Overview -- Bolingbrook, Ill.-based outpatient physical therapy provider ATI Holdings Inc. is being acquired by KRG Capital Partners (KRG) in a leveraged buyout. for $770 million. -- ATI plans to issue a $335 million secured credit facility and $160 million of mezzanine debt to partly finance the acquisition, resulting in very high pro forma leverage of about 7.0x by 2013. -- We are assigning a 'B' corporate credit rating to the company. -- Our stable outlook reflects our expectation that EBITDA will expand as a result of the company's growth strategy supporting some improvement in leverage and modest free operating cash flow (FOCF). Rating Action On Jan. 11, 2013, Standard & Poor's Ratings Services assigned a 'B' corporate credit rating to ATI Holdings Inc. The outlook is stable based on our expectation of solid double-digit revenue growth and steady margins, although we expect FOCF to remain thin. We also assigned a 'B+' issue level rating on the company's $335 million senior secured credit facility that comprises of a $50 million revolver that expires in 2019 and a $285 million term loan B that expires in 2020. The recovery rating is a '2', indicating substantial (70% to 90%) recovery in the event of a principal payment default. The company is also raising $160 million of mezzanine notes, which we do not rate. Rationale The ratings on ATI Holdings Inc. reflect the company's "vulnerable" business risk profile, primarily reflecting low barriers to entry and economic cyclicality, and a "highly leveraged" financial risk profile, based on adjusted leverage that exceeds 8.0x at inception with a moderate drop to 7.0x by 2013. In our opinion, ATI's ambitious growth strategy will support double-digit revenue growth in 2012 and 2013, but will result in slim FOCF over the next 12 months. ATI provides physical therapy and occupational therapy on an outpatient basis, operating 188 clinics across Delaware, Illinois, Maryland, Ohio, Pennsylvania, and Wisconsin. We expect the company to maintain existing margins over the near to medium term. Margins in 2012 reflect a 600-basis-point contraction from its peak, stemming from a 30% Illinois workers' compensation rate cut that was effective September 2011. Our double-digit revenue growth assumptions primarily incorporate an expectation for increased clinic visits for 2012 and 2013, offset by declining revenue per visit for 2012. ATI reported year-to-date double-digit revenue growth for the nine months ended Sept. 30, 2012. In addition to mid-single-digit same-store visit growth for clinics acquired/opened prior to 2010 and 2011, we expect 62 added clinics from recent acquisitions and de novo clinic openings in 2012 and an additional 26 clinic openings in 2013. Combined, we expect over 20% growth in visits in 2013. Following a decline in revenue per visit in 2012 because of the late 2011 Illinois workers compensation rate cut, we expect modest growth in 2013 stemming from better pricing from commercial payors, as the company seeks to expand this payor mix. However, we expect revenue per visit will suffer modestly over time, as the company diversifies away from its geographic concentration in the Midwest region. We expect EBITDA margins, which dropped significantly from its peak in 2011 because of the Illinois worker's compensation cut, to remain at current levels. We expect the company's ongoing investment in its portfolio of clinics to absorb the majority of operating cash in 2012 and 2013. As a result, we expect FOCF to remain thin over the next 12 months. We view ATI's financial risk profile as highly leveraged following the acquisition by KRG. We expect adjusted leverage after the close to be above 8.0x that excludes pro forma adjustments for acquisitions and funds from operations (FFO) to debt to be below 10%. We expect EBITDA growth and minimal debt repayment to push leverage down to about 7.0x by 2013. FFO to debt will still remain thin, supportive of credit metrics of a highly leveraged financial risk profile. ATI's sponsor ownership is also a factor in the company's financial risk. ATI's vulnerable business risk profile reflects its concentrated geographic presence, ambitious growth strategies, vulnerability to economic cycles, and low barriers to entry. The company operates in six states, with 58% of its revenues derived from one state. The company's business risk also reflects its susceptibility to reimbursement from third-party payors. ATI's concentration of revenues in Illinois coupled with the state implementing a rate cut in workers compensation has hurt EBITDA margins for 2012. Despite this cut, we view ATI's payor mix as somewhat stronger than peers, with 33% and 52% of revenues, respectively, from higher-paying workers' compensation and commercial payors. The balance is from Medicare and Medicaid. Third-party payors have generally supported the lower-cost therapies and positive treatment outcomes stemming from physical therapy, leading to relatively stable reimbursement. Nevertheless, risk for rate reductions still exists. ATI's aggressive growth strategy of expanding its presence in new geographical areas should gradually mitigate revenue concentration in one state and diversify its payor mix. Although the strategy also exposes the company to integration risks that are common in expanding into new markets via de-novo clinics and acquisitions, ATI has a good track record. Past acquisitions and de-novo clinic openings have contributed to EBITDA growth, through successful integration on the company's scalable IT billing and time-management platforms. We believe ATI's concentration in Midwest manufacturing exposes the company to economic cycles that affect employment and employee-health benefits. Unemployment has correlated to consumer deferrals in elective surgeries that spur postsurgery physical therapy. Despite this risk, outpatient physical therapy is a growing business, with annual growth of about 8% since 2006, benefiting from an increase in mid-single-digit growth in orthopedic surgeries according to IBISWorld and American Hospital Assn., respectively. The industry benefits from heightened demand from an aging population and increases in sports and work-related joint and musculoskeletal injuries. The highly fragmented nature of the industry also reflects the company's business risk. There are only three national participants and limited regional participants (including ATI) that account for less than 4% of the market. Liquidity ATI's liquidity is "adequate," with sources of cash likely to exceed uses for the next 12 to 24 months. Our assessment of ATI's liquidity includes the following expectations and assumptions: -- We expect sources to cover uses by at least 1.2x or more for the next two years. -- Sources include our expectation of nominal cash reserves in 2012 and 2013 and full availability on its $50 million revolver. We expect limited free operating cash flow, as we expect working capital to be a use of cash because of a slight increase in days sales outstanding and the company's investment in de-novo clinics. -- Uses include our expectation of capital expenditures of about $18 million, which includes de-novo clinic openings and required debt amortization payment of about $3 million. -- We expect net sources to be positive, even if EBITDA declines 15%. -- ATI would unlikely be able to absorb low-probability shocks without incurring more debt. -- We expect cushion on debt covenants of about 25%; however, covenant step-downs begin in the fourth quarter of 2013, which may erode this cushion without adequate EBITDA growth. -- ATI will not have any debt maturities until 2018, when its revolver becomes due. Recovery analysis For the complete recovery analysis, please see the recovery report on ATI Holdings, to be published as soon as possible on RatingsDirect following this report. Outlook The rating outlook is stable, based on our expectation of solid double-digit revenue growth and steady margins, although we expect FOCF to remain thin. We expect ATI to expand EBITDA generation in 2013, supporting a modest fall in leverage. We expect growth in de novo clinics to be funded internally. We do not believe a higher rating is likely in the near to medium term, given our expectation that the company will continue to invest in growth and operate with a highly leveraged financial risk profile. We could lower the rating if anticipated EBITDA growth is delayed or less than we expect. This could result from poor sites for new clinics that do not generate the same level of visits, or another reimbursement cut in a large state. Such a scenario would cause loan covenant cushions to fall below 10%. This could occur if there was close to a 15% decline in EBITDA. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Rating; Outlook Action ATI Holdings Inc. Corporate Credit Rating B/Stable/-- Senior Secured US$285 mil term bank ln due 2020 B+ Recovery Rating 2 US$50 mil revolving bank ln due 2019 B+ Recovery Rating 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.