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Rating Action:

Moody's assigns B3 CFR to Strategic Materials; stable outlook

20 Oct 2017

New York, October 20, 2017 -- Moody's Investors Service (Moody's) assigned SMI Acquisition Inc. (Strategic Materials Holding Corp.) a B3 Corporate Family Rating (CFR) and B3-PD Probability of Default Rating. At the same time, Moody's assigned a B2 rating to SMI Acquisition Inc.'s proposed first-lien senior secured revolving credit and first-lien senior secured term loan facilities and a Caa2 rating to its proposed second-lien senior secured term loan. The rating outlook is stable.

The rating assignments follow the company's plan to raise $355 million of new senior secured debt -- a $40 million first-lien revolving credit facility, a $235 million first-lien term loan and an $80 million second-lien term loan -- to help fund the acquisition of scrap-glass processor Strategic Materials Holding, Inc. (Strategic Materials) by private equity sponsor Littlejohn & Co., LLC.

Moody's took the following rating actions on SMI Acquisition Inc., which will become Strategic Materials Holding Corp. upon closing of the transaction:

- Corporate Family Rating assigned at B3

- Probability of Default Rating assigned at B3-PD

- First-Lien Senior Secured Revolving Credit Facility assigned at B2 (LGD3)

- First-Lien Senior Secured Term Loan assigned at B2 (LGD3)

- Second-Lien Senior Secured Term Loan assigned at Caa2 (LGD5)

- Rating outlook stable

RATINGS RATIONALE

The B3 CFR reflects Strategic Materials' small scale (pro forma revenues of about $260 million), highlighting what has historically been a steady but modest-growth operating model that has produced limited free cash flow (cash flow from operations less capital expenditures). Pro forma leverage is high, increasing to approximately 6x, placing greater importance on generating stronger free cash flow to reduce debt and improve financial flexibility. Additionally, the company has significant supplier and customer concentration as well as heavy reliance on the state of California in generating revenues and earnings. Favorably, the company's supply of glass benefits from recycling regulations/mandates, particularly those with weight requirements or targets. Contracted demand for recycled glass/cullet provides top-line stability as key end markets, containers and fiberglass, are expected to maintain current, though moderate growth trajectories. Strategic Materials is the North American leader in glass recycling and within its niche focus has the footprint from which to further expand into Mexico and Latin America where glass container usage is significantly higher than in the US. Differentiated processing capabilities such as fine grind technology are boosting growth in higher-margin product lines such as abrasives and flat glass which could enhance margins and cash generation based on recent trends. A largely variable cost structure provides flexibility to adjust to changes in market conditions, lessening the potential impact from a sharp drop in demand.

Strategic Materials is the leading supplier of recycled glass, known as cullet, in North America and plays a key role in the supply chain of glass manufacturing. Glass supply is obtained from national solid waste companies who accumulate glass through recycling collections, container deposit glass programs and from flat glass manufacturers that generate post-industrial scrap. Exclusive supply contracts ranging from 3-10 years as well as long-running customer relationships (average 20+ years) with contracts that include minimum thresholds and price increases provide stability to the operating model. Key end markets include containers that are primarily for the food and beverage industry, namely alcohol packaging, and fiberglass for insulation in the residential and commercial construction industries. Despite modest growth rates, glass container production volumes have been stable for over a decade. Fiberglass demand can be cyclical as it is more closely correlated to economic cycles but is currently trending positively as housing starts continue an uneven climb towards 1.5 million units, widely considered a long-term run rate. In addition, other end markets consisting of abrasives, flat glass and highway safety bead support growth prospects over the next 12-18 months.

While the company has less than $300 million in revenues, relative to industry peers it is easily the undisputed domestic leader in glass processing and recycling. With contracted access to supply, unmatched scale and diverse processing technologies, Strategic Materials is well-positioned to benefit from all parts of the glass manufacturing supply chain.

Strategic Materials' adequate liquidity profile includes negligible cash on the balance sheet but is supported by the expectation for free cash flow in the $10 million range over the next twelve months. With this proposed financing, the company is putting in place a $40 million revolving credit facility set to expire in 2022 - pro forma availability is expected to be the entire $40 million. The facility is subject to only a springing total net leverage ratio tested if the aggregate amount of outstanding borrowings exceeds a set percentage of the facility. The term loans do not have financial maintenance covenants. There are no near-term debt maturities and less than $3 million of annual amortization payments required on the first-lien term loan. With the revolving facility and first and second-lien secured term loans, there are limited sources of alternate liquidity as substantially all assets are pledged.

The rating outlook is stable, indicative of Moody's expectations for revenue growth, driven by a significant, contracted, supply of glass and steadily increasing demand for cullet, to gradually accelerate to levels greater than normal GDP expansion. Margins are expected to modestly strengthen with growth in higher-margin abrasives and highway bead offsetting Moody's anticipation of higher costs to obtain recycled glass supply. Free cash flow generation should steadily increase with stronger earnings and capital expenditure needs that are expected to run at 6-7% of revenues over the next couple of years.

Higher than anticipated growth in revenues and margins, buoyed by lower than expected costs to acquire and process recyclable glass and/or sharply stronger demand for cullet, especially for uses outside of low-growth container demand, could result in an upgrade. Reduced reliance on the state of California would also be viewed favorably. Debt-to-EBITDA below 5x on a sustained basis and free cash flow-to-debt in the low-to-mid single digit range would be necessary for an upgrade.

The ratings could be downgraded if debt-to-EBITDA remains near 6x or if free cash flow is flat-to-weaker than historical levels. Weaker free cash flow would likely indicate a deteriorating liquidity position, which would also place downward pressure on the ratings. A lack of revenue growth, possibly due to weaker demand in the non-container end markets (e.g. softening in the housing and construction markets) or unfavorable developments on recycling initiatives could also negatively impact the ratings.

Strategic Materials, Inc. is an environmental services company focused on recycling and processing scrap glass (92% of revenues), known as cullet, as well as processing post-industrial scrap plastic (8% of revenues). Cullet is a necessary input to the glass manufacturing process and utilized across multiple end markets and product categories such as containers, fiberglass, abrasives, flat glass and a range of other industrial applications. Latest twelve month revenues for the period ending June 30, 2017 were approximately $250 million.

The principal methodology used in these ratings was Environmental Services and Waste Management Companies published in June 2014. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

Eric Greaser
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Robert Jankowitz
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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