New Coverage/Issuer Covenant Card: Sally Beauty Holdings, Inc.

Relevant Items:
Covenants Tear Sheet and Debt Document Summaries
Sally Beauty’s Debt Documents
 
Sally Beauty Holdings is a specialty retailer and distributor of professional beauty supplies that operates through two segments, Sally Beauty Supply and Beauty Systems Group. The company operates primarily in the United States but receives about 20% of earnings from foreign operations. Because of Covid-19, the company, like other retailers, was forced to shutter stores beginning at the end of March. On April 27, the company issued $300 million of second lien notes, with the proceeds to be used for general corporate and working capital purposes. On June 2, the company filed an 8-K to provide an update on the business and to pre-release select figures for the third quarter of 2020, which will end on June 30. In the filing, Sally Beauty disclosed that as of May 31, the company had more than $650 million in cash and $200 million available under its ABL facility, and as of June 2, 84% of its U.S.- and Canada-based stores had been reopened to the public.
 
Sally’s capital structure, liquidity and credit metrics as of March 31, adjusted to reflect the issuance of the second lien notes, balance sheet cash as of May 31 and an increase in commitments under the company’s ABL facility, is as follows:
   
In its second-quarter earnings press release, the company disclosed that it had included a $15 million EBITDA addback for costs related to Covid-19. The company further disclosed that:

“For the three months ended March 31, 2020, COVID-19 expenses primarily represents [sic] costs associated with disaster pay and furloughed employees in response to the coronavirus pandemic. These cost[s] were partially offset by an employee retention payroll tax credit provided by the U.S. Coronavirus Aid, Relief, and Economic Security Act (‘CARES Act’).”
 
On March 24, Sally disclosed that it had drawn $396 million on its ABL facility. Then, in April, the company disclosed that it had upsized its total commitments under the ABL revolver to $600 million from $500 million, entered into a $20 million FILO tranche under the ABL and issued $300 million of 8.75% second lien notes due 2025. As of March 31, pro forma for the upsize and issuance, the company had $850 million of liquidity, including $650 million of cash and $200 million of additional revolver availability.

Sally’s revolver contains a springing 1.0x fixed charge coverage ratio (“FCCR”) covenant, which is calculated as the ratio of (a) EBITDA less cash taxes and unfinanced capex to (b) the sum of interest and scheduled debt principal payments. The covenant is tested on a rolling basis if availability is less than the greater of $48 million and 10% of total line cap ($60 million as of March 31, based on $600 million of revolving commitments).

As illustrated below, the company’s FCCR as of March 31 was approximately 1.69x. The covenant was not tested as of March 31 because availability was $200 million.
 
The covenant will be tested if the company draws an additional $140 million on the revolver. Assuming availability under the revolver is reduced below that threshold and assuming all else holds constant, EBITDA as of March 31 of approximately $514 million can decline by no more than about $119 million before the covenant may be breached.
 
Debt and liens - As of March 31, pro forma for the revolver upsize and issuance, Sally could incur $398 million of secured debt and an uncapped amount of unsecured debt up to a 2x interest coverage ratio, which is currently 5.8x.

Dividends and investments - As of March 31, Sally could pay $134 million in dividends and make $402 million of general investments, $134 million of investments in related businesses plus additional amounts under a Builder Basket. Sally will be capped at the greater of $100 million and 10% of tangible assets for investments in unrestricted subsidiaries.