Floor New York, NY 10022 (212) 284-2300 www.jefferies.com