Moody's says ATD must cut costs, add revenue to meet projected payments

NEW YORK — Moody's Investors Service Inc. has issued a report on American Tire Distributors Inc. questioning whether ATD has sufficient cash reserves to cover certain projected interest payments and maintenance costs in the near future.

In order to counter the projected revenue and earnings declines related to the loss of business from Goodyear and Bridgestone Americas Inc., Moody's said ATD must cut costs quickly in order to meet its obligations.

Moody's is forecasting ATD's revenue will decline 23 percent and its earnings before interest, taxes, depreciation and amortization (EBITDA) will fall 38 percent for the year ended March 31, leaving the company with insufficient funds to cover projected annual interest payments and maintenance investments of $243 million.

ATD, North America's largest tire distributor, issued a statement in response to the report, saying it has liquidity of $300 million.

According to Moody's, if ATD cuts 40 percent of its selling, general and administrative costs (SG&A), and if it could replace 40 percent of the revenue lost by the departure of Goodyear and Bridgestone products from its portfolio, it could cover its fixed charges of $243 million.

Moody's predicts ATD needs $64 million in cash over the next eight quarters to cover its cash flow requirements.

"Based on our revised revenue and earnings projections, we believe (ATD) is at high risk of not being able to cover its projected interest payments and maintenance capital expenditure needs," Moody's said.

In response, ATD said it "continues to generate substantial cash flows and as of May 31, 2018, had approximately $300 million of liquidity. We have a loyal base of customers and manufacturer partners with whom we are continuing to work as we always do."

Late last month, Moody's placed its ratings for ATD under review for downgrade in light of Bridgestone's decision to stop supplying ATD in the U.S. with passenger and light truck tires.

"The magnitude and timing of earnings and cash flow erosion following the loss of two prominent suppliers will be more severe and immediate than previously envisioned," Inna Bodeck, Moody's lead analyst covering ATD, said.

In the latest report, Moody's said ATD's "transformation initiatives" that already are under way will help cut costs, but those alone will not be sufficient enough to reverse the fallout from losing Goodyear and Bridgestone.

Moody's said that last year, ATD spent about $50 million on those initiatives, including improved category management to ensure a wide assortment of tires; improved communication between its sales force and customers; enhanced product segmentation; and improved working capital management.

These initiatives helped ATD generate positive free cash flow in 2017, the first time since 2013, Moody's said.

That revolving credit facility will provide liquidity, although the loss of Bridgestone and Goodyear will reduce the company's $1.2 billion revolving facility commitment, according to Moody's.

Capital structure will need to be adjusted, Moody's added, forecasting that ATD's debt/EBITDA ratio, including standard adjustments, would increase to eight times by year-end, and to 9.7 times by year-end 2019, depending on how swiftly ATD is able to adjust its cost structure.

"We do not believe this is a capital structure that ATD will be able to grow into," Moody's said. "Put simply, we assert that there now exists a sudden and irreconcilable mismatch between the company's earnings and cash flow generating capability and its debt capitalization, with the latter needed to be right-sized to the former — likely sooner rather than later, perhaps over the next year or so as the company's revolving facility comes due in April 2020.

"We believe that the company will likely need to reduce its interest expense burden, potentially by proactively purchasing bonds in the secondary market. The senior subordinated notes account for a majority of the interest expense ($105 million) are subsequently a likely target for a prospective debt-for-equity exchange."

Moody's latest review includes ATD's Caa2 Corporate Family Rating (CFR) and Caa3-PD Probability of Default Rating, as well as the Caa1 and Caa3 ratings for the company's senior secured term loan and senior subordinated notes, respectively.

Moody's issued a similar ratings review in early May after Goodyear notified ATD it intended to stop distributing its tires through the Huntersville, N.C.-based wholesaler.

Moody's said ATD relies heavily on its various revolving credit facilities, with one-year average usage of approximately $670 million (and peak usage of $760 million during the first quarter of 2018).

The ratings could be downgraded if the likelihood of default rises and/or Moody's recovery expectations weaken further, including through a potential pre-emptive restructuring of debt obligations. This could be precipitated by a material deterioration in liquidity, potentially stemming from more restrictive terms from suppliers and/or more restrictions in supply, an inability to flex the cost structure in line with lower volumes, or a loss of access to the company's asset-based lending facilities.