Revenue Growth and Profitability Drop in US Not-For-Profit Hospital Preliminary Medians

MEDIAN REPORT

U.S. PUBLIC FINANCE APRIL 23, 2014

Table of Contents:

SUMMARY 1 MAJOR FINDINGS FROM FY 2013 PRELIMINARY MEDIANS 2 FINAL FY 2013 MEDIANS TO BE PUBLISHED IN THE SUMMER 2014 3 APPENDIX 1: FREESTANDING HOSPITALS, SINGLE-STATE MEDIANS FISCAL YEARS 2011-2013 [1] 5 APPENDIX 2: FREESTANDING HOSPITALS, SINGLE-STATE MEDIANS BY BROAD RATING CATEGORY, FY 2013 [1] 7 MOODYS RELATED RESEARCH 9

Analyst Contacts:

NEW YORK +1.212.553.1653

Jennifer Ewing +1.212.553.4429 Analyst [email protected]

Lisa Martin +1.212.553.1423 Senior Vice President [email protected]

Kendra M. Smith +1.212.553.4807 Managing Director - Public Finance [email protected]

Profitability and Revenue Growth Drop in US Not-for-Profit Hospital Preliminary Medians Operating Performance Pressure Continues as Predicted; Balance Sheet Measures Remain Stable

Summary

The fiscal year (FY) 2013 not-for-profit hospital preliminary medians point to continuing operating pressures in the industry. Both the operating margins and operating cash flow margins dropped as revenue growth continued to slow and expense growth continued to surpass revenue growth. Debt coverage metrics remained stable and balance sheet measures grew despite weaker operating performance. Important findings discussed in this report include:

Median operating margins and operating cash flow margins declined, reflecting continued operating pressure on not-for-profit hospitals.

Median expense growth outpaced median revenue growth for a second year contributing to the drop in margins.

Unrestricted cash and investments grew as equity market returns were strong and capital spending levels decreased.

The preliminary medians are based on FY 2013 audited financial statements of about 45% of Moodys rated portfolio. These medians primarily reflect audit year ends of September 30, 2013 and prior; therefore, they do not incorporate the full impact of the Affordable Care Act (ACA) as coverage under the individual mandate did not go into effect until January 1, 2014. We present the preliminary medians in two formats: by year for three years, FY 2011-FY 2013 (Appendix 1), and by rating category for FY 2013 (Appendix 2).

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MEDIAN REPORT: PROFITABILITY AND REVENUE GROWTH DROP IN US NOT-FOR-PROFIT HOSPITAL PRELIMINARY MEDIANS

Major Findings from FY 2013 Preliminary Medians

Profitability margins continued to decline. The preliminary median operating margin and operating cash flow margin declined in FY 2013 for a second year in a row. The declines in both margins come after several years of growth or stability in profitability (see Exhibit 1). The drop is also seen across the Aa and A rating categories, while the Baa and below-Baa rating categories remain relatively flat compared to the prior year.

The margin declines reflect the second straight year of the annual expense growth rate (4.6%) outpacing the annual revenue growth rate (4.1%) as well as a decline of the median annual revenue growth rate (see Exhibit 2). The decline in performance can be attributed to a number of factors including: 1) low rate increases from commercial payors and rate cuts from Medicare and Medicaid; 2) a payor mix shift to governmental payors from commercial payors; 3) an increase in high-deductible health plans with higher levels of patient responsibility contributing to increases in bad debt and lower healthcare demand; and 4) a shift to lower reimbursed outpatient visits and observation stays from inpatient admissions.

EXHIBIT 1

Profitability Margins Dropped in FY 2013

Source: Moodys. Margins for each year are calculated with bad debt as an operating revenue deduction and based on audited financial statements for the

same 203 organizations.

Median expense growth rate dropped, but remained greater than the median revenue growth rate

for a second straight year. The median annual expense growth rate declined in FY 2013 compared to FY 2012, demonstrating a focus on cost containment among hospital operators and the shifting of care to a lower-cost and more efficient setting. The median annual revenue growth rate continued its decline, dropping to 4.1% from 4.6% (see Exhibit 2). It remained lower than the median expense growth rate for a second year in a row contributing to the drop in operating margins. The slowdown in expense growth comes in the midst of increasing costs for physician alignment and information technology, but demonstrates strategies and focus on cost control. We anticipated the decline in revenue growth in FY 2013.1 For some hospitals, however, revenue growth was supported by non-recurring funding sources, including information technology, meaningful use payments and payments under state provider fee programs.

1 2014 Outlook US Not-for-Profit Hospitals

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

2010 2011 2012 2013

Preliminary Median Operating Margin Preliminary Median Operating Cash Flow Margin

For research publications that reference Credit Ratings, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated Credit Rating Action information and rating history.

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3 APRIL 23, 2014


EXHIBIT 2

Median Expense Growth Rate Exceeded Median Revenue Growth Rate For a Second Year in FY 2013

Source: Moodys. The data prior to 2013 are from different sample sets. However the multiple years of data still accurately reflect the trend in the industry over this period. * 2013 is based on audited financial statements of 203 organizations.

Balance sheet ratios remained stable despite lower cash flow. The median unrestricted cash and

investments increased in FY 2013 compared to FY 2012. This growth is consistent across all rating categories and comes as equity market returns were strong and capital spending levels declined. With the increase in cash, preliminary median days cash-on-hand increased, while median cash-to-direct debt remained relatively stable. The median cash-to-comprehensive debt improved as discount rates increased and market returns were strong, reducing defined benefit pension plan liabilities.

Final FY 2013 medians to be published in the summer 2014

We expect the final medians to show weaker operating performance than the preliminary medians due to the inclusion of more hospitals with calendar year-end audits after September 30, 2013 as well as hospitals concentrated in geographic regions with weaker economies. We anticipate the maintenance of general healthy balance sheet ratios in similar to the preliminary medians.

The full medians report will reflect a larger sample size of our rated portfolio of hospitals and health systems. Our entire portfolio of not-for-profit acute care hospitals and single-state health systems consists of 448 rated organizations. We exclude certain specialty hospitals, such as childrens hospitals, cancer centers, and other non acute-care organizations from the medians.

The preliminary medians differ from the full medians in some important respects. Most significantly, the preliminary medians consist mainly of audits ended June 30, 2013 and prior, with a smaller number of audits ended September 30 (see Exhibit 3). In contrast, we estimate just over 60% of the full year medians will consist of audits ended after June 30.

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Median Annual Revenue Growth Rate Median Annual Expense Growth Rate

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EXHIBIT 3

Distribution of Fiscal Year End Dates for 203 Free-Standing and Single-State Systems Included in FY 2013 Preliminary Medians

Source: Moodys.

Jun-30 & Prior63%

July-1 to Sept-3036%

Oct-1 to Dec-311%

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Appendix 1: Freestanding Hospitals, Single-State Medians Fiscal Years 2011-2013 [1]

NOTE: Bad debt is presented as an expense for FY 2011 and as a revenue deduction for FY 2012 and FY 2013. Published FY 2012 Medians are presented with bad debt as a revenue deduction.

Preliminary Medians

2011

Preliminary Medians

2012

Preliminary Medians

2013

Published Medians

2012

Utilization [2]

Maintained Beds 433 421 442 421

Admissions 23,215 24,027 23,380 24,262

Observation Stays 4,797 5,736 6,263 5,218

Combined Admissions and Observation Stays [3] 27,873 28,908 29,858 28,908

Patient Days 107,396 104,463 107,292 109,330

Medicare Case Mix Index 1.60 1.60 1.63 1.59

Average Length of Stay (Days) 4.7 4.6 4.7 4.6

Maintained Bed Occupancy (%) 66.6 63.7 64.7 63.5

Emergency Room Visits 81,367 83,344 85,812 81,703

Outpatient Visits 298,927 319,886 345,870 291,039

Outpatient Surgeries 10,440 10,323 10,389 10,516

Financial Performance ($000)

Net Patient Revenues 507,885 479,083 495,718 488,218

Total Operating Revenue 528,222 515,276 542,128 527,589

Interest Expense 7,662 7,267 7,932 8,104

Depreciation and Amortization Expense 26,919 27,978 30,689 29,819

Total Operating Expenses 504,684 500,082 531,149 506,597

Income from Operations 14,749 14,706 10,775 13,392

Operating Cash Flow 52,804 53,393 48,312 52,297

Excess of Revenue Over Expenses 30,959 31,124 26,395 29,811

Net Revenue Available for Debt Service 67,066 67,670 65,567 68,313

Debt Service 15,380 13,513 15,617 15,508

Additions to Property, Plant, & Equipment 34,756 39,354 36,688 38,973

Balance Sheet ($000)

Unrestricted Cash and Investments 259,360 254,938 285,748 257,819

Total Direct Debt 190,991 198,063 213,325 218,738

Total Comprehensive Debt 263,545 284,499 276,334 294,491

Net Fixed Assets 265,177 284,876 286,132 305,443

Unrestricted Net Assets 345,907 329,308 372,543 331,911

Monthly Liquidity 228,935 228,353 247,217 254,917

Annual Liquidity 241,286 253,814 238,032 264,781

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Preliminary Medians

2011

Preliminary Medians

2012

Preliminary Medians

2013

Published Medians

2012

Key Ratios [4]

Operating Margin 2.7% 2.5% 2.2% 2.5%

Excess Margin 5.4% 5.5% 5.2% 5.2%

Operating Cash Flow Margin 9.5% 9.8% 9.3% 9.5%

Cash on Hand (Days) 179.9 195.9 204.3 185.3

Cash-to-Direct Debt 132.1% 134.8% 137.4% 126.2%

Cash-to-Comprehensive Debt 95.1% 91.8% 100.7% 89.5%

Maximum Annual Debt Service Coverage (x) 4.5 4.4 4.4 4.3

Annual Debt Service Coverage (x) 4.8 4.8 4.6 4.6

Debt-to-Cash Flow (x) 3.3 3.3 3.4 3.4

Debt-to-Total Operating Revenue 34.9% 37.2% 36.5% 37.6%

Annual Operating Revenue Growth Rate 5.3% 4.6% 4.1% 5.2%

Annual Operating Expense Growth Rate 4.8% 5.4% 4.6% 5.5%

3 Year Operating Revenue CAGR 5.7% 5.0% 4.9% 5.1%

3 Year Operating Expense CAGR 5.2% 5.0% 5.0% 5.1%

Debt-to-Capitalization 37.9% 38.3% 35.2% 38.9%

Current Ratio (x) 2.0 1.9 1.9 1.9

Cushion Ratio (x) 16.5 17.5 18.4 16.2

Return on Assets 4.8% 4.4% 4.2% 4.3%

Accounts Receivable (Days) 44.3 50.2 50.0 49.9

Average Payment Period (Days) 57.1 64.2 61.3 64.3

Capital Spending Ratio (x) 1.1 1.3 1.1 1.2

Average Age of Plant (Years) 10.1 10.4 10.7 10.6

Monthly Liquidity to Demand Debt 346.2% 360.8% 405.1% 346.2%

Annual Liquidity to Demand Debt 368.4% 393.5% 428.0% 396.8%

Demand Debt as a % of Total Direct Debt 34.5% 32.2% 31.1% 34.5%

Cash to Demand Debt 383.4% 408.5% 448.3% 415.6%

Monthly Liquidity to Total Cash and Investments 98.2% 99.3% 98.8% 97.6%

Patient Revenue Sources by Gross Revenue (%) [5]

Medicare 43.7% 43.9% 44.3% 44.1%

Medicaid 13.0% 13.0% 12.9% 13.1%

Commercial 34.0% 33.0% 32.1% 33.4%

Self Pay & Other 7.7% 8.0% 7.6% 7.6%

[1] Financial data are based on audited financial statements for 203 free-standing hospitals and single-state healthcare systems.

[2] Utilization statistics are based on a smaller sample size where three years of consistent data are available.

[3] Combined Admissions and Observation Stays is a separately calculated median and does not equal the sum of median Admissions and median Observation Stays.

[4] Monthly and Annual Liquidity statistics are based on a smaller sample size where three years of consistent data are available.

[5] Payor Mix columns do not sum to 100% because each entry is a separately calculated median.

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Appendix 2: Freestanding Hospitals, Single-State Medians by Broad Rating Category, FY 2013 [1]

All Ratings Aa A Baa Below Baa

Sample Size 203 35 103 53 12

Utilization [2]

Maintained Beds 442 1,002 428 307 303

Admissions 23,380 53,621 21,689 15,564 13,548

Observation Stays 6,263 15,699 6,162 4,262 2,664

Combined Admissions and Observation Stays [3] 29,858 69,320 29,714 19,716 18,778

Patient Days 107,292 274,601 101,033 66,237 67,375

Medicare Case Mix Index 1.63 1.73 1.62 1.59 1.54

Average Length of Stay (Days) 4.7 5.1 4.6 4.4 5.0

Maintained Bed Occupancy (%) 64.7 71.9 64.5 61.4 66.5

Emergency Room Visits 85,812 158,824 85,623 54,765 64,622

Outpatient Visits 345,870 741,774 284,421 286,179 177,422

Outpatient Surgeries 10,389 25,472 10,528 7,232 6,165

Financial Performance ($000)

Net Patient Revenues 495,718 1,436,949 495,776 348,200 310,533

Total Operating Revenue 542,128 1,546,874 536,879 363,702 328,609

Interest Expense 7,932 20,092 7,474 6,380 5,007

Depreciation and Amortization Expense 30,689 85,725 30,689 20,329 14,395

Total Operating Expenses 531,149 1,479,641 525,956 358,078 340,999

Income from Operations 10,775 84,725 12,032 2,612 (3,289)

Operating Cash Flow 48,312 183,868 49,321 27,729 10,256

Excess of Revenue Over Expenses 26,395 161,863 29,329 8,995 4

Net Revenue Available for Debt Service 65,567 251,795 69,508 38,293 15,302

Debt Service 15,617 31,398 14,441 13,612 9,654

Additions to Property, Plant, & Equipment 36,688 122,341 36,302 17,106 16,989

Balance Sheet ($000)

Unrestricted Cash and Investments 285,748 1,065,893 313,902 147,303 67,871

Total Direct Debt 213,325 550,008 189,201 153,142 113,984

Total Comprehensive Debt 276,334 767,555 250,819 211,531 211,651

Net Fixed Assets 286,132 866,203 276,593 179,454 138,834

Unrestricted Net Assets 372,543 1,275,879 429,376 183,643 79,325

Monthly Liquidity 247,217 977,321 282,002 124,530 75,596

Annual Liquidity 238,032 1,020,680 285,748 130,363 67,871

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All Ratings Aa A Baa Below Baa

Sample Size 203 35 103 53 12

Key Ratios [4]

Operating Margin 2.2% 3.5% 2.7% 1.0% -1.6%

Excess Margin 5.2% 7.2% 5.8% 3.4% 0.0%

Operating Cash Flow Margin 9.3% 10.0% 10.1% 8.5% 4.8%

Cash on Hand (Days) 204.3 252.0 217.3 147.7 84.4

Cash-to-Direct Debt 137.4% 194.8% 153.1% 103.9% 60.0%

Cash-to-Total Comprehensive Debt 100.7% 146.3% 110.4% 72.9% 37.3%

Maximum Annual Debt Service Coverage (x) 4.4 6.5 4.8 3.2 1.4

Annual Debt Service Coverage (x) 4.6 7.5 5.1 3.4 1.5

Debt-to-Cash Flow (x) 3.4 2.5 3.1 4.5 7.7

Debt-to-Total-Revenue 36.5% 31.9% 37.5% 37.0% 38.1%

Annual Operating Revenue Growth Rate 4.1% 6.7% 5.4% 2.2% 2.8%

Annual Operating Expense Growth Rate 4.6% 6.7% 5.9% 4.2% 3.7%

3 Year Operating Revenue CAGR 4.9% 6.1% 5.1% 4.0% 2.4%

3 Year Operating Expense CAGR 5.0% 6.2% 5.0% 4.4% 2.7%

Debt-to-Capitalization 35.2% 32.0% 33.0% 44.1% 56.5%

Current Ratio (x) 1.9 1.9 2.0 2.0 1.5

Cushion Ratio (x) 18.4 29.4 20.3 12.7 6.0

Return on Assets 4.2% 6.1% 4.6% 3.0% 0.0%

Accounts Receivable (Days) 50.0 45.3 51.8 48.0 48.3

Average Payment Period (Days) 61.3 67.8 58.9 61.0 65.1

Capital Spending Ratio (x) 1.1 1.5 1.1 1.0 1.0

Average Age of Plant (Years) 10.7 9.1 10.5 11.2 12.0

Monthly Liquidity to Demand Debt 405.1% 424.4% 371.3% 312.1% 697.8%

Annual Liquidity to Demand Debt 428.0% 459.3% 380.0% 448.3% 697.8%

Demand Debt as a % of Total Direct Debt 31.1% 37.9% 32.2% 21.7% 12.9%

Cash to Demand Debt 448.3% 495.0% 401.8% 448.3% 697.8%

Monthly Liquidity to Total Cash and Investments 98.8% 86.5% 98.1% 100.0% 100.0%

Patient Revenue Sources by Gross Revenue (%) [5]

Medicare 44.3% 40.0% 46.1% 43.6% 49.1%

Medicaid 12.9% 14.1% 12.3% 13.4% 15.9%

Commercial 32.1% 35.7% 32.0% 32.2% 29.1%

Self Pay & Other 7.6% 8.0% 7.8% 7.2% 6.0%

[1] Financial data are based on audited financial statements for 203 free-standing hospitals and single-state healthcare systems.

[2] Utilization statistics are based on a smaller sample size where three years of consistent data are available.

[3] Combined Admissions and Observation Stays is a separately calculated median and does not equal the sum of median Admissions and median Observation Stays.

[4] Monthly and Annual Liquidity statistics are based on a smaller sample size where three years of consistent data are available.

[5] Payor Mix columns do not sum to 100% because each entry is a separately calculated median.

U.S. PUBLIC FINANCE

9 APRIL 23, 2014


Moodys Related Research

Outlook:

2014 Outlook US Not-for-profit Hospitals, November 2013 (160569)

Median Report:

US Not-for-Profit Hospital 2012 Medians Show Balance Sheet Stability Despite Weaker Performance, August 2013 (157417)

Special Comments:

US Healthcare Reform: Three Risks Reduce Credit Positives for Not-for-Profit Hospitals, March 2014 (166602)

Two-Midnight Rule Will Reduce Revenue For Most Hospitals, March 2014 (165866) To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

U.S. PUBLIC FINANCE

10 APRIL 23, 2014


Report Number: 167463

Author Jenn Ewing

Production Associate Prabhakaran Elumalai

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Revenue Growth and Profitability Drop in US Not-For-Profit Hospital Preliminary Medians