-- U.S. medical products distributor PSS World Medical plans to divest its skilled nursing and specialty dental supply businesses, which account for about one-quarter of its revenues.
-- The company hopes to build on its niche position in the relatively stable medical products distribution field through acquisitions to expand its reach to integrated health systems and community health centers.
-- The loss of earnings from the divested assets, the uncertainty around timing and extent of the proceeds from their sale, and interim funding requirements of acquisitions could increase leverage and weaken liquidity.
-- We are revising the ratings outlook to negative from stable, reflecting increased financial risk during this transition, and affirming our 'BB+' corporate credit and other ratings. Rating Action On May 11, 2012, Standard & Poor's Ratings Services revised its rating outlook on Jacksonville, Fla.-based medical products distributor PSS World Medical Inc. to negative from stable, on the company's plans to divest its skilled nursing and specialty dental supply businesses (about one-quarter of its revenues). We affirmed our ratings on the company, including our 'BB+' corporate credit rating. We also affirmed our 'BB-' rating on the company's $250 million senior unsecured notes and $230 million senior unsecured convertible notes. The '6' recovery rating on the notes, indicating our expectation for negligible (0% to 10%) recovery in the event of default, remains unchanged. The strategic shift does not change our view of the company's business risk profile as "fair." However, the loss of earnings from divested assets, the timing and amount of proceeds from their sale, and redeployment of the funds are variables that increase the possibility that adjusted debt to EBITDA might be sustained above 3x, which would be beyond our guideline for an "intermediate" financial risk profile. Rationale Our rating on PSS is based on its fair business risk profile and intermediate financial risk profile. With a well-established niche position in the relatively stable medical products distribution industry, and aided by acquisitions, PSS' revenues in fiscal 2012 were up about 3%, despite the still-weak economy and a comparably weak flu season. EBITDA margins (including our usual adjustments) were slightly down to 8.6%, from 8.9% in fiscal 2011 given weakness in the elder care business. Before the just-announced strategic decision to jettison this business, our base-case forecast for fiscal 2013 was for better than mid-single-digit revenue growth and flat margins. This was predicated on tuck-in acquisition activity and the increased penetration of higher profit private-label goods. Headwinds in our expectation included the cost to expand the sales force and pricing pressure from customers, particular in the elder care segment. Our core assumptions remain intact, but divesting the elder care business will scale down the business and reduce that segment's dampening effect on profitability. Still, we expect margins to be relatively flat, because there will be costs associated with the adjustment in the business model. Our new assumption that debt to EBITDA will approximate 3.0x replaces our earlier forecast that leverage would be closer to 2.5x. The fair business risk profile reflects PSS' leading position in its niche markets, and its significant supplier and client diversity. PSS distributes medical products and equipment to alternative-site health care providers, including some 160,000 different products to 217,000 physician offices in the U.S. However, the business risk profile also reflects exposure to continued weakness in physician office visits, and more pronounced pressure on nursing home clients coping with Medicare reimbursement cuts. PSS' plan to limit elder care exposure and focus on expanding its physician in-office dispensing, home health, and laboratory products activities does not affect our assessment of its business risk profile. The potential for a loss in purchasing leverage is offset by an enhanced growth opportunity. Divesting the skilled nursing and specialty dental supply businesses in the next six months could eliminate $500 million in revenues (about one-quarter of its current total) and $35 million in EBITDA (about 20%). Despite the contracting revenue base, we expect PSS to retain its well-established, niche position in the physician supply field and supplement it with an expanded reach to integrated health systems and community health centers. We expect acquisitions to help this strategy, in line with PSS' announcement that it will acquire two laboratory service companies and one physician office dispensing company, adding approximately $120 million to annual revenues. The intermediate financial risk profile for PSS is based on credit measures that over the past several years have averaged at the stronger end of our guidelines for debt to EBITDA (2x-3x) and funds from operation (FFO) to debt (30%-45%). At the end of calendar 2011, debt to EBITDA was 2.2x, and FFO to debt was 37%. A February 2012 prefunding weakened those metrics to about 3x and 27%, respectively, while increasing the cash balance. The uncertain timing of the divestitures and the pace of acquisitions will have a highly variable effect upon revenues, profitability and cash flow. Still, our base-case expectation is for annualized debt to EBITDA and FFO to debt of approximately 3x and 30%, respectively. Liquidity We view PSS' liquidity as "strong" (as defined in our criteria), with sources of cash that will exceed mandatory uses of cash over the next 12-24 months. Relevant aspects of PSS' liquidity include:
-- Sources of liquidity will exceed uses by 1.5x or more.
-- Sources of liquidity include cash and cash equivalents of roughly $160 million; free operating cash flow for fiscal 2013 should be at least $50 million, given approximately $25 million of capital expenditures.
-- Availability under the $300 million revolving credit facility is based on inventory and receivables balances and so is not subject to traditional financial covenants.
-- PSS has no significant debt maturities until its $230 million of senior convertible notes mature on Aug. 1, 2014.
-- We expect PSS' credit facility and cash flow to provide enough flexibility to fund working capital expansion, small acquisitions, and modest share repurchases. It repurchased $140 million of common stock in fiscal 2012.
-- During the asset redeployment in the year ahead, we assume there will be minimal share repurchases, and that declines in liquidity tied to acquisitions will be offset with funds from asset sales. Recovery analysis For the complete recovery analysis, please see Standard & Poor's recovery report on PSS World Medical Inc., published Feb. 13, 2012, on RatingsDirect. Outlook The negative rating outlook on PSS reflects our belief that the loss of earnings from the divested assets, the realization of the proceeds from their sale, and interim contribution and funding requirements of acquisitions could contribute to debt to EBITDA of about 3x, and FFO/EBITDA of approximately 30%. However, we could lower the ratings if these credit metrics are weaker than expected, suggesting a revision in our assessment of the financial risk profile to "significant." This could occur if growth of the newer activities fails to quickly replace business lost with the dispositions, or if PSS uses the proceeds for shareholder-friendly actions such as large share repurchases. Within the next year, if we are convinced that there is a reasonably early prospect that PSS can sustain debt to EBITDA of below 3x, and FFO to debt of at least 30%, we could revise the outlook to stable. This would likely accompany the sale of assets at attractive multiples on a timely basis, and the pursuit of modest-sized acquisitions at a measured pace. 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 PSS World Medical Inc. Corporate Credit Rating BB+/Negative/-- BB+/Stable/-- Ratings Affirmed; Recovery Ratings Unchanged PSS World Medical Inc. Senior Unsecured BB-
Recovery Rating 6