Wray Executive Search – Reading Restaurant Results Properly

By John A. Gordon, principal and founder of Pacific Management Consulting Group

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. Read more

The Union Tribune – Qdoba fast casual brand moving to San Diego

By Lori Weisberg • Contact Reporter
JULY 18, 2016, 6:04 PM

Jack in the Box’s fast-casual brand, Qdoba Mexican Eats, is relocating its offices from the Denver area to San Diego, where it will begin sharing space early next year at its parent firm’s Kearny Mesa headquarters.

The move comes with a bonus: 50 new hires and a gradual rollout of Qdoba eateries in San Diego, potentially setting the stage for a rivalry with competitor Chipotle Mexican Grill.

While Jack in the Box is based in San Diego and has numerous fast-food outlets here, Qdoba didn’t have a presence in the county until it recently opened a location at San Diego International Airport.

Jack in the Box acquired Qdoba more than a decade ago but the subsidiary remained headquartered in Denver. Now, it sees the financial wisdom of sharing resources, said Keith Guilbault, the brand president.

Qdoba expects to open new restaurants in San Diego but isn’t ready to say exactly how many, although the first ones would be ready
by next year, the company says. (Courtesy of Qdoba) “The brands grew up separately, but over the years, we started to share resources in functions that make sense like IT, accounting, legal, some of the support services,” he said. “So as we looked for efficiencies, we took a hard look at it and realize there were some of these efficiencies and made the decision over a month
ago to move.”

Guilbault said the company will be scouting for new restaurant locations throughout the county, with the goal of opening some by next year. There are six Qdoba outlets in the Los Angeles area.

“We believe there is room for more fast-casual Mexican,” Guilbault said. “We pride ourselves on coming into the market as a different fast-casual Mexican chain. We have great variety. We don’t nickel and dime our
guests when they add on things like guacamole or queso, which we’ve seen was a frustration with people at other chains. Our restaurants are definitely designed as a place where people can come in and have a great meal with comfortable seating, as opposed to getting people in and out.”

San Diego restaurant consultant John Gordon is surprised that the chain’s relocation to San Diego didn’t happen earlier. The sharing of resources, he said, makes financial sense and opening some Qdoba restaurants here could serve as a convenient proving ground for future store and menu development.

The expected expansion effort comes three years after Qdoba moved to close more than 60 stores in ill-performing locations.

“Qdoba is more important to Jack in the Box now because they’ve identified it as their major growth brand and they want it in a place where they can watch it,” Gordon said. “Qdoba closed stores, made some menu changes and brought in a new CEO, so it’s been on a recovery road ever since.

“And Qdoba will be a direct competitor with Chipotle, whose market share and sales are down.”

Roughly half of Qdoba’s 95 corporate-level employees will remain with the company as it relocates, although some will work remotely, Guilbault said. The remainder either are in positions that are being eliminated or
they opted not to move to San Diego, he said.

The chain has more than 650 restaurants in 47 states, the District of Columbia and Canada.

lori.weisberg@sduniontribune.com (619) 293-2251 Twitter: @loriweisberg
Copyright © 2016, The San Diego Union-Tribune

The Street – Chipotle Is the First, but Not the Last, in Coming Wave of Restaurant Activism

An activist investor could pressure any of these struggling restaurant
chains into the hands of Yum! Brands.
Nov 12, 2016 11:40 AM EST
Editors’ pick: Originally published Nov. 7.

Could an activist hedge fund drive Dunkin’ Brands (DNKN – Get Report) to put itself on the market?

At least one analyst following the fast-food donut and restaurant chain believes the answer is yes. John Gordon, restaurant analyst at Pacific Management Consulting, suggests that an activist at Dunkin’ Brands could agitate for a sale of the chain, and that Yum! Brands (YUM – Get Report) might be a possible buyer now that it has completed the separation of its China business. Yum!, the company behind Taco Bell, Kentucky Fried Chicken and Pizza Hut, completed the spinoff of its China unit on
Nov. 1.

For Gordon, a Yum! acquisition of Dunkin’ Brands would help boost the donut company’s international growth. Yum! is already subject to an activist that is likely looking for more growth-oriented deal-making. And the restaurant chain has the infrastructure and expertise in place to help Dunkin’ Brands expand its franchised model successfully.

“Dunkin’ Brands hasn’t been successful internationally,” Gordon said. “Yum! would have the international infrastructure and business development expertise in place so it could slide Dunkin’ Brands into its existing organization.”

Dunkin’ Brands currently has roughly 5,000 Baskin-Robbins and 3,000 Dunkin’ Donuts locations outside of the U.S., which, as a group, haven’t performed well lately, posting negative same-store sales for the past three quarters. Gordon noted that it opened 11 Dunkin’ Donuts International locations in the third quarter, a low number signaling weakness.

Would Yum! be interested in making a major acquisition? It’s a serious possibility. Yum! CFO David Gibbs told an investor conference on Oct. 11 that if there were an acquisition that the Louisville, Ky., company could make to “accelerate” its growth, it would “certainly be considered.”

In addition, Greg Creed, Yum! CEO, told investors that the company has enough cash to pursue an acquisition despite its commitment to return $13.5 billion to shareholders between 2015 and 2019 in stock buybacks and dividend distributions. “If an opportunity arose, we’ve got plenty of liquidity and we’ve got plenty of cash to take advantage of it,” Creed said at the conference.

In fact, Yum! had about $2.9 billion in cash as of September, up from $861 million in the same period last year, according to its October quarterly report. “The cash amount is way up, fueling the speculation that something could be done with it before it is dividended out or used to reduce debt,” Gordon said.

Sharon Zackfia, restaurant analyst at William Blair, said that one positive aspect to a Yum!-Dunkin’ Brands combination would be that there isn’t much overlap when it comes to each company’s businesses. “They are both franchised concepts and there would be little cannibalization of Dunkin’ by Yum!’s KFC or Taco Bell,” Zackfia said.

However, she noted that it would be easier to accelerate Dunkin’ Brands’
international operations if the company could improve its existing franchised locations first.

Alternatively, an activist could agitate to have Yum! acquire Subway, which is privately held and has over 44,000 locations inside the U.S. and outside. The sandwich retailer’s co-founder, Fred DeLuca, passed away last year, leaving DeLuca’s sister, Suzanne Greco, in charge. Gordon contends that Subway could be a target for acquisition in the months to come.

“The trouble with Subway is they overdeveloped stores in the U.S. and DeLuca’s sister is running the place and she doesn’t have the brand transformational skills,” Gordon said.

In response, a subway spokesman said that Greco grew up in the business and has served in many different roles, including sandwich artist and R&D, and is “leading the evolution of Subway.” In addition, he added that Subway owners have “consistently said the brand is not for sale.”

Corvex Management’s Keith Meister, a protégé of Carl Icahn, has been agitating at Yum! for some time. Meister initially pushed for a separation of the China business, and in 2015, Yum! added the activist manager to its board just as it said a decision was imminent on a strategic review it was working on. The insurgent manager owned 21 million shares, with a $1.7 billion value, as of its most recent positions filing in August. Meister, who is still on the board, could push for Yum! to acquire Dunkin’ Brands, Subway or other fast-food chains to drive growth.

However, Zackfia said she was skeptical that Yum! would be interested in buying Subway, partly because with its numerous locations in the U.S. and abroad it may be too far along on the maturity curve for the KFC, Taco Bell and Pizza Hut owner. “Yum! would likely want something younger that they can grow,” she said.

Another fast-food company that could become an M&A target in the months to come is Chipotle Mexican Grill (CMG – Get Report) . The burrito chain is under pressure from activist investor Bill Ackman’s Pershing Square Capital Management, which has a 9% stake.

One activist fund manager, who requested anonymity, told The Deal that he believed that Ackman could try to force a merger between Restaurant Brands International (QSR – Get Report) , which owns Burger King and Tim Hortons, and Chipotle. In addition to Ackman’s large Chipotle stake, the embattled insurgent fund has a 17% stake in Restaurant Brands and could be trying to drive growth at QSR and reap a premium on his investment in Chipotle.

In addition, a large swath of Chipotle’s shareholders aren’t happy with the company’s performance and executive compensation, including CtW Investment Fund, an organization that advises pensions for unions that is seeking to have the company replace one of its co-founders with an independent director.

Feeling the heat, the burrito chain responded last month with a dizzying array of new initiatives targeted at igniting growth at the same time that it posted a disastrous third quarter.

How would a deal work?

It is extremely unlikely that Restaurant Brands International will be a candidate for an activist-pressured takeover anytime soon. Private equity firm 3G Capital, co-founded by Alexandre Behring, controls Restaurant Brands International’s exchangeable units that convert into about 43% of the voting interest in the company, a major impediment to any dissident-director election effort.

But a Restaurant Brands acquisition of Chipotle would have problems as well. Gordon notes that QSR has accumulated a substantial amount of debt when it was formed to combine Burger King and Tim Hortons in 2014, and as a result it is likely to spend the next few years on developing its existing brands.

Instead of a deal, Ackman could pressure the burrito chain to shift its company owned model into a franchised approach in a move that could drive a hike in capital distributions to shareholders. The idea is simply to sell company-owned stores to their operators or other interested parties to raise cash. Chipotle currently does not franchise and would have to establish the appropriate infrastructure, which includes setting up operational support systems, training and setting up of franchise advisory councils, as well as construction assistance.

However, Zackfia noted that an activist wouldn’t need to push Chipotle into
franchising to raise cash for a hike in its capital distribution plan. “They have no existing debt so they wouldn’t have to do franchising to raise [capital] to repurchase more shares,” Zackfia said.

In addition, it would take significant time for Chipotle to shift to a franchising model, domestically, internationally or both. “There are systems and infrastructure that need to be set up to do franchising. It would take at least 12 months to do it,” Zackfia said.

Still, Ackman could also be privately pressuring Chipotle to expand globally, beyond its 20 or so non-U.S. company-owned locations. Whether driven privately by Ackman or not, the burrito chain appears to be looking to do just that. It recently brought in a new managing director for its European business, Jim Slater, who previously worked at Costa Coffee. Chipotle co-CEO Montgomery Moran told analysts last month that
“expanding … in Europe holds a lot of promise” for the chain’s future.

EDITOR’S NOTE: This article was originally published by The Deal, a sister
publication of TheStreet that offers sophisticated insight and analysis on all types of deals, from inception to integration.

©1996-2018 TheStreet, Inc. All rights reserved.Action Alerts PLUS is a registered trademark of TheStreet, Inc.

Restaurant Finance Monitor – What Happened at Cosi?


From a high stock price of $43 in 2006 to bankrupt and delisted, Cosi is a tough lesson in high rents and disorganized management for fast-casual restaurants.

When Cosi first emerged in the U.S. in 1996, it was among a handful of fast-casual pioneers that relied on three day parts, but unlike other pioneers the company never made much money.

It peaked at 151 units in 2008, but had been struggling to reach AUVs high enough to cover the high cost of rent through the Great Recession. According to a 10-K, rent occupancy costs (which do include paper goods and packaging) sat at 30.1% of sales in 2008. And even as the company closed locations that number continued to rise, reaching a staggering 37% at company locations in 2014 as rents rose and sales slowed.

Unlike fast-casual peer Panera, Cosi over-extended in markets with expensive rent. And the strategy of favoring business centers meant a busy coffee and lunch rush, but a dismally slow dinner hour when business crowds went home. And even the breakfast rush slowed as so many concepts jumped on the day part with high-quality coffee and breakfast fare.

“They were really outclassed at breakfast by everything that has happened in the space,” said restaurant analyst and consultant John Gordon, with Pacific Management Consulting Group.

He said without money to fund strong marketing behind the concept, things only got worse.

“If you’re not promoting with an organized marketing program with some kind of LTO base, maybe at a discount, that is what happens,” said Gordon. “You can’t really do 7% marketing when your rent is 25% of sales.”

According to an analyst report from Anton Brenner at Roth Capital Partners in January of 2016, rent alone averaged out to 21.1% of that occupancy cost. Franchisees faired better as Brenner said the 16 restaurants acquired from then-CEO R.J. Dourney had an occupancy cost between 13% and 14%.

“We estimate that on average the rest of Cosi’s portfolio has rents of around 15% of sales,” said Brenner. “But for the worst performing stores with bad leases and too low sales, rents in some instances are greater than 25% of sales, making it virtually impossible for those stores to be profitable.”

The revolving door for management also kept the concept disorganized from top down.  The August addition of Patrick Bennett as CEO meant five people at the helm since just 2011.

All that change kept the concept from getting any meaningful work done to right the company as it burned through cash; it saw just one quarterly profit during its entire time as a public company. The company reported a loss of $15.5 million in 2015, $15.8 million in 2014 and $11.5 million in 2013 as the revolving door spun. The company saw another $2 million loss in Q1 and expects a loss of between $700,000 and $1.2 million in Q2 of 2016. According to the latest 10-K, cumulative losses were $332 million.

As that was happening at the top of the company, the locations suffered. Unit economics got further out of control.  In a recent report from R.J. Hottovy, a CFA and stock strategist at investment research firm Morningstar, a $1.6 million AUV is the threshold for success. According to the latest Cosi FDD, the 61 company-owned stores averaged $1.1 million. And as time went on without a solid marketing plan or a fresh look to compete with the many concepts that launched or innovated through the years, that relatively low AUV translated to deeper cuts and a lot of time wasted.

“You can’t get some of these years back, once the zebra’s spots are there, it’s hard to restripe it,” said Gordon.

With sour unit economics, hours were cut and quality suffered. One just needs to look at some of the shuttered restaurants’ Yelp reviews to see the outcome: dirty stores and poorly trained staff that weren’t enticing any return visits.

And now, the lenders are stalking horse bidders on the bankrupt company with listed assets of $31.2 million and debts of $19.8 million. AB Value Partners, AB Opportunity Fund and Milfam are providing a $4 million bankruptcy loan. But the cash burn continues, the company has engaged consulting firm The O’Connor Group to fill the CFO role for $21,000 a week and is paying Patrick Bennett $15,000 in consulting fees and expenses each month to stay on as interim president and CEO. Cosi will be de-listed from Nasdaq when trading opens on Monday, October 10.

Franchisees are in an especially bad spot, even those with decent rent metrics. During Quizno’s public implosion, franchisees reported a 10% traffic decline due to the media attention of the bankruptcy as that company collapsed.

Still, despite all the bad news, the bankruptcy could be just what the company needs to retreat and reinvigorate its high performing stores—the top 10 company restaurants still average $1.9 million. The food is still good and unique, and with a bit of capital, innovation could mean the next chapter of Cosi could be a profitable one.

Investor’s Business Daily – Can McDonald’s And Other Quick-Serve Franchises Digest $15 Minimum Wage?

McDonald’s (MCD) won few plaudits a year ago when, under fire from the Fight for $15 movement, it hiked the starting wage in its company-owned stores to $1 over the minimum.

Union organizers were far from satisfied. The hike upped the company’s average hourly wage to just above $10 an hour, and it only applied to workers at the roughly 1,500 company-operated restaurants in the U.S. — only about 10% of the total chain.

But no one was more upset than McDonald’s 3,000 franchise operators, who run the other 13,000 U.S. restaurants and who — as CEO Steve Easterbrook explained in an op-ed announcing the move — “make their own decisions about how they run their business and pay their employees.”

Being put on the spot to match the wage hike — by their hourly workers, if not exactly by Easterbrook — was, to say the least, awkward. The group has more to lose from minimum-wage hikes than non-franchise restaurants in the fast-food industry.

Quick-service franchises often operate on very thin profit margins. A big wage hike would squeeze them in multiple ways.

First, their labor costs go up, which puts pressure on them to raise prices. Higher prices could translate to lost sales.

Second, assuming that higher prices generate enough extra revenue to pay for the higher labor costs, franchisees have an added burden: The fees they pay to the companies behind franchises like McDonald’s and Burger King (owned by Restaurant Brands International (QSR)) are a fixed percentage of sales — a 10% price hike means a 10% hike in franchise fees.

For quick-service chains with few company-operated stores, a much higher minimum wage won’t have much of a direct effect, but a deterioration in the financial health of their franchisees — even if fees from the franchises were increased — would bode ill for the company’s future.

Slow vs. Quick Wage Rate Hikes

Chains such as McDonald’s and Burger King charge franchisees a royalty of around 4%-5% of sales and a similar-sized marketing fee. On top of that, a number of chains, including McDonald’s, Burger King, Tim Horton’s, Wendy’s (WEN) and Jack In the Box (JACK), generally lease out their restaurant locations to franchisees for an additional percentage of sales, said John Gordon, founder of Pacific Management Consulting Group, which provides restaurant industry analysis to investors and franchisees. At McDonald’s, rent can reach 14% of sales or more, Gordon said.

Some simple math illustrates the challenge for a McDonald’s franchisee under a long-term contract to pay out 20% of revenue to the fast-food giant. Assuming a franchisee earns a 2% profit margin, then a 10% price hike that’s just enough to cover extra labor costs would, all else equal, erase its profitability. (See table.)

Historically, “shareholders have benefited” from slow, modest increases in the minimum wage, as prices were pushed higher by wage inflation, said Richard Adams, founder of Franchise Equity Group and a former McDonald’s franchising executive. “The problem is if you accelerate the minimum wage too quickly.”

That looks to be the case in California and New York, where the minimum wage is set to rise to $15 an hour by 2022 and July 2021, respectively. While New York’s statewide minimum wage is only set to rise to $12.50 outside of New York City and surrounding counties, quick-service chains will have to pay $15 statewide under a separate fast-food wage, unless courts strike down the unequal treatment.

A survey conducted for the Employment Policies Institute found that franchise businesses would be more likely than non-franchise businesses to cut jobs (65% vs. 51%) and turn to automation (54% vs. 37%) in response to a $15 wage. While the group advocates against minimum-wage hikes, the notion that franchisees would be less able to manage higher labor costs jibes with analyst comments that labor costs passed through as price increases would also raise the cost of royalties, marketing and rent.

Flawed Franchise Model?

To the extent that advocates of a $15 wage have acknowledged the pressure it would put on franchisees, they have said that disrupting the franchise model is a feature of their strategy, rather than a bug.

The industry’s legal challenge against Seattle’s faster phase-in of its $15 minimum wage for franchisees, which would otherwise be given the same slower timetable as small businesses, prompted Mayor Ed Murray to argue that the franchise business model is exploitative.

“I don’t believe that the economic strain comes from a fairly slow phase-in of a higher minimum wage, but on a business model that really does — in many cases — harm franchise owners,” Murray said.

Industry experts see little chance that financial stress for franchisees exacerbated by minimum-wage hikes will lead to broad change in the model which ties franchise fees to a fixed percentage of revenue. This is, in part, because the franchising contracts tend to be 20 years in length. Still, Gordon of Pacific Management Consulting Group sees potential for revamped deals on a case-by-case basis if franchise locations encounter financial trouble and have to sell.

“The franchisor generally wants to keep the lights on,” Gordon said. By way of encouraging a larger franchise operator to buy out small “mom and pop” operators in financial distress, the company “might think about reducing royalty rates,” he said.

Gordon notes that most companies provide little transparency about the financial status of their franchisees — Popeye’s (PLKI) and Domino’s (DPZ) being exceptions — and Gordon argues that such franchisee metrics are critical.

“Profitable franchises produce an environment for franchise expansion,” Gordon wrote.

Because franchisors are paid based on revenue — not profit — it’s possible for the financial performance of franchisor and franchisee to diverge for a time. Minimum wage hikes that lead to price hikes might cause such a divergence, as might a discounting strategy that boosts sales but doesn’t help the bottom line.

Corporate Cash Flows At An All-Time High

Adams of Franchise Equity Group says the ongoing shift by big fast-food chains away from company-owned stores “is a reflection of the increasing risk and decreasing margins” quick-service restaurant operators face.

He notes that franchising contracts generally require franchisees to invest a few hundred thousand dollars in the restaurants over time to update technology and remodel. McDonald’s, for example, has been previewing its restaurant of the future recently, including “Create Your Taste” kiosks that let people custom-order their burgers.

If franchisees are under stress because of a higher minimum wage, they won’t have the cash flow needed to reinvest, Adams says.

McDonald’s executives on Friday said the company’s own wage hike shrank profit margins at company-owned U.S. restaurants in the latest quarter, but neither Easterbrook nor analysts brought up the $15 wage coming in California and New York.

For now, with commodity costs low and business getting a lift from all-day breakfast, Easterbrook said that franchisees’ cashflows are at an all-time high in many major markets.

Publicly-traded Carrols Restaurant Group (TAST), which operates 705 Burger Kings, says that restaurants remodeled in line with the BKC 20/20 restaurant image at a cost of $400,000 or more have seen a 10% to 12% boost in average sales.

Carrols, which has 133 restaurants in New York after closing three in the state last year, warned of the shift to a $15 minimum wage in its annual 10-K filing: “We typically attempt to offset the effects of wage inflation, at least in part, through periodic menu price increases. However, no assurance can be given that we will be able to offset these wage increases in the future.”

Dunkin’ Brands (DNKN) CEO Nigel Travis told analysts in an earnings call last October that the company has been instructing its franchisees that it’s best not to hike prices in response to minimum-wage hikes.

“We demonstrated by case studies, and I’m thinking of one particular where because of the minimum wage change in one town, they increased prices twice in a short period, and the (sales) in those stores went progressively negative,” Travis said.

Industry trends suggest the goal of quick-service chains that compete on price will be to get customers to spend more by building loyalty programs; offering custom orders and a wider range of quality options; and streamlining their staffing needs. But the challenge is huge, and poor execution could imperil their franchisees in high-minimum-wage areas.

One clue to how difficult it will be for franchise vs. non-franchise models: On February’s earnings call, Morgan Stanley analyst John Glass told management: “I’ve observed in Boston, for example, Dunkin’s pricing about $0.10 above Starbucks for a regular coffee” in response to the $10-an-hour Massachusetts minimum wage.

Dunkin Brands and Restaurant Brands International both plan to report quarterly results on Thursday.

Crain’s Chicago Business – McDonald’s reheats its value menu

By Peter Frost March 19, 2016

Riding a wave of momentum triggered by the launch of all-day breakfast, the world’s largest fast-food company is grappling with the next stage of its turnaround plan: its new value platform.

Turning McPick, as it’s called, into a consistent, advertising-backed national program that appeals to its core cost-conscious consumers is crucial for Oak Brook-based McDonald’s, whose big bet on breakfast is paying off but won’t last forever.

McDonald’s needs McPick to be a supersized hit.

“The reality is 67 percent of transactions (at fast-food restaurants) are under $6,” says John Gordon, a restaurant analyst and consultant in San Diego, citing data from consumer research firm NPD Group. “It’s very
important for them to get a sustainable value menu, and there are so many different ways of doing it. You would hope there are whole floors of corporate staffers in Oak Brook that are thinking about these things.”

Its customers want a new value menu, too. Offering one ranked as the top change McDonald’s could make to drive more customer visits, according to a national survey conducted in August on behalf of Crain’s by Chicago-based research group 8Sages and the late pollster Leo Shapiro. The survey found that 32.4 percent of respondents would dine at the Golden Arches more often.

But executing such a program across more than 14,000 U.S. restaurants owned by McDonald’s and hundreds of franchisees is complex.

“We’ve been trying to develop a new value menu for six years and, obviously, it hasn’t worked out all that well,” says one franchisee from the Southwest, who requested anonymity.

McDonald’s declined to make executives available for interviews. Spokeswoman Lisa McComb says in a statement that the company “is continuing to try new approaches and at a speed not seen before.”

McDonald’s kicked off 2016 with the debut of McPick 2, which allowed customers to choose two items from among four—the McChicken, the McDouble, small fries and mozzarella sticks—for $2. The five-week pilot,
which analysts believe helped boost traffic, may have hurt profitability in some markets because of a “trade-down” factor, in which customers chose the $2 deal over a regular-priced entree or value meal.

As soon as that deal expired, McDonald’s introduced a McPick 2-for-$5 deal, featuring some of its best-known products—the Big Mac, the Quarter Pounder with Cheese, the Filet-O-Fish and Chicken McNuggets. That
promotion remains in most markets today. Others, including the Atlanta market, have kept the 2-for-$2 deal.

“In spite of the mixed success of 2-for-$2, we believe McPick 2 can represent (a meaningful) value brand for McDonald’s,” RBC Analyst David Palmer wrote in a March 7 note to clients.

Franchisees prefer the richer 2-for-$5 promotion, which has enough shine to lure customers and, if bundled with fries and a drink, can bring the average check size to $7 or $8.

McPick represents the restaurant giant’s first major foray into value since its successful Dollar Menu in 2001. While Oak Brook futzed with it, eventually morphing it into the Dollar Menu and More, newly energized
competitors Burger King and Wendy’s went all-in on value offerings of their own, which analysts say took share from McDonald’s.

Indeed, the company lost U.S. market share for 71 consecutive weeks, a streak that finally ended in late September when McDonald’s began to claw back share, in part because of publicity surrounding the launch of
all-day breakfast.

An East Coast franchisee, who asked not to be named, says Big Mac’s lack of a national promotion has hurt the brand. All franchisees are “missing the key element of everyday pricing,” he says. “We need to give the
customer choice and control. That is why (the) Dollar Menu was so successful.”

But much has changed since the introduction of the Dollar Menu, which sparked a decade-long run of robust sales growth in the U.S., its largest and most important market.

Perhaps the biggest difference today is the disparity of wages between certain urban stores and others, the result of minimum-wage laws. That’s led to friction between the regions, and Oak Brook has accomplished little
in the way of getting disparate franchisee groups to march together on a sustained value platform. A deal that makes financial sense in Omaha, Neb., for example, may be a money loser in Manhattan.

Some franchisees are pushing for a customizable value menu that differs by region, an approach McDonald’s plans to test later this year. But that could discount the effectiveness of the chain’s national advertising, which is
paid for with a pot of money funded by franchisees.

“Value today is a necessary evil,” says Darren Tristano, president of Technomic, a Chicago-based consumer research firm. All fast-food companies are “playing in that space because they have a deep fear of losing
share,” which has set up a sort of race to the bottom.

The prevailing thought is: If they don’t discount as deeply as their peers, customers will go somewhere else. It’s a risk McDonald’s can ill afford to take.

The Columbus Dispatch – Bob Evans’ prepared-foods unit growing while restaurants struggle

By JD Malone
The Columbus Dispatch • Friday February 5, 2016 6:05 AM

In a refrigerated case at a QFC grocery store in Portland, Ore., mashed potatoes and macaroni and cheese bearing the red and white
Bob Evans Farms logo await the hands of hungry shoppers.

The side dishes are almost 1,800 miles from the nearest Bob Evans
restaurant (in suburban Kansas City, as it happens) and they are
selling like, well, hotcakes.

“Most people who grow up here think of Bob Evans and they think
sausage,” said Mike Townsley, president of Bob Evans Foods, the
company’s prepared-foods division. “We sell more mashed potatoes than sausage.”

Bob Evans’ side dishes are in more than 30,000 stores in every state and parts of Canada. The lack of brand awareness — the company’s 547 restaurants are in just 18 states, mostly in the Midwest — hasn’t dampened
sales at all. Bob Evans side dishes command 50 percent of the market and have three times as much market share as the closest competitor, Hormel.

“When we first introduced into QFC (a subsidiary of Kroger) in the Portland area, within the first three months, Bob Evans was the leading item in the category,” Townsley said.

Bob Evans, based in New Albany, launched side dishes and breakfast sandwiches in the 1990s to complement its retail sausage business. Sales of side dishes grew so much the company bought its largest supplier, Kettle
Creations, in 2012 and invested $25 million to expand a plant in Lima, Ohio which can now make about 100 million pounds of mashed potatoes and macaroni and cheese a year.

The company is spending $20 million this year to increase capacity in Lima by 30 to 40 percent.

Bob Evans restaurants have wrestled for years with declining traffic and sales, but the food division has been a very different story. Though it makes up less than a third of the company’s overall revenue, the food
division has made more money than the restaurants in recent quarters and is growing at a double-digit clip.

The success at Bob Evans’ prepared food division has made it a target for activist investor Thomas Sandell, who has called for the division to be sold or spun off. In December, Sandell released a letter stating that at
least one potential buyer had stepped forward and he believed the sale price could approach $1 billion. Sandell hopes to reward shareholders like himself with a windfall dividend or expansive share buybacks.

At least one analyst agrees. It is time to sell the division now that a new CEO, Saed Mohseni, is on board, said Gordon sees all those side dishes as a distraction. In his view, Bob Evans’ core business is restaurants and
needs the company’s full attention.

Townsley said his team tries to ignore the chatter, but admits that it is human to be distracted by such talk.

“Our business is doing very well and let’s stay focused on what we can control,” Townsley counsels his staff. “If we do all those things, everything will work out just fine.”

The same market forces that have sent former Bob Evans and Bravo Brio patrons to faster, cheaper and more convenient options like Wendy’s and Panera are also apparent in grocery stores, said John Rand, senior vice
president of retail insights at Kantar Retail.

“Refrigerated side dishes are a huge time saver at what is perceived as moderate expense,” Rand said.

And to Gordon’s point that the two Bob Evans’ divisions have diverged: At the grocery store, the brand name doesn’t matter; product perception is everything in the cold case, Rand said.

“The restaurant’s own brand may be largely irrelevant. It may assist early trial and adoption, but the item has a stand-alone value even if a shopper is not particularly aware of the restaurant chain,” Rand said.

Households headed by a pair of working adults seek out food items that make life easier, no matter where they live, Rand said. That means even in Portland, Ore., people who have never sunk a fork into Bob Evans’
pancakes or sausage will buy its side dishes.

Townsley thinks it is even simpler than that.

“Once we get the product in people’s mouths, the quality of that product sells itself,” he said. “I’m sure your mom and grandmother can make great mashed potatoes, but not in 5 minutes. That’s the crux of it.”

By JD Malone
The Columbus Dispatch • Friday February 5, 2016 6:05 AM


Blue MauMau – 2015 Restaurant Franchisee Profitability Reporting and Implications

Posted Tue, 2016-04-05 00:41 by john a. gordon

I’ve noted the reluctance of virtually all restaurant franchisors to report the profitability of franchised stores. But there are a few franchisors that do.

After watching fourth quarter and year-end results for 2015, Popeye’s (NASDAQ:PLKI) and Domino’s (NYSE:DPZ) continue to stand out in reporting franchise store level “profit,” which is likely an EBITDA
number. Both franchisors have done so for some time, three years now by my count.

The table below shows the trends.

Restaurant Franchisors Who Report Franchisee “Profitability”
Source: Company year-end earnings calls

Brand      2015 US Unit    “Profitability”     Net US New Stores Trend
Popeyes          $340,000             +72                          Up, from $177,000
Domino’s      $120,000              +133                         Up from $80,000.

To its credit, Dunkin’ Brands (NASDAQ:DNKN) typically reveals new year Dunkin’ Donuts Western U.S. opening cohort (i.e., class) sales and simple unlevered (i.e., no debt service) cash on cash return. The McDonald’s (NYSE:MCD) chief financial officer noted in March that the U.S. franchisee “cash flow” was $350,000 per store unit. As with Popeyes and Domino’s, the $350,000 is of course before many costs and expenses. McDonald’s CEO reported franchisee numbers in 2013, when franchised stores reached

Despite the fact that store EBITDA is profit before everything—profit before taxes, franchisee overhead, debt service and future years capital spending (CAPEX), these are still important indicators.

There are two implications that can be easily seen.

1. The timing of the lack of franchisee visibility is unfortunate given the current state and municipal push for minimum wage increases
This week’s minimum wage increases in California and New York were made without the general awareness of how marginal franchisee true cash flows could be, after allowing for brand royalties, rent margins, price discounting, capital expenditures and other fees. The policy makers and the politicians didn’t have the data and have to be educated in any event. Most have only a very hazy understanding of the difference between the large franchisor corporations and franchisees, and most importantly, who pays for what. Some will say the wage increases would have happened anyway; but the small business advocacy game has to be played with all the cards in the deck. Franchisors can improve the odds with better disclosure.

2. The store economics for Domino’s and Popeyes show that franchise unit growth follows the store profitability of a system’s franchises
In other words, profitable franchises produce an environment for franchise expansion. Take for example, both Domino’s and Popeyes. They were in the midst of a recent period of rising store level profitability. The profitability gains of their franchised restaurants encouraged and enabled future unit expansion, as both CEOs noted to analysts. Future franchisee unit growth was funded via retained profits and positive cash flow that franchisees accumulated. Why? Because almost every franchise loan requires injected franchisee capital, and because most franchisors target their own franchisees for expansion. That means profits for the franchised stores first, then franchise unit expansion, not the other way around.

History shows that massive increases in franchise store count without the average store being profitable bodes poorly for a franchise system in the restaurant industry.

Reading Restaurant Results Properly

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.