DBRS Downgrades Centric Health Corporation to B (low), Stable

DBRS Limited (DBRS) has today downgraded the Issuer Rating of Centric Health Corporation (Centric Health or the Company) to B (low) and its Senior Secured 2nd Lien Notes to CCC (high) with a recovery rating of RR5. The trends are Stable. This action follows the Company’s recent announcements that it has completed the acquisition of 100% of the shares of Pharmacare Fulfillment Center Ltd. (Pharmacare), an Edmonton-based specialty pharmacy business, and has reacquired its Senior Wellness and Home Care Operations businesses. The downgrade is based primarily on the Company’s lower expected revenue and earnings going forward (relative to expectations for the previous B (high) rating) as well as significantly weaker credit metrics and uncertainty surrounding the renewal and possible terms of the Company’s revolving credit facility which matures in June 2015. DBRS has removed the ratings from Under Review with Negative Implications.

On March 24, 2014, DBRS placed Centric’s ratings Under Review with Negative Implications following the Company’s announcement that it had entered into a definitive agreement to sell 100% of the common shares of its Home Care business and that it was pursuing the sale of its Senior Wellness Operations. On June 23, 2014, the Company announced that it had reached an agreement to sell its MEDIchair and Motion Specialties retail home medical operations to Birch Hill Equity Partners for $50 million. DBRS maintained the Under Review with Negative Implications on Centric’s ratings, reflecting uncertainty surrounding the use of proceeds from the sales and the Company’s longer-term business strategy and financial management intentions.

On September 2, 2014, Centric completed the previously announced sale of its methadone pharmacy operations for gross proceeds of $20 million. On September 12, 2014, the Company completed the sale of its MEDIchair and Motion Specialties retail home medical operations for gross proceeds of $50 million. The Company stated the following use of proceeds: (1) $10 million to repay amounts drawn on the revolving credit facility and to permanently reduce the borrowing capacity on the facility to $40 million from $50 million, (2) an additional $15 million to some combination of a reduction in its revolving credit facility, redemption of second-lien secured notes or redemption of the preferred partnership units and (3) accretive acquisitions of high-margin businesses.

On February 2, 2015, Centric completed the reacquisition of its Senior Wellness and Home Care Operations for aggregate gross proceeds of $14.5 million in the form of full repayment of the amounts owing under the two promissory notes previously issued in favour of Centric. On March 2, 2015, the Company announced the acquisition of 100% of the shares of Pharmacare, which effectively expanded the number of residents serviced by Centric’s Specialty Pharmacy segment by almost 25%, further solidifying its position as one of the top three long-term care and retirement community pharmacy providers in Canada.

In its review, DBRS focused its analysis on (1) the business risk profile of Centric after the numerous acquisitions and divestitures, including the risks associated with integration and achieving potential synergies; (2) the impact of use of proceeds for debt repayment on the Company’s financial risk profile; and (3) the Centric’s longer-term business strategy (including growth plans) and financial management intentions.

Despite the smaller size, the business profile benefits from a re-focusing on health-care services which tend to be higher margin. The acquisition of Pharmacare gives the Company a presence in pharmacy in western Canada, which will allow Centric to better serve its national customers. DBRS also recognizes the improving operating performance of the core continuing operations, which displayed revenue growth of 9.5% in 2014 and EBITDA growth to $28.0 million in 2014 versus $23.8 million the previous year. DBRS views the cumulative impact of the numerous transactions on the Company’s business risk profile to be relatively neutral. In terms of Centric’s financial profile, the Company used proceeds from the recent divestitures to repay $10 million on its revolving credit facility and to permanently reduce the limit on the facility to $40 million from $50 million. In addition, the Company temporarily repaid an additional $15 million on its revolving credit facility as it continues to contemplate the best permanent debt repayment use of such cash including possibly redeeming preferred partnership units, redeeming senior secured second-lien notes or permanently reducing the credit facility. As a result, Centric had total balance-sheet debt of approximately $255.3 million (including $44.4 million of convertible debt) at YE2014.

DBRS recognizes the merits of Centric’s Strategic Business Model Realignment focusing on the Company’s core strength in health-care service delivery. Revenues should increase modestly toward the $350 million level in the near to medium term as the Company integrates its recent pharmacy acquisition and leverages existing relationships on a national scale. EBITDA margins are expected to continue to display steady improvement as the Company focuses on improving efficiency and investing in its higher-margin health-care service businesses. As such, DBRS believes that EBITDA should increase toward the $35 million level over the near to medium term. In terms of financial profile, DBRS believes that cash flow from operations should grow over the longer term as organic operating income grows, which should translate into rising free cash flow since maintenance capital expenditure remains moderate. DBRS therefore expects that Centric will continue to refine its business strategy and will remain focused on investing in growth organically and through acquisitions as the industry presents opportunities to benefit from consolidation. As such, DBRS expects that any free cash flow will be used to either invest in growth as opportunities present themselves or repay debt. Centric has approximately $10 million of cash remaining from the recent divestitures and is expected to use such cash to acquire new assets. Should no opportunity present itself, the Company will be required to use such cash to repay debt. DBRS therefore believes that Centric’s credit metrics should improve over the next 12 to 18 months (i.e., debt-to-EBITDA toward 7.5 times (x) and EBITDA interest coverage above 1.5x).

Despite the benefits from the acquisitions (Senior Wellness, Home Care and Pharmacare) and divestitures (retail home medical and methadone pharmacy), DBRS believes that Centric’s Issuer Rating is best positioned in the B (low) rating category with a Stable trend. This primarily reflects the smaller size and higher leverage (primarily because of a lower baseline operating income) than contemplated for the previous B (high) Issuer Rating as well as risks related to the renewal of the Company’s revolving credit facility which matures in June 2015 and the integration of new acquisitions and the entry into new geographic markets in certain businesses.

The recovery rating on the Senior Secured 2nd Lien Notes has been changed to RR5 from RR4, representing a decline in the expected recovery to within the 10% to 30% range from the 30% to 60% range. The change in expected recovery reflects a lower level of stressed earnings consistent with the view of a lower baseline operating income as a result of the numerous acquisitions and dispositions, to which DBRS applied a conservative multiple under the primary enterprise valuation approach. The value of the enterprise was subsequently applied to outstanding indebtedness in priority order.

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

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.

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

The applicable methodologies are Rating Companies in the Services Industry (July 2014) and DBRS Recovery Ratings for Non-investment Grade Corporate Issuers (February 2015), which can be found on our website under Methodologies.