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Rating Action:

MOODY'S DOWNGRADES ORIENTAL TRADING COMPANY'S SENIOR IMPLIED TO B2 AND SECOND-LIEN SR SEC CREDIT FACILITIES TO B3; AFFIRMS FIRST-LIEN SR SEC CREDIT FACILITIES AT B1; OUTLOOK CHANGED TO STABLE FROM NEGATIVE

04 Feb 2005
MOODY'S DOWNGRADES ORIENTAL TRADING COMPANY'S SENIOR IMPLIED TO B2 AND SECOND-LIEN SR SEC CREDIT FACILITIES TO B3; AFFIRMS FIRST-LIEN SR SEC CREDIT FACILITIES AT B1; OUTLOOK CHANGED TO STABLE FROM NEGATIVE

Approximately $448.8 Million of Rated Debt Facilities Affected.

New York, February 04, 2005 -- Moody's Investors Service downgraded the senior implied and second-lien senior secured ratings of Oriental Trading Company, Inc. ("OTC") to B2 and B3, respectively, and affirmed the first-lien senior secured rating of B1. In addition, Moody's rated OTC's proposed incremental $30 million first-lien senior secured term loan b and $42 million second-lien senior secured term loan at B1 and B3, respectively. Proceeds and cash-on-hand of $29.7 million will fund a $100.0 million dividend to shareholders and will take leverage to approximately 5.0x net debt to adjusted ebitda from 3.8x. The rating outlook, which had been negative, has been revised to stable at the new rating level.

The following ratings were affected:

Senior implied downgraded to B2 from B1;

$40 million first-lien senior secured revolving credit facility affirmed at B1;

$256.8 million of first-lien senior secured term loan b affirmed at B1;

$30.0 million add-on first-lien senior secured term loan b, assigned at B1;

$80.0 million second-lien senior secured downgraded to B3 from B2;

$42.0 million second-lien senior secured, assigned at B3;

Senior unsecured issuer downgraded to Caa1 from B3.

The outlook is changed to stable from negative.

The ratings are restrained by the non-productive use of cash and an increase in leverage to fund a dividend at a time when sales and profit growth are slowing and OTC needs to invest in capital spending to add incremental distribution capacity. The ratings also recognize the aggressive financial policy that has resulted in significant capital being returned to its financial sponsor through debt-financed transactions over the past few years. Post the transaction, net debt to EBITDA is expected to increase from approximately 3.8x to 5.0x. Higher debt levels, despite expected pricing reductions on its secured facilities, will increase associated interest costs and, in combination with capital spending programs, materially limit free cash flow available to reduce debt.

OTC's stable outlook at the new rating level is based on the company's steady growth and margin expansion in various economic environments, its ability to fund growth initiatives from internal cash flows, its favorable position in its niche of the catalog sales segment of retail, its ability to continue to leverage operating costs as it grows, its relatively modest inventory risk, and its experienced management team. The ratings also anticipate sensible operating strategies going forward, including category expansion into school supplies and party supplies.

Moody's does not anticipate rating changes over the coming year, and notes that the new senior implied rating level provides substantial cushion for erosion in credit metrics. That said, negative rating actions could be possible if the company is unable to sustain profit improvements or increases its debt burden such that leverage exceeds 6.5x or free cash flow turns negative. Further, given the significant size of the first lien facilities relative to tangible assets and the debt structure, Moody's views the B1 ratings on these facilities as weakly positioned in the B1 category. As such, the ratings may not move in step with future senior implied rating changes, and could be downgraded if leverage exceeds 5.5x (particularly if first lien debt levels increase). Potential catalysts for such weakness could include additional shareholder return initiatives or challenges associated with its facility expansion, pricing, customer acquisition costs, or competitive threats. On the other hand, continued discipline with regard to cost efficiency, the successful launch of new product categories, and a smooth transition through facility expansion projects could support positive rating actions, particularly if the company commits to sustaining debt levels below 4.5x and generates mid-to-high single digit free cash flow as a percentage of debt.

Despite the incremental leverage, Moody's believes that the position of the first-lien senior secured facilities was not materially worsened by the transaction and therefore affirmed the ratings at B1. Debt levels through the first lien facilities are only modestly higher than at the last recapitalization and enterprise value support remains available based on a reasonable EBITDA multiple assumptions. In contrast, Moody's believes that the increase in higher priority and pari passu debt meaningfully weakens the standing of the second-lien facilities, and thereby warrants the downgrade to B3.

Oriental Trading Company, a subsidiary of OTC Holdings, is a privately-held company headquartered in Omaha, Nebraska. The company sells novelties and home decor by catalog and the Internet.

New York
William L. Hess
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Kevin L. Ziets, CFA
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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