September 19, 2012 / 6:46 PM / 7 years ago

TEXT-S&P rates Harvard Drug Group

(The following statement was released by the rating agency)

Overview
     -- Harvard Drug Group, a U.S. generic-focused pharmaceutical distributor, 
is acquiring an undisclosed virtual generic drug manufacturer for $117.5 
million.
     -- At the same time, the company is also refinancing its $155 million of 
existing first-lien debt; its $65 million (unrated) unsecured loan will remain 
outstanding.
     -- Harvard Drug plans to raise capital through an undrawn $35 million 
first-lien senior secured revolving credit facility maturing in 2017 and a 
$300 million first-lien senior secured term loan B maturing in 2019.
     -- We are assigning our 'B+' issue-level and '2' recovery ratings to the 
company's new senior secured revolver and term loan and are affirming our 'B' 
corporate credit rating on Harvard Drug.
     -- Our stable rating outlook reflects our belief that the acquisition of 
a virtual generic drug manufacturer is a logical extension to Harvard Drug but 
that the company's "highly leveraged" financial risk profile will be a 
limiting factor for the rating.

Rating Action
On Sept. 19, 2012, Standard & Poor's Ratings Services assigned its 'B+' 
issue-level rating (one notch higher than the corporate credit rating) to 
Generic Drug Holdings Inc.'s (the holding company of Livonia, Mich.-based 
Harvard Drug Group LLC) proposed $35 million revolving credit facility 
maturing in 2017 and $300 million senior secured term loan B maturing in 2019. 
The recovery rating on these credit facilities is '2', indicating our 
expectation for substantial (70%-90%) recovery in the event of payment 
default. 

We also affirmed our 'B' corporate credit rating on Harvard Drug. The rating 
outlook is stable.

We believe that the acquisition is a complementary fit to Harvard Drug's 
existing proprietary-label generic drug business and will not substantially 
alter our view of the company's "highly leveraged" financial risk profile. 

Rationale
The ratings on Harvard Drug reflect what Standard & Poor's considers its 
"weak" business risk and highly leveraged financial risk profiles, according 
to our criteria. The business risk profile incorporates Harvard Drug's 
relative small scale and niche position, while the financial risk profile 
predominantly reflects its substantial adjusted debt.

We believe the company's financial risk profile will remain the primary 
limiting factor on the rating, despite our expectations for increased revenue 
through generic drug introductions and the expanded use of the company's 
proprietary-label drugs. Harvard Drug's revenues declined significantly in 
2011 as it exited a portion of its low-profit branded drug distribution 
business. Despite these sales losses, it substantially increased EBITDA, 
EBITDA margins, and cash flow.

Thus far in 2012, Harvard Drug's revenue growth has met expectations; margins 
have underperformed our initial expectations for modest expansion. We believe 
2012 revenues will grow organically (excluding the impact of the acquisition) 
in the low-double digits as a result of increased proprietary-label generic 
drug sales and the nearly completed partial exit from branded drugs. We also 
believe organic revenue growth will revert to low-single digits in 2013, but 
will be well into double digits with the inclusion of the acquisition. We 
project 2012 EBITDA margins on Harvard Drug's existing business will be down 
slightly, but could improve somewhat in 2013 as modest synergies are realized 
as part of the acquisition. 

The highly leveraged financial risk profile overwhelmingly reflects Harvard 
Drug's high adjusted debt leverage; adjusted pro forma debt to EBITDA is over 
7x. We treat the company's class L common stock as debt, adding roughly 3x 
debt to EBITDA to our debt leverage calculation. Still, given the debt-like 
treatment of the class L stock, we believe Harvard Drug's financial risk 
profile is unlikely to quickly improve, given the 10% accretion rate and 2% 
pay-in-kind (PIK) feature on its unsecured mezzanine notes. The term loan 
amortizes at only 1% annually, but mandatory excess cash flow payments under 
the secured credit facility should help further reduce reported debt. However, 
the growing PIK obligations likely will offset any reductions in debt or 
EBITDA growth on a fully adjusted basis. We believe the company could remain 
acquisitive, which might delay an improvement in its financial risk profile.

Harvard Drug's weak business risk profile reflects its niche position and 
relatively small size in an industry dominated by three large competitors: 
McKesson Corp., AmerisourceBergen Corp., and Cardinal Health Inc. Harvard Drug 
generally serves the same markets as these distributors. While we expect 
low-single-digit revenue growth in 2012 for the pharmaceutical distribution 
industry, we believe Harvard Drug's revenue growth will significantly outpace 
the industry given increased sales of generic drugs and the company's Major 
label.

Despite its small market position, we believe the company will maintain its 
share because of pharmacies' desire to maintain a relationship with a second 
distributor, Harvard Drug's willingness to distribute certain drugs the large 
distributors choose not to stock, and its ability to market generic drugs. 
Harvard Drug has been in business as a complementary distributor for over 40 
years, but we view its niche position as significantly less stable than its 
three large competitors.

Despite its weak business risk profile, there are some positive aspects to the 
company and industry that should lead to increased profitability and 
prescription growth. Harvard Drug's EBITDA margins are substantially above 
those of its larger competitors, largely because its focus is on more 
profitable generic drugs. It also sources and distributes its own 
proprietary-label generic and over-the-counter drugs under the Major brand. 
These drugs are more profitable than its more traditional retail distribution 
and we expect them to grow as percentage of total sales. Harvard Drug should 
also benefit from the generally favorable trends in the drug distribution 
industry, such as the aging U.S. population, the increase in the availability 
and acceptance of generic drugs, and the potential for increased drug volume 
in 2014 from the Affordable Care Act of 2010.

Liquidity
We view Harvard Drug's liquidity as "adequate," with sources of cash that will 
exceed mandatory uses of cash over the next 12-24 months. Relevant aspects of 
the company's liquidity are:
     -- Sources of liquidity will exceed uses by at least 1.2x.
     -- Sources of liquidity included positive cash flow, full availability of 
its $35 million revolver, and solid cash balances (but reduced due to the 
acquisition).
     -- We estimate the company could generate about $40 million to $50 
million of annual operating cash flow.
     -- Its term loan will amortize at 1% annually until maturity in 2019; 
Harvard Drug should easily meet the amortization payments.
     -- Covenants consist of maximum leverage ratio; Harvard Drug should have 
sufficient cushion.

We anticipate the company will make an additional moderate-sized acquisition 
in the near-term, which we expect will be funded through the $45 million 
accordion feature on the term loan and additional debt. 

Recovery analysis
For the complete recovery analysis, please see the recovery report on Harvard 
Drug, to be published shortly after this report, on RatingsDirect.

Outlook
Our rating outlook on Harvard Drug is stable. We believe that the anticipated 
additional moderate-sized acquisition would not alter our issue-level or 
corporate credit ratings on the company. We believe an upgrade is unlikely in 
the near term, as the company's growing PIK obligations would offset any 
EBITDA growth or reductions in funded debt. We believe a downgrade is also 
unlikely, but would probably depend on weakened liquidity at this rating 
level. While unexpected at this time, covenants would need to tighten 
significantly or free cash flows would need to severely decline relative to 
the company's debt obligations. We would likely lower our rating on Harvard 
Drug if we believed that covenant cushion would fall to 10% or less over the 
next year. Such a case could result from a roughly 25% decline in EBITDA, for 
which we do not foresee a likely scenario.

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed

The Harvard Drug Group LLC
 Corporate Credit Rating                B/Stable/--        

New Ratings

Generic Drug Holdings Inc.
 Senior Secured                                         
  US$35 mil revolver bank ln due 2017   B+                 
   Recovery Rating                      2                  
  US$300 mil term bank ln due 2019      B+                 
   Recovery Rating                      2                  

Ratings Affirmed; Recovery Ratings Unchanged

Generic Drug Holdings Inc.
 Senior Secured                         B+                 
   Recovery Rating                      2                  

 (Caryn Trokie, New York Ratings Unit)
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