CASE 7.1 SUNNY DAY STORES, INC. Sunny Day Stores: Analyzing debt covenants and financial distress (LO 7-7) Sunny Day Stores operates convenience stores throughout much of the United States. The industry is highly competitive, with low profit margins. The company's competition includes national, regional, and local supermarkets, oil companies, and convenience store operators. A note to the 20x1 financial statements described the company's long-term debt: Note payable to the Prudential e Company of America ("Prudential") with annual prin cipal payments of $900.000. Interest 93%. Amount outstanding $5.700,000 in 20XI and $6,600,000 in 20X0 Term note payable to ride (Pest Florida) maturing in September 20X6, with quarterly principal payments of $125.000 through June 30, 2022, and $250,000 thereafter, with interest in some (5.5% December 26, 20X1) Amount outstanding $1.563.956 in 20XI and $3.000.000 in 2030 Revolving note payable to First Floride with interest at 15 in excess of prime (5.5% December 26, 20X1)Acting 57.400,000 in 20X1 and 2030 Certain of the Company's loan agreements pertaining to the borrowings from Prudential and First Florida require the Company to maintain minimum interest coverage ratio, working capital, and net worth levels impose restrictions on additional borrowings and prohibit the payment of dividends. Specifically, at the end of fiscal 20X1. Sunny Day must have a net worth of at least $22.850,000, working capital (on a FIFO inventory basis) must be at least $1,300,000, and the interest coverage ratio must be at least 1.6. The company's 20X1 financial statements that follow show that Sunny Day Stores was not in compliance with these loan covenants at year end. Ranny Day Stores, Inc. Comparative Balance Sheets December 31 20x1 200 $ 1,451.688 $ 2,971,457 December 31. 20x1 20x0 $ 9.237.416 1,637,255 1,106,713 $ 6,208.733 1.442.811 635.556 Cash and cash equivalents Accounts receivable less allowances for doubtful accounts of $82,000 and 2.000 and 20X0, respectively Refundable income taxes Inventories--FIFO basis Less: LIFO reserve Total inventories Prepaid expenses and other assets Refundable deposits Total current assets 705.923 135,831 3.690,74 (2.845.703) 5.845.031 774,519 1.186,613 1.136,241 985.987 400,000 10.640,125 (3,057,715) 7.582.410 Accounts payable Tade Money orders Fuel Salaries and wages Seinsurance reserves Current portion of long term det Tal current 846,131 966,770 569.160 1.956,369 17.035.126 1.082,429 11,751,590 764,627 700.000 11,884,712 547.705 380.522 10.586.469 (cond Sunny Day Stores, Inc. Comparative Balance Sheets December 31, 20x1 20XD Property and equipment Land Buildings Fixtures and equipment Leaseholds and improvements December 31. 20X1 2000 400,000 1.477,323 111,426 179.224 13.969,745 16,693,772 11.016.168 19,673,636 32.232.643 Deferred income Une medreven Long term deb, less current portion 13.603.304 19,801.221 32,749,133 5,084,679 68,007,126 4.929,748 71,003,406 Stockholders' equity Common stock Additional pain capital Retained earnings Less: Allowances for depreciation and amortization 170,165 5.124.245 17,735, 240 23,029,650 (31,000,778) 36.998,348 170,165 5.124.245 15.171.001 20.465,411 $51,381,708 (28.988.173) 42,095,233 Total liabilities and stockholders equity $53,131,559 Other assets Land held for sale Other Totales 2.641,735 456.913 $51.981,708 449.857 $53,131.559 Sunny Day Stores, Inc. Statement of Cash Flow 20x1 200 20w $(2.564.239) $(1,042,297) (512.995) (174657) (83_804) $ 613,423 3.793.119 577.235 (100,322) (84.235) Cash flows from operating actitles Net Income (los) Adjustments Depreciation and mortation Deferred income taxes Gain on sale of property Decrease in unearned revenue Changes in assets and liabilities (Increase in accounts receivable (Increase in refundable income taxes (Increase in inventories (Increase) in other assets Increase in refundable deposits Increase in accounts payable and other lisbilities Total adjustments Net cash flow from operations Cash flows from investing activities Purchase of property and equipment.net Sale of property and equipment Collections of notes and loans receivables Net cash used in investing activities Cash flows from financing activities Issuance of long term debt Dividends Payment of long-term debe Net cash provided by financing activities Net increase (decrease in cash 3.980,186 (1.077.323) (532.570) (67,798) (280,064) (264,169) (1.737.379) (263,981) (319,478) 4.409.596 3.847,020 1.282.781 53.121 244.085 2.906.024 (141.910) (15.107) (4304076) 2,433.210 1.390.913 (358.982) (113,675) 412.647 (241,347) (145,866) 3.807.200 7.545,774 8.159.197 (2.790.832) 1.428.051 10.318 (952.463) (2.871,399) 668.656 (103.610) (2,306,353) 2.633.454 22.15 (9.593270) 821.641 7.775 (8.763.854) 4.528.915 (204.198) (1.588.391) 2.736.326 $2,131,669 (1.932.602) (1.850.087) S(1,519,769) (3.108.251) (474,797) S 1.390.237) ny Day Stores, Inc ement of Operations 20x1 $217,710,782 Net revenue Cost and expenses Costs of goods sold Selling general, and administrative Interest expense-net Net gain from sale of property Income (loss) before taxes Provision (benefit) for income taxes Current Deferred 176,102,027 44,631,749 1.551,138 (532.570) 221,752,344 (4.041.562) (400,000) (1,077,323) (1.477.323) $ (2.564,239) $ (1.51) 20x0 $202,393,136 158,643.287 43,687,704 1,728,650 (174,657) 203,884,984 (1.491,848) 63,444 (512,995) (449,551) $ (1,042,297) $ (0.61) 20w9 $191,243,016 146,652,853 41,805,330 1,658,732 (100,322) 190,016,593 1,226,423 50,000 563,000 613,000 $ 613,423 $ 0.36 Net income (loss) Earnings per common share Required: It's late January 20X2, and Prudential and First Florida have hired you to act on their behalf in negotiations with Sunny Day Stores. Both lenders want to restructure their loans to address the company's current financial problems, and the restructured loans may requlre covenant changes. Prudential and First Florida seek your advice on the type and amount of collateral to be required, revised interest rates, and possible changes to the payment schedules. In addition, the lenders have asked you to suggest new minimum net worth, working capital, and interest cover age ratios for 20x2 and 20X3. Specifically: 1. What type and amount of collateral do you suggest be required? 2. Should a higher interest rate be charged? Why or why not? 3. What changes would you suggest be made to the payment schedule? 4. What new minimum net worth, working capital, and interest coverage limits would you suggest the lenders set? 5. Suppose the company asked permission to resume payment of its $0.12 per share dividend, which was suspended in 20X0. What advice would you give Prudential and First Florida? CASE 7.1 SUNNY DAY STORES, INC. Sunny Day Stores: Analyzing debt covenants and financial distress (LO 7-7) Sunny Day Stores operates convenience stores throughout much of the United States. The industry is highly competitive, with low profit margins. The company's competition includes national, regional, and local supermarkets, oil companies, and convenience store operators. A note to the 20x1 financial statements described the company's long-term debt: Note payable to the Prudential e Company of America ("Prudential") with annual prin cipal payments of $900.000. Interest 93%. Amount outstanding $5.700,000 in 20XI and $6,600,000 in 20X0 Term note payable to ride (Pest Florida) maturing in September 20X6, with quarterly principal payments of $125.000 through June 30, 2022, and $250,000 thereafter, with interest in some (5.5% December 26, 20X1) Amount outstanding $1.563.956 in 20XI and $3.000.000 in 2030 Revolving note payable to First Floride with interest at 15 in excess of prime (5.5% December 26, 20X1)Acting 57.400,000 in 20X1 and 2030 Certain of the Company's loan agreements pertaining to the borrowings from Prudential and First Florida require the Company to maintain minimum interest coverage ratio, working capital, and net worth levels impose restrictions on additional borrowings and prohibit the payment of dividends. Specifically, at the end of fiscal 20X1. Sunny Day must have a net worth of at least $22.850,000, working capital (on a FIFO inventory basis) must be at least $1,300,000, and the interest coverage ratio must be at least 1.6. The company's 20X1 financial statements that follow show that Sunny Day Stores was not in compliance with these loan covenants at year end. Ranny Day Stores, Inc. Comparative Balance Sheets December 31 20x1 200 $ 1,451.688 $ 2,971,457 December 31. 20x1 20x0 $ 9.237.416 1,637,255 1,106,713 $ 6,208.733 1.442.811 635.556 Cash and cash equivalents Accounts receivable less allowances for doubtful accounts of $82,000 and 2.000 and 20X0, respectively Refundable income taxes Inventories--FIFO basis Less: LIFO reserve Total inventories Prepaid expenses and other assets Refundable deposits Total current assets 705.923 135,831 3.690,74 (2.845.703) 5.845.031 774,519 1.186,613 1.136,241 985.987 400,000 10.640,125 (3,057,715) 7.582.410 Accounts payable Tade Money orders Fuel Salaries and wages Seinsurance reserves Current portion of long term det Tal current 846,131 966,770 569.160 1.956,369 17.035.126 1.082,429 11,751,590 764,627 700.000 11,884,712 547.705 380.522 10.586.469 (cond Sunny Day Stores, Inc. Comparative Balance Sheets December 31, 20x1 20XD Property and equipment Land Buildings Fixtures and equipment Leaseholds and improvements December 31. 20X1 2000 400,000 1.477,323 111,426 179.224 13.969,745 16,693,772 11.016.168 19,673,636 32.232.643 Deferred income Une medreven Long term deb, less current portion 13.603.304 19,801.221 32,749,133 5,084,679 68,007,126 4.929,748 71,003,406 Stockholders' equity Common stock Additional pain capital Retained earnings Less: Allowances for depreciation and amortization 170,165 5.124.245 17,735, 240 23,029,650 (31,000,778) 36.998,348 170,165 5.124.245 15.171.001 20.465,411 $51,381,708 (28.988.173) 42,095,233 Total liabilities and stockholders equity $53,131,559 Other assets Land held for sale Other Totales 2.641,735 456.913 $51.981,708 449.857 $53,131.559 Sunny Day Stores, Inc. Statement of Cash Flow 20x1 200 20w $(2.564.239) $(1,042,297) (512.995) (174657) (83_804) $ 613,423 3.793.119 577.235 (100,322) (84.235) Cash flows from operating actitles Net Income (los) Adjustments Depreciation and mortation Deferred income taxes Gain on sale of property Decrease in unearned revenue Changes in assets and liabilities (Increase in accounts receivable (Increase in refundable income taxes (Increase in inventories (Increase) in other assets Increase in refundable deposits Increase in accounts payable and other lisbilities Total adjustments Net cash flow from operations Cash flows from investing activities Purchase of property and equipment.net Sale of property and equipment Collections of notes and loans receivables Net cash used in investing activities Cash flows from financing activities Issuance of long term debt Dividends Payment of long-term debe Net cash provided by financing activities Net increase (decrease in cash 3.980,186 (1.077.323) (532.570) (67,798) (280,064) (264,169) (1.737.379) (263,981) (319,478) 4.409.596 3.847,020 1.282.781 53.121 244.085 2.906.024 (141.910) (15.107) (4304076) 2,433.210 1.390.913 (358.982) (113,675) 412.647 (241,347) (145,866) 3.807.200 7.545,774 8.159.197 (2.790.832) 1.428.051 10.318 (952.463) (2.871,399) 668.656 (103.610) (2,306,353) 2.633.454 22.15 (9.593270) 821.641 7.775 (8.763.854) 4.528.915 (204.198) (1.588.391) 2.736.326 $2,131,669 (1.932.602) (1.850.087) S(1,519,769) (3.108.251) (474,797) S 1.390.237) ny Day Stores, Inc ement of Operations 20x1 $217,710,782 Net revenue Cost and expenses Costs of goods sold Selling general, and administrative Interest expense-net Net gain from sale of property Income (loss) before taxes Provision (benefit) for income taxes Current Deferred 176,102,027 44,631,749 1.551,138 (532.570) 221,752,344 (4.041.562) (400,000) (1,077,323) (1.477.323) $ (2.564,239) $ (1.51) 20x0 $202,393,136 158,643.287 43,687,704 1,728,650 (174,657) 203,884,984 (1.491,848) 63,444 (512,995) (449,551) $ (1,042,297) $ (0.61) 20w9 $191,243,016 146,652,853 41,805,330 1,658,732 (100,322) 190,016,593 1,226,423 50,000 563,000 613,000 $ 613,423 $ 0.36 Net income (loss) Earnings per common share Required: It's late January 20X2, and Prudential and First Florida have hired you to act on their behalf in negotiations with Sunny Day Stores. Both lenders want to restructure their loans to address the company's current financial problems, and the restructured loans may requlre covenant changes. Prudential and First Florida seek your advice on the type and amount of collateral to be required, revised interest rates, and possible changes to the payment schedules. In addition, the lenders have asked you to suggest new minimum net worth, working capital, and interest cover age ratios for 20x2 and 20X3. Specifically: 1. What type and amount of collateral do you suggest be required? 2. Should a higher interest rate be charged? Why or why not? 3. What changes would you suggest be made to the payment schedule? 4. What new minimum net worth, working capital, and interest coverage limits would you suggest the lenders set? 5. Suppose the company asked permission to resume payment of its $0.12 per share dividend, which was suspended in 20X0. What advice would you give Prudential and First Florida