The Rating Outlook is Stable.
Gross revenue pledge of the obligated group.
KEY RATING DRIVERS
STRONG OPERATING PLATFORM: Sutter is a large system with a concentrated geographic presence in Northern California. Its physician alignment strategies, Epic implementation, and recent formation of a health plan should position the organization well as it focuses on transitioning from the fee for service model to total cost of care.
SIZABLE SYSTEM TRANSFORMATION INVESTMENTS: Sutter is investing in support function consolidation, care management initiatives, and a health plan, which is expected to enhance performance, lower its cost structure, and transform healthcare delivery across the system. Profitability is expected to be pressured over the near term due to these one-time costs, but these investments are projected to improve cash flow over the longer term.
WEAKER PROFITABILITY IN FISCAL 2013: Sutter's operating performance declined in fiscal 2013 with weak operating cash flow for the rating level. However, adjusting for one-time items, cash flow is improved but still down compared to historical performance.
GOOD FISCAL MANAGEMENT: Sutter has historically had weaker liquidity metrics compared to Fitch's AA category medians, however, management has a long standing philosophy of deploying its free cash flow into capital investments and fully funding its pension plan, which otherwise would have increased days cash on hand. Despite this, days cash on hand have improved year over year. In addition, Sutter maintains a 100% fixed rate debt profile.
LARGE CAPITAL PLAN: Sutter has significantly invested in capital mainly driven by state seismic requirements and the majority of its large scale hospital replacements are complete or near complete. The only major projects remaining are for the
FINANCIAL FLEXIBILITY: Despite weaker performance in fiscal 2013, Fitch believes Sutter has financial flexibility at its rating level due to its size and scale and views Sutter's strategic investments favorably, which should further differentiate the organization in the changing healthcare industry.
System Transformation Investments
Sutter's operating platform is designed to leverage its large regional market presence together with a strong physician alignment strategy to yield a robust and diverse revenue source. The organization is preparing for anticipated changes to the delivery and financing of healthcare, where Sutter is expected to be accountable for patient clinical outcomes, service experience and overall cost of care. To these ends, Sutter is undertaking significant investments to fund several system initiatives targeting the organization's healthcare delivery models and business support functions. These one-time investments, totaling
In addition, Sutter just started its health plan operations and currently has a small membership with gradual growth plans. The health plan is not participating in the exchanges and is currently being offered in certain regions in its infancy stage. Fitch views management's actions positively and believes these investments should allow the system to better coordinate and deliver care in the most cost effective setting, strengthen its competitive position, and prepare it to manage population health.
Weak Profitability in Fiscal 2013
Sutter posted an operating loss in fiscal 2013 and weaker operating cash flow margins due to several one-time items. Operating margin was negative 0.3% in fiscal 2013 compared to 5.6% in fiscal 2012 and operating EBITDA margin dropped to 6.8% from 11.3% the prior year. The major one-time items include expenses related to system strategic investments and information technology, as well as an
Based on first quarter 2014 performance, management expects to end the year with performance similar to fiscal 2013 without the one-time items, which Fitch believes is attainable.
Fitch notes that similar to many
Large Capital Plan
Sutter has spent a considerable amount of capital with major hospital replacements complete or near complete in each region except for
Future projected capital spending totals approximately
The debt burden is moderate with MADS accounting for 2.4% of fiscal 2013 revenue. Fitch notes that Sutter's debt service coverage calculation includes unrealized gains/losses on investments. MADS coverage per Fitch's calculation (excluding unrealized gains/losses on investments) was 3.4x in fiscal 2013 compared to 4.9x in fiscal 2012 and 5.8x in fiscal 2011 and the AA category median of 5x. Without the one-time items in fiscal 2013, MADS coverage improves to 4.8x.
Sutter covenants to provide annual disclosure within 180 days of fiscal year end. Sutter will provide quarterly disclosure within 75 days of quarter end for the first three quarters at the request of a bondholder. Annual and quarterly disclosure has been available on Municipal Rule Making Board's EMMA system.
Fitch has affirmed the following
Additional information is available at 'www.fitchratings.com'.
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
Source: Fitch Ratings
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