TEXT-S&P rates Dispensing Dynamics 'B-', outlook is stable
Overview -- U.S.-based Dispensing Dynamics International, a leading designer of paper towel, tissue, soap, and odor dispensing systems, is proposing to issue $125 million of senior secured notes to refinance its existing debt and to provide a dividend to its existing shareholders. -- We are assigning a 'B-' corporate credit rating to DDI and a 'B-' issue-level rating to the company's proposed $125 million senior secured notes. -- Our stable outlook reflects our view that operating performance will improve but that credit measures, including FFO-to-debt of less than 12%, will remain commensurate with its highly leveraged financial risk profile. Rating Action On Dec. 17, 2012, Standard & Poor's Ratings Services assigned its 'B-' corporate credit rating to City of Industry, Calif.-based Dispensing Dynamics International (DDI). The rating outlook is stable. At the same time, Standard & Poor's assigned its 'B-' issue-level rating (same as the corporate credit rating) to the company's proposed $125 million senior secured notes due 2017. The recovery rating is '3', indicating our expectation of meaningful (50% to 70%) recovery for noteholders in the event of a payment default. The company also has a new $15 million asset-based lending (ABL) facility due 2017, which will not be rated. Proceeds from DDI's proposed offering will be used to refinance all existing debt and to provide a special dividend to its shareholders. Rationale The corporate credit rating on Dispensing Dynamics International reflects what we consider to be the combination of DDI's "vulnerable" business risk profile and "highly leveraged" financial risk profile. Our view of the company's "vulnerable" business risk profile is due to its one manufacturing plant, customer concentration, and small size and scope. Still, the company has a leading share in its niche markets. Standard & Poor's views DDI's financial risk profile as highly leveraged given our expectation that debt to EBITDA will approximate 5.5x on a pro forma basis. We also expect that DDI will generate minimal cash flow going forward resulting in very little funds from operations (FFO) relative to debt as we expect FFO to debt to remain below 10% in the next 12 to 24 months. To a lesser extent, our opinion is influenced by the company's uncertain financial policies related to its ownership by private equity. Our base case scenario envisions DDI sales growth of about 2.3% and 2.7% in 2013 and 2014, respectively, in line with our economist's forecasts of GDP. The sales growth is from higher volume due to increased customer penetration, new product offerings, and increased sales in the foodservice categories. We are assuming about 1% to 2% of annual price increases, which is in line with historical levels. We expect margin improvement from reduced overhead costs from facility rationalization as well as improved material costs. Under this scenario we expect DDI to generate EBITDA of about $30 million in 2013. Consequently, we expect debt to EBITDA of about 4.5x and FFO to debt of about 9%. In addition, our assessment of its financial risk considers the uncertainty of the company's financial policies, specifically its dividend policy, given its private equity ownership. A risk to our forecasts is the execution risk related to DDI's aggressive cost cutting targets, in our view, which if not met, will lead to less-than-expected operating results and weaker cash flow generation. Dispensing Dynamics International is a leading designer of paper towel, tissue, soap, and odor dispensing systems, primarily utilized in commercial or "away-from-home" (AFH) washroom settings. We estimate that it has about a 50% market share of the $150 million North American value-added paper dispensing market. Its designs include electronic, mechanical hands free, center pull dispensers, and hybrid roll paper towel dispensers. Its product portfolio also includes tissue dispensers, soap dispensers, and odor dispensers. Its products are patent protected. However, the majority its patents will expire in 2017, heightening competitive risk. In the first quarter of 2013, DDI plans to consolidate its manufacturing into one facility in City of Industry, California and close its Vancouver, British Columbia manufacturing operations. This consolidation would materially increase the risk of production delays and revenue loss due to unexpected failures of equipment and machinery or any other unexpected events or circumstances at the plant. In addition, any production delays could impact its relationships with its customers, specifically its top two customers, which account for close to 30% of its business, as business is largely based on individual sales orders, as opposed to long-term contracts. Customers prefer to outsource their paper dispensing manufacturing needs to DDI to focus on their core competencies. Because paper manufacturers often design paper programs around DDI's proprietary dispensers, it is more difficult for competitors to enter the market and there are high switching costs for customers. However, some of DDI's paper original equipment manufacturer customers may already have or may develop in-house production capabilities. Any loss or material reduction of business from plant outages, changes in customer preferences or loyalties, shift to in-house production, or the lack of success of sales initiatives, for DDI's products could have a material adverse impact on the future cash flows of the business. Liquidity We view the company's liquidity position as adequate based on full availability of the new $15 million revolving credit facility and our expectation for positive operating cash flow. Key aspects of our liquidity assessment reflect the following expectations: -- That liquidity sources will exceed uses by 1.2x or more over the next year and 1x over the next 18 to 24 months. -- That liquidity sources will continue to exceed uses, even if EBITDA were to decline by 15%. We estimate that free operating cash flow will be no more than $5 million in 2013 as capital expenditures declines significantly from about $9 million in 2012 to $6 million in 2013, due to one-time plant consolidation expenses incurred in 2012. We expect capital spending in a range of $6 million in each of the next two years and we do not expect the company to pay dividends to its owners next year. We expect the new $15 million revolving credit facility to have a fixed-charged covenant ratio applicable only when the revolving credit facility exceeds $10 million or excess availability is less than 33% of the facility. Based on our current assumptions, we expect the company to maintain adequate liquidity and cushion of at least 15% under its revolver covenant. There are no near-term maturities until 2017, when both the ABL and the term loan are due. Recovery analysis For the complete recovery analysis, see our recovery report to be published on RatingsDirect following this report. Outlook The stable rating outlook reflects our expectation that credit measures will remain consistent with its highly leveraged financial risk profile with 2013 debt to EBITDA and FFO to debt of about 4.5x and 9%, respectively, despite our assumptions for both higher volumes and prices. We expect DDI will maintain adequate liquidity based on committed revolving borrowing capacity and minimal capital spending. We could lower the rating if DDI experiences weaker-than-expected end market demand resulting in weaker-than-expected operating performance or the company experiences higher-than-expected costs from its inability to meet its target cost cutting initiatives such that total leverage increases above 6x on a sustained basis or the company fails to generate sufficient FFO such that FFO to debt approaches 5%. This could occur if the aforementioned actions result in more than a 150 basis point decline in gross margins. An upgrade is less likely in the next 12 months given our assessment of DDI's highly leveraged financial risk profile with pro forma leverage of about 5.5x. However, we could raise our rating in the longer term as operating performance improves and DDI establishes a track record of maintaining lower leverage comfortably in the 4x range, with FFO to debt above 12%. Related Criteria And Research -- Key Credit Factors: Business And Financial Risks In The Global Building Products And Materials Industry, Nov. 19, 2008 -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011. Ratings List New Ratings; Outlook Action Dispensing Dynamics International Corporate Credit Rating B-/Stable/-- Senior Secured B- Recovery Rating 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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