COMMUNITY HEALTH SYSTEMS INC quarterly report, Q2 FY2010

Community Health Systems, Inc. — Q2 2010 Form 10-Q

Business context and reporting period. The filing covers the three and six months ended June 30, 2010. CHS operated 123 general acute care hospitals after a July 7 acquisition, alongside home-care agencies and hospital-management services. Results are unaudited; management cautions that interim results are not necessarily indicative of full-year results.

Financial performance

Amounts below are in millions, except per-share data and percentages.

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Net operating revenue	$3,171	$3,017	$6,332	$5,930
Income from operations	$279	$261	$552	$516
Income from continuing operations, before noncontrolling interests	$86	$74	$171	$145
Net income attributable to CHS	$70	$59	$140	$118
Diluted EPS	$0.74	$0.65	$1.49	$1.31
Operating margin	8.8%	8.7%	8.7%	8.7%
Net income attributable to CHS / revenue	2.2%	2.0%	2.2%	2.0%

Revenue increased 5.1% in Q2 and 6.8% year to date. Same-store revenue grew 3.2% and 3.5%, respectively; acquisitions contributed $56.1 million of Q2 growth and $195.2 million of first-half growth.
CHS-attributable net income rose 17.9% in Q2 and 18.4% for the first half. Management attributed improvement mainly to revenue initiatives, reimbursement increases, acquired hospitals and expense management.
Q2 inpatient admissions fell 1.4% overall and 2.5% same-store, while adjusted admissions rose 0.6% overall and declined 0.9% same-store. First-half inpatient admissions rose 0.8% overall but fell 1.8% same-store; adjusted admissions rose 2.6% overall and declined 0.4% same-store. Acquisitions contributed to overall volume growth.
Bad-debt provision was 12.0% of revenue in Q2, unchanged year over year; it was 12.0% for the first half versus 11.8% a year earlier. Self-pay was 11.5% of revenue in both 2010 periods, up from 10.8% in Q2 2009 and 11.2% in first-half 2009.

Cash flow, debt and liquidity

First-half operating cash flow was $542 million, versus $544 million in 2009. Capital expenditures were $264 million; approximate operating cash flow less property-and-equipment purchases was $278 million. Investing activities used $328 million, and financing activities used $9 million.
Cash and equivalents were $549 million at June 30, up from $345 million at year-end 2009. Working capital was approximately $1.5 billion, up $262 million; current assets were $2.98 billion and current liabilities $1.50 billion.
Total debt was approximately $8.88 billion, comprising $64 million current maturities and $8.82 billion long-term debt, compared with approximately $8.91 billion at year-end. First-half net interest expense was $322 million, down from $325 million. The weighted-average Credit Facility rate, excluding swaps, was 3.1%.
The company reported $750 million of revolving-credit-facility capacity, with $92.9 million set aside for letters of credit; the filing also describes up to $300 million of potential receivables financing and a possible $600 million term-loan tranche, neither accessed. Management said internal cash and financing access should fund acquisitions, capital spending and working capital for at least the next 12 months.
Interest-rate swaps covered approximately 89% of variable-rate debt. The swap liability was $386 million at June 30, up from $316 million at year-end; the filing reports a $45 million first-half decline in swap fair value in other comprehensive income. Management estimated about $199 million of swap-related interest expense from fixed-versus-floating spreads over the next 12 months, assuming unchanged rates.
Routine capital spending was $260 million in the first half. Estimated construction costs for three required replacement facilities totaled approximately $318.5 million. The Valparaiso replacement hospital was delayed and expected to be completed in Q4 2012; Siloam Springs construction was required by February 2013.

Material changes and unusual items

Q2 operating expenses excluding depreciation and amortization declined slightly as a share of revenue, to 86.3% from 86.6%. Salaries and benefits rose as a share of revenue, while lower contract labor and other expense efficiencies partly offset acquisition-related cost pressure.
First-half cash from operations was nearly flat despite higher earnings, principally reflecting a $64 million cash outflow from patient accounts receivable in 2010 versus an inflow in 2009; higher payables and accrued liabilities partly offset this.
CHS repurchased 356,000 shares during the first half at a weighted-average $34.24 per share. After quarter-end, it repurchased another 1,173,000 shares from July 1–6; cumulative repurchases under the program reached 1,529,000 through July 30. The July 7 acquisition of Marion Regional Healthcare System cost $25.7 million in cash.
Management disclosed corrections to prior-period supplemental consolidating interest allocations: the 2009 and Q1 2010 issuer/other-guarantor presentations were misstated, but management said combined guarantor information and consolidated financial statements were unaffected and the supplemental misstatements were not material to previously issued consolidated statements.

Outlook, risks and contingencies

No numerical earnings or revenue guidance was provided. Management cited growth opportunities, acquisition synergies and expected operating efficiencies, and said it did not anticipate a significant constraint on investment in the business.
Healthcare reform could expand insured coverage and reduce uncollectible accounts, but may also reduce Medicare and Medicaid reimbursement, lower disproportionate-share payments and increase employee-benefit costs. The company said the ultimate effects were uncertain.
Key operating risks include government reimbursement and rule changes, managed-care rate pressure, bad-debt collectability, labor and supply inflation, substantial leverage and covenant compliance, and execution/integration of acquisitions.
Federal False Claims Act litigation concerning New Mexico Medicaid payments remains active. The government previously alleged approximately $27.5 million in ineligible payments for three hospitals and stated it could seek treble damages and penalties; the court denied CHS’s motion to dismiss the government’s complaint on July 7, 2010. CHS said it was vigorously defending the case. Separate kyphoplasty billing and other government investigations were ongoing.
The company was also defending a certified class action concerning uninsured-patient billing in New Mexico. Management said ordinary-course legal matters were not expected to have a material adverse effect, but acknowledged some proceedings could involve substantial exposure.
The Credit Facility and notes include restrictive covenants and financial-ratio requirements; breach could trigger default and acceleration. The six-month ratio of earnings to fixed charges was 1.65x.

Important facts for investors to verify

Whether same-store revenue and volume trends improve, given falling same-store inpatient admissions and rising bad-debt provision year to date.
How healthcare-reform implementation and Medicare/Medicaid reimbursement updates affect hospital rates, uninsured volume and operating costs.
Accounts-receivable quality and collections: gross receivables were approximately $6.5 billion, self-pay was 37.2% of gross receivables, and days revenue outstanding was 48 days.
Debt-service capacity, covenant headroom, refinancing needs and the cost/coverage profile of interest-rate swaps.
Developments and potential financial exposure in the False Claims Act, kyphoplasty, uninsured-patient billing and other government matters.
Execution, timing and total cost of required replacement facilities, and the effect of post-quarter repurchases and the Marion acquisition on liquidity.