Nov. 19 - Overview
-- Innovation Ventures LLC’s product, 5-hour ENERGY, has been cited in cases of death and illness, as purportedly acknowledged by the Food and Drug Administration (FDA). At this time, 5-hour ENERGY has not been proven to have caused any of the reported incidents of medical concern.
-- While the FDA does not directly regulate dietary supplements, if the agency finds that caffeinated energy drinks pose a potential public health concern, it can influence the discontinuation of sales of such products. Negative publicity independent of regulatory investigation or actions could induce sufficient consumer concern that retailers pull the product from their shelves.
-- We are affirming our ‘B-’ rating on the company.
-- We are revising our outlook to negative based on our view that operating performance could materially deteriorate following the recent unfavorable media attention. Rating Action On Nov. 19, 2012, Standard & Poor’s Rating Services affirmed its ‘B-’ corporate credit rating and revised its outlook on Innovation Ventures LLC to negative from stable. We also affirmed our ‘B-’ issue-level rating on the company’s $450 million senior secured notes maturing 2019. The ‘3’ recovery rating, indicating our expectation for meaningful (50% to 70%) recovery for lenders in the event of payment default, remains unchanged. Rationale Recent unfavorable media attention has highlighted health concerns attributed to the company’s product, 5-hour ENERGY. In recent weeks, similar health concerns have been raised with respect to competing products in the niche energy subset of the dietary supplement industry. The rating affirmation and outlook revision reflect our expectation that 5-hour ENERGY will undergo meaningful public and regulatory scrutiny over the next several months, possibly resulting in material deterioration in operating performance and credit measures. The company stands behind the safety of its product when used as directed by adults as an energy shot (not as a beverage). However, given the possibility of protracted regulatory investigations and legal wrangling, we believe the heightened media attention on the safety of caffeinated energy shots may be sufficient to hurt sales. The affirmation of our ‘B-’ corporate credit rating on the company predominantly reflects our view of the inherent risks related to the nature of the company’s governance. We continue to view the company’s financial profile as “highly leveraged,” particularly informed by what we view as a very aggressive financial policy, and the business profile as “vulnerable,” given its narrow product and brand focus. Our view of governance and financial policy as very aggressive incorporate the fact that Innovation Ventures’ ownership is highly concentrated with the founder and CEO. Directly and indirectly he controls a supermajority of the equity capital and has the primary discretion over financial policy decisions. In these circumstances, we assess whether there are key individuals capably engaged in risk oversight on behalf of debtholders who have the authority to question and challenge the controlling owner. This is critical in cases where the use of the proceeds of the debt is yet to be decided. Although we do not question the depth and experience of the management team, we do not see them as a counterbalance to the CEO’s authority and decision-making power. In addition, his own importance to the growth and success of the business, demonstrated since the launch of Innovation Ventures, constitutes a high level of “key man” risk for investors in this issuer and its securities. The company, in our view, has adequate liquidity to meet its cash needs, thanks in large part to the recent $450 million notes issuance; the net proceeds of this debt have been earmarked for expansion, new product innovation, and potential dividends at the sole discretion of the CEO. Management has a history of distributing large dividends to its shareholders, with more than $225 million paid in each of the past two years. We believe this trend will continue. The company is able to distribute dividends provided that the bond covenant calculation for leverage is below 2x. Based on this covenant, in our view, if EBITDA were to decline approximately 20% from our estimate of current levels, the credit agreement would preclude dividend distributions. Although over the next 12 months we expect credit metrics to remain strong relative to the indicative ratios for a “highly leveraged” financial descriptor, which includes leverage above 5x, we believe the company’s very aggressive financial policy supports the “highly leveraged” designation. We expect credit measures to remain fairly stable. This expectation is based on the following key outcomes of our forecast over the next 12 months:
-- Adjusted leverage ratio below 4x;
-- EBITDA coverage of interest in the low- to mid-single-digit area; and
-- Funds from operations (FFO) to total debt in the double-digits. The assumptions in our forecast for operational performance include:
-- Revenue depression up to 50% following unfavorable media attention;
-- Meaningful EBITDA compression, possibly 50%; and
-- Limited dividend payouts. The company is private and does not publicly disclose its financials. Our “vulnerable” business risk assessment considers the company’s narrow product and brand focus, its participation in the fragmented and highly competitive dietary supplement industry (with a concentration in energy shots), and limited brand and geographic diversity. It is our opinion that the intrinsic risks associated with the nutritional supplements industry are related to product liability, and that negative publicity surrounding the safety of such products may affect the company’s sales volumes, particularly given the fact that Innovation Ventures only sells one product--energy shots in various flavors--with a leading market share in the U.S. The company also faces potential increasing competition from many larger vitamin, mineral, and health supplement (VMHS) players, and we expect the company to respond by expanding into other energy and nutritional supplement categories. We have also factored into our business risk assessment the company’s high degree of key man risk at the management, ownership, and decision rights levels. Liquidity We view Innovation Ventures’ liquidity as “adequate” and expect the company’s sources to be greater than its uses over the next 12 months. Cash sources represent cash on the balance sheet and expected cash flow. Cash uses include working capital, capital expenditures, dividends, and potential legal fees. Based on our forecast for the next 12 months, and in accordance with key quantitative measures, relevant aspects of the company’s liquidity include the following observations and assumptions:
-- We expect coverage of uses by sources to be in excess of 1.2x for the next 12 months.
-- We expect sources would exceed uses even with a 20% drop in EBITDA.
-- The recently issued $450 million notes are subject to negative covenants; financial covenants are not applicable.
-- There are no near-term maturities.
-- Capital spending of approximately $40 million in 2012 and 2013 because of the construction of a new manufacturing facility; thereafter, we expect capital expenditures to stabilize at approximately $10 million annually.
-- Limited dividend activity until the issues inciting the current media attention reach resolution.
-- We expect the company to generate at least $80 million of free cash flow in 2012 and at least $40 million in 2013. Recovery analysis The issue-level rating and recovery rating on the company’s $450 million senior secured notes maturing 2019 remain ‘B-’ and ‘3’, respectively, reflecting meaningful (50% to 70%) recovery to lenders in the event of payment default. For the complete recovery analysis, see Standard & Poor’s recovery report on Innovation Ventures to be published following this report. Outlook The outlook is negative. We believe there is potential that Innovation Ventures’ operating performance and key credit measures could decline following recent media attention on adverse health incidents citing the company’s product, 5-hour ENERGY. We could consider a downgrade if negative publicity continues, inducing retailers to materially curtail purchases, and/or if regulatory actions are taken against the company. Given the company’s product concentration, negative publicity--perhaps coupled with a product recall--and a resulting compromise of operational performance (including an EBITDA decline of more than 30%), could effect a downgrade. We could also consider a downgrade if the company were to engage in an even more aggressive financial policy, specifically debt-financed shareholder dividends to the detriment of reinvesting in the longer term growth of the business. We could revise the outlook to stable if the company’s sales and profits remain relatively stable despite the negative publicity surrounding the niche energy subset of the dietary supplement industry, and upon a favorable outcome of potential regulatory investigation. Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Issuer Ranking: U.S. Personal Care, Consumer Services, Apparel, And Tobacco Companies, Strongest To Weakest, July 24, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Credit Factors: Criteria For Rating The Global Branded Nondurable Consumer Products Industry, April 28, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers’ Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Rating affirmed; Outlook revised
To From Innovation Ventures LLC Corporate credit rating B-/Negative/-- B-/Stable/-- Issue rating affirmed; Recovery rating unchanged Innovation Ventures LLC Innovation Ventures Finance Corp. 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. Primary Credit Analyst: Nalini Saxena, New York (1) 212-438-4080;
email@example.com Secondary Contact: Brian Milligan, Chicago (1) 312-233-7050;