Community Health Systems, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Unless stated otherwise, amounts are in millions. Results include Health Management Associates (HMA) from its January 27, 2014 acquisition; therefore, reported year-over-year growth is not directly comparable with same-store performance.
Business context and material changes
The company operated 196 hospitals in continuing operations at September 30, 2014. The January HMA merger added 71 hospitals and substantially expanded the company’s scale. The company also acquired hospitals in Pennsylvania and Florida during the nine-month period and designated several hospitals for sale.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net operating revenues | $4,795 | $3,174 | $13,759 | $9,628 |
| Income from operations | $371 | $177 | $899 | $687 |
| Operating margin | 7.7% | 5.6% | 6.5% | 7.1% |
| Interest expense, net | $250 | $154 | $728 | $464 |
| Income from continuing operations | $93 | $28 | $93 | $180 |
| Net income (loss) attributable to CHS stockholders | $62 | $4 | $(8) | $113 |
| Diluted EPS attributable to CHS stockholders | $0.54 | $0.04 | $(0.07) | $1.21 |
- Revenue and volumes: Q3 net operating revenue rose 51.1%; nine-month revenue rose 42.9%, primarily reflecting HMA. Same-store revenue increased 2.8% in Q3 but decreased 0.2% for nine months. Same-store admissions fell 3.9% and 5.5%, respectively; adjusted admissions were flat in Q3 and down 2.1% for nine months.
- Margins and earnings: Q3 operating margin improved, with management citing lower expense ratios, integration productivity and reduced corporate overhead. Nine-month operating margin declined. Parent-attributable nine-month results included significant acquisition-related financing and software charges.
- Cash flow: Operating cash flow was $639, up from $441. Investing cash outflow was $3,943, principally reflecting acquisitions; financing cash inflow was $3,152. Cash declined by $152 to $221.
- Liquidity and debt: Total debt was $17,012, compared with $9,453 at year-end 2013; long-term debt was $16,793. Working capital was approximately $2.2 billion. The $1.0 billion revolving facility had approximately $1.0 billion available, including $83 of letters of credit. The nine-month earnings-to-fixed-charges ratio was 1.11x.
Drivers, outlook, risks and unusual items
- The HMA merger was funded in part with $1.0 billion of 5.125% secured notes due 2021 and $3.0 billion of 6.875% senior notes due 2022. Management reported achieved synergies and expected additional efficiencies, but provided no specific financial guidance in the supplied filing text.
- Same-store admission declines, higher interest costs and a substantially larger debt burden are important offsets to acquisition-driven growth. HMA acquisition and integration costs were $99 for the nine months. Interest expense increased mainly because of acquisition debt.
- Nine-month unusual charges included a $73 loss on early debt extinguishment, $75 accelerated software amortization and $24 software impairment. The company recorded $77 of government settlement and related costs, including an after-tax charge of $47 for an agreement in principle to settle New Mexico claims.
- CHS reported a $75 reserve for the New Mexico matter and was discussing whether a corporate integrity agreement would be required. It also recorded $291 for estimated HMA legal liabilities associated with the contingent value rights (CVRs), plus $42 for previously accrued HMA claims. Resolution of HMA legal matters affects potential CVR payments.
- A 2014 cyberattack exposed certain non-medical patient identification data, including Social Security numbers. The company reported ongoing remediation and multiple related lawsuits; potential total costs or liability were not clear in the filing.
- Key operating and regulatory risks include Medicare and Medicaid reimbursement changes, managed-care rate pressure, collection estimates, self-insured professional liability, integration execution, and compliance investigations. Management cautioned that results may differ materially from forward-looking expectations.
- After quarter-end, the company disclosed an expected $36 net recovery related to former HMA hospitals, to be recognized in Q4 2014, and paid $150 to acquire a 30% Lake Norman joint-venture interest, among other transactions.
Important facts for investors to verify
- Whether HMA integration delivers additional savings and stabilizes same-store admissions and revenue.
- Debt service capacity, covenant headroom, interest-rate exposure and refinancing needs following the increase in debt.
- Patient receivables quality and collection assumptions: net receivables were $3,266, and the allowance for doubtful accounts was $3,517 at September 30, 2014.
- Developments and potential cash impact from HMA-related legal matters, the New Mexico settlement, the CVR liability and cyberattack litigation.
- Whether Medicare and Medicaid policy changes, including the projected 0.6% net inpatient reimbursement decrease effective October 1, 2014, affect revenue and margins as expected.