MOODY'S LOWERS SHONEY'S DEBT RATINGS; OUTLOOK REMAINS NEGATIVE
Moody's Investors Service lowered the ratings of Shoney's $75 million revolving secured bank facility and $176.5 million secured bank term note, due 2002, to B2 from B1; $122.5 million convertible zero-coupon debentures, due 2004, to Caa2 from Caa1; and $51.6 million convertible subordinated debentures, due 2002, to Caa2 from Caa1. Moody's also lowered the senior implied rating to B3 from B2 and the senior unsecured issuer rating to Caa1 from B3. The outlook remains negative. The rating action was prompted by our belief that the company's enterprise value has declined in relation to its obligations due to the continuing decline in operating results at the company's flagship Shoney's unit. The negative outlook reflects our expectation that management's turnaround efforts will continue to face significant challenges, due to intense competition in the casual dining segment of the restaurant industry.
The ratings reflect the continued weak operating performance of the company's core Shoney's concept restaurants, high financial leverage, low returns on assets and sales, and intense competition in the family dining segment of the restaurant industry. The company recently announced the engagement of financial advisors to help evaluate how it might reduce debt and associated financing costs. We believe Shoney's compliance with financial covenants will be tight going forward, and required cash debt service payments will consume a good portion of the company's free cash flow over the next several years. While the management team remains committed to revitalize the company's operations, we continue to believe that the turnaround will likely take an extended period of time and that the company's debt protection measures could weaken further in the intermediate term.
The ratings recognize that the company owns a significant proportion of restaurant real estate, that the Shoney's unit maintains a fairly modern store base after several years of remodeling, and that the company has divested practically all extraneous restaurant concepts. The solid performance at Captain D's, with improving same store sales and margins, also support the ratings.
The B2 rating on the bank credit facility recognizes that it is secured by substantially all of the company's assets, including real estate of about 427 restaurants. We believe that the collateral would provide good protection to the banks. The Caa2 ratings on the convertible zero-coupon debentures and the subordinated convertible debt recognize that these debts are contractually subordinate to the bank credit facility and that the company's common shares trade at a small fraction of the conversion price. We believe that the severity of loss in a distressed scenario would be at least partially mitigated by asset value in excess of the bank obligations.
Beyond Shoney's, the family dining segment of the casual dining restaurant industry includes large chains such as Denny's, Perkins, Cracker Barrel, and Bob Evans competing with local restaurants and other meal solution providers. Customer traffic has fallen due to perceived declines in the price/value relationship. Same store sales at the Shoney's unit, which still accounts for over 50% of total revenue, have been declining since 1993. The most recently available year-over-year store traffic counts at the Shoney's unit are down almost 9%.
Shoney's restaurants have been challenged for several years, as evidenced by declining revenue and restaurant operating margins, along with same store sales. Total revenue has decreased as the company has closed or sold to franchisees many of the under-performing stores, but 1999 average unit volume increased 6% to almost $1.5 million following closure or sale to franchisees of 142 stores. Same store sales have decreased for several years after menu price increases were more than offset by decreases in customers. To reverse the negative trends and attract more frequent visits, we expect that the company will maintain the emphasis on improved customer service through better training and more efficient staff utilization. However, we expect that future operating results will likely be dampened by absorption of at least some portion of higher labor costs stemming from expected increases in the minimum wage or probable increases in relatively low chicken, meat, and seafood prices.
As the company's revenue has fallen for the past several years, debt has also decreased as the company has paid down the bank term loans with required principal amortization payments and asset sale proceeds. Given the high proportion of real estate that the company owns, rent expense is relatively minor. For the fiscal year ended September 1999, debt equaled about 4.4 times EBITDA while EBITDA coverage of cash interest was around 3.2 times. We anticipate moderate reductions in debt and cash interest going forward as the company continues to pay down the term loan.
Shoney's, Inc., headquartered in Nashville, Tennessee, operates or franchises 525 Shoney's family dining restaurants, 567 Captain D's quick service seafood restaurants, and 3 Fifth Quarter steakhouses.
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