Fitch Affirms Heartland Health Bonds at 'A'; Stable Outlook

Business Wire, Nov 17, 2005

SAN FRANCISCO -- Fitch Ratings affirms the underlying 'A' rating on the outstanding $142.8 million Industrial Development Authority of St. Joseph, Missouri Health Facilities revenue bonds issued on behalf of Heartland Health (Heartland), listed below. The Rating Outlook is Stable.

The underlying rating reflects Heartland's dominant market position, solid operating profitability and debt service coverage, manageable debt burden, and sound management practices. As a sole community provider, Heartland enjoys a very strong 82.8% primary service area market share. Heartland's market position provides it with considerable contracting leverage over commercial payors, and the sole community provider designation has resulted in $19 million-$20 million in additional Medicare reimbursement in each of the past three years, contributing to Heartland's positive operating performance. Operating income was $14.1 million (3.6% operating margin) in fiscal 2005, a marked improvement from the prior year's $4.4 million operating income (1.2% operating margin), leading to a healthy 4.7 times (x) maximum annual debt service (MADS) coverage.

The positive operating performance in fiscal 2005 is attributed primarily to productivity and revenue cycle improvements, as well as to an increase in high margin volume. Process improvements from six sigma initiatives are estimated to have yielded approximately $7.5 million in cost savings and outpatient surgeries, and total cardiology volume increased 7.6% and 9.6%, respectively, over the prior year. In addition, the health plan achieved a positive net income ($397,000) for the third consecutive year after many years of sizable losses. Heartland also has a manageable debt burden, as measured by its low 2.6% MADS as a percentage of revenue and 3.1x debt-to-EBITDA; however, these ratios are offset somewhat by an above-average 47.1% debt-to-capitalization at fiscal 2005 year-end.

Concerns include Heartland's relatively low liquidity for the rating category, continued losses on employed physicians, stagnant inpatient volume growth, and the service area's below-average socioeconomic indicators. In addition, Heartland has a sizable unfunded liability on its frozen defined benefit plan, as only 59% of the plan was funded at June 30, 2005. At June 30, 2005, days cash on hand and cash-to-debt were 131.7 days and 85.5%, respectively, which were below Fitch 'A' rated medians. Losses on employed physicians, while improving, remain high at $196,000. Inpatient utilization growth has declined in recent years due largely to a temporary shortage of rehabilitation beds caused by the closure of the West Campus, as well as an increase of Heartland clinic physicians in outlying community hospitals. In addition, Heartland's service area is considered a neutral to negative credit factor due to below-average wealth levels and relatively flat population growth.

A five-story patient tower that was partially funded with series 2001 and 2003 bond proceeds was completed in October 2004 on time and within budget. The new tower has 36 new acute rehabilitation and 48 new medical/surgical beds, with shelled space in the top two floors available for additional expansion. Fitch views the completion of the project favorably, given it allowed consolidation of acute care and rehabilitation services onto one campus and created needed capacity for specialty services, including cardiovascular surgery and orthopedics.

Fitch believes the fiscal 2006 budget ($21.1 million operating income) is slightly aggressive. Nevertheless, the Stable Rating Outlook is based on Fitch's belief that Heartland will continue to generate positive operating margins, given its dominant market share and new capacity for higher acuity services. Acute discharges increased 9% through the first three months ended Sept. 30, 2005 compared with the same period in the prior year, and operating income for the obligated group was $5.0 million, a substantial improvement from the $430,000 loss experienced through the same period in fiscal 2005. Moreover, Fitch views positively the recent divestiture of the underperforming West Campus. Heartland has no immediate debt plans but may consider issuing additional debt in 2008 or 2009 to build out the shelled space in the new patient tower.

Heartland Health is a 350-operated bed hospital located in St. Joseph, Missouri. Total revenue was $396.8 million in fiscal 2005. Heartland covenants to provide annual and quarterly disclosure to bondholders. Quarterly disclosure includes a balance sheet, income statement, and utilization statistics.

Outstanding debt:

$42.3 million Industrial Development Authority of St. Joseph, Missouri Health Facilities revenue bonds, (Heartland Regional Medical Center), series 2003E (auction-rate securities)* 'A';

$27.5 million Industrial Development Authority of St. Joseph, Missouri Health Facilities revenue bonds, (Heartland Regional Medical Center), series 2001A (auction-rate securities)* 'A';

$45.2 million Industrial Development Authority of St. Joseph, Missouri Health Facilities revenue bonds, (Heartland Regional Medical Center), series 2001B (auction-rate securities)* 'A';