MOODY'S ASSIGNS B2 RATING TO SR SEC GTD CREDIT FACILITY AND B3 RATING TO GTD SR UNSECURED NOTES OF LA PETITE ACADEMY, INC.
New York, 04-29-98 -- Moody's Investors Service assigned a B2 rating to the $65 million senior secured and guaranteed credit facility, maturing 2004, of La Petite Academy, Inc., the second-largest for-profit provider of child care in the U.S. At the same time, Moody's assigned a B3 rating to the $145 million guaranteed senior unsecured notes, due 2008, a joint obligation of La Petite Academy, Inc. and its parent, LPA Holding Corp. The ratings outlook is stable.
The ratings reflect a weak balance sheet with high leverage, heightened by lease financing, and intangibles representing 45% of assets; very thin fixed charge coverage; a low percentage of EBITA plus rents in relation to the cost of lease adjusted debt; significant competition from not-for-profit and lower-cost operators; and limited ability to reduce costs. However, the rating also incorporates the company's 21 year history in the industry; the geographic dispersion of the schools, which limits the impact of downturns in any one region; and the contribution of $102.5 million from Chase Capital Partners and other investors.
The purpose of the transactions is to provide for the recapitalization of the parent company. The transaction proceeds of $295 million will be used to purchase equity, repay existing indebtedness, and pay related fees.
As a result of the transactions, the company will have very high leverage and negative equity of $82 million. Leverage increases from 70% of book capitalization to 179%. Adjusting for lease obligations, the leverage rises significantly to 8.6 times EBITAR. EBITA coverage of interest will decline from 1.7 times in 1997, to 1.1 times on a pro forma basis. Moody's expects fixed charge coverage to remain at approximately 1 times for the next few years. Delayed or less than planned earnings in new markets could further strain these coverages. Potential future shortfalls may be financed by drawings under $25 million of availability under the secured revolving credit facility.
With debt levels exceeding assets, Moody's considers the EBITA return on debt as a significant indicator of the ability of the company to generate sufficient returns to support the debt level. Pro forma EBITA plus one third of rents as a percentage of debt plus 8 times rents, at 6.5% is thin relative to the company's expected cost of capital.
The covenants under the proposed financings provide little protection against the incurrence of additional debt obligations in conjunction with the company's expansion plans, which include 40 new academies by the autumn of 1999. Sale lease-backs, which the company uses to finance 90% of its academies, are excluded from the leverage test under the credit facility and the debt incurrence test under the indenture. Primary protection is the fixed charge coverage test under the credit facility which is based on the ratio of EBITDAR to fixed charges. The need to meet this test could motivate a delay in necessary capital expenditures. The fixed charge coverage is set at just above 1 times coverage.
Despite yearly tuition increases, the company's gross margins declined from 50% in 1994 to 47% for 1997, as a result of higher labor costs. To stabilize and improve operating margins, the company needs to increase revenues as well as to reduce costs.
To increase revenues, the company plans to continue to exit under-performing markets and to enter demographically favorable markets that are less sensitive to price increases and more likely to produce higher occupancy rates. However, competition may be an inhibiting factor. The company has approximately 1% of the fragmented center-based child care market. Moody's believes that the not-for-profit segment, which has approximately 65% of the market share of center-based care, may remain a significant competitor due to their lower cost structure and adequate quality of care.
To reduce costs, the company will attempt to cluster new properties and better manage pricing and client services. However, with the lion's share of cost contributed by low-wage, low retention labor, the ability of the company to reduce costs further is likely to be limited.
Additionally, closures of under-performing academies could negatively impact performance as in 1995, when the closure of 39 academies led to a $11.6 million charge. At March, 1998 the company had $4.9 million loss reserve for closure costs, and a $5.4 million reserve for unfavorable lease terms.
The B2 rating on the secured credit facility reflects the limited protection afforded to the creditors by the security package in a distressed scenario. The facility is the obligation of the operating company, La Petite Academy, Inc. and outstandings under the facility are guaranteed by the company's direct and indirect subsidiaries and by its parent. The security consists of a first priority perfected lien on substantially all of the tangible and intangible assets of both the company and the parent, other than leasehold interests. The facility consists of a $25 million revolving credit, undrawn at closing, and a $40 million term loan, which mature in 2004. The term loan amortizes by $1 million per annum and escalates in the final two years. The facility provides for possible annual cash sweeps of 75% of excess cash flow to prepay the term debt.
The B3 rating on the senior unsecured notes reflects the effective subordination of the notes to all senior secured indebtedness.
The recapitalization of the holding company will be accomplished via equity infusion of $110 million, $30 million of which will be in the form of PIK preferred stock. An affiliate of Chase Capital Partners and an entity controlled by Robert E. King, a director of the company, will contribute $102.5 million, and Vestar Capital Partners and management will rollover a total of $7.5 million of their existing equity investment.
LPA Holding Corp. and its wholly-owned subsidiary, La Petite Academy, Inc., based in Overland Park, Kansas, is the second-largest not-for -profit provider of child care in the United States. The company operates 692 residential academies, 32 employer-based academies and 20 Montessori schools in 35 states and the District of Columbia.
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