Creating Regional Health Networks: Q&A With LifePoint Hospitals CFO Jeff Sherman
Jeff Sherman has led the financial operations of Brentwood, Tenn.-based LifePoint Hospitals, one of the five largest acute-care, for-profit hospital networks in the country.
Last year, LifePoint recorded more than $3.39 billion in total revenue, and this year, the company expects revenues to top $3.65 billion. A major reason behind the optimistic projections is an increase in its hospital base.
Like many other for-profit hospital operators throughout the country, LifePoint has been ramping up its acquisitions of independent community hospitals, many of which are finding it harder to operate in today's healthcare environment without a parent company for support. Mr. Sherman says mergers and acquisitions in the hospital sector today are a lot more nuanced than before. The financial aspect is omnipresent, but companies like LifePoint are factoring in several other demographic and reform-based reasons as well, such as population growth and high-quality care delivery.
Here, Mr. Sherman sheds some light on LifePoint's recent spate of hospital transactions, why the hospital M&A market will most likely continue to proliferate and how hospital CFOs today can make the right decisions.
Question: LifePoint is one of the biggest players in the hospital market, and your organization has announced a flurry of acquisitions so far this year: Fauquier Health in Warrenton, Va., Bell Hospital in Ishpeming, Mich., and Portage Health in Hancock, Mich. Can you talk about these transactions and how they fit in LifePoint's strategy right now?
Jeff Sherman: As a starting point, LifePoint operates 57 hospitals in 20 states. These communities are similar to the communities you just mentioned, and these acquisitions have been announced but not completed.
In Michigan, the two announced acquisitions are very consistent with our strategy to form a regional network to provide the full continuum of care. We acquired Marquette General Hospital in September 2012 through Duke LifePoint Healthcare, our joint venture with Duke University Health System. Marquette is the only tertiary care hospital in the region, serving 300,000 residents in the Upper Peninsula of Michigan, and as we think about developing regional networks, Marquette represents the foundation of that network. The two additional acquisitions that have been announced up there lead to the full continuum of care, from the community level up to the tertiary level, and this represents a very exciting opportunity for us.
Fauquier is another great opportunity. We currently own five hospitals in Virginia, and Fauquier is another outstanding hospital with the potential for growth. This is a state where we have a significant presence, and it makes sense to add to that. It will increase our market leverage.
We are seeking hospitals in faster-growing communities with a more diversified employer base to complement our existing portfolio of hospitals. Our acquisitions over the last four years have been consistent with this approach, while offering clinical, financial and operational resources to help newly acquired hospitals grow and thrive in the future.
Q: What are your general impressions of the hospital M&A market right now, even outside of LifePoint's moves? It's been at a feverish pace for the past three years — do you see this continuing? And what are the biggest factors behind it?
JS: As we view it, there will continue to be a lot of activity going forward, especially for small community hospitals that aren't affiliated with a bigger system. As we think about hospitals and what are their reasons for looking to partner, there are a couple that stand out: accessing capital for growth and expansion and the ability to recruit physicians. LifePoint is recruiting more than 200 physicians per year, and the centralization of our resources for physician recruiting makes it easier for us. We have built the infrastructure to help do that, too.
It's increasingly difficult for freestanding hospitals to navigate the regulatory environment, including the Affordable Care Act, meeting meaningful use, the ICD-10 conversion — even just daily Medicare and Medicaid changes that are coming out. We believe many hospitals can't afford the increasingly complex technology demands — HITECH, meaningful use, computerized physician order entry, clinical interfaces. At LifePoint, we have a quality department, an IT department, a compliance department, a revenue cycle department and others with resources to stay on top of these daily demands and changes. All of those factors and changes are continuing to exert pressure on unaffiliated hospitals.
We think we're well-positioned to benefit from that. With the right emphasis on quality, and certainly with our partnership with Duke, we can help invest in the future. Communities and community hospitals are equally concerned about the acquiring company's ability to invest in the future. So, with our relatively low leverage and financial strength, we have the resources to compete and expand in those communities.
Q: So does this mean that LifePoint has more acquisitions in mind this fiscal year?
JS: We don't put out specific numerical targets, but over time, LifePoint will continue to acquire hospitals. It is difficult to predict the timing of when an acquisition will take place with local non-profit boards, county officials and, many times, state's attorney general involved.
We're looking to grow both organically in our existing hospitals but also through acquisitions. With more and more hospitals looking for strategic partnerships and alliances, we believe we have a flexible approach that can be tailor-made for an individual hospital.
Q: LifePoint has many hospitals across the country. How does LifePoint know what hospitals make for good partners, and is all consolidation good consolidation?
JS: We have what we characterize as an aggressive but disciplined approach. We perform a significant amount of due diligence to see if a hospital is a cultural fit for LifePoint, and we look to our "High Five Guiding Principles" to help make acquisition decisions. Essentially, we want to create a regional network to provide a local continuum of care, and we are looking at hospitals in communities with faster population growth and a more diversified employment base. The economic environment of the state and local community is also a factor.
In terms of all consolidation being good consolidation: When we acquire hospitals, we view it as adding and expanding services to better meet the needs of their local communities.
Q: LifePoint's revenue topped $3.39 billion in FY 2012, an increase of 12 percent from FY 2011, while profit slipped 6.8 percent to $151.9 million. What do you see as the major catalysts behind the revenue gains? Conversely, what were some of the major reasons behind last year's drop in profit?
JS: Acquisitions represented a big piece of the revenue growth in FY 2012 as well as continued growth in outpatient services. We completed a couple acquisitions earlier in the year, and then the Marquette transaction was finalized in September. That was a large acquisition.
The single biggest reason for the decline in operating income was related to a significant increase in depreciation expenses, which were up $27 million. We made significant upfront investments in IT, which are preparing LifePoint to qualify for HITECH funding available by meeting meaningful use requirements. These capital investments typically have shorter lives, meaning they depreciate over a shorter period. In 2012, we made more than $100 million in IT investments, so those upfront investments drove bigger depreciation expenses. We ramped up physician employment, so that also put pressure on our margins in 2012. We also view this as a long-term investment by expanding physician presence in our markets and adding new services, like cardiology and oncology.
Q: Can you talk about some of the biggest issues around Medicare, Medicaid and commercial payors? What worries you, and what gives you hope?
JS: When I think about Medicare, there is a continuing pressure on reimbursement. There are reductions related to the Affordable Care Act, both in the market basket adjustment and also in disproportionate share payments. There have also been Medicare cuts with the fiscal cliff deal earlier this year, sequestration, reductions related to Recovery Auditor [RAC] audits and prepayment audits — all of this at a time when the bar is being raised on performance. Hospitals are now being penalized for higher readmission rates and hospital-acquired infections, or they receive some incentive for good clinical performance. Pay-for-performance will be an increasingly important factor in hospital reimbursement going forward.
At LifePoint, we believe we are well-positioned to be successful under pay-for-performance methodologies in the future. Over the last four years, we have made significant investments in our quality program. We are one of 26 organizations — and the only for-profit organization — selected by HHS to receive a hospital engagement network contract. Duke is assisting in this effort as well, which is focused on improving quality and clinical outcomes.
For Medicaid, we are keeping up with the regulatory changes in 20 states. Our hospital leadership teams do a great job of staying informed by participating in local and state hospital associations and advocating for rural health issues at the state and federal levels. We represent an important voice for rural health in the country, and we've taken a leadership role in explaining the importance of rural hospitals at the state and federal levels.
Overall, Medicare and Medicaid represent roughly half of our reimbursement, and we are expecting Medicare reimbursement to be flat and Medicaid down slightly in 2013. With half of our revenue base being flat for the year, that's a challenge. In terms of looking at the Affordable Care Act, there is an opportunity for us, most importantly with the expansion of coverage for the uninsured. We don't have charity care hospitals in our markets, so our hospitals treat all of the uninsured patients today. If patients don't have primary care physicians and the flu hits, they come to our emergency room. To receive payment for what we're already treating is a positive for us.
Q: You mentioned the Patient Protection and Affordable Care Act as having some opportunity, particularly with expanded health coverage. What other components of the PPACA do you find to be most promising? ACOs? Bundled payments?
JS: For us, first and foremost is expanding coverage. If a state decides to expand Medicaid, that's pretty seamless for us, too. We are already doing Medicaid eligibility screening for patients today, and we'll see that ramp up very quickly. With regards to exchanges, there are still a lot of uncertainties about how quickly they are going to ramp up. We are making plans to help educate our communities and patients that would quality for exchange products. How can we assist them and be a key educator for them? We're going to be seen as the experts of healthcare reform in our communities, so we intend to be proactively involved in engaging our patients and educating them about the new programs, how they work, what subsidies they are entitled to, etc.
We will be working with physicians to align with them for new payment methodologies in the future. When I think about ACOs and taking on full risk, that's comparable to capitation. We expect those forms of reimbursement will come more slowly to the nonurban markets in which we operate, but we are doing several things to prepare. We are employing more physicians, especially primary care physicians, and as we do that, we'll be positioned well regardless of what reimbursement forms occur over time.
Q: What advice would you give to other hospital and health system CFOs right now? What are the biggest differences between being an individual hospital CFO and a system CFO?
JS: I've been both — I grew up on the hospital side as an individual hospital CFO, both at smaller and larger hospitals. Whether big or small, CFOs must encourage leaders to act as owners of the business, and the right decisions will evolve over time. The key challenge is you have to be investing for future growth while maintaining current performance. It can be conflicting at times. We're managing LifePoint for the long term, but we still have to meet our short-term financial objectives while continuing to improve the quality of care and service that we provide.
We operate in many diverse markets with large and small hospitals, so it's difficult to encapsulate the entire company. Hospitals are driven by local issues, local macroeconomic issues, physician relationships. At times, it is challenging to summarize broad trends because of local dynamics, but it's critical for the CFO to be a key strategic partner to the CEO and to drive future performance and help hold the organization accountable to performance standards.
Q: What is the most difficult aspect of being a CFO of a large hospital chain? What are some of the toughest decisions you have to make, daily, weekly, monthly?
JS: Whether it is system-wide or for an individual hospital, some of the toughest decisions are ones that impact employees. Recently, we decided to adopt a shared services approach and outsource our back office functions to Parallon Business Solutions. This change will allow us to become more efficient and improve our performance in those areas. Some of our employees were hired by Parallon, but it was still a difficult decision because it impacted people across our company. However, we knew it was the right decision for the company. We always weight these types of decisions against the "High Five Guiding Principles" of the company.
Also, with limited capital to deploy, it's been my experience over 25 years that there is an insatiable appetite for hospitals to spend capital. It's critical to balance capital investments. How and where to deploy capital are always difficult decisions to make, and you must balance priorities.
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