Carilion Clinic is losing and borrowing millions as it converts from a hospital to a clinic system.

Construction and recruiting physicians to support the changes has taken a toll on Carilion's bottom line.

That -- combined with other expansion projects, a down economy and a volatile market -- has Southwest Virginia's largest hospital system reporting a $39.7 million loss for the first six months of the fiscal year.

For the same period of last year, Carilion posted a net income of $72.4 million, according to documents released Thursday to The Roanoke Times.

"We budgeted to break even but cautioned everybody that there are a lot of unknowns," said Don Lorton, Carilion's chief financial officer.

Carilion posted $63.5 million in net income for the fiscal year ended Sept. 30, 2007, as spending for the clinic model ramped up.

Lorton said he is not concerned about the midyear results and that Carilion will likely post a loss for the year.

"I'm still very positive we'll get all this figured out and we'll be in a good position," he said.

The midyear financial update came after Carilion borrowed $160 million with the release of two bond series last month.

Hospital revenue bonds worth $50 million and $110 million were issued July 1 for Carilion through the Virginia Small Business Financing Authority. Of the $160 million, Carilion has already spent $52 million, according to a bond prospectus dated July 8.

The borrowed money is slated to help with numerous capital improvement projects, including the construction of the new 250,000-square-foot physician clinic building under way at the corner of Reserve Avenue and Jefferson Street.

Other projects are unrelated to the clinic conversion, including renovation and construction at Carilion New River Valley Medical Center and building a replacement hospital in Pearisburg for Carilion Giles Memorial Hospital.

While revenues are up, expenses have outpaced the gains and left Carilion with an operating loss of $4.8 million for the fiscal year's first six months, which ended March 31, according to the unaudited consolidated financial statement.

"About half of that is attributable to the clinic conversion," Lorton said. "Charity and bad debts are also up from the prior year as we continue to see growth in the number of uninsured and continue to see employers put in place more high-deductible plans."

The bond prospectus provided different financial results, which showed a larger net loss but a slight operating gain for the period. Those figures, however, only represented a portion of Carilion's holdings, Lorton said, whereas the information provided by the clinic reflected all operations.

Carilion reported total patient revenues grew 9 percent to $1.15 billion for the fiscal year's first six months, which ended March 31.

Lorton attributed the uptick in revenues to a 4.4 percent increase in inpatient volumes at Carilion Roanoke Memorial Hospital through March.

"Given the slow population growth around here, that's a big increase," Lorton said. "That may be the largest increase we've seen, and the trend has continued through June."

Taking into consideration deductions for charity care and payer contracts, Carilion posted total revenues of $605.4 million.

But those significant gains are not enough to cover Carilion's expenses, which are up 16 percent from the same six-month period last year because of an increase in charity care and the cost of hiring more physicians and support staff.

Fueled in part by a 16 percent increase in salaries and outside labor costs, Carilion reported $609.8 million in expenses for the first six months. An additional $373,000 loss was reported in nonrecurring items and prior period adjustments.

Since announcing the eight-year transformation plan in June 2006, Carilion has spent an estimated $80 million on the plan, according to the bond prospectus.

That is more than halfway to the $100 million to $125 million officials estimated the conversion to a clinic model would cost.

"A lot of that cost is front-loaded throughout the eight years because of recruiting and building," said Carilion spokesman Eric Earnhart.

Having already recruited about 150 new physicians as part of the transformation, Lorton said Carilion officials are a little ahead of where they had thought they would have been two years into the process.

"It's one of those things that the better the pace of the transition, the worse it is for our short-term financials," Lorton said.

The biggest financial hit, however, isn't associated with the clinic but with the economy. For the first six months of the year, Carilion has seen major losses in its nonoperating income associated with investments.

An accounting requirement that marks long-term debt to market rates has resulted in Carilion reporting a $19.9 million loss. Additionally, Carilion has lost nearly another $15 million in other investments.

Still, Lorton said he thinks Carilion is well-positioned to handle the current market volatility.

"We feel pretty good about our investment strategy," he said. "A couple of years ago we made some changes to minimize the downside risk without giving up the upside gains. We worked hard to come up with a good asset allocation that protects us."