High financial risk remains DJO's dominant credit feature, as it has been
since it merged with ReAble Therapeutics Inc. in 2007. As of Sept. 29, 2012,
total lease-adjusted debt (including accrued interest) was 9x
trailing-12-months' EBITDA. We expect this debt leverage measure to remain
above 8x for the next two years, declining gradually mainly as a result of
EBITDA growth. DJO had free operating cash flow (FOCF; after capital spending
and working capital requirements) in only one of the past six years. We
believe it could continue to need incremental external financing over the next
Uncertain third-party reimbursement and coverage for DJO's products overshadow
relatively stable demand for them, contributing to our "fair" assessment of
its business risk profile. Its activities are concentrated in the fairly
narrow niche of orthopedic and pain management devices. We believe DJO's
recognizable brands, long-standing customer relationships, and its respectable
record of new product development and enhancements have fostered a leading
market position in most product categories.
In a series of transactions during 2012, DJO refinanced most of its debt. As a
result, debt maturity dates were pushed out, the leverage limit in its credit
agreements was loosened and revolver availability was restored, improving
DJO's liquidity. The amount of debt increased about $35 million and DJO
incurred significant cash and non-cash transaction costs, but we expect
minimal changes in its projected interest expense.
We view DJO's liquidity as "adequate." Our liquidity analysis is based on the
following assumptions and expectations:
-- For 2013 and 2014, we expect capital spending of about $35 million to
$40 million annually and working capital growth of about $10 million per year
to be financed internally. Mandatory debt amortization is less than $10
million per year through 2015. We assume DJO will not make any acquisitions
over the next few years.
-- As of Sept. 29, 2012, DJO had $38 million of cash and $62 million of
funds available from its $100 million revolving credit facility. We believe
all revolver borrowing was repaid in October with some of the proceeds from
the issuance of new notes.
-- Over the next 12 to 24 months, we estimate sources of liquidity,
including the revolver, will cover uses by more than 1.2x. Even if EBITDA is
15% below our expectations, sources would still cover uses, based on our
-- We expect DJO to maintain adequate headroom under its loan agreement
covenant, even when the covenant begins to tighten in the fourth quarter of
2013. As of Sept. 29, 2012, leverage (as defined) was 29% below the maximum
-- We believe DJO has sound relationships with its banks, but lacks the
ability to absorb a high-impact, low-probability event, such as an onerous
product liability settlement, without refinancing.
-- We have ratings on the debt of DJO Finance LLC (DJOFL), a subsidiary
of DJO Global Inc.
-- Our rating on DJOFL's first-lien secured debt is 'B+', two notches
above the corporate credit rating on DJO Global, and our recovery rating on
this debt is '1', indicating our expectation for very high (90% to 100%)
recovery of principal in the event of payment default.
-- Our rating on DJOFL's second-lien secured debt is 'B-', the same as
the corporate credit rating on DJO Global, and our recovery rating on this
debt is '3', indicating our expectation for meaningful (50% to 70%) recovery
of principal in the event of payment default.
-- Our rating on DJOFL's senior unsecured debt is 'CCC+', one notch below
the DJO Global corporate credit rating, and our recovery rating on this debt
is '5', indicating our expectation for modest (10% to 30%) recovery of
principal in the event of payment default.
-- Our rating on DJOFL's subordinated debt is 'CCC', two notches below
the corporate credit rating on DJO Global, and the recovery rating on this
debt is '6', indicating our expectation for negligible (0 to 10%) recovery of
principal in the event of payment default.
Our rating outlook on DJO is stable, reflecting our expectation of continued
high leverage, low-single-digit annual revenue growth over the medium term
broadly in line with volume growth for the markets DJO serves, and relatively
stable profit margins. We also assume that DJO will need, at most, moderate
borrowing if cash flow is below our base-case expectation.
We could raise our rating if a combination of wider EBITDA margins,
accelerated growth, or other factors enables DJO to consistently generate
meaningful FOCF and sustain adjusted debt to EBITDA below 7.5x. We could
consider a downgrade if we expect the covenant cushion to fall below 10% or
availability of the revolver is substantially reduced, resulting in impaired
liquidity. This could occur if weaker-than-expected economic conditions in the
U.S. or Europe significantly slow DJO's growth and depress its margins. There
is also potential for intensified price pressure, which we believe could erode
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Standard & Poor's Revises Its Approach To Rating Speculative-Grade
Credits, May 13, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008