Industry Economic And Ratings Outlook:

The Outlook For U.S. For-Profit Health Care Will Remain Stable With Modest Negative Bias
Primary Credit Analyst: Lucy B Patricola, CFA, New York (1) 212-438-3006; lucy.patricola@standardandpoors.com

Table Of Contents
Summary Economic Outlook Effect On Ratings Industry Credit Outlook Rating And Outlook Distributions Key Rating Actions Contact Information Related Criteria And Research

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Industry Economic And Ratings Outlook:

The Outlook For U.S. For-Profit Health Care Will Remain Stable With Modest Negative Bias
Summary
Standard & Poor's Ratings Services expects its ratings on the U.S. for-profit health care companies it rates to remain broadly stable heading into 2014, with a modest negative bias. Although the Affordable Care Act dominates headlines, we continue to believe the Act will not have a meaningful impact on issuers in 2014, but we remain cautious of the effect the new law will have on this sector over the longer term. We do not see any appreciable near-term impacts because the number of newly insured lives that we expect in 2014 remains a fraction of the total insured population. Going forward, key uncertainties at this juncture include: the sign up rate on the federal and state-based insurance exchanges, specifically the composition of the newly insured population; migration of individuals who lose employer-sponsored coverage to the exchanges; utilization of health care services by the newly enrolled; the choice of coverage, including high deductible plans; and the reimbursement rates negotiated by the plans.

Economic Outlook
The key macroeconomic factors that influence our view of the for-profit health care sector include a sluggish U.S. economy and ongoing pressure to reduce the government's overall health care spending. Job creation has been nominally positive, but increasingly characterized by part time employment. We revised consumer spending down in our September forecast to 2% from 2.5% in March. We believe both trends contributed to lower utilization of health care services this year. In addition, our international issuers face ongoing pricing pressure from European single payor health systems, supplemented by good growth in emerging markets.

Effect On Ratings
Capital markets remain receptive to the sector, and many issuers continue to access the markets to address debt maturities, covenant tightness, or to fund growth and value strategies. Since the third quarter of 2012, the ratio of positive to negative rating activity shifted to below 1:1, with upgrade to downgrade activity at about .35:1 for 2013. We attribute about 75% of downgrade activity this year to increasingly aggressive financial policies with operational challenges accounting for the balance. Stable outlooks dominate the portfolio, but of those that are not stable, about three quarters are negative or on CreditWatch negative. Our economists publish quarterly upside and downside scenarios, which contemplate alternatives to their base case. While our ratings do not directly incorporate these alternative scenarios, they do represent an important input into our rating process, particularly with issuers for which we are considering an outlook revision or rating change. In periods of economic volatility, we believe these alternative scenarios are particularly valuable to consider.

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Table 1

2013-2014 Industry Economic Outlook For U.S. Health Care

Forecast/Scenarios Baseline impact on sector

Downside* 2013 2014

Baseline* 2013 2014

Upside* 2013 2014

Actual Comment 2012

Macroeconomic indicators Real consumer spending (% change) Total nonfarm payrolls 1.74 1.48 2.03 2.76 2.31 3.68 2.2 Consumer spending continues to grow modestly, supporting utilization rates. 133.74 Although unemployment is still high, jobs are being created slowly, which should lead to increases in higher paying private coverage segment. 96.82 We expect corporate profit growth to moderate in 2014, which suggests employment growth will continue, but remain slow. Somewhat Favorable Somewhat Favorable

135.83

136.53

136.01

138.58

136.17

140.04

S&P 500 operating earnings per share ($) Industry drivers Federal surplus (fiscal-year unified, bil. $)

102.39

88.29

106.26

113.75

109.35

134

Somewhat Favorable

(702)

(783)

(698)

(726)

(695)

(669)

(1,089) Continued large federal budget deficits should continue to place downward pressure on Medicare reimbursements, which would hurt service provider revenues directly and product manufacturers more indirectly.

Unfavorable

*Based on our U.S. economic forecast "Legends Of The Fall", published Sept. 13, 2013, on RatingsDirect.

Industry Credit Outlook

We believe pharmaceuticals and related companies should see modest revenue growth in 2013
Big pharma We expect low-single-digit revenue growth for the industry overall in 2014, as new product launches offset patent losses on significant products. Despite an improving rate of new product introductions, the introduction of generic drug competition once patents expire will constrain performance. In 2014, products with U.S. sales of about $17 billion will lose market exclusivity. We expect the Affordable Care Act will have a slight positive effect on the volume of prescriptions written, although the majority of the volume is likely to be generic. We expect the trend of double-digit declines in branded drug prescriptions to continue, with generic prescriptions taking an increasing share of total prescriptions written. Generics now comprise 84% of all U.S. prescriptions. Branded volume declines are offset by price increases; we believe average prices on the top selling drugs increased by about 11%, year to date. Specialty pharmaceuticals Most of our rated specialty pharmaceutical companies are experiencing mid- to high-single-digit organic revenue growth in 2013 because of demand for existing marketed drugs, with acquisitions pushing reported revenue growth into the double-digits. We expect this level of growth to continue in 2014, and we would attribute any negative deviation from this trend to company-specific operating problems or selected patent expirations. We do not expect the Affordable Care Act to benefit specialty pharmaceutical companies because most of the incremental volume will utilize generic drugs and also because specialty pharmaceutical companies still have pricing power and patent protection on their branded products.

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Contract research organizations (CROs) CRO industry growth has accelerated over the past year. In 2014, we expect mid-single-digit revenue growth for the industry due to continuing growth in outsourcing penetration and our expectation of low-single-digit growth in pharmaceutical industry research and development spending. We expect late-stage providers to continue outperforming early-stage providers and expect mid- to high-single-digit revenue growth in this segment. We believe preclinical demand, which began to improve in 2013 after several difficult years, will continue to strengthen 2014, resulting in low-single-digit revenue growth. Pharmaceutical distributors The big three distributors, Cardinal Health Inc., AmerisourceBergen Corp., and McKesson Corp. are experiencing varied levels of performance for 2013. We expect "base-line" growth in the low-single digits to date in 2013, reflecting our belief that pricing in the industry remains competitive, but the positive impact of generic drugs on margins will more than offset this pressure. Cardinal's revenue decline in 2013 is solely the result of the Express Scripts and Walgreens contract losses. We expect Cardinal's revenues will continue to decline in 2014 because of the full-year impact from the loss of Walgreens. For McKesson, we expect a low- to mid-single-digit revenue increase aided by the contribution of PSS World. We expect a mid-single-digit increase for AmerisourceBergen because of higher volumes from the Walgreens contract. Implementation of the Affordable Care Act will not likely benefit drug distributors' revenues because we expect the majority of the newly insured patient population to use lower priced generic drugs. We also expect only a modest positive impact on margins because incremental volumes will only be a fraction of the volume of drugs flowing through the distribution channel. Pharmacy benefit managers (PBMs) We expect low- to mid-single-digit revenue growth in the PBM industry in 2014, primarily reflecting very modest increases in pharmaceutical pricing in 2014 and a slight positive impact from higher insurance coverage rates following the implementation of the Affordable Care Act. Our industry growth expectation marks a slight acceleration from the past few years, where we believe industry growth has been around 2%.

The outlook for health care equipment and supplies remains lackluster
First half 2013 performance for the medical device companies we rate remained much in line with our expectations of low- to mid-single-digit growth. Prospects for the second half of the year remain unchanged, with more of the same envisioned heading into 2014. U.S. revenue performance for these companies has on average been tepid, but most have a material global presence with 40%-60% of sales derived outside the U.S. Still, demand remains depressed in the U.S. as a result of still low employment rates, and government spending cuts and fiscal worries have led to austerity measures by government payors, particularly in Europe. Asia remains the strongest region, and emerging markets (most notably China) continue to provide solid, double-digit growth. We do not expect a renewed weakness in capital goods and given that replacement life cycles have now been extended for several years since the recession, we reasoned that sales would experience a rebound. We believe any benefit from the Affordable Care Act in 2014 will be negligible for this sector. This reflects the nondiscretionary nature of many products (medical device companies are paid whether or not patients are insured) and also our assumption that patients receiving these products are typically older and are already covered under Medicare.

Service providers are experiencing lower utilization and ongoing reimbursement pressure
Hospitals For 2014, we expect hospital use rates to continue to decline. Soft patient volume is tied to efforts by both government and private insurance companies to control utilization, a shift to value-based payments, and certain factors tied to a relatively weak economy. We expect adjusted admissions to continue to be flat to lower, and actual admissions to be lower for most companies. The relatively small increase in the insured population resulting from the Affordable Care Act provides a small offset. Low patient volumes, coupled with ongoing reimbursement pressure, will support low-single-digit organic growth in 2014. We believe cost savings opportunities may diminish over time leading to ongoing margin pressure. We expect acquisition activity to be robust as hospitals and hospital companies look for

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Industry Economic And Ratings Outlook: The Outlook For U.S. For-Profit Health Care Will Remain Stable With Modest Negative Bias

ways to improve their local market competitiveness, boost operating efficiency, and enhance access to capital. Skilled nursing facilities We expect sales growth in the skilled nursing sector to be relatively flat through the rest of 2013 and into 2014. We primarily based this on our expectation that the average revenue per patient day will continue to be pressured by the shift of patients from Medicare to managed care payors, which pay 25% to 30% less per patient day. We also anticipate there will be a modest decline in patient days driven by increasing deductibles and a reduction in hospital referrals as their utilization rates decline. Partially offsetting these factors will be low-single-digit reimbursement rate increases from government and private payors. As revenue growth stalls, we expect margin contraction from most companies in the sector. We believe many skilled nursing companies have limited ability to cut costs and that they are likely to face upward pressure on labor costs over the next year as broader utilization of health care services increases demand for health care professionals. Generally, we do not anticipate the Affordable Care Act will have a material impact on the skilled nursing sector since it primarily targets patients with Medicare. Overall, based on our projection for contracting EBITDA margins, we expect most companies in the sector will generate less free cash flow and face higher debt to EBITDA and lower fixed-charge coverage ratios. As a result, ratings in the sector could come under pressure in the coming year, especially for those companies with unfavorable covenants. Clinical laboratories The Affordable Care Act and a strengthening economy could nudge 2014 revenue growth to about 5% for the total U.S. lab industry, in our view. However, we expect uneven benefits for the three lab companies we rate (Quest Diagnostics Inc., Laboratory Corp. of America Holdings, and Aurora Diagnostics Holdings LLC), in part, reflecting changing market shares. We believe these independent lab companies' profit margins will be pressured by flat or less generous pricing from commercial insurers, more payments at relatively low rates (from insurance purchased on the new exchanges), and a shift in mix to lower-margin tests. Selective Medicare rate cuts in 2014 are also possible. We believe cost reduction efforts and lower bad debt expense will mitigate the margin contraction, and we expect Quest and LabCorp to continue generating substantial discretionary cash flow. Dialysis service providers According to our base-case expectation, the rebasing of Medicare rates is likely to reduce dialysis EBITDA margins of service providers in 2014, but their discretionary cash flow and credit metrics will continue to support current ratings. The magnitude of the rate cut and whether it will be phased in over more than one year have not yet been determined. Medicare directly accounts for about one-half of dialysis revenues of rated companies and indirectly affects some revenue from commercial insurers. We expect treatment growth for rated companies to outpace the low-single-digit dialysis patient population growth in 2014. We believe the Affordable Care Act will have no discernible effect on the number of dialysis treatments; it may contribute to a small unfavorable shift in payor mix.

Rating And Outlook Distributions

Rating trends have been negative throughout the year, with the ratio of favorable to unfavorable rating actions in the health care sector at .35:1. We attribute about two-thirds of our negative rating actions to increasingly aggressive financial policies, including debt-financing acquisitions or cash-based shareholder returns. At the lower end of the rating spectrum, lower ratings reflect increasing covenant tightness or liquidity challenges, and largely consist of service providers, where reimbursement and low utilization have pressured growth. Still, about 90% of the portfolio has a stable outlook, which is largely based on the good cash flows and adequate or better liquidity that is characteristic of

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Industry Economic And Ratings Outlook: The Outlook For U.S. For-Profit Health Care Will Remain Stable With Modest Negative Bias

most rated health care issuers.

Chart 1

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Industry Economic And Ratings Outlook: The Outlook For U.S. For-Profit Health Care Will Remain Stable With Modest Negative Bias

Chart 2

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Chart 3

Key Rating Actions

Table 2

Key Rating Actions 2013

Month January Laboratory Corp. of America Holdings February Mylan Inc. Cardinal Health Inc. March AmerisourceBergen Corp. Cardinal Health Inc. Bausch & Lomb Inc. DENTSPLY International Inc. Affirmation CreditWatch Outlook Pos. Outlook Pos. A-/Stable/A-2 A-/Watch Neg/A-2 B+/Positive/-BBB+/Stable/A-2 A-/Stable/A2 B+/Stable/-BBB+/Negative/A-2 Distribution agreement-Walgreens Inc. Operational trends Financial policy Operational trends Affirmation Affirmation BBB-/Stable/-A-/Stable/-Agila Specialties acquisition AssuraMed acquisition Downgrade BBB/Stable/-BBB+/Stable/-Financial policy Company Rating action To From Key driver

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Table 2

Key Rating Actions 2013 (cont.)

April Biogen Idec Inc. Life Technologies Corp. Thermo Fisher Scientific Inc. May Actavis Inc. Hospira Inc. June Tenet Healthcare Corp. Endo Health Solutions Inc. Valeant Pharmaceuticals Int. Inc . St. Jude Medical Inc. July Community Health August Amgen Inc. September Agilent Technologies Inc. *As of Sept. 30, 2013. CreditWatch BBB+/Watch Neg/-BBB+/Stable/-Financial policy Downgrade A/Stable/A-1 A+/Stable/A-1 Financial policy Outlook Neg. B+/Negative/-B+/Stable/-Acquisition Affirmation Downgrade Downgrade Outlook Neg. B/Stable/-BB-/Stable/-BB-/Stable/-A/Negative/A-1 BB/Stable/-BB/Watch Neg/-A/Stable/A-1 Vanguard acquisition Financial policy Acquisition Operational trends Affirmation Downgrade BBB/Negative/-BBB-/Stable/-BBB+/Negative/-Warner Chilcott PLC acquisition Operational trends Upgrade Downgrade Downgrade A-/Stable/-BBB/Watch Neg/-BBB/Watch Neg/A-3 BBB+/Stable/-BBB+/Stable/-A/Stable/A-2 Operational Trends Acquisition Acquisition

Contact Information
Table 3

Contact Information
Credit analyst Lucy Patricola Michael Berrian Gail Hessol David Kaplan Tulip Lim David Lugg Shannan Murphy David Peknay Title Senior Director Director Managing Director Director Associate Director Senior Director Associate Director Director Sector Analytical Manager Location New York Phone (212) 438-3006 (617 530-8307 (212) 438-6606 (212) 438-5649 (212) 438-4061 (212) 438-7845 (617) 872-5949 (212) 438-7852 E-Mail lucy.patricola@standardandpoors.com Michael.Berrian@standardandpoors.com Gail.Hessol@standardandpoors.com david.a.kaplan@standardandpoors.com Tulip.Lim@standardandpoors.com David.Lugg@standardandpoors.com Shannan.Murphy@standardandpoors.com David.Peknay@standardandpoors.com

Specialty Pharma, Distributors and Boston Life Sciences Labs, Dialysis Devices, Hospitals Ambulatory Surgical Centers, Imaging Pharmaceuticals CROs, Pharmacy Benefit Managers Hospitals, Pharmaceuticals New York New York New York New York Boston New York

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Table 3

Contact Information (cont.)

Cheryl Richer Tahira Wright Director Associate Director Devices, Hospitals Home Health, Behavioral Health and Deathcare New York New York (212) 438-2084 (212) 438-1977 Cheryl.Richer@standardandpoors.com Tahira.Wright@standardandpoors.com

Related Criteria And Research

U.S. Economic Forecast: Legends Of The Fall, Sept. 13, 2013 Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

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