Table Stakes

As the casual-dining industry suffers one of its worst downturns, CFOs are in the kitchen and feeling the heat.

December 2008
by Edward Teach/CFO Magazine

Chuck Sonsteby has worked in the restaurant business for most of his professional life. He began while in college, interning for the company that owned the fast-food chain Long John Silver's. Today, at 55, Sonsteby is executive vice president and CFO of one of the country's largest casual-dining companies — Brinker International, the Dallas-based operator of the Chili's Grill & Bar, Maggiano's Little Italy, and On the Border Mexican Grill & Cantina restaurant chains.

"I love the industry," says Sonsteby. "It's a combination of everything: manufacturing in the back and value-added retail in the front, along with entertainment. And it's a great people business." But while Sonsteby's enthusiasm is alive and well, the same can't be said for the industry he loves. "I don't think anyone has ever seen anything like this," he says. "These are truly historic times."

In a bad way, that is. As the economy slides deeper into recession, casual full-service restaurants, which were among the first businesses to feel the tremors of impending collapse, are hungry for customers. Brinker's same-store sales, the key metric for the casual-dining industry, declined across its brands in the latest quarter. Practically everyone else's same-store sales have dropped too, according to Technomic, a Chicago-based restaurant consultancy. Applebee's, Outback Steakhouse, Ruby Tuesday, P.F. Chang's Chinese Bistro — these and other chains have seen a dramatic falloff in their "guest counts" during 2008, not to mention their profits and stock prices.

Some chains have called it quits. In July, the parent company of Bennigan's and Steak and Ale filed for Chapter 7, closing hundreds of company-owned restaurants and dismissing thousands of employees. Startling for its size and suddenness — many workers found out the bad news when they showed up for work and found the doors locked — the liquidation signaled just how bad the economics of the casual-dining industry have become.

Indeed, while the U.S. economy shrank in the third quarter of 2008, the casual-dining industry (which analysts position between fast-food and fast-casual chains on the low end and fine-dining restaurants on the high end) has been in a recession for many months. "We saw a downturn in consumer sentiment in February 2006," says Sonsteby, "and we've been in a downturn in traffic for quite some time." Technomic dates the restaurant recession back to the third quarter of 2007, based on overall same-store growth rates for publicly held chains, says president Ron Paul.

For many restaurant finance chiefs, weathering the current economic climate will be the challenge of their professional lives. "Times like these are when CFOs get called to the test," says Andrew Green, assistant professor of finance at Wofford College in Spartanburg, South Carolina, who was CFO from 2001 to 2005 of Denny's Corp., a family-restaurant chain.

These times are about to get even worse: consumer confidence is sagging and unemployment is rising. In the third quarter of 2008, for the first time in 17 years, growth in U.S. consumer spending turned negative, according to the U.S. Department of Commerce. A recent Technomic study reports that more than a third of consumers are eating dinners out less frequently than a year ago.

Meanwhile, skyrocketing food and energy prices over the past two years have only recently started to moderate. Larger outlays for wheat, corn, soybeans, and cheese have eaten into profit margins, while steeper fuel costs have taken bigger bites out of the bottom lines for restaurateurs and consumers alike. Labor costs have risen, too. No wonder the phrase "perfect storm" has found currency among industry analysts. "I've never seen a time when the consumer was strained this much, when all the commodity prices were up, when every single input was unfavorable," says Brad Ludington, a restaurant analyst at KeyBanc Capital Markets in Cleveland.

Too Much of Everything
As the tide of consumer spending recedes, the weaknesses of the casual-dining sector have been exposed. Foremost among them is overexpansion, fueled in the past few years by cheap credit. The consensus among analysts is that there are simply too many restaurants, which Paul attributes to a prevailing "take-the-hill mentality." As chains sized up new locations they rarely worried whether a Red Lobster or Ruby Tuesday was already next door; the thinking was "our concept is good, our food is better," says Paul. "For a while, it seemed to work, but you couldn't support 4 or 5 percent growth per unit when demand was rising only 1, 2, or maybe 3 percent."

As chains piled on top of each other they all began to look alike to consumers. Asked why they patronized one restaurant versus another on a given night, many focus group participants answered that "the line was shorter." No loyalty was being built up, says Paul. "Restaurants were look-alikes in terms of menu, pricing, and even TV commercials — consumers couldn't remember which chain did which commercial. Restaurants became bland and tired, the decor packages were kind of 'been there, done that.' The customers grew up, but the concepts didn't."

But other things were changing. "Prepared foods from supermarkets and other retailers have gotten infinitely better," says Paul. "The consumer now realizes that the salmon you pick up at Whole Foods is really pretty good" — and less than half the price of a casual restaurant's seafood entrée. Wine and soft drinks are a lot cheaper at the supermarket, too. Combine those options with concern about the cost of gas and babysitting and it's no surprise that more people are dining at home on Saturday night.

Restaurant Makeovers
But the restaurant chains are fighting back. "This is the time we really have to perform," says Sonsteby. As consumers scale back, he says, "their expectations become higher because their dollars are more precious, so we have to make sure everybody gets a fantastic experience."

That experience begins with appearances. Despite the credit crunch (see "On the Financing Menu, Limited Choices" at the end of this article), a number of chains have recently spent millions to "reimage" or refresh the look of their restaurants. "The exterior is your billboard, your drive-by," explains Sonsteby. "It's important." Brinker reimaged 73 Chili's restaurants in fiscal 2008, at a cost of about $250,000 each. "We're putting in glass, making them much brighter and lighter," says Sonsteby. "It's really helped customer traffic."

Ruby Tuesday, a chain of American-style restaurants based in Maryville, Tennessee, completed a nationwide reimaging last spring, according to CFO Margie Duffy. The company recognized three years ago that "the bar/grill segment was becoming commoditized," she says, and that a makeover was necessary. Accordingly, the chain recently said goodbye to the old Ruby Tuesday, spending $65 million to replace Tiffany-style lamps, polished brass, and antiques at more than 600 company-owned restaurants with colorful lighting fixtures, earth tones, and custom artwork. Since Ruby Tuesday had halted its expansion plans a year ago (because of industry overbuilding) and finished its remodeling program this spring, the company's modest capital needs are unaffected by the credit crunch, says Duffy.

Ruby Tuesday is also shifting its advertising emphasis to value, says Duffy. A hamburger is now a dollar cheaper, at $5.99. The chain is also tailoring promotions to local markets; in parts of Florida, for example, it promotes early-bird dinner specials. And the company is emphasizing the freshness and quality of its ingredients and a rededication to service. As a result, Duffy can cite internal surveys showing that Ruby Tuesday has attained its highest-ever levels of customer satisfaction.

The restaurant, in short, has pulled out all the stops — to little avail. For the first quarter of fiscal 2009 (ended September 2), Ruby Tuesday reported that same-restaurant sales had dropped 10.8 percent and 7.9 percent at company-owned and domestic franchise restaurants, respectively, compared with declines of 4.8 percent and 2.9 percent for the same quarter a year ago. Earnings were down to a penny a share, compared with 21 cents last year. The company continues to pay down debt with the free cash flow it generates, so its best bet may be to keep its restaurants shipshape and wait for the economic tide to turn.

Edward Teach is articles editor of CFO.

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