Overview -- U.S.-based Casella Waste Systems Inc. (Casella) is repaying its $180 million second lien notes with the proceeds from an add-on senior subordinated notes issuance and a planned equity offering. -- We affirmed the 'B' corporate credit rating on Casella. -- We also placed the issue-level ratings on the company's senior subordinated notes and unsecured industrial revenue bonds on CreditWatch with positive implications. -- Casella is also amending its financial covenants for additional flexibility. -- The negative outlook reflects the continuation of challenging business conditions and Casella's highly leveraged capital structure. Rating Action On Sept. 25, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporate credit rating on Rutland, Vt.-based Casella Waste Systems Inc. The outlook is negative. At the same time, we placed our ratings on the senior subordinated notes on CreditWatch with positive implications pending the completion of the company's proposed equity and proposed $135 million in new add-on senior subordinated notes. If the transactions are completed as proposed, we expect to raise the issue rating on the senior subordinated debt to 'B-' from 'CCC+' and revise the recovery rating to '5', from '6'. We also placed our ratings on the company's $21.4 million in unsecured industrial revenue bonds on CreditWatch with positive implications pending the completion of the company's proposed equity and new debt offering. The bonds were issued by the Finance Authority of Maine (FAME) in 2005 and are not supported by letter of credit. If the transactions are completed as proposed, we expect to raise the issue level ratings on these FAME bonds to 'BB-' from 'B-' and revise the recovery ratings to '1' from '5'. Rationale The company plans to issue $135 million in new add-on senior subordinated notes, raise about $50 million of common equity, and utilize about $15 million in revolver borrowings to repay its $180 million second-lien notes and pay related fees and expenses. The company is also amending its financial covenants to provide increased cushion levels as part of this transaction. We expect the proposed financial covenant cushion levels related to total leverage and interest coverage will be above 10% after the completion of the proposed transaction. The ratings reflect our view of Casella's financial risk as "highly leveraged" marked by high debt balances and minimal free cash generation. As of July 31, 2012, Casella had total adjusted debt-to-EBITDA of 5.7x and funds from operations (FFO)-to-total adjusted debt of 8.7%--at the current ratings, we expect levels of 5.5x to 6.0x and 10% to 15%, respectively. We view Casella's business risk profile as "fair", reflecting the company's participation in a recession-resistant industry, its competitive market positions in its operating regions, and generally good profitability despite its somewhat modest scale of operations. Casella is a vertically integrated provider of collection, recycling, transfer, and disposal services to residential, commercial, and industrial customers. Annual sales as of July 31, 2012, totaled $475 million, making it one of the larger regional solid waste haulers. The company operates predominantly in the northeastern U.S. and focuses on competing in secondary and tertiary markets. Casella occupies the largest or second-largest market position in about 80% of the markets it serves. The company derives roughly 82% of its revenues from solid waste operations, with 10% coming from recycling assets and another 8% from major accounts. Within Casella's solid waste operations, collection accounted for 52% of segment revenue during the fiscal year ended April 30, 2012, followed by disposal (31%), processing and organics (14%), and power/landfill gas to energy (3%). Casella's operating performance during its fiscal year ended April 30, 2012, improved modestly due to better collection pricing, increased tonnage at expanded landfills, and higher prices on recycled commodities for much of the year. Lower special waste tonnage, higher fuel costs, increased disposal and landfill operating costs, and the downturn in natural gas and energy pricing partially offset these strengths. The company's adjusted EBITDA margin for the 2012 fiscal year was 24%, up slightly from 23% last year. For the past 12 months ended July 31, 2012, the adjusted EBITDA margin was about 23%, and we expect the company will be able to maintain these levels through fiscal year 2013 based on our scenario forecasts. However, we expect slightly negative revenue growth driven by lower special waste volumes and lower commodity prices in fiscal year 2013. This should result in fiscal-year 2013 EBITDA being about flat with fiscal year 2012. Our fiscal 2013 performance expectations for Casella include: -- Sales growth of negative 1% to 0%, driven by overall lower landfill volumes and commodities prices, partially offset by modest collection pricing and additional volumes from recently expanded landfills; -- Adjusted EBITDA margin of about 23%; and -- Free cash flow flat to slightly negative. Liquidity We classify Casella's liquidity as "adequate" (as our criteria define the term). After the proposed transaction, we expect about $100 million of availability under its unrated $227.5 million revolving credit facility due March 18, 2016, after adjusting for $30 million in letters of credit. Based on our scenario forecasts, we expect free cash flow to be neutral to slightly negative in fiscal year 2013 after about $50 million in capital expenditures and a modest use of cash for net working capital requirements. Large growth capital expenditures for landfill development have been largely completed, so we believe that most capital spending will be related to maintenance and should average about 10.5% of revenues--roughly in line with the industry average. After the completion of the transaction, debt maturities are manageable with the earliest maturity in 2016 when its revolving credit facility becomes due. We expect financial covenants related to total leverage and interest coverage to provide more than 10% in EBITDA cushion levels after the completion of the proposed transactions and amendment. Our liquidity assessment reflects the following factors and assumptions: -- We believe sources of liquidity (including FFO; committed unused credit lines; and cash balances) will exceed uses by 1.2x during the next year; and -- Sources less uses of liquidity are likely to remain positive in the unlikely event of a 15% EBITDA decline. Recovery analysis For the complete recovery analysis, see our recovery report on Casella to be published after this report on RatingsDirect. Outlook The outlook is negative. We could lower the ratings if economic weakness, price competition, or adverse movements in recycled commodities or fuel prices cause earnings or cash flow to deteriorate, so that the company cannot maintain FFO-to-total adjusted debt of 10% to 15%. However, we believe Casella could stabilize its credit risk profile by demonstrating improved operating performance in subsequent quarters or by divesting noncore assets and using the proceeds to reduce debt. We believe the company remains committed to reducing debt (as evidenced by pending equity offering and its use of asset divestiture proceeds in 2011 to repay term loan borrowings, reducing debt by more than $100 million). We also believe that the sale of its unprofitable Maine energy facility, which it expects to close in December 2012, could help to support financial metrics. If this transaction closes, we expect some benefit to the company's profitability and cash flows in subsequent quarters. Still, uncertainty regarding asset sales and internal growth lead us to the conclusion that it's unlikely that the pace of deleveraging would be rapid enough to warrant higher ratings within the next year. While less likely, we could raise the ratings if there is improvement in operating results or if proceeds from additional asset sales enable the company to generate FFO-to-total adjusted debt exceeding 15%. CreditWatch The CreditWatch listings on the company's senior subordinated notes and $21.4 in unsecured FAME revenue bonds will be resolved upon the successful completion of its proposed equity and debt offerings. If completed as proposed, we expect to raise the issue rating on the senior subordinated debt to 'B-' from 'CCC+' and revise the recovery rating to '5', from '6'. If the transactions are completed as proposed, we also expect to raise the issue level ratings on the $21.4 million of unsecured FAME bonds to 'BB-' from 'B-' and revise the recovery ratings to '1' from '5'. The higher ratings reflect our view that recovery prospects for the noteholders and the FAME bonds will improve following the completion of the proposed transactions. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Corporate Ratings Criteria 2008, April 15, 2008 Ratings List Ratings Affirmed Casella Waste Systems Inc. Corporate credit rating B/Negative/-- Casella Waste Systems Inc. Senior secured BB- Recovery rating 1 CreditWatch Positive To From Casella Waste Systems Inc. $335 million subordinated CCC+/Watch Pos CCC+ Recovery rating 6 6 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.