Research: Rating Action: Moody’s downgrades Avalign Holdings Inc.’s CFR to Caa1; outlook stable


New York, June 28, 2022 — Moody’s Investors Service (“Moody’s”) downgraded the ratings of Avalign Holdings Inc. Including the company’s Corporate Family Rating (CFR) to Caa1 from B3, Probability of Default Rating (“PDR”) to Caa1-PD from B3-PD, and senior secured first lien credit facilities to B3 from B2. The rating outlook is stable.

The rating downgrades reflects the company’s weak liquidity, incorporating $5 million available under the company’s $35 million revolver (expiring in December 2023) and $15 million in cash on the balance sheet as of March 31, 2022, as well as Moody’s expectation for slightly negative free cash flow in FY2022. Moody’s notes that Avalign’s liquidity needs in FY2021 and the first quarter of FY2022 were supported by equity infusions from the company’s private equity owners. These capital infusions were required to fund investments to support new business wins and growth initiatives. Moody’s notes that the company has secured a strong pipeline of new business wins, which requires elevated near-term investment in capital and working capital that Moody’s expectations will inhibit any positive free cash flow generation in FY2022.

The rating downgrades also reflects the company’s recent underperformance that has contributed to rising leverage (approximately 9.1x debt/EBITDA on Moody’s adjusted basis as of March 31, 2022). In FY2021, management defined adjusted EBITDA declined 24% year-over-year, primarily due to labor and supply chain operating expense headwinds. While Avalign has raised prices on its OEM medical device customer base to offset input cost inflation, with earnings results and leverage improving in the first quarter of 2022, Moody’s expects that a persistent inflationary environment could continue to negatively impact profitability as FY2022 progresses, slowing the pace of earnings growth and deleveraging. To that end, Moody’s projects debt/EBITDA to remain elevated, at 8x or higher, at year-end 2022.

The downgrade of the senior secured credit facilities to B3 reflects the one-notch downgrade in the Corporate Family Rating, and the loss absorption provided by the company’s $100 million 2nd lien term loan (unrated).

Downgrades:

..Issuer: Avalign Holdings Inc.

…. Corporate Family Rating, Downgraded to Caa1 from B3

…. Probability of Default Rating, Downgraded to Caa1-PD from B3-PD

….Senior Secured 1st Lien Term Loan, Downgraded to B3 (LGD3) from B2 (LGD3)

….Senior Secured 1st Lien Revolving Credit Facility, Downgraded to B3 (LGD3) from B2 (LGD3)

Outlook Actions:

..Issuer: Avalign Holdings Inc.

….Outlook, Remains Stable

RATINGS RATIONALE

Avalign’s Caa1 Corporate Family Rating reflects the company’s high financial leverage with debt/EBITDA at 9.1x as of March 31, 2022 on Moody’s adjusted basis. While Moody’s expects top-line trends to continue to improve over the next 12-18 months, propelled by new business wins and underlying orthopedic end-market market growth, Moody’s expects debt/EBITDA to remain at or above 8x through FY2022. Moody’s expects ongoing inflationary headwinds, driven by labor and supply chain disruption, to continue to constrain earnings growth and deleveraging. The rating also reflects the company’s high customer concentration and business risks associated with contract manufacturing, including potential fluctuations in medical device customer demand and inventory levels, less favorable payment terms offered by large medical device customers and industrywide pricing pressure. The rating also reflects Moody’s expectations that financial policies will remain aggressive due to ownership by a private equity sponsor, partially mitigated by ownership’s track record of providing equity capital support when it has been needed.

Avalign’s ratings benefit from high barriers to entry and switching costs in the medical products contract manufacturing industry. This is because of the significant amount of time and investment required for its customers to obtain product regulatory approvals, of which Avalign is an integrated part. For this reason, the company tends to have long-term relationships with its customers, lending stability to revenues. Moody’s notes that the company outperformed peers during the height of the covid-19 pandemic (in FY2020), driven by tailwinds from new business wins.

Avalign has a weak liquidity profile. Moody’s estimates that Avalign will generate slightly negative free cash flow over the next 12 months as the company continues to invest to support new business wins and other growth initiatives. At March 31, 2022, the company had approximately $15 million in cash and $5 million availability under its $35 million revolver due December 2023. The company’s mandatory debt amortization is approximately $2.3 million per year which can be covered with the available liquidity. Moody’s believes that underperformance versus FY2022 projections could further strain the company’s limited liquidity sources, and may require additional equity infusion(s) from the company’s private equity owners. In addition, Moody’s notes that the company’s revolver, which is nearly fully drawn, will become current in approximately 6 months.

The stable outlook reflects Moody’s expectation that liquidity will remain weak over the next 12-18 months, partially mitigated by ownership’s historical track record of providing equity capital support. At the same time, the stable outlook reflects Moody’s expectation that the company’s earnings will benefit from an ongoing volume recovery and new business wins, partially offset by ongoing margin pressure from input cost inflation.

Social and governance considerations are material to the rating. For Avalign, the social risks are primarily associated with responsible production including compliance with regulatory requirements for the safety of medical devices as well as adverse reputational risks arising from recalls associated with manufacturing defects. These social risks are partially offset by favorable demographic and societal trends, including an aging population and the rise in chronic disease. Governance risk considerations include the company’s financial policies which we expect to remain aggressive, reflecting its ownership by private equity investors. Governance risk is partially mitigated by ownership’s track record of providing equity capital support when it has been required in recent periods.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

The ratings could be downgraded if the company’s business/profit recovery stalls, liquidity further deteriorates, or if the company employs an aggressive financial policy that increases financial leverage. If EBITA-to-interest falls below one times, it could also put downward pressure on the company’s ratings.

The ratings could be upgraded if the company’s liquidity position improves, including sustained positive free cash flow and a successful refinancing of its revolver due December 2023. This scenario would likely include continued earnings growth – with new business wins flowing to the bottom line to drive significant deleveraging – as well as a moderation in capital spending.

The principal methodology used in these ratings was Medical Products and Devices published in October 2021 and available at https://ratings.moodys.com/api/rmc-documents/75796. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.

Avalign is a developer, manufacturer and supplier of implants, cutting tools, specialty surgical instruments and metal thermoformed cases and trays for medical devices original equipment manufacturers. It is owned by the private equity firm Linden Capital Partners. The company’s revenue for 2021 was approximately $217 million.

REGULATORY DISCLOSURES

For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.

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Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the UK and is endorsed by Moody’s Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK . Further information on the UK endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

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Michael Weinstein
Vice President – Senior Analyst
Corporate Finance Group
Moody’s Investors Service, Inc.
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Ola Hannoun-Costa
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

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