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RUTH was already in a tough position relative to its debt covenants as evidenced by both its sale-leaseback transactions and its recently announced cost reduction initiatives, but October’s same-store sales decline of 15% has further complicated the situation. RUTH ended the quarter with long-term debt of $167M (reduced by $17M from the proceeds from the sale-leaseback transactions) and a total debt/adjusted LTM EBITDA ratio of 3.23x relative to its maximum debt covenant level of 3.5x.
RUTH announced last week that it has entered into a purchase agreement to sell its support center in Heathrow, Florida, which the company hopes to close by year end. The sale is expected to generate $12M in proceeds and could provide a 20bp cushion to the company’s debt/EBITDA ratio at the end of the year.

Management stated, however, that if the sale of the support center does not happen in Q4 and same-store sales remain down 15% for the balance of the quarter that remaining below the 3.5x covenant “will be tight.” Management even reiterated this point later in the call in response to a question regarding its debt covenant, “Well, David, first, in terms of Q4, I didn't say safe. I said tight and we think we can get over the top but I don't want to suggest that it's a layup, if you will.”

The company’s only flicker of hope, outside of completing the sale, relies on strong gift card sales in Q4, which added $12-$13M of revenues to 4Q07. Management is expecting about the same level of gift card sales in this year’s fourth quarter as a result of RUTH’s increased units and the addition of Mitchell’s (so a decline in gift card sales/unit).

When asked about bank relations, management stated they have a good relationship with their bank lenders and although premature to speculate, that if a default did occur, the strong relationship they have (combined with the strong relationship their largest shareholder, Madison Dearborn, has with the bank lenders) would help to provide a favorable outcome…if it came to that.

So as I highlighted last week, these are clearly desperate times for RUTH.