(The following statement was released by the rating agency)
-- U.S.-based Apria Healthcare Group reported negative $64 million of discretionary cash flow for the first half of 2012.
-- The magnitude of the cash flow deficit raises doubt that the company will reduce its cash flow to our estimate of less than negative $20 million by the end of 2012 and return to positive free operating cash flow in 2013.
-- We have revised the outlook to negative, reflecting less confidence that Apria will meet our expectation for cash flow over the next six quarters.
-- We are affirming the 'B+' corporate credit rating and all other issue-level ratings.
Rating Action On Oct. 4, 2012, Standard & Poor's Ratings Services revised its outlook to negative from stable on Lake Forest, Calif.-based Apria Healthcare Group Inc. The negative outlook reflects decreased confidence in Apria's ability to meet our expectation for cash flow over the next six quarters.
We affirmed the 'B+' rating. The issue-level rating on the A-1 notes is 'BB' (two notches above the corporate credit rating), with a recovery rating of '1', indicating our expectation for very high (90% to 100%) recovery in the event of payment default. The issue-level rating on the A-2 notes is 'B' (one notch lower than the corporate credit rating), with a recovery rating of '5' (10% to 30% recovery expectation).
We assess Apria's financial risk profile as "aggressive," reflecting our expectation that adjusted leverage will remain between 4x and 5x over the near term. The financial risk profile also takes into account the company's current trend of operating at a cash flow deficit. We expect its free operating cash flow (FOCF) to remain negative in 2012, but establish an improving trend from 2011 levels, and turn positive by 2013. The "weak" business risk profile considers Apria's exposure to third-party reimbursement, operating in a highly fragmented industry, and its ongoing challenges with managing the on-shoring of its billing and customer service functions. The company's leading position in providing specialized home health care services and equipment bolsters the company's business profile.
In the first half of 2012, Apria reported $125 million of EBITDA and generated negative free operating cash flow of $64 million. While we expect seasonality to benefit the company for the balance of the year, our full-year expectation is for about $300 million of EBITDA and an improvement in negative cash flow to less than $20 million. The extent of the improvement required to meet our full-year expectations raises concerns that the company may fall short. Improvement in cash flow generation is primarily predicated on the company reducing its bad debt and revenue adjustments and its ability to lower SG&A expenses.
To measure profit trends for Apria, we use adjusted EBITDA, including adjustments for one-time charges primarily supporting its significant cash investment to return its billing function in house. Our base-case scenario for 2012 and 2013 reflects adjusted EBITDA margins of around 12%. EBITDA margins for the first half of 2012 were about 10.5%. Our assumptions take into consideration our expectation of a stronger second half of 2012, driven by seasonality trends of higher demand for Apria's products and services, an improvement in bad debt expense and customer credits as a percentage of revenue, anticipated revenue growth stemming primarily from lower margin infusion businesses, and higher labor costs to support its re-on-shoring of its billing function.
Despite somewhat depressed EBITDA, Apria's revenue growth is in line with our 2012 expectations of mid- to high-single-digit revenue growth, reflecting mid-single-digit revenue growth in the respiratory and HME division. This segment has benefited from a full year of Praxair, added volume from securing new managed care contracts, and Medicare Round 1 competitive bidding areas (CBAs). Projected revenue growth in 2012 is further bolstered by our expectation of 10% organic revenue growth in its infusion therapy and enteral nutrition segment, benefiting from strong market growth trends.
Apria operates in the highly fragmented, $65 billion home health care market, specializing in respiratory therapy, infusion therapy, and HME. The industry benefits from a growing demand of patients preferring in-home care treatment and a strong pipeline of infusion/injectable drugs administered in the home or at ambulatory infusion suites. The home health care market is expected to grow 5% annually, despite Medicare's cost-control programs across subsectors. Specifically, the respiratory and HME division is subject to the Round 2 bidding process in 2012, which is scheduled to go into effect in mid-2013. This will affect more CBAs, resulting in a more competitive industry and lower contract rates. About $141 million of Apria's revenues and $20 to $25 million of EBITDA will be impacted by Round 2 competitive bidding. Managed care pricing and contract turnover are also risks in the industry.
While Apria's weak business risk profile incorporates inherent industry risks, the company benefits from a national platform, a leading market position, and a well-established reputation. This provides a competitive advantage among peers, and helps Apria secure new managed care contracts; it should also help them win new CBAs in the Medicare Round 2 bidding process. Apria's diverse payor and revenue mix somewhat mitigates the exposure of a lost contract or rate cut. However, Medicare and Medicaid reimbursement, albeit across a diverse product/service mix, is still 30% of total revenues. Apria has no significant concentration with any single commercial payor.
The aggressive financial risk profile reflects the company's existing credit metrics, prospects for continued negative free operating cash flow, and sponsor ownership. We expect leverage (using adjusted EBITDA) to remain between 4x and 5x through 2012.
We continue to view Apria's liquidity as "adequate," despite negative cash flow, because of the company's $250 million asset-backed revolver. We expect sources of cash to exceed mandatory uses over the next year. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions:
-- We expect sources of liquidity over the next 12 months to exceed uses by at least 1.2x. Liquidity sources include our expectation of operating cash flow in excess of $100 million, a $250 million ABL revolver and limited cash reserves, which should cover capital expenditures of about $155 million in 2012. However, we believe, Apria will rely on the ABL for funding in 2012.
-- We expect liquidity sources to continue exceeding uses, even if EBITDA declines by 15%.
-- We expect there will be limited availability to absorb a high-impact, low-probability event.
-- Covenant compliance is not a major factor, because the revolver has a springing covenant test that does not take effect unless Apria's excess availability goes below a certain percentage of its available borrowing base.
-- Apria has no material debt maturities until 2014, when its A-1 and A-2 notes expire.
Recovery analysis For the complete recovery analysis, please see the recovery report on Apria, published May 4, 2012, on RatingsDirect.
Our negative rating outlook on Apria reflects our lower confidence that Apria will meet our cash flow expectations for 2012 and 2013, given year-to-date performance. A rating downgrade could result if the company's cash flow deficit is worse than our expectation of less than $20 million. A downgrade could also occur past 2012, if we believe the company is on a trajectory that jeopardizes our expectation for positive cash flow in 2013. The primary driver of better cash flow is Apria's ability to lower revenue adjustments and bad debt expense. When the company has established a track record of improving these expenses, increasing our confidence that cash flow will be positive in 2013, the outlook will be revised to stable.
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 List Ratings Affirmed; Outlook Action To From Apria Healthcare Group Inc. Corporate Credit Rating B+/Negative/-- B+/Stable/-- Ratings Affirmed Apria Healthcare Group Inc.
$700M 11.25% sr secd A-1 notes due 2014 BB
Recovery Rating 1
$317.5M 12.375% sr secd notes due 2014 B
Recovery Rating 5
(Caryn Trokie, New York Ratings Unit)