Fitch Affs Rex Healthcare, NC $112.9MM Ser 1998 Bnds 'A+'.

Business Editors

NEW YORK--(BUSINESS WIRE)--Feb. 20, 2004

Fitch Ratings affirms the 'A+' rating on the North Carolina Medical Care Commission's roughly $112.9 million hospital revenue bonds (Rex Healthcare, Inc.), series 1998. The Rating Outlook is Stable.

The 'A+' rating affirmation is based on Rex Healthcare Inc.'s (RHI) credit strengths, which include its strong financial operations and improving balance sheet, and its affiliation with the University of North Carolina Health System (UNCH). Credit risks include a slowly declining market share, a competitive provider service area, and higher than average days in accounts receivable. Also factored into the rating is RHI's status as a controlled affiliate of UNCH, which is owned by the State of North Carolina. Under the April 2000 merger, RHI continues to operate as a separate, private, not-for-profit entity and retains its separate identity. Additionally, RHI and UNCH remain independently obligated on their respective debt, though UNC provides many services for RHI.

Expense reductions in 2001 and 2002 via divesting from unprofitable service lines, largely RHI's former employed-physician groups, has led to strong operating margins in 2002 and 2003, of 6.6% and 4.5%, respectively, despite generally unfavorable third party reimbursements. RHI also divested from other unprofitable services, including adult day care, sports medicine, and home health programs. RHI has not used nurse agency labor in recent years and its physician relationships are good. Additionally, excess margins of 4.4%, 6.3% and 6.6% from fiscal 2001-2003 have permitted RHI to cash-fund capital projects while simultaneously building cash balances from 135 days at fiscal year-end 2001 to 164 days at Dec. 31, 2003. In July 2003, RHI opened a wholly-owned outpatient surgery center in Cary, NC, due to high demand for outpatient services.

Driven largely by the outpatient surgery expansion, RHI expects $42 million in additional revenue for its 2004 budget, and projects a net income of $22 million. Debt service coverage of maximum annual debt service (MADS) was 3.6 times in both 2002 and in 2003. Fitch's assessment of MADS for RHI is $12.8 million, inclusive of non-cancelable operating leases.

Credit risks include the very competitive environment in the Raleigh-Durham-Chapel Hill service area and flat-to-declining inpatient utilization trends. RHI's inpatient market share has decreased from 38% in 1993 to roughly 32% in 2002 and in 2003. RHI's chief competitor, the Wake County Hospital System, has a 50% market share in Wake County (RHI's primary service area), and is stable. At Dec. 31, 2003, RHI had 71 days in accounts receivable (A/R), which is higher than Fitch's 'A' median average, but lower than RHI's historical days in A/R.

In April 2000 RHI and UNCH finalized the merger agreement, making RHI part of UNCH. The merger is meant to complement and expand existing services offered by RHI and UNCH, as well as enhance the abilities of both organizations to serve patients. UNCH transferred $25 million to RHI via the independent John Rex Endowment for this merger, and agreed to fund $58 million of RHI's capital expenses through April 2010. While RHI remains obligated to its debt only, UNCH controls RHI's board of directors, reviews and approves RHI's operating and capital budget, and negotiates RHI's managed care contracts.

RHI operates a 394-licensed bed acute care tertiary hospital and two convalescent care centers with a total of 247 beds in Raleigh and Apex, NC. UNC Health Care System operates a 684-bed academic medical center located in Chapel Hill, NC. The obligated group accounted for 98% of RHI's total assets and 97% of RHI's total revenue in fiscal 2003. RHI's total operating revenue in 2003 was $313 million. Neither UNCH nor RHI have a separate audit committee, and Ernst & Young has been RHI's auditor since 2003. RHI disclosure is quarterly and is covenanted in its loan agreement. The series 1998 bonds were underwritten by Salomon Smith Barney, now part of Citigroup. Final maturity of the bonds is 2023.