Fitch Initiates Coverage of Computer Associates at 'BBB-'; Outlook Stable.
The ratings reflect the company's consistent free cash flow in excess of $1 billion annually and solid financial flexibility, improving credit metrics, the size, diversity, and quality of the company's installed base (equal to 95% of Fortune 500) and depth of product line, resulting in recurring revenue and solid customer retention and high barriers to entry with significant switching costs. The corporate software market continues to grow for operations management, security, and storage software, which are core competencies of CA. Concerns center on potential ongoing acquisitions for add-on software capabilities and growth, strong competition from larger, more diversified rivals, the absence of a permanent CFO and CEO (but appointments are expected to be announced in the near term), and the company's desire to expand its channel business.
Additionally, while a legal agreement was reached with the Department of Justice (DOJ) and Securities & Exchange Commission (SEC) in September 2004, the credit ratings for CA assume that the company will improve its corporate governance and internal controls and satisfy any additional recommendations by the government-appointed independent examiner as required under the agreement. The review will take place for at least the next 18 months, during which time, if CA violates the terms of the agreement, the current prosecution charges will remain and further legal action against CA could be taken. Previous misstatements of earnings resulting from improper revenue recognition and weaknesses in accounting controls related to timing of revenue recognition were the subject of shareholder lawsuits and government investigations and have required significant litigation and settlement costs from 2001-2004. As part of the agreement, CA also agreed to establish a $225 million restitution fund to compensate CA shareholders. This tax-deductible cash payment will occur in three separate $75 million payments, of which one has already been completed.
CA's credit metrics have improved in the past few years as a result of ongoing debt reduction, solid and consistent free cash flow, and improving earnings. Leverage, measured by total debt to cash flow from operations was 1.7 times (x) as of the second quarter of fiscal 2005 ending Sept. 30 versus nearly 2.4x at fiscal year-end 2003 and approximately 3.1x for fiscal 2002. Interest coverage, measured by cash flow from operations to interest expense, increased to more than 10x for the same time period, compared with nearly 7x for 2003 and 5x for fiscal 2002. While it is anticipated that credit protection measures will decline moderately for the next two quarters as a result of the aforementioned debt offering, Fitch anticipates that these measures will continue to trend positively over the intermediate term as a result of further debt reduction and, to a lesser degree, earnings improvement.
Total debt as of Sept. 30, 2004, was approximately $2.3 billion ($3.1 billion on a pro forma basis), down from $3.1 billion in fiscal 2003 and $3.8 billion in fiscal 2002. At the end of the second quarter, debt consisted of four tranches of senior notes and senior convertible notes (all pari passu), with no commercial paper or bank revolver borrowings outstanding. CA's maturity schedule, which Fitch believes is manageable, includes $660 million 5.0% convertible senior notes due March 2007 but callable in March 2005, $825 million due April 2005, $350 million due April 2008, and $460 million of 1.625% convertible senior notes due December 2009 (non callable).
CA's liquidity is solid with approximately $2.3 billion (approximately $3.1 billion pro forma the bond offering) in cash, cash equivalents, and marketable securities, as well as strong and consistent free cash flow. Annual free cash flow (cash flow from operations minus capital spending and capitalized development costs) was nearly $1.3 billion for the latest twelve months ending Sept. 30, 2004 and has been approximately $1.2 billion for the preceding four fiscal years. The company's liquidity is also enhanced by an undrawn $470 million three-year U.S. revolving credit facility expiring in January 2005, with the most significant covenant being total debt to cash flow from operations not allowed to exceed 3.25x. CA also has a $400 million CP program that is not utilized. In addition to meeting debt maturities, CA must contribute $150 million for the remaining portion of the restitution fund in two $75 million installments on September 2005 and March 2006, as well as fund the recent Netegrity acquisition ($340 million net).
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|Date:||Nov 15, 2004|
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