S&P lowers Continental to B+

Standard & Poor's lowered the ratings on five large U.S. airlines, including Continental Airlines Inc.'s corporate credit rating to B+ from BB-.

Factors spurring the downgrades include a disappointing revenue outlook, rising low-fare competition, increased use of discount tickets by business travelers and limited flexibility to reduce labor costs.

The outlook is negative.

"The pace and strength of the revenue recovery for large U.S. airlines has weakened, prolonging losses and further eroding their weakened balance sheets," said S&P credit analyst Philip Baggaley.

Although revenue measures are improving on a year-over-year basis, the industry was already deteriorating in early 2001, making the comparisons easier as the year proceeds.

Compared against 2000, the last relatively healthy year for the industry, passenger revenue per available seat mile reported by the Air Transport Association in May 2002 was 16.8% lower than levels of two years earlier, versus only 9.6% lower in January.

Business traffic and ticket pricing remain soft, reflecting not only a cyclical downturn, but also an acceleration of existing trends unfavorable to the large hub-and-spoke carriers, in particular growing low-cost competition and increasingly widespread use of information technology to search for low fares.

Increased inconvenience and costs imposed by security measures have added a further disincentive to air travel, especially on short flights.

As a result, and despite stringent cost-cutting efforts, second-quarter and full-year 2002 earnings expectations for the large airlines have slipped in recent months.

Lowering the largest single expense, labor costs, requires negotiations with unions in most cases and these have proven difficult so far, where attempted, despite the industry's clear financial distress.

Some large airlines have weathered the crisis relatively better than others, as a comparison of the pre-Sept. 11 corporate credit ratings with current, revised ratings indicates.

The cumulative downgrade for Continental Airlines Inc. is two notches from BBB- before the terrorism attacks.

All of the airlines have sufficient liquidity to survive under the currently foreseen outlook, S&P said, but all will have accumulated substantial debt and leases to fund losses, debt payments and capital expenditures through this downturn, burdening their financial profile going forward.

Debt and leases as a percentage of revenues is already above peak levels of the early 1990s, after the last industry downturn, and will mount further through at least 2002 before stabilizing at high levels.

Moody's confirms Railtrack

Moody's confirmed Railtrack plc's Baa1 long term debt rating. The outlook is stable.

The confirmation was prompted by Network Rail Ltd.'s purchase of Railtrack plc from Railtrack Group plc for £500 million plus the assumption and repayment of most of Railtrack's debt.

Moody's confirmed the rating based on its belief that the acquisition will be consummated and the debt repaid in full shortly thereafter.

The stable outlook reflects Moody's view that the conditions precedent to the acquisition will be met.

However, should one or more not be met and the failure cannot be accommodated in some way, then negative rating actions may follow.

S&P affirms American Greetings

Standard & Poor's affirmed the ratings for American Greetings Corp., including the 7% convertible due 2006 at BB+. The outlook is negative.

The ratings are supported by a strong market position. In addition, the company's liquidity position benefits from its cash balances.

Those factors are tempered by the greeting card industry's mature and very competitive nature, and a financial profile that is currently weak for the ratings.

During fiscal 2002, ended February, the company successfully completed a major corporate reorganization of its core greeting cards business to rationalize its brands, products and facilities, which are expected to generate pretax savings of about $90 million this fiscal year.

In addition, other actions affected fiscal 2002 performance and resulted in aftertax charges of about $196 million.

The company's financial profile has deteriorated over the past several years, reflecting costs related to the fiscal 2002 initiatives, reduction of inventories over the fiscal 2000-2002 period, higher debt and interest expense levels and ongoing challenging industry conditions.

Adjusted for operating leases, debt to EBITDA is in the 3 times area, and EBITDA to interest is in the 3.5 times area.

Aided by the reorganization benefits and greater free operating cash flow generation, S&P expects the overall financial profile to strengthen meaningfully this fiscal year.

American Greetings has started fiscal 2003 with its first quarter ahead of expectations.

Financial flexibility is provided by the cash position, which totaled about $180 million at May 31, and its undrawn credit facilities.

American Greetings also has a potentially significant cash outlay.

Ratings may be lowered if American Greetings' performance in fiscal 2003 is meaningfully weaker than current earnings and cash flow expectations.

Fitch expected to downgrade Xerox

Fitch Ratings said Xerox Corp.'s announced restatement of financial results for the 1997-2001 periods were within Fitch's expectations and already factored into the existing ratings.

Separately, however, Fitch expects to downgrade Xerox and the B+ convertible trust preferred ratings at least one notch to reflect structural subordination as a result of the security granted in the new $4.2 billion amended credit agreement.

A final rating action, expected next week, is pending a detailed review of the company's 10K and 10Q statements.

Although over $6 billion of equipment revenue, on a cumulative basis will be restated for 1997-2001, the issue is strictly the timing of revenue recognition in this period. Of the $6 billion, $5.1 billion has been reallocated to other revenue components over this period.

Further, reported net income for the historical period will be lower.

The financial restatement arose from a disagreement with the SEC in terms of revenue recognition for sales-type finance leases and operating leases.

The outlook remains negative, reflecting Xerox's weakened credit protection measures, significant debt maturities for the next three years and impaired financial flexibility as well as reduced access to the capital markets.

The ratings also incorporate the competitive nature of the printing industry, the necessity for constant new product introductions and overall weak economic conditions.

As revenues are forecasted flat to down, it is crucial that Xerox continues executing cost cutting programs in order to return the core operations to consistent profitability levels.

Cash flow will have to increase significantly in order to support its debt obligations.

Fitch anticipates core credit protection measures will continue to be challenged for the near term, despite continued anticipated cost reductions from the company's ongoing restructuring programs.

Fitch continues to recognize improving operational performance, strong, technologically competitive product line and business position, completed asset sales, execution of the cost restructuring program.

In addition, Xerox has made significant progress with its turnaround strategy as the previously announced $1 billion cost cutting program was achieved ahead of schedule and larger than anticipated, including a more than 10% headcount reduction from year-end 2000.

Asset sales have totaled more than $2 billion, including an agreement to outsource about half of its manufacturing, the common stock dividend has been eliminated and the company exited the ink-jet market, which was a significant cash drain.

Moody's cuts Encompass

Moody's Investors Service downgraded Encompass Services Corp. and removed it from watch list status. The outlook continues as negative. Ratings affected include Encompass' $130 million senior secured term loan A due 2006, $170 million senior secured term loan B due 2006 and $300 million senior secured revolving credit facility due 2005, all lowered to B2 from B1, its $335 million 10.5% senior subordinated notes due 2009, lowered to Caa2 from B3 and its $295 million accreted amount 7.25% mandatorily redeemable convertible preferred stock, lowered to Caa3 from Caa1.

Moody's said the downgrades and negative outlook reflect continuing strains on Encompass' profitability from the protracted slow down in non-residential construction.

Although a new amendment to the company's bank credit agreement provides covenant flexibility below the low end of the company's revised EBITDA guidance for 2002, Moody's said it is concerned that if Encompass' markets continue to erode, the company's prospective ability to comply with its covenants may yet come under pressure.

The company has again lowered its guidance for 2002 revenues, to a range of $3.4 to $3.6 billion, which Moody's said it below its previous expectations for its performance. Similarly, EBITDA guidance was reduced to a lower-than-expected range of $130 to $160 million.

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