Community Health Systems, Inc. — Q2 2014 Form 10-Q
Period: Three and six months ended June 30, 2014. Amounts are in millions of dollars unless stated otherwise. HMA’s results are included from its January 27, 2014 acquisition date, so reported year-over-year growth largely reflects the transaction and is not directly comparable.
Business context and reporting period
The company operated 198 hospitals in continuing operations at June 30, 2014. It completed the acquisition of Health Management Associates (HMA), which operated 71 hospitals, and acquired two additional hospitals during the first half. The company also classified certain hospitals as held for sale and reported their results as discontinued operations.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net operating revenue | $4,779 | $3,191 | $8,964 | $6,453 |
| Income from operations | $351 | $219 | $529 | $509 |
| Operating margin | 7.3% | 6.9% | 5.9% | 7.9% |
| Income (loss) from continuing operations | $75 | $53 | $0 | $152 |
| Net income (loss) attributable to CHS shareholders | $42 | $30 | $(70) | $109 |
| Diluted EPS | $0.37 | $0.32 | $(0.64) | $1.17 |
| Net cash provided by operating activities | — | — | $514 | $309 |
Q2 net operating revenue rose 49.8%, primarily from HMA; same-store revenue increased 0.4%. Same-store inpatient admissions fell 4.8% and adjusted admissions fell 1.2%. For the first half, same-store revenue declined 1.7%, inpatient admissions 6.3%, and adjusted admissions 3.2%. Management cited weaker volumes, severe winter weather, fewer flu-related admissions, the two-midnight rule, and some service closures.
Six-month results included a $73 loss on early debt extinguishment, $86 of acquisition and integration costs, $75 of accelerated software amortization, a $24 software impairment, and HMA-related legal costs. Q2 included $33 of accelerated software amortization. The company recognized $124 of electronic health record incentives in the first half, versus $43 a year earlier; these reduce operating costs.
At June 30, cash was $389; current assets were $5,397 and current liabilities $3,169, implying working capital of approximately $2.2 billion. Total debt was $16,931, including $209 current maturities; long-term debt was $16,722. Debt rose from $9,453 at year-end 2013, largely due to HMA. Cash and cash equivalents increased by $16 during the first half. Operating cash flow was $514, investing cash outflow $3,652 (including $3,041 for acquisitions), and financing cash inflow $3,154. The company reported $1.0 billion of revolving-facility availability, including $83 reserved for letters of credit. Its six-month ratio of earnings to fixed charges was 0.93x.
Material changes versus prior periods
- HMA acquisition materially expanded revenue, assets, and debt; the transaction added approximately $4.1 billion of goodwill and $4.0 billion of new notes.
- Q2 operating margin improved year over year, while first-half operating margin declined. Higher interest expense—$478 versus $310 for the first half—offset operating income growth.
- First-half shareholder results shifted to a $70 loss from $109 income, driven by acquisition financing and transaction charges, impairment and software costs, and lower same-store volumes.
- Shares outstanding increased materially in connection with HMA stock consideration; weighted-average basic shares were 109.6 million for the first half, versus 91.9 million.
Outlook, risks, and unusual items
Management expressed confidence that operating cash flow, borrowing capacity, and capital-market access would fund expected capital spending, working capital, and acquisitions. It expects HMA integration and synergies to support efficiency and margins, but provided no specific earnings or revenue guidance. The filing cautions that interim results are not necessarily indicative of full-year results.
Key risks include substantial leverage, floating-rate debt and covenant compliance; pressure on Medicare, Medicaid, and managed-care reimbursement; patient collection and bad-debt estimates; and HMA integration and synergy execution. Interest-rate swaps covered about 25.5% of variable-rate debt; management estimated that a 1% rate change on unhedged variable debt would affect first-half interest expense by approximately $26. The filing states that a 1% change in estimated contractual reimbursement could change first-half net loss by approximately $72 and net receivables by $115.
Legal matters include HMA-related investigations and False Claims Act litigation, with $284 recorded for certain HMA legal matters and $42 for previously accrued HMA contingencies. Separately, CHS reported a $102 reserve while negotiating with the DOJ over short-stay admissions and related claims; negotiations and a corporate integrity agreement were not final. A contingent value right may pay HMA shareholders up to approximately $265, subject to reductions for qualifying legal losses. Some possible legal losses could not be estimated. The company said no material risk-factor changes occurred. Disclosure controls were deemed effective, but HMA operations were excluded from the internal-control evaluation during the permitted integration period.
Most important facts for investors to verify
- Whether same-store volumes and revenue stabilize, and whether reported growth translates into post-acquisition organic growth.
- HMA integration progress, realized synergies, and final purchase-price allocations, including the recoverability of substantial goodwill.
- Debt reduction capacity, interest-rate exposure, covenant headroom, and continued access to the revolving facility and capital markets.
- Resolution and cash cost of HMA-related legal matters, the $102 reserve negotiations, and the ultimate CVR payment.
- Receivables quality, bad-debt assumptions, reimbursement estimates, and collection performance after the acquisition.
- Effects of hospital divestitures, EHR incentive timing, and the transition from software identified for abandonment.