Global Healthcare Service Providers

Transcription

1 DECEMBER 21, 2011 CORPORATES RATING METHODOLOGY Global Healthcare Service Providers Table of Contents: SUMMARY 1 ABOUT THE RATED UNIVERSE 2 ABOUT THIS RATING METHODOLOGY 4 THE KEY GRID FACTORS 7 ASSUMPTIONS AND LIMITATIONS AND RATING CONSIDERATIONS ABSENT FROM GRID 11 CONCLUSION: SUMMARY OF THE GRID-INDICATED RATING OUTCOMES 13 APPENDIX A: GLOBAL HEALTHCARE SERVICE PROVIDER INDUSTRY METHODOLOGY FACTOR GRID 14 APPENDIX B: GRID-INDICATED RATINGS 15 APPENDIX C: OBSERVATIONS AND OUTLIERS FOR GRID MAPPING 18 APPENDIX D: HEALTHCARE SERVICE PROVIDER INDUSTRY OVERVIEW 19 APPENDIX E: KEY RATING ISSUES OVER THE INTERMEDIATE TERM 21 Analyst Contacts: NEW YORK Dean Diaz Vice President-Senior Credit Officer [email protected] Peter H. Abdill, CFA Managing Director-Corporate Finance [email protected] Ron Neysmith Vice President-Senior Analyst [email protected] Tiina Siilaberg Analyst [email protected] Summary This rating methodology explains Moody s approach to assessing credit risk for healthcare service providers. This publication is intended to provide a reference tool that can be used when evaluating credit profiles within the healthcare service provider industry, helping companies, investors, and other interested market participants understand how key qualitative and quantitative risk characteristics are likely to affect rating outcomes. This methodology does not include an exhaustive treatment of all factors reflected in Moody s ratings but should enable the reader to understand qualitative considerations and financial ratios that are usually most important for ratings in this sector. This rating methodology replaces the Global For-Profit Hospital Rating Methodology published in September While reflecting the same core principles as the 2008 methodology, this updated framework incorporates refinements in our analysis of the key credit fundamentals of the healthcare service provider industry. The framework also can now be applied to a broader population of healthcare service providers beyond the inpatient acute care hospitals covered under the 2008 methodology. For example, the methodology applies to skilled nursing facility operators, such as Sun Healthcare Group, Inc. and Skilled Healthcare Group, Inc.; dialysis providers, such as Davita, Inc.; homecare companies, such as Gentiva Health Services, Inc.; as well as the for-profit hospital operators, such as HCA, Inc., Tenet Healthcare Corporation and Community Health Systems, Inc. Publication of this rating methodology will not result in any rating changes. This report includes a detailed rating grid and illustrative mapping of a sample of companies against the factors in the grid. The purpose of the rating grid is to provide a reference tool that can be used to approximate most credit profiles within the healthcare service provider sector. The grid provides summarized guidance for the factors that are generally most important in assigning ratings to healthcare service provider companies. The grid is a summary that does not include every rating consideration and our illustrative mapping uses historical results while our ratings also consider forward-looking expectations. Accordingly, the grid-indicated rating is not expected to match the rating of most companies.» contacts continued on the last page

2 The grid contains three key factors that are important in our assessments for ratings in the healthcare service provider sector: 1. Scale and profitability 2. Financial strength 3. Business profile Each of these factors also encompasses a number of sub-factors or metrics, which we explain in detail. Since an issuer s scoring on a particular grid sub-factor and the calculated grid-indicated rating often will not match its overall rating, in the Appendix we include a discussion of outliers companies whose grid-indicated rating for a specific sub-factor differs significantly from the actual rating. This rating methodology is not intended to be an exhaustive discussion of all factors that Moody s analysts consider pertinent for ratings in this sector. We note that our analysis for ratings in this sector covers factors that are common across all industries (such as ownership, management, liquidity, legal structure in the corporate organization, corporate governance) as well as factors that can be meaningful on a company-specific basis. Our ratings consider qualitative considerations and factors that do not lend themselves to a transparent presentation in a grid format. The grid represents a compromise between greater complexity that would result in grid-indicated ratings that map more closely to actual ratings, and simplicity that enhances a transparent presentation of the factors that are most important for ratings in this sector most of the time. Highlights of this report include:» An overview of the rated universe» Summary of the rating methodology» A description of the key factors that drive rating quality» Comments on the rating methodology s assumptions and limitations, including a discussion of rating considerations that are not included in the grid The Appendices show tables that illustrate the application of the methodology grid to a sample of companies (Appendix B) with explanatory comments on some of the more significant differences between the grid-implied rating and our actual rating (Appendix C), a brief industry overview (Appendix D), and a discussion of key rating issues for the healthcare service provider sector over the intermediate term (Appendix E). About the Rated Universe Moody s rates 45 companies in the healthcare service provider industry globally. In the aggregate, these issuers have approximately $93 billion of rated debt. The global healthcare service provider sector is very diverse, covering a number of segments and care settings, including for-profit acute care and specialty hospitals, ambulatory surgery centers, skilled nursing facilities, dialysis providers, homecare, hospice, and behavioral health services. Each of these segments are differentiated by, among other things, level of care provided, care setting and reimbursement or payment mechanisms. As such, healthcare service providers globally exhibit diverse operational and financial dynamics. The rated issuers are predominantly headquartered in the United States with five of the total domiciled in Europe. 2 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

3 For the purpose of applying this methodology, a healthcare service provider is deemed to be an entity that derives most of its revenue from the provision of healthcare services to patients directly and bills based on the services provided. These companies market their services and bear the direct risk of collection from third party payors, including government programs and insurance companies, or the patients themselves. These companies are also directly at risk for any applicable adherence to regulatory requirements and may be susceptible to litigation arising from patient care issues. This document does not apply to companies that contract with third parties for the provision of healthcare and, therefore, may not be at risk for certain aspects of the business, including volumes, payor mix or bad debt. The application of this methodology is limited to corporate issuers operating in various healthcare service provider segments and does not apply to not-for-profit hospitals or other not-for-profit healthcare service providers. The published ratings of the issuers are also diverse. The corporate family ratings (CFR) and senior unsecured ratings of the speculative grade or investment grade issuers (respectively) covered by the rated companies range from Baa2 to Caa3 with a concentration in the B rating category. As of December 15, 2011, 34 companies had stable outlooks, seven had negative outlooks, and four had positive outlooks. TABLE 1 Global Healthcare Service Provider Companies Issuer Long Term Rating Outlook Rhoen-Klinikum AG Baa2 Stable Fresenius Medical Care AG Ba1 Stable Fresenius SE &Co. KGaA Ba1 Stable Universal Health Services, Inc. Ba2 Stable DaVita, Inc. Ba3 Stable LifePoint Hospitals, Inc. Ba3 Positive Alliance Healthcare Services, Inc. B1 Negative Care UK Health & Social Care B1 Stable Community Health Systems, Inc. B1 Negative Drumm Investors LLC B1 Stable HCA Inc. B1 Stable Health Management Associates, Inc. B1 Stable HealthSouth Corporation B1 Positive Kindred Healthcare, Inc. B1 Stable Crown NewCo 3 (Priory Group Ltd.) B1 Negative Sun Healthcare Group, Inc. B1 Stable Surgery Center Holdings, Inc. B1 Stable Advanced Homecare Holdings B2 Stable Ardent Medical Services, Inc. B2 Stable Capella Healthcare, Inc. B2 Stable Genoa Healthcare Group LLC B2 Stable HCR Healthcare LLC B2 Stable IASIS Healthcare Corporation B2 Stable National Surgical Hospitals B2 Stable 3 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

4 TABLE 1 Global Healthcare Service Provider Companies Issuer Long Term Rating Outlook Prime Healthcare Services B2 Stable Radiation Therapy Services B2 Negative RadNet, Inc. B2 Stable Renal Advantage Holdings, Inc. B2 Stable Select Medical Holdings Corporation B2 Positive Skilled Healthcare Group, Inc. B2 Stable Surgical Care Affiliates B2 Stable Tenet Healthcare Corporation B2 Positive U.S. Renal Care, Inc. B2 Stable United Surgical Partners International B2 Stable Vanguard Health Systems, Inc. B2 Stable Physician Oncology Services, LP B2 Stable American Renal Holdings, Inc. B3 Stable CRC Health Corporation B3 Stable Gentiva Health Services, Inc. B3 Negative National Mentor Holdings, Inc. B3 Stable Prospect Medical Holdings, Inc. B3 Stable Symbion, Inc. B3 Stable LifeCare Holdings, Inc. Caa1 Stable OnCure Holdings, Inc. Caa1 Negative Diagnostic Imaging Group Caa3 Negative About This Rating Methodology This report explains the rating methodology for healthcare service provider companies in six sections, which are summarized below. 1. Identification of Key Rating Factors The grid in this rating methodology focuses on three key factors. The three broad factors are further broken down into nine sub-factors. Broad Rating Factors Factor Weighting Rating Sub-Factor Sub-factor Weighting Scale and Profitability 26% Net Revenue 14% Pretax Income 8% Non-acquired Revenue Growth 4% Financial Strength 42% RCF / Net Debt 12% Debt / EBITDA 15% EBITA / Interest Expense 15% 4 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

5 Broad Rating Factors Factor Weighting Rating Sub-Factor Sub-factor Weighting Business Profile 32% Payor Concentration 8% Regulatory Environment 4% Financial Policy 20% Total 100% Total 100% 2. Measurement or Estimation of the Key Rating Factors We explain below how the sub-factors for each key grid factor are calculated or estimated and the weighting for each individual sub-factor. We also explain the rationale for using each particular factor, and the ways in which we apply them during the rating process. The information used in assessing the performance for the sub-factors is found in or calculated using the company s financial statements or is derived from other observations or estimated by Moody s analysts. Moody s ratings are forward-looking and incorporate our expectations for future financial and operating performance. We use both historical and projected financial results in the rating process. Historical results help us understand patterns and trends for a company s performance and facilitate peer comparisons under a particular set of industry conditions. While the rating process includes both historical and anticipated results, this document makes use of historical data only to illustrate the application of the rating methodology grid. Unless otherwise stated, the mapping examples use reported financials for the twelve months ended March 31, All of the quantitative credit metrics shown in this report incorporate Moody s standard adjustments to income statement, cash flow statement, and balance sheet amounts for restructuring, impairment, off-balance sheet accounts, receivable securitization programs, under-funded pension obligations, and recurring operating leases. For definitions of Moody s most common ratio terms please see Moody s Basic Definitions for Credit Statistics, User s Guide (June, 2011, document #78480). For a description of Moody s standard adjustments, please see Moody s Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations, December 2010 (128137). These documents can be found at 3. Mapping Factors to the Rating Categories After estimating or calculating each sub-factor, the potential outcomes for each of the nine sub-factors are mapped to a broad Moody s rating category (Aaa, Aa, A, Baa, Ba, B, Caa, Ca). 4. Mapping Issuers to the Grid and Discussion of Grid Outliers In this section (Appendix B), we provide tables showing how each company maps to grid-indicated ratings for each rating sub-factor. We highlight companies whose grid-indicated performance for a specific sub-factor is two or more broad rating categories higher or lower than its actual rating and companies whose grid-indicated rating is two or more alphanumeric ratings higher or lower than its actual rating. We discuss general reasons for such positive or negative outliers in Appendix C. 5. Assumptions and Limitations and Rating Considerations Absent From Grid This section discusses limitations in the use of the grid to map against actual ratings, additional factors not included in the grid that may be important in determining ratings, and limitations and assumptions that pertain to the overall rating methodology. 5 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

6 6. Determining the Overall Grid-Indicated Rating To determine the overall rating, we convert each of the nine sub-factor ratings into a numeric value based on the scale below. Aaa Aa A Baa Ba B Caa Ca The numerical score for each sub-factor is multiplied by the weight for that sub-factor, with the results then summed to produce a composite weighted factor score. The composite weighted factor score is then mapped back to an alphanumeric rating based on the ranges in the table below. Grid-Indicated Rating Aggregate Weighted Factor Score Aaa x < 1.5 Aa1 1.5 x < 2.5 Aa2 2.5 x < 3.5 Aa3 3.5 x < 4.5 A1 4.5 x < 5.5 A2 5.5 x < 6.5 A3 6.5 x < 7.5 Baa1 7.5 x < 8.5 Baa2 8.5 x < 9.5 Baa3 9.5 x < 10.5 Ba x < 11.5 Ba x < 12.5 Ba x < 13.5 B x < 14.5 B x < 15.5 B x < 16.5 Caa x < 17.5 Caa x < 18.5 Caa x < 19.5 Ca x 19.5 For example, an issuer with a composite weighted factor score of 11.7 would have a Ba2 grid-indicated rating. 6 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

7 The Key Grid Factors Moody s analysis of healthcare service provider companies focuses on three broad factors:» Scale and Profitability» Financial Strength» Business Profile Rating Factor 1: Scale and Profitability (26% weight) Why It Matters Scale Larger scale, which usually goes hand in hand with geographic and business diversity, reduces the risk in the event of regional weakness, business downturn or regional reimbursement changes (e.g., Medicaid changes in a particular state for a company operating in the US). Scale also enhances a company s ability to absorb a temporary disruption, adverse regulatory developments or the effects of acquisitions. Finally, greater size creates economies of scale with regard to administrative operations and purchasing power. Greater scale can also, in certain markets, be perceived a sign of market presence, which can aid in negotiations of reimbursement rates with third party payors and in attracting highly skilled staff (physicians, nurses, therapists, etc.). Profitability Profitability provides an indication for how effectively management is running its business. Profitability is important in the healthcare service provider industry because key business activities require consistent and adequate levels of profitability to internally fund operating needs and capital requirements. Further, many industry sub-sectors face ongoing uncertainty around regulatory issues and changes in reimbursement that must be absorbed from time to time. Growth Prospects Our ratings in this sector take into consideration a company s ability to drive growth within its existing portfolio. Management s quest for growth can drive decisions around mix of services, adoption of new technologies, customer service levels and marketing, which in turn will affect capital investment decisions and expense line items. The ability to grow revenue with existing assets can also result in decisions to maintain assets or divest certain business lines or underperforming assets. How We Assess It Scale: Total annual (LTM) revenues in U.S. dollars. Profitability: The absolute dollar amount of pretax income is an indicator for both size and profitability. Pretax income measures the earnings base of the company after net interest expense but before income tax expense. Growth Prospects: The examples shown in this report mainly use the average of the last four quarters year over year non-acquired or same-facility revenue growth. In some sectors (e.g., acute care hospitals), same-facility growth is a regularly disclosed metric. In other cases, companies may disclose a metric that excludes acquisitions but includes newly opened facilities (i.e., non-acquired revenue 7 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

8 growth). And finally, in some cases we may estimate the amount of non-acquired growth through analysis of recently completed acquisitions. Factor 1: Scale & Profitability (26%) Sub-factor Weight Aaa Aa A Baa Ba B Caa Ca Net Revenues (USD) 14.0% 70 bn bn bn 7-15 bn 3-7 bn bn bn <0.15bn Pretax Income (USD) 8.0% 5bn 3 5bn 1.5 3bn bn.25.75bn 0.25bn bn <-.075bn Non-acquired Revenue Growth 4.0% 13% 11 13% 9-11% 7 9% 5 7% 3 5% 1 3% <1% A chart that illustrates grid mapping results for Factor 1 and a discussion of outliers is included in the Appendix. Factor 2: Financial Strength (42% weight) Why It Matters Healthcare service provider companies are dependent upon earnings and cash flow generation to cover significant labor costs, interest expense, debt amortization, and capital expenditures. Leverage, interest coverage and cash flow metrics are important measures of financial risk and are usually strong indicators of an issuer s level of financial flexibility. Leverage and Cash Flow The strength of the balance sheet is a key indicator of risk because it helps to indicate the degree to which a company has borrowed against future cash flow. A strong balance sheet enhances a company s ability to sustain its competitive position while continuing to grow. Financial strength can mitigate other risks and provides greater operational flexibility with which to combat competition or regulatory changes. A moderate level of leverage, as measured by Debt/EBITDA, is critical as it implies greater ability to repay debt while continuing to fund the capital projects necessary for growth opportunities and provide adequate returns to shareholders. Conversely, elevated leverage will constrain a company s ability both to fund projects that would improve its service offerings and services, and to pursue acquisitions and other growth and value-enhancing strategies. The degree to which an enterprise is able to generate sufficient cash flow to allow for reinvestment and debt service is fundamental to risk assessment in this sector. The grid uses Retained Cash Flow (RCF) to Net Debt as a measure of cash flow. RCF to net debt measures a company s ability to generate cash flow after paying dividends to its shareholders but before working capital changes and funding capital expenditure requirements. This measure also gives credit to excess cash that is available for debt repayment. Coverage Interest coverage is an indication of a company s ability to cover the cost of its borrowed capital. How We Assess It: The financial strength measures shown in the grid use the following metrics for the latest twelvemonth period: Retained Cash Flow [RCF] / Net Debt: Retained Cash Flow to Net Debt is defined as funds from operations less dividends to total debt less available cash. 8 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

9 Debt / EBITDA: Debt to EBITDA is defined as total debt to earnings before interest, taxes and depreciation and amortization. EBITA / Interest Expense: EBITA to Interest is the ratio of earnings before interest, taxes, and amortization to gross interest expense. Factor 2: Financial Strength (42%) Sub-factor Weight Aaa Aa A Baa Ba B Caa Ca RCF / Net Debt 12.0% 75% 55%-75% 40%-55% 25%-40% 15%-25% 5%-15% 0%-5% <0% Debt / EBITDA 15.0% <0.5x x x x x x x 7.0x EBITA / Interest Expense 15.0% 16x 12-16x 8-12x 4-8x 2-4x 1 2x.75 1x <.75x A chart that illustrates grid mapping results for Factor 2 and a discussion of outliers is included in the Appendix. Factor 3: Business Profile (32% weight) Why It Matters The business profile factor provides an assessment of a variety of characteristics related to the operating environment of the issuers, including risks related to concentration of revenue sources that could affect top line growth and profitability. We factor in the degree of exposure to and expected tone of the regulatory environment in which the company operates. We also assess financial policies that could affect the prospect of debt repayment. Payor Concentration This factor provides an assessment of risk related to the concentration of revenue sources, which provides an indication of the level of exposure to a unilateral change in price due to reimbursement changes. It also considers counterparty risk associated with concentration of revenue sources. Regulatory Environment This factor assesses the risks associated with operating in a regulated environment. Local and broader government entities typically have a level of oversight into the provision of healthcare services that can range from the granting of operating certificates needed to open new locations or service lines, enforcement of rules that could lead to financial penalties or closure of businesses, and even the setting of reimbursement rates that will impact revenue growth and profitability. Financial Policy This rating factor assesses the expected impact of strategic and financial decisions on future credit quality. While risk-taking is an integral part of managing an enterprise in this sector, this rating factor considers the balance struck between different investor classes, and the degree to which financial policies are likely to direct returns more towards creditors or other stakeholders. Stated policies, informed by historic practices, can provide important insights about the ability of a company to absorb shocks to its market or business, as well as take advantage of competitive opportunities as they develop. 9 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

10 How We Assess It: Payor Concentration: In the majority of cases, we use amounts disclosed in the financial information of rated issuers identifying the single largest revenue source as a percentage of total net revenue to derive this factor for the grid. For the US operators, this typically equates to the percentage of revenue from Medicare or Medicaid. Notwithstanding the fact that Medicaid rates are set at the individual state level and therefore could differ based on the states in which the company has operations, we note that a portion of Medicaid funding is a pass through from the federal government. Therefore, a unilateral change in the government portion of funding for the Medicaid program could have a significant effect on overall Medicaid reimbursement. The rating methodology also considers countries in which there may be a government sponsored healthcare system or a centrally regulated reimbursement system. Without other providers to carry a portion of the service burden, government cost control measures will be restrained by the need to keep facilities operating. When the government is the payor, the sovereign credit rating provides an indication of the payment counter-party risk for the hospital operator. In these cases, the sovereign rating will be the starting point for the assessment of payor concentration. The rating committee will consider emphasis placed on cost control and cost pressures versus the quality of on-going service levels in determining how far below the sovereign rating this factor should be for the particular company. For example, in Germany the current assessment for this factor is A, while the Sovereign rating is Aaa. In some countries, particularly in Asia, most medical expenses are paid directly by the patient. In such countries, the Aaa score that could be implied by the less than 5% payor concentration may not be consistent with the actual assurance of payment. Analysts score the payor concentration sub-factor based upon a subjective assessment of payment risk that considers our estimation of the issuer s bad debt expense, which can be influenced by the legal framework, the nature of services, and other factors beyond the credit quality of the customer base. Regulatory Environment: This is a qualitative assessment of the future impact of regulatory factors. Regulatory considerations could include expectations of reimbursement rate changes, increases or decreases in regulatory review or focus that may affect expansion plans or investment options, changes in reporting requirements that could have an impact on administrative burdens and thereby affect margin expectations, or other factors depending on the level of regulatory involvement in the subsector in which the issuer operates. Financial Policy: This is a qualitative assessment of the company s overall balance in maintaining creditor and shareholder interests. We consider several aspects of a company s expected financial policy, including management s financial discipline, commitment to ratings, track record of operating and executing business plans, and general approach to dividends and share repurchase activities. This factor incorporates our opinion on management s likely stance towards capital structure changes, financing of growth, and acquisition appetite. 10 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

11 Factor 3: Business Profile (32%) Sub-factor Weight Aaa Aa A Baa Ba B Caa Ca Payor Concentration 8.0% <5% 5 10% 10 15% 15 25% 25 35% 35 45% 45 55% 55% Regulatory Environment 4.0% Environment is expected to be decidedly positive with no impediments to particularly high returns. Financial Policy 20.0% Expect shareholder returns to be managed to maintain extremely conservative and stable metrics. Return on capital and profitability are expected to be assured at high levels given favorable operating environment. Expect stable and predictable returns to shareholders with creditor protection taking priority when allocating growth from cash flow and proceeds from any asset sales. Favorable return and profitability expected to be highly likely given the lack of any anticipated negative pressures or developments. Expect share buybacks and acquisitions to have minimal impact on metrics. Expect the regulatory environment will be neutral. Reimbursement is expected to be neutral to somewhat positive. Expect financial policies to modestly favor shareholder returns. Possible event risk tied to acquisitions. Expect the regulatory environment will be neutral. Reimbursement is expected to be neutral. Expect financial policies to be clearly favorable to shareholders. Track record of ratings migration following acquisitions likely to continue. Expect the regulatory environment will be negative. Reimbursement rates are expected to decline but the impact on operating results will be manageable or can be offset by other measures. Expect financial policies to be very focused on shareholder returns. Material debtfunded acquisitions and share repurchases or dividends possible. Expect the regulatory environment will be negative. Considerable reimbursement declines are expected that will negatively impact operating results and financial metrics. Expect financial policies that are highly unfavorable to creditors. Financial cushion likely to be paid out to shareholders. Expect the regulatory environment will be decidedly negative. Anticipated declines in reimbursement is expected to result in significant financial stress. Expect financial policies that can be major contributors to a high likelihood of near term default. A chart that illustrates grid mapping results for Factor 3 and a discussion of outliers is included in the Appendix. Assumptions and Limitations and Rating Considerations Absent From Grid The rating methodology grid comprises a trade-off between simplicity that enhances transparency and the greater complexity that would allow the grid to map more closely to actual ratings. The three rating factors in the grid do not constitute an exhaustive treatment of all of the important considerations in the ratings of healthcare service provider companies. In choosing the metrics for this rating methodology grid, we did not include certain important factors that are common to all companies in any industry, such as the quality and experience of management, assessments of corporate governance and the quality of financial reporting and information disclosure. The assessment of these factors may be highly subjective and variable over time. Accordingly, ranking them by rating category in a grid would in some cases suggest too much precision and stability in the relative ranking of particular issuers against all other issuers that are rated in various industry sectors. Ratings may include additional factors that are difficult to quantify or that have a meaningful effect in differentiating credit quality in only certain cases. Such factors include litigation, liquidity, technology, and reputational risk, as well as changes to consumer and business spending patterns, competitors strategies, and macroeconomic trends. While these are important considerations, it is not possible to precisely express these in the rating methodology grid without making the grid excessively complex and significantly less transparent. 11 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

12 Ratings may also reflect circumstances in which the weighting of a particular factor is significantly different from the weighting suggested by the grid. This variation in weighting as a rating consideration can also apply to factors that we choose not to represent in the grid. For example, liquidity is a rating consideration frequently critical to ratings that may not, in other circumstances, have a substantial impact in discriminating between two issuers with similar credit profiles. Ratings can be heavily affected by extremely weak liquidity that magnifies default risk. However, two identical companies might be rated the same if their only distinguishing feature is that one has a good liquidity position and the other an extremely good liquidity position. This illustrates some of the limitations inherent in using grid-indicated ratings to predict rating outcomes. Our ratings incorporate expectations for future performance, while the financial information used to illustrate the mapping in the grid is mainly historical. In some cases, our expectations for future performance may be informed by confidential information that we cannot publish. In other cases, we estimate future results based on past performance, industry trends, our expectations for the likely range of future supply, demand and prices, competitor actions, and other factors. In either case, predicting the future is subject to the risk of substantial inaccuracy. Assumptions that can cause our forwardlooking expectations to be incorrect include unanticipated changes in any of the following factors: the macroeconomic environment and general financial market conditions, industry competition, new technology, regulatory and legal action, and management s appetite for M&A or share buybacks. Other Rating Considerations Although Moody s considers other factors in addition to those discussed in this report, in most cases an understanding of the framework presented herein will enable a good approximation of our view of the credit quality of companies in this sector. Moody s considers additional factors, including future operating and financial performance that may deviate from historic performance, the quality of management, corporate governance, financial controls, liquidity management, event risk, and seasonality. The analysis of these factors remains an integral part of our rating process. Management Quality The quality of management is an important factor supporting a company s credit strength. Moody s normally meets with senior executives to assess management s business strategies, policies, and philosophies. Once established, a record of consistency can provide insight into management s likely future performance and business philosophy. Corporate Governance Areas of consideration for corporate governance can include the audit committee s financial expertise, the incentives created by executive compensation packages, related party transactions, interaction with outside auditors, and ownership structures. Financial Controls We rely on the accuracy of audited financial statements to assign and monitor ratings in this sector. Such accuracy relies on adequate internal controls, including centralized operations and positive leadership, and consistency in accounting policies and procedures. 12 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

13 Weaknesses in the overall financial reporting processes, financial statement restatements, or delays in SEC or other regulatory filings are indications of a potential breakdown in internal controls. Liquidity Management Liquidity is especially critical in the non-investment grade area as these issuers typically have less operating and financial flexibility. Moody's forms an opinion on a company s likely near-term liquidity requirements from the perspective of both the sources and uses of cash. This may include monitoring bank covenants and compliance cushions to assess whether a company is likely to require covenant relief in the event of an industry downturn or an issuer-specific decline in performance. Event Risk We also recognize the possibility that an unexpected event could cause a sudden and sharp decline in an issuer's fundamental creditworthiness. Typical special events include mergers and acquisitions, capital restructuring programs, litigation, and large share repurchases. Conclusion: Summary of the Grid-Indicated Rating Outcomes The grid-indicated ratings for the 45 companies map to assigned ratings as follows (see Appendix for details):» 22 companies grid-indicated ratings map to their assigned rating» 15 companies grid-indicated ratings differ by one alpha-numeric notch from their assigned ratings» Eight companies grid-indicated ratings differ by two or more notches from their assigned ratings 13 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

14 Appendix A: Global Healthcare Service Provider Industry Methodology Factor Grid Moody's Healthcare Service Provider Methodology Factor Grid Factor Sub-Factor Weight PROFITABILITY FINANCIAL STRENGTH BUSINESS PROFILE Net Revenue (USD millions) Pretax Income (USD millions) Non-acquired Revenue Growth Aaa Aa A Baa Ba B Caa Ca % 70,000 35,000-70,000 15,000-35,000 7,000-15,000 3,000-7, , < % $5,000 $3,000 - $5,000 $1,500 - $3,000 $750 - $1,500 $250 - $750 $0 - $250 ($75) - $0 < ($75) 4.0% 13% 11-13% 9-11% 7-9% 5-7% 3-5% 1-3% < 1% RCF / Net Debt 12.0% 75% OR [< 0 AND Net Debt < 0] 55-75% 40-55% 25-40% 15-25% 5-15% 0-5% < 0% OR [> 0 AND Net Debt < 0] Debt / EBITDA 15.0% < 0.5x x x x x x 6.0x - 7.0x 7.0x [OR < 0.0x] EBITA / Interest Expense Payor Concentration Regulatory Environment 15.0% 16x 12-16x 8-12x 4-8x 2-4x 1-2x.75-1x < 0.75x 8.0% < 5% 5-10% 10-15% 15-25% 25-35% 35-45% 45% - 55% 55% 4.0% Environment is expected to be decidedly positive with no impediments to particularly high returns. Financial Policy 20.0% Expect shareholder returns to be managed to maintain extremely conservative and stable metrics. Return on capital and profitability are expected to be assured at high levels given favorable operating environment. Expect stable and predictable returns to shareholders with creditor protection taking priority when allocating growth from cash flow and proceeds from any asset sales. Favorable return and profitability expected to be highly likely given the lack of any anticipated negative pressures or developments. Expect share buybacks and acquisitions to have minimal impact on metrics. Expect the regulatory environment will be neutral. Reimbursement is expected to be neutral to somewhat positive. Expect financial policies to modestly favor shareholder returns. Possible event risk tied to acquisitions. Expect the regulatory environment will be neutral. Reimbursement is expected to be neutral. Expect financial policies to be clearly favorable to shareholders. Track record of ratings migration following acquisitions likely to continue. Expect the regulatory environment will be negative. Reimbursement rates are expected to decline but the impact on operating results will be manageable or can be offset by other measures. Expect financial policies to be very focused on shareholder returns. Material debtfunded acquisitions and share repurchases or dividends possible. Expect the regulatory environment will be negative. Considerable reimbursement declines are expected that will negatively impact operating results and financial metrics. Expect financial policies that are highly unfavorable to creditors. Financial cushion likely to be paid out to shareholders. Expect the regulatory environment will be decidedly negative. Anticipated declines in reimbursement is expected to result in significant financial stress. Expect financial policies that can be major contributors to a high likelihood of near term default. 14 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

15 Appendix B: Grid-Indicated Ratings Net Revenue (USD millions) Profitability Financial Strength Business Profile Pretax Income (USD millions) Non-acquired Revenue Growth Grid-Indicated RCF / Net Debt / Regulatory Company Moody's Rating * Rating Debt EBITDA Environment Advanced Homecare Holdings, Inc. B2 B1 Caa B A Ba Baa Ba Caa Caa B Alliance Healthcare Services, Inc. EBITA / Interest Expense Payor Concentratio n B1 B2 Caa Caa Ca Ba B B B Ba Ba American Renal Holdings, Inc. B3 B3 Caa B Ba B B B Caa Ba Caa Ardent Medical Services, Inc. B2 Ba3 B B B Ba Ba Ba Ba B B Capella Healthcare, Inc. B2 B1 B B Ba B Caa B Ba Ba Ba Care UK Health & Social Care Newco Limited Community Health Systems, Inc. B1 B1 B Caa Baa B B B A B Ba B1 B1 Baa Ba B B B B B Ba B CRC Health Corporation B3 B3 Caa B Ca B Ca B Caa Ba B DaVita, Inc. Ba3 Ba3 Ba Ba B Ba Ba Ba Caa Ba Ba Diagnostic Imaging Group, LLC Caa3 Ba3 Caa B Ca Baa Baa Baa Ba B B Drumm Investors LLC B1 B1 B B Ba Ba Ba Ba Caa Caa B Fresenius Medical Care AG & Co. KGaA Ba1 Baa3 Baa A Ba Ba Ba Baa Baa Ba Ba Fresenius SE & Co. KGaA Ba1 Ba1 A A B Ba Ba Ba Baa Ba Ba Genoa Healthcare Group, LLC DBA LaVie Care B2 B2 B B Caa B Caa Ba B Caa B Gentiva Health Services, Inc. B3 B1 B B Ba B B Ba Caa Caa Ba HCA, Inc. B1 Ba3 A A B Ba B B B Ba B HCR Healthcare LLC B2 B3 Ba B B Caa Ca B B Caa B Health Management Associates, Inc. B1 Ba2 Ba Ba B Baa Ba Ba Ba Ba B HealthSouth Corporation B1 B1 B B Ba Ba B Ba Caa Ba Ba Financial Policy 15 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

16 Net Revenue (USD millions) Profitability Financial Strength Business Profile Pretax Income (USD millions) Non-acquired Revenue Growth EBITA / Interest Expense Payor Concentratio n Company Moody's Rating * Grid-Indicated Rating RCF / Net Debt Debt / EBITDA Regulatory Environment Financial Policy IASIS Healthcare Corporation B2 B2 B B B B B B Ba B B Kindred Healthcare, Inc. B1 B1 Ba B Caa Ba Ba B B Caa B LifeCare Holdings, Inc. Caa1 Caa1 Caa Caa Caa B Ca Caa Caa Ba B LifePoint Hospitals, Inc. Ba3 Ba2 Ba B Ba Ba Ba Ba Baa Ba Ba National MENTOR Holdings, Inc. B3 B3 B Caa Caa B Caa B Caa B B National Surgical Hospitals B2 B1 Caa B Baa B B Ba Ba Ba B OnCure Holdings, Inc. Caa1 Caa1 Ca Caa Ca B Caa Caa B B B Priory Group Ltd (Crown NewCo 3) B1 B1 B B Baa B Caa B A B B Prime Healthcare Services, Inc. B2 Ba3 B B Ca Ba Baa Baa B B B Prospect Medical Holdings, Inc. B3 B1 B B B Baa Ba B Ba B B Radiation Therapy Services, Inc. B2 B3 B Caa Ca B Caa Caa B B B RadNet, Inc. B2 B2 B Caa B Ba B Caa Ba B B Renal Advantage Holdings, Inc. B2 B2 B B Ba B Caa B Caa Ba B Rhoen-Klinikum AG Baa2 Baa3 Ba B B Baa Ba Baa A Ba Baa Select Medical Holdings Corporation B2 B2 B B B B B B B Ba B Skilled Healthcare Group, Inc. B2 B1 B B Ba B Ba Ba Ba Caa B Sun Healthcare Group, Inc. B1 B2 B B Ba B B B B Caa B Surgery Center Holdings, Inc. B1 B1 Ca B B Ba Baa Ba B Ba B Surgical Care Affiliates B2 B3 B B B B Caa B Caa Ba B Symbion, Inc. B3 Caa1 Caa Caa Ca B Ca Caa Caa Ba B Tenet Healthcare Corporation B2 Ba3 Baa Ba Caa Baa Ba B B Ba B U.S. Renal Care, Inc. B2 B2 Caa B Ba Ba Ba B Caa Ba B United Surgical Partners International, Inc. B2 B2 B B Ca B B Ba Caa Ba B 16 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

17 Net Revenue (USD millions) Profitability Financial Strength Business Profile Pretax Income (USD millions) Non-acquired Revenue Growth Company Moody's Rating * Grid-Indicated Rating RCF / Net Debt Debt / EBITDA Regulatory Environment Universal Health Services, Inc. Ba2 Ba3 Ba Ba B B Ba Baa Ba Ba B Vanguard Health Systems, Inc. B2 B2 Ba B B B Caa B B B B Vantage Oncology, Inc. (Physician Oncology Services, LP) EBITA / Interest Expense Payor Concentratio n B2 Caa1 Ca B Ba Caa Caa B Caa B B * Moody's Rating is as of 12/15/2011. All quantitative measures are based on As Adjusted financial data and incorporate Moody s standard adjustments. All financial information as of March 31, 2011, except for Care UK Health & Social Care (9/30/2010), Crown NewCo 3 (Priory Group Ltd.) (12/31/2010) and Surgery Center Holdings, Inc. (12/31/2010). Note: Green: Positive Outlier grid-indicated performance is at least two broad rating categories HIGHER than the actual rating in the case of a sub-factor or two alphanumeric rating categories HIGHER than the actual rating in the case of Moody s ratings. Red: Negative Outlier grid- indicated performance is at least two broad rating categories LOWER than the actual rating in the case of a sub-factor or two alphanumeric rating categories LOWER than the actual rating in the case of Moody s ratings. Financial Policy 17 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

18 Appendix C: Observations and Outliers for Grid Mapping We identify positive or negative outliers from the grid-indicated rating as those that are at least two alphanumeric ratings away from the existing rating. A positive or negative outlier for a given sub-factor is one that is at least two broad rating categories higher or lower than a company s existing rating (e.g., a B-rated company whose rating for a specific sub-factor is in the Baa-rating category is flagged as a positive outlier for that sub-factor). We also offer commentary related to general trends. The results of the illustrative mapping shows that the grid-indicated ratings map fairly closely to the actual ratings based on the historical data but there are more positive outliers (the grid-indicated rating is higher than the actual rating of the company) than negative outliers. The ratings of three of the positive outliers (Ardent Medical Services, Prime Healthcare Services and Prospect Medical Holdings) are constrained by significant geographic concentration. Ardent operates in only two markets, Prospect Medical operates only in the Los Angeles, California market and Prime operates predominantly in Southern California. Additionally, the ratings of Ardent and Prime incorporate our expectation that the companies will be aggressively pursuing additional acquisitions that could be debt financed and result in increased leverage. In the case of Diagnostic Imaging Group, volumes for diagnostic imaging companies have been under pressure due to the focus on the potential for over utilization and revenue has been pressured by meaningful reductions in Medicare reimbursement rates. We have also expressed concerns around the company s weak liquidity position, characterized by the lack of a committed credit facility, considerable working capital needs and near-term maturity needs. Health Management Associates and Tenet Healthcare both are also positive outliers in the retained cash flow to net debt sub-factor. The ratings reflect our expectation that these companies considerable cash balances will not be maintained longer term. We expect Tenet to continue to use cash flow and available cash balance to actively pursue acquisitions of outpatient services while HMA is expected to continue to pursue hospital acquisitions and has already announced a number of acquisition and joint venture projects. Additionally, we currently have a positive rating outlook on Tenet, which if the rating is upgraded, will decreases the gap reflected based on the historical data. The only negative outlier is Vantage Oncology. The rating reflects our expectations of growth for the company and benefits from a recent acquisition while the grid-indicated rating based on the historical data is constrained by the modest scale and high leverage. 18 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

19 Appendix D: Healthcare Service Provider Industry Overview Corporate providers of healthcare services usually augment a system of providers made up of not-forprofit entities or providers with municipal or other public funding. Healthcare costs across the globe continue to rise as more expensive medical devices and pharmaceuticals increase life expectancy and as the older portion of the population continues to swell as a percentage of the total, implying that healthcare consumption will continue to rise. Therefore, there is increasing focus on improving efficiency in healthcare systems through the elimination of waste, ensuring that healthcare is provided in the appropriate setting, and aligning reimbursement with outcomes. While companies may operate in multiple disciplines, defined by care setting, reimbursement mechanism or patient population, we have included a short discussion of some of the major healthcare provider subsectors below. Acute care hospitals The majority of the rated debt among the rated for-profit healthcare service providers resides in the acute care hospital operators. An acute care hospital provides general medical and surgical services on both an inpatient and outpatient basis. Inpatient services are usually focused on patients with relatively short lengths of stay since patients may be moved to a more appropriate care setting once they are stabilized. These operations require significant capital investment in both facilities, equipment and technology. Of the healthcare service providers we rate, the acute care hospital operators are the most impacted by bad debt expense since many patients without insurance or an ability to pay for services enter the healthcare system through these facilities emergency departments. Specialty hospitals The term specialty hospital may in and of itself encompass a diverse group of operators. Generally speaking, a specialty hospital will differ from the acute care hospital in that it will not likely have an emergency room, thereby limiting exposure to bad debt. The specialty hospital may also focus on a specific level of care. For example, inpatient facilities focused on rehabilitation, patients requiring long lengths of stay or specific surgical procedures. Capital expense for these hospitals tend to be less intense than the acute care hospital. Ambulatory surgery centers (ASC) ASC operators are focused on providing surgical procedures on an outpatient basis. These facilities usually require much less capital to open and operate and are not equipped to admit patients over night or be staffed beyond the scheduled surgeries. ASC s growth, at the expense of the acute care hospitals, has been driven by a number of factors, including i) technological advances allowing more procedures to be done safely in an outpatient setting, ii) a lower cost per procedure, and iii) preference by physicians due to easier scheduling. Many ASCs are also jointly owned by the surgeons using the facility creating financial incentives to operate efficiently and drive volumes. Skilled nursing facilities (SNF) SNFs provide nursing and or rehabilitation services to predominantly older patients requiring a longer stay at an inpatient facility. Capital expense is moderate due to the lack of need for specialized equipment. Bad debt expense is minimal due to the existence of government programs related to the services provided. 19 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

20 Dialysis Dialysis center operators predominantly provide services to patients with end stage renal disease in an outpatient setting. Capital spend for the centers is moderate since the centers are usually relatively small and equipment can be moved among centers. In the United States, dialysis services are covered by Medicare regardless of the age of the patient making the Medicare program the single largest buyer of dialysis services. Homecare Homecare providers treat patients in their homes on an outpatient basis. In many cases, these patients are referred to the homecare system after the discharge from a higher level of care at an inpatient facility (e.g., acute care hospital, specialty hospital or SNF). Homecare companies have very little capital expense as they do not need to maintain facilities and have minimal bad debt expense since qualification for reimbursement can be pre-determined before services are rendered. Homecare is seen as an effective way to reduce costs in the healthcare system by keeping patients out of higher cost care setting and improving the quality of life of the patient by maintaining an increased level of independence at home. However, in the US, homecare revenue is predominantly from the Medicare program and has been under increased pressure due to a high level of fraud among smaller local providers. Hospice Like homecare services, hospice is seen as an alternative to inpatient stays that could both reduce costs to the healthcare system and improve the quality of the patient service. Hospice is provided as palliative care for chronically ill patients. Also like homecare, hospice in the US is predominantly reimbursed by the Medicare program. Hospice can be provided in the home or in another care setting (e.g., SNF) depending on the condition of the patient. As such, hospice providers have very little capital spending requirements. Behavioral health services Behavioral health can be diverse in the types of treatments, treatment settings and reimbursement mechanisms. For our purposes, we define behavioral health operators as those that provide assistance to developmentally disabled, occupational assistance or assistance or rehabilitation from dependence issues. Payment for these services among our rated issuers can rely heavily on government programs (e.g., Medicaid) or be focused on services the patient pays for directly. Therefore, regulatory compliance requirements will also vary greatly among these companies. 20 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

21 Appendix E: Key Rating Issues over the Intermediate Term While rating issues can vary based on the operational sub-sector and the geographic region in which the healthcare service provider operates, there are certain common themes that remain at the forefront of our consideration of the ratings in this sector. Demand for services The aging of the population is expected to continue to drive the need for additional healthcare services over the intermediate term. The US Census Bureau forecasted in 2009 that the global population of persons over the age of 65 would triple from 516 million in 2009 to 1.53 billion in In contrast, the population under 15 is expected to increase by only 6 percent during the same period, from 1.83 billion to 1.93 billion. In the United States, the population 65 and older will more than double by 2050, rising from 39 million in 2009 to 89 million in The utilization of healthcare services increases as the population ages. However, the prolonged economic downturn in the US has shown that certain parts of the healthcare system are susceptible to cyclicality as patients avoid non-emergent procedures and defer physician visits as they lose insurance coverage or are required to pay an increasing portion of the cost of healthcare services through higher deductibles and co-pay amounts. Pricing pressure Almost universally, there is concern about the continued rise in healthcare spending and the ability to pay for these services. This has led to increased pressure on pricing, or reimbursement rates for the provision of healthcare services. This pricing pressure is forcing healthcare providers to operate more efficiently and focus on containing costs of high cost pharmaceuticals and medical devices. Concerns about the cost of healthcare services are also leading to changes in payment mechanisms, including the development of value based purchasing methodologies, whereby providers are paid based on clinical outcomes and quality of care rather than the number of procedures or tests completed. These initiatives require investments in technology on the part of healthcare providers to more accurately track, analyze and document patient treatment protocols and outcomes, and limit costs associated with readmissions, infections and other preventable events. Regulatory scrutiny The majority of the rated providers operate under regulatory licenses and are, therefore, subject to regulatory scrutiny and review. These reviews sometimes result in companies reporting the existence of ongoing investigations that could result in settlement payments or fines. They could also result in a company having to operate under corporate integrity agreements or at worse, excluded from the ability to provide services (although we have not seen this extreme case in recent history). While the impact of regulators is something that we typically factor into our consideration of the ratings, we believe that increased focus on the costs of healthcare services will likely increase the level of regulatory scrutiny. One example is the introduction of RAC audits by the Medicare program in the US, which are designed to find and recover amounts over paid to healthcare providers. US healthcare reform In 2010, Congress passed the Patient Protection and Affordable Care Act. The Act is designed to, among other things, greatly expand the availability of insurance coverage to uninsured and underinsured Americans. The expected result would be a reduction in the amount of bad debt expense experienced by US healthcare providers stemming from the provision of services to individuals that do 21 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

22 not have the ability to pay. However, the main portions of the bill designed to expand healthcare insurance coverage do not become effective until Additionally, the expansion of coverage is offset by a number of reductions in Medicare reimbursement, some of which is already impacting current reimbursement rates. Additionally, uncertainty surrounds the implementation of many of the provisions of reform as the law itself faces legal challenges and the recent focus on government spending could call into question the ability to fund many of the initiatives included in the law. We continue to believe that the US acute care hospital operators will be most impacted by the provisions of the healthcare reform legislation as they have the largest exposure to the uninsured. We also continue to believe that the net effect of these provisions will initially be neutral to slightly positive for the US acute care hospital operators. Other healthcare providers could also be impacted by provisions of the law surrounding the bundling of payments and the establishment of accountable care organizations. These provisions are designed to reduce the costs within the system by transferring the risk associated with a patient to one responsible party for an entire episode of care. Such a plan could significantly change the way some post-acute care providers are paid as they become part of a bundled payment and receive less reimbursement directly from Medicare based on services provided. Consolidation We expect that consolidation within this sector will continue to be a factor in future rating considerations. The drive to control the spiraling costs of providing healthcare and pricing pressure will increase the need to operate efficiently and effectively. These pressures are expected to make it harder for stand-alone operations to remain competitive. Additionally, increased administrative burdens associated with ensuring quality of care and tracking clinical outcomes will require significant investment that will require sufficient access to capital, which will be more readily available to the larger established providers that can leverage these investments across a larger base. 22 DECEMBER 21, 2011 RATING METHODOLOGY: GLOBAL HEALTHCARE SERVICE PROVIDERS

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