Fitch Rates King's Daughters Medical Center (KY) Series 2014 Revs 'A-'; Outlook Negative

CHICAGO--()--Fitch Ratings has assigned an 'A-' rating to the following bonds expected to be issued on behalf of King's Daughters Medical Center (KDMC):

--$127.9 million City of Ashland, Kentucky medical center revenue bonds, series 2014.

Additionally, Fitch Ratings has downgraded the rating to 'A-' from 'A' on the following bonds issued on behalf of KDMC:

--$48.9 million Kentucky Economic Development Finance Authority revenue improvement bonds, series 2008A;

--$49.1 million Kentucky Economic Development Finance Authority revenue improvement bonds, series 2008B;

--$43.3 million Kentucky Economic Development Finance Authority revenue refunding and improvement bonds, series 2008C;

--$68.1 million Kentucky Economic Development Finance Authority revenue improvement bonds, series 2010A;

--$25.7 million City of Ashland, Kentucky revenue improvement bonds, series 2010B.

The series 2014A bonds are expected to be issued as floating rate notes in a SIFMA based index mode. Proceeds will be used to refund the series 2008A and 2008B bonds; to defease and/or advance refund a portion of the series 2010A, series 2010B and/or series 2008C bonds; to fund a debt service reserve fund (if necessary); and to pay the costs of issuance. In conjunction with the series 2014 issuance, KDMC will amend its indenture. The series 2014 bonds are expected to price the week of July 21 through negotiation.

The Rating Outlook is Negative.

SECURITY

Bond payments are secured by a pledge of the gross receipts of the obligated group and a mortgage interest in certain property including the acute care hospital. Additionally, a debt service reserve fund will be funded if necessary

KEY RATING DRIVERS

RESOLUTION OF DOJ INVESTIGATION: KDMC and the U.S. Department of Justice (DOJ) entered into a final settlement agreement in May 2014. The DOJ initiated an investigation of KDMC in 2011 for alleged violations of the False Claims Act related to KDMC's levels of cardiac stent and catheter procedures between 2006 and 2011. While no civil or criminal charges were ever filed against KDMC, KDMC decided to enter into a settlement agreement with the DOJ to end the investigation. Under the terms of the agreement, KDMC paid a $40.9 million settlement to the DOJ and signed a corporate integrity agreement but did not admit to any wrongdoing.

WEAKENED LIQUIDITY METRICS: The rating downgrade reflects the material decrease in KDMC's liquidity which, in combination with the weakened profitability, has weakened KDMC's credit profile. With the payment of DOJ settlement and related expenses, KDMC's unrestricted cash and investments fell to $207.7 million at May 31, 2014 from $251.4 million at April 30th.

MATERIALLY WEAKENED PROFITABILITY: The Negative Outlook reflects Fitch's ongoing concern related to the significant deterioration in operating performance. Operating EBITDA margin decreased to 3.1% in fiscal 2013 (Sept. 30 year end) and to 1% in the seven-month interim period ending April 30, 2014 (the interim period). Management implemented a financial improvement plan in late fiscal 2013 and has budgeted a 3.3% operating EBITDA margin for fiscal 2014. Operations have shown signs of improvement and achieved an operating EBITDA margin of 4.7% in the four month period between Jan. 1 and April 30, 2014.

DETERIORATION IN COVERAGE: KDMC's weakened profitability and cash flow has caused a deterioration in coverage metrics, with MADS coverage by EBITDA decreasing to a weak 1.5x in fiscal 2013 and 0.7x in the interim period.

DECLINING UTILIZATION: Inpatient and outpatient utilization decreased in fiscal 2013 and in the interim period due to the combined negative impact of an ongoing investigation by DOJ, national utilization trends and the impact of high deductible health plans.

LEADING MARKET SHARE: KDMC's primary service area (PSA) market share decreased to 36.6% in fiscal 2012 from 39.5% in fiscal 2010, however, KDMC continues to maintain a leading market share. The service area characteristics remain challenging.

RATING SENSITIVITIES

IMPROVED OPERATING PERFORMANCE: While Fitch expects KDMC to stabilize and improve operating performance, an inability to realize its financial improvement plans over the next two years would likely lead to further negative rating pressure.

CREDIT PROFILE

King's Daughters Medical Center is a 465-staffed bed regional tertiary referral center located in Ashland, KY, approximately 120 miles east of Lexington, KY and 120 miles south of Columbus, OH. Additional operations include KDMC Ohio (a 10 licensed bed hospital that opened February 2013), four urgent care centers, a long-term and short-term care facility, an ambulance transport company, an integrated physicians group, a research foundation and a philanthropic foundation. Total operating revenue equaled $485.9 million in fiscal 2013.

RESOLUTION OF DOJ INVESTIGATION

The DOJ and KDMC reached a settlement agreement in May 2014 regarding the DOJ's investigation of KDMC that commenced in 2011 for alleged violations of the False Claims Act. The government contended that the number of cardiac catheterization and stent procedures performed between 2006 and 2011 was high, indicating that unnecessary procedures were performed. KDMC denied the DOJ's allegations. The DOJ was focused on the activities of four cardiologists, two of whom are no longer at KDMC. No civil or criminal charges were ever filed against KDMC. In order to put the potential litigation to rest, KDMC decided to enter into a settlement agreement with the DOJ. Under the terms of the settlement agreement, KDMC paid the DOJ $40.9 million in May 2014 and agreed to abide by a corporate integrity agreement but admitted no wrongdoing. In addition to the DOJ settlement, KDMC paid approximately $8 million in related legal and consulting fees in fiscal 2014.

WEAKENED LIQUIDITY METRICS

Liquidity metrics have been materially impacted by settlement of the DOJ investigation. Subsequent to the $48.9 million payment for the DOJ settlement and related fees in fiscal 2014, unrestricted cash and investments decreased 21% to $207.7 million at May 31, 2014. Liquidity ratios declined to 158 days cash on hand, 12.6x cushion ratio and 87% cash debt and now compare unfavorably with the respective 'A' category medians of 196.3, 15.6x and 129.2%.

Capital spending is expected to remain at low levels over the next three years, allowing for recovery of KDMC's liquidity. Unrestricted liquidity is projected to increase 23.9% to $257.3 million by fiscal year-end 2017. However, the publicity surrounding the DOJ investigation increased the number of malpractice allegations which may negatively impact liquidity.

MATERIALLY WEAKENED PROFITABILITY

Operating EBITDA margins averaged 10.2% between fiscal years 2010 and 2012, but declined to a weak 3.1% in fiscal 2013 and further deteriorated to 1% in the seven-month interim period ending April 30, 2014. Fitch's analysis excluded the $48.9 million reserve for the settlement expenses from non-operating expenses in fiscal 2013. The decline is primarily due to decreased inpatient and outpatient utilization rates. However, in the four-month interim period between January and April, operating EBITDA margin improved to 4.7%, indicating that operations have begun to turn around.

Management implemented a financial improvement plan in late fiscal 2013. Initiatives include revenue cycle, staffing productivity, supply chain, hospital service line and physician practice improvements. KDMC eliminated 150 FTEs in August 2013 via a reduction in force. Since that time, the number of FTEs decreased an additional 87 through April 30, 2014 through attrition. Management expects to achieve $59.8 million of operational improvements in fiscal years 2014 and 2015. Operating EBITDA margin is budgeted to slightly improve to 3.3% in fiscal 2014. While Fitch expects KDMC to meet its improvement targets, the failure to improve performance over the next two years will likely lead to further negative rating action.

DETERIORATION IN COVERAGE

Coverage metrics compressed in lock-step with the decrease in profitability and cash flows. Pro forma MADS is expected to equal $16.4 million, assuming a debt service reserve fund is financed, representing a moderate increase from the prior $15.4 million. Pro forma MADS would be lower if a debt service reserve fund is not financed. MADS coverage by EBITDA decreased to 1.5x in fiscal 2013 and 0.7x in the interim period and is very weak relative to Fitch's 'A' category median of 3.8x. MADS coverage by EBITDA is expected to improve to 2.0x by fiscal year end based upon KDMC's fiscal 2014 budget.

DECLINING UTILIZATION

Inpatient and outpatient utilization declined materially across the board in fiscal 2013 with decreases in inpatient admissions by 6.5%, total surgeries by 12.4% and cardiac catheterizations by 48.3%. Utilization continued to decline in the interim period but is showing signs of recovery with admissions and surgeries exceeding budget. Fitch believes the compressed utilization is due to the negative impact of an ongoing DOJ investigation, national utilization trends and the effects of high deductible health plans.

LEADING MARKET SHARE

After consistently increasing between fiscal years 2006 and 2010, KDMC's leading market share in the primary service area decreased to 36.6% in fiscal 2012 from 39.5% in fiscal 2010. The service area remains challenging and is characterized by flat to declining population levels and low median household income levels relative to both state and national averages. These demographic characteristics are reflected in KDMC's high exposure to Medicaid and self-pay at 15.2% and 7.1%, respectively, of revenues in fiscal 2013 and provision for bad debt equal to 10.4% of net revenues.

DISCLOSURE

KDMC covenants to provide annual disclosure within 150 days of the end of each fiscal year and quarterly disclosure within 45 days of the end of each quarter. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA website.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2014.

Applicable Criteria and Related Research:

Nonprofit Hospitals and Health Systems Rating Criteria - Effective July 23, 2012 to May 20, 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=683418

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=837938

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Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1-312-368-3180
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312 368-2059
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1-312-368-3180
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312 368-2059
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com