S&P cuts Hercules outlook, rates notes B+, loan BB

Standard & Poor's lowered its outlook on Hercules Inc. to stable from positive and assigned a B+ rating to Hercules' proposed $250 million senior subordinated notes due 2034 and a BB bank loan rating and '2' recovery rating to the company's proposed $150 million revolving credit facility due 2007 and $400 million term loan due 2010. The '2' recovery rating indicates bank lenders can expect 80%-100% recovery of principal in the event of a default.

Proceeds from the financings will be used to redeem part of Hercules preferred stock due 2029, retire the bank debt due 2007 and redeem some of the senior notes due 2007.

S&P said the lower outlook reflects a slower than expected strengthening of the company's financial profile given higher potential asbestos-related obligations and the replacement of preferred securities, which had some equity-like characteristics, with debt.

The prospects for attainment of a financial profile appropriate for a higher rating appears diminished, even though improved volumes and a continuation of debt reduction are expected to strengthen credit quality ratios, S&P said.

The ratings reflect Hercules' sizable debt burden and some exposure to asbestos litigation, S&P added. These weaknesses are partially offset by Hercules' position as one of the larger specialty chemical companies in North America with annual revenues of approximately $1.8 billion, respectable operating margins, and prospects for improving cash flow generation.

The capital structure remains aggressively leveraged, even with over $150 million of debt reduction last year, S&P said. Moreover, the quality of the capital structure will be diminished by the bank debt and the subordinated notes, which replace a large portion of the hybrid preferred with its equity-like features including long-dated maturities and the ability to defer dividends. On the other hand, the planned refinancing will reduce interest expense and lower the debt maturity spike in 2007.

Including $228 million of hybrid preferred stock, capitalized operating leases, and a portion of potential asbestos obligations, pro forma total debt to EBITDA remains roughly at 4.0x, S&P said. Further strengthening of that ratio close to the appropriate 3.0x area is necessary to sustain the rating, and funds from operations as a percentage of total debt is expected to improve from the substandard 10% of recent years.

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