Restaurant Industry
Restaurants Bi-Monthly: Ratio Tests Using Annualized EBITDA/R May Provide Additional Cushion as Previously Suspended Financial Covenants Continue to Be Reinstated; Cheesecake Factory, Papa John’s Complete Repurchase, Conversion of Convertible Preferred Equity; Krispy Kreme Initiation; US Foods, Chefs’ Warehouse Update
Thu 07/08/2021 12:41 PM
Restaurants Bi-Monthly - May/June 2021
Industry Overview
In this issue of Reorg’s Restaurants Bi-Monthly, we provide an overview of credit-driven developments affecting the restaurant industry in May and June, including how ratio tests based on annualized EBITDA/R are providing companies with additional breathing room as their financial covenants are reinstated, recent recapitalization transactions, and the profits and pitfalls of PACA claims.
Reorg Focus
- After more than a year of covenant relief, Denny’s and Noodles & Co. will each have their financial covenants reinstated for the period ended June 2021. Although Denny’s total leverage for the period ended March 2021 exceeded 10x, its June financial covenant tests (including a 5.25x total leverage test) are based on annualized second-quarter EBITDA and will therefore exclude 2020 performance. Noodles & Co.’s June financial covenant tests are similarly based on annualized EBITDA from the first half of 2021.
- Although its financial covenants remain suspended until the September test period, BJ’s Restaurants must nevertheless meet a one-time $55 million minimum EBITDAR test under its credit agreement for the period ended June 30. Notably, the June minimum EBITDAR test is based on annualized EBITDA from May and June of this year and may provide the company with additional cushion by disregarding performance during the depths of the Covid-19 Pandemic.
- In June, Cheesecake Factory completed offerings of $345 million of 0.375% convertible senior notes due 2026 and $175 million of its common shares, the proceeds of which were used to fund approximately $457.4 million payable in connection with the repurchase and conversion of 200,000 outstanding shares of Series A convertible preferred stock held by Roark Capital and its affiliates. Likewise, in May Papa John’s agreed to pay approximately $183.9 million in connection with the repurchase and conversion of 250,000 shares of its outstanding Series B convertible preferred stock held by Starboard Value LP.
- In May, Reorg published a survey report discussing the implications of claims arising under Perishable Agricultural Commodities Act (or “PACA”) and the Packers and Stockyards ACT, an unusual class of claims that on many occasions have upended some of the well-established power dynamics in chapter 11 cases, particularly in cases filed by restaurants, supermarkets and food distributors. The disruptive nature of PACA/PASA claims was on full display recently in the Country Fresh Holding Co. Inc. chapter 11 cases, where a loose coalition of unsecured creditors used the unique priority profile of claims arising under PACA to force the hand of secured creditors.
Capital Markets
Primary
Carrols Restaurant Group
On June 28, Carrols Restaurant Group issued $300 million of 5.875% senior unsecured notes due 2029. The company said in a press release that it intends to use the offering proceeds, together with $46 million of revolving credit facility borrowings under its senior credit facility, to repay $74 million of outstanding term loan B-1 borrowings and $244 million of outstanding term loan B borrowings under its senior credit facility.
Concurrently with the closing of the notes offering, the company entered into an amendment to its senior secured credit facilities, which generally provides, among other things, increased capacity for incremental debt, restricted payments, permitted investments and prepayments of restricted debt.
Click HERE for Americas Covenants by Reorg’s core analysis of Carrols’ new 2029 notes.
Cracker Barrel
On June 18, Cracker Barrel issued $300 million of 0.625% convertible senior notes due 2026; net proceeds received by the company totaled approximately $291.1 million, after deducting fees, expenses and other adjustments. In connection with the issuance, the company entered into (a) convertible note hedge transactions with certain of the initial purchasers of the notes and other hedge counterparties and (b) warrant transactions with the hedge counterparties “collectively relating to the same number of shares of the Company’s common stock underlying the Notes, which initially is approximately 1.6 million shares.” According to a release, approximately $30.3 million of the notes proceeds were used to fund premiums payable in connection with the hedge transactions.
Recapitalizations
Cheesecake Factory
On June 15, Cheesecake Factory completed offerings of $345 million of 0.375% convertible senior notes due 2026 and $175 million of its common shares. According to a release, proceeds from the offerings were used “to fund approximately $457.4 million payable in connection with the repurchase of 150,000 shares of its previously outstanding Series A convertible preferred stock and the conversion of the remaining 50,000 shares of Series A convertible preferred stock into approximately 2.4 million shares of the Company’s common stock.” Roark Capital and its affiliates were counterparties to the convertible stock transactions.
A portion of the remaining offering proceeds, together with cash on hand, was used to repay $150 million outstanding under the company’s revolving credit facility, reducing the outstanding balance under the revolver to $130 million.
In a June 28 update, the company disclosed that its cash balance as of June 25 was “approximately $144 million” and that it “currently plans to maintain approximately $125 million in cash on its balance sheet and will evaluate additional potential debt repayment as part of its broader capital allocation strategy.”
Papa John’s
On May 11, Papa John’s International Inc. entered into a share repurchase agreement with certain affiliates of Starboard Value LP, which provided for the company’s repurchase of 78,387 shares of the Series B convertible preferred stock from Starboard and the conversion of Starboard’s remaining 171,613 shares of Series B convertible preferred stock into 3,458,360 shares of Papa John’s common stock. According to a May 12 disclosure, the company agreed to pay Starboard approximately $183.9 million in connection with the transactions.
Pre-Restructuring
Covenant Relief Timeline for Select Restaurant Companies
Americas Covenants by Reorg’s updated covenant relief timeline for 11 restaurant companies can be previewed below and is available for download in PDF version here.
(Click HERE for the full timeline.)
The timeline provides a high-level overview of the covenant relief obtained since the onset of the Covid-19 pandemic by a selection of public restaurant companies, including (1) BJ’s Restaurants, (2) Bloomin’ Brands, (3) Brinker International, (4) Cheesecake Factory, (5) Cracker Barrel, (6) Dave & Buster’s, (7) Denny’s, (8) Fiesta Restaurant Group, (9) Noodles & Co., (10) Red Robin and (11) Shake Shack. Specifically, the timeline lays out the timing and level of the next financial covenant test for each company reviewed as well as the duration of the minimum liquidity and basket restriction periods applicable to each company.
Notable updates and developments regarding the covenant relief timeline since April include the following:
BJ’s Restaurants - Although BJ’s Restaurants’ financial covenants remain suspended until the September test period, the company must nevertheless meet a one-time $55 million minimum EBITDAR test for the period ended June 30. On the basis of first-quarter 2021 financials, we estimate that the company’s 12-month EBITDAR as of March 31 was approximately $57 million. Notably, however, the credit agreement’s June minimum EBITDAR test is based on annualized EBITDA from May and June of this year, which may provide the company with additional cushion by disregarding 2020 performance.
Cracker Barrel - On June 15, concurrently with the pricing of its new 0.625% convertible senior notes due 2026, Cracker Barrel amended its revolving credit agreement to provide for, among other changes, termination of the previously provided covenant relief and related restrictions around the use of the accordion, permitted acquisitions, certain investments and restricted payments, and other transactions. The June 15 amendment also eliminated the revolver’s minimum liquidity requirement. Cracker Barrel’s total leverage ratio and fixed charge coverage ratio will be tested again on July 30, the company’s fiscal year-end, based on 12-month EBITDA (that is, without annualizing adjustments).
Denny’s; Noodles & Co. - Denny’s and Noodles & Co. each had their financial covenants reinstated for the period ended June 2021. Although Denny’s total leverage for the period ended March 2021 exceeded 10x, its June financial covenants (including a 5.25x total leverage test) are based on annualized second-quarter EBITDA and will therefore exclude 2020 performance. Noodles & Co.’s June financial covenant tests are similarly based on annualized EBITDA from the first half of 2021.
Fiesta Restaurant Group - On July 1, Fiesta Restaurant Group announced that it had agreed to sell all of the outstanding equity of Taco Cabana Inc. to an affiliate of Yadav Enterprises - a restaurant franchisee company that operates more than 300 locations throughout the United States under a variety of brands, including Jack in the Box, Denny’s and TGI Friday’s - for a cash purchase price of $85 million. The transaction is expected to close in the third quarter of 2021.
According to the release, proceeds from the sale will be used to fully repay the company’s approximately $74.6 million outstanding term loan borrowings under its senior direct lending facility with Fortress Credit Corp., which also provides for a $10 million revolving facility that was undrawn as of April 4. It is unclear from public disclosures whether the revolver will remain in place after the sale; if the revolver is taken out in connection with the sale, the suspended total leverage covenant and minimum liquidity requirement thereunder would cease to apply.
Of the restaurant companies reviewed, Cracker Barrel will be the next to have its financial covenants tested for the fiscal period ending July 2021, followed by BJ’s Restaurants (September 2021), Red Robin (October 2021) and Cheesecake Factory (December 2021). Dave & Buster’s, Fiesta Restaurant Group and Shake Shack will not have their financial covenants tested again until 2022.
Bankruptcy
Filings in the Last 12 Months
A noncomprehensive list of restaurant businesses that have filed for bankruptcy protection in the last 12 months is shown below:
Other Coverage and Analysis
New / Updated Covenant Analysis
In June, Americas Covenants by Reorg initiated coverage on Krispy Kreme, which completed its initial public offering on July 1. For a comprehensive analysis of Krispy Kreme Doughnuts’ credit agreement, click HERE.
We also updated our coverage of US Foods, Chefs’ Warehouse and Nathan’s Famous. For updated covenants tear sheets on these companies, click HERE for US Foods, HERE for Chefs’ Warehouse and HERE for Nathan’s Famous.
Krispy Kreme
On June 1, JAB-owned Krispy Kreme Inc. filed an S-1 in connection with its IPO. The company said it expects to sell 26,666,667 shares at $21 to $24 and receive approximately $565 million of net proceeds from the offering ($650.5 million if the underwriters exercise their overallotment option).
The IPO proceeds are expected to be used to repay all outstanding debt under Krispy Kreme Holdings Inc.’s unsecured parent term loan facility, which will mature four business days after consummation of the IPO. Any remaining proceeds will be used to repurchase common stock and for general corporate purposes. After the repayment of the unsecured term loan, Krispy Kreme Holdings Inc. will merge with and into Krispy Kreme Inc., with Krispy Kreme Inc. as the surviving entity.
Because the unsecured parent term loan will mature after the IPO regardless of how much is raised, to the extent Krispy Kreme Holdings receives less than $500 million of IPO proceeds, because it does not generate cash itself, Krispy Kreme Doughnuts (“KKD”), the operating company, would likely need to dividend cash to its parent to cover any shortfall.
KKD’s ability to make such upstream dividends is subject to the negative covenants under its existing debt facilities, which, on a pro forma basis, include a $652 million senior secured term loan and $500 million of revolving commitments. Our analysis of the credit agreement governing these facilities shows that to the extent the IPO proceeds are not sufficient to repay all outstanding debt under the $500 million unsecured term loan, KKD could have $393 million to $419 million of dividend capacity that could be used to cover any shortfall.
US Foods
On Feb. 4, US Foods issued $900 million of new 4.75% senior unsecured notes due 2029, the proceeds of which were used to repay the remaining balance of its 2020 incremental term loans and redeem its remaining 5.875% senior unsecured notes due 2024.
In our updated analysis, we discuss how the new 2029 unsecured notes provide the company with significantly more capacity to incur new first lien debt relative to the 2024 notes that they refinanced, including by:
- Increasing the fixed dollar amount available under the credit facilities debt basket relative to the 2024 notes; and
- Permitting the company to classify its $1 billion of outstanding 6.25% senior secured notes due 2025 under the 2029 notes’ “existing debt” basket (as opposed to the 2024 unsecured notes, which required the 2025 secured notes to be classified under other secured debt baskets, such as the credit facilities debt basket).
Chefs’ Warehouse
In June 2020, Chefs’ Warehouse entered into an amendment to its term loan agreement, which provided for a three-year maturity extension for $171 million of its outstanding term loans and a $36 million prepayment of its then-outstanding non-extended term loans. As a result of that amendment, the company had $31 million of non-extended term loans due June 22, 2022, and $171 million of extended term loans due June 22, 2025.
In March 2021, the company issued $50 million of additional 1.875% convertible notes due 2024 (increasing the total outstanding under that series to $200 million), the proceeds of which were used to repay the remaining $31 million of non-extended term loans and a portion of the company’s ABL outstandings.
As of March 26, company-reported ABL availability was approximately $54 million, and we estimate that incremental term loan capacity was approximately $102 million, consisting of $35 million under a fixed-dollar basket plus the $67 million of voluntary term loan prepayments made since June 2020. Outside of ABL and incremental capacity, the company’s debt documents provide $50 million of general-purpose debt capacity, which appears to have been tapped in March to issue the new $50 million add-on convertible notes.
Bankruptcy Trend Analysis
Potential Profits and Pitfalls of PACA Claims
In May, Reorg published a survey report discussing the implications of claims arising under Perishable Agricultural Commodities Act and the Packers and Stockyards Act, an unusual class of claims that on many occasions has upended some of the well-established power dynamics in chapter 11 cases, particularly in cases filed by restaurants, supermarkets and food distributors.
PACA and PASA claims present a novel set of risks for DIP lenders and a unique investment opportunity for claims traders. In the 15 food industry cases tracked by Reorg since 2020, debtors have estimated over $64 million in PACA/PASA liabilities, with the below chart based on first day papers relating to PACA claims:
Congress enacted the Packers and Stockyards Act in 1921 and amended it in 1976 after the bankruptcy of American Beef Packers, one of the largest meatpackers in the United States, which caused enormous economic damage to livestock sellers. Congress enacted PACA in 1930 and amended the statute in 1984 “‘to remedy [the] burden on commerce in perishable agricultural commodities and to protect the public interest’ caused by accounts receivable financing arrangements that ‘encumber or give lenders a security interest’ in the perishable agricultural commodities superior to the growers.”
PACA (which is modeled on PASA) and PASA operate through a nearly identical mechanism: Qualifying sellers of agricultural goods, or sellers of livestock, so long as they are in compliance with the PACA or PASA statutes, are the beneficiaries of a nonsegregated floating trust or “equitable lien” that is automatically imposed on all PACA/PASA-eligible goods and their derivatives (such as the proceeds of PACA/PASA eligible goods sold and any PACA-related receivables). These “trusts” are expressly designed to subordinate all third-party liens, rights, and interests in PACA/PASA goods and their derivatives - including such rights held by a debtor’s secured creditors - to those of PACA/PSA-eligible sellers.
The disruptive nature of PACA/PASA claims was on full display recently in the Country Fresh Holding Co. Inc. chapter 11 cases, where a loose coalition of unsecured creditors used the unique priority profile of claims arising under PACA to force the hand of secured creditors, effectively guaranteeing the payment of their unsecured claims.
To access the full report, click HERE.
--Julian Bulaon
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