December 22, 2017 / 4:49 PM / a year ago

Fitch Assigns Final Ratings to ABILITY Network Inc.'s Sr Secured First-Lien, Second-Lien Debt

(The following statement was released by the rating agency) NEW YORK, December 22 (Fitch) Fitch Ratings has assigned ABILITY Network Inc.'s senior secured first-lien and second-lien debt final ratings of 'BB/RR1' and 'CCC+/RR6', respectively. The final ratings are the same as the expected ratings assigned on Dec. 1, 2017 and follow the receipt of documents conforming to information previously received regarding the company's leveraged recapitalization. The ratings apply to $525 million of outstanding debt and a $20 million revolving credit facility (RCF), with issue-specific-ratings noted below. Fitch currently rates ABILITY's Issuer Default Rating (IDR) 'B'. The Rating Outlook is Stable. KEY RATING DRIVERS Durable Revenue Stream/Niche Segment: ABILITY is a provider of cloud-based software for healthcare providers, with a product suite focused on workflow solutions. The majority of revenues are derived from subscription-based software sales, and this provides good visibility into the future revenue stream. Fitch believes the stickiness of ABILITY's revenues is supported by a lack of customer concentration and a high historical retention rate. While Fitch does not believe switching costs for healthcare IT customers are particularly high, ABILITY's value proposition related to the company's network service vendor relationships with Medicare Administrative Contractors (MACs) should support customer retention. High EBITDA Margins: ABILITY generates high operating EBITDA margins that are better than healthcare IT segment peers, and also demonstrates good FCF conversion. High margins are due to some favorable attributes of the business model, including relatively low R&D intensity and a low-cost go-to-market approach that involves a web-based sales and product implementation strategy. Fitch believes these advantages are sustainable. R&D spend should be relatively predictable and consistent, since ABILITY's product suite is well developed and comprehensive with offerings dedicated to each of the end markets the company targets. Good Customer Value Proposition: The low price point of ABILITY's products should provide opportunities to expand and support the 2% organic pricing growth assumption in Fitch's rating case. The company's healthcare provider customers are facing headwinds to volumes and profitability due to a combination of factors that are encouraging patients and payors to seek care in lower-cost settings, particularly in the acute and post-acute segments. Fitch believes that the low-cost nature of ABILITY's products makes them less susceptible to cost cutting and containment initiatives by healthcare providers, but industry headwinds could influence growth of new customers. High Leverage Post Transaction: Fitch expects ABILITY will initially be levered 8x pro forma for the recapitalization and dividend to its shareholders. Leverage is expected to gradually decline through 2020 to below 7x. Fitch calculates leverage on a gross debt/EBITDA basis and does not include all of the add-backs that are allowed under the terms of the credit agreement. This is the first time that Summit Partners, ABILITY's main private-equity sponsor, has extracted equity since a 2014 buyout, and the balance sheet improved materially following that transaction. DERIVATION SUMMARY ABILITY Network's 'B' IDR reflects the company's favorable operating profile in comparison to healthcare IT segment peers including Cerner Corp., AthenaHealth Inc., Allscripts Healthcare Solutions, Medassets Inc., Omnicell Inc., Quality Systems Inc., Computer Programs & Systems, Epocrates LLC and Healthstream Inc. (none of these companies are currently rated by Fitch). ABILITY has higher margins than this group because of a low-cost go-to-market strategy and lower intensity of R&D expenditures. The 'B' IDR also reflects ABILITY's weaker financial profile relative to this peer group, with a highly leveraged balance sheet pro forma for the leveraged recapitalization. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Mid- to high-single-digit annual revenue growth, with about 1% contributed by acquisitions and the rest driven by contracted revenue growth; - Contracted revenue growth assumption based on 2.0%-2.5% growth in pricing, 92% retention of existing contracts and high-single-digit growth in new contracts and existing contract upsells; - Operating EBITDA margins sustain around 46%; - Capital intensity steady at 5.5%; - No additional dividend payments and FCF margins sustain above 10%; - FCF split between small, tuck-in type M&A and term loan repayments (including 1% required amortization of first-lien term loan); - Leverage (total debt/EBITDA) of 8.0x pro forma for the leveraged recapitalization, declining to 6.6x by the end of 2020. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -An expectation for leverage (total debt/EBITDA) sustained at or below 5x; -An expectation for operating EBITDA margin sustained above 50% and FCF margin sustained above 15%; -Fitch does not envision positive momentum at this time, as achieving leverage of 5x by the end of 2020 would require double-digit growth in revenues through the forecast period and a significant amount of FCF applied to debt repayment. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -An expectation of flat EBITDA through the forecast period; - An expectation for operating EBITDA margins of around 40% and FCF margin approaching breakeven in 2020; -An expectation for leverage (total debt/EBITDA) sustained at or above 8x. LIQUIDITY Decent Coverage Despite Higher Leverage: Fitch forecasts EBITDA/interest paid of about 1.8x through the forecast period, adequate relative to the 'B' rating. As a result of the lower cost of debt capital, cash interest expense is only expected to be $8 million higher than prior to the transaction. Maturities Not a Credit Concern: As a result of the transaction, ABILITY extended the term loan maturities to 2024-2025. Annual amortization is limited to 1% of the first-lien term loan principal amount, which can be funded with FCF generation in the ratings case. ABILITY's liquidity position will be further supported by the expectation of a decent balance of unrestricted cash after the recapitalization and the expectation for continued positive FCF. Fitch expects the company will be able to position itself to refinance the remaining debt before maturity given the ability to reduce leverage and a decent operating outlook. Fitch notes that the financial covenant only applies to the RCF. FULL LIST OF RATING ACTIONS Fitch has assigned the following ratings: ABILITY Network Inc. --Senior first-lien secured revolver at 'BB/RR1'; --Senior first-lien secured term loan at 'BB/RR1'; --Senior second-lien term loan at 'CCC+/RR6'. Fitch also maintains the following rating: --Long-Term Issuer Default Rating at 'B'; The Rating Outlook is Stable. Recovery Assumptions The 'BB/RR1' rating for ABILITY's $20 million revolver and $375 million first-lien term loan reflect recovery of 94% of the outstanding principal amount in a hypothetical bankruptcy scenario; the 'CCC+'/'RR6' rating on the $150 million second-lien term loan reflects recovery of 2%. The claims waterfall assumes: --Full draw of the $20 million revolver available balance; --10% deduction from enterprise value (EV) for administrative claims; --1% concession payment made by the first-lien lenders for the benefit of the second lien lenders. --Fitch estimates an EV on a going-concern basis of $374 million for ABILITY after deduction of administrative claims. The EV assumption is based on post-reorganization EBITDA of $59 million and a 7x recovery EBITDA multiple. The post-reorganization EBITDA estimate is 10% lower than Fitch's 2017 EBITDA forecast of $66 million. This assumes that deterioration in cash flow precipitated by underinvestment in the business is ameliorated post-reorganization by corrective actions taken to restore competitiveness of the company's software product offerings. In its 13th edition "Bankruptcy Enterprise Values and Creditor Recoveries" case study, Fitch notes seven past reorganizations in the technology sector where the median recovery multiple was 4.9x. Of these companies, only two were in the software subsector: Allen Systems Group, Inc. and Aspect Software Parent, Inc., which realized recovery multiples of 8.4x and 5.5x, respectively. Fitch believes the Allen Systems Group, Inc. reorganization is highly supportive of the 7.0x multiple assumed for ABILITY given similar product profiles, as both are providers of specialty software to a niche client base where market shares are defendable. Current public company trading multiples (average of 18.1x for a group of public healthcare IT peers) and historical transaction multiples (19.0x median for software companies acquired since 2006) also inform the 7.0x estimate; Fitch believes ABILITY would receive a lower recovery multiple than these reference points given an assumption that stressed operations lead to the recovery scenario. Contact: Primary Analyst Megan Neuburger, CFA Managing Director +1-212-908-0501 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Benjamin Immordino, CFA Associate Director +1-212-908-9163 Committee Chairperson Britton Costa, CFA Senior Director +1-212-908-0524 Relevant Committee Date: Nov. 28, 2017 Summary of Financial Statement Adjustments -Historical and projected EBITDA is adjusted to add back stock-based compensation, personnel restructuring costs, non-cash contingent consideration expense, M&A expenses, office closing costs, and vendor litigation/settlement costs. 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