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Rating Action:

Moody's Downgrades Payless' CFR and Term Loan Ratings; Outlook Changed to Negative

Global Credit Research - 12 Feb 2016

Approximately $665 million of debt affected

New York, February 12, 2016 -- Moody's Investors Service ("Moody's") downgraded Payless Inc.'s ("Payless") Corporate Family Rating ("CFR") to B3 from B2, and Probability of Default Rating to B3-PD from B2-PD. The company's $520 million 1st lien term loan due 2021 and $145 million 2nd lien term loan due 2022 were also downgraded to B2 and Caa1, respectively. The rating outlook is negative.

The downgrades reflect weaker than anticipated operating performance and Moody's expectation that modest improvements to the company's operating performance over the next 12-24 months will be insufficient to return credit metrics back in line with the B2 rating category. Moody's projects free cash flow will be negative and EBIT/Interest coverage will remain weak at less than 1 time in the fiscal year ended January 2017 (fiscal 2016). Over the nine month period ending October 31, 2015, revenue has remained relatively flat compared to the same period in fiscal 2014, but worsening gross margins and elevated borrowings on the company's unrated $300 million Asset Based Revolving Credit Facility have driven Moody's adjusted interest coverage (EBIT/Interest) below 1 time, debt-to-EBITDA leverage to the high 5 times range (incorporating Moody's standard adjustments), and funded-debt-to-EBITDA leverage closer to the low 8 times range. Moody's anticipates that the roll off of some one-time items such as the west coast port slowdown in early 2015 will support improvements to operating performance in fiscal 2016. However, many factors negatively impacting operating performance, such as foreign exchange and declining mall traffic trends, will constrain meaningful improvement.

The negative outlook reflects Payless' weak liquidity and thin interest coverage. Moody's expects the company will be challenged to restore positive free cash flow over the next 12-24 months and anticipates interest coverage will improve only modestly to around 1 time.

Moody's took the following rating actions today:

..Issuer: Payless Inc.

...Corporate Family Rating, Downgraded to B3 from B2

...Probability of Default Rating, Downgraded to B3-PD from B2-PD

...$520 million Sr. Secured 1st Lien Term Loan due 2021, Downgraded to B2 (LGD-3) from B1 (LGD-3)

...$145 million Sr. Secured 2nd Lien Term Loan due 2022, Downgraded to Caa1 (LGD-4) from B3( LGD-4)

...Outlook is Negative

RATINGS RATIONALE

Payless' B3 CFR reflects the company's high leverage, weak interest coverage and negative free cash flow resulting from weaker than anticipated operating performance combined with higher than anticipated borrowings on the company's revolving credit facility. Over the LTM period Moody's lease adjusted leverage has risen about a half turn, leverage for funded debt rose by over 2 turns, and interest coverage (EBIT/Interest) has fallen below 1 time. Also constraining the rating is the company's history of highly-aggressive financial policies and weak liquidity. Factors supporting the rating include the company's meaningful international presence and its solid brand equity and competitive position. Payless benefits from the value-orientation of the brand and its under-$30 price point which Moody's believes helped minimize some of the impact from the most recent downturn. However, Payless' core customer remains under economic pressure, which constrains meaningful growth.

Payless' liquidity is weak, driven by Moody's expectation for negative free cash flow (CFO -- Capex) over the next 12-18 months combined with an already elevated estimated level of borrowings on the company's $300 million ABL revolving credit facility expiring in 2019. While Moody's anticipates some seasonal repayments and borrowings on the revolver to support working capital needs, the company will be challenged to meaningfully reduce outstanding borrowings from current levels. Further constraining availability will be the springing Fixed Charge Coverage test, which is triggered when availability is less than the greater of $20 million or 10% of the borrowing base. Moody's believes there is potential that Payless could trigger the covenant over the next 12-18 months, and projects the company would not comply with the covenant if it were tested. However, Payless may have the ability to pull back on some growth capex if it were in danger of triggering the test. The $520 million first lien term loan due 2021 and $145 million second lien term loan due 2022 do not contain any financial maintenance covenants. Supporting liquidity is approximately $55 million of cash on the balance sheet as of October 31, 2015 and over $50 million of availability on the revolver according to Moody's estimate.

The liquidity analysis is based on Moody's assumptions and estimates. However, there is some uncertainty about the company's liquidity given the absence of information available to Moody's such as the ABL borrowing base, availability, and the current fixed charge coverage calculation. In addition, working capital fluctuations could meaningfully impact free cash flow and the level of revolver borrowings, particularly as the company continues to right size its inventory, which was impacted by the port strike and an intentional build-up of inventory in 2015.

Ratings could be upgraded if the company is able to reverse recent operating trends resulting in improved gross and EBITDA margins combined with consistent same store sales growth. Interest coverage (EBIT/interest expense) sustained above 1.2 times and an improved liquidity profile with meaningful repayments on the revolving credit facility could also lead to an upgrade. Given the company's history of shareholder friendly transactions, an upgrade would also require the expectation that the company will exercise prudent financial policies.

Ratings could be downgraded if operating performance continues to weaken resulting in interest coverage (EBIT/Interest expense) sustained below 1.0 time, if the company is unable to restore positive free cash flow, or there is a further deterioration in liquidity. Additional future shareholder friendly transactions could also pressure the rating lower.

The principal methodology used in these ratings was Retail Industry published in October 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

Payless operates more than 4,500 family footwear stores (including joint-ventures and franchisees) in approximately 30 countries with LTM revenues as of October 31, 2015 of over $2.4 billion. The company is controlled by funds affiliated with Golden Gate Capital and Blum Capital.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Daniel Altieri
Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Alexandra S. Parker
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Downgrades Payless' CFR and Term Loan Ratings; Outlook Changed to Negative
No Related Data.
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