Moody’s Investors Service said it reduced its debt rating outlook on Varsity Brands, the parent of Varsity Spirit, Herff Jones and BSN Sports, to negative from stable. The rating agency said the change reflects the company’s high financial leverage amid school closures across the U.S. in response to the coronavirus and the uncertainty around the duration of the outbreak and pace of re-openings once the pandemic subsides.

Standard & Poors last week reduced its debt rating on Varsity Brands.

In changing its outlook, Moody’s noted that almost all states have canceled on-premise school instruction, as well as athletic events, and Moody’s expects that some graduation ceremonies will also be canceled or held online. In addition, increased unemployment and lower consumer confidence as a result of the coronavirus outbreak will negatively impact demand for the company’s products. Given the anticipated decline in earnings, Moody’s expects financial leverage to increase above 8.0x over the next 6-12 months, and for free cash flow generation to weaken in fiscal 2020.

Moody’s also affirmed Varsity Brands Holding Co., Inc.’s debt ratings, including its Corporate Family Rating (CFR) at B3, its Probability of Default Rating (PDR) at B3-PD, and the rating on the senior secured first-lien term loan at B2.

Moody’s affirmed Varsity Brands’ ratings because school closings are not currently expected to extend into the 2020-2021 academic year, which would meaningfully affect the company’s primary selling season in the summer and fall. Varsity Brands’ product diversity also helps mitigate the risks of temporary school closures, given some products are somewhat non-discretionary because they are required to participate in school activities. A resumption of school activities would provide the company with an ability to reduce leverage and debt taken on to cover the cash burn experienced during school closures.

Affirmations

  • Probability of Default Rating, Affirmed B3-PD
  • Corporate Family Rating, Affirmed B3
  • Senior Secured Bank Credit Facility, Affirmed B2 (LGD3)

Outlook Actions

  • Outlook, Changed To Negative From Stable

Ratings Rationale
Moody’s said, “Varsity Brands’ B3 CFR reflects its high financial leverage with debt/EBITDA projected to increase from an estimated 7.7x for the twelve months period ended December 29, 2019. School closures across the U.S., along with high unemployment and lower consumer confidence as a result of the coronavirus outbreak and related job losses will negatively impact demand for the company’s products at least through the duration of the outbreak. Moody’s expects debt/EBITDA financial leverage to increase above 8.0x over the next 6-12 months, and for free cash flow generation to weaken in fiscal 2020 with a cash burn over the next few quarters above typical seasonal cash usage. The company has high seasonality, which causes volatility in operating results, and its mature Herff Jones business segment faces topline secular headwinds as consumer demand for affinity products gradually erodes. The rating also reflects Varsity Brands’ solid position within niche school apparel, athletic and achievement markets, and the diversification provided by the three business segments. The varied school-related product portfolio helps to limit volatility in financial performance because of the somewhat non-discretionary nature of products that are required to participate in school activities. Governance factors include the company’s aggressive financial policies under private equity ownership, highlighted by high financial leverage and an acquisitive growth strategy. Varsity Brands’ adequate liquidity reflects Moody’s expectations for subdued free cash flow with higher reliance on its $180 million revolving facilities due in 2024, and lack of near term maturities until its revolver is due, other than the first-lien term loan amortization.

“The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions, and markets. The combined credit effects of these developments are unprecedented. The durables sector has been one of the sectors most significantly affected by the shock, given its sensitivity to consumer demand and sentiment. More specifically, the weaknesses in Varsity Brands’ credit profile, including its exposure to U.S. schools, have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions, and Varsity Brands remains vulnerable to the outbreak continuing to spread. Moody’s regards the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. Today’s action reflects the impact on Varsity Brands of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.

“The negative outlook reflects the company’s high financial leverage and further downside pressure on the CFR if sales materially decline as a result of prolonged school closures, canceled graduation ceremonies, or canceled athletic events. The negative outlook also reflects the uncertainty around the duration of school closures and the pace or re-openings once the coronavirus pandemic subsides.”

Photo courtesy Varsity Brands