SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A-' rating to Klamath Falls Intercommunity Hospital Authority, OR's approximately $52,075,000 revenue and refunding bonds, series 2016, issued on behalf of Sky Lakes Medical Center (SLMC; formerly known as Merle West Medical Center). In addition, Fitch affirms the 'A-' rating on the outstanding series 2006 and 2012 bonds.
The Rating Outlook is revised to Positive from Stable.
The series 2016 bonds are fixed rate, and proceeds will be used to fund $25 million of capital expenditures and refund the series 2006 bonds. The series 2016 bonds are expected to price the week of June 13.
Debt payments are secured by a pledge of the gross revenues of the obligated group, a mortgage, and a debt service reserve fund (series 2012 only).
KEY RATING DRIVERS
OVERALL STRONG FINANCIAL PROFILE FOR RATING LEVEL: The Rating Outlook revision to Positive reflects SLMC's continued overall strong financial performance for its rating level with robust profitability, good liquidity and excellent debt service coverage despite the additional debt. SLMC is issuing approximately $25 million of additional debt to fund a portion of its capital project, which includes a new medical office building, parking, and equipment.
SOLID PROFITABILITY: Beginning in 2009, when the current CFO joined, profitability has improved sharply and been consistently strong. Operating margin was 9% in fiscal 2015 and 6.8% through the six months ended March 31, 2016. Strong profitability has been driven by outpatient volume growth, stabilized commercial payor mix after Medicaid expansion, favorable managed care rate increases and ongoing focus on expenses.
STRONG DEBT SERVICE COVERAGE: Historical pro forma debt service coverage is strong at 6.5x in fiscal 2015 and 6.2x through the six months ended March 31, 2016 compared to the 'A' category median of 4.2x.
TEMPORARY DIP IN LIQUIDITY: After an IT conversion in October 2015 to Epic, accounts receivable is higher than normal, which is expected to normalize by fiscal year end 2016. Days cash on hand and days in accounts receivable were 228.9 and 59 respectively, compared to 206.3 and 69.6, respectively at March 31, 2016. Although pro forma cash to debt drops to 141.6% with the new issuance, Fitch expects liquidity to improve due to manageable capital needs after the project.
LIMITED COMPETITION: SLMC is the only acute care provider within 75 miles and has sole community provider status. While independent, SLMC collaborates with a number of healthcare providers in the state and benefits from various relationships.
SMALL REVENUE BASE: Fitch believes SLMC's relatively small revenue base exposes the organization to more operating volatility and evidenced by its performance during the last economic downturn.
UPWARD RATING MOVEMENT: The Positive Outlook reflects Fitch's expectation that Sky Lakes Medical Center will sustain its strong operational performance over the next two years resulting in a strengthening of liquidity and upward movement of the rating.
Located in Klamath Falls, OR, Sky Lakes Medical Center operates a 100-staffed bed general acute care community hospital and several clinics. SLMC generated total operating revenues of $220.2 million in fiscal 2015. The obligated group consists of Sky Lakes Medical Center and Sky Lakes Medical Center Foundation (foundation), which accounted for 100% of operating revenue and 99.3% of net assets of the consolidated entity in FY 2015. Fitch's analysis is based on the consolidated entity. The foundation has the ability to withdrawal from the obligated group at any time once the series 2006 bonds are defeased, and the only financial test would need to be met is not causing an event of default. The foundation is not expected to withdraw from the obligated group in the near term but has the flexibility to do so. In fiscal 2015, the foundation accounted for $16.5 million of SLMC's cash and investments.
Project and Capital Spending
In conjunction with Oregon Health and Science University (OHSU, 'AA-'/Outlook Stable), SLMC operates a Medicare approved Rural and Family Medicine Residency Program. This is a three-year program with eight residents per year. This has been a good recruitment tool as many stay in the community after residency.
SLMC is planning on constructing a collaborative healthcare building, which will consolidate various primary care clinics that are being leased and will also include educational space for OHSU's programs. OHSU is expanding its rural health program to include other types of providers including nurse practitioners, physical and occupational therapists, dietitians, and mental health providers.
SLMC is projected to spend approximately $36 million for the building, parking and equipment. The series 2016 bonds will fund a portion of these costs. Ongoing capital expenditures are projected to be around $10 million a year.
Sole Community Provider
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. SLMC enjoys a dominant market position with virtually no competition, as the nearest hospital offering comparable services is located 75 miles west in Medford. Outmigration is mainly for tertiary care services SLMC does not provide and Portland is located approximately 280 miles north.
Small Revenue Base
Fitch's primary credit concern continues to be SLMC's relatively small revenue base, which is inherently more susceptible to variability in operations and regulatory changes. The organization's sensitivity to operational challenges was evidenced in the 2008-2009 economic downturn, when total operating revenue declined 12.9% driven primarily by softening inpatient volume after opening a replacement facility. However, SLMC has successfully rebounded since then, returning to profitability and rebuilding its cash reserves. SLMC participates in a group purchasing organization and a population health alliance, and benefits from the collective scale and expertise of other providers in the state.
Profitability over the last four years has been strong with a low of 5% in fiscal 2013. SLMC maintains favorable managed care contracts and has been successful in maintaining these. However, management has been preparing for a lower revenue growth environment and focusing on costs and implementing lean principles. SLMC has a goal to reach breakeven on Medicare, which should be feasible given its enhanced reimbursement under sole community provider. Management is targeting to maintain operating margins between 4-5%.
Strong Debt Service Coverage
MADS increases to $6.3 million with the series 2016 issuance from the current $5.4 million. Debt service is front loaded due to various capital leases. Overall debt burden is moderate with 2.8% MADS as a percentage of revenue and 24.6% debt to capitalization in fiscal 2015, compared to the respective 'A' medians of 2.8% and 36.2%. MADS coverage by EBITDA was strong at 6.5x in fiscal 2015 and 5.3x in fiscal 2014 and markedly better than 4.3x in fiscal 2013 and 4.6x in fiscal 2012.
Temporary Decline in Liquidity
SLMC completed its Epic installation in October 2015, which did impact days cash on hand as accounts receivable is higher than normal. Management expects this to normalize by fiscal year end 2016. At March 31, 2016, days cash on hand was 206.3 days and cash to debt was 203.8%. Total available unrestricted cash and investments was $119 million. A portion of SLMC's investments as noted in the audit are not liquid and available unrestricted cash and investments was provided by management. Total available unrestricted cash and investments were $118.9 million at Sept. 30, 2015, $110.5 million at Sept. 30, 2014, $87.7 million at Sept. 30, 2013, and $75 million at Sept. 30, 2012.
SLMC's debt portfolio is 100% fixed rate and total pro forma outstanding debt is approximately $84 million. With the refunding of the series 2006 bonds, only the series 2012 bonds will have a debt service reserve fund. SLMC does not have any swaps outstanding.
SLMC discloses annual financial statements within 150 days and quarterly unaudited financial statements within 45 days through the MSRB EMMA website.
Additional information is available at 'www.fitchratings.com'.
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