Fitch Rates Sky Lakes Medical Center's (OR) Series 2012 Bonds 'BBB'; Outlook Stable
Fitch Ratings assigns a long-term rating of 'BBB' to approximately $17.000 million of series 2012 revenue bonds to be issued by Klamath Falls Intercommunity Hospital Authority (KFIHA) on behalf of Sky Lakes Medical Center (formerly known as Merle West Medical Center).
In addition, Fitch affirms its 'BBB' rating on the following outstanding debt issued through KFIHA:
--$38,720,000 fixed rate revenue bonds series 2006;
--$11,470,000 fixed rate revenue bonds series 2002.
The series 2006 and 2002 bonds are insured by Assured Guaranty, which Fitch does not rate.
The Rating Outlook is Stable.
The series 2012 bonds are expected to be fixed rate and bond proceeds will be used to refund the series 2002 bonds and fund certain equipment purchases. The bonds are expected to price the week of Nov. 12.
Debt payments are secured by a pledge of the gross revenues of the obligated group, a mortgage, and a debt service reserve fund.
KEY RATING DRIVERS
STRONG OPERATING PROFITABILITY: Through 11 months ended Aug. 31, 2012, Sky Lakes Medical Center (SLMC) posted operating and operating EBITDA margins of 8.3% and 14.5%, respectively, which are considerably above Fitch's respective 'BBB' category medians of 1.9% and 8.3%. The strong financial results reflect SLMC's success in executing its turnaround initiatives begun in fiscal 2009.
GROWING LIQUIDITY: Unrestricted cash and investments totalled $70.3 million at Aug. 31, 2012, equating to a very good 174.5 days cash on hand (DCOH) relative to the rating category median of 138.9 days. Strong cash flow generation, driven by operating performance, investment income, and moderate future capital needs, should support further growth in liquidity.
LOW DEBT BURDEN: SLMC's debt burden ameliorated over the past several years. Maximum annual debt service (MADS) as a percentage of revenue of 2.9%, EBITDA MADS coverage of 5.7x, and debt to capitalization of 32.8%, are all stronger than rating category medians. The upcoming issuance will add approximately $5.5 million of new debt, which SLMC has capacity to absorb with robust pro forma ratios.
LIMITED COMPETITION: SLMC is the only provider within 75 miles and has sole community provider status.
SMALL REVENUE BASE: Given SLMC's relatively small revenue base, it is exposed to more operating volatility. This was exhibited within the last five years when performance took a significant downturn in 2008 due to management turnover.
WHAT COULD TRIGGER A RATING ACTION
LONGER TREND OF SUSTAINED IMPROVEMENT: Maintaining current level of financial performance over the next two to three years could result in positive rating action.
The rating affirmation reflects sustained improvements to SLMC's overall financial profile since management's undertaking of a turnaround initiative in fiscal 2009. In fiscal 2011 and through the interim period, SLMC's financial ratios outperformed Fitch's 'BBB' category medians in nearly all key metrics. Management expects to end fiscal 2012 in line with interim results. Fitch believes that maintenance of strong profitability and cash flow generation should strengthen the balance sheet and could lead to positive rating action over the next two to three years. The primary credit concern is SLMC's relatively small revenue base, which can be susceptible to variability in operations and regulatory changes.
Beginning in fiscal 2010, profitability rebounded strongly, which helped grow the balance sheet. The strong and sustained financial and operational improvements reflect management's success to date in implementing a performance improvement plan focusing on tight expense control, enhanced productivity, and revenue cycle management. As a result, SLMC posted operating margins of 6.3% and 7.6% in fiscals 2011 and 2010, respectively, compared to 1.3% in fiscal 2009. Operating margin for the interim period (11 months ended Aug. 31, 2012) rose to 8.3% and was aided by the receipt of $1.1 million in Medicaid meaningful use funds. Management is budgeting an operating margin of 3.7% for fiscal 2012, which does not take into account anticipated receipt of meaningful use funds of $2.5 million. Management has historically been conservative in its budgeting process and Fitch expects SLMC to achieve, if not exceed, this target.
Liquidity continues to grow, supported by strong cash flow generation, investment income, and moderate capital needs. Unrestricted cash and investments increased $16.2 million from August 2011 to August 2012, which equates to 33.6 DCOH. SLMC is budgeting capital spending to be near depreciation levels, aside from certain projects to be funded with the 2012 new issue (total project fund of $5.8 million). A portion of the project fund ($1.8 million) is reimbursement for prior spend, and should return to SLMC's cash and investments.
SLMC is now working on aligning hospital operations and strategies in preparation for healthcare reform. Physician recruitment is a current focus, and SLMC has been successful thus far as physicians in the area are increasingly seeking direct employment by the hospital. The addition of employed physicians has contributed to meaningful growth in outpatient volume, which offset decreases in inpatient utilization. Also, through Cascade Comprehensive Care, which the hospital participates in and is a one-third owner of, SLMC is in the process of qualifying for Coordinated Care Organization status.
SLMC is a Medicare designated sole-community provider, serving a 10,000 square mile area including parts of Southern Oregon and Northern California, covering a population of approximately 70,000. Despite unfavorable economic characteristics and lack of population growth in the service area, SLMC enjoys a dominant position with virtually no competition as the nearest hospital offering comparable services is located 75 miles away. Outmigration to Portland (130 miles north) and Medford (75 miles east) is mainly for tertiary care services SLMC does not provide.
At Aug. 31, 2012, SLMC had $57.9 million of long-term debt and capital leases outstanding, of which $50.2 million were fixed rate revenue bonds supported by Assured Guaranty insurance. SLMC's debt burden is low at 2.1x debt to operating EBITDA, and coverage is strong with 12.9x cushion ratio and 5.7x EBITDA MADS coverage. The new issue will add approximately $5.5 million of new debt to the long-term debt portfolio, which SLMC has sufficient capacity to absorb. Pro forma, debt to operating EBITDA rises to 2.3x and cushion ratio to 13.3x, both favorable to 'BBB' medians. Fitch used an estimated pro forma MADS of $5.4 million occurring in fiscal 2014, which incorporates the refunding and additional debt estimated using current market rates. Beginning fiscal 2015, MADS decreases to $4.8 million. SLMC does not have any swap exposure.
Primary credit concerns reflect SLMC's relatively small revenue base, which can be susceptible to variability in operations and regulatory changes. SLMC produced total operating revenues of $171 million in fiscal 2011, significantly below Fitch's 'BBB' category median of $386.7 million. Sensitivity to operational challenges was evidenced in the 2008-2009 downturn, when total operating revenue declined 12.9% driven primarily by flagging inpatient volume after opening a replacement facility. In 2008, SLMC posted operating losses of 3.1%, following eight years of positive operating results due to management turnover. Although profitability has recovered after implementation of various initiatives, the magnitude of impact experienced during this period indicates lack of insulation from unexpected challenges. However, given SLMC's recent performance and newly demonstrated ability to maintain revenue growth, manage expenses, and increase outpatient volume, SLMC should sustain its current level of performance.
SLMC's recent history has been on a strong upward trajectory and Fitch's Outlook remains Stable at this time given concerns about the ability to sustain the level of performance. Given its small revenue base, SLMC will need to consistently exceed the category medians and if this trend continues over the next two to three years, upward rating action could occur.
Sky Lakes Medical Center is located in Klamath Falls, Oregon and operates a 100-staffed bed general acute care community hospital and several clinics. Total revenue in fiscal 2011 was $171 million. SLMC discloses annual financial statements within 150 days and quarter unaudited financial statements within 45 days through the MSRB EMMA website.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Revenue-Supported Rating Criteria, June 12, 2012;
--Non-Profit Hospitals and Health System Rating Criteria, July 23, 2012.
In addition to the sources of information identified in Fitch's Rating Criteria, this action was additionally informed by information from Piper Jaffray.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria
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