Form 10-Q
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2016

Commission file number 001-15925

COMMUNITY HEALTH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   13-3893191

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

4000 Meridian Boulevard

Franklin, Tennessee

 

 

37067

(Zip Code)

(Address of principal executive offices)  

615-465-7000

(Registrant’s telephone number)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes þ    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

    Large accelerated filer þ   Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company ¨
  (Do not check if a smaller reporting company)                                             

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    No þ

As of April 28, 2016, there were outstanding 113,754,186 shares of the Registrant’s Common Stock, $0.01 par value.

 

 

 


Table of Contents

Community Health Systems, Inc.

Form 10-Q

For the Three Months Ended March 31, 2016

 

Part I.  

Financial Information

     Page   
 

Item 1.

   Financial Statements:   
    

Condensed Consolidated Statements of Income - Three Months Ended March 31, 2016 and March 31, 2015 (Unaudited)

     2   
    

Condensed Consolidated Statements of Comprehensive (Loss) Income - Three Months Ended March 31, 2016 and March 31, 2015 (Unaudited)

     3   
     Condensed Consolidated Balance Sheets - March 31, 2016 and December 31, 2015 (Unaudited)      4   
    

Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2016 and March 31, 2015 (Unaudited)

     5   
     Notes to Condensed Consolidated Financial Statements (Unaudited)      6   
 

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      47   
 

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk      69   
 

Item 4.

   Controls and Procedures      69   
Part II.  

Other Information

  

 

Item 1.

   Legal Proceedings      70   
 

Item 1A.

   Risk Factors      76   
 

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      76   
 

Item 3.

   Defaults Upon Senior Securities      76   
 

Item 4.

   Mine Safety Disclosures      76   
 

Item 5.

   Other Information      76   
 

Item 6.

   Exhibits      77   
Signatures      78   
Index to Exhibits      79   

 


Table of Contents

COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In millions, except share and per share data)

(Unaudited)

 

     Three Months Ended  
     March 31,  
     2016      2015  

Operating revenues (net of contractual allowances and discounts)

    $                                 5,754        $                                 5,646   

Provision for bad debts

     755         735   
  

 

 

    

 

 

 

Net operating revenues

     4,999         4,911   
  

 

 

    

 

 

 

Operating costs and expenses:

     

Salaries and benefits

     2,317         2,257     

Supplies

     799         762   

Other operating expenses

     1,173         1,099   

Government settlement and related costs

              

Electronic health records incentive reimbursement

     (18)         (26)   

Rent

     119         116   

Depreciation and amortization

     298         296   

Impairment of long-lived assets

     17           
  

 

 

    

 

 

 

Total operating costs and expenses

     4,705         4,512   
  

 

 

    

 

 

 

Income from operations

     294         399   

Interest expense, net

     251         241   

Loss from early extinguishment of debt

              

Equity in earnings of unconsolidated affiliates

     (20)         (18)   
  

 

 

    

 

 

 

Income from continuing operations before income taxes

     63         168   

Provision for income taxes

     26         56   
  

 

 

    

 

 

 

Income from continuing operations

     37         112   
  

 

 

    

 

 

 

Discontinued operations, net of taxes:

     

Loss from operations of entities sold or held for sale

             (11)   

Impairment of hospitals sold or held for sale

     (1)         (1)   

Loss on sale, net

             (1)   
  

 

 

    

 

 

 

Loss from discontinued operations, net of taxes

     (1)         (13)   
  

 

 

    

 

 

 

Net income

     36         99   

Less: Net income attributable to noncontrolling interests

     25         20   
  

 

 

    

 

 

 

Net income attributable to Community Health Systems, Inc. stockholders

    $ 11        $ 79   
  

 

 

    

 

 

 

Basic earnings (loss) per share attributable to Community

     

Health Systems, Inc. common stockholders:

     

Continuing operations

    $ 0.11        $ 0.80   

Discontinued operations

     (0.01)         (0.11)   
  

 

 

    

 

 

 

Net income

    $ 0.10        $ 0.69   
  

 

 

    

 

 

 

Diluted earnings (loss) per share attributable to Community

     

Health Systems, Inc. common stockholders:

     

Continuing operations

    $ 0.11        $ 0.79   

Discontinued operations

     (0.01)         (0.11)   
  

 

 

    

 

 

 

Net income

    $ 0.10        $ 0.68   
  

 

 

    

 

 

 

Weighted-average number of shares outstanding:

     

Basic

     110,247,867         114,419,590   
  

 

 

    

 

 

 

Diluted

     110,309,372         115,057,668   
  

 

 

    

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(In millions)

(Unaudited)

 

     Three Months Ended  
     March 31,  
     2016      2015  

Net income

    $                       36        $                       99   

Other comprehensive (loss) income, net of income taxes:

     

Net change in fair value of interest rate swaps, net of tax

     (19)         (9)   

Net change in fair value of available-for-sale securities, net of tax

             

Amortization and recognition of unrecognized pension cost components, net of tax

             
  

 

 

    

 

 

 

Other comprehensive loss

     (16)         (7)   
  

 

 

    

 

 

 

Comprehensive income

     20         92   

Less: Comprehensive income attributable to noncontrolling interests

     25         20   
  

 

 

    

 

 

 

Comprehensive (loss) income attributable to Community Health Systems, Inc. stockholders

    $ (5)        $ 72   
  

 

 

    

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Table of Contents

COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions, except share data)

(Unaudited)

 

           March 31, 2016                December 31, 2015      
ASSETS      

Current assets:

     

Cash and cash equivalents

    $ 181        $ 184   

Patient accounts receivable, net of allowance for doubtful accounts of $4,051 and $4,110 at March 31, 2016 and December 31, 2015, respectively

     3,723         3,611   

Supplies

     587         580   

Prepaid income taxes

            27   

Prepaid expenses and taxes

     218         197   

Other current assets (including assets of hospitals held for sale of $5 and $17 at March 31, 2016 and December 31, 2015, respectively)

     545         567   
  

 

 

    

 

 

 

Total current assets

     5,256         5,166   
  

 

 

    

 

 

 

Property and equipment

     15,084         14,906   

Less accumulated depreciation and amortization

     (4,980)         (4,794)   
  

 

 

    

 

 

 

Property and equipment, net

     10,104         10,112   
  

 

 

    

 

 

 

Goodwill

     9,022         8,965   
  

 

 

    

 

 

 

Other assets, net (including assets of hospitals held for sale of $25 and $41 at March 31, 2016 and December 31, 2015, respectively)

     2,342         2,352   
  

 

 

    

 

 

 

Total assets

    $ 26,724        $ 26,595   
  

 

 

    

 

 

 
LIABILITIES AND EQUITY      

Current liabilities:

     

Current maturities of long-term debt

    $ 249        $ 229   

Accounts payable

     1,179         1,258   

Accrued interest

     158         227   

Accrued liabilities (including liabilities of hospitals held for sale of $2 and $6 at March 31, 2016 and December 31, 2015, respectively)

     1,468         1,358   
  

 

 

    

 

 

 

Total current liabilities

     3,054         3,072   
  

 

 

    

 

 

 

Long-term debt

     16,665         16,556   
  

 

 

    

 

 

 

Deferred income taxes

     599         593   
  

 

 

    

 

 

 

Other long-term liabilities

     1,723         1,698   
  

 

 

    

 

 

 

Total liabilities

     22,041         21,919   
  

 

 

    

 

 

 

Redeemable noncontrolling interests in equity of consolidated subsidiaries

     565         571   
  

 

 

    

 

 

 

EQUITY

     

Community Health Systems, Inc. stockholders equity:

     

Preferred stock, $.01 par value per share, 100,000,000 shares authorized; none issued

     -         -   

Common stock, $.01 par value per share, 300,000,000 shares authorized; 114,731,736 shares issued and 113,756,187 shares outstanding at March 31, 2016, and 113,732,933 shares issued and 112,757,384 shares outstanding at December 31, 2015

             

Additional paid-in capital

     1,952         1,963   

Treasury stock, at cost, 975,549 shares at March 31, 2016 and December 31, 2015

     (7)         (7)   

Accumulated other comprehensive loss

     (89)         (73)   

Retained earnings

     2,146         2,135   
  

 

 

    

 

 

 

Total Community Health Systems, Inc. stockholders’ equity

     4,003         4,019   

Noncontrolling interests in equity of consolidated subsidiaries

     115         86   
  

 

 

    

 

 

 

Total equity

     4,118         4,105   
  

 

 

    

 

 

 

Total liabilities and equity

    $                     26,724        $                     26,595   
  

 

 

    

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)

 

     Three Months Ended  
     March 31,  
     2016      2015  

Cash flows from operating activities:

     

Net income

    $                     36        $                     99   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

     

Depreciation and amortization

     298         296   

Government settlement and related costs

              

Stock-based compensation expense

     14         14   

Loss on sale, net

              

Impairment of hospitals sold or held for sale

              

Impairment of long-lived assets

     17            

Loss from early extinguishment of debt

              

Other non-cash expenses, net

     14         (7)   

Changes in operating assets and liabilities, net of effects of acquisitions and divestitures:

     

Patient accounts receivable

     (109)         (202)   

Supplies, prepaid expenses and other current assets

     (14)         14   

Accounts payable, accrued liabilities and income taxes

     64          (284)   

Other

     (27)         (10)   
  

 

 

    

 

 

 

Net cash provided by (used in) operating activities

     294         (61)   
  

 

 

    

 

 

 

Cash flows from investing activities:

     

Acquisitions of facilities and other related equipment

     (99)         (13)   

Purchases of property and equipment

     (224)         (241)   

Proceeds from disposition of hospitals and other ancillary operations

     12         62   

Proceeds from sale of property and equipment

             

Purchases of available-for-sale securities

     (37)         (59)   

Proceeds from sales of available-for-sale securities

     40         56   

Increase in other investments

     (67)         (39)   
  

 

 

    

 

 

 

Net cash used in investing activities

     (371)         (231)   
  

 

 

    

 

 

 

Cash flows from financing activities:

     

Proceeds from exercise of stock options

             17   

Repurchase of restricted stock shares for payroll tax withholding requirements

     (7)         (20)   

Deferred financing costs and other debt-related costs

             (20)   

Redemption of noncontrolling investments in joint ventures

     (16)         (7)   

Distributions to noncontrolling investors in joint ventures

     (18)         (23)   

Borrowings under credit agreements

     1,564         1,251   

Proceeds from receivables facility

     31         75   

Repayments of long-term indebtedness

     (1,480)         (1,268)   
  

 

 

    

 

 

 

Net cash provided by financing activities

     74         
  

 

 

    

 

 

 

Net change in cash and cash equivalents

     (3)         (287)   

Cash and cash equivalents at beginning of period

     184         509   
  

 

 

    

 

 

 

Cash and cash equivalents at end of period

    $ 181        $ 222   
  

 

 

    

 

 

 

Supplemental disclosure of cash flow information:

     

Interest payments

    $ (307)        $ (300)   
  

 

 

    

 

 

 

Income tax (payments) refunds, net

    $        $ (1)    
  

 

 

    

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The unaudited condensed consolidated financial statements of Community Health Systems, Inc. (the “Parent” or “Parent Company”) and its subsidiaries (the “Company”) as of March 31, 2016 and December 31, 2015 and for the three-month ended March 31, 2016 and 2015, have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for such periods. All intercompany transactions and balances have been eliminated. The results of operations for the three months ended March 31, 2016, are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2016. Certain information and disclosures normally included in the notes to condensed consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission (the “SEC”). The Company believes the disclosures are adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2015, contained in the Company’s Annual Report on Form 10-K filed with the SEC on February 17, 2016 (“2015 Form 10-K”).

Noncontrolling interests in less-than-wholly-owned consolidated subsidiaries of the Parent are presented as a component of total equity on the condensed consolidated balance sheets to distinguish between the interests of the Parent Company and the interests of the noncontrolling owners. Noncontrolling interests that are redeemable or may become redeemable at a fixed or determinable price at the option of the holder or upon the occurrence of an event outside of the control of the Company are presented in mezzanine equity on the condensed consolidated balance sheets.

Throughout these notes to the condensed consolidated financial statements, Community Health Systems, Inc., and its consolidated subsidiaries are referred to on a collective basis as the “Company.” This drafting style is not meant to indicate that the publicly traded Parent or any particular subsidiary of the Parent owns or operates any asset, business, or property. The hospitals, operations and businesses described in this filing are owned and operated, and management services provided, by distinct and indirect subsidiaries of Community Health Systems, Inc.

Allowance for Doubtful Accounts. Accounts receivable are reduced by an allowance for amounts that could become uncollectible in the future. Substantially all of the Company’s receivables are related to providing healthcare services to patients at its hospitals and affiliated businesses.

The Company estimates the allowance for doubtful accounts by reserving a percentage of all self-pay accounts receivable without regard to aging category, based on collection history, adjusted for expected recoveries and any anticipated changes in trends. The Company’s ability to estimate the allowance for doubtful accounts is not impacted by not utilizing an aging of net accounts receivable as the Company believes that substantially all of the risk exists at the point in time such accounts are identified as self-pay. For all other non-self-pay payor categories, the Company reserves an estimated amount on historical collection rates for the uncontractualized portion of all accounts aging over 365 days from the date of discharge. These amounts represent an immaterial percentage of the outstanding accounts receivable. The percentage used to reserve for all self-pay accounts is based on the Company’s collection history. The Company collects substantially all of its third-party insured receivables, which include receivables from governmental agencies.

Collections are impacted by the economic ability of patients to pay and the effectiveness of the Company’s collection efforts. Significant changes in payor mix, business office operations, economic conditions or trends in federal and state governmental healthcare coverage could affect the Company’s collection of accounts receivable and the estimates of the collectability of future accounts receivable and are considered in the Company’s estimates of accounts receivable collectability. The Company also continually reviews its overall reserve adequacy by monitoring historical cash collections as a percentage of trailing net revenue less provision for bad debts, as well as by analyzing current period net revenue and admissions by payor classification, aged accounts receivable by payor, days revenue outstanding, the composition of self-pay receivables between pure self-pay patients and the patient responsibility portion of third-party insured receivables and the impact of recent acquisitions and dispositions.

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Operating revenues, net of contractual allowances and discounts (but before the provision for bad debts), recognized during the three months ended March 31, 2016 and 2015, were as follows (in millions):

 

     Three Months Ended  
     March 31,  
     2016      2015  

Medicare

   $ 1,431        $ 1,398    

Medicaid

     593          586    

Managed Care and other third-party payors

     3,022          2,946    

Self-pay

     708          716    
  

 

 

    

 

 

 

Total

   $                     5,754        $                     5,646    
  

 

 

    

 

 

 

Electronic Health Records Incentive Reimbursement. The federal government has implemented a number of regulations and programs designed to promote the use of electronic health records (“EHR”) technology and, pursuant to the Health Information Technology for Economic and Clinical Health Act (“HITECH”), established requirements for a Medicare and Medicaid incentive payments program for eligible hospitals and professionals that adopt and meaningfully use certified EHR technology. The Company utilizes a gain contingency model to recognize EHR incentive payments. Recognition occurs when the eligible hospitals adopt or demonstrate meaningful use of certified EHR technology for the applicable payment period and have available the Medicare cost report information for the relevant full cost report year used to determine the final incentive payment.

Medicaid EHR incentive payments are calculated based on prior period Medicare cost report information available at the time when eligible hospitals adopt, implement, upgrade or demonstrate meaningful use of certified EHR technology. Since the information for the relevant full Medicare cost report year is available at the time of attestation, the incentive income from resolving the gain contingency is recognized when eligible hospitals adopt, implement, upgrade or demonstrate meaningful use of certified EHR technology.

Medicare EHR incentive payments are calculated based on the Medicare cost report information for the full cost report year that began during the federal fiscal year in which meaningful use is demonstrated. Since the necessary information is only available at the end of the relevant full Medicare cost report year and after the cost report is settled, the incentive income from resolving the gain contingency is recognized when eligible hospitals demonstrate meaningful use of certified EHR technology and the information for the applicable full Medicare cost report year to determine the final incentive payment is available.

In some instances, the Company may receive estimated Medicare EHR incentive payments prior to when the Medicare cost report information used to determine the final incentive payment is available. In these instances, recognition of the gain for EHR incentive payments is deferred until all recognition criteria described above are met.

Eligibility for annual Medicare incentive payments is dependent on providers successfully attesting to the meaningful use of EHR technology. Medicaid incentive payments are available to providers in the first payment year that they adopt, implement or upgrade certified EHR technology; however, providers must demonstrate meaningful use of such technology in any subsequent payment years to qualify for additional incentive payments. Medicaid EHR incentive payments are fully funded by the federal government and administered by the states; however, the states are not required to offer EHR incentive payments to providers.

The Company recognized approximately $18 million and $26 million for the three months ended March 31, 2016 and 2015, respectively, of incentive reimbursement for HITECH incentives from Medicare and Medicaid related to certain of the Company’s hospitals and for certain of the Company’s employed physicians that have demonstrated meaningful use of certified EHR technology or have completed attestations to their adoption or implementation of certified EHR technology. These incentive reimbursements are presented as a reduction of operating costs and expenses on the condensed consolidated statements of income. The Company received cash related to the incentive reimbursement for HITECH incentives of approximately $85 million and $54 million for the three months ended March 31, 2016 and 2015, respectively. The Company recorded $34 million and $75 million as deferred revenue in connection with the receipt of these payments at March 31, 2016 and 2015, respectively, as all criteria for gain recognition had not been met.

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

New Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. This ASU provides companies the option of applying a full or modified retrospective approach upon adoption. This ASU is effective for fiscal years beginning after December 15, 2016. However, the FASB recently issued a final ASU that defers the effective date by one year, with early adoption permitted for annual periods beginning after December 15, 2016. The Company expects to adopt this ASU on January 1, 2018 and is currently evaluating its plan for adoption and the impact on its revenue recognition policies, procedures and control framework and the resulting impact on its consolidated financial position, results of operations and cash flows.

In April 2015, the FASB issued ASU 2015-03, which requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with the accounting for debt discounts. The ASU did not change the measurement or recognition guidance for debt issuance costs. This ASU is effective for fiscal years beginning after December 31, 2015. The Company adopted this ASU on January 1, 2016, which resulted in the reclassification of approximately $266 million of debt issuance costs from other long-term assets to a reduction of the related long-term debt. The adoption of this ASU was applied retroactively to all periods presented, and had no impact on the Company’s results of operations or cash flows.

In November 2015, the FASB issued ASU 2015-17, which amended the balance sheet classification requirements for deferred income taxes to simplify their presentation in the statement of financial position. The ASU requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. This ASU is effective for fiscal years beginning after December 31, 2016, with early adoption permitted. The Company early adopted the provisions of this ASU for the presentation and classification of its deferred tax assets at December 31, 2015. The effect of this change primarily resulted in the current portion of deferred income taxes at December 31, 2015 being included in the noncurrent deferred income tax liability.

In January 2016, the FASB issued ASU 2016-01, which amends the measurement, presentation and disclosure requirements for equity investments, other than those accounted for under the equity method or that require consolidation of the investee. The ASU eliminates the classification of equity investments as available-for-sale with any changes in fair value of such investments recognized in other comprehensive income, and requires entities to measure equity investments at fair value, with any changes in fair value recognized in net income. This ASU is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company expects to adopt this ASU on January 1, 2018, and is currently evaluating the impact that adoption of this ASU will have on its consolidated financial position and results of operations.

In February 2016, the FASB issued ASU 2016-02, which amends the accounting for leases, requiring lessees to recognize most leases on their balance sheet with a right-of-use asset and a lease liability. Leases will be classified as either finance or operating leases, which will impact the expense recognition of such leases over the lease term. The ASU also modifies the lease classification criteria for lessors and eliminates some of the real estate leasing guidance previously applied for certain leasing transactions. This ASU is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company expects to adopt this ASU on January 1, 2019. Because of the number of leases the Company utilizes to support its operations, the adoption of this ASU is expected to have a significant impact on the Company’s consolidated financial position and results of operations. Management is currently evaluating the extent of this anticipated impact on the Company’s consolidated financial position and results of operations, and the quantitative and qualitative factors that will impact the Company as part of the adoption of this ASU, as well as any changes to its leasing strategy that may occur because of the changes to the accounting and recognition of leases.

In March 2016, the FASB issued ASU 2016-09, which was issued to simplify some of the accounting guidance for share-based compensation. Among the areas impacted by the amendments in this ASU is the accounting for income taxes related to share-based payments, accounting for forfeitures, classification of awards as equity or liabilities, and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company expects to adopt this ASU on January 1, 2017. Management is evaluating the impact that the adoption of this ASU will have on its consolidated financial position, results of operations and cash flows.

 

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2. ACCOUNTING FOR STOCK-BASED COMPENSATION 

Stock-based compensation awards have been granted under the Community Health Systems, Inc. Amended and Restated 2000 Stock Option and Award Plan, amended and restated as of March 20, 2013 (the “2000 Plan”), and the Community Health Systems, Inc. 2009 Stock Option and Award Plan, amended and restated as of March 19, 2014 (the “2009 Plan”). In addition, at the annual meeting of stockholders to be held on May 17, 2016 (the “2016 Annual Meeting”), the Company’s stockholders will be voting on whether or not to approve the amendment and restatement of the 2009 Plan (the “Amended 2009 Plan”) which was approved by the Board on March 16, 2016, subject to stockholder approval at the 2016 Annual Meeting.

The 2000 Plan allowed for the grant of incentive stock options intended to qualify under Section 422 of the Internal Revenue Code (the “IRC”), as well as stock options which do not so qualify, stock appreciation rights, restricted stock, restricted stock units, performance-based shares or units and other share awards. Prior to being amended in 2009, the 2000 Plan also allowed for the grant of phantom stock. Persons eligible to receive grants under the 2000 Plan include the Company’s directors, officers, employees and consultants. All options granted under the 2000 Plan have been “nonqualified” stock options for tax purposes. Generally, vesting of these granted options occurs in one-third increments on each of the first three anniversaries of the award date. Options granted prior to 2005 have a 10-year contractual term, options granted in 2005 through 2007 have an eight-year contractual term and options granted in 2008 through 2011 have a 10-year contractual term. The Company has not granted stock option awards under the 2000 Plan since 2011. Pursuant to the amendment and restatement of the 2000 Plan dated March 20, 2013, no further grants will be awarded under the 2000 Plan.

The 2009 Plan provides (and, if approved by the Company’s stockholders at the 2016 Annual Meeting, the Amended 2009 Plan will provide) for the grant of incentive stock options intended to qualify under Section 422 of the IRC and for the grant of stock options which do not so qualify, stock appreciation rights, restricted stock, restricted stock units, performance-based shares or units and other share awards. Persons eligible to receive grants under the 2009 Plan include (and, if approved by the Company’s stockholders at the 2016 Annual Meeting, the Amended 2009 Plan will include) the Company’s directors, officers, employees and consultants. To date, all options granted under the 2009 Plan have been “nonqualified” stock options for tax purposes. Generally, vesting of these granted options occurs in one-third increments on each of the first three anniversaries of the award date. Options granted in 2011 or later have a 10-year contractual term. As of March 31, 2016, 1,122,376 shares of unissued common stock were reserved for future grants under the 2009 Plan. In addition, if the Amended 2009 Plan is approved by the Company’s stockholders at the 2016 Annual Meeting, then 5,000,000 additional shares of unissued common stock would be reserved for future grants under the Amended 2009 Plan.

The exercise price of all options granted under the 2000 Plan and the 2009 Plan has been equal to the fair value of the Company’s common stock on the option grant date.

The following table reflects the impact of total compensation expense related to stock-based equity plans on the reported operating results for the respective periods (in millions):

 

     Three Months Ended  
     March 31,  
     2016      2015  

Effect on income from continuing operations before income taxes

   $ (14)       $ (14)   
  

 

 

    

 

 

 

Effect on net income

   $                   (8)       $                   (8)   
  

 

 

    

 

 

 

At March 31, 2016, $66 million of unrecognized stock-based compensation expense related to outstanding unvested restricted stock and restricted stock units (the terms of which are summarized below) was expected to be recognized over a weighted-average period of 24 months. There is no expense to be recognized related to stock options. There were no modifications to awards during the three months ended March 31, 2016 and 2015.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Options outstanding and exercisable under the 2000 Plan and the 2009 Plan as of March 31, 2016, and changes during the three-month period following December 31, 2015, were as follows (in millions, except share and per share data):

 

                   Weighted-    Aggregate  
                   Average    Intrinsic  
            Weighted-      Remaining    Value as of  
            Average          Contractual        March 31,  
     Shares          Exercise Price              Term                  2016            

Outstanding at December 31, 2015

     1,232,158        $ 31.65          

Granted

                     

Exercised

                     

Forfeited and cancelled

     (9,334)         29.85          
  

 

 

          

Outstanding at March 31, 2016

     1,222,824        $ 31.66        3.8 years    $                     -    
  

 

 

    

 

 

    

 

  

 

 

 

Exercisable at March 31, 2016

                 1,222,824        $                 31.66        3.8 years    $   
  

 

 

    

 

 

    

 

  

 

 

 

No stock options were granted during the three months ended March 31, 2016 and 2015. The aggregate intrinsic value (the number of in-the-money stock options multiplied by the difference between the Company’s closing stock price on the last trading day of the reporting period ($18.51) and the exercise price of the respective stock options) in the table above represents the amount that would have been received by the option holders had all option holders exercised their options on March 31, 2016. This amount changes based on the market value of the Company’s common stock. The aggregate intrinsic value of options exercised during the three months ended March 31, 2015 was $5 million. There were no options exercised during the three months ended March 31, 2016. The aggregate intrinsic value of options vested and expected to vest approximates that of the outstanding options.

The Company has also awarded restricted stock under the 2000 Plan and the 2009 Plan to its directors and employees of certain subsidiaries. The restrictions on these shares generally lapse in one-third increments on each of the first three anniversaries of the award date. Certain of the restricted stock awards granted to the Company’s senior executives contain a performance objective that must be met in addition to any time-based vesting requirements. If the performance objective is not attained, the awards will be forfeited in their entirety. Once the performance objective has been attained, restrictions will lapse in one-third increments on each of the first three anniversaries of the award date. In addition, 835,000 restricted stock awards granted March 1, 2014 had a performance objective that was measured based on the realization of synergies related to the acquisition of Health Management Associates, Inc. (“HMA”) over a two-year period that began on February 1, 2014. The performance objective could be met in part in the first year or in whole or in part over such two-year period. Depending on the degree of attainment of the performance objective, restrictions would lapse on a portion of the award grant over the first three anniversaries of the award date at a level dependent upon the amount of synergies realized. If the synergies related to the HMA merger had not reached a certain level, then the awards would have been forfeited in their entirety. Based on the synergy levels attained in the first annual measurement period ended on January 31, 2015, the performance objective for the first measurement period was met, and one-third of the awards vested on March 1, 2015. Based on the synergy levels attained in the second annual measurement period ended on January 31, 2016, the performance objective for the second measurement period was also met, so the full amount of each award has been earned and one-third of the awards vested on March 1, 2016. The remaining one-third of each award will vest on March 1, 2017. Notwithstanding the above-mentioned performance objectives and vesting requirements, the restrictions with respect to restricted stock granted under the 2000 Plan and the 2009 Plan will lapse earlier in the event of death, disability or termination of employment by the Company for any reason other than for cause of the holder of the restricted stock, or change in control of the Company. Restricted stock awards subject to performance standards that have not yet been satisfied are not considered outstanding for purposes of determining earnings per share until the performance objectives have been satisfied.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Restricted stock outstanding under the 2000 Plan and the 2009 Plan as of March 31, 2016, and changes during the three-month period following December 31, 2015, were as follows (in millions, except share and per share data):

 

            Weighted-  
            Average Grant  
     Shares      Date Fair Value  

Unvested at December 31, 2015

     2,845,579        $                     44.18    

Granted

     1,340,000          15.48    

Vested

     (1,301,337)         43.36    

Forfeited

     (4,667)         43.05    
  

 

 

    

Unvested at March 31, 2016

                 2,879,575          31.20    
  

 

 

    

Restricted stock units (“RSUs”) have been granted to the Company’s outside directors under the 2000 Plan and the 2009 Plan. On March 1, 2015, each of the Company’s outside directors received a grant under the 2009 Plan of 3,504 RSUs. On March 1, 2016, each of the Company’s outside directors received a grant under the 2009 Plan of 11,017 RSUs. Both the 2015 and 2016 grants had a grant date fair value of approximately $170,000. Vesting of these RSUs occurs in one-third increments on each of the first three anniversaries of the award date.

RSUs outstanding under the 2000 Plan and the 2009 Plan as of March 31, 2016, and changes during the three-month period following December 31, 2015, were as follows (in millions, except share and per share data):

 

           Weighted-  
           Average Grant  
     Shares     Date Fair Value  

Unvested at December 31, 2015

     42,678      $                     44.59    

Granted

     77,119        15.43    

Vested

     (21,432     43.60    

Forfeited

              
  

 

 

   

Unvested at March 31, 2016

                         98,365         21.95    
  

 

 

   

3. COST OF REVENUE

Substantially all of the Company’s operating costs and expenses are “cost of revenue” items. Operating costs that could be classified as general and administrative by the Company would include the Company’s corporate office costs at its Franklin, Tennessee office, which were $60 million and $77 million for the three months ended March 31, 2016 and 2015, respectively. Included in these corporate office costs is stock-based compensation of $14 million for both the three months ended March 31, 2016 and 2015.

4. USE OF ESTIMATES

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements. Actual results could differ from these estimates under different assumptions or conditions.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

5. ACQUISITIONS AND DIVESTITURES

Acquisitions

The Company accounts for all transactions that represent business combinations using the acquisition method of accounting, where the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquired entity are recognized and measured at their fair values on the date the Company obtains control in the acquiree. Such fair values that are not finalized for reporting periods following the acquisition date are estimated and recorded as provisional amounts. Adjustments to these provisional amounts during the measurement period (defined as the date through which all information required to identify and measure the consideration transferred, the assets acquired, the liabilities assumed and any noncontrolling interests has been obtained, limited to one year from the acquisition date) are recorded as of the date of acquisition. Any material impact to comparative information for periods after acquisition, but before the period in which adjustments are identified, is reflected in those prior periods as if the adjustments were considered as of the acquisition date. Goodwill is determined as the excess of the fair value of the consideration conveyed in the acquisition over the fair value of the net assets acquired.

Excluding acquisition and integration expenses related to the acquisition of HMA, approximately $2 million of acquisition costs related to prospective and closed acquisitions were expensed during both the three months ended March 31, 2016 and March 31, 2015 and are included in other operating expenses on the condensed consolidated statements of income. Approximately $1 million of acquisition and related integration expense related to the HMA acquisition were recognized during the three months ended March 31, 2015.

On March 1, 2016, one or more subsidiaries of the Company completed the acquisition of an 80% ownership interest in a joint venture entity with Indiana University Health that includes substantially all of the assets of IU Health La Porte Hospital in La Porte, Indiana (227 licensed beds) and IU Health Starke Hospital in Knox, Indiana (50 licensed beds), and affiliated outpatient centers and physician practices. The total cash consideration paid for long-lived assets and working capital in this joint venture was approximately $69 million and $10 million, respectively, with additional consideration of $32 million assumed in liabilities, for a total consideration of $96 million. Based upon the Company’s preliminary purchase price allocation relating to this acquisition as of March 31, 2016, approximately $49 million of goodwill has been recorded. The preliminary allocation of the purchase price has been determined by the Company based on available information and is subject to settling amounts related to purchased working capital and final appraisals of tangible and intangible assets. Adjustments to the purchase price allocation are not expected to be material.

Other Acquisitions

During the three months ended March 31, 2016, one or more subsidiaries of the Company paid approximately $4 million to acquire the operating assets and related businesses of certain physician practices, clinics and other ancillary businesses that operate within the communities served by the Company’s affiliated hospitals. In connection with these acquisitions, during the three months ended March 31, 2016, the Company allocated approximately $2 million of the consideration paid to property and equipment and net working capital and the remainder, approximately $7 million consisting of intangible assets that do not qualify for separate recognition, to goodwill. The value of the noncontrolling interest recorded in these acquisitions was $5 million.

Divestitures

In April 2014, FASB issued ASU 2014-08, which changes the requirements for reporting discontinued operations. A discontinued operation continues to include a component of an entity or a group of components of an entity, or a business activity. However, in a shift reflecting stakeholder concerns that too many disposals of small groups of assets that were recurring in nature qualified for reporting as discontinued operations, a disposal of a component of an entity or a group of components of an entity will be required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. A business or nonprofit activity that, on acquisition, meets the criteria to be classified as held for sale will still be a discontinued operation. Additional disclosures will be required for significant components of the entity that are disposed of or are held for sale but do not qualify as discontinued operations. This ASU is effective for fiscal years beginning after December 15, 2014 and is to be applied on a prospective basis for disposals or components initially classified as held for sale after that date. The Company adopted this ASU on January 1, 2015 and the adoption resulted in the following divestitures occurring subsequent to the date of adoption being included in continuing operations for the three months ended March 31, 2016 and 2015 (the impact of the adoption of ASU 2014-08 in relation to the hospitals and other assets spun off to Quorum Health Corporation (“QHC”) are discussed in footnote 6 below).

 

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Effective February 1, 2016, one or more subsidiaries of the Company sold Lehigh Regional Medical Center (88 licensed beds) in Lehigh Acres, Florida, (“Lehigh”) and related outpatient services to Prime Healthcare Services, Inc. (“Prime”) for approximately $11 million in cash. In connection with the divestiture of Lehigh, the Company recorded an impairment charge of approximately $4 million related to the allocated goodwill during the three months ended March 31, 2016.

Effective January 1, 2016, one or more subsidiaries of the Company sold Bartow Regional Medical Center (72 licensed beds) in Bartow, Florida, (“Bartow”) and related outpatient services to BayCare Health Systems, Inc. for approximately $60 million in cash, which was received at a preliminary closing on December 31, 2015. In connection with the divestiture of Bartow, the Company recorded an impairment charge of approximately $5 million related to the allocated goodwill during the three months ended March 31, 2016.

Effective July 31, 2015, one or more subsidiaries of the Company sold certain assets used in the operation of Payson Regional Medical Center (44 licensed beds) in Payson, Arizona (“Payson”) to Banner Health for approximately $20 million in cash. The Company previously operated Payson under the terms of an operating lease with Mogollon Health Alliance, Inc., an Arizona nonprofit corporation, that expired on July 31, 2015. The lease termination and sale closed effective July 31, 2015.

Pursuant to the Company’s adoption of ASU 2014-08, the divestiture of Lehigh, Bartow and Payson do not meet the requirement for presentation in discontinued operations. The financial results included in discontinued operations for divestitures or hospitals held for sale at December 31, 2014, prior to the Company’s adoption of ASU 2014-08, are summarized below.

During the three months ended June 30, 2015, one or more subsidiaries of the Company finalized an agreement to terminate the lease and cease operations of Fallbrook Hospital (47 licensed beds) in Fallbrook, California. In agreeing to terminate the lease, the Company received approximately $3 million in cash from the Fallbrook Healthcare District, as the landlord, as consideration for certain operating assets of the hospital.

Effective April 1, 2015, one or more subsidiaries of the Company sold Chesterfield General Hospital (59 licensed beds) in Cheraw, South Carolina and Marlboro Park Hospital (102 licensed beds) in Bennettsville, South Carolina and related outpatient services to M/C Healthcare, LLC for approximately $4 million in cash.

Effective March 1, 2015 one or more subsidiaries of the Company sold Dallas Regional Medical Center (202 licensed beds) in Mesquite, Texas to Prime for approximately $25 million in cash.

Effective March 1, 2015 one or more subsidiaries of the Company sold Riverview Regional Medical Center (281 licensed beds) in Gadsden, Alabama to Prime for approximately $25 million in cash. This hospital was required to be divested by the Federal Trade Commission as a condition of its approval of the HMA merger.

Effective February 1, 2015, one or more subsidiaries of the Company sold Harris Hospital (133 licensed beds) in Newport, Arkansas and related healthcare services to White County Medical Center in Searcy, Arkansas for approximately $5 million in cash.

Effective January 1, 2015, one or more subsidiaries of the Company sold Carolina Pines Regional Medical Center (116 licensed beds) in Hartsville, South Carolina and related outpatient services to Capella Healthcare for approximately $74 million in cash, which was received at the closing on December 31, 2014. This hospital was required to be divested by the Federal Trade Commission as a condition of its approval of the HMA merger.

During the year ended December 31, 2014, the Company made the decision to sell and began actively marketing several smaller hospitals, which are classified as held for sale at March 31, 2016. In addition, HMA entered into a definitive agreement to sell Williamson Memorial Hospital (76 licensed beds) located in Williamson, West Virginia prior to the HMA merger, and the Company has continued the effort to divest this facility. In connection with management’s decision to sell these facilities and the sale of the seven hospitals (excluding Payson) noted above during 2015, the Company has classified the results of operations of the above mentioned hospitals as discontinued operations in the accompanying condensed consolidated statements of income, and classified these hospitals as held for sale in the accompanying condensed consolidated balance sheet.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Net operating revenues and loss from discontinued operations for the respective periods are as follows (in millions):

 

     Three Months Ended  
     March 31,  
     2016      2015  

Net operating revenues

   $                         27        $                         56    
  

 

 

    

 

 

 

Loss from operations of entities sold or held for sale before income taxes

             (17)   

Impairment of hospitals sold or held for sale

     (2)         (1)   

Loss on sale, net

             (1)   
  

 

 

    

 

 

 

Loss from discontinued operations, before taxes

     (2)         (19)   

Income tax benefit

     (1)         (6)   
  

 

 

    

 

 

 

Loss from discontinued operations, net of taxes

   $ (1)       $ (13)   
  

 

 

    

 

 

 

Interest expense was allocated to discontinued operations based on sale proceeds available for debt repayment.

Other Hospital Closures

During the three months ended March 31, 2016, the Company announced the planned closure of McNairy Regional Hospital in Selmer, Tennessee, scheduled for the second quarter of 2016. The Company recorded an impairment charge of approximately $7 million during the three months ended March 31, 2016, to adjust the value of the supplies inventory and long-lived assets of this hospital, including property and equipment and capitalized software costs, based on their estimated fair value and future utilization.

6. SPIN-OFF OF QUORUM HEALTH CORPORATION

On August 3, 2015, the Company announced a plan to spin off 38 hospitals and Quorum Health Resources, LLC into Quorum Health Corporation, an independent, publicly traded corporation. The transaction was structured to be generally tax free to the Company and its stockholders.

On April 29, 2016, the Company completed the spin-off of QHC and distributed, on a pro rata basis, all of the shares of QHC common stock to the Company’s stockholders of record as of April 22, 2016. These stockholders of record as of April 22, 2016 received a distribution of one share of QHC common stock for every four shares of Company common stock held as of the record date plus cash in lieu of any fractional shares. Immediately following the completion of the spin-off, the Company’s stockholders owned 100% of the outstanding shares of QHC common stock. Following the spin-off, QHC became an independent public company with its common stock listed for trading under the symbol “QHC” on the New York Stock Exchange.

In connection with the spin-off, the Company and QHC entered into a separation and distribution agreement as well as certain ancillary agreements on April 29, 2016. These agreements allocate between the Company and QHC the various assets, employees, liabilities and obligations (including investments, property and employee benefits and tax-related assets and liabilities) that comprise the separate companies and govern certain relationships between, and activities of, the Company and QHC for a period of time after the spin-off.

The results of operations for QHC have continued to be presented in continuing operations in the condensed consolidated statement of income as the Company has determined that the spin-off of QHC does not meet the criteria as discontinued operations under ASU 2014-08.

 

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7. INCOME TAXES

The total amount of unrecognized benefit that would affect the effective tax rate, if recognized, was approximately $5 million as of March 31, 2016. A total of approximately $3 million of interest and penalties is included in the amount of the liability for uncertain tax positions at March 31, 2016. It is the Company’s policy to recognize interest and penalties related to unrecognized benefits in its condensed consolidated statements of income as income tax expense.

It is possible the amount of unrecognized tax benefit could change in the next 12 months as a result of a lapse of the statute of limitations and settlements with taxing authorities; however, the Company does not anticipate the change will have a material impact on the Company’s condensed consolidated results of operations or condensed consolidated financial position.

The Company, or one of its subsidiaries, files income tax returns in the United States federal jurisdiction and various state jurisdictions. The Company has extended the federal statute of limitations through March 31, 2017 for Triad Hospitals, Inc. for the tax periods ended December 31, 1999, December 31, 2000, April 30, 2001, June 30, 2001, December 31, 2001, December 31, 2002, December 31, 2003, December 31, 2004, December 31, 2005, December 31, 2006 and July 25, 2007. With few exceptions, the Company is no longer subject to state income tax examinations for years prior to 2011. The Company’s federal income tax returns for the 2009 and 2010 tax years are currently under examination by the Internal Revenue Service. The Company believes the results of these examinations will not be material to its consolidated results of operations or consolidated financial position. The Company has extended the federal statute of limitations through December 31, 2016 for Community Health Systems, Inc. for the tax periods ended December 31, 2007, 2008, 2009 and 2010, and through March 31, 2017 for the tax periods ended December 31, 2011 and 2012.

The Company’s effective tax rates were 41.3% and 33.2% for the three months ended March 31, 2016 and 2015, respectively. The increase in the Company’s effective tax rate for the three months ended March 31, 2016, when compared to the three months ended March 31, 2015, was primarily related to a disproportionate substantial decrease in income from continuing operations before income taxes, when compared to an increase in net income attributable to noncontrolling interests for those same periods, which is not tax affected in the condensed consolidated statement of income. Including the expense related to income attributable to noncontrolling interests, the effective tax rate for the three months ended March 31, 2016 and 2015 would have been 68.4% and 37.8%, respectively. The increase in the Company’s effective tax rate for the three months ended March 31, 2016 is primarily due to the impact of permanent tax differences recognized as part of the hospitals divested by the Company during this three-month period.

Cash paid for income taxes, net of refunds received, resulted in net cash paid of less than $1 million and $1 million during the three months ended March 31, 2016 and 2015, respectively.

8. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

The changes in the carrying amount of goodwill for the three months ended March 31, 2016 are as follows (in millions):

 

Balance as of December 31, 2015

   $  8,965    

Goodwill acquired as part of acquisitions during current year

     57    
  

 

 

 

Balance as of March 31, 2016

   $                     9,022    
  

 

 

 

Goodwill is allocated to each identified reporting unit, which is defined as an operating segment or one level below the operating segment (referred to as a component of the entity). Management has determined that the Company’s operating segments and hospital management services operations meet the criteria to be classified as reporting units. At March 31, 2016, the hospital operations reporting unit, the home care agency operations reporting unit and the hospital management services reporting unit had approximately $8.9 billion, $47 million and $33 million, respectively, of goodwill.

 

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Goodwill is evaluated for impairment at the same time every year and when an event occurs or circumstances change that, more likely than not, reduce the fair value of the reporting unit below its carrying value. There is a two-step method for determining goodwill impairment. Step one is to compare the fair value of the reporting unit with the unit’s carrying amount, including goodwill. If this test indicates the fair value is less than the carrying value, then step two is required to compare the implied fair value of the reporting unit’s goodwill with the carrying value of the reporting unit’s goodwill. The Company performed its last annual goodwill evaluation during the fourth quarter of 2015. No impairment was indicated by this evaluation. The next annual goodwill evaluation will be performed during the fourth quarter of 2016.

The Company estimates the fair value of the related reporting units using both a discounted cash flow model as well as an EBITDA multiple model. The cash flow forecasts are adjusted by an appropriate discount rate based on the Company’s estimate of a market participant’s weighted-average cost of capital. These models are both based on the Company’s best estimate of future revenues and operating costs and are reconciled to the Company’s consolidated market capitalization, with consideration of the amount a potential acquirer would be required to pay, in the form of a control premium, in order to gain sufficient ownership to set policies, direct operations and control management decisions.

Intangible Assets

No intangible assets other than goodwill were acquired during the three months ended March 31, 2016. The gross carrying amount of the Company’s other intangible assets subject to amortization was $79 million at March 31, 2016 and $82 million at December 31, 2015 and the net carrying amount was $27 million at March 31, 2016 and $31 million at December 31, 2015. The carrying amount of the Company’s other intangible assets not subject to amortization was $120 million March 31, 2016 and $121 million at December 31, 2015, respectively. Other intangible assets are included in other assets, net on the Company’s condensed consolidated balance sheets. Substantially all of the Company’s intangible assets are contract-based intangible assets related to operating licenses, management contracts, or non-compete agreements entered into in connection with prior acquisitions.

The weighted-average remaining amortization period for the intangible assets subject to amortization is approximately four years. There are no expected residual values related to these intangible assets. Amortization expense on these intangible assets was $4 million and $3 million during the three months ended March 31, 2016 and 2015, respectively. Amortization expense on intangible assets is estimated to be $11 million for the remainder of 2016, $5 million in 2017, $4 million in 2018, $2 million in 2019, $2 million in 2020, $2 million in 2021 and $1 million thereafter.

The gross carrying amount of capitalized software for internal use was approximately $1.5 billion at both March 31, 2016 and December 31, 2015, and the net carrying amount considering accumulated amortization was approximately $737 million at March 31, 2016 and $771 million at December 31, 2015. The estimated amortization period for capitalized internal-use software is generally three years, except for capitalized costs related to significant system conversions, which is generally eight to ten years. There is no expected residual value for capitalized internal-use software. At March 31, 2016, there was approximately $56 million of capitalized costs for internal-use software that is currently in the development stage and will begin amortization once the software project is complete and ready for its intended use. Amortization expense on capitalized internal-use software was $55 million and $53 million during the three months ended March 31, 2016 and 2015, respectively. Amortization expense on capitalized internal-use software is estimated to be $165 million for the remainder of 2016, $185 million in 2017, $102 million in 2018, $74 million in 2019, $65 million in 2020, $60 million in 2021 and $86 million thereafter.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

9. EARNINGS PER SHARE 

The following table sets forth the components of the numerator and denominator for the computation of basic and diluted earnings per share for income from continuing operations, discontinued operations and net income attributable to Community Health Systems, Inc. common stockholders (in millions, except share data):

 

    Three Months Ended  
    March 31,  
    2016     2015  

Numerator:

   

Income from continuing operations, net of taxes

  $ 37       $ 112    

Less: Income from continuing operations attributable to noncontrolling interests, net of taxes

    25         20    
 

 

 

   

 

 

 

Income from continuing operations attributable to Community Health Systems, Inc. common stockholders — basic and diluted

  $ 12       $ 92    
 

 

 

   

 

 

 

Loss from discontinued operations, net of taxes

  $ (1)      $ (13)   

Less: Loss from discontinued operations attributable to noncontrolling interests, net of taxes

             
 

 

 

   

 

 

 

Loss from discontinued operations attributable to Community Health Systems, Inc. common stockholders — basic and diluted

  $ (1)      $ (13)   
 

 

 

   

 

 

 

Denominator:

   

Weighted-average number of shares outstanding — basic

            110,247,867         114,419,590    

Effect of dilutive securities:

   

Restricted stock awards

    45,257         181,120    

Employee stock options

    13,038         452,659    

Other equity-based awards

    3,210         4,299    
 

 

 

   

 

 

 

Weighted-average number of shares outstanding — diluted

    110,309,372                 115,057,668    
 

 

 

   

 

 

 
    Three Months Ended  
    March 31,  
    2016     2015  

Dilutive securities outstanding not included in the computation of earnings per share because their effect is antidilutive:

   

Employee stock options and restricted stock awards

    2,672,726           
 

 

 

   

 

 

 

10. STOCKHOLDERS’ EQUITY

Authorized capital shares of the Company include 400,000,000 shares of capital stock consisting of 300,000,000 shares of common stock and 100,000,000 shares of preferred stock. Each of the aforementioned classes of capital stock has a par value of $0.01 per share. Shares of preferred stock, none of which were outstanding as of March 31, 2016, may be issued in one or more series having such rights, preferences and other provisions as determined by the Board of Directors without approval by the holders of common stock.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

On November 6, 2015, the Company adopted a new open market repurchase program for up to 10,000,000 shares of the Company’s common stock, not to exceed $300 million in repurchases. The repurchase program will expire on the earlier of November 5, 2018, when the maximum number of shares has been repurchased, or when the maximum dollar amount has been expended. During the year ended December 31, 2015, the Company repurchased and retired 532,188 shares at a weighted-average price of $27.31 per share, which is the cumulative number of shares repurchased and retired under this program. No shares were repurchased under this program during the three months ended March 31, 2016.

On December 10, 2014, the Company adopted an open market repurchase program for up to 5,000,000 shares of the Company’s common stock, not to exceed $150 million in repurchases. This repurchase program expired on December 1, 2015. No shares were repurchased under this program during the three months ended March 31, 2015.

The Company is a holding company which operates through its subsidiaries. The Company’s Credit Facility and the indentures governing the senior and senior secured notes contain various covenants under which the assets of the subsidiaries of the Company are subject to certain restrictions relating to, among other matters, dividends and distributions, as referenced in the paragraph below.

With the exception of a special cash dividend of $0.25 per share paid by the Company in December 2012, historically, the Company has not paid any cash dividends. Subject to certain exceptions, the Company’s Credit Facility limits the ability of the Company’s subsidiaries to pay dividends and make distributions to the Company, and limits the Company’s ability to pay dividends and/or repurchase stock, to an amount not to exceed $200 million in the aggregate plus an additional $25 million in any particular year plus the aggregate amount of proceeds from the exercise of stock options. The indentures governing the senior and senior secured notes also restrict the Company’s subsidiaries from, among other matters, paying dividends and making distributions to the Company, which thereby limits the Company’s ability to pay dividends and/or repurchase stock. As of March 31, 2016, under the most restrictive test under these agreements (and subject to certain exceptions), the Company has approximately $318 million remaining available with which to pay permitted dividends and/or repurchase shares of stock or its senior and senior secured notes.

The following schedule presents the reconciliation of the carrying amount of total equity, equity attributable to the Company, and equity attributable to the noncontrolling interests for the three-month period ended March 31, 2016 (in millions):

 

          Community Health Systems, Inc. Stockholders              
    Redeemable
Noncontrolling
Interest
    Common
Stock
    Additional
Paid-In
Capital
    Treasury
Stock
    Accumulated
Other
Comprehensive
Income (Loss)
    Retained
Earnings
    Noncontrolling
Interest
    Total
Stockholders’
Equity
 

Balance, December 31, 2015

  $ 571      $     $ 1,963      $ (7)      $ (73)      $ 2,135      $ 86      $ 4,105   

Comprehensive income

    19                          -        (16)        11               

Distributions to noncontrolling interests, net of contributions

    (14)                                 -                (4)        (4)   

Purchase of subsidiary shares from noncontrolling interests

    (10)               (3)                             (3)        (6)   

Other reclassifications of noncontrolling interests

    (1)                                                  

Noncontrolling interests in acquired entity

                                              29        29   

Income tax payable increase from vesting of restricted shares

                  (15)                                    (15)   

Cancellation of restricted stock for tax withholdings on vested shares

                  (7)                                    (7)   

Share-based compensation

                  14                                    14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, March 31, 2016

  $         565      $         1      $         1,952      $         (7)      $         (89)      $         2,146      $         115      $         4,118   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following schedule discloses the effects of changes in the Company’s ownership interest in its less-than-wholly-owned subsidiaries on Community Health Systems, Inc. stockholders’ equity (in millions):

 

         Three Months Ended      
     March 31, 2016  

Net income attributable to Community Health Systems, Inc. stockholders

   $ 11    

Transfers to the noncontrolling interests:

  

Net decrease in Community Health Systems, Inc. paid-in capital for purchase of subsidiary partnership interests

     (3)   
  

 

 

 

Net transfers to the noncontrolling interests

     (3)   
  

 

 

 

Change to Community Health Systems, Inc. stockholders’ equity from net income attributable to Community Health Systems, Inc. stockholders and transfers to noncontrolling interests

   $   
  

 

 

 

11. EQUITY INVESTMENTS

As of March 31, 2016, the Company owned equity interests of 27.5% in four hospitals in Las Vegas, Nevada, and 26.1% in one hospital in Las Vegas, Nevada, in which Universal Health Services, Inc. (“UHS”) owns the majority interest, and an equity interest of 38.0% in three hospitals in Macon, Georgia, in which HCA Holdings, Inc. (“HCA”) owns the majority interest.

Summarized combined financial information for these unconsolidated entities in which the Company owns an equity interest is as follows (in millions):

 

                                                       
           Three Months Ended        
     March 31,  
     2016      2015  

Revenues

   $                       415        $                       375    

Operating costs and expenses

     324          315    

Income from continuing operations before taxes

     91          60    

The summarized financial information was derived from the financial information provided to the Company by those unconsolidated entities.

In March 2005, the Company began purchasing items, primarily medical supplies, medical equipment and pharmaceuticals, under an agreement with HealthTrust Purchasing Group, L.P. (“HealthTrust”), a group purchasing organization in which the Company is a noncontrolling partner. As part of the HMA merger, the Company acquired HMA’s ownership in HealthTrust. As of March 31, 2016, the Company had a 24.7% ownership interest in HealthTrust.

The Company’s investment in all of its unconsolidated affiliates was $504 million at March 31, 2016 and $479 million December 31, 2015, and is included in other assets, net in the accompanying condensed consolidated balance sheets. Included in the Company’s results of operations is the Company’s equity in pre-tax earnings from all of its investments in unconsolidated affiliates, which was $20 million and $18 million for the three months ended March 31, 2016 and 2015, respectively.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

12. LONG-TERM DEBT

Long-term debt consists of the following (in millions):

 

                                                             
     March 31,      December 31,  
     2016      2015  

Credit Facility:

     

Term A Loan

     $ 820          $ 844    

Term F Loan

     1,668          1,671    

Term G Loan

     1,565          1,568    

Term H Loan

     2,879          2,884    

Revolving credit loans

     323          147    

8% Senior Notes due 2019

     1,993          1,992    

7 18% Senior Notes due 2020

     1,187          1,186    

5 18% Senior Secured Notes due 2018

     1,588          1,587    

5 18% Senior Secured Notes due 2021

     968          967    

6 78% Senior Notes due 2022

     2,924          2,921    

Receivables Facility

     699          699    

Capital lease obligations

     219          227    

Other

     81          92    
  

 

 

    

 

 

 

Total debt

     16,914          16,785    

Less current maturities

     (249)         (229)   
  

 

 

    

 

 

 

Total long-term debt

     $             16,665          $             16,556    
  

 

 

    

 

 

 

Credit Facility

The Company’s wholly-owned subsidiary, CHS, has senior secured financing under a credit facility with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent. In connection with the HMA merger, the Company and CHS entered into a third amendment and restatement of its credit facility (the “Credit Facility”), providing for additional financing and recapitalization of certain of the Company’s term loans, including (i) the replacement of the revolving credit facility with a new $1.0 billion revolving facility maturing in 2019 (the “Revolving Facility”), (ii) the addition of a new $1.0 billion Term A facility due 2019 (the “Term A Facility”), (iii) a Term D facility in an aggregate principal amount equal to approximately $4.6 billion due 2021 (which included certain term C loans that were converted into such Term D facility (collectively, the “Term D Facility”)), (iv) the conversion of certain term C loans into Term E Loans and the borrowing of new Term E Loans in an aggregate principal amount of approximately $1.7 billion due 2017 and (v) the addition of flexibility commensurate with the Company’s post-acquisition structure. In addition to funding a portion of the consideration in connection with the HMA merger, some of the proceeds of the Term A Facility and Term D Facility were used to refinance the outstanding $637 million existing term A facility due 2016 and the $60 million of term B loans due 2014, respectively. The Revolving Facility includes a subfacility for letters of credit. On March 9, 2015, CHS entered into Amendment No. 1 and Incremental Term Loan Assumption Agreement to refinance the existing Term E Loans due 2017 into Term F Loans due 2018, in an original aggregated principal amount of $1.7 billion. On May 18, 2015, CHS entered into an Incremental Term Loan Assumption Agreement to provide for a new $1.6 billion incremental Term G facility and a new approximately $2.9 billion incremental Term H facility. The proceeds of the Term G facility and Term H facility were used to repay the Company’s existing Term D facility in full.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The loans under the Credit Facility bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at CHS’ option, either (a) an Alternate Base Rate (as defined) determined by reference to the greater of (1) the Prime Rate (as defined) announced by Credit Suisse or (2) the Federal Funds Effective Rate (as defined) plus 0.50% or (3) the adjusted London Interbank Offered Rate (“LIBOR”) on such day for a three-month interest period commencing on the second business day after such day plus 1% or (b) LIBOR. Loans in respect of the Revolving Facility and the Term A Facility will accrue interest at a rate per annum initially equal to LIBOR plus 2.75%, in the case of LIBOR borrowings, and Alternate Base Rate plus 1.75%, in the case of Alternate Base Rate borrowings. In addition, the margin in respect of the Revolving Facility and the Term A Facility will be subject to adjustment determined by reference to a leverage-based pricing grid. Loans in respect of the Term F Facility will accrue interest at a rate per annum equal to LIBOR plus 3.25%, in the case of LIBOR borrowings, and Alternate Base Rate plus 2.25%, in the case of Alternate Base Rate Borrowings. The Term G Loan and Term H Loan will accrue interest at a rate per annum equal to LIBOR plus 2.75% and 3.00%, respectively, in the case of LIBOR borrowings, and Alternate Base Rate plus 1.75% and 2.00%, respectively, in the case of Alternate Base Rate Borrowings. The Term G Loan and the Term H Loan are subject to a 1.00% LIBOR floor and a 2.00% Alternate Base Rate floor.

The term loan facility must be prepaid in an amount equal to (1) 100% of the net cash proceeds of certain asset sales and dispositions by the Company and its subsidiaries, subject to certain exceptions and reinvestment rights, (2) 100% of the net cash proceeds of issuances of certain debt obligations or receivables-based financing by the Company and its subsidiaries, subject to certain exceptions, and (3) 50%, subject to reduction to a lower percentage based on the Company’s leverage ratio (as defined in the Credit Facility generally as the ratio of total debt on the date of determination to the Company’s EBITDA, as defined, for the four quarters most recently ended prior to such date), of excess cash flow (as defined) for any year, subject to certain exceptions. Voluntary prepayments and commitment reductions are permitted in whole or in part, without any premium or penalty, subject to minimum prepayment or reduction requirements.

The borrower under the Credit Facility is CHS. All of the obligations under the Credit Facility are unconditionally guaranteed by the Company and certain of its existing and subsequently acquired or organized domestic subsidiaries. All obligations under the Credit Facility and the related guarantees are secured by a perfected first priority lien or security interest in substantially all of the assets of the Company, CHS and each subsidiary guarantor, including equity interests held by the Company, CHS or any subsidiary guarantor, but excluding, among others, the equity interests of non-significant subsidiaries, syndication subsidiaries, securitization subsidiaries and joint venture subsidiaries.

CHS has agreed to pay letter of credit fees equal to the applicable percentage then in effect with respect to Eurodollar rate loans under the Revolving Facility times the maximum aggregate amount available to be drawn under all letters of credit outstanding under the subfacility for letters of credit. The issuer of any letter of credit issued under the subfacility for letters of credit will also receive a customary fronting fee and other customary processing charges. CHS is obligated to pay commitment fees of 0.50% per annum (subject to adjustment based upon the Company’s leverage ratio) on the unused portion of the Revolving Facility.

The Credit Facility contains customary representations and warranties, subject to limitations and exceptions, and customary covenants restricting the Company’s and its subsidiaries’ ability, subject to certain exceptions, to, among other things (1) declare dividends, make distributions or redeem or repurchase capital stock, (2) prepay, redeem or repurchase other debt, (3) incur liens or grant negative pledges, (4) make loans and investments and enter into acquisitions and joint ventures, (5) incur additional indebtedness or provide certain guarantees, (6) make capital expenditures, (7) engage in mergers, acquisitions and asset sales, (8) conduct transactions with affiliates, (9) alter the nature of the Company’s businesses, (10) grant certain guarantees with respect to physician practices, (11) engage in sale and leaseback transactions or (12) change the Company’s fiscal year. The Company is also required to comply with specified financial covenants (consisting of a maximum secured net leverage ratio and an interest coverage ratio) and various affirmative covenants. The Company was in compliance with all such covenants at March 31, 2016.

Events of default under the Credit Facility include, but are not limited to, (1) CHS’ failure to pay principal, interest, fees or other amounts under the credit agreement when due (taking into account any applicable grace period), (2) any representation or warranty proving to have been materially incorrect when made, (3) covenant defaults subject, with respect to certain covenants, to a grace period, (4) bankruptcy events, (5) a cross default to certain other debt, (6) certain undischarged judgments (not paid within an applicable grace period), (7) a change of control, (8) certain ERISA-related defaults and (9) the invalidity or impairment of specified security interests, guarantees or subordination provisions in favor of the administrative agent or lenders under the Credit Facility.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

As of March 31, 2016, the availability for additional borrowings under the Credit Facility, after taking into account the $334 million outstanding at that date, was approximately $666 million pursuant to the Revolving Facility, of which $68 million was set aside for outstanding letters of credit. CHS has the ability to amend the Credit Facility to provide for one or more tranches of term loans or increases in the Revolving Facility in an aggregate principal amount of $1.5 billion, which CHS has not yet accessed. As of March 31, 2016, the weighted-average interest rate under the Credit Facility, excluding swaps, was 4.3%.

8% Senior Notes due 2019

On November 22, 2011, CHS completed its offering of $1.0 billion aggregate principal amount of 8% Senior Notes due 2019 (the “8% Senior Notes”), which were issued in a private placement. The net proceeds from this issuance, together with available cash on hand, were used to finance the purchase of up to $1.0 billion aggregate principal amount of CHS’ then outstanding 8 78% Senior Notes and related fees and expenses. On March 21, 2012, CHS completed the secondary offering of an additional $1.0 billion aggregate principal amount of 8% Senior Notes, which were issued in a private placement (at a premium of 102.5%). The net proceeds from this issuance were used to finance the purchase of approximately $850 million aggregate principal amount of CHS’ then outstanding 8 78% Senior Notes, to pay related fees and expenses and for general corporate purposes. The 8% Senior Notes bear interest at 8% per annum, payable semiannually in arrears on May 15 and November 15, commencing May 15, 2012. Interest on the 8% Senior Notes accrues from the date of original issuance. Interest is calculated on the basis of a 360-day year comprised of twelve 30-day months.

On and after November 15, 2015, CHS is entitled, at its option, to redeem all or a portion of the 8% Senior Notes upon not less than 30 nor more than 60 days’ notice, at the following redemption prices (expressed as a percentage of principal amount on the redemption date), plus accrued and unpaid interest, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the periods set forth below:

 

Period

             Redemption Price              

November 15, 2015 to November 14, 2016

     104.000 %           

November 15, 2016 to November 14, 2017

     102.000 %           

November 15, 2017 to November 15, 2019

     100.000 %           

Pursuant to a registration rights agreement entered into at the time of the issuance of the 8% Senior Notes, as a result of an exchange offer made by CHS, substantially all of the 8% Senior Notes issued in November 2011 and March 2012 were exchanged in May 2012 for new notes (the “8% Exchange Notes”) having terms substantially identical in all material respects to the 8% Senior Notes (except that the 8% Exchange Notes were issued under a registration statement pursuant to the Securities Act of 1933, as amended (the “1933 Act”)). References to the 8% Senior Notes shall also be deemed to include the 8% Exchange Notes unless the context provides otherwise.

7 18% Senior Notes due 2020

On July 18, 2012, CHS completed an underwritten public offering under its automatic shelf registration filed with the SEC of $1.2 billion aggregate principal amount of 7 18% Senior Notes due 2020 (the “7 18% Senior Notes”). The net proceeds from this issuance were used to finance the purchase or redemption of $934 million aggregate principal amount plus accrued interest of CHS’ outstanding 8 78% Senior Notes, to pay for consents delivered in connection therewith, to pay related fees and expenses, and for general corporate purposes. The 7 18% Senior Notes bear interest at 7.125% per annum, payable semiannually in arrears on July 15 and January 15, commencing January 15, 2013. Interest on the 7 18% Senior Notes accrues from the date of original issuance. Interest is calculated on the basis of a 360-day year comprised of twelve 30-day months.

Except as set forth below, CHS is not entitled to redeem the 7 18% Senior Notes prior to July 15, 2016.

Prior to July 15, 2016, CHS may redeem some or all of the 7 18% Senior Notes at a redemption price equal to 100% of the principal amount of the notes redeemed plus accrued and unpaid interest, if any, plus a “make-whole” premium, as described in the 7 18% Senior Notes indenture. On and after July 15, 2016, CHS is entitled, at its option, to redeem all or a portion of the 7 18% Senior Notes upon not less than 30 nor more than 60 days’ notice, at the following redemption prices (expressed as a percentage of principal amount on the redemption date), plus accrued and unpaid interest, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the periods set forth below:

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Period

             Redemption Price            

July 15, 2016 to July 14, 2017

     103.563 %         

July 15, 2017 to July 14, 2018

     101.781 %         

July 15, 2018 to July 15, 2020

     100.000 %         

5 18% Senior Secured Notes due 2018

On August 17, 2012, CHS completed an underwritten public offering under its automatic shelf registration filed with the SEC of $1.6 billion aggregate principal amount of 5 18% Senior Secured Notes due 2018 (the “2018 Senior Secured Notes”). The net proceeds from this issuance, together with available cash on hand, were used to finance the prepayment of $1.6 billion of the outstanding term loans due 2014 under the Credit Facility and related fees and expenses. The 2018 Senior Secured Notes bear interest at 5.125% per annum, payable semiannually in arrears on August 15 and February 15, commencing February 15, 2013. Interest on the 2018 Senior Secured Notes accrues from the date of original issuance. Interest is calculated on the basis of a 360-day year comprised of twelve 30-day months. The 2018 Senior Secured Notes are secured by a first-priority lien subject to a shared lien of equal priority with certain other obligations, including obligations under the Credit Facility, and subject to prior ranking liens permitted by the indenture governing the 2018 Senior Secured Notes on substantially the same assets, subject to certain exceptions, that secure CHS’ obligations under the Credit Facility.

On and after August 15, 2015, CHS is entitled, at its option, to redeem all or a portion of the 2018 Senior Secured Notes upon not less than 30 nor more than 60 days’ notice, at the following redemption prices (expressed as a percentage of principal amount on the redemption date), plus accrued and unpaid interest, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the periods set forth below:

 

Period

             Redemption Price            

August 15, 2015 to August 14, 2016

     102.563 %         

August 15, 2016 to August 14, 2017

     101.281 %         

August 15, 2017 to August 15, 2018

     100.000 %         

5 18% Senior Secured Notes due 2021

On January 27, 2014, CHS issued $1.0 billion aggregate principal amount of 5 18% Senior Secured Notes due 2021 (the “2021 Senior Secured Notes”) in connection with the HMA merger, which were issued in a private placement. The net proceeds from this issuance were used to finance the HMA merger. The 2021 Senior Secured Notes bear interest at 5.125% per annum, payable semiannually in arrears on February 1 and August 1, commencing August 1, 2014. Interest on the 2021 Senior Secured Notes accrues from the date of original issuance. Interest is calculated on the basis of a 360-day year comprised of twelve 30-day months. The 2021 Senior Secured Notes are secured by a first-priority lien, subject to a shared lien of equal priority with certain other obligations, including obligations under the Credit Facility, and subject to prior ranking liens permitted by the indenture governing the 2021 Senior Secured Notes, on substantially the same assets, subject to certain exceptions, that secure CHS’ obligations under the Credit Facility.

Except as set forth below, CHS is not entitled to redeem the 2021 Senior Secured Notes prior to February 1, 2017.

Prior to February 1, 2017, CHS is entitled, at its option, to redeem a portion of the 2021 Senior Secured Notes (not to exceed 40% of the outstanding principal amount) at a redemption price equal to 105.125% of the principal amount of the notes redeemed plus accrued and unpaid interest, with the proceeds from certain equity offerings. Prior to February 1, 2017, CHS may redeem some or all of the 2021 Senior Secured Notes at a redemption price equal to 100% of the principal amount of the notes redeemed plus accrued and unpaid interest, if any, plus a “make-whole” premium, as described in the 2021 Senior Secured Notes indenture. On and after February 1, 2017, CHS is entitled, at its option, to redeem all or a portion of the 2021 Senior Secured Notes upon not less than 30 nor more than 60 days’ notice, at the following redemption prices (expressed as a percentage of principal amount on the redemption date), plus accrued and unpaid interest, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the periods set forth below:

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Period

             Redemption Price            

February 1, 2017 to January 31, 2018

     103.844 %         

February 1, 2018 to January 31, 2019

     102.563 %         

February 1, 2019 to January 31, 2020

     101.281 %         

February 1, 2020 to January 31, 2021

     100.000 %         

Pursuant to a registration rights agreement entered into at the time of the issuance of the 2021 Senior Secured Notes, as a result of an exchange offer made by CHS, all of the 2021 Senior Secured Notes issued in January 2014 were exchanged in October 2014 for new notes (the “2021 Exchange Notes”) having terms substantially identical in all material respects to the 2021 Senior Secured Notes (except that the exchange notes were issued under a registration statement pursuant to the 1933 Act). References to the 2021 Senior Secured Notes shall be deemed to be the 2021 Exchange Notes unless the context provides otherwise.

6 78% Senior Notes due 2022

On January 27, 2014, CHS issued $3.0 billion aggregate principal amount of 6 78% Senior Notes due 2022 (the “6 78% Senior Notes”) in connection with the HMA merger, which were issued in a private placement. The net proceeds from this issuance were used to finance the HMA merger. The 6 78% Senior Notes bear interest at 6.875% per annum, payable semiannually in arrears on February 1 and August 1, commencing August 1, 2014. Interest on the 6 78% Senior Notes accrues from the date of original issuance. Interest is calculated on the basis of a 360-day year comprised of twelve 30-day months.

Except as set forth below, CHS is not entitled to redeem the 6 78% Senior Notes prior to February 1, 2018.

Prior to February 1, 2017, CHS is entitled, at its option, to redeem a portion of the 6 78% Senior Notes (not to exceed 40% of the outstanding principal amount) at a redemption price equal to 106.875% of the principal amount of the notes redeemed plus accrued and unpaid interest, with the proceeds from certain public equity offerings. Prior to February 1, 2018, CHS may redeem some or all of the 6 78% Senior Notes at a redemption price equal to 100% of the principal amount of the notes redeemed plus accrued and unpaid interest, if any, plus a “make-whole” premium, as described in the 6 78% Senior Notes indenture. On and after February 1, 2018, CHS is entitled, at its option, to redeem all or a portion of the 6 78% Senior Notes upon not less than 30 nor more than 60 days’ notice, at the following redemption prices (expressed as a percentage of principal amount on the redemption date), plus accrued and unpaid interest, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the periods set forth below:

 

Period

             Redemption Price            

February 1, 2018 to January 31, 2019

     103.438 %         

February 1, 2019 to January 31, 2020

     101.719 %         

February 1, 2020 to January 31, 2022

     100.000 %         

Pursuant to a registration rights agreement entered into at the time of the issuance of the 6 78% Senior Notes, as a result of an exchange offer made by CHS, all of the 6 78% Senior Notes issued in January 2014 were exchanged in October 2014 for new notes (the “6 78% Exchange Notes”) having terms substantially identical in all material respects to the 6 78% Senior Notes (except that the exchange notes were issued under a registration statement pursuant to the 1933 Act). References to the 6 78% Senior Notes shall be deemed to be the 6 78% Exchange Notes unless the context provides otherwise.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Receivables Facility

On March 21, 2012, through certain of its subsidiaries, CHS entered into an accounts receivable loan agreement (the “Receivables Facility”) with a group of lenders and banks, Credit Agricolé Corporate and Investment Bank, as a managing agent and as the administrative agent, and The Bank of Nova Scotia, as a managing agent. On March 7, 2013, CHS and certain of its subsidiaries amended the Receivables Facility to add an additional managing agent, The Bank of Tokyo-Mitsubishi UFJ, Ltd., to increase the size of the facility from $300 million to $500 million and to extend the scheduled termination date. Additional subsidiaries also agreed to participate in the Receivables Facility as of that date. On March 31, 2014, CHS and certain of its subsidiaries amended the Receivables Facility to increase the size of the facility from $500 million to $700 million and to extend the scheduled termination date. Additional subsidiaries also agreed to participate in the Receivables Facility as of that date. On November 13, 2015, CHS and certain of its subsidiaries amended the Receivables Facility to extend the scheduled termination date and amend certain other provisions thereof. The existing and future non-self pay patient-related accounts receivable (the “Receivables”) for certain affiliated hospitals serve as collateral for the outstanding borrowings under the Receivables Facility. The interest rate on the borrowings is based on the commercial paper rate plus an applicable interest rate spread. Unless earlier terminated or subsequently extended pursuant to its terms, the Receivables Facility will expire on November 13, 2017, subject to customary termination events that could cause an early termination date. CHS maintains effective control over the Receivables because, pursuant to the terms of the Receivables Facility, the Receivables are sold from certain of CHS’ subsidiaries to CHS, and CHS then sells or contributes the Receivables to a special-purpose entity that is wholly-owned by CHS. The wholly-owned special-purpose entity in turn grants security interests in the Receivables in exchange for borrowings obtained from the group of third-party lenders and banks of up to $700 million outstanding from time to time based on the availability of eligible Receivables and other customary factors. The group of third-party lenders and banks do not have recourse to CHS or its subsidiaries beyond the assets of the wholly-owned special-purpose entity that collateralizes the loan. The Receivables and other assets of the wholly-owned special-purpose entity will be available first and foremost to satisfy the claims of the creditors of such entity. The outstanding borrowings pursuant to the Receivables Facility at March 31, 2016 totaled $699 million and are classified as long-term debt on the condensed consolidated balance sheet. At March 31, 2016, the carrying amount of Receivables included in the Receivables Facility totaled approximately $1.7 billion and is included in patient accounts receivable on the condensed consolidated balance sheet.

The Company has transitioned all of its hospitals to the ICD-10 coding system, which was required of all healthcare providers covered by the Health Insurance Portability and Accountability Act (“HIPAA”). This transition involved a significant capital investment in technology and coding of the Company’s information systems, as well as significant costs related to training of staff involved with coding and billing. As noted in the Company’s 2015 Annual Report on Form 10-K, the potential for delay in billing and collection on patient receivables resulting from these changes or from new payment systems and processes implemented by third-party payors could have an adverse effect on the quality of receivables that serve as collateral under the Receivables Facility, resulting in a potential default or repayment of outstanding borrowings. Should such a repayment of borrowings under the Receivables Facility be required, the Company has availability, and expects that it will continue to have availability, under its Revolving Facility to provide sufficient financial resources and liquidity to fund the repayment.

Loss from Early Extinguishment of Debt

The financing transactions discussed above resulted in a loss from the early extinguishment of debt of $8 million for the three months ended March 31, 2015, and an after-tax loss of $5 million for the three months ended March 31, 2015.

Other Debt

As of March 31, 2016, other debt consisted primarily of the mortgage obligation on the Company’s corporate headquarters and other obligations maturing in various installments through 2020.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

To limit the effect of changes in interest rates on a portion of the Company’s long-term borrowings, the Company is a party to 15 separate interest swap agreements in effect at March 31, 2016, with an aggregate notional amount for currently effective swaps of $3.5 billion. On each of these swaps, the Company receives a variable rate of interest based on the three-month LIBOR in exchange for the payment of a fixed rate of interest. The Company currently pays, on a quarterly basis, interest on the Revolving Facility and the Term A Facility at a rate per annum equal to LIBOR plus 2.75%. Loans in respect of the Term F Facility accrue interest at a rate per annum equal to LIBOR plus 3.25%. The Term G Loan and Term H Loan accrue interest at a rate per annum equal to LIBOR plus 2.75% and 3.00%, in the case of LIBOR borrowings, respectively, and Alternate Base Rate plus 1.75% and 2.00%, respectively, in the case of Alternate Base Rate Borrowings. The Term G Loan and the Term H Loan are subject to a 1.00% LIBOR floor and a 2.00% Alternate Base Rate floor. See Note 13 for additional information regarding these swaps.

The Company paid interest of $307 million and $300 million on borrowings during the three months ended March 31, 2016 and 2015, respectively.

13. FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of financial instruments has been estimated by the Company using available market information as of March 31, 2016 and December 31, 2015, and valuation methodologies considered appropriate. The estimates presented in the table below are not necessarily indicative of amounts the Company could realize in a current market exchange (in millions):

 

                                                                                                   
             March 31, 2016                      December 31, 2015          
     Carrying
    Amount    
     Estimated Fair
    Value    
     Carrying
    Amount    
     Estimated Fair
    Value    
 

Assets:

           

Cash and cash equivalents

   $ 181       $ 181       $ 184       $ 184   

Available-for-sale securities

     268         268         271         271   

Trading securities

     63         63         61         61   

Liabilities:

           

Contingent Value Right

     2         2         2         2   

Credit Facility

     7,255         7,255         7,114         7,115   

8% Senior Notes

     1,993         1,954         1,992         2,018   

7 18% Senior Notes

     1,187         1,141         1,186         1,193   

2018 Senior Secured Notes

     1,588         1,615         1,587         1,610   

2021 Senior Secured Notes

     968         1,010         967         997   

6 78% Senior Notes

     2,924         2,715         2,921         2,858   

Receivables Facility and other debt

     780         780         791         791   

The estimated fair value is determined using the methodologies discussed below in accordance with accounting standards related to the determination of fair value based on the U.S. GAAP fair value hierarchy as discussed in Note 14. The estimated fair value for financial instruments with a fair value that does not equal its carrying value is considered a Level 1 valuation. The Company utilizes the market approach and obtains indicative pricing from the administrative agent to the Credit Facility to determine fair values or through publicly available subscription services such as Bloomberg where relevant.

Cash and cash equivalents. The carrying amount approximates fair value due to the short-term maturity of these instruments (less than three months).

Available-for-sale securities. Estimated fair value is based on closing price as quoted in public markets or other various valuation techniques.

Trading securities. Estimated fair value is based on closing price as quoted in public markets.

Contingent Value Right. Estimated fair value is based on the closing price as quoted on the public market where the CVR is traded.

 

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Credit Facility. Estimated fair value is based on publicly available trading activity and supported with information from the Company’s bankers regarding relevant pricing for trading activity among the Company’s lending institutions.

8% Senior Notes. Estimated fair value is based on the closing market price for these notes.

7 18% Senior Notes. Estimated fair value is based on the closing market price for these notes.

2018 Senior Secured Notes. Estimated fair value is based on the closing market price for these notes.

2021 Senior Secured Notes. Estimated fair value is based on the closing market price for these notes.

6 78% Senior Notes. Estimated fair value is based on the closing market price for these notes.

Receivables Facility and other debt. The carrying amount of the Receivables Facility and all other debt approximates fair value due to the nature of these obligations.

Interest rate swaps. The fair value of interest rate swap agreements is the amount at which they could be settled, based on estimates calculated by the Company using a discounted cash flow analysis based on observable market inputs and validated by comparison to estimates obtained from the counterparty. The Company incorporates credit valuation adjustments (“CVAs”) to appropriately reflect both its own nonperformance or credit risk and the respective counterparty’s nonperformance or credit risk in the fair value measurements. In adjusting the fair value of its interest rate swap agreements for the effect of nonperformance or credit risk, the Company has considered the impact of any netting features included in the agreements.

The Company assesses the effectiveness of its hedge instruments on a quarterly basis. For the three months ended March 31, 2016 and 2015, the Company completed an assessment of the cash flow hedge instruments and determined the hedges to be highly effective. The Company has also determined that the ineffective portion of the hedges do not have a material effect on the Company’s consolidated financial position, operations or cash flows. The counterparties to the interest rate swap agreements expose the Company to credit risk in the event of nonperformance. However, at March 31, 2016, all of the swap agreements entered into by the Company were in a net liability position such that the Company would be required to make the net settlement payments to the counterparties; the Company does not anticipate nonperformance by those counterparties. The Company does not hold or issue derivative financial instruments for trading purposes.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Interest rate swaps consisted of the following at March 31, 2016:

 

    Swap #    

   Notional Amount
    (in millions)    
     Fixed Interest Rate              Termination Date                      Fair Value        
    (in  millions)    
 

1

   $ 300          3.447 %             August 6, 2016       $   

2

     100          3.401 %             August 19, 2016           

3

     200          3.429 %             August 19, 2016           

4

     200          3.500 %             August 30, 2016           

5

     100          3.005 %             November 30, 2016           

6

     200          2.055 %             July 25, 2019           

7

     200          2.059 %             July 25, 2019           

8

     400          1.882 %             August 30, 2019           

9

     200          2.515 %             August 30, 2019           

10

     200          2.613 %             August 30, 2019           

11

     300          2.041 %             August 30, 2020           

12

     300          2.738 %             August 30, 2020         16    

13

     300          2.892 %             August 30, 2020         17    

14

     300          2.363 %             January 27, 2021         11    

15

     200          2.368 %             January 27, 2021           

The Company is exposed to certain risks relating to its ongoing business operations. The risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate fluctuation risk associated with the term loans in the Credit Facility. Companies are required to recognize all derivative instruments as either assets or liabilities at fair value in the condensed consolidated statement of financial position. The Company designates its interest rate swaps as cash flow hedges. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

Assuming no change in March 31, 2016 interest rates, approximately $46 million of interest expense resulting from the spread between the fixed and floating rates defined in each interest rate swap agreement will be recognized during the next 12 months. If interest rate swaps do not remain highly effective as a cash flow hedge, the derivatives’ gains or losses resulting from the change in fair value reported through OCI will be reclassified into earnings.

The following tabular disclosure provides the amount of pre-tax loss recognized as a component of OCI during the three months ended March 31, 2016 and 2015 (in millions):

 

                 Amount of Pre-Tax Loss Recognized in               
             OCI (Effective Portion)          

Derivatives in Cash Flow Hedging Relationships

           Three Months Ended March 31,          
         2016              2015      

Interest rate swaps

   $ (43)       $ (22)   

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following tabular disclosure provides the location of the effective portion of the pre-tax loss reclassified from accumulated other comprehensive loss (“AOCL”) into interest expense on the condensed consolidated statements of income during the three months ended March 31, 2016 and 2015 (in millions):

 

                                                       
          Amount of Pre-Tax Loss Reclassified from       
Location of Loss Reclassified from    AOCL into Income (Effective Portion)  

AOCL into Income (Effective Portion)

   Three Months Ended March 31,  
     2016      2015  

Interest expense, net

   $ 14        $   

The fair values of derivative instruments in the condensed consolidated balance sheets as of March 31, 2016 and December 31, 2015 were as follows (in millions):

 

                                                                                                                                                       
     Asset Derivatives      Liability Derivatives  
         March 31, 2016              December 31, 2015              March 31, 2016              December 31, 2015      
     Balance
Sheet
Location
   Fair
  Value  
     Balance
Sheet
Location
   Fair
  Value  
     Balance
Sheet
Location
   Fair
  Value  
     Balance
Sheet
Location
   Fair
  Value  
 

Derivatives designated as hedging instruments

   Other
assets, net
   $       Other
assets, net
   $       Other
long-term
liabilities
   $ 105        Other
long-term
liabilities
   $ 76    

14. FAIR VALUE

Fair Value Hierarchy

Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, the Company utilizes the U.S. GAAP fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumption about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

The inputs used to measure fair value are classified into the following fair value hierarchy:

 

  Level 1: Quoted market prices in active markets for identical assets or liabilities.

 

  Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

 

  Level 3: Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Level 3 includes values determined using pricing models, discounted cash flow methodologies, or similar techniques reflecting the Company’s own assumptions.

In instances where the determination of the fair value hierarchy measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment of factors specific to the asset or liability. Transfers between levels within the fair value hierarchy are recognized by the Company on the date of the change in circumstances that requires such transfer. There were no transfers between levels during the three month periods ending March 31, 2016 or March 31, 2015.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following table sets forth, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 (in millions):

 

     March 31, 2016              Level 1                      Level 2                      Level 3          

Available-for-sale securities

   $ 268         $ 154         $ 114         $ -     

Trading securities

     63           63           -           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 331         $ 217         $ 114         $ -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Contingent Value Right (CVR)

   $ 2         $ 2         $ -         $ -     

CVR-related liability

     261           -           -           261     

Fair value of interest rate swap agreements

     105           -           105           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 368         $ 2         $ 105         $ 261     
  

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2015      Level 1      Level 2      Level 3  

Available-for-sale securities

   $ 271         $ 155         $ 116         $ -     

Trading securities

     61           61           -           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 332         $ 216         $ 116         $ -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Contingent Value Right (CVR)

   $ 2         $ 2         $ -         $ -     

CVR-related liability

     261           -           -           261     

Fair value of interest rate swap agreements

     76           -           76           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 339         $ 2         $ 76         $ 261     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale Securities

Available-for-sale securities and trading securities classified as Level 1 are measured using quoted market prices. Level 2 available-for-sale securities primarily consisted of: (i) bonds and notes issued by the United States government and its agencies, domestic and foreign corporations and foreign governments; and (ii) preferred securities issued by domestic and foreign corporations. The estimated fair values of these securities are determined using various valuation techniques, including a multi-dimensional relational model that incorporates standard observable inputs and assumptions such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids/offers and other pertinent reference data.

Contingent Value Right (CVR)

The CVR represents the estimate of the fair value for the contingent consideration paid to HMA shareholders as part of the HMA merger. The CVR is listed on the NASDAQ and the valuation at March 31, 2016 is based on the quoted trading price for the CVR on the last day of the period. Changes in the estimated fair value of the CVR are recorded through the condensed consolidated statement of income.

 

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CVR-related Liability

The CVR-related legal liability represents the Company’s estimate of fair value at March 31, 2016 of the liability associated with the legal matters assumed in the HMA merger, which are included in accrued liabilities in the accompanying condensed consolidated balance sheet. This liability did not include those matters previously accrued by HMA as a probable contingency, which were settled and paid during the year ended December 31, 2015. To develop the estimate of fair value, the Company engaged an independent third-party valuation firm to measure the liability. The valuation was made utilizing the Company’s estimates of future outcomes for each legal case and simulating future outcomes based on the timing, probability and distribution of several scenarios using a Monte Carlo simulation model. Other inputs were then utilized for discounting the liability to the measurement date. The HMA legal matters underlying this fair value estimate were evaluated by management to determine the likelihood and impact of each of the potential outcomes. Using that information, as well as the potential correlation and variability associated with each case, a fair value was determined for the estimated future cash outflows to conclude or settle the HMA legal matters included in the analysis, excluding legal fees (which are expensed as incurred). Because of the unobservable nature of the majority of the inputs used to value the liability, the Company has classified the fair value measurement as a Level 3 measurement in the fair value hierarchy.

The fair value of the CVR-related legal liability will be measured each reporting period using similar measurement techniques, updated for the assumptions and facts existing at that date for each of the underlying legal matters. Changes in the fair value of the CVR related legal liability are recorded in future periods through the condensed consolidated statement of income.

Fair Value of Interest Rate Swap Agreements

The valuation of the Company’s interest rate swap agreements is determined using market valuation techniques, including discounted cash flow analysis on the expected cash flows of each agreement. This analysis reflects the contractual terms of the agreement, including the period to maturity, and uses observable market-based inputs, including forward interest rate curves. The fair value of interest rate swap agreements are determined by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates based on observable market forward interest rate curves and the notional amount being hedged.

The Company incorporates CVAs to appropriately reflect both its own nonperformance or credit risk and the respective counterparty’s nonperformance or credit risk in the fair value measurements. In adjusting the fair value of its interest rate swap agreements for the effect of nonperformance or credit risk, the Company has considered the impact of any netting features included in the agreements. The CVA on the Company’s interest rate swap agreements resulted in a decrease in the fair value of the related liability of $6 million and an after-tax adjustment of $4 million to OCI at March 31, 2016. The CVA on the Company’s interest rate swap agreements resulted in a decrease in the fair value of the related liability of $4 million and an after-tax adjustment of $2 million to OCI at December 31, 2015.

The majority of the inputs used to value the Company’s interest rate swap agreements, including the forward interest rate curves and market perceptions of the Company’s credit risk used in the CVAs, are observable inputs available to a market participant. As a result, the Company has determined that the interest rate swap valuations are classified in Level 2 of the fair value hierarchy.

15. SEGMENT INFORMATION

The Company operates in two distinct operating segments, represented by hospital operations (which includes its general acute care hospitals and related healthcare entities that provide inpatient and outpatient healthcare services) and home care agency operations (which provide in-home outpatient care).

Only the hospital operations segment meets the criteria as a separate reportable segment. The financial information for the home care agency segment does not meet the quantitative thresholds for a separate identifiable reportable segment and is combined into the corporate and all other reportable segment.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The distribution between reportable segments of the Company’s net operating revenues and income from continuing operations before income taxes is summarized in the following tables (in millions):

 

                                                 
             Three Months Ended March 31,          
     2016      2015  

Net operating revenues:

     

Hospital operations

   $ 4,944        $ 4,857    

Corporate and all other

     55          54    
  

 

 

    

 

 

 

Total

   $ 4,999        $ 4,911    
  

 

 

    

 

 

 

Income from continuing operations before income taxes:

     

Hospital operations

   $ 143        $ 273    

Corporate and all other

     (80)         (105)   
  

 

 

    

 

 

 

Total

   $ 63        $ 168    
  

 

 

    

 

 

 

16. OTHER COMPREHENSIVE INCOME

The following tables present information about items reclassified out of accumulated other comprehensive income (loss) by component for the three months ended March 31, 2016 and 2015 (in millions, net of tax):

 

                                                                                                               
     Change in Fair
Value of Interest
Rate Swaps
     Change in Fair
Value of Available
for Sale Securities
     Change in
Unrecognized
Pension Cost
Components
     Accumulated Other
Comprehensive
Income (Loss)
 

Balance as of December 31, 2015

    $ (48)        $        $ (26)        $ (73)   

Other comprehensive (loss) income before reclassifications

     (28)                         (26)   

Amounts reclassified from accumulated other comprehensive income

                             10    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net current-period other comprehensive (loss) income

     (19)                         (16)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance as of March 31, 2016

    $ (67)        $        $ (25)        $ (89)   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Change in Fair
Value of Interest
Rate Swaps
     Change in Fair
Value of Available
for Sale Securities
     Change in
Unrecognized
Pension Cost
Components
     Accumulated Other
Comprehensive
Income (Loss)
 

Balance as of December 31, 2014

    $ (43)        $        $ (27)        $ (63)   

Other comprehensive (loss) income before reclassifications

     (15)                         (14)   

Amounts reclassified from accumulated other comprehensive income

                               
  

 

 

    

 

 

    

 

 

    

 

 

 

Net current-period other comprehensive (loss) income

     (9)                         (7)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance as of March 31, 2015

    $ (52)        $        $ (26)        $ (70)   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following tables present a subtotal for each significant reclassification to net income out of AOCL and the line item affected in the accompanying condensed consolidated statement of income for the three months ended March 31, 2016 and 2015 (in millions):

 

           Amount reclassified      
from AOCL
    Affected line item in the
Details about accumulated other
comprehensive income (loss) components
   Three Months Ended
March 31, 2016
   

statement where net

income is presented

 

   

 

Gains and losses on cash flow hedges

    

Interest rate swaps

    $ (14)      Interest expense, net
          Tax benefit
  

 

 

   
    $ (9)      Net of tax
  

 

 

   

Amortization of defined benefit pension items

    

Prior service costs

    $ (1)      Salaries and benefits

Actuarial losses

          Salaries and benefits
  

 

 

   
     (1)      Total before tax
          Tax benefit
  

 

 

   
    $ (1)      Net of tax
  

 

 

   
     Amount reclassified
from AOCL
            Affected line item in the        
Details about accumulated other
comprehensive income (loss) components
   Three Months Ended
March 31, 2015
   

statement where net

income is presented

 

   

 

Gains and losses on cash flow hedges

    

Interest rate swaps

    $ (9)      Interest expense, net
          Tax benefit
  

 

 

   
    $ (6)      Net of tax
  

 

 

   

Amortization of defined benefit pension items

    

Prior service costs

    $      Salaries and benefits

Actuarial losses

     (1)      Salaries and benefits
  

 

 

   
     (1)      Total before tax
          Tax benefit
  

 

 

   
    $ (1)      Net of tax
  

 

 

   

17. CONTINGENCIES

The Company is a party to various legal, regulatory and governmental proceedings incidental to its business. Based on current knowledge, management does not believe that loss contingencies arising from pending legal, regulatory and governmental matters, including the matters described herein, will have a material adverse effect on the consolidated financial position or liquidity of the Company. However, in light of the inherent uncertainties involved in pending legal, regulatory and governmental matters, some of which are beyond the Company’s control, and the very large or indeterminate damages sought in some of these matters, an adverse outcome in one or more of these matters could be material to the Company’s results of operations or cash flows for any particular reporting period.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

With respect to all legal, regulatory and governmental proceedings, the Company considers the likelihood of a negative outcome. If the Company determines the likelihood of a negative outcome with respect to any such matter is probable and the amount of the loss can be reasonably estimated, the Company records an accrual for the estimated loss for the expected outcome of the matter. If the likelihood of a negative outcome with respect to material matters is reasonably possible and the Company is able to determine an estimate of the possible loss or a range of loss, whether in excess of a related accrued liability or where there is no accrued liability, the Company discloses the estimate of the possible loss or range of loss. However, the Company is unable to estimate a possible loss or range of loss in some instances based on the significant uncertainties involved in, and/or the preliminary nature of, certain legal, regulatory and governmental matters.

In connection with the spin-off, the Company agreed to indemnify QHC for certain liabilities relating to outcomes or events occurring prior to the closing of the spin-off, including (i) certain claims and proceedings that were known to be outstanding at or prior to the consummation of the spin-off and involved multiple facilities and (ii) certain claims, proceedings and investigations by governmental authorities or private plaintiffs related to activities occurring at or related to QHC’s healthcare facilities prior to the closing date of the spin-off, but only to the extent, in the case of clause (ii), that such claims are covered by insurance policies maintained by the Company, including professional liability and employer practices. In this regard, the Company will continue to be responsible for HMA Legal Matters (as defined below) covered by the CVR agreement that relate to QHC’s business following the consummation of the spin-off, and any amounts payable by the Company in connection therewith will continue to reduce the amount payable by the Company in respect of the CVRs. Notwithstanding the foregoing, the Company will not indemnify QHC in respect of any claims or proceedings arising out of or related to the business operations of Quorum Health Resources, LLC at any time or QHC’s compliance with its corporate integrity agreement.

HMA Legal Matters and Related CVR

The CVR agreement entitles the holder to receive a one-time cash payment of up to $1.00 per CVR, subject to downward adjustment based on the final resolution of certain litigation, investigations (whether formal or informal, including subpoenas), or other actions or proceedings related to HMA or its affiliates existing on or prior to July 29, 2013 (the date of the Company’s merger agreement with HMA) as more specifically provided in the CVR agreement (all such matters are referred to as the “HMA Legal Matters”), which include, but are not limited to, investigation and litigation matters as previously disclosed by HMA in public filings with the SEC and/or as described in more detail below. The adjustment reducing the ultimate amount paid to holders of the CVR is determined based on the amount of losses incurred by the Company in connection with the HMA Legal Matters as more specifically provided in the CVR agreement, which generally includes the amount paid for damages, costs, fees and expenses (including, without limitation, attorneys’ fees and expenses), and all fines, penalties, settlement amounts, indemnification obligations and other liabilities (all such losses are referred to as “HMA Losses”). If the aggregate amount of HMA Losses exceeds a deductible of $18 million, then the amount payable in respect of each CVR shall be reduced (but not below zero) by an amount equal to the quotient obtained by dividing: (a) the product of (i) all losses in excess of the deductible and (ii) 90%; by (b) the number of CVRs outstanding on the date on which final resolution of the existing litigation occurs. There are 264,544,053 CVRs outstanding as of the date hereof. If total HMA Losses (including HMA Losses that have occurred to date as noted in the table below) exceed approximately $312 million, then the holders of the CVRs will not be entitled to any payment in respect of the CVRs.

The CVRs do not have a finite payment date. Any payments the Company makes under the CVR agreement will be payable within 60 days after the final resolution of the HMA Legal Matters. The CVRs are unsecured obligations of CHS and all payments under the CVRs will be subordinated in right of payment to the prior payment in full of all of the Company’s senior obligations (as defined in the CVR agreement), which include outstanding indebtedness of the Company (subject to certain exceptions set forth in the CVR agreement) and the HMA Losses. The CVR agreement permits the Company to acquire all or some of the CVRs, whether in open market transactions, private transactions or otherwise. As of March 31, 2016, the Company had acquired no CVRs.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following table represents the impact of legal expenses paid or incurred to date and settlements paid or deemed final as of March 31, 2016 on the amounts owed to CVR holders (in millions):

 

          Allocation of Expenses and Settlements Paid  
        Total Expenses    
and Settlement
Cost
            Deductible             CHS
     Responsibility     
at 10%
    Reduction to
     Amount Owed     
to CVR Holders
at 90%
 

As of December 31, 2015

    $ 58          $ 18          $ 4          $ 36     

Settlements paid

                           

Legal expenses incurred and/or paid during the three months ended March 31, 2016

    1                        1     
 

 

 

   

 

 

   

 

 

   

 

 

 

As of March 31, 2016

    $ 59          $ 18          $ 4          $ 37     
 

 

 

   

 

 

   

 

 

   

 

 

 

Amounts owed to CVR holders are dependent on the ultimate resolution of the HMA Legal Matters and determination of HMA Losses incurred. The settlement of any or all of the claims and expenses incurred on behalf of the Company in defending itself will (subject to the deductible) reduce the amounts owed to the CVR holders.

Underlying the CVR agreement are a number of claims included in the HMA Legal Matters asserted against HMA. The Company has recorded a liability in connection with those claims as part of the acquired assets and liabilities at the date of acquisition pursuant to the provisions of Financial Accounting Standards Board Accounting Standards Codification Topic 805 “Business Combinations.” For the estimate of the Company’s liabilities associated with the HMA Legal Matters that will be covered by the CVR and were not previously accrued by HMA, the Company recorded a liability of $284 million as part of the acquisition accounting for the HMA merger based on the Company’s estimate of fair value of such liabilities as of the date of acquisition. There was no change in the liability during the three months ended March 31, 2016 and the fair value of such liabilities of $261 million as of March 31, 2016 is recorded in other long-term liabilities on the accompanying condensed consolidated balance sheet. As of March 31, 2016, there is currently no accrual recorded for the probable contingency claims underlying the CVR agreement. The estimated liability for probable contingency claims underlying the CVR agreement that was previously recorded by HMA, and reflected in the purchase accounting for HMA as an acquired liability has been settled and was paid during the year ended December 31, 2015. In addition, although legal fees are not included in the amounts currently accrued, such legal fees are taken into account in determining HMA Losses under the CVR agreement. Certain significant HMA Legal Matters underlying these liabilities are discussed in greater detail below.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

HMA Matters Recorded at Fair Value

Medicare/Medicaid Billing Lawsuits

Beginning during the week of December 16, 2013, eleven qui tam lawsuits filed by private individuals against HMA were unsealed in various United States district courts. The United States has elected to intervene in all or part of eight of these matters; namely U.S. ex rel. Craig Brummer v. Health Management Associates, Inc. et al. (Middle District Georgia) (“Brummer”); U.S. ex rel. Ralph D. Williams v. Health Management Associates, Inc. et al. (Middle District Georgia) (“Williams”); U.S. ex rel. Scott H. Plantz, M.D. et al. v. Health Management Associates, Inc., et al. (Northern District Illinois) (“Plantz”); U.S. ex rel. Thomas L. Mason, M.D. et al. v. Health Management Associates, Inc. et al. (Western District North Carolina) (“Mason”); U.S. ex rel. Jacqueline Meyer, et al. v. Health Management Associates, Inc., Gary Newsome et al. (“Jacqueline Meyer”) (District of South Carolina); U.S. ex rel. George Miller, et al. v. Health Management Associates, Inc. (Eastern District of Pennsylvania) (“Miller”); U.S. ex rel. Bradley Nurkin v. Health Management Associates, Inc. et al. (Middle District of Florida) (“Nurkin”); and U.S. ex rel. Paul Meyer v. Health Management Associates, Inc. et al. (Southern District Florida) (“Paul Meyer”). The United States has elected to intervene with respect to allegations in these cases that certain HMA hospitals inappropriately admitted patients and then submitted reimbursement claims for treating those individuals to federal healthcare programs in violation of the False Claims Act or that certain HMA hospitals had inappropriate financial relationships with physicians which violated the Stark law, the Anti-Kickback Statute, and the False Claims Act. Certain of these complaints also allege the same actions violated various state laws which prohibit false claims. The United States has declined to intervene in three of the eleven matters, namely U.S. ex rel. Anita France, et al. v. Health Management Associates, Inc. (Middle District Florida) (“France”) which involved allegations of wrongful billing and was settled; U.S. ex rel. Sandra Simmons v. Health Management Associates, Inc. et al. (Eastern District Oklahoma) (“Simmons”) which alleges unnecessary surgery by an employed physician and which was settled as to all allegations except alleged wrongful termination; and U.S. ex rel. David Napoliello, M.D. v. Health Management Associates, Inc. (Middle District Florida) (“Napoliello”) which alleges inappropriate admissions. On April 3, 2014, the Multi District Litigation Panel ordered the transfer and consolidation for pretrial proceedings of the eight intervened cases, plus the Napoliello matter, to the District of the District of Columbia under the name In Re: Health Management Associates, Inc. Qui Tam Litigation. On June 2, 2014, the court entered a stay of this matter until October 6, 2014, which was subsequently extended until February 27, 2015, May 27, 2015, September 25, 2015, January 25, 2016, and now until May 25, 2016. The Company intends to defend against the allegations in these matters, but also continues to cooperate with the government in the ongoing investigation of these allegations. The Company has been in discussions with the Civil Division of the United States Department of Justice (“DOJ”) regarding the resolutions of these matters. During the first quarter of 2015, the Company was informed that the Criminal Division continues to investigate former executive-level employees of HMA, and continues to consider whether any HMA entities should be held criminally liable for the acts of the former HMA employees. The Company is voluntarily cooperating with these inquiries and has not been served with any subpoenas or other legal process.

Summary of Recorded Amounts

The table below presents a reconciliation of the beginning and ending liability balances (in millions) during the three months ended March 31, 2016 with respect to the Company’s fair value determination in connection with HMA Legal Matters that were not previously accrued by HMA, the estimated liability in connection with HMA Legal Matters that were previously recorded by HMA as a probable contingency, and the remaining contingencies of the Company in respect of which an accrual has been recorded. In addition, future legal fees (which are expensed as incurred) and costs related to possible indemnification and criminal investigation matters associated with the HMA Legal Matters have not been accrued or included in the table below. Furthermore, although not accrued, such costs, if incurred, will be taken into account in determining the total amount of reductions applied to the amounts owed to CVR holders.

 

                                                                                   
             CVR Related        
Liability
at  Fair Value
     CVR Related Liability
for Probable
Contingencies
     Other
Probable
      Contingencies      
 

Balance as of December 31, 2015

    $ 261         $        $ 10    

Expense (income)

                       

Cash payments

                     (3)   
  

 

 

    

 

 

    

 

 

 

Balance as of March 31, 2016

    $ 261         $        $   
  

 

 

    

 

 

    

 

 

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

With respect to the “Other Probable Contingencies” referenced in the chart above, in accordance with applicable accounting guidance, the Company establishes a liability for litigation, regulatory and governmental matters for which, based on information currently available, the Company believes that a negative outcome is known or is probable and the amount of the loss is reasonably estimable. For all such matters (whether or not discussed in this contingencies footnote), such amounts have been recorded in other accrued liabilities on the condensed consolidated balance sheet and are included in the table above in the “Other Probable Contingencies” column. Due to the uncertainties and difficulty in predicting the ultimate resolution of these contingencies, the actual amount could differ from the estimated amount reflected as a liability on the condensed consolidated balance sheet.

In the aggregate, attorneys’ fees and other costs incurred but not included in the table above related to probable contingencies, and CVR-related contingencies accounted for at fair value, totaled $1 million and $4 million for the three months ended March 31, 2016 and 2015, respectively, and are included in other operating expenses in the accompanying condensed consolidated statements of income.

Matters for which an Outcome Cannot be Assessed

For all of the legal matters below, the Company cannot at this time assess what the outcome may be and is further unable to determine any estimate of loss or range of loss. Because the matters below are at a preliminary stage and other factors, there are not sufficient facts available to make these assessments.

Class Action Shareholder Federal Securities Cases. Three purported class action cases have been filed in the United States District Court for the Middle District of Tennessee; namely, Norfolk County Retirement System v. Community Health Systems, Inc., et al., filed May 9, 2011; De Zheng v. Community Health Systems, Inc., et al., filed May 12, 2011; and Minneapolis Firefighters Relief Association v. Community Health Systems, Inc., et al., filed June 21, 2011. All three seek class certification on behalf of purchasers of the Company’s common stock between July 27, 2006 and April 11, 2011 and allege that misleading statements resulted in artificially inflated prices for the Company’s common stock. In December 2011, the cases were consolidated for pretrial purposes and NYC Funds and its counsel were selected as lead plaintiffs/lead plaintiffs’ counsel. In lieu of ruling on the Company’s motion to dismiss, the court permitted the plaintiffs to file a first amended consolidated class action complaint, which was filed on October 5, 2015. The Company’s motion to dismiss was filed on November 4, 2015 and oral argument was held on April 11, 2016. Discovery is also continuing. The Company believes this consolidated matter is without merit and will vigorously defend this case.

Shareholder Derivative Actions. Three purported shareholder derivative actions have also been filed in the United States District Court for the Middle District of Tennessee; Plumbers and Pipefitters Local Union No. 630 Pension Annuity Trust Fund v. Wayne T. Smith, et al., filed May 24, 2011; Roofers Local No. 149 Pension Fund v. Wayne T. Smith, et al., filed June 21, 2011; and Lambert Sweat v. Wayne T. Smith, et al., filed October 5, 2011. These three cases allege breach of fiduciary duty arising out of allegedly improper inpatient admission practices, mismanagement, waste and unjust enrichment. These cases have been consolidated into a single, consolidated action. The plaintiffs filed an operative amended derivative complaint in these three consolidated actions on March 15, 2012. The Company’s motion to dismiss was argued on June 13, 2013. On September 27, 2013, the court issued an order granting in part and denying in part the Company’s motion to dismiss. An initial case management order was entered on November 11, 2014, but no trial date has been set. Discovery is continuing. The Company believes all of the plaintiffs’ claims are without merit and will vigorously defend them.

18. SUBSEQUENT EVENTS

The Company evaluated all material events occurring subsequent to the balance sheet date for events requiring disclosure or recognition in the condensed consolidated financial statements.

On April 29, 2016, the Company completed the spin-off of QHC and distributed, on a pro rata basis, all of the shares of QHC common stock to the Company’s stockholders of record as of April 22, 2016. These stockholders of record as of April 22, 2016 received a distribution of one share of QHC common stock for every four shares of Company common stock held as of the record date plus cash in lieu of any fractional shares. Immediately following the completion of the spin-off, the Company’s stockholders owned 100% of the outstanding shares of QHC common stock. Following the spin-off, QHC became an independent public company with its common stock listed for trading under the symbol “QHC” on the New York Stock Exchange.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

In connection with the spin-off, the Company and QHC entered into a separation and distribution agreement as well as certain ancillary agreements on April 29, 2016. These agreements allocate between the Company and QHC the various assets, employees, liabilities and obligations (including investments, property and employee benefits and tax-related assets and liabilities) that comprise the separate companies and govern certain relationships between, and activities of, the Company and QHC for a period of time after the spin-off.

Pursuant to a special distribution paid by QHC to the Company as part of the series of transactions engaged in to complete the spin-off, the Company received approximately $1.2 billion in cash generated from the net proceeds of certain financing arrangements entered into by QHC as part of the separation. The Company has used approximately $194 million of such proceeds to repay a portion of its Term F Loans due 2018. In addition, on May 2, 2016, the Company commenced a cash tender offer for up to $900 million of its approximately $1.6 billion aggregate principal amount outstanding of 5 18% Senior Secured Notes due 2018 as noted in a press release issued by the Company on such date. The Company intends to use remaining proceeds from such special distribution to repay other outstanding debt and to pay certain expenses incurred in connection with the spin-off and such debt repayment transactions.

As part of the separation and distribution of QHC to the Company’s stockholders, the Company will record the distribution of the assets and liabilities of the QHC entities from its consolidated balance sheet on a historical cost basis as a dividend from stockholders’ equity, and no gain or loss will be recorded.

On April 1, 2016, one or more subsidiaries of the Company completed the acquisition of an 80% interest in Physicians’ Specialty Hospital (20 licensed beds), a Medicare-certified specialty surgical hospital in Fayetteville, Arkansas. The total cash consideration paid at closing was approximately $13 million.

On April 29, 2016, the Company entered into a definitive agreement with UHS to sell its unconsolidated minority equity interests in Valley Health System LLC, a joint venture with UHS representing four hospitals in Las Vegas, Nevada, in which the Company owns a 27.5% interest, and in Summerlin Hospital Medical Center LLC, a joint venture with UHS representing one hospital in Las Vegas, Nevada, in which the Company owns a 26.1% interest. The Company will receive $445 million in cash from UHS in return for the sale of its equity interests in the second quarter of 2016.

19. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The Senior Notes due 2019, 2020 and 2022, which are senior unsecured obligations of CHS, and the 5 18% Senior Secured Notes due 2018 and 2021 (collectively, “the Notes”) are guaranteed on a senior basis by the Company and by certain of its existing and subsequently acquired or organized 100% owned domestic subsidiaries. The Notes are fully and unconditionally guaranteed on a joint and several basis, with exceptions considered customary for such guarantees, limited to the release of the guarantee when a subsidiary guarantor’s capital stock is sold, or a sale of all of the subsidiary guarantor’s assets used in operations. The following condensed consolidating financial statements present Community Health Systems, Inc. (as parent guarantor), CHS (as the issuer), the subsidiary guarantors, the subsidiary non-guarantors and eliminations. These condensed consolidating financial statements have been prepared and presented in accordance with SEC Regulation S-X Rule 3-10 “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.”

The accounting policies used in the preparation of this financial information are consistent with those elsewhere in the condensed consolidated financial statements of the Company, except as noted below:

 

    Intercompany receivables and payables are presented gross in the supplemental condensed consolidating balance sheets.

 

    Cash flows from intercompany transactions are presented in cash flows from financing activities, as changes in intercompany balances with affiliates, net.

 

    Income tax expense is allocated from the parent guarantor to the income producing operations (other guarantors and non-guarantors) and the issuer through stockholders’ equity. As this approach represents an allocation, the income tax expense allocation is considered non-cash for statement of cash flow purposes.

 

    Interest expense, net has been presented to reflect net interest expense and interest income from outstanding long-term debt and intercompany balances.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The Company’s intercompany activity consists primarily of daily cash transfers for purposes of cash management, the allocation of certain expenses and expenditures paid for by the Parent on behalf of its subsidiaries, and the push down of investment in its subsidiaries. This activity also includes the intercompany transactions between consolidated entities as part of the Receivables Facility that is further discussed in Note 12. The Company’s subsidiaries generally do not purchase services from one another; thus, the intercompany transactions do not represent revenue generating transactions. All intercompany transactions eliminate in consolidation.

From time to time, subsidiaries of the Company sell and/or repurchase noncontrolling interests in consolidated subsidiaries, which may change subsidiaries between guarantors and non-guarantors.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Statement of Income

Three Months Ended March 31, 2016

     Parent
  Guarantor  
       Issuer        Other
Guarantors
     Non -
  Guarantors  
       Eliminations          Consolidated    
     (In millions)         

Operating revenues (net of contractual allowances and discounts)

    $        $ (6)        $ 3,766        $ 1,994        $        $ 5,754   

Provision for bad debts

                     532         223                 755   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net operating revenues

             (6)         3,234         1,771                 4,999   

Operating costs and expenses:

                 

Salaries and benefits

                     1,282         1,035                 2,317   

Supplies

                     543         256                 799   

Other operating expenses

                     817         356                 1,173   

Electronic health records incentive reimbursement

                     (11)         (7)                 (18)   

Rent

                     65         54                 119   

Depreciation and amortization

                     211         87                 298   

Impairment of long-lived assets

                     12                        17   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating costs and expenses

                     2,919         1,786                 4,705   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

             (6)         315         (15)                 294   

Interest expense, net

             35         200         16                 251   

Equity in earnings of unconsolidated affiliates

     (11)         (62)         17                 36         (20)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing operations before income taxes

     11         21         98         (31)         (36)         63   

Provision for (benefit from) income taxes

             10         37         (21)                 26   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing operations

     11         11         61         (10)         (36)         37   

Discontinued operations, net of taxes:

                 

Loss from operations of entities sold or held for sale

                     (1)                          

Impairment of hospitals sold or held for sale

                             (1)                 (1)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loss from discontinued operations, net of taxes

                     (1)                         (1)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income

     11         11         60         (10)         (36)         36   

Less: Net income attributable to noncontrolling interests

                             25                 25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income attributable to Community Health Systems, Inc. stockholders

    $ 11        $ 11        $ 60        $ (35)        $ (36)        $ 11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Statement of Income   
Three Months Ended March 31, 2015   
     Parent
  Guarantor  
           Issuer            Other
  Guarantors  
     Non -
  Guarantors  
       Eliminations          Consolidated    
     (In millions)  

Operating revenues (net of contractual allowances and discounts)

     $         $ (5)         $ 3,488         $ 2,163         $         $ 5,646   

Provision for bad debts

                     447         288                 735   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net operating revenues

             (5)         3,041         1,875                 4,911   

Operating costs and expenses:

                 

Salaries and benefits

                     1,222         1,035                 2,257   

Supplies

                     492         270                 762   

Other operating expenses

                     708         391                 1,099   

Government settlement and related costs

                                             

Electronic health records incentive reimbursement

                     (17)         (9)                 (26)   

Rent

                     61         55                 116   

Depreciation and amortization

                     200         96                 296   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating costs and expenses

                     2,674         1,838                 4,512   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

             (5)         367         37                 399   

Interest expense, net

             21          211                        241   

Loss from early extinguishment of debt

                                              

Equity in earnings of unconsolidated affiliates

     (79)         (104)         (5)                 170         (18)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing operations before income taxes

     79       

 

 

 

70 

 

  

     161         28         (170)         168   

Provision for (benefit from) income taxes

             (9)         61                        56   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing operations

     79        79         100         24         (170)         112   

Discontinued operations, net of taxes:

                 

Loss from operations of entities sold or held for sale

                             (11)                 (11)   

Impairment of hospitals sold or held for sale

                     (1)                         (1)   

Loss on sale, net

                            (3)                 (1)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loss from discontinued operations, net of taxes

                            (14)                 (13)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income

     79         79         101         10         (170)         99   

Less: Net income attributable to noncontrolling interests

                             20                 20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income attributable to Community Health

                 

Systems, Inc. stockholders

     $ 79         $ 79         $ 101         $ (10)         $ (170)         $ 79   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Statement of Comprehensive Income (Loss)  
Three Months Ended March 31, 2016  
     Parent
  Guarantor  
           Issuer            Other
  Guarantors  
     Non -
  Guarantors  
       Eliminations          Consolidated    
     (In millions)  

Net income

   $ 11       $ 11       $ 60       $ (10)       $ (36)       $ 36   

Other comprehensive income (loss), net of income taxes:

                 

Net change in fair value of interest rate swaps, net of tax

     (19)         (19)                         19         (19)   

Net change in fair value of available-for-sale securities, net of tax

                                  (4)          

Amortization and recognition of unrecognized pension cost components, net of tax

                                  (2)          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     (16)         (16)                        13         (16)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive income

     (5)         (5)         63         (10)         (23)         20   

Less: Comprehensive income attributable to noncontrolling interests

                             25                25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive (loss) income attributable to Community Health Systems, Inc. stockholders

   $ (5)       $ (5)       $ 63       $ (35)       $ (23)       $ (5)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Condensed Consolidating Statement of Comprehensive Income (Loss)  
Three Months Ended March 31, 2015  
     Parent
  Guarantor  
           Issuer            Other
  Guarantors  
     Non -
  Guarantors  
       Eliminations          Consolidated    
     (In millions)  

Net income

   $ 79       $ 79       $ 101       $ 10       $ (170)       $ 99   

Other comprehensive income (loss), net of income taxes:

                 

Net change in fair value of interest rate swaps, net of tax

     (9)         (9)                                (9)   

Net change in fair value of available-for-sale securities, net of tax

                                  (2)          

Amortization and recognition of unrecognized pension cost components, net of tax

                                  (2)          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     (7)         (7)         2                       (7)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive income

     72         72         103         10         (165)         92   

Less: Comprehensive income attributable to noncontrolling interests

                             20                20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive income (loss) attributable to Community Health Systems, Inc. stockholders

   $ 72       $ 72       $ 103       $ (10)       $ (165)       $ 72   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

42


Table of Contents

COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Balance Sheet  
March 31, 2016  
     Parent
    Guarantor    
           Issuer            Other
    Guarantors    
     Non -
    Guarantors    
         Eliminations            Consolidated    
     (In millions)  
        ASSETS   

Current assets:

                 

Cash and cash equivalents

     $         $         $ 12         $ 169         $         $ 181   

Patient accounts receivable, net of allowance for doubtful accounts

                     1,232         2,491                 3,723   

Supplies

                     408         179                 587   

Prepaid income taxes

                                             

Prepaid expenses and taxes

                     146         72                 218   

Other current assets

                     347         198                 545   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current assets

                    2,145         3,109                 5,256   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Intercompany receivable

     1,178         16,776         1,638         6,299         (25,891)           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Property and equipment, net

                     6,924         3,180                 10,104   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Goodwill

                     5,462         3,560                 9,022   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other assets, net

                     2,349         1,258         (1,265)         2,342   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net investment in subsidiaries

     3,433         21,416         7,859                 (32,708)           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

     $ 4,613         $ 38,192         $ 26,377         $ 17,406         $ (59,864)         $ 26,724   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                    LIABILITIES AND EQUITY   

Current liabilities:

                 

Current maturities of long-term debt

     $         $ 175         $ 65         $        $         $ 249   

Accounts payable

                     874         305                 1,179   

Accrued interest

             156                               158   

Accrued liabilities

                    956         508                 1,468   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current liabilities

            331         1,896         823                 3,054   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt

             15,739         128         798                 16,665   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Intercompany payable

             17,347         18,975         13,775         (50,097)           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Deferred income taxes

     599                                         599   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other long-term liabilities

            1,342         1,343         295         (1,265)         1,723   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     611         34,759         22,342         15,691         (51,362)         22,041   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Redeemable noncontrolling interests in equity of consolidated subsidiaries

                             565                 565   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity:

                 

Community Health Systems, Inc. stockholders’ equity:

                 

Preferred stock

                                             -      

Common stock

                                             

Additional paid-in capital

     1,951         1,328        1,530        1,042        (3,899)         1,952   

Treasury stock, at cost

     (7)                                         (7)   

Accumulated other comprehensive loss

     (89)         (89)         (21)         (1)         111         (89)   

Retained earnings

     2,146         2,194        2,526        (6)         (4,714)         2,146   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Community Health Systems, Inc. stockholders’ equity

     4,002         3,433         4,035         1,035         (8,502)         4,003   

Noncontrolling interests in equity of consolidated subsidiaries

                             115                 115   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total equity

     4,002         3,433         4,035         1,150         (8,502)         4,118   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and equity

     $ 4,613         $ 38,192         $ 26,377         $ 17,406         $ (59,864)         $ 26,724   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

43


Table of Contents

COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Balance Sheet  
December 31, 2015  
     Parent
    Guarantor    
           Issuer            Other
    Guarantors    
     Non -
    Guarantors    
         Eliminations            Consolidated    
     (In millions)  
ASSETS   

Current assets:

                 

Cash and cash equivalents

     $         $         $ 25         $ 159         $         $ 184  

Patient accounts receivable, net of allowance for doubtful accounts

                     1,197         2,414                 3,611  

Supplies

                     400         180                 580  

Prepaid income taxes

     27                                         27  

Prepaid expenses and taxes

                     138         59                 197  

Other current assets

                     356         211                 567  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current assets

     27                 2,116         3,023                 5,166  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Intercompany receivable

     1,159         16,544         1,491         6,404         (25,598)           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Property and equipment, net

                     6,863         3,249                 10,112  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Goodwill

                     5,460         3,505                 8,965  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other assets, net

                     2,153         1,245         (1,046)         2,352  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net investment in subsidiaries

     3,438         20,964         8,035                 (32,437)           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

     $ 4,624         $ 37,508         $ 26,118         $ 17,426         $ (59,081)         $ 26,595  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                  LIABILITIES AND EQUITY   

Current liabilities:

                 

Current maturities of long-term debt

     $         $ 162         $ 57         $ 10         $         $ 229   

Accounts payable

                     866         392                 1,258   

Accrued interest

             226                                227   

Accrued liabilities

                    901         453                 1,358   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current liabilities

            388         1,824         856                 3,072   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt

             15,604         151         801                 16,556   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Intercompany payable

             16,861         19,021         13,764         (49,646)           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Deferred income taxes

     593                                         593   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other long-term liabilities

            1,217         1,149         370         (1,046)         1,698   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     605         34,070         22,145         15,791         (50,692)         21,919   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Redeemable noncontrolling interests in equity of consolidated subsidiaries

                             571                 571   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity:

                 

Community Health Systems, Inc. stockholders’ equity:

                 

Preferred stock

                                               

Common stock

                                             

Additional paid-in capital

     1,963         1,324         1,506         967         (3,797)         1,963   

Treasury stock, at cost

     (7)                                         (7)   

Accumulated other comprehensive loss

     (73)         (73)         (22)         (3)         98         (73)   

Retained earnings

     2,135         2,187         2,489         14         (4,690)         2,135   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Community Health Systems, Inc. stockholders’ equity

     4,019         3,438         3,973         978         (8,389)         4,019   

Noncontrolling interests in equity of consolidated subsidiaries

                             86                 86   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total equity

     4,019         3,438         3,973         1,064         (8,389)         4,105   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and equity

     $ 4,624         $ 37,508         $ 26,118         $ 17,426         $ (59,081)         $ 26,595   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

44


Table of Contents

COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Statement of Cash Flows

Three Months Ended March 31, 2016

 

     Parent             Other      Non -                
         Guarantor                Issuer              Guarantors          Guarantors          Eliminations          Consolidated    
     (In millions)  

Net cash (used in) provided by operating activities

     $         $ (223)         $ 420         $ 97         $         $ 294   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash flows from investing activities:

                 

Acquisitions of facilities and other related equipment

                     (2)         (97)                 (99)   

Purchases of property and equipment

                     (159)         (65)                 (224)   

Proceeds from disposition of hospitals and other ancillary operations

                     12                         12   

Proceeds from sale of property and equipment

                                            

Purchases of available-for-sale securities

                     (12)         (25)                 (37)   

Proceeds from sales of available-for-sale securities

                     10         30                 40  

Increase in other investments

                     (53)         (14)                 (67)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash used in investing activities

                     (201)         (170)                 (371)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash flows from financing activities:

                 

Repurchase of restricted stock shares for payroll

                 

tax withholding requirements

     (7)                                         (7)   

Redemption of noncontrolling investments in joint ventures

                             (16)                 (16)   

Distributions to noncontrolling investors in joint ventures

                             (18)                 (18)   

Changes in intercompany balances with affiliates, net

            89         (215)         119                   

Borrowings under credit agreements

             1,563                                1,564   

Proceeds from receivables facility

                             31                 31   

Repayments of long-term indebtedness

             (1,429)         (18)         (33)                 (1,480)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash provided by (used in) financing activities

             223         (232)         83                 74   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net change in cash and cash equivalents

                     (13)         10                 (3)   

Cash and cash equivalents at beginning of period

                     25         159                 184   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash and cash equivalents at end of period

     $         $         $ 12         $ 169         $         $ 181   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Condensed Consolidating Statement of Cash Flows

Three Months Ended March 31, 2015

 

     Parent
  Guarantor  
           Issuer            Other
  Guarantors  
     Non -
  Guarantors  
       Eliminations          Consolidated    
     (In millions)  

Net cash (used in) provided by operating activities

     $ (10)         $ (123)         $ 23         $ 49         $         $ (61)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash flows from investing activities:

                 

Acquisitions of facilities and other related equipment

                     (11)         (2)                 (13)   

Purchases of property and equipment

                     (199)         (42)                 (241)   

Proceeds from disposition of hospitals and other ancillary operations

                            58                 62   

Proceeds from sale of property and equipment

                                             

Purchases of available-for-sale securities

                     (22)         (37)                 (59)   

Proceeds from sales of available-for-sale securities

                     19         37                 56   

Increase in other investments

                     (30)         (9)                 (39)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash used in investing activities

                     (239)                        (231)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash flows from financing activities:

                 

Proceeds from exercise of stock options

     17                                         17   

Repurchase of restricted stock shares for payroll tax withholding requirements

     (20)                                         (20)   

Deferred financing costs and other debt-related costs

             (20)                                 (20)   

Redemption of noncontrolling investments in joint ventures

                             (7)                 (7)   

Distributions to noncontrolling investors in joint ventures

                             (23)                 (23)   

Changes in intercompany balances with affiliates, net

     13         77         (101)         11                   

Borrowings under credit agreements

             1,250                                1,251   

Proceeds from receivables facility

                             75                 75   

Repayments of long-term indebtedness

             (1,184)         (15)         (69)                 (1,268)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     10         123         (115)         (13)                  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net change in cash and cash equivalents

                     (331)         44                 (287)   

Cash and cash equivalents at beginning of period

                     368         141                 509   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash and cash equivalents at end of period

     $         $         $ 37         $ 185         $         $ 222   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read this discussion together with our unaudited condensed consolidated financial statements and the accompanying notes included herein.

Throughout this Quarterly Report on Form 10-Q, we refer to Community Health Systems, Inc., or the Parent Company, and its consolidated subsidiaries in a simplified manner and on a collective basis, using words like “we,” “our,” “us” and the “Company”. This drafting style is suggested by the Securities and Exchange Commission, or SEC, and is not meant to indicate that the publicly traded Parent Company or any particular subsidiary of the Parent Company owns or operates any asset, business or property. The hospitals, operations and businesses described in this filing are owned and operated, and management services provided, by distinct and indirect subsidiaries of Community Health Systems, Inc.

Executive Overview

We are one of the largest publicly traded hospital companies in the United States and a leading operator of general acute care hospitals in communities across the country. We provide healthcare services through the hospitals that we own and operate and affiliated businesses in non-urban and selected urban markets throughout the United States. We generate revenues by providing a broad range of general and specialized hospital healthcare services and other outpatient services to patients in the communities in which we are located. As of March 31, 2016, we owned or leased 194 hospitals included in continuing operations, comprised of 190 general acute care hospitals and four stand-alone rehabilitation or psychiatric hospitals. As of April 29, 2016, immediately following the completion of the spin-off of Quorum Health Corporation, or QHC, as discussed below, we owned or leased 157 hospitals included in continuing operations, comprised of 154 general acute care hospitals and three stand-alone rehabilitation or psychiatric hospitals. In addition to our hospitals and related businesses, we own and operate home care agencies, located primarily in markets where we also operate a hospital. Until the completion of the spin-off to QHC on April 29, 2016, as discussed below, we also provided management advisory and consulting services to non-affiliated general acute care hospitals located throughout the United States through our former subsidiary Quorum Health Resources, LLC, or QHR. For the hospitals and home care agencies that we own and operate, we are paid for our services by governmental agencies, private insurers and directly by the patients we serve. For our management advisory and consulting services, we are paid by the non-affiliated hospitals utilizing our services.

On August 3, 2015, we announced a plan to spin off 38 hospitals and QHR into QHC, an independent, publicly traded corporation. The transaction was structured to be generally tax free to us and our stockholders. On April 29, 2016, we completed the spin-off of these 38 hospitals and QHR into QHC and distributed, on a pro rata basis, all of the shares of QHC common stock to our stockholders of record as of April 22, 2016. These stockholders of record as of April 22, 2016 received a distribution of one share of QHC common stock for every four shares of our common stock held as of the record date plus cash in lieu of any fractional shares. Immediately following the completion of the spin-off, our stockholders owned 100% of the outstanding shares of QHC common stock. Following the spin-off, QHC became an independent public company with its common stock listed for trading under the symbol “QHC” on the New York Stock Exchange.

In connection with the spin-off, we entered into a separation and distribution agreement as well as certain ancillary agreements with QHC on April 29, 2016. These agreements allocate between QHC and us the various assets, employees, liabilities and obligations (including investments, property and employee benefits and tax-related assets and liabilities) that comprise the separate companies and govern certain relationships between, and activities of, QHC and us for a period of time after the spin-off.

On March 1, 2016, we completed the acquisition of an 80% ownership interest in a joint venture with Indiana University Health that includes IU Health La Porte Hospital in La Porte, Indiana and IU Health Starke Hospital in Knox, Indiana, and affiliated outpatient centers and physician practices.

On April 1, 2016, we completed the acquisition of 80% interest in Physicians’ Specialty Hospital (20 licensed beds), a Medicare-certified specialty surgical hospital in Fayetteville, Arkansas.

On April 29, 2016, we entered into a definitive agreement with Universal Health Services, Inc., or UHS, to sell our unconsolidated minority equity interests in Valley Health System LLC, a joint venture with UHS representing four hospitals in Las Vegas, Nevada, in which we own a 27.5% interest, and in Summerlin Hospital Medical Center LLC, a joint venture with UHS representing one hospital in Las Vegas, Nevada, in which we own a 26.1% interest. We will receive $445 million in cash from UHS in return for the sale of our equity interests in the second quarter of 2016.

 

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Operating results and statistical data for the three months ended March 31, 2016, exclude our hospitals that have previously been classified as discontinued operations for accounting purposes. In addition, during the year ended December 31, 2015, we divested seven hospitals previously recorded in discontinued operations and one additional hospital. Two of these hospitals were required to be divested by the Federal Trade Commission as a condition of its approval of our acquisition of Health Management Associates, Inc., or HMA, merger.

We are also in the process of negotiating with potential buyers to enter into definitive agreements to sell ten additional hospitals as well as our investment in certain non-hospital operations, and we currently expect those transactions to close during the third quarter of 2016; however, there can be no assurance that these dispositions will be completed or, if they are completed, the ultimate timing of the completion of these dispositions. These ten additional hospitals and non-hospital operations that have been targeted for sale represented approximately $1.0 billion of annual net operating revenues during 2015. These potential transactions, and transactions that have already been completed in 2016, are intended to further implement our strategy to divest of underperforming assets, reduce our debt and refine our portfolio to a more sustainable group of hospitals with higher operating margins. When consistent with this strategy, we may also consider additional hospitals for disposition.

Our net operating revenues for the three months ended March 31, 2016, increased $88 million to approximately $5.0 billion compared to approximately $4.9 billion for the three months ended March 31, 2015. Our provision for bad debts increased to $755 million, or 13.1% of operating revenues (before the provision for bad debts) for the three months ended March 31, 2016, from $735 million, or 13.0% of operating revenues (before the provision for bad debts) for the three months ended March 31, 2015.

We had income from continuing operations before noncontrolling interests of $37 million during the three months ended March 31, 2016, compared to $112 million for the three months ended March 31, 2015. Income from continuing operations before noncontrolling interests for the three months ended March 31, 2016 included an after-tax charge of $14 million for the impairment of long-lived assets and an after-tax charge of $2 million related to costs incurred for the spin-off of QHC. Income from continuing operations before noncontrolling interests for the three months ended March 31, 2015, included an after-tax charge of $5 million for loss from early extinguishment of debt, $1 million after-tax expense for acquisition and integration expenses from the HMA merger and an after-tax charge of $5 million for the government legal settlements for several qui tam matters settled in principle and related legal expenses. These after-tax charges were partially offset by an after-tax income of $4 million from fair value adjustments, net of legal expenses, related to the HMA legal proceedings underlying the CVR agreement. Consolidated inpatient admissions for the three months ended March 31, 2016, decreased 2.6%, compared to the three months ended March 31, 2015, and consolidated adjusted admissions for the three months ended March 31, 2016, increased 0.7%, compared to the three months ended March 31, 2015. Same-store inpatient admissions for the three months ended March 31, 2016, decreased 2.0%, compared to the three months ended March 31, 2015, and same-store adjusted admissions for the three months ended March 31, 2016, increased 1.3%, compared to the three months ended March 31, 2015.

Self-pay revenues represented approximately 12.3% and 12.6% for the three months ended March 31, 2016 and 2015, respectively. During 2015 and through the three months ended March 31, 2016, we experienced a decline in self-pay admissions and adjusted admissions resulting in a corresponding decline in self-pay revenues as a percentage of total net operating revenues. This decrease is reflective of an increase in Medicaid admissions and revenues, primarily in Medicaid expansion states, as a result of the implementation of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, collectively, the Reform Legislation. The reduction in self-pay admissions and revenue was also experienced in non-expansion states, although to a lesser degree. The amount of foregone revenue related to providing charity care services as a percentage of net operating revenues was approximately 2.3% and 2.2% for the three months ended March 31, 2016 and 2015, respectively. Direct and indirect costs incurred in providing charity care services were approximately 0.3% for both the three months ended March 31, 2016 and March 31, 2015.

The U.S. Congress and certain state legislatures have introduced and passed a large number of proposals and legislation designed to make major changes in the healthcare system, including changes that increased access to health insurance. The Reform Legislation mandates that substantially all U.S. citizens maintain medical insurance coverage and expands health insurance coverage through a combination of public program expansion and private sector health insurance reforms. Based on projections issued by the CBO in March 2016, the incremental insurance coverage due to the Reform Legislation could result in 24 million formerly uninsured Americans gaining coverage by the end of 2026.

 

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As the number of persons with access to health insurance in the United States increases, there may be a resulting increase in the number of patients using our facilities who have health insurance coverage. Prior to giving effect to the spin-off of QHC, we operated hospitals in eight of the 10 states that experienced the largest reductions in uninsured rates among adult residents between 2013 and 2015, and after giving effect to the spin-off of QHC, we continue to operate hospitals in five of such 10 states. Most of these states with the greatest reductions in the number of uninsured adult residents have established a health insurance exchange operated either by the state or in partnership with the federal government and also expanded Medicaid. However, states may opt out of the Medicaid coverage expansion provisions of the Reform Legislation without losing existing federal Medicaid funding. A number of states have opted out of the Medicaid coverage expansion provisions, but could ultimately decide to expand their programs at a later date. Of the 28 states in which we operated hospitals that were included in continuing operations as of March 31, 2016, 15 states have taken action to expand their Medicaid programs, including Louisiana, which is expected to implement Medicaid coverage expansion at some point in 2016. At this time, the other 13 states have not, including Florida, Tennessee and Texas, where we operated a significant number of hospitals as of March 31, 2016. Some states that have opted out are evaluating options such as waiver plans to operate an alternative Medicaid expansion plan. Failure to expand Medicaid or implement an effective alternative in these states will likely have a negative impact on the goal of reducing the number of uninsured individuals.

We believe our hospitals are well positioned to participate in the provider networks of various qualified health plans, or QHPs, offering plan options on the health insurance exchanges created pursuant to the Reform Legislation. For the 2016 plan year, all of our hospitals in continuing operations as of March 31, 2016 have arrangements to participate in at least one health insurance exchange agreement, approximately 90% of such hospitals participate in two or more contracts, approximately 87% of such hospitals participate in the first or second lowest cost bronze plan networks (QHPs with a 60% actuarial value) and approximately 90% of such hospitals participate in the first or second lowest cost silver plan networks (QHPs with a 70% actuarial value).

The Reform Legislation makes a number of changes to Medicare and Medicaid, such as reductions to the Medicare annual market basket update for federal fiscal years 2010 through 2019, a productivity offset to the Medicare market basket update, and a reduction to the Medicare and Medicaid disproportionate share hospital payments, each of which could adversely impact the reimbursement received under these programs.

The Reform Legislation includes provisions aimed at reducing fraud, waste and abuse in the healthcare industry. These provisions allocate significant additional resources to federal enforcement agencies and expand the use of private contractors to recover potentially inappropriate Medicare and Medicaid payments. The Reform Legislation amends several existing federal laws, including the Anti-Kickback Statute and the False Claims Act, to make it easier for government agencies and private plaintiffs to prevail in lawsuits brought against healthcare providers. These amendments also make it easier for potentially severe fines and penalties to be imposed on healthcare providers that violate applicable laws and regulations.

We believe the expansion of private sector health insurance and Medicaid coverage will, over time, increase our reimbursement related to providing services to individuals who were previously uninsured, which should reduce our expense from uncollectible accounts receivable. The various provisions in the Reform Legislation that directly or indirectly affect reimbursement take effect over a number of years. In addition, we believe that the Reform Legislation has had a positive impact on net operating revenues and income from continuing operations during 2015 and the three months ended March 31, 2016 as the result of the expansion of private sector and Medicaid coverage that has already occurred from the Reform Legislation, and we believe that the net impact of the Reform Legislation on our net operating revenues will continue to be positive. Other provisions of the Reform Legislation, such as requirements related to employee health insurance coverage, have increased and will continue to increase our operating costs.

Because of the many variables involved, including clarifications and modifications resulting from the rule-making process, legislative efforts to repeal or modify the law, future judicial interpretations resulting from court challenges to its constitutionality and interpretation, the development of agency guidance, whether and how many states ultimately decide to expand Medicaid coverage, the number of uninsured who elect to purchase health insurance coverage, budgetary issues at federal and state levels, and the potential for delays in the implementation of the Reform Legislation, it is difficult to predict the ultimate effect of the Reform Legislation. We may not be able to fully realize the positive impact the Reform Legislation may otherwise have on our business, results of operations, cash flow, capital resources and liquidity. Furthermore, we cannot predict whether we will be able to modify certain aspects of our operations to offset any potential adverse consequences from the Reform Legislation.

 

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Payment under the Medicare program for physician services, which is based upon the Medicare Physician Fee Schedule, or MPFS, changed in April 2015 with the enactment of the Medicare Access and CHIP Reauthorization Act of 2015, or MACRA. The law effectively eliminated a payment reduction that was scheduled for physicians and other practitioners who treat Medicare patients. MACRA provides for a 0.5% update to the MPFS for each calendar year through 2019. In addition, MACRA requires the establishment of the Merit-Based Incentive Payment System, or MIPS, beginning in 2019, under which physicians will receive performance-based payment incentives or payment reductions based on their performance with respect to clinical quality, resource use, clinical improvement activities, and meaningful use of electronic health records. MIPS will consolidate certain existing physician incentive programs, and also requires the Centers for Medicare and Medicaid Services, or CMS, to provide, beginning in 2019, incentive payments for physicians and other eligible professionals that participate in alternative payment models, such as accountable care organizations. In addition, MACRA extended the Medicare Inpatient Low Volume payment and Medicare Dependent Hospital programs to qualifying hospitals through September 30, 2017. If additional legislation is not passed to extend these Medicare hospital payment programs, we could experience a reduction in future reimbursement.

The federal government has implemented a number of regulations and programs designed to promote the use of electronic health records, or EHR, technology and pursuant to the Health Information Technology for Economic and Clinical Health Act, or HITECH, established requirements for a Medicare and Medicaid incentive payments program for eligible hospitals and professionals that adopt and meaningfully use certified EHR technology. These payments are intended to incentivize the meaningful use of EHR. Our hospital facilities have been implementing EHR technology on a facility-by-facility basis since 2011. We recognize incentive reimbursement related to the Medicare or Medicaid incentives as we are able to implement the certified EHR technology and meet the defined “meaningful use criteria,” and information from completed cost report periods is available from which to calculate the incentive reimbursement. The timing of recognizing incentive reimbursement does not correlate with the timing of recognizing operating expenses and incurring capital costs in connection with the implementation of EHR technology which may result in material period-to-period changes in our future results of operations.

As of October 1, 2014, eligible hospitals and, as of January 1, 2015, professionals that have not demonstrated meaningful use of certified EHR technology and have not applied and qualified for a hardship exception are subject to penalties. Eligible hospitals are subject to a reduced market basket update to the inpatient prospective payment system standardized amount as of 2015 and for each subsequent fiscal year. Eligible professionals are subject to a 1% per year cumulative reduction applied to the Medicare physician fee schedule amount for covered professional services, subject to a cap of 5%.

Although we believe that our hospital facilities are currently in compliance with the meaningful use standards, there can be no assurance that all of our facilities will remain in compliance and therefore not be subject to the HITECH penalty provisions. We recognized approximately $18 million and $26 million during the three months ended March 31, 2016 and 2015, respectively, for HITECH incentive reimbursements from Medicare and Medicaid related to certain of our hospitals and for certain of our employed physicians, which are presented as a reduction of operating expenses.

As a result of our current levels of cash, available borrowing capacity, long-term outlook on our debt repayments, the refinancing of our term loans and our continued projection of our ability to generate cash flows, we anticipate that we will be able to invest the necessary capital in our business over the next twelve months. We believe there continues to be ample opportunity for growth in substantially all of our markets by decreasing the need for patients to travel outside their communities for healthcare services. Furthermore, we continue to benefit from synergies from our acquisitions and will continue to strive to improve operating efficiencies and procedures in order to improve our profitability at all of our hospitals.

 

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Sources of Revenue

The following table presents the approximate percentages of operating revenues, net of contractual allowances and discounts (but before provision for bad debts), by payor source for the periods indicated. The data for the periods presented are not strictly comparable due to the effect that hospital acquisitions have had on these statistics.

 

                                                                   
                 Three Months Ended             
March 31,
 
     2016      2015  

Medicare

     24.9 %             24.8 %       

Medicaid

     10.3                 10.4           

Managed Care and other third-party payors

     52.5                 52.2           

Self-pay

     12.3                 12.6           
  

 

 

    

 

 

 

Total

     100.0 %             100.0 %       
  

 

 

    

 

 

 

As shown above, we receive a substantial portion of our revenues from the Medicare and Medicaid programs. Included in Managed Care and other third-party payors is operating revenues from insurance companies with which we have insurance provider contracts, Medicare managed care, insurance companies for which we do not have insurance provider contracts, workers’ compensation carriers and non-patient service revenue, such as rental income and cafeteria sales. In the future, we generally expect revenues received from the Medicare and Medicaid programs to increase due to the general aging of the population. In addition, the Reform Legislation has increased and is expected to continue to increase the number of insured patients in states that have expanded Medicaid, which in turn, has reduced and is expected to continue to reduce the percentage of revenues from self-pay patients. The Reform Legislation, however, imposes significant reductions in amounts the government pays Medicare managed care plans. The trend toward increased enrollment in Medicare managed care may adversely affect our operating revenue growth. Other provisions in the Reform Legislation impose minimum medical-loss ratios and require insurers to meet specific benefit requirements. Furthermore, in the normal course of business, managed care programs, insurance companies and employers actively negotiate the amounts paid to hospitals. The trend toward increased enrollment in managed care may adversely affect our operating revenue growth. There can be no assurance that we will retain our existing reimbursement arrangements or that these third-party payors will not attempt to further reduce the rates they pay for our services.

Net operating revenues include amounts estimated by management to be reimbursable by Medicare and Medicaid under prospective payment systems and provisions of cost-based reimbursement and other payment methods. In addition, we are reimbursed by non-governmental payors using a variety of payment methodologies. Amounts we receive for the treatment of patients covered by Medicare, Medicaid and non-governmental payors are generally less than the standard billing rates. We account for the differences between the estimated program reimbursement rates and the standard billing rates as contractual allowance adjustments, which we deduct from gross revenues to arrive at net operating revenues. Final settlements under some of these programs are subject to adjustment based on administrative review and audit by third parties. We account for adjustments to previous program reimbursement estimates as contractual allowance adjustments and report them in the periods that such adjustments become known. Contractual allowance adjustments related to final settlements and previous program reimbursement estimates impacted net operating revenues and net income by an insignificant amount in each of the three months ended March 31, 2016 and 2015.

The payment rates under the Medicare program for hospital inpatient and outpatient acute care services are based on a prospective payment system, depending upon the diagnosis of a patient’s condition. These rates are indexed for inflation annually, although increases have historically been less than actual inflation. On August 17, 2015, CMS published the final rule to increase this index by 2.4% for hospital inpatient acute care services that are reimbursed under the prospective payment system, beginning October 1, 2015. The final rule also makes other payment adjustments that, coupled with the 0.8% reduction for documentation and coding, a 0.5% multifactor productivity reduction, and a 0.2% reduction to hospital inpatient rates implemented pursuant to the Reform Legislation, yielded an estimated net 0.9% increase in reimbursement for hospitals. For fiscal year 2016, an additional reduction applies to hospitals that do not submit required patient quality data. We are complying with this data submission requirement.

 

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Payments may also be affected by admission and medical review criteria for inpatient services commonly known as the “two midnight rule.” Under the rule, for admissions on or after October 1, 2013, services to Medicare beneficiaries are only payable as inpatient hospital services when there is a reasonable expectation that the hospital care is medically necessary and will be required across two midnights, absent unusual circumstances. Stays expected to need less than two midnights of hospital care are subject to medical review on a case-by-case basis. Enforcement through Recovery Audit Contractor audits is expected to begin in 2016. Reductions in the rate of increase or overall reductions in Medicare reimbursement may cause a decline in the growth of our net operating revenues.

Currently, several states utilize supplemental reimbursement programs for the purpose of providing reimbursement to providers to offset a portion of the cost of providing care to Medicaid and indigent patients. These programs are designed with input from CMS and are funded with a combination of state and federal resources, including, in certain instances, fees or taxes levied on the providers. Similar programs are also being considered by other states. The programs are generally authorized for a specified period of time and require CMS’s approval to be extended. CMS has indicated that it will take into account a state’s status with respect to expanding its Medicaid program in considering whether to extend these supplemental programs. We are unable to predict whether or on what terms CMS will extend the supplemental programs in the states in which we operate, including Texas. Some of these programs are scheduled to expire in 2016. As a result of existing supplemental programs, we recognize revenue and related expenses in the period in which amounts are estimable and collection is reasonably assured. Reimbursement under these programs is reflected in net operating revenues and included as Medicaid revenue in the table above, and fees, taxes or other program related costs are reflected in other operating expenses.

Results of Operations

Our hospitals offer a variety of services involving a broad range of inpatient and outpatient medical and surgical services. These include general acute care, emergency room, general and specialty surgery, critical care, internal medicine, obstetrics, diagnostic services, psychiatric and rehabilitation services. The strongest demand for hospital services generally occurs during January through April and the weakest demand for these services occurs during the summer months. Accordingly, eliminating the effect of new acquisitions, our net operating revenues and earnings are historically highest during the first quarter and lowest during the third quarter.

The following tables summarize, for the periods indicated, selected operating data.

 

                                                       
             Three Months Ended        
March  31,
 
     2016      2015  

Consolidated:

     

Net operating revenues

     100.0 %           100.0 %     

Operating expenses (a)

     (87.8)              (85.9)        

Depreciation and amortization

     (6.0)              (6.0)        

Impairment of long-lived assets

     (0.3)              -         
  

 

 

    

 

 

 

Income from operations

     5.9               8.1         

Interest expense, net

     (5.0)              (4.9)        

Loss from early extinguishment of debt

     -               (0.2)        

Equity in earnings of unconsolidated affiliates

     0.4              0.4         
  

 

 

    

 

 

 

Income from continuing operations before income taxes

     1.3               3.4         

Provision for income taxes

     (0.6)              (1.1)        
  

 

 

    

 

 

 

Income from continuing operations

     0.7               2.3         

Loss from discontinued operations, net of taxes

     -               (0.3)        
  

 

 

    

 

 

 

Net income

     0.7               2.0         

Less: Net income attributable to noncontrolling interests

     (0.5)              (0.4)        
  

 

 

    

 

 

 

Net income attributable to Community Health Systems, Inc. stockholders

     0.2 %           1.6 %     
  

 

 

    

 

 

 

 

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Table of Contents
             Three Months Ended        
March 31, 2016
 

Percentage increase (decrease) from same period prior year:

  

Net operating revenues

     1.8 %     

Admissions

     (2.6)        

Adjusted admissions (b)

     0.7         

Average length of stay

     (2.2)        

Net income attributable to Community Health Systems, Inc. (c)

     (86.1)        

Same-store percentage increase (decrease) from same period prior year (d):

  

Net operating revenues

     2.2 %     

Admissions

     (2.0)        

Adjusted admissions (b)

     1.3         

 

(a) Operating expenses include salaries and benefits, supplies, other operating expenses, government settlement and related costs, electronic health records incentive reimbursement and rent.
(b) Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by multiplying admissions by gross patient revenues and then dividing that number by gross inpatient revenues.
(c) Includes loss from discontinued operations.
(d) Includes acquired hospitals to the extent we operated them in both periods and excludes our hospitals that have previously been classified as discontinued operations for accounting purposes.

Three Months Ended March 31, 2016 Compared to Three Months Ended March 31, 2015

Net operating revenues increased by 1.8% to approximately $5.0 billion for the three months ended March 31, 2016, from approximately $4.9 billion for the three months ended March 31, 2015. Our provision for bad debts increased to $755 million, or 13.1% of operating revenues (before the provision for bad debts) for the three months ended March 31, 2016, from $735 million, or 13.0% of operating revenues (before the provision for bad debts) for the three months ended March 31, 2015. Net operating revenues from hospitals owned throughout both periods increased $106 million or, 2.2% during the three months ended March 31, 2016, as compared to the three months ended March 31, 2015. Non-same-store net operating revenues decreased $17 million during the three months ended March 31, 2016, in comparison to the prior year period. The increase in same-store net operating revenues was attributable to favorable changes in payor mix with corresponding reductions in charity care and self-pay discounts as a percentage of revenue. On a consolidated basis, inpatient admissions decreased by 2.6% and adjusted admissions increased by 0.7% during the three months ended March 31, 2016 as compared to the three months ended March 31, 2015. On a same-store basis, net operating revenues per adjusted admissions increased 0.8%, while inpatient admissions decreased by 2.0% and adjusted admissions increased by 1.3% during the three months ended March 31, 2016 as compared to the three months ended March 31, 2015.

Operating expenses as a percentage of net operating revenues increased from 91.9% during the three months ended March 31, 2015 to 94.1% during the three months ended March 31, 2016. Operating expenses, excluding depreciation and amortization and impairment of long-lived assets, as a percentage of net operating revenues, increased from 85.9% for the three months ended March 31, 2015 to 87.8% for the three months ended March 31, 2016. Salaries and benefits, as a percentage of net operating revenues, increased from 46.0% for the three months ended March 31, 2015 to 46.3% for the three months ended March 31, 2016. This increase in salaries and benefits, as a percentage of net operating revenues, was primarily due to annual merit increases and increases in physician employment. Supplies, as a percentage of net operating revenues, increased from 15.5% for the three months ended March 31, 2015 to 16.0% for the three months ended March 31, 2016, primarily as a result of an increase in drug and implant costs over the same period in the prior year. Other operating expenses, as a percentage of net operating revenues, increased from 22.4% for the three months ended March 31, 2015 to 23.5% for the three months ended March 31, 2016. This increase in other operating expenses, as a percentage of net operating revenues, was primarily impacted by higher costs for outsourced services for housekeeping and dietary services, information systems maintenance, property tax increases, and higher contract labor at our hospitals and ancillary facilities. Government settlement and related costs, as a percentage of net revenues decreased from 0.1% for the three months ended March 31, 2015 to less than 0.1% for the three months ended March 31, 2016. Rent, as a percentage of net operating revenues, was 2.4% for each of the three months ended March 31, 2016 and the three months ended March 31, 2015.

 

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