Steven Volla won this year's turnaround award by remaking every aspect of American Healthcare Management -- and by taking quantitative analysis to the limit

Turnaround Entrepreneur
Steven Volla, American Healthcare Management

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Ever since he got out of school, Steven Volla knew he wanted to be the chief executive of his own company. He just never knew that when the time came, his would be the business opportunity from hell.

Consider this: When Volla took over American Healthcare Management Inc., at the end of December 1989, the for-profit hospital chain was just emerging from a bitter two-year-plus Chapter 11 bankruptcy reorganization. With $292 million in net revenues, AHM ended 1989 with $233 million in long-term debt. Between 1986 and 1989 the company had lost slightly more than $100 million. (AHM reported a tiny profit in 1989, but that was only because of a $30-million accounting gain from debt restructuring.)

If that wasn't bad enough, there was the hospital marketplace as a whole to consider. In the early 1980s the federal government had made fundamental, far-reaching changes in the way it reimbursed hospitals for Medicare, the federal health-insurance program for the elderly. To control costs, the government began specifying the prices it was willing to pay hospitals for given diagnoses, rather than paying based on costs incurred. Suddenly, hospitals had to control the length of patient stays in order to make money. At the same time, advances in technology were making it easier to provide care on an outpatient basis. The results were predictable: shorter hospital stays, more outpatient care -- and a resulting surplus of hospital beds. Meanwhile, because of Washington budgetary realities, Medicare reimbursement rates consistently lagged behind the increases in hospitals' costs throughout the '80s. Today about 70% of hospitals lose money on their Medicare business, says Jon Ross, a spokesperson for the American Hospital Association.

Because of all those changes, hospitals in the '80s were facing tighter margins and overcapacity simultaneously. And the growth of managed-care health plans, such as health-maintenance organizations, also began to put more pressure on hospital margins. Fewer and fewer customers were willing to pay list price for any hospital services.

AHM was particularly ill suited to compete in the new marketplace. When Volla joined the company, he could discern no real strategy behind the previous management's acquisitions; as far as he could tell, management had bought hospitals primarily because the company had accumulated capital through both a public offering and a junk-bond financing. The result was ownership of a group of smallish hospitals, none of them dominant in their market, some of them money losers, and many of them low occupancy in highly competitive urban markets.

Worse yet, AHM's hospitals had an exceptionally high rate of what are known as fixed-reimbursement payers -- that is, payers, such as Medicare, that pay pre-set prices -- in contrast to traditional insurers. From the point of view of hospital managers, who look to traditional insurance to bolster their margins, that's a recipe for trouble.

Besides, even if AHM could have made money in its marketplace, it might not have made enough. Because of the company's crushing debt load, it had interest payments of almost $29 million due in 1990 alone. After the audit of 1989, AHM's accounting firm had concluded that AHM's cash-flow problems raised "doubts about the company's ability to continue as a going concern."

Volla could see all that, but he took the job anyway. "It was premeditated suicide," he jokes today. "There were some warning signals I chose to ignore." An experienced health-care executive who had most recently been senior vice-president of operations at another for-profit hospital chain, Volla had long desired to run his own show. And looking at AHM's numbers convinced him that the company's costs were too high in comparison with industry standards, as were its accounts receivable. With the right management, he thought, the company might start making money and paying down debt.

It was a big gamble, though. To remake AHM, Volla had to cut headquarters staff almost in half, then improve the computer system so it could provide management with up-to-date comparable financial information from all the hospitals. That way Volla and his team could quickly focus on any problem areas and achieve operational efficiencies. At the same time, he stepped up the company's collection efforts and took a good hard look at the strengths and weaknesses of AHM's hospitals.

His conclusion: AHM had considerable strength in providing basic primary care (services like delivering babies and repairing broken bones), particularly to urban communities. So even though that inner-city primary-care market is one most hospitals would prefer to flee, Volla decided that under his management, AHM would do the opposite: urban primary care would be its focus, its niche.

With that in mind, the company would ration its scarce capital very carefully. Since most excess cash had to be used to pay down the crippling debt, top management would compare and prioritize all hospital capital requests. It would approve only those that best met the company's primary-care focus or that were needed to keep the hospitals functioning well. "We were just going to be a boring bread-and-butter company," Volla says.

The results of that strategy were dramatic. After losing money in 1990, AHM has been consistently profitable, improving earnings before interest, taxes, and depreciation by 80% between 1989 and 1992. By the end of 1992 real debt had been reduced by $78.1 million through a combination of payments and a successful debt-for-equity swap. Thanks to AHM's improved financial prospects and falling interest rates, the company's average real interest rate dropped by 40%, from 13.1% in 1990 to 7.9% by the end of 1992. Meanwhile, AHM's stock price jumped, from $1.63 a share in January 1990 to $5 at the end of 1992. By 1993 the company was doing well enough for its stock to list, for the first time, on the New York Stock Exchange rather than the American Stock Exchange.

Last July AHM was able to raise in the public markets $100 million in unsecured debt at 10% interest. That's no small feat for a company that had emerged from bankruptcy just three and a half years earlier, with every available asset secured to one creditor or another.

Despite the substantial improvements, AHM lags behind its competitors in occupancy rates and operating margins. (See "Elements of a Turnaround," page 6.) Company management says that's inevitable, given the markets in which AHM operates. In any case, Volla argues, occupancy rates are an archaic measurement of hospital success because hospitals these days make money by releasing patients quickly, not by keeping them.

Then there's always health-care reform, a giant question mark for anybody in health care these days. AHM's management argues convincingly that on the whole, the company is well positioned for reform. After all, AHM has extensive experience in providing efficient primary care to fixed-reimbursement customers -- a plus under any reform scenario. Still, Volla admits, if new health-care-purchasing alliances are too big and bureaucratic, they could end up negotiating only with big providers, leaving out smaller players like AHM's hospitals. In part because of that fear, the company is hastening to form strategic alliances with large not-for-profit hospitals that provide specialized care. (The theory is that primary-care hospitals like AHM can provide patient referrals to their partners while benefiting from the big hospitals' marketing clout.)

Whatever the future, Volla's results so far are impressive by any measure. There's no magic here, either: AHM is simply disciplined, with a relentless focus on on-line quantitative measurements as a way of achieving its goals.

1. Operations
Stanching the bleeding
When Volla started his new job at the end of December 1989, he quickly flew to Dallas, where AHM was then headquartered. One of his early requests was to see December's internal financial reports so he could get a feel for how the company was doing. At Volla's old employer, such reports were available by about the 12th or 15th of the next month. So when he found out AHM's December numbers wouldn't be ready until March, Volla wasn't impressed.

He quickly discovered that the Dallas operation was highly decentralized. It took headquarters staff members two months to put together reports because they first had to get the data shipped from each hospital and then spent weeks reconciling all the accounts so they'd be strictly comparable. Although the hospitals all had variations of the same computer system, headquarters inexplicably wasn't using it to consolidate the data. And because each hospital controller had autonomy, all had modified their general ledgers to meet their own needs. That was good for the hospitals, but it made any corporate financial comparisons difficult.

This was never going to work, Volla thought. After all, AHM was a business so starved for cash that it had started life out of bankruptcy with only $10 million in working capital, for an almost $300-million company. (To make matters worse, AHM had to make its first interest payment, of $3.5 million, within days of Volla's taking over. That left enough, Volla figured, to run the company for less than a week.) Without a strong day-to-day handle on the company's financial performance, Volla couldn't possibly succeed; he had no margin of error. "It was very obvious that the whole culture was going to have to change," he says.

Volla had to move quickly to improve the company's cash position. Within months he cut the size of the corporate staff from more than 100 to fewer than 60. In September he moved the company from Dallas to smaller, lower-rent quarters in King of Prussia, Pa., a Philadelphia suburb that was his home territory. The net result was a decrease in corporate overhead of $4 million, on an annualized basis. Besides, in King of Prussia Volla knew good people whom he could persuade to join what was effectively a new company -- and one with exceptionally dim prospects.

Like a start-up, AHM after the move had virtually no institutional memory. Controller Bruce Colburn, who came on board in mid-1990, recalls that his first big problem was simply figuring out whom AHM owed and who owed AHM, since the company had gone through a flurry of acquisitions in the early '80s, then a flurry of asset sales. In those early months, as the new staff was unpacking boxes in Pennsylvania, Colburn recalls, "one of the things that always scared me was that someone would quit paying me and I'd never know!"

With interest payments looming, Volla needed to do even more to free up cash. He sold assets and negotiated with professional advisers for lower fees. He brought in new people to work on collecting accounts receivable, setting up a sort of in-house collection agency, before the company turned to outsiders. By the end of 1990, days outstanding on accounts receivable had dropped from a high of more than 70 to 55. Volla also worked on improving relationships with vendors, many of whom had been so burned they had placed individual hospitals on COD terms. The new management worked out repayment plans, aiming to get reasonably current by the end of 1990.

But that still didn't give Volla the day-to-day control he needed. So he quickly began converting the company to a highly centralized IBM AS/400 minicomputer system and building proprietary software to track the numbers he wanted. (To maintain a state-of-the-art system without using up his superscarce capital, Volla set up an unusual arrangement with his computer vendor. Rather than buying or leasing a computer, AHM pays a linkage fee for each device the company hooks up to the AS/400, which belongs to the vendor. As a result, AHM pays more in operating costs, but uses no capital in purchases or upgrades.) By September 1990 Volla could get day-to-day financial information from the company's computer system. It was "the single most important thing we did," Volla says.

Today that on-line system drives the company's management style. All the hospitals use the same accounting structure, so corporate management can extract daily reports on revenues, number of patients, cash position, or just about any other relevant financial statistics. (Some, such as staffing, come in weekly.) By the sixth working day of each month, each hospital sends a financial report for the preceding month to headquarters. Four or five days later headquarters gets what Bob Fleming, senior vice-president of operations, calls its "infamous blue books": blue binders three or four inches thick, each full of computer printouts on the financial status of a hospital -- down to every check written. All of AHM's top managers scan the books, searching for numbers that don't look right. Then they hold marathon meetings comparing notes and getting on the phone with the hospital administrators. Their questions are pointed, specific, and tough: Why do you have too many nurses on the third shift? Why are your average stays per patient up? Why are we spending so much money on Baxter Laboratories this month?

If that doesn't sound like a fun way of doing business, it's not intended to be. "We don't hesitate to take somebody to task," says Fleming. "If you've had a bad month, it can be excruciating." To make up for the pressure, AHM has heavy incentive compensation for hospital executives and for corporate managers; hospital administrators can achieve bonuses of up to 60% for fulfilling their business plans.

Despite its relentlessly hard-nosed, by-the-numbers ways, AHM's management also recognizes the need to invest capital in its hospitals. That hasn't been easy, given the company's scarce cash the past few years. In 1990 and 1991 AHM invested $11.2 million and $12.6 million, respectively, in its facilities. In 1992, as the company's financial situation improved, that amount nearly doubled, to $24.7 million. Some of the company's investments simply addressed deferred maintenance problems of the hospitals. "The first year, I got so tired of getting capital-expenditure requests for roofs," Volla recalls. The company has also launched six centers specializing in minimally invasive surgery -- a technique Volla believes is well suited to reducing the length of hospital stays. Finally, AHM has added needed capacity in departments such as obstetrics to several hospitals. One hospital the managers deemed particularly promising, Lake Mead Hospital, in North Las Vegas, got a $12-million face-lift. After losing $1.3 million on its operations in 1989, Lake Mead now produces 30% of the company's operating earnings.

Throughout the company, AHM concentrates its resources on basic care. For example, the company's previous management had expanded into psychiatric care and chemical-dependency treatment as a way of filling empty beds. But Volla thought it hurt the hospitals' overall operations to put psychiatric wards in small primary-care community hospitals. So he slashed such services. They now represent only 7% of the company's revenues, down from 20%. By focusing on basic community services, he says, AHM avoids getting caught up in the quest for the most expensive new technology that captivates many hospital managers.

Instead, AHM continues to try to beef up its position as a primary-care provider. In the Los Angeles market, where AHM has six hospitals, the company is forming a strategic alliance with a big not-for-profit hospital that offers all the latest high-tech services. AHM plans to send the patients who need specialty care to the big hospital and in return to join that hospital's marketing umbrella to negotiate with managed-care networks. And the company is actively trying to form networks of primary-care physicians, positioning itself both for its own strategic plan and for the picture it sees ahead for health-care reform.

Part of AHM's growth strategy involves acquisitions -- a phase for which AHM finally feels ready. There's a limit to what can be done to improve the efficiency of the existing hospitals, Colburn believes. "We've squeezed them," he says. "They're running about as efficiently as any hospitals in the industry."

2. Financing
Back from the dead
July 28, 1993, was a big day for AHM. That was the day the company raised $100 million in subordinated debt, at 10% interest, with blue-chip investment-banking firm Goldman, Sachs, officially marking the end of a painful era.

That era had begun with the company's pell-mell, junk-bond-financed expansion -- and continued into bankruptcy and a torturous sale of assets. By the time Volla took the helm of AHM, it was a company owned by its banks. In return for letting the company out of Chapter 11, its creditors took 93% of AHM's stock, as well as $180 million in long-term debt in the form of two series of notes. All assets the company had were pledged, some more than once. And because the reorganization plan had been designed by a group of angry creditors, the notes were full of covenants so restrictive that Volla had little flexibility.

The last caught Volla unprepared. As a manager, not a financier, he had looked closely at the company's balance sheet and hospital assets before signing on; he hadn't paid much attention to its charter or debt covenants. So he was in for some rude surprises. For example, the plan allowed AHM to get a line of working capital, secured by accounts receivable, of up to $10 million. That sounded good, Volla thought. But it was only later that he discovered that under the terms of the notes, any working capital the company got would be considered "excess cash flow" and earmarked to pay long-term debt -- completely defeating its purpose.

To make matters worse, there were balloon payments lurking a few years down the road. In 1995, for example, the company would have to pay off the entire senior series of notes, totaling $110 million. "Anybody who could do the projections would say, This company is not going to make that payment," says Rich McDonald, the company's assistant treasurer.

Clearly, AHM needed to pay down debt, fast -- and Volla did, paying $20 million in the first year with cash from asset sales and operations. But just as urgently, the company needed to restructure its balance sheet to get away from the painfully restrictive covenants and the impossible repayment schedule. So as early as July 1990, the company began to explore converting some debt to equity but initially found its options limited.

After AHM became profitable in 1991, Volla and his management team gave it another try. By then the company's prospects had improved enough that they thought they could persuade some bondholders to swap debt for equity. It took five months and a lot of salesmanship, but the company finally arranged a deal. On September 27, 1991, nine institutional bondholders swapped $42.8 million in long-term debt for 11.8 million shares of common stock. In one day Volla and his managers had reduced the company's debt load by 22%. And because the transaction was so clearly beneficial to the company, the addition of new stock did not significantly dilute AHM's stock price.

AHM didn't stop there. As soon as the company had a full profitable year under its belt, Volla and his chief financial officer, Bill Harrigan, began looking for banks to refinance the approximately $100-million remaining postbankruptcy notes. It wasn't an easy task: this was a company just two years out of bankruptcy, in a tough industry many banks don't consider a good risk, asking for money at a difficult juncture in banking history. "I've done a lot of bank deals over the years, but this was probably one of the hardest," Harrigan says now.

After searching for six months and approaching about 80 banks, the AHM team sat down in July 1992 with a consortium of six lenders, to get a variable-rate financing of $105 million. Finally, AHM was free of its onerous bankruptcy debt. Its average real interest rate fell from 12.5% in 1991 to 7.9% by the end of 1992. By April 1993 the company was able to join the New York Stock Exchange.

You'd think the AHM team would have taken a bit of a rest -- and enjoyed the company's newly deleveraged status. But hospitals are a cash-hungry business, always in need of renovations and new equipment. In addition, AHM wanted longer-term debt than banks like to provide. And to improve its competitive position, AHM management believes the company needs to be able to expand in its geographic markets.

So despite all the trouble that leverage has caused the company, AHM began preparing to go back to the public markets as soon as it was feasible, in March 1993. The goal this time: to raise $100 million to refinance debt and to fund acquisitions and capital investments. The new notes couldn't be more different from the postbankruptcy debt: instead of having unusually restrictive covenants, they are unsecured, with only interest payments until the end of their 10-year term.

After their successful offering last July, Volla and his colleagues are eager to start acquiring and investing -- without, they hope, running into the problems of their predecessors and overpaying. "We're now in a position to do what a normal company would do -- and that's to try to work toward enhancing shareholder value over the longer term," says Harrigan.

3. Quality
Tracking the outcomes
Lois Quinn is the first to admit she's the conscience of AHM. As vice-president of professional affairs for the company, her job is to argue for an intangible -- quality of care -- against the numbers jocks in top management. Not surprisingly, she uses statistics to make her case.

Like the rest of the AHM management team, Quinn over the last three years has been busy getting better data to analyze and getting much of that information on-line. But while manufacturers plot statistical information on defect rates and machine precision, Quinn has her hospitals tracking variables she thinks are key to the quality of health care delivered, such as the number of inpatient deaths or the number of times a patient has an unplanned readmission soon after being released from the hospital.

Quinn's data are part of a larger movement within the health-care industry known as "outcomes management,' through which hospitals and the businesses that pay them are trying to get a handle on indicators they think measure the quality and value of health care. But because outcomes management is a relatively new trend, there are few consistent national standards for those measurements.

As a result, Quinn has had to come up with her own variables to monitor. Some of them are obvious -- like tracking the number of patient deaths -- but others Quinn has developed are more specialized. She now has 10 quality indicators on-line and is tracking an additional 18 manually. She also has indicators of the quality of medical records on-line and is in the process of adding data from new patient-satisfaction surveys. Now Quinn can peruse quality reports the way her financial counterparts can browse through numbers, scanning for anything unusual or problematic.

Here's how her system works in practice. Soon after she arrived at AHM, in 1990, Quinn became concerned about patients' falling while in the hospital. She began researching the subject and found some academic data suggesting that a typical fall rate was 2.9 falls per thousand patient bed days. AHM's patients were falling at a rate of about 3.6 per thousand -- which didn't please Quinn. She set a 1992 goal of reducing falls 20% between the first and third quarters. Already she had checked to see if hospitals had a protocol for nurses to follow when admitting patients to determine if the patients were at a high risk of falling. If the nurses decided a patient was high risk, there were certain procedures to follow, such as placing the patient close to the nursing station and checking frequently to see if he or she needed help getting to the bathroom. If the hospitals didn't have a protocol, Quinn distributed samples and asked them to develop one.

By the third quarter of 1992, the number of falls had dropped to 2.7 per thousand, a decrease of 25%. Lately, however, Quinn has seen the rates rising slightly, especially in one or two hospitals. (See chart, below.) She plans to follow up with a discussion with the nursing staff at those hospitals.

The tension between Quinn's task (measuring quality of care down to the last patient fall) and operations chief Bob Fleming's (measuring value of care down to the last nurse on duty) is an obvious one. Here is a for-profit company in tough inner-city markets like East Los Angeles, trying to provide good health care for the urban poor and yet still make a buck. When it comes to quality versus value, AHM must perform a continual, difficult balancing act. But in many ways, the company's day-to-day operating dilemmas mirror the national debate on health-care reform. These days, that tough question -- how much care at what cost? -- is one we all have to ask.


Statement of Operations (in Thousands)

Year ending December 31

1989 1990 1991 1992
Net revenues $292,498 $298,833 $289,466 $313,197
Operating expenses 268,916 265,168 249,431 270,674
EBITD 23,582 33,665 40,035 42,523
Depreciation 16,816 17,182 16,452 17,366
Interest expense 19,361 19,871 15,267 9,401
Write-down of assets and other charges 17,466 11,412 -- --
Provision for income taxes 96 70 280 249
Income (loss) before extraordinary item (30,157) (14,870) 8,036 15,507
Gain on troubled-debt restructuring* 30,455 -- -- --
Gain from early extinguishment of debt -- -- -- 55,571
Net Income (Loss) $298 ($14,870) $8,036 $71,078

*See sidebar on troubled debt, next page.


AHM has made big strides in improving margins, controlling costs, reducing lengths of stay, and collecting accounts receivable. But it still lags behind competitors in operating margins and occupancy rates.

AHM AHM Closest
end of end of industry
1989 1992 average
Average beds/hospital 131 127 173*
0ccupancy rate 38% 33.9% 50.4%**
Average days/ patient stay 5.9 5.2 6.1**
Operating expenses as a percentage of net revenues 91.9% 86.4% 85.2%***
Earnings before interest, taxes, and depreciation as a percentage of net revenues 8.1% 13.6% 17.4%***
Average days in outstanding accounts receivable 71 52 64***

*Average size of a community hospital in 1991. Source: American Hospital Association, Hospital Statistics, 1991.

**Average for investor-owned for-profit hospitals, 100 to 199 beds. Source: Hospital Statistics, 1991.

***Industry average for comparable for-profit hospital chains.

Source: AHM's 1992 estimates.


AHM tracks patient fall rates (per thousand patient days) as a key indicator of the quality of care and attention its hospitals are providing.

First Quarter '92 3.6

Second Quarter '92 3.4

Third Quarter '92 2.7

Fourth Quarter '92 2.9

First Quarter '93 3.0

Second Quarter '93 3.2

Estimated Industry Average 2.9


Call it one more reason to avoid bankruptcy. When American Healthcare Management emerged from Chapter 11, the company was saddled by its creditors with an obscure form of financial reporting known as troubled-debt accounting. That meant it would enter a public-accounting twilight zone, where nothing is quite what it seems.

Under troubled-debt accounting, a company that restructures debt does not get to take all the accounting gain at once. Instead, some of the gain is recorded as a reduction in future interest payments -- as if the lender were forgiving future interest rather than principal.

From a company's point of view, troubled-debt accounting has one big drawback: the company's financials no longer reflect reality. That's because both interest expense and debt amounts are distorted. Interest expense on the income statement looks lower than it actually is (because it's being reduced over time to gradually reflect the gain on restructuring). Meanwhile, long-term debt is recorded at an artificially high level (because it hasn't been reduced to reflect the restructuring that took place).

In AHM's case, troubled-debt accounting provided one more incentive to get rid of all the postbankruptcy debt; only when that happened, in July 1992, could the company return to financial-reporting normalcy. Until then, AHM's financial results were confusing to all but the most sophisticated investors. "I'd never heard of troubled-debt accounting before I came here," says chief financial officer Bill Harrigan. "And I hope I never hear of it again."

Throughout most of this story, we use actual numbers rather than those recorded under troubled debt, because AHM management had to pay its debt in actual, not theoretical, dollars. The one exception is the profit-and-loss statement (see next page), where we have given the numbers as they were actually reported, including the artificially low interest. The gain recorded in 1989 reflects part of the gain from postbankruptcy-debt reduction. The rest of the restructuring benefit is recorded through lower interest payments and, finally, through a $55.6-million gain in 1992. That gain occurred once AHM was at last able to jettison the postbankruptcy debt -- and with it that troubling accounting for troubled debt.

Interest expense (in millions) 1990 1991 1992
Real Interest $26.9 $24.0 $15.3
Troubled-Debt Interest $19.9 $15.3 $9.4