Issue 4 – June 13, 2019

The U.S. health care staffing industry's prospects are tightly tied to those of their health care provider clients, which are grappling with the ever-rising pressure to control costs. While they have turned to outsourcing staffing, their intense focus on cost cutting has put significant pressure on staffing companies to lower prices and increase the value they add by either specializing or expanding their menu of services, or both. Our outlook on the staffing industry is currently stable. However, there is a negative bias given the companies' tight link to health care providers, on which we have a negative outlook.

The Challenge Of Serving An Industry In Transition

Health care providers, most prominently hospitals, are continuing to adapt to an increasingly more constrained and complicated reimbursement environment. Providers are grappling with a growing focus on cost management as well as an ongoing shift toward outpatient services. At the same time, the emphasis on value means they must still ensure that they provide high-quality care and continuously improve patient outcomes. The emergence of consumerism and a health care retail market (such as Minute Clinics) as a competitive factor, and the focus on outcomes and patient-satisfaction measures that are expected to eventually have a direct impact on reimbursement, have made proper staffing increasingly essential. We believe health care staffing companies will need to adapt to the pressures facing providers and become more sophisticated partners to their clients. This can include expanding into services such as diligent labor management, productivity improvement, and workflow design as well as efficiently reducing skilled staffing shortages to lower costs and improve quality.

S&P Global Ratings also believes the transition into the value-based payment realm--and the resultant tracking of outcomes and cost cutting--will only become more crucial for hospitals and therefore for health care staffing companies as well. We expect reimbursement pressure to intensify and hospitals to bear greater insurance risk as they evolve into comprehensive health systems, especially as lower-acuity patients continue their migration to lower-cost settings. We expect staffing companies that are not investing, developing, and offering services that help hospitals reach their goals will see a decline in their client base.

One-Stop Shops Are Now Also Competing With Niche Providers

Historically, health care providers relied on independent physicians and small local practice groups to deliver physician services. Later, they turned to larger local and national physician groups and employed physicians to meet their increasingly complex needs. Hospitals, ASCs (ambulatory surgery centers), and other health care facilities must achieve targeted physician coverage levels and address difficulties in hiring and retaining physicians while improving patient flow, reducing wait times, shortening lengths of stay, and reducing readmission rates. Although providers historically seemed to prefer one-stop-shop staffing companies, a plethora of new staffing companies that offer highly specialized, niche services have emerged.

We continue to view this business as intensely competitive, somewhat dominated by larger, better-financed entities like Envision Healthcare Holdings Inc. (B+/Negative/--) and MEDNAX Inc. (BBB-/Negative/--). However, we believe the prevalence, growth, and client retention rates of smaller competitors suggest that providers are open to contracting with smaller, more niche competitors that offer a core value proposition. These smaller staffers often acquire competitors within their niche--such as in radiology or anesthesia--rather than expanding into other staffing opportunities. Radiology Partners Inc. (B/Negative/--), for instance, has grown very aggressively by acquiring established radiology groups (physician partners retain 40% of the company), and NMSC (B/Negative/--) and U.S. Anesthesia Partners Inc. (B/Stable/--) have grown rapidly through acquiring established groups of anesthesiologists (physician partners often retain some ownership). ScribeAmerica Intermediate Holdco LLC (B/Stable/--) bought PhysAssist Scribes, the scribe staffing business of Team Health Holdings Inc. (B/Negative/--), further increasing its concentration in scribe staffing, as Team Health decreased its own noncore assets. Most recently, MEDNAX has been trying to sell MedData, its IT and billing service division, also divesting one of its noncore assets.

A niche strategy isn't without risks

For the staffing industry, growth opportunities are slim and the prospects for higher ratings are limited. This is due to limitations in the industry's differentiation, barriers to entry, and control over pricing. Moreover, health care industry trends can have a profound impact on a narrowly focused health care staffing company. For instance, declining low-intensity ER visits hurt companies like Team Health and Schumacher (B/Stable/--), which have a large concentration in ER staffing.

Highly niche companies are also more exposed to the risks of reimbursement cuts, changes in medical recommendations, and obsolescence, as the lack of diversification provides little safeguard. Talk of artificial intelligence (AI) entering the radiology scene and assisting in scan reading, for example, has been rampant for several years. The exact value AI brings to the field and the impact it will have on the radiologist staffing market remains up for debate. Nevertheless, there is some consensus that AI will--at the very least--increase the value radiology professionals must provide their patients, in addition to the basic function of reading scans, and help optimize their workflow.

We Believe Adding Value Through New Functions Is Key

Facing increasing competition and pricing pressure for hospital customers, health care staffing companies can no longer simply increase prices. We believe that to thrive they must add value, such as workflow solutions and consultative services, and become more integrated and essential to hospital clients, which would bolster customer retention. In fact, we believe finding ways to add value and strengthen customer loyalty is more important than scale. Sound Inpatient Physician Holdings LLC (B/Negative/--), for example, contracts with hospitals to staff and--in many cases--manage teams of largely internal medicine physicians in acute-care settings. The company uses its proprietary workflow solutions technology and, in certain contracts, administers the revenue cycle management (RCM) function for the hospital. Thus, instead of focusing on a medical service, companies such as Sound Physicians are focusing on complementary value-added services. We expect this increased level of function outsourcing will bolster staffing companies' stickiness, providing some additional competitive advantage and barriers to entry.

Many hospital clients use a number of health care staffing agencies to fulfill their nurse, allied, and locum tenens staffing needs. An increasing number of intermediaries have thus been entering into contracts with hospitals and then subcontract with staffing companies to provide staffing services, somewhat interfering in staffing companies' relationships with their clients. Managed service providers (MSPs) are outsourced service solutions, often with their own in-house technology platforms, that manage the temporary staffing of a hospital by managing its preferred staffing agencies. Some clients prefer a vendor-neutral technology--a vendor management system (VMS)--that allows them to self-manage their procurement of contingent clinical labor.

Some companies--such as AMN Healthcare Services Inc. (BB/Stable/--) and Cross Country Healthcare Inc. (unrated)--are adding value by providing some of these intermediary services on their own, filling customers' orders with the company's own or a third party's health care professionals. We recently upgraded AMN after it successfully expanded and diversified its service lines over the past several years, increasing the workforce solutions offering in its portfolio through multiple acquisitions and decreasing its exposure to nursing cyclicality.

Temporary Staffing, Nurses, And Emergency Departments Are Vulnerable Specialties

Temporary staffing (AMN and CHG Healthcare Services Inc.)

Hospitals' use of intermediaries and the increasing focus on workflow optimization and predictive labor demand modeling to create more accurate staffing plans are inherently a threat for staffing of physicians for temporary assignments, especially given the premium bill rates that such labor demands. Companies offering staffing of locum tenens--such as AMN and CHG--have thus been suffering from slower growth and sometimes decreases in the number of days filled. Increasing the revenue per day filled and average bill rates has only partly mitigated the pressure.

Nursing (AMN, CHG, and Medical Solutions)

Industry conditions for temporary nurse staffing companies are highly correlated to economic cycles. As employment opportunities rise faster than the labor supply, health care facilities experience higher levels of employee attrition and find it increasingly difficult to obtain and retain permanent staff. In times of an economic downturn and high unemployment, permanent full-time and part-time health care facility staff are generally inclined to work more hours and overtime, resulting in fewer available vacancies and less demand for temporary nurse placement. (For more information, see "When The Cycle Turns: Health Care Subsectors Ranked By Vulnerability To Economic Downturn," April 29, 2019.)

Emergency department (ED) staffing (Envision, Team Health, and Schumacher)

ED visits are typically one of the main gateways to hospital admissions. However, the ED is a high-intensity service and a cost burden on the health care system. Cost-containment efforts by public and private payors are encouraging patients to receive coordinated primary care in appropriate venues to avoid unnecessary and preventable ED visits. The increasing use of retail outpatient clinics and urgent care centers creates significant savings for patients and payors compared with services provided to lower-acuity patients in ERs. These lower-cost alternative care sites have led to a decrease in emergency room visits, largely among lower-acuity patients.

The ability to increase prices has become increasingly essential for staffing companies to offset volume declines. ER staffing companies have been pursuing subsidies from hospitals, as revenue from fee-for-service alone is lower. While small rural hospitals are continuing to pay subsidies to staffing companies to make up for the lower volumes, other hospitals have sometimes opted to terminate the contracts.

In addition, ED physician services are exposed to higher bad debt expenses given federal government regulations obligating hospitals to provide emergency care regardless of the patient's ability to pay. While the participants in the physician staffing industry are exposed to reimbursement risk, we believe this risk is particularly acute for Team Health and Schumacher because of their significant exposures to both government reimbursement and uninsured patients. Recent policy decisions to weaken the Affordable Care Act could also lead to increases in the uninsured population, resulting in greater uninsured patient volumes in emergency rooms.

Recent Rating Actions

Fresenius Group (BBB/Stable/A-2)

Return to growth in core dialysis business; disciplined financial policy fuels upgrade

We expect solid organic top-line (estimated roughly at 5%-7%) and EBITDA growth, especially in its core dialysis services business, and we believe the company will maintain an adjusted debt leverage of under 3.5x longer term, resulting in an upgrade to 'BBB' from 'BBB-'. The company has a stated goal of 2.5x-3.0x. Even if the cancelled $5.8 billion acquisition of U.S.-based drug company Akorn had gone through, we projected long-term leverage below 4x, and we do not expect the company to pursue any acquisitions of that size in the near term. Dialysis reimbursement rates in the U.S. will remain scrutinized, but given the 1.5%-1.6% rate increase by the Centers for Medicare and Medicaid Services (CMS) for the federal coverage program in 2019 and Fresenius' relatively diverse business profile (geographically and by business), Fresenius should be able to maintain solid earnings and cash flows.

Primary analyst: Nicolas Baudouin

• Fresenius Group Upgraded To 'BBB' On Reduced Risk Of Acquisitions Denting The Balance Sheet; Outlook Stable, May 23, 2019

CDRH Parent Inc. (CCC+/Negative/--)

Shrinking HBO treatments, centers leading to declining revenues and cash flows, liquidity pressure

Wound care services provider CDRH Parent Inc. (doing business as Healogics Inc.) continues to struggle with declining hyperbaric oxygen (HBO) therapy chamber treatment volumes in the U.S., as payors have implemented more stringent treatment authorization standards, prompting doctors to be much more conservative in prescribing the expensive wound care treatment. The drop in volumes has brought leverage to 11.2x, and we project annual free cash flow deficits of about $15 million-$20 million through 2020, with EBITDA interest coverage ratio of only roughly 1.0x. Management has a number of initiatives to improve operations, though the timing and level of success is uncertain, and we note that CDRH has significant amount of debt maturing 2021, leaving little cushion for underperformance.

Primary analyst: Sarah Kahn

• CDRH Parent Inc. Downgraded To 'CCC+' On Greater Risk Of Debt Restructuring; Outlook Negative; Debt Ratings Also Lowered, May 14, 2019

Quorum Health Corp. (CCC/Negative/--)

Lowered second time this year, as continued operating struggles heightens risk of restructuring

Our ratings on Quorum Health slipped to 'CCC' with a negative outlook from 'CCC+' with a stable outlook. The downgrade followed a downgrade to 'B-' earlier this year. These rating actions reflect our view that the company's progress on operating improvement and divestitures is not rapid enough to enable it to meet its covenant tests in the first quarter of 2020, raising the specter of debt restructuring. Quorum does not face debt maturities until 2021. However, organic growth at the company is tepid, given declining volume trends in key markets, the increased possibility of a debt restructuring over the next year, and lackluster divestitures (proceeds of which will be used to de-lever to lessen pressure on the metrics) thus far.

Primary analyst: Sarah Kahn

• Quorum Health Corp. Downgraded To 'CCC' From 'CCC+' On Tightening Liquidity; Outlook Negative, May 14, 2019

Heartland Dental LLC (B-/Negative/--)

Increased pace of expansion stresses credit metrics

One of the largest dental support organizations (DSO), Heartland is stepping up its pace of office expansion, increasing debt and stressing EBITDA margins (as newer offices are a drag on profitability for the first two to three years), leading to adjusted debt leverage climbing to 13.8x, from 9x at the end of 2017. The rapid pace also increases operational risk, as management needs to invest and integrate more offices at once. This strategy of rapid expansion is similar to that of the other DSOs we rate, which are all rated 'B' or 'B-' and are also highly levered. We affirmed our 'B-' rating, as the company continues to generate steady organic growth at its mature offices. However, at double-digit leverage and our projections of negative operating cash flow through 2020, we revised our outlook to negative to reflect the increased financial as well as perceived operational risk given the accelerated pace of expansion.

Primary analyst: Winter Yeung

• Heartland Dental LLC Outlook Revised To Negative On Weakened Leverage From Aggressive Expansion; 'B-' Rating Affirmed, May 13, 2019

Mylan N.V. (BBB-/Negative/--)

Still investment grade, but a negative outlook on risk that de-leveraging goals are further delayed

The negative outlook reflects our view that Mylan may fall behind schedule on its de-leveraging plans following a mixed first-quarter 2019 performance. Management has re-affirmed its guidance, including its deleveraging targets. Although management remains committed to investment grade, we note that cushion in the ratings for underperformance is limited. The company has been steadily delevering for the past couple of years, but credit metrics (including adjusted leverage of over 4x) remain aggressive for the investment-grade rating.

Primary analyst: Matthew Todd

• Mylan N.V. Outlook Revised to Negative On Potentially Higher Leverage; Ratings Affirmed, May 10, 2019

PerkinElmer Inc. (BBB/Negative/--)

Negative outlook on increased acquisition pace potentially keeping adjusted leverage above 3.0x

PerkinElmer's performance remains solid and in line with our expectations. We believe the life science industry is benefitting from tailwinds, and PerkinElmer's competitive position is steadily improving, helped by acquisitions. However, the industry remains fragmented, and management has expressed interested in further acquisitions. We project a decline in PerkinElmer's adjusted leverage to the low-3.0x range (3.2x) by the end of 2019, with very limited acquisitions. Thus, even with modest-size acquisitions, the company's long-term leverage could remain above 3x, which we view as high for a 'BBB' rating.

Primary analyst: Adam Dibe

• PerkinElmer Inc. Outlook Revised To Negative On Elevated Leverage; 'BBB' Issuer Credit Rating Affirmed, May 6, 2019