Debts, Cutbacks in Health Field Put Westworld in Sore Straits

Just one year ago, Westworld Community Healthcare Inc. seemed to be in the pink of health.

Racking up impressive revenue and earnings growth, the Lake Forest-based company boasted to investors at a December conference that it would expand the number of hospitals in its chain by nearly 25% during 1986.

Today, Westworld staggers under the mountain of debt incurred to finance that rapid growth.

It is in danger of defaulting on that debt and confronted with the ugly reality of its first-ever yearly loss.

The company has been forced to pare back its far-flung chain and stands accused of greedily charging too much by public officials in many of the communities that once eagerly welcomed Westworld.

The company’s troubles may have been most keenly felt by its shareholders, whose holdings plummeted 91% in value this year. From a 1986 high of $15.375 a share, Westworld stock has fallen to new lows, closing Friday at $1.375 a share.

Now the company is mapping a restructuring plan aimed at paring its debt, eliminating money-losing operations and settling regional squabbles over high costs that have driven customers away. In the process, Westworld officials say, the company could return to profitability in 1987.

Focusing strictly on rural areas, where the local hospitals are often poorly managed and financially strapped, Westworld thought it had found the key to success in the difficult and volatile health care business.

Westworld either bought the hospitals for a song or entered into long-term leases on very favorable terms. It then used the facilities as bases on which it built outpatient clinics and specialty programs, such as alcoholism centers, designed to increase revenues.

Usually, local officials were only too happy to let Westworld take over.

Through aggressive acquisitions, Westworld grew from nothing in mid-1982 to a peak of 38 hospitals early this year. To help finance that growth, Westworld last year turned to the junk bond market, retaining the investment firm of Drexel Burnham Lambert to underwrite $65 million in subordinated notes and debentures.

But between the crisis in the farm belt and the shakeout in the oil patch, rural health care has proven to be a tough business: too many patients are simply unable to pay for the care they receive.

“The rural concept looked like a good idea at the time, but it’s not proven to be any more profitable than any other area in health care,” said Steven Reid, an analyst with the Los Angeles brokerage house of Wedbush Noble Cooke Inc.

Earlier this year the federal government began scaling back the amount it would pay for medical services in certain rural areas.

It was last April that Westworld first began sounding an alarm, warning analysts that while net earnings this year would top 1985’s $3.5 million, the increase would be lower than first projected, with the bulk of the shortfall occurring in the second quarter.

Picture Turns Bleak

Since then, the picture has only become bleaker.

During the nine months ending Sept. 30, Westworld had a net loss of $1.8 million, compared with net earnings of $2.7 million a year earlier. Revenues increased 61% to $148.6 million from $92.2 million in 1985. During the first nine months of 1986, the amount Westworld set aside for uncollectable accounts shot up 90% to $34.5 million from $18.1 million a year earlier.

To stem the losses, Westworld is in the process of divesting five money-losing hospitals and nearly two dozen clinics, including some that opened just this year.

Westworld would not specify which facilities would be closed, but a source close to the company said operations to be divested include those in Gold Beach, Ore.; St. Anthony, Ida.; Webb City, Mo.; Muleshoe, Tex., and three in California.

By the end of the year still more hospitals will either be sold or closed, and Westworld will leave some communities altogether, said Westworld Chairman and Chief Executive Officer Michael Dunn in an interview last week.

One source close to Westworld said that the company may divest up to seven more facilities under the restructuring scheme.

The closings will lead to a “substantial” write-down on assets, Dunn said, and as a result, “there is a 100% certainty of a loss” for 1986.

Not only is Westworld attempting to scale back its size, but it is now attempting to refinance the debt that made its explosive growth possible.

In the process, Westworld will not be making a $2.5-million interest payment that is due tomorrow. Dunn said the company has a 30-day grace period in which to make the December interest payment. But, he said, the refinancing may not be complete by the end of the year, and default is a possibility.

Being in default is “not a good long-term way to run a business,” Dunn admitted. But until Westworld can swap its debt for equity, he said, the holders of its $65 million in bonds will “have to tolerate the default.”

Like other analysts, Tom Snow, of New York based-McKinley, Allsopp Inc., says he believes that at least for the short term, Westworld’s survival depends on its ability to convince bondholders to accept new equity in exchange for the $65 million in long-term debt.

But because the bondholders would not be able to collect in a liquidation until after Westworld’s senior creditors collect what they have coming--and because Westworld has few hard assets anyway--significant bondholder opposition is not likely, he said.

Still, even if Westworld can refinance the debt and become profitable as a much smaller company, its problems will be far from over. In many communities, Westworld has engendered considerable ill will among the people it serves.

For example, Westworld is the target of two civil lawsuits filed earlier this year by the attorney general of Missouri, who accuses the company of “instituting and failing to disclose fraudulent billing practices,” at two facilities in that state.

The suits, filed in June after a lengthy investigation, accuse Westworld of adjusting hospital bills to meet preset daily rates, “regardless of services provided or the cost of the services.”

For example, in one case, Westworld charged a patient at its Webb City, Mo., hospital $19 for a single Tylenol tablet in order to boost his bill to the $1,050 a day Westworld charged all patients, something that even Glenn Caster, a Westworld vice president, admitted was a “stupid” thing to do.

“There literally may be millions of dollars at stake in this suit,” said Missouri Atty. Gen. William Webster. “The cost of health care in Missouri is high enough. We don’t need a company doctoring billings on top of it.”

Dunn rejects the allegations as “absolutely false.”

Though other communities have stopped short of legal action, the company nevertheless is under siege in other states, including South Dakota, where public officials openly attack Westworld’s hospital rates as excessive.

Westworld earlier this year instituted a new billing system patterned after Medicare’s “diagnosis related group” system, which bases payments not on how long a patient is in the hospital, but on his or her diagnosis.

Nevertheless, a stay at Custer Community Hospital, a 16-bed facility Westworld has operated since 1982, still costs the patient or his insurer 30% more on the average than at other South Dakota hospitals, said Katherine Kinsman, South Dakota’s secretary of health.

In fact, Kinsman said in a telephone interview, the only other hospital in South Dakota that is more expensive than Custer Community is Estelline Community Hospital, another 16-bed facility operated by Westworld.

“We don’t have any legal basis to go after them, but we’d love to,” remarked Dana Nelson, a senior aide to South Dakota Gov. William Janklow. “The governor is very distressed with the consumer complaints.”

Westworld’s Caster agrees that the company’s charges frequently are higher than what Medicare might consider reasonable. But when compared with the Medicaid program, whose reimbursements are higher than Medicare’s, Westworld charges are in line, he contends. Medicare covers the nation’s elderly, while Medicaid provides care for the poor and indigent.

In an interview earlier this year, Dunn said that rural health care is always going to be more expensive simply because it is less cost-effective to maintain an acute-care hospital for the benefit of a limited population.

“If you run a full-service, primary-care hospital for two patients, you don’t need Economics 101 to realize that it’s an inefficient program,” Dunn said.

Moreover, because Westworld operates what were once city- or county-run facilities, it functions like a “quasi-public utility” and is not immune to local gripes about its rates, which frequently come up at public meetings, Dunn said.

“That’s a reality of our business that will be a problem from now until forever,” Dunn said. “We’d like to be liked, but that’s not our objective.”

Still, residents of some communities have fled Westworld-run hospitals and clinics, instead patronizing facilities in neighboring cities. This “lack of support” as Westworld puts it, is a factor behind the decision to get out of some areas, the company said.

For instance, four clinics currently up for sale are in Webb City, where Westworld earlier this year ended a stormy three-year relationship with local officials by bailing out of its 30-year contract to manage the city’s 50-bed hospital.

Webb City is only about a dozen miles from Joplin, a city with almost 40,000 residents and four hospitals, so boycotting Westworld’s facilities was easy, said Bob Foos, editor of the Webb City Sentinel. “We’re only about 15 minutes from three major hospitals,” he said.

A similar situation exists at Big Bear Lake, Calif., where Westworld has operated the local hospital under contract since late 1984.

Residents Go Elsewhere

Many residents, fed up with what they believe to be excessive charges at the hospital, “go off the hill,” as they say, to San Bernardino or Redlands for their medical care.

Widespread community opposition earlier this year resulted in Westworld’s slashing its charges for some services offered at Bear Valley Community Hospital, including emergency room care and outpatient surgery.

As a result, the charges at Bear Valley are “now high instead of outrageous,” said Dr. Eric Johnson, a one-time chief of staff at the hospital and a member of the teaching faculty at Loma Linda University.

Susan Thomas, president of the Bear Valley Community Hospital District, said that although Westworld recently made further cuts in its charges, the cost of health care is still higher in Big Bear than in surrounding cities.

“But, I think you have to expect it to be higher up here,” she said, stressing that it is simply more expensive to run a small hospital in a resort community such as Big Bear Lake. “It’s like comparing the corner mom and pop market with Safeway.”

Although 1986 has been a rough year for Westworld, Dunn expects his company to return to profitability in 1987--if the bond swap can be accomplished. In the meantime, he agrees, Westworld stock is strictly for speculators.

In fact, Westworld shares might drift even lower before the end of the year as many of the institutional holders who account for 29% of Westworld’s 8.1 million outstanding shares do some tax-loss selling, said analyst Reid of Wedbush Noble Cooke.

If that happens, some analysts say Westworld could become a strong candidate for a leveraged buy-out, especially because its stock is trading for less than the company’s stated book value of $3.40 a share.

“It’s crossed our minds, but our main problem is the existing debt load,” Dunn said. “If we get everything worked out and the stock price stays where it is . . . the heck with being a public company.”

WESTWORLD AT A GLANCE

NET EARNINGS/ (LOSS) REVENUES 9 mos. 9/30/86 ($1.8 million) $116.2 million 12 mos. 12/31/85 $3.5 million $108.7 million 12 mos. 12/31/84 $1.8 million $43.6 million 12 mos. 12/31/83 $279,000 $16.2 million