Reform flattens health provider; Care: Integrated Health Services has plummeted within two years, a victim of Medicaid reform and ill-fated decisions.

THE BALTIMORE SUN

Integrated Health Services Inc., the Sparks-based health care giant that flourished by undercutting higher-cost hospitals, finds itself on the critical list, thanks in part to the same cost-cutting pressures that fueled its spectacular growth.

Weighed down by staggering debt and shrinking revenue, the once-pioneering IHS warned this month of growing losses and a squeeze on cash flow. It hired the investment house Warburg Dillon Reed LLC and business consultant KPMG LLP to assist in talks with lenders and to develop strategies.

The company's plight has put it on analysts' watch list of big companies in the industry that might seek Chapter 11 bankruptcy protection.

"I think the writing is on the wall for them," said Premila Peters, high-yield analyst for KDP Investment Advisors in Montpelier, Vt. "The question of the day is how much cash do they have left to keep going."

Analysts think a bankruptcy filing could come by year's end.

IHS and other companies in the industry are reeling from the impact of the Republican-championed Balanced Budget Amendment of 1997, which slashed payments for patients covered by the government's Medicare health program for the elderly, industry analysts said.

"It's wreaking havoc on this business," said Robert Maines, an Albany, N.Y.-based health care industry analyst with Advest Inc.

Acknowledging its bleak situation, IHS, which has 84,000 employees nationwide and had $3 billion in revenue last year, said in its announcement Oct. 19 that the Medicare cuts had had a "dramatically negative impact" on its revenue, cash flow and liquidity.

The company's mounting woes have erased more than $2 billion in shareholder wealth, reducing its market value to $14.9 million as IHS stock has plummeted from $40 in June of 1998 to 28.13 cents Friday.

Analysts say several miscalculations by IHS created the reckoning it faces. Among them:

The company incorrectly assumed it could reduce operational costs faster than it lost revenue from Medicare payments. It is still struggling to bring down costs.

IHS assumed that it could offset some payment reductions by increasing the number of days patients stayed at its centers. But insurance limits on the time patients can stay at sub-acute centers crimped that plan.

The company did not foresee that customers and payments for ancillary or rehabilitation therapy for such patients as stroke victims would decline, further depressing revenue.

Though IHS and other health providers blame the new Medicare payment system for their plight, analysts say company executives contributed to the problems with acquisitions, repurchases of company stock and taking on more debt even as the budget ax was falling.

"They didn't take steps they could have to conserve cash. Cash is king. Now they are sitting on a ton of debt," said Peters at KDP.

In its Oct. 19 announcement, the company, which carries $3.4 billion in debt, also disclosed that it was suspending an effort to sell its RoTech division. The Orlando, Fla., operation provides durable home medical equipment and respiratory services, a business sector the federal government announced late last week will face big Medicare cuts.

IHS had hoped a sale of RoTech -- bought in 1997 for $900 million -- would raise cash for operating needs.

Analysts suspect that IHS pulled back on selling RoTech because bond and debt holders demanded that cash raised be used to meet payment obligations. Also, analysts suspect that bidders for the division offered prices well below IHS's asking price.

How lenders react in talks to work out payment arrangements will have a lot to do with the company's near and long-term future, said Peters, the KDP analyst.

The company's debts are tied, in part, to a string of acquisitions IHS made between 1994 and 1998, as part of a bold strategy to broaden services.

Integrated Health Services was founded in 1986 by Dr. Robert N. Elkins, a 55-year-old Ivy League-trained physician, who saw opportunity in the national push to hold the lid on health care costs. He built a network of centers that provided rehabilitation services and sub-acute care for those released from hospitals but too sick to go home, specialty therapy services for nursing home residents and home care services.

The reclusive Elkins, who serves as IHS's chairman, chief executive officer and president, declined to be interviewed about the company's situation, as did other company executives.

One thing is clear, said Peters: Integrated has no where to turn for more cash. "The capital markets at this point are completely closed off to them," she said.

Standard & Poor's has lowered its credit rating on the company to near "junk" bond status, a move that makes it impossible to borrow further to make debt payments. The company's bonds currently trade for about 6 cents on the dollar.

The string of bad news comes as the company sets up operations and 1,500 employees at a new multimillion-dollar headquarters in Highland Business Park north of Hunt Valley.

Spending on improvements such as the new headquarters building, and IHS's $24 million stock buyback program this year came at a time when the company should have been conserving cash to weather the transition to the new Medicare payment system, say analysts.

Such decisions in the face of revenue cuts fueled Wall Street's flight from the company.

The changed times are a marked contrast to the heady days of 1994 when the company raised $100 million in a third public offering of its shares on Wall Street.

IHS's troubles are a microcosm of an industry in upheaval.

Since September, at least two major nursing home and sub-acute care operators, Vencor Inc. and Sun Healthcare Group Inc., have filed for Chapter 11 bankruptcy protection.

Sun Healthcare of Albuquerque, N.M., one of the nation's largest nursing home operators, sought court protection Oct. 13 after defaulting on more than $1.57 billion in loans and bonds. The company has fired almost 7,500 workers since the new Medicare system, called the Prospective Payment System (PPS), took hold. On Wednesday, it announced tentative agreements to reorganize its debt.

Under PPS, which began taking effect last year, nursing home operators and sub-acute centers are paid a fixed fee per patient based on the patient's condition.

The fee structure is being phased in over five years. Before PPS, operations were reimbursed whatever they billed, usually a fee based on their cost of care for specific patients plus a profit margin averaging 35 percent.

In March, Elkins said in a statement: "PPS has clearly been more adverse than most people anticipated."

IHS has never specified just how payments due it have fallen. But other companies have.

Genesis Health Ventures, a Kennett Square, Pa.-based skilled nursing home owner which has operations in the Baltimore area, says payments have fallen about $60 a patient to about $305 a day.

Blaine Hendrickson, owner of Rancho Mirage, Calif.-based Legacy Health Care, told House Ways and Means health subcommittee members at an Oct. 1 hearing that Medicare payments for patients with multiple medical needs, or "medically complex patients," have fallen dramatically under PPS.

Under the new payment system, Hendrickson said, payments for such patients, who often need around-the-clock care, medications, and physical or other therapy, fell to an average of $231 a day from $408 a day.

The new system has been particularly tough on IHS because the company had invested heavily in so-called ancillary care services, such as respiratory therapy, in an effort to be a one-stop provider for those needing medical care outside a hospital, said Maines, the industry analyst.

Linda Keegan, vice president for the American Health Care Association in Washington, says companies such as IHS which invested heavily in providing rehabilitative services, have been hit particularly hard by a PPS provision that places a $1,500 a year ceiling on patients needing such services.

Keegan said association studies have found that it costs on average $3,000 a year to care for such patients who often have numerous medical needs. The ceiling, she said, is not only hurting companies, but patients. "People are avoiding services to hoard their Medicare money in case they need it later in the year," Keegan said.

For IHS, the past year resulted in a 17 percent decline in revenue to $1.24 billion for the first six months and an $11.2 million loss. In the same period last year, IHS booked a $79 million profit.

In the middle of all the upheaval, House and Senate leaders are trying to forge a $9 billion package to help the suffering industry.

Analysts aren't hopeful that Congress will adequately address the situation soon.

Maines, the industry analyst, said, "It's like an executive in the industry told me the other day: 'This isn't a life preserver. It's a piece of driftwood.' "

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