COMMUNITY HEALTH SYSTEMS INC quarterly report, Q2 FY2016

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Community Health Systems, Inc. — Q2 2016 Form 10-Q

Business context and reporting period

Unaudited results cover the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. At quarter-end, CHS owned or leased 156 hospitals in continuing operations. The April 29 spin-off of 38 hospitals and Quorum Health Resources into Quorum Health Corporation (QHC) materially changed the company’s footprint: reported results include QHC through the spin-off date, while same-store comparisons exclude QHC hospitals in both periods.

Financial performance and position

  • Revenue: Q2 operating revenues before bad debts were $5.290 billion, down 5.8%; net operating revenues after bad debts were $4.590 billion, down 6.0%. For the first half, these measures were $11.044 billion, down 1.9%, and $9.589 billion, down 2.1%, respectively. Same-store net operating revenues increased 1.2% in Q2 and 1.8% for the half.
  • Volumes and bad debts: Q2 consolidated admissions fell 9.1% and adjusted admissions 8.5%; same-store admissions fell 2.1% and adjusted admissions 0.6%. The provision for bad debts was $700 million, or 13.2% of pre-bad-debt revenues, versus $732 million, or 13.0%, a year earlier.
  • Profit and margins: Q2 net loss attributable to CHS stockholders was $1.432 billion, or $12.91 per diluted share, versus net income of $111 million, or $0.95 per diluted share. First-half net loss was $1.421 billion, or $12.85 per diluted share, versus net income of $189 million, or $1.64. The Q2 operating loss was $1.375 billion; the reported operating margin was negative 30.0%, heavily affected by impairment. Operating expenses excluding depreciation and amortization and impairment were 88.3% of net operating revenues, compared with 84.9% in Q2 2015.
  • Cash flow: First-half operating cash flow was $632 million, up from $504 million. Investing activities provided $1.177 billion, primarily reflecting the $1.219 billion QHC distribution and $403 million proceeds from investment sales; property and equipment purchases were $407 million. Financing activities used $1.532 billion, including $4.279 billion of debt repayments and $2.806 billion of borrowings. Cash increased to $461 million from $184 million at year-end.
  • Debt and liquidity: Total debt was $15.363 billion at June 30, down from $16.785 billion at December 31, 2015; long-term debt, excluding current maturities, was $15.110 billion. Current assets were $4.842 billion and current liabilities $2.728 billion; reported net working capital was approximately $2.12 billion. The revolving facility had about $1.0 billion available, with $65 million reserved for letters of credit. CHS was in compliance with credit-facility covenants. First-half earnings were insufficient to cover fixed charges by approximately $1.5 billion.
  • Interest and other items: First-half interest expense was $496 million versus $481 million, and cash interest paid was $489 million versus $459 million. The company recorded a $94 million pre-tax gain on selling Las Vegas-area joint-venture interests and a $30 million loss on early debt extinguishment.

Material changes versus the prior comparable period

  • A $1.4 billion non-cash goodwill impairment and approximately $239 million of long-lived asset impairments drove the substantial reported loss. The goodwill charge followed declines in market capitalization and projected earnings; the valuation was preliminary and the company expected to complete its analysis in Q3 2016, with possible material adjustment.
  • Q2 consolidated revenue fell partly because QHC was spun off; same-store revenue rose, attributed by management to favorable payer mix. Same-store revenue per adjusted admission increased 1.8% in Q2 and 1.4% for the first half, while same-store admission volumes were weaker.
  • Operating cost ratios worsened: management cited higher physician employment and merit costs, surgical drug and implant costs, outsourced services, information-systems maintenance, legal fees, and specialist fees.
  • Debt declined after the company used spin-off-related cash to repay debt, including a $900 million tender offer for 2018 secured notes and repayment of approximately $190 million of Term F loans. The spin-off also included a $695 million non-cash dividend representing QHC net assets.

Outlook, risks, contingencies, and unusual items

  • Outlook: No specific earnings or revenue guidance is provided. Management said it expected operating cash generation, available borrowing capacity, and capital-market access to support operations and investment over the next 12 months. It planned to continue portfolio rationalization and debt reduction. The company was negotiating sales of 12 hospitals and certain non-hospital operations, representing approximately $1.4 billion of 2015 annual net operating revenues, and anticipated closings before year-end 2016; completion, timing, and assets involved were uncertain.
  • Impairment uncertainty: The $1.4 billion goodwill impairment was an estimate pending completion of the valuation; management warned that changes in market capitalization, asset fair values, or forecasts could materially affect the final amount or lead to further impairment.
  • Legal and regulatory exposure: CHS disclosed multiple government inquiries and litigation, including DOJ-intervened HMA billing and physician-relationship cases, with proceedings stayed through September 26, 2016, and a continuing criminal investigation of former HMA executives. The company reported a $260 million fair-value liability for certain HMA legal matters tied to the contingent value rights (CVR); ultimate HMA losses affect amounts payable to CVR holders. Management said outcomes of some proceedings could materially affect results or cash flows, though loss estimates were unavailable for certain matters.
  • Other risks: Major risks include substantial leverage and debt service, variable interest rates, reimbursement and Medicaid-policy changes, payer negotiations, collection of patient balances, labor and supply-cost inflation, and potential delays in billing or collections under ICD-10. The company had approximately $3.5 billion of interest-rate swaps covering about 46.9% of variable-rate debt. A 1% rate change on uncovered variable debt would change first-half interest expense by approximately $26 million.
  • Other notable matters: A shareholder securities class action was dismissed in June 2016, with plaintiffs appealing; a separate cyberattack-related class action remained pending with a substantially narrowed group of plaintiffs. The company stated that there were no material changes to previously disclosed risk factors and no subsequent events requiring recognition or disclosure.

Important facts for investors to verify

  1. Completion and final measurement of the goodwill impairment, including whether further write-downs are required.
  2. Actual performance and volume trends on a comparable same-store basis after the QHC spin-off, including bad-debt and self-pay trends.
  3. Progress, proceeds, and debt-reduction impact of the planned hospital and ancillary-business divestitures.
  4. Debt maturities, cash interest burden, revolver availability, covenant headroom, and the sustainability of operating cash flow.
  5. Developments and potential financial exposure in HMA-related government cases, CVR matters, and other legal or regulatory proceedings.