Moody’s Investors Service assigned a B2 rating to Varsity Brands Holding Co., Inc.’s new senior secured first lien notes due December 2026. Varsity Brands is the parent of BSN Sports and Varsity Spirit.
Moody’s took no action on Varsity Brands’ B3 Corporate Family Rating (CFR), B3-PD Probability of Default Rating (“PDR”), or B2 rating on the senior secured first lien term loan due December 2026. Moody’s withdrew the B2 instrument ratings on the senior secured first lien term loan due 2024 and senior secured first lien notes due December 2024 because the debts were repaid. The outlook is stable.
Moody’s said the refinancing of the remaining 2024 maturities is credit-positive because it improves liquidity. This transaction addresses all remaining debt that was not extended as part of the amend and extend transaction in February 2023. The transaction has no immediate effect on Varsity’s B3 Corporate Family Rating (“CFR”), the B2 rating on the first lien term loan due 2026, or stable outlook because the refinancing of this debt and increase to interest expense was already factored into Moody’s projections. Moody’s continues to expect the company will generate positive free cash flow in 2024.
Moody’s said Varsity Brands is utilizing proceeds from new $450 million first lien senior secured notes due 2026 to repay remaining borrowing on the roughly $305 million non-extended first lien senior secured term loan due 2024 and $44 million senior secured notes due 2024. The company will also use approximately $95 million of proceeds from the new notes to partially repay borrowings on its revolving credit facility. Extending the maturities and increasing revolver capacity improves liquidity and reduces the risk of default and debt restructuring over the next year. The refinancing will nevertheless put pressure on free cash flow due to the step up in interest expense. Moody’s anticipates that a step-up of approximately $13 million of interest from the new notes is manageable and that the company will generate roughly $20 million of free cash flow in 2024. Additionally, Varsity is benefiting from material interest hedges that expire in 2024 and could meaningfully increase interest expense if the company does not pay down debt. Still, Moody’s believes that improvement in the EBITDA margin, a reduction in working capital and lower legal fees will drive better free cash flow in 2024. The company continues to benefit from strong operating performance at BSN and Varsity Spirit and the recent divestment of the Herff Jones Graduation Business will reduce working capital needs.
The revolver paydown from the refinancing and projected free cash flow in the second half of 2023 will increase revolver capacity, leaving adequate availability to cover highly seasonal cash needs. The company had $245 million drawn on its $350 million revolver as of July 1, 2023.
The B2 rating on the new first lien senior secured notes reflects that the notes are pari passu to the existing first lien senior secured term loan due 2026 and are secured by a common pool of collateral and are subject to the same guarantees.
Moody’s said in its analysis, “Varsity Brands’ B3 CFR reflects its high financial leverage and weak free cash flow. The refinancing helps improve liquidity that had weakened over the last year. Varsity has drawn heavily on its revolver to fund working capital, interest expense, and financing fees and expenses stemming from its February 2023 amend and extend transaction. Varsity Brands has high governance risks primarily related to its aggressive financial strategy under private equity ownership, including operating with high leverage and use of debt to fund acquisitions.
“Despite these challenges, Varsity’s ratings are supported by the company’s strong position within niche school apparel, athletic and achievement markets and decent diversification across its segments. Moody’s expects BSN and Varsity Spirit will continue to see mid-to high-single-digit revenue growth because the company continues to expand distribution into new schools and organizations and improvement to the EBITDA margin will also benefit from further moderation in input cost and realized efficiencies in supply chain investments. Additionally, the sale of the Herff Jones Graduation Business, which closed on October 2, 2023, will help reduce seasonality and improve the EBITDA margin by disposing of the discretionary and low-profit jewelry and fine paper products business. Varsity retained the yearbook business. The remaining product portfolio in BSN Sports and Varsity Spirit is more resilient to changes in economic conditions due to the product utilization in sporting and cheer events. Moody’s sees debt-to-EBITDA leverage declining to 6.7x by the year-end 2024 from 6.9x for the last 12 months ended July 1, 2023. Moody’s also expects free cash flow will improve to around $20 million in 2024 from around negative $5 million for the full year in 2023. Higher earnings, lower working capital usage and a reduction in legal fees will improve free cash flow despite the increase in interest expense.”
