Community Health Systems, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Amounts are in millions unless stated otherwise. The company operated 155 hospitals in continuing operations at quarter-end. Comparisons are affected by the April 29, 2016 spin-off of 38 hospitals and Quorum Health Resources to Quorum Health Corporation (QHC); reported 2016 results include QHC only through the spin-off date, while same-store results exclude QHC in both periods.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenues before bad-debt provision | $5,084 | $5,580 | $16,128 | $16,840 |
| Net operating revenues | $4,380 | $4,846 | $13,969 | $14,639 |
| Provision for bad debts | $704 | $734 | $2,159 | $2,201 |
| Operating income (loss) | $146 | $351 | $(935) | $1,190 |
| Income (loss) from continuing operations | $(54) | $83 | $(1,422) | $335 |
| Net income (loss) attributable to CHS stockholders | $(79) | $52 | $(1,500) | $241 |
| Diluted earnings (loss) per share | $(0.71) | $0.44 | $(13.55) | $2.08 |
- Margins: Operating margin was 3.3% in Q3 2016 versus 7.2% a year earlier, and negative 6.7% for the first nine months versus 8.2%. The nine-month loss was driven chiefly by a $1.395 billion goodwill impairment and $249 million of impairment charges on other long-lived assets.
- Volumes and same-store trends: Q3 net operating revenue fell 9.6% year over year, while same-store revenue increased 1.2%. Consolidated inpatient admissions fell 12.4% and adjusted admissions 13.0%; same-store declines were 2.1% and 1.5%, respectively. For nine months, same-store revenue rose 1.6%, with same-store inpatient admissions down 2.0% and adjusted admissions down 0.2%.
- Bad debts and payors: Bad-debt provision equaled 13.8% of pre-provision operating revenues in Q3, up from 13.2%; nine-month rate was 13.4%, up from 13.1%. Managed care and other third-party payors supplied 53.9% of Q3 revenues; Medicare 23.0%, Medicaid 10.5%, and self-pay 12.6%.
- Cash flow: Nine-month operating cash flow was $810, up from $615. Investing activities provided $751, including the $1.219 billion QHC distribution and $403 from investment sales; financing used $1.612 billion, including $5.492 billion of debt repayments and $3.929 billion of borrowings. Cash ended at $133, versus $184 at year-end 2015. Capital expenditures for property and equipment were $561; routine capital spending excluding replacement-hospital construction was $553.
- Debt and liquidity: Total debt was $15.322 billion at September 30, down from $16.785 billion at December 31, 2015; long-term debt was $15.082 billion. Interest expense was $233 in Q3 and $730 for nine months; cash interest paid for nine months was $767. Current assets were $4.541 billion and current liabilities $2.686 billion; reported net working capital was approximately $1.9 billion. Cash was $133. Revolver availability was approximately $967, including $55 reserved for letters of credit. The company reported compliance with covenants: secured net leverage 3.95 against a 4.25 maximum and interest coverage 2.55 against a 2.00 minimum.
Material changes and unusual items
- QHC was spun off on April 29, 2016, with approximately $695 of net assets distributed as a non-cash dividend. QHC also distributed approximately $1.2 billion in cash to CHS in connection with the separation; CHS used proceeds in part to repay debt, including $900 of 2018 secured notes and approximately $190 of Term F loans.
- Goodwill fell from $8.965 billion at year-end to $6.901 billion at September 30, reflecting the QHC allocation, disposals and $1.395 billion impairment. Management said its updated impairment analysis remained under review and further changes could be material.
- CHS sold its minority interests in two Las Vegas-area joint ventures for $403 cash and recorded a $94 gain. The company agreed to sell four hospitals, recording $31 of goodwill impairment related to the held-for-sale assets; it also recorded other long-lived asset impairment charges. A hospital closure and other divestitures generated additional impairments.
- Q3 EHR incentive reimbursements were $5 versus $54 a year earlier; nine-month amounts were $54 versus $135. The decline reduced the operating-cost offset. Salaries, benefits and supplies consumed higher proportions of net operating revenue; management cited physician employment, wage and employee-health costs, and higher drug and implant costs.
- Interest expense declined $9 in Q3, primarily due to lower average debt, but rose $7 for the first nine months as higher rates and lower capitalized interest offset debt reduction. Early debt extinguishment costs were $30 for nine months.
Outlook, management commentary and risks
- Management said it was exploring options with financial sponsors and other strategic alternatives; the review was preliminary, had no timeline, and might not result in a transaction. A Stockholder Protection Rights Agreement adopted October 3 could dilute an acquirer at the stated ownership thresholds and make an unapproved transaction more difficult.
- Management was negotiating to sell 13 additional hospitals, with potential 2017 closings, estimated annual revenue of approximately $1.7 billion and estimated net proceeds of approximately $875. No assurance was given that sales would close or achieve those proceeds. An October 17 agreement to sell 80% of the Home Care division for approximately $128 was expected to close in Q4, subject to conditions.
- Management expected internally generated cash and available borrowing capacity to support operations and capital needs over the next 12 months. It stated that divestitures were intended to reduce debt and focus the portfolio on higher-margin hospitals. No earnings or revenue guidance was provided.
- Key risks include substantial leverage and debt service, covenant compliance, interest-rate exposure, reimbursement and Medicaid policy changes, managed-care rate pressure, lower patient volumes, bad-debt and collection estimates, labor and supply cost inflation, and the uncertain completion and proceeds of planned divestitures. A 1% change in estimated contractual reimbursement percentages would have changed nine-month net income by approximately $52 and net receivables by $126; a 1% change in estimated collection percentage would have changed net income by $33 and receivables by $78.
- Legal and regulatory matters include HMA billing and physician-relationship investigations and litigation, including DOJ-intervened qui tam cases; the company said an adverse outcome could materially affect results or cash flows in a period. The CVR-related legal liability was $259, with $14 of other probable contingencies recorded. Management reported $61 of accumulated HMA legal expenses and settlements relevant to CVR reductions; total HMA losses above approximately $312 would eliminate any CVR payment. The company also disclosed other government inquiries and cyberattack-related litigation and costs.
Important facts for investors to verify
- Final outcome of the goodwill impairment review and any further valuation changes.
- Comparable operating trends after separating the QHC spin-off effect, including admissions, same-store revenue, payor mix and bad-debt collection performance.
- Progress, closing conditions and realized proceeds from the four-hospital sale, the Home Care transaction and negotiations for 13 more hospitals—and the actual amount of debt reduction.
- Debt maturities, interest costs, revolver availability and covenant headroom as operating performance and asset sales evolve.
- Developments in HMA-related government investigations and litigation, CVR exposure, and other legal contingencies.