Daphne’s Greek Cafe files for Chapter 11

By Lori Weisberg, UNION-TRIBUNE STAFF WRITER Saturday, January 16, 2010 at 12:04 a.m

Daphne’s Greek Cafe filed for Chapter 11 bankruptcy protection this week, but will continue operating all of its 69 restaurants, including the 16 locations in San Diego County.

The filing came after more than a year and a half of talks with the San Diego company’s lender in hopes of restructuring its loan, said George Katakalidis, chief executive of Fili Enterprises, which owns Daphne’s. He was not successful, however, in securing more favorable terms.

The filing, he said, was necessitated by a breach in loan rules, which required Daphne’s to maintain a defined profit level.

“Our covenant was specific, so when sales dropped, profit dropped, and it triggered the covenant breach,” Katakalidis said. “We have a great business, and we didn’t want this to interfere with the business. Chapter 11 will speed up the negotiation.

“We tried to do this humanely over a year and a half. The macro economy for the last year has been a nightmare, and we’re just saying, enough.”

According to the company’s filing in U.S. Bankruptcy Court in San Diego, its creditors number between 1,000 and 5,000. Fili Enerprises estimates both assets and liabilities as between $10 million and $50 million. The company’s largest creditor is U.S. Foodservice in La Mirada with unsecured claims of more than $1.1 million.

Founded in 1991, Daphne’s has locations in California, Arizona, Colorado and Washington.

In an effort to cope with the ailing economy, Fili closed some underperforming cafes and laid off some of its workers over the last year, Katakalidis said. It also has introduced some new, more affordable menu items, one of which includes a pita sandwich, fountain drink and two sides for under $7.

John Gordon, a San Diego-based chain restaurant consultant, said smaller chains are having a difficult time, in part, because they have a tougher challenge obtaining capital.

“Smaller chain restaurants like Daphne’s that are reliant on one bank or line of credit are particularly vulnerable, especially if they negotiated financing deals in the last three or four years,” said Gordon, a principal with Pacific Management Consulting Group.

By John Gordon, Pacific Management Consulting Group

A growing number of publicly traded companies are nearly 100-percent franchisee owned. After its sale of 66 units to Apple American Group last month, DineEquity is now almost 100% franchised: 95% at Appiebee’s and nearly 100% at IHOP. Other chain restaurants are close: Domino’s is about 95% franchised, worldwide. Several more companies are refranchising, especially in the QSR sector, further increasing franchisees’ ownership.

And all of this franchisee business activity is off the books.

Other than the royalties and fees paid by the franchisees, and supply chain profits (in the case of Domino’s and a few others with captive supply chains), none of these publicly traded companies report franchisee financial results. Some analysts may ask but are always given general responses.

The company and franchisees are separate legal entities after all, and many but not all companies do report franchisee same store sales data: Brinker started doing so this year, and Papa John’s has such displays, for example. But not all do. And almost no one, save McDonald’s in one of its Investor Day presentations, directly proactively presents franchisee profit or cash flow.

For most publicly traded restaurants, a spike in bad debt (unpaid royalties) or net opens/closes is about the only way to divine franchisee and overall system health.

This lack of visibility is unhealthy for investors, franchisors, franchisees, lenders and the markets, overall. Some lenders have already taken the industry to task for such unclear disclosure, and situations of imminent system or brand decline and collapse can be muted.

For example, the deteriorating state of the Arby’s operation throughout 2009 to its being placed for sale in January 2011 could not be been divined other than guesses via the number of closures or bad debt expense. Investors and the market would have been interested.

We propose a better way: once companies hit a tip point, such as 80% of units franchised, they should make a voluntary minimum annual disclosure of franchisee average weekly net sales (not gross sales), and store level EBITDA, excluding franchisee G&A, dividends, debt service and other “below the store line” influences. This could be through the annual investors’ presentations almost all companies compose, or through the SEC 10K/10Q reporting cycle.

We are not proposing reporting franchisee personal shareholder returns or owner’s salaries or any of that. Just the store level data.

It would provide for more visibility for investors, and demystify the process, for lenders and potential franchisees, at the very least.

Every franchisor is interested in getting its royalties paid, and the sales data and a mechanism to audit it, now exists. For companies audited, we bet that their auditors do a representative sample of franchisee sales, now.

Likewise, every bank or lender is interested in EBITDA, and franchisors have or should have visibility to that metric since (1) the franchise agreement may specify it be reported and (2)franchisors typically approve sales and transfers, and thus have that visibility.

This could be reported in the management discussion and analysis section of the 10K (or, if it takes time to accumulate year end data, the Q1 10Q next quarter). With the last update of the SEC MD&A disclosure rules in 2003, unit sales and other statistical measurements can be reported simply.

SEC Rules: the 2003 update to SEC Regulation G made clear the basic standard, that a reporting company shall not make public a non-GAAP measure, that taken with the information accompanying the measure, and any accompanying measure, contain an untrue statement of a material fact, or omits to state a fact necessary in order to make the presentation, not misleading. That is all controllable by the discloser.

We’d suggest the company present two single values, average weekly net sales (weekly gets us out of the 52 v. 53 week problem), and store level EBITDA (as a percentage of net sales), for current year and prior two years, and /or it could tier display the data in a simple quadrants (top fifth, second fifth, so forth) view (which we think might be more useful). If less than 100% of data was available, the percentage polled could be noted.

These two metrics are among the most fundamental indicators to restaurant economic vitality.

Other non-public 100% franchised companies like Dairy Queen (99% franchised) and Subway (100% franchised) can take the same recommendation.

This is a voluntary disclosure, a best practices proposal. While everything takes time and effort, it works to solve problems and give visibility to important data that the industry already has, or should have.

John A. Gordon is the principal at the Pacific Management Consulting Group. You can reach John Gordon at jordon@pacificmanagementconsultinggroup.com.

The Dangers Of Going Dark

Mexican Restaurants’ decision to “go dark” by voluntarily de-listing its shares is hardly an unusual decision, Hundreds of companies have made the same decision since Sarbanes-Oxley became law eight years ago, Yet it’s hardly risk free, Such companies see a big stock decline (Mexican’s stock has fallen 10%) and trading on the Pink Sheets is more limited and more volatile Companies that go dark have a tougher time raising money and financing. They’re more susceptible to shareholder lawsuits, And the company may not even save that much because it will still need to be audited. “It seems penny wise and pound foolish,” said John Gordon, principal at the Pacific Management Consulting Group. Still, Mexican’s share price, now at $2,05, has fallen steadily since its $13 a share peak in 2006. In addition, the company is losing money amid big declines in camp sales and it has all but stopped making capital expenditures, It probably needs to save money anywhere it can.

Jonathan Maze, November 2, 2010

The following article can be viewed here: http://www.qsrweb.com/article.php?id=17192

Burger King $1 double cheeseburger results questioned by Christa Hoyland * • 03 Feb 2010

Burger King’s $1 double cheeseburger has met with controversy since the chain first presented the pricing change to franchisees. First, franchisees voted it down — twice — and then a number of them filed suit against the company when it moved ahead with the pricing promotion. Now, The Miami Herald has uncovered a discrepancy between the numbers the chain is providing to franchisees about the sandwich’s success and data found by Restaurants Services Inc., the chain’s independent purchasing cooperative.

According to the story, Burger King has reported to franchisees that the burger’s promotion has boosted sales and gross profits, comparing a five-week period before the promotion began in early October and an 11-week period since it started. RSI reports that sales were up only marginally and gross profits were down, comparing the 12-week period prior to the promotion and the 11-week period after.

Burger King will report its second quarter earnings on Thursday and analysts are eagerly awaiting the report. Many of them have downgraded Burger King’s stock in recent months, some from “buy” to “neutral” and others from “neutral” to “hold,” as they report that sales have continued to decline in recent months despite the promotion.

Seeking Alpha contributor John Gordon said in a recent post that Burger King’s $1 double cheeseburger promotion is only a short-term stop-gap to the company’s sales decline. Instead, the chain needs “a theme to promote.”

The company has many new products in the wings, including the Steakburger XT, due to roll out this month. But while the company was waiting for franchisees to finish installation of the new batch broilers to handle the new burger line, other chains have moved aggressively with product rollouts. Carl’s Jr. and Hardee’s continued their rotation of limited-time premium burgers, McDonald’s added its McCafe beverages and Angus Burger line, Wendy’s added boneless wings and spicy chicken nuggets, and Jack in the Box added its own $1 burger as well as other product innovations.

The $1 cheeseburger results discrepancy is just one more issue in a long list of beefs many Burger King franchisees have against the franchisor. In May, franchisees filed a class action suit against the company when the chain announced it intended to divert 20 percent to 40 percent of the franchisee’s soda rebate fund in order to boost its national advertising spend. The diversion of funds was supposed to begin this month, but the company has decided to allow franchisees to keep their full rebate until the pending litigation is resolved.

Last month, Burger King filed suit against a small number of franchisees who failed to meet a Dec. 31 deadline for installation of the chain’s new point-of-sale system. Some franchisees indicated their failure to meet the deadline was a means to voice displeasure over the franchisor’s recent decisions.

Breaking Out Jody Maroni’s Sausage Kingdom is going mainstream with its first traditional location. By Jamie Hartford

Since opening its first restaurant in 1984, Jody Maroni’s Sausage Kingdom has been confined to non-traditional locations, such as stadiums, airports, and outlet malls. Not anymore. In February, the Venice, California-based quick-serve opened its first traditional location.

Franchisee Anina Siddiqui opened the 1,200 square-foot site—her first—in mid-February in Arcadia, California, a suburb of Pasadena. “I’m happy with the franchise, and I am happy seeing repeat customers,” Siddiqui says.

Rich Leivenberg, executive vice president of Jody Maroni’s, says though the company had previously shied away from locations on the street, they were happy with the site for Siddiqui’s restaurant. It is located in a strip mall and is close to a library, local government buildings, a city golf course, and a 4,000-student high school. “We liked the demographics, and we liked that the strip mall had been recently redone,” he explains. “We think we have a great product, and we’re pretty excited about bringing it to the masses in a new way.”

The restaurant has been open only about a month and a half, but Leivenberg says it is already beating expectations. Sales are trending about 20- to 25-percent higher than the company had anticipated. “She has opened very strongly—much more strongly than we thought,” Leivenberg says. Jody Maroni’s started as a stand on the Venice boardwalk in 1979, and in a way, Leivenberg says the company held on to that type of destination location. The chain has opened shop in airports, outlet malls, and on Universal CityWalk in Los Angeles. “We were so successful in the [non-traditional] avenue that we didn’t even look at [traditional locations],” he says. “You have to choose a direction, and we really liked the non-traditional.”

The leadership of Jody Maroni’s was also afraid that the prices of its premium sausage products—$6.99 for a sausage sandwich combo, including fries and a drink—might make it hard to compete on the street with lower priced quick-service sandwich shops. Many customers thought of Jody Maroni’s fare as a special occasion indulgence, Leivenberg says. “We’re not a cheap hot dog stand, and we don’t want to be,” he explains. “We have gourmet sausage.” The chain currently has 20 locations, mainly in California, but also in Las Vegas, Phoenix, Houston, Cleveland, Indianapolis, and St. Louis. Jody Maroni’s has also built its name through sponsorships with sports teams, such as the Los Angeles Dodgers baseball team and the Los Angeles Kings hockey team, and through a branded retail program that began in the 1990s.

The company’s sausage products were available in Costco, Trader Joe’s, and other grocery stores. That program ended about two years ago because the company wanted to concentrate on being a quick-service restaurant brand.

John Gordon, principal at Pacific Management Consulting Group, a San Diego-based restaurant-consulting group, says starting in non-traditional locations and moving to the street is not the typical trajectory of a restaurant. “It’s true that it’s more typical to get started in a traditional environment, largely because foodservice operators get used to acquiring sites, and there’s less of a barrier, in theory, to using a traditional site,” Gordon says.

In a way though, Jody Maroni’s and other chains that start in non-traditional sites such as stadiums or airports enjoy high visibility that can carry over when they do decide to open traditional locations on the street, he reasons. Jody Maroni’s is hoping that will be the case.

Four or five other potential franchisees have already showed interest in opening traditional locations elsewhere, and the company will soon be launching a new web site to better communicate with interested parties. Even so, Leivenberg says Jody Maroni’s is still not ready to abandon entirely its strategy of growing in non-traditional sites. “We will continue to expand in that arena,” he says. “Our biggest growth is currently in premium outlet malls. We’re about to open our fourth location in Houston, and we hope to continue to grow that side of the business.” Besides the Houston location, the company also has two other stores coming on line in the next few months. “We’re prepared, we’re ready for growth, and we hope it will be substantial,” Leivenberg says.

Cheap Marketing Tips that Work

When it comes to marketing on a budget, there’s a fine line between terrific and terrible.

In the teeth of the recession, Back Yard Burgers developed a new, slimmed-down marketing strategy. The roughly 200-unit, Nashville, Tennessee–based chain cut costs across the board, developed a slick-looking website, and created a social media strategy centered on Facebook and Twitter.

But Ken King, a senior consultant with National Restaurant Consultants Inc., says this was a disaster.

“Their same-store sales in some stores are down as much as 20 or 30 percent,” King says. “They’re just not reaching the public at all.”

Marketing on a budget isn’t an easy thing. Although some concepts have been able to reduce their expenses while gaining sales, others have discovered that cutting can be dangerous. Figuring out the balance requires careful planning and a willingness to learn from the mistakes of the competition.

Cheap Marketing Gone Wrong

Experts say that quick serves should never use a cheap marketing strategy that compromises the brand image. John Keuning, creative director for Out There Advertising, has worked on several campaigns for the Steak Escape chain. He says that while easy-to-make coupons can get people in the door, it will cost a concept in the long run.

“Get out there and highlight the benefits of your product, but don’t do it by discounting,” Keuning says. “As soon as you start discounting to get traffic, people will start to expect that they’ll get that deal every time.”

Another common mistake operators make when marketing is to stick to their strengths. One expert says streamlining marketing so it only focuses on one main item can be a serious blunder. As CEO of the Pacific Management Consulting Group, John Gordon has seen chains struggle because they ignored certain dayparts, like breakfast and afternoon snacks.

“The reason why McDonald’s has been able to take their commanding position in the fast food hamburger segment is that you can get snacks and food items of any type at any time of day,” Gordon says.

“If you’re not going to be putting an insert in the paper, send workers out. Either sweat equity or money, it’s going to take one or the other.”

Finally, quick serves cannot skimp on the implementation of marketing efforts. Although no one sets out with the intention of doing a half-hearted job, some companies end up budgeting so little for marketing that they’re unable to complete what they start, says Melissa D’Aloia, account executive for Out There Advertising. She says that was the case with Out There’s initial efforts on Facebook.

“A couple years ago, when we entered social media with Steak Escape, we didn’t dedicate enough resources to it,” D’Aloia says. “It didn’t really have much of an impact.”

The lesson for operators, D’Aloia says, is that it’s better to carry through with a smallscale plan than come up with a big plan that operators are not ready to pay for.

Cheap Strategies That Work

As Back Yard Burgers discovered, saving money on marketing isn’t simply a matter of cutting back. Instead, it involves rethinking the whole idea of marketing.

King says one of the most efficient cheap ways to get a customer interested in a product is to hand him a sample. Free food generates warm feelings toward a brand, and it gets customers hungry for more. Garbanzo, a Denver-based Mediterranean concept, used this strategy with great results in its stores, King says.

“Talk about guerrilla marketing,” King says. “When you walk through the door, an employee hands you a falafel ball. Look at Chick-fil-A—they invented that model by having a girl handing out a piece of fried chicken in the mall.”

Attention-grabbing signage can also be a successful cheap marketing method. Simple signs that advertise new products or encourage a combo meal are one of the most effective methods of generating additional business, Gordon says.

“Point-of-purchase (PoP) materials are No. 2 or No. 3 in the total scheme,” he says. “Instore PoP posters [and] outdoor PoP is right behind television and radio.”

Loyalty programs are now entering the world of cost-sensitive marketing as well. Though card-based loyalty programs failed to capture the mass public’s attention and were costly investments, new technology is making loyalty easier—and cheaper—than ever to implement.

QR Loyalty, which launched publicly in September, helps brands build loyalty with a vehicle they already have well in stock: receipts. The company provides a specialized QR code on receipts for customers to scan with their smartphones. As consumers collect points by scanning, operators collect information on their purchase habits.

“It enables the restaurant owner to remarket to those customers knowing what their preferences are,” says Nigel Malkin, cofounder of QR Loyalty. “If you have someone who only orders chicken or vegetable dishes, you know how to market to those customers. That kind of customer data is incredibly valuable.”

Malkin says QR Loyalty’s pay-for-performance program costs slightly less than 1 percent of an operation’s gross annual sales after adding up its licensing fees and the rewards given out, but that it can generate a sales lift of 5–10 percent.

Of course, operators who truly want to streamline their marketing can trade time for money.

“If you’re not going to be putting an insert in the paper, send [workers] out,” Keuning says. “Do doorhangers, put them in windshields, etc. Either sweat equity or money, it’s going to take one or the other.”

Some local stores become destinations for kids’ birthday parties, some provide food for events, and some have special incentives for mall employees. This September, a Steak Escape location in Sacramento, California, had success by commemorating an important moment in its own history.

“[They] chose to do an anniversary celebration and they had their entire crew fired up about it,” D’Aloia says. “Through that excitement they have seen their store sales increase in a very slow month over 20 percent.”

Cheap marketing strategies ultimately depend on the quality of the product. Poor service or mediocre food can drive even the best-marketed property into the ground. On the other hand, a very good company can pull off the ultimate frugal marketing move.

Just ask Mary McLeese, brand manager for Five Guys Enterprises. The burger-and-fries chain became a national name solely by word of mouth.

“We do not advertise at all,” McLeese says. “[And] we advise our franchisees not to advertise. If you concentrate on the customers and concentrate on the food, it will grow naturally.”

Retail and Restaurant Valuation Distortions

Analysis Of John A. Gordon

June 03, 2010

Premise

The Wall Street Journal on May 29th discussed the effect of depreciation expense capital spending decisions and how it will affect earnings and valuations, highlighting mature retailers. But, one must look closely at the whole picture. This viewpoint holds for both retailers and chain restaurants.

Discussion

On May 29th, in his well written Financial Analysis and Commentary column, John Janarone of the Wall Street Journal discussed the variability of depreciation expense and the outlook for earnings, for various retailers, such as PetSmart (PETM), Best Buy (BBY), Barnes and Noble (BKS), among others. It highlighted a mature retailer, PetSmart, and the premise of the article was that valuation measures may make stocks look artificially expensive, as companies cut back on expansion and eventually depreciation expense falls.

The article points out correctly that retail (including restaurants) are way overbuilt in the US and slow up is needed.

To us, the article once again highlights the faculty metric and displays the limitations upon focusing on short-term company GAAP earnings trends.

Depreciation is a non-cash expense (but still a charge to earnings) that is a proxy for capital assets charges. On the sources and uses of cash schedule, depreciation is an add to arrive at free cash flow, or roughly, cash flow from operations less capital spending.

The problem is that a decline in depreciation expense, while providing a momentary short-term boost to earnings, is a sign of lack of vitality and business expansion. In reviewing companies, I look for declining depreciation expense as a signal. Even if store openings slow, CAPEX should be spent on remodels and reimaging.

Buffalo Wild Wings (BWLD) faced questions last year as it missed its depreciation target as it was building a lot of new stores. With its comparable sales momentum problems the last two quarters duly noted, it was doing what an underpenetrated US national company should do: build new units.

Retail businesses and chain restaurants battle minute by minute for customer attention and to make a splash. Too old of a store base means something is wrong—the company is in cash cow mode, or it can’t find sites, or that its new stores are not economically viable.

In the chain restaurant arena, refranchising is underway in many companies, driven by the belief that franchising makes company cash flows more predictable, and the royalty stream is worth more than building and maintaining company operated restaurants. So when a chain sells its company units to franchisees, it takes a book gain or loss, and hopefully eliminates some G&A and depreciation expense.

With company operated restaurant margins optimally in the 20-25% range (McDonald’s (MCD) and Chipotle (CMG) are industry leaders), and franchising profit margin at around 70-80%, refranchising seems like an easy decision. But which throws off more free cash flow? It will be interesting to watch YUM and Jack in the Box (JACK) long term as their US refranchising ramps up. In the last year, both have mentioned the earnings shortfall after refranchising and noted plans to cut G&A.

Refranchising can drive percentage margins higher but once completed, the company must rely on franchisees making their growth unit goals. And with franchisees paying more in cost of money (since they are smaller) and have lower unit economics than company operations (franchisees pay a royalty); the growth pattern will be a bit cloudier. Most chain restaurants don’t even discuss franchisee sales, let alone profitability. Earnings disclosure needs to be revamped in the US.

Same-store sales at Ruby Tuesday restaurants began falling in 2005, and the rest of the casual-dining sector soon followed, beginning a period of struggles that’s lasted nearly four years. “Ruby Tuesday was like the canary in the coal mine,” said John Gordon, principal Pacific Management Consulting Group.

Fast Food Restaurants Have Right Menu for Recession

As the U.S. restaurant industry struggles through the economic downturn, quickservice operators such as McDonald’s, Burger King and Wendy’s may enjoy a comparative advantage that helps them navigate the weakness better than their competitors in the casual-dining and higher-end segments, according to Moody’s Investors Service.

“Fast-food restaurants have a lower average check, greater convenience and increased food choices that resonate well with today’s financially stressed consumer,” says Moody’s VP-Senior Analyst William Fahy.

However, one threat to quick-service restaurants (QSRs) is the option of eating at home, or “trading out,” which is almost always less expensive than dining out. “As more consumers choose to eat their meals at home, QSRs will be negatively affected, but to a lesser degree than casual dining,” said Fahy.

With a lower price point and an increased emphasis on healthier food options, QSRs should be better-positioned to satisfy the consumer’s desire to dine out and save money. This will help QSRs better weather the “trading out” effect, the report says.

In addition to these operating advantages, QSRs also benefit from their predominantly franchise-based business model, which should reduce earnings volatility and capital spending. Yet amid a weak economy that shows little sign of near-term improvement, QSRs are not immune to reduced traffic, forcing them to cut costs and offer promotions or discounts to stay competitive and attract customers in order to stem deterioration in operating leverage.

Further, a recent history of generous share repurchases and dividends across the industry —- often funded with debt and other non-operating cash flows —- has placed greater pressure on restaurant operators to manage debt loads and maintain credit ratings as the economic downturn persists.

Key points of Moody’s report:

• Lower average cost of a meal at quick-service restaurants is an advantage as consumers become ever more frugal.

• Conveniences like drive-thru windows and late-night hours remain a competitive advantage over casual dining.

• New menu options at fast-food restaurants increase appeal for consumers that are more health-conscious.

• Franchise-based business model should provide greater stability to earnings.

• Discounting and promotions become key marketing tool to bolster traffic but squeeze margins.

• Many restaurants, including some quick-service operators, face weaker debt-protection metrics and eroding covenant cushions due to weaker operating performance.

A recent analysis by restaurant industry consultant John Gordon showed a mixed picture for fast food restaurants, with McDonald’s (MCD), Chipotle (CMG) and Steak N Shake (SNS) faring better than Yum Brands (YUM) and than Darden’s (DRI) Red Lobster and Olive Garden. All were faring much better than fine dining , where sales are down some 15% from a year earlier. Gordon also questions the wisdom of Wendy’s/Arby’s (WEN) following a multibrand strategy which has not worked well, with the exception of Yum Brands (KFC/Taco Bell).

Technorati Tags: (BKC), (CMG), (MCD), (SNS, (WEN), (YUM), Burger King, Chipotle, Darden, fast food, mcdonald’s, quick-service restaurants, restaurants, Steak N Shake, Wendy’s/Arby’s, Yum Brands

IN $22.9M DEAL, CHAIN TO BUY WESTERN SIZZLIN, WHICH BIGLARI ALSO LEADS engineering,” said Gordon, of Pacific Management Consulting in San Diego. “In terms of ongoing business streams, I’d be looking for any synergies, but I don’t think there will be. These STEAK N SHAKE WHAT: Full-service, casual-dining restaurants famous for Steakburgers and shakes. HEADQUARTERS: Indianapolis. HISTORY: Gus Belt started Steak n Shake in 1934 in Normal, III. EMPLOYEES: 20,000 (2008). CHIEF EXECUTIVE OFFICER: Sardar Biglari. LOCATIONS: 490 restaurants in 21 states; 70 locations in Indiana. 2008 NET SALES: $610 million. 2008 NET INCOME: ($23 million) loss. WESTERN SIZZLIN WHAT: Known for their flame-grilled steaks and fully stocked salad bars. HEADQUARTERS: Roanoke, Va. HISTORY: Nick Pascarella opened his first restaurant in 1962 in Augusta, Ga., and began franchising four years later. EMPLOYEES: Not available. CHIEF EXECUTIVE OFFICER: Sardar Biglari. LOCATIONS: 125 locations in 19 states. None in Indiana. 2008 NET SALES: $17.2 million. 2008 INCOME: ($6.3 million) loss. Biglari was fresh from the takeover of Western Sizzlin in 2007 when he launched a proxy fight for control of struggling Steak n Shake. The young investor, then 29, spent more than $16 million to amass a block of stock used to force out the Indianapolis company’s senior executives and place himself at the top in June 2008. Since then, Steak n Shake has trimmed its menu, focused on burgers, introduced lower-priced meals and begun sprucing up its white-tile eateries. The company earned $2.2 million in the quarter ending April 8 after running up losses totaling $22.4 million over the previous nine months. Reflecting the uptick in profits, Biglari’s annual salary rose in June to $900,000 from $280,000. But the bigger payoff could come in the merger. Under the terms of the deal, each share See Steak, Page A9

The investor who took control of Steak n Shake wants to rename the Indianapolis cheeseburger chain’s parent company for himself.

Shareholders will vote at the annual meeting to rename their company Biglari Holdings Inc.

The parent is now called Steak n Shake Co., based in Indianapolis, and its restaurants are a subsidiary named Steak n Shake Operations Inc.

The proposed name change, disclosed in a filing last week with the Securities and Exchange Commission, follows Texas investor Sardar Biglari’s efforts to diversify outside the restaurant industry using cash from the burger business.

Under Biglari, the parent company’s chairman, Steak n Shake Co. launched a hostile takeover in December of a Michigan-based insurance company, Fremont Michigan InsuraCorp. Biglari earlier fell short in efforts to buy Itex, a West Coast bartering business, and the California-based burger chain Jack in the Box.

Renaming the parent could make it easier for Biglari to possibly spin off the Indianapolis-based restaurant chain in a few years without confusing shareholders, suggested restaurant industry analyst John Gordon, of Pacific Management Consulting Group, San Diego.

Steak n Shake’s annual meeting will be April 8 at the St. Regis Hotel in New York.

The burger chain, which has 485 sit-down eateries, surprised some analysts last week with its strong profit report.

After-tax income of $5.49 million was reported on revenue of $147.58 million. In the same period in 2008, Steak n Shake posted a loss of $3.44 million on revenue of $130.72 million.

Operating costs were relatively flat while sales revenue soared, Gordon said.

Call Star reporter Ted Evanoff at (317) 444-6019

To see more of the Indianapolis Star or to subscribe to the newspaper, go to http://www.indystar.com/.

Copyright (c) 2010, The Indianapolis Star

Many of you know I’ve been working complex restaurant analytical roles and engagements since the early 1980s. I’ve seen over that time advances in restaurant management systems, technology and data gathering has expanded exponentially. Restaurants today of course are complex blend of people, brand building and management systems bundled together; the outgrowth of this is numbers have become incredibly important.

Unfortunately, a series of suboptimal restaurant analytical viewpoints, reporting and practices continue to be seen. The same issues seem to carry over from decade to decade. Such perspectives result in confusion; lack of lessons learned and misdirected effort. Here are five that I see regularly, and suggested solutions are posed.

• The comps trap. Everyone talks and worries about comps. Same store sales are typically calculated as percentage change of average unit sales over prior year period, for the units in the mature, “comp sales store base”. The press and investor community keys on it, a lot of decisions are driven by the comp. The problem is of course is that a one year view over last year is really a tiny snapshot. Let’s face it, weather, menu platform changes, competitive intrusion, national and global events happen every day. A better practice is to consider and report two year or even five year comps. This measure can be either “stacked” (values added together year after year) or on a compound annual growth basis (CAGR). If the sell side analysts keep focusing on the one year comp, report the longer measures anyway.

As an example, look at the very current extract from the February 2016 Miller Pulse report, which shows the industry comps strengthening, not weakening, on a two year basis, versus the flat to negative January 2016 trend on a one year basis. A vastly different two year view!

Restaurant Monthly Same Store Sales through January, 2016

• Transactions v. traffic v. customer count.  Of course, the amount of traffic the restaurant generates is a vital number, which drives food prep and staffing in store. But is it people, entrees or number of times the grand total key on the POS was hit? Restaurants chains report it all differently. For drive thru or catering transactions, it might be hard to know exactly how many customers are served; for bar only customers, there might be many seconds or thirds served. Is each a transaction? Both Panera (PNRA) and Zoe’s (ZOES) have gotten into trouble with this lately; in 2013 and 2014 Panera had rising entrée counts but reported the number “parties”, that is  the number of times the grand total key was pushed on the POS was down. Zoe’s had good comps but flat traffic because catering was up. Was that really a problem? If Panera got big table sizes in, they didn’t get credit for it, and the Investment Community became worried.

The practice that Ruth Chris (RUTH) utilizes is pretty simple; report the number of entrees sold as a proxy for customer count. A conversion factor for catering can be set (and updated annually), drive thrus might be too hard, but every sophisticated QSR brand has the ability to track the number of “menu units sold” and can be noted as color in earnings calls.

• Dollars versus percentages: restaurant managers are taught percentage analysis early on; a fantastic amount of discussion and attention throughout the industry occurs to food cost and labor percentages; percentage restaurant margins are discussed endlessly. Investors get percentages but have to be told a fuller story. Sometimes, merchandizing and even refranchising decisions are justified on a percentage basis; e.g., the franchising margin percentage is greater than that of operating a restaurant. But what about the dollars?

A unit with high profit percentages but low dollars profit per store is not the goal.  A percentage is simply one number divided by another, it is a just a relative measure. The problem is of course percentages can’t be taken to the bank. The powerful effect of average ticket and gross profit cents per customer is not recognized if the focus is to percentages. The suggestion is to supplement “profit cents per customer” or even average weekly store contribution margin dollars per week as metrics, something to get the focus on dollars.

• Misleading marketing event analysis. A lot of promotional events are underway right now, one QSR brand is running three concurrent major promotional efforts (for example, Restaurant Brand’s International’s Burger King (QSR) is fighting the burger wars) that makes it confusing to detect what worked.

There are a multitude of improvements possible in restaurant marketing analysis. First, brands can find and set a control market and measure impacts to remove “noise” from the promotional review. Not all brands do so.  Secondly, more attention to measuring the AUV impact after a promotional window ends is needed. Restaurants are open long after the promotional event ends. In my thirty plus years, I’ve rarely seen reports of the “post promotion lift”. And if the marketing event media spend is expensive, advertising expense over and above plan should be treated as a variable expense and subtracted from the sales lift and other variable expenses in figuring out whether the event worked. And finally, the promoted item hit rate itself is interesting but unless it drives sales and profits higher, it is just an incomplete metric. It is not the measure whether the media worked. To its credit, Burger King, which just announced its Hot Dog rollout, tested the dogs in five markets and had a control market. Honest testing and data gathering does wonder in building credibility in a franchised system and in a company operated system to read and learn from the results.

• Remodel tracking and the first year sales pop: sales are vital of course, and remodels typically (but not always) drive incremental sales. But for how long? The first year lift gets all the attention (example, Wendy’s reported this week its Image Activation (IA) program returns are now lower than what they started with) but incremental sales and profit flow through are needed for years thereafter.

To be sure, stores that aren’t remodeled will trend negative over time, so the change from doing nothing (negative AUVs) to the actual lift is fairly included in the sales and profit lift analysis. Setting the right analytical perspective is also important in the heavily franchised brands; the franchisees fund the CAPEX. Answers like “remodeling is in the contract, so we won’t talk to that” (see Dunkin Brands example) is not productive.  For example, to its credit, in 2015 and 2016, Panera (PNRA) had excellent displays of the sales and profit impact of its Panera 2.0 initiative that helped explain a very complex undertaking.  Suggestions: keep and track the multiyear sales and profit lift trends, publish to franchisees for their planning.

About the author: John A. Gordon is a long time restaurant analyst and management consultant. He founded Pacific Management Consulting Group in 2003 and works complex restaurant strategy, operations and financial management analytical engagements.

In 2014, McDonald’s (MCD) announced it was to refranchise up to 1500 units out of the United States. In 2013, Wendy’s (WEN) announced refranchising of 450 units in its non core markets. In 2012, Burger Bing (BKW) and Jack in the Box (JACK) kicked into serious refranchising, so much so that Burger King now only owns and operates the 50 plus units in Miami out of a 130000 unit total. Even Starbucks (SBUX) is finally in franchising for its flagship Starbucks brand, refranchising stores in the UK and Ireland. It franchised its non premium Seattles Best Brand for some time. YUM has been furiously refranchising since 2009 but intends to keep China company operated.

To be sure, some brands have been defranchising—buying franchised stores back. Red Robin Gourmet Burgers (RRGB), Noodles (NDLS), Qdoba (JACK) and Texas Roadhouse (TXRH), among others. Chipotle (CMG) wont franchise—it would destroy its culture and they make more as company operated stores.

The debate in restaurant circles about the proper mix of company and franchised units has been legendary. In the 1970s and 1980s, the trend was towards company owned locations. In the 1990s, as return on invested capital (ROIC) and awareness of the free cash flow expanded, refranchising picked up.

Refranchising means the company can make more on the royalties, maybe rent spreads (if it owns the real estate) and reduced G&A and capital expenditures (CAPEX) associated with its former units. In almost every case, refranchising involves weaker stores beyond a certain profit or EBITDA point or weaker brands or geographies.

Benefits of refranchising 

Refranchsing can be a stock catalyst, some new news, particularly if it funds increased dividends or buybacks, or if it is associated with more debt that can fund dividends or buybacks. That what McDonalds is doing.

Optical improvement: refranchising takes the lower stores out ofn the base, and optically makes restaurant sales and margins improve, as both WEN and JACK have noted.

Refranchising should lower debt, improve credit ratios to allow for special dividends

Boost ROIC: with units sale proceeds and capital investment falling lower or to near zero if no real estate is involved, it provides a bump to ROIC.

It can help out franchisees, as large franchisees have a need to get larger (WEN example)

And, in some cases, if the company can’t operate stores well, refranchising is a type of outsourcing of the problems. See: YUM’s KFC, Burger King (BKW)

Limitations with refranchising 

The ultimate problem is the company becomes an outsourced restaurant provider—no expertise in running restaurants. Franchisees site “no skin in the game” as a perennial problem in brand management.

Adaptability/Flexibility: franchised concepts take longer to get new products to market and keep the physical plant remodeled and renewed. In the US, Starbucks will always have an advantage over McDonalds as it can make decisions and implement market change quickly, while in McDonalds case it takes years to attain buy in and effect market change.

Unit level economics: while there is the perception that franchisees run a tighter P&L,than company operations, franchisees do have to pay a royalty and are generally territory constrained. In addition, the availability of funds and cost of debt for franchisees typically are unfavorable versus that of the franchisor . This implies higher cost of debt and missed opportunities. Franchisees have higher debt to EBITDA ratios. For example, the McDonalds US franchisees debt/EBITDA is appx. 5.4 X, versus 2.2X at MCD corporate.

Company structure; good franchisors run their company units as a training and development ground for franchisees. If the company store base is deteriorated or nonexistent, quality development staffing comes at risk.

Once the refranchsing is done, that arrow is no longer in the quiver. What next?

Cultural bifurcation, franchisor v. franchisee conflicts.

To any close observer of the ongoing Darden (DRI) conflict as it has unfolded with its opponent activists Barington, and Starboard since late 2013, a Red Lobster sale to private equity was not a shocking outcome.

Consider: 

• Private equity has dry powder–unallocated funds– available that it must put to use to earn a fee. Golden Gate had owned three restaurant brands and continues to own one, California Pizza Kitchen.

• Darden, which was in trouble since at least 2007 trying to hit a 15% EPS model with the mature Red Lobster and Olive Garden restaurant brands, bought a lot of restaurant concepts at high price in 2008-2013, and wound up with a lot of debt. As the rate of casual dining traffic decline fell after the Great Recession, (Darden noted the casual dining overall space traffic fell 18% versus the peak) and core earnings fell, it had both dividends and buyback demands going up at the same time. A true cash flow squeeze resulted.

• Darden had remodeled the entire Red Lobster chain by 2013 and needed to get some money out of its investment. (Why it remodeled Red Lobster first versus Olive Garden is a fascinating question.)

• Red Lobster had underlying real estate that could be levered to lower the effective Golden Gate purchase price.

The question, is what now to do with Red Lobster? What are the “Lobster Levers”?

On the positive side, the brand ratings are not weak. It ranks roughly in the middle of the pack via the 2014 Brand Keys Customer Loyalty index but near the top of the 2013 Q4 Goldman Sachs Brand Equity Survey. The downside is there are no other national seafood players to steal market share from. Bonefish (Blooming Brands, BLMN) is just growing and Joe’s (Ignite Restaurant Group, IRG) has built its own crab niche.

It’s not going to work its way out of trouble with more $10 television advertising that it has been pounding way with this week. It’s going to have rent to pay. Darden has noted Red Lobster’s customer base indexes older and lower income than the most desirable casual dining peers; it’s got 706 units in an overbuilt US restaurant space. Keeping the same units and doing the same thing won’t solve anything.

But what is can do is the following:

Close some units. Now that it is private and protected from the intense investment community focus on every metric, it can examine its store base. Note that American Realty executed sale leasebacks on 500 of the 706 units. A number of units were excluded for a reason, some were leased, some undesirable to do so.

Red Lobster reached its unit count peak in the US in 1996, at 729 units. It then closed 75 stores over the next four years, to arrive at 654 units in 2000, to then slowly grow again until 2013. The natural US unit cap seems to be much smaller than 700. A privately held company can work this.

With a rather low 9% reported adjusted brand EBITDA, the law of large numbers is that must be a number of units that are in the lower profit quadrant that upon closure, could result in positive cannibalization, and will improve the overall brand average profile.

Test and rebred. Maybe because it was part of the central heritage of Darden, other than remodeling or wood grilling, there has been no real new concept ideation for years. A self serve Red Lobster lunch platform and Red Lobster/Olive Garden combo stores were tested recently and were a total waste of time and money. Such poor quality tests are indicated of a big concept ideation problem. Too much seafood on the menu and a very low level of alcohol sales are indicative of the problems.

Work international. All of its peers are. Darden just began a brief foray into ex-Canada international and franchising in 2013. As late as 2013! Missing the international opportunity was a great strategic flaw. The US is filled up with restaurants. Can’t Red Lobster work internationally, somewhere?

Work franchising, joint and limited partnerships. Darden’s problems with franchising went all the way back to a failed franchised venture in the 1970s. Franchising is difficult, well funded and capitalized franchisees have to be found. Darden said they didn’t have the expertise. But it can be found. A new management mindset embracing franchising has to be developed. It can work in casual/fine dining: Ruth Chris (RUTH) has had 50% of its stores franchised to solid players forever, and Cheesecake Factory (CAKE) is working franchising and joint venture partnerships to get its international growth jump started. The Cheesecake founder, restaurant operator, David Overton “got it”, but Clarence Otis, who didn’t have the restaurant operations baked into his DNA, didn’t apparently.

Restaurant Space: 2013 Standouts to Date

A rising tide lifts all ships: Consumer discretionary stocks are doing well, leading the pack with the highest forward PEs in May, as FactSet reported last week, www.factset.com/insight

But for franchisees, the stock price is not the same as free cash flow in the pocket. At Dunkin Brands (DNKN, Dunkin Donuts) for example, the DNKN stock price has more than doubled since its 2011 IPO, but core northeastern franchisee shop level profits are up 1-3% since 2008, per management.

Same store sales: Despite some same store sales headwinds caused by the so called 2013 same store sales cliff, the theme noted http://seekingalpha.com/article/1111341-restaurant-conditions-comp-cliff-coming early this year that sales comps would be down versus mild winter weather in 2012, the industry is doing fine. There are no large publicly traded restaurant companies in real trouble, although one could argue Ruby Tuesday (RT) is, but not any of the major players from a liquidity or default basis.

The industry was at +2.5% SSS (per MillerPulse) in May, almost all driven by ticket. McDonald’s (MCD) May sales gains reported Monday were foreseen and no surprise.  Yum’s (YUM) -19% May China same store sales decline was not moderate but met the Consensus Matrix number. http://finance-yahoo.com/news/yum-says-sales-fell-2051586651.html.

In almost all cases, the two year and five year comps trends are solid; if that was the Street metric we’d all be celebrating.  See the following trend sales display from RBC’s Larry Miller’s MillerPulse Survey.

MAY 2013 RESTAURANT TWO YEAR COMPS TREND (MILLER PULSE)

 Legend; two year comparables are the May 2013 v May 2011 comparison.

What are the Standouts:  I’ve invented a restaurant fundamentals standouts group, to note restaurant companies that have all of the following fundamentals going the right direction:

• Positive same store sales and traffic, both, with no major geographies negative.
• Meets or beats on analyst revenue consensus, beats earnings per share (EPS )by $.01 or more, with no downgrades within 90 days.
• Positive sequential momentum, early peek SSS current period, if revealed, positive.
• No gimmicks with adjusted, proforma or restated EPS values, and as validated by the operating income beat.  A publicly traded track record of one year.

Who are the Standouts: SBUX, with new product new news every quarter, the only restaurant chain growing traffic at a greater rate than average check. Also, Ruth Chris (RUTH), Texas Roadhouse (TXRH) Domino’s (DPZ) and Popeye’s (AFCE) are on the standouts list.  Both Ruth Chris and Mitchell’s in the RUTH house are moving, ahead smartly.  AFCE is building company stores, capturing  US KFC units and reflagging them, and touting itsUS stores franchisee 20% EBITDAR margins, in addition to new flavors/new product news. AFCE was the first franchisor ever to report franchisee profitability in a quarterly call that I can recall.

Implications:  My number one concern going forward is that the industry not shoot itself in the foot via over discounting. NPD noted that after a time, customers see discounted prices as the new normal. Restaurants that don’t play in the ever discounting spiral space are at an advantage.

Restaurant marketing tends to be copy cat in nature, and like a battleship, takes forever to turn. Darden (DRI) has reset to the $12.99 television price point, doing Red Lobster and Olive Garden $3/$4 off coupons too. US Pizza Hut (YUM) is doing $5.55 anniversary pizza price (one large) undercutting even Domino’s (DPZ) and weaker QSR players are at or under the “my $.99” at Wendy’s (WEN). We wonder what customers must think of the long term pounding on price.  NPD https://npd.com/wps/portal/npd/us/news/press-releases/deals-are-no-longer-driving-restaurant-traffic  presented five year data that shows that restaurant deal sales mix is flat and declining, as follows. This means more discounting is chasing even fewer deal consumers.

RESTAURANT SALES MIX CHANGES ON DEAL TRANSACTIONS (NPD)

Legend: Deal Mix” restaurant meals sold at discount, change v. prior year