May 30, 2012 / 9:03 PM / 6 years ago

TEXT-S&P revises Drumm Investors outlook

(The following statement was released by the rating agency)	
    	
Overview	
     -- While Drumm's earnings have met our expectations, liquidity and cash 	
flow have fallen short, causing us to review our expectation for debt 	
repayment and whether we can continue to view its financial risk profile as 	
"aggressive."	
     -- While the company is within bank covenant compliance, the cushion of 	
the ratio compared with the covenant fell below the 15% level we expect for an 	
"adequate" liquidity profile. 	
     -- We therefore changed our liquidity descriptor to "less than adequate" 	
from "adequate" to acknowledge the decline in its cushion and to reflect the 	
50-basis-point step-down on March 31, 2013 that could cause the cushion to 	
weaken further depending on the company's liquidity-enhancing efforts. 	
     -- The negative rating outlook reflects the possibility that weaker 	
liquidity and less debt repayment may result in higher-than-expected leverage.	
	
Rating Action	
On May 30, 2012, Standard & Poor's Ratings Services affirmed its 'B+' 	
corporate credit rating on Fort Smith, Ark.-based Drumm Investors LLC and 	
revised the rating outlook to negative from stable.	
	
We also affirmed our 'B+' senior secured rating on the company's term loan and 	
revolving credit facility. The recovery rating on this debt remains '3', 	
indicating our expectation of meaningful (50% to 70%) recovery for lenders in 	
case of default. 	
	
Rationale	
The ratings on Drumm is based on Standard & Poor's assessment of the company's 	
business risk profile as "weak," reflecting significant reimbursement risk 	
such as the recent Medicare payment cut to nursing homes and adverse changes 	
to the reimbursement rules for group therapy services. We consider the 	
financial risk profile "aggressive," reflecting our expectation of leverage 	
below 5x. We expect Drumm's total revenue to be flat to 1% higher in 2012, 	
compared with 2.4% growth in 2011, primarily because of the full-year impact 	
of the late 2011 Medicare rate cut. This expectation also includes no Medicaid 	
rate increases on average for all the states where Drumm operates. We also 	
expect patient days in its nursing homes to be relatively flat as an extension 	
of the recent trend. 	
	
We expect Drumm's lease-adjusted EBITDA margin to decrease by about 200 basis 	
points (bps) in 2012. This estimate includes our view of the impact of the 	
Medicare rate cut on Drumm's nursing home business and also considers the 	
company's cost-control efforts to partly mitigate the rate cut. These efforts 	
may include labor force reductions and vendor renegotiations.	
	
We view Drumm's financial risk profile as aggressive, reflected in our 	
calculation of debt to EBITDA of 5.1x in 2012, decreasing to about 4.9x by the 	
end of 2013. The estimate of 5.1x reflects an increase in leverage from 4.5x 	
in 2011 due to the recent large Medicare rate cut to nursing homes. This 	
estimation also considers our expectation that Drumm will remain 	
nonacquisitive, and will apply its free cash flow in 2012 to repay debt to 	
limit the pending increase in leverage. We expect Drumm to generate about $30 	
million of free cash flow in 2012. In our view, this use of cash will take 	
priority over paying any substantive dividend to its owner. However, leverage 	
would increase to 5.2x by the end of 2012 if the company did not use cash to 	
repay debt. We believe this leverage level may be temporary because Drumm's 	
cost-control efforts and growth strategies that may diversify its business, 	
could help the company meet our earnings expectations and bring leverage back 	
down below 5x.	
	
Our view of Drumm's weak business risk is heavily influenced by the large 	
concentration of over 70% of its total revenues generated from government 	
reimbursement, (approximately 31% from Medicare and 43% from Medicaid), we 	
believe government reimbursement risk is the most significant key credit 	
factor, despite its size and scale. Drumm, like several other rated peer 	
companies, rely on their nursing home operations for 80%-85% of total 	
revenues. This concentration makes Drumm and its peers very sensitive to 	
Medicare rate cuts to nursing homes. This is in contrast with Kindred, which 	
is more diversified, generating only about 40% of its revenues from its 	
nursing home division. Kindred spreads government reimbursement risk among its 	
several different businesses. We believe Drumm is also subject to growing 	
competition. While nursing homes are increasing their capabilities and 	
offering a wider array of services to more medically complex patients to 	
optimize reimbursement, they are competing with other facilities with similar 	
strategies. We expect this competition to intensify as nursing homes adjust to 	
reimbursement changes, contributing to our view that patient days will remain 	
flat. 	
	
Liquidity	
Drumm's liquidity is "less than adequate," primarily reflecting the potential 	
for tightening covenant cushion. Sources of cash are likely to exceed uses of 	
cash over the next 12 months. 	
	
Relevant aspects of Drumm's liquidity are:	
     -- We expect the company to cover uses by over 2x during the next 12 to 	
24 months. 	
     -- Sources of liquidity include about $120 million of cash flow from 	
operations after working capital needs and before capital expanses that we 	
estimate to be about $90 million.  	
     -- We expect Drumm to have an adequate amount of cash on the balance 	
sheet, and to generate about $30 million of free cash flow in 2012.	
     -- Under Drumm's existing revolving credit facility, we believe that 	
availability will be limited due to a slim covenant cushion. 	
     -- There are no debt maturities until 2016, when the revolving credit 	
facility matures, and then until 2018 when the term loan matures. 	
     -- The senior secured leverage ratio covenant tightens 50 bps to 4.5x in 	
the first quarter of 2013, and another 50 bps to 4.0x in the first quarter of 	
2014.	
     -- Our current forecast projects debt to EBITDA of 4.9x, but only a 6% 	
bank covenant cushion in 2013. This estimate assumes flat to 1% revenue 	
increase in 2012 and 3% revenue increase in 2013.	
	
Recovery analysis	
For the complete recovery analysis, see the recovery report on Drumm, 	
published June 22, 2011, on RatingsDirect.	
	
Outlook	
Our rating outlook on Drumm is negative. We will lower the rating if the 	
company's efforts to counteract the recent reimbursement cuts are unable to 	
sustainably reduce leverage back below 5x; we would also consider lowering the 	
rating within the next six months if Drumm does not address the slim covenant 	
cushion and potential for a covenant violation upon the next step-down in 	
early 2013. We believe an amendment may be necessary as reflected in our slim 	
bank covenant cushion estimate in 2013, leaving little room for error. 	
	
If Drumm's cost-mitigation efforts and debt reduction results in leverage 	
remaining below 5x and we believe it will remain there, we could revise the 	
outlook to stable. This would require Drumm to provide a solution for 	
maintaining a 15% cushion for its restrictive covenant requirements that 	
include 50-bp step-downs in both early 2013 and 2014. Without an amendment, we 	
estimate that bank-calculated EBITDA would have to rise to the $335 million 	
range, assuming repayment of debt with free cash flow to achieve a 15% cushion 	
after the early 2013 step-down. 	
	
Related Criteria And Research	
     -- Methodology And Assumptions: Liquidity Descriptors For Global 	
Corporate Issuers, Sept. 28, 2011	
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009	
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
	
Ratings List	
	
Ratings Affirmed; Outlook Action	
                                        To                 From	
Drumm Investors LLC	
 Corporate Credit Rating                B+/Negative/--     B+/Stable/--	
	
Ratings Affirmed; Recovery Ratings Unchanged	
	
Drumm Investors LLC	
 Senior Secured                         B+                 	
   Recovery Rating                      3                  	
	
 (Caryn Trokie, New York Ratings Unit)

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