The Krystal Company

January 19, 2020

Georgia-based quick-service restaurant chain, The Krystal Company, which features cheap — some might say “iconic” (read: the company = “some”) — square burgers among other horrendous-for-your-health fare (eggnog shakes, anyone?), filed for bankruptcy in the Northern District of Georgia over the holiday weekend. We’re guessing that most of you snobby coastal elites have likely never heard of Krystal and, well, neither had we to be honest. To our surprise, Krystal is purportedly “the oldest quick-service restaurant chain in the South and the second oldest in the United States, the Krystal brand has a prominent place in the South’s cultural landscape.” You learn something new every day.

The chain operates 182 restaurant locations across nine states; it has approximately 4900 employees; it doesn’t own its real estate; it does have 116 franchisees. It also has over $65mm in debt.

Why the bankruptcy? PETITION readers are very familiar with the trends afflicting quick service restaurants. A number have stumbled into bankruptcy in recent years. To point, the company’s Chief Restructuring Officer also recently worked with Kona Grill and Ignite Restaurant Group. There are plenty of distressed restaurant chains to keep the fee meter running, it seems.

So, what are these trends?

• Shifting consumers tastes and preferences (PETITION Note: people are becoming more health-conscious and a slab of previously-frozen meat stacked between a gnarled bun, diced onions, a pickle and some stadium mustard don’t really pass muster anymore). ✅

• Fast casual and online delivery are crushing quick service chains (PETITION Note: we’re going to have to start referring to “The Chipotle Effect”). ✅

• It is increasingly hard to find and retain qualified employees in the current labor market, as turnover exceeds 200% (PETITION Note: #MAGA!!). ✅

• Commodity costs are rising (PETITION Note: but there’s virtually no inflation folks). ✅

• Unfavorable lease terms. ✅

Facing all of this, the company did what struggling companies tend to do: they hired an expensive consultant. Boston Consulting Group came in and to advise the company with respect to “competitive positioning” and this led to a capital intensive rebuilding project of nine of its locations. Yes, they completely demolished and rebuilt nine locations in ‘18 and ‘19. Ultimately, this led to increased sales at those locations but it clearly couldn’t course correct the entire enterprise.

Consequently, the company breached a financial covenant in Q4 ‘18. It obtained an equity infusion which stopped the bleeding…for like a hot second. The company then defaulted under its credit agreement because it couldn’t obtain a “going concern” qualification for the fiscal year ending December 31, 2018. It has been in forbearance since October. Meanwhile, it has been shedding costs: people have been fired and stores have been closed.

About those stores. The average occupancy cost of the company’s locations is $482k/month. Because of this, the company regularly reviews profitability and recently has turned several of its stores “dark” by ceasing all business there. On day one of its chapter 11 bankruptcy filing, the company filed a motion seeking to reject (i) these “dark” leases (38 of them) as well as (ii) several other locations that franchisees operate under subleases that are not profitable (40 total locations).

So, what now? The papers don’t really say much. Oddly enough, the first day declaration ends with some information about a payment processing data breach and says nothing about DIP financing (there isn’t any) or the direction of the case. In a press release, however, the company says that it intends to use the bankruptcy process to pursue “an orderly sale of its business and assets as a going concern.” Now, in the past, we’ve certainly made fun of debtors who have used their first day papers as de facto marketing materials. Not because it’s stupid: it’s rather smart. It was just also rather blatant and shamelessly spinful. Here, though, Krystal doesn’t even mention anything about a marketing process in its papers or, for that matter, a banker (which happens to be the newly merged Piper Sandler).

These guys are off to a rockin start.

*****

Wells Fargo Bank NA ($WFC), the agent under the company’s secured loan, agrees. It filed an objection to the company’s motion seeking authorization to use cash collateral. They wrote:

As the Debtors’ largest stakeholder, the Agent is extremely concerned with the manner in which the Debtors are positioning these cases. The Debtors have yet to file their budget for either the interim period until the second interim hearing or a longer-term budget, but based on the draft budgets that were provided to the Agent prior to filing, it appears that operating on cash collateral alone will not provide the Debtors with sufficient liquidity to make it through a sale process and affords almost no margin for error. The Bankruptcy Code does not permit the Debtors to avoid their obligation to provide adequate protection to the Prepetition Secured Parties on the basis that the Debtors elected a budget that will not permit it. Were the Debtors to run out of cash during the sale process, as they are likely to do, the attendant disruption could jeopardize the entire going concern value of the business and the sale process.

Nothing like a contested cash collateral hearing to get things off on the right foot.

• Jurisdiction: N.D. of Georgia (Judge Hagenau)

• Capital Structure: $10mm RCF, $54.1mm Term Loan (Wells Fargo Bank NA), $1.5mm promissory note (KRY LLC).

• Professionals:

  • Legal: King & Spalding LLP (Sarah Borders, Jeffrey Dutson, Leia Clement Shermohammed)

  • Financial Advisor/CRO: Alvarez & Marsal North America LLC (Jonathan Tibus)

  • Investment Banker: Piper Jaffray & Co. (aka Piper Sandler)

  • Claims Agent: KCC (*click on the link above for free docket access)

• Other Parties in Interest:

  • Wells Fargo Bank NA

    • Legal: Morgan Lewis & Bockius LLP (Jennifer Feldshur, Charlie Liu) & Parker Hudson Rainer & Dobbs LLP (C. Edward Dobbs, Rufus Dorsey, Michael Sullivan)