Wray Search – What’s New in 2020? Well….

The calendar now says that is it 2020, and too many of us remember 1980, 1990, 2000 and 2010. One of the nice things about being a veteran of any line of business, like restaurants, is that your perspective deepens with the additional years. We know what we know now. Sometimes it prohibits expensive mistakes later.

The need to take down competitors to build sales

In the case of 2020, all of the restaurant space’s issues from the 2010 decade have rolled over. Nothing has changed. Exactly the same issues to start the year. That leads to the first restaurant observation noted once again at the 2020 ICR Exchange Conference that just concluded this week where a good number of public and smaller restaurant chains who hope to be public chains one day come to present. When it really comes down to it, this industry is powered by promises of growth, whether it be in the US or US and in international markets. But how is this growth going to materialize? Maturing and growing chains of all sorts need to identity and test their differentiators and competitor take down tactics. In our highly competitive economy, they have to compete not only for guests, but also employees, sites, funding, real estate and suppliers, naming just the most obvious.

This is the key factor that investors should look for: not just unit growth projections, but how will the brand capture market share and take down competitors.

We all hope things will get easier as time goes on of course but our over loaded marketplace produces great stress on startups and smaller players. Jay Sonner, partner at North Point Advisors recently penned a fantastic note[1] that identified  that despite the massive closing of stores in US retail and restaurants, some “new guard” brands are working.  These operations are clearly different and are targeted. The point is that market share has to be taken away from others. Some cited examples:

  • Local alignment : Mendocino Farms and Snooze AM aligning with local farms and purveyors. Dig Inn as investor with upstate NY farms.
  • Alignment to community: Cooper’s Hawk, with its 400,000 member wine club
  • Memory Creation: Torchy’s Taco’s hotter tacos through the month; Punch Bowl Social with fun and approachability driven back into the driving range/golf experience.
  • Photogenic/Instagram connection: are important traffic drivers and high ROI brand impression engines. Examples are Velvet Taco and Snooze high plate sharing rates.
  • Giving respect to Kids and Pets: is important given societal shifts, especially urbanization. Many brands have had kids’ corners; several kid-safe and pet-outdoor space small brands have emerged.

Labor problems, $100,000 general managers in the QSR space? 

The second issue to rolled over from 2019 like a rock was ongoing labor availability problems. At an ICR 2020 Exchange special Piper Sandler luncheon, additional thoughts were presented by  Luke Fryer, CEO of the labor analytics and technology consultancy Harri reminded us that on the hourly associate side, a vast amount of turnover occurs in the first 60 days. This seems to me to be selection or scheduling or orientation issues. It is sometimes not setting out what the career ladders are, or even over promising the number of work hours. The point is that while wage rates might be uncontrollable, there are other ways to work at the labor control issue.

Bloomberg recently reported [2] that Taco Bell was considering paying $100,000 wages for restaurant general managers as the need was so severe. It turns out that this is being done on the company store side. We don’t know if this is some mix of salary and bonus potential, but most likely so. Some analysis is in order. First, Taco Bell has 462 company stores in the US, versus 6446 franchised locations.[3] I’m glad they have company locations and it is typical that the AUV and restaurant margins are higher at the company stores versus the franchisee stores in terms of profit dollars. Company stores do not have the burden of a royalty, and franchisor interest expense is lower or practically zero for these stores, unlike franchisees. However, it is typically true that franchisees run tighter labor cost percentages—they have royalties to pay, after all.

So, franchisees are not going to be able to afford $100,000 GM salaries. This $100,000 tactic might bring some incremental staffing relief to the company store side but will generally be unworkable on the franchisee side. In my view, labor relief has to come from anywhere other than labor rates.

____________________________________________

John A. Gordon is a veteran restaurant industry veteran who can count a lot of new decades in this business. His restaurant consultancy, Pacific Management Consulting Group, works complex restaurant analysis engagements focusing on operations, financial management and strategy topics. He is reachable always at jgordon@pacificmanagementconsultinggroup.com, office 858 874-6626, and website, https://www.pacificmanagementconsultinggroup.com

[1]   https://www.linkedin.com/pulse/six-ways-us-retail-thriving-jay-sonner

[2]   https://www.bloomberg.com/news/articles/2020/-01/09/taco-bell-offering-100-000-salary-amid-mounting-worker-shortage

[3]   2019 Taco Bell Franchise Disclosure Document.

Restaurant Business – Hundreds of Jack in the Box locations are losing money

A lot of the brand’s locations had negative operating income in 2018, and the problem is concentrated in a surprising state, says RB’s The Bottom Line.
jack in the box storefront

Photograph courtesy of Jack in the Box

the bottom line

Whoever takes over as CEO of Jack in the Box will face an immediate problem: what to do about a large number of money-losing franchised restaurants?

Hundreds of the San Diego-based burger chains had negative operating income last year, according to data from the company’s newly filed franchise disclosure document. That would put those locations in near-term danger of closing down.

According to the document, about 300 of Jack in the Box’s 2,200 locations generated $1 million or less in annual sales.

Those locations had a median operating income of negative $36,260. That suggests that between 150 and 200 of those restaurants had a negative operating income.

What’s more, there were locations with higher annual revenues that still finished with negative operating income.

John Gordon, a restaurant consultant out of San Diego who analyzed the document, said he estimates that at least 300 Jack in the Box locations, or about 13% of the system, are cash-flow negative.

The problem may well be worse than this, too. The document, which was filed earlier this month, provides only 2018 numbers, and Gordon believes conditions have likely deteriorated since, given rising labor and other costs.

While 40% of Jack’s locations are in high-cost California, the brand’s problem is most acute in supposedly low-cost Texas, home to 27% of Jack in the Box locations but 50% of the restaurants generating less than $1 million. Only 9% of the under-$1 million locations are in California.

The data highlights the challenge the burger chain faces as it looks for a new chief executive: A large percentage of its restaurants are underwater and face near-term uncertainty. The problem helps explain why franchisees have been fighting with the brand over the past two years.

Jack in the Box did not respond to requests for comment.

Jack in the Box CEO Lenny Comma resigned last week after a tumultuous two years that saw the brand unable to find a buyer and fighting with franchisees who called for his resignation while the company slashed corporate overhead. His successor will feel immediate pressure to generate sales to keep franchisees from closing units.

The new CEO will also face challenges getting operators to build locations.

For much of its history, Jack in the Box was a mostly company-owned brand. Around 2004, it started selling those stores to franchisees, and in the 15 years since then, it has sold all but 137, or about 6% of the brand’s locations.

In many of these refranchising deals, Jack in the Box kept control of the property, leasing it to the operator for about 9.5% of revenues.

Such deals are not uncommon—McDonald’s is the most notable example. Franchise rent now makes up nearly 30% of Jack in the Box’s overall revenues.

Some note that Jack’s charges are too high given the chain’s average unit volumes. Rental charges might be exacerbating an overall profitability problem at the burger chain.

But they may also be putting Jack in the Box in a difficult spot, leaving the brand on the hook for the leases if some stores have to shut down.

For all of Jack’s locations, 10% operating margin is also low, leaving franchisees less able to fund capital expenses and debt, as well as corporate overhead. It may also make it harder for the brand to accomplish its next goal: convincing operators to build new units.

Jack in the Box had hoped the end of the refranchising process, along with improved sales, would convince operators to build new restaurants. Same-store sales have improved in the past two quarters, including 3% in the most recent earnings period.

Operators that had been focused on buying existing locations might now be free to build new, at least in theory.

But franchisees that are filing lawsuits against the brand while their operating margins are low, and hundreds are underwater, are a lot less likely to build new units.

That said, it’s not as if things are hopeless. Gordon said Jack in the Box’s situation is similar to Burger King in 2009, the year before the brand was sold to 3G Capital. The private-equity firm settled lawsuits filed by franchisees and focused on rebuilding the brand’s same-store sales—though the company also quickly refranchised restaurants.

Still, today Burger King’s unit volumes are higher. Operators are building units, and lawsuits are nonexistent. The next CEO of Jack in the Box should take a cue from that experience.

Bloomberg – McDonald’s finds a flaw in its ordering kiosks: No cash accepted

McDonald's

 

 

Guest place their order at a kiosk at the McDonald’s corporate headquarters restaurant during the grand opening in Chicago on June 4, 2018.

McDonald’s Corp. has pitched self-ordering kiosks as a key part of its plans to boost sales by improving technology and renovating restaurants. But it turns out the kiosks aren’t usable by a significant slice of McDonald’s customers: cash payers.

The Big Mac seller is leaning hard into digital ordering and technology improvements to attract on-the-go customers, but a recent test shows the kiosks may need to be replaced or retrofitted to accommodate cash transactions. About 6.5% — or 8.4 million — of U.S. households don’t have a bank account or a debit or credit card, preventing them from using McDonald’s kiosks that are in about 9,000 domestic locations.

That’s problematic for the company because franchisees have been bearing much of the cost for renovations that include the kiosks and creating a more modern look. Many restaurant owners have already having paid as much as $750,000 per store for the kiosks and other improvements.

“As part of McDonald’s efforts to identify the best experience for customers and employees, we are always testing new approaches to meet customer demand,” the company said in an emailed statement. It confirmed it’s testing kiosks that accept cash in a “small handful of U.S. restaurants.”

The kiosks, which started being used in the U.S. in 2015, quickly became a focus of recently departed Chief Executive Officer Steve Easterbrook, who said last month that touchscreen ordering is increasing worldwide. He noted that diners usually spend more when ordering via kiosk, and said in July that 40% of in-store customers used one in Australia and major European markets.

“Potentially the franchisee could have to pay,” said John Gordon, principal at restaurant adviser Pacific Management Consulting Group. He called the oversight for the kiosks a “mistake” and said the world’s biggest restaurant company “should have thought about that.”

He estimates that 30% of fast-food customers use cash in the U.S. McDonald’s says that worldwide, 40% to 60% of its diners use cash.

“Lower income people just don’t have access to credit cards; they’re paying with a lot of things in cash,” Gordon said. “Why should they not have the same access to personalization, or to get in and out quickly if there’s a line?”

McDonald’s says the kiosks offer a faster ordering experience and that some cash-paying customers have said they want to be able to use them.

Cashless restaurants, including Dos Toros Taqueria, have faced criticism that they discriminate against low-income consumers who may not have bank accounts. Amazon.com’s Go grocery markets and the Sweetgreen salad chain reversed their no-cash policies earlier this year.

Cities and states are starting to ban cashless stores. Philadelphia and San Francisco have such rules in place now, and other municipalities are weighing similar measures.

Nation’s Restaurant News – Starbucks straddles the store format fence with minimalist mobile stores and elaborate roasteries

Pickup-Store-Starbucks-b.png Eric Soltan/Starbucks
Coffee shop diversifies store portfolio with Reserve Roasteries and pickup-only stores

Joanna Fantozzi | Nov 15, 2019

In the month of November, Starbucks has opened both its largest location in the world — the Chicago Reserve Roastery — and one of its smallest, minimalist stores: a pickup-only location in New York City.

The sixth Reserve Roastery in the world allows customers to order coffee cocktails, shop for fancy merchandise, and eat liquid nitrogen ice cream in a five-story, 35,000-square-foot mega-Starbucks.

 By contrast, the express, pickup-only Starbucks that just opened last week in New York City is minimally designed for customers and delivery drivers to quickly pick up their order and leave.

At first glance, the strategies behind these two new stores seem to be at odds with each other; one focuses on customer experience while the other favors convenience. Are Starbucks customers the types to want to savor their siren-branded moment, or do they just want to get through their morning coffee routine as quickly as possible?

The answer is both.

During the company’s most recent earnings call, Starbucks CEO Kevin Johnson said that customers are responding to improvements made to the in-store experience, which includes new technologies and staffing enhancements. These are just two different types of store experiences to add to Starbucks’ repertoire.

“I think they are being supremely conscious in terms of not wanting to present too confusing of a message to customers and investors,” John Gordon, a restaurant consultant at Pacific Management Consulting Group said.

“I would say they definitely timed it this way on purpose. … To have two cross-current concepts being developed at the same time would help alleviate some of the pressure and media/investor attention on the roasteries.”

Gordon predicts that this will be the last large-format Reserve Roastery that Starbucks opens for a while, as Starbucks makes the final shift from the Howard Schultz era of Starbucks to the Kevin Johnson era. Although Johnson started his tenure as CEO in 2017, and Schultz ended his the same year, the reserve roasteries were Schultz’s pet project. Originally, Schultz said that he wanted to have 1,000 Starbucks Reserve bars and 20 to 30 of these mega Reserve Roastery stores around the world.

But Johnson has since tried to scale back on the original ambitious vision for the Roasteries:

“One thousand was an aspiration,” he told the Wall Street Journal in a Jan. 2019 interview.

“Starbucks’ aspirational goals for both Reserve Store and Reserve Bar formats remain unchanged,” a Starbucks representative told Nation’s Restaurant News at the time .

Although not much has been said about the future goals of the large-format Reserve Roastery stores beyond Chicago since then, Johnson has put his money where his mouth (and priorities) are: Many of the company’s resources have since been devoted to expanding the convenience of mobile order platforms and delivery. Around the same time that Johnson announced that Starbucks delivery would go nationwide in July, the first Starbucks Now express store opened in Beijing that focused on mobile order pay and delivery customers.

Now four months later, a similar concept — the Starbucks pickup store — has made its way to the U.S. The pickup store in New York similarly focuses on mobile customers: customers can use their mobile order and pay to pick up at the new Penn Plaza location. Once they arrive at the minimalist store with no seating and very little décor or branding, they can track the status of their order on a digital board and pick it up when it’s ready.

But don’t expect these pickup-only stores to start popping up all over the place. Starbucks said that these specialized stores are ideal for “high-traffic, metropolitan areas,” while the Reserve Roasteries seem to be similarly ideal for more tourist-driven, but still high-traffic areas.

“I don’t think there’s much doubt that they will open up more [of these pickup-only locations] because it fits their portfolio perfectly as long as they pin it to the right type of location,” Gordon said.

“But remember, the idea of the traditional third place Starbucks is deeply-embedded and if they try to get too cutesy with [these new concepts], they could lose out on market share.”

Contact Joanna Fantozzi at joanna.fantozzi@knect365.com

Follow her on Twitter: @joannafantozzi

Nation’s Restaurant News – Winter Is Coming: Brace for flurry of restaurant transactions

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Experts see fast pace of mergers, acquisitions to continue in last quarter

Ron Ruggless | Oct 04, 2019

The Cheesecake Factory Inc.’s completion of the Fox Restaurant Concepts acquisition this week capped a frantic nine months of merger dealing that have marked 2019. Restaurant industry experts see the pace continuing or picking up steam.

“It’s a very attractive, large global industry that has been slow-moving and is being disrupted,” said Aaron Allen, principal in the Chicago-based Aaron Allen & Associates global restaurant consultancy.

“When you have negative bond yields in most of the established economies of the world, that will lend itself very well to alternative-asset investments and lots of M&A activity,” Allen noted.

“We see that continuing for the foreseeable future.”

The past week alone illustrated how those investments were being made, in consolidations among established restaurant companies, in private-equity purchases and in bankruptcy acquisitions:

cheesecake-factory-completes-fox-restaurant-concepts.jpgThe Cheesecake-Fox $353 million deal came on the heels of acquisitive Arby’s parent Inspire Brands buying Jimmy John’s Sandwiches last week and private-equity firm L Catterton purchasing Del Frisco’s Restaurant Group in a $650 million deal and spinning off the steakhouse and grill brands to Landry’s Inc. Houston-based Landry’s, meanwhile, in a bankruptcy auction bought locations of Restaurants Unlimited.

Analysts expect the demand for quality restaurant mergers and acquisitions to continue, especially with the benchmark LIBOR, or London Interbank Offered Rate, that banks charge each other remaining fairly low. On Oct. 1, the one-year LIBOR interest rate was 2.04%, down from 2.92% a year ago.

“With interest rates still pretty low and with the recent sea change toward stronger restaurant companies adopting the portfolio — multi-brand — approach, there is and there will be demand for strategic M&A,” said John A. Gordon, principal with Pacific Management Consulting Group.

“However, there are increased underwriting standards,” Gordon warned. “The strongest brands get done at the best terms. Some very weak brands get no offers.”

Allen said the amount of potential investment money available globally is nearing $5 trillion, a near record level that rivals the amount “sloshing around” before the global financial crisis and Great Recession in 2008.

“It’s creeping back up,” Allen noted, adding that it was happening domestically as well as globally.

“It’s a spending spree spurred on by low interest rates and abundance of capital seeking a home,” Allen said in a phone interview. “The global foodservice industry remains an attractive place for that.”

Cracker Barrel third quarter 2019.jpgDisruptions such as third-party aggregators for delivery — similar to what was seen in the hotel industry for room reservations — and a consumer-taste shift to convenience and experience have motivated established brands to invest in younger brands.

Lebanon, Tenn.-based Cracker Barrel Old Country Store Inc. in July agreed to invest up to $140 million in Denver-based Punch Bowl Social, adding an experiential brand founded in 2012 to its 50-year-old brand. The Cheesecake Factory effected a similar move, adding fast-casual Flower Child to its casual-dining portfolio as well as a number of innovative Fox concepts.

L Catterton’s acquisition of the Del Frisco Restaurant Group included spinning off the Double Eagle Steakhouse and Del Frisco Grille concepts to Houston-based Landry’s.

“The Del Frisco/L Catterton/Landry’s situation was exceedingly complicated — with way too much debt and some underperforming brands like the Grille, and the complicated legacy M&A [in the Bartaco and Barcelona Wine Bar] acquisition,” Gordon said.

“Even then, a reasonable separation transaction finally occurred.

“This actually shows the strength of strategic M&A demand,” Gordon said.

That demand had evidenced itself in January with J.H. Whitney Capital Partners LLC’s purchase of Firebirds Wood Fired Grill, a 48-unit “polished-casual” restaurant concept, from Angelo, Gordon & Co.

In continued in March with the purchase of Scottsdale, Ariz.-based P.F. Chang’s China Bistro Inc. by investment firms TriArtisan Capital Advisors LLC and Paulson & Co. Inc. In June, when San Antonio, Texas-based burger chain Whataburger Inc. agreed to sell a majority interest to Chicago-based merchant bank BDT Capital Partners. And in July the investment group behind Hooters of America LLC sold the casual-dining wings brand to Nord Bay Capital and TriArtisan Capital Advisors LLC.

MA-pull-quote.jpgThe sellers included H.I.G. Capital, Chanticleer Holdings and other investors. Financial terms of the deal were not disclosed. Hooters of America, founded in 1983, owns and franchises more than 430 Hooters restaurants in 38 states and 27 countries.

With large sums of private equity investment money looking for a place to land, the public markets have seen little interest from restaurant brands.

In August, Kura Sushi USA Inc., the 22-unit technology-enhanced sushi chain, launched its initial public offering.

However, in late July, CEC Entertainment Inc., parent company of Chuck E. Cheese and Peter Piper Pizza, terminated an agreement that would have taken the 750-unit, Irving, Texas-based company public.

“The US restaurant IPO market remains essentially closed for now,” Gordon said.

“The recent last-minute pullback of CEC Entertainment was very telling, probably an indication of weak demand and/or problems with CEC’s latest numbers. The Kura Sushi IPO is very lightly trading (about 33,000 shares/day) and has drifted lower from a slight stock price rise after its IPO.”

Bankruptcy purchases like the Landry’s-Restaurants Unlimited purchase continue to fuel some consolidation. On Sept. 12, Huddle House Inc. agreed to buy 342 Perkins Restaurant & Bakery locations. Parent Perkins & Marie Callender’s Inc. had filed for bankruptcy protection in August.

One Hospitality Group Inc. was seeking to buy locations of Kona Grill Inc., which had been publicly traded, in a bankruptcy court bid.

Perkins.jpgAllen said more companies are looking to private than public.

“They want to get off the exchanges,” he explained, “because you’re basically in the frying pan. You are in such a hot seat with so much pressure, the investment thesis — not just in restaurants but across the board — is starting to be around the notion of staying private.”

Companies are staying private a lot longer as well. “Who wants to live in an aquarium?” Allen said of the public market.

In the final three months of the year, Allen said he expects “a flurry of deals trying to be pushed through.”

He said he knows of a number of proposed deals that are going through due diligence and would be expected to be announced or to be closed by the end of the year.

“We then think it will be ‘Wait and See’ as we enter into an election year,” Allen said. “We expect there will be more caution, but still cash available for these deals.”

Contact Ron Ruggless at Ronald.Ruggless@Informa.com

Follow him on Twitter: @RonRuggless

New York Post – Papa John’s Scores $200M Investment, New Chairman

There’s a new big cheese at Papa John’s — and embattled founder John Schnatter is not happy about it.

The pizza franchisor announced a $200 million investment from hedge fund Starboard Value Monday in a deal that places the fund’s boss Jeff Smith in the chairman seat.

The deal between Papa John’s and Smith’s Starboard Value also threatens to further loosen Schnatter’s influence over the company he founded in 1984, by expanding the board and diluting his stock.

It weakens Schnatter’s voice on the board by adding three new directors, including Smith and Anthony Sanfilippo, former chairman and CEO of casino operator Pinnacle Entertainment.

The company also added a seat for Schnatter’s nemesis Steve Ritchie — who became CEO in December 2017 after Schnatter was booted over his criticisms of the NFL’s handling of football players kneeling during the national anthem.

In addition to expanding the board, the $200 million investment gives Starboard a new chunk of convertible preferred stock that stands to shrink Schnatter’s stake from 31.1 percent to about 26 percent, according to restaurant analyst Mark Kalinowski of Kalinowski Equity Research.

“It doesn’t neutralize him, but his percentage of voice on the board goes down,” said John Gordon of Pacific Management Consulting Group.

A source following the situation said the deal suggests Papa John’s may be seeking to start a sales process that could have a better chance of success with Schnatter owning a smaller stake.

Private equity firms circling the company during its recent woes were hesitant about bidding for the pizza-maker with Schnatter owning 31 percent, this person said.

Schnatter — who was removed as chairman in July 2018 when it emerged that he used the N-word during a call — isn’t expected to take the setback lying down.

The pizza slinger is evaluating his “legal remedies” over Papa John’s decision to choose Starboard’s offer over his own, according to a filing with the Securities and Exchange Commission.

Schnatter’s SEC filing describes his $250 million counteroffer as “essentially the same” as Starboard’s but at a lesser cost to the restaurant company.

Schnatter could buy more stock to boost his stake, but he faces a “poison pill” that was implemented last year to prevent him from amassing too many shares. The poison pill is set to expire in July.

Shareholders cheered the investment Monday, sending the stock up almost 9 percent, to close at $41.97.

Smith pulled off a coup at Darden Restaurants in 2014 by replacing the entire board of directors and then pushing for culinary changes, including selling more alcohol and better-tasting bread sticks at Olive Garden.

“Papa John’s has always stood for higher-quality pizza, and we believe Papa John’s has a strong foundation, with the best product in the space and a strong franchisee and customer base,” Smith said in announcing the deal.

“We see tremendous potential for the company both in the US and internationally,” Smith said.

Papa John’s has been suffering from stagnating sales amid fierce competition from other fast-food pizza chains.

New York Post – Subway’s Arbitration for Minor Infractions Is Out of Control: Franchisees

The restaurant business is messy — but try telling that to Subway Restaurants, which is being accused of going after franchisees for minor infractions, like smudged glass, in an effort to put them out of business.

Mom-and-pop franchisees of the nation’s largest fast-food chain claim they’re under attack from an army of lawyers and store inspectors who are pressuring them to shutter or sell their stores, according to sources and court filings.

At the heart of the controversy is a 700-page-plus operations manual, which dictates everything from what oven temperatures to use to how to display vegetables.

“No one can comply with that,” Ohio lawyer Mark Shearer said of the manual. “[Celeb chef] Gordon Ramsay can’t comply with this.”

The Milford, Conn., company uses the manual to ding franchisees during monthly inspections for violations that can then put them in jeopardy of breaching their licensing agreements, according to sources and court filings.

In the case of Shearer’s client, Jack El Turk, who runs a Subway in Brook Park, Ohio, the company’s inspections led to complaints of “smudge marks on the glass in the dining room” and “coats and purses in the backroom,” according to court papers filed by Shearer.

 

In some cases, dinged stores are sold to Subway’s own development agents — the very same people who direct the monthly inspections, according to sources and court filings.

“My clients were targeted because sometimes they liked the store’s revenue and wanted the store for themselves,” Shearer told The Post, echoing his statements in a recent court filing about an Ohio franchisee who was allegedly forced out by a development agent “attempting to acquire restaurants in the territory.”

A Subway spokeswoman said the monthly inspections “are ensuring the high standards demanded by us and expected by guests are met.”

“If a restaurant is not meeting the requirements, the brand first makes every effort to work with the franchise owner to fix the issues,” she said.

But the accusations of an uneven playing field come at a time when the company known for the $5 footlong is flooding franchisees with legal actions.

The company took 955 actions against franchisees in 2017 and 718 last year. Most of the actions were through arbitration, which means the reasons behind them were not disclosed.

Based on the numbers alone, Subway is involved in hundreds more disputes with franchisees than McDonald’s, Dunkin’ donuts, Burger King, Pizza Hut and Wendy’s combined, according to restaurant consultant John Gordon of Pacific Management Consulting Group.

Subway initiated 702 arbitration actions against US franchisees in 2017, Gordon said, compared to one by McDonald’s, two by Dunkin’ and none by Pizza Hut, Burger King or Wendy’s.

“It stands out like a sore thumb,” Gordon said of Subway’s arbitration record.

Critics say the legal actions are tied to the company’s plan to slim down the chain amid sagging sales as competition for healthy and fresh food options grows.

Last year, Subway lost a net 1,108 stores, or 4.3% of total locations. McDonald’s, by contrast, lost a net 122 stores in 2018, or just 1% of its US base, according to regulatory filings.

San Diego Union Tribune – Jack in the Box Shelves Efforts to Find a Buyer, Eyes Refinancing

Jack in the Box, a San Diego institution.

Jack in the Box said Wednesday that it has dropped efforts to find a buyer and will now look to recapitalize the company through securitization.
(Jack in the Box)

San Diego restaurant chain is looking at securitization to change its capital structure

San Diego’s Jack in the Box said Wednesday that it has dropped efforts to find a buyer and instead will look to recapitalize the company through a debt securitization.

The move comes after Jack in the Box began exploring strategic alternatives last November, including a possible sale, under pressure from activist investors.

The fast-food restaurant chain also is facing a backlash from some franchisees, who contend it has failed to provide enough marketing and other support for their businesses. A group that represents owners of the bulk of Jack in the Box’s franchise restaurants has called for Chief Executive Leonard Comma to step down, among other things.

In a statement, the company said it contacted “a broad range of potential strategic and financial buyers, both domestic and international.”

At the same time, it looked at a range of financing options including a new capital structure that included adding debt through the securitization.

Jack in the Box’s board of directors opted for the latter. It expects to replace its existing term loan and revolving credit line with the securitization, which essentially means refinancing the loans with marketable debt securities that are sold to investors.

Once it pays off existing loans, Jack in the Box intends to use some of the proceeds for the debt securitization to repurchase shares, which could boost earnings per share and its stock price, depending on future financial performance.

“With this evaluation behind us, we are dedicated to moving the Jack in the Box brand forward,” said David Goebel, lead director of the company’s board, in a statement. “The Board of Directors unanimously and wholeheartedly supports Chairman and Chief Executive Lenny Comma and the entire management team as we collectively pursue a strategic plan focused on value creation as a standalone company.”

Just how much additional debt the company might take on through the securitization remains unclear. In a statement, Jack in the Box said it is targeting a leverage ratio of about 5 times adjusted EBITDA — or earnings before interest, taxes, depreciation and amortization.

“They’re saying we are going to do a securitization that is going to free up funds for general corporate purposes and for the share buyback and the like,” said John Gordon of Pacific Management Consulting Group, a restaurant industry adviser. “That may or may not be enough to get the activists out of their tailpipe. It really doesn’t do anything to alter the fundamentals of the business.”

At the end of its 2018 fiscal year, the company’s debt ratio was four times adjusted earnings of about $264 million, said Lance Tucker, chief financial officer, in a February conference call with analysts.

Jack in the Box has forecast adjusted earnings of $265 million for the 2019 fiscal year ending in September but aims to boost adjusted earnings to about $300 million in coming years, said Gordon.

“It looks like they are moving from approximately $1.1 billion in debt to $1.5 billion in debt,” with the securitization, he said.

Jack in the Box has been talking about securitization for some time. On the February conference call, Tucker said the move allows the company to tap into low interest rates. He added that the leverage ratio of 5 times adjusted EBITDA would be less than the ratio of some of the company’s restaurant industry peers.

Jack in the Box also reported fiscal second quarter earnings on Wednesday after markets closed. Revenue came in at $216 million, compared with $210 million for the same quarter last year.

Earnings from continuing operations were $25.1 million, or 96 cents per share, compared with $25 million, or 85 cents per share, a year earlier.

The company’s shares ended trading Wednesday up 44 cents at $77.84 on the Nasdaq exchange

Nation’s Restaurant News – John Schnatter Sells $6M in Papa John’s Shares

papa-johns-schnatter-sells-shares.gifJoe Raedle/Getty Images News/Getty Images

John Schnatter sells $6M in Papa John’s shares

The sale accounts for approximately 1.1% of his total holdings

Joanna Fantozzi | May 15, 2019

After stepping down from the Papa John’s International Inc. board in March following a settlement with the pizza chain, the company’s controversial founder and former CEO John Schnatter has sold 114,061 Papa John’s shares, worth approximately $6 million, or 1.1% of the total 9.9 million shares he owns, according to a May 10 SEC filing.

Schnatter still owns more than 30% of the company’s total shares.

The move comes just one week after Schnatter enlisted the help of financial advisors to help sell all or part of his 31% majority stake in the Louisville, Ky.-based pizza chain. Although the shares represent just a tiny fraction of the total stake Schnatter has in Papa John’s, he has indicated that this will not be the only shares he sheds.

“Based on his analysis of, among other things, investment considerations, economic conditions and public disclosures made by the Issuer, Mr. Schnatter may sell, trade or otherwise dispose of more or less of his Common Stock in the Issuer in the public markets,in privately negotiated transactions, in registered offerings or otherwise, consider and/or implement various alternatives to maximize the value of his investment in the Issuer, or take any other lawful action he deems to be in his best interest,” the original SEC filing stated. “Mr. Schnatter has solicited the advice of financial advisors regarding a possible disposition of all or some of his common stock in [Papa John’s].”

Schnatter originally stepped down as CEO in December 2017 following controversial comments during an earnings call in which he blamed NFL protests for Papa John’s struggles. Following last summer’s reports of racist language and behavior, he resigned as chairman. After more than a half a year of legal battles, Schnatter and Papa John’s have all but completely cut ties.

John Gordon, analyst at Pacific Management Consulting Group said the sale likely represents a small fraction of what Schnatter might try down the line:

“I believe the small stock sale by John is an attempt to test how much the market would react if he eventually dumps his shares,” Gordon said. “He has a duty not to harm the company … and his own share value. So, just a little check.”

Both Papa John’s and a representative for John Schnatter declined to comment on the sale.

As of March 31, Papa John’s has 5,336 locations worldwide.

Contact Joanna Fantozzi at joanna.fantozzi@informa.com

Follow her on Twitter: @JoannaFantozzi

Restaurant Finance Monitor – Can Franchisees Ever be Satisfied?

Can anything be done to quell several recent franchise upheavals?  Take the public shaming at Jack in the Box.  In a letter dispatched by the National Jack in the Box Franchisee Association, franchisees called for the ouster of management, including Jack in the Box CEO and Chairman of the Board Lenny Comma.

The association griped company leadership coddled Wall Street investors at franchisee expense.  “We need leadership with a strategic vision for the future and a plan to drive transactions, rather than the current management actions that makes JACK appear to be an attractive investment to the Street,” complained NFA official and franchisee Kevin Townsend in a press release issued late last month.

Read more

Restaurant Business – Why Do Struggling Chains Always Turn To Franchising?

Companies with steeply falling sales frequently turn to franchisees to turn stores around. RB’s The Bottom Line examines whether this is a good idea.
Photograph: Shutterstock

the bottom line

Fuddruckers hasn’t exactly set the world on fire lately. Same-store sales in the burger chain’s fiscal second quarter declined 5.3%, parent company Luby’s Inc. reported this week.

And that was an improvement. Same-store sales in the first quarter declined by 11.2%.

Not surprisingly, the company is refranchising. Fuddruckers currently operates 54 company stores, following 14 closures over the past year and after the sale of five locations in San Antonio earlier this year. Franchisees operate another 102.

Refranchising has been a common strategy in the restaurant business for the past couple of decades, as executives embrace an investor-friendly and more profitable “asset light” business model.

But they’re really common when systems struggle, often coming across as a last-ditch rescue effort to keep chains afloat.

“They do it because they don’t have a better alternative,” said John Gordon, a restaurant consultant out of San Diego.

Famous Dave’s announced plans to refranchise its company stores in 2017, for instance. Those company stores had produced 13 straight quarterly same-store sales declines when it announced the plan.

Papa Murphy’s, which had employed a strategy of buying back struggling franchisees, after its 2014, began selling them back in 2017.

Steak ‘n Shake announced plans to refranchise all 415 of its company-owned restaurants last year, after its same-store sales turned south for the first time in nearly a decade. It has closed 31 locations this year to “prepare” those locations for incoming franchisees.

Refranchising isn’t necessarily a bad thing. Oftentimes, companies are simply bad at operating restaurants and better at franchising. And franchisees can do a better job of running the locations.

That was clearly the case when Burger King sold off all of its company restaurants to franchisees in 2012 and 2013. Many operators simply fixed up poorly operated restaurants and yielded improved profits.

“Just because you operate restaurants doesn’t mean you have an operating culture,” Kevin Burke, managing partner at Trinity Capital, told me.

Refranchising done right can inject some energy into restaurants while freeing up executives to concentrate on running the brand. The strategy can work, so long as the system focuses on ensuring franchisee profitability and operates the brand well.

When the brand is struggling, franchisees can frequently get stores at low prices because the franchisor is eager to let the restaurants go. The operators buying the units often pick off the best stores that can be more easily turned around, which can leave the franchisor closing weaker stores—Fuddruckers has been closing unprofitable stores for the past year, after all.

Still, such strategies can sap the credibility of the refranchising model when they’re done so frequently by companies desperate for a turnaround.

And just because franchisees are willing to take the risk of buying such stores doesn’t mean they are making a good decision.

Gordon pointed out that when an operator buys up a store that is losing money, it not only has to get that store to basic profitability, it has to generate enough profits to pay the royalty payment, which is typically about 5%.

And let’s not forget that many of these companies buying up stores are borrowing money to do so.

But the simple fact is that, if running stores were a more profitable venture, then more companies would seek to operate more stores.

And when restaurants are less profitable, companies seek to get out of it and hope someone else can do a better job. They often can, but sometimes they can’t.

Nation’s Restaurant News – 2018 Top 200: Deal-making alters company rankings

Merger-acquisition landscape remains attractive into 2018

Ron Ruggless | Aug 22, 2018

This is part of the Nation’s Restaurant News annual Top 200 report, a proprietary ranking of the foodservice industry’s largest restaurant chains and parent companies.

Mergers and acquisitions again changed the complexion and makeup of this year’s Nation’s Restaurant News top foodservice company rankings, and the deals continued into this year as well.

Merger and acquisition activity in the census, which included 2017 deals, crossed segments and size, ranging from JAB Holding Co.’s $7.5 billion buyout of fast-casual bakery-cafe brand Panera Bread Co. to Darden Restaurants Inc.’s $780 million purchase of Cheddar’s Scratch Kitchen from private-equity owners.

And the activity has continued into 2018, with Roark Capital Group closing in February on the $2.9 billion acquisition of casual-dining Buffalo Wild Wings Inc. by Roark-affiliated Arby’s Restaurant Group Inc.

“In my view, the Panera buyout by JAB in April 2017 and the Buffalo Wild Wings purchase by Roark, via its Arby’s entity, in November 2017 were highly significant and stand out among the large amount of merger and acquisition activity of late,” said John Gordon, principal in the San Diego, Calif.-based Pacific Management Consulting Group.

Scott Olson/iStock/Getty Images Plus

JAB Holding Co.’s acquisition of Panera Bread was the largest deal among many in 2017 tracked by Nation’s Restaurant News.

And Gordon said still favorable, though increasing, interest rates and a hunger for growth on a global scale are helping fuel the merger and acquisition activity.

“The general driving forces behind restaurant M&A remain robust, principally because larger strategic buyers look to acquire brands that have been established and can grow more quickly than building them from square one,” Gordon explained.

“In addition, the cost of debt, while a bit higher in 2017 and 2018 than the very-low cost years prior to 2016, is still favorable,” he said.

Courtesy of Cheddar’s Scratch Kitchen

The acquisition of Cheddar’s contributed to Darden’s double-digit growth in estimated Latest-Year revenue.

Private investment firms are also adding money to the M&A fire.

“Many private-equity funds have available funds from investors seeking a return,” Gordon said. “Also there has been the growth of the global restaurant-brand integrators — like JAB and Restaurant Brands Inc. [backed by the 3G firm] — following in the pathway of Yum! Brands, to gain worldwide scale and scope.” JAB is based in Luxembourg and RBI in Oakville, Ontario, near Toronto.

The biggest M&A deal of 2017 was the JAB acquisition of St. Louis, Mo.-based Panera Bread, which took the longtime publicly traded company into private hands.

Gordon said that deal “was significant because it displayed further development of the JAB Group as a huge privately held restaurant and coffee/consumer products player, as well as recognized the goal of [Panera] CEO Ron Shaich to avoid the rigors and ‘shortsighted nature and demands’ of stock activists.”

Gordon said Panera and Buffalo Wild Wings were at different positions in their businesses at the time of the deals.

“Panera was very strong and growing at time of acquisition,” he said.

Whereas “Buffalo Wild Wings was in a downturn and was in the immediate aftermath of a painful board proxy battle. The long-time CEO had opted to retire and faced a leadership and market momentum void. It was the just in time solution, in my opinion.”

Merger and acquisition impact on company foodservice revenue in the Latest Year was considerable. Orlando, Fla.-based Darden Restaurants, for example, in its Latest-Year saw estimated U.S. revenue increase by 12.7 percent, with much of that gain from a projected $664.1 million in sales from earlier purchase Cheddar’s.

Among other notable foodservice mergers and acquisitions that have or will have an impact on company revenue:

  • Paris-based Sodexo, after the close of its Latest Year in December 2017 acquired the Centerplate contract-management firm from Olympus Partners for $675 million. Centerplate, with estimated Latest-Year U.S. foodservice revenue of about $790 million, could significantly bolster Sodexo’s balance sheet going forward.
  • JAB, in addition to its Panera acquisition, acquired through an affiliate in October 2017 the 270-unit Bruegger’s Bagels bakery-cafe chain from Groupe Le Duff S.A.-affiliate Le Duff America Inc. The company also acquired, through its Panera LLC affiliate, the 304-unit Au Bon Pain bakery-cafe chain held by LNK Partners LLC. And in May of this year, it agreed to acquire Pret A Manger, a London-based bakery-cafe chain, with about 530 locations worldwide, including about 90 in the United States.
  • Houston-based Fertitta Entertainment Inc. in August acquired for $57 million the Joe’s Crab Shack and Brick House Tavern & Tap chains out of bankruptcy from J.H. Whitney affiliate Ignite Restaurant Group Inc.
  • Private-equity firm Olympus Partners in January sold Overland Park, Kan.-based NPC Restaurant Holdings Inc., a franchisor of Pizza Hut and Wendy’s restaurants in the United States with reported Latest-Year revenue of $1.36 billion, to a privately owned joint-venture group that included Los Angeles-based Eldridge Industries.
  • Jack in the Box in March completed its sale of Qdoba to Apollo Global Management in a $305 million cash deal. Affiliates of New York-based Apollo, which also owns the parent companies of the Chuck E. Cheese’s and Peter Piper Pizza dining-and-entertainment brands, gained more than 700 owned and franchised Qdoba restaurants in the U.S. and Canada. In fiscal 2017, the Qdoba brand generated systemwide sales of more than $820 million.
  • Restaurant Brands International, parent to the Burger King and Tim Hortons brands, completed its $1.8 billion acquisition of publicly traded Popeyes Louisiana Kitchen Inc. in March 2017, adding more than 2,600 quick-service restaurants to it portfolio. RBI’s Latest-Year revenue includes an estimated $184.1 million in post-acquisition U.S. sales and franchising income from Popeyes.
  • Irving, Texas-based Del Frisco’s Restaurant Group Inc., parent to the Double Eagle, Del Frisco’s Grille and Sullivan’s Steakhouse concepts, in June acquired for $325 million the Norwalk, Conn.-based Barteca Restaurant Group and its 15 Barcelona Wine Bar and 16 Bartaco full-service restaurants. Barteca, as a freestanding company, had reported Latest-Year U.S. foodservice revenue of $128.2 million.
  • Private-equity deals continued to alter the parent-company landscape, including several over the past year by New York-based Sentinel Capital Partners LLC. In December, Sentinel   acquired from Centre Partners Management LLC the 531-unit Captain D’s and 49-unit Grandy’s limited-service chains. The Sentinel acquisition was offset by the February sale of the 350-unit Huddle House family-dining chain to Elysium Management and the April 2017 sale of Checkers and Rally’s Hamburgers chains, with a combined 850 units, to Oak Hill Capital Partners for $525 million.
  • Cerberus Capital Management L.P. in January 2017 acquired out of bankruptcy the Garden Fresh Restaurant Corp., parent of the Sweet Tomatoes and Souplantation buffet chains, previously controlled by Sun Capital Partners. Those chains previously were controlled by Sun Capital Partners. In a quick flip, Cerberus, in August 2017, sold Garden Fresh to investor groups led by Perpetual Capital Partners, which now owns controlling interest.

Restaurant Business – A good summer for restaurants, but not for chains

July sales spiked 9.7%, but large brands are still seeing traffic problems, thanks perhaps to “chain fatigue.”

This has been a good summer for the restaurant industry. According to federal retail sales data, U.S. restaurant sales jumped 9.7% year over year on a seasonally adjusted basis.

That continued a recent surge. Sales rose just 3.8% in April and have accelerated every month since then—potentially signaling that consumers are opening their pocketbooks as their taxes decrease and their finances improve.

But there’s one problem: Restaurant chain sales, at least for now, don’t appear to be keeping pace.

Same-store sales in July, according to the monthly Black Box Intelligence Index, rose just 0.5%. And same-store traffic has been down all year long, including a 1.8% decline in July. And the monthly Technomic Chain Restaurant Index was also weak in May and June even as total industry sales seemed to jump.

Blame what John Gordon, a restaurant consultant out of San Diego, calls “chain fatigue.” “Guests have always had the desire to try something new, to enjoy a quality experience, and to be entertained,” Gordon said. “We have chain restaurant unit overload that leads to chain restaurant fatigue.”

“The overall experience doesn’t seem to be good enough right now,” he added. “But it can be fixed.”

Chain fatigue?

The annual growth in restaurant sales has spiked the past three months.

Restaurant Sales Monthly Annual Change

Source: U.S. Census Retail Sales, Food Services & Drinking Places, Seasonally Adjusted

Some do question the data itself. Technomic, a sister company of Restaurant Business, does not pay much attention to the federal data over concerns about the limited number of sources for its calculation.

And a 9.7%, annual increase in sales should be reflected more in chain performance.

Yet, for the most part, same-store sales in the second quarter were modest and chains such as McDonald’s, Starbucks, Chipotle, Shake Shack, Dunkin’ Donuts and others reported lower traffic.

Quick service and fast casual chains’ same-store sales averaged under 1.5% in the second quarter. That wasn’t enough to match the 2.8% annual increase in menu prices so far this year—meaning that these chains’ traffic fell.

If consumers were rushing out to their local restaurants the past three months, more of those publicly traded companies would have reported stronger same-store sales.

Still, the discrepancy backs a growing contention among many industry observers that consumers are shifting more of their spending toward small chains and independents that are not typically captured by major indexes.

And there are more chains now than there was even five years ago. Consider that chains such as Shake Shack, Mod Pizza and Blaze Pizza, among others, were barely registered if they existed at all five years ago.

“When you think of how many new players are out there, especially in segments like fast-casual that we didn’t even have a few years ago, there are so many players in there, and some of them are becoming the favorite restaurant of a lot of people,” said Victor Fernandez, vice president of insights and knowledge at Black Box parent company TDn2K.

“If you have six favorite chains and now you have seven, now you lose that much traffic.”

Fernandez noted, for instance, that more chains are doing better this year. He said that half of restaurant chains his company surveys have better same-store sales than a year ago. The year before, that number was just 36%.

And consumers do have a lot of choices in their restaurants. The number of locations in the U.S. has jumped 16% over the past decade, according to federal statistics.

With so many choices, in addition to convenience stores and grocery store prepared food, consumers might be spreading their dollars.

“The number of options are so big that the overall sector is growing at a rapid pace, but chains are not capturing that same spike,” Fernandez said. “The dollar is getting diluted among more locations.”

The Union Tribune – Jack in the Box franchisees press company board to replace CEO

Jack In The Box franchise holders that own 2,000 restaurants are calling for the replacement of the company's executive management.

A group of Jack in the Box’s franchisees is calling for the ouster of Chief Executive Leonard Comma, claiming the San Diego quick service restaurant brand is not spending enough to support them.

The National Jack in the Box Franchisee Association – comprised of 95 owners of roughly 2,000 of the Jack in the Box’s 2,240 locations – published a letter Tuesday calling for its board of directors to replace Comma and the current leadership team.

Michael Norwich, chairman of the association and owner of 14 Jack in the Box franchise restaurants, cited a lack of corporate resources for marketing and other support services – which is causing “unsustainable losses in sales.”

“Management is thinking so quarter to quarter right now,” said Norwich in a phone interview. “That is what is really hurting us.”

“There are two ways to get the value in the business – driving profitable top line sales or cutting expenses, and they have really focused on the latter,” he said. “We don’t even have a chief marketing officer at the moment. There have been key positions in the marketing department that have gone unfilled.”

This summer, Chief Marketing Officer Iwona Alter left the fast-food chain after 13 years with the company. One of its advertising agencies also is no longer working with the firm.

“There has been a lot of turnover,” said John Gordon, head of San Diego-based restaurant industry advisory firm Pacific Management Consulting Group. “When you have the CMO go and do not have a replacement, and the ad agency goes before the CMO, that pattern tells me there is some stress.”

In a statement, Jack in the Box said it has worked closely with the National Franchisee Association leadership over the past year.

“We have always been open to their constructive feedback and have worked to address any legitimate concerns,” said the company. “Importantly, we believe the viewpoints expressed today by the NFA leadership are not reflective of the entire franchise community.”

The franchisee group cast a “no confidence” vote in Jack in the Box’s executive team at its annual meeting in July, according to the letter. It has hired Robert Zarco, a Miami-based trial lawyer with experience in franchisee rights, to represent restaurant owners in the dispute.

The public letter calling for replacement of the CEO is a surprising step for Jack in the Box franchisees, many of whom have operated franchises for a long time, said Gordon, the restaurant industry consultant.

“This is nuclear in the franchise world,” he said. “Jack in the Box, we love it here in San Diego. It is our home brand. But it has always had trouble growing outside of the West Coast.”

Under pressure from activist shareholders, Jack in the Box sold off its Qdoba Mexican restaurants recently. It also has been transforming company-owned restaurants into franchise locations.

Although Jack in the Box posted better-than-expected earnings per share and revenue in its most recent quarter, the gain was driven by a lower tax rate and share repurchases. Same store sales growth — a key metric in the restaurant business — was only 0.5 percent.

Quick service franchise restaurant companies typically spend about 4 percent of revenues providing services and support to their franchisees, said Zarco. With Jack in the Box, the target for this type of spending this year is 1.8 percent, he said. “That is a dramatic reduction.”

Zarco claims he has been trying to engage in direct discussions with Jack in the Box’s board of directors, but at this point has been unable to do so.

New York-based activist investor Jana Partners, which owns 7.5 percent of Jack in the Box’s stock, told Bloomberg News in an email that it shares the franchisees’ concerns about Jack in the Box’s performance and the lack of urgency in addressing it. “We appreciate their input and will incorporate it into our ongoing dialogue with the company.”

Shares of the company closed trading Tuesday up 16 cents at $84.22 on the Nasdaq exchange.

John A. Gordon – Why Is Restaurant CapEx Spending Assistance To Franchisees On The Upswing?

Some interesting developments in restaurant franchising are becoming a reality even in the “asset light” restaurant space. It turns out that it does take money to make money in the future.

The requirement for franchisee capital spending (CAPEX)—the big-ticket construction, equipment and information technology outlays—is often underestimated and almost always under reported. These outlays traditionally have been the franchisee’s responsibility. A few chains, like McDonald’s (MCD) and Tim Horton’s (THI) Canada, kept real estate and construction in house and initially corporately funded it, with franchisor cost recovery occurring over time by the franchisee paying at or above market rents. Later, the McDonald’s franchisee must pay for remodels, as well as the more costly total rebuilds or relocated units. Typically the franchisee remains responsible to pay for all future remodel and maintenance CAPEX outlays. But this is relatively rare, mostly the franchisee funded the capital spending via friends and family, bank debt, partners and injected cash. That was doable by some, especially after the Great Recession as interest rates remained very low.

This “franchisee sole responsibility to fund” reality has begun to change in some brands over the last few years out of necessity.

First, as the utility and success of technology backed loyalty, delivery and digital interfaces have been pioneered by Panera (PNRA) , Starbucks (SBUX) and Dominos (DPZ), the digital level of complexity has been raised. Restaurant franchisors have come to understand that an IT backbone would have to be built and maintained centrally by brand headquarters.[1] It would have been unworkable for there to be thousands of servers among a brand’s franchisee units all maintained separately—the cost to implement would have been impossibly expensive and many of the systems would be built differently and likely couldn’t talk to one another.

Another issue: the level of capital expenditures necessary to remodel restaurants and add new brand mandated systems and equipment has become big numbers. Our calculations show that depreciation expense—the typical proxy for capital spending that is a tax deduction and a non cash expense—isn’t enough to provide a fund. The actual outlay of cash required is greater than that. Even if restricted cash is available to pay for future remodels and upgrades, the effect of inflation on construction and equipment would require even more funds than were originally earmarked to get the same purchasing power. Keep in mind that most franchisees have a store development agreement in place, whereby building new stores or purchasing new stores competes for funding with remodels. Bank debt can partially suffice unless lending covenants are already stretched.

Finally, franchisees are typically in ‘wait and see’ mode on remodels and new sales platforms until the franchisor executes it themselves and proves that it works. That builds in delays–time of implementation lags. If the franchisor has company stores (some do not, such as Dunkin Brands (DNKN) and Subway, for example), it takes time for brands to get proof to market and get the franchisees on board. This has happened with all of the leading franchisors—McDonald’s, Wendy’s (WEN), Burger King (QSR), Sonic (SONC) and many others.

As a result, some franchisors have taken the lead in making co-capital investments with franchisees to jump start future progress. A partial list follows:

  • Since McDonald’s (MCD) owns most of its real estate, it can justify partially funding franchisee costs. This occurred in 2008/2009, with the McCafe co-investments (about $150K per store), and then in 2016/2017 with its Experience of the Future Investment (about $6 billion in total franchisor/franchisee investment over 2018-2020, with the franchisor funding about 55% of that.[2]
  • Via its parent YUM Brands (YUM), Pizza Hut made a basket of investments in 2017 ($130M)[3]and 2018 ($200M)[4] to enhance restaurant operations, marketing and remodeling. This was done to ease the burden on franchisees and to ensure improvements were implemented more quickly.
  • Dunkin Brands (DNKN) recently set aside about $65M for CAPEX and equipment to help fund test store’s expansion to its Next Generation store types.[5]

There are several actions required of both franchisors and franchisees to make these business issues work for all.

First, the franchisor must take the lead to timely source and test lower cost remodels and new store footprints. They are the brand steward and are responsible contractually to define brand standards. Many franchisors are slow to prioritize this, often prioritizing central national marketing expense, share buybacks and debt service requirements. The size, look and location of the remodeled restaurant is critical. A capital investment such as building and locating a new store is costly. If the wrong site is picked, it is almost impossible to reverse the effect of that missed opportunity”

Additionally, better scorekeeping is necessary. Much greater visibility to fully loaded (i.e., with capital spending and debt costs fully allocated) franchise store economics is required. Some franchisees don’t report their capital spending and capital spending data; some franchisors are afraid to know and pretend they don’t have that data. Tracking EBITDAR or EBITDA is of only so much use if the CAPEX and debt service costs can’t be seen.

Finally, franchisees need to ask and document their needs and wants in an organized way. Through either franchisee associations or via brand advisory councils, organized requests and backup needs to be presented. There is strength in numbers—some franchisors prefer to deal with individual franchisees head to head to avoid group pressure.

[1]Some franchise brands have implemented a small fee on loyalty and digital transactions sales to fund this outlay. Dominos and Subway are examples.

[2]Investor’s Business Daily, Q4 MCD Earnings call discussion, January 30 2018

[3]Nation’s Restaurant News, May 3 2017. In 2015, YUM noted it invested $180M for KFC requirements.

[4]https://investors.grubhub.com, February 8 2018.

[5]Restaurant Business Online, July 28 2018

USA Today – Subway $5 Footlong is going away, but paninis may be coming

, USA TODAY Published 5:58 a.m. ET Sept. 10, 2018 | Updated 8:00 a.m. ET Sept. 14, 2018

Subway Restaurants’ $5 Footlong jingle is the kind of ear worm that’s hard to get out of your head, but now you might have to.

The iconic sandwich may no longer be at your local restaurant. Trevor Haynes, current CEO of the Milford, Connecticut, company, told USA TODAY in an exclusive interview that starting this month, each franchisee will be allowed to decide whether to sell the sub that is so famous.

Or infamous.

When the chain brought back the $5 Footlong last winter after a years-long absence, many franchisees were irate. They complained loudly of the slim margins they earned off of the discounted ‘wich, and according to Haynes, the company – whose restaurants are 100 percent franchised – listened to the gripes.

“How do we help our franchises with more of a regional value message, so they’re able to (have) a value proposition that fits with their economic model,” Haynes said. “If you look at California, there’s a very different cost of business than in Arkansas.”

The 53-year-old privately-held company, originally called Pete’s Super Submarines, had $16.8 billion in global sales in 2017, thanks to some 44,000 restaurants worldwide, including 25,000 in the U.S. Subway, which has put about 1,300 stateside locations on the chopping block in two years, declined to share growth percentages or customer traffic numbers.

Haynes, 47, became CEO this summer after Suzanne Greco, sister of Subway co-founder Fred DeLuca, retired. The Australian has worked for the company for 12 years on three continents and inherited a brand still smarting from the sex and child-pornography scandal of former company spokesman Jared Fogle.

The demise of the $5 Footlong is just one of the differences customers will notice at Subway. Here are four other changes Haynes shared with USA TODAY.

Other cheap eats are available

Remember that some franchisees may choose to retain the $5 Footlong, but Subway is encouraging different markets to try their own value options. For examples, customers in San Francisco can now buy a $3.99 6-inch sub.

“Affordable food is what we’ve always stood for,” Haynes said. “It’s not just about one price point.”

Restaurant consultant John Gordon of Pacific Management Consulting Group questions how low Subway can drop its prices, due to its main meats – ham, roast beef and chicken.

“Those are generally more costly on a per-pound basis than the ground beef that the burger guys use, so Subway has a hard time discounting,” he said. “There’s a tremendous amount of franchisee disruption and negativity regarding this discounting … They take it in the shorts. Their average check goes down.”

So what about wacky stunt foods, so beloved by other fast-food brands such as Starbucks and Taco Bell?

“Maybe off-the-menu-type products or Unicorn-type drinks at some time, but it needs to be profitable and successful for our franchisees,” Haynes said.

The chain is testing some more exotic tastes. Haynes said they’re working on what’s been dubbed Firebird chicken, a spicier rotisserie-type poultry, and guajillo steak.

Plus, 200 San Diego locations are testing a quartet of new sandwiches, which the chain refers to as “regional flavors” – a Steakhouse Melt (shaved steak, American cheese, onions, green peppers, spinach and Sub Spice), a California Club (oven-roasted turkey, fresh avocado and Mustard Seed Spread), a Provencal Tuna Melt (tuna, cheese, tomatoes, spinach and Provencal herbs) and an Italian Grinder (pepperoni, Genoa salami, Black Forest ham, onions, Signature Herb Garlic Oil and cracked black pepper).

New beverages include Watermelon Agua Fresca and Passion Fruit Agua Fresca.

And while the large, long rolls are a key part of Subway sandwiches, the company is now experimenting with paninis in California.

They’re not the brand’s first foray into alternative breads. In March, Subway launched a line of wraps, which Haynes called “extremely successful for our brand.” Subway had tried this carb form in in 2004, followed by a tortilla option in select markets three years later.

Gordon doesn’t expect much from Subway’s move to new tastes, though, explaining, “Bold flavors and spices have been a big deal in restaurants for at least five years. They totally missed that. They were asleep at the switch.”

He said the $5 Footlong was a hit in 2007-2008 due to the recession and the healthy image the veggie-heavy subs had at a time when Americans began to care more about what they ate. Then, crickets.

“That was 10 years ago. Nothing has happened at Subway essentially in 10 years,” he said.

Gordon gives Subway a thumbs-up for its new wraps but advises moving away from bread and starting to serve meats shaved and stacked deli-style, if the chain wants to avoid fellow sub chain Quiznos’s downward spiral.

You want how many pickles?!?

They key to Subway’s continued success is underscoring customers’ ability to pick precisely what they do and don’t want on their sandwiches, according to Haynes.

“With other brands, it’s very much packaged formats. We customize. You can add as many tomatoes or olives as you want,” he said. “We have millions and millions of combinations and flavors.”

Aaron Allen, founder of the Orlando, Florida-based eponymous global restaurant consulting firm, is unimpressed by Subway’s continued emphasis on customization.

“It’s certainly in the playbook of many more (fast-food) restaurants than it was previously,” he said, explaining that with an increasing number of chains focusing on self-ordering – both at in-store kiosks and online – the approach becomes even less unique to Subway.

Subway also is bumping up against increased competition from sandwich upstarts and their step-sibling, the hamburger joint.

“We need to stick to what we know and do it very, very well. We can’t be distracted,” Haynes said. “Burger chains are big competitors. We need to make sure we’re playing in that arena as well.”

The company records more than 7 million transactions globally every day, he added.

Don’t just Instagram the food

Subway restaurants are being redesigned. The bright, fresh, green palette is vegetable-inspired, and the decor overhaul for everything from freestanding drive-thru locations to the kiosks will “start in earnest” next year, Haynes said.

The cost is about $40,000 for a typical 1,200-square-foot store.

But Allen wonders how many franchisees, more accustomed to makeovers every five to seven years, will be happy about spending money to spiff up their stores.

“It’s one of the lowest price-point franchises to get into,” he said. “But it also makes it hard to refresh and modernize. It’s difficult to get the franchisees to buy into that.”

Even though the U.S. is famous for its burgers and fries, you won’t have the same fast food experience in every state.

Follow USA TODAY reporter Zlati Meyer on Twitter: @ZlatiMeyer

Wray Executive Search – Restaurants and Weather: Deeper Thinking is Required

john-a-gordon

by John A. Gordon, Principal and Founder of Pacific Management Consulting Group

We heard it quite frequently mentioned last quarter in restaurant earnings calls: the effect of weather. Any restaurant veteran knows it matters, but how much and over what period of time? Weather does matter, but it impacts unequally and sometimes in short bursts.

Research says that retail spending is positively influenced by sunlight, lower humidity, higher barometric pressure and higher temperatures. [1] 2.3% of retail sales levels are said to be influenced by weather. [2] One alternative now present is online sales, which jumps during bad weather, which can be both good and bad for restaurants.

Bad weather can shut down virtually outside all human activity. Other than running out of food at home, we know there is no biological survival imperative to eat at restaurants; it is typically both impulse and planned occasion driven in nature, with both kitchen replacement and social/entertainment as prime motivations. But it represents superior convenience and positive for socialization. Over the last several decades, the ratio of food spent away from home has surpassed food spending at home. That is great for us; the problem is that spending is spread over more and more establishments in the US.

Consider the following recent restaurant weather examples:

  1. An international QSR operator with a mix of both hot and cold beverage sales mix has noted in the past that it the US has been too hot in the winter and too rainy or cooler in the spring or summer months. One winter there was a stretch of 60-degree highs in the northeast that was considered “too hot”. This was said that despite the mix of beverages; now the menu mix is so balanced that a drink for any kind of weather is obtainable, and that virtually all of their sales came from the pre-lunch period, when temperatures were cooler in the day. Business can’t be both ritualistic and impulsive at the same time.
  2. From my own review of store sales numbers, restaurant concepts with primarily a cold drink base (think, Jamba Juice (JMBA) and the ice cream and yogurt players) have a legitimate weather gripe. For example, the Jamba unit at Boston Logan Airport will be busy even early in the day but a walkup Jamba Juice unit in Honolulu will struggle to get traffic on a windy, cooler winter day. Their menus are so limited that there is no weather alternative.
  3. Casual dining operators with outdoor patios can be affected by either too hot or too cold weather as both conditions have noted in the past. Other casual diners might be positively impacted from bad weather in that poor weather cuts down on other options and it becomes a great use of time to go to an eatertainment venue such as Dave and Buster’s (DAVE), as an example.
  4. During one of the frequent snow and cold snaps in the northeast this year, CNBC interviewed a steakhouse operator within walking district of the Financial District in Manhattan. His weather analysis was that when the daytime high was around 20 degrees or less, or if there was snowfall, that was the “kill business” zone.
  5. Dominos ‘s has noted they vastly prefer rain and snow and national distractions where people might cluster at home. Casual diners might prefer a summer rain but not a winter rain.
  6. Sonic (SONC) may also have legitimate weather gripes, with a portion of their sales mix drive in based. They detailed their projected Q1 2018 impact by time zone, as the following shows:

JGordon1

There are several good weather analytics firms, such as Planalytics, The Weather Channel and more. I’d suggest that restaurant prediction models be more calibrated over time to account for the presence of drive-thrus, delivery, dense urban/CBD walk-in store mix (that is more impacted by the potential to walk in) and menu diversity as explanative factors.

Restaurant executives on the spot to explain what has happened in and why should be wary to overuse the weather factor. After all, almost all of the comparisons are versus prior year, and weather happens and is embedded in early month’s results. Unlike the retail demand for a winter coat, restaurant desire is more evenly spaced. Too much mention of weather blends in with empty earnings call words such as “it performed up to our expectations” and “we’ll make our projection via second half of year excessive performance”.

[1]  The Effect of Weather on Consumer Spending, Journal of Retailing, 2010, No. 17, 512-520.

[2]  Weathernomics, The Weather Channel, 2015.

Restaurant Business – Franchisors need to say more about franchisee finances

The bankruptcy filing of large Applebee’s franchisee shows that franchisors don’t reveal enough of their operators’ financial health, says RB’s The Bottom Line.

The Bottom Line

By Jonathan Maze on May 10, 2018
Earlier this week, my colleague Peter Romeo wrote about the bankruptcy filing of RMH Franchise, the 163-unit Applebee’s operator, the chain’s second-largest.Such a filing was not quite unexpected. Applebee’s same-store sales plunged in the past two years before its recent, modest recovery, following a significant operator investment in kitchen processes in 2016.Indeed, RMH pretty clearly blames those moves for many of its problems.“The franchisor has had four presidents since the beginning of 2014,” RMH CFO Mitchell Blocher said in one bankruptcy court filing this week. “Throughout this period, different franchisor-mandated initiatives led franchisees … to incur significant capital expenditures, further straining liquidity. These initiatives included converting existing grills to new wood-fired grill platforms in all restaurants and a new ad campaign, neither of which were received favorably by customers …”Still, the bankruptcy filing illustrates a big problem when it comes to the financial reporting of restaurant franchises: the vast majority of them do not include any information about the financial health of their franchises in securities filings.

For the most part, franchises will report royalty or ad fund income, but little that provides an indication of overall operator health.

Given that many publicly traded restaurant companies are relying more and more on franchisees to operate their restaurants, it would be good to know how healthy that franchisee base is, would it not?

And more than just provide information to analysts, more franchisors should provide some general data in their securities filings that give a good indication of their operators’ overall financial health.

“So many franchisors are so intensely franchised and so intensely asset light, sometimes 95%, sometimes 100%, that the investor is just not informed quickly enough, or at all able to discern what the underlying business fundamentals are,” said John Gordon, a restaurant consultant who has long advocated for more reporting of franchise financial data.

A few brands have reported information on franchise finances over the years. Domino’s, for instance, has long provide operator cash flow, even when that cash flow wasn’t so good. Popeyes, before it was sold to Restaurant Brands International last year, would report franchisee EBITDAR, or earnings before interest, taxes, depreciation, amortization and rent.

McDonald’s and some others will also provide regular updates on the earnings of operators, though not formally.

To be sure, many systems work hard to ensure the financial health of their operators. And even the healthiest system is going to have some franchisees that struggle and close restaurants. Individual market challenges, operator decisions and other factors all play a role in a franchisee’s fiscal health.

But as the Applebee’s situation illustrates, a brand’s overall actions can have a big impact on the health of the entire system. When that system’s same-store sales plunge the rate that its sales did in 2016 and into 2017, that can have a broad impact on operator health.

Dine Brands executives have been talking about their operators’ finances in recent earnings calls, as analysts have pressured them about those issues. As Peter noted in his story, the company said last week that three franchisees are behind on royalty and ad fund contributions—a potential indication of financial problems.

To be sure, all franchises have to publish and make available their franchise disclosure document, or FDD. But the federal government does not require the FDD include relevant information on operator finances—though a large number of systems do report average unit volumes and more progressive systems will provide franchisee earnings data.

But for the most part, FDDs can be big and complex and intimidating, even for sophisticated researchers.

The issue of franchisee health could become a bigger issue in the coming years. Industry same-store sales have been generally weak, especially for casual dining chains. And many systems have refranchised many of their locations, at the request of Wall Street.

To buy these locations, these operators, like RMH, undertook massive amounts of debt. RMH filed for bankruptcy protection with $68.5 million in secured loans, plus another $30 million in unsecured loans. The company used the funds to acquire a number of franchisees and grow larger.

That’s been a common practice since the end of the recession. But, as some of these systems have problems, many of these operators could find themselves behind the financial 8-ball. They could ultimately file for bankruptcy protection or close units or both.

That makes it more important than ever for franchisors to publicly disclose more about the health of their franchisees.

BNN – Freshii’s reach out to Subway is creative, but don’t expect action: Analyst

John Gordon, principal at Pacific Management Consulting Group, joins BNN’s Michael Hainsworth for a look at Freshii’s latest outreach to disenfranchised Subway franchisees and why he believes the move is shrewd but likely won’t be able to see the light of day.

https://www.bnn.ca/company-news/video/freshii-s-reach-out-to-subway-is-creative-but-don-t-expect-action-analyst~1305924

Franchise Today – How to be a Winner Restaurant Franchisor

This week on Franchise Today, host, Paul Segreto, welcomes as his guest, John Gordon, Principal of Pacific Management Consulting Group. Gordon is a finance and economics expert who provides research and niche earnings analysis, management consulting and advisory expertise to those who need to know about franchise and chain restaurants, hospitality and multi-unit retail sector companies. Paul and John will be joined by Franchise Today co-producer, Joe Caruso. The topic of discussion is QSR Franchise Unit Economics and Profitability and what this show title states, How to be a Winner Restaurant Franchisor.