Fitch Ratings Affirms Heartland Health (Missouri) Bonds at ‘A’; Outlook Stable

Fitch Ratings has affirmed the underlying ‘A’ rating on the Industrial Development Authority of St. Joseph, Missouri’s outstanding $142.8 million health facilities revenue bonds issued on behalf of Heartland Health (Heartland). The outstanding bonds are insured by Ambac Assurance Corp. (Insurer financial strength rated ‘AAA’ by Fitch.) The Rating Outlook is Stable.

The underlying rating reflects Heartland’s dominant market position, solid operating profitability and debt service coverage, manageable debt burden, and positive trend in strengthening liquidity. As a sole community provider, Heartland garnered a very strong 83.7% primary service area market share in 2005 (the most recently available year-end numbers). Heartland’s sole community provider designation resulted in a net financial impact of $20.7 million in fiscal-year (FY) 2006 and is expected to net $16 million in FY2007 (volume dependent).

On a consolidated basis, operating profitability declined for the nine-month interim period ending March 31, 2007, with income from operations equaling $6.1 million (2.2% operating margin), down from the $16.6 million (3.9% operating margin) at fiscal year end June 30, 2006. However, earnings before interest, depreciation and amortization (EBIDA) margins were a strong 14.6% at March 31, 2007 and 12.5% at June 30, 2006, both above Fitch’s ‘A’ rated median of 12%.

The operating income decline is principally attributed to losses from Heartland’s owned health plan. After three years of positive net income results, the health plan booked an operating loss of $1.7 million in FY2006 and a $3 million loss for the nine-month interim period ending March 31, 2007. In FY2006, Heartland had a substantial decrease in participation in providing coverage for the Missouri Consolidated Healthcare Plan (health benefit plan for state employees and their dependents); resulting in declining premiums while incurring increased medical claim costs. Management expects this experience to continue matriculating through the plan and should ease in fiscal year 2008 resulting in a break-even operating income for the health plan.

Solid operating profitability lead to a healthy 5.4 times (x) maximum annual debt service (MADS) coverage for the nine months ending March 31, 2007 and 5.3x MADS coverage at June 30, 2006, both above Fitch’s ‘A’ median of 3.9x. At June 30, 2006, days cash on hand and cash-to-debt were 158.5 days and 108.7%, respectively, which were below Fitch ‘A’ rated medians of 188.6 days and 111.1%, respectively. However, at nine months ended March 31, 2007, these ratios moved more towards the ‘A’ rated medians as days cash on hand improved to 185.3 days and cash-to-debt improved to 118.0%. Heartland also has a manageable debt burden, as measured by its low 2.4% MADS as a percentage of revenue and 2.7x debt-to-EBITDA at June 30, 2006.

A noted concern in the past has been Heartland’s under funded defined benefit pension plan (the plan was frozen in 2001). Management has aggressively addressed this issue and funded $7.2 million at June 30, 2006 and plans an additional $7.2 million of funding for June 30, 2007; bringing the funded status on an accumulated benefit obligation (ABO) basis to 77% and 90% respectively. Heartland expects to continue to fund the plan at necessary levels to have the plan fully funded by 2012.

Concerns include Heartland’s decrease in operating income compared with historical experience; due in large part to losses on Heartland’s owned health plan, continued losses on employed physicians, and those concerns typical of sole community providers: a medical staff with concentrated referral patterns, the continuing ability to attract physicians, flat population trends, and a payor mix weighted toward governmental payors. Losses on employed physicians, while improving, remain high at $182,000.

Although little population growth is expected over the near term in Heartland’s primary service area, the growth in the secondary service area may help bolster future volumes. Heartland’s secondary service area is realizing some marginal population growth, especially in Platte County, Missouri – which has the second highest median household income levels in the state.

The Stable Rating Outlook is based on Fitch’s belief that Heartland will continue to generate positive operating margins, given its dominant market share and strong management practices. Heartland has no immediate debt plans but may consider issuing additional debt in 2008 or 2009 to build out the shelled space in the new patient tower which was completed in 2005.

Heartland Health is a comprised of Heartland Regional Medical Center (HRMC), a 350-operated bed hospital located in St. Joseph, MO; Community Health Plan; Community Health Insurance Company; Midwestern Health Management & Subsidiary; and HHS Properties. HRMC is the obligated entity and comprised 98% of total consolidated entity revenue of $425.6 million in fiscal 2006. Heartland covenants to provide annual and quarterly disclosure to bondholders. Quarterly disclosure includes a balance sheet, income statement, and utilization statistics.

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