(The following statement was released by the rating agency) Overview
-- Dave & Buster's Entertainment Inc.
, parent of Dave & Buster's Inc., announced that it is suspending its IPO.
-- We are affirming all ratings on Dave & Buster Inc., including our 'B-' corporate credit rating, and removing them from CreditWatch with positive implications.
-- The positive outlook reflects the possibility that we might upgrade the company in the next 12 months if it continues to improve its credit protection measures through earnings growth.
Rating Action On Oct. 10, 2012, Standard & Poor's Ratings Services affirmed its ratings on Dallas-based restaurant and out-of-home entertainment company Dave & Buster's Inc., including the 'B-' corporate credit rating. At the same time, we removed all ratings from CreditWatch, where they were placed with positive implications on Sept. 28, 2012. The outlook is positive.
The ratings on Dave & Buster's Inc. reflect our expectations that credit measures over the next 12 months will improve, but remain consistent with a "highly leveraged" financial risk profile under our criteria. We expect leverage to decline slightly on earnings improvement, but we think the company's cash flow coverage ratios will remain thin because of still high debt levels, while it maintains adequate liquidity. The financial risk profile also incorporates the company's very aggressive financial policy, influenced by its private equity ownership. We view Dave & Buster's business risk profile as "weak" under our criteria because its small-size operations make it more susceptible to swings in commodity costs and consumer spending.
Credit protection measures improved over the past year, and we expect additional improvement in the next year on earnings growth. EBITDA has increased to about $126 million for the 12-month period ended July 29, 2012, up from $121 million the same time last year. The growth was propelled by new store openings, same-store sales growth of about 5%, and benefits from marketing and cost initiatives. Debt to EBITDA declined to 6.2x from nearly 6.5x over the same timeframe, and funds from operations (FFO) to debt increased to 12% from 9%. We expect this trend of improvement to continue in the next 12 months. The key assumptions under our base case for the next year include the following:
-- Improving unemployment levels of under 8% and modest U.S. gross domestic product growth of about 2% should fuel same-store sales to the mid-single digit area.
-- Cost inflation of about 50 basis points.
-- EBITDA growing to about $130 million on new-store contribution and organic sales growth.
The company forecasts $71 million in capital spending for 2012, and we anticipate similar levels next year. We think these expenditures will be funded with generated cash flows and existing cash balances.
Given our cash flow expectations, we think debt levels will increase on incremental pay-in-kind (PIK) debt. However, earnings growth should offset additional debt. We do not expect any material dividends in the next year.
Considering these assumptions and expectations, we expect leverage to decline slightly to under 6x and FFO to debt to be about 14%. All credit metrics include PIK debt issued at the holding company. A key risk to our forecast is the potential for higher-than-expected commodity costs--which could hurt metrics meaningfully because of the company's smaller-size operations, and stall the improvement we expecting over the next year.
Dave & Buster's liquidity position should remain adequate over the next 12 months in our view. Relevant assumptions in our liquidity analysis are:
-- We believe liquidity sources will exceed uses by at least 1.2x.
-- Sources would continue to exceed uses, even if EBITDA declines by 15%.
-- We expect free cash flow of between $5 million and $10 million on higher capital spending.
-- Compliance with maintenance financial covenants will likely withstand a 15% drop in EBITDA.
-- Debt amortization is minimal and the credit agreement stipulates a cash flow sweep based on leverage ratios.
-- We do not view financial risk as prudent because the ownership structure of the company directs financial policy, and its prior use of debt to fund dividends.
Dave & Busters indicated that its cash balances, which totaled nearly $55 million at July 29, 2012, will serve as an essential funding source to its capital spending program. We think its liquidity sources are also supported by its generated cash flows and a $50 million committed revolving credit facility. We expect cash on hand to decline to about $15 million next year on new-store openings and renovations, but the revolving credit facility will remain undrawn.
Recovery analysis We rate the bank credit facilities 'B+' with a recovery rating of '1', indicating our expectation of very high (90% to 100%) recovery in the event of a payment default. We rate the $200 million senior notes 'CCC+' with a '5' recovery rating, indicating our expectation of modest (10% to 30%) recovery in event of default. (For the complete recovery analysis, please see our "
7163147&rev_id=6&sid=1005973&sind=A&", published on Feb. 29, 2012, on RatingsDirect.)
The positive outlook on Dave & Buster's incorporates our expectation that positive sales trends and earnings growth over the next year will result in credit measures that are in line with a one-notch higher rating. In our forecast for the next 12 months, modest cost pressures will be offset by same-store sales growth of 5% and benefits from new store openings, leading to EBITDA margins of about 22% and leverage of slightly under 6x. We also see FFO to debt increasing slightly, to around 14%, albeit still at thin levels. In our ratings assumptions, we do not foresee material dividends. We think that if the company can execute its IPO and use the proceeds to reduce debt, an upgrade could occur earlier than we anticipate.
We could revise the outlook to stable if further improvement in credit protection is not likely, possibly as a result of cost inflation that offsets the benefits from new store openings, or if competition heightens and leads to meaningful promotional activities. These factors could result in EBITDA margins of slightly under 21% and leverage in the mid-6x area on a sustained basis. We could also revise the outlook to stable following debt-financed shareholder initiatives.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Credit Factors: Business And Financial Risks In The Restaurant Industry, Dec. 4, 2008
-- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008
-- Analytical Methodology, April 15, 2008
Ratings List Ratings Affirmed, Recovery Rating Unchanged; CreditWatch/Outlook Action To From Dave & Buster's Inc. Corporate Credit Rating B-/Positive/-- B-/Watch Pos/-- Dave & Buster's Inc. Senior Secured B+ B+/Watch Pos Recovery Rating 1 1 Senior Unsecured CCC+ CCC+/Watch Pos Recovery Rating 5 5
(Caryn Trokie, New York Ratings Unit)