Business context and reporting period
Community Health Systems, Inc. (CHS) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. CHS operated 196 hospitals in continuing operations at quarter-end. The prior-year comparison includes HMA from its January 27, 2014 acquisition; reported growth therefore reflects acquisition timing as well as underlying performance.
Key financial metrics
Amounts are in millions except per-share data. “Net operating revenues” are after the provision for bad debts.
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Operating revenues before bad-debt provision | $5,614 | $5,508 | $11,260 | $10,383 |
| Provision for bad debts | $732 | $743 | $1,467 | $1,442 |
| Net operating revenues | $4,882 | $4,765 | $9,793 | $8,941 |
| Income from operations | $447 | $352 | $846 | $531 |
| Operating margin | 9.1% | 7.4% | 8.6% | 5.9% |
| Income from continuing operations | $140 | $76 | $252 | $1 |
| Net income (loss) attributable to CHS stockholders | $111 | $42 | $189 | $(70) |
| Diluted EPS | $0.95 | $0.37 | $1.64 | $(0.64) |
- Cash flow: Six-month operating cash flow was $504, down from $514 in 2014. Investing used $512, versus $3,652 in 2014, largely reflecting the prior-year HMA acquisition. Financing used $136, versus $3,154 provided in the prior year. Cash ended at $365, down from $509 at year-end 2014.
- Capital spending: Purchases of property and equipment were $474 in the first half; this included $80 for replacement-hospital construction. Routine capital expenditures excluding replacement-hospital construction were $394.
- Debt and liquidity: Total debt was $16,867 at June 30, compared with $16,916 at December 31, 2014. Cash was $365; working capital was approximately $2.3 billion. The $1.0 billion revolving facility had approximately $1.0 billion available, including $83 reserved for letters of credit. CHS reported compliance with debt covenants.
- Interest: Net interest expense was $239 in Q2 and $481 for the first half. Cash interest paid in the first half was $459, versus $352 in 2014. The company reported a 1.67x ratio of earnings to fixed charges for the first half.
- Receivables: Days revenue outstanding increased to 65 days from 63 at year-end 2014; management’s target range was 53–63 days. Net patient accounts receivable was $3,491.
Material changes versus prior comparable periods
- Net operating revenues rose 2.5% in Q2 and 9.5% in the first half. Same-store revenue increased 2.2% and 3.7%, respectively; first-half reported growth also included 26 additional operating days for HMA hospitals and revenues from other acquired hospitals.
- Same-store inpatient admissions declined 2.2% in Q2 and 0.9% in the first half; same-store adjusted admissions fell 0.2% in Q2 and rose 1.1% in the first half. Management attributed same-store revenue growth primarily to improved payor mix and lower charity-care and self-pay discounts.
- Operating margin improved as operating expenses excluding depreciation and amortization fell to 84.9% of net operating revenues in Q2 from 86.0%, and to 85.4% for the first half from 87.3%. Management cited productivity gains and HMA corporate-function integration.
- Self-pay represented 11.9% of gross operating revenues before bad debts in Q2, down from 12.8%; first-half self-pay share fell to 12.3% from 13.5%.
- First-half results improved substantially against a 2014 period affected by HMA integration charges, software write-offs and accelerated amortization, and a larger debt-extinguishment loss. First-half 2015 included a $16 debt-extinguishment loss and $6 impairment of long-lived assets.
- Total debt declined modestly, while CHS refinanced the Term E loans into Term F and replaced the Term D facility with new Term G and H loans. First-half capex increased, while cash declined by $144.
Outlook, commentary, risks and unusual items
- Management said it expected operating cash generation, available credit and access to capital markets to fund capital needs, acquisitions and working capital for the next 12 months. It anticipated funding routine capital expenditures from operating cash flow. No specific earnings or revenue guidance was provided.
- CHS announced on August 3, 2015, after quarter-end, a planned spin-off of 38 hospitals and Quorum Health Resources into Quorum Health Corporation, targeted for the first quarter of 2016. Completion remained subject to regulatory, tax, legal, market and board conditions; there was no assurance it would occur.
- Significant legal exposure includes HMA billing and physician-arrangement investigations and litigation, as well as other government inquiries. A $271 liability was recorded for HMA legal matters tied to the contingent value rights (CVRs), with an additional $2 accrued for previously recorded claims. Further legal costs are expensed as incurred; management cautioned that adverse outcomes could materially affect results or cash flows in a particular period.
- A cyberattack disclosed in 2014 resulted in the theft of certain patient identification data, excluding medical, clinical and credit-card information. Related class-action litigation and remediation costs remained unresolved; the company could not estimate the outcome or impact.
- Risks include substantial indebtedness, reimbursement and regulatory changes, collection performance, ICD-10 implementation and possible billing delays, labor and supply cost inflation, managed-care pricing, litigation, and execution of the planned spin-off. Management noted that ICD-10-related collection delays could affect receivables collateral under the $700 facility, although it expected revolving-credit capacity to be available if repayment were required.
- Other unusual items included $6 of goodwill impairment associated with a hospital sale, and $9 of Q2 debt-extinguishment loss. Seven hospitals classified as discontinued operations were divested during the first half; discontinued operations generated a $20 after-tax loss. Payson Regional Medical Center was sold on July 31, 2015 for approximately $20.
Important facts for investors to verify
- Separate acquisition-driven growth from same-store results, and monitor admissions, adjusted admissions and payor mix.
- Assess whether improved margins and earnings are sustainable after excluding debt refinancing costs, legal adjustments, impairments and discontinued operations.
- Track cash conversion, capital spending, days revenue outstanding and the collectability of patient receivables.
- Review debt maturities, interest costs, covenant headroom, revolver availability and exposure to floating rates; only about 16.8% of variable-rate debt was covered by swaps.
- Follow developments and potential costs in HMA-related government matters, CVR liabilities and cyberattack litigation.
- Verify the spin-off’s approvals, terms, timing and effects on the remaining company’s operations and debt profile.