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RRGB can join the list of companies that have added significant leverage to their balance sheets at exactly the wrong time. In 2Q08, the company’s total debt increased nearly $70 million on a sequential basis from the first quarter to about $222 million. RRGB increased its borrowings in the second quarter to fund both franchise acquisitions and a $50 million share repurchase program. As I have said many times before, I don’t understand the capital allocation decision to borrow money in order to repurchase shares. RRGB spent $50 million to buy back about 1.5 million shares at an average purchase prices of $33.76. The stock is trading closer to $13 today…How has that generated shareholder returns? In August 2008, RRGB’s board authorized an additional repurchase of up to $50 million so the borrowing to buy more may not yet be over.
  • Through the third quarter, RRGB has generated $66.9 million in cash from operations relative to its $65 million of capital spending needs so outside of its franchise acquisitions, the company did not need to increase its borrowings in order to maintain its FY08 unit growth targets, which highlights the financial irresponsibility of increasing debt levels to buy back shares in today’s environment. RRGB has increased its financial leverage at the same time same-store sales are falling off a cliff and margins are declining significantly (EBIT margins are down 420 bps from 2005 levels and down 250 bps YOY in 3Q alone). Additionally, RRGB is still targeting 7% company-operated unit growth in FY09. Although the 20 units targeted in 2009 represents a slowdown from the 31 openings expected in 2008, RRGB’s new unit targets seem aggressive relative to the current environment. And yet, when the company was questioned about its debt covenant levels, management appeared to dismiss the concerns:
  • Analyst
    Got you. And then, Katie, you mentioned your covenants - 2.5 times coverage is the--I guess is what you need to achieve. What will you be at for the year based on your new guidance?
    Katie Scherping - Red Robin - CFO
    It should be just over two or two and a smidge.
    So you're just over two times the EBITDA coverage versus the 2.5 times that you need?
    Katie Scherping - Red Robin - CFO
    And what happens if you went above--what if you broke the covenant? What is the remedy?
    Katie Scherping - Red Robin - CFO
    We don't plan to.
    But there is cure in the debt covenant probably?
    Katie Scherping - Red Robin - CFO
    We'd probably have to go and ask for a waiver.
    Okay, which would imply a higher interest rate probably?
    Katie Scherping - Red Robin - CFO
    That's purely speculation at this point. That's pretty far out, so I--.
    Denny Mullen - Red Robin - Chairman, CEO
    --We've got a lot of room in that 2.5 covenant. And if we projected forward, if there was any issues moving towards it, we would take other courses of action.

  • Given the lack of visibility around same-store sales trends, the direction margins are heading and the company’s current level of debt, this line of questioning was warranted and should not have been taken so lightly by the company.

  • RRGB reported yesterday that its October same-store sales deteriorated from 3Q levels and were down 8%. However, 4Q guidance assumes a slight improvement in trends for the balance of the quarter with same-store sales down 5% to 7%. Of the five casual dining companies that have reported October comparable sales trends over the last couple of days, RRGB is the only company that is basing its 4Q guidance on an acceleration of same-store sales trends from October levels. The company attributed its optimism to easier comparisons in November and December, but easier comparisons are no longer too meaningful in today’s consumer environment. Making matters worse, RRGB is facing its most difficult operating margin comparison from 2007 in the fourth quarter.