DBRS Confirms Centric Health Corporation at B (high), Trend Changed to Negative

DBRS has today confirmed the Issuer Rating and Senior Secured 2nd Lien Notes rating of Centric Health Corporation (Centric or the Company) at B (high), and changed the trend to Negative from Stable. The Senior Secured 2nd Lien Notes continue to have a recovery rating of RR4. The rating action reflects DBRS’s concern that weaker-than-expected operating performance through Q3 2013 could result in the Company’s credit risk profile weakening beyond a level considered consistent with the current rating category. In addition, performance will be further challenged by recent Government of Ontario changes to the Ontario Health Insurance Plan (OHIP) funding model for publicly-funded physiotherapy in long-term care and retirement homes. Should Centric be successful in gaining traction toward improving operating performance and achieving sustainable EBITDA above the $50 million level and a platform for continued growth by the end of 2014, the trend could be changed to Stable. However, should operating performance remain challenged through the course of 2014 resulting in flat or declining EBITDA, a downgrade of Centric’s ratings will likely result.

On April 9, 2013, DBRS assigned an Issuer Rating of B (high) with a Stable trend to Centric and stated its expectation that the Company’s earnings profile should strengthen as the Company shifted its focus from completing acquisitions to integration, organic growth and cost-saving initiatives. DBRS believed the Company could reach EBITDA of $50 million to $55 million in the near term.

Since then, the Company has released results through Q3 2013 which included a moderate increase in revenues to approximately $457 million for the last 12 months (LTM) ended Q3 2013 versus $437 million in 2012, while earnings remained flat versus the same period the previous year at approximately $42.5 million. That said, credit metrics improved modestly – i.e., debt-to-EBITDA of 5.95 times (x) or 4.83x excluding convertible securities (DBRS considers credit metrics with and without convertible securities as all convertible securities are subordinate in right of payment to any senior indebtedness and all but one (which totals $5 million) carry at least the option to satisfy interest and payment upon maturity in the form of common shares) versus DBRS estimates of 6.5x and 5.1x, respectively, at the time of the issuance of the Company’s Senior Secured 2nd Lien Notes.

The Company’s failure to improve earnings despite solid operating performance in its Physiotherapy (non-Senior Wellness), Pharmacy and Assessments segments can be attributed to weaker-than-expected results in three operating segments: Physiotherapy (Senior Wellness), Retail and Home Medical Equipment and Surgical and Medical Centres:

(1) Physiotherapy (38% of total revenue and 56% of EBITDA): On August 22, 2013, a judicial review by the Ontario Divisional Court ruled that the Ontario Ministry of Health and Long-Term Care could implement changes to the OHIP funding model for publicly-funded physiotherapy provided in long-term care and retirement homes. The changes, which took effect immediately upon the rendering of the decision, negatively affect the Senior Wellness component of Centric’s Physiotherapy segment by up to $27 million of revenue (representing 6% of consolidated revenue) and $6.5 million of EBITDA annually (calculated on an LTM basis as of Q2 2013) before taking into account the offsetting impact of the Company’s actions to mitigate the effects of the change.

(2) Retail and Home Medical Equipment (25% of revenue and 13% of EBITDA): Despite revenue growth (partially attributable to the acquisition of Motion Specialties in Q1 2012), slower than expected integration and streamlining efforts (i.e., IT, inventory, day-to-day activities ) and investments in revenue generating personnel for initiatives with a longer sales cycle negatively affected margins.

(3) Surgical and Medical Centres (7% of revenue and 4% of EBITDA): Performance of the segment was significantly below expectations for the first nine months of 2013 (despite signs of stability in Q3 2013), negatively affected by low utilization of operating room capacity and its Sarnia operations as the Company undertook management changes including the departure of the primary surgeon for the location.

In response to the challenges in the above listed segments, the Company plans to and is currently undertaking a number of initiatives to improve operating performance going forward, including head-count reduction, integrated IT systems and centralizing inventory in Retail and Home Medical, the recruitment and hiring of new surgeons and physicians for its Sarnia facility in Surgical and Medical Equipment and exploring reimbursement alternatives as well as implementing a cost containment program in the Physiotherapy segment. Should such initiatives be successful in helping Centric gain traction toward improving operating performance and achieving sustainable EBITDA above the $50 million level and a platform for continued growth by the end of 2014, the trend could be changed to Stable. DBRS continues to believe that potential for improvement in credit metrics will be based primarily on growth in EBITDA as the Company is expected to use any free cash flow to invest in growth rather than to repay debt or provide cash returns to shareholders.

On the other hand, should operating performance remain challenged through the course of 2014 resulting in flat or declining EBITDA, a downgrade of Centric’s ratings will likely result.

Notes:
All figures are in Canadian dollars unless otherwise noted.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Services Industry, Rating Companies in the Merchandising Industry and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.