S&P Downgrades IMPAX Laboratories ((IPXL) to 'BB-'; Outlook Stable

S&P Global Ratings said that it lowered its corporate credit rating on IMPAX Laboratories (Nasdaq: IPXL) to 'BB-' from 'BB' and revised the outlook to stable.

We also lowered our issue-level ratings on the senior secured facilities to 'BB+' from 'BBB-'. The recovery rating remains '1', indicating our expectations for meaningful recovery (90%-100%) in the event of a payment default. In addition, we lowered our rating on the senior unsecured notes to 'B+' from 'BB-'. The recovery rating remains '5', indicating our expectations for modest (upper half of the 10%-30% range) recovery in the event of a payment default.

The rating action reflects the company's underperformance in the third quarter due to continued pricing pressure in parts of its legacy generic portfolio and unexpected price concessions to maintain market share in its recently acquired portfolio of generic products from Teva. Excluding generics for Solaraze and Skelaxin, pricing pressure was in line with our prior expectations for
mid-single-digit percent declines. We have lowered our EBITDA expectations for the next two years and now expect the company's adjusted debt leverage to remain in the 3x-4x range.

IMPAX completed acquisition of 15 marketed generic products and some pipeline products from Teva for about $600 million in August 2016. The acquisition bolsters IMPAX's generic drug franchise, adding a number of complex and difficult-to-manufacture generic drugs to its portfolio. However, this drug portfolio is now facing significant competition and pricing pressure.

IMPAX received a subpoena from the U.S. Department of Justice in 2015 related to a probe into generic-drug price collusion, and the outcome is uncertain. While an unfavorable outcome has the potential to significantly affect the company's operations, its cash balance of about $230 million may partially offset the risk and support the current rating.

Our ratings on IMPAX reflect the company's narrow branded pharmaceutical portfolio as well as its limited scale and market share in the generic pharmaceutical industry. The company's branded specialty business is focused on treatments for the central nervous system. Moreover, IMPAX has limited research and development capabilities as its branded portfolio consists of only one internally developed drug, Rytary. IMPAX operates on a very modest scale compared with that of large competitors like Teva and Mylan N.V. that dominate the generic pharmaceuticals industry. The company's market share of
about 1% of the global generic pharmaceuticals market limits its bargaining power with suppliers, pharmacy benefit managers, distributors, and retailers, increasing the pricing pressure on its product portfolio. IMPAX's business risk somewhat benefits from its history of successfully developing higher-margin, difficult-to-manufacture generic formulations and first-to-file Paragraph IV patent challenges that enable it to attain 180 days of marketing exclusivity for drugs.

• We expect overall revenues to grow by low–single-digit percents in 2016 and mid–double-digits in 2017 due to growth from the acquisition of generic drugs from Teva, strong performance of IMPAX's branded drug Rytary, and new product launches in the generic segment. This growth is expected to be partially offset by significant competition faced by generic drugs and is in line with our expectations for low- to mid-single-digit percent growth for the pharmaceutical industry.
• We expect EBITDA margins to improve by about 400 basis points (bps) in 2016 due to the absence of major restructuring charges like those incurred in 2015. This increase is expected to be partially offset by the decline in margins due to significant pricing pressure.
• Margins in 2017 are expected to improve by about 250 bps due to higher margin products from the acquisition, benefits generated from restructuring initiatives, continued strong growth of high margin drug Rytary, and operating leverage benefit generated from the increase in operating scale, partially offset modest pricing pressure.

Based on these assumptions, we arrive at the following credit measures:

• The acquisition of some drugs from Teva is expected to increase adjusted debt to EBITDA to about 4.5x in 2016 (reflecting less than a full year EBITDA of recent acquisitions), but it is expected to improve to the mid-3x range in 2017 after a full year EBITDA contribution from Teva portfolio and improvement in operating performance.
• Funds from operations (FFO) to debt of about 15% in 2016, improving to the high-teens rate in 2017.

We view IMPAX's liquidity as adequate. We expect sources of liquidity to exceed uses by 1.2x. We also expect sources to exceed uses even if EBITDA declines by 15%. We believe the company has a sound relationship with its banks and has a generally satisfactory standing in the credit markets. We do not believe the company has the ability to absorb high-impact, low-probability events—such as a major product recall or a litigation settlement related to pricing collusion--without refinancing.

• Cash and cash equivalent of about $232 million as of Sept. 30, 2016;
• Full availability under its $200 million revolver as of Sept. 30, 2016; and
• Cash FFO of $180 million-$200 million over the next 12 months.
• Annual working capital investments of $20 million-$30 million;
• Capital expenditures of $50 million-$65 million annually; and
• Debt amortization of $20 million.

The company has a maximum total net leverage covenant of 5x under its credit facilities. We expect covenant cushion on the leverage covenant to remain above 15% over the next two years.

The stable outlook reflects our expectation that adjusted debt leverage (pro forma for the full year impact of recent acquisitions) will remain 3x-4x as growth in Rytary and new products offset pricing pressure in the portfolio. The substantial cash balance supports the current rating, despite decreased visibility and uncertainty with the investigation across the generics industry
into allegations of price collusion.

A downgrade could occur as the result of a non-accretive debt financed acquisition of over $500 million. We could also lower the rating if generic pricing pressure intensifies, resulting in debt leverage staying over 4.0x. This could occur if sales growth is below our expectation in the mid-single-digit percent range and gross margins contract by 100 bps.

Although unlikely given current headwinds, we could raise the rating if the company generates sales growth and EBITDA that enable it to reduce leverage below 3x. This would likely result if pricing pressure in its generic portfolio stabilizes to the mid-single-digit percent range and Rytary continues its trajectory of double-digit growth.

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