In December 2008, Moody's lowered its rating outlook for the Company, citing JAH's 2009 revenue guidance.  What's surprising is that Moody's has not reduced its outlook from stable to negative given the headwinds facing the Company and it's difficult leverage position.  During JAH's Q3 08 conference call, CEO Martin Franklin stated that he expected that the Company's leverage ratio would decline from 3.6x as of Q3 08 to under 3.5x by year-end 2008.  Instead, in December, the Company released a warning stating that its leverage ratio would be roughly 3.7x as of Q4 08.

This matters because the majority of JAH's cash flow is produced in Q4.  The Company's first three quarters of the year are financed by revolver drawdowns as opposed to any real cash flow production so the fact that JAH's leverage ratio actually increased during what is supposed to be its strongest cash flow quarter should trouble investors and lenders alike.  Secondly, JAH is facing a step down in its loan covenants from 4.25x to 4.00x in Q4 09.  This means that the Company does not have much wiggle room before encountering loan issues.  JAH is likely to face significant sales pressure as the majority of what it sold was consumer-oriented.  So the top-line will be pressured in 2009 and due to foreign exchange ("FX") issues, any potential savings from operational improvements may be fully offset by FX translation losses.  One would expect ratings agencies to take a close look at JAH given these headwinds and where the Company's leverage ratio currently stands.

Another issue is the status of the Company's Goodwill and Intangible Assets and hopefully one of the analysts that follows the Company would consider broaching this subject on the Q4 08 conference call.  JAH is currently valued at 0.5x GAAP book value which includes Goodwill and Intangible Assets, suggesting that these two assets are at risk for impairment charges.  While a write-off would be non-cash, it would be symbollic and a warning to investors and lenders of the value destruction that has occured by management's willingness to pay such exorbitant valuations for the Company's various acquisitions to present the illusion of growth in recent years.

JAH's share price may react positively to a write-off of Goodwill as investors may think the worst is behind them but there are significant longer term implications.  As CFO magazine has recently pointed out, lenders may react to write-offs differently than equity holders and in JAH's case, lenders may be quite nervous because they know that given JAH's consumer exposure and focus on products that consumers frankly don't need to regularly replenish (skis, baseball gloves, tents, coffee makers, playing cards, etc) along with significant leverage and weak cash flow, there's just a thin equity cushion between investors and lenders.  Secondly, while leverage ratios are critical, lenders do focus on Debt/Equity and Debt/Capitalization and a significant write-off in Goodwill could render Shareholder Equity worthless, making lenders reluctant to continue funding basic working capital needs through revolving credit lines. 

If this may sound harsh or far fetched, consider that Mohawk Industries Inc. ("MHK") CFO Frank Boykin and his decision to incur a goodwill impairment in 2007.  Assets shrank by 16% but the CFO anticipated that MHK's credit line would be safe as Debt/Capitalization would be below 60%.  In contrast, if JAH's Goodwill was written down to zero, it's assets would shrink by nearly 30% and its Debt/Capitalization ratio would be (as of Q3 08 as Q4 08 numbers are not available) 64%.  Given JAH's excellent track record of spin control, however, it will be interesting to see if management can continue its status quo of spoon feeding the sellside and its investors in 2009.