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Regulation play

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Fine Print – May 2011

Regulation play
By G.D. Gearino

If anyone decides to compile a list of the most unsettling sentences ever found in a news report, I’ll nominate this candidate, culled from my local daily newspaper a few weeks ago: “A battle is shaping up over 101 new hospital beds that state regulators say are needed to meet the surging demand for health care in Wake County.” Who knew that through those 27 simple words the unhappy state of our modern regulatory apparatus could be unwittingly revealed?

There are people, of course, who believe there is not enough regulation in life, that all economic ills could be cured by imposing more rules and exercising more oversight upon the business world. The problem with that belief is that it runs contrary to everything we know about human behavior. After all, we’ve been refining, updating and expanding history’s most famous set of formal regulations — the Ten Commandments — for thousands of years. In hindsight, it’s all been for naught. Can anyone make the case that we’ve eliminated, or even significantly reduced, adultery, theft, murder, idol worship and taking that name in vain during the millennia since Moses brought the tablets down the mountain?

But belief in the power of regulation is hard to shake. That’s how we find ourselves at a moment in time when anonymous state bureaucrats can claim to know the exact number of hospital beds fast-growing greater Raleigh will need in the future. Ninety-eight will be too few; 103 will be too many. We’ll need exactly, specifically, precisely 101 of them.

Lest you lump me in with the crowd of hard-core regulation haters, please understand that I think some (and maybe even most) regulatory agencies have a place in the world. I’ll go even further and say that most regulators, if given the flexibility to exercise judgment, probably would turn out to have good sense. Problem is, what once was a clear line separating the regulated from the regulators is now blurred. The federal government is both a securities regulator (through the Securities and Exchange Commission) and an investor in a global public company (General Motors Corp.) — which issues securities. Similarly, the government was an investor in hundreds of banking companies, through the Troubled Asset Relief Program, and a regulator of the banking industry by way of the SEC, Federal Deposit Insurance Corp., Office of Thrift Supervision and the Federal Reserve. Needless to say, you shouldn’t be an investor and a regulator. When it comes to the medical industry, the state of North Carolina is on that same kind of spongy ground.

All regulation starts with a noble premise, and in the state’s case it’s this: The health of North Carolina citizens is too important to be left entirely to the whims of the marketplace. (That’s literally the first declaration in the law establishing the state’s authority to regulate the industry.) But from that point forward, the integrity of the regulatory process is challenged in two separate ways — both of which are illustrated in the debate over who gets the 101 beds in Wake County.

First, regulators are in the position of picking a winner from a group of applicants that includes … well, the state of North Carolina. The three hospital groups vying for the beds are WakeMed, the Raleigh-based hospital once owned by Wake County but now independently operated; Novant, the Winston-Salem-based owner of hospitals in the Carolinas and Virginia; and Rex Healthcare, which is owned by UNC Health Care System. And UNC Health Care, of course, is owned by the state. All parties can pledge that such a circumstance will make no difference when the decision is made, but the stark reality is that the state sits on both sides of the table as the fate of the 101 beds is discussed. Little wonder that WakeMed has made a legal case over UNC Health Care’s built-in advantage in an unrelated decision refereed by the state.

The second challenge is the fact that one of the state’s primary considerations as it goes about the business of supervising the health-care marketplace is the state’s own bond rating. A majority of the hospitals in North Carolina have financed their construction or expansion through tax-exempt state bonds, according to a top executive in the Department of Health and Human Services. Since 1974, he says, some $17 billion of bond financing has been used to build hospitals, “and we’ve never had a default in the history of the program.” That’s one reason why the state’s bond issues have long enjoyed good ratings — and thus command lower rates in the financial markets, which keep borrowing costs down.

But that’s also why regulators find themselves putting a cap on the supply of hospital beds in Wake County (as well as the rest of the state) — in essence, limiting the supply. You see, hospital beds are to regulators what oil is to OPEC: a commodity whose availability is carefully controlled to ensure a good revenue stream. Seen in that light, the determination that Wake County will need 101 additional beds — no more and no less — has a subtle precision. It balances the health needs of citizens against the need for hospitals to make enough money to guarantee the health of the state’s bond rating. Funny, but I didn’t find the second of those considerations emphasized quite as lyrically in the statute books as the first.

Regional Report Western May 2011

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REGIONALREPORT Western

Volvo Construction Equipment North America LLC will close its sales and rental operations in Asheville by September 2012, moving 220 jobs — averaging $82,400 a year — to Shippensburg, Pa. The company, part of Swedish automaker AB Volvo, closed its Arden assembly plant, which made front-end loaders and excavators, in March 2010, letting go 228. It or a predecessor had operations there since 1976. Volvo employs about 2,100 in North Carolina — mostly in Greensboro.

GRANITE FALLS — Ailing Bank of Granite shrank its losses in 2010 but is having trouble raising capital as required by regulators last year. The bank lost $23.7 million in 2010 — compared with $25.6 million in 2009 — but was still undercapitalized by three important measures. It has operated under a Federal Deposit Insurance Corp. cease-and-desist order, the most drastic corrective action short of failure, since August 2009.

ASHEVILLEAsheville Savings Bank plans to convert from a mutual savings bank owned by its customers to one owned by stockholders. It hasn’t set a timeline but says it will form a new holding company to sell and issue stock. Account holders will get a chance to buy shares before they become available to the public.

ASHEVILLE — Sales of existing Buncombe County homes increased 7.9% in February. It was the first year-over-year increase since June.

MARION — McDowell County commissioners offered an unidentified company 125 acres as an incentive to build a factory here. They say the company, expected to make a decision within the next few months, would invest $30 million for a building and equipment. It would create 113 jobs.

CHEROKEEGreat Smoky Mountains National Park opened a $3 million, 63,000-square-foot visitor center — the first one on the North Carolina side of the park. Park officials hope it will boost attendance, which dropped 0.3% to 9.5 million last year.

Regional Report Western March 2011

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REGIONALREPORT Western

Asheville bank is third but won’t be last to fail 

When federal regulators closed Bank of Asheville in January and brokered its sale to Troy-based First Bancorp, 18 months had passed since North Carolina’s last bank failure. It won’t be that long, experts say, before another one bites the dust, though it probably won’t be a heavyweight.

The message from Bank of Asheville’s failure is clear, says Tony Plath, associate professor of finance at UNC Charlotte: “We have a tale of two banking industries. The big banks, except for Bank of America, are doing well. But when you get to the regionals, the industry is distressed.” Ray Grace, the state’s deputy commissioner of banks, says 15 state-chartered banks are classified as troubled. “Three years ago, we had one.” The main problems are the weakness of the commercial real-estate market and high unemployment. “Banks operate in the context of the economy they’re in. When people don’t make money, they don’t spend and businesses — including banks — don’t make money.”

He agrees that there is a divide between large and small banks, partly because the larger ones got more help from the federal government. But he also notes that the three North Carolina banks that have failed since the national financial crisis of 2008 have either been on the coast — Wilmington-based Cape Fear Bank and Wilmington-based Cooperative Bank — or in the mountains. Both are regions where real-estate values had appreciated rapidly during the housing boom, and both have been hurt by weakness in the second-home and resort markets. Bank of Asheville had other problems: Its former CEO, Buddy Greenwood, has been indicted on charges of bank fraud, stemming from a $500,000 loan he made, and money laundering.

Plath believes the problems are broader and expects more contraction of the 85 state-chartered banks this year — possibly three or four more closures. He expects the number of state-chartered banks to shrink to 50 within five years. In addition to the 15 banks officially classified as troubled are as many as 25 others that are weak. Many are operating under agreements with regulators. “All of those banks are not going to live.”

Grace doesn’t believe it will come to that, though he acknowledges there could be another failure or two this year. “We work hard to find partners and private equity groups to get through their problems.” But, he says, “it has been a long, grinding recession. The longer it grinds on, the longer equity markets remain skeptical of bank stocks and the more wear and tear there is on bank capital.”

OLD FORTPisgah Yarn & Dyeing agreed to sell its assets to Canada-based Spinrite Yarns. Terms of the deal, scheduled to close in late February, weren’t disclosed. Spinrite plans to use the company’s buildings as a distribution center, eliminating jobs for all but a handful of Pisgah’s 81 employees.

CHEROKEEHarrah’s Cherokee Casino & Hotel opened its third hotel tower, adding 454 rooms and 78 suites to the complex. That increases the total room count to 1,108. The tower is part of a three-year, $633 million expansion (cover story, October).

BREVARDThe Conservation Fund bought 786 acres near the South Carolina border for $5.5 million. It’s the first piece of an 8,000-acre tract the Arlington, Va.-based conservation group and others plan to buy from Charles Taylor, a former Republican congressman from here, for $33 mil-
lion. Environmentalists say that’s the largest undeveloped privately owned tract in the region.

FLETCHERVision Airlines plans to start twice-weekly flights April 1 between Asheville Regional Airport and Northwest Florida Regional Airport, near Fort Walton Beach and Destin. The discount carrier is based in Suwanee, Ga.

BRYSON CITY — A specialty license plate featuring a black bear against a green mountain background raised $356,000 in 2010 for Great Smoky Mountains National Park. The plate is the second-most popular in North Carolina, behind the Blue Ridge Parkway plate.


Regional Report Western January 2011

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REGIONALREPORT Western

Manufacturing’s loss is data center’s gain

Nearly two years after Springfield, Mo.-based boat builder Mako Marine International Inc. closed its plant in Forest City, Facebook Inc. announced it would spend $450 million to create a data center at the site. Completion is slated for early 2012. The 40 or so jobs promised by the Palo Alto, Calif.-based social-networking giant don’t come close to matching the 150 that went down with Mako, but they show once again how western North Carolina has become a magnet for high-tech data centers, aided by cheap electricity and available land. “The main thing is that the infrastructure they need is here,” says Glenn Bottoms, professor of information-management systems and economics at Gardner-Webb University in Boiling Springs. “They can put in all the special, fast Internet lines they need — T1, T4 or whatever — and Rutherford County, with its decline in textiles, has a lot of space available. Data centers can be not only capital-intensive but land-intensive.”

Apple Inc. is building a $1 billion data center that will employ about 50 in Maiden, and Google Inc.’s $600 million data center eventually will employ about 210 in Lenoir. T5 Partners Inc., based in Atlanta, says it will build a shell to house a server farm on 260 acres in Cleveland County, and Wipro Ltd., an Indian information-technology company, said a few days after Facebook’s announcement in November that it would open a $75 million, 17-employee data center in a building vacated in 2009 by another boat company, Chris-Craft, near Kings Mountain. Those aren’t random events. Spokesman Jason Walls says data centers are one of Charlotte-based Duke Energy Corp.’s economic-development targets. Its electricity rates are among the lowest in the nation, and it has plenty of generating capacity, partly because of the state’s shrinking manufacturing base.

While landing big-name high-tech companies burnishes the region’s image, some people are skeptical about the economic impact of data centers. Facebook’s incentives total more than $11 million over 30 years. Because many jobs will be filled by outside contractors or relocated workers — Bottoms estimates Facebook will hire 10 to 20 local workers, most with two-year college degrees — that could amount to nearly $1 million per job. To collect its incentives, Facebook must pay $13.45 an hour, the average wage for Rutherford County. “The multiplier effect will be tiny, and mostly in the construction phase,” Bottoms says. “In the long term, for every job generated by, say, the Carolina Panthers in Charlotte, another eight are created in Charlotte. For data centers, the numbers are nothing like that.”

BLACK MOUNTAIN — Buncombe County commissioners agreed to support supermarket chain Ingles Markets in its quest to get $100 million in low-interest federal bonds. Ingles plans to build an 830,000-square-foot refrigerated distribution center in Black Mountain that would add 160 employees by the end of 2012. Its existing warehouse employs 750.

CANTON — The Western North Carolina Regional Livestock Center will open next month, giving cattle farmers in the region a more convenient place to sell their animals. Many have had to travel to South Carolina or Tennessee since the local market closed in 2004.

HENDERSONVILLE — Kris Hoce resigned as CEO of Margaret R. Pardee Memorial Hospital to take a job as chief operating officer at Morton Plant Hospital in Clearwater, Fla. Gerald Maier, former CEO of the University of Oklahoma Medical Center in Oklahoma City, was named interim CEO.

HUDSON — Austrian textile maker Sattler plans to buy the Outdura brand from Shuford Mills and form a company with the same name as the brand. It also plans to spend nearly $5 million within three years to expand Shuford’s plant here and add 16 workers, bringing the total to 76.

HENDERSONVILLE1st Financial Services, Mountain 1st Bank’s parent, plans to close two of its 14 branches by March because of the weak economy. About 20 of the company’s 175 employees will lose jobs.


Regional Report Western February 2011

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REGIONALREPORT Western

Ingles tries to restock pre-recession earnings

At first glance, Black Mountain-based Ingles Markets Inc. seems to be sitting on top of the world. The grocery chain, with 202 stores in Georgia, North Carolina, South Carolina, Tennessee, Virginia and Alabama, produced net sales of $3.4 billion in the fiscal year that ended in September — its 46th straight annual increase. Net income totaled $31.7 million, up 10% from the year before. That looks great until you compare it with 2007, when it netted $58.6 million, or the $52.1 million it made in 2008. So what happened?

In a few words: The economy weakened, and the competition stiffened. Ingles goes toe-to-toe with discount retailers such as Aldi, Bi-Lo, Food City, Food Lion, Kroger, Publix, Target and Wal-Mart. It has had to slash prices — and its profit margin — to boost sales and retain market share. Meanwhile, expenses have gone up from $564 million in 2007 to $653.7 million last year. Salaries and wages made up the biggest part of the increase. Ingles now has about 18,800 employees, compared with about 17,000 in 2007. The company closed three stores and opened eight during that time, with the average store size increasing from 49,382 square feet in 2007 to 53,524 in 2010.

Company executives don’t discuss much about their operations, but Chief Financial Officer Ron Freeman told analysts during a recent conference call that Ingles plans to continue its expansion by building or remodeling five stores in 2011 and adding six gas stations either at those new stores or other locations. In all, he says, the company will spend between $100 million and $140 million — more than the $92 million it spent in 2010.

He says the company hopes to continue to improve sales in all four of its categories — groceries, which includes canned, frozen and dairy products; nonfoods, which encompasses alcoholic beverages, tobacco and pharmacy items; perishables such as meats, produce and delicatessen and bakery goods; and gasoline. Customers made 5.4% more trips to the stores last year but spent less per trip.

Meanwhile, investors are paying less for the company’s stock than they did in 2007. Shares closed at $18.85 in the first week of January, down 29% from the corresponding week four years ago but up more than 32% from the first week of January 2010.

Freeman expects the company’s fortunes to continue to get better as consumers gain more confidence in the economy and return to pre-recession spending. “Overall, they’re feeling a little better, but like most things in the economy these days, it’s going to be a slow, incremental move forward,” he told analysts. “You hope that it continues to be a move forward.”

WEAVERVILLEArvato Digital Services, part of Germany-based Bertelsmann, plans to spend $2 million within three years to build a call center and add 408 jobs, giving it nearly 1,000 locally. The company makes compact discs and DVDs.

ARDENAlliance-Carolina shut down two factories, putting about 80 people out of work. It made plastic parts and molds used to make parts. Chief Financial Officer Richard Stokes blamed the poor economy and the loss of a key contract.

ASHEVILLEMills Manufacturing, which makes parachutes and related components, won a contract to make cargo-parachute assemblies for the Army. It began adding 30 jobs in January. That will bring the total to about 255.

ASHEVILLE — Carolyn Ward replaced Houck Medford as CEO of the Blue Ridge Parkway Foundation, a non-profit that has raised millions for the parkway. Ward will run the foundation from here, though its offices will remain in Winston-Salem, where Medford helped start it 12 years ago.

WEST JEFFERSON — The state is weighing whether to close Mount Jefferson State Natural Area to cut costs. It also is considering closing most state parks on Tuesdays, Wednesdays and Thursdays.

ASHEVILLE
Mission Hospital fired three employees who failed to get flu shots. A new policy required all of the hospital’s 6,300 employees to be vaccinated.


Recovery lets shoppers lap up some luxury items

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2005 Industry Report: Retail

Recovery lets shoppers lap up some luxury items

checkout

TREND: Personal income in North Carolina grew at a record rate between June 2003 and June 2004, boosting retail sales in 2004.

OUTLOOK: Sales growth will continue but at a lower rate than in 2004.

Shop until you drop. It’s the American way, says James F. Smith, professor of finance at UNC Chapel Hill’s Kenan-Flagler Business School. “When income goes up, spending goes up.”

And income has been going up in North Carolina. Personal income increased to $249.1 billion in the second quarter of 2004, a 6% jump from the second quarter of 2003, according to the U.S. Bureau of Economic Analysis. “That’s an all-time record for growth in personal income for North Carolina,” Smith says.

Retail sales rose 5% during the fiscal year that ended in June, according to the state Department of Revenue. Smith projected 7% growth for calendar 2004. Michael Walden, an economist at N.C. State University, projected an 8% increase. Sales grew just 1% in 2003. “I think 2004 will be the year when we turned the corner and paved the way for more economic growth,” Walden says.

Economists attribute the income gain to changes in employment: Job losses slowed in the state’s traditional manufacturing strongholds — textiles, furniture and tobacco — while job creation was ahead of the national pace. At the same time, interest rates remained low, making borrowing for large purchases more attractive.

Those with money found many more places to spend it in 2004 as high-end retailers such as Saks Fifth Avenue, Burberry, Louis Vuitton and Kate Spade opened their first stores in North Carolina. Birmingham, Ala.-based Saks opened an 80,000-square-foot store in Raleigh at Triangle Town Center in September. Though that store was doing 50% more business than it expected, Saks, discouraged by a developer’s delays, backed away from plans to open one in Charlotte (Tar Heel Tattler, January).

Charlotte shoppers weren’t without opportunity to buy pricey wares. SouthPark mall opened a cache of upscale shops as part of a $100 million renovation and expansion. Nordstrom opened its second North Carolina store there in March, two years after opening one in Durham. “Getting a Nordstrom is the mark of a metropolitan area that has advanced,” Smith says. “It says it’s a good market, and people want to be in it.”

Despite ongoing construction of shopping centers, retail vacancy rates fell during the first half of 2004, says Brian Reece, managing partner of Karnes Research in Raleigh. The Triangle rate was 4.7% for the period, down from 5.2% the year before. Charlotte’s rate was 5.5%, down from 7.3%. Both figures could rise as new stores and shopping centers open. The biggest under construction is the 1.2-million-square-foot Northlake Mall, scheduled to open in September near Lake Norman, an affluent, fast-growing region north of Charlotte.

While upscale retailers appealed to those with money to spend on luxury and status symbols, bargain and big-box retailers continued to compete on price. Penny-pinching shoppers helped deliver a good year for Matthews-based Family Dollar Stores. The discount chain reported sales of $5.3 billion for the fiscal year that ended in August — 11.2% more than 2003. Net income was up 6.1%. Family Dollar opened 500 stores in 2004, giving it more than 5,480 in 44 states.

Mooresville-based hardware giant Lowe’s saw revenue rise 18% to $27.9 billion during the nine months ending in October. Net earnings rose 14% to $1.7 billion. Chairman and CEO Robert L. Tillman planned to retire in January and turn over the reins to President Robert Niblock. The company plans to add 150 stores this year.

Statewide, sales are expected to grow at a lower rate in 2005 — just 5%, Walden says — mainly because most of the pent-up demand from 2003 has eased.

One high-profile Tar Heel retailer hoping to rebound from a bad year is Winston-Salem-based Krispy Kreme Doughnuts. After three years of rapid growth and soaring stock values, investors pushed away from the table in 2004. And their reluctance wasn’t only a shunning of carbs. The company lost $18.7 million during the six months that ended in August and delayed filing its third quarter report while it sorted out accounting issues. By December, the combination of red ink and a formal investigation of its accounting practices by the Securities and Exchange Commission had driven down the company’s stock price more than 70% from its 2004 high of $39.74.

Practices make perfect targets for regulators

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2005 Industry Report: Insurance

Practices make perfect targets for regulators

premium notices

TREND: N.C. Insurance Commissioner Jim Long, spurred by insurance probes elsewhere, is turning up the regulatory heat on insurers.

OUTLOOK: Insurance companies may change their business practices to stay out of trouble.

Things were going great in the insurance industry in 2004. Life and annuity companies were boasting about better bottom lines, thanks to strong annuity sales and rising interest rates that boosted investment income. Health insurers continued to enjoy hefty profits but not as big as in 2003, when they sparked complaints from consumer advocates and regulators. Auto insurers finally declared a truce in their long rate war with N.C. Insurance Commissioner Jim Long. And casualty companies dodged big payouts when hurricanes flooded inland rivers, causing significant damage — but not the kind covered by most policies.

Then along came Eliot Spitzer. In October, New York’s attorney general launched an investigation of bid rigging and kickbacks to agents by major insurance companies. His earlier probe of cozy trading agreements in the mutual-fund industry led to billions of dollars in fines and settlements, so his insurance offensive sent shock waves around the country. Long soon launched his own probe, asking more than 5,000 companies and brokers doing business in the state to certify that they haven’t engaged in bid rigging.

The issue revolves around a common practice called contingent commissions, paid by insurance companies to brokers for steering business their way. Spitzer’s investigation likens them to kickbacks. “The Spitzer thing hangs over the entire industry,” says John Leonard, an insurance analyst with SNL Financial in Charlottesville, Va. While the initial probe involved corporate clients of big insurers, it expanded deep into the industry across just about every line and could touch health, life, auto and casualty, he says. He expects companies to change business practices and to pay big fines and settlements.

But regulators and insurers have been battling over other issues here for a long time. Blue Cross and Blue Shield of North Carolina spent 2004 trying to defend its hefty profits. Long said he might demand that it issue rebates if they continued to surge. Blue Cross shared some of its take with members in the form of benefits such as free generic drugs. And it said it would try to slow rate increases and bring its profit margin back below 6% after having it blow past 8% in 2003. Net income dropped 16% the first nine months of 2004 to $145.5 million.

Health-maintenance-organization profits for the first nine months of 2004 were down 20% to 30% from 2003. United Healthcare of North Carolina, the state’s largest, reported net income of $30.1 million for the first nine months, down 25% from the same period a year ago. Blue Cross’ HMO made $20.5 million in the same period, down from $26.8 million in 2003.

Premiums also have been a major issue in auto insurance. Rate disputes that had dragged on in the courts for years were settled in June when the state Supreme Court ruled in Long’s favor. The North Carolina Rate Bureau, which represents insurers, promptly settled a pending case and dropped a requested rate hike for 2004. The result, Long says, is a savings of up to $1.2 billion for Tar Heel drivers, including up to $700 million in refunds to those who paid earlier rate hikes.

Life-insurance companies had a good 2004 due to higher investment income. Falling interest rates cut into those returns in 2003. But with rates inching up, profits rose. Greensboro-based Jefferson-Pilot reported improvement in its investment portfolio. Meanwhile, a new line of fixed annuities caught on, helping boost sales 66% in the third quarter. For the first nine months of 2004, the company reported net income of $400.5 million versus $375.3 million a year earlier. The 2004 total included a $16.6 million charge for a change in accounting methods.

Independent insurance agents, regained ground lost to banks that have been buying agencies. Bo Walker, president of the Independent Insurance Agents of North Carolina, estimates that his organization added 25 to 30 agencies in the past year, a sign that new ones are replacing those bought by banks. Banks, meanwhile, have backed off their buying spree, having established positions in major markets.

Money proves to be real pill for industry

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2005 Industry Report: Lifesciences

Money proves to be real pill for industry

prescriptions

TREND: Venture capital for North Carolina companies declined during the last four years.

OUTLOOK: Businesses will look more aggressively for alternative funding such as federal grants.

Executives at life-sciences companies in North Carolina have at least one thing to be thankful for: Their industry’s popularity with venture capitalists isn’t fading as fast as it has for some others. Through three quarters of 2004, they had grabbed 29% of the venture capital received by North Carolina companies, compared with 14.4% during the first nine months of 2000. Still, they got less money in 2004, about $64 million, compared with $226 million in 2000. That’s because the amount of venture capital declined sharply, from about $1.6 billion in the first three quarters of 2000 to about $220 million in 2004.

That isn’t the only problem. The U.S. Food and Drug Administration has faced increased scrutiny since September when Merck pulled its FDA-approved Vioxx pain reliever because of studies showing it can increase the risk of heart attacks. That makes life tougher for all drug companies. “They can’t get drugs through,” says Monica Doss, president of the Research Triangle Park-based Council for Entrepreneurial Development. “They can’t get things looked at. They can’t get things done quickly.”

Even before the news about Vioxx, Durham-based Inspire Pharmaceuticals had trouble leaping regulatory hurdles. It expected FDA approval for diquafosol, a treatment for dry-eye disease, by the end of 2003, but regulators asked for more testing. Additional trials began in June, and the company has said it hopes to resubmit by midyear its application to begin selling the drug.

The drought of initial public offerings in the state continued — there have been none since 2002 — despite an increase nationwide that started in late 2003. There were 216 IPOs in the United States in 2004, compared with 221 the three previous years combined, according to Renaissance Capital, a Greenwich, Conn.-based IPO research company.

A few drug companies have declared their desire to go public but haven’t followed through. Winston-Salem-based Targacept, developing drugs to treat nervous-system disorders, and Durham-based Icagen, seeking treatments for diseases such as sickle-cell anemia, both filed IPO plans with the U.S. Securities and Exchange Commission in 2004. Each aimed to raise about $86 million. Neither had issued stock by year-end. Six North Carolina companies went public in 2000, but only one, Cary-based drug researcher Inveresk Research Group, has since then. Wilmington, Mass.-based Charles River Laboratories bought it last year for $1.5 billion.

The more immediate growth in the industry should come from older companies, says Leslie Alexandre, president and CEO of the North Carolina Biotechnology Center. Employment in drug manufacturing should increase, aided by a growing work force from community-college programs training life-sciences workers.

Companies that can find venture capital likely will get it sooner — but with strings attached, Doss says. Instead of funding multiple rounds, venture capitalists will commit more money in the first round but dribble it out in stages. “They don’t give them all the money up front. It’s all benchmarked on milestones.” Knowing the money will be there if the company hits its marks keeps CEOs focused on growth rather than glad-handing potential investors, she says.

With venture capital harder to come by, expect to see more life-sciences companies looking for alternatives. They’ll go after government money as companies did before venture capital began flowing into the sector. Research Triangle Park-based AlphaVax won a $4.8 million grant from the National Institutes of Health to develop a vaccine for severe acute respiratory syndrome. CED is counseling more companies on how to get such grants, Doss says.

There also will be more partnerships between large and small drug companies as large companies try to spread research-and-development costs. Durham-based BioStratum agreed in 2004 to collaborate with Danish insulin maker Novo Nordisk to develop a cancer treatment. The deal could be worth $80 million, plus royalties. “It allows the company to build some heft,” Doss says. “It’s not going to be a huge blockbuster for a company, but it allows them to build sales and build a sales force.”

Looking back to see ahead

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Up Front: February 2005

Making a name for yourself

Twenty years ago, Business North Carolina published its first Economic Almanac, an issue of the magazine devoted to examining changes that affected the state economy during the past year while trying to forecast those it would face in the future. Over the years, we accomplished that by breaking the state apart and examining the pieces.

Some years we did it by industry; others, by region. Sometimes we picked a theme — the way we work, the decade ahead, the state’s rivers, its highways — as a frame to build the editorial content upon. These special issues proved popular with readers and advertisers and won the magazine national awards. But taken as a whole — comparing one year’s almanac with the next — they didn’t provide a comprehensive, coherent picture of what was transpiring over time.

So in 1994 we launched the Business Handbook. The first featured our Mover and Shaker of the Year, but the focus was on packing as much data on Tar Heel industries and places as we could get between two covers. The next year, we plucked the Mover and Shaker piece, placing it in the preceding issue, where it appears today.

By 1996, we were back to themes — concentrating on big stories that kicked off the issue and led into the lists, snapshots, charts and other data. Some could have run in any issue of BNC. Though we produced some groundbreaking journalism — which won more awards — we realized that we once again had wandered away from the issue’s purpose. The Business Handbook you hold in your hands is our effort to get back to the basics. In many ways, it resembles the 1995 version more than it does those that followed. Call it back to the future.

But don’t dare think of it as a relic we’ve dug up and dusted off. Most of what you’ll find on these pages are the things you’ve come to expect. But we’ve also realigned the industry snapshots to convey more accurately what’s happening here in the 21st century and made sure the stories cover not only the year that was but the year that will be. After all, as I’ve said on this page dozens of times during these last two decades, change is what business in North Carolina — and Business North Carolina — is all about.

Look both ways

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Economic Outlook – February 2005

A famous forecaster and a top policy adviser discuss where the economy has been and where it’s going.
By Edward Martin

James Smith is director of the Center for Business Forecasting at the Kenan Institute of Private Enterprise at UNC Chapel Hill and chief economist for the national Society of Industrial and Office Realtors. He was a consultant to the President’s Council of Economic Advisers during the Reagan administration. Dan Gerlach is senior policy adviser for fiscal affairs to Gov. Mike Easley. He was director of the nonprofit North Carolina Budget and Tax Center and taught at N.C. State University before joining Easley’s staff in 2001.

BNC: Characterize 2004 and the year ahead.

Gerlach: In 2004, we saw the state with an above-average recovery in terms of adding jobs. We’ve seen the underlying strength of our service sector, not just in retail but in the business-, financial- and professional-services sectors. We expect to see that trend continue.

Smith: North Carolina is back in business. With our high proportion of manufacturing jobs, we went down ahead of the recession and then bounced back more rapidly. Now we’ve got to fix our horrible K-12 education system — our No. 1 problem — namely with a statewide voucher system.

Gerlach: I disagree on K-12. Our system is quite strong, especially in our early grades. We’re one of the nation’s leaders. Clearly, we can’t rest on our laurels because the dropout rate is a problem, and the governor is very interested in keeping young people in middle school and high school. We see a higher proportion of our high-school seniors going to college than ever before. Problem is, not enough students make it that far. That’ll be a focus of the governor’s second term.

What impact will Easley’s victory and Democrats controlling both the state Senate and House have on our economy?

Gerlach: It shows North Carolinians agree with the governor that education and economic development will create a more prosperous state. We saw that in the overwhelming vote to bring Dell here. [After the election, legislators approved a record $243 million incentives package for the Texas computer maker to build a plant in the Triad.]

Smith: Well, Dan still has his job, which was predictable. But the trick is, can they get North Carolina back on its normal post-World War II track of growing more rapidly than the national average, which has occurred in the last 12-to-14 months. In the last five years, we’ve slipped from the second- or third-largest economy, as measured by personal income, in the South to the fourth. Not a good direction.

Will we hear more about a lottery?

Gerlach: Yes. It puts us at a competitive disadvantage when everybody around us has one. We need more money for education. We’re growing so quickly we’re outstripping our facilities. It’s safe to say the governor will continue to talk about the need for a lottery.

Smith: Lotteries are for losers. It’s an immoral approach that says poor people are so dumb they willingly allow themselves to be taken to the cleaners. Lottery players are overwhelmingly poor, with low education and low language skills. They couldn’t calculate odds if they had to, and it’s rare to find a lottery that pays out more than 50% of the proceeds. In Las Vegas they pay 98%. If our good, honest Tar Heel workers want to go to Virginia or South Carolina, let them.

What do Bush’s re-election and Republican Richard Burr winning a U.S. Senate seat mean for the state?

Gerlach: It’s too early to tell. But a first step is, we need some kind of relief on the expiration of textile quotas in January. Hopefully, Senator Burr is communicating that to the president.

Smith: We’ve ripped off consumers for 30 years with those stupid quotas. I’m all for transition assistance to folks who lose their jobs, but the solution is to send them back to school and use our tax money to pay for it — not to have everybody else in the country paying more for textiles.

Gerlach: Because of globalization and manufacturing jobs lost to China, people are going to have to be better-educated. But we also need enforcement of trade laws already on the books. The governor has had to look in the eyes of 6,000 laid-off Pillowtex workers. It’s not much comfort to say you should have seen this coming.

Will the Bush administration’s record deficits hurt North Carolina?

Gerlach: Somebody’s going to have to pay for them, and most economists believe they’ll eventually affect the economy. We need to watch carefully that they don’t use this as an opportunity to shift costs down to the states.

Smith: I’d love to tell you deficits are the bane of our existence, but the top 75 studies of the last 25 years have failed to connect federal deficits — or surpluses — with interest rates, inflation, growth or employment. I’m sure they’re highly correlated with the amount of hot air from politicians.

Is offshoring a problem or a plus for North Carolina?

Smith: It’s the biggest phony-baloney issue I’ve ever heard. The Bureau of Labor Statistics in June told us it can identify 129,000 jobs nationwide offshored. But according to the federal government, one out of six of us gets his or her job from a foreign source. That’s 15 to 20 million jobs, and we’re wringing our hands over 129,000.

Gerlach: How, in the governor’s words, do we prepare ourselves for competition in the world? Look at where cars are made — Hondas are made in America, Ford is made in Mexico. The only way we’re going to succeed is to have the best-educated work force and provide the lowest possible costs. I agree with Jim — we can’t just pray to hold on to things with which we can’t compete anymore.

Would you say North Carolina is a net beneficiary of globalization?

Gerlach: No. Take textile and apparel jobs: The Carolinas are hit harder by trade policies than most states because we have more of those jobs.

Smith: I wouldn’t say we’re a huge beneficiary. But 38% of the students at Kenan-Flagler Business School are from another country. One of four patients at Duke, Wake, UNC or Presbyterian Hospital in Charlotte is a foreigner, so we’re exporting medical services. We’ve got Bank of America, one of the world’s leading banking institutions, and we export their services. We export a lot of computers and pharmaceutical products, agricultural chemicals, school buses and Freightliner trucks. We’re a magnet to the world.

Sum up Easley’s first term.

Gerlach: What we did right was we hit the budget crisis head-on. A lot of states didn’t. The governor made a lot of unpopular choices. But when the recovery came, we were in a better position than most states to capitalize on it. Secondly, the governor pushed economic development through the Job Development Investment Grant program and the One North Carolina Fund. We saw the problems and addressed them early. We didn’t try to sweep them under the rug. The things we need to work on now are getting high-schoolers to stay in school and controlling health-care costs.

Is that a major problem?

Gerlach: In the first two or three years of the administration, our health-care costs as an employer through the State Employees Health Plan and Medicaid increased 52% while everything else in state government was down. That can’t continue. Your thoughts, Dr. Smith, on the governor?

Smith: Gov. Easley was a wonderful attorney general, and I can’t imagine why on earth he wanted to be governor. We’ve got all this red ink and funding programs that are hard to get rid of. He did as well as anybody could, and I’m not going to be critical of the poor man. But until you cut spending, have a flat tax and get rid of income taxes, I can’t imagine why anyone would want the job.

How can health care be fixed?

Gerlach: It’s a huge issue. State employees are concerned because in the last four years they didn’t get a lot of wage increases. But one reason is, we’re putting a lot of their compensation into health care. We pay the entire health-care premium for employees, and our annual payment is $300-and-some million higher than when the governor took office. We’re going to have to devote more attention to people living healthier lifestyles. I say that as I put my cookie and Pepsi down.

Smith: Dan will agree with me that one of the most dreadful statistics just came out from the National Association of State Budget Officers. It was for fiscal year 2004: For the first time, the proportion of spending on Medicaid was 21.9% of state budgets, and spending on education was 21.4%. Medicare, Medicaid and Social Security are going to bankrupt the United States in a decade. There’s going to have to be some form of rationing. Health care is a luxury good. Economists know if your income goes up 1%, your health care goes up by far more than 1%.

Tar Heel doctors want a $250,000 cap on noneconomic malpractice damages.

Smith: My brother-in-law is a doctor in Texas, where they have that, and he says malpractice premiums are down and lawsuits dropped dramatically. We have a culture that says if you screw up, hire a lawyer and sue someone.

Gerlach: Sorry, but it’s more complicated than that. Part of the problem is, insurers haven’t gotten the return on investment they wanted. Noneconomic damages are something we can look at, but it’s not going to control the problem.

Are our economic incentives effective in recruiting industry?

Gerlach: Some are, some aren’t. The governor trimmed back some of the William S. Lee Act tax credits to make it harder for companies to qualify in prosperous counties, to avoid subsidizing things that would happen anyway. But reasonable people can differ when we get out to the margins, so we’ve tried to be very transparent, to do everything in the light of day. Basically, some have been very effective in attracting high-wage jobs.

Smith: The only thing you can say is ours are less horrible than some other states’. We lost Mercedes-Benz to Alabama because they paid through the nose. We lost BMW to South Carolina because they paid through the nose. We’re better off we didn’t burden the taxpayers. When you’re subsidizing competitors of the person who’s already here, that’s hard to sell. It’s a constant battle to keep the legislature from throwing money at a nonproblem. North Carolina is usually at the top of the list of places people want to move to and retire to. If we’d just get rid of the damned income tax, we’d be ahead of Florida, which has no income tax.

Gerlach: We’re not trying to outbid anybody with incentives. We’re just trying to take advantage of the natural head start we have in our educational system, including higher education and work-force training, then use enough incentives to make the deal. We’re creating the image that it’s a good state to do business in.

Smith: That may be true, but up until 1953 we had the largest economy in the Southeast. Now we’re fourth, behind Florida, Georgia and Virginia. If we could get Congress to outlaw incentives, all states would save money and economic activity wouldn’t change one dime. But unless you get Congress to do it, you have to be in the game.

The poverty rate in 2000 was 14.1% in rural areas versus 10.3% for urban areas. Can we change that discrepancy?

Gerlach: You certainly don’t want to level down. We’re trying to locate jobs in rural North Carolina that are going to stay. Not every county is going to have a textile plant. But if you’ve got a computer and a T1 connection, there’s a lot of stuff you can accomplish in rural areas.

Smith: It could make a huge difference if the federal government got rid of the ridiculous restrictions on drilling for natural gas off Cape Hatteras. They all think it’s out there. If they found it, it could be brought ashore in Eastern North Carolina, our most depressed area, and we’d have a boom in industries looking for cheap energy.

We hear a lot of complaining about our corporate income-tax rate, which is 6.9%. But isn’t that moderate compared with other states?

Gerlach: Yes, but the corporate tax rate combined with the individual rate — that’s the one that’s higher — needs to come down.

Smith: There’s no economic theory that justifies the corporate tax. It should be zero. Most small businesses are paying their personal income-tax rate on their Schedule C or Subchapter S businesses, so if you can get the personal rate down, we’ll be a mecca for small-business people. Figure it out and run everything as a flat tax on consumption, and do away with income taxes altogether.

What about sleeper industries? For example, a recent study said motor sports is worth $4 billion a year to North Carolina’s economy.

Gerlach: Motor sports is part — perhaps the biggest piece — of our automobile industry. We don’t have big players like BMW in South Carolina or Saturn in Tennessee, but we’re seeing incredible growth in parts suppliers. Beyond that, no state does the quality of research we do in biotechnology. We need to turn that into biotech manufacturing. California and Massachusetts are not places where you’re going to be able to make things. We’ve already got players like Wyeth Vaccines, which employs more than 1,000 in Sanford, and Merck pharmaceutical manufacturing in Wilson. We hope to see more biotech growth in rural areas.

Smith: One unsung thing is that people who come to North Carolina for graduate education stay to start a business. That’s happening all over the state.

Gerlach: One thing we have to do is take this explosion of research and channel it into products. We create the same number of patents as California and Massachusetts, but we’re not getting the economic activity coming out of our campuses.

Some fear we’ll lose the $10-billion-a-year military industry.

Gerlach: It’s unlikely any bases are going to be closed. Realistically, you’re not going to offshore your national defense. And deployment for the Iraq war hasn’t had the same bad effect on the economies of Jacksonville and Fayetteville as we saw in the Gulf War.

Smith: Where are you going to move an East Coast Marine training base? Plus we don’t have bases in metro areas that would have much higher value as something else. We get a lot of highly qualified MBA students who plan their military careers to finish in North Carolina so they can attend a local university. They stay here and start businesses.

Which regions of the state will prosper in 2005 and which won’t?

Gerlach: Growth will be sustained in all areas of the state.

Smith: Who’s going to grow the most? The Triangle — it usually does. Asheville just looks fabulous. I don’t see anything slowing down in Charlotte. And look at the incredible growth in Pinehurst and Southern Pines. It’s made Moore County one of our 10 highest-income counties.

Polls show that Tar Heels are optimistic. But should they be? The average weekly wage has increased less than $8 a week since 2001, and the state has 70,000 fewer jobs.

Gerlach: In 2001, the kind of manufacturing we had — durable goods, textiles, apparel — was hit hard, harder than other states. We lost most of those jobs from January 2001 until about October 2001, toward the end of the recession. In 2002 and 2003 we were gaining jobs in the service sector, but they were offset by losses in manufacturing. Now the decline in manufacturing jobs has gone, and jobs in the service sector are increasing. That’s reason to be optimistic.

Smith: In the last 100 quarters, ending with the second quarter of 2004, the U.S. economy has grown in 91 and shrunk in nine. So odds are 10-to-1 we’ll grow. We’ve gotten farther and farther behind Florida since 1953, and we’ve let those Georgians and even Virginians get ahead of us. But we should experience decent economic growth of 4% a year or better in each of the next four years — we may do better than 5% in 2005. Are we perfect? Nope. In a perfect environment, I’d have more money than Bill Gates and Warren Buffett combined. But I’m still optimistic.