S&P revises Rural/Metro outlook to negative
(The following statement was released by the rating agency) Overview
-- U.S. emergency transport services provider Rural/Metro announced very weak EBITDA for the June 2012 quarter, well below our expectations, driven by a significant charge for uncollectible receivables.
-- Cash flow is also negative for fiscal-year 2012, whereas we had been expecting modest positive cash flow.
-- We are revising our outlook to negative, reflecting delays in achieving the run-rate EBITDA that we had expected and persistently high leverage. We are affirming our 'B' corporate credit rating.
-- The negative outlook reflects increased potential that cash flows will not improve at a pace that will allow the company to reduce borrowings under its revolving credit facility in fiscal-year 2013.
Rating Action On Oct. 4, 2012, Standard & Poor's Ratings Services revised its outlook on Scottsdale, Ariz.-based Rural/Metro Corp. to negative. The revision reflects weaker earnings and cash flow, prompting higher borrowings on its revolving credit and leading to very weak debt protection measures. We had expected these measures to improve. The revision is also based on ongoing cash outflows resulting from weaker earnings, prolonged AR collection, and higher capital spending than anticipated. We also revised our liquidity assessment to "less than adequate," reflecting cash outflows and prospects for diminished covenant headroom.
The rating reflects a "highly leveraged" financial risk profile (according to our criteria). This is attributable to thin cash flows and very high debt to EBITDA in excess of 7x. Additionally, bank-defined EBITDA will not add back the addition of reserves to cover uncollectible receivables, adversely affecting cushions against covenants. The rating also reflects a "weak" business risk profile, given its narrow market focus providing emergency transport and limited geographic operation. Rural/Metro is a national emergency transport provider, with some concentration in California and the Southwest.
We expect that discretionary cash flow will be very modestly positive for the 2013 fiscal year and that leverage will only decline slightly, likely ending the year still over 7x. Rural/Metro's EBITDA generation since its leveraged buyout transaction in June 2011 only reached the level we expected in the March 2012 quarter. Our earnings expectations were further hampered by the June 2012 announcement that a sizable adjustment was made to the calculation of uncollectible receivables. We now expect the company to generate about the same level of EBITDA in fiscal-year 2013 (ending June) that we originally expected for fiscal-year 2012, despite acquisitions and new contracts. (We calculate EBITDA largely as reported.) We are not expecting much improvement because weaker receivable collectability has eroded ongoing levels of profitability. Cash flows also continue to lag as a result of ongoing slow receivable collection, higher capital spending, and weaker earnings. Rural/Metro had $30 million in borrowings outstanding under its $110 million revolving credit facility as of June, boosting leverage to over 7x.
We view Rural/Metro's business risk as weak. Despite its position as one of the largest commercial providers of medical transport services, with good growth in emergency transports, the company operates in a highly fragmented industry with less than 10% market share, has higher uncompensated care than many health care providers, and faces third-party reimbursement risk. Rural/Metro receives about 60% of its revenues from Medicare and Medicaid and 34% from commercial insurance. Rural/Metro has some geographic concentration, with the majority of its EBITDA generated in four states. The company generally contracts with government entities, hospitals, nursing homes, and other health care facilities to provide emergency and nonemergency medically necessary ambulance transportation. Rural/Metro also provides fire protection services to residential and commercial property owners (less than 13% of revenues).
We expect uncompensated care to remain a credit factor in fiscal-year 2013 and beyond. Despite steps to reduce uncompensated care and improve cash collections, such as access to electronic medical records in ambulances, levels of uncompensated care have increased modestly. Higher levels of uncompensated care are also contributing to shortfalls in earnings and cash flow.
Once recent acquisitions are fully annualized, we expect debt to EBITDA will remain over 7x through fiscal-year 2013. Given cash flow generation that is below expectations, we do not envision significant debt reduction in the near term. Over time, gradually expanding EBITDA levels could modestly strengthen leverage. These factors underpin our highly leveraged financial risk profile.
Rural/Metro's liquidity is less than adequate, with sources of cash likely to very modestly exceed uses for the next 12 to 24 months. Cash sources include $40 million available under the $110 million revolving credit facility (accounting for about $45 million of letters of credit and $30 million outstanding as of June 30, 2012), and about $30 million of expected annual funds from operations for fiscal-year 2013. We expect cash uses to include capital expenditures of about $20 million in fiscal-year 2013. While working capital has been a use of funds through June 2012, we expect a reversal by the first half of fiscal-year 2013 and minimal working capital investment thereafter. Our assessment of Rural/Metro's liquidity profile incorporates the following expectations and assumptions:
-- We expect coverage of uses of about 1.25x for the next year.
-- We do not expect net sources to be positive in the event that EBITDA drops 15%. In that scenario, which is not in our base-case expectation, the covenant cushion would likely have been fully eroded, limiting availability under the revolving credit.
-- The covenant cushion on the term loan and revolving credit facility has diminished to the mid-teen area. While covenant cushion is likely adequate given our 2013 operating expectations, availability could become constrained should earnings fall short of our estimates following the September 2012 step down.
-- We believe Rural/Metro is unlikely to absorb low-probability shocks with limited need for refinancing, given its substantial debt obligations.
-- The company benefits from nominal amortization payments under its term loan.
Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Rural/Metro, published Jan. 31, 2012, on RatingsDirect.
The outlook is negative, based on the increased potential that cash flows will not recover at a pace sufficient to allow the company to reduce debt. If negative cash flows are not reversed by the December 2012 quarter, we could lower the rating. Over the balance of fiscal-year 2013, a lower rating could be prompted if uncompensated care estimates are still insufficient or if new contracts are not as profitable as expected, which results in negative cash flows and escalated covenant pressure. A 5% contraction in EBITDA would trigger such a rating action.
We would consider revising the outlook to stable once Rural/Metro is on a clear trajectory to achieve our fiscal-year 2013 expectation EBITDA and at least $10 million of free operating cash flow, and is able to reduce debt.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings Affirmed/Outlook Action
To From Rural/Metro Corp. Corporate Credit Rating B/Negative/-- B/Stable/-- Ratings Affirmed Rural/Metro Corp. Senior Secured B+ Recovery Rating 2 Senior Unsecured CCC+ Recovery Rating 6
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