Wahoo Fitness debt rating downgraded

Wahoo Fitness’s debt ratings were downgraded by Moody’s and S&P Global Ratings due to weaker-than-expected demand and intense price competition in the home fitness space.

Moody’s downgraded its rating Wahoo Fitness Acquisition LLC, including its Corporate Family Rating (CFR) of B3 to B2, Probability of Default Rating (PDR) to B3-PD of B2-PD and Premier Credit Facility Rating the company’s first guaranteed rank to B3 from B2. The senior credit facility consists of a $30 million senior revolver maturing in 2026 and a $225 million senior term loan in an initial principal amount maturing in 2028. The outlook is negative.

Moody’s wrote, “Today’s downgrade and negative outlook reflect Moody’s expectation that Wahoo’s debt-to-EBITDA leverage will increase significantly in fiscal 2022 and liquidity is limited due to revenue and earnings below Moody’s previous expectations. Wahoo delivered strong year-over-year revenue growth of 38% in fiscal 2021, driven by strong consumer demand for the company’s products. However, Moody’s believes that 2021 earnings were supported by demand for home fitness products due to the pandemic and increased channel inventory, and so this level of earnings does not appear to be sustainable. Wahoo is experiencing lower sales of its workout products at the start of fiscal 2022. The sales weakness is due to channel destocking due to high inventory levels of retail trainers at the end of 2021, strong discounts on competing products, as well as a return to more normal seasonality from strong non-seasonal sales in the first quarter of 2021. As a result, Moody’s expects Wahoo’s revenues to decline in the mid-teens and a decline EBITDA growth of approximately 45% in fiscal 2022. Wahoo’s debt to EBITDA leverage is expected to increase to 5.5x in fiscal 2022 from 3.1x at year-end 2021. Moody’s expects debt to EBITDA leverage to be significantly higher in the second and third quarters of 2022, due to business seasonality.

“Wahoo’s liquidity will be constrained over the next 12 months by Moody’s expectations of negative free cash flow of approximately $30-35 million and heavy reliance on its $30 million revolver facility. of dollars. Free cash flow will be pressured by significant working capital investments, primarily in inventory to support new product launches and refreshes in 2022. Moody’s Wahoo projects will rely on revolver borrowing during coming quarters to fund inventory investments. Given the expected decline in profitability, Moody’s expects the company to breach the financial sustainment covenant of the senior credit facility of a maximum total net leverage of 5.0x, in particular in the second and third quarters before the winter selling season. To address its limited liquidity, Wahoo announced a proposed first lien credit facility amendment that will waive the financial sustainability clause through the third quarter of fiscal 2022 and replace it with a minimum liquidity clause. of $5 million. Starting in the fourth quarter of 2022, the covenant test will reset to 7x, drop to 5.5x in the first quarter of 2023, and finally drop to 5.0x in the fourth quarter of 2023 and thereafter. Moody’s believes the proposed amendment will alleviate Wahoo’s compliance issues and provide some financial flexibility over the next 12 months. In addition, the company received an equity co-investment of approximately $12 million from a new board member which is expected to provide near-term liquidity.

“Wahoo has a good track record of successful new product launches and expects a significant sales and earnings contribution from several new products and updates in late 2022. However, there is uncertainty about the sustainability of demand from consumers for the company’s products. Demand could moderate or turn negative as continued inflationary pressures begin to erode consumer purchasing power and consumers shift spending to categories that have been constrained in recent years, such as travel. There is also uncertainty regarding macro-economic conditions, particularly in Europe, the company’s largest market, and current supply chain challenges could also put pressure on profitability if the company does not is unable to mitigate cost inflation.

S&P lowered its issuer credit rating on Wahoo from “B” to “B-“. At the same time, it downgraded the issue level of its senior secured credit facilities from “B+” to “B”. The recovery rating remains “2”, indicating its expectation of substantial recovery (70% to 90%; rounded estimate: 70%) in the event of default.

The negative outlook reflects the potential for a lower rating over the next year.

S&P wrote in its analysis: “The downgrade reflects weak operating conditions and our expectation of a material decline in corporate earnings in 2022, which will weaken credit metrics. Wahoo’s revenue grew significantly in the first half of fiscal 2021, driven by strong end-customer demand as well as tight supply chain conditions at the end of 2020. Its partners in distribution therefore entered 2021 with significantly lower available stocks. However, demand from end-user customers fell well below expectations in the second half of 2021, resulting in an overloaded channel at the end of the year. Additionally, the company faces intense competition from larger competitors such as Garmin and, to a lesser extent, Peloton, who engage in aggressive promotional activity to sell excess channel inventory. We understand that Wahoo has not engaged in such promotions as it expects these discounts to be temporary and has better brand equity to maintain higher prices.

“In addition, the company is vulnerable to economic cycles given the discretionary nature of its products. We recognize the unique nature of Wahoo’s loyal customer base and anticipate that in the event of a downturn, many would reduce discretionary spending in other areas before reducing cycling-related purchases. Nevertheless, we believe that a large segment of customers would postpone purchases of product upgrades in an environment of recession and/or inflation that is increasingly likely.

“As a result, we expect revenue to fall by approximately 20% and S&P Global Ratings Adjusted EBITDA by approximately 30% in fiscal year 2022, resulting in high leverage of approximately 5.5x Stabilizing sales and earnings at these levels would likely be enough to maintain the rating, however, we note the risk that some of the strong demand in early 2021 will prove to be one-off, with significant uncertainty over where normalized demand for home trainers and indoor cycling accessories would settle after the COVID-19 pandemic.

“Due to weak industry momentum and the highly seasonal nature of the business, Wahoo is at risk of breaching its quarterly net leverage commitment and has initiated an amendment to its credit agreement, including a covenant waiver. and stricter restricted payments Typically, the company’s sales are concentrated in the second half of the year (around 65% of total revenue), which coincides with the coldest months of the northern hemisphere and the holiday season. However, Wahoo reported an exceptionally weaker second half for fiscal 2021 and expects a seasonally weak first half of fiscal 2022. This will result in weak trailing 12-month EBITDA and a breach of the covenant if not rescinded or relaxed. We expect the Company to obtain a covenant waiver from its lender group. Nonetheless, it is important to note that Wahoo believes q that point-of-sale demand for its products remains strong (some large distribution partners saw double-digit percentage sales growth in the first two months of 2022) and that its sales are expected to rebound from oversupply in the channel is resolved.

“We expect Wahoo’s margins to contract throughout fiscal 2022 due to cost inflation. The business is facing rising raw material prices and transportation costs. We understand that Wahoo is evaluating price changes to offset higher costs. However, this may be insufficient to account for the increasingly inflationary environment. We expect margins to remain under pressure next year.

“Wahoo’s negative outlook reflects continued operational headwinds related to weaker-than-expected demand, intense price competition and mounting cost pressures. If the company’s cash flow and liquidity position deteriorate further in 2022, this could add significant uncertainty to its ability to maintain a sustainable capital structure. »

Julio V. Miller