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02 Nov 2004
CORRECTION TO TEXT: MOODY'S DOWNGRADES K&F INDUSTRIES' SR IMPLIED RATING TO B2 AND ASSIGNS Caa1 RATING TO NEW SR SUB NOTES (SR SUB NOTES RATING SHOULD BE Caa1)
Approximately $845 million of debt securities affected
New York, November 02, 2004 -- Moody's Investors Service has downgraded the senior implied rating of
K&F Industries, Inc. to B2 from B1, and has assigned
ratings to the company's proposed senior secured credit facilities
and senior subordinated notes. The purpose of the proposed facilities
is to partially fund the acquisition of K&F by Aurora Capital Group
for $1.06 billion in cash, including re-financing
of existing debt. Aurora and certain investors will contribute
approximately $315 million in equity (PIK preferred and common
stock) for the purchase. This completes a review for possible downgrade
that was initiated on October 20, 2004.
The downgrade reflects Moody's view that this recapitalization will
result in K&F operating with a much more aggressively leveraged capital
structure than in the past. This will considerably reduce the company's
financial flexibility and credit metrics, and leave it more vulnerable
to any downturn in the aircraft sector or an increase in competitive pressures.
Pro forma for the transaction, EBIT/interest declines to around
2.0x from 2.4x (LTM Sept. '04) and debt/EBITDAR rises
to 6.6x from 3.4x (LTM Sept. '04). Moody's
recognizes that the management of K&F has demonstrated a strong track
record of operating with high leverage and reducing debt over time,
as evidenced in the period following the 1997 LBO. The rating agency
believes, however, that over the intermediate-term
the level of debt being taken on in this transaction will result in debt
protection measures remaining weaker than historic levels. Notwithstanding
less robust credit metrics, K&F should continue to benefit from
important operating strengths. These include the company's position
as one of the world's leading sole source suppliers of aircraft wheels,
brakes and anti-skid systems, and aircraft fuel tanks,
its large diversified customer base, its technological expertise,
and capable management.
The stable outlook reflects Moody's expectations that although leverage
will remain high over the next few years, a healthy operating environment
should result in a modest amount of free cash flow generation that could
be applied to moderately reduce debt balances over time.
The affected ratings include:
Senior implied rating downgraded to B2 from B1
Unsecured issuer rating downgraded to B3 from B2
In addition, the following ratings have been assigned:
$50 million senior secured revolving credit facilities due 2010,
rated (P) B2
$430 million senior secured term loan B due 2012, rated (P)
$365 million senior subordinated notes due 2014, rated (P)
The ratings outlook is stable.
The ratings on the existing bank credit facilities, which will remain
in effect under their original terms until closing, have been confirmed.
The company has indicated that these facilities will be fully repaid and
cancelled upon closing of the transaction, at which time the ratings
for these facilities will be withdrawn. In addition, the
company intends to use proceeds from the transactions to retire the existing
$145 million 9 ¼% senior subordinated notes due 2007
and $250 million 9.625% senior subordinated notes
due 2010 by way of a tender offer. Since tender includes a consent
solicitation that would strip holders of any remaining notes of essentially
all covenant protection currently enjoyed under those notes' indentures,
these ratings remain under review for possible downgrade. The ratings
on these notes would be withdrawn if 100% of the outstanding amounts
are successfully tendered and the issues are cancelled. However,
if less than 100% of the outstanding amounts are tendered,
Moody's would likely lower the ratings of any remaining notes after
these transactions are completed to levels below that of the new senior
K&F's ratings had been placed on review for possible downgrade
following the announcement that the company had signed a definitive agreement
to sell the company to Aurora Capital Group. Moody's has
reviewed the terms of the proposed financing associated with the transaction
and has assessed the impact that the re-capitalization of the company
will have on the future credit fundamentals of the company. Moody's
recognizes that the company had successfully reduced debt after prior
re-capitalization programs, but that the current transaction
will employ a degree of leverage that is considerably higher than in the
past. Also, through the acquisition by Aurora, the
creation of a new management group leaves uncertainties as to the risk
tolerance of management going forward, although this is mitigated
by continued involvement of Bernard Schwartz and K&F management.
Hence, Moody's believes that the new highly-levered
capital structure will diminish the company's cash flow generation
and the margin of protection in meeting its debt service requirements,
increasing overall credit risk associated with the company, which
is reflected in the rating downgrades.
The ratings continue to consider the Company's modest size with
respect to its pro-forma debt load (balance sheet debt will equal
about 2x revenue and this does not include the preferred equity at the
holding company), the high proportion of intangible assets (80%
of pro forma total assets), the majority of which is goodwill,
and the negative net worth position. However, the ratings
are supported by the Company's record of consistently strong operating
performance and track record of rapid debt reduction. As a leading
manufacturer and supplier of aircraft braking systems, the company
has successfully employed a business model that has secured strong returns
on development investments on a number of smaller, high-cycle
aircraft platforms over many years. Ratings could be subject to
downward revision if competitive pressures increase in the aviation after
market sector in which the company operates, slowing revenue growth
and decreasing margins, or if the company were to substantially
further increase debt levels, resulting in retained cash flow generation
below 7% of total debt for a prolonged period of time. Conversely,
the rating outlook could improve if stronger than expected operating performance
were to allow the company to repay debt more quickly than expected,
reducing debt to less than 5x EBITDA.
Upon close of the proposed transactions, K&F's senior
debt will double, from $395 million as of September,
2004, to $795 million. This results in high balance
sheet leverage, with debt representing about 89% of total
capital (excluding the proposed $215 million PIK preferred shares
at the holding company level). As this purchase essentially leaves
the company's management and business operations unchanged,
total debt increases from about 3.5x LTM EBITDA (as of September
2004) to over pro forma 6.5x (6.6x on a lease-adjusted
basis). While operating income will not be greatly affected by
the transactions, increased interest expense associated with the
re-capitalization will affect net earnings and cash flows.
Pro forma interest expense increases as a result of the transaction,
which Moody's estimates results in interest coverage (EBIT/Interest) around
2.0x and free cash flow to debt well under 10%. In
Moody's opinion, this illustrates substantial deterioration
in credit protection owing to the increase in debt.
The ratings continue to be supported by the company's record of
consistently strong operating performance and debt reduction. Moody's
believes this is largely due to the primary advantage of K&F's
business model, whereby the company invests in the development of
wheel and brake systems for various aircraft in the early phase of their
production cycles, thus securing the company's position as
sole-source provider of after market parts on those platforms under
a stable and reliable pricing system, well into the full lives of
such aircraft. Since the November 2002 re-capitalization,
K&F has been able to reduce debt by $40 million (about 9%),
having reduced debt more dramatically in the period between the prior
recapitalization (1997) and 2002. Over the past five years the
company's revenue base and EBITDA have remained steady, averaging
about $356 million and $114 million per year respectively.
LTM Sept. 2004 EBITDA was $115 million, compared to
$107 million in FY 2003, reflecting improved results in the
commercial aviation sector. The Company has maintained consistently
high operating margins, as gross profit levels have ranged between
41% and 44% of sales over the past three years (42%
in LTM Sept. 2004). CAPEX levels have been moderate,
ranging between $5 million and $10 million over the last
five years, less than 5% of revenues annually. Strong
cash flows have enabled the company to reduce debt from $435 million
as of December 2002 to $395 million as of Sept. 30 2004.
Debt/EBITDA reduced from 4.5x in upon close of the 2002 recapitalization
to 3.5x in prior to this transaction.
The ratings also positively reflect the Company's position as one of the
world's leading sole source suppliers of aircraft wheels, brakes
and anti-skid systems, and aircraft fuel tanks for commercial
and military aircraft, and the significant aftermarket portion of
the business. The Company serves a large diversified customer base,
with an installed base of over 27,000 aircraft. The U.S.
Government is the single largest client with 26% of 2003 sales
on an installed base of about 11,000 aircraft. The ratings
further consider the Company's technological expertise (only U.S.
aircraft wheel and brake manufacturer to offer anti-skid brake
systems), high barriers to entry, and the Company's focus
on short haul/frequent take-off and landing aircraft, which
require a higher level of replacement brake parts.
The (P) B2 rating assigned to the $480 million senior secured credit
facilities, the same as B2 the senior implied rating, reflects
the senior position that these facilities hold in the new debt structure,
although lacking the benefit of robust asset coverage. These facilities
are guaranteed by all of the company's subsidiaries, and are
secured on a first priority basis by all assets of the company and its
subsidiaries. The company will have an estimated $1.4
billion in total assets on its balance sheet upon completion of the acquisition
and associated re-financing. Intangible assets, mostly
goodwill arising from the acquisition by Aurora Capital, will represent
a large portion of this (approximately $1.1 billion),
resulting in negative tangible equity. The remaining asset base
is largely comprised of fixed assets ($62 million, mostly
vessels) and accounts receivable ($41 million) and inventory ($50
million). Moody's notes that the company's assets may
not provide adequate coverage to the senior secured facilities in the
event of default, particularly if they are subject to a distressed
sale scenario. The (P) Caa1 rating assigned to the $365
million senior subordinaed notes, similarly guaranteed by all of
the company's subsidiaries, reflect the effective subordination
of these notes to a substantial level of committed and drawn senior secured
K & F Industries, Inc., headquartered in New York
City, is a leading manufacturer of wheels, brakes and brake
control systems for commercial, general aviation and military aircraft
through its subsidiary Aircraft Braking Systems Corporation. In
addition, the company is the world's leading manufacturer of flexible
bladder-type fuel tanks for aircraft through its subsidiary Engineered
Fabrics Corporation. 2003 revenues totaled $343 million.
Michael J. Mulvaney
Corporate Finance Group
Moody's Investors Service
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
No Related Data.
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