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Rating Action:

Moody's lowers Aeroflex's senior secured loan ratings following unsecured debt repayments; outlook stable

22 Dec 2010

Approximately $553 million of rated debt affected

New York, December 22, 2010 -- Moody's Investors Service has lowered the rating on Aeroflex Incorporated's ("Aeroflex") senior secured first lien revolver due 2013 and (first-out) senior secured term loan due 2014 to Ba3 from Ba2; lowered the rating on the (first-loss) senior secured term loan due 2014 to B3 from B2; and revised the LGD point estimate on the 11.75% senior subordinated unsecured PIK term loan due 2015 (PIK term loan) in accordance with Moody's LGD Methodology. All other Aeroflex ratings remain unchanged and the rating outlook remains stable. The rating actions and LGD revision result from Aeroflex's recent purchase of a portion of the 11.75% senior notes due 2015 (unrated) and PIK term loan following the company's November 2010 tender offer announcement.

Following is a summary of today's rating actions and assessment revisions, and Aeroflex's current ratings:

..Rating Actions:

$ 50 Million Senior Secured First Lien Revolver due 2013 to Ba3 (LGD-2, 25%) from Ba2 (LGD-2, 19%)

$373 Million (originally $400 Million) (First-Out) Senior Secured Term Loan due 2014 to Ba3 (LGD-2, 25%) from Ba2 (LGD-2, 19%)

$116 Million (originally $125 Million) (First-Loss) Senior Secured Term Loan due 2014 to B3 (LGD-4, 66%) from B2 (LGD-4, 53%)

..LGD Assessment Revisions:

$ 14 Million (originally $120 Million) 11.75% Senior Subordinated Unsecured PIK Term Loan due 2015, currently Caa1, LGD assessment revised to (LGD-6, 96%) from (LGD-6, 92%)

..Current Ratings:

Corporate Family Rating -- B2

Probability of Default Rating -- B2

Speculative Grade Liquidity Rating affirmed -- SGL-2

RATINGS RATIONALE

The downgrade of the senior secured debt obligations is due to the reduced size of the unsecured creditor class (roughly $207 million outstanding following the debt purchases vs. $345 million outstanding previously) relative to the size of the senior secured creditor class, which remained the same after the debt repayments (i.e., $373 million first-out term loan and $50 million first lien revolver). Essentially, the senior secured creditor class must now absorb a disproportionately higher amount of losses under Moody's LGD framework given the reduced amount of junior debt in the capital structure.

When we upgraded Aeroflex's Corporate Family (CFR) and debt ratings in September 2010, our press release noted that "to the extent an IPO is consummated and proceeds (depending on offering size) allocated to meaningfully reduce the unsecured debt obligations maturing 2015, ratings on the secured term loans would possibly experience a one-notch downgrade. The downgrade would result from the reduction of unsecured obligations in the consolidated capital structure, requiring the senior secured creditor class to absorb a higher loss under Moody's Loss Given Default Methodology."

In November 2010, Aeroflex went public via an IPO and sold 19.8 million ordinary common shares (includes the overallotment option exercised by the underwriters) at a price of $13.50/share. The company used a portion of the net proceeds to reduce the 11.75% senior notes by roughly $32.2 million to $193 million and to reduce the PIK term loan by approximately $154.4 million to $14 million.

Aeroflex's B2 CFR continues to reflect the company's moderately high financial leverage (5.1x adjusted debt to LTM EBITDA pro forma for debt repayments, adjusted for operating leases and 25% debt treatment for hybrid securities), thin credit protection measures, modest scale and limited asset protection from a small base of tangible assets. It also captures the company's exposure to customers in volatile wireless and networking verticals and to government-policy dependent aerospace / defense electronics end markets. The rating takes into account Moody's hybrid security treatment for the original $372 million of sponsor preferred-like member interests in which 25% of the equity is treated as debt-like.

At the same time, the B2 CFR considers Aeroflex's leading market position as the primary or sole source provider in niche markets, strong intellectual property portfolio with proprietary technology, and highly visible and diversified revenue base with no specific defense platform exposure. It also incorporates the company's stable competitive landscape, mission-critical products with high switching costs resulting in relatively stable and high gross margins (50%), good operating profitability and positive free cash flow (FCF) given its low capex fabless operating model.

The SGL-2 rating reflects Aeroflex's good liquidity from internal sources, which consists of $65 million of cash balances as of September 30, 2010 and our expectation for solid FCF levels in fiscal 2011. External liquidity is supported by full access to an undrawn $50 million revolver. We expect Aeroflex to remain compliant with its financial covenants over the next year.

The stable rating outlook reflects the company's exposure to the less cyclical aerospace/defense (government) sector, well-diversified product portfolio in which Aeroflex is the only (or principal) supplier and a rich portfolio of new products expected to ramp and contribute to revenue growth in fiscal 2011.

Aeroflex's ratings could experience upward pressure to the extent the company is able to: de-lever through expanded EBITDA and/or debt reduction resulting in total debt to EBITDA (Moody's adjusted) under 4.5x; and drive top-line revenue growth via effective R&D investments and product development targeted to moving up the value chain, and continued progress towards increasing the dollar content in existing programs and broadening applications for existing technologies into new end markets.

Ratings could migrate lower if: Aeroflex experienced an erosion in its competitive position or product functionality due to under-investment in R&D, as evidenced by below market revenue growth, diminished pricing power or significant customer losses; the company suffers a sustained contraction in gross and operating margins, increases financial leverage above 7.0x or materially increases capital expenditures leading to negative FCF generation on a sustained basis; the company's liquidity position were to weaken; or there was a material change in the business profile.

Moody's subscribers can find additional information in the Aeroflex Credit Opinion published on www.moodys.com.

The last rating action was on September 30, 2010 when Moody's upgraded Aeroflex's CFR to B2 from B3, upgraded the term loans and revolver by one notch and changed the outlook to stable from positive.

The principal methodologies used in this rating were Global Semiconductor Industry published in November 2009, and Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009.

Aeroflex, headquartered in Plainview, NY, is a fabless specialty provider of microelectronics and test and measurement products to the aerospace, defense, wireless, broadband and medical markets. For the twelve months ended September 30, 2010 (LTM) revenues were $681 million.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service's information, and confidential and proprietary Moody's Analytics' information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

New York
Gregory A. Fraser
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

Moody's lowers Aeroflex's senior secured loan ratings following unsecured debt repayments; outlook stable
No Related Data.
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