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Moody's Concludes Review of Salix Pharma (SLXP); Maintains Ratings, Outlook is Negative

December 19, 2014 2:04 PM EST

Moody's Investors Service confirmed the B1 Corporate Family Rating of Salix Pharmaceuticals, Ltd (Nasdaq: SLXP) and certain other ratings including the B1-PD Probability of Default rating, the Ba1 senior secured rating and the B2 senior unsecured rating. At the same time, Moody's lowered the Speculative Grade Liquidity Rating to SGL-3 from SGL-2. These rating actions conclude the review for downgrade initiated on November 7, 2014. The rating outlook is negative.

Ratings confirmed:

B1 Corporate Family Rating

B1-PD Probability of Default Rating

Ba1 (LGD 2) $150 million senior secured revolving credit facility

Ba1 (LGD 2) $1.2 billion senior secured term loan

B2 (LGD 4) $750 million senior unsecured notes

Rating lowered:

Speculative Grade Liquidity Rating to SGL-3 from SGL-2

The confirmation of the rating reflects Moody's expectation that underlying prescription trends of Salix's core products will remain strong, and that the need to reduce excess inventory at drug wholesalers is a temporary operating issue. Management has announced plans to have the excess wholesaler inventory worked down at a faster rate than its prior plans, i.e. over five quarters instead of two years, in order to place the matter behind the company. Under this scenario, debt/EBITDA will erode significantly in 2015 (to over 8.0 times) but then decline significantly in 2016 to under 4.0 times.

Liquidity remains adequate, reflected in the SGL-3 Speculative Grade Liquidity Rating. While cash on hand was high at $462 million as of September 30, 2014, free cash flow will be volatile and likely negative in some quarters. Access to the revolving credit facility will be limited to 25% of the $150 million capacity because financial covenants apply if more than 25% of the revolver is drawn, and Salix's debt/EBITDA will exceed the covenant level (a maximum of 5.25 times) until 2016. Salix has a convertible note maturity of $345 million. Cash on hand should be adequate to cover the maturity but will a slim amount of cash.

RATINGS RATIONALE

Salix's B1 Corporate Family Rating reflects the company's position as the leading specialty pharmaceutical company operating in the gastroenterology segment. Revenue is somewhat concentrated in three key products: Xifaxan, Glumetza and Uceris. Both Xifaxan and Uceris face high barriers for generic competitors. Underlying prescription demand for Salix's key products will be strong. Offsetting these strengths, strong growth in Xifaxan and Uceris will be necessary to offset upcoming 2016 genericization of Glumetza and Zegerid. Financial leverage will be extremely high for most of 2015 because sales will be adversely affected by the wholesaler inventory workdown, with debt/EBITDA in excess of 8.0 times. The workdown is temporary and sales will rebound in 2016, resulting in significant improvement in debt/EBITDA to below 4.0 times. Salix's earnings will improve even more rapidly in 2016 if the FDA approves Xifaxan for the treatment of irritable bowel syndrome, potentially in May 2015.

The B2 rating on the senior unsecured notes reflects a one-notch override of Moody's Loss Given Default methodology due to potential changes in the capital structure arising from the upcoming convertible note maturity.

The rating outlook is negative to reflect Salix's financial flexibility during 2015 as a result of EBITDA and cash flow pressure until wholesaler inventory levels are reduced. In addition, the Audit Committee has not yet concluded its review related to disclosures of wholesaler inventory levels, creating event risk until this matter is resolved.

The ratings could be downgraded if there is any material downturn in underlying prescription trends for Salix's key products, if the company does not receive approval for Xifaxan in irritable bowel syndrome, or if the Audit Committee review results in earnings restatements. Inventory issue aside, debt/EBITDA sustained above 5.0 times would pressure the rating. Conversely, the ratings could be upgraded if Salix sustains debt/EBITDA sustained below 3.0 times, if matters related to the inventory situation are resolved, and if strong sales trends continue.



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