Waiting to Exhale

The squeeze is on for providers of oxygen and inhalation therapy drugs. The respiratory side of the home medical equipment industry, long considered one of the best bets in HME for growth and consistent profits, is learning once again what happens to a profitable but Medicare-dependent business when Congress is looking for ways to save money. Reimbursement gets tighter, margins shrink and only the most efficient providers can make a profit.

This is not a new story in respiratory; in some ways it is a replay of the crunch that came after the 1997 Balanced Budget Act. But the cuts that have come in the wake of the Medicare Modernization Act of 2003 may be the most serious yet.

How can providers survive, and maybe even thrive, in this challenging new economic environment? The answer from providers, consultants and other expert observers of respiratory HME is that survival is possible but not painless.

The new reimbursement regime will demand highly efficient management practices that some providers will probably not be able to achieve. It is also likely to adjust prevailing levels of customer service in ways that many providers — and their customers — will not like. The nature of the respiratory business will change even if the roster of principal players remains largely the same.

The following are possible strategies for staying profitable in oxygen and inhalation therapy services.

For some providers, these may not be enough, and they may have to drop one or more service lines. For others, the suggestions here may reflect their current practices. If so, these companies may be in a position to gain business as others pull out of the market.

Keep an eye on what’s coming next — and how it affects you.

A nimble business anticipates change, and there is plenty of change yet to come under provisions of the MMA.

Already, MMA-mandated reimbursement cuts averaging 8 percent have gone into effect for oxygen, and the reimbursement for Medicare Part B inhaler drugs has been reduced in stages. At this writing, the dispensing fee has been cut to $33 per month after a first-month fee of $57, and allowable drug prices are pegged at average sales price plus 6 percent.

At these levels, at least some providers doubt that they can continue to provide inhalation therapy services profitably, and industry leaders are looking ahead to a significant drop in revenue and earnings.

Bill Bonello, an analyst with Wachovia Securities, expects the dispensing fee change to cut Lincare Holdings’ 2006 revenue by $31 million and its earnings per share by 18 cents. At Apria Healthcare Group, he projects a revenue hit of $8 million and a cut of 12 cents in EPS.

But these reimbursement cuts are only part of the story. At press time, Congress was expected to enact a new formula for oxygen service that would cap equipment rentals at 36 months. The mandate for competitive bidding is still in place, though the program and its locations have not been finalized.

The precise impact of these approaching events is hard to predict, but providers must somehow be prepared for them.

The new rental cap, for instance, will make it necessary for providers to get more precise information on their patient population — specifically, to see how many customers typically have oxygen treatment for more than 36 months.

As merger-and-acquisition expert Dexter Braff notes, this length-of-service data can vary widely among both companies and regional markets. Among The Braff Group’s clients, he says, the percentage of patients over the three-year mark can be as low as 5 percent or as high as 30 percent.

“This is not surprising, due to local differences in clinical protocols,” he says. “It can be very much like the fact that in some areas of the country the average hospice stay is much less than in others.”

Providers with the most patients past the rental cutoff will be the ones most affected by the 36-month rule, and need to plan accordingly.

Braff points to another risk in the new cap: the possibility that lawmakers may be tempted to lower it to save more Medicare money. “It scares me when there is now a new mechanism available to Congress [to cut reimbursement] that wasn’t previously there,” he says.

Another sleeper on the inhalation therapy side is the possible loss of sales to inhaler drugs. HME consultant Wallace Weeks of Weeks Group notes that these, like other patient-administered medications, are now covered under the new Medicare Part D drug benefit.

“They’re not for everyone, but they’re going to steal some market share away,” Weeks says.

As for competitive bidding, the future will belong to the most efficient operators, though not necessarily the largest. In other words, what steps providers take to cut costs and tighten operations for their present-day survival are likely to serve them well if they end up in a competitive-bidding arena.

To stay in the business, be ready to change with the times.

HME is evolving under the pressure of tightening reimbursement, and not all like what they see. A traditionally labor-intensive rental business — in which patients could expect frequent visits and providers could count on being paid to cover the costs of staff time and transportation — is giving way to a model based on technology and patient self-help. This trend presents providers with three choices: Try to fight it, make the best of it — or leave.

The choice is especially stark in nebulizer-based inhalation therapy, where the dispensing-fee cut on top of the shift to ASP+6 pricing has sharply cut (or even wiped out) the margins of respiratory pharmacy services. With inhaler meds no longer a profit center, home care companies must decide whether to continue at a reduced level of service, hold on in hopes of higher reimbursement or drop inhalation therapy altogether.

Seeing no reimbursement relief on the horizon, providers are cutting overhead as much as possible while they mull the feasibility of a long-term commitment.

“We’re taking a close look at the numbers,” says Bill Butler, president of American Respiratory Systems, a Florida pharmacy management company. He explains that he is not bolting from inhalation meds, at least not yet: “We’ll be looking at the numbers in the first and second quarters [of 2006].”

But, he adds, “We anticipate that this jolt on January 1 is really going to make a lot of people look very closely at their business.”

Others put the issue more dramatically. One Arizona provider told HomeCare, “This is looking like the end of the home respiratory medication business.”

California-based HME President Darren Friedman of BreatheRite Pharmacy, a division of Unicare Health Services, says he is cutting his staff drastically — from 12 to four — and will see how 2006 goes. “I’m going to give [the respiratory medication business] one year. If it’s not feasible, I’m not going to lose a night’s sleep if it closes down.”

Getting out of respiratory meds may be the best solution for many providers, experts say, but such a move would have costs. Though this service no longer contributes much profit, if any, by itself, it can also be used to pull in customers for other business lines, such as DME and oxygen.

For those who still want to retain this service for its strategic advantage, the challenge is to operate it in such a way that it doesn’t drain the firm’s resources. This may require changing the way the service is delivered and what patients can expect.

To many providers, this simply means less service.

“As far as patient care, it’s gone,” says Friedman. “There’s not much you can do. We call every 28 days and we ask them how they’re feeling.”

Or it means services delivered from afar, and maybe not as well. Kevin Joplin, vice president of medical services for Boise, Idaho-based respiratory firm Norco Inc., says mail-order companies are eating into traditional oxygen HME business by selling concentrators and in-home filling systems that don’t require regular delivery of tanks. What’s gained is profit for the mail-order firm, he says. What’s lost is personal contact and care.

“We’re the guy who’s servicing them locally for oxygen, and we’re doing it better than anyone … can,” Joplin says.

Jacki McClure, who runs the National Respiratory Network of the HME service organization The Med Group, says the respiratory medication business “functioned very highly on service,” such as patient contacts, but is now moving to a “fill-and-bill” retail model.

No one in HME seems pleased that the old model of personal service is passing. But observers disagree on what to do about the trend, whether to fight it in hopes that Medicare will change its mind or to live with it.

Joplin thinks change, or at least a “backlash” against the new respiratory pharmacy rules, is possible in six months or so. But he fears that small providers may have been pushed out by then.

Butler says the feds might change course “when they see the patients who were able to take care of themselves” under the old system “showing up in hospitals.” But then, he asks, “How do they un-shoot themselves in the foot?”

But Weeks says the momentum of Medicare budgeting is too powerful for any mid-course correction. “Even if Democrats took control of the House and Senate, and even if they had enough voters to override a presidential veto, I don’t think they would override MMA and, in particular, competitive bidding,” he says.

Mickey Letson, president of the specialty wholesale drug and technology firm The Letco Companies, says the government doesn’t value hands-on disease management in HME. And “if Medicare sees no value in it, Medicare won’t pay for it,” he says.

Marcus Kruk, who left the respiratory business two years ago and now works with software company Jaysec Technologies, also is skeptical on the prospects for continued survival of a specialized respiratory medication industry within HME. “Medicare has made a decision to get rid of this industry, and they’re closer to it than they’ve been for years,” he says.

Run lean, embrace technology.

So what’s a respiratory firm to do if it wants to maintain all its business lines, including inhalation therapy, and sees no hope of a change of heart in Washington? One common-sense response is to pare costs and improve revenue generation as much as possible before cutting into services. Companies need to speed up collection cycles and update billing processes.

Weeks says salaries and wages make up 27 percent of the overall costs for a typical respiratory firm, with indirect employee costs (insurance, payroll taxes, rent of space to house the workforce) adding further expenses.

“The way to reduce those [costs] is to reduce man-hours by the solution you offer and the customers you offer it to,” he says. That is, stick with low-overhead services, both through choice of the services themselves and by choosing a patient population that is less costly to service.

Among product lines, Braff suggests focusing on those that “don’t need a lot of customization.” Oxygen already fits this bill, which is why Braff says it is still considered the most reliable source of profit in HME. He suggests that non-custom rehab products for firms with a DME component are also promising.

Letson says smart firms will invest in new technology, such as systems that allow a central office to monitor patients in their homes and receive daily status reports. (His firm sells global positioning systems to track drivers along with other HME-related products.)

These companies “will handle twice as many patients with the same number of people,” he says. And they aren’t necessarily the big firms, though he says the nationals have been more aggressive adopters than the mom-and-pops.

The cost of software and equipment tends to follow the size of the customer base, so “the fewer patients you have, the less expensive it is,” and software providers are eager to do business with the little guy.

“It’s important to have small providers as part of your program,” he says. “You try to develop technology for the masses and not for the three largest companies in hopes that you get their business.”

Watch your ASPs.

Miriam Lieber, an HME consultant based in Sherman Oaks, Calif., says the reimbursement based on ASPs for respiratory meds are adjusted each quarter and the changes can be dramatic, up to 20 percent. For providers, this represents both a threat and an opportunity.

The threat is that a drug that was profitable in one quarter could suddenly be subject to a sharply lower reimbursement in the next, forcing the business to sell it at a loss. The opportunity lies in adjusting one’s marketing to the ASP fluctuations.

“You need to educate physicians that you may not be able to deliver the same medication from quarter to quarter,” Lieber advises. In other words, learn to be flexible about which drugs are sold when, and teach physicians and patients to be flexible, too.

Consider diversifying.

Every business has to be ready to adjust its product and service mix to changing market conditions. This is nowhere more true than in respiratory HME. Oxygen may still be relatively reliable, but the shift in respiratory drug dispensing has been dramatic.

“If you had asked me three years ago [what would be profitable],” says Wachovia’s Bonello, “I would have said delivering drugs.” Now, say Bonello and others, all or most profit for that business has dried up, even for the nationals. It serves mainly as a way to “get access to patients at an earlier point in time,” he says.

But with capped rentals and competitive bidding on the way, even oxygen no longer looks like such a safe bet in the long term.

Braff says potential buyers of HME firms still put the highest value on respiratory services, but they have started looking for companies with some non-respiratory revenue sources as well. “It is possible that, in an increasingly hostile environment, buyers may not only continue to look at companies with less respiratory but will begin ascribing some value to non-core secondary DME,” he says.

So, diversification looks better as the respiratory outlook grows bleaker. And the stingier Medicare gets, Braff says, the more it makes sense to check out non-Medicare alternatives such as managed care.

On the pharmacy side, Letson foresees a chance for the HME providers to pick up business in drugs now covered under Medicare’s new Part D program. Without needing to run full-line pharmacies, they can expand their range of maintenance drugs and devices. Along with nebulizers, for instance, they might expand into heart monitors.

Grow or die?

Who will the survivors be? Talk to different observers and you get different answers. Some see the respiratory drug dispensing business as a lost cause except for firms that use it to generate sales in other lines.

Kruk predicts that nationals such as Lincare and Apria will stay in it, in part because they “will be able to mine that patient base for oxygen referrals.” He also thinks independent pharmacies have a chance if they already have a strong business and “a creative way to reach out to DME companies.”

Weeks thinks companies over a certain size have a chance. “People who have 100 to 200 patients, maybe 300 patients, will probably need either to be finding a way to grow their business very quickly, or they should be considering whether they can achieve their profit objectives if they stay in the business.”

Providers with a big enough patient base can use their respiratory meds business to pull in referrals, at least in markets that are large enough to provide sufficient business but not so large that they attract the attention of big pharmacy firms. He says a trade area with a population of 100,000 to 200,000 seems best for this strategy.

But Letson, for one, does not buy any grow-or-die theories. He disagrees with those who say the new reimbursement climate favors the big firms.

“It favors the small companies because of their lack of overhead,” he says. And efficiency is what matters — not size — whether a home care company’s focus is respiratory meds, oxygen, rehab or any other line of home medical equipment.

As Letson puts it, “If you’re not running a very lean operation, you’re not going to survive in DME as a whole.”