-- U.S.-based diversified health care company Endo Health Solutions Inc. has paid down more than $600 million of debt since it acquired American Medical Systems Inc. in June 2011.
-- We are affirming our 'BB' corporate credit rating on Endo. We are also raising our issue-level rating on the company's senior unsecured notes to 'BB' from 'BB-' and upwardly revising our recovery rating on that debt to '4' from '5'.
-- Our stable rating outlook reflects our belief that, over the next 12 months, Endo will use its free cash flow to reduce leverage to less than 3x in anticipation of a potential decline in EBITDA. Rating Action On Nov. 6, 2012, Standard & Poor's Ratings Services affirmed its 'BB' corporate credit rating on Chadds Ford, Penn.-based diversified health care company Endo Health Solutions Inc. The outlook is stable. At the same time, we raised our issue-level rating on the company's senior unsecured notes to 'BB' (the same as the corporate credit rating) from 'BB-'. We revised our recovery rating on this debt to '4', indicating average (30% to 50%) recovery for noteholders in the event of a payment default, from '5' (10% to 30% recovery expectation). Our issue-level rating and recovery rating on the company's senior secured debt remain unchanged at 'BBB-' and '1', respectively. Rationale We raised our issue-level and our recovery rating on Endo's unsecured notes following the company's voluntary and mandatory secured term loan B payments of more than $600 million since acquiring American Medical Systems (AMS) in June 2011. The decrease in secured debt results in improved recovery prospects for the holders of the company's $900 million senior unsecured notes due in 2019 and 2022. The corporate credit rating on Endo reflects the company's "significant" financial risk profile (according to our criteria), which incorporates leverage of about 3.2x as of Sept. 30, 2012. Leverage has improved, from more than 4x in the prior year period, because of mandatory and optional debt repayments made over the past year. We believe Endo has only a "fair" business risk profile, given franchise and product concentrations. Endo is tracking to our expectation that it will generate low-double-digit sales growth in 2012. Our expectation is primarily based on low-single-digit growth of Lidoderm, low-double-digit growth in generics, and mid- to high-single-digit growth in medical devices and technology. Full-year 2012 EBITDA and free cash flow will likely be less than we expected because of one-time items and product shortfalls related to a contract manufacturer shutdown in the first half of 2012. When adjusted for one-time items, EBITDA and free cash flow should meet our expectation of $965 million and $585 million, respectively. In 2013, we expect total sales to decline about 3% because of the generic launch of Lidoderm. Endo is heavily reliant on Lidoderm, and growth in other products or business segments will not offset this decline. We expect EBITDA to decline by at least 15% in 2013. The decline in EBITDA is higher than revenues because of the loss of higher margin Lidoderm and also because the full effect of cost reductions will not be realized until 2014. Still, we believe Endo will generate more than $450 million of free cash flow in 2013, which Endo will use for debt reduction and share repurchases. Therefore, we believe leverage should decline to about 3x over the next 12 months. In 2014, we estimate Lidoderm revenues could decline by about 40%, based on historical data of branded product sales declines following generic launches. However, in that year, we also expect total sales to decline in the low single digits because of continued growth in other branded products as well as the generics and devices and services segments. Endo's significant financial risk profile reflects leverage of about 3.2x as of Sept. 30, 2012. Although we expect EBITDA contraction in 2013, our belief that Endo will continue to reduce debt over the next year gives us a high degree of confidence that leverage will not exceed 4x following the launch of generic Lidoderm. The financial risk profile also reflects a shift toward a more aggressive financial policy following the higher leverage incurred for the $2.9 billion acquisition of AMS, which followed closely after the company's $1.2 billion purchase of Qualitest Pharmaceuticals in November 2010. We believe Endo could complete other acquisitions as an offset to greater-than-expected sales decline of Lidoderm after Watson's launch of generic Lidoderm in September 2013. In the nine months ended Sept. 30, 2012, about 48% of Endo's revenues were from branded pain medications and about 30% of total revenues were from Lidoderm. Endo's fair business risk profile reflects product and therapeutic sales concentration that continues to persist, despite acquisitions made over the past two years to provide diversity. It also reflects our belief that this concentration will decline as the generics and medical devices businesses grow and after Lidoderm goes generic in 2013. Moreover, the addition of generics and medical devices businesses enhances product and geographic diversity and, over the longer term, reduces Endo's dependence on patented pharmaceutical products. Liquidity Endo has "strong" liquidity, as defined by our criteria. We expect sources of liquidity to exceed uses by more than 1.5x, or by at least $1 billion, over the next 12 to 24 months. Our assessment of Endo's liquidity profile incorporates the following expectations and assumptions:
-- Sources of liquidity include funds from operations of about $600 million expected in 2012, full availability of its $500 million revolving credit facility, and surplus cash of at least $250 million.
-- Uses of cash include modest working capital outflows, capital expenditures of $75 million to $100 million annually, and yearly share repurchases of about $150 million.
-- Endo has no near-term debt maturities; the earliest debt maturity is for the convertible notes, due 2015.
-- We believe Endo can absorb, without refinancing, a high-impact, low-probability event. Recovery analysis For the complete recovery analysis, see the recovery report on Endo Health Solutions, to be published subsequently on RatingsDirect. Outlook Our stable rating outlook reflects our expectation that the company's debt-to-EBITDA ratio will remain consistent with our guidelines (3x to 4x) for a significant financial risk profile, even though EBITDA will likely decline after Watson Pharmaceuticals launches its generic version of Lidoderm on Sept. 15, 2013. We expect Endo to reduce costs and use free cash flow to reduce debt in advance of the generic launch. This should establish some capacity to absorb lower EBITDA at the current rating level. Despite the potential for an EBITDA contraction in 2013 and 2014, we have a high degree of confidence that Endo's leverage will not exceed 4x over that period. In the next 18 to 24 months, we could lower the rating if, following the commercialization of generic Lidoderm by Watson, sales and EBITDA decline more than we expect and Endo maintains leverage at more than 4x, indicative of an aggressive financial risk profile. This could occur if Endo does not reduce its selling, general, and administrative (SGA) expenses as we expect, resulting in lower EBITDA; if it chooses to use free cash flow for acquisitions instead of debt reduction; or if there is no significant growth in its other products. An upgrade is unlikely over the next one to two years, given the uncertainty surrounding a decline in Endo's market share of Lidoderm following Watson's launch. Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Endo Health Solutions Inc. Ratings Affirmed Corporate Credit Rating BB/Stable/-- Senior Secured BBB- Recovery rating 1 Upgraded
To From Senior Unsecured BB BB-
Recovery Rating 4 5