Shortly after Detroit Medical Center recorded a big operational improvement for 2001, reducing losses to $6 million from $34 million in 2000, its management and its bankers pressed ratings analysts for an upgrade.
They especially coveted a bump from Fitch Ratings, the only one of the three rating agencies that carried a noninvestment-grade rating on DMC's nearly $600 million of outstanding bonds.
But Fitch wouldn't budge.
"We said, 'This is great. We commend you.' But we felt it was necessary to have more time to validate a sustained turnaround," says Craig Kornett, a senior director at Fitch.
For Fitch, it turned out to be the right call. Instead of completing a recovery, the system spiraled further into the red, posting a loss of nearly $102 million in 2002. Instead of the upgrade its officials had sought, the system saw its credit ratings plummet. Now, all three rating agencies hold DMC at speculative grade.
Former DMC Chief Financial Officer Nick Vitale acknowledges that in hindsight, he and other DMC officials should have been more conservative in revenue growth projections for the system's suburban facilities, which were expected to offset an increasing indigent-care load. "We felt at the time that we had the necessary plan in place to achieve the results we were budgeting. Clearly, the volume we were anticipating did not develop," he says.
Such scenarios are not unusual in the increasingly volatile hospital industry, where rating downgrades have outpaced upgrades for six consecutive years. Several hospitals and systems have declared a turnaround, only to experience another backslide. Among them: Columbia Hospital for Women, Washington; Island Medical Center, Hempstead, N.Y.; and Mount Sinai Medical Center, Miami Beach, Fla.
Experts say turnarounds are becoming more difficult to sustain because basic cost-cutting moves already have been made.
"The hospitals we're going into now have already had one or two firms that have tried to turn them around over the last three or four years. A lot of the low-hanging fruit has already been taken care of," says Tom Singleton, president of Cambio Health Solutions, Brentwood, Tenn., which employs about 50 full-time consultants.
Cuts in unprofitable services, managed-care contract revisions, physician practice divestitures, staff reductions and wage freezes-steps that might have been sufficient to achieve a turnaround a few years ago-are being replaced by more complicated strategies to enhance revenue and improve clinical efficiency, experts say.
Those steps include recruiting physicians, standardizing clinical processes, improving collections and supply management and developing new service lines.
To achieve these goals, turnaround firms are hiring more operational consultants such as nurses, revenue and supply cycle specialists, and strategic marketers, in addition to financial experts. In some cases, engagements last two years or more as firms stay on to do heavy lifting.
Spinning their wheels
Consultants say sometimes their handiwork is wasted because hospitals have waited too long to act, or because managers fail to continue monitoring and improving performance once the consultants leave.
"Boards probably have some responsibility for not being as diligent as they should have been in holding their management teams accountable," says George Whetsell, a principal at Wellspring Partners, Chicago. In 2000, Wellspring led a turnaround effort at Mercy Hospital and Medical Center in Chicago, a standalone not-for-profit that has continued to hemorrhage red ink and is now on the selling block, despite receiving state financial assistance.
Not-for-profit Columbia abruptly closed in May 2002, three years after emerging from the first of two bankruptcies with a plan to improve operations and expand services.
Reynolds & Co., New York, which was hired during the hospital's second bankruptcy, says it helped Columbia make operational improvements that yielded more than $3 million in savings and identified opportunities for future cuts. But ultimately Columbia's bank lender forced a closure when it would not amend financing terms, says the firm's president, James Reynolds.
Officials at the independent, 75-bed hospital near Capitol Hill blamed the closure on late payments from insurers and inadequate Medicare and Medicaid rates, but Reynolds believes the hospital's board and management could have acted years earlier to address its shrinking volume as women of child-bearing age moved to the suburbs.
Months before Columbia closed its doors, congressional representatives approved a $5 million federal grant to fund its operations. "I think Congress felt kind of a moral obligation," Reynolds says. "But I think the place was just too far gone."
In some cases, turnarounds are undermined by shortsightedness. "There is a tendency to slash and burn and make bad decisions in the urgency of the moment," says Paul Salomon, chief operating officer at 217-bed Henry Mayo Newhall Memorial Hospital, Valencia, Calif., which emerged from bankruptcy earlier this year.
Newhall Memorial turned a $15 million operating deficit in fiscal 2001, ended Sept. 30, to a profit of about $7 million in fiscal 2003. The hospital's annual revenue is about $95 million. Key moves in the restructuring included ending unprofitable services, reducing reliance on temporary staffing, updating its charge structure and renegotiating real estate leases and managed-care contracts, Salomon says.
The hospital also decided to restore its behavioral health program, which had been decimated in the early stages of the hospital's financial crisis. Salomon says the previous administration closed its outpatient behavioral health facilities, which were losing about $700,000 a year; those moves hurt the inpatient program as well as eliminating an important community service.
The outpatient program has since been reopened with a lower cost structure and now generates about half a million dollars in profits annually, Salomon says.
Some hospitals and systems can't be turned around absent a change in their financial structure, say experts, who point to Detroit Medical Center as a prime example. In Detroit, a state-appointed task force has been charged with exploring long-term solutions to the system's indigent-care load, including creation of a public authority.
Vitale, who left DMC in August to become CFO at two-hospital Bon Secours Cottage Health Services, Grosse Pointe, Mich., credits the Hunter Group, which was hired to orchestrate a turnaround at DMC, with doing "a lot of things that needed to be done," such as privatizing physicians.
But despite operational improvements that continued after Hunter left, he says, "Revenue continued to drop. Payer mix didn't improve." Vitale says the experience taught him to be "ultraconservative in the good-news assumptions."
Proceeding with caution
Meanwhile, rating agencies are becoming more cautious in declaring turnarounds. Deciding when to change a rating outlook from negative to stable or positive, indicating that a hospital or system has turned a corner financially, is tricky, says Martin Arrick, managing director of Standard & Poor's not-for-profit healthcare group. He cites Mount Sinai in Miami Beach, which had a year or two of improved results before slipping in 2001. The system has been undergoing another turnaround.
"You have to get around all the noise in the numbers and pull out the one-time stuff," Arrick says. "And you have to make judgments."
Managers, let alone analysts, are often taken off guard by changes in government reimbursement and market conditions, such as the proliferation of specialty hospitals. Analysts say subjective measures, such as how management reacts to unexpected problems, can sway an analyst's opinion of a hospital's long-term viability.
Catholic Healthcare West won an outlook change from Standard & Poor's in October, to positive from stable, indicating that the rating agency might raise the system's BBB rating if it continued to show operating profits and improve its balance sheet. But it took the 41-hospital system several years to convince analysts that it had passed its nadir.
Analysts were encouraged that the system reported its first positive operating margin since 1996, albeit a small one at 1%, and beat its own stated projections for the year ended June 30. It also helped that Catholic Healthcare West achieved its projected results a year earlier despite the January 2002 defection of three of its 48 hospitals to its sponsor, the Daughters of Charity Health System.
"They took an $80 million or $90 million hit to their income statement and they still managed to do better and reduced the magnitude of their (total system) loss," Arrick says. "It was around there that I thought, OK, back to stable." Arrick says the system still needs to continue its improved results and strengthen its balance sheet to achieve an upgrade.
Even the definition of turnaround, which used to imply that a company needing one was losing money, is changing. Even hospitals that operate in the black are calling in turnaround firms. Lawrence Scanlan, managing director at Hunter, a unit of Navigant Consulting, Chicago, calls them the "worried well," hospitals with positive margins that are weakening financially because of lower Medicare and Medicaid reimbursements while their cushions of investment income have disappeared.
"The need for capital expenditures to keep up with technology and increasing demand for services surpasses the cash generation of even the organizations that are doing well," Scanlan says. "Even a 3% operating margin is not going to be sufficient to meet their communities' needs moving forward."
Via Christi Health System, Wichita, Kan., never went into the red but nevertheless hired Wellspring Partners for guidance to help make decisions on reducing staff, cutting supply expenses and improving collections amid increasing competition from physician-owned specialty hospitals. Its goal was to increase its operating margin from 1% to 5%, Whetsell says. "They treated it as a turnaround," he says.
Reynolds & Co. is advising a highly profitable AA-rated community hospital in the Southeast that is worried about shrinking Medicaid reimbursements and new competition for its lucrative children's and cancer services, Reynolds says. "We are looking at a laundry list of things to fill the gap" between revenue and expenses, Reynolds says, including improving productivity of clinical departments and improving clinical outcomes. "It's a turnaround on the clinical side," he says.
In California, Newhall Memorial hopes to increase its operating margin to a generous 15%-which Salomon says will negate the need for future borrowing. It benchmarks its financial performance measures to the top 25% of midsize California hospitals.
As far as Salomon is concerned, a turnaround is never completely over. "The disciplines we have in place have got to continue. If short-term the idea is that we have to hit certain margins, we're done. But we can't return to the old practices," he says.
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