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Rating Update:

MOODY'S AFFIRMS LAKELAND REGIONAL HEALTH SYSTEMS' (FL) A2 BOND RATING; OUTLOOK REMAINS STABLE

10 May 2011

AFFIRMATION AFFECTS TOTAL OF $196 MILLION OF RATED DEBT OUTSTANDING

Lakeland (City of) FL
Health Care-Hospital
FL

Opinion

NEW YORK, May 10, 2011 -- Moody's Investors Service has affirmed Lakeland Regional Health Systems' (LRHS) A2 bond rating, affecting approximately $196 million of outstanding bonds (see rated debt listed below). The rating outlook is stable.

SUMMARY RATING RATIONALE

The A2 debt rating and the stable outlook reflects Lakeland Regional Health Systems' (LRHS) leading market position as the sole acute care provider in the City of Lakeland, rapid implementation of revenue growth and cost reduction strategies by management including the direction of a new CEO, and conservative debt structure. These factors are offset by LRHS' weak and inconsistent operating performance relative to the rating, growing Medicaid exposure and some decline in unrestricted cash and investments.

STRENGTHS

*851-bed LRHS maintains leading market share in the primary service area of the City of Lakeland and Aa2-rated Polk County; sole inpatient provider in Lakeland and the fourth largest provider in the state of Florida (over 38,000 admissions)

*Good liquidity position with 183 days cash on hand at fiscal year end (FYE) 2010 (A2 median is 169 days cash on hand); strong cash-to-debt of 149% (A2 median is 132% cash-to-debt); 95% of LRHS' liquidity is available within one month

*Conservative all fixed rate debt structure with no derivatives exposure and adequate debt coverage measures relative to the rating level with 4.4 times maximum annual debt service coverage (MADS), 3.3 times debt to cash flow and 31.9% debt to revenue in FY 2010; no plans for additional debt and master facility capital plans are on hold at this time while management conducts feasibility studies over the next eighteen months to re-evaluate capital needs

*Rapid response to operating challenges from new CEO (in place since September 2010) with the implementation of a new hospital strategic plan, cost reduction initiatives and the engagement of an outside consultant to improve revenue cycle, supply chain management and documentation; smooth transition to new CFO as current CFO retires is expected

*Improved managed care contracts and receipt of one-time $6.5 million settlement from a Medicaid managed care company in fiscal year (FY) 2011 for underpayment in prior years

*LRHS maintains a defined contribution pension plan mitigating pension funding risk

CHALLENGES

*Weak operating performance at the A2 rating category with 7.1%% operating cash flow margin in FY 2010 (compared to A2 median of 9.7%), although up from 6.1% in FY 2009 as a result of cost reductions and some reversal of reserves

*Weak demographics in Polk County Florida as indicated by 11% unemployment, above the national average

*High and increasing 15.6% Medicaid exposure as the safety net provider in Polk County relative to the national median (11%); impending 12% cut to Florida's Medicaid reimbursement in 2011will further challenge financial performance

*Annual lease payments to the City of Lakeland, reaching $11.9 million in FY 2010, suppresses financial performance

*Dependence on a large multi-specialty physician practice, the Watson Clinic, located approximately one half mile north of LRHS

*Aging facility with an average age of plant of 13 years (A2 average age of plant median is 10 years) and 1.3 times capital spending ratio indicating moderate capital needs

*Union presence for RN and licensed technical staff although union contracts extended to 2014

DETAILED CREDIT DISCUSSION

LEGAL SECURITY: The bonds are secured by a pledge of gross revenues of the obligated group after the payment of operating expenses of the obligated group which includes Lakeland Regional Health Systems (LRHS) and Lakeland Regional Medical Center (LRMC).

INTEREST RATE DERIVATIVES: none

RECENT DEVELOPMENTS/RESULTS

Over the last three years, LRHS has exhibited inconsistent operating performance that has been weak relative to the A2 rating category. In FY 2010, LRHS' operating performance showed improvement following a material decline in FY 2009 which reflected numerous one-time items including Medicaid overpayments from an emergency room coding error, reserves for federal government claims, and reduced Medicaid reimbursement. Following quick management action to reduce over $12 million in expenses, LRHS posted a $1.8 million operating gain (0.3% operating margin) in FY 2010, up from a $11.0 million operating loss (-1.9% operating deficit margin) in FY 2009 (Moody's computations include the addition of capitalized interest in FY 2009 and FY 2010). System operating cash flow increased to $43.5 million (7.1% operating cash flow margin) in FY 2010 from $35.3 million (6.1% operating cash flow margin) in FY 2009. Although operating performance showed some improvement in FY 2010, LRHS performance has become increasingly inconsistent and has moved away from FY 2007 and FY 2008 levels when operating cash flow margin averaged 9.5% and operating margin averaged 1.3%. We note that annual performance is suppressed by lease payments made of the City of Lakeland (2.25% of annual net patient revenues). In FY 2010, the lease payment totaled $11.9 million with $12.3 million expected in FY 2011.

Following modestly improved operating performance in FY 2010, LRHS' performance materially weakened during the first two quarters of FY 2011. Through the first six months of FY 2011, LRHS reported a $6.0 million operating loss (-1.9% deficit margin), significantly down from the prior year $2.6 million operating gain (0.9% operating margin). The operating cash flow margin declined to 4.7% through six months of FY 2011 from 7.6% the prior year, far below the A2 median of 9.7%. LRHS' weakened operating performance comes as a result of the reinstatement of salary increases following a temporary freeze in FY 2010, increased health insurance expense, an increase in staff at LRHS, increased city lease transfer payments and lower revenue growth due to reduced Medicare and Medicaid reimbursement while Medicaid patient mix continues to grow.

Despite moderating performance, management's projected budget reflects a $6.3 million operating bottom line and a 7.3% operating cash flow margin in FY 2011 which is a $12.3 million improvement from LRHS' actual bottom line through the first six months of FY 2011. With a new CEO in place since September 2010 following the former CEO's retirement, management has responded quickly to implement operating improvements and a new strategic plan. In September 2010, LRHS management engaged FTI consultants to enact a number of aggressive revenue cycle and supply chain initiatives that include improving clinical documentation and the adoption of new revenue management software. Management expects to meet its projected operating bottom line for FY 2011 as a result of adjustments and improvements anticipated during the second half of the fiscal year that include: 1) the release of approximately $8.6 million in reserves to the income statement; 2) the receipt of $900,000 of Medicaid-Buy Back; 3) a $2.3 million payment from its FY 2010 Medicare cost report settlement; and 4) a onetime $7.3 million net revenue payment from a settlement with a Medicaid managed care company for underpayments in prior years. Looking forward, projections for FY 2012 through FY 2014 show very strong results with a 9.4% operating cash flow margin in FY 2012. We view these projections with a fair amount of skepticism as LRHS has never achieved these levels of performance and the industry is heading into a period of strong revenue headwinds. LRHS' inability to demonstrate improvement in FY 2011 and FY 2012 and approach the estimated levels of performance may result in a rating change over the next year.

Despite weak operating performance trends, LRHS' inpatient admissions remain sizeable growing 2.6% in FY 2010 over FY 2009 38,724 from 37,732. Observation stays increased 4.7% over the same period. However, LRHS' outpatient surgical volume declined 11% in FY 2010 due to cyclical loss in volumes and economic pressures. Through the first six months of FY 2011 however, inpatient admissions are down 2.3% from the prior year period to 19,341 from 19,797 in part due to the impact of the economy. Weaknesses in Aa2-rated Polk County's construction industry and slow economic recovery contribute to below-average wealth and 11% unemployment, well above the national rate and slightly above Florida's. Economic pressures in the county contributed to a 3% increase in Medicaid patient mix over the last three years as indicated by a high 15.6%, well above the national median of 11.0%.

Despite its weaker performance, LRHS' debt coverage measures remain adequate relative to the rating category with 4.4 times MADS coverage (A2 median is 5.0 times), and 3.3 times debt to cash flow (A2 median is 3.2 times) in FY 2010. LRHS' debt to revenue remains strong at 31.9% (A2 median is 33.8%). LRHS' conservative all fixed rate debt structure and no derivative exposure provides some comfort.

LRHS' balance sheet remains good relative to the A2 rating level despite some softening and is a factor for the rating and outlook affirmation. LRHS' unrestricted cash and investments decreased to $290 million (183 days cash on hand) at FYE 2010 from $306 million (201 days cash on hand) at FYE 2009 relative to the A2 median (A2 median is 169 days cash on hand). Unrestricted cash and investments declined further to $274 million (165 days cash on hand) at March 31, 2011 due to $10.6 million in city lease transfer payments, timing of bond payments and some one-time IT costs. LRHS maintains a defined contribution pension plan and 95% of LRHS' unrestricted cash and investments are available within one month. In response to weaker operating performance and softening of its balance sheet, management placed a hold on capital plans and expects capital spending to come in at under its $40 million budgeted amount. Management is conducting a study of its existing master facility plans and capital needs before making any capital commitments.

LRHS continues to maintain a leading 40% market share in Polk County as a result of its tertiary level of services, admission base (over 38,000 admissions) and proximity to similarly sized hospitals. LRHS also continues to compete on the outpatient side with the Watson Clinic (WC), a large physician multi-specialty group located approximately a half mile from LRHS. LRHS remains co-dependent with WC whose over 260 physicians comprise over 53% of total admissions at LRHS (LRHS maintains an active staff of 515 physicians). Management continues to cultivate its relationship with the WC as indicated by its long-standing joint venture ambulatory surgery center and its joint physician recruitment efforts.

Outlook

The stable outlook reflects our belief that LRHS will maintain above average balance sheet measures and that its rapid implementation of revenue growth and cost reduction strategies by management will result in improved performance in FY 2011 and continued improvement during FY 2012 as projected by management. However, the inability to show improvement as projected will result in negative rating pressure.

WHAT COULD MAKE THE RATING GO UP

Material and sustained financial performance improvement that translates into strengthened liquidity measures

WHAT COULD MAKE THE RATING GO DOWN

Further operating performance departure or inability to reach FY 2011 budget or FY 2012 projections, a decline in liquidity, or increase in debt without a commensurate increase in cash flow

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Lakeland Regional Health Systems, Inc. and Subsidiaries

-First number reflects audit year ended September 30, 2009

-Second number reflects audit year ended September 30, 2010

-Investment returns normalized at 6% unless otherwise noted

*Inpatient admissions: 37,732; 38,724

*Total operating revenues: $579.5 million; $612.5 million

*Moody's-adjusted net revenue available for debt service: $58.4 million; $69.3 million

*Total debt outstanding: $201.2 million; $195.6 million

*Maximum annual debt service (MADS): $15.8 million; $15.8 million

*MADS Coverage with reported investment income: 3.3 times; 3.9 times

*Moody's-adjusted MADS Coverage with normalized investment income: 3.7 times; 4.4 times

*Debt-to-cash flow: 4.2 times; 3.3 times

*Days cash on hand: 201 days; 183 days

*Cash-to-debt: 152%; 149%

*Operating margin: -1.9%; 0.3%

*Operating cash flow margin: 6.1%; 7.1%

RATED DEBT (debt outstanding as of September 30, 2010)

- Series 1996 Hospital Revenue Bonds, fixed rate ($31.6 million outstanding), rated A2 (also insured by MBIA)

- Series 1999 A & B Hospital Revenue Bonds, fixed rate ($8.2 million outstanding), rated A2 (also insured by MBIA)

- Series 1997 A & B Hospital Revenue Bonds, fixed rate ($43.2 million outstanding), rated A2 (also insured by MBIA)

- Series 2006 Hospital Revenue Bonds, fixed rate ($112.5 million outstanding), rated A2

CONTACT

Obligor: Mr. Paul Powers, Chief Financial Officer, Lakeland Regional Health Systems, (863) 687-1284

The last rating action with respect to Lakeland Regional Health System was on March 26, 2010, when its municipal finance scale rating of A2 was affirmed and the outlook was stable. That rating was subsequently recalibrated to A2 on May 7, 2010.

The principal methodology used in this rating was Not-for-Profit Hospitals and Health Systems published in January 2008.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of maintaining a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Lisa Goldstein
Analyst
Public Finance Group
Moody's Investors Service

Beth I. Wexler
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


Moody's Investors Service
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New York, NY 10007
USA

MOODY'S AFFIRMS LAKELAND REGIONAL HEALTH SYSTEMS' (FL) A2 BOND RATING; OUTLOOK REMAINS STABLE
No Related Data.
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