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PetIQ, LLC -- Moody's assigns first time B3 CFR to PetIQ, LLC; outlook stable

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Rating Action: Moody's assigns first time B3 CFR to PetIQ, LLC; outlook stableGlobal Credit Research - 23 Mar 2021New York, March 23, 2021 -- Moody's Investors Service, ("Moody's") assigned first time ratings for PetIQ, LLC ("PetIQ") including a B3 Corporate Family Rating (CFR), a B3-PD Probability of Default Rating, a Speculative Grade Level of SGL-2, and a B3 rating on the proposed $300 million senior secured first lien term loan. The outlook is stable.The rating assignments reflect PetIQ's small scale with revenues of $780 million, a low EBITDA margin and free cash flow, and elevated Moody's adjusted debt to EBITDA leverage (pro-forma for the new term loan and a full year of EBITDA from Capstar) of 7.6x as of the twelve months ended December 31, 2020. The liquidity position is good with expectations to hold cash on balance sheet and a $125 million senior secured asset-based revolving credit facility.The ratings assignments follow the company's plan to raise new senior secured debt comprised of a $125 million senior secured asset-based revolving credit facility (not rated) and a $300 million senior secured first lien term loan due 2028. Proceeds from the term loan will be used to refinance existing debt and to add approximately $36 million to balance sheet cash. All ratings are subject to Moody's review of final documentation.The following ratings/assessments are affected by today's action:Ratings Assigned:..Issuer: PetIQ, LLC.... Corporate Family Rating, Assigned B3.... Probability of Default Rating, Assigned B3-PD.... Speculative Grade Liquidity Rating, Assigned SGL-2....GTD Senior Secured Term Loan, Assigned B3 (LGD3) Outlook Actions: ..Issuer: PetIQ, LLC ....Outlook, Assigned Stable RATINGS RATIONALE The B3 CFR reflects PetIQ's, expanding portfolio of pet medications and related products sold into retail channels, growing market opportunity in veterinary pet services through mobile clinics and wellness centers located primarily within retailers, and high leverage with debt to Moody's adjusted EBITDA of 7.6x (pro-forma for the new term loan issuance and a full year of EBITDA from Capstar) as of December 31, 2020. Moody's views many of the company's products as consumer staples or health care, which will provide earnings resilience during an economic downtown. Offsetting these factors are the company's relatively small scale with revenues of $780 million for the twelve-month period ended December 31, 2020 and its lack of meainingful international presence.PetIQ's operations generate low margins, high working capital swings characteristic of a distribution business, and little to negative free cash flow. PetIQ's distribution of a mix of prescription and over-the-counter pet medications into retail channels is an alternative to traditional distribution through veterinary offices. The company's wellness clinics also offer a range of basic veterinary services. Moody's believes the company has good opportunity for growth in these businesses but also significant execution risk to scale the operations profitably, in addition to acquisition integration risk, event risk, and high price competition. PetIQ's purchases of Perrigo's animal health business and Capstar over the last two years broadens the portfolio of proprietary manufactured products to help solidify the company's market position. The majority of the company's revenue and earnings are generated from distribution of products to retailers that are significantly larger. This limits PetIQ's negotiating leverage and creates the need to invest to capture shelf space, manage inventory and maintain high service levels while also exposing the company to pricing pressure. The company intends to invest meaningfully to grow its veterinary services business over the next three years.PetIQ's SGL-2 rating reflects good liquidity based on approximately $67 million of cash as of December 31, 2020 pro forma for incremental cash from the proposed refinancing, $0-5 million of annual projected free cash flow in 2021, an undrawn $125 million ABL revolver expiring in 2026, and no other debt maturities through 2028. The cash sources provide ample resources for the $3 million of required annual term loan amortization, reinvestment needs and potential acquisitions. The term loan has no financial maintenance covenantsThe coronavirus outbreak, the government measures put in place to contain it, and the weak global economic outlook continue to disrupt economies and credit markets across sectors and regions. Our analysis has considered the effect on the performance of corporate assets from the current weak US economic activity and a gradual recovery for the coming months. Although an economic recovery is underway, it is tenuous and its continuation will be closely tied to containment of the virus. As a result, the degree of uncertainty around our forecasts is unusually high. Notwithstanding, PetIQ's medication distribution business is likely to be more resilient than companies in other sectors, although some volatility can be expected through 2021 due to uncertain demand characteristics, channel shifting, and the potential for supply chain disruptions and difficult comparisons following these shifts. Temporary closure of the company's veterinary clinics diminished service revenue in 2020 and a return to pre-coronavirus volumes as well as ramping up volume at new mobile clinics and wellness centers could be restrained by ongoing social distancing measures. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.Moody's views PetIQ's environmental risk as moderate as the company's products are subject to EPA, FDA, and other state and local laws and regulations relating to environmental matters as well as safety and quality control. Compliance with environmental and other public health regulations or changes in such regulations or regulatory enforcement priorities could increase the company's costs of doing business or limit the ability to market its products. Product safety and safeguarding employees and customers is a social risk.Demographic and societal trends including growth in the number of US households that own pets provide favorable long term trends in the pet care sector that will drive organic growth.Moody's views PetIQ's governance risk as balanced. As a public company, PetIQ is subject to certain standards in terms of transparency, disclosures, management accountability, and compliance. The company does not pay a dividend, but generates limited free cash flow and is utilizing debt to fund acquisitions to expand scale and the product portfolio.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSThe stable outlook reflects Moody's expectation that PetIQ will continue to grow its services segment which along with expanding distribution and revenue of pet medications will lead to lower leverage on a Moody's adjusted debt to EBITDA basis in the next 12 to 18 months. In addition, the stable outlook also reflects Moody's view that PetIQ will maintain disciplined financials policies and that the company can manage through potential disruptions that may occur as a result of the coronavirus.PetIQ's ratings could be upgraded if organic growth is consistently positive, the EBITDA margin improves, the company generates consistent and comfortably positive free cash flow, and maintains good liquidity. In addition, if debt to EBITDA is sustained below 6.0x, the ratings could be upgraded. Alternatively, ratings could be downgraded if EBITDA declines due to distribution losses, pricing pressure or cost increases, free cashflow is low or negative, liquidity deteriorates, or adjusted debt-to-EBITDA is sustained above 8.0x.The proposed first lien credit agreement is expected to contain provisions for incremental debt capacity up to the greater of $83 million and 100% of trailing four quarter consolidated EBITDA, plus additional amounts subject to a pro forma first lien net leverage requirement not to exceed 2.8x (if pari passu secured); other restrictions on junior secured or unsecured facilities. Alternatively, the ratio test may be satisfied so long as leverage does not increase on a pro forma basis if incurred in connection with a permitted acquisition or investment. The proposed credit agreement allows leverage-based step downs in the asset sale prepayment requirement to 50% and 0% at pro forma Consolidated First Lien Net Leverage ratios of 2.30x and 1.80x, respectively.The proposed credit agreement permits collateral leakage through the transfer of assets to unrestricted subsidiaries, subject to carve-out capacity, with no explicit "blocker" provisions restricting such transfer. Only wholly-owned material subsidiaries are required to provide subsidiary guarantees, posing risks of potential guarantee release following a partial change in ownership. The above are proposed terms and the final terms of the credit agreement can be materially different.The principal methodology used in these ratings was Consumer Packaged Goods Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1202237. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.PetIQ, LLC ("PetIQ", NASDAQ: PETQ) based in Eagle, Idaho, is a publicly traded pet medication and wellness company. The company has two business segments: Products and Services. The Products segment consists of the company's manufacturing and distribution business. Through the Products segment, PetIQ distributes prescription and over the counter medication as well as its own branded medications. The Services segment consists of veterinary services and related product sales and is operated through VIP Petcare which has over 2,900 retail partners in 41 states. PetIQ generated net sales of $780 million for the twelve months ended December 31, 2020.REGULATORY DISCLOSURESFor 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 at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.At least one ESG consideration was material to the credit rating action(s) announced and described above.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 www.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 www.moodys.com.Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Frank Henson Vice President - Senior Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. 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