Companies providing radiology services are experiencing a variety of pressures including higher interest rates, a slower-than-anticipated recovery in volumes post-pandemic, and tight labor markets that are contributing to wage inflation and greater utilization of temporary staff at a premium. They are also dealing with several adverse changes to reimbursement including surprise billing legislation, unfavorable trends in patient mix (a greater portion of revenues from Medicare), the resumption of sequestration, and cutbacks in the Medicare Physician Fee Schedule.

Although we expect volumes and labor conditions to gradually improve over 2023, we recently revised our rating outlooks on the two radiology services companies. We revised the outlook on Radiology Partners Holdings LLC (B-/Negative/--) to negative from stable in September 2022, and the outlook on US Radiology Specialists Inc. (USRS; B-/Stable/--) to stable from positive on Jan. 19, 2023.

We continue to view Radiology Partners' creditworthiness as weaker than that of USRS, for a variety of reasons. In this report, we answer frequently asked questions from investors on Radiology Partners and US Radiology Specialists.

Frequently Asked Questions

What factors can result in a downgrade or upgrade on these companies?

We could downgrade the issuer-credit ratings on either of these companies to the 'CCC' category if we conclude that the capital structure is likely not sustainable or if we believe there is more than a one in three chance of a default (or distressed exchange transaction that we would deem to be a default).

As a practical matter, we often view the 'B-' rating as appropriate for this type of health care company when we expect even modest free cash flow generation, whereas we view a 'CCC' category rating as more appropriate if we expect sustained free cash flow deficits. Our negative outlook on Radiology Partners reflects an elevated possibility for a downgrade, whereas we consider this as relatively unlikely for USRS.

Conversely, while we do not expect to do so in the near term, an upgrade to 'B' would likely hinge on an improvement in free cash flow generation. We typically look for the ratio of free cash flow to debt to exceed 3% and remain above that level on a sustained basis for such companies to be rated 'B'.

How has the surprise billing legislation affected these companies? And how will recent developments in this program affect these companies?

Congress passed the "No Surprises Act" on Dec. 22, 2020, which went into effect at the beginning of 2022. The act seeks to protect patients from unexpected (surprise) medical bills which arise from utilizing out-of-network providers. Under the legislation, the payor and the provider must each submit their settlement offer for the out-of-network (OON) claim to a certified Independent Dispute Resolution (IDR) entity, the IDR determines which of the two offers to select.

Although the radiology service companies had an immaterial portion of revenues out-of-network prior to these legislations, since roll out of legislation some insurers terminated some of their in-network contracts that involved a higher-than-average reimbursement rate to providers with the intent of using the arbitration process to lower reimbursement rates. We believe Radiology Partners has about 5% of its business out-of-network (compared to about 1% for USRS), and that there is some risk that this percentage could increase.

In the meantime, Radiology Partners has been submitting the out-of-network claims to the IDR arbitration process. While the company has won about 85% of the resolved cases, only 15% of the submitted cases have been resolved, because the IDR process is running very slow, taking more than 250 days to resolve claims and leading to a significant delay in cash collections.

While this only affects a small part of Radiology Partners' revenue, the delay in cash collections is weighing on liquidity and reducing the capacity for further operational challenges in the short term. USRS, on the other hand, has no exposure to the No Surprise billing act.

There were two recent developments on the IDR process.

• In December 2022, the administrative fee for the IDR was increased to $350 per side (for the payor and provider) from $50 (per batch of similar claims), to help address the backlog of disputes. We expect the higher expense will result in a modest reduction in the number of claims submitted to the IDR arbitration by the payors and providers and help speed up the IDR process. Although this may constrain margins, we expect this should improve the pace of collections and liquidity and bring payors and providers to the negotiating table for in-network contracts.

Table 1

• In February 2023, a judge in Texas ruled that the IDR process unfairly favored insurers by overemphasizing the qualified payment amount (QPA), which is generally the median in-network rate for the same or similar service, as that is not consistent with the final legislative rule. Following this judgement, CMS temporarily paused the IDR determination process for several weeks to evaluate and update the process in line with the judgement. They recently resumed the IDR process with the revised guidelines in mid-March. We view this revision as positive for reimbursement prospects for providers, though this pause may have further delayed collections temporarily on the outstanding claims.

What are your expectations for EBITDA margin in 2023, given various reimbursement headwinds including the latest Medicare Physician Fee Schedule (MPFS), sequestration, and Paygo?

There were three recent reimbursement changes in Medicare as we discuss below.

Medicare Physician Fee Schedule (MPFS) Rate Cut.  The Medicare Physician Fee Schedule (MPFS) final rule for 2023 includes a decline in reimbursement rates for radiology services. CMS estimates a 2% decrease to radiology reimbursement overall, while interventional radiology would see an aggregate decrease of 3%, nuclear medicine a 2% decrease, and radiation oncology and radiation therapy centers a 1% percent decrease. The decreases are due to change in PFS conversion factor, changes in the rates paid for relative value units (RVUs), the second year of the transition to clinical labor pricing updates, and a budget-neutrality conversion factor.

Medicare Sequestration.  Medicare Sequestration was introduced in the Budget Control Act of 2011 to reduce overall federal spending; it reduces the amount Medicare will pay to providers by 2%. Medicare Sequestration was suspended due to the pandemic but has resumed in two stages, a 1% reduction in reimbursement as of April 1, 2022, that stepped up to a 2% reduction as of July 1, 2022.

Statutory Pay-As-You-Go or PAYGO Reduction.  The PAYGO Act of 2010 aims to ensure that legislation passed by Congress does not increase projected deficits. Although Congress has repeatedly deferred a 4% reduction in Medicare reimbursement, including for 2023 till 2025, we believe it remains an incremental source of reimbursement risk over the longer term for providers.

In our view collectively these Medicare reimbursement cuts will have only a modest impact on Radiology Partners' and USRS' EBITDA margins, as Medicare represents about 31% and 23% of revenues, respectively. Offsetting this pressure is that the companies will likely obtain at least slight rate increases from the commercial payors (in some cases via subsidies from hospitals) and will try to offset this with a tighter focus on cost efficiencies. Moreover, we expect continued albeit gradual improvement in the volumes and labor conditions to help margins. Overall, we project a slight decline in EBITDA margins for 2023 for both companies.

Why do you view Radiology Partners as weaker than USRS?

Both companies are majority owned by private equity sponsors, are relatively highly leveraged, and have prioritized aggressive growth via acquisitions.

There are several reasons we view Radiology Partners as weaker than USRS, include Radiology Partners' weaker margins (about 11%-12%), weaker cash flows (free operating cash flow to debt below 2%), higher leverage (about 10.5x-11.5x), higher exposure to Medicare (about 30% of revenue), higher exposure to No Surprise Billing legislation (about 7% of revenue), and a more aggressive growth strategy. About 80% of Radiology Partners' debt is maturing in 2025 which may raise some refinancing issues amid risk from operational and macro challenges, while for USRS' 12% of debt (including RCF) is due in 2025. This is only partially offset by Radiology Partners' greater scale and the interest rate hedges it has in place. Radiology Partners has recently initiated some cost-saving measures which we expect will help improve margins and adjusted leverage in 2023.

In contrast, we view USRS's focus on outpatient settings (approximately 80% of revenues) more favorably due to a continued patient shift to outpatient centers. USRS bills its payors globally (bundled professional and technical fee) while Radiology Partners primarily provides physician services and bills payors for a professional fee. For further comparison, please see table below.

Table 2

What are our expectations on industry conditions, including volume growth, labor market, and interest rates?

Volumes.  In first half of 2022, both companies experienced softer-than-expected volume growth as the post-pandemic recovery was constrained by the Omicron-variant, however, patient volumes have been improving since then. We expect low- to mid-single-digit range volume growth in 2023 helped by more patient visits to health systems for deferred care.

Staffing/labor conditions.  Radiology companies, like the broader health care services sector, has been experiencing staffing shortages and wage inflation, both for radiologists and technicians as well as for the nonclinical staff, as an elevated number of medical professionals retired early, permanently reduced their workloads, or otherwise left the health care industry over the course of the pandemic. Although the labor situation is easing a little since fourth quarter of 2022, we believe that staff costs will remain elevated in 2023, given pent-up demand for services and providers.

Elevated interest rate environment.  This has been a material headwind in 2022 for many highly leveraged companies with floating rate debt, to the extent the companies have not entered interest rate hedges. We assume interest rates will remain elevated through 2023 and much of 2024.

Related Research

• Industry Top Trends 2023: Healthcare, Jan. 23, 2023
• U.S. Radiology Specialists Holdings LLC Outlook Revised To Stable Amid Operating Challenges And Weaker Cash Flow, Jan. 19, 2023
• Radiology Partners Holdings Outlook Revised To Negative Amid Operating Challenges; ‘B-’ Rating Affirmed, Dec. 12, 2022