RestauRant Finance Monitor - David...

RestauRantFinance Monitor

Volume 24, Number 10 • Restaurant Finance Monitor, 2808 Anthony Lane South, Minneapolis, MN 55418 • ISSN #1061-382X

October 18, 2013

OUTLOOK

© 2013 Restaurant Finance Monitor

Continued on Page 7

Michael Kelter, Goldman SachsAndy Barish, Jefferies

Bob Bielinski, The CIT GroupNick Cole, Wells Fargo Restaurant Finance

Cristin O’Hara, Bank of America Merrill LynchTrey Brown, GE Capital, Franchise Finance

Kevin Burke, Trinity CapitalAdam Birnbaum, Grandwood Capital

Jim Walsh, JefferiesJim Ellis, CapitalSpring

Dan Holland, Cadence BankEric Renaud, Direct Capital

Robert Daniel, Regions BankDavid Farwell, RBS Citizens

Bill Pabst, The Cypress GroupRod Guinn, FocalPoint Advisors

Dennis Monroe, Monroe Moxness BergRick Thompson, BMO Harris Bank

Brad Saltz, SS & GMichael Gottlieb, Ernst & Young

Gary Levy, Cohn ReznickAnna Graves, Pillsbury Winthrop

Scott Roehr, Restaurant BizGene Baldwin, DeloitteSteven Liff, Sun Capital

Larry Hester, Geraty InvestmentsBlyth Jack, TSG Consumer Partners

Allan Hickok, Boston Consulting GroupScott Pressly, BIP Opportunities Fund

Quinton Maynard, Morehead Capital Mgmt.Beth Solomon, NADCO

Barbara Morrison, TMC FinancingDavid Sobelman, Calkain Companies

George Harrop, Capital Source

The Monitor Welcomes as Speakers the TopRestaurant Finance Experts

Restaurant Finance & Development Conference November 4-6, 2013 at Wynn, Las Vegas.

800-528-3296 / www.restfinance.com

With Special GuestsGene SimmonsHenry Winkler

Charles Krauthammer

Between a Rock and a Hard PlaceContrary to popular belief, we here at the Monitor don’t throw darts at casual dining chains just for fun and we don’t whack piñatas designed to look like bar & grill CEOs. We even like a few casual dining chains out there, and think many of them are doing the right things.

But we are bearish on the sector as a whole. There are too many things going against casual dining right now to endorse a concept that employs waitstaff over one that doesn’t.

All the numbers bear this out. According to the Chicago-based market research firm NPD Group, casual dining and what it calls “midscale” restaurants haven’t had an increase in traffic in any quarter since before the recession. According to the closely watched Knapp Track Index, traffic at casual dining chains fell 3.1% in August. That number was better than it was in July, but it has been brutal all year long.

According to former sell-side analyst Larry Miller’s MillerPulse index, QSR chains have outperformed casual dining concepts for 26 of the past 27 months. On average, Miller said, QSRs have outperformed casual dining concepts by 200 basis points during that period. In short, casual dining’s problems date back several years now, and in spite of the economic recovery, things just aren’t improving.

To some extent, some of this is beyond the concepts’ control. The economy stinks, and consumers are broke after their taxes increased this year and they had to buy a new car or appliance.But we also think that some casual dining concepts have put themselves in a negative position. Some have cut costs, and lost some of the reasons why customers went to their restaurants in the first place. Or they tried to be something they weren’t, and thus lost touch with their core customers. Given how hyper-competitive the current environment is, such mistakes can be brutal.

Losing Core CustomersAfter Ruby Tuesday’s sales began falling in 2007, the company undertook a major project. Sensing a “sea of sameness” in the bar & grill space, the chain decided to go upscale. The company changed its menu, and spent tens of millions of dollars to renovate its restaurants. The goal was to make the chain more like a dinner club, with an average check of $12-$14.

FINANCE SOURCESWells Fargo’s New Initiative to Focus on Smaller Credits

In addition to their existing target, middle- to large-sized restaurants, Wells Fargo Restaurant Finance recently announced it will now have a dedicated team focused on financing franchisees with less than 20 stores.

According to Nick Cole, Executive Vice President with Wells, they’ve been working on the initiative since early 2013, and recently launched it once they had built the program and had the team in place and ready to go. Mike Record, formerly of TD Bank and GE Capital, Franchise Finance, has joined the bank as Senior Vice President-Program Finance and will lead the team.

“Banks are tripping over themselves to fund the franchisees with more than 50 stores,” said Cole, “but franchisees with less than 20 stores were very much underserved.” And, franchisors have been pushing for this help, too.

“They (franchisors) know the bigger guys have no trouble (getting capital),” he said. “They’ve been pushing all the banks in this direction for some time.”

He added that they were ready to grow their business at Wells Fargo Restaurant Finance even further, and learned some good lessons on smaller credits by working with their McDonald’s customers. “We’ve been working with them for the last three years, and we had success—we could look at what we learned there, and it naturally led us in this direction,” said Cole. When he started with the bank seven years ago, “we weren’t doing any franchise lending at the time.” They started an emphasis on it about five years ago, and he reports about 40 percent of their current portfolio is franchise loans.

Loan size with the new program will be from about $5 million to $10 million, and the funds can be used for acquisitions, refinancings, development lines and remodeling activity, to name a few. They have a list of eight or 10 brands with which to begin the program, and will be adding concepts later.

Cole added with 6,000 branches around the country, Wells Fargo has a lot of other resources for restaurant operators. “We have small business lenders who can interact with these folks in their local environment. That’s a network that is hard to duplicate,” he said. Wells has other products from insurance, wealth management and other financial services to help small business owners.

“Lending money efficiently and effectively is at the heart of what we do,” said Cole. “If the customer is getting a term sheet from us, and they have to break the tie with someone else, we want them to think about what a relationship with Wells Fargo does for them. And that’s customers of all sizes.”

For more information on Wells Fargo Restaurant Finance, contact Nick Cole, Executive Vice President at [email protected], or at (760) 918-2705, or Mike Record, Senior Vice President at [email protected] or at (760) 918-2726.

TD Bank Provides Wendy’s Franchisee with Refinancing, Remodeling CapitalTD Bank’s Franchise Finance Group recently provided Wendy’s franchisee Square Treasure Foods (also Space Coast Foods and Race Coast Foods) with $7.25 million in financing. The capital is earmarked for refinancing existing debt and remodeling efforts.The franchisee company, owned by Hans Sohlen and Mark Reed, operates 39 units in Florida, between Ormand Beach and Daytona Beach, to the north end of West Palm Beach. Sohlen is the financial partner, while Reed is the operating partner for the business.Sohlen himself had years of experience financing restaurants as a financial advisor to multi-unit operators. He decided in 2007 to buy nine Wendy’s restaurants with Reed, and has continued to acquire units to become one of the largest operators in Florida. “I probably worked on $800 million of restructurings throughout the years,” he said. “I thought, ‘if all of these other people can do it, I probably can, too,’ and it was my chance to build some equity.” He liked working with TD Bank because, first of all, they have a low cost of capital. “I’m probably saving 200 basis points and that’s definitely of interest to me,” he said. “It makes a big difference.” And, “they are friendlier with a more typical franchisee borrower covenant structure.”Sohlen also cited TD’s strong Maine-to-Florida retail footprint. For the first time, “we now have cash management and long-term credit under same roof,” he explained. “This yields further cost and cash management efficiencies for us in terms of TD pricing out a fuller relationship where they can leverage a fuller banking platform, not just long-term credit.”Brian Frank, head of TD’s Franchise Finance Group, liked the deal with Square Treasure, because they are “experienced and tenured operators, who are continuing to invest in their business and grow,” he said. And it is right in the bank’s sweet spot where deal size is concerned. We’re truly committed to the space, and we’re doing deals.” For more information on TD Bank, contact Brian Frank, head of Restaurant & Franchise Finance, at [email protected], or by phone at (203) 761-3818.

Hung Joins RBS Citizens Franchise FinanceThomas Hung recently joined the RBS Citizens Franchise Finance team as senior vice president, where he will be responsible for covering regional chain restaurants. He was formerly with GE Capital Franchise Finance, where he headed up chain restaurant originations and prior to that, managed club syndications. RBS Citizens Franchise Finance is headquartered in Boston with a major office in Irvine, Calif., and offers financial support to multi-unit operators nationwide, including credit facilities and risk management advisory services and more. Citizens Bank is the 12th largest bank in U.S., measured in assets and has 18,944 employees. You can reach Hung at 949-726-7306, or by e-mail at [email protected].

Auspex Closes Yum Franchisees Transactions

Auspex Capital, an investment banking firm that provides advisory on restaurant industry transactions, recently closed on the following transactions:

• Debt placement advisory: Represented Border Foods, a Minn.-based Taco Bell franchisee, in securing a $98 million senior secured term loan, including a $17 million remodel and development line of credit and a $5 million revolving line of credit. The transaction was financed by a three-bank syndicate which included RBS Citizens Franchise Finance, City National Bank and BMO Harris Bank. Border Foods is owned by longtime franchisees Lee and Jeff Engler, who own and operate 83 Taco Bell restaurants throughout Minnesota, Wisconsin, and Wyoming and the real estate underlying 46 of those locations.

• Sell-side M&A advisory: 4M, Inc., a Pocatello, Idaho-based Taco Bell franchisee owned by Craig and Nancy Moss, has sold its six high-volume Taco Bell restaurants in southeastern Idaho. Snake River Restaurants, LLC, owned and operated by Yum Brands franchisees Brett and Adam Sibert, was the buyer.

• Buy-side M&A and debt placement advisory: Represented JC Restaurants, LLC, a New York, NY-based Yum Brands franchisee, in securing a $13 million senior secured term loan and a $1.2 million development line of credit to fund the acquisition of six Taco Bell restaurants and the underlying real estate at two locations from an existing franchisee. RBS Citizens Franchise Finance was the lender. JC Restaurants is owned by Yum Brands franchisees Joe Cugine, John Antonaccio and Jim Bodenstedt.

• Debt placement advisory: Represented Cugine Foods LLC, a New York-based Yum Brands franchisee, in securing a $6.25 million senior secured term loan, including a $1.65 million line of credit to refinance existing debt and equity cash distribution. RBS Citizens Franchise Finance was the lender. Cugine Foods is owned by Joe Cugine, who first became a franchisee in 2011 and now owns 10 stores in the New York area.

• Debt placement advisory: Represented RGT Foods, Inc., a Memphis, Tennessee-based Yum Brands franchisee, in securing a $49.3 million senior secured term loan, including a $5 million line of credit to refinance existing debt and provide for store remodels and new store developments. The transaction was financed by a two-bank syndicate which included Huntington National Bank and City National Bank. RGT Foods is owned by Sean Tuohy and Michael Roe, who now own and operate 94 stores across five states.

Auspex’s services include buy-side and sell-side M&A advisory, debt placement, asset valuation, institutional private equity and mezzanine placement, sale/leaseback structuring and placement and financial restructuring.

For more information contact Chris Kelleher, Managing Director at 562-424-2455 or by e-mail at [email protected].

CIT Group Lends to REIT for Purchase of Wendy’s LocationsCIT Group, which provides financing and advisory services to the multi-unit restaurant industry, recently provided a senior secured term loan to Cole Real Estate Investments, a real estate investment trust. The $15.5 million financing supported the purchase of 21 properties with Wendy’s, located in Las Vegas, San Antonio and Indianapolis.

CIT Corporate Finance, Retail and Restaurants served as sole lender and lead arranger for the transaction. Financing was provided by CIT Bank, the U.S. commercial subsidiary of CIT.

Bob Bielinski, Managing Director with CIT, was pleased with the transaction because it utilized the expertise they already have with the restaurant industry, which allows them to continue to grow their business. “It’s a great addition to our product line,” he said.

There were a number of boxes CIT could check off when it came to this transaction, he added.

“We like the Wendy’s system—it’s a tier one brand,” said Bielinski. “We liked the structure of the transaction: The borrower structured the rent stream and the purchase price really well. It’s a good lease.”

And he added, they like working with Cole. “It’s an experienced group, and they know what they’re doing,” he said.

This is the retail and restaurant group’s first loan to a REIT, but Bielinski says, “I hope it’s not the last one. It’s just a nice natural extension of our business. Generally, we get to put money to work in a good, quality transaction, with a significant amount of collateral in real estate. It’s just good business.”

And, he added, it fits within their philosophy of being “open minded” and looking at a variety of brands and various transaction types. “Our restaurant expertise makes us flexible in our approach,” said Bielinski.

And the restaurant space is where Cole wants to be. “The recent purchase of these properties with Wendy’s restaurants further expands our portfolio of net lease restaurant assets,” said Matt Donnelly, Senior Vice President and Head of Real Estate Finance at Cole. “We continue to look for restaurants, as well as other single-tenant properties, with credit tenants and experienced operators who meet our acquisition criteria.”

For more information on CIT Group, contact Bob Bielinski, Managing Director, at (312) 906-5872, or by e-mail at [email protected].

A new equity investor has entered the market with Equity Development Partners, LLC. Founded by Howard Spunt, also the co-founder of LandMark Retail Group, a real estate development company, Equity Development will provide equity capital and real estate development services to fast casual, multi-unit restaurant companies.The first transaction coming out of the gate earlier this year for Equity Development was their minority investment in casual brands Stir Crazy and Flat Top Grill, which were owned by private equity firm Walnut Group and a handful of individual investors. The investment, made in conjunction with Doug Pack, a large multi-unit restaurant operator of Papa John’s and Spaghetti Warehouse, pulled the two concepts out of bankruptcy and gave Equity Development and Pack about a 20% stake in Flat Top Grill and 40% in Stir Crazy.. Both Equity Development and Pack serve on the board of each company.Currently the largest shareholder in the two brands is HillStreet Capital, a fund that invests junior and mezzanine capital in middle market companies. Originally, HillStreet held debt on the two concepts. As part of the transaction, part of HillStreet’s debt was converted to equity. Equity Development will be actively involved in the real estate strategy as the company develops its expansion plans. Stir Crazy has nine locations; Flat Top, 14—throughout the East coast and Midwest. In addition to making their initial investment, Equity Development will provide additional capital as needed to continue to develop the two brands— the other piece of the puzzle the firm brings to the table is development expertise. “We help grow the brands, and work with management from the beginning, the strategy stage, all the way through to completion of construction” on new units, said Spunt. His background, and the work of his other business, LandMark Retail, is focused on multi unit tenant expansion , so the firm brings an expertise in real estate strategy, site selection and other aspects of the development process. He indicated that Equity Development will take a methodical approach to making future investments in brands; he thinks perhaps they will invest in one additional brand in 2014, and possibly one or two more in 2015. Each $1.0 million to $1.5 million investment will give them a minority, up to 50% ownership stake. After three years, says Spunt, they will re-evaluate further investments in the brands. Most of the capital raised is from Spunt’s personal funds and those of a few other partners whom Spunt has worked with for over the last 20 years. “We don’t syndicate and raise capital from 30 or 40 other investors,” he said of his particular brand of investing, where he has a lot of skin in the game himself.

Another project underwaySpunt is also consulting with another company called Cal-American Corporation, which owns 1 million square feet of shopping center space throughout California. Cal-American’s objective is to carve out space specifically designated for QSR and fast casual brands, with a goal of becoming a franchisee of those concepts. Cal-American would be open to working with an operator who would lead the operations of the restaurants and provide the sweat equity, said Spunt, while Cal-American

FINANCE SOURCES

Trinity Capital Closes Recap Transaction and Seller Advisory DealsTrinity Capital, a boutique investment banking firm that specializes in the restaurant industry, recently completed the following deals:• Recapitalization: Trinity was the financial advisor to ES-O-EN Corp., a 44-unit Taco Bell franchisee, in the completion of a $33 million recapitalization. Wells Fargo Restaurant Finance was the lender in the transaction. The recap was used to fund “substantial capital expenditures to address the aging store base in their Salt Lake City market,” said Kevin Burke, Managing Director of Trinity, “and to build new restaurants.” According to Burke, the funding will bring the Salt Lake City store base in line with “the system-leading sales that ES-O-EN has in its other markets. Two of their markets are doing fantastic, and this was a plan to fix the other. We were also successful in extricating the company from substantial prepayment penalties and defeasance penalties on securitized debt.”• Sale of 22 restaurants and one convenience store: Trinity represented Luihn Food Systems in their sale of 22 KFC restaurants in the Greensboro, Fayetteville and Highpoint, NC markets. They sold the locations to KBP, another KFC operator. Trinity bifurcated the real estate from the business enterprise and separately sold these entities to different buyers to maximize the proceeds and capitalize on capital gains tax treatments. Luihn Food Systems is redeploying their resources in their Taco Bell business, according to Burke.• Sale of Taco Bell restaurants: Trinity was the financial advisor to Orlos and Company in their sale of their five Florida-based Taco Bell restaurants to Luihn Food Systems. “Dennis Orlos, the owner, was actually able to retire after the sale,” Burke reported, and the seller was able to “protect a substantial amount of net worth.” Purchase price multiples have been holding up nicely, added Burke, for a number of reasons, including low interest rates, a nice IPO pipeline of restaurants which indicates there are other exits available to operators, and “people feel investing in the food chain is a safer place to put their money” than into other sectors. Trinity Capital provides strategic advice to middle-market restaurant businesses regarding mergers and acquisitions, leveraged and management buyouts, debt restructurings and private placements of debt and equity. For more information, contact Kevin Burke, Managing Director, at (310) 268-8330, or by email at [email protected].

could potentially fund the actual development capital and facilitate the build out process including planning, permitting, store opening and operation.

For more information on Equity Development Partners contact Howard Spunt at [email protected], or by phone at (310) 457-0619. For more information on Cal-American Corporation, contact Anat Fromm at [email protected], or at (310) 432-4901.

Equity Development Partners to Invest in Fast Casual

Seacoast Commerce Bank Serves Western States

Seacoast Commerce Bank, headquartered in San Diego, California, is a business bank with $200 million in assets and a focus on providing SBA-guaranteed 7(a) and 504 loans. According to Chris Spivey, senior vice president, Seacoast provides financing for hard assets, the buildings, furniture, fixtures and equipment.

“We get a lot of deals that are turned down by larger lenders for a lot of reasons,” said Spivey. “We can take a look at those. Their credit doesn’t have to be perfect. We’re more interested in that the borrower has experience in the industry. And some liquidity.”

The bank’s focus is deals below $5 million, and doesn’t finance start ups. Again, experience matters.

And, because Seacoast is a smaller bank, “we’re very quick on processing. We’re not like a big bank. We have a lot more flexibility. We’re able to listen to a borrower’s story. We take the time to get to know them,” he said. “We pay attention to the details borrower’s tell us. Especially when there are hiccups in credit. We’re willing to take some of those risks.”

For more information on Seacoast Commerce Bank, contact Chris Spivey, Senior Vice President, at 949-373-0640, or by e-mail at [email protected].

The Monitor recently reported on Pinnacle Capital, a specialty finance company, and its successful efforts in pulling together a consortium of community and local banks nationwide to fund franchisees, even those that are smaller—a group that sometimes has more difficulty than most finding capital.

Pinnacle has built on the success of that network and has formed an alliance with a large, publicly traded life insurance company to fund real estate for restaurant, specialty retail brands and other branded businesses. Quite simply, Pinnacle will fund either the land and building, or just the building on a long-term ground lease. Pinnacle originates the opportunities and does the due diligence and underwriting on the deals, and on a post-closing basis, manages the portfolio.

Pinnacle’s president, Bill Wildman, points out the benefits of this product are threefold for the franchisee or borrower.

First, “the insurance company is a multi-billion life and disability company that has been around for over 100 years. They have long-term liabilities and therefore would like to match them with long-term assets and be paid interest and a small amount of principal for a long, extended period of time,” said Wildman, unlike a bank that generally requires the loan have a maturity of five to seven years, and a 15 to 20-year amortization. Here, he reports, the borrower pays it back more gradually. And, there are no balloons with this product, unless the borrower so chooses.

Secondly, the product is flexible enough the borrower can choose their own combination of amortization and term, and “then we price it,” he explained. If a borrower wants to pay off a loan early, there are no prepayment penalties at the reset period. A unique element is borrowers can be provided a reset period when they can reset their interest rate or pay off the loan without penalty.

Third, there are no restrictive covenants you would ordinarily find in a loan agreement. “There’s none of that,” said Wildman. “Just pay the loan payment as agreed.”

“This product is allowing us to fund the real estate portion of the loan request with the insurance company, and then bifurcate the enterprise loan with one of the banks in our network,” he added. “It gives our clients a tremendous amount of flexibility with enhanced cash flow to operate their business. It is especially good for those operators who prefer to own their real estate—if only they could have cheap, fixed-interest rate pricing combined with long-term amortization.”

Wildman said the transaction size varies from $1 million to $5 million per site. “Another advantage for our borrowers,” he added, “is the insurance company doesn’t have a brand or borrower concentration limit nor are they brand sensitive.” Pinnacle will be targeting large and small deals alike in most any brand.

Wildman sees the product becoming even more popular as interest rates start to climb and operators who currently have floating rate credit facilities will want to fix those rates

for a longer period of time. “I don’t think borrowers in our industry have had reasonable opportunities to set their loan terms out beyond five to seven years and get good pricing,” at the same time he said. “This pricing is below what they are used to seeing in the market when combined with long term amortizations of 25 years.”

And it doesn’t hurt that the insurance company has been doing deals like this for years in other asset classes—to the tune of funding $1.2 billion of real estate transactions a year. “They are like a machine,” said Wildman. “We have definite timelines for every transaction. Once a loan is approved, closing has been running between 30 to 45 days depending on third party reports.” Pinnacle has added Jeff Conyer to their team, specifically for real estate origination.

Wildman said the insurance company has provided them a full underwriting and closing team to help ensure they can close loans efficiently as possible. He indicated they are anticipating closing a minimum of $50 million of real estate loans within the first year of this relationship, and “are well on our way to achieving that goal.”

For more information on Pinnacle Commercial Capital, contact Bill Wildman at (317) 472-2828, or by e-mail at [email protected] or Jeff Conyer at (317) 514-7576 or by email at [email protected].

Pinnacle Forms Alliance with Major Life Insurance Company to Fund Real Estate

FINANCE SOURCESBMO’s First Year in Franchise Finance Is a Hit

What a difference a first year makes. Since joining BMO Harris Bank one year ago, Rick Thompson and Rick Meiklejohn, managing directors and co-heads of the bank’s Franchise Finance Group, reported their team has grown double digits and completed in excess of several hundred million dollars in restaurant commitments through the end of September.

“We’ve had a great year so far helping some of the best-in-class operators in Taco Bell, KFC, Pizza Hut, Applebee’s, Hardee’s and other well-known restaurant brands,” said Thompson. He went on, “It’s also a nice mix of franchisee and private equity-owned restaurant operators across the United States.”

“Senior management of BMO Harris Bank is very pleased with our accomplishments and has provided us a ‘green light’ to continue to build our team. We’ll be adding staff to fuel the growth in the coming months,” added Meiklejohn.

Recently, the group hired originator Angelo Maragos as a Director located in Boston, a 12-year veteran of franchise finance previously with Bank of America.

Michael Eagen, director and loan originator is bullish about the year ahead and the group’s prospects:

“We’re likely in the sixth year of a seven year balance sheet recession or slowdown, where consumers are deleveraging, gasoline prices remain low and commodity price relief is happening. Healthy sale multiples of 5x to 7x EBITDA of late will bring out more sellers as the consolidation into larger franchisees and ongoing remodeling continues. Long rates are rising with a wider recovery in sight, and this financing environment right now is as good as it gets to grow again,” said Eagen.

With over $2.2 trillion of excess deposits at domestic banks, financing terms remain very competitive, not only on price, but are beginning to stretch on structure.

“We’ve won on creativity and some great long term relationships over some tough competition. We’ve been flexible and able to deliver on exactly what we say in early proposals, which is the only way to do business. Our clients highly value that promise,” said Thompson.

To learn more about BMO Harris Bank, contact Rick Thompson at [email protected] or (949) 341-6103.

Franchise Capital Advisors Arranges Multiple Restaurant Financings in Third Quarter

Franchise Capital Advisors, a specialized financial advisory in the restaurant industry, reports a busy quarter of transactions involving financings, refinancings and sale-leasebacks including:

• A large multi-unit sale-leaseback transaction in conjunction with an acquisition of a franchisee by Hooters of America.

• $12 million acquisition, sale-leaseback and senior debt placement for a regional Sonic franchisee, CNC7, operated by Rhett Smith.

• $12 million partner buyout, senior debt placement and development commitment for Arizona and New Mexico Taco Bell franchisees, Karecor & Ringing Bells.

• $7 million acquisition, sale-leaseback and remodel loan facility for K-Bob’s Steakhouse, a regional independent casual dining chain based in New Mexico.

• $15 million development line of credit and sale-leaseback for franchisees of Alamo Drafthouse, a Texas-based chain of theaters and restaurants. The franchisees funded were Triple Tap Ventures, a three-unit franchisee based in Houston, Texas, and Reel Dinner Partners, a San Antonio-based franchisee of six units.

“We continue to see positive indicators in the economy and the restaurant segment with improvements in availability of capital and increased M&A activity,” said Ryan Kress, managing director.

For more information, contact Steve Schwanz, President, at [email protected] (480-355-4399), or Ryan Kress Managing Director, at [email protected] (480-355-4390).

Cypress Helps Wendy’s Operator RefinanceThe Cypress Group acted as the exclusive advisor to Raleigh, North Carolina-based Wendy’s franchisee Bryant Restaurants in the refinancing of its 19 locations in North Carolina and South Carolina. Bryant is a 30-year franchisee of the Wendy’s system. Cypress helped Bryant identify opportunities for the refinancing, conduct a competitive process, structure the transaction and manage the closing. The financing was ultimately provided by RBS Citizens. Bryant expects to use the funds to add new units and remodel existing locations under Wendy’s Image Activation upgrade.

“The real value from Cypress comes from looking at the business from all angles,” said Richard Bryant, chief operating officer of Bryant Restaurants. “Most small companies start up as mom-and-pop organizations. In many instances, there is a void in understanding the steps to grow an organization. This is not to be undervalued, as that financial and strategic advice is just not in abundance,” said Bryant.

For more information, contact Dean Zuccarello at [email protected] or (303) 680-4141.

OUTLOOKContinued from Page OneIt seemed to be working for a time. In 2011, same-store sales peaked at 0.9%. But then comps began falling again. Activist investors took positions in the chain’s board, and then CEO Sandy Beall decided to retire (while receiving a fairly hefty severance package to boot). The company put in his place a former Darden executive, JJ Buettgen.

Why didn’t that effort work? Consider Ruby Tuesday’s customer. In 2007, Ruby Tuesday was struggling because its customer had low incomes and began to feel the impact from the oncoming recession.

As it turned out, Ruby Tuesday customers didn’t want something more upscale. They wanted lower prices. By going upscale, Ruby Tuesday alienated those diners. And it wasn’t going to make up for that loss with new customers. People that did have money weren’t likely to go to Ruby Tuesday.

On our blog, we likened the situation to that of J.C. Penney, which tried to make itself more hip and upscale and instead alienated existing customers that had come to love its discounts and sales. Ruby Tuesday tried to get away from its habit of couponing and discounts, which was admirable, but which hurt its existing customer base.

But now the chain is stuck. Under Buettgen, Ruby Tuesday is in the process of righting its menu, with a series of offerings priced between $5.99 and $9.99. Among them: a pretzel burger, priced at about $9. Add the tip and the price is about $11.

At MUFSO, Miller compared that offering with a similar one, from Wendy’s. While Ruby Tuesday’s version is undoubtedly better, and comes with fries, Wendy’s costs $4.50. Add the fries and the price is about $6.

Is Ruby Tuesday’s version that much better? For a time, consumers could find a $3 off coupon for one of Ruby Tuesday’s burgers, which made the price a more equitable $7.15 after tip. Even at that price, it’s still difficult for casual diners to compete. Not with consumers as broke as they are now. “QSR has a significantly better price-value proposition today,” Miller said, quoting a casual dining franchisee.

Losing Customers’ FaithWe were frequent customers of Olive Garden in the 1990s. It was great. We filled up on salad, ate a ton of breadsticks, nibbled at the generous dinner put in front of us and then brought the leftovers home in a box to eat for lunch the next day. We didn’t care at all how much we paid for it, because from our perspective that was two meals. It had great value.

So we couldn’t help but notice some changes the last time we went to Olive Garden, for a family event. The salad bowls were smaller. The waiter took his time refilling our breadsticks, and then the portion size had noticeably shrunk.

Some of this might have been my perception, but I clearly left the restaurant that day with a sense that this wasn’t the Olive Garden I grew up with.

We thought of this story recently, when Darden said that its sales at Olive Garden and Red Lobster had plunged in its most recent quarter, by 4% and by 5%, respectively. In response, Darden announced that its chief operating officer was stepping down, and it said it planned to make cost cuts.

Because of pressure from investors and analysts, Darden has to cut costs to maintain margins in an era of weaker sales. But cost cuts here and there ultimately add up. The customer eventually notices, and then comes back less—or stops coming altogether. Managing to margins is a dangerous business. And it doesn’t do anything to address a chain’s primary problem: getting more people in the door.

While Olive Garden faces many challenges at the moment, it’s hard not to think that customers saw the smaller salad bowls and the smaller portions and concluded the same thing I did. And then went to Noodles the next time they wanted to eat out.

Consumers have a lot of power now. Social media and websites like Yelp help customers point out which restaurants work, and which don’t. So when cash-strapped consumers do go out for a casual dining meal, they want to make sure the experience will be a good one. It forces restaurants to provide good value and a clean environment. Those that fail lose customers.

“Fundamentally, you have to be really good operators,” said Malcolm Knapp, who was only speaking in general terms at the recent conference in Dallas. “If I had a successful concept 10 years ago, and took the same standards that were successful then and applied them today, I’d fail. The bars are ratcheted up on every level of food service, taste and quality.”

Darden now finds itself beset by activist investors and analysts who think the company should make huge changes—including a split of the company into two or more pieces.

Doing It RightWe like a lot of casual concepts out there. Red Robin has managed to keep many of its customers despite the incursion of fast-casual burger chains. Buffalo Wild Wings figured out that combining chicken wings and big televisions will get people to stay for hours and drink lots of beer.

Chili’s is adding technology to its kitchens, and tabletop ordering systems, to make themselves more efficient and speed up service. Franchisees love the idea, and yet its traffic is still weak.

In other words: the environment is challenging even for companies that are doing things the right way. Companies that lose their connection with customers are going to have an even tougher time.

— Jonathan Maze

“The lack of good sites is definitely forcing operators to stretch,” Andrew Moger, CEO of BCD Development, a New York site location firm tells me. Moger toils in one of the most competitive and expensive cities in the nation and worries that some chains “will look back and wonder about their recklessness.”

With a lull in new retail development because of the Great Recession, restaurant chains are getting raked by landlords and settling for expensive sites on new locations, even those not at the corner of Main and Main.

That operators are giddy at the prospect of building a new restaurant is a given in our traditionally cheery industry. New restaurant openings are akin to spring training in baseball, when in March, every team has a shot at the pennant. Likewise, when a new restaurant is under development, the traffic is always thick, the demographics rich and the spreadsheets scream “killer site.”

Rick Celio, a consultant and former IHOP and DineEquity executive, says when the supply of good locations is tight like it is now, sales forecasting becomes very creative.

“Many a real estate committee meeting is spent justifying the cost of an expensive location. We all have convinced ourselves that A locations will do 25-30% better. The trouble is, one great location that doesn’t hit the necessary sales volume can tank the whole operation,” says Celio.

Back in the day, when restaurants were primarily a freestanding proposition with miles of open fields surrounded by new malls and power centers, restaurant owners had plenty of choice. They preferred owning to leasing. With ownership of the land, operators used a basic, back-of-the-napkin sales-to-investment test as their analytic tool for development decisions.

If the sales-to-investment ratio of a new location, with the land, building and equipment costs included, was better than 1-to-1, it was go time. If the ratio wasn’t 1-1, the sales estimate was often the variable that was fudged. There was a belief that a new restaurant would eventually grow into the site.

Most new restaurant development these days is of the fast casual variety—deli, bakery, burrito, cafe, pizza and sandwich shop—located primarily in existing strip centers, malls and mixed-use developments. Hence, restaurant real estate is primarily leased, rather than owned. And with this change in ownership, I’ve noticed operators are all over the map as to what constitutes an economic deal.

Should restaurant operators revise the simple, sales-to-investment ratio to handle leased locations, a ratio that worked admirably for so many years for free-standing locations?

Should operators rely on achieving a satisfactory cash-on-cash return, calculated by taking the annual EBITDA of a restaurant, less capital replacements, and dividing it by the initial cash investment?

Or, should operators forget the analysis altogether and grab the best location, regardless of its annual expense?

I attended a franchising conference in Atlanta last week and listened to a fast casual operator, Pierre Panos, optimistically project the growth potential of his Fresh to Order concept to be approximately 1,000 units. That’s pretty heady stuff, I thought, considering Panos has only 10 stores open.

Panos isn’t just a promoter, he’s an experienced restaurateur and founder of Stoney River Legendary Steaks, which he sold to O’Charley’s in 2000. At the conference, Panos trumpeted Fresh to Order as a 2.5-to-1 sales-to-investment winner, one he assumes is financially better than other fast casual restaurants in his segment and one that should entice potential franchisees to his brand.

To arrive at his ratio, Panos took his $1.75 million average unit volume and divided it by the $700,000 cash investment that it takes to build out and equip each new unit. What Panos actually offered up was a sales-to-“cash”-investment ratio of 2.5 times, a relatively meaningless metric. For operators who lease their real estate, and put up little to no cash for equipment and leaseholds, and use leverage instead, the sales-to-cash-investment ratio could be infinitesimal and means nothing.

Like Panos, operators often spout this ratio and fail to mention the most important risk factor in their development scheme—namely the capitalized lease obligation. Restaurants commit to real estate leases of 10 to 20 years, with regularly scheduled rent bumps and tough operating clauses. Leases are serious business and can be a thorn in the side of restaurant chief financial officers, especially if the store isn’t performing well. They must be taken into account.

In Panos’s case, assuming the typical Fresh to Order restaurant is a 2,500-3,000 square foot location paying $30 to $40 per square foot in rent, I calculated his lease obligation to be approximately $750,000 (2,500 square feet times $30 per foot and capitalized it at 10%) to $1.2 million (3,000 square feet times $40 per foot capitalized at 10%). Restaurant chains and their financiers can quibble about the capitalization rate, which depends on the size and relative strength of their enterprise. For my calculations, 10% is fair enough.

Each time Panos signs a new lease for Fresh to Order, he is committing $750,000 to $1.2 million, plus the cash investment for equipment and leaseholds. It’s no different than if he borrowed the money to build a new location. He’s is on the hook to pay it back either way.

The $750,000 capitalized lease obligation together with the $700,000 cash investment for build out and equipment means Panos has committed $1,450,000 to build a new unit. Panos’s sales-to investment ratio is $1,750,000 in sales divided by $1,450,000 investment, or 1.2 to 1. Not bad, but using another baseball analogy, not a grand slam.

If Panos can find leases in this range and maintain his sales average and 22% store-level margins, he should keep building. His payback on his cash investment, based on expected sales and margins, is less than three years, which is pretty good. And when he invests $700,000 to generate a 22% store margin on $1.75 million in sales, his margin, $385,000, divided by the

FINANCEHurdle Rates Rise When Landlords Demand Top Rents

Potbelly said that it targets locations where it can get an 25% cash-on-cash return after two full years of operation. That suggests a slow ramp-up in volume and margins for each Potbelly store. In 2012, Potbelly restaurants averaged $1.06 million in sales and had an operating margin of 20.7%. That equates to $219,000 of average store level profit.

The average investment cost in a new Potbelly is $600,000, which given their reported sales and margins translates into an unleveraged cash-on-cash return of 36%. Assuming Potbelly secures a 2,300 square foot site and pays $30 per square foot and meets the average sales numbers, the sales-to-investment ratio would be .82 times.

Historically, franchisees find it tougher to generate above average cash-on-cash returns without leveraging the investment with sale-leasebacks and equipment loans. Dennis Monroe, a restaurant and franchise deal attorney, and Monitor columnist, sees cash-on-cash returns of franchisees targeted at 25%, but that assumes 60% debt and 40% equity layered on the equipment and leasehold improvement piece of the investment.

In a survey prepared for the Monitor a few years ago by the accounting firm SS&G, franchisees generated unleveraged returns well below the targeted 25%, but their ability to borrow funds allowed participants to leverage returns significantly—by 60% on average. As pointed out in the survey then, franchisees have greater access to borrowed funds, and a greater proclivity to use them.

Restaurant owners contemplating new unit development would be wise to use both the sales-to-investment ratio (properly computed) and the cash-on-cash return metric as analytical tools. Restaurant chains with higher margin concepts can get away with paying more rent and accepting a lower sales-to-investment ratio. For most concepts with average margins, enterprise risk is accelerated each time a new unit is added below a 1-1 sales-to-investment ratio.

—John Hamburger

initial investment, $700,000, is a 55% cash-on-cash return.

Sounds good so far. However, lets assume Panos needs to take on a larger space and agrees to pay a higher rent per square foot—let’s say he needs 3,000 square feet, instead of 2,500, and agrees to pay $40 per square foot.

Under this scenario, the capitalized lease obligation, using the same capitalization rate, would be $1.2 million. If you add this $1.2 million lease obligation to the $700,000 cash investment, and sales remain the same, Panos’s sales-to-investment ratio comes in at less than 1-1, a dicier proposition than before. Panos’s margin is also lower by at least $45,000, or 2.5% of sales because of the higher rents. And, the larger store size will cost more in terms of common area maintenance, real estate taxes and utilities, perhaps another 1-2% of sales.

With the larger footprint, Panos’s margin could be reduced by as much as 4.5%, assuming sales don’t go up with the added square footage. And, don’t forget, because of the larger footprint, Panos’s cash investment will be higher too. If for some reason, sales and margins don’t meet expectations, Panos’s cash-on-cash return will be smaller.

In my book, anytime an operator takes on a new site with a sales-to-investment ratio of less than 1, he is taking on more risk. By the same token, an operator that leverages his initial cash investment on top of signing a long-term lease increases their risk exponentially. That’s what franchisees like to do. A franchisee of Fresh to Order would likely pay a 5% royalty, and now all of sudden the operating margin is 12%-16%, not the 22% in the original example.

A restaurant with a high operating margin, say greater than 20%, has more wiggle room when it comes to larger footprints and more expensive sites. Still, if the projections don’t pan out, opening new units can depress the value of the enterprise, not add to it. This is the expansion risk of the restaurant business.

Here is a good example of the differences in returns for various concepts as outlined to the right on Exhibit A: The gold medal winner for great restaurant returns is Chipotle. In 2012, the average Chipotle restaurant did $2.1 million in sales and had operating margins of 26.3%. That’s an average of $555,000 in store level profit for those of you keeping score at home. The investment cost in a new leased property is around $800,000 making the cash-on-cash return 70%. No wonder Chipotle is building stores as fast as they can and the company’s common stock trades at 20 times EBITDA. If any of our readers have numbers like this, please tell me you are building more stores.

Assume Chipotle leases a 2,500 square foot site and pays $30 per foot (using the same capitalization rate, the lease obligation would be $750,000) and meets the above sales numbers, the ratio is 1.35 to 1. Because of it high cash-on-cash return, sales-to-investment ratio and margins, Chipotle can take on risks with sites that other restaurant companies shouldn’t.

Not every restaurant concept is as fortunate as Chipotle. Potbelly, which went public to great fanfare last month, reports decent unit level returns in the 20% range. But its sales and cash-on-cash returns are half that of Chipotle.

ChipotleFresh to Order Potbelly

Average Sales $2,100,000 $1,750,000 $1,060,000

Square Footgage 2,500 2,500 2,300

Operating Margin % 26.3% 22.0% 20.7%

Operating Margin $ $553,000 $385,000 $219,000

Cash Investment $800,000 $700,000 $600,000

Capitalized Lease $750,000 $750,000 $700,000

Total Investment $1,550,000 $1,450,000 $1,300,000

Sales-to-Investment Ratio

1.35 to 1 1.2 to 1 .81 to 1

Cash-on-Cash Return 70% 55% 36%

Exhibit A: Averages for Selected Concepts

Note: Sales, margins and investment reported by the companies

Take The Ultimate Emerging Brands QuizPrivate equity firms have become riskier in the restaurant space, scattering their dry powder among emerging brands—more than likely still owned and managed by founders. The small companies typically boast few restaurants, no visible market share, and thin infrastructure at the time of the investment. Private equity’s bets may nonetheless pay off in spades. New concepts, after all, boast new facilities, differentiated menus, and an ability to market effectively through social media. If you’ve been reading the Monitor closely, you’ll have no problem posting a high score in our first-ever Ultimate Emerging Brands Quiz. Good luck!

1. Which PE firm active in the restaurant space currently doesn’t have an emerging restaurant brand in its portfolio?

a. KarpReillyb. Black Canyon Capitalc. Brentwood Associatesd. Goode Partners

2. True or false: The contract a majority-owner founder signs with a private equity firm will likely prevent him or her from bank borrowing, compensation planning, and site approval.

3. Which investment criterion isn’t a game-changer during the due diligence process?a. Scalabilityb. Food costc. Concept differentiationd. Management’s experience

4. What percentage of an emerging brand do private equity firms typically want to own?a. 5 to 20 percentb. 100 percentc. 30 to 70 percentd. None of the above

5. Which reason most accurately reflects why restaurants make viable investments for private equity?a. New technology isn’t capable of “disrupting” the

restaurant experienceb. Experienced management teams are always successfulc. Diners in new markets readily embrace new conceptsd. The current surfeit of “A” sites and motivated

landlords

6. Which of the following restaurant industry executives has Catterton Partners relied on for advice about emerging brands?a. Bill Allenb. Greg Dollarhydec. Phil Hickeyd. Michael Hislop

7. Which of these is true about fast-casual Veggie Grill?

a. It features a “secret” meat dishb. Its second market is Portlandc. Its founders are chefsd. Its CEO was on CBS’s “Undercover Boss”

8. To help founders understand the relationship with a private equity firm, they are often advised to think of the deal as:a. A marriageb. Someone living in your underwearc. Getting an MBA on steroidsd. Having a much smarter older brother

9. True or false: Private equity firms with a minority stake will typically have the right to approve CAPEX projects to protect their investment in your business.

10. Which industry executive partnered with the Beekman

Group in the recent Ted’s Café Escondido deal?a. Phil Hickeyb. Bill Allenc. Hal Smithd. Greg Dollarhyde

11. Which emerging brand was Yelp.com’s second highest-

rated restaurant in 2011?a. MOD Pizzab. Burger Loungec. Bruxied. Chop’t Creative Salad

12. Which private equity firm is a capital source for

emerging brands Bruxie and Mendocino Farms?a. Catterton Partnersb. Apollo Global Managementc. Golden Gate Capitald. Bruckmann Rosser Sherrill & Co.

13. Which emerging brand has the most (58,186) Facebook

“Likes”?a. Blaze Pizzab. My Fit Foodsc. Burger Lounged. Piada

14. Which three industry executives were early-stage

investors in Bruxie?a. Tom Baldwin, Tilman Fetitta, Jim Parishb. Nick Marsh, Lane Cardwell, Fred LeFrancc. Guillermo Perales, Kerry Kramp, Sardar Biglarid. Gordon Miles, Paul Fleming, Bill Allen

15. True or false: Founders need to understand that private

equity firms will only go out and raise the necessary capital for the deal after the two parties reach terms.

16. During Morehead Capital’s acquisition of Hash House

A Go Go, the chain’s management team was interviewed by which industry executive and why?a. James Maynard, because he is the father of the PE

firm’s managing directorb. Dick Rivera, because he was an early-stage investor

in the conceptc. Phil Hickey, because he’s a Morehead operating

partnerd. Richard Melman, because he consulted management

for several years 17. What three characteristics of restaurants reduce the risk

of owning them?a. Consistency, labor, and leasesb. Commodities, consumers, and geographyc. Décor, menu, and service styled. Atmosphere, location, and debt level

— David Farkas(Answers are on page 12.)

EMERGING BRANDS

Effective Use of Private Placements for Emerging Restaurant ConceptsBy Dennis L. Monroe

The one consistent issue in the restaurant industry is the inability of small, start-up or emerging restaurant companies to find a source of early-stage financing, particularly equity capital.

Further, it is rare for an intermediary (such as a broker/dealer) to do fundraising and be involved with emerging restaurant companies.

What is the solution? Let’s first look at recent developments.

The JOBS Act of 2012 (the “Act”) is an attempt to facilitate the flow of investment capital for early-stage companies and improve access to equity capital for growth companies. The Act allows companies to find investors on their own, thus reducing the need for intermediaries. The Act has three components:

A. Raising the Regulation A limitations from $5M to $50M

B. Allowing for general solicitation to accredited investors

C. Reducing compliance and oversight, particularly as it relates to small IPOs.

Given the backdrop of the Act, what does an equity funding look like for a growing restaurant company? The most common early stage equity investment for these growth companies is the use of private placements.

A private placement is normally facilitated through a private placement memorandum (“PPM”). The PPM structure normally provides for a preferred class of investment where the preferred investor has an absolute preference as to his investment and a preferential return (somewhere between 8% to 12%).

This preferential return is not a guaranteed return if there are not available funds to pay the investor. The operator (common investment owner) gets nothing or at most a minimal distribution until the preferred investors get back their investment plus the preferential return.

Let me give you an example of a growing company that wants to develop five corporate stores of its concept. Each store costs approximately $400,000 to open. The company is able to secure bank financing of $200,000 per store for a total of $1 million and needs to raise $1 million of equity.

Normally, this new development is facilitated using a separate legal entity controlled by the concept company. A license agreement is entered into for the use of the concept (usually at a very low rate), as well as a management agreement. This new entity develops new stores and distributes available cash to the investors.

The first distribution out of available cash is to pay the preferential return. The second distribution is to repay the

investors’ actual investment. Once the investors have received their total preferential return and investment, the operator then gets a significant share of the cash flow. Available cash is what is left after all expenses and debt have been paid and reasonable reserves are established. There are other governance rights that are provided to the preferred investors for their protection.

The value of the preferred investment is that it provides for high yield based on a strong cash flow model. Most restaurant companies are cash businesses and deliver a strong unit-level economics, thus making this type of investment appropriate for wealthy individuals, self-directed investment funds or family offices. In all cases, we are dealing with Accredited Investors.

The process of finding investors is tricky and normally needs to be conducted by the restaurant company owners seeking out friends, family, advisors and key contacts.

What about crowd funding?

I am aware of a start-up Italian concept that was able to raise $1M through crowd funding. In part this was done through PR pieces, local periodicals and the use of table tents at the restaurants to advertise the investment opportunity. In general, however, crowd funding has not been successful in the restaurant industry.

The capital-intensive nature of restaurants requires a significantly larger investment than most other start-ups. It is also better to have a few large investors than to have a bunch of small investors. Another problem with crowd funding is that this investment vehicle can make it significantly more difficult to raise subsequent rounds of capital.

Private placements are one of the best ways (other than a rich uncle) to raise appropriate equity for early stage and emerging restaurant companies, and with certain changes in the law, they have become a much more interesting and viable funding mechanism.

Dennis L. Monroe is a shareholder and Chairman of Monroe Moxness Berg PA, a law firm specializing in multi-unit franchise finance, mergers and acquisitions, and taxation. Monroe Moxness Berg PA is located at 8000 Norman Center Drive, Suite 1000, Minneapolis, MN 55437-1178; (952) 885-5999. For previously published articles, and other Monroe Moxness Berg PA information, please refer to our Web site at www.MMBLawFirm.com.

means he’ll be looking for another target soon, if he doesn’t already have one.

A growing number of restaurant chains are considering IPOs now that Noodles & Company and Potbelly have proven that investors actually want growth chains on the public markets. But we admit to being a bit surprised to have heard the latest to consider it, Orange Leaf Frozen Yogurt. On our blog at restfinance.com, CEO Reese Travis indeed said the company could consider that route as early as 2015 or 2016. But he would have to make a number of acquisitions first for that to work.

The MillerPulse survey is all grown up. Larry Miller, the former RBS Capital Markets analyst, has left the company to form his own firm around the monthly MillerPulse restaurant sales survey.

Bojangles excutive vice president of development, Eric Newman, told a Boefly franchise lending conference in Atlanta two weeks ago that the chain should hit $1 billion in systemwide sales in 2013. That’s pretty impressive considering 45% of the units have been built in the last five years. Newman reported a $1,782,000 franchisee average volume while the company stores average $1,630,397.

Former Outback Steakhouse CFO Bob Merritt was fired in September as CEO of Benjamin Moore Paints by Berkshire Hathaway Chairman, Warren Buffett. Berkshire owns Benjamin Moore. Buffett told CNBC’s Becky Quick on October 16th that “recently we had to make a change for reasons which I can’t get into.”

QUIZ ANSWERS(From Page 10)1, B; 2. True; 3. B.; 4. C; 5. A; 6. A; 7. B; 8. A; 9. True; 10. C; 11. C; 12. A; 13. B; 14. D; 15. False; 16. A. 17. B.

CHAIN INSIDER

?

Wiborg bolts Burger King. Steve Wiborg told the company that he was resigning his position as chairman, North America, effective October 20. We probably should have seen this coming. Wiborg had just been promoted to the position in April of this year. And then in the chain’s subsequent quarterly report, the company noted that Wiborg received an out clause we would label “interesting.” The clause gave Wiborg the ability to leave Burger King between October 20 and December 31 if he is unsatisfied with the changes to his position. Wiborg didn’t waste any time. Late last month, the former CEO of Heartland Food Corp. told the company that he, indeed, planned to leave on October 20. Suffice it to say, Wiborg’s departure is a sign that all is not well in Miami. There have been a lot of rumblings about the office culture out of Burger King headquarters. The company’s owner, 3G Capital, has a reputation for operating challenging office environments. It’s difficult not to see Wiborg’s departure as anything but confirmation of those issues.

When restaurant sales didn’t rebound this summer like many observers expected, many wondered why. One theory: consumers bought more durable goods like cars and washing machines, and didn’t have enough left over to eat out. That may still be true, but the biggest factor behind the lingering weakness is the same factor that caused sales to stumble this year in the first place: the 2-percent increase in the payroll tax. That hike cost consumers $125 billion, according to Goldman Sachs analyst Michael Kelter. By comparison, the durable goods increase amounted to just $38 billion.

Here’s a tidbit we heard from a QSR franchisee this week: His business gets a nice boost in traffic around the first of the month. That boost lasts a week and then fades. The suggestion? Lots of customers on government assistance. This might help explain why QSRs have been able to weather the recession. Many of their customers are on unemployment or other government assistance now, whereas casual dining customers have been hit by higher taxes and higher expenses.

Count us among those who expect major changes at Darden. The Orlando-based casual dining giant is coming off a bad quarter marked by brutal sales at its flagship concepts Olive Garden and Red Lobster. Now, an activist investor and at least one analyst say the company should divide into two or more concepts. While we wouldn’t necessarily predict an outright breakup, it wouldn’t be surprising if the company made some major move to improve shareholder value. And we do know that the activist, Barington Capital, is in active discussions with Darden executives.

Is Mr. Big’s Cracker Barrel effort losing steam? If Sardar Biglari doesn’t get his desired seats on the Cracker Barrel board next month, don’t be surprised if he starts selling off his stock in the chain. He more or less said so in his most recent public filing, suggesting that if he doesn’t get seats this time he will no longer be beholden to a previous commitment to hold onto his stock forever. That will provide him “flexibility” with his investment. Of course, we think his heart isn’t quite in this one, anyway, and that his primary goal is to get shareholders to approve a one-time, $20 special dividend, which would net his Biglari Capital $95 million. Oh, this probably also

Ruby Tuesday

Date announced: September 9, 2013

INCOME STATEMENTThirteen weeks ended September 3, 2013

Revenues:.....................$289,674,000Net Loss............................($21,764,000)Net Loss Per Share............................($.37)

BALANCE SHEETAs of September 3, 2013

Cash:..................................$35,853,000Total Debt:.................$274,660,000Shareholders’ Equity:........$497,733,000

SUMMARY:Tough first quarter at Maryville, Tennessee-based Ruby Tuesday. The casual dining restaurant said that same-store sales at company owned restaurants fell 11.4% in its fiscal first quarter. Same-store sales at its few remaining franchisee owned stores were hardly better, down 8.4%.

The result from this: the company reported a net loss of $21.9 million. The company had net income of $2.9 million in the same period a year earlier. Loss per share was $0.37. The company had $35.9 million in cash at the end of the quarter, compared with $65.5 million the year before.

The company’s outlook wasn’t much better. The company said it anticipates same-store sales to be down in the “high single digits” in the second quarter, with “sequential improvement” in the following two quarters.

JJ Buettgen, the company’s new CEO that recently replaced long-time CEO “Lord” Sandy Beall, largely blamed the economy for the chain’s problems, but said the company is launching new items with price points between $5.99 and $9.99 to bring customers back in the door.

Reports 11.4% same-store sales decline in first quarter

Potbelly Corporation

Date Completed: October 9, 2013Shares sold by company: 8,625,000Shares sold by shareholders: 150,131Net proceeds: $108,800,000Price per share: $14.00Underwriters: BofA Merrill Lynch and Goldman, Sachs & Co. acted as joint book-running managers for the offering, and Robert W. Baird, William Blair, and Piper Jaffray acted as co-managers.Use of Proceeds: The company will use approximately $49.9 million of the proceeds to pay a cash dividend immediately prior to the closing date of the offering. The remaining net proceeds will be used for working capital and general corporate purposes.

INCOME STATEMENTTwenty-six weeks ended June 30 2013

Revenues:.....................$146,930,000Net Loss:................................($7,524,000) Net Loss Per Share..........................($1.77)Adjusted EBITDA.................$16,183,000

BALANCE SHEETAs of June 30, 2013

Cash:..................................$21,746,000Total Debt:.............................$15,132,000Shareholders’ Deficit:........($175,095,000)

SUMMARY:Potbelly Sandwich Works is a Chicago-based sandwich chain that has 289 locations, most of which are company owned.

The company raised $108.8 million in its IPO debut, a more than 33-percent increase over the $75 million it initially planned to raise. The chain’s stock then surged, going up by as much as 138% before settling down at an increase of 120%. The first-day pop made Potbelly the most successful restaurant debut in recent memory, beating Noodles’ 104% surge and the 100% increase in 2006 by Chipotle.

Initial Public Offering

The Wendy’s Co.

Sale of 24 Seattle area Wendy’s restaurants

Date announced: October 7, 2013Sale Price: $14,431,517 plus a $550,000 payment to Wendy’s for franchise technical assistance fees.Buyer: SeaWend, Ltd., a unit of Cedar Enterprises, Inc.

INCOME STATEMENTYear ending December 30, 2013

Revenues:.....................$2,505,200,000Net Income........................$7,100,000Net Income Per Share....................$0.02

BALANCE SHEETAs of June 30, 2013

Cash:..................................$489,017,000Long-term Debt...........$1,222,285,000Shareholders’ Equity:......$1,996,113,000

Summary: Wendy’s sold 24 locations and two units under development in Seattle to a subsidiary of Cedar Enterprises, Inc. Cedar is based in Columbus, Ohio, and with the acquisition will own 170 locations in five states. In 2013, Cedar was ranked as the 33rd largest restaurant franchisee according to Monitor 200 annual ranking. The company is owned by Joe, David and Jim Karam and has been in operation since 1975.

Wendy’s announced in May it will sell 425 locations in 13 markets. The demand for those locations has been strong. The sale will make Cedar the third largest Wendy’s franchisee, continuing a trend in which Wendy’s sells to large, experienced franchisees.

The purchase price includes $11,900,853 for the assets; $1,739,664 for the development of a Tacoma location; a $105,000 future development fee; $286,000 for inventory, vans and special items; and $400,000 for reimbursement of Wendy’s out-of-pocket expenses. Cedar will also pay Wendy’s a $550,000 technical assistance fee.

MARKET SURVEILLANCE

PBPB WEN RT

Chuy’s HoldingsCHUY-NASDAQ

(Outperform)Recent Price: $37.77

Chuy’s Holdings is the Texas-based company that operates the Chuy’s chain, a 46-unit casual Tex-Mex concept. The company has locations in 12 states and was founded in 1982.

Baird analyst David Tarantino upgraded Chuy’s Holdings to Outperform after the chain’s recent stock market declines, and gave it a price target of $45. Tarantino had downgraded Chuy’s in July because he felt the company’s price had become overheated. Since then, the company’s stock price has declined 17%. Thus, the valuation, at EV/EBITDA of 23x, is more consistent with the median level seen for early stage growth companies. “We remain confident in operating fundamentals,” Tarantino said, “and we think premium valuation metrics are justified by the company’s visible unit growth profile, strong unit-level returns on capital, and expectations for solid near-term operating performance.” Tarantino likes the company’s positive near-term outlook, and said it should be able to drive above-average EPS increases in 2013 and 2014. He is estimating that EPS will grow 25%, to 17 cents per share, which is about consensus for the third quarter. He’s also expecting that comps will grow 1.5%.

Bob Evans FarmsBOBE-NASDAQ

(Outperform)Recent Price: $58.05

Bob Evans Farms operates a full-service restaurant chain and also sells retail gifts and food items, all under the Bob Evans name. The company includes 560 Bob Evans restaurants, primarily in the Midwest. The chain is based in Ohio.

An activist investor, Sandell Asset Management, is pushing Bob Evans to buy back stock with a combination of a sale-leaseback of company real estate and a spinoff of its food product business. Sandell believes this could lead to a valuation of $73-$85 per share. Oppenheimer analyst Brian Bittner believes some of these assumptions could be conservative. He also believes the activism could provide “optionality” for the company. Otherwise, Bittner raised his price target on the stock, suggesting that the company has $200 million of debt capital unaccounted for after its recent $175 million leveraged buyback. He believes that Bob Evans could make another grocery acquisition, or it could pay a special dividend or make other stock repurchases. In other words: the company could do something to boost shareholder value even without the activist’s efforts.

Domino’s PizzaDPZ-NYSE

(Buy)Recent Price: $66.66

Domino’s Pizza is the big, Michigan-based pizza delivery chain. The system includes well over 10,000 locations around the world. The company was founded in 1960.

Domino’s third-quarter EPS came in “a tad light,” according to Buckingham Research Group analyst Mitchell Speiser. EPS was 51 cents per share, or up 19%, but that was 1 cent below consensus. Still, Speiser said, “we remain bullish” as the company’s comp sales growth continues, driven by online ordering. The company’s comp sales grew 5.4% in the U.S. International comps rose 5%. The sales performance was above Speiser’s forecast. Also, openings in the U.S. are increasing, and international comps and unit growth are consistent and “top-tier in the industry.” Speiser’s price target of $75 a share reflects a valuation of 15.5x his 2014 EBITDA estimate, but that’s still a 12% discount to one of its peer companies, Dunkin’ Brands, “despite better metrics in most cases.”

ANALYST REPORTS

Yum BrandsYUM-NYSE

(Market Perform)Recent Price: $66.46

Yum Brands is the huge restaurant operator based in Louisville, Kentucky. The company operates KFC, Pizza Hut and Taco Bell. Combined, those brands have more than 39,000 locations worldwide, including a significant presence in China.

KFC in China continues to disappoint. Yum Brands said that its KFC unit there reported an 11% decline in same-store sales in September. The company also lowered its guidance for the fourth quarter, and a weaker recover than either it or the market expected. Sequential comp improvement “is still the most probable trajectory,” said Bernstein Research analyst Sara Senatore, especially as comparisons ease, “the magnitude of the rebound now looks to be smaller.” Measures of consumer perception of the company remain below 2012, and KFC’s new products haven’t driven more sales, which “speaks to the challenges of rebuilding customers’ trust.” Competition is intense, and the soft macro environment in China will be a further challenge to navigate, Senatore said. While margin improvement in China was a surprise, the combination of rising costs and input inflation could dampen the margin recovery, particularly if the top line fails to match input cost increases.

Cheesecake FactoryCAKE-NASDAQ

(Neutral)Recent Price: $42.87

The Cheesecake Factory owns casual dining and full-service restaurants in the U.S. The California-based company operates 165 restaurants, including 11 under its Grand Lux Café name and one called RockSugar Pan Asian Kitchen.

Retail traffic at mall-heavy retailers may signal a weak quarter for the Cheesecake Factory, according to Goldman Sachs analyst Michael Kelter. Ninety percent of Cheesecake locations are in shopping centers or malls. Goldman Sachs regularly tracks comps by non-restaurant retailers that might be neighbors of Cheesecake in many malls. There is a correlation between mall-based retailers’ comps and those at Cheesecake. Because many of those retailers reported soft same-store sales in September, Kelter sees increasing potential for Cheesecake’s third quarter sales and earnings to come up short when they’re reported later this month. The retailers’ sales decelerated to 1% in the third quarter, from up 3-4% in prior quarters. “We also believe there is risk that CAKE may need to reduce its full-year EPS guidance for the second consecutive quarter.”

Ruby TuesdayRT-NYSE

(Underperform)Recent Price: $6.05

Ruby Tuesday is the Maryville, Tennessee-based chain of casual dining restaurants. The company operates 706 Ruby Tuesday restaurants and franchises another 77. It also operates 18 Lime Fresh restaurants and franchises six of them.

Raymond James analyst Bryan Elliott lowered his rating on Ruby Tuesday to Underperform following another weak quarter. Indeed, Elliott didn’t provide much positive news about Ruby Tuesday at all. He said that the sales declines have the company producing material earnings losses and negative free cash flow. If that continues, that could force the company to sell real estate to cover its cash needs. That would dissipate the real estate value that currently supports the company’s stock price. That value amounts to about $5 per share net of debt. “With casual dining demand weak overall, it is also a very difficult environment to affect a strong turnaround,” Elliott wrote. “We thus see a negative risk/reward profile.” Elliott’s report came after the company reported FQ1 EPS of ($0.36), including a 10-cent loss due to impairments for store closures. Comp sales fell 11.4%, well below Elliott’s estimate. Ruby’s average annual sales per square foot have fallen well below $350. Most casual diners are over $450.

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ANSWER MAN

Sales are soft in many concepts. Analysts attribute it to negative consumer sentiment, the 2% payroll tax hike last January and the government shutdown. What’s your take? It’s easy to point to these things as the cause of the restaurant industry’s malaise. I suppose at the end of the day, it does come down to how much is available in the dining-out envelope after the house payment, utilities and groceries are paid. However, I believe a restaurant is essentially a local business, with a general manager who is either involved in the community, or isn’t, and either runs a clean operation and serves good food, or doesn’t. These simple things can propel a restaurant to the top of the list for consumers, whatever the economic times. So brand value is inconsequential for restaurants? Restaurant executives overestimate the value of their brands. Brand this, brand that. What is the brand value of a restaurant that hasn’t been remodeled in years, or one where the booths are torn and bathrooms are dirty? You can produce all the great ads in the world and have a social media team second to none, but when the customer comes to a shabby old restaurant, the brand goes out the window. In my book, restaurants are a local proposition where the magic combo is food quality, manager ability and engagement, physical plant condition and location.

What’s your beef with food quality?Our industry, unfortunately, has developed a “serve it out of the bag” mentality. I understand. It’s expensive to prep food. Ray Kroc himself went from hand-making milk shakes to buying mix. However, I can taste the difference between a hand-made milkshake and one from mix. Or, a freshly prepared soup versus the stuff that comes out of plastic bags. All consumers, no matter the demographic, want freshly prepared, good tasting food. Too many restaurants are into heating up what comes off the Sysco truck. What about manager engagement and ability?The manager at the unit level makes all the difference in the world. They should be treated like royalty. Instead, many operators still pay lousy wages and make them work like dogs. I used to think the chains had the highest quality managers. I don’t believe that anymore. I think independents have closed the gap and are generally offering better working conditions. General managers in many public chains used to get nice bonuses and stock options and that drew the top performers. I hope the private equity mavens keep their managers in mind when they are dolling out the cash. You get what you pay for.

A restaurant can only handle so much labor expense, right?There are two schools of thought here: I can squeeze labor, and hope to hang on to the sales I already have. Darden is trying that approach and it obviously isn’t working. Or, I can staff the restaurant adequately, hire the best talent, pay them a good wage, and insure an excellent guest experience that ultimately will build sales and bottom line. You must have confidence in the latter approach, because it is counter intuitive. Sales go down and everyone wants to cut. It’s the wrong approach.

Anyone can tell the difference between a good-looking restaurant and one that isn’t. What’s the issue here?The next time you are in a restaurant ask yourself these questions: Is the restaurant clean? Does it have today’s mess on the floors, or still last week’s mess? Is the parking lot picked up and properly patched? Are the windows and doors clean? Does the landscaping look like as nice as your neighbors? Is the dumpster door closed and the bags of garbage put away? Are the trash receptacles emptied? How badly does the restaurant need to be remodeled? Operators often neglect to see what is right squarely in front of them. The customer sees it all.

Remodeling is expensive.It’s less expensive than becoming irrelevant.

Local store marketing and community involvement is what everyone does these days, right?Store managers must be taught to engage the community. It’s not in their DNA. This was why franchising took hold, to get local owners behind the counter. Nowadays, franchisees own 10, 20 and 100 plus stores and can’t extend their personalities and enthusiasm to all the stores. They need good managers. Restaurants take on the personality of the manager. I know of one of the highest volume Quizno’s restaurants in the country with an owner-manager who engages his customers every day. He’s overcome a disastrous franchise situation and succeeds because of work ethic and personality. A good manager can overcome a lousy concept.

So what you are saying in all of this is the economic climate isn’t always to blame for a restaurant’s problems?Yes. It’s easier to blame the economy, or the weather.

Answer Man will be attending the Restaurant Finance & Development Conference next month at the Wynn Hotel in Las Vegas. He intends to be incognito, of course.

Answer Man’s Soft Sales Wake Up Call

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