S&P puts Avaya on negative watch

Standard & Poor's put Avaya Inc. 's ratings on negative watch, including the BB+ rated 0% convertible due 2021, reflecting continuing weak operating performance and concerns about financial flexibility stemming from ongoing cash-based special charges and potential covenant amendments.

Avaya, based in Basking Ridge, N.J., the leading supplier of enterprise voice communications equipment, had $914 million of outstanding debt as of June 30.

In its earnings announcement, Avaya indicated the prospect for additional softening in demand among enterprise customers for its communications products.

While S&P has previously stated that it expects sluggish business conditions to persist for Avaya, sequential declines in quarterly revenues and contracting EBITDA have resulted in debt protection measures that are subpar for the rating level.

Avaya reported EBITDA was $39 million for the June quarter, down from $90 million in the March quarter.

While Avaya has not indicated that it is at risk of covenant violation, it did state that it is in talks with creditors to amend its existing covenants.

In addition to operating performance, S&P is concerned that additional cash-based charges, outlined by Avaya on July 26 will put further pressure on its cash balances.

Avaya will incur $125 million to $135 million of cash charges, to be paid out over the next several quarters, for reducing headcount and consolidating facilities.

The company had $406 million of cash as of June 30.

While Avaya currently has availability under its revolving credit line, S&P is concerned that ongoing charges, combined with declining cash generation from operations, might constrict the company's financial flexibility.

Fitch revises SBC outlook to negative

Fitch Ratings revised the outlook on SBC's long-term debt rating of AA to negative from stable.

The outlook on SBC's F1+ commercial paper rating is stable, incorporating the expectation that a rating action over the near-term time horizon of the outlook would likely be limited to one notch.

The change reflects concern over the deterioration in SBC's core wireline business.

EBITDA in the wireline business has been pressured by the weak demand for telecom services, competitive entry and a difficult regulatory environment. While SBC is mitigating the impact of these forces through cost management activities, pressure on revenue growth and EBITDA is likely to remain in place for the near future.

Financial quantitative protection measures are expected to remain relatively stable over the near-term due to forecasted debt reductions, however, the change in outlook reflects the increased business risk posed by the pressures on operating profitability.

Should such pressures continue, SBC may be challenged to sustain its credit measures at current levels.

SBC's total switched access lines declined 3.8% in the second quarter of 2002 relative to one year ago and continuing a trend of access line declines that began with the second quarter of 2001. A significant portion of the recent decline in revenue can be attributed to the success its competitors are having in marketing services using SBC's unbundled network element platform (UNE-P).

Operating profits are pressured owing to the low prices SBC receives on UNE-P in certain states. Also indicative of the weak demand for services and competitive effects was the 6.6% decline in business lines in the quarter, as well as the reduction in data revenue growth rates.

SBC's external financing needs in 2002 consist primarily of the refinancing of maturing long-term and short-term debt.

During the course of the year, SBC is expected to produce about $3 billion in net free cash flow.

Debt levels are expected to decline by yearend 2002, producing stable credit protection measures.

Potential improvements in credit protection measures that could be generated from free cash flows will be restrained by SBC's 100 million share buyback program.

In 2002, SBC's overall liquidity is expected to benefit from a material reduction in the capital spending program. Capital spending is expected to decline to less than $8 billion in 2002 from $11.2 billion in 2001.

In 2002, SBC's debt leverage is expected to be about 1.2 times to 1.3 times, including EBITDA from the proportionate results of Cingular. Including Cingular's proportionate results, EBITDA-to-interest is expected to be in the 12.5 times to 13.5 times range.

Moody's cuts Reliant Energy, Orion Power

Moody's downgraded Reliant Energy Inc. senior debt to Baa2 from Baa1 and Orion Power Holdings senior unsecured bonds to Ba3 from Ba1, as well as Reliant Resources Inc. ratings.

All ratings remain on review for possible downgrade.

Moody's lowered Orion Power Holdings rating to Ba3 since plans to refinance subsidiary bank debt have changed. Moody's expect that cash flows to service the Orion Power Holdings bond will remain structurally subordinated to $1.3 billion of bank loans which mature this fall.

The Reliant Resources downgrade reflects Moody's view that cash flow from operations is unpredictable relative to its debt load and limited financial flexibility. The company needs to refinance some $2.9 billion of bridge bank debt maturing in February 2003 and $800 million of the $1.6 billion corporate revolver that matures six months later.

Moody's downgraded Reliant Energy and regulated units, reflecting concern that Reliant Energy and CenterPoint face potential credit issues associated with delays in executing the spinoff of Reliant Resources.

The delay has constrained flexibility given that $4.7 billion of bank and bridge debt matures this October. Extension of these facilities is contingent upon the spinoff of Reliant Resources.

S&P revises Georgia-Pacific outlook to negative

Standard & Poor's revised the outlook on Georgia-Pacific Corp. to negative from stable. All ratings were affirmed.

Georgia-Pacific has total debt of about $12 billion.

Georgia-Pacific plans to separate into two publicly traded companies by spinning off its consumer products, packaging, pulp, and paper operations and retaining its building products and distribution businesses.

The outlook revision stems from concerns about continued high debt levels, as well as a difficult earnings environment and turbulent financial market conditions that increase refinancing risk at Georgia-Pacific and make it more challenging to achieve the expected post-separation capital structure.

Debt levels have remained high since the 2000 acquisition of Fort James Corp.

Although debt has been reduced through asset sales, free operating cash flow has fallen short of expectations due to poor conditions in some of the company's markets during the past two years.

The ratings reflect an expectation that Georgia-Pacific will reduce debt to $9.5 billion by the end of 2003.

An additional negative factor is that the company may not successfully remarket the entire $863 million of senior deferrable notes due Aug. 16, 2002 - the convertible PEPS notes will convert to common equity on that date.

The company intends to extend its $850 million bridge facility that matures on Aug. 16, 2002, for another year. The convertible originally contemplated a refinancing for a two-year period.

As of June 30, Georgia-Pacific had $1.15 billion of availability under its $3.75 billion revolving credit facility maturing in 2005.

The company is in compliance with financial covenants in its unsecured credit facilities, which include maximum leverage of 72.5%, minimum EBITDA interest coverage of 2.25 times, minimum net worth that changes quarterly, and maximum debt of $13.065 billion.

However, the covenants are currently tight and step up over time.

Georgia-Pacific has $1.3 billion of short-term accounts receivable financing outstanding that may terminate if the company's debt is rated below investment grade by both S&P and Moody's. Moody's lowered GP's ratings below investment grade on May 8.

The company said recently that it is renegotiating these facilities - $400 million of which expires in September and $900 million in December 2002 - to eliminate the triggers.

The company has about $130 million of other debt maturities during the remainder of 2002.

Based on management's current financing plans, including completion of an IPO at CP&P generating at least $1 billion in proceeds, and S&P's assessment of the business and financial risks associated with each of the two companies, S&P expects to assign a BBB- corporate credit rating to CP&P. The outlook would be negative.

S&P expects to assign a BB corporate credit rating to the building products and distribution company with a stable outlook.

Ratings could be lowered if debt is not reduced as currently anticipated due to difficult conditions in the company's markets, inability to execute the CP&P IPO in a timely manner, or other reasons.

A downgrade could also occur if there are any significant snags in upcoming debt refinancings, which S&P does not currently expect.

Moody's revises Duane Reade outlook to stable

Moody's confirmed the ratings of Duane Reade Inc., including the 3.75% cash-to-zero convertible due 2022 at Ba3, but revised the outlook to stable from positive.

The revision was prompted by Moody's understanding that the economic slowdown in and around New York City has measurably impacted front-end sales, but that operations and financial measures likely will remain appropriate for the current ratings over the next 12 to 18 months.

Ratings reflect the company's leveraged financial condition, especially adjusted for operating lease obligations, risks associated with a continued rapid increase in store count and uncertainties about the ultimate disposition of shares still held by the equity sponsor.

The ratings also consider the industry-wide trend of decreasing gross margins as low margin drugs, relative to general merchandise, steadily make up a larger proportion of the sales mix.

However, the ratings recognize the company's leading market share in the New York metropolitan area generally, and Manhattan specifically, and the relatively modern condition of the store base.

The expectation that prescription drug sales growth will exceed 10% annually for the foreseeable future provides a foundation to build front-end sales. Moody's opinions that the company has developed an effective model to continue the rapid expansion pace and has significant asset value in the form of below-market leases also benefit the ratings.

The stable outlook reflects an expectation that the currently assigned ratings will remain appropriate for the company over the intermediate term.

Given the company's philosophy of minimizing cash investment in new stores through leasing all real estate and that material improvements in front-end sales are not expected until several downsized Manhattan industries, such as financial services and advertising, recover, debt protection measures such as adjusted leverage likely will stabilize near the current level.

However, inability to find efficiencies that keep operating margins relatively constant, difficulties in achieving strong performance at the significant number of new non-Manhattan stores, or failure to maintain an adequate liquidity cushion, would place downward pressure on the ratings.

The bank loan rating reflects Moody's belief that the fair market value of tangible assets, principally accounts receivable and inventory, materially exceeds the bank debt commitment. The credit facility, comprised of an $80 million revolver, $10 million term loan A and a $93 million term loan B, is secured by substantially all tangible and intangible assets of the company and operating subsidiaries.

In a worst case, we expect that the company would be able to realize substantial value through the disposition of below market leases. Duane Reade currently has about $57 million of cash on hand, some of which may be used to further pay down the bank loan.

The convertible rating considers, besides the guarantees provided by subsidiaries, the subordination to the secured bank loan. Moody's observed that these convertible notes provide substantial interest savings over the life of the notes, but also that complications could arise over a longer term than considered in this rating analysis if the company's equity price does not eventually appreciate above the put levels.

Duane Reade has substantially reduced balance sheet debt over the past two years from using excess operating cash flow and convertible proceeds to pay down debt.

The industry-wide pattern of pharmacy comparable store sales increasing at double-digit rates is expected to continue indefinitely, which will continue placing downward pressure on gross margins.

Up until the quarter ending June when front-end sales were measurably affected from the New York City economy, the company had minimized decreases in operating margins by leveraging overhead costs over a larger revenue base and achieving comparable store sales increases for front-end products.

Adjusted debt to EBITDAR modestly fell to 5.1 times for the 12 months ending June from 5.4 imes in the year-ago period, even as gross margin fell from 24.2% in the first half of 2001 to 20.6% in the first half of 2002.

Proforma for replacement of the high coupon subordinated debt with the low coupon convertible and further retirement of bank debt, adjusted leverage and interest coverage will improve from current levels, even tough the company will generate less operating cash flow than we had previously anticipated.

S&P puts Sealed Air on negative watch

Standard & Poor's placed the ratings of Sealed Air Corp. on negative watch, including the BB-rated convertible preferred.

This action follows the recent announcement that the federal court overseeing the W. R. Grace & Co. bankruptcy proceeding, which will hear the Sept. 30 trial of fraudulent transfer claims against Sealed Air, issued a potentially adverse ruling on the legal standards applicable to the trial.

The ruling held that, subject to certain limitations, post-1998 asbestos claims should be included in the solvency analysis of Grace. Sealed Air is seeking to appeal this ruling promptly.

Saddle Brook, N.J.-based Sealed Air was named as a defendant in several lawsuits involving asbestos-related liabilities of Grace and its subsidiaries, which transferred Cryovac's packaging operations to Sealed Air in a cash and equity deal worth $4.9 billion in March 1998.

These lawsuits generally allege that the transaction between the companies resulted in a fraudulent transfer. The suits seek to void and recover the assets transferred by Grace to Sealed Air in 1998, which the asbestos claimants say were done to place some Grace businesses beyond the reach of asbestos and other creditors.

Sealed Air has disputed these allegations and claims that the 1998 deal was negotiated in good faith and that it considered all relevant issues, including Grace's solvency under applicable law. Grace has also denied that the fraudulent transfer claims have any merit and has intervened on Sealed Air's behalf.

A key issue in the suits is whether Grace's unit was insolvent or rendered insolvent when it transferred some businesses to Sealed Air in 1998. To answer these questions, the unit's liabilities at the time of the transfers would need to be estimated, including asbestos defense and indemnity costs.

The recent ruling, to include post-1998 asbestos filings, could enhance the plaintiffs' argument against Sealed Air that Grace was left insolvent after the Cryovac transaction.

However, Sealed Air contends that in determining Grace's solvency, the liabilities that should be considered are those that were known or reasonably foreseeable at the time of the transaction and at that time asbestos claims to Grace were much lower and trending downwards.

The company contends that the spike in claims that took place after the merger was not determinable at the time of the transaction.

S&P believes the defenses are consistent with the experiences of many other corporate defendants that did not foresee the spike in asbestos litigation trends that developed in the 1999-2001 period. Indeed, Grace filed for bankruptcy in April 2001 following a sharp and seemingly unexpected rise in its asbestos claims.

The developments elevate credit concerns about a company that is otherwise considered to maintain a solid credit profile.

The ratings on Sealed Air continue to reflect above-average business risk profile, strong free cash flow generation and a somewhat aggressive financial management. Sealed Air is a world-leading manufacturer of food, protective, and specialty packaging materials and systems with attractive profitability and sales of more than $3 billion.

Financial flexibility is currently ample due to the firm's strong cash flow generation and ample borrowing capacity under its revolving credit facilities. The company also has a relatively light debt maturity schedule.

Should any meaningful adverse rulings against Sealed Air arise, the ratings could be lowered.

S&P cuts Elan convertible to CCC+

Standard & Poor's lowered the ratings of Elan Corp. PLC, including the 0% convertible due 2018 to CCC+ from B, due to increased concern over its ability to meet obligations as they come due.

The outlook is negative.

The ratings were on negative watch as of July 2 following the filing of Elan's 2001 financial report, which provided details of previously undisclosed risk-sharing arrangements on a number of Elan's drugs that implied potentially substantial near-term cash outflows by the company for the repurchase of these rights.

The low speculative-grade rating reflects declining pharmaceutical sales prospects, significant upcoming debt maturities and other funding needs and the uncertain value of its investment portfolio, mitigated somewhat by its still substantial cash position.

Elan's pharmaceutical business has suffered various setbacks in the past year, including slower-than-expected sales growth of its newer products and the earlier-than-expected generic competition now facing Zanaflex. Zanaflex, which generated $160 million in 2001, was one of the largest and faster growing products in Elan's portfolio.

Elan is currently restructuring operations as it looks to refocus on neurology, pain and autoimmune therapeutic areas, reduce it pharmaceutical sales force and divest assets, including select drugs from its portfolio.

Although Elan currently has roughly $900 million in cash on-hand, it also has significant debt maturities and cash commitments.

The roughly $1 billion of convertibles can be put to Elan at the end of 2003, and the company has subordinated guarantees on $840 million in off-balance-sheet debt due in 2004 and 2005.

In addition, the company projects that it will incur cash restructuring charges of not more than $200 million over the next 18 months and plans for $250 million to $300 million in R&D joint venture funding and capital expenditures over the same period.

The company also has contingent product payments of $164 million and an option to purchase royalty rights to other products in its portfolio for $385 million.

Going forward, Elan will be operating without a bank facility.

As the company transitions to a smaller operating base, it will be challenged to produce break-even cash flows from continuing operations, excluding cash-restructuring charges.

As part of its restructuring, Elan hopes to raise $1.5 billion from asset sales by the end of 2003. The timely receipt of proceeds from asset divestitures is essential to the current rating.

Elan's $900 million cash balance, the prospect of cost savings from the restructuring and major asset sales still afford the possibility that the company will be able to meet its debt obligations as they come due over the intermediate term.

However, the core pharmaceutical business has experienced some setbacks and the drug pipeline is still in the earlier stages of development.

Moreover, Elan has stated that it has no formal plans to repurchase the convertible. It can satisfy the put with cash or stock.

Given the significant dilution that could result from a repayment with stock at relatively low-share prices, it is possible that Elan will retire the convertible in a manner that would be viewed as tantamount to a default by S&P.

Fitch affirms St. Paul ratings

Fitch Ratings affirmed the ratings on The St. Paul Cos. Inc., following the convertible offering.

The outlook is negative.

Moody's raises Whole Foods Markets outlook

Moody's Investors Service raised its outlook on Whole Foods Market, Inc. to positive from stable and confirmed its ratings including its $220 million unsecured revolving credit facility at Ba2 and its $141.4 million 5% zero-coupon convertible subordinated notes due 2018 at B1.

Moody's said it raised Whole Foods' outlook because of its industry-leading operating performance, robust operating cash flow, successful business plan of rapidly growing store count through acquisitions and new store construction, and consistent policy of paying down debt.

If this pace of improvement continues, Moody's said it expects that the company's operational and financial performance will eventually support a higher rating.

The ratings acknowledge the company's well-recognized trade name, its leading market position within the fast expanding natural/organic niche of the supermarket industry, and the stores' broad geographic diversification, Moody's said. Also benefiting the ratings are the pace of growth in the natural/organic grocery segment relative to the general supermarket industry and the perception among a certain population of consumers that natural/organic foods are an integral part of their lifestyle.

Negatives include intense competition within the supermarket industry and the likelihood that larger supermarket companies will increase their natural foods merchandising efforts, Moody's said. The ratings reflect that proceeds from the exercise of employee stock options, in contrast to operating cash flow, have been the primary source of debt reduction.

Lease adjusted leverage of 2.4 times for the 12 months ending April 2002 represents material improvement over fiscal 2001 and 2000 with levels of 2.7 times and 3.1 times, respectively, Moody's said. Rolling fixed charge coverage has increased to about 4.6 times for the 12 months ending April 2002 versus fiscal 2001 coverage of 3.7 times.

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