Smart Business Forecasting: Turning HME Threats Into Opportunities

July 28, 2014 The Lodge & Spa at Callaway Gardens Pine Mountain, GA

Before we begin…some comments regarding the potential for nationwide implementation of competitive bid programs and/or pricing and the Round 2 “recompete”…

• •

CMS-1614-P

The Affordable Care Act amended the Medicare Modernization Act statute to mandate use of information from the DMEPOS competitive bidding program to adjust the fee schedule amounts for DME in areas where competitive bidding programs are not implemented by no later than January 1, 2016. CMS estimates that by applying bid rates throughout the entire United States it would save over $7 billion over FY 2016 through 2020.

DME Provisions…

• • Proposed (changes to) the methodology for making national price adjustments based upon information gathered from (all previous) competitive bidding program (CBPs). Proposed phase in of special payment rules in a limited number of areas (12) under the CBP for certain DME and enteral nutrition.

• • Update the definition of minimal self adjustment of orthotics.

Change of Ownership Rules to Allow Contract Suppliers to Sell Specific Lines of Business

“National” Pricing

• • • How? Adjust fee schedule amounts for states in different regions of the country based on previous competitive bidding round pricing in these “regions”. The regional prices would be limited by a national ceiling (110% of the average of regional prices) and floor (90% of the average of regional prices) “Regions” are yet to be finalized…

• • • CMS determines a regional price for each state equal to the un-weighted average of the single payment amount for an item or service from the CBAs that are fully or partially located in the same region where the state is located. CMS determines a national average price equal to the average of the regional prices. The regional price cannot be greater than 110 percent of the national average nor less than 90 percent of the national average price.

• • • Adjust fee schedules annually using CPI-U Revise the SPA each time there is a new round of bidding.

Use national ceiling for rural states and outside contiguous US.

“Bundling”…

• • This is a limited phase in (12 areas) of bundled monthly payment amounts for the equipment, supplies, accessories, maintenance and repairs for enteral nutrition, oxygen, standard wheelchairs, hospital beds, CPAP/RAD in place of capped rental policies.

Bidding would start sometime after 1/1/2015.

• • • • The SPA is based on bids submitted and accepted on a monthly basis for each month of medical need during the contract period.

Monthly single payment amount would include payment for all nutrients, supplies and equipment. Payment is made on a continuous monthly rental basis for DME. The SPA Includes rent, maintenance and service, and replacement of supplies and accessories necessary.

No separate payments for M&S

Round 2 Recompete

• • Current Round 2 product categories, the associated HCPC single payment amounts and geographic coverage areas remain in effect until June 30, 2016. CMS is conducting a Round 2 “Recompete” with seven product categories that differ from Round 2, but somewhat mirror the Round 1 recompete categories.

Round 2 Recompete: Same Geographic Coverage but New Bidding Areas (CBAs)

• • 90 MSAs for the Round 2 Recompete CBAs in multi-state MSAs have been defined so that there are no multi-state CBAs. There are 117 CBAs in the Round 2 Recompete.

• • • • •

Area CBAs…

Atlanta-Sandy Springs-Roswell, GA Catoosa, Dade & Walker Counties, GA Augusta-Richmond County, GA Catoosa, Dade & Walker Counties, GA Birmingham-Hoover, AL

• • • Grandfathering will be allowed, but on a bundled basis.

If beneficiary moves out of one of these 12 bundled areas, then a new capped rental period begins.

Program authority runs to 2019. Comment period open now.

Today’s Program…

• • Revenues, demographics and new market potentials remain strong, but with cuts looming, HME businesses have to retool and retrain to deal with the challenges providers are facing from every direction. Today I’ll provide analysis, update and commentary… plus new industry metrics and trends.

• What We Know: 2014 & Beyond Will See Major Reductions in Per Unit Reimbursement!

Enormous pressures on reimbursement ▫ Healthcare cost increase not sustainable ▫ ▫ ▫ Cuts across Healthcare continuum Federal policies mimicked by states and carriers Natural order of maturing industry • • Prepare for 50% reduction in per unit reimbursement on existing product lines But…let’s look at some actual data…

Actual Durable Medical Equipment Expenditures ($Billions) Source: National Health Expenditure Projections 2012-2022 http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and Reports/NationalHealthExpendData/Downloads/Proj2012.pdf

Projected Durable Medical Equipment Expenditures ($Billions)

U.S. DMEPOS Spending 30 20 10 0 60 50 40 1960 1970 1980 1990 2000 2010 2020

Actual Per Capita DME Expenditures ($) Source: National Health Expenditure Projections 2012-2022 http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and Reports/NationalHealthExpendData/Downloads/Proj2012.pdf

Projected Per Capita DME Expenditures ($)

NOTE: Florida per capita DME spend is $231 in 2014

Source: National Health Expenditure Projections 2012-2022 http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and Reports/NationalHealthExpendData/Downloads/Proj2012.pdf

$2,000 $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0

Annual Revenue Per Patient

Lincare Apria AHP Independents

• • Health spending is projected to grow at an average rate of 5.8 percent from now to 2022, 1.0 percentage point faster than expected average annual growth in the Gross Domestic Product (GDP). Health spending growth during 2013 remained just under 4.0 percent due to the sluggish economic recovery, continued increases in cost-sharing requirements for the privately insured, and low growth for Medicare and Medicaid.

•

Let’s look at the historical (actual) and some predictions of payer models in our industry…

• •

The Payors: Medicare

Medicare spending growth was 4.2 percent in 2013 and it reflects the 2-percent reduction in Medicare payments mandated in the Budget Control Act of 2011, also referred to as sequestration.

I predict for DME, with the implementation of NCB nationwide, and the prospect of bundled monthly payments (which we will discuss at the end of this program), FFS Medicare as a percentage of overall revenue, will drop to less than 25% for HMEs nationwide within five years.

• •

Medicaid

Total Medicaid spending is projected to increase 12.2 percent in 2014. Enrollment is projected to increase by 8.7 million, nearly all due to the ACA coverage expansion. As some states are expected to expand their Medicaid programs after 2014 (see next series), an additional 8.8 million people are expected to enroll in the program by 2016. Overall Medicaid spending is expected to grow by 7.9 percent on average in 2015 and 2016. After 2016, Medicaid spending growth is expected to be about 6.6 percent per year on average, mainly driven by spending by aged and disabled beneficiaries.

• •

Affordable Care Act (ACA) coverage expansions

Improving economic conditions, the ACA coverage expansions, and the aging of the population, drive faster projected growth in health spending in 2014 and beyond. Expected growth for 2014 is 6.1 percent, as 11 million Americans are projected to gain health insurance coverage, predominantly through either Medicaid or the Health Insurance Marketplaces.

• • • •

Uninsured and the ACA

The Congressional Budget Office (CBO) estimated that the ACA would newly insure 30-33 million people (still leaving 26-27 million uninsured in 2016).

The ACA aimed to fill in “gaps” by extending Medicaid to nearly all nonelderly adults with incomes at or below 138% of poverty (about $32,500 for a family of four in 2013).

However, with the June 2012 Supreme Court ruling, the Medicaid expansion became optional for states, and about half did not implement the expansion.

In states that do not implement the expansion Medicaid eligibility for adults (including AL and GA) will remain quite limited.

• •

Alabama and the ACA

Despite previously supporting Alabama’s implementation of a state-based health insurance exchange, Governor Robert Bentley (R) announced the state will default to a federally facilitated exchange.

The ACA requires that all non-grandfathered individual and small-group plans sold in a state, including those offered through the Exchange, cover certain defined health benefits. Since Alabama has not put forward a recommendation, the state’s benchmark EHB plan will default to the largest small group plan in the state, Blue Cross Blue Shield of Alabama 320 Plan PPO.

• • •

Alabama and the ACA

There are 660,000 uninsured Alabamians. Under the ACA, in Alabama, nearly half (46%) of currently uninsured nonelderly people are eligible for financial assistance in gaining coverage (see Figure 2, next). The main pathway for the currently uninsured to gain coverage is the Marketplace, the new coverage option in the state: nearly 200,000 (nearly three in ten) uninsured Alabamians are eligible for premium tax credits to help them purchase coverage in the Marketplace.

• • The ACA will help many currently uninsured Alabamians gain health coverage, but many who could have obtained financial assistance through the Medicaid expansion will remain outside its reach. Further, the impact of the ACA will depend on take-up of coverage among the eligible uninsured, and outreach and enrollment efforts will be an important factor in determining how the law affects the uninsured rate in the state.

The ACA includes a requirement that most individuals obtain health coverage, but some people (such as the lowest income or those without an affordable option) are exempt and others may still remain uninsured.

• •

Georgia and the ACA

Governor Nathan Deal (R) announced that the Georgia had stopped planning for an exchange. In the previous year Governor Deal issued an Executive Order to create the Georgia Health Exchange Advisory Committee to assess whether and how Georgia should establish a health benefit exchange The ACA requires that all non-grandfathered individual and small-group plans sold in a state, including those offered through the Exchange, cover certain defined health benefits. Since Georgia did not put forward a recommendation, the state’s benchmark EHB plan will default to the largest small group plan in the state, Blue Cross Blue Shield of Georgia- HMO Urgent Care 60 Copay.

• • • There are 1.8 million uninsured Georgians. Under the ACA, in Georgia, nearly half (45%) of currently uninsured nonelderly people are eligible for financial assistance in gaining coverage (Figure 2, next).

The main pathway for the currently uninsured to gain coverage is the Marketplace, the new coverage option in the state: 28% of uninsured Georgians (over half a million people) are eligible for premium tax credits to help them purchase coverage in the Marketplace.

• •

Georgia Bottom Line…

In Georgia, 409,000 uninsured adults (22% of the uninsured in the state) who would have been eligible for Medicaid if the state expanded fall into the coverage gap. These adults are all below the poverty line and thus have very limited incomes. Because they do not gain an affordable coverage option under the ACA, they are most likely to remain uninsured.

The 20% of the uninsured with incomes too high to be eligible for premium tax subsidies or who have an affordable offer of coverage through their employer are ineligible for financial assistance. Some of these people are still able to purchase unsubsidized coverage in the Marketplace, which may be more affordable or more comprehensive than coverage they could obtain on their own through the individual market.

National Impact of insuring more people (AL/GA estimated at 2%) 30 to 50 million fewer uninsured people over next 5 years Insured people spend 220% more on healthcare than uninsured Up to 4% increase in DME spend

ACA Durable Medical Effect: Alabama Estimates • • • • • Health Care Expenditures per Capita (AL) Medical Durables: $108 Population of Alabama: 4.8 million Current DME Spend = $518,400,000 Estimated New AL Eligibles: 325,000 2% increase of DME Spend (Kaiser estimate of current per capita of $108*325,000) Potential increase in Annual DME Spend: $23,256,000 Source: http://kff.org/other/state-indicator/health-spending-per-capita-by-service/

ACA Durable Medical Effect: Georgia Estimates • • • • • Health Care Expenditures per Capita (GA) Medical Durables: $114 Population of Georgia: 9.9 million Current DME Spend = $1,128,600,000 Estimated New GA Eligibles: 200,000 2% increase of DME Spend (Kaiser estimate of current per capita of $116.28 *200,000) Potential increase in Annual DME Spend: $35,800,000 Source: http://kff.org/other/state-indicator/health-spending-per-capita-by-service/

• •

Private Health Insurance

Private health insurance spending growth is expected to remain somewhat elevated at 6.2 percent in 2015, primarily related to continued enrollment of the newly insured into Marketplace plans. BUT…analysts predict continued “slow growth” largely due to ongoing increases in plan cost-sharing and continued restraint in the use of physician office visits. I predict for DME, even with the implementation of the Affordable Care Act, private health insurance, as a percentage of overall revenue, will decrease by 2-3% nationwide within five years…mainly due to the plans emulating competitive bid pricing.

• •

Managed Care

As many HMEs may not be aware, Medicare Managed Care (HMOs/Part C) is not under the program rules for competitive bidding. More than a quarter of beneficiaries fall within Part C Advantage Plans. This number will grow to 30% within 5 years. While many managed care contracts are at rates above Medicare, I predict for DME, as a percentage of overall revenue, managed care will remain flat within the next five years.

Out of Pocket/Retail

• • • • In 2012, overall out-of-pocket spending grew 4.1 percent compared to 2.8 percent growth in 2011. This growth rate is be the highest experienced since the recession began in 2007!!

However, out-of-pocket spending growth is projected to grow faster over the remainder of the projection period, reaching a peak of 5.6 percent in 2020 in all categories.

I predict for DME, out of pocket spending for medical durables, as a percentage of overall revenue, will increase by 5% nationwide within five years…an estimated $3.5 billion cash market.

• • EVEN WITH COMPETITIVE BIDDING…Nationwide, the average annual projected growth of the DME spend is almost six percent per year projected for 2015 through 2022, largely as a result of faster projected economic growth, the aging of the population, and chronic care diseases such as heart disease, COPD, diabetes, and arthritis.

U.S. obesity (see next slides) is a major factor.

• • Nationwide, the average annual projected growth of the Durable Medical spend is almost six percent per year projected for 2015 through 2022, largely as a result of faster projected economic growth, the aging of the population, and chronic care diseases such as heart disease, cancer, stroke, diabetes, and arthritis.

U.S. obesity (see next slides) is a major factor.

Obesity…

Obesity Trends* Among U.S. Adults 1985

No Data <10% 10%–14%

(*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person)

Obesity Trends Among U.S. Adults 1990

No Data <10% 10%–14%

Obesity Trends Among U.S. Adults 1995

No Data <10% 10%–14% 15%–19%

Obesity Trends Among U.S. Adults 2000

No Data <10% 10%–14% 15%–19% ≥20%

Obesity Trends Among U.S. Adults 2005

No Data <10% 10%–14% 15%–19% 20%–24% 25%–29% ≥30%

Obesity Trends Among U.S. Adults 2010

No Data <10% 10%–14% 15%–19% 20%–24% 25%–29% ≥30%

Obesity drives healthcare demand

50% 40% 30% 20% 10% 0% Obese Smoker Heavy Drinker Past Smoker % increase in health spending (over norm)

• • • •

Chronic Diseases…

About 133 million Americans—nearly 1 in 2 adults—live with at least one chronic illness.

More than 75% of health care costs are due to chronic conditions.

Approximately one-fourth of persons living with a chronic illness experience significant limitations in daily activities.

The percentage of U.S. children and adolescents with a chronic health condition has increased from 1.8% in the 1960s to more than 7% in 2010.

The cost of a long life…

COPD:

Number of noninstitutionalized adults with diagnosed chronic bronchitis in the past year: 9.9 million Percent of noninstitutionalized adults with diagnosed chronic bronchitis in the past year: 4.4% Number of noninstitutionalized adults who have ever been diagnosed with emphysema: 4.9 million Percent of noninstitutionalized adults who have ever been diagnosed with emphysema: 2.2%

Power Mobility:

Approximately 13,000 new spinal cord injury cases, 1,500 new Muscular Dystrophy cases, 2,000 new Multiple Sclerosis Cases, and 10,000 infants are diagnosed with Cerebral Palsy each year Thousands of disabled veterans returning from service each year

Sleep Apnea:

Is prevalent in an estimated 18 million Americans. This statistic denotes that approximately 1 in every 15 Americans, or 6.62% of the total American population have a case of sleep apnea.

Diabetes:

23.6 million children and adults in the United States—7.8% of the population Diagnosed: 17.9 million people Undiagnosed: 5.7 million people Pre-diabetes: 57 million people New Cases: 1.6 million new cases of diabetes are diagnosed in people aged 20 years and older each year.

Senior Population Explosion

Unprecedented Growth = HME Demand!

65+ growth rate

Arizona +157% 90% Nevada +142% 80% Florida +127% 70% 60% 50% 40% 30% 20% Arkansas +125% Texas +100% Ohio +49% 10% 0% Penn +48% NY +48% 1990 to 2010 2011 to 2030 Iowa +47% W Virginia +46%

Limitations of 65+

65+ and living with a significant impairment No significant impairment

Spending will follow age

Impoverished Seniors?

Key Metrics, Benchmarks & Survey Data

37.0%

Personnel Costs - % of Rev

36.1% 37.0% 35.0% 33.0% 32.5% 31.0% 29.5% 31.0% 29.0% 27.0% Apria Lincare Hanger HME News USR

Revenue per Employee

$200,000 $180,000 $160,000 $140,000 $120,000 $100,000 Lincare AHP Rotech Apria Hanger USR Independents

64% 62% 60% 58% 56% 54% 52% 50% 48%

Operating Expenses - %

Lincare Apria 2010 2011 AHP 2012 2013 Rotech Hanger

Vehicle Cost Benchmark (Lincare)

3.2% 3.0% 2.8% 2.6% 2.4% 2.2% 2.0% 2007 2008 2009 2010 Vehicle expense - % of revenue 2011 2012

Bad Debts - %

9% 8% 7% 6% 5% 4% 3% 2% 1% 2009 Lincare 2010 Apria 2011 AHP Rotech 2012 Hanger 2013

30% 25% 20% 15% 10% 5% 0% -5%

Operating Income - %

Apria’s numbers are HME segment, excluding infusion segment 2009 Lincare 2010 Apria 2011 AHP 2012 Rotech 2013 Hanger

DSO - net

45 40 35 30 70 65 60 55 50 2007 Lincare 2008 Apria 2009 AHP 2010 Rotech 2011 Hanger 2012 2013 Independents

Trends in Valuations & Investment in HME

Some content used with permission: Don Davis, President, Duckridge Advisors

http://www.duckridge.com

• How Have Valuation Multiples and Valuations Changed since the announcement of Round 2 Rates?

Example: $5 million HME – Assume Round 2 or Recompete Awardee – – – – 50% Medicare 20% EBITDA in 2013 No New Patients Obtained (Due to Contracts) Loyal Referral Sources

Sales EBITDA Revenue Multiple EBITDA Multiple Revenue EBITDA

2012

5,000,000 1,000,000 0.7

3.5

HME Valuation 3,500,000 3,500,000

2014

4,000,000 600,000 0.6

3 2,400,000 1,800,000

What Did We See in Round 1?

• • • • Majors and Regionals Identified Gaps – Moved Quickly to Fill – Valuations in the 3.5-5X Projected EBITDA - $.50-.$80 on Projected Revenue Dollar Referral Sources Became Free-Agents – Strongest Marketing Teams Moved Quickly – Big Got Bigger, Small Stayed Small Once Gaps Got Filled Deal Flow Slows – Smaller Regionals and Hospitals Slower to Move and More Demanding Private Equity Entered Scene

What Did We See in Round 2?

• • • • • • “Discovery Period” – Who Has Been Awarded Contracts and What Are They Going to Do With Them?

Early Strike by Marketing Teams Scale and Filling In the Gaps Buy vs. Build Strategy $800-$1200 per O2 patient moved to $500-$800 EBITDA Multiple 3-4 times; some in 2’s.

• • •

2014: Who Will Be the Buyers?

National and Regional Providers Must Remain Full Service Providers – Need Medicare contracts to remain relevant – – Need 50% more Medicare patients to offset cuts Protect & Strengthen Core Markets New Investors – Private Equity will expect Outsized Returns – Require 20-30% Average Annual Returns Local Providers Looking For Niche Positions – Maintain Already Strong Referral and Patient Relationships – Clean Balance Sheet & Strong Management Teams

Why the HME Market Is An Attractive Investment

• • • Investment returns – – Buying For 3-4X EBITDA and Achieving These Results in Future Results in 25-33% Annual Returns Borrowing Rates Lowest in Decades Buy vs. Build – Immediate Returns, Referral Access Opportunity Costs, Risk and Reward

Can I transfer (or can I acquire) a competitive bid contract?

Source: Jeffrey S. Baird http://www.bf-law.com/attorney-profiles-1/Jeffrey-S-Baird

Thank You!

Mark Higley

Vice President – Regulatory Affairs VGM Group, Inc. (O) 888-224-1631 (C) 319-504-9515

[email protected]