Late News: Sour earnings report

Community Health Systems' earnings preview—which showed larger-than-expected drops in patient volume and net income—may set the stage for a difficult quarter going into earnings season for publicly traded hospital operators. Those difficulties may be heightened by ongoing federal investigations into Community and another large hospital operator, Health Management Associates.

Franklin, Tenn.-based Community on July 18 braced investors for earnings results that are expected to show a 57.2% decline in net income, which it attributed to weak patient volume, higher-than-expected bad debt and an adverse payer mix.

It also said the U.S. Justice Department had handed down an additional subpoena as well as a request to interview two high-ranking executives as part of its two-year investigation into the company's admissions practices.

The admissions numbers—a 5.7% drop in same-facility admissions and a 2.6% decline in adjusted same-facility admissions, a number that includes outpatient activity—came just days after HCA, the country's largest hospital chain, surprised Wall Street with an upbeat earnings preview that surpassed expectations for volume and net income.

“I think HCA will be your outlier,” said Brian Tanquilut, an analyst at Jefferies & Co. “HCA has differentiated themselves from everyone else.”

Tanquilut noted that some of the difference may be because of HCA's urban focus compared with Community's more rural focus. He added that HCA offers a greater number of ancillary services. “I think having a lot of side businesses basically opens up a lot of referral opportunities,” he said.

HCA has also “made a very concerted effort to cut costs,” said Tom Gallucci, an analyst at Lazard Capital Markets. “It sounded like that worked out very well to their benefit.”

Community said it expects to report

$65 million in net income on revenue of $3.2 billion for the second quarter, compared with net income of $151.7 million on revenue of about $3.2 billion during the same period last year. It is scheduled to report earnings July 29.

The government opened its investigation into Community's admissions practices in April 2011, after Tenet Healthcare Corp.—in an attempt to thwart a takeover attempt—accused Community of improperly using short-stay admissions instead of observation.

The latest subpoena came on July 9, shortly after the second of two meetings that Community held this year with the Justice Department.

But the feds want more documents supporting Community's position, requesting for instance its criteria for observation status and its financial relationships with physicians who have admitting privileges, the company said.

Justice also served “civil investigative demands” to interview two current employees, a division president and a senior vice president, according to the company. Community said it would cooperate with the government's investigation.

HMA, Naples, Fla., is also under investigation into its short-stay admissions practices, and received similar subpoenas in May and July 2011. The company used the same emergency department management software as Community.

The investigation has been one of the ongoing issues that hedge fund Glenview Capital Management has raised in its campaign to unseat HMA's current board of directors and install nominees who may be more receptive to a takeover.

While Community is rumored to be the lead suitor for a potential tie-up with HMA, the company said in its earnings preview that the negative second-quarter results have “intensified its focus on core operating strategies, volume initiatives and expense management”—which will likely heighten speculation about whether it has the focus and firepower for a deal.

But Tanquilut said he thought Community's troubles might offer more incentive for the company to seek out the synergies a strategic transaction would offer. “It's going to prompt them to do a deal—I'm in that camp,” he said. “The only concern I have is financing.”

Scott Becker, a healthcare attorney at McGuireWoods, noted that Community has a “pretty driven” leader in President and CEO Wayne Smith, and the company—like Tenet, which recently scooped up Vanguard Health Systems in a $4.3 billion deal—is in “growth mode.” Federal investigations, he said, aren't necessarily a hurdle. “The larger the company, the less it will hold up a deal.”

Glenview, for its part, is moving forward with its consent solicitation process to replace HMA's current board.

The hedge fund said on its Revitalize HMA website that its nominees have met three times in the past several weeks “to establish committee structures and a transition plan to foster quality of care and continuity.” The group also tapped turnaround firm Alvarez & Marsal to conduct a review of HMA's operations.

Follow Beth Kutscher on Twitter: @MHbkutscher