Overview -- U.S. systems management and cloud computing software provider Allen Systems Group violated its bank agreement financial covenants for the reporting period ended June 30, 2012. -- We are lowering our corporate credit rating to 'CCC-' from 'B' and lowering the issue-level ratings on the company's debt. -- We are also placing our corporate credit rating and issue-level ratings on CreditWatch with developing implications. -- We could raise the ratings if the company improves its liquidity and obtains significant covenant relief (including a waiver of its current covenant breach). Rating Action On Aug. 21, 2012, Standard & Poor's Ratings Services lowered the ratings on Allen Systems Group Inc. and placed them on Credit Watch with developing implications, which means that we could raise or lower the ratings. We lowered our corporate credit rating on the company to 'CCC-' from 'B'. We also lowered our issue-level rating on its first-lien senior secured loan to 'CCC+' from 'BB-'. The recovery rating on its first-lien senior secured loan remains at '1', indicating our expectation for a very high (90% to 100%) recovery of principal in the event of payment default. At the same time, we also lowered our issue-level rating on the senior secured second-lien notes to 'CC' from 'B' and revised the recovery rating to '5' (formerly '4'), reflecting our expectation for modest recovery (10% to 30%) if a payment default occurs. Rationale The downgrade and CreditWatch placement follow the deterioration in the company's liquidity profile and profitability, as well as its recent covenant breach. We revised Allen's liquidity profile from "less than adequate" to "weak," reflecting its current minimal cash balances, the remaining availability under the revolver, and lower-than-expected cash from operations. Cash sources may not exceed cash uses over the near term, depending on operating performance. In addition, the company did not comply with its total leverage, fixed charge coverage, and minimum liquidity covenants for the financial reporting period ended June 30, 2012. It is our understanding that the company is in discussions with its lenders to obtain covenant relief. Allen's revenue growth and EBITDA margins in recent quarters were below our expectations, as the company's significant investments in acquisitions and sales force coverage during 2011 did not result in high-teens revenue growth. Furthermore, increased investments in new technologies and softness in legacy product markets contributed to depressed margins. We still believe that recent acquisitions and the expansion of the company's product offering to cloud computing solutions will generate revenue growth over the remainder of the year, though at lower levels than we previously expected, especially given continuing economic headwinds in Europe and increased competition in the company's legacy product offerings. Allen Systems' credit metrics have deteriorated in fiscal 2012, reflecting margin erosion and an increase in debt to finance additional acquisitions. As of June 2012, debt to EBITDA was over 8x (including some of the acquisition-related synergies). We revised our view of Allen Systems' business risk profile to "vulnerable" from "weak," reflecting its modest scale and operations in a highly competitive sector against larger and better capitalized companies such as IBM and BMC. In addition, the company continues to find it a challenge to mitigate revenue declines from legacy products and solutions. Moreover, it has not yet realized benefits of acquisitions at levels the company expected. These factors are partly offset by the high percentage of contractually recurring revenues--which compose 60% of the company's total revenues--a diversified customer base, and broad geographic coverage. Recovery Analysis For the complete recovery analysis, see the recovery report on Allen Systems, to be published as soon as possible on RatingsDirect, following the release of this report. Credit Watch Standard & Poor's will monitor the company's progress in negotiating a covenant amendment with its lenders and its progress in enhancing its liquidity profile, prior to resolving the CreditWatch listing. Our review will also include an assessment of near-term business prospects. We could raise the ratings if the company improves its liquidity and obtains significant covenant relief (including a waiver of its current covenant breach). Alternatively, we would lower the rating if the company is not able to address its financial covenant breach and therefore its debt obligations are accelerated. Related Criteria And Research -- Top 10 Investor Questions: How Will The Global Technology Industry Fare Amid An Economy In Flux?, April 26, 2012 -- Global Technology Ratings Trend Shifts To Negative In The First Quarter, April 11, 2012 -- Issuer Ranking: Global Technology Ratings, Strongest To Weakest, March 29, 2012 -- U.S. Technology Companies' Liquidity Is Higher, For Now, Jan. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Global High Technology Industry, Oct. 15, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; CreditWatch Action To From Allen Systems Group Inc. Corporate Credit Rating CCC-/Watch Dev/-- B/Negative/-- Downgraded; CreditWatch Action To From Allen Systems Group Inc. Senior Secured CCC+/Watch Dev BB- Recovery Rating 1 1 Senior Secured CC/Watch Dev B Recovery Rating 5 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.