Quiznos

• Quiznos renegotiated it’s debt load and took in an infusion of equity capital from JP Morgan and other existing shareholders.   You can read both good and bad into this.  The good being the investors saw enough upside to invest more, the bad being Quiznos desperately needed this to happen so their financial soundness probably isn’t strong.

Chipotle

• Chipotle still showing a growing customer base with 1st quarter same-store sales up 4.3%.  They plan to open a new store every three days in 2010.

Fuddruckers

• Fuddruckers filed for bankruptcy a few weeks ago.   It received approval to sell 62 Fuddruckers and a dozen Koo Koo Roo (similar to Boston Market) for $65 million.  It also plans to close 20 restaurants with “lease issues or low-foot traffic” stores.  Sales were down 10% in 2009.
• I woudn’t consider Fuddruckers part of the “better burger” craze of Five Guys and Counter, the brand is simply too old and retail square footage is way too large.  Red Robin’s are large in size too, but it invested plenty of capital in marketing and bradning to keep its brand appealing to the next generation of customers…much more so than Fuddruckers.

Pizza Fusion

• Plans to offset its entire “carbon footprint” by paying a percentage of sales to a company to construct renewable energy facilities.

Test time!  Is the following non-competition agreement enforceable?

“Frank, a Jimmy John’s franchisee, hired his nephew, Nick, to begin working at his Jimmy John’s franchise in Ohio.  Three months after Nick started working, Frank realized that Nick never returned the noncompete agreement he gave Nick during their initial discussions about the job.  The non-compete agreement states that Nick is prohibited from participating in another sub shop within 15 miles while employed and for two years following employment.

Frank has trusted Nick with recipes and procedures that are proprietary and trade secrets of Jimmy John’s, so Frank wants to be sure his entrepreneurial minded nephew doesn’t get any funny ideas about starting his own neighborhood sub shop.

When Frank approached Nick about signing the non-compete agreement, Nick said he forgot and promptly signed and returned the agreement to Nick.  Two months later, Nick quits to open up Nick’s Original Gourmet Subs a few blocks away.  It’s modern decor and authentic rocker vibe is attracting Frank’s customers away, and Frank’s sales drop 40%.   Frank sues Nick for breaching his non-compete agreement.  Who wins?

Hint:  The issue is whether an employee’s continued employment is sufficient consideration (is it enough benefit) for the employee to make the agreement enforceable.

The short answer is… it depends what state you are in.  In Ohio, it would be enforceable.  In Washington, South Carolina, Colorado and Minnesota, the non-compete agreement would not be enforceable because continued employment IS NOT sufficient consideration, courts require more benefit such as a pay raise.  In Illinois, the outcome is uncertain.  Illinois courts have held that continued employment for a “substantial period of time” will constitute sufficient consideration.  The length of time that the employee remains on the job, along with the manner in which the employment ends, are relevant factors for Illinois courts to consider when examining the validity of afterthought covenants.

In the above example, not only is Frank going to have a tough time stopping Nick, but Frank likely violated his franchise agreement which has it’s own set of ramifications.  So the lesson is don’t do casual hires!   Seemingly minor legal oversights can sink you.

As you’ve probably heard, Papa Murphy’s was acquired by a private investment firm for $180 million, about $150,000 per store.  I think it will turn out to be a good acquisition even with the steep price.  Papa Murphy’s has a combination of economic advantages that no other pizza chain has – 1)  it doesn’t have the overhead and capital costs of in-store baking, AND 2)  it is gaining strong penetration in grocery stores.

I admit, from the consumer’s stand point, a take and bake concept is a little confusing at first. “You mean I have to bake my own pizza?”   But that impression soon fades.   The pizza in its raw form looks fresh and the final product cooked in the home oven is as good as pizza delivery.   One hurdle overcome by the industry was the difficulty of using a home oven to cook a pizza because it doesn’t brown up well with the ordinary pizza dough recipe.   To solve this, chains like Papa Murphy’s increase browning by increasing the sugar percentage and providing a disposable reflective baking tray.

Another potential acquisition target is Homemade Pizza, a regional 25 unit chain in IL, MN and DC of classy take-and-bake stores where the average price of an “unbaked” large pizza is almost $20.   It seems to be doing well and has great branding.  Homemade Pizza pizzas are still priced on the high end because it is made with fresh and local ingredients.  The dough is prepared in a commissary to simplify store operations and reduce size requirements.

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Update:  Below is more interesting history on Papa Murphy’s from a November 2009 article in Portland Business Journal.  Average store sales are about $535k.

Papa Murphy’s is a holding of Charlesbank’s Equity Fund V, a $590 million private equity fund that holds several other food-related concerns, including Captain D’s Seafood and Del Taco.

Charlesbank teamed with Papa Murphy’s current president, John Barr, and company management, to recapitalize the pizza chain in a deal announced July 7, 2004. As part of the transaction, Wells Fargo Bank provided a revolving line of credit.

Terry Collins formed Papa Murphy’s in 1995 by merging Petaluma, Calif.-based Murphy’s Pizza with Hillsboro-based Papa Aldo’s. Together, the two chains had 140 locations.

By the time it partnered with Charlesbank, Papa Murphy’s had grown to about 800 stores in 24 states.

In late 2009, it has 1,153 locations in 32 states and two Canadian provinces. It has expanded largely by franchising its concept.

The company owns about 50 stores. The balance are operated by a network of more than 450 franchisees

More than half its franchisees own only one or two stores.

Quick service segment 4th quarter average same store sales: -4.7%

• Arby’s: -11% (only down 7.4% in January)
• Wendy’s: -3%
• Sonic:  -13% (blames the heavy snow)
• Carl’s Jr.: -2.6%
• Hardees: -6.2%
• McDonald’s: +.6%

Casual dining segment 4th quarter average same store sales: -4.2%

• Buffalo Wild Wings:  +2.0%
  • fun facts—-Buffalo Wild Wings essentially sells a neighborhood sports bar concept. It features Buffalo style chicken wings, burgers, and other “bar” foods. Takeout represents about 13% of sales. Another 22% of total sales are derived, not surprisingly, from traditional chicken wings. Boneless wings, which have better margins than the regular kind, were 19% of Q4 sales, up from 17% in Q4 2008.
• Famous Daves:  -6.3% for company-owned restaurants and -8.5% for franchise-operated restaurants.
• Morton’s: -11.6%

Fast Casual segment 4th quarter average same store sales: -.08%

• Panera Bread: +7.4%
• Cosi: -11.9%

Pizza segment 4th quarter average same store sales: +1.8%

• Domino’s: +1.8%
• Papa  Murphy’s +2.0%

Family dining segment 4th quarter average same store sales: -2.7%

• Steak n Shake: +14.4%
• Frisch’s Big Boy: -.4%
• Cracker Barrel: -.2%
• Denny’s: -6.1% at corporate owned units, -7.2% at franchised units
• iHOP: -3.1%

[updated so moved back to the top]

Founded in 1999, Spicy Pickle is not have a good run.  In 2008 the company’s income was $4.4 million but their expenses were $10 million, for a loss $5.6 million.  In 2009 income was $4.1 million, and they slashed expenses and payroll to $6.1 million, for a loss of $2 million.  They now have $800,000 left in the bank.   They are desperately working on a new round of financing.   I’d have to see unit performance and lease rates, but it could be an attractive acquisition for veteran QSR investor.

It also franchises a brand called Bread Garden Urban Cafe…a Canadian sandwich and bakery QSR I never heard of.   The franchisor employs 28 people.

Update: March 18, 2010, 10:00PM CST

I updated the above financials stats with more details.  I was still curious about Spicy Pickle’s financial predicament so I did more research.

Back in 2007, Spicy Pickle needed to raise more money.  So it sold preferred equity that gave the holders superior rights to its assets and priority to dividend payments, and I’m sure other special treatments were in the agreement like rights of refusal for issuing more preferred equity.  Fast forward to 2009, and Spicy Pickle needs money again.  What’s left to give away?  Not much, so it had to buy back the preferred equity.  In 2009 with around $2 million in cash left, Spicy Pickle paid $1 million of its common stock and $800,000 cash to buyout the preferred equity holders.  Clearly they wanted those preferreds out!

In Boston, the area developer is not paying its bills.   If Qdoba was the only fast fresh Mexican game in town they’d be doing fine.   That segment is being flooded with new concepts and the industry is suffering.   But, over-staturation is the norm now with with every ‘hot’ franchise segment nowadays.   Things will eventually shake out with the strong surviving.

Staying on the pizza topic for a moment…..Little Caesar’s and Donatos (both pizza) have a large number of former company executives that have transitioned to franchisees. That is a good sign and both are adding units faster than their counterparts in the industry, each for different reasons (LC for price, D for uniqueness). Little’s Caesars hot-and-ready pizza deals have been a hit with a simultaneous improvement in quality from high speed impingement ovens. Donatos’ pizza is a very unique thin pizza similar to a St. Louis style or Chicago thin style, and it has operations and pizza assembly down quicker than anyone I’ve seen. Surprisingly, Little Caesars makes their own dough while Donatos uses preformed frozen dough that arrives ready to bake on a disc.

Asking a franchisor salesman how many executives or former executives are franchisees is a great question.

I don’t know about you, but I like the new Donatos store design.

I thought Obika, a Fresh Mozzarella Bar concept from Europe, would do fine in the big cities and may ultimately make a good franchise, succeeding by shadowing the locations of Au bon Pain. I assumed their dozen overseas locations would have been prepared a powerful USA launch. But, the NYC location is not earning universal fondness from New Yorkers.

The look is modern and euro, and it has the right formula of escalating a familiar food to a higher level of passion. However, it fails in execution – service is too slow and the sandwiches are simply average. When people are paying a premium ($10 a sandwich), your niche is smaller and there is more pressure to earn repeat business from the local workers. I would imagine they have to do at least 350 transactions per day to break even. Eventually the number of potential new customers will dwindle to unsustainable levels and survival will depend on repeat business. I still think Obika will make it, but the chances of it being a 10+ unit chain in the USA are very slim.

It works.

Elevation Burger, the well branded organic better-burger franchise, closed it’s Baltimore franchise.  Reviews were pretty bad.

As a whole, healthy, all-natural, and organic concepts have been having a hard time making their sales goals,  except for notable exceptions like Chipotle.  Everybody says they’ll go for healthy options, right?

You have to watch what people do and not what they say.  I’m sure most people reading this post would say during a focus group, “Yes, I’ll pay a little premium for the organic meal”.  But, in reality what do you do?   Most of the time you purchase based on convenience, taste and price as long as you deem the quality above an acceptable level.  I was reminded of this recently from a PepsiCo executive.  Chipotle is the rare bird – it succeeds because it tastes good, is priced competitively, the line moves very fast, and most people don’t even realize the food is mostly organic.

Another “healthy” brand to watch is Naked Pizza because it has signed several area development agreements for hundreds of units but lacks experienced management. A reviewer on Yelp stated, the “cheese was rubbery and the pizza was cardboard” – ouch! Naked Pizza has gathered remarkable attention for only having a single location.  The buzz is the result of winning an open venture funding call in a blog post from billionaire Mark Cuban.  It’s also reknowned for embracing of twitter (a billboard simply lists it’s twitter address).  A recent article summarizes the Naked Pizza idea:

NakedPizza’s solution is an all-natural, fortified pizza, made with simple, unprocessed ingredients, informed by science and made affordable and available through the proven carry-out and delivery model. It’s signature difference is a crust made with a diverse blend of “ancestral” whole grains, seeds and beans fortified with prebiotic fiber and probiotics (live, beneficial, cultures) for digestive health, balance and well being. The sauce, cheese, meats and vegetables toppings are all-natural with no added sugar, trans fats or high-fructose corn syrup. The company also offers a glutten-free crust and all-natural soy cheese. With less calories, lower glycemic index, and more protein than traditional pizzas and benefits including bone health and immunity, NakedPizza is the world’s first functional pizza.

Seattle’s Best will replace BK JOE’s coffee program in Burger Kings by September 2010.

I’m sure this is a good financial deal for Seattle’s Best (owned by Starbucks) and will help BK increase its perceived coffee quality, but in the long run I believe this will hurt Seattle’s Best perceived brand quality.  Why?  Because BK is unable to enforce quality standards in its stores.

Most people have an above average perception of Seattle’s Best Coffee, a somewhat premium coffee brand akin to Caribou Coffee or Gloria Jean’s.  On the other hand, Burger King quality image is quite poor, with people citing dirty stores, low quality meals and lazy employees.  Quality issues are due almost entirely to unmotivated employees and lack of leadership from the absentee franchisees.  It’s clear as soon as you step into a BK that there is little company pride or culture.  And when your employees don’t give a crap, your coffee standards (brewing methods, time in the pot, keeping coffee at ideal temperatures, etc.) will be ignored, to the eventual detriment to Seattle’s Best.

On a side note, Burger King is wisely taking a page from McDonald’s by dropping a slice of cheese from it’s $1 double cheeseburger.  The article mentions that BK is signaling removal of the $1 double cheeseburger from the dollar menu in the spring, and it’s testing higher prices for its $1 Whopper Jr.   Was the $1 double cheeseburger really worth all the fighting with franchisees?

Over at the BlueMauMau blog, there was a post about Huddle House discounting their upfront franchise fee from the magical $25,000 to $5,000 and waiving the royalty for the first five months. Some comments frowned upon franchisors who discount franchise fees. Here my opinion:

Count me as one who loves to see franchisors discount their fees as done by Huddle House. The goal of the franchisee should be to get the highest likely return on invested capital for their risk profile. My point is that franchisors should be more willing to base their fees on market demand like all other services.

Nearly all industries (and even financial instruments liked bonds) fluctuate their pricing based on many internal and external factors, particularly balancing prices with demand. Selling franchises should be no different.

Support suffers to the point of reduced sales for the franchisee if fee are discounted? Perhaps in some instances, but it is the exception rather than the rule. Per franchisee support expenses between can vary tremendously between franchisors, and the use of technology and other efficiencies can dramatically reduce support expenses. Maybe the franchisor’s fees were too high to begin with and now they are drifting in line?

A few commenters missed the point and disagreed, arguing that reduced fees makes it almost certain you’ll earn lower returns.  My response:

Come on – I wasn’t suggesting investors focus on year one returns, nor was I suggesting you ignore non-financial issues.  I am suggesting that a franchisor reducing upfront and ongoing fees often can, but not always, make the investment more attractive.

Projecting your return on invested capital is based on the entire expected life of the investment.  After you review your expected return on invested capital, then you consider and adjust for intangible factors such as franchisor quality, location, levels of controllable and non-controllable expenses, desired income and investment return given the risk, alternative investments, and so forth.

The forums are temporarily down due to technical issues with the web hosting company.  I’ll get them back up shortly.  Thanks for your patience!

•  Update Feb 9, 2010: We’re back in business, all is fixed. 

Bain Capital employs some of the smartest financial and strategic professionals in the USA.  Bain Capital originally funded Dominos Pizza back in the late 1990’s and reaped a hefty profit when it went public in 2004.  Now, Bain Capital is jumping back in with Dominos by acquiring the Japanese master franchisee, who delivers pizzas that often cost over $40 in Japan.  With Bain’s history in Dominos, I would bet that this is a smart investment.