Nov. 19 - Overview
-- The Centers for Medicare & Medicaid Services (CMS) announced a
surprisingly large reduction in reimbursement rates for certain anatomic
pathology (AP) services, effective Jan. 1, 2013.
-- We believe these reimbursement rates will substantially reduce U.S. AP
services provider Aurora Diagnostics Holdings LLC's revenues, EBITDA
generation, and cash flow beginning in 2013 and will hinder its ability to
generate cash over the next few years.
-- We are lowering our corporate credit rating on Aurora to 'B-' from
'B', our rating on subsidiary Aurora Diagnostics LLC's senior secured debt to
'B+' from 'BB-', and our rating on Aurora Diagnostics Holdings LLC's senior
unsecured debt to 'CCC' from 'CCC+'.
-- The rating outlook is negative, reflecting the possibility that
Aurora's cost-reduction initiatives will not sufficiently offset the Medicare
rate cut and other market pressures, and the potential for slim headroom under
Aurora's loan covenant.
On Nov. 19, 2012, Standard & Poor's Ratings Services lowered its corporate
credit rating on Palm Beach Gardens, Florida-based Aurora Diagnostics Holdings
LLC to 'B-' from 'B'.
We also lowered our rating on subsidiary Aurora Diagnostics LLC's senior
secured debt to 'B+', two notches above the corporate credit rating, from
'BB-', and our rating on Aurora Diagnostics Holdings LLC's senior unsecured
debt to 'CCC', two notches below the corporate credit rating, from 'CCC+'. We
affirmed our '1' recovery rating on the senior secured debt, indicating our
expectation for very high (90% to 100%) recovery of principal, and our '6'
recovery rating on the senior unsecured debt, indicating our expectation for
negligible (0 to 10%) recovery of principal, both in the event of payment
The ratings on Aurora Diagnostics Holdings LLC, a provider of anatomic
pathology (AP) diagnostic services, continue to reflect the company's
"vulnerable" business risk profile (according to our criteria), unchanged as a
result of the CMS decision. We downgraded the company because we expect the
Medicare rate cut to substantially reduce Aurora's revenues, EBITDA
generation, and cash flow, beginning in 2013 and to hinder its ability to
generate cash over the next few years. We previously expected Aurora to borrow
modestly in 2012 and 2013 to finance large earn-out payments, and then to
resume generating discretionary cash flow after earn-out payments in 2014.
The business risk profile is characterized by a narrow operating focus,
vulnerability to customer in-sourcing, price pressure, and weakened
profitability. Despite lower margins, we expect Aurora to continue generating
discretionary cash flow, but it will require borrowing from its revolving
credit facility to cover large earn-out payments in 2012 and 2013. Further
borrowing may be needed in subsequent years. We expect Aurora's adjusted debt
to EBITDA to rise above 6x, higher than our earlier expectation that leverage
would peak at about 5.5x, but still consistent with the company's "highly
leveraged" financial risk profile. We revised our liquidity assessment to
"less than adequate" from "adequate," primarily on weakened cash flow and loan
We expect 2012 revenues to grow about 5%, propelled by 2011 acquisitions;
growth was 11.2% for the 12 months ended Sept. 30, 2012, but declined 4.7%
year over year in the third quarter of 2012. In 2013, we expect a double-digit
revenue decline mainly as a result of the Medicare rate cut. From this lower
base, we expect low-single-digit annual organic volume and revenue growth for
Aurora, similar to growth for the total U.S. outpatient AP market. We believe
revenue per accession (generally correlated with profitability) will continue
to decline, reflecting reduced Medicare payment rates, customer in-sourcing,
price pressure from commercial insurers, and possibly a continued unfavorable
shift in service mix.
In the third quarter of 2012, Aurora wrote off $115 million of goodwill and
intangibles and we expect further write-offs in the fourth quarter. These
noncash charges do not affect cash flow or covenant compliance, but they do
signal the reduced earning power of the business. Management recently
implemented staff reductions and is taking other cost-cutting actions that we
believe could save about $5 million per year, but this will be partly offset
by information technology investments and higher costs to retain pathologists.
Under our base case, we expect the EBITDA margin (adjusted for nonrecurring
items, stock compensation, and the capitalization of operating leases) to fall
to about 21.0% in 2012, corresponding to adjusted EBITDA of about $60 million.
Although we expect Aurora to implement additional cost controls, we estimate
adjusted EBITDA could drop to about $40 million in 2013 (a 500-basis-point
Medicare accounted for about 30% of Aurora's 2011 revenue; 25% on the
physician fee schedule. In 2013, Medicare will sharply reduce reimbursement
rates for the technical component and modestly raise rates for the
professional component of a common procedure. Aurora estimates these changes
will reduce its revenue by $21 million. We also expect some commercial
insurers to follow suit, and we expect Aurora to lose an additional $1.5
million in annual revenue as a result of new rules that require it to bill
hospitals, rather than Medicare, for in-patient testing. The 2013 Medicare
rate cut follows a reduction in reimbursement rates on the physician fee
schedule that are reducing Aurora's Medicare revenue by about 3.5% to 4.5% in
Since its founding in 2006, Aurora has grown rapidly, fueled by more than 20
acquisitions. We believe Aurora has curbed its appetite for acquisitions and
is now focusing on organic growth, efficiency improvements, and cost cutting.
Aurora competes mainly in the AP subsector of the diagnostic laboratory
industry. AP is the examination of tissue samples and cells to detect cancer
and other diseases. The AP market has fairly low barriers to entry and remains
very fragmented, which contributes to Aurora's vulnerable business risk
profile. We estimate the two largest participants, Quest Diagnostics Inc. and
Laboratory Corp. of America Holdings, have a combined share of only about 10%
to 15%. They also have been hurt by customer in-sourcing. We believe
independent labs are generally losing market share to hospital labs when
previously independent doctors become hospital employees, an ongoing trend.
Aurora has established positions in dermatology and women's health within its
local markets, but its scale is small relative to LabCorp and Quest, which
offer a broader, more diverse range of diagnostic services. Aurora's
competitors also include local providers, as well as its own customers that
can in-source the technical component (e.g., specimen preparation) of
diagnostic testing. We believe in-sourcing has materially reduced Aurora's
revenue and EBITDA growth during the past few years.
Despite its smaller scale, we believe Aurora generally has had higher profit
margins than LabCorp and Quest because the larger companies are more
concentrated in lower-margin clinical testing and may receive lower
reimbursement rates under national contracts with commercial insurers. Aurora
typically has been paid an in-network rate under local contracts, but we
believe large commercial insurers may push the company to accept national
contracts at lower rates. Commercial payors (57% of Aurora's 2011 revenue)
generally have been aggressive in reimbursement negotiations with service
We expect adjusted debt to EBITDA (5.5x as of Sept. 30, 2012) to rise to above
7x by the end of 2013, largely as a result of sagging EBITDA. The main
adjustments we make when calculating leverage are to capitalize operating
leases and add to debt the fair value of contingent consideration, including
our estimate of that amount for pre-2009 acquisitions. The fair value of
contingent consideration ($47.2 million as of Sept. 30, 2012) will decline
substantially over the next few quarters as earn-outs are paid, but we expect
Aurora to borrow to finance some of these payments. Therefore, while we expect
little change in adjusted debt, leverage will increase. Over the next two
years, we assume Aurora will not take on new debt to finance acquisitions or
shareholder-friendly actions. Financial sponsors own a majority of Aurora.
We have revised our assessment of Aurora's liquidity to less than adequate, as
defined in our criteria, reflecting diminished cash flow generation and the
potential for a thin covenant cushion. Its business has relatively low capital
requirements. We expect about $30 million in funds from operations (FFO) in
2012 and $15 million to $20 million of FFO in 2013 to easily finance about $5
million in annual capital expenditures and, at most, small annual increases in
working capital. We expect earn-out payments of $29 million in 2012 and $22
million in 2013 to be the largest use of cash. However, these payments will be
much smaller in subsequent years. We believe Aurora will require incremental
borrowing in 2012 and 2013.
Our analysis is based on the following assumptions and expectations:
-- We expect liquidity sources, including the $60 million revolving
credit agreement, to exceed uses by more than 1.2x for the next 12 to 24
-- If EBITDA is 15% lower than we expect, coverage would still be
-- As of Sept. 30, 2012, Aurora had $5.7 million in cash and $52 million
of the $60 million revolving credit facility was available.
-- We assume Aurora will not make any acquisitions in 2012 and 2013.
-- In connection with a recent loan amendment, Aurora prepaid $10 million
of its term loan.
-- Debt maturities are minimal until the term loan matures in 2016.
-- The loan amendment included the elimination of an interest coverage
test and a loosening of the leverage limit. We believe headroom under this
covenant could decline to 10% to 15% in 2013. As of Sept. 30, 2012, there was
ample headroom under the old financial covenants.
For our complete recovery analysis, see our recovery report on Aurora
Diagnostics, to be published as soon as possible after this report on
The rating outlook is negative, reflecting the possibility that Aurora's
cost-reduction initiatives will not sufficiently offset the Medicare rate cut
and other market pressures, and the potential for slim headroom under Aurora's
loan covenant. We would consider lowering the rating if liquidity is impaired,
evidenced by a projected loan covenant cushion below 10%, limited revolver
availability, or our belief that after 2013 Aurora could not generate cash
after earn-out payments. We would consider revising the outlook to stable if
Aurora is able to reduce its costs or take other actions that enable it to
generate cash after earn-out payments, and we expect the covenant cushion to
stay above 15%.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- 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
Aurora Diagnostics Holdings LLC
Aurora Diagnostics Inc.
Corporate Credit Rating B-/Negative/-- B/Negative/--
Aurora Diagnostics Holdings LLC
Senior Unsecured CCC CCC+
Recovery Rating 6 6
Aurora Diagnostics LLC
Senior Secured B+ BB-
Recovery Rating 1 1
Temporary contact number: Gail Hessol, (646) 285-7768.
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
Primary Credit Analyst: Gail I Hessol, New York (1) 212-438-6606;
Secondary Contact: Jesse Juliano, CFA, Boston (1) 617-530-8317;