Close to Home

Close to Home

By Jean Gruss | Editor/Lee-Colier

When J. David McCormack arrived at Peace River Regional Medical Center in February 2005, the Port Charlotte hospital had 22 managers.

Today there are just four, including McCormack, the hospital's chief executive officer.

Lean management like that is one reason why Naples-based Health Management Associates is one of the most profitable hospital companies in the country. HMA bought Peace River Regional from Bon Secours Health System and turned it around the same way it has dozens of other underperforming hospitals. It brought in a seasoned chief executive, cut middle management, invested in new equipment, recruited doctors and used the company's heft to get volume discounts on expensive supplies.

Under the leadership of William Schoen, 70, now chairman of the board, HMA now operates 60 hospitals in 16 states, including 20 hospitals in Florida. Fortune magazine recently ranked HMA as the most admired company in its industry for 2006 and the hospital chain was one of only nine most admired Florida companies to make the 303-company list.

For the fiscal year ended Sept. 30, 2005, HMA reported net income of $353 million on revenues of $3.6 billion. Schoen is the largest individual shareholder, owning 9.6 million shares recently valued at $204 million.

In 2001, Schoen ceded the management reins to Joseph Vumbacco, 60, a former real estate executive with Turner Corp. who joined HMA in 1996 and now is the company's chief executive officer and vice chairman. When Vumbacco started in 1996, HMA had 19 hospitals and $500 million in revenue. Vumbacco's total compensation in 2005 was $1.69 million.

Vumbacco has recently tweaked HMA's winning formula of acquiring small rural hospitals and turning them around. For example, the company recently formed a partnership with Orlando Regional Healthcare, a not-for-profit hospital, to acquire an 80% stake in Orlando Regional St. Cloud Hospital. This is the first time HMA has partnered with a not-for-profit hospital (see related story, next page).

HMA may have to find more creative deals as it faces dramatic changes in healthcare spending and a growing number of competitors seeking to emulate its success in rural areas. As employers shift a greater portion of rising healthcare costs to their employees and states cut back on Medicaid funding for the poor, all hospital companies have been forced to write off a greater portion of their revenues. HMA's provision for doubtful accounts rose from $186 million in 2003 to $306 million in fiscal year 2005, nearly double in two years.

"It doesn't show any signs of abating," says Vumbacco.

Indeed, charity care has started weighing on profitability. The company's net margin has fallen from 11.1% in 2003 to 9.8% in 2005, according to a profitability analysis by Morningstar.

Despite the adverse trend, HMA's margin is twice that of its industry peers and it's widely acknowledged as one of the best operators in the country.

Small towns = winning strategy

Vumbacco is fond of repeating the five words that constitute the HMA's mission: "Excellent healthcare close to home." It reflects HMA's strategy of carefully acquiring underperforming rural hospitals, then buying new equipment and recruiting physicians so local residents don't drive long distances to urban areas for similar care.

HMA targets existing hospitals in the Southeast with growing elderly populations and in states that require regulatory approval to build a new hospital or add beds. This way it benefits from growth while keeping the competition at bay.

Peace River Regional is a case in point. The 212-bed hospital in Port Charlotte was unprofitable and local residents often traveled as far away as Tampa or Orlando for hospitalization. But the hospital fit HMA's profile because it's in an area with a fast-growing elderly population and Florida's regulatory approval process limits competition.

When McCormack came in as the new chief executive at Peace River Regional, HMA invested $5 million in new equipment that included computer systems to cut wait times. McCormack eliminated 18 management positions so he could hire more doctors and nurses.

He also streamlined operations. For example, when patients enter the emergency room, a nurse is the first person to greet them, instead of a clerk or a security guard.

A proprietary computer system called Nurse First helps the nurse immediately order tests so the doctor can review them when he first examines the patient. The result: Patients receive faster service and the hospital can admit more people in its emergency room.

HMA doesn't break down emergency room statistics by individual hospitals, but Vumbacco says that the company strives to reduce wait times in its emergency rooms to two hours or less. That compares with national wait times of four to six hours.

To further streamline the emergency room registration process, HMA has distributed more than 1.5 million identification cards to current and prospective patients called MedKey. The credit-card sized MedKey contains personal information so that the patient can skip filling out most of the tedious paperwork that is the bane of every emergency room visit.

The emergency room isn't the company's only focus, however. At Peace River Regional, for instance, McCormack says he plans to spend another $5 million this year on equipment such as a faster magnetic resonance imaging machine (MRI) that can perform 25 outpatient tests per day instead of 15 with the older machine. "We have a sense of urgency about what we do," McCormack says.

The only hospital in town

To keep track of activity at its far-flung hospitals, HMA has developed another proprietary computer system called Pulse, which keeps track of everything from admissions to surgeries and related financial information. At any time, Vumbacco and the company's executives in Naples can review any of its hospitals' operations on a daily basis.

Faster and more efficient service also helps recruit doctors. HMA employs few doctors, preferring to contract with physicians who run their own practices. These physicians help patients make decisions on which hospitals to use, so HMA strives for better and faster service to win business from doctors.

In rural areas where there are physician shortages, HMA will often lend money to help doctors move there to establish a practice. These loans are typically forgiven over a two- to three-year period, contingent on the physicians continuing to practice in the community. Because there's typically less competition in rural areas, physicians generally receive higher insurance reimbursements than their colleagues in highly competitive urban areas.

Because the hospitals HMA owns are often the only hospital in town, the company can negotiate better payment terms from private insurers that represent 47% of the company's revenues. Other payers are Medicare (35%), Medicaid (10%) and self-payers (8%).

Medicare is the federal health insurance program for older people and Medicaid is the state health insurance program for the poor. HMA says Medicare reimbursements have been adequate and cuts aren't likely because of the approaching congressional and presidential elections.

But some states have started cutting Medicaid funds. To counter some of that, HMA hospitals routinely help indigent patients fill out the often lengthy and complicated paperwork required to qualify for and make claims under Medicaid. "So far," Vumbacco says, "we've been able to weather it."

Although financial reporting is centralized at the company's Naples headquarters, each hospital is responsible for its own billing and collections. HMA says this decentralized approach means administrators are much more aggressive about collecting unpaid bills because they're held accountable.

Leveraging growth

Through the mid-1990s, HMA typically acquired about one hospital a year. When Vumbacco joined the company in 1996, the company became more aggressive, and by 2000 it was buying two to four hospitals a year.

Until now, much of the growth has been fueled by debt and internal cash flow. But the company is now buying five to seven hospitals a year, which may require additional sources of financing.

In January, investors exercised their right to have HMA repurchase $317.3 million worth of existing bonds. To repay bondholders, HMA used money from a $600 million line of credit from a syndicate of banks. As of Feb. 2, $60 million was available for borrowing; the banks have since agreed to lend HMA another $150 million.

With a low level of debt on its balance sheet, HMA is in a strong position to return to the bond markets if it chooses. However, company officials say they plan to remain conservative in their use of debt. "We don't believe in over-leveraging," Vumbacco says.

Still, some analysts viewed the hiring in November of Burke Whitman, 49, as the new president and chief operating officer, as a sign that the company may increase its reliance on debt for future growth. Whitman was the former chief financial officer of Triad Hospitals, a competitor that used leverage more aggressively than HMA, says Curt Morrison, an analyst with Morningstar in Chicago.

"He'll bring a different set of eyes," says Morrison. "The company has room to handle more leverage."

Meanwhile, there's growing competition to acquire rural hospitals, which may drive up prices investors pay. HMA's pioneering success has attracted other hospital companies such as Lifepoint Hospitals and Community Health Systems. More recently, private-equity groups that seek to mimic HMA's strong returns have also started to acquire rural hospitals.

Vumbacco says private equity firms prefer to buy groups of hospitals, while HMA usually narrows acquisitions to individual hospitals. Plus, Vumbacco says HMA's track record attracts hospitals that want to negotiate a sale, rather than put themselves up for bid and end up with a less seasoned, but more aggressive operator. "We pass on many more than we acquire," he says.

As for geographic diversity, Vumbacco says HMA may expand beyond the Southeast, though there is no timetable for that. "There's no map in the other room that says that in 2007 we'll be in Colorado," Vumbacco jokes. Still, he says the company may find more opportunities in Mississippi and Texas, as well as the Midwest and western states.

Florida hospital deals

highlight HMA's creativity

Two recent hospital acquisitions highlight Health Management Associates' creative deal making under Joseph Vumbacco, its chief executive since 2001.

On Jan. 24, HMA said it had reached a deal to buy the Cleveland Clinic's Naples hospital. A few weeks later, it acquired a controlling interest in Orlando Regional St. Cloud Hospital.

Of the two deals, the Cleveland Clinic created the bigger splash because of the Cleveland's Clinic failure to make inroads in Collier County. But from a strategic standpoint, the St. Cloud hospital acquisition is more significant.

By acquiring an 80% stake in Orlando Regional St. Cloud Hospital for $38.2 million, HMA teamed up with Orlando Regional Healthcare, a not-for-profit organization. Normally, HMA buys a hospital outright and it has never co-owned a hospital with a not-for-profit organization.

The negotiations with Orlando Regional began as HMA was planning to build a new hospital north of Orlando. In the course of discussions, Vumbacco says the two organizations agreed on a deal that would provide Orlando Regional Healthcare with much-needed capital. Besides the St. Cloud hospital, Orlando Regional Healthcare operates seven hospitals including the M.D. Anderson Cancer Center Orlando and the Arnold Palmer Hospital for Children and Women.

For HMA, the deal allows it to tap into Orlando Regional's vast managed-care network and an immediate source of doctors and patients. "We would not have acquired St. Cloud without the partnership," Vumbacco says.

With a majority stake, HMA can now run the St. Cloud hospital with the same laser focus on efficiency and improving operations as it does with its other hospitals. "The mission is the same," Vumbacco says. "That's where our cultures matched up."

Officials with Orlando Regional Healthcare declined to comment on the deal.

Vumbacco says the St. Cloud hospital deal does not represent a shift in the company's acquisition strategy. However, he says that HMA will consider similar deals on a case-by-case basis. "I think there are opportunities to do some more," he says.

Meanwhile, HMA agreed to buy the Cleveland Clinic's 83-bed Naples hospital. The Cleveland Clinic opened the hospital in 2001 but faced tough competition from NCH Healthcare Systems, another not-for-profit organization based in Naples.

Because the deal won't close until later this spring, HMA and Cleveland Clinic officials declined to provide details, except to say the hospital's inability to obtain regulatory approval for a new cardiac facility in Naples was a main obstacle to its expansion. The Cleveland Clinic is world-renowned for its cardiac care, so denial of its program was a significant setback.

Vumbacco says HMA and Cleveland Clinic were on good terms because HMA supported Cleveland Clinic's bid for a cardiac center while the Cleveland Clinic supported HMA's new 100-bed hospital under construction in south Collier County. NCH Healthcare, which has more than 500 beds in Collier, opposed the Cleveland Clinic's cardiac-center bid. An NCH spokeswoman declined to comment.

Health Management

Associates

Headquarters: Naples

CEO: Joseph Vumbacco

FY 2005 revenues: $3.6 billion

Stock symbol: HMA

Recent stock price: $21.20

52-week stock-price range: $20.41 to $27

Price-earnings ratio: 15

Dividend (Yield): $0.24 (1.1%)

Market capitalization: $5.1 billion

Sources: Securities and Exchange Commission, Yahoo Finance.

Health Management Associates

Income Statement

(in thousands) Years ended Sept. 30

Revenues 2004 2005 %Chg.

Net patient service revenue 3,174,832 3,554,533 12%

Gains on sales of assets & insurance recoveries 0 34,289

Total revenue 3,174,832 3,588,822 13%

Costs and expenses 2004 2005 %Chg.

Salaries and benefits 1,242,470 1,393,647 12%

Supplies and other 946,056 1,080,657 14%

Provision for doubtful accounts 239,628 305,559 28%

Depreciation and amortization 133,644 155,173 16%

Rent expense 64,705 72,452 12%

Interest, net 16,182 12,922 ?20%

Total costs and expenses 2,642,685 3,020,410 14%

Net income 325,099 353,077 9%

Balance Sheet

Assets 2004 2005 %Chg.

Cash and equivalents 112,946 78,575 ?30%

Accounts receiv. less allow.for doubtful accounts 588,046 634,280 8%

Accounts receivable, other 38,103 47,160 24%

Supplies, at cost 78,927 91,865 16%

Prepaid expenses 80,215 107,701 34%

Restricted funds 16,852 10,578 37%

Assets of discontinued operations 19,482 17,996 ?8%

Deferred income taxes 23,541 0

Liabilities 2004 2005 %Chg.

Accounts payable 140,695 181,776 29%

Accrued payroll and related taxes 62,119 75,766 22%

Accrued expenses and other liabilities 85,299 119,278 40%

Dividends payable & treas. stock repurchase oblig. 9,739 31,158 220%

Due to third-party payers 9,573 12,575 31%

Deferred income taxes 0 14,966

Cur. maturities/long-term debt & capital lease obligations 9,742 633,338 6,400%

Deferred income taxes 121,618 121,491 ?0.01%

Other long-term liabilities 96,500 95,887 ?1%

Long-term debt & capital lease oblig. less cur. maturities 925,518 366,649 ?60%

Minority interests in consolidated entities 43,369 45,828 6%

Total liabilities 1,504,172 1,698,712 13%

Source: Securities and Exchange Commission filings