Hospital M&A: Due Diligence Considerations

1 Presenting a live 90-minute webinar with interactive Q&A. Hospital M&A: Due Diligence Considerations Evaluating Transaction Risks, Liabilities and Pricing for Buyers and Sellers WEDNESDAY, JUNE 20, 2012. 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today's faculty features: Thomas J. Cuccia, CFA, ASA, Managing Director, Valuation Services, Reimbursement and Advisory Services Division Altegra Health, Los Angeles Charles P. Sukurs, Atty, Hall Render Killian Heath & Lyman, Indianapolis Roger D. Strode, Partner, Foley & Lardner, Chicago The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext.

2 10. Tips for Optimal Quality Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory and you are listening via your computer speakers, you may listen via the phone: dial 1-866-927-5568 and enter your PIN. when prompted. Otherwise, please send us a chat or e-mail immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again. continuing education Credits FOR LIVE EVENT ONLY. For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps: In the chat box, type (1) your company name and (2) the number of attendees at your location Click the SEND button beside the box Conference Materials If you have not printed the conference materials for this program, please complete the following steps: Click on the + sign next to Conference Materials in the middle of the left- hand column on your screen.

3 Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides for today's program. Double click on the PDF and a separate page will open. Print the slides by clicking on the printer icon. Hospital M & A : DUE Diligence Considerations . Evaluating Transaction Risks, Liabilities and Pricing for Buyers and Sellers June 20, 2012. Thomas J. Cuccia, CFA, ASA. Managing Director 5. Forces Driving M & A Activity Healthcare Reform Patient Protection and Affordable Care Act (PPACA) March 21, 2010. Health Care and education Reconciliation Act of 2010 March 30, 2010. Government Regulation CMS Audits (Recovery Audit Contractor). Stark AKS. Fraud & Abuse Reporting requirements Great Recession Greater number of uninsured patients & indigent care Delay in elective procedures 6. Forces Driving M & A Activity Competition Specialty hospitals on the rise Ambulatory surgery centers (ASCs).

4 Difficulty Recruiting Personnel Doctors Nurses Skilled Technicians 7. Forces Driving M & A Activity Reimbursement CMS 2012 increases for both in-patient & out-patient services. CMS cuts if not successful with quality programs (up to 2%). Concern over reimbursement decreases for Disproportionate Share Hospitals (DSH). 2014 CMS reductions up to 75% are scheduled Medicaid decrease of approximately $18 billion 2014-2020. 8. Current Trends In Hospital M & A. What the Hospitals are Doing 78% of organizations are exploring or have M&A deals under way 56% of organizations have specific teams dedicated to Hospital - physician practice acquisition opportunities A clear majority of organizations are using M&As to strengthen what they're already doing, only secondarily to explore new opportunities: 65% use M&As to strengthen existing markets; 52% to acquire physician practices to strengthen current service lines 43% use M&A to expand into new markets; 37% to acquire practices to strengthen new service lines 48% say their organization is likely to pursue an acquisition in the next 12 18 months Data provided by: Media Intelligence, M & A: Hospitals Take Control, January 2012.

5 9. Current Trends In Hospital M & A. What the Hospitals are not Doing 6% say their organization has no M&A strategy 13% say their organization's strategy is to maintain independence and enter into no M&A. activity 21% expect no M&A activity in the next 12 18. months Data provided by: Media Intelligence, M & A: Hospitals Take Control, January 2012. 10. Current Trends In Hospital M & A. M & A Acquisition Targets 18% of Hospital and health system organizations have a high interest in the insurance, payor plan sector 50% or more cite hospitalist, cardiology, orthopedics, and primary care as most relevant to their M&A strategy Data provided by: Media Intelligence, M & A: Hospitals Take Control, January 2012. 11. Current Trends In Hospital M & A. Top Three Reasons Deals are Terminated 58% of respondents have terminated an M&A over the past 12-18 months Culture (49%).

6 Political/governance Considerations (41%). agreement on valuation (39%). Data provided by: Media Intelligence, M & A: Hospitals Take Control, January 2012. 12. Hospital M & A Market Activity Historic M & A Activity Year Done Deals Hospitals Acquired 2006 57 249. 2007 58 149. 2008 60 78. 2009 52 80. 2010 72 125. Data Provided by Irving Levin Associates, The 2011 Health Care Services Acquisition Report, Seventeenth Edition,. 13. Hospital M & A Market Activity Deal Pricing Year Price to Price to EBITDA. Revenue 2006 .73 2007 .60 2008 .70 2009 .77 2010 .65 Data Provided by Irving Levin Associates, The 2011 Health Care Services Acquisition Report, Seventeenth Edition,. 14. Valuation Due Diligence Activity What Contributes to Risk? Degree of regulation more difficult to forecast cash flows Important to ID reimbursement trends that aren't sustainable Nuclear medicine cuts of 2009 drastically cut reimbursement for technical component of certain CPT codes Payors Coding Conversion to ICD 10.

7 Compliance Contracts with physicians For profit vs. non-profit Transaction Structure 15. Hospital M & A Market Activity What Drives Value Competition in primary market area Population demographics Types of services offered Primary vs. specialized Types of physicians Employees or contracted through professional services agreements (PSAs). Ease of recruiting new physicians Pricing power in hands of Hospital or commercial payors Managed care contracting Location, Location, Location Age and curb appeal of Hospital campus 16. Hospital M & A Market Activity Due Diligence Key Financial Metrics Admissions (inpatients). Number of inpatient days and growth of inpatient days Length of stay Daily census Occupancy rates Outpatient visits and growth in visits Adjusted patient days Case mix percent of volume (inpatient and outpatient).

8 Commercial, self pay, Medicare, Medicaid Medicare outpatient cost to charge 17. Hospital M & A Market Activity Due Diligence Key Financial Metrics Income from operations The greater the operating income greater the value Expenses influencing operating income Salaries and benefits easily the largest expense Bad debt expense Medical supplies 18. Hospital M & A Market Activity Non-Financial Due Diligence ICD 9 conversion to ICD 10. Compliance & risk management programs Physician contracting Revenue Cycle Coding Purchasing and supply management Information technology Patient experience 19. Hospital M & A Market Activity Ways to Increase Value Reduce salaries & benefits Reduce medical supply costs Improve efficiency Especially operating rooms and emergency room Increase revenue Critically evaluate revenue cycle from time patient is admitted to discharge to time fees are collected Improve physician alignment 20.

9 Hospital M&A: Due Diligence Considerations Evaluating Transaction Risks, Liabilities and Pricing for Buyers and Sellers June 20, 2012. Charles P. Sukurs Hall, Render, Killian, Heath & Lyman, Indianapolis, IN. Phone: (317) 977-1452. Email: A Word About Purpose Q: What is the purpose of legal due Diligence ? A(1): Generally, the purpose is to identify any legal concerns that may have a material or significant impact on: the decision to acquire; and/or the purchase price to be paid; and/or the legal structure of the transaction and issues to be addressed in the purchase documents. A(2): Sometimes, the Acquirer will have specific purposes and those need to be taken into account in structuring the due Diligence process and conducting the actual review. Example: Information gathering to assist in operational transition planning, preparation of schedules to definitive agreements, or post-closing integration.

10 22. FOCUS - Issues That Are Unique to Hospitals Proper legal due Diligence must include issues common to any M&A transaction (regardless of industry). For example: General Tax Compliance Environmental and Real Estate Pending and Threatened Litigation Question for this presentation: What legal due Diligence issues are unique to Hospital M&A transactions? 23. How is Health Care Different? Hospital mergers and acquisitions are unique: Threats to future cash flow (at least a majority of business comes from one payor - Medicare/Medicaid). Potential for successor liability Complex revenue sources and customer relationships Regulation of referral source relationships (due Diligence issues separately discussed by Roger Strode). Importance of regulatory compliance Multiple regulatory oversight bodies Must be able to assess identified risk 24.