The following discussion and analysis of financial condition and results of
operations should be read in conjunction with (i) our condensed consolidated
financial statements and accompany notes included elsewhere in this report and
(ii) our consolidated financial statements and accompany notes and discussion
and analysis of our financial condition and results of operations include in our
Annual Report on Form 10-K for the year ended December 31, 2011 (the "2011
Annual Report on Form 10-K"). We intend for this discussion to provide
information that will assist in understanding our financial statements, the
changes in certain key items in those financial statements from period to
period, and the primary factors that accounted for those changes. Unless the
context requires otherwise, Capella Healthcare, Inc. and its subsidiaries are
referred to in this section as "Capella," the "Company," "we," "us" and "our."
This report and other materials the Company has filed or may file with the
Securities and Exchange Commission, as well as information included in oral
statements or other written statements made, or to be made, by senior management
of the Company, contain, or will contain, disclosures that are "forward-looking
statements," which are intended to be covered by the safe harbors created by
federal securities laws. Forward-looking statements are those statements that
are based upon management's current plans and expectations as opposed to
historical and current facts and are often identified in this discussion by use
of words, including but not limited to, "may," "believe," "will," "should,"
"expect," "estimate," "anticipate," "intend," and "plan." In this report, for
example, we make forward-looking statements, including statements discussing our
expectations about: our business strategy and operating philosophy, including
efforts to provide high quality patient care and service excellence, investments
in technology, recruitment and retention of physicians and nurses, expansion of
service lines, and growth strategies for existing markets and for potential
acquisitions; future financial performance and condition; industry and general
economic trends, including the impact of the current economic environment,
changes to reimbursement, patient volumes and related revenue; our compliance
with new and existing laws and regulations, as well as costs and benefits
associated with compliance; effects of competition and consolidation on our
hospitals' markets; costs of providing care to our patients; the impact of bad
debt expenses; anticipated revenue from Medicare and Medicaid electronic health
records ("EHR") incentive payments; future liquidity and capital resources;
existing and future debt; and the effects of inflation and changing prices.
These statements are based upon estimates and assumptions made by Capella's
management that, although believed to be reasonable, are subject to numerous
factors, risks and uncertainties that could cause actual outcomes and results to
be materially different from those projected. There are several factors, some
beyond our control, that could cause results to differ significantly from our
expectations. Any factor described in this report and the 2011 Annual Report on
Form 10-K could by itself, or together with one or more factors, adversely
affect our business, results of operations and/or financial condition. There may
be factors not described in this report or the 2011 Annual Report on Form 10-K
that could also cause results to differ from our expectations. We operate in a
continually changing business environment, and new risk factors emerge from time
to time. We cannot predict such new risk factors nor can we assess the impact,
if any, of such new risk factors on our business or the extent to which any
factor or combination of factors may cause actual results to differ materially
from those expressed or implied by any forward-looking statements. Except as
required by law, we undertake no obligation to update publicly or to revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
22
--------------------------------------------------------------------------------
Table of Contents
EXECUTIVE OVERVIEW
We are a provider of general and specialized acute care, outpatient and other
medically necessary services in primarily non-urban communities. We provide
these services through a portfolio of acute care hospitals and complementary
outpatient facilities and clinics in seven states. As of June 30, 2012, on a
consolidated basis, we operated 12 acute care hospitals (eleven of which we own
and one of which we lease pursuant to a long-term lease) comprised of 1,529
licensed beds, excluding assets held for sale and included in discontinued
operations. We are focused on enabling our facilities to maximize their
potential to deliver high quality care in a patient-friendly environment. We
invest our financial and operational resources to establish and support services
that meet the needs of our communities. We seek to achieve our objectives by
providing exceptional quality care to our patients, establishing strong local
management teams, physician leadership groups and hospital boards, developing
deep physician and employee relationships and working closely with our
communities.
Effective April 30, 2012, we entered into a joint venture agreement with St.
Thomas Health ("St. Thomas") in Tennessee. In exchange for a 6.49% minority
ownership at our four Tennessee hospitals, St. Thomas contributed approximately
$0.5 million in equipment. St. Thomas will co-brand our Tennessee hospitals as
well as clinically support certain services and future growth opportunities. Our
partnership with St. Thomas will be the exclusive development vehicle for a
60-county region in middle Tennessee and southern Kentucky.
Effective July 1, 2012, we executed a long-term lease agreement for Muskogee
Community Hospital ("MCH"), a 45-licensed bed facility located in Muskogee,
Oklahoma. As part of the transaction, we executed an asset purchase agreement in
which we acquired specific components of net working capital, as defined, and
certain intangible assets for $19.4 million. Of the purchase price, $8.4 million
is in the form of a promissory note payable in fifteen equal installments
beginning July 2013. We also executed a master lease agreement for the real
property and certain equipment used in the operation of MCH. Under the master
lease agreement, we will pay a monthly lease payment of $565,000 per month,
which payment will be adjusted for inflation beginning in the third year of the
lease. We have the option to purchase the leased real property and equipment at
fair value on July 20, 2014 and again after the expiration of the initial lease
term (15 years). We also have an option to renew the lease for an additional 15
years, after which we could also exercise a purchase option for fair value.
Significant Industry Trends
The following sections discuss recent trends that we believe are significant
factors in our current and/or future operating results and cash flows. Certain
of these trends apply to the entire hospital industry, while others may apply to
us more specifically. These trends could be short-term in nature or could
require long-term attention and resources. While these trends may involve
certain factors that are outside of our control, the extent to which these
trends affect our hospitals and our ability to manage the impact of these trends
play vital roles in our current and future success. In many cases, we are unable
to predict what impact, if any, these trends will have on us.
Impact of Healthcare Reform
The Patient Protection and Affordable Care Act and the Health Care and Education
Reconciliation Act of 2010 (collectively, the "Affordable Care Act") were signed
into law on March 23, 2010 and March 30, 2010, respectively. The Affordable Care
Act dramatically alters the United States healthcare system and is intended to
decrease the number of uninsured Americans and reduce the overall cost of
healthcare. The Affordable Care Act attempts to achieve these goals by, among
other things, requiring most Americans to obtain health insurance, expanding
Medicare and Medicaid eligibility, reducing Medicare disproportionate share
("DSH") payments and Medicaid payments to providers, expanding the Medicare
program's use of value-based purchasing programs, tying hospital payments to the
satisfaction of certain quality criteria, bundling payments to hospitals and
other providers, and instituting certain private health insurance reforms.
Although a majority of the measures contained in the Affordable Care Act do not
take effect until 2014, certain of the reductions in Medicare spending, such as
negative adjustments to the Medicare hospital inpatient and outpatient
prospective payment system market basket updates and the incorporation of
productivity adjustments to the Medicare program's annual inflation updates,
became effective in 2010 and 2011 or will be implemented in 2012. On June 28,
2012, the United States Supreme Court upheld the "individual mandate" provision
of the Affordable Care Act that generally requires all individuals to obtain
healthcare insurance or pay a penalty. However, the Supreme Court also held that
the provision of the Affordable Care Act that authorized the Secretary of Health
and Human Services to penalize any state that chooses not to participate in the
expansion of the Medicaid program by removing all of the states existing
Medicaid funding was unconstitutional. In response to the ruling, a number of
states have indicated that they will not expand their Medicaid programs, which
would result in some low-income persons in those states not receiving coverage
through the Affordable Care Act. Additionally, several bills have been and will
likely continue to be introduced in Congress to repeal or amend all or
significant provisions of the Affordable Care Act. It is difficult to predict
the full impact of the Affordable Care Act on our revenue and results of
operations due to its complexity, lack of implementing regulations and
interpretive guidance, gradual and potentially delayed implementation, and
possible repeal and/or amendment, as well as our inability to foresee how
individuals and businesses will respond to the choices afforded them by the
Affordable Care Act.
23
--------------------------------------------------------------------------------
Table of Contents
Adoption of Electronic Health Records
The Health Information Technology for Economic and Clinical Health Act (the
"HITECH Act"), which was enacted into law on February 17, 2009 as part of the
American Recovery and Reinvestment Act of 2009 (the "ARRA"), includes provisions
designed to increase the use of computerized physician order entry at hospitals
and the use of EHR by both physicians and hospitals. We intend to comply with
the EHR meaningful use requirements of the HITECH Act in time to qualify for the
maximum available Medicare and Medicaid incentive payments. We will recognize
income related to the Medicare or Medicaid incentive payments as we are able to
satisfy all appropriate contingencies, which includes completing attestations as
to our eligible hospitals adopting, implementing or demonstrating meaningful use
of certified EHR technology, and additionally for Medicare incentive payments,
deferring income until the related Medicare fiscal year has passed and cost
report information used to determine the final amount of reimbursement is known.
Our compliance has resulted in significant costs including professional services
focused on successfully designing and implementing our EHR solutions along with
costs associated with the hardware and software components of the project. We
currently estimate that at a minimum the total costs incurred to comply with the
HITECH Act will be recovered through EHR incentive payments. During the three
and six months ended June 30, 2012, we recognized $0.4 million and $1.2 million,
respectively, of other income related to estimated EHR incentive payments.
Medicare and Medicaid Reimbursement
Medicare payment methodologies have been, and are expected to be, significantly
revised based on cost containment and policy considerations. CMS has already
begun to implement some of the Medicare reimbursement reductions required by the
Affordable Care Act. These revisions will likely be more frequent and
significant as more of the Affordable Care Act's changes and cost-saving
measures become effective.
On May 11, 2012, CMS published its hospital inpatient prospective payment system
("IPPS") proposed rule for federal fiscal year ("FFY") 2013, which begins on
October 1, 2012. Under the proposed rule, hospitals that successfully report the
quality measures for the Hospital Inpatient Quality Reporting Program will
receive a 2.3% rate increase and those that do not will receive a 0.3% rate
increase in FFY 2013. The update is based on a proposed hospital market basket
increase of 3.0%, which is reduced by a multi-factor productivity adjustment of
0.8% and an additional 0.1% as required by the Affordable Care Act and is
increased by a documentation and coding adjustment of 0.2%.
On July 6, 2012, CMS issued the Medicare outpatient prospective payment system
("OPPS") proposed rule for calendar year ("CY") 2013. Under the proposed rule,
hospitals that meet the reporting requirements of the Medicare Hospital
Outpatient Quality Reporting Program will receive a rate increase of 2.1% in CY
2013 and those that do not will receive a 0.1% rate increase. The increase is
based on the projected IPPS market basket percentage increase described above.
On July 6, 2012, CMS also issued a proposed rule to update Medicare ambulatory
surgery center ("ASC") payment rates for CY 2013. The proposed rule provides for
a 1.3% increase to ASC payment rates, which is comprised of a 2.2% increase in
the consumer price index for urban consumers, less a multifactor productivity
adjustment of 0.9%, as required by the Affordable Care Act.
In addition, many states in which we operate are facing budgetary challenges and
have adopted, or may be considering, legislation that is intended to control or
reduce Medicaid expenditures, enroll Medicaid recipients in managed care
programs, and/or impose additional taxes on hospitals to help finance or expand
their Medicaid programs. Budget cuts, federal or state legislation, or other
changes in the administration or interpretation of government health programs by
government agencies or contracted managed care organizations could have a
material adverse effect on our financial position and results of operations.
Pay for Performance and Quality Related Reimbursement
Many payors, including Medicare and several large managed care organizations,
currently require hospital providers to report certain quality measures in order
to receive the full amount of payment increases that were awarded automatically
in the past. For FFY 2012, Medicare expanded the number of quality measures to
be reported to 72, compared to 55 during FFY 2011. In addition, the Medicare
2013 Proposed Inpatient Prospective Payment System rule continues the focus on
tying Medicare payments to value-based and quality-driven efforts. Medicare
proposes to create a more streamlined set of 59 quality measures for FFY 2015
and 60 for FFY 2016. The proposed rule also would implement payment provisions
related to CMS's effort to reduce the number of hospital readmissions. Many
large managed care organizations have developed quality measurement criteria
that are similar to or even more stringent than these Medicare requirements.
While current Medicare guidelines and contracts with most managed care payors
provide for reimbursement based upon the reporting of quality measures, we
believe significant payors will utilize the quality measures to determine
reimbursement rates for hospital services. We have developed key processes and
infrastructure that we believe enable us to meet or exceed the current
established quality guidelines. We plan to continue to invest in quality
initiatives and technology in order to meet the quality demands of our payors in
the future.
Physician Alignment
Our ability to attract skilled physicians to our hospitals is critical to our
success. Coordination of care and alignment of care strategies between hospitals
and physicians will become more critical as reimbursement becomes more
episode-based. We have
24
--------------------------------------------------------------------------------
Table of Contents
physician recruitment goals with primary emphasis on recruiting physicians
specializing in family practice, internal medicine, general surgery, oncology,
obstetrics and gynecology, cardiology, neurology, orthopedics, urology,
otolaryngology and inpatient hospital care (hospitalists). To provide our
patients access to the appropriate physician resources, we actively recruit
physicians to the communities served by our hospitals through employment
agreements, relocation agreements or physician practice acquisitions. We seek to
invest in the infrastructure necessary to coordinate our physician alignment
strategies and manage our physician operations. The costs associated with
recruiting, integrating and managing a large number of new physicians will have
a negative impact on our operating results and cash flows in the near term.
However, we expect to realize improved clinical quality and service expansion
capabilities from this initiative that will impact our operating results
positively over the long term.
HIPAA
In January 2009, CMS published its 10th revision of International Statistical
Classification of Diseases ("ICD-10"), which establishes an updated code set to
be used for classifying health care diagnoses and procedures. Entities covered
under HIPAA will be required to use the ICD-10, which contains significantly
more diagnostic and procedural codes than the existing ICD-9 coding system.
Because of the greater number of codes, the coding for the services provided in
our facilities will require much greater specificity. Implementation of ICD-10
will require a significant investment in technology and training. We may
experience delays in reimbursement while our facilities and the payors from
which we seek reimbursement make the transition to ICD-10. HIPAA currently
requires implementation of ICD-10 to be achieved by October 1, 2013. However, on
April 9, 2012, CMS released a proposed rule that would delay the effective date
of the ICD-10 transition to October 1, 2014. If any of our facilities fail to
implement the new coding system by the deadline, the affected facility will not
be paid for services. We are not able to predict the timeframe or the overall
financial impact of the transition to ICD-10.
Uncompensated Care
Like others in the hospital industry, we continue to experience high levels of
uncompensated care, including charity care and bad debts. These elevated levels
are driven by the number of uninsured and under-insured patients seeking care at
our hospitals and increasing healthcare costs and other factors beyond our
control, such as increases in the amount of co-payments and deductibles as
employers continue to pass more of these costs on to their employees. In
addition, as a result of high unemployment and its continued impact on the
economy, we believe that our hospitals may continue to experience high levels of
and growth in bad debts and charity care. For the three months ended June 30,
2012, our same-facility uncompensated care as a percentage of revenue, which
includes the impact of uninsured discounts and charity care, was 23.3%, compared
to 20.3% during the same prior year period. For the six months ended June 30,
2012, our same-facility uncompensated care as a percentage of revenue was 21.7%,
compared to 19.8% during the same prior year period.
We anticipate that if we experience further growth in uninsured volume and
revenue, including increased acuity levels and continued increases in
co-payments and deductibles for insured patients, our uncompensated care will
increase and our results of operations could be affected adversely.
25
--------------------------------------------------------------------------------
Table of Contents
Similar to others in the hospital industry, we have a significant amount of
self-pay receivables (including co-payments and deductibles from insured
patients), and collecting these receivables may become more difficult if
economic conditions worsen. The following table provides a summary of our
accounts receivable payor class mix as of December 31, 2011 and June 30, 2012:
December 31, 2011 0-90 Days 91-180 Days Over 180 Days Total
Medicare(1) 26.4 % 0.7 % 0.4 % 27.5 %
Medicaid(1) 6.2 0.7 0.6 7.5
Managed Care and Other 18.9 1.8 1.1 21.8
Self-Pay(2) 10.6 9.6 23.0 43.2
Total 62.1 % 12.8 % 25.1 % 100.0 %
June 30, 2012 0-90 Days 91-180 Days Over 180 Days Total
Medicare(1) 27.1 % 0.8 % 0.7 % 28.6 %
Medicaid(1) 6.3 0.7 0.6 7.6
Managed Care and Other 18.9 1.9 1.2 22.0
Self-Pay(2) 11.1 9.9 20.8 41.8
Total 63.4 % 13.3 % 23.3 % 100.0 %
(1) Includes receivables under managed Medicare or managed Medicaid programs.
(2) Includes both uninsured as well as estimated co-payment and deductible
amounts from insured patients.
The volume of self-pay accounts receivable remains sensitive to a combination of
factors including; price increases, acuity levels, higher insured patient
co-payments and deductibles, economic factors and the increased difficulties of
patients who do not qualify for charity care programs. We have implemented a
number of practices to mitigate bad debt expense and increase collections
including; increased focus on upfront cash collections, incentive plans for our
hospitals' financial counselors and registration personnel, increased focus on
payment plans with non-emergent patients, among other efforts. Despite these
practices, we believe bad debts will remain a significant risk for us as well as
the rest of the hospital industry.
Impact of Current Economic Environment
Similar to others in the industry, we continue to experience volume pressure
based on reduced demand for inpatient healthcare services and increased
competition for patients. The recent economic downturn impacted healthcare and
many other industries negatively. While many healthcare services are considered
non-discretionary in nature, certain services including elective procedures and
other non-emergent services may be deferred or canceled by patients when they
are suffering personal financial hardship or have a negative outlook on the
general economy. Continually high unemployment results in high numbers of
uninsured patients, and employer cost reduction programs may result in a higher
level of co-pays and deductible limits for patients. Governmental payors and
managed care payors may reduce reimbursement paid to hospitals and other
healthcare providers to address economic and regulatory pressures. We believe a
more severe economic downturn could have an adverse impact on our revenue
whether in the form of payor mix shifts from managed care to uninsured or
Medicaid, additional charity care, lower patient volumes, lower collection rates
of patient co-pay and deductible balances or a combination of such factors.
Revenue/Volume Trends
Revenue for the three months ended June 30, 2012, increased 8.3% to $184.3
million, compared to $170.1 million in the same prior year period. Revenue for
the six months ended June 30, 2012, increased 11.9% to $381.2 million, compared
to $340.6 million in the same prior year period. Our revenue depends upon
inpatient occupancy levels, outpatient procedures, ancillary services and
therapy programs as well as our ability to negotiate appropriate payment rates
for services with third-party payors and our ability to achieve quality metrics
to maximize payment from our payors.
Revenue
The primary sources of our revenue before the provision for bad debts include
various managed care payors, including managed Medicare and managed Medicaid
programs, the traditional Medicare program, various state Medicaid programs,
commercial health plans and patients themselves. We are typically paid less than
our gross charges, regardless of the payor source, and report revenue before the
provision for bad debts to reflect contractual adjustments and other allowances
required by managed care providers and federal and state agencies. Our revenue
for the six months ended June 30, 2012 was impacted by the following items.
Our Oklahoma facilities participate in the State of Oklahoma's Supplemental
Hospital Offset Payment Program, or SHOPP. On January 17, 2012, CMS approved
SHOPP with an effective date of July 1, 2011. The legislation related to SHOPP
was signed into law
26
--------------------------------------------------------------------------------
Table of Contents
by the Governor of Oklahoma on May 13, 2011, but subject to approval by CMS.
SHOPP, with an initial term of three fiscal years, allows for the establishment
of a hospital provider fee assessment on all non-exempt Oklahoma hospitals. The
state plans to use revenue from this assessment to maintain hospital
reimbursement from the SoonerCare Medicaid program and to secure additional
matching Medicaid funds from the federal government. Since CMS approval of the
program did not occur until, January 17, 2012, we recorded twelve months of
revenue and expenses associated with SHOPP during the six months ended June 30,
2012. CMS approval was necessary to meet the revenue recognition criterion that
persuasive evidence of an arrangement exists, pursuant to generally accepted
accounting principles.
We also recorded revenue and expenses related to the rural floor provision
settlement litigation during the six months ended June 30, 2012. The Balanced
Budget Act of 1997, or BBA, established a rural floor provision, by which an
urban hospital's wage index within a particular state could not be lower than
the statewide rural wage index. The wage index reflects the relative hospital
wage level compared to the applicable average hospital wage level. The BBA also
made this provision budget neutral, meaning that total wage index payments
nationwide before and after the implementation of this provision must remain the
same. To accomplish this, CMS was required to increase the wage index for all
affected urban hospitals, and to then calculate a rural floor budget neutrality
adjustment to reduce other wage indexes in order to maintain the same level of
payments. Litigation had been pending for several years contending that CMS
miscalculated the neutrality adjustment from 1999 through 2011. The litigation,
in which we and several other hospital companies participated, has now been
settled with a settlement agreement signed on April 5, 2012. As a result of the
agreement, we recorded revenue and expenses related to the rural floor provision
settlement during the six months ended June 30, 2012.
During the six months ended June 30, 2012, we recorded revenue and expenses
related to the prior period SHOPP and rural floor provision settlement of $13.6
million and $5.1 million, respectively.
Admissions increased 4.6% and 5.5%, respectively, for the three and six months
ended June 30, 2012, compared to the same prior year periods. Adjusted
admissions increased 11.6% and 11.8%, respectively, for the three and six months
ended June 30, 2012, compared to the same prior year periods. On a same-facility
basis, admissions decreased 0.1% and increased 0.6% for the three and six months
ended June 30, 2012, compared to the same prior year periods, while adjusted
admission increased 5.9% and 6.1%, respectively, for the three and six months
ended June 30, 2012, compared to the same prior year periods.
On a same-facility basis, our inpatient volume was pressured by a decline in
inpatient surgeries of 6.0% and 6.7%, respectively, for the three and six months
ended June 30, 2012, compared to the same prior year periods. Also, our hospital
volumes were impacted negatively, in part, by the impact of continued high
unemployment and patient decisions to defer or cancel elective procedures,
general primary care and other non-emergent healthcare procedures, all resulting
from the impact of the current economic environment. We experienced an increase
in same-facility outpatient surgeries of 3.1% and 9.8%, respectively, for the
three and six months ended June 30, 2012, compared to the same prior year
periods. The increase in outpatient surgeries is due, in part, to the addition
of a surgery center at one of our hospitals and the continuing industry shift
from an inpatient hospital setting to a more outpatient focused healthcare
environment.
We believe our volumes over the long-term will grow as a result of our business
strategies, including the continued investment in our physician alignment
strategy, increased efforts to promote our commitment to patient care excellence
and patient satisfaction, and the general aging of the population.
27
--------------------------------------------------------------------------------
Table of Contents
The following table sets forth the percentages of revenue after the provision
for bad debts by payor for the three and six months ended June 30, 2011 and
2012:
Three Months Six Months
Ended June 30, Ended June 30,
2011 2012(2) 2011 2012(2)
Medicare(1) 44.3 % 44.7 % 44.0 % 44.5
Medicaid(1) 13.7 16.1 13.7 17.4
Managed Care and Other 41.5 38.5 41.3 36.8
Self-pay 0.5 0.7 1.0 1.3
Total 100.0 % 100.0 % 100.0 % 100.0 %
(1) Includes revenue received under managed Medicare or managed Medicaid
programs.
(2) Our percentage of revenue by payor for the three months ended June 30, 2012
has been impacted by SHOPP revenue recorded. Our percentages for the six
months ended June 30, 2012 have been impacted by the rural floor provision
settlement and prior period SHOPP described previously.
Revenue per adjusted admission decreased 2.9% and increased 0.1%, respectively,
for the three and six months ended June 30, 2012, compared to the same prior
year periods. Same-facility revenue per adjusted admission decreased 1.6% and
increased 1.7%, respectively, for the three and six months ended June 30, 2012,
compared to the same prior year periods. Our revenue per adjusted admission for
the six months ended June 30, 2012 was impacted by the revenue recognized from
SHOPP and rural floor provision settlement discussed previously. Excluding the
revenue related to SHOPP and the rural floor settlement, our same-facility
revenue per adjusted admission declined 2.1% for the six months ended June 30,
2012, compared to the six months ended June 30, 2011. The decrease in our
same-facility revenue per adjusted admission for the three and six months ended
June 30, 2012 compared to the same prior year periods is primarily due to an
increase in uncompensated care and the impact of service line rotation as we saw
a higher number of lower reimbursement cases such as behavioral and urology
combined with a decline of higher reimbursement cases such as orthopedics. We
also have experienced moderating rates of pricing growth resulting from the
impact of high unemployment and other industry pressures, including elevated
levels of Medicaid and managed Medicaid, which typically result in lower
reimbursement on a per adjusted admission basis. Also, the impact of state
budgetary issues on Medicaid funding has resulted in some rate cuts to
providers, which has caused a decline in pricing related to Medicaid and managed
Medicaid volumes. As states continue to work through budgetary issues, any
additional cuts to Medicaid funding would negatively impact our future pricing
and earnings.
See "Item 1 - Business - Sources of Revenue" and "Item 1 - Business - Government
Regulation and Other Factors", included in our 2011 Annual Report on Form 10-K,
for a description of the types of payments we receive for services provided to
patients enrolled in the traditional Medicare plan, managed Medicare plans,
Medicaid plans, managed Medicaid plans and managed care plans. In those
sections, we also discussed the unique reimbursement features of the traditional
Medicare plan, including the annual Medicare regulatory updates published by CMS
that impact reimbursement rates for services provided under the plan. The future
potential impact to reimbursement for certain of these payors under the
Affordable Care Act is also addressed in the 2011 Annual Report on Form 10-K.
Critical Accounting Policies
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires us to make estimates and
assumptions that affect the reported amounts and related disclosures. We
consider an accounting estimate to be critical if:
• it requires assumptions to be made that were uncertain at the time the
estimate was made; and
• changes in the estimate or different estimates that could have been made
could have a material impact on our consolidated results of operations or
financial condition.
Our critical accounting estimates are more fully described in the 2011 Annual
Report on Form 10-K. There have been no changes in the nature of our critical
accounting policies or the application of those policies since December 31,
2011.
28
--------------------------------------------------------------------------------
Table of Contents
RESULTS OF OPERATIONS
The following table presents summaries of results of operations for the three
and six months ended June 30, 2011 and 2012, respectively.
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2011 June 30, 2012 June 30, 2011 June 30, 2012
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
Revenue before provision for bad debts
$ 189.7 111.5 % $ 208.2 113.0 % $ 377.1 110.7 % $ 426.4 111.9 %
Provision for bad debts (19.6 ) (11.5 )% (23.9 ) (13.0 )% (36.5 ) (10.7 )% (45.2 ) (11.9 )%
Revenue 170.1 100.0 % 184.3 100.0 % 340.6 100.0 % 381.2 100.0 %
Costs and expenses:
Salaries and benefits 82.1 48.3 % 85.8 46.6 % 165.8 48.7 % 176.6 46.3 %
Supplies 28.0 16.5 % 28.7 15.6 % 55.7 16.4 % 57.8 15.2 %
Other operating expenses 36.2 21.2 % 46.4 25.2 % 72.2 21.2 % 93.3 24.5 %
Other income (1.9 ) (1.1 )% (0.4 ) (0.2 )% (1.9 ) (0.6 )% (1.2 ) (0.3 )%
Management fees 0.1 - 0.1 - 0.1 - 0.1 -
Depreciation and amortization 8.0 4.7 % 8.8 4.7 % 16.4 4.8 % 17.6 4.6 %
Interest, net 12.7 7.5 % 12.9 7.0 % 25.4 7.5 % 25.9 6.8 %
Total costs and expense 165.2 97.1 % 182.3 98.9 % 333.7 98.0 % 370.1 97.1 %
Income from continuing operations before
income taxes 4.9 2.9 % 2.0 1.1 % 6.9 2.0 % 11.1 2.9 %
Income taxes 0.9 0.5 % 0.9 0.5 % 1.8 0.5 % 1.8 0.5 %
Income from continuing operations 4.0 2.4 % 1.1 0.6 % 5.1 1.5 % 9.3 2.4 %
Loss from discontinued operations, net of
taxes (0.3 ) (0.2 )% (2.4 ) (1.3 )% (0.4 ) (0.1 )% (5.7 ) (1.5 )%
Net income (loss) $ 3.7 2.2 % $ (1.3 ) (0.7 )% $ 4.7 1.4 % $ 3.6 0.9 %
Less: Net income attributable to
non-controlling interests 0.4 0.2 % - - 1.0 0.3 % 0.2 -
Net income (loss) attributable to Capella
Healthcare, Inc. $ 3.3 2.0 % $ (1.3 ) (0.7 )% $ 3.7 1.1 % $ 3.4 0.9 %
29
--------------------------------------------------------------------------------
Table of Contents
The following table sets forth certain unaudited operating data for each of the
periods presented.
Three Months Ended June 30, Six Months Ended June 30,
2011 2012 2011 2012
Continuing operations:(1)
Admissions(2) 10,661 11,156 21,559 22,738
Adjusted admissions(3) 21,742 24,268 43,372 48,482Revenue per adjusted admission $ 7,824 $ 7,594
$ 7,853 $ 7,863
Inpatient surgeries 2,550 2,483 5,036 4,891
Outpatient surgeries(4) 5,323 5,659 10,098 11,424
Emergency room visits(5) 49,767 58,636 98,746 115,466
Same-facility:(6)
Admissions(2) 10,661 10,646 21,559 21,694
Adjusted admissions(3) 21,742 23,029 43,372 46,020
Revenue per adjusted admission $ 7,824 $ 7,695
$ 7,853 $ 7,983
Inpatient surgeries 2,550 2,396 5,036 4,699
Outpatient surgeries(4) 5,323 5,488 10,098 11,088
Emergency room visits(5) 49,767 54,601 98,746 107,632
(1) Excludes all operations included in discontinued operations.
(2) Represents the total number of patients admitted to our hospitals and used by
management and investors as a general measure of inpatient volume.
(3) Adjusted admissions are used as a general measure of combined inpatient and
outpatient volume. We compute adjusted admissions by multiplying admissions
by the outpatient factor (the sum of gross inpatient revenue and gross
outpatient revenue and then dividing the result by gross inpatient revenue).
(4) Outpatient surgeries are surgeries that do not require admission to our
hospitals.
(5) Represents the total number of hospital-based emergency room visits.
(6) Excludes DeKalb Community Hospital and Stones River Hospital which were
acquired in July 2011 through our acquisition of a 60% interest in Cannon
County Hospital, LLC ("CCH").
30
--------------------------------------------------------------------------------
Table of Contents
Three Months Ended June 30, 2012 Compared to June 30, 2011
Revenue. Revenue for the three months ended June 30, 2012 was $184.3 million, an
increase of $14.2 million, or 8.3%, over the prior year quarter. The increase in
revenue is due to the following items: (i) the acquisitions of DeKalb Community
Hospital and Stones River Hospital, which became part of the Company in July
2011 through our acquisition of a 60% interest in Cannon County Hospital, LLC,
and contributed approximately $7.2 million of revenue during the three months
ended June 30, 2012, and (ii) an increase in same-facility adjusted admissions
of 5.9%, offset by a decline in same-facility revenue per adjusted admission of
approximately 1.6%.
Our revenue was impacted by an increase in our provision for bad debts, which
was up $4.3 million, or 21.9% compared to the prior year period. The increase in
bad debts was due to the growth in uninsured patient volume and revenue. On a
same-facility basis, self-pay admissions were 6.8% of total admissions, which
was an increase from 5.5% in the prior year. Self-pay gross revenue increased
19.2%, compared to the prior year period.
Salaries and benefits. Salaries and benefits for the three months ended June 30,
2012 were $85.8 million, or 46.6% of revenue, compared to $82.1 million, or
48.3% of revenue in the prior year quarter. We have reduced contract labor by
approximately $1.2 million compared to the prior year quarter and continue to
make labor productivity improvements that have favorably impacted our salaries
and benefits expense margin.
Supplies. Supplies expense for the three months ended June 30, 2012 was $28.7
million, or 15.6% of revenue, compared to $28.0 million, or 16.5% of revenue in
the prior year quarter. The improvement in our supplies margin was due to a
decline in supply intensive in-patient surgical cases as well as our continued
efforts to manage supply costs.
Other operating expenses. Other operating expenses include, among other things,
professional fees, repairs and maintenance, rents and leases, utilities,
insurance, non-income taxes and physician income guarantee amortization.
Other operating expenses for the three months ended June 30, 2012 was $46.4
million, or 25.2% of revenue, compared to $36.2 million, or 21.2% of revenue in
the prior year quarter. The increase in our other operating expenses margin was
due to the following items: a $3.3 million increase in contract services from
the implementation of new service lines at our facilities, a $3.4 million
increase in provider taxes and fees, a $1.7 million increase in professional
fees due to the implementation of hospitalist programs at two of our hospitals,
a $1.0 million increase in acquisition costs and an increase in information
technology expenses due to meaningful use requirements as well as infrastructure
build-outs in our growing physician practice clinics.
Other income. Other income includes EHR incentive payments, which represent
those incentives under the HITECH Act for which the recognition criterion has
been met. For the three months ended June 30, 2012, we recognized approximately
$0.4 million of incentive reimbursements, compared to $1.9 million in the prior
year.
Income taxes. Our effective tax rate from continuing operations was
approximately 45.0% for the three months ended June 30, 2012 compared to 18.4%
for the prior year quarter. The change in the effective tax rate is driven by
changes in the level of pretax income combined with our net deferred tax
liability position and related limitations with respect to deferred tax
liabilities associated with indefinite-lived intangible assets.
Six Months Ended June 30, 2012 Compared to June 30, 2011
Revenue. Revenue for the six months ended June 30, 2012 was $381.2 million, an
increase of $40.6 million, or 11.9%, over the six months ended June 30, 2011.
The increase in revenue was due to the following: (i) the acquisitions of DeKalb
Community Hospital and Stones River Hospital, which contributed approximately
$13.8 million of revenue during the six months ended June 30, 2012, (ii) the
revenue recorded related to the prior period SHOPP and rural floor settlement
which contributed approximately $13.6 million of revenue and (iii) an increase
in same-facility adjusted admissions of 6.1%, offset by a decline in
same-facility revenue per adjusted admission (excluding SHOPP and the rural
floor settlement) of approximately 2.1%.
Our revenue was impacted by an increase in our provision for bad debts, which
was up $8.7 million, or 23.8% compared to the six months ended June 30, 2011.
The increase in bad debts was primarily due to the growth in uninsured patient
volume and revenue. On a same-facility basis, self-pay admissions were 6.5% of
total admissions, which increased from 5.5% during the six months ended June 30,
2011. Self-pay gross revenue increased 18.1%, compared to the prior year period.
Salaries and benefits. Salaries and benefits for the six months ended June 30,
2012 was $176.6 million, or 46.3% of revenue, compared to $165.8 million, or
48.7% of revenue during the six months ended June 30, 2011. Our salaries and
benefits margin was impacted by the prior period SHOPP and rural floor
settlement revenue discussed previously. Also, as a result of the rural floor
provision settlement, we recorded an additional $2.2 million in incentive
compensation for our employees in accordance with our incentive plan provisions
during the six months ended June 30, 2012. On a same-facility basis, and
excluding the revenue and expense related to the prior period SHOPP and rural
floor settlement, salaries and benefits as a percentage of revenue was 47.0% for
the six
31
--------------------------------------------------------------------------------
Table of Contents
ended June 30, 2012, compared to 48.7% in the same prior year period. We have
reduced same-facility contract labor by approximately $2.4 million compared to
the prior year and continue to make labor productivity improvements that have
favorably impacted our salaries and benefits expense margin.
Supplies.Supplies expense for the six months ended June 30, 2012 was $57.8
million, or 15.2% of revenue, compared to $55.7 million, or 16.4% of revenue for
the six months ended June 30, 2012. Our supplies margin was impacted by the
SHOPP program and rural floor settlement revenue discussed previously. On a
same-facility basis, and excluding revenue related to the prior period SHOPP
program and rural floor settlement, supplies expense as a percentage of revenue
was 15.8%, compared to 16.4% in the prior year period. The improvement in our
supplies margin was due to a decline in supply intensive in-patient surgical
cases as well as our continued efforts to manage supply costs.
Other operating expenses. Other operating expenses include, among other things,
professional fees, repairs and maintenance, rents and leases, utilities,
insurance, non-income taxes and physician income guarantee amortization.
Other operating expenses for the six months ended June 30, 2012 was $93.3
million, or 24.5% of revenue, compared to $72.2 million, or 21.2% of revenue for
the six months ended June 30, 2011. Our other operating expense margin was
impacted by the SHOPP program and rural floor settlement discussed previously.
On a same-facility basis, and excluding revenue and expenses related to the
SHOPP program and rural floor settlement, other operating expenses as a
percentage of revenue was 24.4%, compared to 21.1% in the prior year period. The
increase in same-facility other operating expenses margin is due to a $5.4
million increase in provider taxes and fees, a $4.3 million increase in contract
services from the implementation of new service lines at our facilities, a $2.4
million increase in professional fees due to the implementation of hospitalist
programs at two of our hospitals, a $1.6 million increase in acquisition costs
and an increase in information technology expenses due to meaningful use
requirements as well as infrastructure build-outs in our growing physician
practices.
Other income. Other income includes EHR incentive payments, which represent
those incentives under the HITECH Act for which the recognition criteria have
been met. For the six months ended June 30, 2012, we recognized approximately
$1.2 million of incentive reimbursements, compared to $1.9 million for the six
months ended June 30, 2012.
Income taxes. Our effective tax rate from continuing operations was
approximately 16.2% for the six months ended June 30, 2012 compared to 26.1% for
the six months ended June 30, 2011. The change in the effective tax rate is
driven by changes in the level of pretax income combined with the Company's net
deferred tax liability position and related limitations with respect to deferred
tax liabilities associated with indefinite-live intangible assets.
32
--------------------------------------------------------------------------------
Table of Contents
LIQUIDITY AND CAPITAL RESOURCES
The following table shows a summary of our cash flows for the six months ended
June 30, 2011 and 2012.
Six Months Ended
June 30,
2011 2012
(In millions)
Cash provided by operating activities $ 22.3 $ 23.6
Cash used in investing activities (42.1 ) (22.4 )
Cash used in financing activities (0.5 ) (3.0 )
Operating Activities
Cash provided by operating activities was $22.3 million for the six months ended
June 30, 2011, compared to $23.6 million for the six months ended June 30, 2012.
At June 30, 2012, we had working capital, excluding assets held for sale, of
$114.4 million, including cash and cash equivalents of $40.6 million, compared
to working capital at December 31, 2011 of $109.9 million, including cash and
cash equivalents of $42.4 million.
Investing Activities
Cash used in investing activities was $42.1 million for the six months ended
June 30, 2011 compared to $22.4 million for the six months ended June 30, 2012.
We spent approximately $6.5 million during the six months ended June 30, 2012
for our purchase of Artesian Cancer Center at Muskogee in Muskogee, Oklahoma.
Capital expenditures for the six months ended June 30, 2011 were $13.0 million
compared to $17.5 million for the six months ended June 30, 2012. During the six
months ended June 30, 2012, we spent approximately $9.0 million on information
technology, $2.7 million on routine capital and $5.8 million on growth capital.
We also received proceeds for the divestiture of Hartselle Medical Center in
Hartselle, Alabama of $1.6 million during the six months ended June 30, 2012.
Financing Activities
Cash flows used in financing activities was $0.5 million for the six months
ended June 30, 2011 compared to $3.0 million for the six months ended June 30,
2012. Cash flows used in financing activities includes approximately $1.1
million in repurchases of non-controlling interests during the six months ended
June 30, 2012.
Capital Resources
The Refinancing
In June 2010, we completed a comprehensive refinancing plan, or the Refinancing.
Under the Refinancing, we issued $500.0 million of 9 1/4% senior unsecured notes
due 2017, referred to as the 9 1/4% Notes, in a private placement offering and
entered into a new senior secured asset based loan, or the ABL, consisting of a
$100.0 million revolving credit facility maturing in December 2014, referred to
as the 2010 Revolving Facility. The proceeds from the 9 1/4% Notes were used to
repay the outstanding principal and interest related to our previous term loan
facility and to pay fees and expenses relating to the Refinancing of
approximately $21.7 million.
Effective November 4, 2011, in accordance with a registration rights agreement
entered into by us in connection with the private placement offering of the 9
1/4% Notes, we completed the exchange of the 9 1/4% Notes for $500.0 million in
registered 9 1/4% notes with substantially identical terms as the 9 1/4%
Notes. We did not receive any proceeds from this exchange.
Debt Covenants
The indenture governing the 9 1/4% Notes contains a number of covenants that
among other things, restrict, subject to certain exceptions, our ability and the
ability of our subsidiaries, to sell assets, incur additional indebtedness or
issue preferred stock, pay dividends and distributions or repurchase our capital
stock, create liens on assets, make investments, engage in mergers or
consolidations, and engage in certain transactions with affiliates. At
December 31, 2011 and June 30, 2012, we were in compliance with all debt
covenants that were subject to testing at such dates.
We expect that cash on hand, cash generated from our operations and cash
expected to be available to us under the 2010 Revolving Facility will be
sufficient to meet our working capital needs and planned capital expenditure
programs for the next 12 months and into the foreseeable future. However, we
cannot assure you that our operations will generate sufficient cash or that
future borrowings under the Refinancing will be available to enable us to meet
these requirements.
33
--------------------------------------------------------------------------------
Table of Contents
We had $42.4 million and $40.6 million of cash and cash equivalents as of
December 31, 2011 and June 30, 2012, respectively. We rely on available cash,
cash flows generated by operations and available borrowing capacity under the
2010 Revolving Facility to fund our operations and capital expenditures. We
invest our cash in accounts in high-quality financial institutions. We
continually explore various options to increase the return on our invested cash
while preserving our principal cash balances. However, the significant majority
of our cash and cash equivalents are held in accounts that are not
federally-insured and could be at risk in the event of a collapse of the
financial institutions at which those accounts are held.
In addition, our liquidity and ability to fund our capital requirements are
dependent on our future financial performance, which is subject to general
economic, financial and other factors that are beyond our control. If those
factors significantly change or other unexpected factors adversely affect us,
our business may not generate sufficient cash flows from operations or we may
not be able to obtain future financings to meet our liquidity needs. We
anticipate that, to the extent additional liquidity is necessary to fund our
operations, it would be funded through borrowings under our 2010 Revolving
Facility, the incurrence of other indebtedness, additional note issuances or a
combination of these potential sources of liquidity. We may not be able to
obtain this additional liquidity when needed on terms acceptable to us.
We also intend to continue to pursue acquisitions or partnering arrangements,
either in existing markets or new markets, which fit our growth strategies. To
finance such transactions, we may draw upon cash on hand, amounts available
under our revolving credit facility or seek additional funding sources. We
continually assess our capital needs and may seek additional financing,
including debt or equity, as considered necessary to fund potential
acquisitions, fund capital projects or for other corporate purposes. We may be
unable to raise additional equity proceeds from the investment funds affiliated
with GTCR Golder Rauner II, L.L.C. (collectively, with GTCR Golder Rauner,
L.L.C. and certain other affiliated entities, "GTCR"), which are our principal
investors, or other investors should we need to obtain cash for any of these
purposes. Our future operating performance, ability to service our debt and
ability to draw upon other sources of capital will be subject to future economic
conditions and other business factors, many of which are beyond our control.
As market conditions warrant, we and our major equity holders, including GTCR,
may from time-to-time repurchase debt securities issued by us, in privately
negotiated or open market transactions, by tender offer or otherwise.
Obligations and Commitments
During the six months ended June 30, 2012, there were no material changes in our
contractual obligations as presented in our 2011 Annual Report on Form 10-K.
Guarantees and Off-Balance Sheet Arrangements
We are a party to certain master lease agreements and other similar arrangements
with non-affiliated entities.
We enter into physician income guarantees and other guarantee arrangements,
including parent-subsidiary guarantees, in the ordinary course of business. We
do not believe we have engaged in any transaction or arrangement with an
unconsolidated entity that is reasonably likely to affect liquidity materially.
We do not have any relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities, established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. Accordingly, we are not materially exposed to any financing,
liquidity, market or credit risk that could arise if we had engaged in such
relationships.
Effects of Inflation and Changing Prices
Various federal, state and local laws have been enacted that, in certain cases,
limit our ability to increase prices. Revenue for acute hospital services
rendered to Medicare patients is established under the federal government's
prospective payment system. We believe that hospital industry operating margins
have been, and may continue to be, under significant pressure because of changes
in payor mix and growth in operating expenses in excess of the increase in
prospective payments under the Medicare program. In addition, as a result of
increasing regulatory and competitive pressures, our ability to maintain
operating margins through price increases to non-Medicare patients is limited.
