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Maybe it's not as bad as it looks: J. ALEXANDER’S (JAX) warning of noncompliance with debt covenants

|Includes: J. Alexander's Holdings, Inc. (JAX)
For the 3rd quarter, 2009, J. Alexander’s (NASDAQ:JAX) SEC filings stated that it was in compliance with its debt covenants. However, the filing also included a warning of possible noncompliance. Additionally, earlier in 2009, JAX was in fact out of compliance:  "As of March 29, 2009, the Company did not meet the debt to EBITDAR and fixed charge coverage ratios specified in the loan agreement, and the Company has obtained a waiver of these covenants for the first quarter of 2009. Management believes the Company will be able in the near future to amend and extend the loan agreement or obtain replacement financing on terms satisfactory to the Company. … The maturity date of this credit facility is July 1, 2009. There were no borrowings outstanding under the line as of March 29, 2009, or subsequent to that time.” (1st q 09)
JAX not only secured the waiver from Bank of America but "On May 22, 2009, the Company terminated its previous secured bank line of credit agreement and entered into a new bank loan agreement that provides two new credit facilities. The new credit facilities consist of a three-year $5,000,000 revolving line of credit, which may be used for general corporate purposes, and a $3,000,000 term loan which funded the purchase of 808,000 shares of the Company’s common stock from Solidus Company, L.P., which was the Company’s largest shareholder prior to the purchase, and E. Townes Duncan, a director of the Company." (3rd qtr 10q)
The company has been in compliance in the 2nd and 3rd quarters, with the warning however, "The Company was in compliance with the financial covenants of its debt agreements as of September 27, 2009. However, given the negative effects of the same store sales declines the Company has experienced this year, the continuing adverse effects of current economic conditions and the scheduled step down of the maximum debt to EBITDAR ratio allowed under the Company’s bank loan agreement from 6 to 1 for the quarter ended September 27, 2009 to 5 to 1 for the quarter ending January 3, 2010, there is a possibility that the Company will not meet the financial covenants of its bank loan agreement as of the end of fiscal 2009 or in 2010 when the required leverage ratio decreases to 4.5 to 1. Should the Company fail to comply with these covenants, management would request waivers of the covenants, attempt to renegotiate them or seek other sources of financing. However, if these efforts were not successful, the unused portion of the Company’s revolving bank line of credit would not be available for borrowing and amounts outstanding under the Company’s bank loans would become immediately due and payable, and there could be a material adverse effect on the Company’s financial condition and operations." (3rd quarter 2009)
There are a few reasons why I believe things are not so bad:
* As far as has been reported, JAX is not out of compliance.  I have reworked the Debt to EBITDAR and Fixed Charge ratio and I believe that at the end of the 3rd quarter JAX was just about 4.5 and 1.15, respectively (I would love to have someone double-check my numbers.  Send me an email/post a comment if you do). The Debt to EBITDAR requirement for January 2010 is still 5-to-1. This gives JAX one more quarter, in addition to any reductions of debts performed in the last quarter of 2009, to establish a margin of safety below the 4.5-to-1 ratio.
* I won't count on Same Store Sales to save the day.  However, "the Company opened three new restaurants in the last half of 2008 and two new restaurants in the fourth quarter of 2007. " (2008 10k)  These obviously took a toll on expenses, not only because of the openings themselves but also because while these restaurants are ramping up toward profitability they are dragging down the full earnings potential of JAX.  In effect, 28 stores, already having a difficult time with the general economy, are pulling the weight of 5 immature stores.  With no new restaurants in 2009, none planned for 2010 (so far anyway) and hopefully full revenue from the newer restaurants, things should not be as difficult as they were last year. While same store sales will probably be flat to negative this last quarter, total sales have some positive forces behind it.  
* JAX has filed with the SEC, "The Company believes that cash and cash equivalents on hand at September 27, 2009 and cash flow generated by future operations will be adequate to meet the Company’s operating and capital needs through 2009."
* The revolving line of debt has not been used, not as far as has been reported anyway.
 * I expect JAX will keep cash expenditures for capital assets in 2010 between 3 and 4 million. “Management does not currently plan to open any new restaurants in 2009 or 2010 and is opting to be cautious and conserve the Company’s capital until there is a clearer picture of the future of the economy before making any additional commitments for new restaurants. Additionally, new restaurant development could be constrained due to lack of capital resources depending on the amount of cash flow generated by future operations of the Company or the availability to the Company of additional financing on terms acceptable to the Company, if at all, especially considering that credit markets remain relatively tight."
* JAX is in a seasonal business and the third quarter is normally its worst quarter. The Fourth and First quarters are typically its best.
* Lower commodity prices are pulling up the bottom line as lower same store sales are pulling down the top.  
* JAX has been in operations for about 20 years.  It successfully secured a waiver in 2009. It also secured new loan facilities last year.  Lonnie Stout has been with JAX for 20 years and was involved with Jack C. Massey (of KFC ─ but that’s another story).  Of its 33 restaurants, 15 include owned land; 11 restaurants were used to secure its credit facilities. I believe the company’s long operating history, CEO Lonnie Stout's competence, and/or the 4 other properties (with owned land) will give the company enough influence to amend the agreements or secure waivers, if that should prove necessary.
Text from SEC filings
The loan agreement also includes certain financial covenants. The Company must maintain a fixed charge coverage ratio of at least 1.05 to 1.00 as of the end of any fiscal quarter. The fixed charge coverage ratio will be measured for the three fiscal quarters ending September 27, 2009 and for the four fiscal quarters ending each quarter thereafter. The fixed charge coverage ratio is defined in the loan agreement as the ratio of (a) the sum of net income for the applicable period (excluding the effect on such period of any extraordinary or non-recurring gains or losses, including any asset impairment charges, deferred income tax benefits and expenses and up to $500,000 (in the aggregate during the term of loan) in uninsured losses) plus depreciation and amortization plus interest expense plus scheduled monthly rent payments plus non-cash stock based compensation expense minus certain capital expenditures, to (b) the sum of interest expense during such period plus scheduled monthly rent payments made during such period plus scheduled payments of long term debt and capital lease obligations made during such period, all determined in accordance with U.S. generally accepted accounting principles (“GAAP”).
In addition, the Company’s adjusted debt to EBITDAR ratio must not exceed 6 to 1 for the quarter ending September 27, 2009 and 5 to 1 for the quarter ending January 3, 2010 and 4.5 to 1 for each quarter thereafter. Under the loan agreement, EBITDAR is measured based on the then-ending four fiscal quarters and is defined as the sum of net income for the applicable period (excluding the effect of any extraordinary or non-recurring gains or losses, including any asset impairment charges, and up to $500,000 (in the aggregate during the term of loan) in uninsured losses) plus an amount which, in the determination of net income for such period has been deducted for (i) interest expense; (ii) total federal,  state, foreign or other income taxes; (iii) all depreciation and amortization; (iv) scheduled monthly rent payments; and (v) non-cash stock based compensation expense, all as determined in accordance with GAAP. Adjusted debt is (i) the Company’s debt obligations net of any short term investments,  cash and cash equivalents plus (ii) rent payments multiplied by seven.
If an event of default shall occur and be continuing under the loan agreement, the commitments under the loan agreement may be terminated and the principal amount outstanding, together with all accrued unpaid interest and other amounts owing in respect thereof, may be declared immediately due and payable. No amounts were outstanding under the revolving line of credit at September 27, 2009, or subsequent to that time through November 12, 2009. A total of $3,000,000 was outstanding under the term loan at September 27, 2009, and remains outstanding through November 12, 2009.
 A mortgage loan obtained in 2002 represents the most significant portion of the Company’s outstanding long-term debt. The loan, which was originally for $25.0 million, had an outstanding balance of $20.5 million at September 27, 2009.
 It has an effective annual interest rate, including the effect of the amortization of deferred issue costs, of 8.6% and is payable in equal monthly installments of principal and interest of approximately $212,000 through November 2022. 
Provisions of the mortgage loan and related agreements require that a minimum fixed charge coverage ratio of 1.25 to 1 be maintained for the businesses operated at the properties included under the mortgage and that a funded debt to EBITDA (as defined in the loan agreement) ratio of 6 to 1 be maintained for the Company and its subsidiaries. The loan is secured by the real estate, equipment and other personal property of nine of the Company’s restaurant locations with an aggregate book value of $22.2 million at September 27, 2009. 
The real property at these locations is owned by JAX Real Estate, LLC, the borrower under the loan agreement, which leases them to a wholly-owned subsidiary of the Company as lessee. The Company has guaranteed the obligations of the lessee subsidiary to pay rents under the lease. JAX Real Estate, LLC, is an indirect wholly-owned subsidiary of the Company which is included in the Company’s Condensed Consolidated Financial Statements. However, JAX Real Estate,  LLC was established as a special purpose, bankruptcy remote entity and maintains its own legal existence, ownership of its assets and responsibility for its liabilities separate from the Company and its other affiliates. (3rd quarter 2009)
 “On April 23, 2009, J. Alexander’s Corporation received notice that, in connection with its loan agreement dated May 12, 2003, as amended to date, by and between J. Alexander’s Corporation, J. Alexander’s Restaurants, Inc. (collectively, the “Company”) and Bank of America, N.A (the “Loan Agreement”), Bank of America, N.A. has waived the covenants requiring the Company to maintain a minimum Fixed Charge Coverage Ratio and a maximum Adjusted Debt to EBITDAR Ratio during the first quarter of 2009 (the “Waiver”)." 8k